Are You Practicing Securities Law and Don’t Know It? If you don’t know, you probably are.
By Patrick C. Clary

– If you are forming business organizations for clients, including corporations, limited partnerships and limited-liability companies, and preparing documentation, including minutes of meetings, stock purchase agreements, limited partnership agreements, and operating agreements respectively, which provide for the issuance of debt or equity interests in such business organizations, including corporate stock, limited liability interests and limited-liability member interests;
– If you are negotiating and preparing for clients financing-related agreements, including, again, stock purchase agreements, limited partnership agreements, operating agreements and even joint-venture agreements;
– If you are advising clients regarding financing arrangements and agreements for their business or advising other clients who are, directly or indirectly, providing financing for business enterprises;
– If you have been involved in business or residential real estate transactions which involve clients who sell, or clients who buy, debt or equity interests in such real estate projects that are financially more complicated than a mere direct sale or purchase of a real estate ownership interest; or
– If you are representing clients who are acting as intermediaries in financial transactions but are not licensed broker-dealers of securities;

THEN, for the reasons set forth below, you probably are practicing securities law perhaps without even knowing it. If so, you may be failing to advise your clients about the enormous impact that the securities laws have on people and entities who are on both sides, or even in the middle, of financing transactions!

What is or is not a “security?”
Not only is a “security” specifically defined in the federal securities laws as what a person unsophisticated in securities law would consider a security to be, such as “stock, treasury stock, preorganization certificate or subscription, and voting-trust certificate,” but it is also, for example, a note, bond, debenture, evidence of indebtedness, investment contract, option, and fractional undivided interest in oil, gas or other mineral rights.” Section 2(1) of the Securities Act of 1933, as amended (“the Securities Act” or “the ‘33 Act”), 15 U.S.C. §77a(1), and Section 3(a)(10) of the Securities Exchange Act of 1934, as amended (“the Exchange Act” or “the ‘34 Act”), 15 U.S.C. §78c(10). For example, Nevada’s Uniform Securities Act also expressly includes in the definition of a “security,” “a limited partnership interest” and “an interest in a limited-liability company,” in order to make it clear that, unbeknownst to some, those interests are clearly “securities.” NRS 90.295.

Under SEC v. W.J. Howey Co., 328 U.S. 293 (1946) and its progeny, the “catch all” (as I put it an “investment contract”) is a “security” when a person invests his money in a common enterprise with the expectation of profits from the significant efforts of others. I won a case in the Ninth Circuit and beyond in Hocking v. Dubois, 88 F.2d 1449 (9th Cir. 1989), cert. denied 494 U.S. 1078 (1990), where a condominium in Hawaii was held to be a security under the circumstances under which it was offered and sold, because it met the foregoing Howey test. Hocking, supplemented by its progeny, still stands as the leading case in the Ninth Circuit with respect to real estate securities.

Registering securities vs. complying with an exemption from registration
While the “heart” (in my opinion) of the Securities Act is full and accurate disclosure, more specifically its “thrust” is what I call the “11th Commandment,” namely: “Thou shall register thy securities.” However, to go through the full registration process to raise capital is often too costly and time-consuming, especially for small businesses, which I have mostly represented, so the alternative for a prospective issuer of securities is to comply with an exemption from the registration requirements of the Securities Act.

Congress empowered the United States Securities and Exchange Commission (“the SEC”) to implement and enforce rules and regulations under the federal securities laws. Regulation D, which was originally adopted by the SEC in 1982 under the Securities Act, provides the most commonly used method of complying with an exemption from registration and to provide a “safe harbor” for issuers. Regulation D was adopted under both the small offering exemption provided by Section 3(b) and the private, or non-public, offering exemption provided by Section 4(2) of the Securities Act, 15 U.S.C. §77c(b) and §77d(2), respectively.

Rule 501 of Regulation D, 17 CFR §230.501, provides definitions of terms, and the most commonly used definitions for an “accredited investor” are: (1) a director, executive officer, or general partner of an issuer; and (2) a natural person with a net worth exceeding $1,000,000 or with an individual income in excess of $200,000 or joint income with that person’s spouse in excess of $300,000, subject to certain other details.

