506(c):The return of caveat emptor?

Caveat emptor is Latin for “let the buyer beware.”  The principle is most often applied in the sale of property — the buyer has sufficient amount of time to discover any defects and must live with those defects after the sale closes.  There is no remedy available for a buyer that merely phones in the research and buys something unfit for use.  The only exception to the principle is if the seller actively conceals defects or makes misrepresentations about the property.  That is fraud.

While securities fraud is gussied up in statutes and rules — Securities Act Section 11, Securities Act Section 12(a)(2), Securities Act Section 17(a), Exchange Act Section 9, Exchange Act Section 10(b), and Exchange Act Rule 10b-5 — the basic principles for fraud are the same as in any other purchase or sale of property.  Anyone involved in the sale of a security who misrepresents material information, whether through affirmative statements or omissions, has committed fraud.

Even with these fraud provisions on the books, purchasers of securities may still end up buying a bag of goods they did not want because they did not make fully informed investment decisions.

Offerings made under new Rule 506(c) may only be sold to accredited investors, and when offerings are only to accredited investors, there are no information or disclosure requirements specified by law.  Many issuers in the new 506(c) landscape may try to take advantage of the lack of an information requirement in order to avoid fraud liability.  After all, if an issuer says nothing but “I’m a company, buy my securities,” the only way it has made a misstatement is if it is not actually a company.  Liability for “material omissions” only exists if the issuer has made a substantive statement in the first place.

If the Rule 506(c) offering is made through a broker-dealer, that broker-dealer will have specific due diligence and suitability obligations that it has to comply  with before an offering goes forward.  As a result, broker-dealers typically generate a due diligence file and may provide information from those findings to investors, helping to fill out the investor’s own research on the company.

But an offering does not have to go through a securities intermediary like a broker-dealer.  Instead, Rule 506(c) allows companies to directly pitch their offers to investors on their own, or they may utilize a bulletin board type service, which are a relatively new development, and the obligations of which (if they have any) are not settled under law.

In that solo or bulletin board environment,  the investors must do their homework and dive deep into the details of a company.  Investors have the right to ask questions of the company, and the company should have answers.  If investors don’t do this, they may not get what they thought they were getting, and all they can do is eat the loss.

The important takeaway is that investors always need to conduct their own research and determine if a particular investment is right for them.  Offerings made under Rule 506(c) have no requirements with regard to how much information or disclosure is required.  Investors may receive more information to begin their research when the offering is done through a securities intermediary.  Solo or bulletin board raises may require more effort on the part of the investor to make an informed investment decision.  An uninformed decision may result in the loss of the entire investment without the recourse of a securities fraud claim.  Caveat emptor.

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