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When Raising Money For Investment Purposes From Any Source, BEWARE

Raising money or obtaining other property for investment purposes from whatever source in Virginia, including from family and friends, implicates state and federal law.

Some may have read about the recent action for fraud filed by Andrew Cuomo, the Attorney General of the State of New York, against Ernst & Young, LLP, one of the largest accounting firms in the United States.  Some, noting that this action was not brought under the Securities Exchange Act of 1934, may have wondered from whence the Attorney General’s authority arose.  Authority arose under the Martin Act, a New York law initially passed in 1921, and amended and codified in 1982 in Article 23-A of the New York General Business Law.

What is important for those in the Commonwealth of Virginia attempting to raise money or obtain other property for investment purposes is that Virginia has similar securities laws.  Virginia’s Securities Act is codified in Title 13.1, Chapter 5, of the Code of Virginia.  As with that of the State of New York, the reach of Virginia’s Securities Act differs from, and is more extensive than, that of the federal securities acts.

Thus, when attempting to raise money or obtain other property for investment purposes  from whatever source in Virginia, including from family and friends, one should be thinking “security” and “securities legislation,” state and federal.

A “security” includes a great deal more than you might think.  Under both federal and state securities laws, the definition of a “security” includes “investment contracts,” in addition to those types of investment vehicles generally thought to be “securities,” such as stocks and bonds.

Virginia’s Securities Act defines a security, in pertinent part, as “any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral trust certificate; pre-organization certificate of subscription; transferable share; investment contract; voting-trust certificate; certificate of deposit for a security; oil, gas or other mineral lease, right or royalty, or any interest therein; or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”  Emphasis added.

An investment contract is a contract, transaction, or scheme whereby a person [1] invests his money [2] in a common enterprise and [3] is led to expect profits [4] solely [or mostly] from the efforts of the promoter or a third party.

As such, investments deemed to have been securities have included investments in scotch whiskey, self-improvement courses, condominiums, cosmetics, earthworms, beavers, muskrats, rabbits, chinchillas, fishing boats, vacuum cleaners, cemetery lots, cattle embryos, recording contracts, animal feeding programs, pooled funds and fruit trees, among others.

Fraud with respect to the purchase or sale of a security is prohibited and may result in both civil and criminal actions.  Under the federal securities acts, fraud exists where a person or entity in connection with the purchase or sale of any security (a) employs any device, scheme, or artifice to defraud, (b) makes any untrue statement of a material fact, or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) engages in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

For a civil remedy to exist for fraud under the federal securities acts there must have been a fraudulent statement knowingly made, the statement must have been relied upon by the investor, and the investor must have been damaged thereby.

Importantly, the requirements for a civil remedy for fraud under the Virginia Securities Act do not include a “knowing” fraudulent statement.  Under the Virginia Securities Act, the burden is on the defendant (the alleged defrauder) to prove it did not know of the fraudulent nature of the statement (including both omissions of important facts and untruths) and in the exercise of reasonable care could not have known.  Also, to succeed in a claim for fraud under the Virginia Securities Act, it is not necessary for the plaintiff to prove reliance on the fraudulent statement or that the fraudulent statement or omission was the cause of the plaintiff’s loss.

Thus, the only requirements for a civil action for fraud under the Virginia Securities Act are that the defendant made the statement, that the statement was false or insufficiently complete to make it not misleading, and that without reasonable diligence the defendant could not have determined that the statement was false or insufficiently complete.  Section 13.1-522(A) imposes liability for damages, interest, and attorneys’ fees on an unsuccessful defendant in a Securities Act action.  Rescission of the transaction also may be a potential remedy.

In addition, before a security may be lawfully offered or sold in Virginia, an effective registration statement must be in place or an exemption from registration must be available.

The “take-away” from the foregoing is that anyone raising money or obtaining other property for an investment of any kind from whatever source, perhaps especially from “family and friends,” should take care to obtain competent legal advice from an attorney well versed in securities law.

P.S.   The allegations in The People of the State of New York v. Ernst & Young LLP (N.Y. Sup. Ct. Filed Dec. 21, 2010) are essentially that Ernst & Young was complicit with Lehman Brothers in dressing up Lehman Brothers’ balance sheets, thereby causing them to be misleading.  From a reading of the complaint, I believe that if I were a partner of Ernst & Young I would be concerned.

Tarley Robinson, PLC, Attorneys and Counsellors at Law

Williamsburg, Virginia

Neal Robinson

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Neal Robinson

Neal specializes in corporation and business entity law, mergers and acquisitions, business planning and strategic analysis. His clients have ranged from start-up operations to well established organizations.

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Filed under: Business Planning, Merger & Acquisition, Neal J. Robinson, State & Federal Litigation by Neal Robinson

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