Home Featured Story How to Protect Yourself from Potential Risks

How to Protect Yourself from Potential Risks


WeigelCoverSecurities Attorney Russell Weigel talks with Opportunist’s Managing Editor Leslie Stone about his new book, Capital For Keeps, and why it’s so important for people raising capital to know how to protect themselves from potential risks.

Russell Weigel has spent nearly a quarter of a century litigating securities cases and counseling entrepreneurs. As president of Russell C. Weigel, III, P.A, he advises public and private company clients on capital raising transactions, preparing their SEC reports and registration statement filings, taking companies public, defending corporate executives and financial professionals involved in shareholder/investor corporate litigation and securities litigation claims, securities arbitration, and SEC and state securities enforcement matters.

Weigel’s new book, Capital For Keeps: Limit Litigation Risk While Raising Capital, has been praised by Hon. Arthur Levitt Jr., former chairman of the U.S. Securities and Exchange Commission as “valuable for capital raisers and boards of directors as they try to follow complex regulations to avoid the risk of litigation.”

“My book is a tool to assist executives and entrepreneurs, and I think of it as a contribution to society—to basically let people know this is the society we now live in,” Weigel explains. “There are plenty of books on how to find investors and raise capital, but I’m not aware of any other resource out there like this that tells people about the risks they face and the planning considerations they might want to have before they step into those waters. Most business people doing a capital raise get an education from their lawyers about what they can and cannot do. I tried to explain it in layman’s terms, to educate people on what I think the obvious planning considerations are, and also to show them examples of what can go wrong if you don’t stick to the literal letter of the law. Most people who are contemplating a capital raise really have no idea of the risks, so I also wanted it to serve as a warning.”

Opportunist: You have mentioned a so-called ‘perfect storm’ that exists in our society, which makes it easy for people to unwittingly raise capital without being fully knowledgeable of the risks. What are the elements of this ‘perfect storm?’

Russell Weigel: What I meant by ‘perfect storm’ was a set of conditions that our society is in at this moment. One is the convenience of social media mechanisms and other low-cost electronic communications media, which make information readily available and enable a large portion of society to communicate instantly to the entire electronic world. Anybody with a cell phone can tweet to 500 million people about their interest in soliciting investors for their corporate endeavor and, because it can be done so quickly and automatically, the danger is that there won’t be any meaningful review or thought put into the consequences of that communication being disseminated.

Another condition is the fact that the Great Recession caused a lot of people to be unemployed and in need of finding jobs and creating an income source. It’s my perception that a large number of folks started their own business in this environment or became self-employed, and those who thought it prudent to seek capital funding quickly found that traditional capital sources such as banks weren’t lending. So the next available opportunity or potential source was simply to look for investors. That is where the problem exists, ultimately, because people turn to investors when they cannot turn to traditional sources. This is the area that brings the investor protection-oriented securities laws into the process. That’s really the second and third angle of the storm wrapped into one. Lots of unemployment caused people to start creating lots of small businesses or startups and, ultimately, to seek capital when traditional means weren’t available. This exposes these folks, who likely aren’t trained in compliance and securities laws considerations, to reach out and seek funding from investors. That’s where the danger is.

Opportunist: What kind of mistakes do people typically make?

Russell Weigel: The trouble usually starts with one investor deciding that he or she wants his or her investment money back. Rightly or wrongly—no matter what they might have represented when they made their investment—some investors simply decide they need the cash. Maybe an unplanned need arises or they’re unhappy with the company’s progress or performance and fear losing their investment. They can easily turn to the securities laws, which have many regulations about how things must be done, and look for ways in which the company didn’t comply. They usually do that with the benefit of plaintiff’s counsel, who will try to find some regulation that wasn’t complied with—and that alone can be the straw that breaks the company’s back.

Opportunist: How so?

Russell Weigel: If the company didn’t comply precisely with the registration exemption regulations, for example, that situation may give the investor a rescission right. Many suits or threats of suits also allege that the company somehow misinformed the investor or defrauded the investor, and when these suits are filed, they are public record. This, of course, can cause a snowball effect with the potential for the investors or plaintiff’s attorneys to complain to regulators. Others may complain to news media, and regulators read the news. That is where the reputational damage issue becomes apparent.

Reputational damage is one of the utmost concerns. To borrow one example, I had a client who suffered from a press release about an SEC suit brought against him because one of his neighbors saw it, made copies and put one in everybody’s mailbox in my client’s neighborhood and brought it up at a homeowner’s association meeting. Publicity and all kinds of social and business consequences happen from these situations.

