What is a Stock Promoter? Securities Lawyer 101

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Securities Lawyer 101 Blog

The securities laws contain specific rules and regulations that apply to issuers who use the services of promoters.

These include disclosure obligations under the Securities Act of 1933, (“Securities Act”) and the Securities Exchange Act of 1934, (“Exchange Act”).

Additionally, Regulation D of the Securities Act disqualifies an issuer from relying upon the Rule 506 exemption if the issuer uses the services of a stock promoter that is found to have violated securities and other laws or engaged in certain wrongful conduct.

Who is a Promoter?

The definition of “promoter” is found in Rule 405 of the Securities Act. Rule 405 defines “promoter” very broadly and includes officers, directors, and direct or indirect control persons of entities involved in the launch of an enterprise.

Rule 405 defines a promoter as:

• any person that, alone or together with others, directly or indirectly, takes initiative in founding the business or enterprise of the issuer, or
• any person that, in connection with founding or organizing the business or enterprise of an issuer, directly or indirectly receives in return for services or property (or both services and property) 10% or more of any class of securities of the issuer or 10% or more of the proceeds from the sale of any class of securities of the issuer, provided that a person who receives those securities or proceeds solely as underwriting commissions or solely in return for property is not a “promoter” if that person does not otherwise participate in founding and organizing the issuer.

Disclosure of Transactions with Promoters

Form 10-K, Form S-1 and Form 10 as well as other SEC forms require the issuer to provide the specific disclosures found in Item 404(c) if the issuers used promoters at any time during the last five fiscal years including:

• the name of the promoter;
• transactions with the promoter;
• the nature and amount of anything of value received by each promoter from the issuer and the nature and amount of any consideration received by the issuer; and
• additional information regarding any assets acquired by the issuer from a promoter.

Many times reverse merger purveyors fall within this definition and as such issuers must undertake appropriate due diligence of any promoters involved in their reverse merger transaction.

Rule 506 Disqualification of Promoters

Rule 506 provides an exemption from the registration statement provisions of the Securities Act for certain private placements.  The Rule 506 Exemption is unavailable if the issuer or specified persons who are affiliated with the issuer fail to disclose necessary information.  These persons include directors, executive officers and promoters of the issuer.

An Issuer that relies on the Rule 506 Exemption for its securities offering must determine whether if its promoters have any disqualifying events under this rule.  Failure to do so could lead to disqualification of the issuer’s entire Rule 506 offering.

More information about these disqualifying events can be found here.

Under Rule 506(d), if one of an enumerated list of covered persons is subject to a “disqualifying event” that occurred on or after September 23, 2013, then the issuer is generally disqualified from relying on Rule 506 of Regulation D. It is important to understand who is covered by Rule 506(d)’s disqualification provisions (such persons are referred to in this article as covered persons).  The scope of covered persons under the rule not only includes the issuers, officers and directors. Covered persons, include persons beneficially holding 20 percent of the issuer and promoters.

Many issuers are unaware that Rule 506(e) requires disclosure of events that would have triggered disqualification at the time of the offering had Rule 506(d) been in effect.  Matters that would otherwise be disqualifying are required to be disclosed in writing to investors within a reasonable time before selling securities in reliance upon Rule 506.  Issuers who fail to provide the required disclosures are prohibited from relying upon the Rule 506 exemption for their offering.

Disqualifying Events

Events that disqualify issuers from relying upon Rule 506 include the following:

• Criminal convictions that occurred within ten years of the proposed sale of securities, or five years in the case of the issuer and its predecessors and affiliates in connection with: (i) the purchase or sale of a security, (ii) making a false filing with the SEC or (iii) the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.
• Final orders of state regulators of securities, insurance, banking, savings associations or credit unions; federal banking agencies; the Commodity Futures Trading Commission and the National Credit Union Administration that: (i) bar the covered person from associating with the regulated entity, engaging in the business of securities, insurance or banking, or engaging in savings association or credit union activities or (ii) are based on fraudulent, manipulative, or deceptive conduct and were issued within 10 years of the proposed sale of securities.
• Court injunctions and restraining orders, in effect at the time of the proposed sale of securities, that were entered within the preceding five years in connection with: (i) the purchase or sale of a security, (ii) making a false filing with the SEC or (iii) the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities.  Note that injunctions and court orders are not in effect at the time of the proposed sale are not disqualifying, even if they were issued within the five-year look-back period.
• SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies, and investment advisers and their associated persons under Section 15(b) or 15B(c) of the Securities Exchange Act, or Section 203(e) or (f) of the Investment Advisers Act that: (i) suspend or revoke the person’s registration as a broker, dealer, municipal securities dealer or investment adviser, (ii) place limitations on the person’s activities, functions or operations or (iii) bar the person from being associated with any entity or from participating in the offering of any penny stock trigger disqualification.  This disqualification continues only for as long as some act is prohibited or required to be performed pursuant to the order.  As a result, censures and orders to pay civil money penalties, assuming the penalties are paid in accordance with the order, are not disqualifying, and a disqualification based on a suspension or limitation of activities expires at the time that the suspension or limitation expires.

• SEC orders to cease and desist from violations and future violations of: (i) scienter based anti-fraud provisions of the federal securities laws or (ii) Section 5 of the Securities Act are triggering events. Disqualification applies to cease-and-desist orders that were issued within five years before the proposed sale of securities and remain in effect.

• SEC stop orders will cause an offering to be disqualified if any covered person has filed a registration statement under the Securities Act or Regulation A offering statement that was the subject of an SEC refusal order, stop order or order suspending the Regulation A exemption within the last five years, or is the subject of a pending proceeding to determine whether such an order should be issued. Further, the offering will be disqualified if a covered person was, or was named as, an underwriter of securities under a registration statement or Regulation A offering statement that was the subject of an SEC refusal order, stop order or order suspending the Regulation A exemption within the last five years, or is the subject of a pending proceeding to determine whether such an order should be issued.

• Suspension or expulsion from membership in an SRO or from association with an SRO member will cause an offering to be disqualified if any covered person is suspended or expelled from membership in, or suspended or barred from association with a member of, a securities self-regulatory organization or “SRO” (i.e.  self  regulatory organization such as FINRA or a registered national securities exchange) for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade.

• An offering to be disqualified, if the issuer or another covered person is subject to a U.S. Postal Service false representation order entered within the preceding five years, or to a temporary restraining order or preliminary injunction with respect to conduct alleged to have violated the false representation statute that applies to U.S. mail.

Issuers should exercise extreme caution when engaging the services of promoters with disciplinary backgrounds and ensure that all required disclosures are made. Further issuers should avoid using the services of promoters who are “Bad Actors” to prevent disqualification of their Rule 506 offerings.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com.  This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
www.SecuritiesLawyer101.com