When do companies need to tell investors about criminal proceedings that allege their officers and directors have engaged in fraud? According to some state regulators, it may be sooner than companies expect.
In a recent settlement, an issuer was found liable for failing to disclose in its Reg A offering the ongoing criminal proceeding involving allegations of fraudulent behavior against their CEO even though there had not been a conviction. Further, the criminal proceedings at issue were outside the United States.
The Form 1-A, which sets forth the SEC’s disclosure requirements for Reg A offerings, requires disclosure of any legal proceeding material to the business or financial condition of the issuer, as well as any convictions in a criminal proceeding (except for traffic violation or minor offenses) within the past 5 years for its control persons. The latter requirement is U.S. focused. In the example, the company’s CEO had not yet triggered this disclosure requirement pending a conviction (and, technically, may never because the incident was outside the U.S.). However, states have the authority to take a much broader view of when disclosure is required based on their retained anti-fraud authority, and that any criminal proceeding involving fraudulent behavior must be disclosed even before a final judgment is rendered.
In the example, the company was able to negotiate that the offering did not amount to a disqualification under the SEC's bad actor rules. But other companies may not be able to avail themselves of that outcome as well, and similar circumstances may resulted in disqualification to offer or sell any securities for 10 years under Reg A, Reg CF or any provision of Reg D.
Edited: November 8, 2022