FAQs: Securities Law
1) What’s a security?
Generally speaking, any investment that yields a return is a security. It can be debt, equity, royalty agreement, and a zillion other things. If you lend money and don’t charge interest, however, that would not be a security. Nor are donations or most pre-purchases of goods and services.
2) What are securities laws?
Securities laws are laws, enacted in the 1930s and 1940s at both the federal and state levels, that govern investment transactions. There are three foundational laws. The Securities Act of 1933 governs the issuance of securities. The Exchanges Act of 1934 governs the resale of securities, like over a stock exchange. And the Investment Company Act of 1940 governs the pooling of securities.
3) What do securities laws require?
Lots of things, mostly from anyone selling securities. A company that sells a security must register it with the national Securities & Exchanges Commission (SEC) and with any other state in which the security will be bought or sold. The type of registration a company does will determine whom it can sell to, when, and where. Securities filings can be expensive and time consuming.
4) Are there exemptions to securities law?
Yes. For example, if you are borrowing from a friend or someone in your family, you don’t need to register the security. And there are other areas of securities, like banking, that are governed by other, more specific laws.
5) Are small businesses exempt from securities registrations?
No. But there are numerous “exemptions” in securities laws that provide simpler pathways for small businesses. For example, Regulation D provides a fairly simple path if a business wants to raise under $1 million in a 12-month period from wealthy investors. An intrastate exemption is for companies that just sell securities to people living locally in their state—then state law kicks in. Investment crowdfunding is another exemption.
6) Is it difficult to sell securities to grassroots investors?
It can be. Securities law is constructed on the premise that wealthy people, also known as “accredited investors,” can take care of themselves, while the rest of us, unaccredited investors, cannot. We supposedly need lots of “disclosures” about the company, its business, its risk, and so forth. What we get, however, is often a very thick booklet, filled with legalese in small type, that’s hard to read and digest.
7) What’s an “accredited” investor?
An “accredited” investor is a person with enough income or wealth to afford taking risks in securities transactions. The current definition is that an accredited investor is a person who makes $200,000 per year, or a couple who makes $300,000 per year, or a household with at least $1 million of wealth (excluding the house). The last criterion is the loosest, and allows about five percent of the American public to qualify.
8) How broad is the “friends and family” exemption to registering a security?
Technically, there is no such thing. But some exemptions allow private offerings to people you have a strong “preexisting relationship” with, and that’s where friends and family fit in. Since states have securities laws that often parallel federal law, the definition of that may depend what state you live in. Generally, a preexisting relationship needs to be someone you have a closer, longer, and more intimate relationship than with, say, a Facebook friend.
9) How difficult is it to set up a community investment fund?
Very. Unless you can qualify for an exemption under the Investment Company Act of 1940. Nonprofits, for example, are exempt (though they may not be under parallel state laws). You can learn more about community investment funds—what’s being done and what the rules are—from a “Community Investment Fund Handbook” prepared by the National Coalition for Community Capital. And if you're in Maryland and are interested in this topic, check out Invest York Road, an initiative we're helping to coordinate that's creating a community-controlled fund to buy, redevelop, and then maintain ownership of commercial property along a currently blighted commercial corridor in Baltimore.
10) Would it be difficult to set up a local stock exchange?
Difficult and expensive. Before the Exchanges Act of 1933, many regions of the United States had local stock exchanges. All of them have since been acquired or closed. Today, only two stock markets really operate—the New York Stock Exchange and the NASDAQ—and both only trade global securities. That said, some people have begun discussing ways to reform the Act and allow state and local experimentation.
11) What does “going public” mean?
A “public offering” means that a company can advertise the sale of securities to the general public. A “private offering” is between a company and an investor with whom the company has a “preexisting relationship.” A public offering is more expensive and difficult, though investment crowdfunding—which is a type of public offering—has made it cheaper and easier.