Securities Regulations: How These Laws Affect Your Business

            Having a firm understanding of securities regulations is necessary when forming a corporation or an LLC.  This is because shares of corporate stock are always securities, and membership interests in an LLC are sometimes classified as securities.  A “security” is an ownership interest in a company or venture over which you have no control or management authority.  Both state and federal securities laws govern the sale and management of securities.  These laws prohibit a business—known as an “issuer” in this context—from selling or offering to sell any security without first registering with 1) the relevant authority of the state in which the business was formed, 2) the federal Securities and Exchange Commission (“SEC”), and 3) any other state in which a given purchaser of the stock resides (this is what is meant by “blue sky laws”).

            The purpose of these registration requirements is somewhat paternalistic.  The relevant governmental authorities want to protect those individuals who have an ownership interest in a given enterprise, but have limited power over or knowledge of how that enterprise is managed.  Notifying the federal authority—the SEC—is called registration; whereas in California, such notification is known as qualification.  At both the federal and state level, this process is quite complex, expensive, and time-consuming.  Both federal and state law, fortunately, recognize several exemptions from these registration/notification requirements.

            The most common federal exemptions are as follows:

            1) §4(2) of the Securities Act of 1933 (15 USC 77d(2)): this is a “self-executing” exemption for private offerings.  What qualifies for this exemption is a moving target as there are several factors that determine when this exemption is available.  Relying on this exemption alone can sometimes be risky.

            2) §4(6) of the Securities Act (15 USC 77d(6)): this exemption is available for “Accredited Investors.”  It is not self-executing, as you must file a “Form D Notice.”  Accredited Investors are defined under the Regulation D regulations, below.

            3) Regulation D Offerings (embodied in 17 CFR 230.501–508): Regulation D covers three possible exemptions, all of which require a Form D Notice to be filed with the SEC.  The three exemptions are as follows:

                                      a) 17 CFR 230.504: the offering must be limited to under $1 Million in value, the number of investors is unlimited, and there are no information disclosure requirements for the issuer to give to investors.

                                      b) 17 CFR 230.505: the offering must be limited to under $5 Million, the number of non-accredited investors is limited to 35 (with no limit as to accredited investors), and there are detailed information disclosure requirements for the issuer to give to non-accredited investors, if any.

                                      c) 17 CFR 230.506: the offering has not dollar value limit, the number of non-accredited investors is limited to 35, even non-accredited investors must a “sophistication requirement,” and there are detailed information disclosure requirements for the issuer to give to non-accredited investors, if any.

            California State law has a number of exemptions from qualification of securities, most of which are embodied in Corporations Code §25102.

            Even if you are forming a closely held corporation (the owner(s) are just you or you and your spouse or family member), your ownership interest is still a security.  This means you must use an exemption or else you have to register and qualify your securities.  If you are forming an LLC, and someone other than yourself is managing its operations, your membership interest is likely a security.

            The take home point for all of this is that regardless of the type of entity you are forming, you need to be careful that you are complying with the relevant securities laws and regulations.  If you need any assistance or simply have a question about how securities regulations affect your business, please contact our law firm.  We are proud to serve clients throughout the North State, from Sacramento up to Eureka and the Oregon Boarder.