Compliance with federal and state securities laws is a serious consideration for every company. Learning what you can and cannot do under the securities laws is a valuable tool in your arsenal of knowledge. Every time your company issues or sells securities, the transaction must comply with federal securities laws and the securities laws of the state in which it is sold. Doing it right the first time can mean the difference between survival and failure of your business.
Understanding Securities Laws
What is a security? Basically, securities have been held to exist in any case in which a person provides money to someone with the expectation that they will derive a profit through the efforts of that person. This can apply to any situation in which someone buys stock in or makes a noncommercial loan to your business. The company that sells securities is known as the issuer.
There are basically two types of securities offerings—public and private. The private placement offering is the means used by most new businesses to raise their initial capital. It is far less costly than a public offering, and is not subject to the review process of the Securities and Exchange Commission (SEC) and the state agencies. The sale is accomplished through the use of an offering document known as a private placement memorandum (PPM), which is prepared by an attorney who specializes in securities law. When you sell equity in your company (common stock or preferred stock, limited partnership interests, or LLC membership units), you must comply with the federal and state laws regulating the sale of securities.
Brief History of Securities Laws
The states got into the act first. Massachusetts enacted a law in the 1850s that regulated the sale of railroad stock. In 1911, Kansas adopted the first securities statute with a broad application to protect the welfare of its citizens from unscrupulous promoters of securities. A handful of states followed suit. There were constitutional challenges to these states regulation of securities that were defeated in 1917, which opened the way for the wholesale adoption of state regulatory controls. Today, each state has some form of securities regulation.
State securities laws were a great starting point in protecting investors from fraud and abuse, but something more was needed. Congressional hearings into the cause of the Great Depression uncovered that one-half of the total sales of securities during the 1920s proved to be worthless due to massive fraud, abuse of trust, and lack of disclosure standards. State regulation was largely ineffective due to lack of resources and the fact that people committing these crimes were moving from state to state to avoid getting caught.
One of the first things President Roosevelt did when he got in to office was to urge Congress to adopt legislation controlling the issuance and sale of securities. One of the first pieces of New Deal legislation was the Securities Act of 1933 (33 Act), which created the Securities and Exchange Commission (SEC) and instituted a process for federal registration of securities and an administrative process to review securities offerings.
Curiously enough, while other New Deal legislation created federal bureaucracies that supplanted state services, the creation of this new federal review mechanism of securities also left in place the existing state securities laws. This concurrent jurisdiction over securities created, in many cases, a dual registration process at the federal and state level that still exists today.
Since 1933, issuers of securities either had to register their securities or qualify for an exemption from registration. Securities registration is an expensive and time-consuming process. Rather than filing a public registration, most small companies use an exemption from registration provided, in part, by Regulation D of the 33 Act.
