Often, when I am asked what type of law I practice, I am given a look of confusion when I say “Securities Law.” Then I am usually asked a series of questions about internet security and/or home security (as in security systems). When teaching an Introduction to Business Entities class at a local University, I see a sea of confused and perplexed faces when I give the brief overview of Securities Regulations.
So what is a Security and why does it need to be regulated? There are several definitions of the term Security, but put simply- it is a transferable ownership interest in a business entity. Generally, there are two types of Securities:
- Equity Securities: This is the most common form of securities. Shares of Stock of a Corporation, Membership Interests or Units of a Limited Liability Company and (in most cases) Partnership Interests in a Limited or General Partnership. You will generally hold a certain number of securities representing a percentage of the whole ownership of the company (i.e. 5% of the total issued (and owned) shares) Ownership of Equity Securities entitles you to a portion of the profits or losses of the company each year. Equity securities also include Options and Warrants exercisable into stock or membership interests. If you have an IRA, 401K or other brokerage accounts, you own a portion of the companies listed on your monthly statement; publicly traded securities.
- Debt Securities: Where the Company is in debt to you– they owe you money. This is usually through a Note (loan) usually convertible into shares or stock or membership/partnership interests. You have the choice to 1) be paid back in cash, the amount you are owed, or 2) convert that debt into the number of shares of stock or membership interests equal to the value you are owed.
Whether they are debt or equity, the ownership interests are transferable (after the lifting of any applicable restrictions), meaning you can sell, pledge, assign, gift or otherwise transfer them on-the-market (think NASDAQ, etc.) or to another private party, at your discretion— making them Securities.
The offer or sale of these securities is subject to many state and federal laws restricting the way the offer is made, to whom, and how much is raised. These regulations, enforced by the Securities and Exchange Commission and state securities agencies in each state, are designed to protect the investors from fraud. They encourage full disclosure by the company to the potential investor and helps ensure that the investor’s money is used as promised.
Companies selling securities through private offerings, crowdfunding offerings, or public offerings need to ensure strict compliance with these regulations in order to avoid liability.
Note: There are several exemptions and exceptions to what is considered to be a “security” so please consult with a Securities attorney if you have any specific questions. This is a very simplified explanation of a complex subject and should not be construed as legal advice.