Securities Laws — Yes, they ALWAYS Apply

I was reminded by a recent blog post I read about the importance of making material disclosures in connection with the sale of securities. I find myself always reminding clients — and myself — that the securities laws always apply to every transfer of securities. Two of the important concepts to keep in mind as a result are: 1) every issuance of securities must be accompanied with a federal AND state registration of the securities -or- qualify for an exemption at both the federal and state level; and, 2) even if your offering qualifies for an exemption that requires no filings whatsoever, you are still obligated to follow the rules regarding making material misstatements or omissions of fact in connection with a transfer of securities.

While entrepreneurs likely bear these rules in mind when, say, offering securities to angels or VCs — indeed, most professional investors will uncover all of the company’s material information during the due diligence process — it also applies to all other transfers of securities — for example, offering equity compensation to employees. Just about all states have registration exemptions for employee equity offerings, but startup owners should also be careful not to misstate or omit material facts about the company. Although this is generally not an issue in very small startups, where everyone knows everything about the company because everyone has to work on everything in the company!, you don’t want to cover up or misstate material negative information about the company (as hard as that may be!). Even an unintentional misstatement or omission is prohibited.

You don’t want to hide a failing relationship with a significant customer, or grossly overstate a potential investor’s interest in the company. If the material facts are ultimately discovered, not only would you violate the trust of your purchaser (whether it’s an investor, or worse, one of your employees), but the company may be subject to liability that could result in legal damages, up to and including rescission — the return of the purchase price (plus interest and legal costs!).

There is often no magical set of documents that will satisfy a company’s responsibility to avoid making material misstatements or omissions of fact in connection with the transfer of securities, especially if there are no forms to be filed in connection with the registration exemption. However, using common sense (and consultation with an attorney!) will help identify the information the company should disclose to everyone who purchases or receives the company’s securities