securities issues in closely held companies first run ... · intrastate offerings — rule 147...
TRANSCRIPT
SECURITIES ISSUES IN CLOSELY HELD COMPANIES
First Run Broadcast: November 27, 2017
1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)
Closely held companies are subject to securities regulation as much as large, publicly traded
companies. Though the areas of emphasis may vary between smaller and larger companies,
federal securities regulations establish a range of eligibility and impose disclosure requirements
when closely held companies raise capital and substantial liability for any compliance failure.
Also, rapidly growing private companies issuing incentive stock to employees and new investors
also risk triggering “reporting company” status under federal securities law, which would impose
ongoing reporting obligations on the private company. This program will provide you with a
guide to how securities law applies when closely held companies issue new equity or debt, with
an emphasis drafting subscription agreements, and planning to avoid “reporting company” status.
• Securities law issues for closely held companies
• Framework of securities law requirements when issuing equity, debt or incentive
securities
• Subscription agreements – essential components to ensure adequate disclosure and avoid
financial liability
• Exemption planning – Regulation D, accredited investors v. qualified purchasers, non-
solicitation, and disclosures
• Understanding exempt securities v. exempt offerings
• How closely held companies trigger “reporting company” status and techniques to avoid
it
Speakers:
Eric R. Smith is a partner in the Baltimore, Maryland office of Venable, LLP, where he
represents closely held and publicly traded companies in capital raising transactions, mergers and
acquisitions, and joint ventures. He has extensive experience advising companies on securities
compliance issues in capital raising, periodic reporting, the fiduciary duties of directors and
communications with stockholders. He is a member of the ABA Committee on Federal
Regulation of Securities and the Committee on Corporate Governance. Mr. Smith earned his
B.S. from Cornell University, his J.D. from the University of Baltimore School of Law, and his
LL.M. in securities and financial regulations from Georgetown University Law Center.
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Securities Issues in Closely Held Companies Teleseminar
November 27, 2017 1:00PM – 2:00PM
1.0 MCLE GENERAL CREDITS
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Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: November 27, 2017 Seminar Title: Securities Issues in Closely Held Companies Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
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© 2011 Venable LLP
Securities Law Framework for Exempt Issuances and Essential Components of Subscription Agreements
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Issuing Securities Under the
Securities Act of 1933
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Three types of offers under the '33 Act
Registered
Exempt
Illegal
Securities Act Exemptions
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Securities Act Exemptions
Exemptive provisions of the '33 Act:
§3 (Exempt Securities) — generally exempt due to the
nature of the issuer or the nature of the security itself
§4 (Exempt Transactions)
§19(a) — gives SEC general powers to prescribe rules
§28 — grants SEC broad exemptive authority if in the
public interest and consistent with protection of investors
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Securities Act Exemptions
Note that exemptions are from
registration and not from the antifraud
provisions of the '33 Act
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Securities Act Exemptions
Although styled “exempt securities,” some of the
Section 3 exemptions actually are transactional
exemptions (e.g., 3(a)(10) (Court Approved exchange)
and 3(a)(11) (Intrastate Offering))
Additionally, section 3(b) is not self-effecting - it
requires SEC rulemaking and is limited to $5
Million (or $50,000,000 once rules enacted by the SEC)
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Securities Act Exemptions Section 3
• 3(a)(1) Reserved
• 3(a)(2) Government securities; bank securities;
certain insurance contracts
• 3(a)(3) Commercial paper
• 3(a)(4) Certain non-profits
• 3(a)(5) S&Ls (and others)
• 3(a)(6) Railroad equipment trusts
• 3(a)(7) Certain bankruptcy securities with court
approval
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Securities Act Exemptions Section 3
3(a)(8) Certain insurance policies
3(a)(9) Exchanges with Issuer without other
remuneration
3(a)(10) Court-approved exchanges
3(a)(11) Intrastate offerings
3(a)(12) Acquisition of bank by holding company
3(a)(13) Certain church plans
3(a)(14) Certain securities futures products
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Securities Act Exemptions
In this portion of the webcast, we will focus on the
following:
Integration Intrastate Offerings
Private Placements Regulation A (and A+)
Rule 701 Subscription
Agreements
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Securities Act Exemptions
Integration
Prevents circumvention of registration
requirements by separating single non-
exempt offering into several exempt
offerings
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Securities Act Exemptions
Integration (cont’d)
Five-factor test:
single plan of financing
same class of security
made at or about the same time
same consideration
same general purpose
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Securities Act Exemptions
Integration (cont’d) - “safe harbors”
• Rule 147(b)(2) - “intrastate” offerings
• Rule 152 - public offering following private
offering
• Rule 155 - public offering following abandoned
private offering (and vice versa)
• Rule 251(c) - Regulation A offerings
• Rule 502(a) - Regulation D offerings
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Securities Act Exemptions
Intrastate Offerings
§3(a)(11) exempts securities offered and
sold only to persons resident in a single state
by an issuer incorporated in, and doing
business in, that state
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Securities Act Exemptions
Intrastate Offerings - Early Challenges
• Is the issuer doing business in that State?
