Software of the Month Club 1997 March/Software of the Month Club 1997 March.iso/pc/dos/biz/sbadvisr/f268.sbe

Text File | 1996-10-25 | 18.8 KB | 445 lines

@198 CHAP 11

             ┌─────────────────────────────────────┐
             │    SECURITIES LAW CONSIDERATIONS    │
             └─────────────────────────────────────┘

Yet another factor to take into account in choosing the
legal form of a business is the potential application of
federal and state securities laws if the new business is
to have more than one owner or should it become necessary
to raise capital for an existing business.  Because of the
potentially dire consequences of violating federal or state
securities laws, it is important to consult with a business
attorney as early as possible when considering issuing or
transferring a security.  Note that corporate stock and
limited partnership interests are generally considered
securities, and even a general partnership interest can be
a security in appropriate circumstances, as can certain
kinds of debt instruments.

@IF901xx]Since your business is not yet in existence, you may need to
@IF901xx]comply with state or federal securities laws if you need to
@IF901xx]sell ownership interests in @NAME.
@IF901xx]
@IF125xx](NOTE: So long as you are the sole owner of the business,
@IF125xx]you are unlikely to have to be concerned with securities
@IF125xx]law problems.  SEC and state "blue sky" laws will only
@IF125xx]become a consideration if or when you should decide to take
@IF125xx]in other investors who buy an interest in your business,
@IF125xx]generally speaking.)
@IF125xx]
Since the Securities Act of 1933, federal law has required
registration as a prior condition to the issuance or transfer
of securities.  The law exempts various types of securities
and certain types of transactions.  The most important of
these exemptions for small or new businesses have been the
exemptions for securities sold to persons residing within a
single state and transactions by an issuer not deemed to
involve any public offering.  The Securities and Exchange
Commission (the SEC) from time to time has issued regulations
exempting small securities issues, attempting to balance the
needs of small businesses to raise capital against the public
policy of protecting investors.  In 1982, the SEC adopted
Regulation D as its primary method of regulation of
securities offerings by small businesses (although not to
the exclusion of other exemptions which might apply in a
given case).  These regulations were revised in April 1988
and again in April, 1989.


RULE 504:
--------

Rule 504 under Regulation D exempts the issuance of
securities by an entity if the aggregate offering price of
all exempt securities sold by the entity during a 12-month
period does not exceed $1,000,000.  (Limited to $500,000 if
the securities are not registered under any state securities
law.)  The securities cannot be offered or sold by any form
of general solicitation or general advertising, and the
securities so acquired cannot be resold (generally) without
registration or an exemption from registration.

This rule does not require any specific information to be
given to the purchasers of the securities.  However, since
the anti-fraud provisions of the securities laws apply even
though the transaction is exempt from registration, it is
helpful to memorialize in writing the material information
regarding the offering.


RULE 505:
--------

Rule 505 exempts offers and sales of securities if the
offering price for all exempt securities sold over a
12-month period does not exceed $5,000,000.  To obtain
this exemption, the issuer must reasonably believe that
there are not more than 35 purchasers, other than certain
"accredited investors."

Examples of "accredited investors" include banks, insurance
companies, a natural person whose net worth (or joint net
worth, counting spouse) at the time of purchase is in excess
of $1,000,000 or who has individual income in excess of
$200,000 (or joint income, with a spouse, in excess of
$300,000) in each of the two most recent years and expects
the same in the current year, or corporations, partnerships
or business trusts having total assets in excess of $5
million (unless formed for the specific purpose of acquiring
the securities).

For purposes of Rule 505, the issuer must furnish extensive
information and certified financial statements to the
investors, unless securities are sold only to accredited
investors.  The prohibition against advertising and
solicitation applies to this rule, as do the anti-fraud
provisions of the securities laws.


