Securities Law Definition Career and State Information

securities law definition
Compliance with federal and state securities laws is a serious consideration for every company. Learning what you can and cannot do under the securities laws is a valuable tool in your arsenal of knowledge. Every time your company issues or sells securities, the transaction must comply with federal securities laws and the securities laws of the state in which it is sold. Doing it right the first time can mean the difference between survival and failure of your business.

Understanding Securities Laws

What is a security? Basically, securities have been held to exist in any case in
which a person provides money to someone with the expectation that they
will derive a profit through the efforts of that person. This can apply to any
situation in which someone buys stock in or makes a noncommercial loan
to your business. The company that sells securities is known as the issuer.
There are basically two types of securities offerings—public and private.

The private placement offering is the means used by most new businesses
to raise their initial capital. It is far less costly than a public offering, and is
not subject to the review process of the Securities and Exchange Commission
(SEC) and the state agencies.

The sale is accomplished through the use of
an offering document known as a private placement memorandum (PPM),
which is prepared by an attorney who specializes in securities law. When
you sell equity in your company (common stock or preferred stock, limited
partnership interests, or LLC membership units), you must comply with
the federal and state laws regulating the sale of securities.

Brief History of Securities Laws

The states got into the act first. Massachusetts enacted a law in the 1850s
that regulated the sale of railroad stock. In 1911, Kansas adopted the first
securities statute with a broad application to protect the welfare of its citizens
from unscrupulous promoters of securities. A handful of states followed
suit. There were constitutional challenges to these states regulation
of securities that were defeated in 1917, which opened the way for the wholesale adoption of state regulatory controls. Today, each state has some
form of securities regulation.

State securities laws were a great starting point in protecting investors
from fraud and abuse, but something more was needed. Congressional
hearings into the cause of the Great Depression uncovered that one-half of
the total sales of securities during the 1920s proved to be worthless due to
massive fraud, abuse of trust, and lack of disclosure standards. State regulation
was largely ineffective due to lack of resources and the fact that people committing
these crimes were moving from state to state to avoid getting caught.

One of the first things President Roosevelt did when he got in to office
was to urge Congress to adopt legislation controlling the issuance and sale
of securities. One of the first pieces of New Deal legislation was the
Securities Act of 1933 (33 Act), which created the Securities and Exchange
Commission (SEC) and instituted a process for federal registration of securities
and an administrative process to review securities offerings.

Curiously enough, while other New Deal legislation created federal
bureaucracies that supplanted state services, the creation of this new federal
review mechanism of securities also left in place the existing state securities
laws. This concurrent jurisdiction over securities created, in many cases, a
dual registration process at the federal and state level that still exists today.
Since 1933, issuers of securities either had to register their securities or
qualify for an exemption from registration. Securities registration is an
expensive and time-consuming process. Rather than filing a public registration,
most small companies use an exemption from registration provided, in
part, by Regulation D of the 33 Act.

The Rise of Rule 506 of Regulation D

In 1982, the SEC adopted Regulation D, which provided three exemptions
from registration under the 33 Act—Rules 504, 505, and 506. If the guidelines
are followed, these rules collectively provide a safe harbor to sell securities
in a private transaction without having to file a registration statement
with the SEC.
In 1996, Congress passed the National Securities Market Improvement Act
 (NSMIA). NSMIA brought some semblance of uniformity to the widely variant state exemptions from registration. It created a federal preemption over state registration for what it called covered securities. Essentially, it provided that Rule 506 offerings were to be recognized as valid exemptions inall states, thus preempting state securities law for this type of offering.

Today, virtually all young companies will issue their securities in accordance
with Regulation D. Rule 506 is a popular choice because of its
acceptance by all of the states.
Rule 506 provides that an offering of securities will be exempt from registration
if it meets the following requirements.

• There can be no more than thirty-five purchasers who are not accredited
in any given offering, but there can be an unlimited amount of
accredited purchasers.
• Each purchaser who is not an accredited investor either alone or with
their purchaser representative(s) must have such knowledge and experience
in financial and business matters that they are capable of evaluating
the merits and risks of the prospective investment, or the issuer
reasonably believes immediately prior to making any sale that such purchaser
comes within this description.
• Certain financial and nonfinancial disclosure requirements must be met
by the company.
• Financial disclosures include financial statements for up to two years,
and in some cases they must be audited, depending upon the amount
of the offering, and the balance sheet must be dated within 120 days of
the start of the offering.
• There can be no general advertising or general solicitation of potential
purchasers.
• Resale limitations on the securities must also be disclosed.
• Notice of the sale of securities (Form D) under Rule 506 must be filed
with the SEC no later than fifteen days after the first sale of securities.
(Form D is a statistical reporting form that is not, at present, reviewed
by the SEC.)

Accredited Investors

An issuer typically determines an investor’s accredited status by having the
investor answer written questions regarding his or her accredited status. Regulation D defines an accredited investor as a person or business entity
meeting the following qualifications.

• Any individual with an individual net worth, or joint net worth with
that person’s spouse, of $1,000,000, or with an individual income of
$200,000 ($300,000 with that person’s spouse).
• An officer, director, or general partner of the company issuing the securities.
• A nonprofit company with total assets in excess of $5,000,000 that was
not formed for the specific purpose of acquiring the securities offered.
• A bank, saving and loan association, broker, dealer of securities, insurance
company, investment company, or any employee benefit plan with
assets exceeding $5,000,000.
• Any trust with total assets in excess of $5,000,000 that was not formed
for the specific purpose of acquiring the securities offered.
• Any entity in which all of the equity owners are accredited investors.

Nonaccredited Investors

Nonaccredited investors are everybody else who falls below or comes outside
the qualifications of an accredited investor. Accredited investors are determined
by a quantitative test, while nonaccredited investors are determined
by a qualitative test. You have to be a bit more careful with nonaccredited
investors.

The issuer has to make certain that a nonaccredited investor has
enough knowledge and experience in financial and business matters to be
capable of evaluating the merits and risks of the prospective investment.
The issuer must reasonably believe, immediately prior to making any sale,
that such purchaser comes within this description.

