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What is a Security?

Many businesses seek additional financing from time to time. In their quest, they may encounter laws and regulations not ordinarily faced in day-to-day operations. One area of concern relates to federal and state securities laws.

If the securities laws apply, a business may face a maze of legal and regulatory burdens. If they are violated, a business and its principals may face substantial civil, administrative, and even criminal sanctions. Because of increased enforcement efforts by the North Carolina Secretary of State and continuing enforcement efforts by the SEC, it is imperative that a business understand when the securities laws will apply to a transaction.

To trigger the applicability of the securities laws, the purchase or sale of a "security" must be involved. Certain registration and disclosure requirements then may apply.

The definition of a security is very broad. Generally, a securities transaction occurs if a person invests in an enterprise and expects profits from the managerial efforts of others. A security may also be involved if a person provides the risk capital for an enterprise and expects profits without receiving the right to exercise practical and actual control over managerial decisions.

Determining whether an investment constitutes a security may be difficult. Some investments, such as stocks and bonds, are traditional forms of securities.

Other investments, however, may or may not be securities, depending upon the circumstances. While limited partnership interests will almost always be securities, general partnership and limited liability company interests may not be securities, depending upon the number and type of partners or members involved and the distribution of powers and control in the partnership or limited liability company.

Another investment that may constitute a security is the promissory note. The traditional business loan in which a business borrows money from a bank and delivers its promissory note will generally not trigger the securities laws. On the other hand, if the business issues its promissory notes to a number of investors as a means of raising capital, such notes may be determined to be securities.

Other investments not ordinarily thought to be securities may be considered so under certain circumstances. For example, while a condominium unit is generally an interest in real estate and not a security, a separate security may exist if the unit is offered together with the opportunity to participate in a rental pool. Similarly, the sale of real estate tied with a management agreement may involve the sale of a security. While a country club membership is generally not thought to be a security, a typical start-up country club membership offering in most instances will be found to be a securities offering under North Carolina law.

Because of the potentially devastating risks associated with noncompliance with the federal and state securities laws, it is imperative that a business raising capital review the proposed transaction carefully to determine first whether a security is involved and, if so, whether it complies with the securities laws.

© 2009 Poyner Spruill LLP. All rights reservedNational Law Review, Volume , Number 227


About this Author

Michael S. Colo, Poyner Spruill Law firm, Mergers and Acquisitions Lawyer

Mike has more than 40 years of experience helping a broad spectrum of clients with complex mergers and acquisition transactions. He has extensive expertise in a wide variety of corporate and transactional matters, contract drafting and interpretation, mergers and acquisitions, corporate finance securities regulation and compliance under state and federal laws and municipal law. In addition, Mike represents the two joint municipal power agencies located in North Carolina, North Carolina Eastern Municipal Power Agency and North Carolina Power Agency Number 1, and...