The risks presented by artificial intelligence (AI) are becoming an increasing concern for corporate boards as emerging technologies influence business strategy, operations, and long-term planning. At the same time, regulators are closely examining how accurately companies disclose AI-related risks and the mitigation measures being implemented.

The U.S. Securities and Exchange Commission (SEC) has already initiated enforcement actions challenging misleading or incomplete disclosures related to artificial intelligence claims.

Growing Focus on AI Risk Reporting

A recent study conducted by Cornell University analyzed more than 30,000 filings from over 7,000 companies during the past five years. Using both quantitative and qualitative analysis, researchers identified a significant increase in AI risk disclosures. Mentions of AI-related risks in company filings increased from 4% of filings in 2020, to more than 43% of filings in 2024. This dramatic increase reflects both expanded corporate reliance on artificial intelligence and heightened regulatory scrutiny.

The Role of Form 10-K Disclosures

Evaluation of AI-related risk disclosure begins with Form 10-K, the annual report most U.S. public companies must file with the SEC. The Commission establishes required disclosure topics and prescribes how information must be presented to investors.

Companies must disclose:

• Material risks affecting business operations;
• Methods used to evaluate emerging risks;
• Strategies implemented to mitigate potential threats.

Because artificial intelligence can affect nearly every aspect of business operations, AI risks may be considered material at multiple levels, including:

• The broader economy;
• Industry-wide impacts;
• Geographic exposure;
• Company-specific operational risks.

Material Disclosure Obligations

Federal securities laws prohibit companies from:

• Making materially false or misleading statements; or
• Omitting material information necessary to prevent investor deception.

To reinforce accountability, both the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) must certify the accuracy and completeness of Form 10-K disclosures.

Categories of Material Risk

Companies generally evaluate disclosure obligations across four recognized categories of material risk.

Market Risk

Market risk arises from broad economic fluctuations such as:

• Interest rate changes;
• Foreign exchange volatility;
• Commodity price movements;
• Stock market valuation shifts.

These risks are largely outside company control but must still be disclosed when material.

Credit Risk

Credit risk evaluates the likelihood that customers or counterparties may fail to meet payment obligations. Companies may manage this risk through:

• Structured repayment terms;
• Collateral requirements;
• Credit evaluation procedures.

Liquidity Risk

Liquidity risk concerns a company’s ability to meet financial obligations as they become due. Companies must assess how quickly they can:

• Obtain financing; or
• Convert assets into cash during downturns.

Operational Risk

Operational risk involves failures in internal systems or external dependencies, including:

• Cybersecurity threats and AI system vulnerabilities;
• Ineffective internal controls;
• Employee training deficiencies;
• Supplier concentration risks;
• Financial reporting fraud or system failures.

Why Compliance Matters

Failure to comply with SEC disclosure requirements—including Form 10-K reporting obligations—can result in significant regulatory consequences and enforcement actions. Accurate disclosure not only promotes investor confidence but also protects companies from allegations of misleading statements.

Consultation with experienced securities counsel helps companies maintain compliance while developing practical risk mitigation strategies aligned with evolving regulatory expectations.

The securities lawyers at Corporate Securities Legal LLP assist companies in navigating disclosure obligations, strengthening compliance frameworks, and implementing effective governance practices related to emerging technologies such as artificial intelligence.

Contact Corporate Securities Legal LLP to ensure your company’s SEC disclosures remain accurate, compliant, and aligned with current regulatory standards.

Materiality in is a type of fraud, because it uses informational defects to evade a transaction. A fact is material if “there is a substantial likelihood a reasonable investor would consider important” while deciding something concerning securities. (TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976). The Supreme Courts wanted to make the definition stronger than the mere possibility that an investor would consider it important, they wanted it more than likely that that bit of information would be deemed decisive by the investor. The misinformation must therefore be significant enough to sway an investor’s decision on whether or not they would buy the securities being offered.

A reasonable investor is one who is not an irrational investor, someone who suffers from hindsight bias, over-optimism, availability bias, endowment effects, or just one who follows what everyone else thinks. Most of this disclosure is meant for professional securities analysts who usually combine the new data with their prior knowledge to get a confirmation about the company. In some court cases materiality is a mixture of law and fact, and the judges have to decide whether or not the issue concerns the law or not, assuming the role of the “reasonable investor.”

Capital Formation, Liquidity, and Risk Management

The three basic functions of securities markets are: capital formation, liquidity, and risk management. These markets pair the companies that need capital to function, and the investors with capital that are looking for a return on their investments. It also connects investors together, those that are looking to liquify and sell their securities, and those who want to buy those same securities. The liquidity of securities is crucial to the buyer, and it can be the decision maker on whether or not the buyer will invest. These markets diminish the risk involved with purchasing securities by diversifying and hedging their investments. They can purchase groups of securities to lower the overall risk, despite some of the securities having a higher individual risk.Derivative are further measures to eliminate risks; they create a maximum loss and secure investment gains. Other options like mutual funds, which allow one to be financially involved without having to deal with investment and voting discretion, and put options, which gives the owner the right, but not obligation, to sell a certain amount at a specific price within a certain time frame, are other ways that investors can lower the risks of purchasing securities.

Collateral Benefit

This market, of buying, selling, and trading securities, has beneficial repercussions for the economy. This market helps evaluate the price of certain companies, and even the economy as a whole. Securities prices can help judge management performance, and can act as a valuation for tax or other purposes. The market is not intended to act as an evaluation of companies and their performance or worth, however that is that is a direct result that benefits the economy.

