SEC Takes Action Because Issuer Did Not Effect A Public Offering

Until the addition of paragraph (c) to Rule 506 three years ago, securities lawyers spent a lot of time advising their clients on how to avoid a public offering of their securities.  Thus, I found it somewhat ironic to read that the Securities and Exchange Commission had taken enforcement action against a California lawyer for not conducting a public offering.

According to the SEC's order, the lawyer or intermediaries acting at his direction, solicited straw shareholders who provided funds or, sometimes, only the use of their names, for subscriptions of stock in the IPOs.  In fact, no public offering actually took place because the lawyer retained control over most of the issued shares.  The SEC found that the lawyer's conduct constituted a willful violation of Sections 17(a)(2) and (3) of the Securities Act, which prohibit fraudulent conduct in the offer and sale of securities, and within the meaning of Section 4C(a)(3) of the Exchange Act and Rule 102(e)(iii) of the Commission’s Rules of Practice.  There are a lot of details in the order and it is worth a read.

This lawyer was no Horatius

The SEC's press release is entitled "SEC Charges Gatekeepers in Microcap Frauds".  However, it appears that the lawyer was the gate, not the keeper.  According to the SEC, the lawyer not only participated in but directed the scheme.  Notably, the SEC doesn't examine its own role as gatekeeper.  The SEC reviewed, commented on, and declared effective the allegedly false and misleading registration statements.  While I don't necessarily expect the SEC's review process to uncover schemes such as these, the case does raise some questions that are worth asking:

  • If the SEC's review process can't detect fraud, how does it provide meaningful investor protection?
  • What are the benefits of SEC review?
  • Could the SEC's review process have performed better?