Tuesday, September 3, 2013

How Will the SEC Know I'm Advertising in a Rule 506 (c) Private Placement?


By Jim Verdonik

I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW

When I counsel a client, I always get worried when I hear the words:  "How will they know?"
Sometimes these words are a signal that the client is willing to do anything to achieve their goals.  But in my long years counseling clients, I've found that people usually don't intend to commit a crime.  They often back into it without really being fully aware of what they are doing.  And it's usually pretty easy to convince them they are making a big mistake.
Often, they are just being naïve about how the world works.  The often rationalize about ways to escape a bad situation.  They are like a deer standing in the road harboring the illusion that your oncoming car won't hit them if they stand still long enough.  That works until your car crashes into the deer.  Sometimes you get hurt, but the deer is usually a bigger loser.
But what matters is that the client is at a dangerous cross road in their life.
It's up to me to convince them that they are better off not taking the risk of ending up like the deer in the road.
Here's a link to a video that tells how I did that with the CEO of a public company who was acting like a deer in the headlights.
http://www.youtube.com/watch?v=OFwdVWQlASA&feature=c4-overview-vl&list=PLEyL-gjb9p8yqMcjg4lsrt8r69XYcSU7Q

Another common client complaint is:  "Everyone else is doing it, why can't I do it?"=
Every parent gets lots of practicing answering this question from their children.  Children are born with the notion that they should be able to do anything they see other people doing.  This probably has evolutionary benefits.  Maybe it’s the instinct that drives us to learn by mimicking others.  But it's also how we get ourselves into trouble.
Let's explore how these two common human traits can get you into trouble when you try to raise capital to grow your business.
Scope of this Article
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation more D than three decades ago.
More than 90% of private placements rely on SEC Rule 506.  These changes include prohibiting you from using Rule 506 if someone affiliated with your business or with your capital raising efforts has violated securities or other finance industry laws.  The SEC also added new Rule 506 (c), which allows you to raise capital in private placements by advertising or doing a general solicitation.  But new Rule 506 (c) requires you to verify accredited investor status of all buyers if advertise.
See the end of this article for links to other articles about these Rule 506 changes.
This article explores:
  • How will the SEC and state securities regulators will find out about your advertising?
  • Why is it dangerous to assume that what you see other people doing in their advertisements is legal?
  • What happens if you are caught advertising when you didn't comply with the Rule?
  • What happens if your advertising is misleading??



How Will the SEC Find You?

Let me count the ways.
If you pretend you are invisible to the SEC or state securities administrators, you will probably end up being road kill.  We might not live in a full-fledged police state, but securities regulators see more and know more than you think.  Let's explore a few tools the SEC and state securities administrators you often use to learn that you are up to.
·         State and Federal securities regulators are likely to see your advertising materials because they are public.  Securities regulators already devote substantial time looking for Internet securities fraud.  They are increasing their manpower devoted to monitoring the Internet and social media.  So, it's foolish to assume that big brother won’t see what you are doing.

·         The Form D you file with the SEC and state securities regulators filings when you sell securities will probably trigger requests by state and Federal securities regulators to see copies of your advertising materials. 

·         The SEC has already proposed new rules that will require businesses to file advertising materials before you use them.

But the SEC is far away in Washington.
They don't look at local media, do they?
First of all, the Internet means there is no such thing as local media.  Virtually all local media ends up on the Internet and can be found by anyone (including the SEC).
But the SEC isn't alone in its fight against securities fraud.  Each state has its own securities administrators who focus on state and local securities fraud.
Finally, your investors or their professional advisers may call securities regulators with questions or complaints about you.  Or state securities regulators may stumble upon your advertising without any complaint.
Everybody's Doing it Isn't an Defense to Securities Fraud
Let's think about securities fraud in light of the new advertising that Rule 506 (c) will permit all sizes of businesses to conduct.  Most of these advertisements probably won't look like traditional tombstone ads in The Wall Street Journal or other traditional business publications – especially ads by small new businesses with extremely limited budgets. 
The Internet and social media will become the battleground most businesses use to win the hearts and minds of investors.  It's highly unlikely that businesses will just download old print journal advertisements into the new social media environment.  So, we can expect that the new Rule 506 (c) advertisements will look and feel very different than the advertisements large public companies traditionally do for their public securities offerings.
Businesses will try to sell securities by using every tool other people use to sell travel, music and porn on the Internet and social media.
Although the media and tools for securities offerings will be new, both state and Federal securities laws will apply the normal fraud tests to the content of advertising materials.
What do think will happen when social media sales techniques collide with the traditional anti-fraud provisions of securities laws?
Right.  It's going to be fun to watch. 
But if you’re a participant and not just a bystander who takes perverse joy watching the equivalent of a massive demolition derby, let's talk about some basic things you should do to survive. 
Temptations to push the envelope on your advertising will be everywhere. 
You will undoubtedly begin to see really "cool" stuff that other business will use to sell securities through social media. 
But remember that just because people are doing something doesn't mean it's legal.  Keep your head down while the bullets are flying wildly. 
The lawsuits that will decide the differences between "cool" and securities fraud probably won't happen for at least several years.  It will probably take that long for most businesses that raise capital to burn through the money they raise.  Then it will probably take  several more years for judges and juries to decide which side of the line between creativity and fraud each sales effort was on.
The history of new securities rules is that issues like these will eventually be worked out over time as people talk with the SEC and request clarification and as the securities industry adopts standardized practices, but the initial period after a new rule comes into effect an create a "Wild West" environment in which no one knows for certain what the law lets you do or not do

