Last month, the SEC issued a user-friendly guide for potential investors in avoiding fraudulent unregistered offerings. I highly recommend the advice given here, but I have a few specific clarifications:
- In point 1, the SEC identifies promises of high returns with little risk as a red flag. This is of course true, but one shouldn’t necessarily be concerned if a PPM contains projections of future financial results that look rosy, as long as there is appropriate risk disclosure included. Particularly if the company is a startup without meaningful historical financials to disclose, you’re likely to see projections in the PPM, and even the most scrupulous and honest companies are not going to have projections that make the investment opportunity look like a sure-bad thing.
- Point 4 implies that you should be concerned if the offering doesn’t have a PPM, but as I’ve noted before, it’s not uncommon for private placements to go without a PPM for all-accredited investor offerings. The other point made here about sloppy documentation is well-taken.
- Point 5 notes correctly that many exempt transactions rely on the accredited investor definition. In such cases, as noted, it would be a red flag if the documentation did not ask about the investor’s accredited investor status. However, the heading of this point could be interpreted to mean that you can’t participate in these offerings without the requisite net worth or income, but of course several of the exemptions permit a certain amount of non-accredited investors.
- Point 8 says it’s a red flag if the entity isn’t in good standing in its state of incorporation/organization. It’s pretty common for smaller companies to be delinquent in franchise tax payments and therefore not in good standing pending the payment, and in the great majority of these cases, it’s probably more about inattention to detail than a scam. A reasonable investor could deem such sloppiness to be a red flag, but not necessarily as an indicator that the promoter will abscond with the investor’s funds.