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.
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.
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.
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 underwriting and misjudged what the risks are. That’s not illegal, they warned their investors that that could happen. They’re probably not going to be going to jail. They’re probably okay at the end of the day. Now, will they be able to do another deal again? No, I doubt it. Possible, but not likely. Because that’s a pretty bad mistake losing $240 million. Would you really invest with that guy again? Probably not.
But when loans are coming due, and when things are gonna have to get renewed, this is gonna bite. This is gonna eat up a lot of people. And when this comes out, there’s gonna be lawsuits filed. And that’s how the SEC is gonna see. They’re going to ask, “Wait a minute, why are they setting up and trying to claim that they’re not under Regulation D?” They’re not under Regulation D actually. Which means it’s a securities violation because this sure is a security. So these people are gonna get nailed.
I don’t know if they’ll go after the gurus who told them that this is an okay setup, because it’s not, but this is going to bite them. Because those finders, those people are going to be desperate to get their money back. And they’re going to immediately be telling their plaintiff’s attorney, “Hey, you know what? This was Joe Smith, who brought me in, he actually didn’t really have anything to do with the deal. He just sold me the security. So we’re suing him. But you know who the real bad guy is? It’s the guy who put it all together and said it was okay – the guy with the lightbulb. He’s got a problem.”
So fake JV, these people are going down. That’s my prediction. We’ll see if I’m right. Legally, I know I’m right, whether or not they go down or not. We’ll see. That’s up to the regulators to figure out.
Number two, we’ll save the worst for last. So number two, we’ll call it compensation. Now this is actually a problem that I do see from time to time happen. It looks something like this. It’s not a problem in the structure. It’s a problem of disclosure. And inherent in that is a problem of structure because if it was disclosed properly, it would be properly structured.
So you’ve got this guy here. He put together an amazing LLC and he did everything absolutely right, or so he thought. He did a great PPM. And he raised money from investors. Now the investors are actually all happy. They’re making money.
Now what was this investing into? It was investing into this company up here, or let’s call it a project. This project, what happened is the LLC just goes and invests, right? It doesn’t matter if it was a development project or some other kind of security. The one I heard about this happening on first wasn’t even real estate at all. It was another kind of security altogether.
So it was a project to make money. It was a completely sound business idea, and it made total sense. Now that project was run by these guys. And these guys were super smart. Let’s say it was run by this one guy, and he’s super smart. He’s doing everything right. Everything was totally legit, paperwork looks good.
So the compensation problem is this: This guy comes up with a brilliant idea. His brilliant idea is “I’m gonna make it so there’s no fees. There’s no management fees, and incredible splits. We’re like 98% to the investor.” Wow, that sounds pretty good. So 98% to the investor. And then we’ve got all these people investing here. That sounds pretty amazing. I want to go in on that deal.
But how is this guy getting paid? Well, this guy is getting paid by that guy, because he wants to get this project done. And it looks legit, it’s set up in a way that is not a fake JV. It’s not anything like that. It looks compliant. And probably would be, except for one problem.
This guy here is the problem. Actually, everybody on this side is the problem, because they have no idea that this is going on. They have no idea that this guy is being compensated by this guy. And that’s a problem.
And so what happened in the instances that I know about is the regulators said, “Aha! I know how I can protect my investors. I know how I can protect these people from this state, because they never had the opportunity to look at this compensation. This compensation was being made. It’s quite possible that if he knew about it, he wouldn’t have been an investor at all. And this guy, if he knew about it, he wouldn’t be an investor at all. And if he knew about it, he wouldn’t be an investor at all, because you’ve got this conflict of interest here.”
And you know what? He’s right. It is a conflict of interest. And the problem with conflicts of interest is they can exist, but they’ve got to be disclosed in your PPM everywhere. Make it super clear, so that everybody knows that it actually exists.
So that is the compensation problem. That happens. Why is it an inverted structure? Because it was structured everything right, except the disclosure wasn’t structured at all. So you can take that money, but you’ve got to tell them that you’re gonna take that money and make it super clear, and give a basis for allowing you to. If it’s part of some sort of thing that requires a license, you gotta disclose whatever it is. It’s got to be disclosed, and the mechanism for getting that paid should be disclosed as well. Otherwise, it is a failure to disclose, which is punishable by right of rescission, which comes with lost opportunity costs, and possible criminal penalties for fraud. So bad, bad, bad. That is the compensation problem.
The third, and my new favorite way of trying to cheat the system is the fund of funds. I want to use the most egregious form of it that I’ve seen recently, and why it’s bad. Now, this gets really complicated, and I’m going to try desperately to simplify it. So I’m going to focus really on what is inherently bad, most of all about the fund of funds problem.
So we’ve got this guy here. He thinks to himself, “Wow, I’ve got a great idea.” He’s very smart, has a master’s degree in finance. He knows a lot about securities. He knows a lot about alternative investments. He knows a lot about cryptocurrency, he knows everything about money, right? He knows how the whole system works. He doesn’t know about the laws, but he knows how the money system itself works and how to make good money.
And his friends, he’s got two friends. And both of them are like, “Whoa, dude, you know a lot about making money. Can you help us and invest some of this money for us?” And he answers, “Well, sure, I know how to do this.”
So he goes to a securities attorney and says, “Hey, can I do this?” The securities attorney says, “Well, I don’t know. Let’s look at it. You know, that’s a complicated question.” And then he asks, “Well, what’s the fee?” So he tells him the fee, and he’s like, “Oh, I don’t need to pay that. These are just friends, I’m just going to invest it for them. After all, I found this amazing website with a YouTube video that plays at the top. And it says that I can set this up.”
That beautiful website, what it does is it lets this guy come in, and it lets this guy come in, and it lets me charge fees to manage their account. That’s amazing. So I get to manage this account for these guys. And these guys all have their own individual accounts, they can keep making money deposits in, they can put money in, and they just keep getting money back.
This is kind of starting to sound like something that may be a little familiar. Well, think about what a broker-dealer does. Isn’t this pretty similar to what a broker-dealer or a registered investment advisor does?
And so this guy has already thought of that. He’s like, “Yeah, I know all about them. But here’s where it’s different. These assets that I’m putting in here, they’re not full-on things. These are funds. I’m just choosing different certifications out there that I think are really good. And I’m putting them into this hopper. And then these guys get to choose which ones of those they like.”
Well, that’s certainly interesting, because now it sure sounds like this guy is putting together a fund of funds. Wow, maybe on the surface. But to me, and probably my guess is to the SEC and every state regulator who would look at this, they’re gonna say, “No, that’s a big problem. You’re not acting as a true fund of funds. You’re acting as a broker-dealer. You’re buying securities on behalf of clients, probably advising them on what exactly they need to do and what they need to be doing. And if you’re not advising them, well, then you’re certainly acting in their stead, which is definitely a problem.”
Because if they’re not actually making the decisions, then it’s another problem. But if you’re making a management fee after placing them into these funds, well, you’re either acting as an unregistered broker, or you’re buying them for your own account and then divvying things up, which is basically acting as an unregistered dealer. Either way, you’re going down.
And so the SEC or the state regulator sees what to do and shuts it down. Now, I have seen that this is heavily in existence right now. These platforms exist. They’re out there. I’ve read the private placement memorandums for them. I know how they work.
My prediction: these guys are gonna go down. By facilitating an unlawful thing, they’ve got multiple problems. These guys are not only giving out PPMs, but they’re not attorneys. So they’re going to be hit with unauthorized practice of law. But they’re also facilitating the functions of not even the broker-dealer, but the guy who holds the license under the broker-dealer. These guys have a big, big problem coming.
I predict the SEC, FINRA, and the states are coming after that guy with vengeance and look for that fairly soon. We’ve got a recession coming, people are going to start losing money. And when that happens, they are not going to be in business too much longer, and they have a mountain of securities problems coming.
If that guy with a brilliant idea had just called a securities attorney, we could have set up a system for him to basically do what he wants to do in a manner that would be totally compliant. But he fell into the marketing hype from another company, or from a company that thinks it knows what it’s doing but is not an attorney, and is causing massive, massive problems for its subscribers.
So hope that helps. That is the section on improper structures. I see those three things as major problems of structure that are going to start hitting people or could be four.
So we’ve got the fake JVs, we’ve got the Finder System where it’s like, “Hey, we’ll be partners, and I’m going to basically just be paying you finder’s fees” and that’s not going to work. We’ve got the fake JV of the SED where “I’ll pretend that I’m not the manager, but I’ll really be the manager” – fake JV, going down. Then we’ve got the issue of compensation. This is an inherent problem that’s so easy to prevent – oh my gosh, just disclose and make it super apparent that it exists. And then it becomes so much less of a problem.
A state regulator isn’t going to be spending every nickel and dime that he has in his budget to go after somebody who disclosed everything about what’s going on. It’s just not going to happen. Even if it’s coming close to a gray line. The fact is state regulators are way overworked. They are doing a monumental task against people who are committing massive frauds, like the people running fake JVs and funds of funds. They’re working hard to prevent those. They’re not going to be spending time almost certainly going after the guy who did disclose a compensation model.
And then we’ve got the issue of the funds of funds. I mean, come on. If you want to be a broker-dealer, go be a broker-dealer, go get a securities license, hang that license under somebody and be a broker-dealer. It’s a great job. It’s very unpleasant. And if you love securities, and you love financial instruments, it’s fantastic. I know broker-dealers, I know they love their job, they totally are obsessed with it and love it. They call them Masters of the Universe for a reason. Because they feel like Masters of the Universe. They love it. So if you want that world, just go do it. And then you’re not going to be in trouble. Because you’re going to be fine with all those compliance rules. Absolutely. I mean, there’s like a stack of those, but be compliant.
Again, I’m going to reiterate one thing, just because this is a video on the internet. And this specific one is giving kind of closer to what some people may consider legal advice. This is not legal advice. This is what I’m giving to you as education about what I see going on in the securities world and urging you to not fall victim and to stay compliant. Just follow the rules. If you need help with those, talk to a securities attorney who can help you navigate it. You know, that’s what we’re there for. Yes, we get paid. But isn’t it much better to pay a securities attorney than to go to jail? I think so. And isn’t it much better to pay a securities attorney than to lose all your investors’ money? Absolutely. That’s even worse than jail in some ways.
And if you are somebody who fell victim to one of these types of problems, one of these inherent structural problems, look, I’m not saying you don’t have a real issue here. But I’m just not the attorney for you. I work with the guys setting these things up, the ones who do it in compliance and do it right. That’s the people I help. So if you need help, you definitely need help. If you have questions, you definitely should get the answers. Talk to your state regulators if that’s helpful. Talk to the SEC if that’s helpful. They’re actually very good at helping people. They’re actually very approachable and will help with what your issue is. And if you’ve got a legitimate litigation type issue, or you’ve got something that happened that went wrong, then talk to an attorney who can help you.
It’s just not my firm. So I don’t have referrals for people who do that. I represent the other guys, and I make sure that they’re always in compliance. So I never run across the people who are suing the people because my guys never have this issue.
Again, my name is Tilden Moschetti. I am a securities attorney, syndication attorney with the Moschetti Syndication Law Group. Now if we can help you stay in compliance, I would like to talk with you. Feel free to give us a call or visit our website. Let’s set up a meeting to talk.