Legal Definitions - Section 4(1 ½)

Section 4(1 ½), sometimes referred to as Section 4(a)(1 ½), is a practical approach in U.S. securities law that allows for the resale of certain privately placed (or "restricted") securities without requiring them to be registered with the Securities and Exchange Commission (SEC).

When a company sells securities in a private placement, typically to a limited number of sophisticated investors, these securities are "restricted." This means they cannot be freely traded on public stock exchanges like shares that have been registered with the SEC. Section 4(1 ½) provides a pathway for an investor who holds these restricted securities to sell them to another private investor, bypassing the lengthy and costly public registration process.

This method isn't a formally numbered section in the Securities Act of 1933 itself but rather a judicial and regulatory interpretation that combines principles from two existing exemptions:

• Section 4(a)(2): This exemption allows a company (the "issuer") to sell securities in a non-public offering (a private placement) without registering them. The securities sold this way are restricted.
• Section 4(a)(1): This exemption allows a person who is not an issuer, underwriter, or dealer to sell securities without registration.

The "trick" of Section 4(1 ½) is that an investor holding restricted securities can use the Section 4(a)(1) exemption for their resale, provided they do not act as an "underwriter." An underwriter is generally someone who buys securities with the intent to distribute them to the public. By ensuring the resale itself is also a private transaction (similar to the initial private placement), the selling investor is not considered to be "distributing" the securities to the public. Therefore, they are not an underwriter, and their private resale can proceed without SEC registration. This concept was later formalized by Congress in Section 4(a)(7) of the Securities Act.

Here are some examples of how Section 4(1 ½) might apply:

• Startup Investor Selling Shares: Imagine Apex Innovations Inc., a promising tech startup, raises capital by selling shares directly to a venture capital firm, Growth Capital Partners, in a private placement. These shares are restricted. Two years later, Growth Capital Partners decides to rebalance its portfolio and wants to sell a portion of its Apex Innovations shares to another private equity fund, Strategic Investments LLC, before Apex goes public. Since Growth Capital Partners is not the original company (issuer) and is selling the shares in a private transaction to a sophisticated buyer (not distributing them to the general public), they can rely on Section 4(1 ½) to resell these restricted shares without having to register them with the SEC.

• Private Equity Fund Divesting a Stake:Horizon Holdings, a private equity fund, acquired a significant ownership stake in a manufacturing company, Industrial Solutions Co., through a private transaction. After several years of successful operation, Horizon Holdings identifies another institutional investor, Global Asset Managers, that is interested in purchasing a minority stake in Industrial Solutions Co. from Horizon Holdings. Because Horizon Holdings is not the issuer and is conducting a private sale to a sophisticated buyer, this resale can be structured under Section 4(1 ½), allowing Horizon Holdings to divest part of its investment without the need for a public offering registration.

• High-Net-Worth Individual Seeking Liquidity: Dr. Evelyn Reed, a high-net-worth individual, invested directly in a private biotechnology firm, BioGenius Labs, during an early funding round. Her shares are restricted. Years later, Dr. Reed needs to free up capital for a new personal venture and finds another accredited investor, Mr. David Chen, who is interested in purchasing her shares in BioGenius Labs. Since Dr. Reed is not the original company (issuer) and is selling her shares privately to Mr. Chen (not making a public offering), she can utilize Section 4(1 ½) to facilitate the sale of her restricted shares without the burden of SEC registration.