In addition, although it is not a requirement under Rule 506, the financial
capability of the investor should not be ignored. The issuer should provide
disclosures that this is a high-risk investment and obtain an assurance
that the investor is capable of losing their entire investment.
For purposes of Rule 506, there can be no more than thirty-five nonaccredited
investors purchasing securities in any offering. An issuer can, however,
count certain groups of investors as one investor. Multiple purchasers
who are counted as one purchaser for the thirty-five count include:

QUICK Tip
Accredited vs. Nonaccredited Investors: Accredited investors are assumed to
have knowledge and experience in financial matters. With nonaccredited
investors, you have to find out. Typically, you ask the investor a series of written
questions regarding their financial and business experience.


• any relative, spouse, or relative of the spouse of a purchaser who has the
same principal residence as the purchaser;
• any trust or estate in which the purchaser owns, either alone or
together with related persons, more than 50% of the beneficial interest;
• any business entity majority-owned by the purchaser either alone or
with (1) related persons as described in the first bullet or (2) a trust or
estate as described in the second bullet; and,
• persons or business entities that are, or the issuer reasonably believes to
be, accredited investors.


Nonaccredited investors who do not have such knowledge and experience
in financial and business matters may rely on a purchaser representative
to evaluate the investment to make them capable of evaluating the merits
and risks of the prospective investment.


HOW TO...Determine the Status of Your Investor

Part of a private placement document is a subscription agreement,
which all investors must complete. There are questions in the subscription
agreement that determine whether the purchaser is an accredited
or nonaccredited investor. In some smaller offerings, investors complete
an investor letter. 


Disclosure Requirements

The guiding principle behind all offerings of securities, whether public or
private, is full disclosure of all material facts concerning the company and
the offering. This is so an investor can make an informed investment
decision. It is always advisable to err on the side of inclusion in terms of
disclosure.
 

All disclosures must be in writing and made available to each purchaser
at a reasonable time prior to the purchase of the securities. Each
investor must have the opportunity to ask questions and receive answers
concerning the terms and conditions of the offering. The investor may
request any additional information that the issuer possesses, or can
acquire without unreasonable effort or expense, that is necessary to verify
the accuracy of the information provided in the disclosure document.
 

Essentially, every investor must have equal access to information. An
issuer should not rely upon ad hoc conversations with individual investors
to convey all of the information necessary to provide full disclosure. For
these reasons, it is important to draft a clear and concise document containing
all material information. That document is referred to as a private
placement memorandum (PPM).

Private Placement Memorandum

The PPM is intended to be an all-inclusive document providing specific
information on the company, its business, its management, the risks
involved in the investment, and a description of the securities offered.
Much like a business plan, it is imperative that the principals of the company
participate in the process of drafting a disclosure document to ensure
the accuracy and completeness of the information. In addition, an understanding
of the private offering exemption rules is essential, because if you
violate any of the rules you could get into trouble with the SEC or state
securities administrator. 


THE PRIVATE PLACEMENT MEMORANDUM
The information in the PPM should include the following.
• A summary of the offering, containing a synopsis or snapshot of the
information that will be discussed in detail throughout the rest of the document,
including (but not limited to):

  • the name, address, and telephone number of the company; 
  • the date of the offering document;
  • a description of the securities being offered;
  • a description of any minimum dollar amount that has to be invested by an investor;
  • any minimum dollar amount that must be raised in the offering before the funds are spent by the company;
  • the total amount of money being raised;
  • any escrow requirements of the offering; and,
  • the resale or transfer restrictions of the securities.
• A cover page that contains information about any commissions paid
to selling agents or finders (where allowed by law) and disclaimers
about the high risk nature of the investment and the fact that the securities
have not been recommended or approved by any federal or
state securities commission and are being offered under an exemption
from registration.
• A table of contents to provide a road map for the document.
• A description of the company, including the name of the company, date,
state of incorporation, street address, telephone number, and contact
person.
• A description of the factors that the company considers to be the most
substantial risks to an investor (risk factors) in this offering. This includes
all the facts and circumstances that otherwise make the offering high risk
or speculative. The following are possible risk factors that will have to
be tailored to the company’s unique situation—some will be applicable
and others will not:

