Year: 2017

Crowdfunding – Letter to the SEC

Capital Markets, Issuers , , ,

The SEC and New York University recently held a dialogue on securities crowdfunding.  SEC Commissioner Kara M. Stein offered closing remarks and asked some questions that need to be answered. https://www.sec.gov/news/statement/stein-closing-remarks-sec-nyu-dialogue.html. These are my thoughts and responses to Commissioner Stein’s remarks.

Dear Commissioner Stein:

By way of background I am a securities attorney with 40 years of experience representing broker/dealers, issuers of securities and large and small investors.  I have also taught economics and finance at a well reputed business school.

My interest in securities offerings that are made directly to investors over the internet goes back to the late 1990s when the first offering was made by the Spring Street Brewery company. I have spent the better part of the last two years studying and writing about crowdfunding under the JOBS Act.

I currently advise clients who are issuers, Title II platforms and Title III portals.  I believe that crowdfunding can work and that it can be a valuable tool in aid of the capital formation process especially for smaller companies.

To this point in time, a large percentage of successful offerings involve various forms of real estate investments. The vast majority are being offered under Regulation D. Several real estate funds have raised $25-$50 million from accredited investors on Title II platforms. Thousands of smaller real estate offerings have also been successful. These offerings are proof that funding is available outside of the traditional broker/dealer sales network.

Small companies and start-ups on the other hand, have had a much more difficult time attracting investors.  Start-ups, of course, are far riskier investments than most real estate offerings.  There are far fewer investors in the market place who are looking for that risk.  Some will take on the risk if they are satisfied with the potential for the company’s success.

There has been a push to offer securities in these companies to smaller investors under Regulations A and CF on Title III portals. The question that you asked in your remarks at the SEC-NYU dialogue: “Are registered portals appropriately considering the companies and offers hosted on their platforms?” is the appropriate question to ask.

There are fewer than 2 dozen registered portals today. I have reviewed offerings on most and have had direct contact with several. The answer to your question is that some of the portals do indeed act appropriately and several clearly do not.

You can easily identify those portals that do not comply with the rules. Most of those do not have a well trained and experienced professional in the role of compliance director.  The compliance director at any Title III portal should, at the very least, have a complete familiarly FINRA’s due diligence and advertising rules.

There are several portals who do not even attempt to conduct a due diligence review. There are also several consulting firms that provide due diligence investigations to the crowdfunding industry that lack the experience or expertise to do it correctly. These consultants get a lot of work from the portals because they charge very little.

You asked whether there should be minimum and uniform standards for vetting companies seeking to be hosted on a portal.  FINRA already has very specific rules for due diligence that require the member firm to verify the facts that the issuer is presenting to investors.  New rules are not needed; just compliance with and the enforcement of the existing rules.

One FINRA member portal in particular that has specialized in Reg. A offerings has listed several issues which are questionable in terms of their disclosures and economic viability. That portal makes no attempt to vet the offerings it lists.  One of these offerings is currently the subject of an SEC enforcement action.  I cannot know if the Commission’s enforcement staff intends to sanction the portal for its participation in that offering.  In my opinion, it should.  This portal unfairly competes with the portals that take their responsibilities seriously.

This portal does not spend money on due diligence. It does not care whether the issues it lists misrepresent their prospects for success to prospective investors.  It has a track record of successful offerings because the issuers are making promises to investors that they are unlikely to keep.

You suggested that some people have registered their concern at what may be a “race to the bottom” as portals compete for offers. That is exactly what is happening.  That same portal is currently offering a one day Reg. CF workshop that provides issuers with accountants, lawyers, copywriters and other vendors to get their campaign to “go live” on the same day as the workshop with no cost.

I cannot imagine that the SEC staff or FINRA would believe that adequate due diligence is being done if the offering is going live on the same day that the portal is first introduced to the issuer. I cannot personally believe that a competent securities attorney would participate in the preparation of these offerings or that the attorney’s professional liability carrier would approve.

