As we’ve previously discussed, a serial issuer operating or using a website that displays and advertises offerings of securities (a “funding platform”) does not necessarily need to register with the SEC (or FINRA) as a broker-dealer.fn1
However, what about State blue sky laws?
While Rule 506 of Regulation D and Regulation A+ Tier 2 offering exemptions eliminate the need to register (“blue sky”) a securities offering in the various states, state regulatory efforts remain focused on licensing persons who are effecting securities transactions within their borders. In other words, although the securities themselves are exempt from blue sky registration, the act of selling those securities to residents of the state may itself require registration. States generally license and regulate market participants such as brokers, dealers, investment advisers, business brokers and salespersons (including agents of issuers) who engage in the business of selling securities (broker-dealers) or advising others in regard to their purchase or sale (investment advisers). Serial issuers of securities thus need to comply with state blue sky laws, which require that the persons selling securities, or advising others in regard to the sales, be registered or exempt from registration in each state where securities are sold.
State securities “blue sky” laws generally predate federal law. And both federal and state securities laws exist side by side and may regulate securities offerings. As such, each securities transaction in which you participate must not only comply with federal law, but state law as well. The states not only have separate laws, but also their own securities regulatory and enforcement agencies. These state securities administrators fn2 regulate securities activities in their respective states and bring actions to enforce state laws. Serial issuers are thus well advised to review the laws of each state in which securities are being offered or sold to ensure compliance with blue sky laws.
Although the specific rules of each state vary widely, state laws generally require 1) the registration of securities offerings (unless exempt), and 2) the licensing of the market participants who sell them. First, state laws require the registration of securities that will be offered or sold within a state, unless a specific exemption eliminates this requirement. Rule 506 offerings, as well as those under the new Reg A+ Tier 2, are exempt offerings under federal law.fn3 Although state registration is preempted, the states for 506 offerings impose a “notice filing” requirement to alert state authorities that a securities offering is occurring in their state. States historically also require participants to consent to service of legal process and to pay a filing fee.fn4 Generally, notice filings for Rule 506 offerings consist of the filing with the state all the documents (Form D) the issuer filed with the Securities and Exchange Commission (SEC), as required by the Securities Act of 1933.fn5 The same remains true under Reg A+ Tier 2. fn6
Secondly, market participants such as brokers, dealers, investment advisers and agents (including agents of issuers) must be licensed with each state absent an exemption. State blue sky laws focus on who is permitted to engage in the business of selling securities, or advising others in regard to the purchase or sale of securities in the state. fn7 Indeed, state regulators frequently target their regulatory efforts on the persons engaged in these securities activities. While the specific requirements of when a market participant is required to be registered differs state by state, market participants must be licensed in each state where they conduct business, absent an exemption from this requirement. The states generally have broadly defined the activities requiring registration too, thus capturing the conduct of individuals who may mistakenly think their conduct is occurring outside of the securities industry (e.g., finders, business brokers), and often require that these individuals be licensed to conduct their business activities in the state.
This may pose a dilemma if you are undertaking a securities offering that targets investors in multiple states. While many states have adopted a version of the Uniform Securities Act (an effort to make uniform state registration requirements), not all states have done so. Large states including New York, Texas, California and Florida have not adopted the Uniform Securities Act. The states that have adopted it have not necessarily adopted the most recent version fn8 or adopted it with some variation or change. Yet it is incumbent on those engaging in securities transactions to comply with state law, regardless of the challenges required in evaluating registration and exemption requirements for each state. The bottom line is that market participants are required to be registered, or exempt from registration, before any securities offering may take place in a state, as the states have the important job of regulating securities activities within their borders and protecting their citizens.
The Uniform Securities Act (2002) defines “broker-dealer” as “a person engaged in the business of effecting transactions in securities for the account of others or for the person’s own account.”fn9 Historically, a broad interpretation has been applied to the terms “effect” and “engaged in the business.” Similarly, the definition of “investment adviser” is “a person that, for compensation, engages in the business of advising others … as to the value of securities or the advisability of investing in, purchasing or selling securities… .”fn10 And an “agent” is a person who represents a broker-dealer or issuer in “effecting or attempting to effect purchases or sales of securities,” or, where investment advisers are involved, a person “who makes any recommendations or otherwise gives investment advice regarding securities, manages accounts or portfolios of clients… .”fn11 These agents must also be registered and licensed absent an exemption.