On Thursday, December 27, 2018 the Securities and Exchange Commissionbegan operation within its plan during a federal government shutdown. They say they have “staff available to respond to emergency situations involving market integrity and investor protection.” That meansthat out of the 4,426 active staff employees of the SEC, 175 will be retained to protect life or property, 110 of them, who are engaged in law enforcement, will continue working, and only one employee will be working part time on investor protection.The SEC”will be available to answer questions about fee calculations for filings during the partial shutdown, but they will not respond to other questions.”

The Investment Adviser Registration Depository system will continue to accept filings but the Division of Investment Management will not be available to provide advice. Certain SEC systems, which are contracted out to third parties, will remain in operation, including EDGAR, the Electronic Data Gathering, Analysis, and Retrieval system that allows companies to electronically file initial public offerings and other crucial documents. The shutdown will have no impact on those services, but with the SEC not responding to those filings, it could cause a delay in several IPOs, as well as a lasting impact on the state of the IPO market in 2019.Smaller businesses, particularly those in need of an infusion of capital to continue operating, will bear the brunt of any IPO delays.

These limited and curtailed services will affect different investors in different ways, depending on their needs and objectives. The most critical harm to all investors could be that the SEC will only retain a few staff employees to review complaints from investors, but they will not be in a position to respond to those complaints, questions, or requests for information.

Market Watch reports that If the shutdown were to continue for a prolonged period, companies could end up with financial statements that have gone stale. That means they have reached a point where the quarterly financials included have become so old that the issuer needs to provide numbers for the subsequent quarter. Those numbers need to be audited to be included in a prospectus, creating another potential holdup.

However, the weak stock market in late 2018 and early 2019 signals that investors are being cautious, which may force new IPOs to devalue their prices.Also, the delay in IPO approvals may be a blessing for some IPOs, because, as the stock market strengthens, going into spring, the values may increase.

Navigating the securities markets can be difficult and confusing for those who do not work in it constantly. Without available help from the SEC, it can be more of a challenge.Fortunately, the law office of Wilson, Bradshaw & Cao will not be shutdown, but will be available to assist investors and business owners with professional legal advice on the securities market.

The JOBS (Jumpstart Our Business Startups) Act of 2012, is an amendment to both the Securities Act and the Exchange Act. Its purpose is to encourage economic growth and the increase in jobs, by relaxing the regulatory encumbrances on business start-ups that trying to raise capital in securities markets. There are three major differences in the JOBS Act, along with other smaller revisions of existing rules.

Crowdfunding

This gives small companies the ability to use online markets to sell securities to many small investors. This is the first time that non-public companies can raise capital from public investors without needing to go to register their offerings under state or federal law. This does not mean that there are no restrictions on crowdfunding, however. Among other conditions, the seller has to provide an elaborate offering document, and that the intermediary must be registered by the SEC. One of the biggest crowdfunding platforms today is Kickstarter, which helps smaller companies gain the funding that they need to successfully launch their business, project, etc.

General Solicitations

This act also simplifies the company’s process of marketing private placements. As long as the securities are sold to exclusively “accredited investors,” the company can market their private offerings in far-reaching public markets under Regulation D (which allows smaller companies to raise capital by selling equity or debt securities without having to register their securities with the SEC).

Emerging Growth Companies

The JOBS Act alleviates some of the restrictions and difficulties of “emerging growth companies.” When registering their IPOs they face fewer requirements, like confidential filing and the ability to “test the waters.” In the following five years the companies receive exceptions from some of the disclosure and corporate governance rules that would be enforced for other public companies.

Through the JOBS Act of 2012, “emerging growth companies” will have an easier time gaining capital and marketing their securities. This expedites economic growth stimulation and the creation of more jobs.

SOn December 21, 2018, the Securities and Exchange Commission (“SEC”)announced settled charges against New York-based investment advisers American Portfolios Advisers Inc. (“APA”) and PPS Advisors Inc. (“PPS”), and PPS’s CEO Lawrence Nicholas Passaretti. The advisers selected mutual fund share classes inconsistent with their client disclosures. As a result, the firms and the CEO will pay an amount exceeding $1.8 million and the payment amounts will be returned to injured investors.

APA invested advisory clients in mutual fund share classes that charged 12b-1 fees instead of share classes of the same funds that were less expensive and available. APA’s disclosure did not adequately inform its clients of the conflict of interest presented by its share class selection practices. According to the charging order, APA received $850,000in avoidable fees as a result of its investment practices. APA incorrectly stated that its investment adviser representatives (“IARs”) either did not receive 12b-1 fees, or alternatively, only selected the more expensive share classes when less expensive classes of the same funds were not available. Further, by investing clients in mutual fund share classes that charged these fees in place of less expensive share classes of the same funds, APA violated its duty to seek best execution for those transactions.

PPS and its CEO, Lawrence Nicholas Passaretti, committed similar disclosure violations as APA when they also invested advisory clients in mutual fund share classes that charged 12b-1 fees, even though less expensive share classes of the same funds were available without fees. According to theSEC’s order, PPS failed to disclose that its IARs had a conflict of interest because of the additional compensation IARs receivedwhen investing advisory clients in a fund’s fee-paying share class instead of an available, less expensive share class of the same fund. PPS also incorrectly stated that it selected higher-cost share classes for the “long-term benefit” of clients. Similar to APA’s actions, PPS’s invested in mutual fund share classes that charged fees, which was inconsistent with PPS’s duty to seek best execution for those transactions.