Your presentation also noted that FINRA had expelled a portal for listing 16 questionable Reg. CF offerings. Those offerings were essentially done with a “cookie cutter” approach. What besides a cookie cutter approach can be expected when a portal is proposing to create and list multiple offerings on a single day at a workshop?

I have singled out this portal because its conduct is so egregious that I suspect that the Commission staff has already taken note.  I am not the only person in the crowdfunding industry who would understand if FINRA or the Commission did its job and closed this portal down.  If the crowdfunding industry is to succeed, investors must be able to look to this market with confidence.

You also asked what needed to be done to ensure that crowdfunding opportunities are accessible to everyone from the businesswoman in Missouri to the immigrant in West Virginia.  I have personally been contacted by potential issuers from all over the country. I know that Title II platforms exist in many states and several portals are “under construction” outside of major money centers.

Many of these issuers lack the knowledge and skills to put together an offering that might attract investors.  They lack experienced managers, quality boards of directors and well thought out business plans.  The Small Business Administration (SBA) has an existing mentoring program (SCORE). The Commission would be doing the marketplace a service by partnering with the SBA to make accurate information about crowdfunding available to more potential issuers.

There is currently a lack of good information about crowdfunding in the marketplace and much of the information that is available is inaccurate.  Much of the information about crowdfunding is being disseminated by a remarkably small group of people.  Many of these people have no experience selling securities and treat the process as if they were selling soap powder.

You expressed a desire on behalf of the Commission to improve this marketplace. There are those who are advocating making these very risky investments more accessible to small investors. I urge the Commission to reject that approach.  The risk should be allocated to those investors who can afford to absorb the loss.

As you noted, “portals that are effective at vetting issuers and offers are important as both gatekeepers and facilitators of repeat investment.” Keeping the portals focused on that task is the best thing that the Commission can do for this market.  Investors will come when there are better offerings. Better offerings will come when the portals insist that issuers demonstrate that they have real potential for success.

Respectfully,

 

Irwin G. Stein, Esq.

 

 

 

FINRA Arbitration – Why Customers Lose

Law

There are a number of commentators, including some consumer groups, who believe that FINRA arbitration is inherently unfair to public investors.  I have heard these commentators refer to FINRA arbitration as a “kangaroo court” where investors do not get a fair hearing because arbitrators are biased.  Evidence of that bias has never been presented.

Surprisingly, some of the most fervent critics are lawyers who regularly practice in these forums.  I can only wonder if they voice their concerns or make a written disclosure when they are asking new clients to engage their services for arbitration at FINRA.

For many years, both parties were required to state on the record at the end of the hearing that they had been afforded an opportunity to fairly present their evidence to the panel. It was rare when someone on either side of the table refused to state that they had.  I think that I refused once in 40 years practicing before FINRA arbitrators and their predecessors.

Much of the “evidence” of bias and unfairness is based upon statistical research.  The researchers start with the mythical assumption that customers should win at least one half of the claims that are brought. That assumption has no basis in fact and belies the fact these claims are far easier to defend than to prosecute.

I was a pretty good defense attorney when I was representing firms for the first 15 years of my career. I learned a lot more about how to defend a brokerage firm from the defense lawyers with whom I tangled during the last 25 years representing customers.  The brokerage firms are almost always well represented and the critics of FINRA arbitration should give some credit to the defense where it is due.

Investors are generally better educated and more aware than average consumers.  A claim against a stockbroker is not the same as a claim against a drunk driver.  Investors usually know that the stock market goes up and down and that they can lose money every time that they invest.

“I lost money” or “I lost more money than I thought I would” may not be the basis for a claim without some affirmative bad act by the broker.  To be successful in a claim the customer may have to prove that the broker or brokerage firm did something out of the bounds of appropriate conduct and that the losses are a direct result of that conduct.

