Key Takeaways

Transcript

Regulation D Compliance and “Improper Structures”

Welcome to part two of this video series on how to stay in compliance with the SEC and state regulators when doing a securities offering under Regulation D. This is an exciting video because it covers a problem I see coming up time and time again. Let’s go through exactly what I’m talking about. I call this section “Improper Structures.”

What exactly does that mean? Does the structure of my regulation security have to do with it? My name is Tilden Moschetti. I am a securities attorney with the Moschetti Syndication Law Group.

We’re going to talk about three different structures that I call improper structures. In my opinion as a securities attorney specializing in syndication law, these are big, big problems. I think the SEC is going to be looking extremely closely at these two or three setups. If they find out what’s going on, there is going to be an issue.

How the SEC Gets Notified and Why Rescission Is So Dangerous

Let’s talk briefly about how the SEC normally gets notified about things. Most of the time, 99% of the time, the SEC gets wind of things when there is a lawsuit filed. When a lawsuit is filed, the plaintiff’s attorney will usually file a complaint with the SEC, saying that the Regulation D is not set up properly or it’s not compliant, and therefore, it’s not under what we call the safe harbor of Regulation D. If it’s not under the Safe Harbor of Regulation D or any of the other exemptions, then it automatically is a public security. And if it’s a public security and there is a violation, then the investor themselves has a right of rescission. That means the investor has the right to say, “Hey, there was no contract whatsoever, give me all my money back, give me the money that I lost as opportunity cost.” And the SEC states, “Go get them. Just go get them, grab them, drag them to the ground.” And they will.

Let’s go through what these three structures look like and why exactly I think they are a big problem. I’ll explain what I think the SEC is going to be doing about them and looking very closely at.

Again, I am an attorney, and I’m not saying that they will look closely at these things. This isn’t legal advice for you. So this is the kind of normal caveat, I don’t normally put this out there except in the show notes. But this isn’t legal advice for you. If you’re watching this video and you are part of an investment that gets set up like this, that may or may not be something that is relevant to you. So do not call my office if you are an investor and this is something that happened to you. We just don’t handle that kind of case. I want you to get help; you should find a securities attorney who does litigation and discuss it with them. But that’s just not us. We help syndicators and fund managers put these together in compliance.

Improper Structure #1: The Fake JV and Finder-Like Equity Raising

So, let’s go through what these structures are. They’re similar. Number one is what I call the fake JV. I’ve done another video on this. It’s a phony system. Let’s talk about what a fake JV is. JV stands for joint venture.

The idea goes something like this: We’ve got a syndicator here, and he’s got this wonderful investment that he is syndicating out. He’s got a number of investors who all want to be a part of it. But this guy has a problem. He needs more money. So he’s trying to put this great deal together, but he hasn’t raised enough money.

Let’s say where I see this happening a lot is under Rule 506b also. So this is a 506b offer. So 506b offer, say that also lists that there can be no general solicitation, he cannot put advertisements out there. He these people here are just friends and family really wants to do this deal. Everybody’s going to make a lot of money in this deal goes forward, this guy knows it. But he’s doing a 506b, and he’s hasn’t come up short. He’s come up short. He’s got half of the money that he needs. So what does he do? He calls his friend over here.

He calls a friend and says, Hey, I’ve got I’ve got this problem, I need to raise another $2 million to make this project, go for it. Forget about the dollar. It’s just we need some sort of dollar. So I need 2 million more dollars. In order to do this, do you want to invest? And he says I $2 million, I don’t have $2 million, you know that? You know, I’ve got a lot of friends who would invest. And so this guy has a great idea. But he thinks it’s a great idea. This is supposed to be a lightbulb. He says okay, why don’t you go and tell your three buddies that they can invest in this in this property? Well, this guy has heard of securities rules, right? So he knows kind of what he’s doing. And he says, Well, I can’t you don’t have a personal relationship with them. And he says, oh, yeah, I don’t this guy’s I don’t have a personal relationship with them. What can I do? What if you either put together your own syndication here. Or sometimes they say, What if you put together an LLC and bring them in that way, they can either come in on that 506b that you’re putting in or they can come in through this LLC and then invest up here. And if you do that, I’m gonna give you 10% of the equity that you raise, because I’m desperate. And this money this is going to make a big this is gonna make us so much money we can afford I can afford to pay a 10% Okay, so so this is the joint V JV problem. This guy says, well, we can’t do this. We we know we can’t do this. That’s that’s not we can’t join like that. And so this guy being clever, being clever gets us in trouble here. being clever says, oh, yeah, we can because what we’re gonna do is on our paperwork here, on our ppm, we’re gonna say that we’re doing a joint venture. And that’s how you come in, you’re coming in as a joint venture out, which is in itself investing into this thing. This is the fake JV JV problem, because, well, it seems like this should work. It doesn’t. So he is not this is not a joint venture at all right? This guy is acting as a finder being paid a commission in order to bring people to the investment. It’s a clear cut case of what is actually going on here. The SEC would not like this, this does not comply with the rules, and it would immediately get kicked out.

Improper Structure #1B: The “Passive But Active on Paper” Fake JV

Now there’s actually another kind of fake JV. Let’s call this Fake JV A, which is finders, and then there’s Fake JV B.

In this scenario, we’ve got a syndicator who doesn’t want to pay a great syndication attorney any money. He doesn’t want to pay the guy; he just wants to be able to syndicate this. After all, all these people here, who are very excited about his investment, are going to come in. They’re all friends and family. And this isn’t for that much money – it’s only for $2 million or $4 million, like the last example.

So it’s only $4 million, and he knows them all really well. He’s thinking that they’re all friends. “I don’t want to pay some amount to the syndication attorney to set it up and go comply. I also don’t want to file a Form D, that sounds really hard. I don’t want to put together a private placement memorandum, that sounds really hard.”

So what he’s going to do is put together this LLC. And he’s going to go to all his friends and tell them, “Okay, we’re all coming into this LLC together, and we’re gonna invest in this really great property. It’s really great, we’re gonna buy it, we’re gonna make lots of money.”

And to the investors he says, “Listen up. I know you want to be passive. I know you don’t want to be actively working on this thing and banging on toilets for this multifamily building, right? So you don’t have to worry, I am going to be the manager of this. And I’m going to take care of everything. I’m going to do everything for you. But if you read the paperwork, what we’re actually saying is that you’re going to be an active decision maker, but you’re not okay. You don’t need to be an active decision maker. You don’t need to come to meetings or do anything, I’m going to do all the work, I’m going to get a small management fee. But just if anyone asks, tell them that you’re active, okay?”

Well, you can tell already that this can’t be good. This can’t be something that’s actually legit. And it’s not legit at all. It’s awful. But there are still some people out there in the world, including here on YouTube, who think this is a compliant solution. It’s not. That guy is going to have that right of rescission problem. One of those investors is gonna get mad and he’s gonna get compensated for it.

We’re going to call this the SED (Self-Employed Director) type of thing I manage. We’re calling it still under the umbrella of JV because it’s a joint venture under that LLC with those other people. Everybody is all together doing a joint venture together. Except it’s not – that is a fake JV.

This is a real problem. This is something that is absolutely going to bite people in the butt. And there are going to be people losing money left and right. When is it going to start happening? You know, we’ve got bank rates really high right now and properties are starting to need to get refinanced. And now the actual amount of money that’s coming in is tanking.

Look at my stuff that I’ve published about Applesway. Applesway, look it up. Google it. They lost $240 million of investor money. Do you think they were in trouble? Yeah. Do you think they wanted to lose it? Absolutely not. They didn’t want to lose investor money but they screwed up. They weren’t doing this setup, though. Let me preface that. They’re not following the setup here. They actually set up a proper way and they’re probably not going to jail for it. They made mistakes, but not this kind of mistake. They were inaccurate in their underwritin