Chief of the SEC Enforcement Division’s Management Unit,C. Dabney O’Riordan,said, “Advisers must be vigilant in disclosing all conflicts of interest arising from compensation received based on investment decisions made for clients. The documents these advisers provided to clients were incorrect and investors were harmed. We are continuing our efforts to stop these violations and return money to harmed investors as quickly as possible.”

If you have questions about your company’s compliance with federal securities laws or are unsure if your company is providing adequate disclosures to investors, call Wilson, Bradshaw& Cao, LLP today.

On November 29, 2018, the Securities and Exchange Commission (“SEC”) charged two celebrities with unlawfully touting initial coin offerings (“ICOs”). This is the first time that the SEC has brought touting violation charges involving ICOs. Professional boxer, Floyd Mayweather Jr. and music producer Khaled Khaled, commonly known as DJ Khaled, each received cease and desistorderswith the charges.

According to the SEC orders filed November 29, 2018, Mayweather and Khaled did not disclose promotional payments from ICO issuers, including Centra Tech Inc. (“Centra”), and touted on social media accounts to entice potential investors to participate in the offering. May weather posted on twitter that Centra’s ICO “starts in a few hours. Get yours before they sell out, I got mine…” This storm hits after the DAO Report in 2017 indicated that ICO’s may need to be registered as securities and just a little over a year after the SEC issued an informal warning urging caution around celebrity backed ICOs. Now the SEC is cracking down.

In April 2018, the SEC filed an action against Centra founders alleging that the ICO was fraudulent and parallel criminal charges were brought by the U.S. Attorney’s Office for the Southern District of New York.

Mayweather and Khaled have agreed to pay disgorgment, penalties, and prejudgement interest, totaling just over three-quarters of a million dollars, and agreed to not participate in securities offerings for three and two year periods, respectively.

The SEC’s goal is to encourage promoters to fully disclose to investors that they are being endorsed by the company and not to appear as though they are unbiased investors themselves.

Here at Wilson Bradshaw & Cao, we help businesses solicit investors for ICOs in a compliant manner. We restrict our practice to securities law, in particular private and public offerings and SEC enforcement work.

Rule 504

Rule 504 of Regulation D provides an exemption from registration for a 12-month period on the offer and sale of up to $5,000,000.Rule 504 permits general offerings and solicitations so long as they are restricted to accredited investors.

Companies that are not eligible to use the Rule 504 exemption include: companies that are already Exchange Act reported companies, investment companies, companies that “have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company,” and companies with people disqualified under the “bad actor” disqualification provisions.

See: https://www.sec.gov/divisions/corpfin/guidance/rule504-issuer-small-entity-compliance.html

Rule 501(d)(1)(i)-(viii) lists the bad acts that fall under the “bad actor” disqualification rule. Only “bad acts” that have occurred on or after September 23, 2013 can destroy the exemption. Bad actors include:

• Those who have been convicted within ten years of the saleof a felony or misdemeanor in connection with the purchase or sale of any security, involving any false filing with the SEC, or arising out of the business conduct of financial intermediaries.
• Those subject to an SEC order at the time of sale entered under provisions related to investment companies, dealers, and brokers
• Those subject to an SEC order at the time of sale that mandates the person to “cease and desist from committing or causing violations or future violations” of any intentional antifraud provision of the federal securities laws
• Those suspended or expelled from membership in a registered national securities exchange or affiliated securities association for acts found to be incompatible with the just and equitable principles of trade

See: https://www.lexisnexis.com/legalnewsroom/banking/b/banking-finance/posts/rule-506-d-bad-actor-disqualifications-who-s-a-bad-actor-and-why-are-they-bad-part-i for more information

Rule 506

Rule 506 of Regulation Dpermits two distinct exemptions from registration when companies offer and sell securities. These two exemptions are split based on whether the issuer will engage in general solicitation to market securities.

The first exemption falls under Section 4(a)(2) of Rule 506(b). Section 4(a)(2) provides a “safe harbor” for companies that comply with certain requirements. In addition to a prohibition from using general solicitation to market securities,the requirements of the exemption include:

The second exemption amends Section 4(a)(2) by permitting general solicitation.Companies remain exemptif participating investors are all accredited. For this exemption to apply, companies must take reasonable steps to confirm investors are in fact accredited. This amendment is stated in Rule 506(c).

Companies that comply with exemption requirements do not need to register their securities offering with the SEC. However, these companies must electronically file a “Form D” with the SEC after they initially sell securities. This form is a short notice that contains names and locations of promoters and executives and brief information about the offering.

See: https://www.sec.gov/fast-answers/answers-rule506htm.html

Why is it important to get an exemption from registration?

It is important to get an exemption from registration because by operating under Rule 506 exemptions, companies can raise unlimited capital from an unlimited number of accredited investors (and up to thirty-five (35) non-accredited investors).

Accredited investors are individuals with a joint net worth with their spouse of at least $1 million. Accredited investors also include individuals with income exceeding $200,000 in each of the two most recent years, or joint income with their spouse exceeding $300,000, plus “a reasonable expectation of reaching these income levels in the current year.” Companies with total assets in excess of $5 million are also accredited investors.

