Most individuals and companies looking to raise money for a business venture take very little thought as to whether their capital raising activities implicate any state or federal securities laws.
Yet with the substantial civil and, in some cases, criminal penalties associated with the violation of state and federal securities laws, anyone looking to raise capital should consider whether its proposed financing plan complies with any applicable securities laws and regulations.
The first question that should be addressed is the same question courts and the Securities and Exchange Commission (the “SEC”) has been grappling with since the federal securities regulatory regime was introduced in 1933 - what is a security? If you are not offering or selling a security in connection with your fundraising plan, your activities likely fall outside the scope of securities laws.
In addition to the list of both debt and equity instruments that will be considered securities under the Securities Act of 1933, case law addressing this question provides that any investment contract will be considered a security if it satisfies all three of the following elements:
The investment of money;
Into a common enterprise with other investors; and
With the expectation of profits derived primarily from the efforts of others.
Thus, if you are accepting funds from individuals or entities to be pooled together to generate returns and then distributing those returns to such individuals or entities based on your efforts or the efforts of your affiliates, you are most likely offering and selling securities and should be careful to comply with applicable state and federal laws.
The general rule underlying securities regulation at both the state and federal levels, is that a transaction in securities must be registered with the appropriate regulatory bodies unless the seller of such securities is able to rely upon an applicable exemption from registration.
On a state level, many exemptions for low dollar amounts to individuals investing for their own purposes are self-executing – meaning that no notice or fee is required to qualify for such an exemption.
On the federal level, however, there are no self-executing exemptions. Some of the most common exemptions from registration of a securities transaction from an issuer standpoint include Rule 147 offerings, Regulation D offerings, Regulation A offerings, and Regulation CF offerings.
Each of the foregoing exemptions have specific rules regarding how much capital can be raised, how issuers and their placement agents can interact with investors and potential investors, the qualifications of potential investors, regulated intermediaries facilitating sales, and, perhaps most importantly, the level of disclosure of material information about the offering, the issuer, and the risks involved with purchasing such securities.
Each exemption has its own direction as to disclosure, but they all revolve around the following two principles: (i) issuers should not provide any misleading information to any potential investors and (ii) issuers should not withhold any information from investors that would have a material impact on their decision to purchase securities from the issuer. Courts and the SEC have held that these principals are dependent on the offering specifics, including size, manner of solicitation, and level of sophistication of investors.
Naturally, the larger the offering in terms of potential investors, actual investors, and dollar amount raised, the more heightened the disclosure obligations of an issuer. As individuals and companies seek to raise necessary capital for their business operations or investment objectives, they should consult with qualified legal counsel to structure any such financing plan in accordance with appropriate securities laws and exemptions to reduce their exposure to civil and potentially criminal penalties.
In future posts, we will provide an overview of each of the following types of offerings:
Initial Coin Offerings (not a separate exemption, at least for the time being, but unique enough to merit their own separate discussion)