• Is the issuer incorporated in that State?
• Are the proceeds used in that State?
• Is the offering part of another issue?
• Are the offerees and purchasers all residents of
that State?
• Have the securities come to rest in that State?
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Securities Act Exemptions
Intrastate Offerings — Rule 147
•Residency
- Issuer must be incorporated and doing
business - financial objective tests provided in Rule
147 - so-called “80%” calculation
•Use of Proceeds - financial tests provided in Rule
•Integration - six month safe harbor rule
•Coming to Rest - 9 month resale test to residents of
same state
•Rule 147 only available to issuer
•Non-exclusive; may rely upon Section 3(a)(11)
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Securities Act Exemptions
Intrastate Offerings — Benefits
‒ No limitation on dollar amount
‒ Investor suitability not required although each
must be a “resident” of a particular state
‒ Unlimited number of investors in that state
‒ No required disclosure of information
‒ Securities sold were eligible for immediate resale
to residents of that state
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Securities Act Exemptions - Section 4
• 4(a)(1) “other than issuer, underwriter or dealer”
• 4(a)(2) by an issuer not involving a public
offering
• 4(a)(3) dealer
• 4(a)(4) broker’s transactions
• 4(a)(5) offers/sales to accredited investors subject
to 3(b) limit
• 4(a)(6) crowdfunding exemption
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Securities Act Exemptions
Private Placements
Section 4(2) creates an exemption for:
...transactions by an issuer not involving
any public offering...
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Securities Act Exemptions
Private Placements
The Ralston Purina Case - 346 U.S. 119 (1953)
The Court’s decision confirmed the SEC’s position
that the sales by Ralston Purina under its stock plan
were not exempt under Section 4(a)(2).
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Securities Act Exemptions
Private Placements - Ralston Purina “guidance”
• Focus is on “offerees” rather than actual purchasers.
• Court rejected SEC’s argument that extensive number of
offerees alone resulted in loss of the exemption.
• Availability of the exemption “should turn on whether the
particular class of persons ... need the protection of the
1933] Act” and whether the offerees “are shown to be able
to fend for themselves.”
• If offerees do not have “access to the kind of information”
which a registration statement would disclose, the issuer
must provide the same kind of information that otherwise
generally would be available in a registration statement.
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Securities Act Exemptions
Aftermath of Ralston Purina
After a series of questionable judicial decisions rejecting
the availability of Section 4(a)(2), ABA Sub-committee
on Federal Regulation of Securities published the factors
it deemed most relevant in determining whether Section
4(a)(2) should be available:
‒ offeree qualification
‒ availability of information
‒ manner of offering
‒ absence of redistribution
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Securities Act Exemptions
Rule 701 Offering
• Size?
• Manner of offering?
• Qualification/ suitability of offerees/purchasers?
• How many purchasers?
• What information required?
• Status of securities?
• Who can/can’t use Rule 701?
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Securities Act Exemptions
Rule 701 Offerings
• Permits non-’34 Act companies to offer securities
pursuant to a written compensatory benefit plans to:
employees, directors, general partners, trustees,
officers, consultants and advisors pursuant to written
contracts.
• No limitation on number of offerees or purchasers
(note, however, that you do not want to exceed the
threshold requirements for becoming a ‘34 Act
reporting company).
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Securities Act Exemptions
Rule 701 Offerings (cont’d)
•Amount available during any 12 month period is
limited to the greater of:
‒$1 million,
‒15% of the issuer’s total assets measured at the end
of the year, or
‒15% of the outstanding securities of that class.
•No integration requirement.
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Securities Act Exemptions
Rule 701 Offerings (cont’d)
• Disclosure - purchasers must be furnished a copy of
the written plan; in addition, if amount of securities
sold in a single year exceeds $5 million, issuer
required to provide additional disclosures specified by
the Rule.
