BUSINESS & SECURITIES

Securities Law Isn’t Just for Indicted CEOs

November 2002

By Dodd S. Griffith*
for New Hampshire Business Review

Like many, my attention has been captured by the corporate scandals that have played themselves out this year. Like all good horror stories, they make our spines tingle, but seem far enough removed to allow us all to sleep at night.

As the typical owner of a small-to-medium-sized business in New Hampshire, you might feel that you are immune from the scandals. You are an honest businessperson, and you do not sell your stock on any public stock exchange. However, much like the horror movie villain that refuses to die, state-level violations of the securities laws have been known to bite even the most honest businessperson.

It is unlikely that a local securities regulator will show up on your door step and tell you that it is time to do the “perp walk” for the benefit of the local news. Nonetheless, more than one local businessperson has had the unpleasant experience of receiving a letter from a local securities regulator asking for an explanation regarding how the business could lawfully have taken the actions that it recently completed.

In most cases, the simple answer to such an inquiry is ignorance rather than intentional wrongdoing. However, securities regulators take a dim view of one’s lack of knowledge as a justification for a violation of the law, regardless of how well-meaning the act resulting in the violation.

Thus, every businessperson should have a basic knowledge of the securities laws, if only for purposes of knowing when to ask an expert for more advice.

What’s a security?

In New Hampshire, securities transactions are governed by RSA Chapter 421-B and regulations adopted pursuant to that statute. These laws are enforced by the state Bureau of Securities Regulation, a division of the New Hampshire secretary of state’s office. Like most New Hampshire regulatory bodies, the bureau is very accessible and has an informative Web site that provides answers to many basic questions. The bureau, however, is not in a position to give legal advice on how to complete a particular transaction.

It may surprise many business owners to know that, generally speaking, all securities must be registered prior to sale. More specifically, securities must be registered unless the law specifically exempts them from registration — based either on the type of security or type of transaction in which the security is transferred.

Thus businesspeople must ask themselves a few basic questions as they endeavor to stay on the right side of the securities laws. First, “Am I offering or selling a security?”

In order to answer this question, you must understand what a “security” is, and when one is “offering” or “selling” one.

While most people understand that stock in a corporation is a security, they may not understand that promissory notes, bonds, other evidences of indebtedness, partnership interests and limited liability company interests are securities. Thus any time a business sells equity or debt, the offer and sale of that equity or debt must either be exempt from the registration requirements of the securities laws or registered in compliance with those laws.

Fortunately for the average business owner, the state and federal securities laws contain many exemptions for typical business transactions. Many of these exemptions require no action on the part of the business owner in order to qualify. For example, there is a standard exemption that allows up to ten persons to join together to form a corporation, limited liability company, partnership or similar entity. This exemption is automatic, provided that all securities are sold within 60 days of the entity being formed, and without the benefit of any advertising. Sound simple? Perhaps not as simple as you think. The ban on advertising can easily make this exemption unavailable.

You might assume that this is not a problem for you. After all, when you form your company, you will not place advertisements to sell stock in your company. You will simply prepare a one-page proposal for a few business associates you know and privately distribute it to each of them. Unfortunately, such a one-page proposal could ultimately prove to be your undoing because it meets the definition of an “advertisement” as set forth in state securities laws. New Hampshire law broadly defines this term to include any written communication distributed to more than one person.

The unavailability of this basic exemption under such circumstances is not necessarily fatal. Plenty of other exemptions exist. However, many of these exemptions require the filing of some basic documents and payment of certain fees in order to qualify.

Haunting proposition

Another issue that often trips up business owners is New Hampshire’s requirement that most offers and sales of securities be done through a properly licensed sales agent, either a broker-dealer or an issuer-dealer.

While it probably comes as no surprise that New Hampshire wishes to regulate the activities of persons who sell securities for a living, what is less well understood is that in many cases New Hampshire law requires businesses to become licensed to sell their own securities directly (i.e. without a broker). Thus, even if the president of the company will sell the securities directly and without any compensation for doing so, she may still need to be licensed.

It can be tempting to assume that these securities laws will never affect your business, even if technically applicable. After all, if you are an honest businessperson, why would a minor infraction ever come back to haunt you? This sort of thinking can seem expedient, especially in difficult economic times. However, it is wrong on several levels.

In short, a seemingly harmless violation of the securities laws is likely to come back to haunt you at the worst possible time. Typically, such infractions come to light during shareholder disputes, when you are seeking new investors or when you are trying to sell your business. In such cases, an unhappy shareholder may try to use such violations as leverage to force you to buy his stock back — and may be successful, since New Hampshire’s securities laws provide for the forced repurchase of securities at the price initially paid for them, plus interest, if the stock was not sold under an applicable exemption.

Perhaps even worse, just as you think you have closed a deal to take your business to the next level with additional investors, or to sell your business and retire, you may discover that your earlier transgressions make the deal much more difficult, if not impossible. Your target investor or purchaser will likely employ legal counsel to review your company and its prior securities transactions. That review will likely uncover any problem transactions, and you will be required to clean up the problems prior to the deal closing — at your expense.

As you shepherd your business through these lean economic times, it may be tempting to ignore such issues. However, by building a strong foundation in these lean times, you stand a much better chance of reaping the benefits when good times return.

*Dodd S. Griffith is admitted in New Hampshire.

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