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Preemption Of Secondary Trading Is Fast Becoming More Obscure

Secondary trading of securities in California must be qualified unless exempt or not subject to qualification due to federal preemption.  Cal. Corp. Code § 25130.  Similarly, the offer and sale of securities are subject to registration under the Securities Act of 1933 unless exempt.  Sections 4(a)(1) and 4(a)(3) of the Securities Act are the exemptions that allow most secondary trading to occur without federal registration.  Further, Section 18(b)(4)(A) preempts state registration requirements for transactions exempt under either Section 4(a)(1) or 4(a)(3) provided the issuer “the issuer of such security files reports with the [Securities and Exchange] Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934”.

The recently enacted Fixing America’s Surface Transportation Act (aka the FAST Act) cleaned up a drafting error in Section 18(b)(4) created by the JOBS Act – there had previously been two subparagraph Ds.  Unfortunately, Congress failed to notice that Section 18(b)(4)(A) continues to refer to paragraphs (1) and (3) of Section 4 of the Securities Act of 1933 even though the JOBS Act had previously redesignated those paragraphs as subparagraphs (a)(1) and (a)(3).  Thus, anyone looking for Section 4(1) or 4(3) of the Securities Act might be a bit flummoxed.

The California Corporate Securities Law of 1968 is even more muddled.  Corporations Code Section 25101.1 is intended to reflect the preemption effected by Section 18(b)(4)(A).  However, it also continues to refer to Sections 4(1) and 4(3) of the Securities Act and confounds the mystery by adding a parenthetical “15 U.S.C. 77r”, which is the codification of Section 18, not Section 4, of the Securities Act.  Section 25101.1 generally tracks the language in Section 18(b)(4)(A), but adds the word “required” so that the statute reads in relevant part: “files the required reports with the Securities and Exchange Commission”.

The State of California, of course, can’t add additional conditions to federal preemption.  However, the addition of the word “required” highlights an interpretative question.  If an issuer is a voluntary filer, will it have the benefit of federal preemption?  Another question is whether preemption is extended to secondary trading after an issuer’s registration statement has been declared effective under the Securities Act but before any filings have been made under the Exchange Act.

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