  • the limited operating history of the company; 
  • the potential fluctuation of operating results; 
  • the intensity of competition in the market or industry;
  • the company’s business model (if unique);
  • the dependence on key personnel of the company;
  • the dependence on third-party vendors for goods and services;
  • the need to hire and retain skilled personnel;
  • the timing of positive revenue generation;
  • the need for additional capital;
  • applicable government regulations that affect the company;
  •  the need to expand operations;
  • the need to obtain and maintain intellectual property protection;
  • any conflicts of interest that exist among the company and officers,
    directors, or key employees;
  • the fact that this is a high-risk investment—that the investors may lose
    their entire investment;
  • the heavy reliance on the plans and concepts of management;
  • the arbitrary determination of the offering price of securities—the fact
    that no independent valuation of the company was conducted
  • the resale and transfer restrictions of the securities imposed by the limited
    offering exemption rules;
  • the fact that no dividends are anticipated in the near future;
  • if there are no escrow provisions, the funds raised in the offering may
    be used immediately by the company;
  • the lack of an independent review of the information in the offering—
    the investor must rely upon the company for the accuracy of the information;
  • that the securities have not been registered with or approved by any
    federal or state securities commission;
  • that any forward-looking statements in the document are based on
    assumptions made by the company; and,
  • that the financial projections in the document are based on assumptions
    made by the company. 
  • Description of the business of the company, including
  • what the company does and proposes to do, including what products
    or goods are or will be produced, or services that are or will be rendered;
  • how these products or services are to be produced;
  • how the company intends to carry out its activities;
  • the industry and competition of the company;
  • the company’s marketing strategies;
  • any firmly written orders for products or services;
  • the number of employees and anticipated employees;
  • any real property and intellectual property that the company owns or
    has rights to;
  • the extent to which the company operations depend on patents, copyrights,
    trade secrets, know-how, or other proprietary information, and
    the steps undertaken to protect this intellectual property;
  • whether the company’s business, products, or properties are subject
    to government regulation, indicating the nature and extent of regulation
    and its effects on the company;
  • the names of any subsidiaries and which, if any, are included in the
    financial statements; and,
  • the material events in the development of the company, including any
    mergers or acquisitions during the past five years—or for whatever
    lesser period the company has been in existence—and any pending
    or anticipated mergers, acquisitions, spin-offs, or recapitalizations.
    • If the company was not profitable during the last fiscal year, list the
    events or milestones that—in management’s opinion—must or should
    occur in order for the company to become profitable, and the manner
    in which the company will achieve these milestones. Also, state the
    probable consequences to the company if delays occur.
    • Description of the offering price factors and indicate:
  • what the net, after-tax earnings were for last year;
  • the offering price of securities as a multiple of earnings if the company
    had profits; 
  • what the net tangible book value of the company (the total assets
    minus total liabilities) is (if the net tangible book value is substantially
    less than the offering price, explain the reasons for the variation);
  • the details of all other securities offerings in the last twelve months;
  • what percentage of the outstanding shares of the company investors
    will own after this offering; and,
  • what the post-offering value of the company will be.
    • Description of what the funds raised in this offering will be used for,
    including such categories as:
  • legal and professional consultants;
  • intellectual property protection;
  •  research and development;
  • marketing and advertising;
  • repayment of debt;
  • acquisition of assets;
  • salaries and benefits;
  • insurance;
  • lease or purchase expenses;
  • travel and entertainment;
  • inventory;
  • working capital (office expenses, telephone, etc.); and,
  • expenses of the offering.
    • Indicate whether the company anticipates having cash flow or liquidity
    problems in the next twelve months, or is subject to any unsatisfied judgments,
    liens, or settlement obligations.
    • State whether the proceeds of the offering will satisfy the company’s
    cash flow requirements for the next twelve months or whether it will be
    necessary to raise additional funds.
    • Describe the capitalization of the company from the most recent balance
    sheet date, with any adjustments since then, and also as adjusted
    for the sale of securities now being sold. 
  •  
  • • Describe the securities, indicating:
  • the attributes of the securities being offered, including the type (common,
    preferred, promissory notes, etc.), voting rights, dividend rights,
    liquidation preference, conversion rights, redemption rights, etc.;
  • any other outstanding securities; and,
  • whether there is any debt or other class of securities that have the right
    to be paid before the securities now being sold.
    • Describe who will be selling the securities. Typically, securities offered
    through private placements are offered by the officers, directors, and
    key employees of the company. The company may, however, employ a
    licensed selling agent or finder (where allowed by law).
    • Describe any compensation to selling agents or finders, if the selling
    agents or finders will be held harmless for any mistakes they might
    make, and if there is any kind of business or personal relationship
    between the selling agent or finder and the company.
    • Describe the resale or transfer restrictions to which the securities are
    subject.
    • Identify any escrow agent that will be used to hold the securities if there
    is a minimum amount to be raised in the offering. The escrow agent
    holds the money until the minimum amount is raised. If the minimum
    amount is not raised, the escrow agent returns all monies to the
    investors, with or without interest, as provided in the PPM.
    • Explain the resale restrictions of any presently outstanding securities and
    when those restrictions will expire.
    • If the company has paid dividends, made distributions, or redeemed
    any of its securities in the past five years, describe when and how much.
    • Describe the officers and key personnel of the company, indicating:
  • the employment, education, business or personal bankruptcy, and litigation
    history of all officers for the past five years, an
  •  any details of any key man life or other insurance policies on the officers
    and key personnel. Key man insurance is used for business purposes,
    usually to reimburse a company for the loss it sustains when an
    important member of the company dies. 
  • • Describe the directors of the company, indicating:
  • the number of directors and any special election or voting trust
    arrangements for the election of directors;
  •  the employment, education, business or personal bankruptcy, and litigation
    history of all directors for the past five years; and,
  • any details of any key man life or other insurance policies on the
    directors.
    • Provide information on the principal owners of the company (those who
    directly or indirectly own 10% or more of the presently outstanding common
    or preferred stock) and how much they paid for their stock.
    • Describe the management relationships, transactions, and remuneration,
    and:
  • describe any conflicts of interest that the officers, directors, and key
    personnel have;
  • describe if any of the officers, directors, key personnel, or principal
    stockholders are related by blood or marriage;
  • provide details if the company has made loans to or is doing business
    with any of its officers, directors, key personnel, or principal stockholders,
    or if they have guaranteed or co-signed any of the company’s
    debt or other obligations;
  • list all salaries and compensation to the officers, directors, and key
    personnel for the past and upcoming year, and describe any employment
    agreements the company may have;
  • list any outstanding stock purchase agreements, stock options, or warrants;
    and,
  • if the business is highly dependent upon the services of certain key
    personnel, describe noncompete or nondisclosure agreements the
    company has with them.
    • Describe any past, pending, or threatened litigation or administrative
    actions that have had or may have a material effect upon the company’s
    business, financial condition, or operations, including any litigation or
    action involving the officers, directors, or key personnel.
    • If it is anticipated that any significant tax benefits will be available to
    investors, discuss them as they relate to the offering. 
  • • Describe any other material factors that could affect the company or its
    business, or that are necessary to make any other information in this
    document not misleading or incomplete.
    • For companies that have a significant operating history, include a management
    discussion and analysis of certain relevant factors, such as:
  • if the company’s financial statements show losses from operations, the
    causes and what steps the company has taken or will take to address
    these causes;
  • any trends in the company’s historical operating results;
  • if the company is selling products and had significant sales last year
    (state the existing gross margin as a percentage of sales and the anticipated
    gross margin for the next year of operations);
  • any foreign sales, domestic government sales, and anticipated
    changes; and,
  • any strategic alliances, corporate partnerships, or special marketing
    arrangements.
    • Appendices to the PPM should include:
  • subscription documents
  •  financial statements of the company (balance sheet and income
    statement);
  • financial projections (if used);
  • operating agreement (in the case of an LLC); and,
  • any other documents and agreements material to the offering. 
  •  

