An exemption from registration as a broker dealer under Section 15(a) of the Securities Exchange Act of 1934 is available for persons associated with an issuer and involved in the sale of the issuer’s securities.
Under Section 3(a)(4)(A) of the Exchange Act, a 'broker' is defined to mean “any person engaged in the business of effecting transactions in securities for others.”
The ‘Issuer Exemption,’ as it’s commonly known, typically applies to individual employees or agents of the issuer. The rule has customarily been interpreted to not require the issuer itself to register as a broker because the issuer is not effecting transactions for the account of others, however persons acting on behalf of the issuer engaged in distributing its securities, including the issuer’s own directors, officers or employees, may be deemed 'brokers' under Section 3(a) of the Act.
The SEC recognizes that it would not be practical for all officers and employees of an issuer to refrain entirely from all involvement in the offering or sale of the issuer’s private offering and that it may be useful for certain officers to speak to prospective investors about the business strategy or financial condition of the company.
Nevertheless, an officer or employee’s status as a paid agent of the issuer necessarily brings into question their involvement in the sale of securities by the company. For a long time, the application of any relief from registration for officers and employees of the issuer had been addressed through no-action letters by the SEC staff. Then, in 1985, the Commission promulgated Rule 3a4-1 as “an appropriate and efficient way to provide guidance in this area.”
Safe Harbor Rule
Rule 3a4-1 is a “non-exclusive safe-harbor” under which an “associated person” of an issuer that performs limited securities sales for the issuer would not be deemed to be a 'broker' under Section 3(a)(4) of the Exchange Act, and thus not be required to register. In order for the safe harbor to apply though, each of three preliminary requirements and one of three alternative conditions must be satisfied.
The Three Preliminary Requirements
The three preliminary requirements that a person associated with the issuer must meet are that they not:
- Be subject to a statutory disqualification, as defined in Section 3(a)(39) of the Exchange Act, at the time of their participation in the sale of the issuer’s securities.
- Be associated with a broker or dealer at the time of the sale.
- Be compensated in connection with the sale of the issuer’s securities by the payment of commissions or other remuneration based either directly or indirectly on transactions or sales of securities.
- In determining whether payment of salary or a bonus satisfies this standard, all of the facts and circumstances of the compensation arrangement must be considered. The ‘Adopting Release’ cites the following relevant factors in determining whether the payment of a bonus would be permissible under the rule:
- When the offering commences and concludes
- When the employee’s bonus is paid
- When it is determined that the employee’s bonus will be paid
- When associated persons are informed of the issuer’s intention to pay a bonus
- Whether the bonus paid to an associated person varies with their success in selling the issuer’s securities
It has been pointed out that even an increase in an employee’s base salary beyond its normal amount to compensate for the additional burdens of selling securities may be sufficient for the SEC to conclude that the compensation is indirectly related to transactions in securities.
Three Alternative Conditions (of which one is required)
In addition to satisfying each of the above preliminary requirements, one of the following conditions must also be satisfied in order for the safe harbor to apply:
- Sales restricted to certain classes of purchasers or certain transactions. This applies where sales of the issuer’s securities are made to a registered broker or dealer, a registered investment company, an insurance company, or a bank or similar institution.
- Sales duties are limited in frequency and proportion. Under this exception three conditions must be satisfied:
- The associated person primarily performs substantial duties other than those in connection with transactions in securities.
- The associated person was not a broker or dealer within the preceding 12 months.
- The associated person does not participate in selling an offering of securities for any issuer more than once every 12 months
- Sales duties are passive. This exception applies where the person restricts their activities to one or more of several specified types of selling activities, each of which is ‘passive’ or restricted in nature:
- Preparing any written communication or delivering such communication through the mail or other means that does not involve oral solicitation by the associated person of a potential purchaser provided that the content of such communication is approved by a partner, officer or director of the issuer.
- Responds to inquiries of a potential purchaser in a communication initiated by the potential purchaser provided that the content of such response is limited to information contained in an offering document.
- Performs ministerial and clerical work involved in effecting a transaction.
An issuer that permits its unregistered directors, officers, employees or other associated persons to participate in the offer or sale of its securities outside the safe harbor afforded by Rule 3a4-1 runs the risk the offering may be subject to rescission by investors whose purchases were induced by such persons.