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How to Avoid Liability in a Private Placement

Improper drafting of PPM disclosures often results in significant liability, even when the company did not overtly intend to deceive investors. The SEC and state securities commissions have developed a complex system of disclosure regulations, with which a company must comply for the securities to be deemed properly sold. In recent years, SEC regulations have undergone and continue to undergo major shifts, largely in response to the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd Frank) and the Jumpstart our Business Startups Act (JOBS Act). Failure to properly navigate the complex and continually changing regulations carries significant liability, including personal civil liability and criminal penalties in some cases.

Liabilities for Violating Federal Anti-Fraud Provisions

Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), imposes liability on a person who misrepresents or omits a material fact in connection with the sale of securities. The primary penalty imposed is a rescission of the investor’s contract to purchase the security.
A rescission of the contract means that the company, and in some cases an officer or director, would be required to repay the purchase price of the investment made, as well as interest, attorney fees, and other costs. Payment of the liability under this section can be ordered by the court against the individual directors’ and officers’ personal assets.

Furthermore, if the SEC believes and can prove that the material omissions or misstatements were willful, a court can impose fines on individuals up to five million dollars and/or imprisonment of up to 20 years.

Liabilities for Violating State Anti-Fraud Provisions

Similar to the SEC, each state has its own securities laws that effectively piggyback the Exchange Act and impose civil liability on persons who misrepresent or omit material facts. They include personal liability against directors and officers. Thus, after the SEC imposes its penalties, each state in which a security was sold may then impose their own penalties against the directors and officers of the issuing company.

Adequate Disclosures

A PPM not only requires specific disclosures of present information about the company, but also requires a recitation of potential risks of the offering (known as risk factors). Risk factors vary from one offering to another and require the drafting attorney to foresee potential contingencies and assumptions that may result in unfavorable returns. The risk factors must be crafted to fit specific risks that the business may face.

Experienced securities counsel will help the issuer make the proper disclosures required throughout the PPM and protect the issuer from unintentionally making misleading statements and material omissions. A PPM requires specific language, drafting style, disclosures, and content. An issuer that chooses to prepare its own PPM using a purchased template or software without the guidance of an experienced securities attorney may unintentionally subject itself to one of the SEC’s or state securities commissions’ many traps. Rather than allowing a commercial template to drive the structure of private offering, the structure should be driven by the advice of experienced counsel that has been provided with detailed information about the company and the contemplated offering.

Properly Preparing Ancillary Documents

The PPM references other documents in the set of offering documents, which (depending on the offering) can include such documents as the company’s operating agreement, bylaws, promissory note, security agreement, subscription agreement and others. Only a licensed attorney is permitted to prepare or amend these agreements. An issue that regularly arises with equity offerings is rights to the distributions. Distribution provisions must be spelled out in the operating agreement or bylaws of the issuer and followed exactly in the PPM.  Experienced counsel can identify and resolve such issues on the issuer’s behalf to eliminate these types of conflicts.



Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.

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