Securities Registration and Exemption Analysis under Federal and Arizona Law

Securities transactions are regulated by both federal and state law. There are two main federal securities statutes: the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). The Securities Act regulates the primary market―the initial public offerings of securities―by prohibiting the offer and sale of unregistered securities and requiring companies to give investors full disclosure of all material facts concerning their securities.[1] The Exchange Act regulates the secondary market―the trading of previously issued and outstanding securities―by requiring publicly held companies to file reports and continually disclose documents and information about their business operations, financial condition, and management.[2] Both of these federal laws contain anti-fraud provisions that prohibit fraud, deceit, and material omissions or misrepresentations in the offer or sale of such securities.[3]

The Arizona Securities Act (the “Act”) governs the offer and sale of securities from or within Arizona. The Act was enacted in 1951 to protect the public, preserve fair and equitable business practices, suppress fraudulent or deceptive practices in the sale or purchase of securities, and prosecute persons engaged in such practices.[4] To achieve its legislative purpose, the Act is liberally construed and not given a narrow or restricted interpretation or construction.[5]

In determining whether these federal and state securities statutes apply to certain business or commercial transactions, one must answer the following questions:[6]

1. Does the transaction involve a security?

2. Does the transaction constitute an offer or sale of that security?

3. Is the security properly registered with the federal and state securities authorities?

4. If the security is not registered, is it exempt from the registration provisions?

This article will analyze the securities registration and exemption provisions pursuant to federal and Arizona securities laws by thoroughly discussing in turn each of the above questions.

 The first step in deciding whether the securities statutes apply is to determine whether the transaction at issue actually involves a “security”. Arizona broadly defines a security as any:

[N]ote, stock, treasury stock, bond, commodity investment contract, commodity option, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, viatical or life settlement investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, real property investment contract or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.[7]

The definition for each of these securities is either listed in the Act under A.R.S. Section 44-1801 or provided by judicial interpretations and tests.[8] In determining whether a certain instrument is a security, a court will consider the substance rather than the form of the instrument.[9] “Essentially, if the purchaser will be a passive owner―relying on someone else’s efforts or conduct in order to make money on the investment―the instrument is probably a security.”[10]

“Investment contract” is one such term that is vague and not defined by the Act. Because Arizona’s definition of a security is patterned after and nearly identical to that under federal law, Arizona courts look to federal law for guidance in interpreting its securities laws.[11] Thus, Arizona courts have adopted the three-prong Howey test developed by the U.S. Supreme Court that defines an investment contract as an: (1) investment of money; (2) in a common enterprise; and (3) with the expectation that profits will be earned solely from the efforts of others.[12]

Under the first prong of the Howey test, there must be an investment of money. “An ‘investment of money’ means only that the investor must commit his assets to the enterprise in such a manner as to subject himself to financial loss.”[13] While the first prong is a straightforward inquiry, the second and third prongs require a more complicated analysis.

Courts use two tests, vertical commonality and/or horizontal commonality, to examine the second prong, a common enterprise.[14] “Horizontal commonality requires a pooling of investor funds collectively managed by a promoter or third party. Vertical commonality requires a positive correlation between the success of the investor and the success of the promoter, without requiring a pooling of funds.”[15] In Arizona, a common enterprise exists where there is horizontal commonality or vertical commonality; the pooling of funds is not strictly required.[16]

The third prong of the Howey test requires the profits to be derived solely from the efforts of others for the transaction to constitute an investment contract.[17] The Ninth Circuit Court of Appeals broadened this prong by only requiring that the profits be earned from the “undeniably significant” efforts of others.[18] Accordingly, under Arizona law, “the ‘efforts of others’ must involve significant managerial efforts which affect the failure or success of the investment.”[19] In addition, the efforts may be those of others and not just the efforts of the investment promoter.[20] Finally, the efforts of others must be substantively examined by looking at the economic realities of the transaction and deciding whether the typical investor would accept third-party efforts.[21] The economic realities of the transaction include the promotional emphasis, contractual materials, and investor’s motivation and ability to exercise control over the investment, such as whether the investor has the requisite knowledge, skill, and expertise to manage the investment.[22]

If the subject transaction involves a security, such as an “investment contract” involving the investment of money in a common enterprise with profits due from the significant efforts of others, then the next question to ask is whether there has been an offer or sale of that security.

The Arizona Securities Act regulates the offer and sale of securities. The term “offer” has a different and far broader meaning in securities law than in contract law.[23] Under the Act, an “offer to sell” or “offer for sale” is an “attempt or offer to dispose of, or solicitation of an order or offer to buy, a security or interest in a security for value or any sale or offer for sale of a warrant or right to subscribe to another security of the same issuer or of another issuer.”[24] The term “sale” or “sell” means “a sale or any other disposition of a security or interest in a security for value, and includes a contract to make such sale or disposition.”[25]

Given these broad terms, almost any attempt to dispose of a security for value will amount to an offer or sale in Arizona.[26] If there has been an offer or sale of a security, the next issue is whether the security was properly registered under federal and Arizona securities laws.

 The Securities Act[27] divides the federal registration process into three periods: the pre-filing period, the waiting period, and the post-effective period. The pre-filing period occurs after the offer is conceived, but before the registration statement is filed. It is unlawful for any person to use interstate commerce or the mail to offer to sell or offer to buy securities during the pre-filing period; such offerings cannot begin until after the registration statement has been filed.[28]

The waiting period occurs after the registration statement has been filed with the Securities and Exchange Commission (the “SEC”) but before the registration statement becomes effective. It is unlawful for any individual to use interstate commerce or the mail to sell or deliver securities during the waiting period; the sale and delivery of securities cannot begin until after the registration statement is in effect.[29] Any person who offers, sells, or delivers unregistered securities is subject to criminal prosecution[30] and civil liability, as the purchaser “may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he [or she] no longer owns the security.”[31] Section 77k(a) of the Securities Act also sets forth civil liabilities arising from a false registration statement, including misstatements or omissions of material fact therein.

An issuer may register any security with the SEC by filing a signed registration statement and paying a filing fee.[32] The registration statement consists of two principal parts: (1) the prospectus, otherwise known as the legal offering or selling document, which must be made available to every offeree and purchaser of the securities; and (2) information and exhibits, which do not have to be delivered to the investors, but are made available by the SEC for public inspection.[33] The schedule of information and accompanying documents that must be included in the registration statement are listed in section 77aa of the Securities Act, otherwise known as Schedule A.[34] Section 77j(a) of the Securities Act then specifies which of those informational items from Schedule A must also be included in the prospectus, such as the issuer’s business operations, financial condition, and management.[35]

The Securities Act has authorized the SEC to require that the registration statement include more information and documents, or allow the registration statement to contain less information and documents with respect to certain classes of issuers or securities, than what is mandated by law.[36] Under this authority, the SEC has created different registration statement forms for various offerings. The general registration statement form is Form S-1, which all companies can use to register their securities offerings for which no other form is authorized or prescribed.[37] “Form S-3 can also be used by issuers which have been filing reports under the 1934 Act [Exchange Act] for at least 12 months, to register (a) offerings of senior securities, secondary offerings, and certain special kinds of offerings, and (b) new offerings of equity securities if the market value of the issuer’s publicly-held voting stock is at least $75 million.”[38]

Any company qualifying as a small business issuer could previously choose to file its registration statement using a simplified business form instead, such as Form SB-1 for offerings up to $10 million worth of securities in any 12-month period or Form SB-2 for an unlimited amount of securities.[39] These alternative registration forms for small business issuers, however, were no longer being accepted by the SEC as of February 4, 2008. Other types of registration statement forms currently made available by the SEC include Form S-4 for mergers and acquisitions, Form S-6 for unit investment trusts, Form S-8 for employee stock purchase plans, Form S-11 for real estate companies, and Form S-20 for standardized options.