Being eligible for an exemption is important for getting help with funding from these types of accredited investors. About 90-95% of all private placements are conducted pursuant to Rule 506, and deals with accredited investors are generally private placements exempt from registration under Rule 506.

See: https://www.thesecuritiesedge.com/2012/09/securities-law-101-part-ii-avoiding-the-pitfalls-in-a-private-placement/

Also: Without an exemption from registration, the issuer, salespeople, officers, directors, and agents may be personally liable. If found liable, the investor can recover the principal, interest, and attorney fees.

See: https://www.equitynet.com/crowdfunding-terminology/general-solicitation

What is an Opportunity Zone?

The Internal Revenue Service (“IRS”) describes the Opportunity Zones as economically-distressed communities where new investments may be subject to preferential tax treatment, according to the criteria laid out in the Tax Cuts and Jobs Act. These low-income communities must be designated as a qualified Opportunity Zone in order to benefit from the tax incentives and each state has a limited number of “population census tracts” (neighborhoods as determined by the Bureau of Census) that can be designated as qualified Opportunity Zones.

How are Opportunity Zones Created?

Opportunity Zones are designated

What are the Benefits of Investing in Opportunity Zones?

• You can defer the capital gain tax
• Possible reduction of the amount of gain realized through a basis adjustment; and

Possible permanent exclusion of gain on the appreciation for the interest in an Opportunity Fund

The 2017 Tax Cuts and Jobs Act established a section of the tax code that allows taxpayers to utilize a new investment vehicle called “Opportunity Funds”, in an effort to bring resources to low income communities known as Opportunity Zones.

What is an Opportunity Zone?

The Internal Revenue Service (“IRS”) describes Opportunity Zones as economically-distressed communities where new investments may be subject to preferential tax treatment, according to the criteria laid out in the Tax Cuts and Jobs Act. A low-income community must be designated as a qualified Opportunity Zone in order to benefit. Each state has a limited number of “population census tracts” (neighborhoods as determined by the Bureau of Census) that can be designated as qualified Opportunity Zones.

How are Opportunity Zones Created?

Opportunity Zones are created by a nomination and designation process. The Tax Cuts and Jobs Act laid out criteria for governors to designate potential Opportunity Funds for nomination. Up to 25% percent of low-income communities could be nominated. Low-income communities requirements are defined by the Internal Revenue Code Section 45D(e) as any neighborhood where:

• The poverty rate is at least 20 percent; or
• In a non-metropolitan area:
  • the median family income does not exceed 80% of statewide median family income; or
• · In a metropolitan area:
  • the median family income does not exceed the 80% of statewide median family income and does not exceed the metropolitan area median family income.

In addition, 5% of each jurisdiction could qualify to be nominated if they met income and geographic criteria, including:

• that the neighborhood shares a border with a low-income community; and
• the median family income is no more than 125% of the median family income of the neighborhood it shares a border with.

Where are Opportunity Zones?

Opportunity Zones have been designated in every state and the U.S. territories. For an up-to-date detailed map published by the U.S. Department of the Treasury, click here.

What are the Benefits of Investing in Opportunity Zones?

• You can defer the capital gain tax
• Possible reduction of the amount of gain realized through a basis adjustment; and
• Possible permanent exclusion of gain on the appreciation for the interest in an Opportunity Fund

If you are interested in starting an Opportunity Zone Fund, reach out to Wilson Bradshaw & Cao, LLP and realize potential tax benefits.

Wilson Bradshaw & Cao, LLP is a boutique securities law firm in Irvine California and New York City. We help businesses solicit investors for both public and private companies in a compliant manner. We restrict our practice to securities law, focusing on private and public offerings and SEC enforcement work.

General solicitation includes websites, blast emails, and social networking media that can be viewed or accessed by the public. Thus, PPMs should not be made available on an uncontrolled basis through internet access.

If a PPM is posted on a website that is protected by a password to limit access to those persons with whom the issuer or its representatives “have a pre-existing personal relationship,” this communication will not be considered general solicitation.

See: http://www.wnj.com/files/Publication/a941cb2d-f6db-40da-9cb0-85b44f514c70/Presentation/PublicationAttachment/ba8ac6ec-6388-4a90-b2fa-cb6b5b30328d/FAQ_Regarding_the_Private_Placement_of_Securities_under_Regulation_D_Rule_506.pdf

However, it is important to be careful how you provide the PPM. You must keep careful track of potential investors that register for your website.You may lose exemption status if a PPM ends up in the hands of enough unintended unaccredited investors, because the post then may qualify as general solicitation. It is key to keep control of who sees and who can access and edit your offering materials.

See: https://www.thesecuritiesedge.com/2012/09/securities-law-101-part-ii-avoiding-the-pitfalls-in-a-private-placement/

For more information on posting your PPM online, call Bradshaw Law Group today.

• Financial rights of the securities that are being transacted
• Financial performance of the issuer
• Prospect’s and management of the issuer
• Competitive information
• Trends in the economy, etc.

Issuer Transactions

Those who sell their securities to raise capital for their company, Primary Market, try to sell their securities in public markets or in negotiated, private placements. To make a public offering (primary distribution) one must be trying to raise capital from a bigger group of investors. If you are attempting to obtain capital from the public for the first time, then it is an initial public offering (IPO).

