CHAPTER 9 APPLICATION OF THE FEDERAL SECURITIES LAWS TO MINERAL FINANCING
| Jurisdiction | United States |
(Nov 1982)
APPLICATION OF THE FEDERAL SECURITIES LAWS TO MINERAL FINANCING
David M. Abbott, Jr.
Martha S. Fulford
U.S. Securities and Exchange Commission
Denver, Colorado
ERRATA
In the places noted below, the correct word or number is underlined. Please make these changes in the text.
Page 9-5: The first line of the inset paragraph at the bottom of the page should read:
Wild Turkey Oil and Gas has drilled...
Page 9-10: Under "B. Small Offering Exemptions," the sixth line of the second paragraph should read:
"....Regulation F provides a Section 3(b) exemption..."
Page 9-20: The first line under heading IV. should read:
In general, the Commission has not defined many terms...
Page 9-21: In the middle of the page, make the following line correction:
(b) Oil and Gas (Regulation S-X, Rule 4-10(a)(11) and (16).
Page 9-25: In footnote 4, Wilson's paper is Paper 7, this Institute.
Note to Pages 9-20 and 9-21: Rule 4-10 of Regulation S-X is referred to on both these pages. The Commission proposed that most of this Rule, including the definitions referred to, be moved to Regulation S-K, Rule 302(c); see Release 33-6412 of June 24, 1982. This change may occur in late 1982 or early 1983. Rule 4-10 of Regulation S-X contains the Commission's rules on oil and gas reserve disclosure and Reserve Recognition Accounting (RRA). The proposed rule changes would remove reserve disclosure from the financial statements, among other things.
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I. INTRODUCTION
The nexus between the minerals industry and the securities laws is money. The Commission's Regional Geologist in Denver, whose job it is to know such things, notes that J. P. McKee's First Law of Mineral Exploration states, "Use somebody else's money." This sage advice recognizes both the fact that few individuals and companies have the individual resources to finance an exploration or development venture and the fact that most mining prospects and wildcat wells do not produce sufficient revenue to return the sums expended on them. Therefore, in order to raise sufficient money to examine enough prospects to find those which are profitable and to do the required exploration and development work to convert a prospect to a producer, the minerals industry turns to somebody else for money. The general public is the ultimate somebody else to whom an issuer turns, be it through direct appeal in a public offering, indirectly by enticing a "big" public company to take part in the project, a private or nonpublic offering, or through other arrangements.1
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In turning to someone else to obtain financing, a security is usually created, offered, sold, and issued. What is a security under federal law? The Securities Act of 1933 defines a "security" as follows:
The term "security" means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificates, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, or, in general, any interest or instrument commonly known as a "security" or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.2
The best simple definition we have found is the following:
If in the beginning, Mr. A has a dollar and Mr. B has a deal, then in the end, after all the action of whatever sort has taken place, Mr. A's dollar is now in the possession of Mr. B and Mr. A has an interest in the deal, then, in all probability, the transaction comes under the Corporate Securities Laws.3
The question then becomes not, are the securities laws applicable, but rather which aspects of the securities laws are applicable to the particular venture for which financing is sought.
In considering financing for a particular venture, a series of questions must be answered and the answers will then lead to those particular aspects of the securities laws which should be considered in detail. How much money is needed? When is the money needed — now or at intervals in the future? Is the venture exploring for minerals or have mineral reserves been identified and funds are being sought for development? What is the current supply and demand for the mineral product in question and how does this affect the marketability of both the mineral product and the financing venture? What is the organizational form of the venture (stock, partnership, joint venture, etc.)? What tax consequences result from the organizational form4 and how do they affect the marketability? Do you want public or private financing? Are you seeking equity or debt financing?
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William L. Young, who has promoted several mining ventures in Canada, recently published a paper describing his promotional experience.5 Based on his experiences, Young conceived some "Laws" of Mining Survival.
First Law: Know the economics of your end product.
Second Law: Know the supply and demand situation for today and project your thinking over the next decade.
Third Law: Unless you have discovered a staggeringly revolutionary financing concept — and I mean staggeringly — let the other guy be the first to sell new financial concepts.
Fourth Law: Presenting the material is your prime selling tool. Spare no effort to make the material clear, interesting, and comprehensive.
Young's "Laws" are considered by some as a capsule summary of important considerations for mineral venture financing.
The full disclosure concepts of the securities laws are the portion of securities laws of greatest interest in mineral financing. The federal laws of immediate concern are the Securities Act of 1933, as amended, (1933 Act) and the Securities Exchange Act of 1934, as amended, (1934 Act).6
The 1933 Act sometimes referred to as the "truth in securities" law has two basic objectives: (a) to provide investors with material financial and other information concerning securities offered for public sale; and (b) to prohibit misrepresentation, deceit and other fraudulent acts and practices in the sale of securities generally (whether or not registration is required).
The first objective applies to securities offered for public sale by an issuing company or any person in a control relationship to such company. Before the public offering of such securities, a registration statement must be filed with the Commission by the issuer, setting forth the required information. When the statement has become effective, the securities may be sold. The purpose of registration is to provide disclosure of financial and other material information. To that end, investors must be furnished with a prospectus (offering document) containing the salient data set forth in the registration statement to enable them to evaluate the securities and make informed and discriminating investment decisions.
The registration requirement applies to securities of all issuers. There are, however, certain exemptions from the registration requirements, some of which will be discussed later. The antifraud provisions referred to above, however, apply to all sales of securities involving interstate
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commerce or the mails, whether or not the securities are exempt from registration.
Registration of securities does not insure investors against loss in their purchase, nor does the Commission have the power to disapprove securities for lack of merit—and it is unlawful to represent otherwise in the sale of securities. The basic standard which must be met in the registration of securities is an adequate and accurate disclosure of the material facts concerning the company and the securities it proposes to sell. The fairness of the terms of securities (whether price, promoters' or underwriters' profits, or otherwise), the issuing company's prospects for successful operation, and other factors affecting the merits of securities, have no bearing on the question whether securities may be registered. The purpose of registration is to provide disclosure of these and other important facts so investors may make a realistic appraisal of the merits of the securities and thus exercise an informed judgment in determining whether to purchase them.
In the 1934 Act, Congress extended the "disclosure" doctrine of investor protection to securities listed and registered for public trading on the national securities exchanges; and the enactment in August 1964 of the Securities Acts Amendments of 1964 applied the disclosure and reporting provisions to equity securities of hundreds of companies traded over-the-counter (if their assets exceed $1 million and their shareholders number 500 or more). On April 15, 1982, the Commission adopted a new rule and rule amendments under the 1934 Act. As a result, companies whose fiscal years end on or after December 20, 1981, but whose total assets are below $3 million on or after that date, are not required to register under Section 12(g) of the 1934 Act.7
Companies which seek to have their securities listed and registered for public trading on an exchange must file a registration statement with the exchange and the Commission. A registration statement also must be filed by companies whose equity securities are traded over-the-counter if they meet the size test referred to. The Commission's rules prescribe the nature and content of these registration statements, including certified financial statements. The prescribed disclosures are generally comparable to, but less extensive than, the disclosures required in 1933 Act registration statements. Following the registration of their securities, such companies and entities must file annual and other periodic reports to keep current the...
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