A trap exists for investors in business deals and those seeking investors in business deals. It is called the Securities and Exchange Commission. If you have ever been solicited, privately, to invest in a deal that seemed “too good to be true” or if you are in the business of offering potential investors deals that “are just too good to be true,” this blog is for you.
Back during the Great Depression (you remember, the one where Hoover and Franklin Roosevelt got involved), the U.S. Government created the Securities and Exchange Commission (the SEC, not to be confused with the Southeast [football] Conference). The SEC oversees and, yes, regulates stocks and bonds (think Apple, AT&T, and ExxonMobil). This is actually a good law for consumers (purchasers of stocks and bonds). The companies and entities that issue these securities are subject to regulation: regular reporting and auditing; legal ramifications for misstatements and omissions. The whole idea is to make investing in stocks and bonds “transparent.” If a company said it made $1,000,000 in the last calendar quarter then there is an independent auditor ready to independently confirm that. This provides a baseline for investors, large and small, to make informed investment decisions.
The securities may be, among other things, common or preferred stock, limited partnerships interests, a membership interest in a limited liability company, an interest in an oil or gas well, or an investment product such as a note or bond.
However, not all offerings of securities must be registered with the Commission. Some exemptions from the registration requirement include:
· private offerings to a limited number of persons or institutions.
· offerings of limited size.
· intrastate offerings.
· securities of municipal, state, and federal governments.
A security offering exempt from registration with the SEC is sometimes referred to as a private placement or an unregistered offering. These private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Many are legitimate – but you are on your own to determine whether it is a “good investment.”
As an individual investor, you may be offered an opportunity to invest in an unregistered offering. You may be told that you are being given an exclusive opportunity. The opportunity may come from a broker, acquaintance, friend or relative. You may have seen an advertisement regarding the opportunity. The securities involved may be, among other things, common or preferred stock, limited partnerships interests, a membership interest in a limited liability company, an interest in an oil or gas well, or an investment product such as a note or bond.
Unregistered offerings are often identified by capitalized legends placed on the offering documents and on the certificates or other instruments that represent the securities. The legends will state that the offering has not been registered with the SEC and the securities have restrictions on their transfer. You should read the offering documents carefully to understand the risks involved.
What type of Investors are out there available to be solicited?
And what kind of investors are there? – according to the SEC, basically two:
Accredited Investors and
An individual will be considered an “Accredited Investor” if he or she –
1. has an earned income in excess of $200,000 (or $300,000 if married) for each of the preceding two years and reasonably expects the same for the current tax year; or
2. has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence and any loans secured by the residence (up to the value of the residence)).
As you can see, there are a lot of “Accredited Investors” running around. It is based on wealth, not education, investment experience, or knowledge of any particular field of business.
Remember, basically everyone else is a Non-Accredited Investor.
Who can market unregistered securities and to whom can these marketers legally solicit?
The Securities and Exchange Commission has a Regulation D consisting of three SEC rules—Rules 504, 505 and 506—these are the rules “issuers” sell securities in unregistered offerings The entity selling the securities is commonly referred to as the issuer [the person forming the partnership; the person promoting the drilling of an oil well – think Promoter]. Each rule has specific requirements that the issuer must meet – to be exempt from the registration process.
For instance, Rule 504 permits issuers to offer and sell up to $1 million of “unregistered” securities in any 12-month period. These securities may be sold to any number and type of investor [Accredited or Non-Accredited], and the issuer is not subject to specific disclosure requirements. Generally, securities issued under Rule 504 will be restricted securities – e.g. not subject to sale to a third party.
Under Rule 505, an issuer may offer and sell up to $5 million of their “unregistered” securities in any 12-month period. There are limits on the types of investors who may purchase the securities. The issuer may sell to an unlimited number of Accredited Investors, but to no more than 35 Non-Accredited Investors. If the issuer sells its securities to non-accredited investors, the issuer must disclose certain information about itself, including its financial statements.
Last, an unlimited amount of money may be raised in offerings relying on one of two possible Rule 506 exemptions, without registration of the security. Similar to Rule 505, an issuer relying on Rule 506(b) may sell to an unlimited number of Accredited Investors, but to no more than 35 non-accredited investors. However, unlike Rule 505, the Non-Accredited Investors in the offering must be financially sophisticated or, in other words, have sufficient knowledge and experience in financial and business matters to evaluate the investment. This sophistication requirement may be satisfied by having a purchaser representative for the Non-Accredited Investor who satisfies the criteria.
As with a Rule 505 offering, if Non-Accredited Investors are involved, the issuer is supposed to disclose certain information about itself, including its financial statements.
Issuers relying on the Rule 506(c) exemption can generally advertise their offerings. As a result, you may see an investment opportunity advertised through the Internet, social media, seminars, print, or radio or television broadcast. Only Accredited Investors, however, are supposed to be allowed to purchase in a Rule 506(c) offering that is widely advertised, and the issuer is supposed to take reasonable steps to verify your accredited investor status.
In summary – be careful whichever side of the transaction you are on!
So, if you are raising money for a new oil and gas drilling venture, you should consider consulting with an attorney to make sure that you do not run afoul of complicated Federal Securities law (we didn’t even talk about rules of individual states). Seriously, securities laws are complicated and violations, however innocent, can result in prison sentences.
If you are being offered an investment opportunity in an “unregistered” security (any oil and gas drilling venture), be careful. There may be no “government back-stop.” As a first instance, you should consider consulting with an attorney who may well refer you to a financial planner, accountant, or other type of advisor. For you, the investor, it may well be the “wild, wild west.” So, BUYER BEWARE!
Interestingly, an interest in an oil and gas well (think nonoperating working interests) are “securities” as defined by the Securities and Exchange Commission. So, just what about all of those small oil and gas prospects that are regularly marketed over the telephone? Are they subject to SEC oversight? Maybe, maybe not.
Whichever side of the table you are on in an oil and gas drilling venture, the money you spend on legal advise will some of the best use of your money, ever.
by Jack M. Wilhelm
Edward Wilhelm and Jack Wilhelm provide tremendously high value legal assistance to a large number of very desirable clients.
THE WILHELM LAW FIRM, 5524 Bee Caves Road, Suite B5, Austin, TX 78746; (512) 236 8400 (phone); (512) 236 8404 (fax); www.wilhelmlaw.net
DISCLAIMER: The information on this site is not intended to and does not offer legal advice, legal recommendations, or legal representation on any matter. You need to consult an attorney in person for legal advice regarding your individual situation.