Capital Formation

Capital Formation Overview

In addition to its role to protect Kansas investors, the Office of the Kansas Securities Commissioner (KSC) works to foster capital formation by promoting the integrity of capital markets and by consulting with entrepreneurs and their representatives to guide them through the process of legally raising capital in Kansas. Every sale of a security in Kansas is registered, exempt or illegal. This simple statement is a powerful analytical tool for any person considering raising capital in Kansas. It poses several important questions.

Hidden

Is the interest a security?

Definition of a Security

K.S.A. 17-12a102(28) provides the definition of a security. The definition is very broad and includes those things everyone knows as securities, such as notes, stocks, bonds, and options, but also includes much broader concepts through the inclusion of the term “investment contract”. Generally speaking, any interest that is included in the laundry list provided in the definition of security or any interest which does not allow for the active participation of the investor is a security.

Is there an exemption available?

Exemptions

Most sales will meet one of the many exemptions from registration provided by K.S.A. 17-12a201 and 17-12a202. Those sales that do not comply with an exemption must be registered.

Exemptions from registration exist because there is something about the proposed sale that reduces the risk to investors. There are two types of exemptions, exempt securities, provided for by K.S.A. 17-12a201, and exempt transactions, provided for by K.S.A. 17-12a202.

Exempt Securities

Exempt securities are viewed as being inherently safer, principally either due to the nature of the issuer or the existence of additional regulation. They include securities issued or guaranteed by governmental entities, banks, insurance companies and public utility companies as well as securities listed on some securities exchanges or certain securities issued by not-for-profit entities or cooperative associations.

Exempt Transactions

Exempt transactions are viewed as being safer because they are limited in scope, made only to a limited number of people known to the issuer or to a limited class of people either meeting certain income and/or net worth criteria, or made to people already well informed about the issuer, or specified transactions through a registered broker-dealer.

Federal Covered Securities

Federal covered securities represent a special kind of exempt security. Pursuant to the Securities Act of 1933, states are preempted from requiring registration for certain securities. These include mutual funds, securities traded on the most prominent stock exchanges and private placements sold pursuant to Regulation D, Rule 506.

 

Caution

It is essential to note that no exemption from registration provides an exemption from the fraud provisions provided for in K.S.A. 17-12a501. Selling securities is not like selling other products where the rule is simply buyer beware. There is a duty on the part of all persons selling securities not to make misrepresentations and not to omit facts that are necessary to understand the disclosures given (what many might call half-truths.)

 

 

If not, how do I register securities?

What are the consequences of non-compliance?

Consequences of Non-Compliance

Failure to comply with registration requirements or an eligible exemption can have many consequences for an issuer.

First of all, failure to comply creates civil liability for the issuer pursuant to K.S.A. 17-12a509.

Additionally, failure to comply with securities laws in an offering may hamper any future capital formation attempts because the past error has to be corrected, usually through a rescission offer, and/or because of the requirement to disclose the liability arising from the original non-compliance.

Finally, failure to comply is illegal and is subject to an Administrative Order issued by the Securities Commissioner to Cease and Desist, pay a fine of up to $40,000 per violation, and/or pay restitution or disgorgement of all proceeds of the offering plus interest. The Commissioner may also file civil litigation seeking equitable remedies or file criminal charges for which the penalty is usually imprisonment if the loss involved is greater than $25,000.

General Issues to Consider

Raising capital is a complicated undertaking with many consequences to your business

  • Legal and accounting fees may be prohibitive if only a small amount is being raised
  • The expenses may be incurred and you may still fail to raise the money you need
  • You will also be giving up part of your business and will have investors that expect to be kept informed about how “their” business is doing and making useful “suggestions”

These are just a few of the items you should consider before conducting a securities offering. For more considerations we suggest you read:

 Resources

Consultation with staff

North American Securities Administrators Association

Securities and Exchange Commission

Common Exemptions

Limited Offering

This exemption allows an issuer to sell securities in a single issue to no more than 25 purchasers in Kansas during any 12 consecutive months provided there is no general solicitation, no commissions are paid to persons not registered in Kansas, and the purchase is being made for investment and not for resale. This exemption may be combined with the Institutional Investors exemption provided under K.S.A. 17-12a202(13).

