Securities Law: A Basic Understanding

Article Scope: Securities law can be complex and confusing, and this article will provide you with a foundational understanding of key principles, definitions, and topics.

Disclosure: This information is provided for educational purposes only and cannot be construed as legal advice or to create an attorney-client relationship. Securities Law is a very complex area of law and you should seek advice from a qualified attorney to determine if your intended investment vehicle complies with federal and state law.

Introduction to Securities Law

What is the SEC and where did it come from?

The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) as an independent agency of the United States federal government. U.S. Congress passed this act in response to the stock market crash of 1929 and the subsequent Great Depression, which had devastating effects on the U.S. economy. The SEC functions to protect investors, maintain fair and orderly markets, and facilitate capital formation. Its formation marked a major turning point in the regulation of U.S. financial markets, as it established the first federal agency with broad regulatory powers over securities transactions and trading. Today, the SEC continues to play a critical role in enforcing securities laws, promoting market transparency and integrity, and protecting investors.

Securities law Generally

Securities Law refers to the body of laws and regulations that govern the issuance, sale, and trading of securities (i.e., financial instruments like loans, stocks, and other investment devices that represent ownership or debt in a company or other organization). These laws require issuers (i.e., the individual or business offering to sell the securities) to make certain required disclosures to the investors to prevent fraud and abuse of all investors.

Securities Defined.

The SEC defines “security” very broadly under the Securities Act of 1933. In general, the term “security” includes a wide range of investment contracts, notes, stocks, bonds, and other instruments commonly used in financial transactions. The SEC has stated that “the definition of a security … is flexible enough to encompass virtually any instrument that might be sold as an investment” [1].

It’s worth noting that the definition of a security is important because securities are subject to regulation under federal securities laws. Companies that offer securities for sale to the public must comply with the registration requirements of the Securities Act of 1933, unless an exemption from registration is available.

The Goal of Securities Laws.

The overarching goal of securities law is to maintain fair and transparent financial markets that provide investors with reliable information and protect them from fraud and other abuses. To accomplish this, these laws establish registration, reporting, and anti-fraud requirements for companies that offer securities to public and private investors. They primarily regulate the activities of securities brokers and dealers, but these regulations often have implications on the transactions of small business owners. The regulations required disclosure of certain information about the offering business’ financial condition and operations among other things.

Types of Investors.

Regulations classify investors into principally two categories: (1) educated, wealthy, and financially sophisticated investors and (2) those that are not. The regulations presume those of the first classification to be sufficiently educated and insulated financially to prevent bad investments. Therefore, those qualified investors have a larger variety of different classes and sizes of investments they can participate in.

Relationship between Federal and State Securities Laws

There are two cannons of securities law, Federal and State. State securities laws are known as “blue sky laws” and often impose additional registration and disclosure requirements on companies selling securities within their state borders.

Federal Securities Law

The Securities Act of 1933 and the Securities Exchange Act of 1934 are the governing securities laws in the U.S. All securities offered in for investment or purchase within the U.S.A. must comply with the SEC regulations. This federal law provides exemptions from registration requirements for certain types of securities that are offered under certain conditions. For example, the act provides exemptions for private offerings, intrastate offerings, and Regulation D offerings.

Utah State Securities Law

The Utah Uniform Securities Act, codified as Utah Code Ann. §§ 61-1-1 et seq. (2021), governs the regulation of securities in Utah. The act requires the registration of all securities offered in Utah unless an exemption is available. Issuers of securities in Utah must comply with both federal and state securities laws. The Utah Uniform Securities Act also provides exemptions from registration requirements similar to the exemptions provided by federal securities laws.

Note that state securities laws, such as the Utah Uniform Securities Act, are not preempted (i.e., invalidated or subordinated) by federal securities laws, including the Securities Act of 1933. Section 18 of the Securities Act of 1933 (15 U.S.C. § 77r) explicitly provides for this.

Basic Securities Law Definitions

To understand any topic we need to start with some basic Definitions. Here are some definitions for some of the most important terms used in securities law:

