09 December 2015

Section 4(a)(7) of the US Securities Act of 1933 – a New Exemption for Private Resales of Restricted and Control Securities

On December 4, 2015, President Obama signed into law the Fixing America’s Surface Transportation Act (the "FAST Act"). Although primarily directed at improving transportation in the United States, it contains a number of ancillary provisions, including certain changes to the US securities laws. Many of these changes are to provisions of the JOBS Act, which facilitated the ability of smaller companies to access the US capital markets, and are principally relevant to companies seeking to register their securities with the SEC and list on a US exchange.[1]

One significant change implemented by the FAST Act, which applies equally to domestic US and foreign issuers, whether or not registered with the SEC, is the adoption of a new statutory exemption under Section 4(a)(7) of the US Securities Act of 1933, which provides for private resales of restricted and control securities. Section 4(a)(7) provides a statutory basis for resales of securities by persons other than the issuer, who previously relied on "Section 4(1½)" private placement procedures that had evolved in the marketplace over a number of years.[2] 

To qualify under Section 4(a)(7), a transaction must meet the following requirements:

  • Each purchaser must be an “accredited investor” as defined in Rule 501(a) of Regulation D;
  • Neither the seller nor any person acting on its behalf may engage in any general solicitation or general advertising in connection with the offer or sale of the securities;
  • In the case of an issuer that is not filing reports with the SEC under the US Securities Exchange Act of 1934, is not exempt from such reporting pursuant to Rule 12g3-2(b) and is not a foreign government eligible to register under Schedule B, the seller and a prospective purchaser designated by the seller obtain from the issuer upon request from the seller, and the seller in all cases makes available to a prospective purchaser, certain information (including financial statements) regarding the issuer and the securities being offered;[3]
  • The seller may not be the issuer or a direct or indirect subsidiary of the issuer;
  • Neither the seller nor any person receiving remuneration or a commission for participating in the sale is subject to an event (such as a conviction for violation of the securities laws) that would disqualify the issuer or other covered person as a “bad actor” under Rule 506(d)(1) of Regulation D or subject to a statutory disqualification under Section 3(a)(39) of the Securities Exchange Act;
  • The issuer must be engaged in a business, not be in the organizational stage, and not be a blank check, blind pool or shell company that has no specific business plan or business purpose, or has indicated that its primary business plan is to engage in a merger or business combination with an unidentified person;
  • The securities being offered cannot constitute all or part of an underwriter’s unsold allotment; and
  • The class of securities being offered must have been authorized and outstanding for at least 90 days prior to the date of the transaction.

Securities sold under Section 4(a)(7) will be deemed “restricted securities” within the meaning of Rule 144 and will not be freely transferable in the United States following the sale.  Securities sold pursuant to Section 4(a)(7) will also be “covered securities” under Section 18(b)(4) of the Securities Exchange Act and so be exempt from certain registration and qualification requirements under state securities “blue sky” laws.

The enactment of Section 4(a)(7) is significant in that it provides a statutory basis for private resales of restricted and control securities and so gives greater certainty to the exempt status of such transactions, compared to the procedures that had evolved under Section 4(1½). A principal application of Section 4(a)(7) in the markets will likely be for “block trade” or “accelerated bookbuild” sales of equity securities held by significant shareholders, such as members of the founding family of a company or investors who acquired stakes in a pre-IPO financing.

In certain respects, Section 4(a)(7) can be seen as a liberalization of the procedures that developed under Section 4(1½).  For example, Section 4(a)(7) has no limit on the number of offerees, whereas Section 4(1½) transactions frequently limited the number of offerees to avoid being considered a public offering of securities prohibited under Section 4(a)(2).  Similarly, Section 4(a)(7) does not require that the seller inform purchasers that they are acquiring restricted securities in a transaction exempt from the registration requirements of the Securities Act, or exercise reasonable care to ensure that the purchasers are acquiring for investment purposes and not with a view to distribution, for example by obtaining letters containing representations and warranties from investors.

However, in other respects, Section 4(a)(7) appears more stringent than customary Section 4(1½) procedures and may, in practice, be more difficult to implement.  For example, the information requirements of Rule 4(a)(7) have no counterpart under Section 4(1½) and are considerably more extensive than the information required to be provided under Rule 144A. The required information is also unlikely to be available to a selling shareholder without the cooperation of the issuer, who may have no incentive to facilitate the sale. Even if the issuer does make the information available, the seller may be unwilling to certify that it has no reasonable grounds to believe that the issuer is in violation of the US securities laws or regulations as required by Section 4(a)(7).  Although many foreign private issuers with listings on their local exchanges qualify for Rule 12g3-2(b), in which case the detailed information requirements of Section 4(a)(7) will not apply, because the SEC no longer issues a notice of qualification, selling shareholders seeking to rely on Section 4(a)(7) may be unsure as to whether the issuer is, in fact, exempt under Rule 12g3-2(b).[4]

Importantly, Section 4(a)(7) provides that it is not the exclusive means for establishing an exemption from the registration requirements of the Securities Act.  As a result, the Section 4(1½) procedures should continue to be available for shareholders who are not willing or able to comply with the requirements of Section 4(a)(7). As market practice develops, it will be interesting to see to what extent, if at all, sales conducted under Section 4(a)(7) continue to use certain Section 4(1½) procedures, such as the use of investor representation letters, and to what extent current Section 4(1½) procedures are influenced by Section 4(a)(7).

