There is a reason why public advertising and other forms of general solicitation are so crucial for many small businesses - they dramatically increase access to capital. In the private placement market, one of the best ways to advertise your offering is to utilize a particular exemption to the Securities and Exchange Commission (SEC) registration requirements. Keep in mind that if you use this exemption, it is especially important to comply with its terms and pay particular attention to the verification of some essential information about all your investors.
Issuers that struggle with these requirements and can potentially be investigated and penalized. That situation does not have to happen to you. In this article, we would like to share some critical insights about the SEC’s investigations and some easy ways to verify your investors.
The Rule 506(c) SEC Registration Exemption
Rule 506(c) of Regulation D of the Securities Act is an SEC registration exemption that went into effect in 2013 as part of Title II of the Jumpstart Our Business Startups Act (JOBS Act). There are no monetary limits on Rule 506(c) crowdfunding method, and you may advertise your offerings wherever you choose, including traditional and social media. Since only accredited investors may participate, the Safe Harbor provided by the SEC requires issuers to "reasonable steps” toward SEC accredited investor verification. To verify that your investors qualify as accredited investors, the SEC requires an extensive review of tax returns, bank statements, and other financial documents. This ensures that all investors in Rule 506(c) crowdfunding offerings have net worth or income above certain thresholds.
How the SEC Investigates Issuers
Although many SEC meetings are public, the Commission conducts private investigations of securities law violations and other noncompliance with related regulations. In criminal matters, the SEC’s Division of Enforcement liaises with law enforcement agencies in the U.S. and abroad. The Division may also recommend and prosecute civil actions, either in federal court or before an administrative judge who is independent of the Commission. To gather evidence, SEC staff will surveil the markets and review media reports, investor complaints, and other tips. Also, the Enforcement Division works closely with other divisions and offices of the SEC, as well as the self-regulatory organizations.
Investigations may involve extensive documentation reviews and witness interviews, as well as less formal proceedings. Courts may also use subpoenas to compel a witness to produce records and other documentation, or to testify.
Frequently, the Commission and the charged party opt to settle without a trial. Common remedies may include cease-and-desist orders and injunctions, which are court orders prohibiting further violations of the rules or the law. Special supervisory arrangements, audits, or accounting for frauds may also be required. Other remedies include revoking or suspending investment adviser and broker-dealer registrations, returning unlawful profits (also referred to as disgorgement), and other monetary penalties. Additionally, an individual wrongdoer may be legally prohibited from acting as a corporate director or officer. It’s essential to keep in mind that violating a court order may lead to additional penalties and even imprisonment.
The SEC cites several common reasons to investigate, including:
"• misrepresentation or omission of important information about securities;
• manipulating the market prices of securities;
• stealing customers' funds or securities;
• violating broker-dealers' responsibility to treat customers fairly;
• insider trading (violating a trust relationship by trading while in possession of material, non-public information about a security); and
• selling unregistered securities."
Recent SEC Investigations
According to a May SEC press release, the SEC investigated Ares Management LLC, a California-based registered investment adviser, and private equity firm, for failing to properly implement policies and procedures related to the misuse of material nonpublic information. Although the firm neither admitted nor denied wrongdoing, it agreed to a civil penalty of $1 million USD, along with a cease-and-desist order and a censure.
According to another May SEC press release, California-based blockchain firm BitClave PTE Ltd. was charged with conducting an unregistered $25.5 million USD initial coin offering (ICO) of digital asset securities called Consumer Activity Tokens (CAT). The settlement included returning the funds and paying additional money to investors through a “Fair Fund.” Here’s how the release explained the firm’s wrongdoing:
“BitClave emphasized its expectation that the tokens would increase in value, and took steps to make the tokens available for trading on third-party digital asset trading platforms after the ICO. The order finds that BitClave failed to register their offers and sales of CAT, which constituted securities.”
An Easy Way to Verify Accredited Investors
Reviewing financial documentation for all investors in a Rule 506(c) offering is risky and expensive to conduct internally. Furthermore, non-compliance is costly. Instead, third-party verification services, for example, VerifyInvestor.com, works with highly experienced and detail-oriented attorneys who will provide streamlined verification services for you. Please note that the use of VerifyInvestor.com fully complies with accredited investor verification requirements.
