This talk describes the various pitfalls and sources of securities law, corporate law, fraud, and other liability crowdfunding project sponsors and their advisors may suffer. FIRA guidelines for private offerings are mentioned, as are other ways to provide full disclosure and avoid liability.

1. Related Liability With A
Crowdfunded Offering
William A. Price
Attorney at Law
Growthlaw.com
1-800-630-4780

2. What Does The Law Mean?
“A man who cares nothing for an ethical
rule which is believed and practised by his
neighbors is likely nevertheless to care a good
deal to avoid being made to pay money, and will
want to keep out of jail if he can.”
-- Oliver Wendell Holmes, Jr. “The Path of
the Law”, 10 Harvard Law Review 457 (1897)

3. LIABILITY OF ISSUERS AND
AFFILIATED PERSONS

4. 17 CFR § 240.10b-5 Employment of manipulative and deceptive
devices.
It shall be unlawful for any person, directly or indirectly, by the
use of any means or instrumentality of interstate commerce, or
of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
(Sec. 10; 48 Stat. 891; 15 U.S.C. 78j)

5. 815 ILCS 5/12 Violation.
It shall be a violation of the provisions of this Act for any person:
G. To obtain money or property through the sale of securities by
means of any untrue statement of a material fact or any
omission to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which
they were made, not misleading.
H. To sign or circulate any statement, prospectus, or other paper
or document required by any provision of this Act or pertaining
to any security knowing or having reasonable grounds to know
any material representation therein contained to be false or
untrue.
I. To employ any device, scheme or artifice to defraud in
connection with the sale or purchase of any security, directly or
indirectly.

6. “Plaintiffs' Counts VI, VII, VIII, and X are based on subsections (F),
(G), (I), and (J), respectively of § 12 of the Illinois Securities Law.
Subsections (F), (G), and (I) largely mirror the fraud provisions
of the federal Rule 10b-5, compare 815 Ill. Comp. Stat. § 5/12(F),
(G), (I) and 17 C.F.R. § 240.10b-5”
-- Gandhi v. Sitara Capital Mgmt. LLC, 689 F. Supp.2d 1004, at
1013 (N.D. Ill., 2010)

7. What The SEC Must Prove In A 10b-5
Case
(i) Manipulation or Deception (through
misrepresentation and/or omission);
(ii) Materiality;
(iii) "In Connection With" the purchase or sale of
securities, and
(iv) Scienter.

8. What Private Plaintiffs Must Also Prove
In A 105-5 Case
(v) Standing - Purchaser/Seller Requirement;
(vi) Reliance (presumed if there was an omission
of a material fact);
(vii) Loss Causation; and
(viii) Damages.

9. State Statute: Burden Of Proof On
Defendant
“…Certain blue sky laws do not require the
plaintiff to prove scienter. They place the burden
upon the defendant to establish lack of
knowledge as an affirmative defense…”
-- In re Nat'l Century Fin. Enters., Inc., Inv. Litig.,
846 F.Supp.2d 828, at 888 (S.D. Ohio, 2012)

10. Control Persons: Section 20(a) provides as follows:
“Every person who, directly or indirectly, controls any person liable
under any provision of this title or of any rule or regulation thereunder
shall also be liable jointly and severally with and to the same extent
as such controlled person to any person to whom such controlled
person is liable, unless the controlling person acted in good faith and
did not directly or indirectly induce the act or acts constituting the
violation or cause of action. 15 U.S.C. § 78t(a) (1988). To establish
control person liability, a plaintiff must show that the defendant has
"the practical ability to direct the actions of the people who issue or
sell the securities." Barker v. Henderson, Franklin, Starnes & Holt, 797
F.2d 490, 494 (7th Cir.1986).”
-- Donohoe v. Consolidated Operating & Production Corp., 982 F.2d
1130, at p. 1138 (C.A.7 (Ill.), 1992)