Trading Transactions

After the securities have been bought by the investor,and the investor wishes to trade them, they enter the Secondary Market. There is no longer capital being raised for the issuer if the investor tries to trade their securities in the Secondary Market. The securities are merely liquidated or partially liquidated for the investor, and a different investor now owns the securities for which they traded. These investor to investor transactions can happen in privately negotiated transactions or in public trading markets, like through a stock exchange or a securities firm’s computerized trading. The liquidity that the secondary market provides to the investor also enlivens primary markets. Ninety-nine percent (99%) of securities transactions occurs in the Secondary Market.

Markets within the Secondary Market

Within the Secondary Market there are two principle markets for trading securities in the United States.The first market is the exchange markets, where buy and sell orders all come together at a centralized location, and where there are “specialists” to pair buyers and sellers and to manage a “book” of orders. The second market for trading securities is the over-the-counter (OTC) market. This market is between securities firms that can obtain information about securities that are being sold by other firms. They can get this access to the bidding and selling information through their computer terminals and price sheets. NASDAQ is the most well-known of these OTC markets. A more private and less expensive route than exchanges and OTC markets is electronic communication networks (ECNs). This eliminates and middle man between investors and allows them to directly trade with each other.

According to the SEC’s complaint filed November 28, 2018, Eric Landis arranged with third party advertisers forpublicly traded, small, often relatively infrequently traded, companies (“microcap” companies) to distribute promotional materials for the stocks using email lists, when in fact there were no distribution lists. Landis manipulated the market by creating the mirage that those companies’ securities were in high demand by trading thousands of microcapshares himself using brokerage accounts in his own name, in the name of an entity he controlled, Ridgeview Capital Partners LLC (“Ridgeview”), and in the names of several third parties. His goal was to induce others to trade in the securities by infusing the securities markets with false information concerning supply and demand of the penny stocks he was paid to promote.

The director of the SEC’s Boston Regional Office, Paul Levenson, gives this warning to penny stock investors, “microcap investors should know that sometimes market volume in a particular stock can be driven by a single fraudulent actor, as alleged here.”

The SEC’s complaint charges Landis and Ridgeview with violating the antifraud and market manipulation provisions of the securities laws. The SEC is requesting a permanent injunction stopping Landis from engaging in these practices in the future, disgorgement of all ill-gotten gains from the unlawful conduct with other penalties, and prohibiting him from participating in any offering of a microcap stock.

How could Landis have generated demand for public companies’ stock legally? Well, he shouldn’t have been buying and selling stock in companies that he had no interest in investing in. This is a recipe for fraud.

Here at Wilson Bradshaw & Cao, we help businesses solicit investors for both public and private companies in a compliant manner. We restrict our practice to securities law, in particular private and public offerings and SEC enforcement work.

On February 14, 1975, Commissioner of Corporations of the State of California, Willie R. Barnes, issued a release on Repurchase Offers that commented on Section 25507 (b) of the Corporate Securities Law of 1968.(link to release)This release also discussed Rule 260.507 of the California Code of Regulations in the context of the rule’s requirements for issuing an offer under Section 25507 (b).

Section 25507 (b) bars suit if the buyer receives a written offer approved by the Commissioner before the suit begins. The written proposal must contain:

• an offer to repurchase the security for cash price (payable on delivery of the security);
• a cash offer to pay the buyer an amount recoverable by him under Section 25503 (link to 25503); or
• an offer to rescind the transaction by putting the parties back in the same position they were in before the transaction.

Rule 260.507 sets forth requirements related to an offer’s content. These requirements include thatan offer mustbe in writing and that an offer mustcontain necessary information about the offeree’s investment decision related to the offer.

Selective Offers

Rule 260.507 details the application requirements when seeking the Commissioner’s approval of an offer. Item 6(a) of the application form requires disclosure of any offer made to less than all investors as to whom liability may exist. Substantial unfairness results when offers are only made to selected shareholders, and there is only sufficient justificationfor partial repurchase offers in unusual circumstances. Lacking sufficient funds to meet offers if all shareholders accept is not a sufficient basis for according preferences to selected investors.

Valuation of Consideration

Item 6(b) of the application form requires a showing of the basis for the value of the initial consideration paid by the buyers when the initial consideration was not cash, but a cash repurchase offer is anticipated. It is unsatisfactory to consider the valuation of the consideration as merely nominal in particular circumstances. These situations include reorganizations, recapitalizations, or employee stock options.

Rescission

Section 25507 (b) states that when rescission is to be offered, the rescission must put the parties in the same situation they were in before the transaction occurred.Often, an offer will be considered illusory or misleading unless the obligations of the offeror and offeree (and sometimes third parties) are described. The obligations must include specific provisions stipulating the time frame when performance of an offer must be completed.

An offeree can commence an action under the statute if the offeree rejects the offer on the basis that offered damages or rescission are insufficientwhen there is reasonable doubt about the sufficiency of the offer. This condition is only imposed if the consideration paid by the offeree is not monetary, or if rescission is offered.

The Commissioner will generally require that adequate protection is afforded to securities and other transmitted property. The offer must be sent within thirty days after Commissioner approval. The specified time period could be extended if a showing Is made within a reasonable time after Commissioner approval.

Required Warnings in Offers

If all offerees accept and the total assets of the offeror are not enough to meet cash demands, a repurchase offer will generally not be approved. Information furnished to the offeree must include descriptions of situations where possible acceptances may jeopardize the offeror from continuing in business or where possible acceptances may imperil the interests of the offeree. Further, the offer must provide adequate warning to those who reject the offer if they discover that the issuer is finding it difficult or impossible to continue in business after rejection.

