Business owners sell securities to raise funds to operate or expand their business. Investors buy securities in the hopes of gaining a return for that investment. The sale of securities is regulated at both state and federal levels. The principal purpose of the regulation is the protection of investors. The general rule is that securities must be registered unless the securities, or the transactions in which the securities are sold, are exempt from registration requirements under applicable statutes or regulations. Sale of unregistered, non-exempt securities is unlawful, and can result in civil, and in some cases even criminal, liability for the issuer.
What is a Security?
The definition of a “security” is provided by state and federal statute, with some judicial gloss added over the years as securities fraud cases have been litigated. State law definitions are unique to each state. The Oregon definition is found in ORS 59.015(19)(a):
“Security” means a note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in a pension plan or profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, certificate of interest or participation in an oil, gas, or mining title or lease or in payments out of production under such title or lease, real estate paper sold by a broker-dealer, mortgage banker, mortgage broker or a person described in subsection (1)(b) of this section to persons other than persons enumerated in ORS 59.035(4), or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificates for, receipt for, guarantee of, or warrant or right to subscribe to or purchase any of the foregoing.
Commonly encountered securities include the following:
- stock in a corporation
- certain promissory notes or debentures
- limited partnership interests
- investment contracts
- options to acquire any of these items
Promissory notes in typical commercial or consumer transactions are usually not treated as securities, even though they are expressly included in both federal and several state statutory definitions of a security (including Oregon). If notes are issued in a context that has stronger “investment,” rather than typical commercial or consumer transaction overtones, the issuer of the notes should speak with an attorney or other professional with significant knowledge of securities to ensure compliance with applicable state and federal law.
An investment contract is something of a catch-all category defined to include:
- investments of money or equivalent,
- in a common enterprise,
- with the expectation of profit, and
- derived principally from the management of others.
The category includes many forms of investment opportunities that do not fit squarely into another defined category. Any unincorporated enterprise or business venture involving centralized management, along with more passive owners or investors, should be analyzed to determine applicability of investment contract theory to render the investment a “security” under applicable law. For example, an ownership interest as a partner in an Oregon partnership or member in a limited liability company (LLC) is certainly subject to this analysis. A membership interest in a manager-managed LLC will be an investment contract, as will an interest as a limited partner in a limited partnership. A membership interest in a member-managed LLC or a general partnership may be an investment contract (and therefore subject to securities law compliance) if members delegate management authority or do not have the practical ability to participate in management of the entity, regardless of their legal authority to do so.
Why Should I Care? The Consequences of Noncompliance
Availability of an exemption from registration does not exempt an issuer of securities from the antifraud restrictions of securities laws. Securities “fraud” does not imply or require intent to deceive. A simple failure by an issuer to disclose a material fact, or a misrepresentation of a material fact (even if innocently done), may violate antifraud restrictions if the issuer knew or reasonably should have known of the existence of the true fact. A careful issuer seeks protection from securities fraud claims not only by attention to registration or exemption requirements, but also by full disclosure of material facts to potential investors, usually in the form of a written disclosure document.
Sales of securities in violation of applicable law can be disastrous for a small business and its promoters. A purchaser of securities sold in violation of Oregon law may be entitled to rescission of the investment (i.e., recovery of the purchase price), plus interest and attorneys fees, from the seller and material participants in the transaction (e.g., officers and directors). In addition, a purchaser may seek “actual damages” under Oregon law against a person who violates or materially aids in the violation of the law’s antifraud provisions, and against any person who directly or indirectly controls a person considered liable under Oregon law.
At Harrang Long Gary Rudnick P.C., we have several years of experience with securities exemptions, registrations, and related transactions and compliance activities for small businesses and individuals. Please contact J. Lee Lashway for assistance on any of these matters.