HOW TO...Begin Drafting a Private Placement Memorandum

Work closely with an attorney that specializes in securities law to draft your
PPM. To begin the process, organize and provide copies of the the following
documents to your attorney:
  • articles of organization and operating agreement for an LLC;
  • articles of incorporation and bylaws for a corporation;
  • minutes of board of directors and shareholder meetings for a corporation;
  • business plan and financial projections;
  • financial statements (for two years or from inception);
  • a list of how you intend to spend the money raised in the offering (use of proceeds);
  • any promissory notes or debt instruments the company has entered into;
  • joint venture agreements or contracts with strategic partners (companies depended on to make, sell, or distribute products or services);
  • any employment and work made for hire agreements;
  • documentation of any litigation the company is involved in;
  • any real and material personal property owned by the company;
  • documentation of any intellectual property (patents, trademarks, or copy rights);
  • any intellectual property assignments, licenses, or agreements pertaining to copyright, trademark, trade secret, or patent filings, including vendor agreements; and,
  • all significant contracts or agreements.

No General Advertising or General Solicitation of Securities.

In a private placement, the company or anyone acting on behalf of the company
may not offer or sell the securities through any form of general advertising
or solicitation. Two examples of these types of prohibited activities
are set forth in Regulation D.
1. Any advertisement, article, notice, or other communication published
in any newspaper, magazine, or similar media or broadcast over television
or radio.

2. Any seminar or meeting whose attendees have been invited by any
general solicitation or general advertising.

General solicitation is allowed for registered (public) offerings, but not
for private placements. By their nature, private placements must be sold to
a limited number of investors. If the company or its principals have a preexisting
relationship with those persons to whom the offering is made, then
prohibitions against general solicitation do not apply.

Consequently, an investor meeting could be held to discuss the offer, as
long as the attendees were not solicited through general advertising and the
company or its principals had a preexisting relationship with the attendees.

Do not post a PPM on your company’s website. Allowing unrestricted
access to your PPM on the Internet is a proven way of receiving a warning
letter from the enforcement division of the SEC or your state securities
administrator. It is viewed as a violation of the prohibition against general
solicitation and advertising.

You can post your PPM on the Internet if (1)
the offering is to accredited investors only who have completed an investor
questionnaire and (2) they have been prescreened by the company prior to
being given access to the PPM. Access to the PPM should be password-protected
with a record kept of all persons to whom access is granted.
Registered offerings, which are not subject to the general solicitation rules,
can be sold through the Internet under certain circumstances.

HOW TO...Sell Securities in a Private Placement

  • Prepare a private placement memorandum with appropriate appendices and a subscription agreement.
  • File a Form D with the SEC and then file with each state in which a purchaser lives.
  • Filing fees may be charged in any of the states, and they may require a U-2—consent to service of process—be filed.

Limitations on Resale of Securities. 


Securities purchased in a private placement offering are restricted securities.
They cannot be freely transferred or resold. A restrictive legend should be included in the PPM
and on the actual certificate for the shares being purchased that states:

The securities represented hereby have not been registered under the
Securities Act of 1933, as amended (the Act) and may not be offered,
sold, or otherwise hypothecated unless and until registered under the
Act; or in the opinion of counsel, in form and substance satisfactory to
the issuer of these securities, such offer, sale or transfer, pledge, or
hypothecation is in compliance with the Act.

Under Rule 144, a one-year holding period is the minimum required
period for resale of restricted securities subject to certain volume restrictions.
After two years, the security may be traded without limitation unless
you are an officer, director, or more then 5% shareholder. In that case, you
continue to be subject to the volume restrictions of Rule 144 until you no
longer occupy any of those positions for more than ninety days.

This information is relatively useless to shareholders of nonpublic companies, since
there is no market for their securities anyway. The restrictions of Rule 144
only apply to brokerage trades of securities (sales in the public markets).
You can sell or transfer restricted securities in a private (nonbrokered) transaction
as long as there is a private sale exemption available.

The issuer must take reasonable steps to inform investors that they are
purchasing restricted securities, that they are acquiring the securities for
their own purposes, and that they are not buying the securities with the
intention of reselling or transferring them. Normally, the investor makes
these representations in the subscription documents or in the investor letter.

The Sale of Securities and the Issuer Exemption

Once you have decided to sell securities in your company, you can sell them
yourself under what is called an issuer’s exemption or you can engage a licensed
broker-dealer to sell for you. Federal and state securities laws require people
who sell securities to be licensed unless an exemption from licensure exists.

Federal securities rules permit any partner, officer, director, or employee
of an issuer of the securities to make and accept offers to purchase securities,
as long as that person:

• is not disqualified from selling securities for another reason;
• does not receive commissions or other remuneration based directly or
indirectly on the sale of the securities;
• is not a broker or dealer, or an associated person of a broker or dealer
of securities, at the time of the offering or within twelve months preceding
the offering of securities;
• primarily performs, or is intended to primarily perform, at the end of
the offering, substantial duties for or on behalf of the issuer otherwise
than in connection with the transaction of securities; and,
• does not participate in selling an offering of securities for any issuer
more than once every twelve months.

Most states have a comparable provision to the federal issuer’s exemption.
If the company engages a licensed broker-dealer, they customarily enter into
a placement agreement that sets forth the terms of the selling engagement.
Broker-dealers are licensed with the National Association of Securities Dealers
(NASD) and with the states in which they conduct business.

Some companies enlist individuals or companies to act as finders of potential
investors. Finders are under the same limitation as issuers in that they can
only approach people with whom they have had a preexisting relationship.
Finders can only refer leads to the company and cannot offer the securities or
discuss the offering with any prospective investor. If finders receive referral fees
based upon a percentage of the amount raised, they run the risk of being
regarded as unlicensed brokers under federal and state securities laws.

Alert!
The legitimate use of a finder depends upon the law of the state where the
investor resides. Some states allow a limited use of finders, while others are stridently
opposed to finders. Check with that state’s securities administrator and
work with an attorney experienced in securities law before using a finder.