We will continue to monitor developments in this area as they arise. Should you have any questions regarding any of the matters discussed in this memorandum, please contact Bart Capeci (T: +44 20 7111 2234; E: [email protected]) in our London office, Hao Zhou (T: +852 3443 1080; E: [email protected]) or Christine Chen (T: +852 3443 1067; E: [email protected]) in our Hong Kong office, or your regular King & Wood Mallesons contact.


[1]The Jumpstart Our Business Startups Act of 2012 significantly liberalized the SEC registration regime for smaller companies known as "emerging growth companies" ("EGCs"). The FAST Act furthers a number of the reforms of the JOBS Act, including (i) reducing the waiting period between public filing of a registration statement and commencing roadshows applicable to EGCs from 21 days to 15 days, (ii) establishing a grace period for EGCs that lose their status as EGCs during the SEC registration process, (iii) permitting EGCs to omit certain historical financial information from some SEC filings, (iv) permitting the use of a summary page in Form 10-K filings, (v) allowing smaller reporting companies to incorporate by reference documents filed after the effective date of a Form S-1 registration statement, and (vi) directing the SEC to simplify the disclosure requirements of Regulation S-K. The majority of these changes are relevant principally to US companies and accordingly are not the subject of this memorandum. Should you wish further information regarding any of these changes, please contact one of the partners listed above.

[2]Section 4(1½) is not a provision of the Securities Act but refers to transactions structured to fit between the exemptions provided by Section 4(a)(1) and Section 4(a)(2) (these sections were previously designated Sections 4(1) and 4(2), respectively). Private placements of securities in the United States are typically conducted under Section 4(a)(2) of the Securities Act and Regulation D thereunder, both of which by their terms apply only to issuers.  Secondary market trades (other than by dealers) are conducted under Section 4(a)(1) of the Securities Act, which exempts "transactions by a person other than an issuer, underwriter, or dealer”. Section 2(11) defines “underwriter” to include any person who participates in a distribution of securities purchased from the issuer or an affiliate of the issuer. This, abetted by certain positions taken by the SEC, led to a concern that an affiliate (such as a large shareholder) reselling securities of the issuer in a private offering may be deemed to be participating in a distribution of those securities on behalf of the issuer, in effect making it an “underwriter”. As a result, an affiliate of an issuer will not be able to sell those securities under Section 4(a)(2) because it is not the issuer, and may not be able to sell under 4(a)(1) because it can be deemed to be an underwriter, leaving the affiliate with no statutory basis on which to make private resales. Market practice responded to this lacuna by developing a set of procedures to ensure that affiliates engaged in private resales of securities of the issuer would not be deemed to be engaged in a distribution and so would not be underwriters. These became known as Section 4(1½) transactions because they inhabit the metaphysical space between Section 4(a)(1) and Section 4(a)(2).

[3]The information required (which must be reasonably current in relation to the date of resale) is:  (a) the exact name of the issuer and its predecessor (if any), (b) the address of the issuer’s principal executive offices, (c) the title and class of the security, (d) the par or stated value of the security, (e) the number of shares or total amount of the securities outstanding as of the end of the issuer’s most recent fiscal year, (f) the name and address of the transfer agent, corporate secretary or other person responsible for transferring shares and stock certificates, (g) a statement of the nature of the business of the issuer and the products and services it offers, which shall be deemed to be reasonable current if the statement is as of 12 months before the transaction date, (h) the names of the officers and directors of the issuer, (i) the names of any brokers, dealers or agents that will be paid a commission or other remuneration for participating in the sale, (j) the issuer's most recent balance sheet and profit and loss statements, which shall be (i) for the last 2 fiscal years (or such shorter period as the issuer has been in operation), (ii) prepared in accordance with US GAAP or IFRS (in the case of a foreign private issuer) and (iii) presumed reasonably current if (a) the balance sheet date is no more than 16 months prior to the transaction date, (b) the profit and loss statement is for the 12 months preceding the date of the balance sheet, and (c) if the balance sheet is not of a date within six months of the transaction, it is accompanied by an interim profit and loss statement covering the period from the date of such balance sheet to a date within six months of the transaction; and (k) to the extent that the seller is a control person with respect to the issuer, a brief statement regarding the nature of the affiliation and a statement certified by the seller that they have no reasonable grounds to believe that the issuer is in violation of the US securities laws or regulations.

[4]  Rule 12g3-2(b) provides an exemption from the reporting requirements of the Securities Exchange Act. It is available to (i) a foreign private issuer, (ii) whose primary trading market for its securities is a foreign exchange, (iii) which is not currently required to file reports under the Securities Exchange Act, and (iii) which publishes, in English, on its website or through an electronic information delivery system generally available to the public in its primary trading market, all material information that it has (x) made public or has been required to make public under the laws of its country of incorporation, organization or domicile, (y) filed or has been required to file with the principal securities exchange in the primary trading market on which its securities are traded, and the documents have been made public by the exchange, and (z) distributed or has been required to distribute to its security holders. Prior to 2008, issuers were required to apply to the SEC for exemption under Rule 12g3-2(b), following which the SEC would issue a notice of exemption.  Since then the exemption has applied automatically to qualifying issuers without action by the SEC, leading to uncertainty on the part of third parties (and some issuers) as to whether an issuer does, in fact, meet the requirements of the Rule.

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