In the United States, both the Securities Exchange Commission (SEC) and the various states' securities commissions regulate securities. Proper securities compliance when a private issuer is engaging in sales of securities requires exemption from registration under federal and applicable state(s) laws or registering securities. This article focuses on exemption compliance.

Determining which state laws apply is likewise important and is dependent upon the states of residence of investors, state of incorporation of the entity, principal place of business of an issuer of securities, and the place of business of any broker-dealers that are engaging in sales. This is particularly important because even when exemptions are available, satisfying the exemption typically requires a notice filing be made.

This article attempts to answer common questions that we receive from companies planning private capital raises.

1. Is a preorganization stock/membership interest unit certificate or subscription regulated as a security? Yes. Under the Securities Act of 1933, as amended ("Securities Act"), a "preorganization stock certificate or subscription" are included in the definition of a security. See Securities Act, §2 (15 U.S.C. §77b). This relates to corporations, limited liability companies, and partnerships. See id.

2. Does relying on the SEC's accredited investor exemption (Rule 506) require filing a Form D? Yes. Since passage of the JOBS Act, Rule 503 requires filing of Form D to establish exemption under Rules 504 and 506. The Form D must be filed within fifteen (15) days of the first sale, and most state law requirements are similar.

3. What doI need to consult with a Securities Attorney for?

  • For any transaction, to obtain subscription documents, operating agreement and board and shareholder/member resolutions documenting exemptions
  • Multi-state transaction: issuer and all investors are from more than one state
  • Relying on accredited investor exemption under SEC Rule 506
  • Relying on SEC's Rule 504 limited offering exemption for sales of $10 million or less
  • Plan to pay commission for sales of securities
  • Engage in general advertising, including mass email, social media, and advertisements
  • Documentation of exemptions should be made before any securities are offered

4. What documentation is necessary in a wholly-intrastatetransaction? We recommend issuers use an attorney to document any exemption in subscription and governance documents properly, and for required notice filings. Documentation of the exemption is the most important part of establishing it. Failure to document the exemption and file the proper notices can lead to regulatory consequences for the issuer, including fines.

For example, in Ohio, Ohio Revised Code §1707.03(O) provides a self-executing exemption if all of the following conditions are met:

  • Issuer is an Ohio corporation or other entity that is also headquartered in Ohio;
  • Sale involves only equity securities by an Issuer to 10 or fewer purchasers in Ohio (purchasers calculation includes all members/shareholders of an entity that is not itself an accredited investor, all grantors of a Revocable Trust with less than $5 million, and joint owners);
  • Issuer reasonably believes purchasers are purchasing for investment, and not for distribution;
  • there is no general advertising; and
  • sales commissions are limited to ten percent (10%) and may be paid only to securities dealers and salespersons licensed in Ohio.

It is crucial that these various conditions are documented as part of the subscription agreements and related investor questionnaires. Proper documentation may require investors to complete multiple investor questionnaires, and so it's important to have a knowledgeable securities attorney involved. Other states, like Illinois, closely follow the SEC exemptions, and a notice filing is required even for an intrastate transaction, regardless of the number of investors. In many states, the filing of a Form D and making state filings electronically are the easiest and most cost-effective means to establish state and federal exemptions. See e.g., Illinois Securities Act §2a and Sections 130.293 of the Illinois Sec. Rules and Regulations (SEC Rule 506(b)and (c) corollary) and §4.G of Sections 130.440, 130.441, and 130.442 of the Illinois Sec. Rules and Regulations (SEC Rule 504 corollary). See also SEC Rules 503, 504 and 506.

5. If I have satisfied state law requirements can I avoid filing a Form D and utilize §4(a)(2)?

There are a number of requirements to utilize §4(a)(2) without a specific SEC Rule exemption-See SEC v. Ralston Purina Co. 346 U.S. 119 (1953). One of the most important criteria is that the transaction is one "with persons who do not need the protection of the [Securities Act of 1933, as amended]." Id. Typically, this means a negotiated transaction where both parties are sophisticated enough to do their own due diligence.

In the cases of intrastate offerings, §3(a)(11) of the Securities Act is generally known as the intrastate offering exemption. See also SEC Rule 147. This exemption seeks to facilitate financing of local business operations. The requirements of this exemption are as follows:

  • Issuer must be organized in the state where it is offering the securities;
  • Issuer must carry out a significant amount of business in that state; and
  • Issuer may make offers and sales only to residents of that state.

Brouse McDowell has experienced securities counsel available to help you properly document your securities transactions.

6. Should I consult with a securities attorney for exemption documentation even if I know I have a good exemption? Yes. Securities regulators recommend properly documenting any securities exemption through investor questionnaires, subscription agreements, operating agreements and resolutions. Accordingly, we recommend clients consult with a securities attorney in any instance that securities are being sold to properly document exemptions and make any required notice filings necessary under state or federal law to satisfy exemption requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.