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Securities Registration: Keeping the Skies Clear

If you’ve built your business to the point where you want to raise capital in public markets, life can become both cumbersome and expensive. You may need to deal with more than 50 state and local regulatory agencies in addition to the federal Securities and Exchange Commission. That’s right, each state — as well as Puerto Rico, Guam, the District of Columbia and the U.S. Virgin Islands — has its own rules, regulations and securities commission that oversees what are commonly called “Blue Sky Laws.”

A Taste of History

Trading in securities has been regulated at least since the Thirteenth Century, when King Edward required all London brokers to be licensed.

In the U.S., the real push for legislation came from the Midwest and West in the latter half of the 19th Century when investors complained of being victimized by wheeler-dealers on the East Coast. Kansas passed the first “comprehensive” law and more states quickly followed. It wasn’t long before the laws were being challenged for their constitutionality. Opponents charged that the laws significantly blocked capital formation.

Finally, the Supreme Court took up the issue and in 1917, upheld the securities laws of three states. In the courts’ opinion, Justice Joseph McKenna wrote: “The name that is given to the law indicates the evil at which it is aimed, that is, to use the language of a cited case, ‘speculative schemes which have no more basis than so many feet of ‘blue sky,’ or, as stated by counsel in another case, “to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other like fraudulent exploitations.”

These laws, dating back to the early part of the century regulate all securities offerings (see the box at right). They’re aimed at preventing fraud and requiring full financial disclosure so that potential investors have sufficient information to make informed decisions.

Full registration is costly and time consuming, and many small businesses and start-ups are unable to comply with the rules. Fortunately, there are state and federal exemptions that can help avoid the cost and delays associated with public offerings:

Limited private. These are stock, debt or hybrid offerings (for example, convertible preferred shares matched with warrants) that are limited both in amount and in the number and type of investors. They must meet federal and state criteria for exemptions.

Regulation “D.” These exemptions are most common at the federal level for small businesses and start-ups. The offerings fall under Rule 504, which exempts private companies from registering offerings valued at less than $1 million. The number of investors isn’t limited, but the sales must be made within 12 consecutive months.

Offerings to professionals. You can usually get exemptions if the sale or offering is made to broker-dealers, banks, savings institutions, trust companies, insurance companies, investment companies and pension or profit-sharing trusts.

Depending on the jurisdiction, the company must file for an exemption before an offering. A handful of states let you file after the sale.

Understanding the Blue Sky Laws, as well as federal securities laws, can help minimize the regulatory effects and costs associated with an offering. But since the laws are complicated and rigid, consult a legal adviser.

Timely tip: Most states have adopted a time-saving Small Company Offering Registration (SCOR) process. You can register and sell your offering in those states even if your company isn’t based in one of them.

Warning: Regardless of exemptions for registration, all offerings are still subject to state and federal anti-fraud laws that ban misrepresentations or significant omissions of facts about the offering. Your attorney can ensure that your prospectus is sound and provides the information potential investors need and you are required to supply.