Many of the claims at FINRA involve its “suitability” rule.  The rule requires brokers to ascertain whether the customer understands the risk of loss from a particular investment or strategy, whether they want to take that risk and whether or not they can comfortably afford to take the loss should it occur.

A customer who claims at the hearing to be a conservative investor but who checked the box that they would still be comfortable if the account value declined by 20% is going to have a hard time convincing the panel that they were truly conservative. A 20% decline in account value is not a conservative loss.

Likewise, a conservative investor who follows the broker’s recommendation to invest in stocks is not conservative because there is no such thing as a conservative stock or portfolio of stocks.  Truly conservative investors buy bonds because they want to conserve their account value.

The brokerage industry collects information on a new account form and sends out monthly statements as a way of protecting itself, not the customer.  Customers who do not read the account application form, check the boxes even if the boxes do not set forth what they really want or who sign the forms with some items left blank have only themselves to blame.

Customers receive account statements every month but many never read them or claim at the hearing that they could not understand them but never asked for help.  With statements that are delivered on -line or through e-mail the brokerage firm will have a record of when the statement was sent, when it was opened and in some cases how long the customer spent on-line reading it.

When you get an account statement and do not complain about the transactions or positions in your account the firm will assert a legal defense called “ratification and waiver”.  Once the customer is notified and identifies a problem, they cannot just wait and see what happens next.  Invariably, the losses may get worse.

It is not unfair for a defense attorney to ask the customer a question like “Your account declined in value for 6 months, you knew it because you read the monthly statements and you did not complain about it. Why should the panel now believe that these losses were unacceptable to you?”

In many cases the response will be: “I spoke with the broker and he told me to stay the course and the account value will come back.”  Of course, the broker cannot know what the market will do in the future.

The legal term for this is “assumption of risk” which is what the customer is doing. Once informed that the investments have lost value, the customer is assuming the risk that the account may decline further by not demanding the broker sell the investments that they are now telling the arbitration panel were unsuitable because they were too risky.

Some claims assert that the broker committed fraud. This is frequently the case where the customer bought a private placement, such as a non-traded REIT, and all of the facts that should have been disclosed were not. Where the true facts could have been ascertained with a reasonable amount of due diligence, the brokerage firm is usually liable.

But to succeed on a claim of fraud, the customer must show that the loss was caused by the fraud.  This is not always easy to do.  A customer who was suitable for a real estate fund was not always awarded compensation for their loss.  This became evident after the real estate market collapsed in 2009.

In the case of a non-traded REIT that committed fraud by failing to disclose the operator’s many lawsuits, it could still be shown that the fund collapsed because the properties it owned suffered from high vacancy rates.  Defense attorneys will argue, often successfully, that the customer would have suffered the same loss if the broker had sold him any one of a dozen other REITS that the firm was offering which did not misstate the facts about the operator’s history.

Consider that a stockbroker is a trained salesperson who can usually look the arbitrators in the eye and tell a convincing story. They usually testify well and seem to always remember all the pertinent facts that will discredit the customer’s case. Customers, on the other hand, are often not as good on the witness stand.

All of this would be equally true if these cases are brought in court. Judges and juries are far from perfect and can be biased or worse, they just miss the point.  That is less likely to happen where one of the arbitrators is a representative of the securities industry like a retired branch office manager. A good branch manager who has been listening to stockbrokers for years can often ferret out the truth.

The essential difference is that aggrieved investors can wait years to get a jury trial and spend thousands of dollars on pre-trial motions and depositions before they get there.  Arbitration is quick and inexpensive.  The customer’s counsel usually does better if they understand the transaction from the industry point of view.

Finally, there is a tendency by some lawyers to try to prove too much. In a court case, a lawyer will plead all the alternative ways the court might find the defendant liable to his client.  I never recommend doing thatin an arbitration. Too often, there is a lot of testimony about things that arbitrators do not care about.

A customer in arbitration will always do better by telling the arbitrators “I would not have lost this money if the broker had acted appropriately.”  Arbitrators are fact-finders. Stick with the facts.