Specifics

  • Citation: K.S.A. 17-12a202(14)
  • Filing Requirement: Exemption is self-executing, no filing is required
  • Fee Requirement: None

Invest Kansas Exemption (IKE)

This exemption is designed to enable small businesses and other organizations formed in Kansas to raise up to $1,000,000 during a 12-month period with minimal regulatory requirements. Sales to anyone purchaser are limited to $5,000 unless the purchaser is an accredited investor as defined by Rule 501 of SEC Regulation D under the Securities Act of 1933.
Click here for more information about IKE

Specifics

  • Citation: K.A.R. 81-5-21.
  • Filing Requirement: Notice in either written or electronic form on Form IKE. The notice filing is due before any general solicitation.
  • Fee Requirement: None

Accredited Investor

This exemption allows an issuer to raise capital through sales to accredited investors, as defined by Regulation D, Rule 501 of the Securities Act of 1933, provided all sales are made to accredited investors and certain other conditions are met, some of which are listed below in summary form:

  • Purchase is being made for investment and not for resale.
  • Not available if the issuer is in the development stage and either has no specific business plan or purpose, or has indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.
  • A general announcement of the proposed offering may be made and disseminated if certain criteria are met.
  • No telephone solicitation is permitted, unless, before placing the call, the issuer reasonably believes that the prospective purchaser is an accredited investor.

Specifics

  • Citation: K.A.R. 81-5-13
  • Filing Requirement: Within 15 days after the first sale in Kansas, the issuer shall file a notice of transaction on Form D and a copy of the general announcement, if applicable.
  • Filing Fee: $250 (See K.A.R. 81-5-8)

Institutional Investor

This exemption allows for sales to an institutional investor, a federal covered investment adviser, or any other person exempted by rule adopted or order issued; currently, none have been issued. This exemption may be combined with the Limited Offering exemption provided under K.S.A. 17-12a202(14).

Specifics

  • Citation: K.S.A. 17-12a202(13)
  • Filing Requirement: Exemption is self-executing, no filing is required
  • Filing Fee: None

Existing Security Holder

This exemption applies to an offer to the existing security holders of the issuer and includes holders of convertible securities, options or warrants provided no commissions are paid for soliciting a security holder in Kansas.

Specifics

  • Citation: K.S.A. 17-12a202(15)
  • Filing Requirement: Exemption is self-executing, no filing is required
  • Filing Fee: None

Employee Benefit Plans

This exemption allows for the sale of the issuer’s securities to participants in employee benefit plans established by the issuer, or its affiliates. In addition to employees, the exemption covers sales to other individuals and entities.

Specifics

  • Citation: K.S.A. 17-12a202(21)
  • Filing Requirement: Exemption is self-executing, no filing is required
  • Filing Fee: None

Oil & Gas

This exemption applies to the offer and sale of limited partnership interests, fractional undivided interests or certificates based upon any fractional undivided interest involving any oil and gas royalty, lease or deed, including subsurface gas storage and payments out of production, if the land subject to the interest or certificate is located in Kansas and all sales are made in accordance with one of the following conditions:

  • Each sale is made to a person who is or has been during the preceding two years engaged primarily in the business of drilling for, producing or refining oil or gas.
  • Sales are limited to a total of 32 purchasers without regard to whether they reside within or outside of Kansas, purchases are made for investment and not for resale and no commission is paid.
  • Each sale involves property that produces oil, gas or petroleum products in paying quantities on the date of sale and the seller, after the sale, does not retain any ownership interest in or control over the lease or the interest or interests that are being sold.

This exemption may not be used in conjunction with any other exemption provided by K.S.A. 17-12a202.