The Commissioner may impose a condition that operates to void the offer ifthe issuer is disabled from continuing business because of acceptances. This revives the right of offerees to assert their civil remedies.

Thirty Day Waiting Period

Section 25507 Subdivision (b)(3) provides a statutory “waiting period” of thirty days after the receipt of the offer when the offer cannot be accepted by the buyer. The purpose of the provision is to give the offerees adequate time to think about their interests in the matter whenconsidering potential complexities. This condition does not preclude an offereefrom rejecting the offer prior to the specified time period. The offeree may deem termination to be in his best interests and in this situation, the statutory waiting period does not serve public interest.

Legend Conditions

Subsection 8 D(9) stipulates that the possibility of an imposition of a legend condition must be disclosed in the offer. However, this disclosure is not mandatory where the facts are such that the imposition of a legend condition is a remote possibility.

A rescission offer takes place when an issuer offers to repurchase an investor’s securities and refund his purchase price plus interest. Most states provide that an issuer can offer those who invested in transactions that violate securities laws a chance to pre-emptively buy back their securities at the original purchase price plus interest. These offers must be performed with strict compliance with the respective state’s laws. California is governed by Ca. Corp. Code Section 25507(b).According to Ca. Corp. Code Section 25507 (b), (Link to code)after being made an offer that complies with the state’s requirements, the investor has 30 days to take advantage of the offer.[1] If the investor does not take advantage of the offer within 30 days, any rescission action that investors have under state securities laws are barred.[2]

A rescission offer takes place when an issuer offers to repurchasean investor’s securities and refund hispurchase price plus interest. Most states provide that an issuer can offerthose who invested in transactions that violate securities laws a chance to pre-emptively buy back their securities at the original purchase price plus interest. These offers must be performed with strict compliance with the respective state’s laws. California is governed by Ca. Corp. Code Section 25507(b).According to Ca. Corp. Code Section 25507 (b), (Link to code)after being made an offer that complies with the state’s requirements, the investor has 30 days to take advantage of the offer.[1] If the investor does not take advantage of the offer within 30 days, any rescission action that investors have under state securities laws are barred.[2]

Issuers of securities often resort to rescission offers to insulate themselves against liability. Rescission offers are useful for shareholders to avoid lability when a company might have violated registration requirements, and for shareholders that have supplied investors with misinformation or have omitted material information.[3]

The policy behind state rescission statutes is that an investor should not be permitted to refuse an offer by a sponsor that is willing to rescind a transaction and thenbring suit against that sponsor later. Every state but four (Arizona, New York, Tennessee, and West Virginia) have statutes that bar suits under civil liability provisions if the purchaser receives an offer to return the consideration paid with the interest anddoes not accept the offer within 30 days.[4]The effect of states’ civil liability provisions is to release the sponsor from liability from state securities laws. However, rescission offersdo not insulate the offeror from liability for common-law fraud.[5]

Federal statutes do not explicitly provide the same protection for issuers of rescission offers. Section 14 of the Securities Act of 1944 and Section 29(a) of the Securities Act of 1934 expressly stipulates that “any condition, stipulation, or provision binding any person to waive compliance with any provision of [the laws] shall be void.”[6]Thus, there is no federal statute permitting an issuer to protect themselves from liability by making a rescission offer.

However, an investor who accepts a rescission offer will have given up her rights (under federal law) because there has been a return of the original investment and interest. It is unclear if an investor’s rights to federal claims will be cut off when an investor rejects a rescission offer. The courts are split, and at least two courts have used common law principles to prohibit an action under federal securities laws by plaintiffs who turn down a rescission offer.[7]

Violations of the registration provisions of Section 5 of the Securities Act of 1933 provide the purchaser a right to rescind the transaction within one-year under Sections 12(a)(1)[8](link to code) and 14[9](link to code)of the Act. This right can be asserted against any seller who has violated Section 5. If the one-year period has expired, issuers might continue to be exposed to liability and may attempt to cut off liability by making a rescission offer.[10]

Importantly, issuers must remember that a rescission offer is also an offer to sell the underlying security, and the underlying security must be registered under Section 5 of the 1933 Act (if noexemption is available).

The rescission offer’s disclosure permits investors to exercise an informed decision when determining whether to rescind. The disclosure must include a detailed factual statement of the alleged violation and an estimated amount of liability.[11] The offeror is not required, however, to admit a violation or waive the statute of limitation.[12]

The 1933 Act does not define an interest rate, so interest under Section 12(a) is often based on the applicable state rate.

Choosing how to draft the rescission offer’s disclosure is an important part of the process. Disclosure is sometimes viewed as a renewed offer to sell, or alternatively, as a repurchase offer.[13] The disclosureshould be forward-looking if it is framed as a renewed offer to sell. It should specify the issuer’s prospects and risks of holding thesecurities in question.[14]If a disclosure is drafted as a repurchase offer, the document should emphasize the risks of returning the securities anddescribe the purpose and effect of the offer. In some states, securities regulators simplify the disclosure process by supplying simple form-letters for the offerors of rescission.[15]In situations where a rescission offer is framed as an offer of securities, issuers might be required to submit a prospectus with updated financial statements to regulators before making an offer.[16]

[1]https://codes.findlaw.com/ca/corporations-code/corp-sect-25507.html

[2]https://www.strictlybusinesslawblog.com/2012/11/16/neogenix-oncology-a-good-case-study-on-securities-law-noncompliance-by-a-high-growth-company-part-3-when-the-genie-cant-be-put-back-in-the-bottle/

[3]https://www.cuttingedgecapital.com/part-two-section-42-unregistered-public-offerings-and-offering-rescission/

[4]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[5] Id.