Upon receipt of the registration statement and documents, the SEC staff will conduct a disclosure review of the items to ensure that they comply with the disclosure requirements.[40] If on its face the registration statement appears incomplete or inaccurate in any material respect, the SEC can, after providing proper notice and an opportunity for hearing, issue an order refusing to permit the registration to become effective until the statement is amended in accordance with the refusal order.[41] Similarly, if the SEC discovers that the registration statement contains a misstatement or omission of material fact, the SEC may, after providing proper notice and an opportunity for hearing, issue a stop order suspending the effectiveness of the registration statement until the statement is amended in accordance with the stop order.[42]

Absent a refusal order or stop order, a registration statement automatically becomes effective 20 days after it is filed with the SEC.[43] The registration statement will be deemed effective only as to the proposed securities offerings specified therein.[44] After the registration statement becomes effective, the post-filing period begins and continues until the issuer completely distributes its securities. During the post-filing period, the issuer may offer and sell its registered securities to anyone in the public. Whenever a security is sold and delivered, however, it must be preceded or accompanied by a proper final prospectus.[45]

Arizona’s blue sky laws, namely the Arizona Securities Act, also require securities to be registered before they are sold or offered for sale within or from Arizona, unless they are specifically exempt from the Act’s registration requirements.[46] Any individual who offers to sell or sells unregistered securities in Arizona is guilty of a class 4 felony.[47] In addition to criminal liability, a violation of A.R.S. Section 44-1841 may result in civil liability as the investor can void the purchase and file suit against the seller to “recover the consideration paid for the securities, with interest, taxable court costs and reasonable attorney fees, less the amount of any income received . . . on tender of the securities purchased or the contract made, or for damages if the purchaser no longer owns the securities.”[48] A civil action under A.R.S. Section 44-2001 may be brought against any person who made, participated in, or induced the unlawful sale or purchase of an unregistered security, and the court will hold such persons jointly and severally liable to the investor.[49]

In Arizona, one may register securities with the Arizona Corporation Commission (the “Commission”) through two standard registration methods: registration by description or registration by qualification. There are also two shortened registration formats available to certain types of securities: fast track registration and uniform limited offering registration. Unlike some state securities laws, however, the Arizona Securities Act does not provide for registration by coordination with SEC registration.

Securities, except real property investment contracts,[50] may be registered by description if either of the following two conditions are met:

1. If such securities are commodity investment contracts or commodity option contracts and the financial condition of the party filing the registration statement meets the requirements specified by any rule of the commission.[51]

2. If securities are of an issuer that both:

(a) Has been in continuous operation for not less than three years.

(b) Has shown, for a period of not less than three years during the five years prior to the date of registration, average annual net income adjusted by adding back interest expenses net of applicable income tax benefits arising therefrom of securities to be retired out of the proceeds of sale, as follows:

(i) In the case of interest-bearing securities, not less than one and one-half times the annual interest charges on the securities and on all other outstanding interest-bearing securities of equal rank.

(ii) In the case of securities having a specified dividend rate, not less than one and one-half times the annual dividend requirements on the securities and on all outstanding securities of equal rank.

(iii) In the case of securities wherein no dividend rate is specified, not less than five percent calculated by dividing the adjusted average annual net income by the product of the number of all outstanding securities of equal rank at the completion of the offering and the maximum price at which any of the securities are to be offered for sale.[52]

If a security qualifies for registration by description, the issuer[53] or registered dealer can register the security accordingly by submitting the following to the Commission: (1) a non-refundable registration fee; (2) a registration statement;[54] and (3) a consent to service of process[55] if the registrant is not a registered dealer or Arizona corporation.[56] The registration fee is equal to 0.1% of the aggregate offering price of the securities that are to be sold in Arizona, with a minimum fee of $200.00 and a maximum fee of $2,000.00.[57]

Upon receipt of the registration fee, registration statement, and consent to service of process, if required, the Director of the Securities Division of the Commission will record the security’s registration by description in a register of securities.[58] The registration statement will become effective when it is filed with the Commission.[59] The registration is then effective for one year and may be renewed for additional periods of one year if the securities are still entitled to registration by description and a new registration statement and registration fee are filed with the Commission.[60] Once effectively registered by description, the securities may be sold in Arizona by any registered dealer or any registered salesman employed by a registered dealer.[61]

If a security does not qualify for registration by description, the security may be registered by qualification under the Act. An issuer may register securities by qualification by filing the following with the Commission: (1) an application (Form U-1);[62] (2) a prospectus;[63] (3) a non-refundable registration fee; and (4) a consent to service of process [64] if the issuer is not an Arizona domiciliary or entity.[65] The registration fee is equal to 0.1% of the aggregate offering price of the securities which are to be sold in Arizona, with a minimum fee of $200.00 and a maximum fee of $2,000.00.[66]

After receiving and examining the application, prospectus, registration fee and consent to service of process, if required, and determining that the registrant fully complied with all of the registration by qualification provisions, the Director of the Securities Division of the Commission will register the security in a register of securities.[67] The director will then notify the issuer by mail of the effective date of registration.[68] The registration is then effective for one year and may be renewed for additional periods of one year by filing, no later than 15 days prior to the registration’s expiration, a registration fee and prospectus containing information no older than 90 days before the filing date.[69] Once effectively registered by qualification, the securities may be sold by any registered dealer or registered salesman employed by a registered dealer.[70] Prior to the conclusion of any contract of sale of securities registered by qualification, a copy of the prospectus satisfying the statutory requirements must be delivered to each purchaser if the prospectus is used more than one year from the effective date of registration of the securities.[71]

Certain types of securities may be eligible to register by fast track registration, a shortened form of registration by qualification. Fast track registration is available to offerings of shares, warrants, options or other rights to purchase shares[72] and offerings of limited partnership interests that meet their prescribed conditions.[73] An issuer or underwriter may achieve fast track registration for such qualifying securities by filing the following with the Commission: (1) an application for registration by qualification;[74] (2) documents required for registration of securities by qualification;[75] (3) one copy of the prospectus on file with the SEC in its most recent form as of the filing date; (4) one copy of any and all amendments and supplements to the prospectus; and (5) a final prospectus.[76] Unless the Commission or director declares the registration effective at an earlier time, a fast track registration becomes effective on the latter of the following: (1) twenty business days after filing the required documents; (2) in the case of limited partnership interests, ten business days after filing any amendment; (3) concurrently with the effectiveness of the registration statement filed under the Securities Act; or (4) a later date as requested by the issuer.[77]

Another shortened registration format is the Uniform Limited Offering Registration (ULOR), which has been adopted in many states to facilitate and standardize capital formation for small businesses.>[78] An issuer may register securities under the ULOR format if the offering does not exceed $5 million in any 12-month period, the offering is not a blind pool offering, the issuer is not subject to the Investment Company Act of 1940, the issuer is not subject to the reporting requirements of the Exchange Act, the issuer and offering meet the qualifications for use set forth in the Small Company Offering Registration Issuer’s Manual, and the issuer of debt offerings can demonstrate an ability to service its debt.[79] To register securities under the ULOR format, the issuer must submit the following items to the Commission: (1) a small company offering registration form (Form U-7);[80] (2) exhibits and such other documents as required by the Issuer’s Manual;[81] and (3) a $250 non-refundable registration fee.[82] The issuer may not distribute advertising and sales materials until the Division notifies the issuer that it may use them.[83]

