Why Engage a Securities Lawyer?
Are you a business
owner who wants to raise capital, give your employees or contractors an
ownership interest in your company, or do any other transactions which involve
your Company’s ownership? Or are you an
attorney with clients whose requirements include these kinds of securities projects? If so, take a look at the following… This is
an example of a relatively simple scenario; yet even in this case the federal
and state securities laws and regulations call for a complex set of filings. And if your transactions involve parties who
live in different states, the complexity gets exponentially greater.
If are a business
owner and your attorney says you should consult a securities lawyer, this
example demonstrates why they are making that recommendation. If you are an
attorney and do not know exactly what each of the item discussed belows is,
then you owe it to your client to consult with a securities law attorney. Often
general business lawyers try to do this work themselves using their corporate
and contracts knowledge, and common sense, which seems like it should
work. Unfortunately, many issues in the
securities law are counter-intuitive, and it is easy to miss the crucial
details which only a securities attorney will catch.
In this example, a Washington
start-up company sold $100,000 of its common stock to 10 investors based on a
copy of their business plan. The
investors live in either Washington or two other states (States A and B). About the same time, the Company granted its
new president, who lives in Washington, shares of common stock. No
offering documents were prepared and no securities law analysis or exemption
filings were done. When they subsequently
engaged a general business lawyer, that attorney contacted me to advise on the
relative risks of not making securities exemption filings versus filing late.
The Investors. My
preliminary recommendation, based only the bare facts above, was that the
Company should file the following exemption filings even though they will be
late:
(a) File a Form D with the SEC (no filing fee),
which must be done on-line after filing a Form ID in order to obtain the required
CIK access codes.
(b) File a hard copy of the Form D, and of Forms U-2
and U-2A, by mail with the Washington Securities Division along with the $50
filing fee for the Section 504 offering equivalent.
(c) File on-line in State A under its small offering
exemption (est. $100-$150 filing fee).
(d) File in “State B” under whatever exemption can
be found after research.
With
respect to the late filing risks, under federal Regulation D, and for the
states like Washington that accept Form D filings for small offerings, filing
late causes the Issuer to lose the safe harbor presumption that the offering
was “non-public” in compliance with Section 4(2) and its state
equivalents. Instead, the burden of proving compliance is shifted to the
Issuer, which is always an undesirable position given 20/20 hindsight in front
of a court or administrative agency faced with an investor who has lost
money. In addition, that proof is subject to the less-than-precise
multi-factor test developed in case law interpreting Section 4(2) over the
years since 1933. That is why complying with Reg D is so
preferable.
That
being said, however, filing under Reg D and under state law small offering
exemption rules does not foreclose the Company from relying on Section 4(2) or
any other available securities registration exemptions. Thus, even if
untimely, making the recommended filings will put the facts contained in the
Form D and other filings contemporaneously of record, and demonstrates a good
faith effort to correct the mistakes of a previously unrepresented or
under-represented client.
If
the Company’s offering disclosure documents were adequate under the federal and
state securities anti-fraud rules, and if the signed investor certifications
were sufficient to support a reasonable knowledge that the investors were
either “accredited” or “sophisticated” investors, then a complaint by a
disgruntled investor is likely to found in the issuer’s favor. Securities
counsel would need to review those documents in order to determine whether they
were adequate under the relevant rules.
The President.
Assuming that the
executive who received equity resides in Washington and did not receive it
pursuant to a filed employee equity compensation plan, I recommended that the
form of the executive’s equity grant agreement (in blank) be filed with the
Washington Securities Division under Washington’s employee plan
exemption. If the executive is not a documented accredited investor, this
filing is necessary to prevent the equity issuance to the executive from being
integrated with, and irrevocably tainting, any accredited investor offering
made within the six months following that stock award.
Securities lawyers are
intimately familiar with all of the reasons why clients, particularly start-ups
or real estate investment companies, think that they do not need to go to all
of this effort or expense. If a client does not understand why all of
this is necessary, here the pros and cons:
Cons. If the Company is found
to have not complied with any available exemption from registering the
securities offering, or of having provided inadequate or misleading disclosure
to its investors, then the Company (a) may be held liable for treble damages to
the complaining investor, and potentially to all of the investors, and (b) may
become subject to a cease and desist order that it would then have to disclose
in any future fundraising efforts. In addition, the individual
directors/officers/managers of the Company might also become subject to similar
cease and desist orders that they would then have to disclose in any future
offering for the Company, or for subsequent employer or other company in which
they were involved. Not good at all for aspiring entrepreneurs and
developers.
Pros. In addition to avoiding
the above risks, there is significant upside to engaging special securities
counsel to prepare fundraising offering documents. First, the Company will receive a
professional-looking presentation document to distribute to potential investors
which should enhance the credibility of the offering. Second, each investor will receive the same
information. This helps alleviate the risk of various Company representatives
inconsistently ad-libbing the offering terms and investment opportunities, and
putting the Company at risk for misleading statements in the 20/20 hindsight of
an investor lawsuit or regulatory administrative hearing. And of course, there
is peace of mind in knowing that the Company or your client is protected.
As we said before,
this example isn’t even a complex securities transaction. If you are a business
person reading this, it almost certainly has caused you to glaze over and feel
mind numb. If you are a business attorney, it should be readily apparent that
you aren’t doing your client any favors, and are potentially putting yourself
at risk, by trying to do the work when it isn’t your area of expertise. An
attempt to save expense up front can have huge financial implications down the
line. You and your clients should consider engaging experienced securities counsel
as a form of insurance: you wouldn’t build a building without insurance,
nor should you build your business without the protection that experienced
securities legal work provides.
