Raising Capital from Investors without Violating SEC Rules

Many companies raising capital from investors unintentionally violate SEC rules and get civil and criminal penalties from the Securities and Exchange Commission (“SEC”) and Department of Justice.

The bottom line is that looking out for your investors’ interests is a key to protecting you from SEC and criminal violations.

If your business has accepted money from the sale of stocks, bonds, notes, or any other type of investment, you not only need to make sure the information you disclose in your private placement memorandum, Form 1A Regulation A+ disclosure, or S-1 registration statement you present to investors is accurate, but also complete, to the point that any investor will not be misled into making the investment.  Failure to do so, can result in disastrous consequences for you and your business.

On December 4th, the SEC charged an outdoor digital signage advertising company and two of its senior executives with stealing funds from investors.  According to the Complaint, Digi Outdoor Media, Inc., and two of its senior officers raised $4.5 million in promissory notes by claiming they would use investor money to construct and install digital signs for commercial advertising.  Instead, they secretly diverted about $2.4 million of investor money for their own personal use, including luxury cars, rent on a mansion, nanny and housekeeping services, private school tuition for their children, and payment on sham invoices to their other unrelated businesses.

Digi’s business model was to offer investments in the form of convertible notes, which had two-year terms and paid 25 percent interest annually.  The notes entitled investors to convert their loans to Digi into common stock.  The company structured the notes with favorable conversion terms in order to encourage investors to convert the notes to common stock.  That way it hoped to avoid having to repay the outstanding debt to investors.  The executives pitched prospective investors using a slide presentation, which described Digi’s business and business plan, projected revenues, and touted “higher than usual returns on investment.”

Their presentation also included an assertion that Digi “is currently in process of a public offering.”  Digi’s planned public offering was an important factor for investors considering the private offering because it would allow them to sell their shares to the general public, presumably for a profit.

As we have all seen, in high profile cases, the cover up can be more damaging than the original misdeed.  Instead of taking action to inform and protect their investors, the executives at Digi tried to hide their theft by creating fake invoices and sham loans to justify the money they took.  They created forged leases to Digi’s independent auditor, and filed false financial statements with the SEC in an attempt to take the company public rather than pay off their outstanding debt to their investors.  They also encouraged investors to convert their promissory notes to common stock.

In addition to the SEC complaint, the U.S. Attorney’s Office filed criminal charges against the executives for conspiracy to commit wire fraud, submitting false writings to a government agency, obstruction of official proceedings, and destruction, alteration or falsification of records in federal investigations.

The SEC took the position that they violated SEC rules. The SEC charged the Defendants with employing devices, schemes, or artifices to defraud, and engaging in acts, practices, or courses of business which operated or would operate as a fraud or deceit upon other persons.  They also claim that Defendants made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in light of the circumstances in which they were made, not misleading, both to prospective investors, and to an accountant in connection with the preparation or filing of any document or report required to be filed with the Commission.

The relief sought by the Commission is to prohibit the executives from serving as an officer or director of any entity having a class of securities registered with the Commission, to permanently restrain and enjoin defendants from participating in the offering of any penny stock, including engaging in activities with a broker, dealer, or issuer for purposes of issuing, trading, or inducing or attempting to induce the purchase or sale of any penny stock.  They are also seeking a court order requiring the Defendants to disgorge the ill-gotten gains received as a result of the violations alleged herein, plus prejudgment interest thereon, and to pay civil monetary penalties, and for the Court to retain jurisdiction, in order to implement and carry out the terms of all orders and decrees that may be entered, or to entertain any suitable application or motion for additional relief within the jurisdiction of the Court.

Call the Bradshaw Law Group to review your business practices and published statements to make sure that they are completely accurate and complete, so as to not mislead any investor, both experienced and novice.  If mistakes have been made, you can then take steps to make corrections so as to be in full compliance.

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