New Law to Ease Restrictions on Resale of Private Stock?
The US House of Representatives approved a bill, which if passed by the Senate and signed into law by the President, could make it easier for people to resell private stock. If you’re lucky enough to be an investor in Airbnb, Uber, or some other startup that took off but hasn’t yet gone through an IPO, how do you turn your private stock into cash? It can be tougher than you might think. As a general rule, every offer and sale of a security must be registered or exempt from state and federal securities registration requirements. This includes the resale of private securities, meaning if you have shares of Airbnb or Uber, you have to make sure you’re not violating state or federal securities laws when you sell them.
Currently, there’s an informal rule called 4(a)(1 1/2) that allows for resale of private stock if certain conditions are met. That rule is a hybrid of two official rules–4(a)(1) and 4(a)(2). Both 4(a)(1) and 4(a)(2) are exemptions from the general rule that before you can offer to sell stock, you have to register your offering with the SEC or state regulators.
The 4(a)(1) rule provides an exemption for transactions “by a person other than an issuer, underwriter, or dealer.” And the 4(a)(2) rule provides an exemption for “transactions by an issuer not involving any public offering.” The issues with these two exemptions for individuals reselling private stock are: (1) It’s not always clear whether the individual reselling the stock is an underwriter in the eyes of securities regulators–and if they’re an underwriter they do not qualify for the 4(a)(1) exemption; and (2) the individual reselling the company is not an issuer who would be exempt under 4(a)(2)–an issuer is a term for the company whose stock is being sold.
The 4(a)(1 1/2) rule is a creation of court rulings and SEC no-action letters. There is no official statutory authority for the rule, and the standards for what qualifies for a 4(a)(1 1/2) exemption are not clear–this new legislation tries to clarify. Additionally, each state has its own regulations on 4(a)(1 1/2) and related offerings. This new federal legislation would preempt state law, further clarifying the murky legal waters of 4(a)(1 1/2) exemptions.
The RAISE Act
House Resolution 1839 – Reforming Access for Investments in Startup Enterprise Act of 2015 (or the RAISE Act of 2015) passed the U.S. House of Representatives unanimously last month. The Senate is now reviewing the measure. In order for this bill to become law, the Senate would have to pass it, and the President would have to sign it.
The way this exemption works is it says if you meet 8 requirements, you qualify for this new exemption (if the law passes, the exemption will be section 4(a)(7)). The 8 requirements are:
- All of the purchasers must be accredited investors.
- The seller can’t advertise or use general solicitation.
- The company whose stock is being sold, and the seller have to make information available to the purchaser. This information includes, among other things, details on the corporate structure, the officers, the nature of the company’s business, and two years of financial statements.
- The seller cannot be the issuer–this is not a way for a company to sell its own stock.
- The seller cannot be a bad actor.
- The company whose stock is being sold must be doing business–it can’t be an empty corporate shell or a startup that hasn’t yet started.
- The seller can’t be a broker or dealer acting as an underwriter for the sale of the stock.
- The stock being sold must have been authorized (created by the company) and issued (in the possession of someone other than the company) for at least 90 days prior to the sale.
Potential Importance of The RAISE Act
The major downside to being a private company is a lack of liquidity for shareholders. The RAISE Act could help with the lack of liquidity by providing guidance on how holders of private stock can sell that stock in a manner compliant with securities regulations.
Liquidity for private shareholders is increasingly becoming an important issue, because its easier for companies to remain private. The JOBS Act lengthened the runway for private companies–companies used to have to “go public” when they had more than 500 shareholders, but the JOBS Act raised that number to 2,000.
Additionally, it is becoming increasingly attractive for companies to remain or become private. From 1996 to 2015, the number of publicly traded companies has dropped by about half. CEOs appreciate that public companies are more short-term focused and have incredibly burdensome on-going reporting obligations. Acquirers target public companies, thinking they can capture value by making them private, and the rise of larger pooled funds has increased capital available to private companies.
Between the JOBS Act increasing the shareholder threshold and the shrinking number of public companies, it is reasonable to assume there are more holders of private stock. And because there are more private shareholders seeking liquidity, legislation like The RAISE Act could be more useful now than ever before.
Now, we wait and see what the Senate and President do with the bill passed by the house. The bill is currently in the Senate’s Committee on Banking, Housing, and Urban Affairs.
If you’d like more information about compliance with securities regulations, you can give us a call at (206) 745-5229 or send us an email at firstname.lastname@example.org.