Rule 504, 17 CFR §504, is the easiest to comply with and permits the offer and sale of securities not exceeding an aggregate of $1,000,000 in any 12-month period to an unlimited number of offerees and purchasers, none of whom need be accredited investors. Rules 505 and 506, 17 CFR §§ 505 and 506, permit offers and sales to not more than 35 investors who are not accredited investors, the rest of whom must be accredited, with Rule 505 limited to $5,000,000 but with Rule 506 having no monetary limitation. While full and complete disclosure is always required, Rule 504 has no specific disclosure requirements, but Rules 505 and 506 do have specific informational and financial disclosure requirements but not if the securities are offered only to accredited investors.

There also must be compliance with a securities or transactional exemption under the securities or “blue sky” laws of the states in which the offerees and purchasers reside.

Liabilities under the securities laws
There are basically three types of liabilities that can arise under the securities laws, (1) criminal liabilities, (2) civil liabilities resulting from actions brought by governmental agencies and (3) civil liabilities to investors and others. While the federal and state governments are empowered to prosecute criminally, in their respective names, violators of securities laws, the SEC is empowered, in its name, to bring civil enforcement actions in the federal courts seeking injunctions, disgorgements, and other relief, and certain state securities agencies can also file administrative and court actions. For example, the Securities Division of the Secretary of State of the State of Nevada is empowered to issue cease and desist orders against securities violators. NRS 90.360.

Nevertheless, the most common action that issuers should actively seek either to avoid by compliance, or successfully to defend in litigation, are civil actions brought by investors, generally seeking recovery of the amount of their investments, interest thereon, and attorneys’ fees against issuers and their officers, directors and controlling persons. See Section 18 of the Securities Act, 15 U.S.C. §77(o), and Section 20 of the Exchange Act, 15 U.S.C. §78(t), as well as NRS 90.660, et seq., which impose civil liability of controlling persons. Furthermore, unlike the normal rule in civil cases where the plaintiff has the burden of proof, when the issuer asserts as a defense compliance with an exemption, the burden of proof shifts to the defendant(s) to prove such compliance. See NRS 90.690(1).

Moreover, broker-dealers of securities are required to be licensed (see Section 15 of the Exchange Act, 15 U.S.C. §78o). Intermediaries in financing transactions, who charge compensation (e.g. brokerage commissions or finder’s fees) but who are not so licensed, also can incur severe liabilities.

“Substance” over “form”
Unlike other areas of administrative law, where it could be argued that “form” over “substance” prevails, under the securities laws it is clearly the opposite: “substance” over “form” prevails. See Hocking, supra.

In Preliminary Note No. 7 to Regulation D, the SEC states as follows: “In view of the objectives of these rules and the policies underlying the [Securities] Act, Regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with these rules, is part of a plan or scheme to evade the registration provisions of the [Securities] Act. In such cases, registration under the [Securities] Act is required.” How do you explain that to a client? I can tell you that it is not easy.

Conclusion
Business practitioners who are not familiar with or have not fully recognized the complexities of the securities laws should surely be wary and circumspect when getting involved in financing transactions. Yet, do not fear! When I graduated from law school and went to work for Sam Lionel and Grant Sawyer on March 1, 1967 (the day they started Lionel & Sawyer), I had never taken a course in securities law or ever worked for the SEC or any state securities agency. So I started my learning process in the field a year or so later, and here I am now. Just don’t try to learn it overnight, and get some help. You’ll sleep better at night.

Many years ago some corporate lawyer in California opined that, when it was required for the board of directors of a corporation to adopt a resolution to create Section 1244 stock under the Internal Revenue Code (no longer a requirement), it was malpractice, particularly in a new corporation involving speculative investments, not to do so. In representing issuers of securities, may I offer the proposition that failing to evidence at least the minimal compliance with Rule 504 of Regulation D when forming a new corporation and issuing stock, for example, may amount to the same thing? Let’s pull together and try to avoid the possible professional problems of failing our clients and ourselves by at least recognizable and reasonable compliance with the securities laws.

