Disclosure, Disclosure, Disclosure

In the annals of securities law, the maxim repeated more than any Geico commercial is: disclosure, disclosure, disclosure.

Just as location is a dominant force in real estate investing, full disclosure of material information that a reasonable investor would be entitled to know before making an investment decision is the bedrock of our federal securities laws. Any company raising money from investors, sending information to shareholders or filing reports with the SEC does so pursuant to rules that have been enunciated in statutes and carved into our court systems’ decisions for many decades:

One reason investors and shareholders are provided with lengthy and detailed reports and SEC filings is that the federal and state securities laws mandate detailed disclosures and then the regulators review disclosures in determining whether or not compliance has occurred. Material omissions can be sanctioned just as heavily as outright false statements. Did the issuing company (or selling shareholder) adequately disclose the material information that an investor would reasonable want to know in forming an opinion with regard to the purchase or sale of the security? If not, liability could ensue based upon sections 11 or 12 of the Securities Act of 1933, under the fraud provisions of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, the Martin Act in New York, or under case law decisions that have evolved both under federal and state statutes and through the common law that has become defined through thousands of court decisions.

Any investor would want to know about pending or threatened litigation that would affect the issuer’s ownership of patents protecting intellectual property essential to the company’s operations.

Any investor would want to know if the CEO/Founder had previously been convicted of fraud or had recently made bad decisions that resulted in the bankruptcy of a prior company. If losing a threatened litigation would material affect the company’s value or chances for success, who would not want to know the details of the litigation in considering a purchase (or sale) of the company’s stock?

On the other hand, is it material to the company’s operations or future if the company’s chief operating officer is being sued in an auto accident case in which no one was severely injured?

That is probably not material, and, therefore, probably not required to be disclosed. But what if the accident occurred because the COO was driving under the influence of a narcotic? And, what if it was his second accident under such circumstances? That would certainly be material; a reasonable investor would want to know what was being done and what was planned for dealing with this type of situation in which it is likely that there will be a serious consequence affecting   the company’s management and operations.

Any company raising funds from investors, whether in a private placement, through crowd funding or in a public offering, needs to review all of the material matters and issues that are, or could create, serious risk factors for the company. Disclosure of the material facts helps to insulate the company against future claims from investors, in the event things do not work out as planned. And, investors who are not tolerant of risk are weeded out in the process, which, in the long run, is better for the company and its management.