EXEMPTIONS Pennsylvania Securities Commission ENTREPRENEUR EDUCATION PROGRAM Exemptions to the Pennsylvania Securities Act The Pennsylvania Securities Act of 1972 (Pennsylvania Securities Act) specifically provides that all securities sold within the Commonwealth of Pennsylvania must be “registered” with the Pennsylvania Securities Commission (Securities Commission), unless the security or transaction is exempt. Registration is the process by which a company files with the Securities Commission 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 Pennsylvania 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 to protect investors. Thus, the two basic exemptions to the registration process are: • Securities Exemptions, which apply to certain types of securities that, by their nature, need not be registered with the Securities Commission. 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. 1 • Transactional Exemptions, which apply in situations where the manner in which securities are offered and/or sold is of such character that the Securities Commission 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. Securities Exemptions The Pennsylvania Securities Act contains 11 general categories of “exempt securities” that need not be registered with the Securities Commission before being sold to Pennsylvania residents. The first 10 exempt securities are listed in Section 202 of the Pennsylvania Securities Act: 1. Securities issued by a governmental body; 2. Securities issued or guaranteed by a bank or savings association; 3. Commercial paper arising out of a current transaction; 4. Securities issued or guaranteed by a Federal credit union or any credit union or similar association supervised under the laws of Pennsylvania; 5. Securities (except debt securities, such as notes or bonds) of certain not-for-profit organizations or chambers of commerce, trade or professional associations; 6. Securities listed for trading on certain exchanges; 7. Securities issued in conjunction with an employee stock option, purchase, savings, pension, profit-sharing or similar plan; 8. Securities of a registered broker-dealer issued to its officers, partners or employees; 9. Membership interests in a limited liability company that renders professional services; and 10. Any other security the Commission finds by regulation that should be exempt. 2 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 Securities Commission to be legally entitled to rely on the exemption. The final category of exempt securities applies to federally-covered securities. These securities are subject exclusively to federal Securities and Exchange Commission (SEC) and not state (e.g., Securities Commission) 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), 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 must file SEC Form D with the SEC and the Securities Commission within 15 days of the first sale in Pennsylvania. Transactional Exemptions Like the exempt securities, some transactional exemptions are self-executing, but others require a filing with the Securities Commission before sales can be made. The filing involves submitting to the Securities Commission the information required by Securities Commission 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 Securities Commission issues a “clearance letter” before selling securities in Pennsylvania. The consequences for selling securities without satisfying all conditions to an exemption may include administrative, criminal and civil penalties. Self-Executing Transactional Exemptions The most common self-executing exemptions that do not require a filing include: • Secondary market/non-issuer transactions: Except in limited circumstances (which are discussed in the “Transactional Exemptions Requiring a Filing” section), the Securities Commission does not regulate sales made by persons other than the issuer of securities (e.g., the “aftermarket” or “secondary market”). 3 • Sales to institutional investors: 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. • Pre-organization sales: 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. • Small issuer exemption: 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. 4 • Isolated transaction exemption: Pennsylvania companies may sell securities to no more than two Pennsylvania investors in a 12-month period without registration or filing with the Securities Commission. Like the small issuer exemption, companies relying on this exemption must not have any affiliate 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: 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: Companies with existing 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: 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 and a sale through dividend or liquidation. 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 Securities Commission prior to selling securities in Pennsylvania include: 1. Limited Offering Exemption 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.1 This exemption requires an issuer, prior to selling any securities, to file Securities Commission Form E and all disclosure materials that 1 By adoption of Regulation 204.010, the Securities Commission 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. 5 are to be provided to prospective investors. The disclosure materials should be prepared in accordance with the Securities Commission’s Prospectus Guidelines. The Form E and the prospectus guidelines are available on the Securities Commission’s website at www.psc.state.pa.us. The issuer must also prepare two additional documents for delivery to prospective purchasers: 1) a notice of a right to withdraw and 2) an agreement not to resell 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 Securities Commission will be reviewed by Securities Commission 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 Securities Commission staff has completed the review, determined that all documents are complete and issued a clearance letter. Once the necessary documents have been accepted as complete by the Securities Commission and a clearance letter has been 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. 6 2. 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 Pennsylvania 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. 3. Accredited Investor Exemption Finally, Pennsylvania has an exemption for sales of securities to accredited investors only. This exemption requires the same filings as the Rule 505 exemption. 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). This brochure is meant to provide a general overview of the exemptions contained within the Pennsylvania Securities Act. It should not be relied upon to make a securities offering. For additional information, please contact experienced legal counsel or the Securities Commission at 1-800-600-0007 (in Pennsylvania). 7 8 Commonwealth of Pennsylvania Edward G. Rendell, Governor Commissioners Robert M. Lam Thomas A. Michlovic Steven D. Irwin Pennsylvania Securities Commission Eastgate Office Building, Second Floor 1010 North Seventh Street Harrisburg, PA 17102-1410 P: 717-787-8062 Toll-Free Number for PA Residents: 1-800-600-0007 Alternate formats of this document may be available upon request by calling 717-787-1165 TTY users via AT&T Relay Center: 1-800-654-5984 www.psc.state.pa.us This brochure is prepared for small business persons through the Entrepreneur Education Program of the Pennsylvania Securities Commission. Permission for reproduction with appropriate attribution may be acquired by contacting the Pennsylvania Securities Commission.