I. Introduction

Financing a new or existing business is a very challenging process for the owners. Finding potential investors with capital they are willing to risk in a particular venture is a time consuming and often frustrating process even for mature owners. This process also contains many legal pitfalls into which even sophisticated business owners may fall if not properly informed. This article contains an analysis of rescission offers under the Missouri securities laws as a means to remedy the contingent liabilities associated with violations of the Missouri securities registration requirements that arise from common practices business owners use to raise capital. This article includes: (i) an overview of the federal and Missouri securities laws regulating offers and sales of securities; (ii) an explanation of the rescission offer remedy under Missouri law and its effect on potential claims of securities holders against the issuer; and (iii) suggestions regarding mechanics of the offer itself.

II. The Registration Requirement and Exemptions

Under both the federal and Missouri securities laws, no person may offer or sell securities in the state of Missouri without registration, unless exemptions from the respective registration requirements apply.³ This prohibition includes “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value.”⁴ Therefore, common practices used to raise capital, such as distributing a business plan to potential investors, casually selling securities to friends and family, and using the Internet to communicate with potential investors and to sell securities, violate the registration requirements under federal and Missouri securities laws unless specific exemptions apply to that activity.⁵

Exemptions from the registration requirements under both federal and Missouri securities laws are of two general types: securities exemptions (which exempt certain types of securities);⁶ and transaction exemptions (which exempt certain transactions in an issuer's securities).⁷ The exemptions from the Missouri registration requirement most commonly relied on are: (i) the limited offering exemption;⁸ (ii) the annual limited transaction exemption;⁹ and (iii) the existing security holder exemption.¹⁰ Issues which the practitioner must consider in determining availability of a particular exemption include the ability to use certain exemptions in combination and the effect of prior acts of the issuer or its owners.

Liabilities for violations of the registration requirements of the securities laws can be significant. The federal securities laws impose a fine of between $5,000 and $100,000 for violations.¹¹ The Missouri securities laws impose a fine of up to $500,000 for violations.¹² In addition to fines imposed by the securities regulators, an issuer violating the registration requirements of the securities laws is liable to each purchaser of the securities for the amount of the consideration paid for the securities plus interest and attorneys' fees less the amount of income received on the securities.¹³ This liability can affect an issuer's balance sheet and income statement because of the existence of a put or rescission right held by the existing securities holders for their investment plus statutory interest less investment income.¹⁴ Furthermore, violations can disqualify an issuer from using certain exemptions in the future.¹⁵ In short, the liabilities created from failing to comply with the registration requirements under either or both of the federal and Missouri securities laws can disrupt future financings and possibly force an issuer out of business.

III. The Rescission Offer Remedy

Under §409.411(g), RSMo 1986, an issuer of securities which violates of the Missouri registration requirement may offer rescission to any purchaser of these securities at any time before the purchaser brings a suit to refund the consideration paid by such purchaser for such securities if the purchaser received a written offer, together with interest at a rate of eight percent per annum from the date of the purchase, less the amount of any income received on the security. The issuer must keep the rescission offer open for a period of 30 days from its receipt by the purchaser. The federal securities laws do not provide for a tender of rescission by the issuer.

A valid rescission offer will bar each offeree of rescission from bringing an action under the Missouri securities laws.¹⁶ The rescission offer has no effect on the ability of the federal or state governments to bring an enforcement action. Therefore, an offeree of a valid rescission offer may only claim under the federal securities laws or for fraud or negligent misrepresentation under the common law to recover against the issuer, and must then overcome significant obstacles to recover as discussed below.

The federal securities laws provide broader transaction exemptions from the registration requirements than the Missouri securities laws.¹⁷ The types of small offerings that are the prime subject of this article generally fall under Rule 504 of the Securities Act of 1933, which represents the deference that federal securities regulators give to state securities regulators for an offering, or a group of related offerings, of less than $1,000,000.

