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The Scope of Sarbanes-Oxley: Securities and Issuers

To understand which parts of SOX apply to your company, you need to understand what type of investments are considered securities and which types of issuers are subject to or exempt from SOX.

For example, Section 807 creates a new securities fraud provision that appears in the criminal code. This provision makes it a crime "to defraud any person in connection with a security" or to obtain "by means of false or fraudulent pretenses, representations or promises, any money or property in connection with the sale or purchase of any security." In order to determine whether you've broken the law under Section 807 and can be sent to jail, you need to know if the transaction you've conducted involves a security. If it doesn't, you may still be sued in a civil action for fraud but won't serve time in a federal penitentiary under this provision.

What is a "security"?

SOX makes reference to the Securities Act of 1933 and the Securities Exchange Act of 1934 for purposes of defining what is and is not a security. Both acts contain similar specific definitions.

There has long been confusion about the term investment contract as it's used in the definition of a security along with all the other terms. The use of this particular phrase has really extended the scope of transactions the statute covers. Those words don't have any real meaning in a commercial context, so the courts have had to interpret them in deciding when an agreement between two or more parties constitutes an investment contract that's subject to the registration and reporting requirements of federal securities law.

A famous Supreme Court case in the 1940s, SEC v. WJ Howey Co., made it clear that federal securities law covers a broad scope of commercial transactions. In this case, the court held that companies that offered sections of orange groves for sale along with contracts to harvest the oranges and distribute the profits were indeed selling investment contracts subject to federal securities law and had to register such contracts with the SEC.

In the Howey case, the Supreme Court stated that the test for whether the securities laws apply in a given transaction is "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Although this is a pretty broad definition, not all investments are considered securities under SOX. For example, courts have also held that transactions such as purchasing a share in a cooperative housing project or participating in a pension plan funded solely by employers (with no employee contribution) aren't securities.

Under the Howey case, the key questions to ask in determining whether a particular transaction may be a security subject to SOX are:

  • Is there an investment of money?
  • Is this a common enterprise?
  • Is there expectation of profits?
  • Do profits come solely from the investments of others?

Who is an "issuer"?

SOX provides that issuers of all stock in all publicly traded corporations of all sizes must meet its requirements — that's a lot of issuers. Issuer is the term used to refer to companies that sell securities to the public and either are required to register with the SEC or meet the requirements for an exemption from registration.

Your company is required to register its securities if they're going to be traded on a securities exchange or if the company meets certain criteria with respect to the number of shareholders and the amount of assets held.

Section 207(a) of SOX identifies the types of issuers that are subject to SOX, including:

  • Companies whose securities trade on a securities exchange: Companies that offer stock to the public though the New York Stock Exchange (NYSE) or other stock exchange must register securities under Section 12(b) of the Securities Exchange Act of 1934.
  • Companies with more than 500 investors and $10 million in assets: SOX requires issuers with over $10 million in assets to register securities that are held by at least 500 persons, regardless of whether the securities are traded on a securities exchange. These companies are required to register under Section 12(g) of the 1934 Act.
  • Companies with more than 300 investors: Some companies aren't required to file under 12(g) of the 1934 Act because they have less than 500 shareholders. However, if these companies have more than 300 securities holders (and therefore don't qualify for a specific registration exemption), they must file under Section 15(d) of the 1934 Act. This category of issuers often includes companies that have privately held stock but offer debt instruments (such as bonds) to the public. Offering debt pushes them over the 300-investor mark.
  • Voluntary filers: Some companies decide to file reports with the SEC for a variety of reasons even though they're not legally required to do so. For example, to trade stocks on NASDAQ (which isn't technically a stock exchange), a company must file SEC disclosures even if it isn't otherwise required to do so.
  • Companies with registrations pending: A company conducting an initial public offering of equity or debt securities must file a registration statement on one of the public offering forms, one of the S-series forms, or one of the SB-series forms. Then the company must file three 10-Qs and one 10-K in the first year (even if it hasn't filed under the 1934 Act). Upon filing these statements these companies become subject to many provisions of SOX.

When interpreting the requirements of SOX, it's important to look at each particular statutory provision for definitions and criteria identifying to whom that particular statute applies. Some sections of SOX apply to management, and others apply to auditors or benefit plan administrators.

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