My name is Tilden Moschetti. I’m a securities attorney with Moschetti Syndication Law Group. We specialize in helping syndicators and funds put together offerings for Regulation D Rule 506b and 506c offerings. Today we’re going to talk about probably the greatest myth of all time when it comes to syndications. It’s something I hear at least once a week, most of the time two or three times a week.
The myth goes something like this: I get the phone call, I answer it. And there they are. They say, “Hi, well, I’ve done some syndication in the past, well, it actually wasn’t syndication, because what I did was, I just got some friends and family together, took some money. And we bought a couple different things, we bought some buildings, or we invested in some businesses, but they were all friends and family, and it was under $1 million. It was $900,000 that we raised. And so it didn’t fall under the rules where we needed to do a filing with the SEC.” That’s the story that I oftentimes get.
The reason they’re calling me is because now they’re ready to go into what they consider the big leagues where they do need to make such a filing. The myth here is that they didn’t need to make the filing. There’s a general idea out there, and I have no idea where it came from, because I’m trying to find it on the Internet somewhere. Somewhere it must exist where people got into their minds that they can do a securities offering if it’s just friends and family, or just family, or if it’s under some certain dollar amount. But that’s just not the case.
There is no rule that relates to dollar amounts or to friends and family. We often refer to Regulation D Rule 506b as a friends and family offering because you need to have a relationship with your investors. But you’re still not considered a private security until you’ve registered the Form D with the SEC; you’re not in that safe harbor of Regulation D. In fact, you’re probably considered a public security, which means you need registration, but you don’t fall under any sort of protection whatsoever.
So what could happen is if one of your investors got mad, and where else do investors get mad but if they’re family of yours, right? So if one of them gets mad and they call their friend who is a plaintiff’s attorney, and they tell them about their woes and how you’ve lost money on them. And they say, “Well, okay, why don’t you send me your private placement memorandum?” And they say, “Well, I never got a private placement memorandum.” And then suddenly, the plaintiff’s attorney knows he has a good case.
The reason is because it didn’t go under that safe harbor to be a security. So anything is a security that meets this simple test. It’s called the Howey Test. It really is the standard. Now there’s a lot of other interpretation that’s related to the Howey Test, to reinterpret things that are much more complicated than a typical syndication or fund. But the Howey Test stands on its own as the standard that would have to be met, no matter what anyway.
The Howey Test looks at four elements. Basically, it’s looking for an investment in a common purpose. So they invest for this common purpose, which might be to invest in a business or it’s to invest in a real estate building, or something like that. So there’s been an investment in a common purpose where they’ve given money, right? So they’ve given money to you. And they are expecting to receive a profit back. And that profit back is based on – this is the big one – the reliance on a third party. That’s you, that’s the syndicator, that’s the sponsor, that’s the person who they’re relying on. That fourth step is almost always present in all these cases that I’ve talked about.
My next question when I ask somebody who’s telling me that this is part of how they did the syndication without filing a Form D, is, “Okay. So was this a joint venture? Did they have decision-making power?” And it almost invariably is no, I had all the power and I had all the control, which means it’s a security by pure definition.
Now if they had said, “No, see what happened is my three brothers and I all came in, we all put in $250,000 into the bank, we bought an apartment building. And then my brother Joe, he did the property management of it. I did the asset management, the long term planning of it and made sure that all was good there. My brother Sam, he did all the construction work on it. And my brother Lou, well, he’s an accountant. And so he did all the tax preparation for us and made sure it was all legit. And we’d come together every quarter, and we’d discuss the building, we’d look over everything. And we’d all together make the decisions.” Well, at that point, that is definitely a joint venture, that is a partnership, that is not a security.
But what always happens in the stories that I hear is, “We all participate, you know, they all put their money in, but I’m the one that made all the decisions. I’m the one that had the control.” So at that point, it’s automatically a security.
So what do you do is sort of the next question I oftentimes get. And it’s sort of a question of, well, it’s up to you. Because you have put together this thing that is a security. And you can file a Form D late, and you can file a notice to the states late, but maybe you’re going to decide not to. Many of the people who I talked to decide not to because it’s too small.
These things really come up when there’s that lawsuit when that plaintiff’s attorney gets involved. If the issue is already done, it’s already done. There’s no really going back, you’re not going to file a Form D when all the investors have already gotten all their money back and the deal is done. But it could come up if the deal is still alive. And in that case, it might make sense to go back and put together as best you can that PPM and to file Form D and to notify the states that this happened in retrospect.
Now there will be a penalty probably from the states for such a late filing. There won’t be a penalty from the SEC. But the SEC does say that, well, if things are filed late, there’s a possibility that we’ll decide we’re not going to let you file Form Ds in the future. But I can’t see that happening. The SEC really wants people to notify it when there’s a security being offered. That’s what it really wants. And they don’t want to punish people for doing what they want them to be doing in the first place. So I think it’s unlikely the SEC would ultimately decide to punish somebody for a late filing of a Form D.
So if I can help you with your syndication and being compliant with the SEC and the states and all the rules that are out there, and you’re putting together a syndication or fund, you just need to give me a call. I focus exclusively on Regulation D Rule 506b and 506c offerings, and I’d love to talk to you.