A purchaser claiming under the federal securities laws or the common law for fraud or misrepresentation after a rescission offer must overcome significant obstacles as a result of the bar created by a rescission offer. The procedural requirements – especially the pleading requirements – under the federal securities laws are more burdensome than those under the Missouri securities laws and the remedies provided under Missouri law are generally more generous than those provided under the Federal securities laws,¹⁸ such as aiding and abetting liability under § 409.411(c) which was abolished under the federal securities laws in Central Bank of Denver v. First Interstate Bank of Denver.¹⁹ The Missouri Court of Appeals for the Eastern District, in Dunn v. Bemor Petroleum, Inc.,²⁰ held that equitable defenses of estoppel and in pari delicto are not available to an issuer in violation of the Missouri securities laws when a purchaser sues for rescission under § 409.411 of the Missouri securities laws. A rescission offer bars a purchaser from suing under the Missouri securities laws so that purchaser must make a claim under the common law for fraud or negligent misrepresentation for which equitable defenses are available.²¹

IV. Mechanics of a Rescission Offer in Missouri

The form and content of a rescission offer can vary based upon the facts and circumstances of the prior securities law violations the issuer seeks to cleanse. A rescission offer, in its base form, is a letter from the issuer to the purchasers informing them of their individual right to rescind the transaction under the Missouri statute and then offering each purchaser the opportunity to either accept rescission or to reject and continue to hold the securities.²² The timing of the offer is crucial to minimize the number of transactions that the rescission offerees will choose to rescind. The statute does not require that rescission be offered to all purchasers in suspect transactions,²³ nor does the statute require that the issuer allow the rescission offerees to rescind the purchase of any part of a transaction.

From a transactional point of view, the issuer may consider using the rescission offer as an opportunity to engage counsel to conduct a comprehensive legal audit, which also presents a good opportunity to prepare or update a disclosure document. Generally, if securities violations exist, other unknown compliance issues may exist that a legal audit will discover and remedy. In addition, the preparation or update of a disclosure document in tandem with the conduct of the legal audit will provide a base form of disclosure that the issuer may choose to transmit to investors along with the rescission offer, and that will prove useful in future exempt and registered financings.²⁴

If the issuer prepares a disclosure document in conjunction with a rescission offer, the authors suggest preparation of a disclosure document in accordance with Regulation S-B or Regulation A of the Securities Act of 1933.²⁵ Specifically, this document should present the information required by Items 101 to 103 (regarding disclosures about the issuer's business and properties), 401 to 404 (regarding disclosures about the ownership and management of the issuer), and 503 (requiring a disclosure of risk factors) and 601 (exhibits) of Regulation S-B and such analogous disclosures required under Regulation A, in addition to compiled financial statements. A disclosure document responding to these items contains a complete description of the issuer's business, the risks of the investment and the issuer's management and ownership, which constitutes the basic disclosures an investor needs to evaluate an investment.

While the Missouri statute does not require the issuer to prepare and circulate a disclosure document to effect a valid rescission offer, the use of a disclosure document will protect the issuer from a claim by a purchaser accepting a rescission offer and other potential securities law claims rescission offerees may bring forward based upon nondisclosure of material information.²⁶

V. Conclusion

The process of financing a new or continuing business enterprise contains many pitfalls for the unwary business owner, and the liabilities created by technical violations of the state and federal securities laws adversely affect a business. In the course of raising capital for a new or continuing venture, owners often fail to abide by the restrictions imposed by the federal and Missouri securities laws. If, in the process of business counseling, issues arise regarding the legality of any sale of securities in the state of Missouri, the careful and well timed use of a rescission offer provides an efficient means to negate these liabilities. The use of a rescission offer, though, will not bar a claim of a purchaser under the federal securities laws nor bar an enforcement action against the issuer by either state or federal securities regulators.

© 2000, Thomas W. Van Dyke and Marc D. Stone

Endnotes

¹ Thomas W. Van Dyke received his B.A. in economics from the University of Kansas and his J.D. from the University of Michigan. He is a partner in the law firm of Bryan Cave LLP.

²Marc D. Stone received his B.A. from the University of Kansas and his J.D., summa cum laude, from Temple University. He is an associate with the firm of Bryan Cave LLP.

³ 15 U.S.C. § 77e; and § 409.301. RSMo Cum. Supp. 1999.