I am a fan of FINRA arbitration. Over the years I participated in more claims than most other attorneys.  If I thought FINRA arbitration was biased against the customer to the extent that I could not win, I would have stayed on the defense side of the table.

Any lawyer who frequents courthouses will tell you that there are judges that they do not like for one reason or another.  None would think to argue that the entire system is rigged.  The lawyers who complain about FINRA arbitration should do something else. If you cannot make FINRA arbitration  work, leave it to the lawyers who can.

 

 

 

 

 

Crowdfunding – Impractical Business Plans

Capital Markets, Investors, Issuers , , ,

There seems to be an overriding attitude in the crowdfunding industry that it exists solely to provide access to capital to small entrepreneurs who have previously been denied access by the evil barons of Wall Street.  Many people in the industry are amazed when I tell them that under the regulatory scheme in the US, the owner of an equity crowdfunding platform or portal is in the business of selling securities and every sale that they do is highly regulated.

The regulations include provisions that are firmly rooted in the idea of investor protection. The regulators will never accept the idea that investors in the crowd can be left to fend for themselves or that proper disclosures do not have to be made. Equity crowdfunding is not a caveat emptor marketplace.

Small investors are being hyped with the idea that crowdfunding portals are offering opportunities for them to invest in the next Facebook or Amazon that will turn their modest investments into huge profits. Investors are actually being offered shares in breweries, distilleries and a lot of small companies with dubious products and often inexperienced managers.

In the mainstream financial market, virtually all of the brokerage firms are members of FINRA so the rules are uniform one firm to the next. In the crowdfunding marketplace only those Title III portals that sell offerings to small investors under Reg. A or Reg. CF need to apply for FINRA membership.  That was intended to provide an extra level of protection for smaller investors.

Unfortunately, some of the portals do not seem to understand their responsibilities as FINRA members.  Several have no personnel on staff with any experience in any aspect of selling securities, let alone compliance with the regulations.

When FINRA expelled crowdfunding portal UFP (uFundingPortal) late last year, in part for listing companies with “impractical business plans”, I expected to see some articles or at least comments from some members of the crowdfunding community about impractical business plans.  The silence from the industry and industry experts has been deafening.

So what, exactly, does FINRA mean when it is telling crowdfunding portals not to list a company that has an “impractical” business plan? It starts with what the company that is raising money is trying to accomplish and whether or not the business plan has a reasonable chance of getting them there.

Everyone would agree that a company that is raising $100,000 and promising that it will be enough money to build a skyscraper in Manhattan or to develop a drug that will cure all cancers has an impractical business plan.  The same would be true if the skyscraper was not designed by an architect or the drug was intended to be sold without FDA approval.

A business plan that suggests that the company will sell one million units of its product using social media would be impractical if the company did not have some way of backing-up that assertion.  FINRA has a consistent policy that requires that there be a reasonable basis for all sales and revenue projections.

As the regulators move forward they will likely find that a company that intends to market a product that infringes on another company’s patent has an impractical business plan. It is also impractical to raise funds to operate a business that is illegal, like a brothel. But not every case will be as clear cut.

The FINRA regulations governing these portals are in addition to the regulations that stem from the federal securities laws. They require additional work and additional skills. Being able to identify and eliminate impractical business plans is one of those skills.

This will make it more expensive to operate a Title III portal than a Title II platform.  Potentially, it is also far more lucrative to be able to accept investments from a larger group of smaller investors.  If you are operating a FINRA portal but you do not have people on staff or as advisors who have experience working at FINRA firms and a clear understanding of what is expected, then I suspect that FINRA will tell you that it is your business plan is “impractical” and put your portal out of business.

In the mainstream markets, FINRA and the SEC have begun enforcement actions signaling that they intend to hold the compliance directors at the brokerage firms personally liable for unlawful transactions that took place on their watch.  I would wager that at least a few of the compliance directors at the 2 dozen or so crowdfunding portals already have regulatory targets on their backs.

