What are securities laws?

November 28, 2008

The SEC publishes a guide titled: Q&A: Small Business and the SEC that provides a simple answer.

In the chaotic securities markets of the 1920s, companies often sold stocks and bonds on the basis of glittering promises of fantastic profits – without disclosing any meaningful information to investors. These conditions contributed to the disastrous Stock Market Crash of 1929. In response, the U.S. Congress enacted the federal securities laws and created the Securities and Exchange Commission (SEC) to administer them.

Companies selling common stock, preferred stock or issuing options or warrants are issuing “securities.”  The Securities Act of 1933 generally requires companies selling securities to give investors full disclosure of all material facts that investors would find important in making an investment decision. The Act also requires companies to file a registration statement (i.e. see the Google IPO registration statement) with the SEC that includes information for investors, unless the security or the type of transaction is exempt from registration.

However, registering a securities offering with the SEC is a very expensive (typically costing over $1,000,000) and time-consuming process.  Therefore, sales of securities by companies to private investors or venture capitalists are usually structured to be exempt from the registration requirements of the Act.  These exemptions (post to come) are fairly technical and companies need advice from competent securities attorneys to ensure compliance.

Even if a securities offering is exempt from federal registration requirements, the company must also comply with securities laws in each state where securities are offered.  States may impose their own registration or qualification requirements that must be complied with unless an exemption is available.

Failure to comply with securities laws allows a purchaser to rescind or undo the purchase of securities and get his or her money back or recover damages.  These rescission rights create potential exposure to the company if its stockholders demand their money back.

Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the date of the violation upon which the action to enforce liability is based.  State remedies and statutes of limitations vary and depend upon the state in which the shares were purchased.  For example, the California statute of limitations for noncompliance with the requirement to register or qualify securities under the California Corporate Securities Law is the earlier of two years after the noncompliance occurred, or one year after discovery of the facts constituting such noncompliance.

In extreme cases, a company may make a rescission offer (i.e. offer to repurchase the securities plus interest) to stockholders that were sold securities in noncompliance with securities laws in an attempt to eliminate the exposure from rescission rights.  The rescission offer itself must comply with all relevant securities laws.  For example, Google’s noncompliance with securities laws in connection with option grants required it to file a registration statement with the SEC to make the rescission offer at the time of its IPO and resulted in a cease and desist order by the SEC.


  • http://ralphhaygood.org Ralph Haygood

    It's interesting that Google, which was well connected and financed and should therefore have been well counseled from its founding, ran afoul of the securities laws. I wonder whether it was truly an honest mistake or some kind of brinkmanship.

  • http://www.intensedebate.com/people/Yokum Yokum

    @Ralph – Please see the below clip from the registration statement for the rescission offer. David Drummond, the general counsel of Google is a former WSGR partner, and WSGR advised Google in connection with the rescission offer.

    There are various situations where there is a tension between strict compliance with securities laws and business needs (in Google's case, financial statement disclosure). For example, in order to minimize liability in a highly dilutive financing, a company may offer to sell the securities on all existing stockholders in order to avoid claims of unfairness. However, there may be too many stockholders or unaccredited stockholders to fall within an exemption from registration. Thus, a board may face the difficult choice between violating securities laws or failing to make an offer to all stockholders that may decrease the risk of stockholder litigation in connection with a dilutive financing.

    "Shares issued and options granted under our 1998 Stock Plan, our 2003 Stock Plan, our 2003 Stock Plan (No. 2) and our 2003 Stock Plan (No. 3) from September 2001 through July 2004 may not have been exempt from registration or qualification under federal securities laws and the securities laws of certain states. Certain of the shares issued during this period may not have been exempt from registration and qualification requirements under Rule 701 under the Securities Act of 1933 and under those state securities laws that provide an exemption to the extent the requirements under Rule 701 are met. We became aware that we were approaching the numeric limitations prescribed by Rule 701 in September 2002 and thereafter determined that we could not continue to count on being able to rely on Rule 701 to provide an exemption from the registration requirements of the Securities Act of 1933. In addition, continued compliance under Rule 701 would have required broad dissemination of detailed financial information regarding our business, which would have been strategically disadvantageous to our company. In evaluating how to issue stock upon exercise of outstanding options in light of these limitations we determined we would utilize “private placement” exemptions provided by Section 4(2) of the Securities Act of 1933 in order to exempt these issuances from federal registration requirements notwithstanding the factual and legal uncertainties inherent in Section 4(2). These uncertainties arise because analyzing whether or not issuances of securities qualify for the exemptions afforded by Section 4(2) involves a number of subjective determinations including whether the number of offerees constitutes a general solicitation, the financial sophistication of offerees and their access to information regarding the issuer, as well as whether the offering was designed to result in a distribution of shares to the general public. We considered various alternatives in determining to rely on the exemption provided by Section 4(2) despite its inherent uncertainties. We considered ceasing granting options and shares to service providers. However, we determined that this would be detrimental to our development, as equity compensation was an essential ingredient to building our company. We also considered becoming a reporting company for the purposes of federal securities laws. We determined that this too would be contrary to the best interests of our stockholders. We therefore concluded that relying on Section 4(2) despite its uncertainties was in the best interest of our security holders. Because of this uncertainty in relying on Section 4(2), the options we granted and the shares issued upon exercise of these options during this period may have been issued in violation of either federal or state securities laws, or both, and may be subject to rescission. In order to address this issue, we are making a rescission offer to the holders of these shares and options. We will be making this rescission offer to 1,362 persons who are or were residents of Arkansas, California, Colorado, Connecticut, the District of Columbia, Georgia, Illinois, Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington."

  • http://ralphhaygood.org Ralph Haygood

    Thanks for replying. I'm not surprised that "[t]here are various situations where there is a tension between strict compliance with securities laws and business needs," and I take the point that these situations can involve "a number of subjective determinations." I imagine that this kind of thing keeps life interesting, sometimes uncomfortably so, for folks like you.

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  • Whoxisxjohnxgalt

    In the event the statute of limitation is expired, doesn't the fact that SEC enforcement actions have no statute of limitations still give investors recourse even if for registration related claims?