MORE THAN YOU EVER WANTED TO KNOW ABOUT
SECURITIES
ISSUES IN REAL ESTATE LLCS
(or why you should have a securities attorney as part of your team)
(or why you should have a securities attorney as part of your team)
Important
note: This memo generally discusses the basic
federal and state securities laws governing the issuance of securities, how
they intersect with the ownership structure of limited liability companies, and
the penalties for non-compliance with the Securities Laws. This memo, however, is a generic discussion
and not specific legal advice or a legal opinion to you.
1. 30,000 Foot summary
Ø Almost all LLC membership interests (“LLC
Interests”) are “securities”. Even
if the LLC has no other assets or business activities than holding and managing
real estate.
Ø All issuances of LLC Interests to members who are not
actively involved in the LLC’s business must either be registered or qualify
under both federal and state registration exemptions.
Ø Luckily, many exemptions are available, and their
conditions generally are not prohibitively difficult or costly. (Particularly in comparison to a securities
lawsuit or administrative penalty!)
Ø However, except for offerings that are restricted to
Accredited Investors (see below), every state has unique exemptions with
differing amount, participant, disclosure, and filing requirements.
Ø Even Accredited Investor securities offerings require
both federal and state Form D filings, and the payment of state filing fees,
within 15 days after the sale.
Ø The penalties for violating the Securities Laws can be
severe, including (a) return of the entire investment amount, (b) fines of up
to three times of the investment amount, and (c) “cease and desist” orders
against the promoters or developers.
Ø
Thus, when offering or issuing any LLC Interests, (a)
assume all LLC Interests are securities, and (b) consult with a securities
attorney to assist on complying with the Securities Laws.
2. OVERVIEW OF THE SECURITIES LAWS AND LLCs
Both the federal and state securities laws (“Securities
Laws”) define “securities” extremely broadly. The express definition includes notes, stock,
warrants, options, and any number of other investment contracts and agreements.[1] In addition, the courts have found a “security”
to exist where a person (a) is investing money or other property, (b) is not
personally involved in the LLC’s business, and (c) is therefore relying on the
efforts of others to provide a financial return. Every security sold in the United States
either must be registered with the SEC or qualify for a federal exemption from
registration. In addition, the
securities either must be registered or exempt from registration in each state
in which each potential investor lives.
Limited liability companies (“LLCs”)
are a relatively new, hybrid form of entity that combines the pass-through tax
treatment of partnerships with the owner liability protection provided by
corporations. LLCs have relatively few
statutory requirements, compared to the extensive laws governing corporations. For this reason, LLCs may be structured so
that the economic and control relationships of the members mirror those found
in (a) a general partnership, (b) a limited partnership or corporation, or (c)
most commonly, somewhere on the continuum between them. For tax reasons, LLCs are generally the
entity of choice for investing in and holding real property.
The
flexibility and customizability of the relationships between LLC members are
often cited as greatest advantages of using the LLC structure. In the securities context, however, that
flexibility can cause the LLC to run inadvertently afoul of the Securities
Laws. If there is only one member, who
does not plan to accept other members or take investments from outsiders, the LLC
Interests should not be considered a “security”. However, for multi-member LLCs, the LLC
Interests generally meet one of the definitions of a security. The only exception is if all of the members
are all actively involved in running the LLC or its business (mirroring a
general partnership), in which case their LLC Interests generally would not be
considered securities at that time.
Unfortunately, once any original or subsequent member is not actively involved
in the LLC’s business, or an LLC Interest are sold to someone not active in
management, then the LLC Interests owned by that person would most likely turn
into securities under the Securities Laws.[2]
LLCs can be managed by either the members themselves or
by a manager designated by the members.
However, simply designating an LLC as “member-managed” will not absolve
the LLC of compliance with the Securities Laws if, in fact, all of the members
do not actively participate in the LLC’s management. In addition, as time passes, members who were
initially active in the LLCs management may become passive investors. Subsequent investments by those members, or
by other passive investors, will constitute the purchase of securities. Even the issuance of LLC Interests to
employees as additional compensation may well constitute an offering of
securities if that employee does not function in a managerial capacity.
Thus, given the availability and relative ease of
qualifying for exemptions from registration as a security, it rarely makes any
sense to make entity-structuring decisions solely for the purposes of avoiding compliance
with the Securities Laws.
3. WHY AM I
READING THIS MEMO? I'M INVESTING IN REAL ESTATE, NOT SECURITIES, RIGHT?