RULE 506:
--------

Rule 506 is similar to the exemptions provided by Rule 505,
except that the five million dollar limitation does not
apply.  The 35 purchaser limitation does apply (with the
exception for accredited investors), but a separate
limitation requires that the issuer must reasonably believe
immediately prior to making any sale to a non-accredited
investor that such investor, either alone or with a
representative, has such knowledge and experience in
financial and business matters that he is capable of
evaluating the merits and risks of the prospective
investment.  The prohibitions against advertising and
solicitation also apply under this rule, as do anti-fraud
provisions of the securities laws.


FILING OF NOTICE UNDER REG. D:
------------------------------

An issuer that relies upon any of the above Regulation D
exemptions must file Form D with the SEC, generally not
later than 15 days after the first sale of securities and
at other specified times thereafter.  (However, failure to
file Form D will no longer disqualify an issuance of
securities, in general, that otherwise meets the Rule 504,
Rule 505 or Rule 506 requirements, unless the issuer has
been enjoined by a court for violating the filing
obligation. -- Rule 507, as interpreted in SEC's Securities
Act Release No. 6825, March 14, 1989.)


Regulation D is not the sole federal securities exemption.
Other major federal exemptions are described below.


RULE 147 (Intrastate Offering Exemption):
----------------------------------------

Rule 147, under the Securities Act of 1933, exempts from
registration a sale of securities solely to persons resident
in one state, where the issuer has at least 80% of its
assets in that state, and uses at least 80% of the proceeds
of the sale within the state.  Resales of such securities
may be made only to persons within the state during the
period of the offering and for 9 months thereafter.  No SEC
filing is required under a Rule 147 offering.


REGULATION A EXEMPTION:
----------------------

Yet another possible exemption is under Regulation A,
which allows an issuer (which is not a "public" company
immediately before the offering) to sell up to $5 million
of securities within a one year period without registration.
No limits are placed on the number of offerees, nor is any
minimum degree of financial sophistication required of the
offerees.  However, purchasers must be given an offering
circular and a copy of the offering circular must also be
filed with the SEC.

Financial statements included in the offering circular
need not be audited statements.  However, a Form 1-A
offering statement must be filed with the SEC, followed
by a 20 day waiting period, before sales may commence.


SEC REQUIREMENTS FOR "PUBLIC" COMPANIES:
---------------------------------------

A company whose equity securities are considered to be
publicly traded must be registered with the SEC under the
Securities Exchange Act of 1934.  Any such "public"
companies will be subject to a host of costly reporting
requirements, including:

 .  Filing an annual report (Form 10-K), which includes
    audited financial statements;

 .  Quarterly (unaudited) Form 10-Q reports; and

 .  Form 8-K monthly reports that must be filed when a
    "material event" occurs.

Issuers who must register their securities under the '34
Act include:

 .  A company that has any security (stock, bonds, or other)
    which is traded  on a national security exchange; or

 .  A company with total assets in excess of $5 million, if
    it has a class of equity securities held by 500 or more
    shareholders and that is traded in interstate commerce.
    (Note:  Recent SEC regulations adopted in May, 1996, will
    increase the $5 million threshhold to $10 million, to be
    effective on the date of publication of the regulations
    in the Federal Register.)


REGULATION S-B -- "GOING PUBLIC" EASIER FOR SMALL FIRMS:
-------------------------------------------------------

In 1993, the SEC issued new Regulation S-B, which permits
smaller firms to issue securities under a simplified
registration form, new Form SB-2.  Unlike the former S-18
short form, use of which was limited to offerings of $7.5
million or less, there is no dollar limit on the amount
of securities that can be issued under SB-2 for eligible
"small business" issuers.  Regulation S-B provides a new
set of rules designed to make it easier and simpler for
small businesses to raise capital in the public market.

