What Every Accountant Should Know about Securities Law
WHAT EVERY ACCOUNTANT SHOULD KNOW ABOUT SECURITIES LAW Stephen M. Quinlivan, CPA, JD, an attorney practicing corporate law in New York City, offers a warning about traps for CPAs involved in client negotiations. The scene at first is positive and familiar and then turns into a legal nightmare. A CPA is helping a client in the sale of a business. The client finds a buyer, and they agree on a stock transfer. The CPA attends meetings at which the client makes aggressive representations about various facts. The practitioner doesn't know if they are true or false and makes no investigations. After the sale, a problem arises and the buyer sues the CPA and the client under the securities acts. Is the CPA liable? As this article will show, it is unclear to what extent a CPA can participate in negotiations without becoming liable. However, a passive observer would not incur liability. IDENTIFYING A SECURITY The analysis begins by investigating how a security is defined under the 1933 and 1934 securities acts. This is important for two reasons. 1. Securities must be registered with the Securities and Exchange Commission before they are offered for sale, unless the transaction qualifies for an exemption. Sales of securities without a public offering is one type of exemption. 2. The antifraud provision of the securities acts applies even if the transaction is exempt. That means those involved with the transaction can be sued under those provisions. The analysis then examines the various antifraud provisions and their applicability to those not actually transferring the security, such as a CPA. CPAs must understand the analysis so they can identify transactions in which lawsuits are possible and take steps to protect themselves. LEGAL DEFINITION The U.S. Supreme Court defined the term "stock" in Landreth Timber Co. v. Landreth. In this case, a father and son offered 100% of a timber company's stock for sale. Fire subsequently damaged the mill, but the company promised potential investors it would make repairs. When the mill did not live up to buyers' expectations, they sued under the 1933 and 1934 securities acts. The sellers asserted the term "stock," as used in the securities acts, did not include the transfer of 100% of the stock of a closely held company. The Court rejected the sellers' interpretations. It ruled any instrument that is called stock and bears the usual characteristics falls under the securities acts. It called stock "the quintessential security" and said stock purchasers normally expect the securities acts to apply. As such, the acts must be considered whenever stock is transferred. More recently, the Court defined the term "note" for the purposes of the securities acts. In Reeves v. Ernst & Young, it adopted the "family resemblance test" to decide if a note falls under the securities acts. This test compares the note in question with a family of typical transactions that fall outside the securities acts. This family includes consumer financing notes, home mortgages, short-term business notes secured by assets or an open account debt incurred in the normal course of business. Notes that closely resemble the family are not securities. Reeves noted the family of nonsecurity transactions can be expanded. Factors to consider are * An assessment of the buyer's and seller's motivations to enter the transaction. * The means by which the purchaser will acquire the instrument. * Whether some factor (such as another regulatory mechanism) reduces the instrument's risk, making application of the securities laws unnecessary. Generally, any transaction used to obtain long-term capital for a business falls under the securities acts. Short-term borrowing to smooth cash flow, such as commercial paper, generally isn't covered by the acts. Other business interests also may be securities. …