The Pennsylvania Securities Act of 1972 (“Securities Act”) specifically provides that all securities sold within the commonwealth of Pennsylvania must be registered with the Pennsylvania Department of Banking and Securities (“department”), unless the security or transaction is exempt. Registration is the process by which a company files with the department all disclosure materials required to provide prospective investors with the information necessary to make an informed investment decision.
Because the registration process may be cumbersome and expensive, the Securities Act contains a series of exemptions, which cover situations where the nature of the securities or the character of the transaction is such that a full registration is not necessary. Thus, the two basic exemptions to the registration process are Securities Exemptions and Transactional Exemptions.
Securities Exemptions, which apply to certain types of securities that, by their nature, need not be registered by the department. The general rationale for these securities exemptions is that regulation of such instruments is either not necessary, or the particular securities already are subject to regulation by another government agency.
The Securities Act contains 11 general categories of “exempt securities” that need not be registered with the department before being sold to Pennsylvania residents. The first 10 exempt securities are listed in Section 202 of the Pennsylvania Securities Act:
- Securities issued by a governmental body (202(a));
- Securities issued or guaranteed by a bank or savings association (202(b));
- Commercial paper arising out of a current transaction (202(c));
- Securities issued or guaranteed by a federal credit union or any credit union or similar association supervised under the laws of Pennsylvania (202(d));
- Securities (except debt securities, such as notes or bonds) of certain not-for-profit organizations or chambers of commerce, trade or professional associations (202(e));
- Securities listed for trading on certain exchanges (202(f));
- Securities issued in conjunction with an employee stock option, purchase, savings, pension, profit-sharing or similar plan (202(g));
- Securities of a registered broker-dealer issued to its officers, partners or employees (202(h));
- Membership interests in a limited liability company that renders professional services (202(j)); and
- Any other security the department finds by regulation or order should be exempt (202(i)).
All of the above-referenced securities exemptions are “self-executing,” meaning that the issuer of any of the listed securities need not file a form or document with the Department to be legally entitled to rely on the exemption.
The final, eleventh category of exempt securities applies to federally-covered securities. These securities are subject exclusively to U.S. Securities and Exchange Commission (SEC) and not state (e.g., Department of Banking and Securities) jurisdiction.
Federally-covered securities include securities traded on the exchanges, mutual funds and securities sold under Rule 506 of SEC Regulation D. Rule 506 provides an exemption from federal and state registration for sales of unlimited amounts of securities to “ accredited investors” (e.g., individuals with net worth of at least $1 million or annual income of $200,000-excluding one’s primary residence), and no more than 35 non-accredited, but sophisticated investors (investors with substantial experience investing in securities offerings).
To use a Rule 506 exemption, the issuer is required to file SEC Form D with the SEC within 15 days of the first sale to any purchaser. The issuer is also required to file the SEC Form D with the department within 15 days of the first sale in Pennsylvania.
Transactional Exemptions, which apply in situations where the manner in which securities are offered and/or sold is of such character that the department need not subject the issuer of the securities to the full registration process. However, it is important to remember that generally the purchaser of a security issued under a transaction exemption may not resell that security until it is either registered or qualifies for another exemption. Please refer to Rules 144 and 502(d) of the Securities Act of 1933 for more information.
Like the exempt securities, some transactional exemptions are self-executing, but others require a filing with the department before sales can be made. The filing involves submitting to the department the information required by Pennsylvania Form E, as well as all disclosure materials that are to be provided to prospective investors.
Where such a filing is required to rely on a Transaction Exemption, the issuer must wait until the department issues a letter declaring the exemption available before selling securities in Pennsylvania. The consequences for selling securities without satisfying all conditions to an exemption may include administrative, criminal and civil penalties.
The most common self-executing exemptions that do not require a filing include:
Secondary market/non-issuer transactions (203(a)): Except in limited circumstances (which are discussed in the “Transactional Exemptions Requiring a Filing” section, below), the department does not regulate sales made by persons other than the issuer of securities (e.g., the “ aftermarket” or “ secondary market”).
- Sales to institutional investors (203(c)): Sales to certain institutions (e.g. corporations with $10 million or more in net worth, small business investment companies, colleges or other educational institutions with $5 million or more in net worth) are exempt from registration. See the PA Code for more information.
- Pre-organization sales (203(f)): Pennsylvania provides a one-time exemption allowing newly-formed companies to sell securities to no more than five persons within six months of the date of incorporation or formation.
- Small issuer exemption (203.187): Pennsylvania also provides one-time exemptions allowing Pennsylvania companies to sell securities to 10 persons from the date of the formation of the business. To use this exemption, however, no one affiliated or associated with the issuer may have a history of securities law violations.
- Isolated transaction exemption (203.189): Pennsylvania companies may sell securities to no more than two Pennsylvania investors in a 12-month period without registration or filing with the department. Like the small issuer exemption, companies relying on this exemption must not have any officer, director, or promoter with a history of securities law violations. Those companies not located or organized in Pennsylvania may rely on this exemption if they are selling to no more than two accredited investors in Pennsylvania.
- Sales to principals (203.184): Companies may sell unlimited amounts of securities to “principals,” which includes officers and directors, controlling shareholders, key management personnel, and the immediate families of the aforementioned.
- Sales to existing shareholders (203(n)): Companies with existing equity stockholders may offer those stockholders the opportunity to purchase more shares. The offer must be given on a pro-rata basis. That is, a 10 percent shareholder should be offered the opportunity to purchase 10 percent of the total number of new shares to be sold.
- Notes secured by a mortgage (203(j)): Pennsylvania law permits the sale of a mortgage if the entire mortgage is sold as a single unit to the purchaser.
Additional self-executing exemptions include sales of securities approved by a court of law or bankruptcy, sale through dividend or liquidation, or sale pursuant to a merger or other reorganization. It is important to note that, in relying on these exemptions, general solicitation—including cold calling, mass media and Internet advertising—is prohibited.
Transactional Exemptions Requiring a Filing
Exemptions that require an issuer to file a form and disclosure materials with the department prior to selling securities in Pennsylvania include:
Limited Offering Exemption (203(d))
Under Sections 203(d) and 203(e) of the Pennsylvania Securities Act, an issuer may offer securities to no more than 50 persons and may sell securities to no more than 25 persons in Pennsylvania (see note below). This exemption requires an issuer, prior to selling any securities, to file the Pennsylvania Form E and all disclosure materials that are to be provided to prospective investors. The disclosure materials should be prepared using the department’s Prospectus Guidelines.
The issuer must also ensure that each prospective purchaser receives the following: 1) a notice of a right to withdraw, and 2) an agreement not to resell or transfer the securities for 12 months. The notice of a right to withdraw gives investors the right to withdraw their purchase of securities within two business days of receipt of all disclosure documents. The agreement not to resell prohibits investors from reselling their securities for one year after the initial purchase, with limited exceptions.
The disclosure materials filed with the department will be reviewed by department staff, who may request that the issuer make certain changes to the disclosure materials. It is important to remember that the documents are not considered “filed” until the department staff has completed their review, determined that all documents are complete and issued a letter declaring the exemption available.
Once the necessary documents have been accepted as complete by the department and a letter declaring the exemption available issued, the issuer may begin selling securities in Pennsylvania.
The issuer may contract with a broker-dealer to complete the offering, or it may sell through the efforts of the company’s officers and directors. However, only registered broker-dealers may receive compensation (such as a commission) for selling securities to the public; officers, directors and employees of the company may not receive compensation of any kind for the sale of securities. Moreover, because these securities are sold under an exemption, rather than through a registration, no advertising or general solicitation may be used to sell the securities. Advertising and general solicitation includes cold-calling, mass media and Internet advertisements.
NOTE: By adoption of Regulation 204.010, the department increased the number of offerees to 90, and the number of purchasers to 35. However, to use this related regulation, no one affiliated (connected) with the issuer may have a history of securities law violations. In addition, for any Issuers not organized in PA or who have their principal place of business outside of Pennsylvania, a Pennsylvania-registered broker-dealer must be used.
SEC Rule 505 Exemption
SEC Rule 505 of Regulation D permits issuers to sell no more than $5 million of securities to 35 non-accredited investors and an unlimited number of accredited investors. The corresponding Pennsylvania exemption is contained in Section 203(s) of the Securities Act. Under that section, an issuer must file the same materials as required under Section 203(d) above.
The issuer is also subject to the same limitations with respect to sales (no advertising and no payment of commissions to anyone other than a licensed broker-dealer). However, to use this exemption, no one affiliated (connected) with the issuer may have a history of securities law violations.
Accredited Investor Exemption
Pennsylvania has an exemption for sales of securities to accredited investors only under Section 203(t) of the PA Code. An issuer must file the same materials as other exemptions previously mentioned. Under the Pennsylvania accredited investor exemption, issuers may advertise their securities within Pennsylvania, provided such advertisement clearly states that the offer is available only to accredited investors (e.g., individuals with $1 million in net worth or $200,000 in annual income-excluding one’s primary residence).