The traditional sale and purchase
of real estate by more than one person, with each of the purchasers holding a
direct ownership interest in the real estate, is not subject to the Securities
Laws. However, where an LLC owns the
real estate, the persons who own LLC Interests do not have any legal right to
the real estate owned by the LLC. On the
other hand, as discussed above, LLC Interests may not be considered securities if
the LLC is member-managed and all members have (a) a say in the management of the
LLC and the property in proportion to their LLC Interests, (b) proportionate
allocations of profits and losses, and (c) the right to proportionate
distributions from the LLC. This
arrangement is typical of many LLCs formed by a small number of members, who
already know each other, to purchase residential real estate.
In contrast, in a typical commercial[3] real
estate investment LLC, the non-management investors have almost no right to
vote except on whether to dissolve the LLC, and sometimes, but not always, on
management’s proposal to sell the property.
Economically, the investors generally have the right to receive specific
“preferred” distributions from the LLC.
Preferred distributions generally equal the return of their original
investment, plus a specified percentage, before the manager starts receiving
distributions. In exchange, the
investors don’t share in any additional profits over the preferred return
amount, which are retained by the managers. This arrangement is functionally the
equivalent of a loan from the investors to the LLC without a promissory note,
which qualifies them as securities. For
this reason, the Washington Securities Division is specifically watching for
non-compliant offerings by commercial real estate LLCs.
Recently, “Tenant-In-Common”
(TIC) arrangements have become a popular commercial real estate financing
vehicle designed in order avoid application of the Securities Laws. In a TIC arrangement, the investors each
purchase a percentage of direct ownership in the real estate as joint owners,
but then designate a property management company, which is usually a company
related to the developer, to manage all of the property’s affairs and make
distributions of profits according to a TIC Agreement. TIC Agreements are similar to investment LLC
Agreements in that the purchasers have almost no rights beyond voting on the
sale of the property, and are therefore actually passive investors. For
this reason, many states, including Washington, have passed regulations making
TIC arrangements subject to the Securities Laws.
The penalties for violating the
Securities Laws can be severe. They potentially
include (a) being required to return all of the non-active members’ investments
(i.e. rescission), (b) penalties to
the government of up to three times of the investment amount, and (c) “cease
and desist” orders against the active members which will have to be disclosed
in any future fund raising efforts.
Luckily, there are many exemptions
from the registration requirements of the Securities Laws available and
qualifying for them is generally not prohibitively difficult or costly. On the other hand, there are no
exemptions from compliance with the “anti-fraud” provisions of the Securities
Laws. Those laws require the Company to
provide potential investors with sufficient material information about the
Company and the investment opportunity that the potential investor is
reasonably able to make an informed investment decision. Therefore, in most circumstances, all potential
investors should be provided with a written package of all information
pertinent to the offered investment in the LLC, before they invest.[4]
Generally, investors only file
a lawsuit for rescission or make an administrative complaint when they receive
less return than they expected, or lose their entire investment. However, real estate promoters or developers are
generally very optimistic, and always believe that their deal will succeed;
otherwise they would not pursue the project.
For this reason, at the beginning of the investment, the penalties for
violating the Securities Laws do not feel very threatening to the promoter or
developer. Unfortunately, when things go
wrong, it is frequently for reasons the promoters or developers did not predict
or could not control. Regardless, the
regulators or disappointed investors may seek remedies and penalties against
the LLC, and sometimes against the promoters or developers personally, for
technical filing failures that may have little to do with the reasons for the
economic situation. Unfortunately, if
rescission or penalties are sought, it usually will be when you and your LLC (“Company”) can least afford to
fulfill the demands.
4. HOW DO I SELL SECURITIES WITHOUT REGISTERING THEM WITH THE SEC?
Registering securities with the
SEC is prohibitively expensive and time consuming unless your company is ready
to become a public reporting company. For
this reason, most LLC investments are made in reliance on federal and state
exemptions from registration. You should
hire a securities attorney, well before accepting an investor’s money, to identify
the available exemptions and to prepare any necessary disclosure documents and exemption
filings. The following is a very brief
discussion of the most commonly used federal exemptions.
Regulation D - Generally. Many private
offerings of securities (i.e. “private
placements”) in the United States are done in reliance on Regulation D of the
federal Securities Laws. This is because
Regulation D (a) provides fairly bright line rules for compliance, and (b) if
an investor sues or files an administrative complaint, the investor has the
burden of proving that the Company did not comply with its rules.