Patrick C. Clary, a native Las Vegan, who holds bachelor of arts and juris doctor degrees from The American University in Washington, D.C., has practiced law in Nevada for 40 years.

What Your Small Business Client Should Know About a PEO
By Abran E. Vigil

–Bright business ideas? Check.
–Business plan? Check.
–Great product and services? Check.
–Paying $7,647 per employee for regulatory compliance costs?
–Time to cut a check—unless your small business client knows of the potential benefits and risks of using Professional Employer Organizations.

The burden of regulatory compliance on small business.
When counseling our business clients, we should be aware of the often overlooked fact that they will be confronted with the economic and operational burdens of having to comply with various state and federal regulations. The financial reality of regulatory compliance costs on a small business can be devastating. As recently as 2005, small businesses--those with less than 500 employees--paid a disproportionate share toward regulatory compliance, up to $5,411 per employee. W. Mark Crain, The Impact of Regulatory Costs on Small Businesses, for the SBA Office of Advocacy, September 2005. That amount is comprised of compliance with economic, workplace, environmental and tax regulatory schemes. Id. If a business has 20 employees or less, then the cost of compliance skyrockets to $7,647 per employee. Id. These numbers are far more than statistics to our clients; they are actual dollars out of pocket. And the impact of regulatory compliance costs on Nevada’s small businesses cannot be understated. According to the most recent statistics from the United States Small Business Administration, small businesses make up 95.7 percent of employer businesses in Nevada. Those same businesses employ 43.8 percent of Nevada’s non-farm private workforce. SBA Office of Advocacy Small Business Profile for Nevada, 2006.

Even if an entrepreneur has a good idea, a good business plan and a marketable product or service, the cost of complying with government regulation can do far more than deflate an ego; it can put a business at risk.

Good attorneys advise their business clients about the need to plan ahead. Such planning can include drafting a good operating agreement, assuring that the proper business and professional licenses are obtained and referring the client to an employment attorney to seek advice on how to avoid turning everyday foibles into workplace disasters. When an attorney acts as both legal consultant and business advisor—and we all do—we should not forget to advise our clients about the regulatory cost of running a small business and at least one possibility for dealing with the costs associated with complying with regulators. That possibility is a Professional Employer Organization, or PEO.

How can a PEO help your client’s small business?
A PEO is a company that specializes in administering many functions that small businesses are forced to tackle, even if those businesses do not know how to do it. As shown by the statistics above, to the extent those functions relate to regulatory compliance, they must be performed at a cost that may be too much for a small business to bear. Those functions can include providing and administering health benefits, workers’ compensation claims, payroll, payroll tax compliance and unemployment insurance claims.

On its website, the National Association of Professional Employer Organizations (“NAPEO”), an accrediting agency, describes how a PEO can help its clients lower their overhead by transferring certain administrative functions from the client to the PEO. According to the NAPEO, A PEO provides integrated services to effectively manage critical human resource responsibilities and employer risks for clients. A PEO delivers these services by establishing and maintaining an employer relationship with the employees at the client’s worksite and by contractually assuming certain employer rights, responsibilities, and risk.

NAPEO online, http://napeo.org/newscenter/peo.cfm. The answer for small businesses, then, can be quite simple: contract with a PEO so that the PEO can perform human resource and other administrative functions. This can help the small business to focus on doing what it does best--providing its goods and services to its own customers.

