Section 4(a)(1) Exemption

Section 4(a)(1) Exemption- Just like for an issuer, when a shareholder sells or transfers shares that sale or transfer must either be registered or exempt from registration. The most common exemption relied upon is Section 4(a)(1) and the Rule 144 safe harbor under Section 4(a)(1). Section 4(a)(1) provides an exemption for a transaction “by a person other than an issuer, underwriter, or dealer.” Rule 144 provides a non-exclusive safe harbor for the sale of securities under Section 4(a)(1). In the event that Rule 144 is unavailable, a holder of securities may still rely upon Section 4(a)(1). Section 4(a)(2) of the Securities Act provides an exemption for sales by the issuer not involving a public offering.

The issuer itself may not rely on Section 4(a)(1), and selling security holders may not rely on Section 4(a)(2).

Case law and the SEC unilaterally conclude that an affiliate which is an officer, director or greater than 10% shareholder may not rely on Section 4(a)(1) for the resale of securities that results in the purchaser receiving freely tradeable shares. In particular, an affiliate is presumptively deemed an underwriter unless that affiliate meets the requirements for use of Rule 144.

The Rule 144 requirements cannot always be satisfied by an affiliate, such as when such affiliate desires to sell securities in a private transaction without the use of a broker-dealer. The court system, recognizing this gap in the statutory regime, developed the Section 4(a)(1½) exemption. When an affiliate sells a control block of a public company, they are in essence relying on Section 4(a)(1½) as no other exemption would technically be available.
Separately, in 2008, the SEC amended Rule 144 to make its use unavailable for the sale of securities initially issued by a shell company or any issuer that has, at any time, previously been a shell company unless all the requirements of Rule 144(i) are met. These requirements include that the issuer no longer be a shell company, is subject to the reporting requirements of the
Securities Exchange Act for 12 months following the time that it filed Form 10 information indicating it was no longer a shell company, and is current with all Exchange Act reporting requirements.

In an effort to gain liquidity in securities of companies that do not meet the Rule 144(i) requirements due to current or former shell status, selling security holders have begun to rely directly on Section 4(a)(1), disregarding the Rule 144 safe harbor. However, as noted, Section 4(a)(1) is not available for use by affiliates, who instead rely on the Section 4(a)(1½) exemption. The same series of cases define both exemptions.

In the next Lawcast in this series I will discuss the requirements for use of the Section 4(a)(1) and 4(a)(1½) exemptions.

Laura Anthony, Esq.
Founding Partner
Legal & Compliance LLC.
330 Clematis Street, Ste. 217
West Palm Beach, FL 33401

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