Does Your Company Need to Comply with Securities Laws?

Kenneth Charette      Dec. 2, 2016

Is your company in the process of raising capital?  Do you have someone who wants to invest in your business?  Are considering selling stocks or issuing debt instruments?

One of the things that entrepreneurs often find surprising is the restrictions that both the federal and state governments impose on their ability to raise capital. However, if you answered “Yes” to any of the questions posed above, then it’s likely that your activities will implicate state and/or federal securities laws.  Anytime a company sells (or, in some cases, offers to sell) a “security”, it will generally be subject to securities law compliance.  There are essentially two components to such compliance: 1) registration of securities with the SEC and the applicable state’s securities commission (or compliance with an applicable “exemption” from registration); and 2) a general prohibition on fraud.

The government has broadly defined to the term “securities” to encompass a wide range of business transactions, including, for example, any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest, profit-sharing agreement, investment contract, voting-trust certificate, or any other similar item.  Because of this broad definition, it is likely that most capital raising activities of a small business will implicate securities law.  The SEC has stated that “if a small business is offering and selling securities, even if to just one person, the offer and sale of the securities must either be registered with the SEC or conducted in accordance with one of the many registration exemptions under the Securities Act.”

Generally speaking, “registering” an offering (which is essentially “going public”) with the SEC and the relevant state securities commissions can be a very expensive and time consuming process, and therefore, many small business choose instead to proceed under the various “exemptions” from securities registration.  Most exemptions have detailed requirements that must be satisfied in order for a company to qualify for them. For instance, exemptions usually require notice filings with the SEC and the applicable state securities commissions (although some may be “self-executing”).  In addition, exemptions may involve certain limitations on the manner in which the securities are offered and sold, such as a restriction on general advertising or a requirement that the securities only be sold to accredited investors (i.e., high net worth individuals).

As noted above, in addition to the filing requirements and the restrictions on the manner in which the offering is conducted, companies must also take certain steps to prevent fraud. Accordingly, some exemptions specify particular disclosures that must be made to investors (e.g., financial statements, etc.), while others do not.  However, even if a company sells securities in a manner that is not subject to specific disclosure requirements, the company still must ensure that sufficient information is available to any potential investors to satisfy the general anti-fraud rules.  This means that an issuer should: 1) consider whether the necessary information was made available to investors; and 2) ensure that any information provided to investors is free from false or misleading statements (or from material omissions).

A failure to comply with securities laws can result in civil and criminal penalties.  In addition, a compliance failure may increase the risk that a disgruntled investor will be successful in any ligation against the company.  Furthermore, in addition to fines and lawsuits, violating securities laws could negatively impact the ability of a company to raise capital going forward. Sophisticated investors will perform due diligence on the company, which will commonly include a review of any prior securities offerings.  Any previous compliance issues may be seen as a “red flag” by the potential investor that could cause them to abandon the deal altogether.  Therefore, if you are considering raising capital, it is critically important that you ensure that any such offering is conducted in a manner that complies with state and federal securities laws.  Compliance will prevent major headaches down the road.

The Attorneys at Fitzpatrick Lentz & Bubba have extensive experience advising clients on a wide variety of business law matter, including securities law compliance. For more information, please contact Kenneth Charette  or any other attorney in our Corporate, Business & Banking Group.

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