Business

What happens if you do not follow securities law procedures to a "T" in private placement offerings?  The answer is messy.  In large part it depends on what type of securities law violation you are talking about. 

The first type of violation is procedural.  Examples may include a company relying on a 4(2) exemption but offering certain securities to non-sophisticated investors (which is a Section 4(2) requirement).  Another example may be simply failing to make, or untimely make, a securities filing.  

The second violation type is related to securities fraud.  Examples of this may include failure to disclose material information (e.g., financial data, relevant risk factors) or making misleading statements in a private placement offering documents.

Obviously the damages for the second type of violation are much more steep than the first.  For the second, civil and criminal damages are in the minefield.  Think Martha Stewart for worst case scenario.  Civil damages are similar to other fraud claims and can include punitive damages. 

The hard thing about securities fraud, as opposed to other areas of fraud, is that it does not require reliance on the part of the investor in order for the investor to have a solid cause of action.  In standard fraud claims a person has to show that there was a misrepresentation of a material fact which was relied upon by the person that resulted in damage to that person.  In securities fraud, you remove the reliance element.  It makes it borderline strict liability.  This is why full disclosure of terms and risk factors at the time of the offering is so important.

For procedural violations, damages are all over the place, ranging from “no harm, no foul” slaps on the wrists to rescission of the investment, plus interest  Note that certain procedural violations can give rise to fraud and open damages to those Martha Stewart levels.  One of the more common procedural violations is when companies ignore securities procedures and either make public solicitations of private securities or make offerings to investors who are not classified under the appropriate guidelines of the exemption rule which the company is filing under. 

For instance, certain securities exemptions allow for unlimited accredited investors and up to 35 non-accredited investors.  If a company sells securities to 36 non-accredited investors, a procedural violation has occurred and may give rise to a right to rescission from investors. 

Of course this is the fire hose version.  I am amazed at how much uncertainty there is from the SEC and courts in what damages to apply in certain common violations, but that is the simple truth of the legal landscape we live in.  Best thing is to walk the line and do the offerings and subscriptions in full compliance with the exemption rules.  Consult with securities attorneys, like those at Alerding Castor Hewitt, as you navigate through your private equity offering.