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In general, M&A transactions are structured in one of three broad categories: (1) asset sales, (2) stock sales, and (3) mergers. Of course there are many nuances and combinations of these broad categories that may be implemented when structuring a particular deal. Deal attorneys and the business people involved in these transactions typically center their attention on drafting the main deal document whether it is an asset purchase agreement, stock purchase agreement, or merger agreement. Securities law issues are often overlooked. Securities law implications may affect even seemingly straightforward deals, which if not handled appropriately can cause an inquiry from the SEC or state law regulators. Securities Overview The securities laws are triggered when there is a sale of a “security.” This includes the transfer of stock (or membership interests) in connection with the sale of a business. For example, in the case of a merger, a company’s issuance of new stock (or membership interests) to the shareholders of another company in exchange for their shares of stock is a securities offering under the securities laws. The securities laws require that when securities are being sold they must be registered under the Securities Act or the transaction must be exempt from registration. Registration is an expensive and time-consuming task with large fees for accountants and lawyers who prepare the registration statement. For these reasons, issuers try to avoid registration by issuing the securities pursuant to an exemption. Mistakes during the registration process or in qualifying for an exemption can lead to serious consequences. Under Section 11 of the Securities Act, issuers are liable if a registration statement “contain[s] an untrue statement of a material fact or omit[s] to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” Further, Section 12 of the Securities Act establishes liability for sales of non-exempt unregistered securities and creates remedies including a right of rescission for purchasers and liability for fraud. Many penalties under the securities laws apply to the officers and directors of the company as well as the company itself. Exemptions Whenever attempting to conduct an unregistered offering of securities, the first two legal issues that must be addressed are: (a) which exemption from the registration applies, and (b) what type of disclosure is required. The most common exemption used for stock issued as consideration in a merger or acquisition is the private placement exemption pursuant to Section 4(a)(2) of the Securities Act, and corresponding safe harbor contained in Regulation D. Generally, there can be no public solicitation or advertising (although the JOBS Act will change this) and the issuer must make (or make available, depending on the specific exemption and the nature of the purchasers) certain disclosure. There are some consequences to using an exemption to sell securities. The securities sold in reliance on an exemption from registration are generally considered “restricted securities” under the securities laws, and therefore are subject to resale limitations. Further, when an company sells securities in an unregistered offering, it can sell to an unlimited number of “accredited investors,” but it may only sell to a limited number of “non-accredited investors.” State Law When making an unregistered offering, the company must find an exemption at both the federal level and the state level. Thus, a careful analysis of the residency of each potential buyer and of the securities laws of these states’ should be conducted before offering securities for sale in a particular state. Many states require a notice filing even when a federal exemption applies. Read about Legal Steps Required to Sell a Colorado Corporation Anti-Fraud Compliance The anti-fraud provisions of the securities laws apply to all sales of securities whether the sale qualifies for an exemption or they are sold under a registration statement. In general, the anti-fraud provisions require disclosure of (or access to, depending on the applicable exemption) all available material information about the company’s business and the securities being offered. In the context of an M&A transaction for example, assume that the shareholders of the target company will receive shares of the acquiring company in exchange for their shares of the target company. In this transaction, under state law the target shareholders will likely have to vote to approve the transaction. To comply with the securities anti-fraud provisions, the acquiring company must provide disclosure of all material information (or make it available, depending on the applicable exemption) to the target shareholders. Typically, this disclosure is disseminated through combined prospectus/proxy statement that is delivered to each shareholder entitled to vote. Drafting the combined prospectus/proxy statement requires input from both the target company and the acquiring company. Resales When shares are issued under an exemption from registration, the securities laws place resale restrictions on these shares and these shares are called “restricted securities.” The shareholders who purchased the restricted securities must register the shares or comply with SEC Rule 144 before selling. While not addressed here, I am planning a future post that discusses the specific requirements of Rule 144. Further, in the M&A context, often the recipients of the acquiring company’s shares become executive officers and directors of the acquiring company. Thus, these officers and directors must be aware of the insider trading laws, which restrict sales when such insiders are in possession of material nonpublic information. The parties to an M&A transaction should be advised of these resale restrictions early in the negotiation process. Bottom Line. There are complex securities laws that can be triggered in the business acquisition context. Because the penalties for securities violations are severe, it is always worth the time to have securities counsel review the transaction and confirm compliance with the securities laws. For more articles about Finance, Business and Law, please visit www.biztaxbuzz.com
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