Alabama Securites Commission Update

Posted on October 6, 2010


Following up on our earlier post of recent Alabama Securities Commission administrative action, the recent Cease and Desist Order In the Matter of HP Technology, Inc. and Kevin David Palm caught my attention.  According to the order, Mr. Palm and his company, HP Technology, convinced an individual to invest $30,000 in his company. Although it is a little difficult to tell from the facts, apparently $23,500 of the investment was debt capital and $6,500 was an equity investment.

As evidenced by the administrative decision, the investment did not go well.  Although $21,525 did go toward the purchase of a milling machine, the rest of the funds (presumably of the entire investment, i.e. $8,475) were “utilized for various and sundry personal living expenses.”  Left unclear is what these sundry expenses were, but nonetheless this must have been an extremely flagrant pocketing of the proceeds.  Additionally, although unclear, we must presume that the milling machine, while purchased, was largely underutilized and unprofitable.  We can make these conclusions because a little over a year after the investment, the Madison County Sheriff’s Department is requesting the Alabama Securities Commission assistance.

The ASC responds by issuing a Cease and Desist Order on the following grounds:

1)      Palm is an “agent” of the company under Alabama Code Section 8-6-2(2) and “acted as an agent of HPT as it pertains to the sale of HPT stock and the issuance of the Promissory Note. [I do not have an issue with this assertion per se, but see #5.];

2)      Palm “sold” a security under Alabama Code Section 8-6-1(8).

3)      The Note and the stock certificate represent a security under Alabama Code Section 8-6-2(10).

4)      By acting as an agent of the company without being registered with the Commission, Palm violated Alabama Code Section 8-6-3(a).

5)      Palm issued and sold securities that were not exempt under Alabama Code Section 8-6-10 or 8-6-11 or “registered under this article,” thereby violating Alabama Code Section 8-6-4.   [Upon this assertion, the entire legal argument rests, and I have an issue with this assertion, without additional facts (not present in the administrative order).]

This case is another example of a potential problem with enforcement of the Alabama Securities Act under the Code of Alabama of Alabama Code Section  with respect to “unperfected exemption”.  As background let me provide the Alabama Code Section upon which I believe that this transaction should have been exempted from registration.  Alabama Code Section 8-6-11 (a)(9) reads in its entirety:

(9) Any transaction which is part of an issue of which there are no more than 10 purchasers (other than those designated in subdivision (a)(8) of this section); wherever located, of securities from the issuer during any period of 12 consecutive months if:

a. The issuer reasonably believes that all the buyers are purchasing for investment and not with a view to distribution, and such issuer exercises reasonable care to assure this investment intent, which reasonable care shall be presumed if the following conditions are satisfied:

1. Reasonable inquiry to determine if the purchaser is acquiring the securities for himself or for other persons;

2. Written disclosure to each purchaser prior to sale that the securities have not been registered under the act and, therefore, cannot be resold unless they are registered under the act or unless an exemption from registration is available;

3. Placement of a legend on the certificate or other document that evidences the securities stating that the securities have not been registered under the act and setting forth or referring to the restrictions on transferability and sale of the securities; and

b. No commission or other remuneration is paid or given directly or indirectly for soliciting any prospective buyer; and

c. No public advertising or general solicitation is used in connection with the issue of which the transaction in reliance on this exemption is a part.

Sections 8-6-3 through 8-6-9 shall not apply to any offer made pursuant to this subdivision (a)(9) in which no sale results.

But the Securities Commission may by rule or order, as to any security or transaction or any type of security or transaction, withdraw or further condition this exemption or decrease or increase the number of purchasers permitted, or waive the conditions in paragraphs a. and b. of this subdivision (9) with or without the substitution of a limitation on remuneration.

I also note the language the interpretive comment which suggests that the Securities Commission believes that the statutory exemption is a stand alone exemption.

830-X-6-.11 Limited Offering Exemption.

830-X-6-.12 Further Limited Offering Exemption.

INTERPRETIVE COMMENT: In response to some questions, it should be understood that this transactional exemption is an expansion of, and an alternative to, the statutory exemption found in Code of Ala. 1975, §8-6-11(a)(9).

Based on the statute and the position in the regulations taken by the ASC, I do not see how the facts presented in the case violate 8-6-11(a)(9).  There is no indication of any more individuals or parties involved than the investor and the company, which puts the investment clearly under ten investors.  Conceivably, they have found one of the other requirements lacking, but the administrative order does not explicitly reference how those requirements were violated.  Additionally, I would argue that unless they were flagrantly violated, the other requirements were more technicalities than real transgressions.

Again, I see the ASC relying on technicalities in the pursuit of fraud. The problem with this is now every company who takes an investment must hire a competent attorney who understands this problem.  The transaction cost of these friends and family deals has gone up.  Additionally, I have a belief that in these situations (mind you we are talking about relatively sophisticated parties) that the parties involved are the best decision makers, and the government’s role should be limited.  If it is illegal fraud, then let them prove illegal fraud.

Please be mindful that I am not in any way defending the rights of the fraudsters.  The lack of respect that people have when they are using other people’s money is frightening, and in my opinion, a core contributor (by many parties) to the Great Recession of 2008 and beyond.  A person who does not use his or her best efforts to return capital is shameful.  I am also mindful that additional regulation is part of the new reality.

However, in this era of new regulation, we need to be careful of regulation that impedes entrepreneurship.  Friends and family investment is a crucial aspect of fundraising for most start-ups and cannot be so restricted as to stifle the growth of small business and new companies.

Mike Goodrich
Goodrich Law Firm, LLC