For Investors in Texas Reg D Offerings: What if That Exempt Security Isn’t Exempt?

It’s a basic rule of securities trading that securities offered for sale to the general public have to be registered with the SEC and, in Texas, with the Texas State Securities Board (TSSB). With registration come expansive (and expensive) disclosure requirements so that purchasers can have all the facts necessary to make an informed decision. Fail to register, and the issuer is subject to civil liability.

Registration Exemptions

But some securities and transactions are exempt from the usual registration requirements, both under the federal laws and the Texas Securities Act (TSA). These sales are sometimes known as Reg D offerings, from the applicable federal regulation. Stock issues that are exempt under Reg D are also exempt from the TSA’s registration requirements. In order to maintain this exemption, issuers must follow a set of particular rules, including:

• no advertising or solicitation to the general public;
• limits on the number of and type of investors; and
• in some cases, limits on the amount of capital to be raised from the sale.

These offerings are also known as private placement offerings, because they cannot be offered to the general public and still be exempt. While the SEC revised its rules a few years ago to permit general solicitation and advertising, issuers who take advantage of this new leniency can only sell to accredited investors, and must make reasonable efforts to verify that all purchasers are in fact accredited. For an individual purchaser (that is, a person, not a bank or other entity) to be accredited, she must be either a director, officer, or general partner of the issuer, or have a net worth in excess of a million dollars.

The point of a private offering, of course, is to raise money by selling investments. Sellers being sellers, however, sometimes the rules regarding exemption get broken in pursuit of sales. When that happens, the law is clear that the issuer is liable for failing to register a security that doesn’t comply with the exemption requirements. And a stock that isn’t exempt under Reg D is also not exempt from state registration. In Texas, the rule is particularly strict – under section 33A(1) of the TSA, a purchaser is entitled to rescission if he has purchased an unregistered security that doesn’t qualify for an exemption. And the TSA places the burden on the issuer (or seller) to prove that all conditions for an exemption are satisfied.

Exempt No More

If you’re a Texas investor who’s made investments through a private placement offering, what are some of the signs that the security you’ve purchased may not really qualify for an exemption? In many cases, exemption is lost through improper advertising or solicitation, or through selling to too many unsophisticated or unaccredited investors. One old-school way that can happen is by cold-calling — when a seller picks up the phone, dials a number, and tries to sell to whomever answers the phone. These days, the Internet sometimes plays a role. Signs that your private offering might not be exempt include:

• Shares or interests can be purchased via a website accessible to the general public.
• The offering is touted on social media sites like Facebook, LinkedIn, or others.
• You learned about the opportunity at a conference open to the public.
• Nobody made any effort to verify your status as an accredited investor. In fact, maybe you were told that nobody’s status was verified, because “we’re not going to play paperwork police” (yes, that’s an actual quote from a TSSB case.)
• You were allowed to participate even though you don’t meet the requirements for an accredited investor.

It appears that when the SEC changed its rules to allow advertising and solicitation to the general public, some issuers might have just run with that and paid scant attention to the second half of the rule change requiring all investors to be accredited and the issuer to make reasonable efforts to verify investor status, in light of just how many TSSB cases find that issuers and sellers failed to do just that.

If you suspect that you’ve bought into a private offering that fails to satisfy all the conditions for a registration exemption, you may be able to get out again without losing all of your investment. Remember, the TSA allows the purchaser of an unregistered security that does not qualify for an exemption to have the sale rescinded. Contact our office to discuss your situation by calling 866-597-2221 our using our online contact form. We have 30 years of experience representing investors like you in nearly every variety of securities arbitration and litigation. We can help.