Raising Capital? Avoid Pitfalls of a Private Placement

Recently, federal securities regulators accused six people of deceiving investors in connection with unregistered securities offerings for a supposed marijuana farm and CBD extraction facility in California. Allegedly, the defendants raised $25 million from more than 400 investors from across the country promising huge returns of 100% or more.

At the core of the case, the United States Securities and Exchange Commission (“SEC”) alleges that the defendants acted as unregistered broker-dealers in the sale of their securities, failed to register their offerings, and accepted investment from unaccredited investors without taking reasonable steps to verify the investors’ accreditation status.

The SEC complaint highlights important rules around registration which are often overlooked when startups and other early-stage companies are reaching out to raise capital. Ignorance of the securities laws is certainly not a shield to regulatory scrutiny.

First, it’s important to note that a small business can raise capital in a number of different ways, including borrowing money from banks, other financial institutions or friends/family — and by selling securities in a “private placement” also known as an unregistered offering.  Because securities offerings can sometimes be exempt from registration with the SEC in a private placement, many startups and smaller businesses gravitate to these offerings.  While there are a lengthy list of exemptions noted here, you can quickly see that laws and regulations around determining securities exemptions are complex — which can mean many small businesses may be unknowingly selling securities without registration, and opening themselves up to lawsuits by state regulators and the SEC alike.

Based on the SEC’s complaint, below are a few of the defendants’ significant alleged missteps which others considering capital raising should keep in mind.

  • Soliciting as Unregistered Broker-Dealers: According to the complaint, three unregistered broker-dealers solicited investors using their own website as well as Facebook, Craigslist ads, and LinkedIn and by cold-calling telephone numbers from purchased lead lists. When these people solicited investors or received compensation, they should have registered with the SEC and Financial Industry Regulatory Authority (“FINRA”) as a broker and be associated with a registered broker dealer firm. It’s important to know that even a seemingly harmless act of paying a friend a finder’s fee for bringing in an investor would make them an unregistered broker dealer.
  • Guaranteeing Returns is Fraud: The defendants allegedly touted the status of a third broker-dealer as an attorney and described 100% returns as a “worst case scenario,” and “guaranteed” returns of 100%. The SEC defines this sort of behavior as “fraud” on its website.
  • Too Many Unaccredited Investors: Unaccredited investors are defined as having less than $1 million in assets, outside of their primary residence, and an annual income below $200,000. The SEC limits investment choices for unaccredited investors to protect them from getting into investments they may not fully understand. Rules 505 and 506 of Regulation D (which establishes the basis for most private placement offerings to be exempt from SEC registration) allow for up to only 35 non-accredited investors to take part in a round of funding. The defendants allegedly did not take reasonable steps to verify the investors’ accreditation status. This article explains how the sale of unregistered securities can take advantage of unsuspecting investors.
  • Concealing Background of Broker-Dealer: The complaint also alleges that the defendants concealed the background of one of the unregistered broker dealers whose previous convictions included domestic violence, possession of marijuana for sale, felony taking of a vehicle, and felony assault with a deadly weapon.

In this case, the SEC’s claims include fraud in the offer or sale of securities, fraud in connection with the purchase or sale of securities, unregistered offer of sale of securities, and unregistered broker-dealer violations. As to relief, the SEC seeks permanent injunctions against defendants, disgorgement of all funds received from illegal conduct, and civil penalties.

While some of defendants’ alleged conduct appears to be egregious, the case does shed light on how small companies can unintentionally run afoul of the securities rules and regulations. The SEC provides a helpful guide here, which outlines how small businesses can raise capital and comply with the federal securities laws.  Keep in mind that raising capital is only getting more complex with the advent and implementation of crowd-funding and cryptocurrencies.

Bottom line: Any company looking to raise capital should first consult a securities attorney who can ensure their fundraising actions stay in check with securities laws, and avoid the long arm of regulators like the SEC.

ATTORNEY ADVERTISING. Prior Results Do Not Guarantee Similar Outcome.



Warren Law Group defends individuals and companies in all types of litigation. Our team has decades of experience in all types of litigation, white collar defense, securities litigation, and financial services enforcement proceedings.