Are you an Investor who would like to Resell Private Stock without using a Broker under Section 4(a)(1) of the Securities Act?

The basic rule of securities laws is that absent an exemption, securities may not be sold without registration. Since registration is often financially infeasible, holders of stock in start-up companies looking for some cash flow from their valuable but illiquid asset must ensure that any sales fit under an exemption. This is an issue of both federal and state law, as the sale must comply with both.

Under federal law, sales of stock from one investor to another are usually exempt from registration. The relevant statute is Section 4(a)(1) of the Securities Act of 1933, as amended. That section states that sales by anyone other than an issuer or an underwriter are exempt.

Securities lawyers spend a good many hours in their career over the definition of “underwriter” found in Section 2(a)(11) of the Securities Act. This is because an underwriter is not just a Wall Street bank that agrees to buy a company’s stock for its own account if it can’t sell all of it in a registered public offering. The term includes anyone who buys the stock with the intent to offer the stock publicly.

Section 4(a)(1) covers both private and public resales. Rule 144 is a safe harbor that protects against being deemed an underwriter in a public resale by a broker for the account of an investor. That’s a topic for another day; this posting is only about a private resale from one investor to another not involving a broker.

Private resales, on the other hand, are much more like private placements by issuers. Section 4(a)(2) of the Securities Act exempts private placements by the issuer from registration. What is or isn’t a private placement is a subject that securities lawyers discuss regularly with their clients, but making sure that the buyer is not an underwriter plays a big part in this. There are three basic steps the issuers undertake to make sure the sale is truly a private placement. First, the issuer places restrictive legends on the stock certificates (or better yet, issues uncertificated stock). Second, the issuer takes steps to ensure that the buyer has investment intent and that the buyer is contractually bound not to distribute the stock. Third, the stock is subject to a shareholders’ agreement which contains right of first refusal that would allow the issuer to repurchase the stock from the buyer were the buyer to offer to resell the stock.

For investors, the main burden after finding another investor and agreeing on price will be compliance with the shareholders' agreement. In addition, the issuer will often request a legal opinion from counsel of the seller. Securities lawyers like me will review the proposed transaction to ensure that it falls under Section 4(a)(1). The steps here are similar to those in a private placement by the issuer, as the investor too will want to ensure that the buyer cannot be deemed an underwriter. In addition, counsel will look into the relevant state exemption from registration or qualification with the securities regulator in the buyer’s state. In Washington, that’s often the isolated transaction exemption found in RCW 21.20.320(1).  A number of active investors on the West Coast are private equity funds located in California. Under California law, non-issuer transactions need to be qualified by the Commissioner of Corporations under Section 25130 of the California Corporations Code. However, Section 25104(a) exempts most sales by the owner for his own account.

Sometimes the person trying to sell stock is not an investor. Instead, the seller is one of the founders of the company. Here, Section 4(a)(1) does not readily apply because the law treats affiliates of the issuer as if they were the issuer themselves. But that’s a topic for another day.

John A. Myer is a corporate and securities lawyer with Myer Law PLLC in Seattle, Washington.   This posting does not constitute legal advice.