As an investor who wants to optimize your portfolio, there are certain things you must have good knowledge of, one of which is about unregistered securities and stocks.
This article discusses everything you need to know about unregistered securities and stocks.
Whether you’re just starting investing or are an established accredited investor, you should proceed with caution while dealing with unregistered securities.
Although many unregistered securities offerings are legitimate, perpetrators frequently hide behind these transactions to conduct various investment scams and securities frauds.
To avoid falling victim to these types of scams, you should understand what constitutes unregistered securities, the exemptions that define legitimate unregistered offerings, and how to recognize the red flags of potential fraud or fraudulent unregistered securities.
Before delving further into the subject, let us get a clear picture of what securities are.
What are Securities?
The Securities Act of 1933 defines securities as follows:
“any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights”
This means that firms that sell securities to residents must register and follow SEC and state-level regulations unless an exception exists.
The nature of the consideration obtained in exchange for securities has no bearing on securities legislation.
In other words, accepting Bitcoin instead of dollars in return for stock in a fledgling company does not waive the registration requirement.
While registration may be an undesirable bother and expense, neglecting to register puts the firm and its managers at risk of significant fines, including imprisonment.
Having fully grasped what securities are, let us delve into the world of unregistered securities and get everything you need to know about it.
What are Unregistered Securities?
Unregistered or restricted securities are shares not registered with the Securities and Exchange Commission (SEC).
They are usually given out through private placements, Regulation D offerings, or employee stock benefit plans to pay for professional services or help fund a new business.
For instance, a privately held company might give its executives and board members unregistered shares as part of their pay.
Understanding Unregistered Securities
Unregistered shares provide less investor protection and entail different risks than registered securities. As a result, corporations may only sell unregistered shares to “qualified investors.”
To be regarded as a “qualified investor,” you must be a high-net-worth individual (HNWI) or high-income investor.
Who qualifies as an HNWI varies by financial institution, but you usually must have liquid assets of six to seven figures. A high-income investor typically earns at least $200,000 per year or at least $300,000 per year if married.
Previously, soliciting or advertising unregistered securities was forbidden. However, as part of the Jumpstart Our Business Startups (JOBS) Act of 2013, the SEC enacted Rule 506(c), which allows for the solicitation and advertising of certain unregistered securities.1
Selling unregistered securities is typically a felony, but there are certain exceptions to this regulation. SEC Rule 144 specifies the conditions under which unregistered securities can be sold, and they include;
- They must be kept for a specified time.
- There must be enough public disclosure of the security’s historical performance.
- The sale must be for less than 1% of the outstanding shares and less than 1% of the average trading volume over the previous four weeks.
- All usual trading conditions for each trade must be met.
- Sales of more than 5,000 shares or $50,000 in value must be preregistered with the Securities and Exchange Commission. If the seller is not involved with the company that issued the unregistered securities (and has not been for at least three months) and has owned the shares for more than a year, this criterion does not apply.
Moving forward, let us walk through why it is vital to register securities in the stock market.
Importance of Registering Securities
Some of the importance of registering securities include;
- Compiance with ega reguations
- Increased investor base
- Enhanced Credibility and reputation
- Regulatory protections for investors
Compliance with Legal Regulations
Registering securities is a legal requirement enforced by regulatory agencies such as the Securities and Exchange Commission (SEC) in the United States.
By registering securities, issuers meet disclosure obligations and provide potential investors with important information about the company’s financial health, operations, risks, and prospects.
This transparency builds trust and confidence in the market, safeguarding investors from fraudulent schemes and maintaining a level playing field for all participants.
Increased Investor Base
Registering securities allows you to reach a broader pool of possible investors. Unregistered securities frequently suffer restrictions, which reduce their marketability and accessibility.
Registered securities, on the other hand, can be freely exchanged on regulated exchanges, allowing a larger pool of investors to participate.
This additional liquidity improves market efficiency, which could lead to better pricing and returns for investors.
Enhanced Credibility and reputation
Registering securities implies a desire for transparency and responsibility. It communicates to potential investors that the company will subject itself to regulatory scrutiny and follow industry standards.
This commitment may increase the company’s Credibility and image, attracting additional investors and potentially lowering the cost of capital.