[6]http://docplayer.net/30408168-Rescission-offers-under-regulation-d.html

[7]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf. “In Meyers v. C & M Petroleum Producers, Inc., 476 F.2d 427 (5th Cir. l973), the court reversed a lower court decision holding that plaintiffs had waived their rights by rejecting a rescission offer, but stated in dictum that the rejection of the offer might have estopped the plaintiffs from later filing suit. In a more recent Fifth Circuit case, Topalian v. Ehrman, 954 F.2d 1125 (5th Cir. 1992), the rescission offer extended to investors in an oil and gas limited partnership helped shield the general partners from securities claims by investors. The court affirmed the district court’s summary judgment for defendants because the investors had been adequately warned of the risks associated with the venture and had been offered a rescission opportunity. And, in Electronic Specialty Co. v. International Controls Corp., 295 F. Supp. l063 (S.D.N.Y. l963), where suit had been filed following the circulation of a rescission offer, the court held that the offer had mooted the cause of action, since the offer was identical to the relief sought in the complaint.”

[8]https://www.law.cornell.edu/uscode/text/15/77l

[9]https://www.law.cornell.edu/uscode/text/15/77n

[10]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[11]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[12] Id.

[13]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[14] Id.

[15]https://www.cuttingedgecapital.com/part-two-section-42-unregistered-public-offerings-and-offering-rescission/

[16] Id.

Issuers of securities often resort to rescission offers to insulate themselves against liability. Rescission offers are useful for shareholders to avoid lability when a company might have violated registration requirements, and for shareholders that have supplied investors with misinformation or have omitted material information.[3]

The policy behind state rescission statutes is that an investor should not be permitted to refuse an offer by a sponsor that is willing to rescind a transaction and thenbring suit against that sponsor later. Every state but four (Arizona, New York, Tennessee, and West Virginia) have statutes that bar suits under civil liability provisions if the purchaser receives an offer to return the consideration paid with the interest anddoes not accept the offer within 30 days.[4]The effect of states’ civil liability provisions is to release the sponsor from liability from state securities laws. However, rescission offersdo not insulate the offeror from liability for common-law fraud.[5]

Federal statutes do not explicitly provide the same protection for issuers of rescission offers. Section 14 of the Securities Act of 1944 and Section 29(a) of the Securities Act of 1934 expressly stipulates that “any condition, stipulation, or provision binding any person to waive compliance with any provision of [the laws] shall be void.”[6]Thus, there is no federal statute permitting an issuer to protect themselves from liability by making a rescission offer.

However, an investor who accepts a rescission offer will have given up her rights (under federal law) because there has been a return of the original investment and interest. It is unclear if an investor’s rights to federal claims will be cut off when an investor rejects a rescission offer. The courts are split, and at least two courts have used common law principles to prohibit an action under federal securities laws by plaintiffs who turn down a rescission offer.[7]

Violations of the registration provisions of Section 5 of the Securities Act of 1933 provide the purchaser a right to rescind the transaction within one-year under Sections 12(a)(1)[8](link to code) and 14[9](link to code)of the Act. This right can be asserted against any seller who has violated Section 5. If the one-year period has expired, issuers might continue to be exposed to liability and may attempt to cut off liability by making a rescission offer.[10]

Importantly, issuers must remember that a rescission offer is also an offer to sell the underlying security, and the underlying security must be registered under Section 5 of the 1933 Act (if noexemption is available).

The rescission offer’s disclosure permits investors to exercise an informed decision when determining whether to rescind. The disclosure must include a detailed factual statement of the alleged violation and an estimated amount of liability.[11] The offeror is not required, however, to admit a violation or waive the statute of limitation.[12]

The 1933 Act does not define an interest rate, so interest under Section 12(a) is often based on the applicable state rate. Choosing how to draft the rescission offer’s disclosure is an important part of the process. Disclosure is sometimes viewed as a renewed offer to sell, or alternatively, as a repurchase offer.[13] The disclosureshould be forward-looking if it is framed as a renewed offer to sell. It should specify the issuer’s prospects and risks of holding thesecurities in question.[14]If a disclosure is drafted as a repurchase offer, the document should emphasize the risks of returning the securities anddescribe the purpose and effect of the offer. In some states, securities regulators simplify the disclosure process by supplying simple form-letters for the offerors of rescission.[15]In situations where a rescission offer is framed as an offer of securities, issuers might be required to submit a prospectus with updated financial statements to regulators before making an offer.

[1]https://codes.findlaw.com/ca/corporations-code/corp-sect-25507.html

[2]https://www.strictlybusinesslawblog.com/2012/11/16/neogenix-oncology-a-good-case-study-on-securities-law-noncompliance-by-a-high-growth-company-part-3-when-the-genie-cant-be-put-back-in-the-bottle/

[3]https://www.cuttingedgecapital.com/part-two-section-42-unregistered-public-offerings-and-offering-rescission/

[4]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[5] Id.

