- Fundamentals
- Posts
- ⚖️ A quick guide to avoiding securities fraud
⚖️ A quick guide to avoiding securities fraud
What to include (and exclude) in your marketing materials
Michael Huseby
August 23, 2024
Securities fraud is no good! 👎️
As a general rule, GPs prefer to avoid securities fraud when raising money for an investment fund or SPV.
(Though, based on what I’ve seen on the internet, some GPs don’t seem to care 🤷).
Let’s learn how to avoid securities fraud! 🤓
⚖️ Rule 10b-5 – What is it?
Rule 10b-5 is a key law governing securities offerings:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
✅ So, your goal is to avoid misleading the public.
This post will address general guidelines to ensure you don’t run afoul of securities laws.
😡 Can angry investors sue?
Yes, courts have held that both the SEC and private individuals can sue misbehaving GPs for violations of 10b-5.
As discussed by the Supreme Court in Halliburton Co. v. Erica P. John Fund, Inc.
Although section 10(b) does not create an express private cause of action, we have long recognized an implied private cause of action to enforce the provision and its implementing regulation…To recover damages for violations of section 10(b) and Rule 10b–5, a plaintiff must prove (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.
So, if a GP knowingly makes a material misstatement that causes an LP to invest – and the LP loses money as a result – the LP may be able to sue the GP for securities fraud under 10b-5.
A few tips for avoiding securities fraud
Here are some guidelines you should discuss with your lawyer. In general, your goal is to avoid misleading potential investors.
👍️ What should you include in your disclosure materials?
1. Accurate Financial Information
✅ Provide clear, accurate, and complete financial information about the fund.
✅ Support financial claims and projections with reasonable assumptions and evidence.
✅ Discuss your assumptions!
2. Risk Factors
✅ Clearly disclose all potential risks associated with the investment.
✅ Include general market risks and specific risks related to the fund's strategy or sector.
3. Conflicts of Interest
✅ Fully disclose any potential conflicts of interest involving the fund managers or related parties.
✅ Disclose any fees paid by the fund to the fund managers and/or their affiliates. This might include management fees, acquisition fees, carried interest, etc. Discuss how/when these fees are calculated and charged.
4. Performance Information
✅ If past performance data is included, ensure it is accurate and accompanied by appropriate disclaimers.
✅ Clarify that past performance is not indicative of future results.
✅ If your past performance is your personal investment track record, you must make this very clear. A 20% IRR personal investment is not instructive for fund returns, because the fund will take fees and carried interest. The LP’s cut of a 20% IRR may only be 16%.
✅ Distinguish between gross (deal/fund-level) IRR and net (after fees/carry) IRR.
👎️ What should you avoid in your marketing materials?
1. Misleading Statements
⚠️ Avoid making any statements that are false or misleading.
⚠️ Do not exaggerate the potential returns or downplay the risks.
⚠️ Do not list projected returns without assumptions or caveats.
⚠️ Do not list “gross” (i.e., before-fee) returns without clear disclosure – it’s safer to list “net” (after-fee) returns, which is closer to what LPs can actually expect to earn.
2. Omissions of Material Facts
⚠️ Do not omit any material information that an investor would need to make an informed decision.
⚠️ Ensure all relevant facts are disclosed, even if they are negative. This includes the less-than-stellar aspects of your track record. Don’t cherry-pick! 🍒
⚠️ Don’t make general claims without evidence.
⚠️ Don’t disclose facts to some investors but not others. Everyone should get the full picture.
3. Avoid Unclear Language
⚠️ Avoid using jargon or complex language that could confuse investors.
⚠️ Ensure marketing documents are written in clear, understandable language.
4. No Guaranteed Returns
🚨 Never, ever, ever, ever, ever, guarantee a specific return or performance!
🔈️Where can you market your fund or SPV?
For a full discussion of who you can market to, please see this article on the Securities Act.
In the article, we discuss 506(b) and 506(c) in the context of raising money for an investment fund or SPV.
Ask your lawyer!
This article provides general guidelines. For specific questions about your disclosure, ask your lawyer.
Thanks for reading, everyone.
Have a great weekend! 🙌
How did you like today's post? |
⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.
Reply