After registering the securities under the ULOR format, the issuer must comply with specified delivery and reporting requirements. Pursuant to A.A.C. Section 14-4-134(I), the issuer must deliver to each offeree a copy of any literature mandated by the Commission, the Form U-7 that has been declared effective by the Commission, and any supplements thereto. Further, if any securities sold in the offering are outstanding, the issuer must deliver to its investors any reports required by the Form U-7 or under the Exchange Act, unless there are ten or fewer shareholders and they all consent in writing to end such reporting.[84] Finally, the issuer must deliver to the Commission, in the form and time specified by the Commission, a report stating the number of purchasers and dollar amount of the securities sold, a statement indicating that the issuer has not made any changes or amendments to the Form U-7 or sales and advertising materials other than those filed with and declared effective or cleared by the Division, a report stating in reasonable detail the issuer’s use of the offering proceeds, and any other reports, brochures, letters, or similar documents furnished to the investors through any medium.>[85]

In Arizona, the Commission reviews applications for the registration of securities through a disclosure review and merit review. During disclosure review, the Commission reviews the documents to ensure that the issuer clearly and adequately disclosed all material information.[86] Merit review means that the Commission reviews the documents to ensure that the offering is not unfair or inequitable, and complies with additional statutes and rules.[87] Accordingly, even if the issuer has submitted the required documents and information relating to the securities offerings, the Commission can still deny, revoke, or suspend the registration for various reasons.

Except as provided in A.R.S. Section 44-1901 for fast track registration, the Commission may deny registration by qualification for any securities if it finds, after a hearing or notice and opportunity thereof, any of the following: (1) the application or any related materials are incomplete, inaccurate or misleading, or the information contained therein is insufficient for a true appraisal of the securities; (2) the designated issuer, dealer, or salesman has violated any securities statutes or rules; (3) the sale of the securities works a fraud or deceit upon the purchasers or is unfair or inequitable to the purchasers; (4) the issuer is insolvent or in an unsound financial condition; (5) the issuer has refused to allow the Commission to examine its affairs or failed to furnish the required information; or (6) the issuer, director, officer, trustee, fiduciary, partner, or any other controlling person has been, within five years of registration, convicted of fraud or wrongdoing in the securities industry or, within three years of registration, enjoined from engaging in the sale or purchase of securities.[88] The Commission may also revoke a security’s registration by qualification on the same grounds for denial listed above or a security’s registration by description if the security is not entitled to registration by description.[89] Finally, based on the same grounds for denial or revocation, the Commission may also suspend the security’s registration for up to 30 days, pending an examination into the issuer’s affairs.[90]

Even if the Commission does not deny, revoke, or suspend the registration of a security for any of the above reasons, an applicant’s inaction may automatically void the registration process. An application is considered abandoned if the application has been on file with the Commission for at least six months, the applicant has failed to respond to a request for information for at least two months after the date of the request, or the applicant has failed to respond to the Commission’s notice of warning of abandonment within 60 days after the date of the warning.[91]

If the issuer has not complied with the securities laws’ registration provisions, or the registration has been denied, revoked, suspended or abandoned, the next question is whether there are any exemptions from the registration requirements that apply to the securities offering.

An issuer may offer and sell unregistered securities if they qualify for an exemption from the federal and state registration requirements. A securities offering that is exempt under the federal securities laws is not necessarily exempt from the state securities laws.[92] Further, exempt securities transactions are still subject to the anti-fraud provisions of the securities laws.[93] This section will discuss the primary securities exemptions available under federal and Arizona law. 

Section 77e of the Securities Act prohibits the sale of securities unless a registration statement is filed and in effect or such securities are specifically exempted from the registration provisions of the Securities Act. The SEC, however, by rule or regulation, may conditionally or unconditionally exempt any person, security, or transaction, or any class thereto, from any registration provision to the extent that such an exemption is necessary or appropriate in the public interest and is consistent with the protection of investors.[94]

Under federal law, 15 U.S.C. Section 77c exempts certain securities while Section 77d exempts certain securities transactions. A securities exemption will exempt all of the transactions involving that security whereas a transactional exemption will only exempt one securities transaction; a separate exemption must apply to all of the subsequent securities transactions.

i. Statutory Securities Exemptions.

Section 77c of the Securities Act exempts the following securities from registration: (1) certain government securities; (2) certain types of commercial paper; (3) securities issued by certain nonprofit corporations; (4) securities issued by certain banks and savings and loan associations; (5) any interest in a railroad equipment trust; (6) certificates issued by a receiver or by a trustee or debtor in possession in a bankruptcy; (7) certain insurance, endowment, and annuity policies and contracts; (8) any security exclusively exchanged by the issuer with its existing security holders where no commission or other remuneration is paid or given for soliciting such an exchange; (9) certain securities which are issued in exchange for one or more bona fide outstanding securities, claims or property interests; (10) intrastate offerings;[95] (11) certain equity securities issued in connection with the acquisition of a bank or savings association by a holding company; (12) certain securities issued by or interest or participation in any church plan, company or account; and (13) certain securities futures products.[96]

ii. Statutory Securities Transaction Exemptions.

Section 77d of the Securities Act exempts the following securities transactions from registration: (1) transactions by any person other than an issuer, underwriter, or dealer;[97] (2) transactions by an issuer not involving any public offering;[98] (3) certain transactions by a dealer; (4) brokers transactions executed upon customers orders on any exchange or in the over-the-counter market but not the solicitation of such orders; (5) transactions involving the sale of certain private mortgage-backed securities; and (6) transactions involving accredited investors.[99] 

The intrastate offering exemption facilitates the local financing of local business operations through local investment.[100] Under Section 77c(a)(11) of the Securities Act, the intrastate offering exemption applies to “any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.” Accordingly, an issuer must satisfy the following three criteria to qualify for the federal intrastate offering exemption: (1) the issuer is a resident of and doing business within a state or, in the case of a corporation, is incorporated by and doing business within the state, which has been interpreted to mean having substantial business or operational activities in the state; (2) the issuer only offers and sells the securities to residents of that same state; and (3) the securities that are sold come to rest in the hands of investors who are residents of that same state.[101] The intrastate offering exemption may be easily lost if any of the securities are offered or sold to even just one out-of-state person or the purchaser resells any of the securities to an out-of-state person within a short period of time after the issuer’s offering is complete.[102] Therefore it may be hard for an issuer to rely on the intrastate offering exemption unless the issuer knows the purchasers and directly negotiates the sale with those purchasers.[103]

In order to provide greater certainty for those issuers who want to use the intrastate offering exemption, the SEC created Rule 147 (17 CFR Section 230.147). Rule 147 is a safe harbor rule, which means that if its objective requirements are satisfied, the issuer’s securities offering will automatically qualify for the exemption. If the offering does not meet the Rule 147 conditions, the issuer can still qualify for the exemption pursuant to the statute, Section 77c(a)(11).

Rule 147 covers the following transactions:

Offers, offers to sell, offers for sale and sales by an issuer of its securities made in accordance with all of the terms and conditions of this rule shall be deemed to be part of an issue[104] offered and sold only to persons resident within a single state or territory where the issuer is a person resident and doing business within such state or territory, within the meaning of section 3(a)(11) [Section 77c(a)(11)] of the Act.