A short notice, called a
Form D, must be filed with the SEC (and with each state in a Rule 506
offering), within fifteen days after the first “sale” of securities under
Regulation D. However, failure to file
on time may not affect the availability of the exemption if a good faith effort
to comply is made. Your acceptance of
subscription funds triggers the filing requirements, even though you have not
yet “closed” the offering. To avoid
timing problems, we advise have the Form D filed on the date that the offering
package is finalized.
Rule 506 Offerings. Rule 506
of Regulation D is the most popular exemption because you can raise an
unlimited amount of funds from an unlimited number of “Accredited Investors” (discussed
below) so long as:
(a)
no non-accredited
investors are accepted (unless audited financial statements and a public-company
style disclosure document are provided, in which case there can be no more than
35 non-accredited investors);
(b)
no “general
solicitation” is used to attract potential investors to the offering.
Rule 504 Offerings. If you must
include non-accredited investors in your offering (and you can’t comply with
the information and audit requirements of Rule 506), then federal Rule 504
permits you to conduct an exempt offering under the following conditions:
(a) The offering amount is no more than $1 million in any
12-month period.
(b) No more than 35 non-accredited investors are
permitted.
(c) No “general solicitation” may be used to attract
potential investors to the offering, except under very limited specified
circumstances.
Section 4(2) Offerings. If Regulation D exemptions are unavailable
for some reason, the “non-public” offering exemption found in Section 4(2)
of the federal Securities Act of 1933 (“Securities Act”), may be available. Section 4(2) permits the raising of
unlimited funds without registering the securities with the SEC. Unfortunately, Section 4(2) says only that a “transaction
not involving any public offering” is exempt from the registration requirements
of the Securities Act, leaving the requirements for the Section 4(2)
exemption uncomfortably vague and uncertain. In addition, if an investor sues or complains,
the Company, not the investor, has the burden of proving that it complied with
Section 4(2).
The case law and SEC guidance
are, not surprisingly, inconsistent. Viewed most restrictively, Section 4(2)
requires that each person to whom the securities are offered (and not just the
actual purchasers), be “sophisticated investors”, i.e. they have substantial financial means, have access to
adequate information regarding the proposed investment, and are capable of evaluating the merits of
the investment.[5] There is also an ill-defined limit (perhaps
thirty-five or fewer) on the maximum number of offerees. The greater the number of offerees over just
a handful, the more likely it is that the offering may not comply with
Section 4(2). Also, like Regulation
D, no “general solicitation” may be used to attract potential investors to the
offering.
Despite its lack of clarity,
the Section 4(2) exemption is a very useful fallback exemption where there are
a limited number of founders and/or investors who are sophisticated, or if an
intended Regulation D offering fails to qualify for some reason.
5. ARE THERE STATE REGISTRATION REQUIREMENTS?
The requirements for Rule 506
offerings, at the state level, are all the same, due to having been pre-empted
by federal law, although each state may charge a fee for filing the Form D.[6] However, offerings made under federal Rule
504 or Section 4(2) are not pre-empted by federal law, and must therefore
qualify under various state “limited offering” exemptions.
State limited offering exemptions
often contain significantly different requirements as to the maximum offering
amount, number and type of purchasers, limitations on commissions, and filing
requirements. Certain states also have
unique requirements regarding net worth, income, or sophistication standards
for investors. In addition, state exemptions
may require filing of an exemption notification either before or after
the date of first sale of the securities in the state. For example, Washington
has a Rule 504 equivalent exemption, however, no more than 20 non-accredited
investors are permitted, and the Form D must be filed at least 10 days before
the first offer or sale to a Washington resident, along with a small filing
fee.
For those reasons, before you first
make an offer (not sale) in any state, you should advise us where your
potential investor lives as soon as possible.
This will permit us to research the applicable state exemptions, make any required regulatory filings, and add
to the offering package any legends required by those state’s Securities Laws. Failure to do so may violate the state’s
Securities Laws and give the investor a right to rescission or money damages.
As part of the offering
documentation, we will prepare a state‑by‑state analysis summarizing the
requirements of each available state exemption.
You will need to confirm that you intend to make offers in no other
states, unless you let us know before doing so.
However, while the securities exemption memorandum summarizes the most
important requirements of the listed states, each state may have unique
definitions or interpretations regarding such things as what constitutes an
offer, or who is deemed to be a broker or dealer, that are not discussed. If you have any questions regarding the
requirements of any state, please contact us.