I just completed the paperwork for a client who is making an offering through one of the better crowdfunding firms. The offering documents, risk factors, and advertising materials were all reviewed by the firm and the comments demonstrated to me that the reviewers were knowledgeable, competent and well-versed in the rules and requirements. It is not all that hard to comply with the rules if you know what you are doing.  The portals who follow the rules are generally the ones who hire people with some relevant experience.

At the same time, it is very easy for anyone to find crowdfunding portals that are actively inviting small investors to invest in companies that are, for want of a better word, crap.  A portal that lists even one company that would garner this distinction is not doing its job. To my mind, it makes every other offering listed on the portal suspect.  If you cannot make that distinction, you should not be investing at a crowdfunding portal and you certainly should not be operating one.

Please do not push back and tell me that it does not really matter because most start-ups will fail anyway or that investors in these companies know that they are really gambling.  Even casinos are regulated and are expected to operate correctly and in accordance with the rules.

This issue is not that most start-ups fail. The issue is that any start-up funding on a crowdfunding portal should have at least a legitimate chance of success.  They should know how much money they will need and how they will spend it. There is nothing wrong with raising funds to conduct research and development for a new product as long as there is a demonstrable market for the product and the company has people on staff or on hand to conduct the research.

I realize that insisting on “practical business plans” will eliminate a fair amount of the companies that are currently trying to get funded on the crowdfunding portals. That is exactly the point. The JOBS Act was supposed to help companies that could provide sustainable jobs.  Funding companies that are here today and gone tomorrow was never anyone’s idea of what this legislation was intended to do.

The capital  markets, like all markets, work best when they are efficient.  Funding companies that are not likely to succeed is never efficient.  Efficiency results when the companies that have the best chance of success  get funded and those with little or no chance of success do not.

People in the crowdfunding industry tell me that the problem is that the industry is new and just finding its way.  They want to be excused from regulatory compliance until they figure out what to do.

Except that what the crowdfunding portals are doing is not new. People have been selling securities to investors for a long time. The only reason some of the portals are not following the rules is that they do not want to spend the money to do it right.  If they do not believe me, they can explain it to FINRA and the SEC, who are not likely to give them the fair warning that I keep trying to offer.

 

The Artificially Intelligent Lawyer

Law ,

In the last few months I have read several articles that suggested that artificial intelligence will soon transform the practice of law. The general spin of the articles was that artificial intelligence would eventually take over many if not most of the tasks currently performed by lawyers and perform those tasks much better than we mere mortals.

Forgive me if I question the validity of this idea. It is not that I am anti-tech or just too old to appreciate what technology can do.  To the contrary I have been a user of technology all my professional life and I fully appreciate that it has exponentially increased my productivity and reduced my costs.

When I started my career as a lawyer, I dictated to a secretary who took my words down in shorthand and typed them up. She made copies using carbon paper. My first personal computer was an Apple II and later the first Macintosh.  Over the years, using ever better personal computers, my personal productivity has greatly increased and the quality of the work that I put out has gotten better and better.

So I certainly appreciate that technology can be a tool that helps lawyers perform better. But the idea that tech will replace lawyers or do some of the tasks that lawyers do, makes me pause.

I certainly am not the best lawyer who ever wrote a contract or legal brief.  I fully acknowledge that over time, I got better at both by working with and often against lawyers who were better than I was. Lawyers learn from each other.  So I question the idea that machines can learn how to be better lawyers much faster than human beings and that they will quite easily surpass the best of us, if they do not interact with lawyers.

I acknowledge that a computer can research the universe of case law on any subject far better and much faster than I can. I will admit that a computer can assemble those cases into a brief that will be more on point than anything that I can write.  But the best brief is not always the one that carries the day.