Accordingly, to qualify for the intrastate offering exemption under Rule 147, the issuer must, at the time of any offers and sales, be a person residing and doing business within the state or territory in which all of the issuer’s offers and sales are made.[105] The issuer is deemed to be a resident of the following: (1) the state or territory in which a corporation, limited partnership, trust or other organized business is incorporated or organized; (2) the state or territory in which a general partnership or other unorganized business’s principal office is located; and (3) the state or territory in which an individual’s principal residence is located.[106] The issuer is deemed to be doing business within a particular state or territory if: (1) the issuer derives at least 80% of its gross revenues from doing business within the state; (2) the issuer has at least 80% of its assets within the state; (3) the issuer uses at least 80% of the net proceeds of the offering within the state; and (4) the issuer’s principal office is located within the state.[107] Rule 147 also requires that the offerees and purchasers be residents of the same state.[108] Finally, while the securities that are part of an issue are being offered and sold by the issuer, and for nine month from the date of the last sale by the issuer of such securities, all resales of any part of the issue by any person can only be made to residents of the same state or territory.[109] In other words, the securities may not be resold outside the state for at least nine months after the last sale.[110] As a precautionary measure against interstate offers and sales, whenever any securities are sold pursuant to Rule 147, the issuer must place a legend on the certificate or other document evidencing the security that states the securities are unregistered and subject to limitations on resale, issue stop transfer instructions to the issuer transfer’s agent with respect to the securities or, if the issuer transfers its own securities, make a notation in the issuer’s appropriate records, and obtain a written representation from each purchaser as to his or her residence.[111]

There is no fixed limit on the size of the offering or number of purchasers for the intrastate offering exemption.[112] Further, no federal filing requirements exist to claim the Rule 147 exemption.[113] The issuer, however, may still need to fulfill any registration or exemption requirements set forth by the securities laws of its state.[114]

Section 77d(2) of the Securities Act exempts “transactions by an issuer not involving any public offering”, otherwise known as private offerings. An issuer attempting to use the private offering exemption may rely upon the federal case law interpreting 15 U.S.C. Section 77d(2)[115] or the safe harbor provisions contained in Rule 506 of Regulation D.[116] In general, to satisfy the private offering exemption, the sales of such securities can only be made without advertising or any other form of general solicitation to a limited number of sophisticated persons[117] with access to information that would typically be included in a registration statement and who agree not to resell or distribute the securities to the public.[118] Federal courts have therefore adopted the following four-part test to determine the application of the federal private offering exemption, which analyzes: (1) the number of offerees; (2) the sophistication of the offerees; (3) the size and manner of the offering; and (4) the relationship of the offerees to the issuer.[119]

The majority of these private offerings consist of “‘private placements’ of large blocks of securities with institutional investors―typically the sale of notes or debentures to one or more insurance companies or pension funds.”[120] The private offering exemption has also been effectively utilized “in offerings to key employees of the issuing company and in exchange offers to acquire the stock of closely-held companies.”[121] The statutory private offering exemption under Section 77d(2) is self-executing and therefore has no filing requirements.[122]

Pursuant to section 77d(6), the following transactions are exempt from the registration provisions set forth in the Securities Act:

Transactions involving offers or sales by an issuer solely to one or more accredited investors, if the aggregate offering price of an issue of securities offered in reliance on this paragraph does not exceed [$5 million], if there is no advertising or public solicitation in connection with the transaction by the issuer or anyone acting on the issuer’s behalf, and if the issuer files such notice with the Commission as the Commission shall prescribe.

Accordingly, the accredited investor exemption allows an issuer to offer and sell unregistered securities to accredited investors[123] if the total offering price is less than $5 million, the issuer does not use any advertising or public solicitation to execute its transactions, and the issuer files any required notice with the SEC. There are no specific disclosure requirements for the accredited investor exemption under section 77d(6), but “the antifraud provisions of the securities laws will apply to an offering under this exemption and therefore adequate disclosure to avoid material misrepresentation and omission is [still] required.”[124]

Section 77b of the Securities Act also gives the SEC the authority to add any class of securities to this list of exempted securities if the Commission finds that the enforcement of such securities is not necessary in the public interest and for the protection of investors by reason of the small amount involved or the limited character of the public offering. However, no issue of securities is exempt if the aggregate amount at which such issue is offered to the public exceeds $5 million.[125] In other words, if no other maximum is specified, such exempt offerings are limited to $5 million. Under this authority, the SEC has adopted various rules providing exemptions for certain specialized, smaller types of offerings, such as those provided in Regulation A and Regulation D,[126] both of which are discussed in detail below.[127]

i. Regulation A Exemption.

Regulation A (17 CFR Section 230.251 – 230.263) provides a federal registration exemption for smaller public offerings of ordinary securities.[128] Unlike other exemptions, Regulation A is satisfied upon compliance with certain procedures rather than a finding that specified conditions exist.[129] Accordingly, Regulation A resembles more of a simplified or miniature registration procedure for small issues rather than an exemption from registration requirements.[130]

Regulation A is an exemption that eligible issuers may use for public offerings that do not exceed $5 million in any 12-month period.[131] An issuer of securities is eligible to use Regulation A if the issuer is an entity organized under U.S. or Canadian law with its principal place of business in the U.S. or Canada, and the issuer is not a reporting company under the Exchange Act, a development stage company that either has no specific business plan or purpose or has indicated that its business plan is to merge with an unidentified company, an investment company registered under the Investment Company Act of 1940, or an issuer of fractional undivided interests in oil, gas, or other mineral rights.[132] Further, the issuer cannot be in violation of any of the “bad boy” disqualification provisions listed in Rule 262.[133]

Except as allowed by Rule 254 to solicit interest or “test the waters”, the issuer cannot offer securities under Regulation A until a Form 1-A offering statement[134] has been filed with the SEC.[135] After a Form 1-A offering statement has been filed, the issuer can make certain offers, including oral offers, written offers,[136] or printed advertisements or radio or television broadcasts so long as such advertisements or broadcasts state from whom a preliminary offering circular or final offering circular may be obtained, and contain no more than the name of the issuer of the security, the title of the security, the amount being offered and the per unit offering price to the public, the general type of the issuer’s business, and a brief statement as to the general character and location of its property.[137] After the Form 1-A offering statement has been qualified, other written offers may be made, but only if they are accompanied with or preceded by a final offering circular.[138] Unlike other exempt public offerings, Regulation A offerings are not restricted securities; they are freely tradeable in the secondary market after the offering.[139]

The issuer cannot sell securities under Regulation A until all of the following events have occurred: (1) the Form 1-A offering statement has been qualified; (2) a preliminary offering circular or final offering circular is furnished to the prospective purchaser at least 48 hours prior to the mailing of the confirmation of sale to that person; and (3) a final offering circular is delivered to the purchaser with the confirmation of sale, unless it has been delivered to that person at an earlier time.[140] Further, sales by a dealer that take place within 90 days after the qualification of the Regulation A offering statement may be made only if the dealer delivers a copy of the current offering circular to the purchaser before or with the confirmation of sale.[141] If permitted by Rule 415, continuous or delayed offerings may be made under Regulation A.[142]

At any time the SEC may enter an order temporarily suspending a Regulation A exemption for certain enumerated reasons.[143] Offering statements may also be withdrawn or abandoned. If none of the securities that are the subject of an offering statement have been sold and the offering statement is not the subject of a suspension, the offering statement may be withdrawn with the SEC’s consent.[144] On the other hand, when an offering statement has been on file with the SEC for nine months without an amendment and has not become qualified, the SEC may, in its discretion, declare that the issuer has abandoned the offering statement.[145]

ii. Regulation D Exemption.

Regulation D (17 CFR Section 230.501 – 230.506) consists of a series of rules that establish registration exemptions for three small issues. These exemptions under Regulation D are limited in the type and number of offerees as well as the dollar amount of the offering. Rules 501, 502, and 503 set forth the definitions, terms, conditions, and filing requirements that apply to all three exemptions, which are then separately provided for and discussed in Rules 504, 505, and 506.