• Although issued as restricted securities, securities sold
in a Rule 701 offering become non-restricted and
otherwise freely tradable 90 days after the issuer
becomes subject to the reporting Requirements of the
‘34 Act.
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Securities Act Exemptions
Regulation A (Rules 251-263)
Up to $5M of securities of an issuer plus up to
$1.5M of securities offered by affiliated selling
security holders in any 12-month period
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Securities Act Exemptions
Regulation A - the Process
• Requires filing of a Form 1-A and delivery of offering
circular to investors
• Solicitation of Interest or “Testing the Waters” - Rule 254
‒ No pre-clearance with SEC of documents or advertising
or soliciting materials
‒ Consideration cannot be accepted
‒ No binding commitments permitted
• Offering Circulars
‒ Preliminary Offering Circulars permitted and
encouraged by SEC
‒ Content dictated by Form I-A
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Securities Act Exemptions
Regulation A - Advantages
‒ Permits interstate offerings to an unlimited
number of offerees
‒ Suitability of purchasers not required
‒ Immediate resales without restrictions
‒ Permits issuers or underwriters to obtain
“indications of interests” from the market
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Securities Act Exemptions
Regulation A — Disadvantages
‒ Limited dollar amount still may make the cost per
funds raised expensive - also limited number of
underwriters willing to participate in Regulation A
offerings
‒ Not available for ‘34 Act reporting companies nor
certain other companies
‒ State qualification still required
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Securities Act Exemptions
Proposed Regulation A+
– Two tiered system
– Tier 1 would preserve the current $5 million
threshold and offerings would be subject to
state securities review.
– Tier 2 would provide an exemption for
offerings of up to $50 million in any 12-
month period, including no more than $15
million in securities sold on behalf of
selling stockholders.
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Securities Act Exemptions Regulation A+ (continued)
– Offerings in both tiers would be subject to the same basic
requirements relating to issuer eligibility, disclosure and other
matters.
– The proposed rules would incorporate a new investment limit.
The proposed rule would limit the permissible amount to be
invested by any individual to the greater of 10% of the
individual’s net worth or annual income.
– In addition, the proposed rules contain certain ongoing reporting
requirements. An issuer that has conducted a Regulation A
offering will be required to make certain limited ongoing SEC
filings.
– In order to address the most significant impediment associated
with current Regulation A, the proposed rule preempts state
securities law review for Tier 2 Regulation A offerings (those up
to $50 million). The proposed rule does so by defining a
“qualified purchaser” as any offeree or purchaser in a Tier 2
offering.
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Potential Exchange Act Issues
The “Inadvertent” Public Company
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The Securities Exchange Act of 1934
Becoming a ‘34 Act Company
Section 12(g)
More than 500 shareholders (non-accredited) or up to
2,000 if less than 500 are non-accredited
More than $10 million in assets
If test is met at the end of a fiscal year, must register
under the ‘34 Act
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The Securities Exchange Act of 1934
Consequences of Becoming a ‘34 Act Company
• Periodic reporting (section 13 - basic obligation)
• Proxy and tender offer rules (section 14)
• Section 16
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Subscription Agreements
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Subscription Agreement Overview
Describes the type of securities purchased by the
investor and the purchase price.
Sets out representations and warranties of the
issuer relating to the issuance of the securities.
Includes representations and warranties and
other acknowledgements by the investor to help
ensure the issuer's compliance with applicable
US securities laws in connection with the
issuance of the securities.
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Documents Needed in Private Placement
Subscription Agreement
Private Placement Memorandum
Registration Rights Agreement
Investor Questionnaire
Additional Materials (e.g. general solicitation
under 506(c) may involve additional materials
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Securities Legend
A subscription agreement typically has securities
law legends on its cover page. The legends are
placed on the agreement and on the securities
issued to investors to assist the issuer in
complying with applicable US securities laws.
Legends alert potential investors to the fact that
Securities issued under Reg D and 4(a)(2)
exemptions are restricted securities that cannot
be freely resold by an investor without registration
or exemption from registration with the SEC
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Securities Legend
Specifically, for an issuer to qualify for a Regulation D exemption,
Rule 502(d) requires the issuer to take reasonable steps to ensure
that the securities are not bought by underwriters and that the
purchasers are aware that they are buying restricted securities. The
issuer can demonstrate reasonable care by, among other things,
– giving adequate written disclosure to each purchaser prior to
sale that the securities have not been registered and cannot be
resold unless they are registered or an exemption from
registration is available. This disclosure usually takes the form
of a restrictive legend.
