Federal Securities Law: A Plea for Simplification

It's past time we do something about federal securities law. I don't mean a new exemption or changes to a few rules. I mean a complete rewrite of federal law. First enacted 75+ years ago, the federal securities laws have grown into a complex morass that is totally inaccessible to business people without the intervention of sophisticated securities law specialists.

Federal securities law is based primarily, but not exclusively, on four statutes: the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Investment Advisers Act of 1940. Those statutes cover literally hundreds of pages, and the regulations associated with those statutes are even more extensive. Size alone is an issue; it’s not surprising that someone might get lost in all that detail. But the complexity lies in more than just the magnitude of the enterprise as a whole.

Consider one small, but important, provision, subsection 5(b)(1) of the Securities Act. Section 5(b)(1) says, in its entirety:

It shall be unlawful for any person, directly or indirectly –

(1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed under this subchapter, unless such prospectus meets the requirements of section 10 of this Act; . . .

Understanding exactly what this small subsection does and does not prohibit requires a circuitous traipse through the statute and the SEC rules. First, one has to deal with the lengthy interstate commerce language at the beginning of the subsection—what exactly does it mean to “make use of any means or instruments of transportation or communication in interstate commerce or of the mails”? The statute provides little guidance.

But, putting that jurisdictional issue aside, one must next determine what a “prospectus” is. There’s a lengthy definition in section 2(a)(10) of the statute, with two exceptions to that definition which depend on when the communication is made and what the communication includes. The section 2(a)(10) definition and exceptions require statutory side trips into section 2(a)(3) to determine what an “offer” is and to determine exactly what section 10(a) requires. But the journey to define a prospectus is incomplete without looking at the SEC’s view on what constitutes an offer—which, not surprisingly given that it’s the SEC, does not require that one actually ask people to buy a security, or even mention that one is offering securities, for that matter. It’s enough to “condition the market.” And there are a multitude of rules providing that certain communications either are not prospectuses or are not offers at all: Rules 134, 134A, 134B, 135, 135A, 135B, 137, 138, 139, 139A, 167, 168, and 169, although I’m sure I missed a few.

Let’s assume you’ve waded through the rules and cases, and what you’re transmitting is a prospectus. You’re not done yet. It’s not a violation if the prospectus you’re transmitting “meets the requirements of section 10” of the Securities Act. When you look at section 10, you find two things. First, section 10(a) says that a prospectus must include most of the information contained in the registration statement, with a cross-reference to two statutory schedules listing what the registration statement must include. But don’t be misled by that—the SEC has exercised its statutory power to change what must be in the registration statement, so those statutory schedules are obsolete. You have to look at the SEC forms instead.

The SEC has also exercised the power granted in section 10(b) to approve other communications for purposes of section 5(b)(1), so it’s back to the rules. Rule 430 and 431 are relatively straightforward, but God help anyone who stumbles into the Rule 164/433 combination. Whether a communication falls within the Rule 433 safe harbor can depend on, among other things:

(1)    whether the issuer has filed a registration statement, Rule 433(a);
(2)    characteristics of the company issuing the securities, such as its size and how long it has been a reporting company, Rule 433(b);
(3)    the content of the communication, Rule 433(b)(2)(i), (c);
(4)    who is making the communication, Rule 433(d), (f);
(5)    where the information in the communication originally came from, Rule 433(d)(1)(i)(B), (h)(2);
(6)    whether the information in the communication is otherwise available to the general public, Rule 433(d)(8)(ii); and
(7)    whether the issuer or anyone else associated with the offering paid for the communication, Rule 433(b)(2)(i), (f)(1)(i).

This is one subsection in one statute—a very important subsection, admittedly, but still only one tiny part of the morass. And most of this comes from the same agency that has chided lawyers for their inability to write in “plain English.”

This is the rule of lawyers, not the rule of law. Anyone who tries to navigate through the Securities Act provisions without a sophisticated securities lawyer, either to register an offering or to avoid registration, will fail. They will violate the law--not “might” but “will.” Only SEC restraint has avoided wholesale prosecution of a large number of entrepreneurs. (The SEC must be too busy investigating and prosecuting insider trading.)

It’s time to have a set of offering and exemption rules that, even if they’re not accessible to the average lay reader, at least are understandable to a reasonably competent lawyer who isn’t versed in securities law. We need rules that entrepreneurs can understand—straightforward answers to the question of what they may or may not do in raising capital. If that means a complete rewrite of the statute, so be it.

-Steve Bradford