Business Finance / General

Is That a Security? – Nothin’ but Blue Skies Do I See

3002022_20f06fefI frequently speak to entrepreneurs in the beginning stages of their company.  They’re excited, driven, brilliant and often, broke.  They’re looking for people to help them financially to get enough capital to build their product.  I ask them if they’ve gotten an opinion of if they are offering a security.  Then I get the blank stare.  “A what?”  “Surely not.”  “I have no idea.”

Blue sky laws are state-created statutes that require specific disclosures to investors in an effort to combat fraud.  In Texas, they are found under Title 19 of the Texas Civil Code and “include any limited partner interest in a limited partnership, share, stock, treasury stock, stock certificate under a voting trust agreement, collateral trust certificate, equipment trust certificate, preorganization certificate or receipt, subscription or reorganization certificate, note, bond, debenture, mortgage certificate or other evidence of indebtedness, any form of commercial paper, certificate in or under a profit sharing or participation agreement, certificate or any instrument representing any interest in or under an oil, gas or mining lease, fee or title, or any certificate or instrument representing or secured by an interest in any or all of the capital, property, assets, profits or earnings of any company, investment contract, or any other instrument commonly known as a security, whether similar to those herein referred to or not. The term applies regardless of whether the ‘security’ or ‘securities’ are evidenced by a written instrument. Provided, however, that this definition shall not apply to any insurance policy, endowment policy, annuity contract, optional annuity contract, or any contract or agreement in relation to and in consequence of any such policy or contract, issued by an insurance company subject to the supervision or control of the Texas Department of Insurance when the form of such policy or contract has been duly filed with the Department as now or hereafter required by law.”  TEX CV. CODE ANN. § 581-4.

Does that all seem very broad?  It should, because it is.  The reason many transactions do not have to comply with the blue-sky information disclosure requirement is because they are either exempt transactions, or exempt securities.  There are a lot of transactions and securities that are exempt from the blue sky laws.  However, it is vitally important to know that you have an exemption before offering a security to a potential investor.

This may already seem overwhelming, but bear in mind that all of this only deals with the blue sky regulations of a transaction located entirely within one state, Texas.  If you were to offer securities outside of the state, you must also deal with the regulations of those states and the federal Securities and Exchange Commission (SEC) as well.  (Because of the limited powers of the federal government granted by the constitution, exempted from the SEC regulations are “[a]ny security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.” Securities Act of 1933.)

What should you do?

Involve an attorney, a registered broker-dealer (or even better, both) as part of your fund-raising efforts.  With the assistance of counsel you can identify whether or not you’re dealing with a security and if so, if any exception applies.  There are numerous exemptions, and it’s quite possible that you will fall within one.  However, if not, it’s vitally important to adhere to the requirements upfront.  Otherwise, if the venture is unsuccessful, you may find yourself facing a disgruntled investor sitting on evidence of a state-securities regulation violation.

For more information about securities in Texas, visit the Texas State Securities Board website.

A press release related to crowd funding under the federal Jumpstart Our Business Startups (JOBS) Act is available here.

Image “Blue sky at last!” courtesy of (Graham Hogg) / CC BY-SA 2.0

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