So, be careful not to assume that you are safe copying any sales techniques you see on the Internet.
What Happens If You Are Caught? Penalties for Non-Compliance
Securities regulators carry a big stick.
If you don't comply with Federal or state securities laws, the usual remedy is rescission.  That means that investors have the right to get their money back, plus interest.  If the business cannot re-pay investors the money they invested and interest, officers and directors, investment bankers and other people might have personal liability to investors.
Securities regulators understand that it's easy to omit a material fact from a private placement memorandum or other long disclosure document by mistake.  Mistakes are different from having criminal intent.  That's one reason why regulators rarely bring criminal prosecutions for simple mistakes.  Regulators usually think rescission is an adequate remedy. 
But advertising is usually much shorter that long disclosure documents.  So, there is less excuse for mistakes.  If your advertising makes you look like you are a bad guy who is trying to commit securities fraud instead of just making a mistake, you might be subject to criminally prosecution.


Articles in Private Placement Series
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation D more than three decades ago.
More than 90% of private securities offerings are affected by these changes.
The SEC's recent changes are a mixed blessing for businesses selling securities.  These changes include:
  • Prohibiting using Rule 506 if someone affiliated with your business or with your capital raising efforts has violated securities or other financial industry laws. 
  • Adding new Rule 506 (c), which allows you to advertise when you raise capital in a private placement.
  • Rule 506 (c) also requires you to take reasonable steps to independently verify that all people who buy securities are "accredited investors," if you advertise your offering.
Our articles in this series about SEC Rule 506 private placements help you decide how you can use these new rules to raise the capital your business needs by balancing three competing factors:
  • Advertising effectiveness
  • Budget
  • Securities law compliance 
You have to get all three right to successfully raise capital.
Here's a list of our articles that discuss the primary issues you will face when you try to balance these three objectives in your capital raising efforts:
  • Advertising Messages   Tweeting Your Way to Securities Fraud in 140 Characters: What Do you Say in SEC Rule 506 (c) Advertising in Private Placements?  How do you decide what you say in your advertising?  How do you say it?  What current SEC and state advertising rules can you use to guide your advertising decisions?  Can you combine effective sales messages with complying with securities laws?  Or is it an either or choice?  What's the point of advertising if securities laws prevent you from selling effectively? http://jimverdonikintersection.blogspot.com/2013/08/tweeting-your-way-to-securities-fraud.html
  • Choosing the Right Media for your Advertising. Don't Tweet when You Should Have LinkedIn: Choosing Your Advertising Media in SEC Rule 506 (c) Private Placements  How do you advertise within your budget?  How do you identify your "sweet spot" target investors and the right media to reach them?  What social media tools can you use?  How do you attract accredited investors who meet SEC criteria for making investments?  http://jimverdonikintersection.blogspot.com/2013/08/dont-tweet-when-you-should-have.html
  • Building your Sales and Legal Team.  Would You Let Your Lawyer Run Your Sales Department?  How Can You Build the Right Team for Advertising in SEC Rule 506 (c) Private Placements?  How do you build teams to help you do effective advertising while still complying with SEC and state anti-fraud rules?  What role should your sales team play?  What role should your lawyer play?  How do you choose a lawyer who can help you create effective advertising that also complies with securities laws. http://jimverdonikintersection.blogspot.com/2013/08/would-you-let-your-lawyer-run-your.html
  • Accredited Investor Verification.  Will SEC Rule 506 (c)'s Permission to Advertise Cure Your Capital Woes or is Its Accredited Investor Verification Requirement a Poison Pill?  If you want to advertise your securities offering, you must take reasonable steps to verify that everyone you sell to is an "accredited investor."  You can't just rely on the investor checking a box that tells you it is accredited.  How much checking is "reasonable"?  How do you qualify for the "safe harbor" the SEC included in Rule 506 (c)?  What happens if you don't obtain the right type of proof that the people you sell securities to are "accredited investors?"  Why will some investors refuse to comply with your verification requests?  What can you do to reassure investors about privacy issues and make the verification process more convenient for investors? http://jimverdonikintersection.blogspot.com/2013/07/sec-rule-506-c-sec-throws-new.html
  • Beware of SEC Integration Rules:  SEC RULE 506 (c) Integration Pitfalls: Don't Use the SEC's New Advertising and Solicitation Private Placement Rule to Saw Off the Limb You are Sitting On  Why should you look before you leap into advertising?  What integration and related pitfalls does Rule 506 (c) create for businesses that choose to advertise or engage in general solicitations?  How do you sell securities to people who are not accredited investors under another SEC private placement exemption, if your advertising doesn't attract enough accredited investors to finance your business?  http://jimverdonikintersection.blogspot.com/2013_07_01_archive.html
·         Getting Caught : How Will the SEC Know I'm Advertising in a Rule 506 (c) Private Placement?   How will the SEC know about your advertising?  Why isn't it a defense that everyone else is breaking the rules?  How do you deal with the interim period when people are figuring out what the new rules let you do and don't let you do? http://jimverdonikintersection.blogspot.com/2013/09/how-will-sec-know-im-advertising-in.html

·         Bad Actors:  SEC's Bad Actor Rule: When You Lie Down with Dogs Expect to Get Fleas  To use Rule 506 (with or without advertising) you have to verify that a long list of people who are affiliated with your business or with selling your securities offering haven't violated securities or other financial industry laws.  How do you make sure the SEC's Bad Actor Prohibition for Rule 506 private placements from cut off your ability to raise capital?  http://jimverdonikintersection.blogspot.com/2013/07/secs-bad-actor-rule-when-you-lie-down.html
 


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