 Integration of Offerings

One of the limitations with a Rule 506 offering is that you are limited to
thirty-five non-accredited purchasers in any one offering, and you cannot get
around this limitation by creating multiple offerings, of smaller portions.
When two or more offerings are substantially similar, the SEC treats them
as a single integrated offering and applies the thirty-five person limitation to
the combined offerings. The following are the factors to consider when
deciding whether two offerings will be integrated.


• Are the different offerings part of a single plan of financing?
• Are the offerings offering the same type of security?
• Are the offerings made at or about the same time?
• Is the same type of consideration to be received in both?
• Are the offerings made for the same general purpose?


The best way to avoid having two offerings integrated is to either offer
substantially different types of securities in subsequent offerings that are
close together in time or wait six months between offerings. The six month
rule—no securities sold six months before or six months after—is another
safe harbor provision. If you meet the time requirements of the safe harbor
rule, you do not have to consider the factors mentioned and you are free to
offer a similar or identical security.


If your company seeks to raise several million dollars in a private placement,
holding to the thirty-five non-accredited limitation can become problematic.
As a possible strategy, the company could stage the total capital
raise in phases, six months apart, to avoid integration. Integration is only an
issue with the number of non-accredited investors since Regulation D allows
an unlimited amount of accredited investors. If, for example, your second or
third round is sold to accredited investors only, the issue of integration does
not arise.


Offering different types of securities is another viable solution. For example,
sell common stock in your first offering. Close that offering and then
open a second offering selling a class of preferred stock.



 QUICK Tip
Avoid Integration Problems: The best way to avoid integration is to wait six
months between rounds of raising capital. Alternatively, sell a different security,
such as preferred stock after common stock, or a debt instrument so the two
offerings are very different from one another.


State Securities (Blue Sky) Laws

Blue sky laws is the term given to the myriad state regulations that are
written to protect investors. The term blue sky originated in the early 1900s
when a Supreme Court justice declared his desire to protect investors from
speculative ventures that had “as much value as a patch of blue sky.” In the
United States legal system, there are federal and state statutes that regulate
the sale of securities. With the one possible exception, both federal and
state securities laws must be considered in an offering.


When selling a security in a private placement, the company must find
an exemption at both the federal and state level. Some state exemptions
mirror federal exemptions, and other state exemptions are unique to the
state. Exemptions are not mutually exclusive, such that an offering may be
able to claim multiple exemptions.


State securities laws regulate the sale of securities within their borders.
When determining which state securities law applies, look to the state in
which the purchaser resides. It makes no difference whether you sell a security
to a Texas resident while attending a meeting in California—Texas blue
sky laws apply.


Exemptions from registration of securities vary among the states, but
there is some common ground. Most state exemptions allow for ten purchasers
during any twelve-month period, if the seller reasonably believes
the buyer is purchasing for investment (as opposed to wanting to resell the
securities) and no commission or other remuneration is paid for soliciting
any buyer. 


Most states set a dollar limit on these exemptions and require a
disclosure document to be drafted, and as always, antifraud provisions
apply. Also, these state transactional exemptions are not mutually exclusive,
so you may qualify for one or more at the same time. 


Check with your state securities administration or an attorney experienced in securities offerings
before undertaking any offering of securities.

Notice Filings of Securities

The National Securities Market Improvement Act of 1996 preempted state
registration provisions for transactions that are exempt from registration
under Rule 506 of Regulation D of the Securities Act of 1933, but allowed
the states to preserve notice filing requirements that are substantially similar
to the Rule 506 requirements.


Notice of a Rule 506 offering is accomplished by completing and filing
Form D, Notice of Sale of Securities Pursuant to Regulation D, which gives the
contact information of the company selling the securities and the details of
the offering, to the Securities and Exchange Commission (SEC) in
Washington, D.C., and filing a copy of the Form D with each state in which
a sale of securities is made. Naturally, the states charge a fee for this notice
filing that varies from state to state.


Most states also require the filing of Form U-2, Uniform Consent to Service
of Process, which designates the state securities administrator as the person
to contact for any complaints lodged against the company selling securities.
A few states also require Form U-2A, Uniform Corporate Resolution, to be
filed stating that a corporation’s board of directors authorized the sale of the
securities.


The following is a comprehensive list of the forms and fees required by
the SEC and each state for notice filings under Regulation D, Rule 506.
With the exception of Hawaii and New York, all notice filings are made
after the first sale of securities in the state. If no sales are made, then no
filing is required.


Alert!
Both federal and state statutes change frequently, particularly filing fee
amendments, so it is advisable to check for current information before filing
any document. 


SECURITIES AND EXCHANGE COMMISSION BY STATE

Federal: File one original and four copies of Form D no later
than fifteen days after the first sale of securities.
There is no filing fee.


Alabama: File Form D, Form U-2, and the Offering Documents
with the Alabama Securities Commission along with
a certified or cashier’s check for $250 made out to
State Securities Commissioner of Alabama no later
than fifteen days after the first sale of securities in
the state.


Alaska: File Form D and Form U-2 with State Appendix with
the Department of Commerce and Economic
Development, Division of Banking, Securities and
Corporations along with a check for $600 made
out to State of Alaska no later than fifteen days after
the sale of securities in the state. The notice filing
must be renewed every twelve months.


Arizona: File Form D with the Arizona Corporation
Commission, Securities Division along with a check
for $250 made out to Securities Division, Arizona
Corporation Commission no later than fifteen days
after the first sale of securities in the state.


Arkansas: File Form D with the Arkansas Securities Department
along with a fee of 1⁄10 of 1% of the maximum aggregate
offering price at which the securities would be
offered in Arkansas, with minimum and maximum
fees of $100 and $500, respectively, in the form of
a check made out to Arkansas Securities
Department no later than fifteen days after the first
sale of securities in the state.


California:  File Form D, Form U-2, and the statement, “This filing
is pursuant to Rule 506 and §18(b)(4)(d) of the
Securities Act of 1933,” with the California
Department of Corporations along with a check for
$150 made out to California Department of
Corporations no later than fifteen days after the first
sale of securities in the state.
 


