Module 5 covers a few remaining aspects involved in the post-IPO trading of securities and required reporting, as well as the limited sale of securities within a state. The initial public offering of securities opens the door wider to SEC oversight and on-going reporting requirements under the Securities Exchange Act of 1934, which we’ll refer to as the “Exchange Act.”. The Act requires any company whose equity security is traded on a national exchange- for example, the New York Stock Exchange- to register that security under Section 12(g). Furthermore, under Section 13(a), the company is also required to file certain periodic reports with the SEC. These requirements are separate from other federal disclosure reporting found in other laws such as the Sarbanes- Oxley Act of 2002.
Finally, the Module examines the requirements for offering and selling securities within the borders of a single state. An offering of securities limited to residents of a single state is categorized as an intrastate offering exception under Regulation D. The state laws governing the sale of these intrastate offerings are referred to as Blue Sky Laws.
Reporting Requirements under the Exchange Act
The Exchange Act was enacted by Congress to govern secondary trading of securities, and to establish the Securities Exchange Commission. Companies whose equity securities are traded on national stock exchanges are categorized as reporting companies. These companies must file periodic reports through the SEC’s EDGAR website. The Act also prohibits the trading of a company’s securities by individuals who may gain confidential inside information about the company’s new opportunities or set-backs to prevent insider trading.
An Exchange Act reporting company is required to file several Forms with the SEC.
A Form 10-K  must be filed within 60 to 90 days of the end of the company’s fiscal year. The preliminary purpose of Form 10-K is to update the company’s information contained in Form 10 that was filed as part of the initial registration with the SEC as well as all subsequent Form 10-K’s filed.
Form 10-K provides updated disclosures on the following topics:
- audited financial statements;
- five-year trend analysis covering the company’s revenue, net profit, gross margin;
- business development activities;
- real property assets;
- legal proceedings having a material effect on the company’s operations;
- market for the company’s securities;
- management discussion and analysis of the company’s financial condition and business operations;
- any disagreements between management and the company’s public accountants;
- background of the company’s executive officers and directors;
- compensation and security ownership of executive officers and directors;
- listing of major shareholders of the company; and
- related party transactions involving the company.
The company’s chief executive, chief financial officer, chief accounting officer and a majority of its board of directors must sign the Form 10-K. Those signing the Form-10K must acknowledge that they understand their obligations to be truthful in their statements. Furthermore, they must attest that their Form 10-K responses adequately provide the information required under the Exchange Act.
Form 10-Q is the quarterly equivalent of the annual Form 10-K, and is due 40 days after the end of the quarter. A company uses the 10-Q to update its financial statements for the past quarter. However, the quarterly financial results do not have to be audited. The company must disclose in the 10-Q:
- certain financial information;
- management’s discussion and analysis of financial condition;
- results of operations for the reported quarter;
- legal proceedings having a material impact on business operations;
- report on any significant nonrecurring events which occurred during the reporting quarterly period;
- updated risk factors faced by the company; and
- any default by the company on its senior securities.
Form 8-K  must be filed by the company to promptly report certain material events concerning its management, business, operations or changes in financial conditions. For example, a company must promptly disclose the sale of major assets, acquisition of assets, merger, the resignation of directors or officers or changes to its certifying accountant.
Other Reporting Requirements
The Williams Act, which addresses hostile takeovers, mandates that a person who acquires beneficial ownership in excess of 5% of a security registered under Section 12 of the Exchange Act is required to file Schedules 13D and or? 13G. These schedules must disclose the purpose behind their accumulation of shares, from whom they obtained financing to purchase the shares, the names of the parties and other pertinent information that might disclose the strategy in accumulating the shares.
To make public inforation about major shareholders’ transactions, Section 16 of the Exchange Act requires officers and directors who beneficially own more than 10% of a company’s equity securities to file reports with the SEC concerning the transaction. This information is valuable to public investors who look for signs from insiders to determine whether to invest in a company. The filings by the insiders include disclosing the purposes behind sales of stock to better inform investors.
Any registered security is subject to proxy solicitation rules of Section 14. Under these rules, no solicitation of shareholders’ votes may be conducted without first providing to those shareholders written proxy statements providing certain key information. These require very detailed information concerning proposed resolutions offered for votes at shareholders’ meetings.
Blue Sky Laws
Under the pre-emption doctrine, where the federal government has pervasive oversight of a regulatory area, federal laws and regulations supersede the laws and regulations enacted by the states covering the same area. Where federal laws permit the states to share enforcement of a regulated industry, such as securities sales, the states may set up their own regulatory schemes. As the 1933 Act exempts from registration certain securities offerings, the issuers of those exempt securities are allowed to offer such securities under the auspices of state securities laws. These laws are referred to as Blue Sky Laws.