Rule 501 defines the key terms used in Regulation D. One such definition is the calculation of the number of purchasers, which will not include any relative, spouse or relative of a purchaser’s spouse who has the same principal residence as the purchaser, any trust or estate in which a purchaser and any of the purchaser’s above relatives that have more than 50% of the beneficial interest (excluding contingent interests), any corporation or other organization of which a purchaser and any of the purchaser’s above relatives are beneficial owners of more than 50% of the equity securities (excluding directors’ qualifying shares) or equity interests, and any accredited investor.[146] Accordingly, the most important provision in Rule 501 is that which defines an “accredited investor” as any: (1) bank, savings and loan association, registered broker or dealer, insurance company, investment company, state employee benefits plan with total assets in excess of $5 million, or certain employee benefits plan; (2) private business development company; (3) charitable organization or educational institution with total assets in excess of $5 million; (4) director, executive officer or general partner of the issuer; (5) person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase exceeds $1 million; (6) person with an annual individual income of more than $200,000 for the past two years (or, together with that person’s spouse, an annual joint income of more than $300,000) and has a reasonable expectation of reaching the same income level in the current year; (7) trust with more than $5 million in assets which is managed by a sophisticated person and not formed for the specific purpose of acquiring the securities offered; and (8) entity in which all of the equity owners are accredited investors.[147]

Rule 502 sets forth the general conditions that are applicable to all three of the Regulation D offerings, including integration,[148] information requirements, and limitations on the manner of the offering and resale. The issuer is not required to furnish any specified information to accredited investors, or purchasers of securities offered and sold under Rule 504.[149] If the issuer sells securities to non-accredited investors under Rule 505 or Rule 506, however, the issuer must, within a reasonable time prior to the sale, provide such investors with certain information, some of which depends on whether the issuer is registered under the Exchange Act.[150]

For example, if the issuer is not registered under the Exchange Act, the issuer must provide the information that would be contained in an offering circular under Regulation A if the offering does not exceed $2 million, information that would be contained in a registration statement on Form SB-2 if the offering is between $2 million and $7.5 million, or information that would be contained in a registration statement on the form the issuer would be entitled to use if the offering exceeds $7.5 million.[151] Conversely, if the issuer is registered under the Exchange Act, the issuer must provide its most recent annual report to shareholders and proxy statement, or the information contained in its most recent annual report to the SEC, plus specified updates and supplemental information.[152] The issuer must also provide non-accredited investors with a brief written description of any material written information concerning the offering that the issuer provided to any accredited investor,[153] advise non-accredited investors of the limitations on resale,[154] and give each purchaser, at a reasonable time prior to purchasing the securities, the opportunity to ask questions and receive answers concerning the terms and conditions of the offering and obtain any additional information which the issuer possesses or can acquire without unreasonable effort or expense that is necessary to verify the accuracy of all this information.[155]

Under Rules 505 and 506, the issuer may not offer or sell the securities to any person by any form of general solicitation or general advertising.[156] Further, securities acquired under Rules 505 and 506 are restricted securities that may not be resold without registration under the Securities Act or an exemption therefrom.[157] Therefore the issuer must exercise reasonable care to ensure that the purchasers of such restricted securities are not underwriters.[158]

Finally, Rule 503 dictates when the notice of sales must be filed with the SEC. “An issuer offering or selling securities in reliance on Rule 230.504, Rule 230.505, or Rule 230.506 must file with the Commission a notice of sales containing the information required by Form D (17 CFR 239.500) for each new offering of securities no later than 15 calendar days after the first sale of securities in the offering . . .”[159] An issuer may file an amendment to a previously filed notice of sales at any time.[160] The issuer must, however, file an amendment to a previously filed notice of sales to correct a material mistake of fact or error, reflect changes in certain information, and annually, on or before the first anniversary of the filing of the notice of sales or the filing of the most recent amendment to the notice of sales, if the offering is continuing at that time.[161] Regardless of why the issuer is filing an amendment to a previously filed notice of sales, he or she must provide current information in response to all requirements of the notice of sales.[162] Notice of sales must be filed with the SEC in electronic format and signed by a person duly authorized by the issuer.[163] An issuer’s failure to file the notice of sales with the SEC does not destroy the exemption, but an issuer who has been sanctioned for such a failure is disqualified from making any further offerings under Regulation D unless the SEC determines, upon a showing of good cause, that such a denial is unnecessary under the circumstances.[164]

I. Rule 504.

To qualify for an exemption under Rule 504, the issuer’s offers and sales must satisfy the terms and conditions in Rule 501 and Rule 502(a), (c) and (d),[165] as discussed above, and the aggregate offering price[166] must not exceed $1 million in any 12-month period.[167] There is no limitation on the number of purchasers of a Rule 504 offering. Rule 504, however, is not available to an issuer that is a company registered under the Exchange Act, an investment company, or a development stage company that either has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company, other entity, or person.[168] Offers and sales of securities by eligible issuers that satisfy the foregoing conditions are exempt from the federal registration requirements pursuant to section 77c(b) of the Securities Act.[169]

II. Rule 505.

To qualify for an exemption under Rule 505, the issuer’s offers and sales must satisfy all of the terms and conditions in Rules 501 and 502, as discussed above, the aggregate offering price[170] must not exceed $5 million in any 12-month period, and there must be no more than, or the issuer must reasonably believe that there are no more than, 35 purchasers (excluding accredited investors and others as discussed in Rule 501).[171] Offers and sales of securities that satisfy the foregoing conditions are exempt from the federal registration requirements pursuant to section 77c(b) of the Securities Act.[172] The Rule 505 exemption, however, is not available to an issuer that is an investment company or an issuer that is disqualified by Rule 262 from using Regulation A, unless the SEC determines otherwise upon a showing of good cause.[173]

III. Rule 506.

To qualify for an exemption under Rule 506, the issuer’s offers and sales must satisfy all of the terms and conditions in Rules 501 and 502, as discussed above, there must be no more than, or the issuer must reasonably believe that there are no more than, 35 purchasers (excluding accredited investors and others as discussed in Rule 501), and each purchaser who is not an accredited investor, either alone or with the purchaser’s representative, has such knowledge and experience in financial and business matters that the purchaser is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that the purchaser has such knowledge and experience.[174] There is no limitation on the dollar amount of a Rule 506 offering. Offers and sales of securities that satisfy the foregoing conditions are considered private offerings within the meaning of 15 U.S.C. Section 77d(2), and are therefore exempt from the registration requirements set forth in the Securities Act.[175]

iii. Employee Benefit Plans Exemption.

Rule 701 of the Securities Act (17 CFR Section 230.701) exempts from registration certain offers and sales made by eligible issuers[176] under a written compensatory benefit plan[177] or written compensation contract for the participation of their employees, directors, general partners, trustees, officers, or consultants and advisors,[178] and their family members[179] who acquire such securities from such persons through gifts or domestic relations orders.[180] The aggregate sales price or amount of securities sold in reliance on Rule 701 during any consecutive 12-month period cannot exceed the greater of the following: (1) $1 million; (2) 15% of the issuer’s total assets; or (3) 15% of the outstanding amount of the class of securities being offered and sold in reliance on Rule 701.[181] To take advantage of Rule 701, the issuer must deliver to investors a copy of the compensatory benefit plan or the compensation contract, and, if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $5 million, the issuer must also deliver certain other disclosures to investors in a reasonable period of time before the date of sale.[182] Finally, securities issued under Rule 701 are not integrated with any other offering,[183] but they are restricted securities that cannot be resold unless they are registered under the Securities Act or are exempt from its registration requirements.[184]

Under the Arizona Securities Act, a security and the individual offering or selling the security must be registered with the Securities Division unless a valid exemption exists.[185] Securities or transaction exemptions tend to exist where the offerees or purchasers are able to “fend for themselves”, where the security or transaction is sufficiently protected from the possibility of fraud, or where the need to trade freely outweighs the risk of fraud.[186] Anyone applying for a registration exemption must strictly comply with the exemption requirements,[187] and he or she will have the burden of proving the existence of the exemption in any civil or criminal action.[188] If the individual proves that an exemption applies, it typically covers the registration of the security and the dealer or salesman offering or selling the security.[189]

In Arizona, A.R.S. Section 44-1843 exempts certain securities while A.R.S. Section 44-1844 exempts certain securities transactions. A securities exemption will exempt all of the transactions involving that security whereas a transactional exemption will only exempt one securities transaction; a separate exemption must apply to all of the subsequent securities transactions.

i. Statutory Securities Exemptions.

