The SEC charged three individuals and an issuer with conducting two fraudulent crowdfunding schemes; the SEC also brought charges against the registered crowdfunding portal on which the offerings were conducted and its CEO for failing to respond to red flags. This is the SEC's first case involving Regulation Crowdfunding.
In a Complaint filed in the U.S. District Court for the Eastern District of Michigan, the SEC alleged that, through two cannabis and hemp companies (one of which is now defunct), the three individuals raised funds on an SEC-registered funding portal to conduct their offerings. (One of the individuals played a leading role in both offerings, and the other two each served as CEO to one of the two issuers.) The SEC alleged that the three individuals (i) misled investors in the marketing of the offerings by concealing the "leading" individual's criminal history and (ii) misused the proceeds for their personal benefit. The SEC stated that the crowdfunding platform and its CEO, by serving as gatekeepers, were responsible for detecting red flags, and, despite warning signs of fraud, continued to allow the offerings.
The SEC charged the three individuals and issuer with violations of Sections 5(a) ("Sale or delivery after sale of unregistered securities"), 5(c) ("Necessity of filing registration statement") and 17(a) ("Use of interstate commerce for purpose of fraud or deceit") of the Securities Act, Section 10(b) of the Exchange Act and SEA Rule 10b-5 ("Employment of manipulative and deceptive devices"). The SEC charged the crowdfunding platform and its CEO with violations of Section 4A(a)(5) ("Requirements with respect to certain small transactions") of the Securities Act and Rule 301(c)(2) ("Regulation Crowdfunding: Measures to reduce risk of fraud") thereunder.
The SEC is seeking relief in the form of (i) permanent injunctions, (ii) disgorgement, (iii) civil penalties and (iv) officer and director bars.
Commentary Charles Munn
In the first case under Regulation Crowdfunding, the SEC charged a registered portal for failing to deny access to an issuer where the portal allegedly had a reasonable basis for believing that the issuer or offering had the potential for fraud. The SEC alleges (i) that the portal was involved in drafting some of the offering documents and (ii) that the portal's CEO was told by a securities lawyer, to whom he referred the issuer, about a possible "red flag" concerning one of the participants' prior conviction for mortgage fraud. On the basis of that red flag, the SEC inferred that the registered portal should have promptly removed the offering, cancelled it, and directed the return of any funds that have been committed by investors. Registered portals and other crowdfunding intermediaries should take notice and ensure that they have mechanisms in place to screen issuers and take appropriate action when necessary.
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