Test Your Knowledge of the Issuer Exemption
Rule 3a4-1, otherwise known as the "safe harbor" of the issuer exemption, can be challenging to navigate. We've put together a few questions so you can test your basic knowledge of the rule. Because every offering is unique, it's important to consult a broker-dealer or legal professional for advice when selling private securities.
The issuer safe harbor (issuer exemption) applies to “Associated Persons” of securities issuers and has four requirements. The associated person may not be (i) subject to a statutory disqualification (“DQ Test”); (ii) compensated directly or indirectly based on the securities transaction (“Transaction-based Comp Test”); (iii) an associated person of a broker or dealer (“Association Test”).
As set forth in Rule 3a4-1(a)(4), the fourth requirement is an “Activities Test.” The Activities Test may be met in one of three Types, as further described in detail in the regulation itself. The associated person (i) must restrict the sale of securities to certain types of securities or to certain types of purchasers (“Security Type”); (ii) primary job cannot be to sell securities, cannot have been associated with a broker or dealer in the preceding 12 months, and limits participation in selling securities to only once in a 12-month period (“Job Type”); or (iii) limits selling behavior to certain specific activities (“Passive Selling Type”).
Think you have a good understanding of the issuer exemption? Test your knowledge by reviewing the following scenarios.
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I’m a small business owner raising capital to grow my business. I’m not paying myself a commission from the sale of my securities, but do plan to give myself a bonus based on how successful the offering is. This is my only raise in the last 12 months and I plan to use an outside broker-dealer on this deal. Could I fall under the issuer exemption?
Yes
No
The issuer’s safe harbor would likely not apply in this situation because the individual is receiving transaction-based compensation in violation of Rule 3a4-1(a)(2). One of the requirements to even claim the issuer’s safe harbor is that the individual not receive remuneration for her participation in the offering, whether direct or indirect. In this case, the individual paying herself a bonus based on the success of the offering would violate this requirement.
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I’m raising money to build a craft brewery in my hometown. I have a Series 7 and am employed by a broker-dealer, but work in their research department. Could I fall under the issuer exemption?
Yes
No
This associated person would almost certainly not fall under the safe harbor because the individual raising capital fails the Association Test. He or she must not be currently associated with a broker-dealer to qualify for the exemption. Additionally, if this individual were to attempt to raise funds for the brewery away from his broker-dealer, he would likely be trading-away in violation of FINRA Rule 3280, for which the recommended sanction is a bar from the securities industry.
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I’m a real estate developer raising money for my next multi-family project. I’m not receiving a commission from the sale of securities and not associated with a broker-dealer currently. I’ve been doing three to four deals a year for the past 20 years, and this will be my second offering in the last 12 months. I have existing business and investor relationships, and want to use a portal to connect with my existing investors. I was associated with a broker-dealer until five years ago when that broker-dealer accused me of selling securities that they had not authorized. To make the matter go away, I settled with FINRA and was suspended from the industry for two years. Could I fall under the issuer exemption?
Yes
No
This scenario would likely not fall under the safe harbor. Despite the fact that the real estate developer is not being compensated for the transaction of securities and is not currently associated with a broker-dealer, he would be unable to rely on the safe harbor as a result of his previous suspension from the securities industry by FINRA. This makes him statutorily disqualified under section 3(a)(39) of the Securities and Exchange Act, which disqualifies him from being able to use the issuer’s safe harbor and most likely from the Regulation D exemption in its entirety.
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I manage a real estate fund. I am doing my first raise in more than a year and I plan on actively selling my securities. I’m thinking about contacting potential investors by phone. Until 4 months ago, I was a registered representative with a broker-dealer. Could I fall under the issuer exemption?
Yes
No
This person most likely would not fall under the safe harbor. In order for the safe harbor to apply to an individual, he must meet the requirement of Rule 3a4-1. In this case, the individual intends to actively sell the offering, which in WealthForge’s opinion, means that he must approach the offering in accordance with the Job Type approach. Unfortunately, that type requires that the individual have not been associated with a broker-dealer for the last 12 months, whereas here the individual was associated with a broker-dealer 4 months ago. Therefore, he may not rely on this form of the exemption.
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I’m raising money for my next oil and gas project. It’s my second raise this year and I do not plan to use a broker-dealer. I’ll just respond to any investor inquiries about the Private Placement Memorandum myself, as well as provide any new updates about the firm that have occurred since we created the PPM. Could I fall under the issuer exemption?
Yes
No
The individual would likely not be able to use the issuer’s safe harbor since he fails the “Activities Test.” If this is his second raise in the last 12 months, he likely was planning on relying on the Passive Selling Type of Activities. This allows him to respond to investor inquires with only information contained in the offering’s Private Placement Memorandum. If he provided additional information not included in the original PPM, he would be in violation of the safe harbor and would need to be registered to conduct the offering.
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I plan to file the paperwork to set up a securities offering for farmland in the Midwest. It’s the third deal this year that I have worked on for my company. I am not now, nor have I ever been associated with a broker-dealer, and am not compensated in any way for my work on these offerings. I have never been accused of a securities crime, or any other crime for that matter. Since my company raises capital regularly, I complete all related paperwork, send PPMs to retail investors and otherwise provide administrative support for the offering. Could I fall under the issuer exemption?
Yes
No
This associated person likely could fall beneath the safe harbor, though additional facts could disqualify him. He clearly indicated that he is neither associated with a broker-dealer nor paid transaction-based compensation. Additionally, as he has never been found to have violated either securities rules or FINRA (or another self-regulatory body’s) rules, he is likely not statutorily disqualified.
The facts of this scenario center around the applicability of the Activities Test. As the securities are directed at retail investors and he has been involved in more than one offering within 12 months, the only type of activities allowed to him would be Passive Selling. Under the Passive Selling Type, the associated person may, in relation to a securities transaction, (i) prepare written, but not oral, solicitations; (ii) respond to inquiries initiated by a potential purchaser provided that the responses are limited to information already contained in the offering documents; (iii) perform ministerial or clerical work.
Based on the information presented in the example, it seems the person is only performing ministerial or clerical work. It will be especially important in this case to assess each associated person in the organization. Although the administrative person may fall beneath the safe harbor, with all the securities activity that seems to be going on at the company, each employee should be considered. As a reminder, the issuer’s safe harbor is a very technical and complicated doctrine that many people even within the securities industry disagree on. An issuer’s associated person should always consult with a registered broker-dealer and/or an experienced securities attorney before relying on the safe harbor.
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