While the definition of who is required to be registered and licensed is broad, there are available exemptions, but you must consult the laws of each individual state where you are conducting a securities business to find them. NSMIA for example limits a states’ ability to regulate de minimus transactions by agents of broker-dealers. As a result, the Uniform Securities Act (2002) provides that broker-dealers with no place of business in a state and with no more than three customers there during the previous twelve month period, are exempt from registration so long as they are federally registered (or not required to be registered) under the Securities Exchange Act of 1934.fn12 NSMIA also removes the state’s ability to license (other than notice filings) SEC registered investment advisers, and applies a de minimus exemption to investment advisers too. The Uniform Securities Act (2002) provides that advisers with no place of business in the state and with no more than five clients in that state are exempt from registration.fn13 There are also exemptions for agents. fn14
Similarly, non-Uniform Securities Act states have similar broad definitions of market participants who are required to be licensed, unless meeting an exemption. California fn15, for example, like the Uniform Securities Act, defines a “broker-dealer” as a “person engaged in the business of effecting transactions in securities in this state for the account of others or for his own account.”fn16 Texas makes no distinction between a broker and dealer, and defines a dealer as a person “who engages in this state, either for all or part of his or its time, directly or through an agent, in selling, offering for sale or delivery or soliciting subscriptions to or orders for, or undertaking to dispose of, or to invite offers for any security or securities and every person or company who deals in any other manner in any security or securities within this state.”fn17 In addition, Texas has interpreted that any “issuer other than a registered dealer of a security or securities, who, directly or through any person or company, other than a registered dealer, offers for sale, sells or makes sales of its own security or securities shall be deemed a dealer and shall be required to comply with the provisions hereof,”fn18 absent meeting an exemption.fn19
New York’s Article 23A of the General Business Law (the “Martin Act”) is different from all other state laws. An issuer falls into the definition of a securities dealer and it is unlawful to hire a securities salesman unless that person is registered.fn20 And it is unlawful for any dealer, broker or salesman to sell or offer for sale to the public within or from the state any securities issued absent the filing a registration statement.fn21 Yes, issuers sometimes are defined under state blue sky laws as broker-dealers. Even in states where issuers do not need to be registered, their sales agents may need to be so.
We can go on infinitely pointing out distinctions and nuances in each state law, but the point is that state laws must be considered and complied with when offering or selling securities in any given state. It is very complex. And the failure to meet the registration or exemption requirements can, and often does, result in state enforcement proceedings or rescission of offerings, which can impact your company’s reputation and both your and its ability to sell securities in the future. fn 22
This is true of everyone engaging in technology-driven capital formation and who use websites (funding platforms) to engage with investors, including;
a. Issuers (direct offerings on websites, no fees charged since it is the issuer’s own website)
b. Listing (offerings displayed on a website that simply charge a non-refundable fee for listing, advertising, tech tools, etc.)
c. Investment Advisers (generally who create SPVs or other funds and earn standard 2%/20% model)
d. Broker-Dealers (who charge commissions for selling securities).
Issuers that operate or use a funding platform and that are not acting or registered as a broker-dealer in the various states where investors reside, will generally have difficulty navigating the intricacies of state regulation. Fortunately there is another way to proceed. When you offer securities pursuant to Rule 506 or Reg A+, you can use a third party broker-dealer to effect the securities transactions on your behalf. You can do this in two different ways:
1. Become a branch office of a registered broker-dealer. This is a higher friction choice as it subjects you and your offering(s) to an extra layer of direct regulatory oversight fn23, including review (and sometimes pre-review) of all deal marketing; or,
2. A simple contract with a registered broker-dealer like FundAmerica to effect your securities transactions in each state you do business. This allows you to stay focused on your business while using a regulated broker-dealer that meets state licensing requirements as the broker-dealer of record for your securities offering(s).
Regardless of which direction you go, as a serial issuer you need to be aware of, and in compliance with state blue sky in every state where your investors reside. How easy or complicated this will be depends on how you structure your business and your offering(s), together with the advice from your securities attorney.
1 The term “issuer” is defined under both the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act) as “the person who issues or proposes to issue any security… .” The issuer exemption, found in Exchange Act Rule 3a4–1, provides a nonexclusive safe harbor for persons associated with issuers to participate in the sale of an issuer’s securities and without registering as a broker-dealer. While the issuer exemption may provide relief for issuers of a single offering, the exemption may be called into question when an issuer’s associated persons seek to participate in multiple offerings in a single calendar year (i.e., functioning as a “serial issuer”).
