Federal securities laws play a crucial role in regulating how companies raise capital, communicate with investors, and ensure transparency in their financial operations. For companies in California, compliance with these laws is not only mandatory but essential to avoid costly penalties, regulatory scrutiny, and potential lawsuits. Compliance with California’s securities laws is also required. Understanding the impact of these Federal and state laws is critical, whether you are an emerging technology startup or an established publicly traded corporation. In this post, we’ll explore the key federal securities regulations, common pitfalls companies should avoid, and how to navigate the complexities of compliance.
Key Federal Securities Laws That Can Impact Your Business
The U.S. securities regulatory framework is vast, but several key laws have direct implications for all companies that wish to raise money in the United States:
The Securities Act of 1933
The Securities Act of 1933 primarily regulates the issuance of new securities. Under this law, companies must provide comprehensive and truthful disclosures to investors when offering securities such as stocks or bonds to the public. This process, known as registration, requires businesses to file detailed prospectuses and financial statements with the Securities and Exchange Commission (SEC). The goal of the Securities Act is to ensure transparency so that investors can make informed decisions about purchasing a company’s securities. Registration is expensive and imposes on-going reporting requirements on a company that wants to sell registered securities to the public. There are exemptions from registration that are available for smaller companies that want to raise capital from private sources of money, but avoid all the costs of registration and obligations of public companies. Small company issuers may avoid registration by qualifying to sell their securities under Regulation D or Rule 144A, or other exemptions from registration under the Securities Act, which can simplify the capital formation process, and greatly reduce the cost of raising money for your company.
The Securities Exchange Act of 1934
The Securities Exchange Act of 1934 governs the secondary trading of securities, meaning after they are issued by companies and are traded on public stock exchanges or among private investors. This law also established the Securities and Exchange Commission (“SEC”) as the primary regulator of the securities markets. Under the Exchange Act, public companies are required to submit on-going disclosure reports to the SEC, including annual (Form 10-K) and quarterly (Form 10-Q) financial reports, which help maintain transparency and prevent fraud and ensure the public knows what is taking place within publicly traded companies. For private companies considering going public, this law’s reporting obligations can significantly impact day-to-day operations, strategic planning and costs of doing business.
The Sarbanes-Oxley Act of 2002 (SOX)
SOX was introduced in response to major corporate financial scandals in the early 2000s, such as Enron and WorldCom, to enhance corporate governance and accountability. This act imposes strict controls on financial reporting and the responsibilities of company executives in ensuring those reports are accurate. Under SOX, CEOs and CFOs must personally certify the accuracy of financial reports. Severe criminal and civil penalties can apply to those individuals personally for fraudulent reporting or failure to maintain proper financial and institutional controls over the company. Even if your business is not publicly traded, certain provisions of SOX could still apply, particularly if you’re working with financial institutions or other public companies.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)
Dodd-Frank brought about sweeping reforms aimed at increasing oversight and reducing risk in the financial industry. Although it primarily targets financial institutions like commercial banks and investment banks, its whistleblower protections, corporate governance rules, and regulations surrounding executive compensation also affect companies across industries. Private companies, especially those planning to go public, should be aware of how Dodd-Frank’s rules could influence their governance and financial policies.
Regulation Fair Disclosure (Reg FD)
Reg FD, adopted in 2000, aims to ensure that all investors have equal access to material information about public companies in an easier and more understandable format. This regulation prohibits selective disclosure of information to favored analysts or investors, leveling the playing field for all investors and members of the public. For companies, compliance with Reg FD is essential when communicating with shareholders, analysts, or the media. Violations can lead to significant reputational damage and penalties.
Common Pitfalls to Avoid in Securities Compliance
While understanding federal securities laws is critical, many company executives still fall into common compliance traps. Here are a few frequent pitfalls that companies encounter, and how to avoid them:
Inadequate Disclosure Practices
Failure to provide accurate, complete, and timely financial and management disclosures can lead to significant penalties from the SEC. Whether you’re offering securities privately or publicly, disclosures of all material information must be transparent and up to date. Inadequate disclosures can lead to accusations of fraud that can result in costly and time consuming litigation.
Misuse of Exemptions
While federal laws provide numerous exemptions to reduce the burden of a full registration of a company’s securities, improper reliance on these exemptions can create legal exposure for you, your management team and the entire company. For example, Regulation D exemptions allow private companies to raise capital without full SEC registration, but companies must adhere strictly to the regulatory terms of the exemption. Material missteps, such as failing to limit investor participation or provide the full disclosures in all required documentation, can negate the exemption and expose the business to SEC action. It can also expose your company to shareholder lawsuits alleging fraud. Take steps to avoid this at all costs.
Neglecting Corporate Governance Standards
Lax corporate governance practices, particularly around financial reporting and internal controls, are often a red flag for regulators that something is amiss in a corporation. As a chief executive officer, ensuring that your board and executive team adhere to best practices in corporate governance is absolutely essential. This includes regular board meetings, regular internal audits, regular financial reporting and full transparency, and an emphasis on establishing, managing and enforcing internal compliance programs.
Ignoring Whistleblower Protections
Under the Dodd-Frank Act, employees who report violations of securities laws and regulations are protected from retaliation by whistleblower provisions in the law. Ignoring or mishandling whistleblower complaints can lead your company to suffer severe penalties and lawsuits from employees, shareholders and regulators. Establishing a robust internal compliance and reporting mechanisms, and ensuring that your company responds properly to all internal employee complaints is crucial for maintaining compliance with the law.
Lack of Ongoing Training and Monitoring
Federal securities laws are complex, and regulatory changes are frequent. Many companies fail to provide on-going training for executives and employees on existing and newly promulgated regulations. This is a major management mistake. Additionally, companies should have compliance monitoring systems in place to ensure adherence to the latest requirements, and senior executives responsible for ensuring those compliance programs and systems are rigorously adhered to. Regular financial audits, legal reviews, and consultations with securities lawyers can help your business stay compliant and avoid very costly errors.
Best Practices for Navigating Securities Regulation
To avoid pitfalls and ensure compliance with federal securities laws, consider the following best practices:
- Work with experienced legal counsel: Securities laws are complex, and having a knowledgeable legal team at your disposal is essential to ensuring compliance.
- Implement internal compliance programs: Establishing rigorous compliance protocols, including regular audits and internal management controls, helps prevent legal issues before they arise.
- Stay updated on regulatory changes: Securities regulations evolve, and staying current with the latest laws and SEC rules is vital for consistent long-term compliance.
- Maintain transparency in financial reporting: Accurate and complete financial disclosures are critical in building trust with investors and avoiding regulatory scrutiny.
How Experienced Legal Counsel Can Help
Federal securities laws significantly impact how businesses operate, particularly in terms of raising capital, corporate governance, and financial reporting. By understanding the key laws and regulations, and avoiding common pitfalls, you can protect your company from the severe legal risks that frequently accompany securities laws violations and ensure consistent compliance. For California companies, working with experienced securities lawyer is essential to navigate these complex laws and regulations and build a solid foundation for future sustainable growth.
About Finkel Law Group
Finkel Law Group P.C., with offices in San Francisco and Oakland, has more than 25 years of experience helping our clients navigate federal and state securities laws and regulations. Over the last 25 years we have assisted hundreds of privately held companies raise capital in compliance with federal and states securities laws and thrive. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist your company with compliance with federal and states securities laws, please contact us at (415) 252-9600, (510) 344-6601, or info@finkellawgroup.com to speak with one of our attorneys.