1. Securities: Financial instruments that represent ownership in a company or a debt owed by a company. Examples of securities include stocks, bonds, loan agreements, and investment contracts. Basically, if you are asking if something is a security in the financial industry, it most likely is. See The Securities Act of 1933, Section 2(a)(1) [15 U.S. Code § 77b(a)(1)]; Utah Code Ann. § 61-1-13 (2021); Utah Admin. Code R164-1-2.
2. Issuer: The entity that offers or issues securities to an investor. This can include people, corporations, partnerships, and other organizations. See The Securities Act of 1933, Section 2(a)(4) [15 U.S. Code § 77b(a)(4)]; Utah Code Ann. § 61-1-13 (2021); Utah Admin. Code R164-1-2.
3. Investor: The individual or entity that purchases securities. See The Securities Act of 1933, Section 2(a)(13) [15 U.S. Code § 77b(a)(13)]; Utah Code Ann. § 61-1-13 (2021); Utah Admin. Code R164-1-2.
4. Accredited Investor: Accredited investors are individuals or entities with a minimum income or net worth, with financial sophistication to assess the risk of complex fiancial investments. Accredited investors include individuals with a net worth of at least $1 million, excluding their primary residence, or have earned income of at least $200,000 in each of the two most recent years (or $300,000 together with their spouse) and have a reasonable expectation of the same income level in the current year. Accredited investors also include certain entities, such as banks, investment companies, and large corporations. See Rule 501 of Regulation D under the Securities Act of 1933, at 17 CFR § 230.501.
5. Qualified Investor: An investor who meets certain requirements, such as having a certain net worth or income, and is therefore considered capable of understanding the risks associated with a securities offering. See Regulation D, Rule 501 [17 CFR § 230.501]; Utah Code Ann. § 61-1-13.5 (2021); Utah Admin. Code R164-6-1 et seq.
6. Registration: The process of filing documents with the Securities and Exchange Commission (SEC) or state securities regulators to register a securities offering. See The Securities Act of 1933, Section 6 [15 U.S. Code § 77f]; Utah Code Ann. § 61-1-6 (2021); Utah Admin. Code R164-2-3.
7. Exemption: A provision in federal or state securities laws that allows certain types of securities offerings to be made without registration. See The Securities Act of 1933, Section 3 [15 U.S. Code § 77c]; Utah Code Ann. § 61-1-13.3 (2021); Utah Admin. Code R164-6-1 et seq.
8. Private Offering: A securities offering that is made only to a limited number of persons who have a pre-existing relationship with the issuer. Regulation D, Rule 506 [17 CFR § 230.506]; Utah Admin. Code R164-6-1 et seq.
9. Intrastate Offering: A securities offering made and sold exclusively within a single state. See Rule 147 under the Securities Act of 1933, 17 CFR § 230.147(b); Utah Admin. Code R164-6-2.
10. Regulation D Offerings: Exemptions from registration requirements for private placements of securities provided by the SEC’s Regulation D. These exemptions are commonly referred to as Rule 504, Rule 505, and Rule 506. Regulation D, Rules 504, 505, and 506 [17 CFR §§ 230.504, 230.505, and 230.506]; Utah Admin. Code R164-6-1 et seq.
11. Crowdfunding: The practice of funding a project or venture by raising small amounts of money from a large number of people, typically via the internet. See Regulation Crowdfunding, Title III of the JOBS Act 17 CFR § 227; 15 U.S. Code § 77d; Utah Admin. Code R164-6-1 et seq. See also Investopedia’s article on Crowdfunding.
12. Disclosure: The process of providing information about a securities offering to potential investors. This includes financial information about the issuer, as well as information about the risks associated with the offering. See The Securities Act of 1933, Section 5 [15 U.S. Code § 77e]; Utah Code Ann. § 61-1-6 (2021); Utah Admin. Code R164-2-3.
13. Prospectus: A document that provides information about a securities offering to potential investors. It includes information about the issuer, the securities being offered, and the risks associated with the offering. See The Securities Act of 1933, Section 10(a) [15 U.S. Code § 77j(a)]; Utah Admin. Code R164-2-3.

These definitions are not exhaustive, but they cover some of the most important terms used in securities law.

Securities Offerings and Registration Requirements

Under the Securities Act of 1933, issuers of securities must register their offerings with the Securities and Exchange Commission (SEC) unless an exemption applies. The Utah Uniform Securities Act similarly requires the registration of securities offerings, unless an exemption is available.

Exemptions from Securities Registration Requirements

Both federal and state securities laws provide exemptions from registration requirements for certain types of securities offerings. Here are some of the most common exemptions:

1. Private Offerings: Securities offerings made only to a limited number of persons with a pre-existing relationship with the issuer are exempt from registration. This exemption is provided under §230.506(b) of Regulation D under the Securities Act of 1933.
2. Intrastate Offerings: Securities offerings made and sold exclusively within a single state are exempt from registration. This exemption is provided under § 3(a)(11) of the Securities Act of 1933.
3. Regulation D Offerings: The SEC’s Regulation D provides three exemptions from registration requirements for private placements of securities:
   • Rule 504: Allows issuers to offer and sell up to $5 million in securities in a 12-month period. This exemption is provided under § 230.504 of Regulation D.
   • Rule 505: Allows issuers to offer and sell up to $5 million in securities to a limited number of accredited investors and up to 35 non-accredited investors. This exemption is provided under § 230.505 of Regulation D.
   • Rule 506: Has no limit on the amount that can be raised but restricts the number of non-accredited investors to 35. This exemption is provided under § 230.506 of Regulation D.
4. Crowdfunding Offerings: Securities offerings made through crowdfunding platforms can be exempt from registration if they comply with the SEC’s Regulation Crowdfunding, which allows issuers to raise up to $5 million. This exemption is provided under 17 CFR § 227.100 – Crowdfunding exemption and requirements.
5. Employee Benefit Plans: Securities offerings made to employees or through employee benefit plans are exempt from registration under federal securities laws. This exemption is provided under § 4(a)(2) of the Securities Act of 1933.

Conclusion

Securities law is complex and can be difficult to navigate. Issuers of securities in Utah should consult with an experienced securities attorney to determine their compliance obligations under federal and state securities laws. By understanding the exemptions, rules, and regulations that apply to securities offerings, issuers can avoid potential legal pitfalls and ensure offerings comply with securities law requirements.

References:

1. U.S. Securities and Exchange Commission. (n.d.). Introduction to the Securities Act of 1933. Retrieved from https://www.sec.gov/smallbusiness/exemptofferings/secg/securities-act-1933.htm