ISSUANCE OF PREFERRED STOCK BY IOWA AGRICULTURAL COOPERATIVES
By Greg Wilcox
*Note this is the full version of the article found in the IIC Spring Newsletter
Several Iowa cooperatives have contacted me recently to discuss the legal requirements for the issuance by a cooperative of preferred stock for working capital purposes or for purposes of making capital improvements.
Prior to offering preferred stock for sale, a cooperative will need to make sure that its articles of incorporation have a class of preferred stock authorized that has the desired terms of the preferred stock to be issued.
The cooperative will also need to comply with the Federal and state securities law in connection with the preferred stock offering. Initially, it should be noted that preferred stock issued by a cooperative for capital purposes is, for purposes of the securities laws, generally treated differently than preferred stock issued by a cooperative pursuant to Chapter 499 of the Code of Iowa in exchange for patronage dividends issued by the cooperative (“Patronage Preferred Stock”). Depending on the terms of the Patronage Preferred Stock, the Patronage Preferred Stock may not be a security, whereas, preferred stock issued to raise capital (“Investment Preferred Stock”) will be a security under the Federal and state securities laws. This article discusses the requirements of the securities laws with respect to the offering and sale of Investment Preferred Stock, which will constitute a security under the Federal and state securities laws.
Investment Preferred Stock is considered a security under state and federal law and, as a result, a cooperative is required to comply with numerous state and federal laws prior to offering or selling the Investment Preferred Stock. Since Investment Preferred Stock issued by cooperatives are securities, unless there is a registration exemption available, federal and state law requires that the Investment Preferred Stock, prior to issuance, be registered federally with the Securities and Exchange Commission and also in those states in which the Investment Preferred Stock will be offered or sold. If there is not an exemption from registration available, the failure to register the Investment Preferred Stock prior to the cooperative issuing or offering the Investment Preferred Stock for sale may subject the cooperative, its officers and directors, to various civil penalties and criminal charges and may give the purchaser a right of recission. Additionally, because the cost of registering the Investment Preferred Stock with the Securities and Exchange Commission and in each state in which the Investment Preferred Stock will be offered or sold is prohibitively expensive, it is important that the Investment Preferred Stock offering fall within applicable registration exemptions.
There are two registration exemptions generally relied upon by Iowa cooperatives when issuing securities. Iowa law exempts from registration in Iowa a security issued by an agricultural cooperative association (which is defined under Iowa law) provided the following conditions are satisfied: First, no commission or remuneration can be, directly or indirectly, paid or provided for the sale, except as permitted by the Iowa Securities Administrator by rule or by order issued upon written application showing good cause for allowance of a commission or other remuneration.
Another exemption from registration under Iowa law that is sometimes used by cooperatives is an exemption that is available if the cooperative, as a part of a single issue of securities, makes sales to fewer than thirty-six purchases in Iowa within any twelve consecutive month period if (i) the cooperative reasonably believes that all buyers in the State of Iowa are purchasing for investment, (ii) no commission or other remuneration is, directly or indirectly, paid or given (unless authorized by the Iowa Securities Administrator), and (iii) the cooperative does not offer or sell the securities by any form of general solicitation or advertising.
A cooperative issuing Investment Preferred Stock needs to keep in mind that the registration exemptions discussed above only provide an exemption from registration under Iowa law. Accordingly, a cooperative must also determine whether there is an exemption from registration available under the federal securities laws and the laws of the states (other than Iowa) where the Investment Preferred Stock is sold or offered for sale.
There are various registration exemptions available under the federal securities laws. A common exemption that is relied upon by Iowa cooperatives in issuing securities is the exemption for transactions by an issuer not involving a public offering. This exemption is sometimes referred to as the “private offering exemption.” The problem with the “private offering exemption” is determining at what point an offering is no longer a “private offering” and becomes a public offering subject to registration. The Securities and Exchange Commission has issued numerous rules, regulations and interpretive rulings concerning this exemption. The availability of the exemption and compliance with the various rules and regulations depends upon many factors, including (i) the number of purchasers, (ii) the manner of solicitation, (iii) the type of persons and entities to whom the securities are offered and sold, (iv) the dollar amount of the offering, and (v) the type of information provided to the offerees.
Another common registration exemption that is relied upon by cooperatives in issuing securities is the “intrastate offering exemption,” which exempts from federal securities law registration requirements, any security that is a part of an issue offered and sold only to persons who are residents in a single state where the issuer of such security is a corporation incorporated by and doing business within such state. Because the requirements of the “intrastate offering exemption” are very strict, it is very difficult to qualify for this exemption, especially if the issuer of the security is situated near the border of a state. For example, even a single offer or sale by a cooperative of Investment Preferred Stock to a non-resident of the state at any time since the commencement of the Investment Preferred Stock offering will prevent the cooperative from satisfying the requirements of the “intrastate offering exemption.” Similarly, the term “offer” is construed very broadly and would include any contact between an employee of the cooperative and a prospective purchaser to discuss the purchase of the Investment Preferred Stock, even though that contact may not have resulted in an actual sale.
Two additional securities law issues that arise in connection with the registration requirements and registration exemptions are as follows. First, both federal and state laws impose on the issuer of a security the obligation to provide full and fair disclosure of all facts material to the decision of an investor to purchase the Investment Preferred Stock. The disclosure obligation applies regardless of whether the Investment Preferred Stock has been registered or qualifies for an exemption from registration. Thus, the cooperative, as the issuer of Investment Preferred Stock, is required to provide prospective purchasers with all information regarding the business and affairs of the cooperative and the terms of the Investment Preferred Stock that a reasonable investor would deem important in making his or her decision to purchase the Investment Preferred Stock. Accordingly, even if the Investment Preferred Stock is issued pursuant to a registration exemption, the cooperative should deliver to each investor a disclosure document and have each investor sign a subscription agreement that includes various representations and warranties of the investor. A second area of concern deals with the registration of employees of the cooperative selling the Investment Preferred Stock as “agents” of the cooperative under federal and state securities laws. If the Investment Preferred Stock to be issued by a cooperative fails to qualify for both federal and state exemptions from registration, it will be likely that the employees of the cooperative involved in selling the Investment Preferred Stock will be required to register under the federal and state securities laws as agents of the cooperative. However, if the Investment Preferred Stock is issued pursuant to the registration exemptions discussed above, the employees would likely qualify for an exemption from registration as sales agents.
As noted above, this article primarily focuses on the registration requirements and registration exemptions under federal and state securities laws when Iowa cooperatives are issuing Investment Preferred Stock, however, there are numerous other securities law matters involving the issuance of Investment Preferred Stock that are beyond the scope of this article.
In summary, there are numerous state and federal securities laws that a cooperative is required to satisfy when issuing Investment Preferred Stock. The issuance of Investment Preferred Stock is a highly regulated matter at both the state and federal level and is subject to a myriad of rules and regulations, the application of which is very fact specific. Accordingly, if a cooperative plans to issue Investment Preferred Stock, it should first obtain legal advice.
Greg Wilcox is an attorney with Nyemaster Goode, P.C.
[email protected] (515) 283-3128
May 24, 2018
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