⁴ Section 409.401(m)(2), RSMo Cum. Supp. 1999; and 15 U.S.C. § 77b. Though much consideration has been given to the topic of what constitutes an “offer” or a “sale” under the securities laws, for the purpose of this article and for brevity and focus recognize that these terms are given very broad construction. In addition, this article will not discuss what constitutes a “security” under the securities laws.

⁵ 15 U.S.C. § 77e; and § 409.301, RSMo Cum. Supp. 1999.

⁶ See generally 15 U.S.C § 77c; and § 409.402(a), RSMo 1994. For the purposes of this article the securities exemptions are assumed not to apply and not discussed. For most small privately held businesses that are the prime subject of this article, the regulatory exemption of 17 CFR § 229.504 (more commonly referred to as Rule 504) under the Securities Act of 1933 adopted under the Securities and Exchange Commission's rule making authority in 15 U.S.C. § 77c(b) will generally apply to the activities of the owner(s). This rule exempts public offerings by non-reporting companies (i.e. companies not subject to the periodic reporting requirements of the Securities Exchange Act of 1934) not exceeding $1,000,000 in a twelve month period from the registration requirements under the Federal securities laws. There are qualifications on the application of this exemption in addition to the limitation on the amount of the offering and a thorough analysis of the specific facts and circumstances of the issuer's and its owners' activities must be considered prior to concluding that the exemption applies. Other transaction exemptions from the Federal registration requirement commonly used in this context are the private placement exemption (15 U.S.C. § 77d(2); and 17 CFR § 229.506) and the accredited investor exemption (15 U.S.C. § 77d(6)).

⁷ See generally 15 U.S.C. § 77d; and § 409.402(b), RSMo 1994.

⁸ Under § 409.402(b)(9), RSMo 1994:

[a]ny transaction by an issuer in a security of its own issue [is exempt from the registration requirements of the Missouri securities statute] if immediately thereafter the total number of persons who are known to the issuer to have any direct or indirect record or beneficial interest in any of its securities . . . does not exceed twenty-five and if no commission or other remuneration is paid or given to anyone for procuring or soliciting the transaction[.]

⁹ Under § 409.402(b)(10), RSMo 1994:

[a]ny transaction by an issuer in a security of is own issue [is exempt from the registration requirements of the Missouri securities statute] if (A) during the twelve months period ending immediately after such transaction the issuer will have made no more than fifteen transactions exempted by this paragraph . . ., and (B) the issuer reasonably believes that the buyer is purchasing for investment and the buyer so represents in writing and (C) no commission or other remuneration is paid or given to anyone for procuring or soliciting the sale . . .

¹⁰ Under § 409.402(b)(11), RSMo 1994:

[a]ny transaction pursuant to an offer to existing security holders of the issuer . . . [is exempt from the registration requirements of the Missouri securities statute] if (A) no commission or other remuneration . . . is paid or given directly or indirectly for soliciting any security holder in the state, or (B) the issuer first files a notice specifying the terms of the offer and the [Missouri] commissioner does not by order disallow the exemption within the next five full business days.

¹² Section 409.410, RSMo 1994.

¹³ 15 U.S.C. § 77l(a); and § 409.411(a), RSMo Cum. Supp. 1999.

¹⁴ Financial Accounting Standards No. 5 provides:

An estimated loss from a loss contingency . . . shall be accrued by a charge to income if both of the following conditions are met:

1. information available prior to the issuance of the financial statements indicates that it is probable (i.e. the future event or events are likely to occur) . . . a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
2. The amount of the loss can be reasonably estimated.”

¹⁶ Under Clodfelter v. Thuston, 637 F. Supp. 1034 (E.D. Mo. 1986), even if a valid exemption from the Missouri securities laws applied to a particular transaction, that exemption does not bar a purchaser's claim to rescind for fraud under the statute. A rescission offer bars a purchaser from making a claim for a violation of the anti-fraud provisions and the registration requirements of the Missouri securities laws.

¹⁷ See note 6 accompanying text.