Colorado: Even though it is not required to make a notice filing
in Colorado unless the issuer makes more than ten
sales in Colorado, it is strongly recommended that a
notice filing be made with the first sale of securities
just to let them know that you are making sales in
Colorado under Rule 506. File Form D and a cover
letter with the Colorado Department of Regulatory
Agencies, Division of Securities along with a check
in the amount of $75 made out to the Colorado
State Treasurer.


Connecticut: File Form D and Form U-2 with the Department of
Banking, Securities and Business Investments
Division along with a check in the amount of $150
made out to the Connecticut State Treasurer no later
than fifteen days after the first sale of securities in
the state. In addition, file Connecticut Sales
Agent/Broker/Dealer Licensing Questionnaire.


Delaware: File Form D with State Appendix and Form U-2 with
the Secretary of State no later than fifteen days after
first sale of securities in the state. There is no notice
filing fee in Delaware.


District
of Columbia:  File Form D and Form U-2 with the Division of
Securities, Department of Insurance and Securities  Regulation along with 

a check for $250 made out to DC Treasurer no later than fifteen days after first
sale of securities in the District.


Florida :There is no notice filing requirement in Florida if you
are an issuer-dealer or if it is a limited offering
defined as no more than thirty-five nonaccredited
purchasers with no advertising.


Georgia:  File Form D and Form U-2 with the Georgia Office
of Secretary of State, Securities and Business
Regulation along with a check in the amount of
$250 made out to the Secretary of State no later
than fifteen days after the first sale of securities in
the state.


Hawaii : File Form D with State Appendix, Form U-2, and
Form U-2A with the Hawaii Department of check or money order in the amount of $200 made
out to the Commissioner of Securities, State of
Hawaii not later than ten days after the first offer of
securities in the state.


Idaho:  File Form D and Form U-2 with the Idaho
Department of Finance along with a $50 check
made out to the Idaho Department of Finance no
later than fifteen days after the first sale of securities
in the state.
 

Illinois:  File Form D with the Illinois Secretary of State,
Securities Department along with a check in the
amount of $100 made out to the Secretary of State
of Illinois no later than fifteen days after the first sale
of securities in the state.


Indiana : File Form D and Form U-2 with the Indiana Office of
Secretary of State, Securities Division no later than
fifteen days after the first sale of securities in the
state. There is no notice filing fee in Indiana.


Iowa : File Form D with State Appendix and Form U-2 with
the Iowa Division of Insurance, Securities Bureau
along with a check or money order in the amount of
$100 made out to the Insurance Commissioner of
Iowa no later than fifteen days after the first sale of
securities in the state.


Kansas: File Form D with the Kansas Office of Securities
Commissioner along with a check or money order in
the amount of $100 made out to the Securities
Commissioner of Kansas no later than fifteen days
after the first sale of securities in the state.


Kentucky: File Form D and Form U-2 with the Kentucky
Department of Financial Institutions along with a
check in the amount of $250 made out to Kentucky
State Treasurer no later than fifteen days after the
first sale of securities from or into Kentucky.


Louisiana: File Form D, Form U-2, and Form U-2A with the
Louisiana Commissioner of Securities along with a
check in the amount of $300 made out to the
Louisiana Commissioner of Securities no later than fifteen
days after the first sale of securities in the state.
Commerce and Consumer Affairs along with a 


Maine :File Form D with State Appendix and Form U-2 with
the Maine Securities Administrator along with a
check in the amount of $300 made out to Maine
Securities Administrator no later than fifteen days
after the first sale of securities in the state.


Maryland :File Form D and Form U-2 with the Maryland Office
of Attorney General, Division of Securities along
with a check in the amount of $100 made out to the
Office of the Attorney General no later than fifteen
days after the first sale of securities in the state.


Massachusetts :File Form D with the Massachusetts Secretary of the
Commonwealth, Securities Division along with a
check (no personal checks) or money order made
out to the Commonwealth of Massachusetts according
to the following schedule no later than fifteen
days after the first sale of securities in the state.
Less than $2,000,000 = $250
$2,000,000–$7,500,000 = $500
More than $7,500,000 = $750


Michigan :File Form D and Form U-2 with the Michigan
Department of Consumer and Industry Services,
Corporation, Securities and Land Development
Bureau along with a check or money order in the
amount of $100 made out to the State of Michigan
no later than fifteen days after the first sale of securities
in the state.


Minnesota: File Form D and Form U-2 with the Minnesota
Department of Commerce along with a check or
money order in the amount of $50 made out to the
State Treasurer no later than fifteen days after the
first sale of securities in the state.


Mississippi: File Form D with State Appendix with the Mississippi
Office of Secretary of State, Business Services
Division along with a check or money order in the
amount of $300 made out to the Secretary of State
no later than fifteen days after the first sale of securities
in the state.


Missouri File Form D and Form U-2 with the Missouri Office
of the Secretary of State along with a check or
money order in the amount of $100 made out to
the Director of Revenue, State of Missouri no later
than fifteen days after the first sale of securities in
the state.


Montana: File Form D and Form U-2 with the Montana State
Auditor’s Office, Securities Department along with
cash or negotiable instrument in the amount of
$200 for the first $100,000 of initial issue or portion
thereof in Montana, based on the offering
price, plus 1⁄10 of 1% of any excess over $100,000,
with a maximum fee of $1,000 made out to the
Montana State Auditor, Securities Commissioner no
later than fifteen days after the first sale of securities
in the state.


Nebraska: File Form D and Form U-2 with the Nebraska
Department of Banking and Finance, Bureau of
Securities along with a corporate check or money
order in the amount of $200 made out to
Department of Banking and Finance no later than
thirty days after the first sale of securities in the state.
Nevada File Form D with State Appendix with the Nevada
Secretary of State, Securities Division along with a
cashier’s check, certified check, or money order in
the amount of $300 made out to the Secretary of
State no later than fifteen days after the first sale of
securities in the state.


New Hampshire: File Form D with State Appendix, Form U-2, and
Form U-4 (if no broker-dealer is used) (just pages 2,
3, and 4 and original signature, no CRD # required)
with the New Hampshire Secretary of State along
with a check in the amount of $500 made out to the
State of New Hampshire no later than fifteen days
after the first sale of securities in the state.


