Rule 10b-5 and Offering Disclosure
Even when an offering is exempt from registration, the anti-fraud rules apply. Rule 10b-5 prohibits untrue statements of material fact and omissions that make statements misleading in connection with buying or selling securities. The Texas Securities Act adds its own civil liability, including rescission and liability for people who control a seller. The practical defense is complete, accurate and specific disclosure of the deal, its risks and the sponsor's conflicts.
What the rule prohibits
- A false statement of a material fact.
- Leaving out a material fact needed to make other statements not misleading.
- Any scheme or act that operates as a fraud on investors.
A fact is material if a reasonable investor would consider it important in deciding whether to invest. Fraud under Rule 10b-5 generally requires intent or recklessness, while some other provisions apply to negligence.
Texas Securities Act
Texas law gives a buyer a right to sue to rescind a purchase made by means of an untrue statement or misleading omission, with the possibility of recovering the consideration paid plus interest, less income received. Texas law can also make people who control a seller, and certain others involved in the sale, jointly liable with the seller. Because Texas liability can reach beyond the issuer and does not always require the same proof of intent as federal law, sponsors and their principals should take it seriously.
Common sources of liability
| Problem | Example |
|---|---|
| Overstated track record | Showing only the best deals or inflating returns |
| Rosy projections without basis | Projecting rents or sale prices with no support |
| Hidden fees and conflicts | Affiliate payments not described in the PPM |
| Misuse of funds | Using investor money for a different purpose than stated |
| Omitting known problems | Not disclosing a lender default or a lost key tenant |
How to reduce risk
- Use a thorough PPM with specific risk factors. See what a PPM contains.
- Support projections with documented assumptions and a cautionary statement.
- Disclose all compensation to the sponsor and affiliates.
- Update investors on material changes during the offering.
- Keep communications consistent across the website, deck and PPM.
- Use funds only as the offering documents say.
Why the exemption does not help
Exemptions from registration do not exempt the offering from fraud liability. A technically compliant 506(b) deal with misleading statements can lead to rescission claims and enforcement. Investors who lose money often look for any misstatement. Clear, specific disclosure before the sale is much cheaper than a dispute after it. See is my syndication a security.
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Book Free ConsultationFrequently asked questions
Does Rule 10b-5 apply to private deals?
Yes. It applies to any purchase or sale of securities, registered or exempt.
Can projections create liability?
Yes, if they are unreasonable or misleading. Include assumptions and cautionary language, and keep support for the numbers.
Can my partners be liable too?
Texas law can reach those who control the seller and certain others. Federal law has control person liability as well.
Does a disclaimer protect me?
Generic disclaimers help little. Specific risk disclosure matters more.