Recent Activities of the Alabama Securities Commission in Connection with Private Offerings

Posted on March 24, 2010


With the capital markets in decline, securities fraud is on the rise. In particular, I have noticed an uptick in enforcement actions by the Alabama Securities Commission [ASC] related to small businesses.  This is not surprising as this had been mentioned as a target area for enforcement.  Indeed, a good deal of fraud exists in this area.  What I believe is noteworthy is that the ASC is targeting what appear to be actual existing, operating businesses.  As opposed to financial schemes in which the only business is the ponzi scheme itself, several actions have targeted companies with an underlying  business.  Supporters and promoters of the business may have made misrepresentations or may have sold stock without proper registration, but underlying the sale is an actual business.

For the small business owner, this trend underscores the caution that one needs to have in raising funds for a venture.  With commercial loans increasingly difficult to arrange, business owners are seeking alternative fundraising strategies including equity and debt raises from friends and family members.  Such strategies are often essential for a new business.  However, such sales of stock raise serious issues, such as securities law compliance and corporate governance best practices.  These issues are much easier to deal with on the front end as opposed to trying to solve it after the sale is made (and the money perhaps already spent).  From my vantage point, I believe it essential that both the company and the shareholders clearly understand prior to investing  so that they can weigh that risk (complete investment loss) with the reward (hopefully tremendous financial gain).

One trend that I have noticed in the enforcement actions is an increase in enforcement actions on small (under 10) shareholders.  These small investment transactions are rife with fraud. However, it’s the small friends and family transactions that provide the capital fuel for several good business.

As I reviewed some of the most resent ASC  enforcement actions, a concern that I had was the reliance by the ASC on the failure of companies to have a ‘perfected exemption.’  Of particular concern was that this term was applied in situations with seemingly less than 10 investors. In my opinion (and I believe the bulk of practitioners), the less than 10 exemption  is self-executing.  Nothing is required to be filed.  If this interpretation is inaccurate, then the burden placed on incorporators is substantially higher than is now being practiced, and the Alabama Securities Commission should clarify their position.

I suspect that fraud is the primary, if not only, part behind these orders. These small business investments can be rife with fraud. The cases of late, in which the ASC is the plaintiff, seem to fall into some new, and sometimes gray, territory and there is an emphasis with technical compliance grounds. Unless the rules with respect to small under 10 investors are crystal clear, pursuing companies on technical compliance issues could be a large impediment to entrepreneurial ventures. Some recent enforcement actions highlight this point:

1. In the matter of Carina Technology and Magna Vista Group, this action involved an unregistered broker making an unregistered sale of stock.  The securities commission action alleges that the principles of one company took proceeds as commission from the investement into another company for which they were also principles. This payment violated the requirements of registering as a broker/dealer.

Take away: A gray area has always existed as to whether business consultants, business brokers and other transactional professionals, who are not licensed and acting as licensed brokers when they take payment upon closing. Are these legitimate consulting fees or prohibited commissions? The SEC has increased enforcement in this area and this action indicates that this issue is on the radar of the Alabama Securities Commission.

2. In the matter of  Envizions Computer Entertainment Corporation. In a suit filed against Envizions Computer Entertainment Corporation, the action involved the sale of promissory notes. The ASC claimed that the company took promissory notes from 53 investors, while only 46 –being friends and family members—“were qualified to receive rescission.” Envizions then offered rescission offers to the 46 qualified investors, of which 35 were not interested and chose to stay with the company. Eleven (out of 46) individuals accepted rescission. Envizions chose to resolve the matter as quickly as possible and quickly made efforts to follow all ASC rules.

Take away: (1) Promissory notes can be securities, this is by statute; (2) cooperation with the ASC can help; (3) even potentially profitable operating companies (remember 35 out of 46 investors stayed in) ar e subject to securities laws. .

3. In the matter of CBS Homes of Alabama and James Antonic. This action  involves failing to register securities and failing to register as a broker.  CBS Homes is a Florida-based company that attempted to fundraise and make stock arrangements with an Alabama individual. CBS and James Antonic offered stock in a company as partial payment for a Lowndes County land deal. Although a ppm was issued, no Form D was filed with the SEC now was the exemption perfected in Alabama. The principal was not registered.

Take away: (1) A sale of a security in one state subjects you to that state’s security law; (2) completing a PPM is good, filing the Form D and state filings are also required.; (3) failure to register the securities can allow a principle of the issuer to fall into the dealer definition and subject the individual to securities laws.

4. In the matter of Helping Hands Development, Inc. The company sold one investment contract to a Michigan investor. As any investment contract represents a security, the ASCdetermined this action was unlawful because the particular security was not registered. A cease and desist order was issued to keep Helping Hands from “further offers or sales of any security into, within or from the state of Alabama.”

Take away: (1) One investment is all it takes; (2) a sale from Alabama to a Michigan resident still subjects you to the jurisdiction of the Alabama Securities Commission.