Under blue sky laws, issuers are required to register securities exempt from federal registration. Typically, the process of registering securities within a state is referred to as qualifying a security for sale. State securities regulators are charged with enforcing the qualification process for newly issued securities. The states’ securities regulators develop guidelines to follow for qualifying a security to be sold to in-state residents.
These guidelines are usually modeled after the Uniform Securities Act of 1956 which is a model statute enacted by the states to establish guidelines for the regulation of the sale of securities and for enforcing investors’ protections against securities fraud. The Uniform Securities Act provisions have been adopted by most states, including major corporate states New York, California, Florida and Delaware.
The North American Securities Administrators Association is a body with membership that includes most states’ securities regulators that educates and informs regulators on proposed changes to securities laws and lobbies on behalf of states’ rights to implement their own statutory schemes to police securities fraud.
Recall that the registration requirements under Section 5 of the 1933 Act applies to the offer or sale of securities using the channels of interstate commerce. Accordingly, Congress addressed the issue of an intrastate offering by adding Section 3(a)(11) of the 1933 Securities Act, generally known as the “intrastate offering exemption,” Section 3(a)(11) states:
Any security which is 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.
To facilitate this interstate offering exemption, the SEC adopted Rules 147 and 147(a) to clearly set out the requirements that issuers must follow to obtain the intrastate exemption in the offering of securities for sale. These rules, effective as of 2018, are as follows:
- Issuers of securities must be organized (that is, incorporated) in the state in which the offering and sale of its securities will occur;
- The officers, partners or managers of the issuer must primarily direct, control and coordinate the issuer’s activities at its principal place of business, located in-state;
- The issuer must meet at least one of these “doing business” tests:
- Derives at least 80% of its consolidated gross revenues from operations of the business or of real property located in-state or from the rendering of services in-state, OR
- Have at least 80% of its consolidated assets located in-state, OR
- Intent to use and uses at least 80% of the net proceeds from the offering towards the operations of a business or of real property in-state, the purchase of real property located in-state, or the rendering of services in-state, OR
- A majority of the issuer’s employees are located in-state.
- Offers and sales are limited to in-state residents or those whom the issuer reasonably believes are in-state residents; and
- The issuer must obtain written representations from each purchaser as to residency
In addition, the resale of securities purchased via intrastate offerings is limited to those residing in the state during the six months beginning from the date of original sale by the issuer and the resale of these securities requires registration with the SEC unless an exemption applies.
When conducting an intrastate offering under Rule 147, the issuer is not required to file any disclosures documents with the SEC or pay fees to the SEC. However, the issuer must comply with state securities laws.
An Example: California’s Blue Sky Law
We will use California as a model because of the size of its economy and large presence of emerging companies that raise funds privately in the state. Moreover, California has adopted the language and provisions of the Uniform Securities Act of 1956 to construct its securities laws.
Under California law, “…every offer or sale of securities must be qualified with the Commissioner of Corporation…” Section 25019 of the California Corporations Code, a security is defined to include “an interest, whether or not evidenced in writing…
(a) a note, stock, treasury stock, …bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement…
(b) an interest or instrument commonly known as a ‘security’… and
(c) a certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or rights to subscribe to or purchase an item specified in section 25019.
In Hamilton Jewelers v. Department of Corps. (1974), the California Supreme Court pointed out that the definition of a security was modeled after that in the federal securities Act, and “accordingly, the federal cases are therefore authoritative.” The Court further noted that “…the purpose of the law is to protect the public against spurious schemes to attract risk capital…”
In that case, which involved a note secured by previous notes, the Court needed to determine whether the instrument was a regulated security. The Court took a case-by-case approach to determining what qualifies as a security because Section 20019 contains over 25 examples of securities. Instead of trying to fit the note offered to investors under one of the categories listed in Section 25019, the Court instead applied the “risk-central” test to determine the concept of a security. The Court asked: Did the Hamilton Jewelers investors assume risk when they purchased the note?
The Court answered in the negative, finding that the purchasers of the note were not offered a “spurious scheme” because the notes were backed by valid, valuable collateral. The Court reasoned since the Hamilton Jewelers note investors did not have investment capital at risk, the notes were not securities under California law. Thus, the “risk capital” test is the prevailing view of a majority of California courts on what constitutes a security.
In contrast, the federal approach to determining what is a security is much broader under the definitions in the 1933 Act and the Supreme Court decision in SEC v. W.J. Howey Co. (1946) that defined a security as any investment contract where the purchaser sought to make a profit. The so-called “Howey Test” centers on the promise of a return or profit at the core of defining “security.”