The legal relationship between a PEO and your business client.
The relationship between a PEO and its business client is a blend of contractual privity and statutory obligations. By agreement, substantial administrative functions are transferred from the client business to the PEO. The PEO does, of course, charge a fee for taking on those functions, but because of the PEO’s focus on providing administrative functions to its clients, the fee can be less than what the client will pay in overhead costs if such tasks are handled in-house. Under most PEO agreements, the PEO becomes an employer of the client’s workers, thus assuming employment responsibility for specific purposes. NAPEO online, http://www.napeo.org/peoindustry/coemployers.cfm. The client business retains the right to direct and control the employees so that it holds onto the responsibility of providing its product or service. Id. At the same time, the PEO pays wages and employment taxes out of its own accounts, and it handles all reporting and deposit requirements for employment taxes. The PEO also aids in administering other human resource functions, such as assuring compliance with certain federal laws and aiding in the process of hiring, firing or reassigning employees within the client’s organization. To that extent, the NAPEO website describes the PEO-client relationship as one of co-employment. Id.

In Nevada, PEOs, as business entities, are governed by statute. In addition to the usual corporate formation requirements, a business that operates as a PEO must comply with NRS 616B.670 to .697 (the “Employee Leasing Company Statutes”.) The Employee Leasing Company Statutes apply when one business places a client company’s regular, full-time employees on its own payroll, and then for a fee, leases those employees back to the client company. NRS 616B.670(3).

To comply with the Employee Leasing Company Statutes, a PEO must apply for and obtain a certificate of registration from the Nevada Division of Industrial Relations. NRS 616B.673(1). This is a yearly requirement. NRS 616B.673(2). The application that must be submitted by the PEO requires disclosure of a laundry list of information for the Labor Commissioner to review before issuing a certificate of registration. NRS 616B.679. To further comply with the Employee Leasing Company Statutes, a PEO must also have written, as opposed to oral, agreements with its client businesses, and it must provide written notice of the employment relationship to the affected workers. NRS 616B.688. In addition, the PEO must maintain, at a location within Nevada, payroll records and copies of written agreements with its clients. NRS 616B.682. Finally, a PEO cannot offer to its leased employees any form of self-funded workers’ compensation insurance. NRS 616B.691(3).

If a PEO complies with the Employee Leasing Company Statutes, its ability to provide services to its client businesses is triggered. The PEO is deemed to be the employer of the employees it leases to its client business. NRS 616B.691(1). It is also deemed to be the employer of its leased employees for purposes of providing employee benefits, including health plan benefits governed by ERISA. NRS 616B.691(2).

The written contract, the client-business and compliance with the Employee Leasing Company Statutes are the keys that unlock the PEO’s ability to become a recognized employer that can provide administrative and human resource functions at a lower cost—and with specialized skill—than what many small businesses can provide for themselves.

Are there risks to using a PEO?
Of course. There is risk with any business decision, especially when outsourcing functions to an unknown industry. The answer here is to research the PEO and make an informed decision about using it.

In decades past, PEOs were suspect. PEO’s were criticized because unscrupulous entrepreneurs found that they could use a combination of state based enabling statues in conjunction with ambiguous federal laws to avoid paying taxes or to avoid certain forms of regulation. See, e.g, Barry Neier, “Some ‘Worker Leasing’ Programs Defraud Insurers and Employers,” New York Times, published March 20, 1992, available in online archives.

Today, while the potential for abuse may still exist, a client business can engage in prudent, but very simple, research to protect itself and to verify the legitimacy of a PEO. First, your client can look to the NAPEO to see if the entity with which it is considering doing business is a member of that accrediting body. Your client can also browse the Employer Services Assurance Corporation’s (“ESAC”) website to see whether the PEO is a member: http://www.esacorp.org/AccreditedPEOs.aspx. The ESAC is yet another accrediting body, and it requires members to obtain surety bonds and other safeguards to assure the solvency of the PEO. Id.

Conclusion.
Nevada is a hotbed for small business. While large corporations in the resort and gaming industry appear to dominate our markets, the SBA Office of Advocacy confirms that over 95 percent of employer businesses in Nevada are small businesses. Just ask any of your peers how many times they have helped the start up of a new business and this statistic makes sense. In our roles as business advisors to our business clients, knowing what a PEO can do for our clients could mean the difference between your client’s success and failure.

Abran E. Vigil is an attorney with Lewis and Roca LLP. He practices in commercial and business litigation and is listed in the current edition of The Best Lawyers in America® in the category of Commercial Litigation.