Entanglement with third-party communications

Lawyers and finance peeps who practiced around the turn of the millennium will recall many of the issues that were raised by the misbehavior of investment banks’ research departments. I-bank analysts would take company executives golfing and, somewhere round the fourth hole, would ask “So, Executive, how is the distribution channel for the next quarter looking? If I said four thousand units a month, would I be off-base?” If the executive gave any answer other than “No comment and is that your ball in the sand?” then the company could be held to have “entangled” itself in the research report that resulted, and be responsible for any misleading statements in it.[1]

I am seeing echoes of those days in the crowdfunding community right now. There are a number of newsletters and webinar providers (I’ll call them publishers) who are hyping up the Reg A and Reg CF markets, claiming that potential gains of 100X are possible, and telling the story of that one truck driver who made a modest investment into a Silicon Valley pre-IPO favorite and is now worth gazillions.

Once a potential investor is signed up to their service, these publishers will send him or her stories or reports about companies that are currently raising funds under Reg A or Reg CF. If the companies or their agents didn’t solicit that coverage, then there’s no issue, even if they don’t agree with the statements made. An issuer has no obligation to police the internet. However, if the company or its service providers (marketing companies, brokers, online platforms and the like) did solicit the coverage, then the issuer might be “entangled” with, and responsible for, any reports or articles produced about the company. Even worse, they might be entangled with the hyped publicity (“How to make 100X profits”) that led the investor to the publisher’s services.

How to avoid this result? Well the most obvious option is not to engage with the publisher at all. The problem is, though, that right now those publishers are getting amazing results from these activities. Despite the fact that investors could themselves go to a crowdfunding portal or search “Form 1-A” on the SEC’s EDGAR system to find “pre-IPO companies” (most of whom, frankly, are not ever going to do an IPO), the publishers can help the company attract multiples of the amounts they’d raise on their own. So the companies involve themselves with the publisher’s product. This can lead to problems where the publisher provides information that is not the same as in the company’s SEC filings. For example, it may run projections as to the company’s future operations or profitability. Is the company liable for any misleading statements that the publisher makes?

It’s generally going to be a facts-and-circumstances analysis. If the company is able to make the publisher include links to the SEC filings and a statement that the company is only responsible for that content and that everything else is the publisher’s responsibility, that might help. On the other hand, getting that involved might itself link the company closer to the content of the report or article. Also, if the company’s personnel were to review any of the publisher’s content (even if just to check for misstatements) that could be a problem. Even more problematic is where the company structures the deal (such as including warrants) to respond to the preferences of the publisher.

Added to the uncertainty are a couple of recent Supreme Court cases, the impact of which on the online capital formation market are untested. The Janus case looked at what it means to “make” a statement under the securities laws. The Lorenzo case said that anyone who “disseminates” misleading statements are liable, even if they didn’t “make” those statements. For the life of me, I cannot understand why parties such as online platforms, brokers and publishers are not more terrified of the implications of the Lorenzo case.

Bottom line: both companies and publishers should be careful to ascertain the accuracy of any statements they publish or allow to be published with respect to securities offerings.

[1] This sort of thing, and other abuses in the production of research reports, were addressed in the SEC’s Rule FD (Fair Disclosure) and the settlement that i-banks made with NY Attorney General Elliot Spitzer, who later dealt with entanglement problems of an entirely different nature.

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