PUBLIC SECURITIES REGISTRATION
For the company that wants to accept money from any investors or be set up on a stock exchange, registration is a necessary evil. Registration can be a lengthy and expensive process, although failure to register securities before they are offered to investors can leave an issuer, and possibly his, her, or its accountants, attorneys, and other affiliates standing in an administrative proceeding facing sanctions or fines by the Securities and Exchange Commission (“SEC”), the leading securities regulatory body.
Securities registration began with the states. The first securities registration and regulation laws were passed by the State of Kansas in 1911. States began to require securities registration because of the sheer amount of fraud. These laws were named, and are still referred to as, blue sky laws. The name comes from the idea that, at the time, issuers would sell “everything but the blue sky” to investors.
The state systems were originally completely merit based systems. The state securities boards would do a full evaluation of the business and the investment, which even today can take a considerably long time. Today, only a small number of states still have have merit based securities regulation systems.
Congress felt there was a need for greater oversight over the securities market. This was primarily brought on by the amount of fraud occurring leading up to the Great Depression. The SEC was created, along with various other organizations, to make sure that information concerning securities transactions were at the very least disclosed to investors. State securities laws were seen by Congress as insufficient, largely because rules varied, and still vary greatly, from state to state, and it was difficult to monitor securities transactions that took place in multiple states.
Nearly everyone is aware of the Securities Act of 1933. However, that was just the first part of the federal securities laws. While there have been many amendments and subsequent laws modifying the basic regulations, federal securities laws are based on:
• Securities Act of 1933 – regulating the sale of securities
• Securities Exchange Act of 1934 – regulating securities traders, broker dealers, and exchanges
• Trust Indenture Act of 1939 – regulating debt securities and bonds
• Investment Company Act of 1940 – regulating mutual funds
• Investment Advisers Act of 1940 – regulating investment advisers
Federal Registration and Disclosure
So here’s where the federal disclosure based regulation system comes into play. The federal regulation system, even from the beginning, was far less invasive than state registration. This is because the SEC regulates based on a disclosure based system. This means they care about one thing: that an issuer is disclosing every aspect of his, her, or its business and background, and the investment itself. Basically, the disclosure requirements include all the information necessary for an investor to fully understand and evaluate the issuer, the business, and the investment. Failing to comply with the disclosure requirements can mean vulnerability to civil and criminal suits, including SEC sanctions.
Additionally, even if an issuer does not intentionally leave out information, it is still considered failure to comply. This is why it is important to include the information if in doubt, and if an attorney is drafting the documents for the issuer, the issuer is best served by informing the attorney of all relevant information concerning the investment, the business, the issuer, including the issuer’s education, experience, past legal issues, and current, present, and future business ventures. Our firm has worked with many issuers in the past and has created documents tailored not only towards the investment, but also the investor, while looking out for the issuer’s best interests.
Public federal registration requires that the issuer create and submit a detailed prospectus, or a registration statement, to the SEC. An issuer includes all relevant information concerning the company in this registration statement. And when I say all, I mean ALL. This includes financial statements, an in-depth description of the business, any other financing, conflicts of interest, amount and price of the securities being offered, risks, offering terms, management and advisor background information, use of proceeds, organizational structure, and an ongoing list of information that must be included in the registration document, form S-1. This document becomes public after submission to the SEC. Because they are public, all registration documents are available to the SEC for examination for disclosure requirements. This means there is a greater likelihood, as opposed to a private securities offering, that if information is omitted, information is intentionally left out, or a fraudulent securities scheme is being conducted, it will be discovered, and civil and criminal penalties will follow.
State Registration and Merit-Based versus Disclosure States
Public state registration varies state by state. Securities laws have evolved differently state by state for a variety of reasons, but the most standout reason is that some states simply have more securities transactions occurring within their borders. Texas and California are two examples of states which conduct merit-based reviews, and they both have some of the more arduous state securities laws. Merit reviews are important in some states because of greater instances or concerns about fraud. As an example, Texas has a larger amount of oil and gas securities offerings occurring throughout the state, and these offerings are highly susceptible to fraud.
Unless the securities are pre-empted from state registration by a Federal law, a securities offering must comply with state securities laws. Now, this means that in every state the securities are being offered, they must be registered and in compliance with that particular state’s securities laws. Many states have a registration process fairly similar to the federal registration process. The focus is generally on whether you have met the state’s disclosure requirements. However, for states such as Texas and California that conduct a merit review, the process may take longer because the state evaluates the securities offering itself to ensure it is valid and fair to the investors. For example, in Texas, securities offerings are examined to ensure they are fair, just, and equitable, plus the registration documents must meet the state’s disclosure requirements.
Of course, certain companies can be exempt from registration requirements. These include private offerings to a limited number of persons or institutions, offerings of limited size, intrastate offerings, and securities of municipal, state, and federal governments. These exemptions allow an issuer an easier path to offering securities. However, some of the exemptions are better suited for certain issuers and business plans. For some of these exemptions, the offering document, referred to as a private placement memorandum, or PPM for short, is generally kept completely private, unless it becomes subject to SEC disclosure review due to an investor complaint, or otherwise arouses suspicion. The specifics can vary dramatically from exemption to exemption, but that is a a topic for another time.
The most commonly utilized of the registration exemptions is Regulation D, Rule 506, which allows for an unlimited amount of capital. Under rule 506, there is first subsection 506(b), which allows an unlimited number of accredited investors and up to 35 unaccredited “sophisticated” investors. There is also Rule 506(c), which allows general solicitation and advertising, but is limited to verified accredited investors. There are many stipulations on making investment offers under these registration exemptions, and you should contact an attorney before relying on any registration exemption.
Keep in mind that registration is only a part of the securities offering process. Depending on an issuer’s business plans, there may be other agreements that need to be drafted, entities that need to be created, including a short list of basic documents if a new entity is created, offering circulars that need to be drafted, lender requirements that must be met, and a host of other considerations and steps that must be taken in order to commence with a public securities offering, or even a private securities offering. Additionally, the steps that must be taken in commencing with a securities offering are be time consuming and complex, but failing to follow through with the necessary steps can also have big consequences. Our firm is experienced in this area and has handled many of the steps necessary in the securities offering process, so do not hesitate to contact us if you are interested in a public, or private, securities offering.