11. First SEC Crowdfunding Action
See http://Ascenergy LLC et al. (Release No. LR-
23394; October 28, 2015):
• Ascenergy raised $5 million from 90 investors
via crowdfunding.com, equitynet.com,
fundable.com and angel.com
• Routine fraud: raised money for oil leases
when none had been secured
• Portals were not named defendants

12. LIABILITY ISSUES FOR FUNDRAISING
PORTALS AND AFFILIATED INDIVIDUALS

13. “Securities Act Section 4A(a)(1)
requires that each intermediary in a
crowdfunding transaction be
registered with the Commission either
as a broker-dealer or a funding portal.”
-
https://www.sec.gov/divisions/market
reg/tmcompliance/fpregistrationguide
.htm

14. A registered funding portal is prohibited from:
Offering investment advice or recommendations;
Soliciting purchases, sales or offers to buy the securities
displayed on its platform;
Compensating employees, agents, or other persons for
such solicitation or based on the sale of securities
displayed or referenced on its platform; or
Holding, managing, possessing, or handling investor
funds or securities.
--
https://www.sec.gov/divisions/marketreg/tmcomplian
ce/fpregistrationguide.htm

15. SEC Fundraising Portal Rules
• Official Release (Review in detail, if you have a
client): https://www.sec.gov/rules/final/2015/33-
9974.pdf
• Implements Title III of the Jumpstart Our Business
Startup (“JOBS”) Act, which added Sections
4(a)(6) and 4A to the Securities Act and Sections
3(h) and 12(g)(6) to the Securities Exchange Act
of 1934 (“Exchange Act”).

16. Investment Advisers Law (1940), 15 USC 80b-1 through 80b-21,
generally applies to anyone who:
“[E]ngage[s] in the business of advising others. . . .as to the value
of securities or as to the advisability of investing in securities. . ..”
or “[I]ssues or promulgates analyses or reports concerning
securities.”
-- IAA 1940 Section 202(a)(11)
-- No caselaw yet on portals as advisers

17. 815 ILCS 5/12 (J) When acting as an investment
adviser, investment adviser representative, or federal
covered investment adviser, by any means or
instrumentality, directly or indirectly:
(1) To employ any device, scheme or artifice to
defraud any client or prospective client;
(2) To engage in any transaction, practice, or course of
business which operates as a fraud or deceit upon any
client or prospective client; or
(3) To engage in any act, practice, or course of
business which is fraudulent, deceptive or
manipulative.

18. FINRA Rules
• SEC Approved new FINRA Rules for Fundraising
Portals,
https://www.sec.gov/rules/sro/finra/2016/34-
76970.pdf
• FINRA has details on its website:
http://www.finra.org/industry/about-funding-
portals
• Rules text as proposed is at
http://www.finra.org/sites/default/files/NoticeAt
tachment/p369763.pdf

19. BEST PRACTICES AND HOW TO
AVOID LIABILITY

20. Broker-Dealer Status
• FINRA limited BD status as portal encouraged
• Fraud Issues Are Similar: JOBS Act does not
provide different liability protection or
standard for limited BD’s: Anti-Fraud Rules
Apply
• FINRA Regulations text for portals is at
http://www.finra.org/sites/default/files/Notic
eAttachment/p369763.pdf

21. FINRA Rule 200: Portal
Communications
• (2) Content Standards
• (A) No funding portal communication may:
• (i) include any false, exaggerated, unwarranted, promissory or misleading
statement or claim;
• (ii) omit any material fact or qualification if the omission, in light of the
context of the material presented, would cause the communication to be
misleading;
• (iii) state or imply that FINRA, or any other corporate name or facility
owned by FINRA, or any other regulatory organization endorses,
indemnifies, or guarantees the funding portal member’s business
practices; or
• (iv) predict or project performance, imply that past performance will recur
or make any exaggerated or unwarranted claim, opinion or forecast. A
hypothetical illustration of mathematical principles is permitted, provided
that it does not predict or project the performance of an investment or
investment strategy.

