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KCD Financial: SEC Says Press Releases are Advertising for Purposes of Rule 506(c)
In general, securities offered or sold in San Diego and or in California must be registered unless there is an exemption to registration. See US Securities Act, 15 U.S.C. § 77b; Cal. Corp. Code, §§ 25000 et seq.
SEC Regulation D provides the two main exemptions (Rules 504 and 506). Under both rules, an offer or sale is not exempt if the offering/sale is made through “general solicitation or general advertising.” If you are offering securities via a private placement memorandum, you need to hire an experienced and talented private placement attorney. What constitutes a “general solicitation” is given a strict meaning by the Securities and Exchange Commission (“SEC”). In the case of In Re: KDC Financial, Inc., File No. 3-17512 (SEC Admin. Proc. 2017), the SEC affirmed that a claimed Rule 506(b) exemption was foreclosed by a press release issued by the offerors which then resulted in the publication of two news articles. Here is a brief discussion of the case.
San Diego Private Placement Memoranda: Legal Principles Rule 506(b)
As noted, for the exemption from registration to apply with respect to Rule 506 of Regulation D,
at the time of offers and/or sales, an offeror must show:
- That neither the issuer nor any person acting on its behalf offered or sold the securities by general solicitation or by general advertising
- That the securities were sold to no more than 35 purchasers who were NOT accredited investors and
- That the non-accredited investor-purchasers met certain criteria regarding knowledge and experience
Case law and SEC guidance makes it clear that ALL of these criteria must be met for the Regulation D exemption to apply. If the exemption is “lost” by violation of any of these conditions, then the offeror/seller has violated the securities laws.
San Diego Private Placement Memoranda: Facts of KCD Financial
In KCD Financial, the securities being offered related to various distressed real estate properties. See SEC Opinion here. The offering was called the WRF Distressed Residential Fund 2011, LLC (the “Fund”). A private placement memorandum was prepared and stated that the Fund would invest up to $10 million to fund “bulk acquisition of distressed residential properties and related assets at deep discounts.” The Fund was located in the Dallas/Fort Worth area. A Notice of Exempt Offering was duly filed with the SEC.
Pursuant to the offering, KCD Financial, Inc. (“KCD”) sent emails to approximately 1,200 individual accredited investors and registered investment advisors in KCD’s database of preexisting investors informing them of the offering. A press release was also prepared and issued by the Fund offerors, not KCD.
Shortly thereafter, two articles ran in Dallas newspapers. Importantly, both articles were generally available without restriction on the websites of the respective newspapers. Furthermore — and this fact was highlighted by the SEC — the articles were linked and re-posted on websites operated by KCD. The first article reported that “… a $10 million real estate fund [had been launched] to acquire bank-owned residential properties and non-performing, discounted residential loans,” that the fund would have a 12-month investment window, that it was expected that the sales proceeds would be reinvested, and provided other details about the Fund. The second article was headlined “Dallas investor launches residential property investment fund” and provided information similar to the first article.
Various attorneys and employees of KCD warned KCD owners that the articles and the re-posting of the articles on the KCD-operated website was “general solicitation.” However, rather than pulling the offering, KCD owners instructed their sales force to ask any potential investor where they heard about the offering. If they said “from the newspaper” or similar, no sales were to be made to those individuals. The first sale with respect to the fund occurred nine days after the newspaper articles ran and sales continued for several months thereafter. Eventually, the SEC brought action against KCD for violation of the federal securities laws.
San Diego Private Placement Memoranda: SEC Discipline
In disciplining KCD, the SEC stated that offered interests in the Fund were made by “means of a general solicitation.” This holding was based on these facts:
- KCD wrote the press release that was the basis of the Dallas newspapers’ articles
- The press release was designed to “arouse public interest” in the Fund
- The articles provided information about the funds and did, in fact, “arouse public interest”
- KCD re-posted the articles on its own websites
The SEC further held that KCD’s effort to prohibit sales to those that read the articles did not “cure” the defect. Once the “general solicitation” was made, the exemption under Regulation D was lost. Finally, the SEC gave no credence the KCD’s argument that it had not issued the press release. The facts showed KCD knew of the general solicitation but proceeded with the sales anyway.
Contact San Diego Corporate Law
For further information on Regulation D and private securities offerings/sales, contact Michael Leonard, Esq. of San Diego Corporate Law by email or by calling (858) 483-9200.