A.R.S. Section 44-1843(A) provides an exemption for the following types of securities: (1) government securities;[190] (2) securities issued by certain banks; (3) securities issued by certain savings and loan associations; (4) certain insurance, endowment, and annuity policies and contracts; (5) securities issued or guaranteed by a railroad or public utility; (6) securities issued by certain nonprofit corporations;[191] (7) securities listed or approved for listing on certain stock exchanges;[192] (8) certain types of commercial paper; (9) certain securities issued or guaranteed by foreign governments;[193] (10) certain secured notes or bonds; and (11) certain mortgage-related securities.[194]

ii. Statutory Securities Transaction Exemptions.

Under A.R.S. Section 44-1844, an exemption is available for the following types of securities transactions: (1) private offering transactions;[195] (2) certain transactions by trustees and receivers; (3) certain transactions by pledges; (4) isolated transactions; (5) certain stockholder distributions; (6) transactions incident to approved reorganizations, mergers, or consolidations; (7) certain exchanges of securities by an issuer with its existing security holders; (8) sales to banks, savings institutions, insurance companies, dealers, and certain other persons; (9) transactions pursuant to a right of conversion.; (10) issuance of corporate securities to ten original incorporators; (11) certain transactions involving securities whose issuer is listed in a manual of securities;[196] (12) certain sales of registered securities; (13) sales of commodity investment contracts traded on recognized exchanges;[197] (14) transactions in connection with pension, profit sharing, and other employee benefit plans; (15) transactions within the exclusive jurisdiction of the Commodity Futures Trading Commission; (16) certain transactions in connection with precious metals contracts; (17) certain commodity investment contracts; (18) certain non-issuer transactions involving the sale of securities listed on automated quotation systems of national securities associations;[198] (19) certain transactions involving non-residents; and (20) transactions involving the sale of certain private mortgage-backed securities.

A.R.S. Section 44-1844(A)(1) provides a registration exemption for private offerings or “transactions by an issuer not involving any public offering”. Accordingly, the private offering exemption is a securities transaction exemption available only to an issuer[199] of a security. The private offering exemption is essentially for offerings made by issuers without any advertisement to a limited number of sophisticated investors with access to the information that would ordinarily be included in a registration statement.[200]

An issuer attempting to use the private offering exemption may rely upon: (1) Arizona case law interpreting A.R.S. Section 44-1844(A)(1) and federal case law interpreting its federal counterpart, 15 U.S.C. Section 77d(2);[201] or (2) safe harbor provisions of Arizona Administrative Code section 14-4-126(F).[202] If the security qualifies for a private offering exemption, so too does the issuer. If, however, the issuer “is engaged principally and primarily in the business of making a series of private offerings . . . [which] means in excess of four private offerings within, from, or outside Arizona in any consecutive 12-month period,” the issuer cannot use the private offering exemption and must register as a dealer or salesperson or qualify for a different exemption.[203]

i. Case Law.

Although an Arizona court has yet to interpret the private offering exemption under A.R.S. Section 44-1844(A)(1),[204] federal courts have adopted a four-part test to analyze the availability of the corresponding federal private offering exemption.[205] The test focuses on the qualitative nature of the following factors: (1) the number of offerees; (2) the sophistication of the offerees; (3) the size and manner of the offering; and (4) the relationship of the offerees to the issuer.[206] These factors help to determine whether the sort of accurate, material information about the issuer that the public registration statement typically reveals is available[207] to and understood by each offeree.[208] If so, the offeree does not need the protection of securities laws and therefore the issuer and its offering are exempt from any registration requirements.

With regard to the first factor, there is no rigid limit on the number of offerees to whom an issuer can make an offering, but the fewer the offerees, the greater the likelihood that a court will consider the offering to be private rather than public.[209] A court is also more likely to consider an offering to be private if it involves more knowledgeable, sophisticated offerees―the people who are not in need of the protections afforded by the registration provisions of the Arizona Securities Act.[210] Regarding the third factor, a smaller offering made directly to the offerees rather than through the facilities of public distribution, is more likely to be considered a private offering.[211] Finally, if the offeror-offeree relationship[212] is such that the offeree is privy to the disclosure of or access to the type of information typically provided through the registration process,[213] a court is more likely to consider the offering to be private.[214] If, however, this requisite offeror-offeree relationship does not exist, then the offeror must disclose, at a minimum, the use of investor funds, the benefits to be derived by the issuer such as direct and indirect commissions, and accurate financial statements.[215] Accordingly, offerings most likely to qualify for the private offering exemption are those that are small and made directly to a small number of sophisticated offerees who have a pre-existing relationship with the offeror.

The private offering exemption is self-executing, and therefore an issuer does need to file any paperwork or submit a filing fee with the Securities Division to utilize the exemption.[216]

ii. Commission Rule.

Instead of relying upon case law, issuers may rely upon the safe harbor provisions of Arizona Administrative Code Section 14-4-126(F) to qualify for the private offering exemption. Offers to sell or sales of securities that are a part of an offering that complies with all of the conditions listed in 14-4-126(B)-(D) and (F) are automatically considered private offerings within the meaning of A.R.S. Section 44-1844(A)(1), and are therefore exempt from registration.[217]

In order to be deemed a private offering, Arizona Administrative Code Section 14-4-126(F) requires compliance with the following conditions: (1) there are no more than, or the issuer reasonably believes that there are no more than, 35 purchasers;[218] (2) each purchaser who is non-accredited, either alone or with the purchaser’s representative(s), has such knowledge and experience in financial and business matters that the purchaser is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sales that the purchaser has such knowledge and experience;[219] (3) the issuer discloses specific information to the non-accredited investors;[220] (4) the issuer files a notice of sales form (Form D) with the Commission, containing a manual or facsimile signature of a person duly authorized by the issuer, no later than 15 days after the first sale of securities within or from Arizona and no later than 30 days after the termination of the offering;[221] and (5) the issuer pays the Commission the initial $250.00 filing fee and final $100.00 filing fee, if applicable, as specified in A.R.S. Section 44-1861(E).[222]

The safe harbor exemption is not available to issuers who are part of a plan or scheme to evade the registration provisions of the Arizona Securities Act,[223] who offer or sell the securities through any form of general solicitation or general advertising,[224] who fail to take reasonable care to assure that the purchasers are not underwriters who intend to resell the securities,[225] or who have been enjoined by a court or ordered by administrative agency to cease-and-desist for failing to comply with the exemption’s filing requirements.[226] The Commission, however, has the discretion to waive the latter disqualification,[227] or such a disqualification may cease to exist if the jurisdiction removes it, waives it in writing, or declines to enforce it in writing.[228]

Under A.R.S. Section 44-1845(A), the Commission may also create securities or transactions exemptions as follows:

“The [C]ommission may by its rules, and subject to the terms and conditions prescribed in those rules, add any class of securities or transactions to the securities or transactions exempted as provided by [A.R.S. Sections] 44-1843, 44-1843.01 and 44-1844, if it finds that registration of such securities under this chapter is not necessary in the public interest and for the protection of investors by reason of the special characteristics of the securities or transactions, the small amount involved or the limited character of the offering.”