New Jersey: File Form D and Form U-2 with the New Jersey
Department of Law and Public Safety, Division of
Consumer Affairs along with a check or money
order in the amount of $250 made out to the State of New Jersey, Bureau of Securities no later than fifteen days after the first sale of securities in the state.
Form U-2 should appoint the Chief of the Bureau of
Securities as the Attorney for Service of Process.


New Mexico: File Form D with State Appendix and Form U-2 with
the Regulation & Licensing Department, Securities
Division along with a check in the amount of $350
made out to the Securities Division, State of New
Mexico no later than fifteen days after the first sale
of securities in the state.


New York: Prior to any offer or sale of securities in or from New York:
1. New York State Department of Law. File an original
NY Form 99, a copy of Form U-2 (if an out
of state issuer), and a copy of State Notices form
with the New York Department of Law along with
a certified check or money order according to
the following schedule made out to the New York
State Department of Law:
Less than $500,000 = $500
More than $500,000 = $1,200
2. New York State Department of State. File a copy
of NY Form 99, an original Form U-2 (if an out
of state issuer), and an original State Notices
form with the New York State Department of
State along with a certified check or money order
in the amount of $75 made out to the New York
State Department of State and a certified check
or money order in the amount of $35 made out
to the New York State Department of State for the
filing of the Form U-2.


North Carolina: File Form D and Form U-2 with the Department of
the Secretary of State, Securities Division along with
a certified check or money order in the amount of
$350 made out to the Office of the Secretary of
State no later than fifteen days after the first sale of
securities in the state.


 North Dakota:File Form D and Form U-2 with the North Dakota
Office of Securities Commissioner along with a
check (no personal checks) in the amount of $100
made out to North Dakota Securities Commissioner
no later than fifteen days after the first sale of securities
in the state.


Ohio: File Form D with State Appendix with the Ohio
Department of Commerce, Division of Securities
and Form U-2 with the Ohio Secretary of State
along with a check or money order in the amount
of $100 made out to the Division of Securities no
later than fifteen days after the first sale of securities
in the state.


Oklahoma: File Form D, Form U-2, and Form U-2A with the
Oklahoma Securities Department along with a
check in the amount of $250 made out to the
Oklahoma Securities Department no later than fifteen
days after the first sale of securities in the state.


Oregon: File Form D with State Appendix with the Oregon
Department of Consumer & Business Services,
Division of Finance and Corporate Securities along
with a check in the amount of $225 made out to the
Department of Consumer & Business Services no
later than fifteen days after the first sale of securities
in the state.


Pennsylvania: File Form D with the Pennsylvania Securities
Division along with a check in the amount of
$500 made out to the Commonwealth of
Pennsylvania no later than fifteen days after the
first sale of securities in the state.


Rhode Island: File Form D and Form U-2 with the Rhode Island
Department of Business Regulation, Securities
Division along with a bank draft or certified check
in the amount of $300 made out to the Department
of Business Regulation—Securities Division no later
than fifteen days after the first sale of securities in
the state.


South Carolina: File Form D and Form U-2 with the South Carolina
Office of the Attorney General, Division of Securities along with a certified check, or cashier’s check in the amount of $300 made out to the Attorney
General of South Carolina no later than fifteen days
after the first sale of securities in the state.


South Dakota: File Form D and Form U-2 with the South Dakota
Department of Commerce and Regulation, Division
of Securities along with a check, certified check, or
postal money order in the amount of $200 made
out to the Division of Securities no later than fifteen
days after the first sale of securities in the state.


Tennessee: File Form D with State Appendix, Form U-2 and a
copy of the offering documents with the Tennessee
Department of Commerce and Insurance, Division of
Securities along with a check in the amount of $500
made out to the Department of Commerce and
Insurance no later than fifteen days after the first
sale of securities in the state.


Texas: File Form D with State Appendix and Form U-2 with
the Texas Securities Board along with certified
check, cashier’s check, or money order in the
amount of 1⁄10 of 1% of total offering (maximum fee
of $500) made out to the State Securities Board no
later than fifteen days after the first sale of securities
in the state.


Utah: File Form D with State Appendix and Form U-2
with the Utah Department of Commerce, Division
of Securities along with a check in the amount of
$60 made out to the Division of Securities no later
than fifteen days after the first sale of securities in
the state.


Vermont: File Form D with State Appendix and Form U-2 with
the Vermont Department of Banking, Insurance,
Securities and Health Care Administration along
with a check or money order in the amount of $1.00
for each $1,000 of the aggregate amount of the
offering, with minimum and maximum fees of $400
and $1,250 made out to Treasurer of State of
Vermont no later than fifteen days after the first sale
of securities in the state.


Virginia File Form D with State Appendix and Form U-2 with
the Virginia State Corporation Commission, Division
of Securities and Retail Franchising along with a
check or money order in the amount of $250 made
out to the Treasurer of Virginia no later than fifteen
days after the first sale of securities in the state.


Washington: File Form D and Form U-2 with the Washington
Department of Financial Institutions, Securities
Division along with a check in the amount of $300
made out to the State Treasurer no later than fifteen
days after the first sale of securities in the state.


West Virginia: File Form D and Form U-2 with the West Virginia
State Auditor, Securities Division along with a check
or money order in the amount of $250 made out to
State Auditor no later than fifteen days after the first
sale of securities in the state.


Wisconsin: File Form D with State Appendix with the Wisconsin
Department of Financial Institutions, Securities
Division along with a check in the amount of $200
made out to Office of Commissioner of Securities no
later than fifteen days after the first sale of securities
in the state.


Wyoming: File Form D and Form U-2 with the Wyoming
Secretary of State, Securities Division along with a
check in the amount of $200 made out to Secretary
of State no later than fifteen days after the first sale
of securities in the state. 


Rule 504 and 505 Offerings

Federal Regulation D actually contains provisions for three types of limited
offerings in Rules 504, 505, and 506. Rule 504 contains an exemption for
an offering up to $1,000,000 in securities by an issuer during any twelve
month period. No specific disclosures are required, but the company is still
subject to the anti-fraud rules. 


