Securities Laws: Private Companies' Obligations And Exemptions

Securities laws apply to private companies, and non-compliance can result in serious consequences, including criminal liability, monetary fines, and prohibitions on conducting future sales. The Securities Act of 1933 and the Securities Exchange Act of 1934 are the primary federal laws governing securities in the US, and they apply to both public and private companies. The Securities Act of 1933 requires the registration of securities with the Securities and Exchange Commission (SEC) unless an exemption is met, while the Securities Exchange Act of 1934 created the SEC, which has oversight, regulatory authority, and disciplinary power over the US securities industry.

Private companies and securities registration

The Securities Act of 1933 requires that any offer or sale of securities be registered with the SEC, unless there is an exemption from registration. Private companies can take advantage of exemptions for such offerings. For instance, Rule 701 of the Securities Act allows an exemption for securities issued by non-reporting companies as part of compensatory arrangements. However, this exemption does not apply to the resale of the securities.

Another exemption is Rule 506, which is the most widely used. It allows an unlimited amount of securities to be issued as long as they are not offered through general solicitation or advertising, and no more than 35 non-accredited investors participate. Accredited investors include certain financial institutions, entities with $5 million in total assets, directors, executive officers, partners of the issuer, and natural persons with $1 million net worth or $200,000 annual income.

Regulation D includes three rules that issuers often rely on to sell securities in unregistered offerings: Rules 504, 505, and 506. Rule 504 permits certain issuers to offer and sell up to $1 million of securities in a year, with no limit on the number or type of investor, and no specific disclosure requirements. Rule 505 allows issuers to offer and sell up to $5 million of securities in a year, with no limit on the number of accredited investors but a limit of 35 non-accredited investors. Rule 506 is similar to Rule 505 but requires non-accredited investors to be financially sophisticated.

It's important to note that even exempt transactions are subject to the antifraud provisions of federal securities laws, prohibiting false or misleading statements. Criminal, civil, and administrative proceedings can be initiated by the government, and private parties can also bring actions under certain securities laws.

Before investing in unregistered offerings, investors should be aware of the risks involved and conduct thorough due diligence. It's important to review the materials provided, ask questions, and understand the security.

Securities Act of 1933

The Securities Act of 1933 was the first federal legislation in the US to regulate the stock market. The Act was passed into law to protect investors in the wake of the 1929 stock market crash.

The Act has two primary goals: to ensure transparency in financial statements, and to establish laws against misrepresentation and fraud in the securities markets.

Transparency in Financial Statements

The Securities Act of 1933 requires companies selling securities to the public to disclose key information about their property, financial health, and executives. This includes descriptions of the company's business, past performance, information about the company's officers and managers, audited financial statements, information on executive compensation, risks of the business, tax and legal issues, and the terms of the securities issued.

This information is made available to investors through a prospectus and registration statement, which must be submitted to the Securities and Exchange Commission (SEC). The prospectus must be made available on the SEC website.

Laws Against Misrepresentation and Fraud

The Act prohibits deceit, misrepresentations, and other fraud in the sale of securities. It provides for liability for fraudulent sales of securities, with issuers being strictly liable for any material misstatements or omissions in the prospectus or registration statement.

The Act is enforced by the SEC, which can prosecute issuers and sellers of unregistered securities. The SEC can also seek injunctions and issue cease-and-desist orders. Individual investors can also bring civil actions under several provisions of the Act.

Exemptions

It is important to note that some securities offerings are exempt from the registration requirement of the Act, including intrastate offerings, offerings of limited size, securities issued by municipal, state, and federal governments, and private offerings to a limited number of persons or institutions.

Securities Exchange Act of 1934

The Securities Exchange Act of 1934 ("1934 Act" or "Exchange Act") regulates the trading of securities in the secondary market. This means that it typically governs transactions that occur between parties who are not the original issuer, such as trades executed by retail investors through brokerage companies.

The Act created the Securities and Exchange Commission (SEC), which has oversight, regulatory authority, and disciplinary power over the US securities industry, including brokerage firms, transfer agents, and self-regulatory organisations (SROs) such as the New York Stock Exchange, NASDAQ, and the Financial Industry Regulatory Authority (FINRA).

The 1934 Act requires companies with registered publicly held securities and companies of a certain size (over $10 million in assets and securities held by more than 500 owners) to make periodic disclosures by filing annual and quarterly reports, as well as promptly disclosing important events. These reports include information about the company's officers and directors, line of business, audited financial statements, and management discussions.

The Act also mandates disclosure at certain crucial points, such as during proxy contests, so that investors can make informed decisions before purchasing stock. Additionally, it requires anyone seeking to acquire more than 5% of a company's securities to disclose important information, allowing investors to decide whether to sell.

The 1934 Act also protects investors by prohibiting fraud and establishing severe penalties for those who defraud investors or engage in trading practices that take advantage of non-public information. Section 10(b) is the primary anti-fraud provision, prohibiting the use of any "device, scheme, or artifice to defraud" and imposing liability for misstatements or omissions of material facts.

Furthermore, the Act empowers the SEC to require periodic reporting of information by companies with publicly traded securities and to establish rules regulating the conduct of market participants, stock exchanges, and SROs. The SEC can sanction, fine, or otherwise discipline market participants who violate federal securities laws.

Overall, the Securities Exchange Act of 1934 provides a comprehensive framework for regulating the secondary market for securities, protecting investors, and ensuring transparency and fair practices in the US securities industry.

Regulation D

Companies that comply with Regulation D do not have to register their offering of securities with the SEC, but they must file a Form D disclosure document electronically with the SEC after they first sell their securities. Form D includes the names and addresses of the company's promoters, executive officers, and directors, and some details about the offering.

Issuers relying on Regulation D must still comply with all applicable laws, including state securities laws. Regulation D does not exempt companies from the antifraud, civil liability, or other provisions of federal securities laws.

There are some limitations to Regulation D. For example, the benefits of Regulation D only apply to the issuer of the securities, not to affiliates of the issuer or any other individual who might later resell them. Additionally, the regulatory exemptions offered under Regulation D only apply to the transactions, not to the securities themselves.

Rule 701

There are conditions and limitations to the rule. Firstly, there are strict mathematical limits that cannot be exceeded. If the value of the equity goes over $5 million, 15% of the issuer's total assets, or 15% of the outstanding securities in the class in any consecutive 12-month period, special disclosure requirements are triggered. In this case, the company must provide financial statements, a summary of the material terms of the plan, and information about risk factors associated with the investment.

Secondly, benefit plans and compensation contracts must be in writing and can only be offered to individuals. Eligible persons include directors, general partners, trustees, advisors, consultants, and officers. Former employees, partners, officers, directors, and advisors can be offered equity compensation if they were employed by or offering services to the issuing company at the time the securities were offered.

It is important to note that transactions under Rule 701 are not exempt from civil liability, anti-fraud provisions, or other federal securities laws. Those who have received stock options and equity awards under this rule cannot sell the stock without registering the shares with the SEC, unless they use an applicable exemption.

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