Opportunist: That sounds like a witch-hunt.

Russell Weigel: Probably every defense attorney and regulatory attorney would agree with those words. That’s the way it’s often perceived by defense counsels, due to how things are done by government. But it’s not just government—it’s investors too, in their zeal to recover their money, who often throw bigger rocks than they need to in an effort to get results. As in any other circumstance where somebody is unhappy with somebody else and decides to sue, the leverage they may apply to get faster results typically includes letting the media know or complaining to regulators in the hopes of forcing the other side into capitulating. That can have unintended consequences, however, because government may start investigations. Although the government may sue or indict executives, investors may never receive remuneration and the defendant, obviously, is financially and reputationally destroyed. Those are the realities.

Once such allegations are unleashed into the Internet, they never really go away. That’s kind of how problems typically start for companies. Even if a company does everything right, an investor lawsuit can happen just as it can to anyone who is otherwise running a good business can be sued by a customer who said they slipped and fell within the business’ premises. Laws are designed to be pro-investor and anti-issuer or anti-company.

To give another example, certain federal and state securities statutes will sustain liability based on a claim of negligent conduct—and the statutes refer to negligent representation as being fraud. Fraud is commonly thought of as an intentional act, but in the securities laws it can also be a negligent, unintentional act. It’s very easy for a plaintiff to sustain a claim of liability against the executives involved using a negligence-based standard, but also damaging is that the executives are often referred to as ‘fraudsters’ because negligent conduct is labeled as fraud under the securities statutes.

Opportunist: Doesn’t an LLC, limited liability corporation, protect the individual?

WeigelBookCoverRussell Weigel: Even with an LLC, investors and regulators can still go after the individual executives. There is no corporate veil of protection under the securities laws—at all. The government, whether it’s the SEC or Dept. of Justice, will almost always charge executives individually whether or not the company is charged or indicted. Investors can do the same.

Private companies do and will have their corporate veils pierced by the individual responsibility statutes in the securities laws. People assume that because they have a corporation they are insulated from liability but there is no corporate protection to hide behind. The truth is that executives are legally insulated from liability only for contractual transactions; they are not insulated from so-called tort claims. Securities laws are statutory tort claims. What that means is, similar to a situation where people can sue their doctor individually for medical malpractice, investors have the ability under the securities laws to sue for a personal liability. The difference with a medical malpractice case and an investment recovery case is that the issue is about the investment and not whether somebody left a sponge inside a patient during a surgery.

Opportunist: How does the government pursue people?

Russell Weigel: From my enforcement background, particularly now that I see it from the defense side, the way the government goes about pursuing people is really no different from the way a private investor does it. The difference is that the government has an unlimited war chest. Most companies in the position of having to raise capital from investors are doing so because they need the money and lack self-funding. They don’t have the financial resources to fight back or withstand a lengthy government inquiry, and certainly not litigation. So the ultimate problem becomes not just that your personal life is being scrutinized by an unforgiving government system but also that the government’s modus operandi is one that essentially ensures your personal financial destruction if it can conclude that you did something wrong.

Opportunist: That sounds terrifying.

Russell Weigel: Whenever the government sues somebody, typically it sends press releases to the news media announcing who was charged with fraud. As defense attorneys we know there are two sides to every story, but the public believes what they read. Most people aren’t set up to have a press campaign on equal footing with the one the government has rolling along continuously. Also, the government never takes down its press releases from the Internet whether it wins or loses a case. We have a problematic system out there. It’s not unique to the SEC—it’s really the whole federal government, and most state governments also operate that way. No rules require fair and full disclosure by the agencies themselves, but the laws enforced by the government require full and fair disclosure by capital raisers.

Opportunist: Crowdfunding has become quite popular in recent years. Are there risks involved to that as well?

Russell Weigel: Absolutely, but in crowdfunding there are different kinds of risks. The crowdfunding that people are most often talking about is the Kickstarter style, which is more of a commercial endeavor where people are buying a product—whether a prototype or a finished product—and getting something in return that is not investment related. It’s known as a donation-solicitation model, which is legal and has gone on forever. The investment style of crowdfunding, however, is not legal in the United States today. We are still awaiting SEC approval. Until the SEC acts and finalizes the crowdfunding rules, crowdfunding for investments is presently still illegal.