Regulation S-B is an integrated system of rules, forms,
and reporting requirements designed especially for small
firms, which have traditionally found the costs and
complexity of "going public" to be prohibitive.  To make
a public offering of securities that qualifies under the
streamlined procedures of Regulation S-B, an issuing
company must meet all the following requirements:

  .  Must be a U.S. or Canadian company;

  .  Revenues must be less than $25 million;

  .  Aggregate value of its outstanding securities (not
     counting those held by affiliated companies or persons)
     must not exceed $25 million;

  .  Cannot be an investment company; and

  .  If issuer is a majority-owned subsidiary of another
     corporation, the parent company must also meet these
     criteria.


STATE "BLUE SKY" LAWS:
----------------------

Keep in mind that the exemptions available under the federal
securities laws are more liberal than those available under
the securities laws of many states. In connection with any
issuance or transfer of securities, it is necessary to
consider the possible application of securities laws in the
state where the business entity is established or operates,
and, if different, the states where purchasers of the
securities live.

Although most state securities ("blue sky") laws are based
on the Uniform Securities Act, every state's laws and even
the interpretation of identical laws is different from the
other states.  Fortunately, a large number of states have
adopted the SEC regulations and rely on SEC oversight to
enforce the securities laws within such states.  As an
example, many of the states provide for transactional
exempmtions for Regulation D securities offerings, if there
is full compliance with SEC Rules 501 through 503, and
transactions in exchange-listed securities are also exempt
under state laws.

NOTE ON RECENT DEVELOPMENTS:   FEDERAL PRE-EMPTION OF
STATE BLUE-SKY LAWS.  A new law, the National Securities
Markets Improvement Act of 1996 was approved by the House
on September 28, 1996, and by the Senate on October 1,
1996.  This law revolutionizes the regulation of securities.
A key feature of the law is the repeal of Section 18 of
the Securities Act of 1933, which had authorized states
to regulate most sales of securities under state "blue-sky"
laws.  The repeal of this section of the 1933 Act has, in
effect, pre-empted most such state security registration
or qualification requirements under their blue-sky laws,
although the new law still allows states to continue to
enforce anti-fraud laws in connection with issuances of
securities.

However, it appears that this pre-emption will mostly be
for the benefit of large issuers of securities, such as
investment companies registered with the SEC, a "blue-chip"
or marketplace exemption for securities listed on stock
exchanges or included in the NASDAQ system, sales to
certain qualified purchasers (to be defined by the SEC),
and various other exemptions, such as private placements
under SEC Rule 506 or sales to qualified institutional
buyers under SEC Rule 144A.  Even these transactions may
still be subject to state "notice filing" requirements
and payment applicable filing fees in some cases, however.

Most small businesses will still have to be concerned with
state securities regulations, as the states retain the
right to regulate penny stocks, certain small and
intrastate offerings, and some offerings of securities
that are exempt under federal laws.

Another interesting provision in the new law adds a new
section 3(c)(7) to the Investment Company Act of 1940.
This new section allows, for the first time, an exception
from registration under the Investment Company Act for an
investment company whose securities are held exclusively
by certain "qualified purchasers," such as natural persons
with at least $5 million in investments, and other large
and sophisticated investors.

@CODE: NM
New Mexico has adopted a Small Corporate Offering
Registration ("SCOR") procedure, designed to coordinate
with the SEC's Regulation D, Rule 504 exemption.  Eligible
issuers may register under SCOR on New Mexico Form U-7.

To qualify for a SCOR offering:

  . The issuer must be a U.S. corporation;

  . The issuer must not be engaged in petroleum exploration
    or production, or mining or extractive industries;

  . The price of the common stock must be at least $5.00 a
    share; and

  . The aggregate amount of the offering must not exceed $1
    million.

[New Mexico Securities Division Rule 95-5.23]

Securities issued under this rule are to be registered by
qualification, together with applicable filing fee.  The
fee is 1/10 of 1% of the amount of the offering, with a
nimimum and maximum of $350 or $2500, or if claiming a
Federal Rule 504 exemption, a flat fee of $350, after July
1, 1996, payable to the N.M. Securities Division.