22. FINRA Rule 200: Portal
Communications (II)
(B) All funding portal member communications must be
based on principles of fair dealing and good faith, must
be fair and balanced, and must provide a sound basis for
evaluating the facts in regard to any particular security or
type of security, industry, or service.
(C) All funding portal member communications must
prominently disclose the name of the funding portal
member, or the name under which the funding portal
member primarily conducts business as disclosed on the
member’s Form FP-NMA.

23. FINRA Rule 200 : Issuer
Communications
(3) Issuer Communications
The content standards of paragraphs (c)(2)(A) and (B) of
this Rule shall not apply to any communication on the
funding portal member’s website that is prepared solely
by an issuer; provided, however, that no funding portal
member may include on its website any issuer
communication that the funding portal member knows or
has reason to know contains any untrue statement of a
material fact or is otherwise false or misleading.

24. Due Diligence And Suitability
Standards
• Broker-Dealers are obligated to conduct due
diligence on Regulation D Private Placements
Which They Recommend:
https://www.finra.org/industry/notices/10-22
• The recommended security must also be
suitable in type and quantity for the specific
customer, and the BD must have a reasonable
basis to believe it is suitable for at least some
customers

25. FINRA BD Due Diligence Requires
Reasonable Investigation Of:
• „The issuer and its management.
• „The business prospects of the issuer.
• „The assets held by or to be acquired by the
issuer„
• The claims being made in the private
placement memorandum (PPM) or other
offering document.
• „The intended use of the proceeds of the
offering.

26. Additional Due Diligence Under FINRA
Notice 10-22 (I)
• Affiliation with the Issuer: If the Portal is
affiliated, this must be disclosed, and
insider/control person standards may apply
• Representations in the PPM: Check FINRA Rules
2010 and 2210, but cf Janus Capital Group, Inc. v.
First Derivative Traders, 131 S. Ct. 2296 (June 13,
2011) that only the "maker" of a statement, and
not those who simply helped prepare and publish
the statement, can be primarily liable

27. Additional Due Diligence Under FINRA
Notice 10-22 (II)
• Red Flags: Additional investigation required if
initial due diligence or client statements reveal
any information that would alert a prudent
person to conduct a further inquiry which is
substantial adverse information about the
issuer.
• Reliance on counsel or other experts: Check
their qualifications and scope of work

28. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer and Management (I)
➤ Examining the issuer’s governing documents, including any
charter, bylaws and partnership agreement, noting particularly
the amount of its authorized stock and any restriction on its
activities. If the issuer is a corporation, a BD might determine
whether it has perpetual existence.
➤ Examining historical financial statements of the issuer and its
affiliates, with particular focus, if available, on financial
statements that have been audited by an independent certified
public accountant and auditor letters to management.
➤ Looking for any trends indicated by the financial statements.

29. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer and Management (I)
➤ Inquiring about the business of affiliates of the issuer and the
extent to which any cash needs or other expectations for the
affiliate might affect the business prospects of the issuer.
➤ Inquiring about internal audit controls of the issuer.
➤ Contacting customers and suppliers regarding their dealing
with the issuer.
➤ Reviewing the issuer’s contracts, leases, mortgages, financing
arrangements, contractual arrangements between the issuer and
its management, employment agreements and stock option
plans.

30. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer and Management (III)
➤ Inquiring about past securities offerings by the issuer and the
degree of their success while keeping in mind that simply
because a certain product or sponsor historically met obligations
to investors, there are no guarantees that it will continue to do
so, particularly if the issuer has been dependent on continuously
raising new capital. This inquiry could be especially important for
any blind pool or blank-check offering.
➤ Inquiring about pending litigation of the issuer or its affiliates.
➤ Inquiring about previous or potential regulatory or
disciplinary problems of the issuer. A BD might make a credit
check of the issuer.

31. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer and Management (IV)
➤ Making reasonable inquiries concerning the issuer’s
management. A BD might inquire about such issues as the
expertise of management for the issuer’s business and the
extent to which management has changed or is expected to
change. For example, a BD might inquire about any regulatory or
disciplinary history on the part of management and any loans or
other transactions between the issuer or its affiliates and
members of management that might be inappropriate or might
otherwise affect the issuer’s business.

32. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer and Management (V)
➤ Inquiring about the forms and amount of management
compensation, who determines the compensation and the
extent to which the forms of compensation could present
serious conflicts of interest. A BD might make similar inquiries
concerning the qualifications and integrity of any board of
directors or similar body of the issuer.
➤ Inquiring about the length of time that the issuer has been in
business and whether the focus of its business is expected to
change.

33. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer’s Business Prospects (I)
➤ Inquiring about the viability of any patent or other intellectual
property rights held by the issuer.
➤ Inquiring about the industry in which the issuer conducts its
business, the prospects for that industry, any existing or
potential regulatory restrictions on that business and the
competitive position of the issuer.

34. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer’s Business Prospects (II)
➤ Requesting any business plan, business model or other
description of the business intentions of the issuer and its
management and their expectations for the business, and
analyzing management’s assumptions upon which any business
forecast is based. A BD might test models with information from
representative assets to validate projected returns, break-even
points and similar information provided to investors.

35. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer’s Business Prospects (III)
➤ Requesting financial models used to generate projections or
targeted returns.
➤ Maintaining in the BD’s files a summary of the analysis that
was performed on financial models provided by the issuer that
detail the results of any stress test performed on the issuer’s
assumptions and projections.

36. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer’s Assets (I)
➤ Visiting and inspecting a sample of the issuer’s
assets and facilities to determine whether the value of
assets reflected in the financial statements is
reasonable and that management’s assertions
concerning the condition of the issuer’s physical
plants and the adequacy of its equipment are accurate.

37. Industry Best Practices For Due
Diligence Under FINRA Notice 10-22:
Issuer’s Assets (II)
➤ Carefully examining any geological, land use,
engineering or other reports by third-party experts that
may raise red flags.
➤ Obtaining, with respect to energy development and
exploration programs, expert opinions from engineers,
geologists and others are necessary as a basis for
determining the suitability of the investment prior to
recommending the security to investors.

38. DIFFERENCES BETWEEN SEC, FINRA,
AND JUDICIAL RELIEF

39. SEC/State Securities Department Relief
• Agency does not have to prove standing and
damages
• Agency (like state agency) has less time and
resources for investigation than private
parties: attention to big cases
• Agency may seek civil or criminal prosecution
for securities fraud
• Agency, like private parties in federal suits,
must prove fraud was intentional

40. FINRA Relief
• FINRA relief may be available against persons
involved in selling private placements
• FINRA rules reference and elaborate on SEC
rules and legal standards
• Restitution of customer funds invested a
primary remedy
• FINRA rules for complaints and proceedings
before FINRA apply

41. Judicial Relief
• New private securities litigation legal
requirements for standing to sue in federal
court
• Punitive damages possible for fraud
• Contract actions possible counts
• State counts may be easier to prove than
federal scienter

42. Illinois Securities Act Voidability
• 815 ILCS 5/13 makes fraudulent sale voidable,
with 10% interest plus refund to purchaser
• Notice within 6 months of purchaser knowledge
of voidability is required: this means 1) the date
upon which the party bringing the action has
actual knowledge of the alleged violation of this
Act; or (2) the date upon which the party bringing
the action has notice of facts which in the
exercise of reasonable diligence would lead to
actual knowledge of the alleged violation of this
Act.

43. Any Questions?
William A. Price
Attorney at Law
www.growthlaw.com
Tel/Fax 1-800-630-4780
Email: wprice@growthlaw.com