In California, the registering of a security for sale also differs from the federal approach. First, California’s approach is more flexible, permitting three ways to register a security. Qualification of a security may be accomplished through (a) coordination, (b) notification, or (c) by permit, depending on the character of the security and the nature of the transaction.
An “issuer” of securities in California is defined as “…a person who issues or proposes to issue securities.” To qualify a proposed security, the California commission of corporations must be satisfied that:
(a) the applicant’s business plan and the proposed issuance of securities are fair, just, and equitable,
(b) the applicant intends to transact its business fairly and honestly, and
(c) the proposed securities and issuing method will not defraud purchasers.
The California commissioner of corporations has broad authority in the qualification process. For example, the commissioner may issue a stop order to deny, suspend or revoke the effectiveness of a prior qualification if (a) the basic fairness and honesty test have not been met and the order is in the public interest, or if the issuance will defraud purchasers.
Only sales and offers made in California require qualification. An offer or sale is deemed to be made in California under any of the following circumstances:
- First, the offer originates in California;
- Second, the offer is directed to California and is received at the place to which it is directed;
- Third, the acceptance of an offer to buy is communicated to the offeree in California;
- Fourth, the offer is directed to California and is received at the place to which it is directed;
- Fifth, both seller and purchaser are domiciled in California and the security is delivered to the purchaser in California; and,
- Sixth, the offer is directed to California and received at the place to which it is directed.
As a company moves from a privately-held to a publicly-held status it faces a new stage of complexity. Under the Exchange Act, companies face high-stakes timely and full disclosers of all material information, certified by the company’s executives and half of its board members. A misstep can lead to civil penalties, and criminal penalties may be applicable where fraud is the basis of misleading disclosures.
Intrastate private offerings similarly involve complex securities offerings rules under the states’ Blue Sky Laws. Finally, as the market for security offerings continues to grow globally, the demand for professional services will continue to expand. The future requires even more highly specialized paralegal teams working to assist and support client companies’ search for capital in the global securities markets.
Thank you for participating in LawShelf’s video-course on corporate finance. We hope that you now have a better understanding of the public offering process and how companies can raise money by selling shares to the public. We also hope that you will take advantage of our other business law courses. Please let us know if you have any questions or feedback.
 15 U.S.C. Section 78a et seq; https://legcounsel.house.gov/Comps/Securities%20Exchange%20Act%20Of%201934.pdf
 15 U.S.C. Section 78a et seq
 15 U.S.C. Section 78d(a) (“There is hereby established a Securities Exchange Commission…”)
 Visit https://www.sec.gov/edgar/searchedgar/companysearch.html to view company filing information
 15 U.S.C. Section 78p (The trading on inside information is referred to as “insider trading”.)
 Section 13(a) of the Exchange Act
 A large accelerated filer must file with 60 days, an accelerated filer has 75 days, and a non-accelerated filer may file within 90 days. See Rule 12b-2 under the Exchange Act for definitions of accelerated filer and large accelerated filer.Footnote 11 I inserted has this info in an easy to find format
 General Form for the Registration of Securities is filed pursuant to Sect. 12(b) of the 1933 Act
 Pub. Law 90-439, 15 U.S.C. Section 78a et seq.
 Visit website cited in footnote 20 to view the provisions of the Uniform Securities Act; https://www.nasaa.org/wp-content/uploads/2011/08/UniformSecuritesAct1956withcomments.pdf
 17 C.F.R. § 230.147
 “Intrastate Offering Exemptions: A Small Entity Compliance Guide for Issuers”, SEC, April 19, 2017, http://www.sec.gov/info/smallbus/secg/intrastate-offerings-exemptions-compliance-guide-041917.htm I couldn’t access this link. Ones that worked: https://dart.deloitte.com/USDART/obj/1d63428f-358b-11e7-a0c7-dbd1970f78f1; https://www.sec.gov/info/smallbus/secg/intrastate-offering-exemptions-compliance-guide-041917.htm
 California Corporations Code, Sections 25110 and 25120
 Id, Section 25019 (over 25 examples of securities are listed in Section 25019)
 Hamilton Jewelers v. Dep’t of Corps., 37 Ca. App. 3d 330 (1974)
 SEC v. W.J. Howey Co.,328 U.S. 293 (1946)
 California Corporations Code Section 25111
 Id, Section 25112
 Id, Section 25113
 Id, Section 25010
 Id, Section 25140
 Id, Section 25140(a)
 Calif. Corp. Code Section 25008