2 See http://www.nasaa.org/about-us/contact-us/contact-your-regulator/ .
3 Rule 506 offerings constitute “covered” securities under the National Securities Markets Improvement Act of 1996 (NSMIA). See Uniform Securities Act (2002), Section 301 (“It is unlawful for a person to offer or sell a security in this State unless: (1) the security is a federal covered security; (2) the security, transaction, or offer is exempted from registration under Sections 201 through 203; or (3) the security is registered under this [Act]”).
4 See Uniform Securities Act (2002), Section 202, Official Comments (“Section 18(b)(4)(D) of the Securities Act of 1933 defines as federal covered securities as those issued under [SEC] rules under Section 4(2) of the Securities Act. This would include Rule 506, which uses the ‘accredited investor’ definition in Rule 501(a). When a transaction involved Rule 506, Section 18(b)(4)(D) further provides ‘that this paragraph does prohibit a state from imposing notice filing requirements … .’ ”)
5 Id. at Section 302.
6 States retain the authority under Reg A+ Tier 2 to require issuers to file with the states any document filed with the SEC for purposes of notice and assessment of a filing fee.
7 States assess the competency of salespersons through testing (series 63) and determine whether or not to allow a salesperson to conduct business in a state. States generally deny registration if it is in the “public interest,” among other criteria.
8 See http://www.uniformlaws.org/Act.aspx?title=Securities%20Act .
9 Uniform Securities Act (2002), Section 102.
10 Id. The term, however, excludes a federal covered investment adviser.
11 State licensing of agents occurs through the Central Registration Depository (CRD). Some states require background checks, bonding and payment of a fee. Most states require that an associated person pass the Series 63. The Texas State Securities Board requirements are illustrative. Texas reviews applications for the registration of dealers, agents, investment advisers, and investment adviser representatives to ensure that individuals and firms dealing with Texas investors “meet certain minimum qualifications and are financially solvent.” A background check is performed in Texas on every applicant.
12 Uniform Securities Act (2002), Section 401.
13 Id. at Section 403. Investment advisers are dually registered by the federal and state governments. NSMIA divided authority between who needs to be SEC registered and who needs to be state registered. Dodd-Frank further expanded the state’s authority by raising the assets under management threshold for federal regulation to $100 million. State laws for advisers impose licensing and qualification standards.
14 Id. at Section 402.
15 California Corporations Code Sections 25000 – 31516.
16 Id. at Section 25004.
17 The Texas Securities Act Section 4.
19 Texas has recently enacted and will soon place into effect a “private fund adviser” exemption. A private fund adviser is defined as an investment adviser who provides advice either solely to one or more private funds or to one or more private funds and certain other clients pursuant to another exemption from investment adviser registration. See http://www.ssb.state.tx.us/Dealer_And_Investment_Adviser_Registration/FAQ_Private_Fund_Adviser_Rules.php
20 NY General Business Law Section 359-e.
21 Id. New York requires issuers selling securities pursuant to Regulation D to either register with the state or apply for an exemption. The exemption, however, is not self-effecting, but rather, must be expressly granted by New York before offers and sales of securities may be made. General Business Law Sections 359-e and 359-f and Department Regulations New York Codes, Rules and Regulations Title 13 Part 10 Brokers, Dealers and Salespersons. See http://www.ag.ny.gov/investor-protection/broker-dealer-and-securities-registration-information-sheet .
22 State enforcement actions, depending on the state involved, can be criminal, civil or administrative actions. For example, both California and Texas have recently brought administrative actions against securities participants who effected securities sales without registering under state blue sky laws. See Enforcement Action by the California Department of Business Oversight, Spirit of California Entertainment Group, Inc., James Brent Rogers, et al., Desist and Refrain Order (acting as a broker-dealer without registration in violation of Corporation Code section 25210)(January 26, 2015); Enforcement Action by the Texas State Securities Commissioner, Clifton Curtis Sneed, Jr. DBA The Joint Venture Group, et al, Emergency Cease and Desist Order (failure to register as a dealer or agent in violation of Section 12 of the Texas Securities Act)(December 11, 2014).
23 FINRA’s Corporate Financing Department reviews private securities offerings in which FINRA firms will participate, thus adding a layer of regulatory oversight. See http://www.finra.org/industry/issues/corporate-financing . Rule 5123 provides “Each member that sells a security in a non-public offering in reliance on an available exemption from registration under the Securities Act (“private placement”) must: (i) submit to FINRA, or have submitted on its behalf by a designated member, a copy of any private placement memorandum, term sheet or other offering document, including any materially amended versions thereof, used in connection with such sale within 15 calendar days of the date of first sale; or (ii) notify FINRA that no such offering documents were used… .” FINRA advertising and supervision rules are also applicable.
The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.