@CODE:OF
@CODE: CA
@CODE:NF
       ┌────────────────────────────────────────────────┐
       │   COMPLIANCE WITH CALIFORNIA SECURITIES LAWS   │
       └────────────────────────────────────────────────┘

When your newly-formed corporation issues shares of its
stock to you and to any other shareholders, you must be
very careful to comply with BOTH federal and California
securities laws.  Otherwise, you will be an inviting target
for lawsuits from disgruntled investors in your corporation
and could also be subject to criminal prosecution.

In the case of the typical small corporation startup, you
will probably be able to qualify for exemptions from the
burdensome and costly procedures of registering with the
SEC under federal securities laws (under one of the several
exemptions described above) or from "qualifying" with the
California Dept. of Corporations under California securities
laws.

In general, when a corporation issues stock in California,
the issuance must be approved (qualified) by the Corporations
Commissioner, unless the stock issuance meets one of the
exemptions provided under the California securities laws.
However, most new corporations issuing their original shares
of stock can qualify under at least one of the two main
exemptions for small corporations noted below.

LIMITED OFFERING EXEMPTION--Section 25102(f) of the
California Corporations Code.  This is the exemption that
most new corporations issuing stock in California will want
to come under.  To be able to meet the requirements of this
exemption, a stock issuance must comply with all of the
following restrictions:

    . Stock must not be issued to more than 35 "counted"
      shareholders.

    . Certain shareholders don't have to be counted, such
      as officers or directors of the corporation, certain
      relatives of uncounted persons (living at the same
      address), promoters of the corporation, and certain
      wealthy or sophisticated individuals.

    . Each shareholder must come within one of three
      "suitability" categories.  They must be either
      one of the following:

         .  Uncounted shareholders;

         .  Persons who have certain types of pre-existing
            personal or business relationships to directors
            or officers of the corporation (or to any
            "controlling persons" -- such as a promoter or
            founder); or

         .  Certain "sophisticated investors" with business
            or financial experience (or who are represented
            by professional advisers), who have a net worth
            of over $500,000 and who are able to bear the
            economic risks of the transaction.

    . No advertising of the stock offering is allowed, by
      radio, mail, TV, seminars, etc.

    . Each shareholder who buys shares must sign a
      "representation letter" stating that he or she is
      buying the stock for his or her own account, and not
      for resale or distribution.

    . Stock can only be issued for cash, real estate, or
      tangible or intangible personal property.  It may
      not be issued for a promise to render future services
      or (in general) in exchange for a promissory note
      from the purchaser.

    . A Notice of Transaction form must be filed with the
      California Department of Corporations within 15 days
      after the first sale of stock occurs, together with
      a filing fee of $25 to $300 (which varies based on
      the value of the securities sold).

SMALL OFFERING EXEMPTION--Sec. 25102(h) of the California
Corporations Code.  While less frequently used, this
exemption may be available in some situations where the
"limited offering exemption" is not, such as where you have
a purchaser who cannot meet the 25102(f) "suitability"
standards.  Note that in order to use the small offering
exemption, an attorney must sign a statement that the stock
issuance qualifies under the Sec. 25102(h) exemption and
file it with the Department of Corporations.  Thus, under
this exemption you cannot self-incorporate without paying
at least some legal fees to an attorney.  There are numerous
technical requirements under which your attorney must
determine that the issuance complies, in order to qualify
under this exemption.

Finally, any issuance of securities under California law,
whether under one of the above exemptions or not, is
subject to Section 25401 of the California Corporations Code.
This section makes it unlawful to offer or sell a security
in the state by means of any written or oral communication
which includes an untrue statement of a material fact or
fails to state a material fact that is necessary to make
sure that the statements made are not misleading.  In
short, be completely honest and do not withhold any
unfavorable information from any prospective investor in
your company's stock or you may be in BIG trouble from a
securities law standpoint.