Additionally, registered securities may be eligible for inclusion in various indices, attracting institutional investors and strengthening the company’s market position.
Regulatory Protections for Investors
Registering securities affords investors certain legal protections. For example, registered securities are subject to antifraud rules that prohibit deceptive claims and fraudulent conduct related to the sale of securities.
In the event of a violation, investors have the right to take legal action and seek redress. These safeguards give investors a sense of security and recourse, reducing the dangers of investing in unregistered securities.
Before we call it a day here, we will also take you through some red fags or pointers that you should look out for to avoid falling into the scams of these seers of unregistered securities.
Potential Red Fags of Unregistered Securities
Along with carefully researching an investment and the investment professional selling it, if you are presented with an opportunity to invest in an unregistered offering, you should be on the lookout for these typical indicators of possible fraud.
- Claims of Little or No Risk with High Returns
- Unregistered Advisors for Investments
- Aggressive Sales Strategies
- Sales Document Problems
- No Income or Net Worth Requirements
- Sham or Virtual Workplaces
- Unsolicited Investment Offers
- Uncertain or Dubious Biographies of Managers or Promoters
Claims of Little or No Risk with High Returns
Classic warning indicators of fraud include promises of great returns with little or no risk. Every investment involves some risk, so the possibility of more significant rewards comes with more risk.
Any investment declared to have no risk should make you dubious.
Unregistered Advisors for Investments
Many securities frauds aimed at ordinary investors are carried out by unregistered individuals selling securities.
Even if you know the individual proposing to sell you personally, always find out if they are registered and appropriately licensed.
The Investment Adviser Public Disclosure website and FINRA’s BrokerCheck allow one to view an investment professional’s registration, background, and credentials.
Aggressive sales strategies
They often pitch an investment as a “once-in-a-lifetime” offer to generate a false sense of urgency scam artists.
Before making any decisions or sending money, fight the urge to invest fast and give yourself the time to research properly.
Any respectable investment adviser or promoter will not urge for a quick conclusion; they will allow investors to take their time to undertake research.
Sales Document Problems
Avoid an investment if the salesman will not send you anything in writing. Usually, a valid private offering will be explained in a private placement memorandum or PPM.
Likewise, messy offering documentation with spelling, grammar, or other mistakes could raise questions about whether the investment is a fraud.
No Income or Net Worth Requirements
Federal securities rules limit many private securities issuances to accredited investors.
Anyone who presents you with private investment prospects without first asking about your net worth or income should be very dubious.
Just to clarify, one is said to be an accredited investor if they:
- In each of the past two years, earned income above $200,000 (or $300,000 combined with a spouse) and reasonably expects the same for the current year or
- Either alone or with a spouse, has a net worth of more than $1 million (excluding the value of the person’s primary residence or any loans secured by the residence).
Sham or Virtual Workplaces
In a dishonest effort to qualify for an exemption from registration, a corporation could set a mailing address inside a state in which it has no actual activity.
Be cautious if the company’s corporate address is a mail drop, and you cannot confirm that the company has any genuine functioning presence (like a headquarters building, plant, or other physical operations) inside the same state.
Unsolicited Investment Offers
You should exercise great caution when you get an unsolicited, meaning you did not request, investment offer.
Whether from a friend, trustworthy coworker, random stranger, or even family member, constantly evaluate the reason the individual investing is proposing.
Sometimes known as affinity fraud, fraudsters take advantage of the trust and friendliness among groups of individuals who share something in common.
You should be dubious if instructed to keep the investment opportunity hidden or confidential.
Uncertain or dubious biographies of managers or promoters
When nothing could be further from the truth, con artists may promote themselves as legitimate by claiming to have had a successful career in the pertinent field.
Take not only the word of the promoter but also their background. Try independently checking any assertions using a basic Internet search or reference request.
Conversely, even if the promoter is honest about their history, take note of this as well should they seem to lack pertinent experience.
Summary
Investors can more successfully negotiate the complexity of unregistered securities by knowing the risks, doing extensive due research, and consulting professionals.
Although the possible benefits could be significant, moving carefully and guaranteeing adherence to relevant laws and rules is imperative.
Recall that knowledge is power in investing; hence, keeping current is essential to make wise investment decisions.