Specifics

  • Citation: K.A.R. 81-5-10
  • Filing Requirement: Exemption is self-executing, no filing is required
  • Filing Fee: None

Rule 506

Securities and Exchange Commission (SEC) Regulation D, Rule 506 under the Securities Act of 1933 provides a federal exemption for limited offerings without regard to the dollar amount of the offerings. Sales, other than to accredited investors as defined by Regulation D, Rule 501 are limited to no more than 35 purchasers who either alone or with their purchaser representative have the knowledge and experience to evaluate the merits and risks of the offering. Offers and sales of securities under Rule 506 can also be exempt in Kansas.

Specifics

  • Citation: K.A.R. 81-5-15
  • Filing Requirement: A notice filing on Form D is required within 15 days after the first sale of securities in Kansas under Rule 506 unless conditions for another exemption are met. See Electronic Filing Depository (EFD) Announcement Effective December 15, 2014, for information regarding the electronic filing of Form D for Rule 506 offerings. Read more about EFD.
    • Important Notice: As of July 1, 2016, the Form D and fee must be filed through the EFD system as required by the Special Order issued May 18, 2016.
  • Filing Fee:
    • The fee is $250 for a timely filing within 15 days after the first sale in Kansas.
    • The fee for late filing is the greater of $500 or one-tenth of one percent of the dollar value of the securities that were sold to Kansas residents before the date on which the Form D is filed up to a maximum late fee of $5,000 unless the Commissioner allows a lower fee for good cause shown.
  • Possible Other Exemption: Please note that under K.A.R. 81-5-15(c), a notice filing may not be required if the security being offered or the transaction is exempt under some other exemption, such as the Limited Offering exemption provided by K.S.A. 17-12a202(14).

Burden of Proof

K.S.A. 17-12a503 provides that any person claiming an exemption from registration or an exception, preemption or exclusion from provisions of the Kansas Uniform Securities Act has the burden to prove the applicability of the claim. This applies whether or not a filing is required for an exemption or federal covered security. For the self-executing exemptions or preemptions not requiring a notice filing, persons claiming exemption or preemption are expected to have sufficient records to demonstrate compliance with requirements or conditions of statutes or regulations if challenged by anyone.

Registration of Securities

Before any offers or sales of securities are made to Kansas investors, it is necessary to carefully consider the registration or exemption alternatives under the Kansas Uniform Securities Act (KUSA). It is also necessary to consider provisions of federal securities laws and regulations that are administered and enforced by the U.S. Securities and Exchange Commission (SEC).

Before Public Offering

If an issuer of securities in Kansas does not qualify for any of the exemptions under KUSA sections K.S.A. 17-12a201 through K.S.A. 17-12a203 and if the securities to be offered are not federal covered securities as defined under K.S.A. 17-12a102(7), then the securities must be registered with the Office of the Kansas Securities Commissioner (KSC) before a public offering can be conducted in Kansas. The most typical exemptions to consider are outlined on the Common Exemptions webpage.

Note: This website information does not constitute an exhaustive description of all aspects of legal and accounting requirements for conducting a securities offering in compliance with the KUSA and regulations. Officers and promoters of issuers should consult with securities counsel and independent accountants for more extensive analysis of regulatory requirements under both state and federal securities laws.

Recommendation

It is recommended that persons planning a securities offering in Kansas should contact KSC staff to discuss registration requirements or exemption alternatives. For more information view the Consultation with Staff webpage.

Merit Regulation

Kansas Pioneered Merit Regulation

Kansas pioneered merit regulation in 1911 when the first comprehensive securities act was passed by the Kansas Legislature and became law on March 15 of that year. Several states and Canadian provinces followed with the enactment of similar laws shortly thereafter and 22 years later the United States enacted the federal Securities Act of 1933. However, the federal securities laws do not include substantive merit requirements but require only that securities offerings include full disclosure of all material facts in an offering of securities.

