As a business owner considering ways to fund your business, you need an experienced securities attorney to help you structure your private offering, prepare your private placement memorandum and file all necessary SEC and state forms. Unfortunately, this can be much more difficult than it first appears. Fraud is rampant in the investment industry and there are strict laws in place as a result. Many business owners don’t understand that selling any form of ownership in their business is considered selling a security, which might be subject to state and federal securities laws.
When you are considering structuring securities, protect yourself and your business by turning to securities attorneys with concrete understanding of the investment industry. Lei Jiang Law Firm offers experienced, professional representation in all matters involving securities law, as well as general corporate and litigation matters.
Securities Laws Basics
Many corporate transactions have securities law implications. Therefore, it is almost impossible to ignore securities law in the corporate life. There are two major pieces of federal laws that deal with securities: Securities Act of 1933 and Securities Exchange Act of 1934. The Sarbanes-Oxley Act of 2002 is another major law passed by Congress to deal with massive corporate scandals.
Any time a corporation or business offers or sells securities, it should consider federal and state securities laws. Under federal law, unless there is an exemption, a registration statement must be filed and be effective before a security may be sold. Prospectuses must be prepared and used in each case. The followings are the things to consider:
- Does the transaction involve a security?
- Is the security being offered or sold?
- Is a registration exemption available?
These questions are trickier than they may first appear. For example, the second question may look quite straightforward, but in corporate mergers and asset acquisitions, where the acquiring corporation pays for the acquisition with its own securities, although shareholders of the acquired corporation have no dealings with the acquiring corporation, if they vote to approve the merger or asset sale, then the security is being offered and sold. (For more on mergers and acquisitions, click here).
Exemption on registration is extremely important. Most publicly held companies can register and sell securities for a lower percentage of the dollar amount involved, so registration is more practical for them. But for a privately owned company, registration is often simply too expensive and time consuming. Therefore, an exemption must be available for every offer and sale of its securities. Usually an exemption can be found. The company just needs to be represented by counsel expert enough in securities law to know exactly how the offering has to be done. Lei Jiang Law Firm has this expertise to help you navigate securities exemptions.
The Security Exchange Act (referred to as Exchange Act later) requires registration under two circumstances. First, an issuer must register securities when the securities are to be traded on a stock exchange. Second, an issuer must register securities if the number of shareholders and amount of assets reach the statutory threshold. Under §12(g)(1), the threshold is 500 shareholders and $10 million assets. Form 10 is the general registration form used by most issuers.
Both the Securities Act and the Exchange Act require registration, but the purposes are different. Registration under the Securities Act allows the securities to be sold in a particular transaction, while registration under the Exchange Act subjects the issuer to the Act’s periodic reporting requirements and other requirements.
The Sarbanes-Oxley Act mostly impacts publicly held companies. Section 301 regulates the audit committees of publicly held companies. Section 302 regulates the certification of annual and quarterly reports by the CEO and CFO of Exchange Act reporting companies. Section 303 makes it fraudulent to influence the conduct of audits for the purpose of making financial statements materially misleading. Section 401 regulates the disclosures in periodic reports. A critically important provision about periodic reporting is Section 409 – Real Time issuer Disclosures, which requires each reporting company to disclose, on a rapid and current basis, any additional information concerning material changes in the financial condition of the issuer, typically via Form 8-K.
Insider Trading and Other Securities Fraud
Rule 10b-5 under the Exchange Act is the basis of the federal regulation dealing with insider trading and various fraudulent conducts in the sale of securities. The rule prohibits any person by any means
- to employ any device or scheme to defraud, or
- to make any untrue statement of a material fact or to omit a material fact, or
- to engage in any act which operates as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
The goal is to protect the investing public and to ensure fair dealings in the securities markets by promoting full disclosure of inside information.
Rule 10b-5 involves criminal liabilities. A willful violation of the rule is a felony and action may be brought by the Justice Department. The Securities and Exchange Commission (SEC) may bring actions seeking injunctions against violations and requesting the court to impose civil penalties. In order to ensure that you do not find yourself faced with 10b-5 violations, it is important to consult an experienced securities attorney. Don’t hesitate to protect yourself and your business.
One key to the question is what constitutes materiality. The courts utilize a probability/magnitude analysis to determine whether information or an omitted fact is material. Basically, materiality depends on the significance a reasonable inventor would place on the withheld or misrepresented information.
Another question is who is subject to these trading constraints. The courts have found violations of 10b-5 where corporate insiders used undisclosed information for their own benefit. This is because they have the duty to disclose based on a fiduciary or other similar relationship, such as trust and confidence, placed upon them.
Rule 16 under the Exchange Act deals with short-swing trading, which is a form of the insider trading. Rule 16 is a spring gun that can hit the innocent as easily as the guilty. To comply with the Rule, insiders affiliated with a public company, or any owners of more than 10%, are required to electronically file Form 3 with the SEC no later than 10 days after the individual becomes affiliated with the company. If there is a material change in the holdings of the company’s insiders, they are required to file Form 4 with the SEC. Also, pursuant to Section 16, Form 5 must be filed by an insider who has conducted an insider transaction during the year if it was not previously reported on Form 4.
Specific rules are:
- each owner of more than 10% of any equity security registered under the Exchange Act, and each director and officer of an issuer of such security, file reports with the SEC and relevant stock exchanges reporting their holdings and changes in such holdings,
- any profit realized by any of the above persons on any purchase and sale, or sale and purchase, of non-exempt equity security within period of less than 6 months, shall be recoverable by the issuer,
- it is unlawful for any of the above persons to sell any non-exempt equity security if (1) the person does not own the security (short sale) or (2) if owning the security, does not deliver it against the sale within prescribed period.
It is entirely possible to have profits under Rule16 when, in fact, one has suffered a loss when all transactions during a period are taken into account. This is because transactions will be matched and if several transactions are involved, any losses during the period are ignored.
Securities laws have an enormous impact on corporate conduct and can cover many issues. Corporations need to hire competent securities law attorney for expert guidance in this complex area of law. Lei Jiang Law Firm provides legal services and counsel in securities law for companies both large and small… For more detailed information, tailored analyses, and legal opinions, please contact us today.