This report addresses legal opinions regarding the resale of securities conducted in reliance on the so-called “Section 4(1½)” exemption from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”). The Section 4(1½) exemption, which does not appear in the Securities Act, has been developed by applying some of the elements of Section 4(a)(2) of the Securities Act to the exemption provided by Section 4(a)(1) of the Securities Act.
Section 5 of the Securities Act requires offers and sales of securities to be registered with the Securities and Exchange Commission (“SEC”) unless an exemption from registration is available. Section 4(a)(2) exempts from registration offers and sales of securities by issuers in transactions “not involving a public offering” (i.e., private offerings). Section 4(a)(1) exempts resales of securities “by any person other than an issuer, underwriter, or dealer.”
Today, many unregistered resales are conducted pursuant to Securities Act Rule 144. Under Rule 144, a person who resells securities in compliance with its conditions is deemed not to be engaged in a “distribution” of securities and, therefore, not to be an “underwriter” for purposes of the Section 4(a)(1) exemption. Rule 144 permits resales by non-affiliates of “restricted securities” that have been held for at least six months if the issuer has been subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is current in its reports or for at least one year in all other cases. Importantly, Rule 144 also permits resales of securities by affiliates, subject to compliance with holding period, volume and manner of sale limitations, and Form 144 filing requirements. The availability of the Rule 144 safe harbor has significantly reduced the need for resales apart from Rule 144.
Rule 144 is not, however, the only exemption available for unregistered resales of securities. In addition to other exemptions provided in the Securities Act and SEC rules, holders of restricted securities and affiliates also may rely on the Section 4(1½) exemption. Although not expressly provided in the Securities Act or an SEC rule, Section 4(1½) “‘allows … private sales of securities … so long as some of the established criteria for sales under both Section 4(1) and Section 4(2) of the [Securities] Act are satisfied.’” The challenge presented by the Section 4(1½) exemption—as reflected in this quotation—is knowing which and how many of, as well as the extent to which, these “established criteria” will need to be satisfied in any particular case.
The Subcommittee has issued this report to assist lawyers in preparing Section 4(1½) opinions. This report first discusses the statutory and analytical basis for the Section 4(1½) exemption. It then discusses legal issues that commonly arise with respect to compliance with the exemption and related matters for counsel to consider in connection with the preparation of a Section 4(1½) opinion. Included in this report is an illustrative form of opinion that may be used as a starting point in drafting a Section 4(1½) opinion, as well as illustrative forms of supporting holder and purchaser certificates.
II. Statutory and Analytical Basis for Section 4(1½)
The SEC has not issued any guidelines for the use of the Section 4(1½) exemption, apart from no-action letters issued by the Division of Corporation Finance prior to the adoption of Rule 144 in 1972, and judicial opinions and administrative decisions discussing the exemption are infrequent and sometimes contradictory in their legal analysis.
By its terms, Section 4(a)(2) is available only to an “issuer,” which Section 2(a)(4) of the Securities Act defines as a “person who issues or proposes to issue any security.” Accordingly, while Section 4(a)(2) principles inform the analysis, the Section 4(1½) exemption is grounded in the exemption from registration provided by Section 4(a)(1). As noted above, Section 4(a)(1) provides an exemption from registration for “transactions by any person other than an issuer, underwriter, or dealer.” Given that a holder of securities is not an “issuer,” and assuming that the holder is not a “dealer,” the availability of a Section 4(a)(1) exemption turns on the question of whether the holder will be treated as an “underwriter,” as defined in Section 2(a)(11) of the Securities Act.
Section 2(a)(11) defines an “underwriter” as a holder who acquires securities from an issuer (or, through the definition of “issuer” for purposes of that section, from an affiliate) with a “view to … distribution” or who sells securities “for an issuer in connection with [a] distribution.” To determine the existence of a distribution under Section 2(a)(11), courts and commentators have long turned to Section 4(a)(2) jurisprudence, which treats a distribution as substantially equivalent to a public offering. As a result, the analysis of whether a holder is an underwriter for purposes of the Section 4(a)(1) exemption “necessarily entails an inquiry into whether the transaction involves a public offering.”
If a holder of restricted securities or an affiliate cannot resell its securities pursuant to another exemption from registration and its resale is not registered, then its resale must take on certain elements of a private offering under Section 4(a)(2). This is because, if the applicable elements of Section 4(a)(2) are satisfied, then the resale will not constitute a public offering and this, in turn, will mean that the resale will not be part of a distribution and the holder will not be an “underwriter.” Therefore, the resale will be eligible for the exemption provided by Section 4(a)(1) by way of Section 4(a)(2)—in other words, Section 4(1½).