Securities Exchange Act of 1934 May Have Material Adverse Effects on Your Company
This is a note that might be helpful to a few companies. If your company is a privately held company with more than $10 million in total assets, with no intention to immediately become a public company, that issued stock, options or other securities to a large number of investors, then this information could be relevant. This information especially relates to companies that issued or will issue stock or securities if the number of record holders of any class of stock or other securities exceeds, or may in the future exceed, a count of 500. The Securities Exchange Act of 1934 contains burdensome and costly reporting requirements, and if the Securities Exchange Act governs your company, all of the Exchange Act reporting requirements would apply so that the company thus shall be required to file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements on Schedule 14A, and certain persons (directors, officers, and certain holders) would be required to report transactions on Forms 3, 4, and 5 and Schedules 13D and 13G. The Securities Exchange Act of 1934 very significantly affects a company. The obligation to comply with the burdensome, challenging and costly Exchange Act only falls upon a company with more than $10 in total assets (but this is gross assets, before subtracting liabilities). In addition, a company must have issued securities, such as stock, options, convertible notes, warrants, or other securities, and that class of securities must be held of record by more than a threshold number of holders in order for the company to be subjected to the compliance burdens of the Exchange Act. The threshold is found in the Securities Exchange Act in Section 12(g). The JOBS Act changed the Exchange Act by raising the shareholder threshold. Before the JOBS Act, the 1934 Act only affected issuers of securities of any class once they were held by 500 or more persons. The JOBS Act altered the Exchange Act so that its threshold is now exceeded only if the company has either more than 500 “unaccredited" shareholders, or more than 2,000 total shareholders, including both accredited and unaccredited shareholders. The JOBS Act changed the Securities Exchange Act in this positive and very specific way, but the costly periodic reporting requirements remain in place and compliance remains extremely burdensome if registration of the class of securities is required by Section 12(g). Therefore, if the Exchange Act is triggered, it will continue to be necessary to hire additional management personnel and clerical and supporting personnel. The Exchange Act registration requirement remains a lurking danger for an unprepared or unwary company. Growing to 500 shareholders can happen by virtue of transfers subsequent to the company's sale of the stock to a far smaller number of people. With every transfer by one person to more than one person, the number of shareholders can grow. When the shareholder threshold is crossed under the Securities Exchange Act of 1934, not only are the reporting obligations triggered, the SEC also can sue owners and management for several possible reasons. This regulatory structure costs a company large amounts of money. Registering and thereafter filing periodic and current reports, and filing ownership reports and current reports, all under the Exchange Act, are major undertakings. If these burdens are unwanted, they would not merely be distractions, they could result in a complete change in the management team. Those in management or upon whom management may be reliant should monitor this number of holders very carefully. An example of the inner workings of the new shareholder threshold would be a company with 500 unaccredited shareholders, which cannot add one more unaccredited shareholder but can add up to 1,500 more accredited shareholders before reaching the shareholder ceiling. A significant issue in the relationship between a company and its shareholders (or holders of any class of equity security) was introduced by this differentiation between accredited and unaccredited. If the number of holders of that class of stock or securities is or may potentially be approaching the 500 number, there will be an important distinction drawn between unaccredited shareholders and accredited shareholders. Companies need to be prepared to deal with this distinction because they can be swept up into 1934 Act registration unless they can determine whether their shareholders are "accredited". A company can essentially miss out on this wonderful opportunity by being oblivious to it in the early years, when planning and strategy can be 100% effective at avoiding perpetually (or as long as wanted) the burdens of the Securities Exchange Act of 1934. Has your company adopted all of the appropriate charter provisions to assure that the company is immunized from Securities Exchange Act of 1934 registration and reporting? Subsequently, even if this problem is not recognized until the number of shareholders is approaching 500, corrective actions may be possible and must be be attempted before it is too late. Even when the number of record shareholders is almost 500, it may not be too late.