6. CAN I ADVERTISE THE OFFERING IN THE PAPER OR ON THE INTERNET?
Both Regulation D and Section
4(2) prohibit the Company, or any person acting on its behalf, from offering or
selling securities by any form of “general solicitation or general advertising.” For example, the Company cannot advertise in
the paper, engage in a mass mailing, conduct informational meetings with
potential investors, or issue a press release that discusses the existence of
the offering, until after the offering has been concluded and all sales to
investors have been finalized. A conservative interpretation of the SEC’s view
is that all potential investors should be people with whom the Company, its
directors, officers, or full-time employees have a pre-existing personal or
business relationship.
Unfortunately, that
interpretation does not come close to the reality of information flow in
today’s world. Several years ago, the
SEC begun permitting offerings conducted through the Internet, but only to
accredited investors that are qualified through a web portal, and a waiting
period expires, before receiving any information about the offering. In addition, the recently adopted federal
JOBS Act requires the SEC to adopt regulations permitting general solicitation
in offerings that are limited to accredited investors. However, these regulations are still in
proposed form and the final version is yet to be seen.
7. WHO CAN BUY THE SECURITIES?
Under federal Regulation D, securities
can be sold to an unlimited number of accredited investors but no more than 35
non-accredited investors (subject to the information requirements of Rule 506). However, in some states, the number of
non-accredited and/or total investors may be far less, depending on the
requirements of the specific exemption. The Company should require a detailed
Investor Qualification Questionnaire from each potential investor in order to reasonably
rely on proposed investors’ assertions that they are accredited.
Accredited Investors. Whether an investor is considered “accredited”
depends on the investor’s classification and whether the investor meets the
requirements for that classification.
Individuals (rather than entities) qualify as accredited investors if
they satisfy any one of the following standards: (1) have a net
worth (with their spouse) in excess of $1 million not including their
personal residence, or (2) individual income for the past two years and a
reasonable expectation of income for the current year of at least $200,000
(excluding spouse), or (3) joint income with their spouse of at least $300,000,
for the past two years and a reasonable
expectation of such income for the current year. Directors and executive officers of the
Company also are classified as accredited investors.
There are different
requirements for corporations, partnerships, trusts, and non-profit
organizations to qualify as accredited investors. Generally these entities will be accredited
investors only if: (1) all of the equity owners are accredited
investors (not available for trusts) , or (2) the entity has assets (as
distinguished from net worth) in excess of $5 million, and was not formed for
the purpose of making the investment.
Employee benefit plans are accredited investors only if: (1)
the investment decision is made by a plan fiduciary, a savings and loan
association, bank, insurance company, or registered investment advisor, (2) the
plan has total assets in excess of $5 million, or (3) a self-directed employee
benefit plan where its investment decisions are made solely by one or more
individuals who are accredited investors. Finally, an IRA benefiting an accredited investor also is an accredited
investor.
Non-Accredited but Sophisticated Investors. Investors who
do not qualify as accredited investors are referred to as a “non-accredited
investors”. Under Regulation D, you may
sell to non-accredited investors only if each non-accredited investor, either
alone or with a purchaser representative, has sufficient knowledge and
experience in financial and business matters that the potential investor is
capable of evaluating the merits and risks of the proposed investment. This is generally analogous to the “sophisticated”
investor requirements under the court rulings in connection with Section 4(2).
8. WHO CAN SELL
THE SECURITIES?
Under Securities Laws, both the
Company and any individuals involved in the selling process must either
register, or be exempt from registration, as a broker-dealer, if they receive a
commission. Broker-dealer exemptions
vary from state to state and often do not parallel federal exemptions. Therefore, even if a federal broker‑dealer
exemption is available, there may be a different or no comparable state
exemption.
In order to avoid registration as
a broker-dealer, many financial consultants will locate investors in exchange a
flat “consulting” fee, which is due whether or not the offering closes. This is not as common in real estate
investments as it is in operating companies.
Many (but not all) states
exempt issuers and their employees who sell their own securities in an exempt transaction,
provided that (a) they are not engaged in the business of effecting
transactions in securities, (b) they receive no sales compensation or
commission for their sales activities, and (c) they have substantial duties for
the Company other than the sale of its securities.
9. HOW DO I
SATISFY THE DISCLOSURE REQUIREMENTS?
