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Last Updated on May 1, 2019 by John Fischer

The Securities and Exchange Commission (SEC) was set up to protect the interests of those who invest in securities. As such, it does so, through a series of rules and regulations that govern and answer questions like:

  • What is a security?
  • What disclosures are required when selling securities?
  • What are the consequences of failing to meet SEC requirements?

Perhaps the easiest trap for a business to fall into is to ignore the difference between the full disclosure as a general rule and the full disclosure required when selling securities. The difference is slight by can have enormous consequences.

When selling property under a general rule, the burden falls on the buyer to be aware of minor defects should those defects be easily findable with due diligence. This is known as caveat emptor (“buyer beware”). As such this rule tends to ignore minor inconsistencies or exaggerations if the buyer had the ability to detect them during the sale.

On the other hand, the SEC mandates a much higher standard when selling securities. Accordingly securities sales have to meet the burden of caveat venditor (“vendor beware”) which required that the vendor provide a comprehensive and full disclosure of every possible defect, whether or not it could be found by the investor upon close and comprehensive scrutiny. Any exaggeration or failure to reveal minor inconsistencies are seen as a deliberate misrepresentation on the part of the seller, who can face serious regulatory and financial penalties.

This is hard for a biased business owner to do under most circumstances, virtually impossible when the business needs revenue and the entrepreneur is in sales mode. Covering up smaller defects seems the right thing to do for a society programed to think in terms of caveat emptor. Saving money and selling are often the driving factors that cause a company to cut corners and, sadly, find themselves staring the SEC in the eye.

The SEC does not make any attempt to hide the length and scope of disclosures required, and any entrepreneur can find this information with relative ease. Understanding and then applying the required laws, as well as the recommended precautions is another matter, and usually one best addressed through the experience of a securities attorney.

Unfortunately business seeking investment, especially newer and smaller businesses, are often in a situation where they are very short of operating capital. For such companies bringing in cash is the key to success and the idea of spending large outlays to hire attorneys can often seem unnecessary and even counter-intuitive. Entrepreneurs, being optimistic by nature, will often wing it or simply find the cheapest solution by means of the internet. These are the companies that most often find themselves in regulatory hot soup from where it is virtually impossible for a small business to recover. Penalties are steep, both in terms of regulation and money. Even worse the looming of an SEC investigation is the fastest way to drive investors into hiding and as far away as possible from a particular investment opportunity.

Every business has the chicken or the egg conundrum. By preparing correctly and being willing to spend a slightly large outlay of capital up front, a business can save itself time, money, and heartbreak by finding the right professionals to guide them through the minefield of SEC regulations and Reg D exemptions.

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