¹⁸ See Ramirez, Steven A., Caveat Plaintiff, pp. 16-29, The Journal of the Kansas Bar, November 1998, in which Professor Ramirez discusses the effects of recent securities law reforms on private litigation and concludes that remedies for securities laws violations provided under state securities statutes and the common law are generally superior to those provided under Federal law and the procedural requirements for obtaining remedy under state law and the common law are less burdensome than those under the Federal securities laws. Of particular note, is the limitation on the availability of the rescission remedy under 15 U.S.C § 77l(a)(2) as construed in Gustafson v. Alloyd Company, Inc., 513 U.S. 561 (1995) (holding that the rescission remedy extends only to purchasers in initial public offerings) and the imposition of a loser pays regime under 15 U.S.C. § 77z-1(c).

¹⁹ 511 U.S. 164 (1994). The abolition of aiding and abetting liability significantly reduces the value of the put right held by the purchaser because the potential lack of a “deep pocket” to satisfy the purchaser's claim. See Caveat Plaintiff, p. 19. As a result, a purchaser may be forced to claim rescission sooner rather than later and liquidate the position to ensure that the claim will be satisfied and to minimize the credit risk borne by the purchaser.

²⁰ 680 S.W.2d 304, 306 (Mo. App. E.D. 1984).

²¹ See generally, Anselmo v. Manufacturer's Life Ins. Co., 771 F.2d 417, 420 (8th Cir. 1985) (holding that, “a valid fraud claim is relinquished when the victim of the fraud enters into a subsequent agreement with the perpetrator concerning the same subject matter.”); and Heitz v. Champagne, 839 S.W.2d 700, 704 (Mo. App. S.D. 1992) (citing Peck v. Jadwin, 704 S.W.2d 708 (Mo. App. S.D. 1986), providing that, “a party fraudulently induced to enter a contract is deemed to have waived the fraud by entering into a second agreement only where, at the time of making the second agreement, the party has knowledge of the fraud”). See also Little v. Morris, 967 S.W.2d 685 (Mo. App. S.D 1998); and Harper v. Barket, 557 S.W.2d 455, 456 (Mo. App. W.D. 1977) (providing that a purchaser fraudulently induced to contract may either sue for rescission of the contract or affirm the contract and sue for damages).

²² The form of rescission offer suggested by the Commissioner of Securities for the State of Missouri is set forth in 15 CSR § 30-52.260. The issuer may tailor this form to the specifics of the transaction and should consider incorporating release language into the letter to bar a purchaser's common law fraud or negligent misrepresentation claims if the circumstances so require. Anselmo, 771 F.2d at 420. Use of a release for any claim for a violation of the Federal securities laws is void under the anti-waiver provisions of the Federal securities laws contained in 15 U.S.C. § 77n and 15 U.S.C. § 78cc.

²³ Care should be taken when discriminating among equity holders as these transactions may come under attack from other equity holders as a breach of a fiduciary duty of fairness and loyalty owed to all equity holders. For a general discussion regarding fiduciary duties in this area, see Gilbert v. El Paso Co., 575 A.2d 1131 (Del. 1990); Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983); Dawson v. Dawson, 645 S.W.2d 120,125 (Mo. App. W. D. 1982); Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939); and Bromschwig v. Carthage Marble & White Lime Co., 66 S.W.2d 889 (Mo. 1933).

²⁴ Issuers must take caution when offering rescission in conjunction with another offering of its securities. The restrictions on bids or purchases during a distribution by the issuer and others are contained in Regulation M under the Securities Exchange Act of 1934, 17 CFR §§ 242.100 et seq. The Securities and Exchange Commission issued several no-action letters under Rule 10b-6 of the Securities Exchange Act of 1934 which preceded Regulation M and contains many of the same prohibitions currently governing this area. See Xian Food Corporation, 1986 WL 67668 (S.E.C.);and AirSensors, Inc., 1986 WL 68330 (S.E.C.).

²⁵ 17 CFR §§ 228.10, et. seq.; 17 CFR §§ 230.251, et. seq.

²⁶ See Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972); Chiarella v. United States, 445 U.S. 222 (1980) (providing that Rule 10b-5 creates a duty to disclose material non public information to a person from whom a security is being purchased or sold or a duty to disclose or abstain from trading).