Years ago, in the days before personal computers, I had dinner with a single practitioner who had a rural, small town practice.  He was fresh off a victory against the largest law firm in his state in a contested land use matter.  He was complimenting the brief that the other firm had filed, noting that it was extremely well researched and had included myriad footnotes citing cases and authorities from all 50 states. He told me that he thought that the brief was good enough to be published as a law review article.

His own brief had cited a single legal treatise and the cases in it. He was successful because the nearest law library was two hours away and in that small town that treatise was “all the judge had and all the judge used.”

If an intelligent computer is writing a brief, then it is fair to assume that eventually it will put out the same brief on the same points of law for all for cases with similar facts and issues.  It is fair to say that the computer should make the “best” argument every time.

As long as we are still arguing cases in front of judges who are not computers, knowing the arguments to which a particular judge might be receptive can be at least as important as knowing the best arguments that could be made. Trial judges are not perfect and not uniform in their interpretation of the law.  I cannot imagine how a computer will input information about a particular judge’s preferences, prejudices or idiosyncrasies.

I spent a lot of years doing arbitrations at FINRA over investments that went bad. Both the plaintiff’s bar and the defense bar practicing in these forums is pretty small and I would see the same firms and often the same lawyers on the opposite side of a lot of cases.

A lot of defense firms have a playbook. They know what arguments they are going to make to the arbitrators and what questions they are going to ask witnesses in every case with a similar fact pattern. After a while, I got to know the playbook used by different defense firms.  Knowing what a specific defense lawyer was likely to ask helped me to prepare witnesses.

Knowing what these lawyers were likely to argue in rebuttal of the arguments I was making caused me to change the emphasis of my arguments, case to case.  I would sometimes try two or more cases involving the same investment differently, just to keep the opposing lawyer a little off base.

Seeing the same experts used again and again helped me to understand where they were strong and where they were weak.  Will an artificially intelligent computer ever get intelligent enough to understand how an individual firm is likely to defend a case or how an individual expert is likely to respond to cross-examination?

When I write a contract I do not just put boilerplate together. I try to understand what the client needs and expects from the underlying transaction.  Part of it is trying to predict the future; understanding what might precipitate a breach by either party or how a court might interpret the language that I am putting into the contract should the need arise.

The law is dynamic; it evolves. Will a computer actually be able to see trends in the law and to predict how it is likely to evolve?  Will a computer be able to disregard decisions from another era when attitudes, statutes or procedures were different?

Juries are often hard to predict even after the trial. If you do not believe me, ask any lawyer who has spent time pacing the courthouse hallways waiting for a jury to deliberate. If you’ve done it enough, you have certainly been surprised by a jury’s verdict, probably more than once.

More importantly, will a computer be able to explain to a client the emotional side of writing a will, getting a divorce or  filing a lawsuit against a  family member?  Having those conversations is part of the practice of law and it takes some amount of “emotional” intelligence to do them well.

Nothing that I have read about artificial intelligence indicates to me that this type of “artificial   emotional intelligence” is in the offing. Rather, artificial intelligence is the ability of a machine to analyze and assimilate data and to draw logical and rational conclusions from that data. That may help some, but it does not replace the very human interactions that clients have with their lawyers. If clients were always logical and rational they would not need lawyers in the first place.

 

Crowdfunding Fraud –Lessons from Elio Motors

Investors, Issuers , , , , ,

A colleague suggested that the demise of Elio Motors would be a “teachable moment” for the crowdfunding industry. This lesson is necessary because too many people who are active in the crowdfunding arena would not know a scam if one bit them on the butt.

The lesson is that people who operate crowdfunding platforms or portals should have some background in corporate finance. The lesson is being paid for by the investors who made a $17 million investment in Elio and got nothing for it. These are losses that would have been avoided if the crowdfunding portal that listed Elio had operated correctly and refused to list it.

I raised questions about Elio when it was making its offering last spring. At the time it seemed to be a lot more hype than substance. That offering was ongoing at least until March.

