As an attorney who drafts many private placement memorandums for my clients doing offerings under Regulation D Rule 506(b) and Rule 506(c), one thing I often think about while drafting, and when talking to my clients as they provide information about their offering, is: how much of this is puffery? And how much goes a bit beyond it? In today’s video on staying in compliance with the SEC and state regulations, as part of this special seven-part series, we’re going to talk about puffery. What is it? Where does it cross the line? Why is it a problem? And what’s the thought process behind it?
So, what is puffery anyway? In law, puffery is generally defined as a statement made by a syndicator, fund, or someone raising money that’s so general that it describes something optimistic and may induce somebody to want to invest with you, but not so specific as to start crossing lines. For example, what’s probably okay would be a statement like, if it were a real estate deal, “The Austin market is really hot right now.” That’s just puffery. It’s a nice, very general statement that’s not specifically going to induce an investor to give you money.
Where it starts to cross the line is when there’s a falsehood to it. The best example I know comes from a case out of the Seventh Federal Circuit. It was called Makor Issues and Rights v. Tellabs. In that case, there was an accusation of fraud about their stock. Tellabs was trying to maintain value in their stock even though they were facing declining sales around two of their major product lines.
There had been a few calls with analysts that were brought in, as well as the 10-K report. The court ultimately said some things were just pure puffery – they didn’t rise to the level of concern. For example, saying “We feel good about our company’s prospects” is totally fine. However, they did have a problem with specific language related to some of their product lines.
Two of their product lines were flatly declining, with sales going straight down. When an analyst asked about it, the CEO remarked, “We’re very confident in the strong growth of our products, and we know that these two products specifically are achieving a great deal of acceptance amongst customers.” That’s where it started to cross the line. If you have strongly declining sales, saying you have strong acceptance is questionable. How strong is it really if you have declining sales?
Let’s think about how a matter comes before the State or the SEC when something goes wrong. For instance, take Appgate in Texas, who lost about $250 million of investor money. I don’t know of any specific indication that they committed fraud, but I looked at their sales material and literature. They used a lot of puffery-type language about the growth of the Houston area and claimed these assets specifically had way under-market rents and would be enjoying grand appreciation in value. To me, that starts crossing the line of where puffery becomes problematic.
As a syndicator or fund manager trying to find investors for your project, you’re putting things out there to attract those investors. The language of sales often includes some puffery, communicating why they should invest. If you don’t do that as part of the sales pitch, it might look strange because your pitch would probably fall flat.
The problem I see, and why I include puffery in this discussion, is because I see it included in PPMs (Private Placement Memorandums). I’m very careful to ensure there’s no puffery whatsoever in the PPMs I draft. I don’t want somebody relying on the most important document to protect you, the syndicator or fund manager, that contains even what could be considered puffery, let alone anything beyond that.
The PPM’s job is to protect you and to let the investor know, very objectively, these are the risks, these are the conflicts, these are the terms. It is not the place for a private placement memorandum to do selling. Its job is protection, not selling.
Sometimes, what I do for context is talk about the market decisions and why it makes sense. For example: “This area is enjoying this kind of growth. The management believes that because of this growth, assets within this region are going to appreciate in value, decrease their vacancy, and probably increase their rents, which will increase investor yields. That’s the thought process. These buildings appear to be very good buildings, and we’ve identified add-value components, which when done, management believes will probably turn into something more valuable for investors.”
That’s not puffery. Those are just facts and the thought process going on in the manager’s head. It gives the investor an understanding that there’s a logical reason behind why these assets were chosen. But it’s not acting as a sale pitch, saying, “Hey, you’ve got to buy this right now because this particular investment is going to take off like a hockey stick.”
The problem, and this is the cautionary note that I think regulators are going to be picking up on more and more, is what does that private placement memorandum look like? What was being communicated? Not just in those advertisements, where there’s certainly tons of it, but what was said in the private placement memorandum? Because if it’s in the private placement memorandum, the investor is being sold quite a bill of goods and they’re not really being informed of their risks. And that’s the problem.
My name is Tilden Moschetti. I am a syndication attorney for the Moschetti Syndication Law Group. If we can help you by putting together a private placement memorandum, or on all of the documents and making sure that your 506(b) or 506(c) offering is compliant with state and federal regulations, we’d love to talk with you. Give us a call and let’s discuss your project.