Disclosure Requirements. The Securities Laws require the Company to provide all
potential investors with full, fair, and complete disclosure of all “material”
facts about the offering and the Company, its management, business, operations,
and finances. However, materiality is a
difficult concept to define precisely. Generally, information is material if a
reasonable investor would consider the information important in making an
investment decision. At a minimum a fact is “material’’ if you are reluctant to
disclose the information out of fear that if the investors know about it they
would not buy the securities.
Facts which are disclosed must
be developed fully. For example, you
cannot state that the Company owns a manufacturing facility and not disclose
that the building is uninsured, has been hit by lightning, or has been
condemned by the health department. At a
more subtle level, you cannot state that the Company owns a building and not
disclose that the property is subject to a mortgage, a fact that does not
conflict with ownership but does affect the economic value and other attributes
of real estate ownership.
For offerings that accept non-accredited
investors under Regulation D, the Company must provide substantially the same
information as required in a public offering prospectus, including audited
financial statements. However, audited
financial statements are not required if (a) the investors are required to be
accredited, or (b) the offering is being conducted under Rule 504 and certain
other conditions are met. For this
reason, most private placements under Rule 506 are limited to accredited
investors.
In all cases, the Company must
comply with the “antifraud” provisions of the Securities Laws.[7] For
securities law purposes, fraud is a much broader concept than you might think,
including omissions in disclosure (sometimes even unintentional ones) rather
than just deliberate misrepresentations.
Regardless of whether you intend to defraud an investor, you will be
liable if you fail to disclose a material fact.
For example, information related to sensitive areas such as risk
factors, conflicts of interest, source and use of funds, compensation and other
ownership and benefits to management and promoters, and other business
information must be disclosed.
Failure to comply with these provisions can result in the imposition of
money damages against the Company and potentially against its managers and any others
associated with the offering, personally.
Disclosure Documents. We provide assistance to the Company in
drafting the offering package so that it complies with the disclosure
requirements and antifraud provisions of the Securities Laws. While we assist with the drafting the offering
package, and will review and comment on the parts prepared by the Company, the accuracy
of the offering documents generally are the Company’s responsibility. You must be satisfied that the disclosures
are balanced, set forth all the material pros and cons, and take all material
facts and circumstances into consideration.
The offering package
functionally serves two purposes that are inherently in conflict with each
other. First, it may serve as a
marketing tool to sell the securities.
Because selling the securities is your primary goal, your tendency will
be to create an offering package that describes the Company in an overly
positive way. The offering package,
however, also is a document that protects you from being sued by disappointed
investors and regulators if the investment is not successful. Because protecting you is our primary goal,
our tendency will be to recommend as much disclosure to investors as possible,
even if it causes the offering package to be a less effective marketing tool.
I always encourage clients to
look at the offering package and filings under the Securities Laws as a type of
insurance policy. The role of the
offering package is to protect the Company from disgruntled investors’ claim
that they did not receive adequate information to make an investment
decision. However, the protective value of
the offering package may be damaged severely or completely destroyed if any
person involved in the selling effort makes oral or written representations
different from those in the offering package.
All sales presentations, both oral and written, should be governed by
the content and general thrust of the offering package. This includes any transmittal letters to
investors and any deal summaries provided to them. I strongly recommend that summaries
in any form, be passed by us before distribution to investors.
During the offering period, the
offering package must be amended and updated to correct any inaccurate
information, or to add any new material information that occurs with respect to
the Company’s business, management, financial condition, or other matters. When in doubt, assume the changes are
material and check with us. If the
information is material, then you must circulate a supplement to the offering package
which discloses the new or changed information.
10. WHAT
INFORMATION AND COMMITMENTS DO I NEED FROM THE INVESTORS?
The Company must have a
reasonable basis for believing that each proposed investor satisfies the
suitability standards stated in the offering package, and that the proposed investor
understands the risks of the offering. Unfortunately,
the Company generally has no way to make this determination, as that information
can be provided only by the prospective investor.
The subscription documents for
the offering generally contain an investor questionnaire designed to elicit
this information and other appropriate representations from investors. Several important elements of qualifying for
exemption from the Securities Laws (such as investor sophistication, investment
intent, and ability to bear the economic risk of an investment) depend on facts
that only the individual investor will know. The Company must ascertain and confirm these
elements. That is why there are so many seemingly intrusive and personal
questions in the subscription documents.
The Company or its attorney must carefully
review the signed subscription documents to confirm (a) that they are
completely filled out and internally consistent, and (b) that based on the investor’s
representations in the subscription documents, and the Company’s personal
knowledge of the investor, the Company has a reasonable basis for believing
that the investor is suitable either as an accredited or sophisticated
investor.