More specifically, if the Commission finds that registration is not necessary for the public interest and for the protection of investors, A.R.S. Section 44-1845(B) allows it to exempt or provide special registration for two types of securities and transactions. The first are transactions, including resales, that involve securities offered and sold in reliance on Rule 504 of Regulation D (17 Code of Federal Regulations Section 230.504) or any other exemption under sections 3(b) or 3(a)(11) of the Securities Act of 1933, or involve a small business issuer under the Securities Act of 1933 to accredited investors or other investors meeting lesser net worth of suitability requirements[229] as set forth by the Commission.[230] The second are any solicitations of interest in securities that may be offered and sold under the Arizona Securities Act.[231] Pursuant to this statutory authority, the Commission has established various rules exempting certain securities and transactions from registration, the most common of which are discussed in detail below.[232]

i. Rule 101 Existing Stockholders and Employees Exemption.

Arizona Administrative Code section 14-4-101 (“Rule 101”) provides that an offering of securities within or from Arizona that is exclusively to bona fide employees or existing security holders of the issuer, a subsidiary of the issuer, or its parent if the issuer is a subsidiary, is an exempt securities transaction under A.R.S. Section 44-1844.[233] However, this exemption for existing stockholders and employees does not apply to an offering made in connection with or integrated with an offering otherwise subject to A.R.S. Sections 44-1841 and 44-1842, and it is not available to any issuer for any transaction that, although in technical compliance with Rule 101, is part of a plan or scheme to evade the registration provisions of the Arizona Securities Act.[234]

An issuer relying on Rule 101 must comply with all of the following conditions to qualify for the exemption: (1) the aggregate amount of all offerings made by the issuer under Rule 101 within or from Arizona does not exceed $500,000;[235] (2) the issuer does not pay a commission or remuneration of any kind, other than transfer agent’s fees, directly or indirectly, to any person in connection with the distribution or sale of such securities; (3) at least 10 business days before the offering is made, the issuer must file a verified statement[236] of the details and purposes of the offering and the issuer’s financial condition[237] with the Commission;[238] (4) the issuer must obtain the Commission’s approval of any subscription contract calling for deferred payments; and (5) if the issuer is not domiciled in Arizona or incorporated under the laws of Arizona, the issuer must file a consent to service (Uniform Form U-2) with the verified statement.[239] In addition to filing two originally executed copies of the verified statement―the Notice of Intention to Sell Securities―the issuer must file a copy of any subscription form or written material describing, or to be used in connection with, the offering, and a $100 filing fee with the Commission.[240]

The Commission may deny or revoke this exemption to any issuer for the reasons listed in A.R.S. Sections 44-1921(1)-(6), although it must notify the issuer of such denial or revocation by certified mail.[241] Otherwise, the exemption is effective for one year from the date the Director of the Securities Division acknowledges the Notice of Intention to Sell Securities.[242]

ii. Rule 102 Restricted Public Offering Exemption.

Arizona Administrative Code section 14-4-102 (“Rule 102”) provides that an offering of securities within or from Arizona made to a maximum of 10 people is an exempt securities transaction under A.R.S. Section 44-1844.[243] However, the Rule 102 transaction exemption does not apply to an offering made in connection or integrated with an offering otherwise subject to A.R.S. Sections 44-1841 and 44-1842, and it is not available to any issuer for any transaction that, although in technical compliance with Rule 102, is part of a plan or scheme to evade the registration provisions of the Arizona Securities Act.[244]

An issuer relying on Rule 102 must comply with all of the following conditions to qualify for the exemption: (1) the aggregate amount of all offerings made by the issuer under Rule 102 within or from Arizona does not exceed $100,000; (2) the issuer does not pay a commission or remuneration of any kind, other than transfer agent’s fees, directly or indirectly, to any person in connection with the distribution or sale of such securities; (3) at least 10 business days before the offering is made, the issuer must file a verified statement[245] of the details and purposes of the offering and the issuer’s financial condition[246] with the Commission;[247] (4) the issuer must obtain the Commission’s approval of any subscription contract calling for deferred payments; (5) if the issuer is not domiciled in Arizona or incorporated under the laws of Arizona, the issuer must file a consent to service (Uniform Form U-2) with the verified statement; and (6) the issuer and any person acting on its behalf must reasonably believe prior to making any sale that the investment is suitable for the purchaser, meaning it does not exceed 20% of the investor’s net worth (excluding principal residence, furnishings therein, and personal automobiles).[248] In addition to filing two originally executed copies of the verified statement― the Notice of Intention to Sell Securities―the issuer must also file a copy of any subscription form or written material describing, or to be used in connection with, the offering, and a $100 filing fee with the Commission.[249]

The Commission may deny or revoke this exemption to any issuer for the reasons listed in A.R.S. Sections 44-1921(1)-(6), although it must notify the issuer of such denial or revocation by certified mail.[250] Otherwise, the exemption is effective for one year from the date the Director of the Securities Division acknowledges the Notice of Intention to Sell Securities.[251]

iii. Rule 126 Limited Offering Exemption.

Arizona’s counterpart to federal Regulation D is Arizona Administrative Code section 14-4-126 (“Rule 126”). Subsections (A)-(D) lay out the terms, general conditions, and filing requirements for Rule 126. Rule 126(E) provides that offers and sales of securities by an issuer that is not an investment company under the Investment Company Act of 1940 are securities transaction exempt from registration under A.R.S. Section 44-1844,[252] so long as the following conditions are satisfied: (1) the offers and sales satisfy the terms and conditions of subsections (B)-(D);[253] (2) the aggregate offering price[254] does not exceed $5 million;[255] and (3) there are no more than, or the issuer reasonably believes that there are no more than, 35 purchasers of securities from the issuer in any offering under section 14-4-126(E).[256] Accredited investors,[257] however, among certain other purchasers, are excluded from the calculation of the number of purchasers.[258] Pursuant to section 14-4-126(C)(1), other offers and sales made by the issuer may be integrated into the offering and can cause the offering to exceed the aggregate offering price limitations or the number of non-accredited investors, or lead to noncompliance with disclosure requirements. Accordingly, the issuer’s other offers and sales should be carefully examined to make sure that they do not negatively affect the exemption for the current offering.

The limited offerings exemption under Rule 126(E) is subject to various restrictions. First, neither the issuer nor anyone acting on the issuer’s behalf may offer or sell the securities through any form of general solicitation or general advertising.[259] Second, the exemption only covers original offers and sales made by an issuer; it does not cover subsequent sales of the securities, which must be either registered or exempt from registration.[260] Accordingly, the issuer must exercise reasonable care to ensure that the purchasers of the securities are not underwriters.[261] Third, the issuer must provide the following information to all non-accredited investors: (1) a brief description in writing of any material written information concerning the offering that has been provided by the issuer to accredited investors but not previously delivered to non-accredited investors;[262] (2) the opportunity to ask questions and receive answers concerning the terms and conditions of the offering and to obtain any additional information which the issuer possesses or can acquire without unreasonable effort or expense that is necessary to verify the accuracy of such information;[263] and (3) notice that the securities cannot be resold by the purchaser unless they are registered under the Arizona Securities Act or are exempt from such registration.[264] In addition, depending on the federal filing status of the issuer, certain other information must be provided to non-accredited investors.[265] However, the issuer never has to furnish such specified information to any of its accredited investors.[266]

If an issuer qualifies for the Rule 126 limited offering exemption, the issuer must file with the Commission a notice of sales (Form D) no later than 15 days after the first sale of securities within Arizona and no later than 30 days after the termination of the offering,[267] together with an initial $250 filing fee and, if applicable, a final $100.00 filing fee.[268] Unless the Commission rules provide otherwise, the exemption becomes effective upon receipt of the notice in the Phoenix office or as of the date the notice is posted by U.S. registered or certified mail if it is delivered after the date on which it must be filed.[269]

The Rule 126 limited offering exemption is not available to an issuer, or any of its predecessors, affiliates, directors, officers, general partners, or beneficial owners of 10% or more of any class of its equity securities, or the underwriter of the securities, who have been disqualified under the “bad boy” provisions.[270] In addition, the limited offering exemption is not available to an issuer, or any of its predecessors or affiliates, that has been subject to any order, judgment, or decree of any court of competent jurisdiction temporarily, preliminarily, or permanently enjoining such person, or any final order of an administrative agency directing such person to cease-and-desist, for failing to satisfy the exemption’s filing requirements or its counterpart, if any, in such jurisdiction.[271] The Commission has the discretion to waive such a disqualification,[272] or the disqualification may cease to exist if the jurisdiction removes it, waives it in writing, or declines to enforce it in writing.[273]

iv. Rule 139 Qualified Purchaser Public Offering Exemption.

