Business Counselor November 4, 2013 Daniel J. Broxup

The Hidden Pitfalls of Securities Laws

Lawyers love to use Latin and the following ancient Roman Legal Maxim certainly applies in this situation: “Ignorantia juris non excusat” (i.e. “Ignorance of the Law is No Excuse.”) Businesses attempting to raise outside capital routinely encounter complex legal and regulatory compliance issues relating to the issuance and sale of securities (whether they realize it or not). Many businesses (particularly small and mid-sized businesses) fail to spot the legal issues associated with their securities issue. Unfortunately, they do not seek legal advice until after they have already “stepped in it,” by which time it may be too late to correct the problem. Another old familiar chestnut is equally applicable here: “An ounce of prevention is worth a pound of cure.” When it comes to raising capital, it definitely behooves the issuer to seek appropriate legal counsel before they start to seek funds from friends, family and potential investors. For those who are concerned about the cost of compliance counseling, they should heed the warning of more modern philosophers (such as auto mechanics): “You can pay me now, or pay me later.”

Some of the unpleasant legal consequences of securities-law violations can include regulatory action by the U.S. Securities and Exchange Commission and/or Michigan’s Department of Insurance and Financial Services, as well as civil liability to disgruntled investors. Under Michigan law, there are a variety of causes of action that may be available to disgruntled investors, including statutory claims under the Michigan Uniform Securities Act (“MUSA”). Under Section 509 of the MUSA, a “seller” of a “security” can be held liable to a purchaser for, among other things, selling a non-registered, non-exempt security, or selling securities by means of an untrue statement of a material fact or by means of a material omission. Courts applying the MUSA have held that civil liability under the MUSA extends not only to “direct sellers,” i.e., issuers, but also to “solicitor sellers” who “urge[] a prospective purchaser to buy.” Under this standard, owners and officers of businesses can be exposed to personal liability. Furthermore, various authorities have held that, under certain circumstances, the owners and officers of an issuer can be held individually liable for acting as “brokers” in the sale of the issuer’s securities.

One of the principle reasons that businesses run afoul of securities laws is that they mistakenly presume that they are merely borrowing money from individual lenders and issuing promissory notes, when in fact they are issuing “securities.” This situation arises in part because securities laws tend to define the term “security” very broadly. Under MUSA for example, “security” is defined so as to include “a note; . . . evidence of indebtedness; . . . investment contract; . . . or, in general, an interest or instrument commonly known as a ‘security.’” In addition, all of the following may be covered under the MUSA definition of “security”: contractual or quasi-contractual arrangements; investment in a common enterprise; an investment contract; or, an interest in a limited partnership, limited liability company, or a limited liability partnership. There is an extensive body of case law surrounding most, if not all, of these terms. Given the breadth with which the term “security” is defined, it is hardly surprising that many businesses unwittingly engage in securities-law violations.

If your business is considering an attempt to raise outside capital and has concerns about potential securities law violations, call one of our business attorneys for guidance. We can counsel you to help you avoid the pitfalls of securities laws, including potential individual liability. Conversely, if you are considering “loaning money” to finance a start-up company, you should also seek professional legal and financial advice. Yet another familiar Latin phrase is apropos vis-à-vis the-would be investors: “Caveat emptor!” (i.e. “Buyer beware!”).

Let’s start a partnership worth keeping.