WHY DO CPAs NEED TO KNOW
ABOUT SECURITIES LAWS?
- Bank financing is limited, but
businesses need capital to grow
- Owners must seek “friends and family”
financing or find “angel” investors
- CPAs may be first advisors to know
about clients’ plans to seek capital
- Professionals involved may have liability
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WHAT’S THE PROBLEM?
It is illegal to offer securities to the public
unless:
1. The offering is registered with SEC
and/or state regulators OR
WHAT IF RULES ARE BROKEN?
-
Seller must return investor’s money plus
interest, less any profits investors received
-
Joint and several liability for issuer and
persons involved in soliciting sales
-
Plaintiffs’ lawyers will frequently pursue
issuer principals and advisers, possibly
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WHAT IS A “SECURITY”?
-
Stock
-
Notes, Bonds, Debentures – loans from
family members can be securities!
-
Options, calls, puts
WHAT IS A “SECURITY”?
Investment Contract → SEC v. W.J. Howey & Co. (1946)
- Case involved interests in orange groves
(1) A person invests money (2) In a common enterprise (3) Is led to expect profits
(4) Primarily from the efforts of others
- Scotch Whiskey, chinchillas, cemetery lots,
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WHAT IS A “SECURITY”?
What about LLC interests?
- Definitely can be securities for Federal law purposes under the
Howey
test- NC presumption:
- member-managed LLCs not securities - manager-managed LLCs are securities - presumption can be overcome
- a “manager” or “member-manager” must have substantial rights or be expected to provide substantial
services
WHAT DOES IT MEAN TO
“REGISTER”?
1. Traditional Initial Public Offering (“IPO”)
- Very expensive and time consuming
- Underwriters fees, legal fees, accounting fees,
broker’s fees, etc.
- Ongoing reporting (SEC, Sarbanes – Oxley)
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2. Regulation A - “Short-form registration”
- Theoretically, a “streamlined” IPO for
“small” businesses
- Limited to $5,000,000
- Requires full financial disclosures under
GAAP
- Must comply with state blue-sky laws
- Infrequently used because the transaction
ARE EXEMPTIONS AVAILABLE?
Section 4(2) Exemption – non-public offerings
- narrowly construed, multi-factor test - must comply with state blue sky laws
- risky to rely on – burden of proof on issuer - only applies if all investors “shown to be able
to fend for themselves”
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ARE EXEMPTIONS AVAILABLE?
Section 4(6) – Offers only to Accredited Investors
- limited to $5,000,000
- no advertising or public solicitation
- must comply with state “blue sky” laws - only “accredited investors” – see below
ARE EXEMPTIONS AVAILABLE?
Section 3(a)(ii) – Intrastate Exemption
- Issuer must be incorporated and do significant business in state
- Offers and sales only to residents of state - Strictly and narrowly construed
- Issuer can’t have substantial business or assets outside the state
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REGULATION D SAFE HARBORS
- Provides clarity and certainty for private
offerings
- Avoids uncertainty of 4(2) and 4(6) - Allows multi-state offerings
- State blue sky compliance required, except Rule
506
- No public advertising or solicitation allowed
WHAT IS AN “ACCREDITED
INVESTOR”?
Institutional Investors
(Banks, pension funds, insurance companies, etc.)
Nonprofits with over
$5,000,000 in assets
Trusts with assets
over $5,000,000 and run by sophisticated persons
Individuals:
Net Worth over
$1,000,000 excluding principal residence OR
Income over $200,000
OR
Income with spouse
over $300,000
Directors, executives,
Special NC LLC Rules
- If issuer is an LLC, LP, or GP:
- All investors must have $225,000 net worth
excluding home and cars OR $60,000 net worth and $60,000 income
- All investors must receive notice of
requirements
- Must make additional disclosures to NC 10
days before first offer
- Rules generally don’t apply if all buyers are
individuals who will be actively engaged in issuer’s business
REGULATION D – RULE 504
- $1,000,000 limit
- No special disclosures required (but antifraud
laws still apply)
- Per NC rule, may only offer to 25 people - Must follow special NC LLC rules
- File Form D and all sales materials with NC 10
days before first sale (but not if all buyers
“actively engaged” in business, plus up to 5 non-engaged persons)
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REGULATION D RULE 505
- $5,000,000 limit
- 35 unaccredited/unlimited accredited investors - Unaccredited investors must receive full
Regulation A disclosure documents
- No special disclosure required for accredited
investors (but antifraud provisions still apply)
- Simple Form D filing to SEC
REGULATION D RULE 505
- NC rules make Rule 505 unattractive
- issuer must “reasonably believe” investment is
suitable for investors, even accredited
investors (unless sold to accredited investors through registered broker)
- additional NC requirements if LLC
- Form D required 10 days before first sale
- Other burdensome disclosures required if there
RULE 506 – THE REG D “CADILLAC”
-
Best Exemption for Small Business
-Unlimited Offering Amount
-
35 unaccredited investors
-
Unlimited accredited investors
Best part: limited blue sky compliance!
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REGULATION D – RULE 506
- Generally, only accredited investors approached - Full Regulation A disclosures required for
unaccredited investors
- File Form D with SEC and NC 10 days after first
sale
- No special NC requirements for LLCs
- No additional NC filings, even if more than 5
IS MY CLIENT A “BROKER”?
“Effects transactions in securities for the
account of others”
Watch out for commission compensation
If unregistered broker/dealer involved,
investors may have rescission rights
Issuer and broker jointly liable for
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IS MY CLIENT A BROKER?
- “Transaction-based compensation - “success fees”
- “finder’s fees” (very narrow exception) - sales commission
- All brokers must register or be associated with registered firm
- Beware of out of state, unregistered advisors - no-action letters from other states or
What is “Securities Fraud”?
Under Section 10b-5 of ‘34 Act:
“any untrue statement of a material fact or any
omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading”