The purpose of the qualified purchaser public offering exemption under Arizona Administrative Code section 14-4-139 (“Rule 139”) is to allow small businesses to raise capital in an efficient and affordable manner.[274] Under Rule 139, offers and sales of up to $5 million of securities during any 12-month period made by an issuer in compliance with the conditions set forth in the rule are exempt from the registration requirements of A.R.S. Sections 44-1841 and 44-1842.[275] The issuer’s employees, officers, and directors who were not retained for the primary purpose of making offers or sales of securities may also sell the issuer’s securities in a Rule 139 offering without registering as a salesperson.[276] This exemption from A.R.S. Section 44-1842 is not available for third parties or dealers, however.[277] In addition, the Rule 139 exemption is not available to a blind pool offering,[278] an issuer whose business plan is to engage in a merger or acquisition with an unidentified entity or person, an issuer who has been disqualified under the “bad boy” provisions,[279] or any transaction that, while in technical compliance with Rule 139, is part of a plan or scheme to circumvent the registration provisions of the Securities Act.[280]

An issuer must satisfy the following conditions to qualify for the Rule 139 exemption: (1) the offers and sales of securities are made only to qualified purchasers[281] or to persons the issuer reasonably believes, after inquiry, to be qualified purchasers;[282] (2) the issuer reasonably believes, after inquiry, that each purchaser is purchasing the security for the purchaser’s own account and not with the view to, or for sale in connection with, a distribution of the security;[283] (3) the consideration received for securities sold in the same offering, whether pursuant to Rule 139 or another exemption, does not exceed $5 million in any 12-month period;[284] (4) no later than 10 business days prior to the publication of a general announcement[285] of the proposed offering or the initial offer[286] of the securities, whichever occurs first, the issuer must file with the Commission a notice[287] briefly describing the business of the issuer and the terms of the transaction, a consent to service of process, a copy of the general announcement, and a $100 filing fee;[288] and (5) at least five business days before a sale of securities to, or a commitment to purchase securities is accepted from, a qualified purchaser, the issuer must meet the disclosure requirements of 14-4-126(C)(2).[289] If a security is acquired in a Rule 139 transaction, it has the same status as securities acquired in an exempt transaction under A.R.S. Section 44-1844, and cannot be resold without registration under the Arizona Securities Act or an exemption therefrom.[290]

v. Rule 140 Accredited Investor Exemption.

Arizona Administrative Code section 14-4-140 (“Rule 140”) is also designed to allow small businesses to raise capital in an efficient and affordable manner.[291] “Rule 140 significantly benefits issuers by allowing them to seek capital from accredited investors without registration of the transaction and in a significantly more cost-effective manner than that of an offering of securities registered under federal securities laws or the Arizona Securities Act.”[292] Further, there is a limited risk of substantial harm to the general investing public as initial offers and sales of these securities are restricted to accredited investors.[293]

Offers and sales of securities by an issuer in compliance with Rule 504 of Regulation D (17 CFR Section 230.504) and Rule 140 are exempt from the registration requirements of A.R.S. Sections 44-1841 and 44-1842.[294] The issuer’s employees, officers, and directors who were not retained for the primary purpose of making offers or sales of securities may also sell the issuer’s securities in a Rule 140 offering without registering as a salesperson.[295] This exemption from A.R.S. Section 44-1842 is not available for third parties or dealers, however.[296] In addition, the Rule 140 exemption is not available to a blind pool offering,[297] an issuer whose business plan is to engage in a merger or acquisition with an unidentified entity or person, or an issuer who has been disqualified under the “bad boy” provisions[298] of subsection (M).[299]

In addition to the Rule 504 requirements,[300] an issuer must satisfy the following conditions to qualify for the Rule 140 exemption: (1) the offers of securities must specify that sales are to be made only to accredited investors,[301] and the sales of securities must be made exclusively to accredited investors;[302] (2) the issuer shall reasonably believe, after inquiry, that each purchaser is buying the security for the purchaser’s own account and not with the view to distribute, or for sale in connection with a distribution of, the security;[303] and (3) the issuer must file a copy of Form D of Regulation D (17 CFR Section 239.500) within 15 calendar days after the first sale within or from Arizona, a consent to service of process, a copy of the general announcement of the offering,[304] and a $100 filing fee.[305] “Since initial sales of securities can only be made to accredited investors, no specific information is required to be furnished by the issuer to investors, [a] legend[306] is required on any offering document or subscription documents.”[307]

vi. Rule 141 Solicitation of Interest Exemption.

Under Arizona Administrative Code section 14-4-141 (“Rule 141”), an issuer, or a registered dealer on behalf of the issuer, may solicit interest in an offering prior to filing a registration statement.[308] To use this exemption from A.R.S. Section 44-1842, the issuer must be, or will be, a business entity organized under the laws of a state of the United States or Mexico or province or territory of Canada, and cannot be conducting or intending to conduct a blind pool offering as defined in A.R.S. Section 44-1801.[309] Further, the issuer and its affiliates cannot be in violation of any of the “bad boy” provisions contained in Rule 141(D). The Commission has the discretion to waive such a disqualification,[310] or the disqualification may cease to exist if the jurisdiction removes it, waives it in writing, or declines to enforce it in writing.[311]

Ten business days prior to the initial solicitation of interest, the issuer must file a Solicitation of Interest Form[312] with the Commission, any other items to be used, directly or indirectly, to conduct solicitations of interest, such as scripts for broadcast, published notices and advertisements,[313] and a nonrefundable $100 filing fee.[314] Then, five business days prior to usage, the issuer must file any material amendments to the foregoing items or additional items to be used to conduct solicitations of interest with the Commission, except for items provided to a particular offeree pursuant to a request by that offeree.[315] The issuer cannot use any Solicitation of Interest Form, script, advertisement or other item to solicit indications of interest which the Securities Division has specifically notified the issuer not to distribute.[316]

During the solicitation period, the issuer, or the dealer on behalf of the issuer, may communicate with any offeree about the contemplated offering so long as the issuer supplies the offeree with the most current Solicitation of Interest Form within five business days from the communication.[317] The issuer or dealer cannot, however, solicit or accept money or a commitment to purchase securities.[318] In addition, the issuer must intend to register the security in Arizona prior to its sale, or the securities must be sold under a valid exemption in Arizona.[319] If a registration statement is filed in Arizona, the issuer must cease all communications with prospective investors made in reliance on this exemption.[320] Finally, an issuer cannot make a private offering in reliance on an exemption from registration under A.R.S. Section 44-1844(A)(1) (private offering exemption) or A.A.C. 14-4-126 (limited offering exemption) until six months after the last communication with a prospective investor made pursuant to Rule 141.[321]

In sum, an issuer must properly register a security under the Securities Act of 1933 and the Arizona Securities Act, or qualify and obtain an exemption from the registration provisions therein, before offering and selling the security to investors.