– Placing a restricted security legend on the securities stating that
the securities have not been registered under the Securities Act
and cannot be resold by the purchaser in the US without
registration or an applicable registration exemption.
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Confirming Accredited Investor Status
In a traditional Rule 506 offering under Rule 506(b), the
issuer must reasonably believe that the prospective investor
is an accredited investor or that it has enough knowledge
and sophistication to properly evaluate the investment
opportunity. This standard is often met by prospective
investors' self-certifications and by a further review of
prospective investors by the issuer.
More extensive disclosure requirements apply to non-
accredited investors under Regulation D. Rule 502(b)(2) of
Regulation D requires disclosure to non-accredited investors
similar to the type provided in a Securities Act registration
statement (often impractical).
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Subscriber Representations
Concerning the Company:
– Received a copy of the Offering Documents.
– The purchase involves risks.
– Not relying on any communication of the
Company as investment advice.
– Familiar with the business and financial
condition and operations of the Company
– Representations reaffirmed at Closing
– No federal or state agency has passed upon
the merits or risks of the investment or made
any finding concerning the advisability of the
investment.
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Subscriber Representations
Reasons for Representations in Prior Slide
– Address the need for the investor to have
access to the information of the company to
evaluate the investment that it is undertaking.
– Limit the liability of the company to the
information that has been provided to the
investor.
– To preclude any claims by the purchaser for
implied representations and warranties of the
issuer.
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Subscriber Representations
Status of Purchaser:
– Purchaser has such knowledge, skill and
experience in business, financial and investment
matters that the undersigned is capable of
evaluating the merits and risks of an investment in
the Securities.
– Purchaser is an "accredited investor“ (and has
completed questionnaire).
The burden of determining the status of potential
investors is placed on the company. This
representation causes the purchasers to represent to
the company that they are investors that are both
sophisticated and accredited.
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Subscriber Representations
Restrictions on Transfers of Securities
– Acquiring the Securities solely for the undersigned’s own
account, for investment purposes, and not with a view
any distribution.
– Acknowledging the securities are "restricted securities"
under securities laws and that the Securities may only be
disposed of pursuant to an effective registration
statement or an exemption
This representation is included to confirm the purchasers
acknowledgement of the restricted nature of the securities
and restriction on resale. This goes hand-in-hand with the
legends included to provide notice to Purchasers of these
restrictions.
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Subscriber Representations
No General Solicitation or Advertising:
– Purchaser acknowledges that the Company
did not offered to sell the Securities by means
of any form of general solicitation or
advertising.
This provision should be included if the issuer is
conducting the offering under Rule 506(b)
prohibiting the use of general solicitation. If the
issuer is conducting the offering under Rule
506(c) this representation should not be included.
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Subscriber Representations
Statutory Liability:
– Section 17 of the Securities Act is the general antifraud
provision of the Securities Act. It applies to any purchase of
securities, whether part of a registered or an exempt offering. It
prohibits:
• any device, scheme or artifice to defraud.
• Obtain money or property by means of material
misstatements or omissions. (This only applies to the
disclosure documents provided to the investor before or at
the time of the contract of sale.)
• Engaging in any course of business that would operate as a
fraud.
– Section 17 does not give a private right of action to a purchaser.
Claims based on Section 17 may be enforced by the SEC.
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Subscriber Representations
– Section 10(b) of the Exchange Act
• Section 10(b) makes it unlawful for any
person: "to use or employ … in connection
with the purchase or sale of any security …
any manipulative or deceptive device or
contrivance in contravention of such rules
and regulations as the [SEC] may
prescribe….."
• This section applies to all offerings of
securities. However, the statute requires
the SEC to prescribe rules to implement it.
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Subscriber Representations
– The most important of the SEC's rules
enacted under Section 10(b) is Rule 10b-5.
Rule 10b-5 prohibits any of the following:
• Fraudulent devices and schemes, material
misstatements and omissions of any
material facts.
• Acts and practices that operate as a fraud
or deceit on any person.
– Neither Section 10(b) nor Rule 10b-5 provide
an express private right of action to securities
purchasers, however, an implied right of
action has developed over time.
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Questions???
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© 2014 Venable LLP
contact information
www.Venable.com
Eric R. Smith, Partner
t 410.528.2355