Investment Crowdfunding Requires an Attorney — with Long Securities Law Experience

Joseph R. Soraghan

By Joseph R. Soraghan

The entrepreneurial press, indeed, even the popular press, is abuzz about regulation crowdfunding (i.e., investment crowdfunding), which became legal on May 16, 2016.  And according to some advertisements (primarily by portals, the businesses which will provide the platforms for such crowdfunding), the fund-raising company does not need an attorney, although it would be “nice.”  Rather, they say, or imply, small and large businesses with their portals can simply get on the internet to quickly fund their ideas and better the economy at the same time!

Do not believe either the buzz or the advertisements.

Regulation CF is Only a Small (Albeit Very Important) Part of the Applicable Law

Regulation crowdfunding (17 CFR Parts 200,  et seq.)(“Reg. CF”) though it is a sea change from (some of) the rules governing entrepreneurial finance, it is not for everyone.  Indeed, for most entrepreneurs it should be considered as a last resort only.  (See, for example, “Regulation Crowdfunding; Is it Right for You?”, St. Louis Small Business Monthly, June 2016, p. 29.)  Secondly, Reg. CF adds to the rules and required steps for legally raising capital , and thus creates even more of a need for the assistance of a lawyer.

That is, the only (albeit very important) change in the law is that now certain “general solicitation” is allowed to promote certain types offerings of securities.  But not all general solicitation is allowed.  (For example, much information which could be promulgated other than on the platform of a portal such as by newspaper or television is still illegal.)

Virtually all other regulations, statutes, laws – and judicial lore – applicable to raising capital prior to Reg. CF remain applicable and will be applied by securities regulators – and by attorneys for investors who lose money in their crowdfunded investments. The securities regulators, which have authority to prosecute suspicious offerings,  have been opposed to and wary of investment crowdfunding since it was required by the JOBS Act in 2012, including Missouri (see, for example, “Kander Issues Investor Alert on Crowdfunding.”)

With the exception of allowing (limited) general solicitation, all the law (and the lore of the regulators and courts which developed since the Securities Act of 1933) still applies to all offerings, including crowdfunded offerings.  So do the complicated rules and methods. For example:

  • The contents of required disclosure documents (the entrepreneur must provide the information meeting the requirements of Form C instructions (17 CFR Part 227.203)), which consist essentially of those of the classic disclosure document which have been in place – and in constant change and interpretation  – since the 1933 Act was adopted;
  • When persons involved in the selling process must be registered as broker-dealers, otherwise exposing both themselves and their entrepreneur clients to liability and prosecution;
  • When two or more otherwise exempt “offerings” will be “integrated” (i.e., combined), voiding the exemption from registration with the SEC and the relevant states;
  • When states have jurisdiction, how the myriad state statutes, regulations and court decisions apply and must be complied with.
  • How to minimize the need to make a material change to the Form C disclosure document after it appears on the portal’s website. With each such change, all prior investment commitments by investors are automatically cancelled. Inevitably some investors will decline the opportunity to recommit  because they will be suspicious and wonder if there are problems not being disclosed or just because they are already nervous about their risky investment. This event could be disastrous.  Long securities law experience can reduce the possibility of such changes being required.

The attorney chosen to assist an offering issuer must assure his or her client is aware of and complies with the requirements arising from these considerations.

And the Attorneys Chosen Should Have Long and Deep Experience with All the Relevant Law and Methods of Practice

With all the “buzz” about crowdfunding, some attorneys without securities law experience have generated considerable visibility (and “search engine optimization”), essentially only after reading the new crowdfunding rules – and the buzz.  But an attorney qualified to perform the work necessary for a crowdfunding offering – and to advise the client whether to use  crowdfunding in the first place, must be experienced in handling all the myriad non-crowdfunding aspects relevant to offering securities in general.  Only such experience allows that attorney to advise the client, to craft the documents and filings, and to discuss the offering with the crowdfunding portals and securities law officials with whom filings must be made, in such a way as to minimize problems during (and perhaps more dangerous – after) the offering.

To be at least minimally qualified to represent a regulation crowdfunding company, an attorney will have: (1) handled numerous private placements/public offerings of securities before crowdfunding was even proposed to Congress; and (2) litigated cases in court concerning private offerings of securities (so the attorney will know how to avoid litigation and attack by securities law regulators and also how to prepare the offering documents to meet the practical difficulties of presenting a case in court should such a need arise).  To be more than simply minimally qualified, such attorney should have:

  1. Practiced securities law and private offerings for a significant time prior thereto;
  2. Performed in-depth legal research into the law of unregistered offerings, and written court briefs and/or law review articles concerning them;
  3. Participated at length in the entrepreneurial community, assisting entrepreneurs with securities law and other issues for a number of years;
  4. Represented entrepreneurs in disputes with the SEC and the state securities commissions concerning unregistered offerings;
  5. Been a member, and board member, of entrepreneurial support organizations, giving him or her a deep understanding of the needs of entrepreneurs.

Conclusion

Even minimum protection for entrepreneurs raising capital by crowdfunding (either Title II, Title III or Reg. CF) requires attorneys. One of many reasons is that attorneys have a fiduciary duty to the entrepreneur. Portals, platforms and other advisors do not. Also, communications between entrepreneurs and their attorneys are “attorney-client privileged.”  Their disclosure can never be required by plaintiffs suing, or regulators investigating, capital-raising entrepreneurs. Communications with portals, and other advisors, are not similarly protected.

And the attorney should have long time and broad experience in securities law. Preparing the documents required, particularly the Form C, requires much more than filling in blanks with short, simple facts. It requires significant knowledge of and experience with the interpretations  of those questions from courts and regulators over many years —  and often a “gut feeling” as to what will satisfy a court or a securities commission. And much of that experience must come from not only drafting securities law documents,  but also from litigating over the language and related concepts, for years.

Posted by Attorney Joseph R. Soraghan. Soraghan practices in legal matters pertaining to business operations and growth. He guides businesses in financing, contracts, acquisitions, mergers, and sales. Soraghan frequently resolves commercial disputes as an arbitrator or mediator, or through litigation. 


Comments are closed.