Generally, a security is an investment instrument that represents either a debt owed or an ownership (equity) stake in an enterprise. From a business perspective, issuing securities is one way for a business to raise money to help finance the company’s expansion or ongoing operations. There are a wide variety of securities, bonds and stocks being the most common.
Bond
A bond is evidence of a debt owed to the bondholder. The issuance of bonds is a method by which an organization can raise money without having to forfeit a portion of the business. Essentially, by issuing bonds, an organization is taking out numerous small loans from a number of lenders. The relationship is one of debtor/creditor. The organization (debtor) is responsible for repaying the debt to the bondholder (creditor) with interest.
Stock
Unlike a bond, stock is not evidence of a debt. Instead, stock represents an ownership interest in the corporation (a piece of the business usually evidenced by a certificate). This interest in the business is usually exchanged for the stockholder’s financial contribution, and the stockholder is generally free to sell that interest to someone else. Unlike a bondholder, a stockholder is an equity (not a debt) investor. Therefore, the amount given to the corporation does not have to be repaid.
Securities regulation is extremely complex. Some law firms devote their entire practice to the execution of securities transactions and compliance with securities laws. This is the briefest of overviews, intended for those who have no familiarity with securities regulation. If you intend to issue securities, you need the advice of an experienced attorney.
Why This Matters
You May Need to Raise Capital:
It is important to know about securities and securities regulation because your attempts to raise capital for your business could be construed as an offering of securities. Note that the rules apply to offers, not just sales of securities. If your capital-raising efforts are construed as an offering of securities and you are not in compliance with the applicable securities regulations (which include disclosure and reporting requirements, registration, and certain fees), you could find yourself subject to civil and criminal charges.
Offer of Securities May be Broadly Interpreted:
Large public stock offerings aren’t the only actions that may be subject to securities regulations. In general, any offer of an equity interest in your company, in exchange for something of value from an investor, could be construed as a sale of securities. The exchange doesn’t have to be cash, although it usually is, and could include certain profit-sharing agreements or ownership interests exchanged for debt guarantees. There are offerings that are exempt from certain securities regulations based on the size of the offering and the sophistication level of the investors. Private placements (securities offerings that are not available to the general public) are also exempt. Securities are regulated at both the federal and state levels. It is possible to be in compliance with federal securities regulations but violate state regulations.
Why Regulate Securities?
Broadly, the purpose of securities regulations is to promote full and fair disclosure of all material information regarding dealings in securities. Full and fair disclosure is intended to protect the interests of potential investors and ensure fair and honest securities dealings, upon which the protection and effectiveness of (among other things) interstate commerce, the national banking system, and Federal Reserve systems depend.
In keeping with this objective, the Sarbanes-Oxley Act was signed into law on July 30, 2002. Under this law, financial documents filed with the Securities and Exchange Commission (SEC) must be certified by a company’s executive officers. Criminal and civil penalties may be imposed for violations of this law.
Securities transactions are regulated by federal laws, state laws, and common law.
Federal Securities Laws
The federal government has enacted a series of statutes governing securities dealings, which authorize the SEC—the federal agency that functions as the watchdog of the securities industry—to issue regulations to ensure that the objectives of the statutes are met. Of these statutes, the most significant from a business owner’s perspective are the Securities Act of 1933, the Securities Exchange Act of 1934, and the exemptions to both. (The Investment Company Act of 1940 is also significant because it regulates mutual funds; however, it has less impact on individual businesses.) Each of those wide-ranging statutes includes numerous specific rules that can be modified by the SEC as necessary.
The Securities Act of 1933 (’33 Act):
Generally, this act, sometimes known as the “truth in securities” act, regulates the initial issuance of securities by the issuer. With some exceptions, the ’33 Act requires that any security offered interstate be registered with the SEC by filing a registration statement that must include descriptions of the company’s business, properties, and the security being offered; information about company management, and financial statements certified by independent accountants. Its main purpose is to ensure that the investing public is fully informed about a security and its issuing company when it is first sold to the public. The ’33 Act also contains provisions intended to prevent fraud in the sale of securities.
The Securities Exchange Act of 1934 (’34 Act):
The ’34 Act governs securities trading. It established the SEC and was enacted primarily to maintain a fair and orderly market for the investing public. The ’34 Act governs corporate reporting, proxy solicitations, tender offers, and insider trading, and prohibits market manipulation, deception, misrepresentation of facts, and fraudulent practices.
Exemptions Under Federal Statutes
Certain qualified offerings are exempt from federal registration. The exemptions apply to small business offerings (less than $1 million worth of securities sold in a year) and offerings made to sophisticated investors, such as accredited investors who are generally investors with sufficient knowledge and experience in business to evaluate the related benefits and risks. Such offerings may be subject to state registration laws. (State laws include similar exemptions.) Even though exempt, filings and fees may be required at both the federal and state levels for the exemption to be effective. No offerings are exempt from the anti-fraud regulations.
State Securities Laws (Blue-Sky Laws)
State securities laws are also known as blue-sky laws. The term is believed to have originated in a 1917 Supreme Court decision over state securities regulations, in which a judge said such laws were aimed at preventing schemes that had “no more basis than so many feet of blue sky.” Most state’s laws typically require companies making offerings to register their offerings before they can be sold. States also have the power and authority to bring actions against security law violators. Some state blue-sky laws provide exemptions, though they may not parallel the federal exemptions.
Blue-sky laws vary from state to state. Even states with identical laws may interpret those laws differently. Failure to comply with the requirements of applicable blue-sky laws can subject a company and its principals to substantial liability. The relevant laws of each state must be consulted prior to making any offers or sales of securities to determine what is permitted and what is not permitted.
Common Law (Judge-Made Law)
In addition to the statutes and regulations discussed, there is a large body of law that governs securities dealings. This law, known as common or judge-made law, consists of decisions rendered by judges in cases involving securities. What this means is that it is possible to conduct an offering that complies with the federal regulations but runs contrary to common law. Briefly, those areas of the common law that impact securities dealings include common law fraud, contract law, and the law of negligence.
If you have questions, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