[6]http://docplayer.net/30408168-Rescission-offers-under-regulation-d.html

[7]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf. “In Meyers v. C & M Petroleum Producers, Inc., 476 F.2d 427 (5th Cir. l973), the court reversed a lower court decision holding that plaintiffs had waived their rights by rejecting a rescission offer, but stated in dictum that the rejection of the offer might have estopped the plaintiffs from later filing suit. In a more recent Fifth Circuit case, Topalian v. Ehrman, 954 F.2d 1125 (5th Cir. 1992), the rescission offer extended to investors in an oil and gas limited partnership helped shield the general partners from securities claims by investors. The court affirmed the district court’s summary judgment for defendants because the investors had been adequately warned of the risks associated with the venture and had been offered a rescission opportunity. And, in Electronic Specialty Co. v. International Controls Corp., 295 F. Supp. l063 (S.D.N.Y. l963), where suit had been filed following the circulation of a rescission offer, the court held that the offer had mooted the cause of action, since the offer was identical to the relief sought in the complaint.”

[8]https://www.law.cornell.edu/uscode/text/15/77l

[9]https://www.law.cornell.edu/uscode/text/15/77n

[10]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[11]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[12] Id.

[13]https://www.pillsburylaw.com/images/content/4/7/v2/477/RobbinsRescissionD2013.pdf

[14] Id.

[15]https://www.cuttingedgecapital.com/part-two-section-42-unregistered-public-offerings-and-offering-rescission/

thesecurities in question.[14]If a disclosure is drafted as a repurchase offer, the document should emphasize the risks of returning the securities anddescribe the purpose and effect of the offer. In some states, securities regulators simplify the disclosure process by supplying simple form-letters for the offerors of rescission.[2]In situations where a rescission offer is framed as an offer of securities, issuers might be required to submit a prospectus with updated financial statements to regulators before making an offer.[3]

[1] Id.

[2]https://www.cuttingedgecapital.com/part-two-section-42-unregistered-public-offerings-and-offering-rescission/

[3] Id.

The SEC’s order against Wealthfront stated that the adviser violated antifraud, advertising, compliance, and other provisions of the Investment Advisers Act of 1940. According to the order, Wealthfront falsely asserted that its tax loss harvesting program monitors all client accounts to avoid any transactions that might trigger a wash sale when in fact, Wealthfront did not monitor clients’ accounts for this purpose. (A wash sale occurs when an investor sells a security at a loss and within 30 days of the sale, buys a substantially identical security.) Concurrently, Wealthfront retweeted client testimonials, which investment companies are prohibited from publishing without required disclosure, and paid bloggers for new client referrals without complying with applicable disclosure requirements. Wealthfront was ordered to pay a civil money penalty in the amount of $250,000 to the SEC and to cease and desist from committing any disclosure violations. (link to complaint: https://www.sec.gov/litigation/admin/2018/ia-5086.pdf)

The SEC’s order against Hedgeable found that the adviser violated antifraud, advertising, compliance, and books and records provisions of the Investment Advisers Act of 1940. The order describes Hedgeable’s “Robo-Index”, which supposedly permitted clients to compare the performance from 2014 and 2015 of two other robo-advisers to the performance of Hedgeable’s clients during the same period in a “Hedgeable Composite.”. The Robo-Index and Hedgeable Composite were misleading because the composite only included a small subset of the number of Hedgeable’s clients, and the calculation methodology of the Robo-Index was not based on the two other robo-advisers actual trading models. Hedgeable also did not maintain enough documentation to substantiate the returns presented in the Robo-Index or Hedgeable Composite. Hedgeable was ordered to pay a civil money penalty of $80,000 and to cease and desist from causing any present or future disclosure violations. (link to complaint: https://www.sec.gov/litigation/admin/2018/ia-5087.pdf)

C. Dabney O’Riordan, Chief of the SEC Enforcement Division’s Asset Management Unit, commented: “Technology is rapidly changing the way investment advisers are able to advertise and deliver their services to clients. Regardless of their format, however, all advisers must take seriously their obligations to comply with the securities laws, which were put in place to protect investors.”

More information about robo-advisers is in a bulletin published by SEC’s Office of Investor Education and Advocacy. (link to bulletin: (https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-robo-advisers)

https://www.sec.gov/news/press-release/2018-300

If you have questions about your company’s compliance with provisions of the Investment Advisers Act of 1940 and SEC disclosure requirements, call Wilson, Bradshaw, & Cao, LLP today.

“Merit Regulation” called to bring in the government to determine the reliability of the securities that were being sold. Of the many bills presented to Congress, this bill was received better by members of Congress. However, many still did not want any sort of government’s intervention, but wanted the private investors be the ultimate arbiters of the investments. To create the final document that would be accepted by Congress, the current president, President Roosevelt, asked Felix Frankfurter, alongside James Landis, Thomas Corcoran, and Benjamin Cohen, to make a “disclosure” statute.

These draftsman kept the same structure that Thompson had drafted, but added their disclosure scheme, which was developed modeled after the English Companies Act of 1929 and certain state securities regulation statutes. They added significant liability for the participants in the securities offerings. Those liabilities would lead to the implementation of the Securities Act of 1933. This was the first step to the federal regulation of securities. It covered many topics from the requirement of filing a registration statement with the Securities and Exchange Commission prior to the transaction of securities with the investor, to creating a detailed and intricate liability scheme for misinformation that is given to the investor during any part of the transaction.