By the end of September Elio was already bankrupt even if it has not formally filed the paperwork. Its balance sheet showed less than $5 million in current assets and more than $30 million in current liabilities. Elio had less than $100,000 in unrestricted cash on hand on September 30. Elio would likely have already closed its doors if it had not borrowed another $3 million at the end of last year.

Elio spent all of the money that investors put up and more in less than 6 months. That money was spent on “soft costs”, mostly administrative costs and R&D. Elio actually needs more money to get its vehicle into production now than before the offering.

Elio has been held out as one of the first great successes of the crowdfunding industry. It was one of the first offerings to file under the new Reg. A and one of the first to come to market. The offering was deemed a success because it raised $17 million from thousands of small investors.  Elio attempted to raise $25 million and raised $17 million. In the world of finance that is a failure, not a success.

Elio executives made the rounds at crowdfunding conferences last year, basking in that success and telling attendees how to raise money. Elio attracted investors the same way that Bernie Madoff did; by making promises about their future performance that they knew that they could not keep.

Elio has been taking deposits for its 3 wheeled, gas efficient vehicle and was first promising to deliver the vehicle before the end of 2014, then 2015 and then 2016.  Let’s be clear, there is no vehicle; certainly not one ready for production that could be delivered to the 65,000 people who put down a deposit to get one.  If you take someone’s money promising to deliver a product that you know you will not be able to deliver it is fraud.

Elio had also very publically promised to have its manufacturing facility in Shreveport, LA operational before the end of 2015 creating more than 1500 jobs. That promise of “we are getting ready to start production” was one way in which Elio bolstered its claim that it could deliver the vehicles. A lot of people in Shreveport were excited at the time, but those jobs never materialized. Today, a lot of people in Shreveport are very angry.

That same financial statement indicates that for the entire year of 2016, Elio spent about $1 million less than the year before on maintenance, insurance and property taxes for that Shreveport facility. Elio has been selling off manufacturing equipment at that facility to pay its bills, not gearing up to produce its vehicles. The financial report says that it still needs $300 million before it can start manufacturing. If it does not get substantial additional financing soon Elio admits that it may have to cease operations.

You can go to Elio’s website today and still put down a deposit believing that you are purchasing one of the vehicles at a reduced price. If a thousand people would each send me $100, I promise to send each of you a picture postcard from a beach in Bali. That is not much but it is more than you are likely to get from Elio.

At the time of the Reg. A offering, Elio represented that it hoped to obtain a $165 million loan from the US Department of Energy and still mentions that loan program in its recent financial statement. Elio does not qualify for that loan program, then or now.  Mentioning the program in the offering is what is known as “window dressing”; something that makes the company look more substantial or potentially successful than it is.

The fact that Elio did not qualify for the loan at the time of the offering and the fact that Elio had been taking deposits for a vehicle that it could not afford to manufacture should not have escaped the due diligence review conducted by StartEngine, the portal that listed Elio’s Reg.A offering.   The compliance director of StartEngine told me that they do not even attempt a due diligence review of Reg. A offerings based upon the mistaken belief that they are not required to do so.

Any crowdfunding portal that fails to conduct an adequate due diligence investigation does not care if investors who invest through their portal get ripped off.  I speak with start-ups that are interested in crowdfunding every month.  I only refer them to platforms or portals that follow the rules.

What will the regulators do about this? Perhaps nothing.  Regulators do not rectify every situation.

Still, as regards Elio it is not hard to imagine the conversation between someone in Shreveport who put down a deposit for a vehicle that will never be built who happens to share a duck blind with an Assistant US Attorney. As I said Elio is still taking deposits and apparently will continue to do so until some government agency stops them.

The SEC has already issued an order halting the Reg.A offering of Med-X, another offering listed on StartEngine. That case is still under investigation and it should be a lot easier for the SEC to prove that StartEngine did not act appropriately as the facts in the Med-X case are fairly clear cut.

FINRA recently expelled another portal claiming its offerings presented “impractical business plans.”  Exactly what FINRA meant by that would take another article. