Wednesday, July 18, 2018

Federal Securities Law: Securities Offerings: Registration Requirement

Federal Registration is required for all securities offerings, unless an exemption is available.

Section 5 is a prohibition and is about as absolute as can be. Were it not for the exemptions that are also allowed, every offering would need to be registered according to Section 5.

Almost all securities offerings are unregistered because registration is very expensive

Exemptions are meant to handle the market's need for inexpensive and quick transactions in a context that does not require extensive investor protections. Registering securities with the Securities and Exchange Commission is expensive and time-consuming. For a small securities offering, registration cannot be cost-justified. 

Registration of an issuer's securities would have further expensive consequences like the expense of future compliance with periodic reporting rules.

On the other hand, in some cases the cost and expense of registration under the Securities Act of 1933 can possibly be justified on a cost-benefit basis if and only if a very large amount of investor money is involved.  But the equation needs to comprehend an additional ongoing cost, A public offering requires, among other things, a commitment to public financial reporting on an ongoing basis. In a small securities offering, the entity issuing securities is not necessarily sophisticated at finances or reporting. Small entities usually should not go to great expense to comply with the audit, governance, accounting and reporting requirements that go along with good financial reporting that is meaningful for pubic companies. There are several other costs that go along with becoming publicly reporting, obviously.

Section 5 of the Securities Act of 1933 is entitled "Prohibitions Relating to Interstate Commerce and the Mails." 

  • Section 5(a) of the 1933 Act makes mandates that every securities sale (provided the offer will be made in or through interstate commerce or the mails) is registered with the Securities and Exchange Commission (see below, in 5(a), the prohibition on effecting sales "unless a registration statement is in effect as to a security").
  • Section 5(c) of the 1933 Act mandates that every securities offered or solicited to be subject to a registration statement filed by the issuer of the securities with the Securities and Exchange Commission (see below, in 5(c), the prohibition on making offers unless a registration statement is filed as to a security) . 

Section 5 reads as follows:

  • (a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly—
    • (1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or
    • (2) to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.
  • (b) It shall be unlawful for any person, directly or indirectly—
    • (1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed under this title, unless such prospectus meets the requirements of section 10; or
    • (2) to carry or cause to be carried through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale, unless accompanied or preceded by a prospectus that meets the requirements of subsection (a) of section 10.
  • (c) It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8.
  • (d) LIMITATION.—Notwithstanding any other provision of this section, an emerging growth company or any person authorized to act on behalf of an emerging growth company may engage in oral or written communications with potential investors that are qualified institutional buyers or institutions that are accredited investors, as such terms are respectively defined in section 230.144A and section 230.501(a) of title 17, Code of Federal Regulations, or any successor thereto, to determine whether such investors might have an interest in a contemplated securities offering, either prior to or following the date of filing of a registration statement with respect to such securities with the Commission, subject to the requirement of subsection (b)(2).
  • (e) Notwithstanding the provisions of section 3 or 4, unless a registration statement meeting the requirements of section 10(a) is in effect as to a security-based swap, it shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell, offer to buy or purchase or sell a security- based swap to any person who is not an eligible contract participant as defined in section 1a(18) of the Commodity Exchange Act (7 U.S.C. 1a(18)).

Thankfully enough, there are some important exemptions to the Section 5 registration requirement, and you can find exemptions in, e.g., Regulation A, Regulation A+, Regulation D, Section 4(2), Section 4(6).  Exemptions provide the means to accomplish sales of securities economically, that is, without registration.  

If the exemption is not available, the Securities and Exchange Commission enforces Section 5 by, among other things, issuing orders to cease and desist from making offers and sales of securities without registration.