In addition, purchasers do not have to meet
any sophistication test and there is no limitation on the number of purchasers.
Rule 504 also allows a limited solicitation of investors; however, most states do not permit solicitation without first registering the offering in the state so the relaxation of this solicitation rules at the federal level is of little practical use.
 

While no specific disclosures are required under Rule 504, it is better
practice to provide full disclosure to investors to avoid later misunderstandings.
Unlike Rule 505 and 506, for which states adopted similar
rules, the states did not adopt rules similar to Rule 504—so the exemption
at the state level is of limited use unless the company files a full state
registration or uses a SCOR offering. Typically, a Rule 504 offering
would, in the absence of a state registration or SCOR compliance, have
to rely on limited state exemptions, such as the ten or under rule, found
in most state blue sky statutes.
 

Rule 505 offerings are limited to $5,000,000 in any twelve-month
period. A disclosure document is required if you sell to any nonaccredited
investors and you are required to provide financial statements to
investors. You are also limited to thirty-five nonaccredited investors and
an unlimited number of accredited investors, but there are no defined
purchaser qualifications.


While there are no qualifications required for purchasers under Rule 505, it
is the best practice to ensure that all nonaccredited purchasers meet the
qualifications established under federal Regulation D—that they have such
knowledge and experience in financial and business matters that they are
capable of evaluating the merits and risks of the prospective investment.
 

When the National Securities Market Improvement Act came along in
1996, Rule 506 became the dominant and preferred choice among companies
offering securities under an exemption from registration because of the
standardized disclosure standards and uniform notice filing procedures, and
Rule 504 and 505 offerings declined because their perceived advantages
were outweighed by their disadvantages. 


SCOR Offerings

Most states have adopted a shortened registration form for limited offerings
being registered at the state level called the Small Corporate Offering
Registration form (SCOR). The SCOR offering is the response of the states
to the federal Rule 504 offering. 


A SCOR offering, which is conducted pursuant to Rule 504 at the federal
level, allows companies to raise up to one million dollars by selling
securities to the general public, and the disclosure and registration requirements
are encompassed in one document, Form U-7, in a question-andanswer
format. The offering price for securities in a SCOR offering must be
at least $5.00 per share, which precludes most small companies from conducting
a SCOR offering.


STATES ADOPTING SCOR REGISTRATION

The following states have either adopted the SCOR registration program or
recognize and accept Form U-7 filings under a state offering exemption.


Alaska Missouri
Arizona Montana
Arkansas Nevada
California New Hampshire
Colorado New Jersey
Connecticut New Mexico
Delaware North Carolina
District of Columbia North Dakota
Florida Ohio
Georgia Oklahoma
Hawaii Oregon
Idaho Pennsylvania
Illinois Rhode Island
Indiana South Carolina
Iowa South Dakota
Kansas Tennessee
Kentucky Texas
Louisiana Utah
Maine Vermont
Maryland Virginia
Massachusetts Washington
Michigan West Virginia
Minnesota Wisconsin
Mississippi Wyoming




 

To conduct a SCOR offering, an issuer must obtain the approval of each
state where it intends to selles securities, which is sometimes a lengthy
process. 


To alleviate some of this burden, some states have banded together
into regional review groups, in which one state will take the lead on
reviewing a SCOR offering and the rest of the states in the region
acknowledge the lead state’s approval once it is granted. In addition,
Alabama, Nebraska, and New York have not adopted the SCOR offering.
The use of SCOR offerings has not been as widespread as was intended.


This may be because of the lack of uniformity in the states’ review
processes. SCOR was designed to create a simplification of the small issue
registration process, but the disclosure requirements of the Form U-7 and
review process believes that for admirable goal. Any registration of a SCOR offering
requires a review by one or more state securities administrators, which
increases the time and effort it takes for an issuer to make an offering. 


QUICK Tip

Put Form U-7 to Work for You: While the promise of simplified state registrations
under SCOR may not have lived up to their intended potential, the Form U-7
SCOR offering form is an excellent checklist and guide for reference when
drafting a disclosure document for any offering of securities. 


Regulation A Offerings

Regulation A offerings are small public offerings—limited to $5,000,000
during any twelve-month period. In addition, Regulation A offerings allow
an unlimited number of investors, permit general solicitation of investors,
and have no qualification standards for investors. The Form U-7, which
was developed for use with SCOR offerings, may also be used for a
Regulation A offering.


You are required to file a registration statement with the SEC that
includes two years of unaudited financial statements. Regulation A offerings
are reviewed by the SEC like any other public offerings, and must be
cleared or declared effective by the SEC before they can be sold. The SEC
review process could take three to six months from the date of filing, and
therefore, increases the costs to the company and amount of time associated
with starting to raise capital.


Follow-up and Closing an Offering

Once you have made a sale of securities to an investor, there are essential
record keeping requirements. The following are some guidelines for keeping
accurate records of your securities offering.

  • When a sale of securities appears imminent, check the notice filing requirements of the state in order to have timely filings.
  • Open a separate file on each investor. In that file, place the completed subscription documents, copies of the check you received from the investor, and any correspondence with the investor.
  • Check the subscription documents for completeness and make certain they contain all of the information requested. Also, be certain they have been signed in all appropriate places. In particular, make sure the investor has noted whether they are an accredited investor.
  • When you have accepted the subscription, sign it in the appropriate place, keep the original document, and send a photocopy and the investor’s stock certificate (or LLC membership unit certificate) to the investor. You should also send a welcome letter.
  • Keep a master list of investors, including the names, addresses, Social Security numbers, dates and amounts of purchases, number of shares or units purchased, and whether the investor is accredited or nonaccredited.
  • End the offering of securities on a specific documented date and close it out.
  • Send periodic reports to the investors including financial reports. Your shareholder database can be an important source of referrals for accredited investors. If you keep investors informed about the progress of the company and they are satisfied with their investment, you can return to them for further offerings.  
Your shareholder database can be an important source of referrals for
accredited investors. If you keep investors informed about the progress of
the company and they are satisfied with their investment, you can return to
them for further offerings.

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