11.WHEN CAN THE INVESTOR SELL THE SECURITIES THAT THEY PURCHASED?
All securities sold in a Regulation
D offering or under Section 4(2) are “restricted” securities, meaning that
investors may not sell them without registration or another applicable
exemption. In the securities purchase documents,
the investors must represent that they (a) are purchasing the securities for
investment purposes only, and (b) understand that the securities have no resale
market and very limited transferability.
Restricted securities may not be resold for an
indefinite period of time. For persons
not closely associated with the Company that period is generally two years or
more, and for insiders it may be far longer. Generally the Company should require a selling
investor to provide an opinion from their attorney detailing the exemption upon
which they are relying, and that opinion should be reviewed by the Company’s
securities attorney.
12. WHAT OFFERING PAPER TRAIL SHOULD I CREATE?
Before the offering begins, you
should establish internal procedures and checklists that will make it easier
for you to comply with the rules concerning the conduct of the offering and the
information sent to, and received from, prospective investors. Only specifically designated persons should
distribute the offering package, each copy of which should be numbered. Copies for internal use also should be
numbered. A list of each person to whom
the offering package is sent should be maintained and should indicate whether
it is for internal use, bankers, purchaser representatives, lawyers,
accountants, or specified investors. A
file should be maintained for each potential investor containing accurate
records of correspondence, meetings, phone calls, etc., to record what
questions were asked, what additional material was provided, and what due
diligence was performed to determine each investor’s accreditation.
After the offering closes, the Company
should maintain a complete set of the offering materials, including all signed subscription
documents, as that information will be essential if the securities exemption
ever is challenged. The absence of
appropriate written records may make it impossible for the Company to defend
itself successfully against a future exemption challenge. Furthermore, the more information provided by
the investor in writing, the better able the Company will be to later defend
its exemption.
13. CONCLUSION
We know that the securities
laws can be complex and often seem overly burdensome and complex when applied
to investing in real estate. However,
the importance of doing so is clearer if you think of securities law compliance
as a form of insurance. You would not dream
of start construction without having your contractor’s bond and liability
insurance in place to protect you from unexpected events. In the same way, the time and money you spend
on obtaining good offering documents and the necessary exemption filings will
go a long ways towards protecting you from the potentially severe consequences
of a securities lawsuit or administrative action.
This is an exciting process,
and we would be pleased to assist you with it!
Eugenie Rivers - Securities / Real Estate Attorney
Rivers Business Law
Advocates Law Group
Rivers Business Law
Advocates Law Group
[1] While a number of states have now added LLC
ownership interests to their express definitions of “securities”, the federal
securities laws, and many state securities laws, do not. However, under several court-developed interpretations
of the Securities Laws, there is currently no doubt that many, if not most LLC
Interests are securities, and are therefore subject to the Securities Laws.
[2]
If for some reason it is important that the LLC
Interests in a multi-member LLC not be considered securities, the LLC Agreement
should expressly require all members to actively participate in management,
forbid the admission of passive investors in the future, and require any member
who becomes inactive to sell their LLC Interests to the Company or the active
members.
[3] Commercial real estate includes multi-family complexes
of five units or more, and construction of residential developments.
[4] This informational package can be referred to as
private placement memorandum (PPM), an offering memorandum or package, or the
disclosure documents. The required level of detail will depend on a number of
variables, including which exemptions from registration is being relied on, and
the sophistication of the potential investors.
[5]
Theoretically,
if an offer is made to even one “unsuitable” investor, i.e., an investor who is unsophisticated or without “access” to
information, the Section 4(2) exemption may be unavailable for the entire
offering. Rule 506, on the other
hand, primarily deals with actual purchasers of the offered securities, so may
still be available if a prohibited offeree does not actually purchase the
security.
[6] New York is the only state that does not comply with
the federal pre-emption of Rule 506 offerings, on the basis that it regulates
the issuing companies as broker-dealers, and not the securities being offered
in the Rule 506 offering. New York
considers the sale of interests in a real estate investment LLC to be “real
estate syndications” requiring the approval of substantial documentation and
filing fees of over $3,000 before closing the investment from even one New York
investor.
[7] The federal antifraud provisions arise primarily from
Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934,
as well as Section 12(2) of the Securities Act. These provisions
collectively prohibit any person, in connection with the purchase or sale of
any security, from misrepresenting or omitting a material fact or engaging in
any act or practice that constitutes a “fraud” or deceit upon any other person.