There is another kind of crowdfunding, however, that is legal and it is investment related. It is part of the JOBS [Jump-start Our Business Startups] Act of 2012, which is where all the crowdfunding noise started. The JOBS Act had seven titles, one of which allowed a change to Rule 506 under Regulation D, permitting solicitation in advertising for private offerings. That was a gigantic change to the securities laws and it went into effect in September 2013. People are now calling that rule change ‘crowdfunding.’

The JOBS Act also contains a literal title called ‘crowdfunding,’(Title III) but it’s the one which is not legal yet. It permits companies to raise up to $1 million from investors with less than $100,000 annual income, and it allows general solicitation for investment funding. Therefore, you can take up to $2,500 from almost anybody. That model, known as Title III, has not yet gone into effect—the model that did go into effect and is now being termed ‘crowdfunding’ is only available to accredited investors (i.e., those investors having at least $1 million in liquid assets or at least $200,000 in annual income).

Opportunist: Do you believe rulings from Title III will eventually come into effect and enable unaccredited investors to participate?

Russell Weigel: Yes, I think so. The SEC published proposed crowdfunding rules about a year ago but has not finalized them. They are obligated, and ordered by Congress, to complete the job, and I believe that it will happen.

Opportunist: How are the guidelines for raising capital as a private entity different than those a publicly traded company must adhere to?

Russell Weigel: Public company rules are very well spelled out, whereas private offering rules give great latitude. But, at the end of the day, the rules really are the same for both. A public company must make sure it fully and fairly reveals all material facts about its business and its capital raise offerings. Private companies have latitude to determine the level of detail they want to give their select investor audience. The level of detail can theoretically be scaled based on the relative sophistication of the investor audience. Public companies have a one-size-fits-all regime, for the most part. There are differences between bigger and smaller companies within those rules, but a public company must disclose details all the time because it is publicizing information to the general public and that includes unaccredited investors, i.e. those not meeting the definition of an accredited investor.

Private offerings have the discretionary ability to scale the information and its delivery because capital raisers may not be making an offering to the general public. The broader the distribution of a company’s capital raise offering and the more strangers potentially being enticed to invest in your company, the more public company rules become relevant to your private company offering. And the fraud liability statutes apply to both public and private companies, so there is no difference there.

Opportunist: Is the government vigilant in ensuring that people are prosecuted to the full extent of the law?

Russell Weigel: Absolutely, although most people probably don’t know of anybody who got into trouble with the SEC or the Dept. of Justice. There is also a level of complacency out there, and certainly it is a numbers game. All 50 states, with their securities commissions and the Dept. of Justice and the SEC, still will not catch or prosecute all crimes or situations that have occurred. It’s just impossible. There are too many. The government picks and chooses which cases it wants to pursue. Lots of times they are middle of the road cases where their likelihood of winning is perceived to be great and litigation risks are minimal. They probably don’t want to programmatically pursue cases that might be somewhat dicey. Not to say they can’t or won’t, but when they choose to go forward against an individual or group of people they will not stop until they get all the relief they sought from the outset. In doing that they leave no stone unturned.

Opportunist: What determines whether a case is civil or criminal?

Russell Weigel: The nature of the case, usually. Most cases are brought as civil suits. If you visualize what a pyramid looks like with the lower part of the pyramid being the bulk of cases being civil in nature and a much smaller percentage towards the top of the pyramid being criminalized. Most people, if they are caught up in this, will probably be in the civil realm. But every statute in the securities laws is both civil and criminal, so criminal authorities could prosecute any violation—and securities commissions in many states also hold criminal powers and can decide on their own which way they will go. At the federal level the SEC has only civil litigation authority and the Dept. of Justice has criminal jurisdiction. There is a bifurcation but the two agencies very much work together.

You never know what investors are going to do, but the best time to think about what you’re doing in terms of raising capital and how you’re going to do it is at the beginning. It’s certainly less expensive. You can buy Capital For Keeps for under $25 and, hopefully, get 25 years of legal advice—in layman’s terms—rather than paying thousands to your legal counsel. Or, if you’re in the defense situation already, it will let you know what you should’ve done right in the first place.

Opportunist: Do you plan to write more books in the future?

Russell Weigel: Yes. I have one in the works, which is titled Florida Securities Law. This next book will be about the state of Florida’s securities laws.

LesphotoLeslie Stone is an award-winning writer, editor and journalist with more than two decades of experience covering business, finance, real estate and lifestyle issues for newspapers, magazines and online publications. Originally from Virginia, she currently resides between Florida and Michigan. Follow Leslie on Twitter: @lescstone.

Follow Russell Weigel on Twitter: @RussellWeigelPA

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