History

Kansas Securities Regulation – In 1911, Kansas became the first state to pass a law regulating the sale of investments.  According to J.N. Dolley a driving force for the law’s passage, it was an effort to prevent the sale of securities by promoters who promised rain, but delivered only “blue sky”.  In the next few years, other states passed similar laws and today, all states’ securities laws are referred to as “blue sky laws”.  Following the great stock market crash of 1929, the federal government began to regulate investment activity with the passage of the Securities Act of 1933, and the creation of the U.S. Securities and Exchange Commission in 1934.

Role of the Office of the Secuities Commissioner – The Office of the Kansas Securities Commissioner is an independent state agency funded entirely by industry fees.  The agency regulates and monitors the offering of securities and financial services within Kansas by registering securities, broker-dealers and their agents, investment advisers and their representatives, and load brokers.  Agency staff conduct periodic examinations do determine whether registered persons comply with industry, legal and accounting standards specified by laws and regulations and also investigate potential violations of the laws and regulations administered and enforced by the agency.  Special Agents and law enforcement powers conduct criminal investigations of alleged frauds or other unlawful acts.  The staff has the authority to investigate any investment-related activity that occurs in Kansas, even when companies or individuals from outside of the state are involved.

The Securities Commissioner and staff administer the Kansas Uniform Securities Act and the Loan Brokers Act and enforce these laws through administrative, civil and criminal proceedings.

Merit Provisions

The merit provisions in the 1911 Kansas Blue Sky law consisted of a section that gave the commissioner broad authority to determine whether the plan of business of an issuer was fair, just and equitable or whether any aspects were judged to be unfair, unjust, inequitable or oppressive by the commissioner.

The modern Kansas Uniform Securities Act (KUSA) includes the same unfair, unjust or inequitable language under K.S.A. 17-12a306(a)(7)(C) as grounds for denial, suspension or revocation of a securities registration. However, KUSA further requires specific standards to be published in regulations for defining conduct or terms that are deemed unfair, unjust, inequitable or would otherwise tend to work a fraud on purchasers. The specific standards are published under K.A.R. 81-7-1 and K.A.R. 81-7-2, in which various NASAA statements of policy were adopted by reference.

Registering

In order to register securities in Kansas and a majority of other states, fairness criteria must be met in addition to full disclosure of all material facts that investors need to make an informed investment decision. Registration with the Securities and Exchange Commission (SEC), however, is possible with unfair, unjust or inequitable terms as long as there is full disclosure of such terms of the offering or plan of business of the issuer.

Forms & Fees

K.A.R. 81-2-1(a) specifies the following forms for securities filings in Kansas:

Form Name Form Title & required use Fee
Form D Notice of Exempt Offering of Securities
Required by: K.A.R. 81-5-15 for Rule 506 Offerings fee for late filing:
$250, if timely $500 or 0.01% of sales in Kansas at time of filing up to $5,000, if greater
Required for Accredited Investor Exemption by K.A.R. 81-5-13, and K.A.R. 81-5-8(a)(2) $250
Form IKE Notice of IKE Offering
Required by K.A.R. 81-5-21 (a)(7)
None
Form U-1 Uniform Application to Register Securities
Required by K.A.R. 81-4-1(a)(1) and (a)(5) for registrations by qualification or coordination
0.05% of amount registered with$100 minimum, and $1,500 maximum
Form U-2 Uniform Consent to Service of Process
Required by K.A.R. 81-4-1(a)(1)
None
Form U-2A Uniform Corporate Resolution
Required by K.A.R. 81-4-1(a)(2), if applicable
None
Form U-7 Disclosure Document (for SCOR applications)
Required by K.A.R. 81-4-2 unless another form of disclosure is allowed under K.A.R. 81-6-1(b)(2); the Form U-1, and same fees above are required
None
Form KSC-1 Sales Report or Renewal Application
Required by K.A.R. 81-3-1(d) for renewals, and by K.A.R. 81-4-1(f) for Final Reports
(Same as original) 0.05% of amount registered with $100 minimum, and $1,500 maximum
Form KSC-15 Solicitation of Interest Form
Required by K.A.R. 81-5-12 (Kansas-based Issuers)
None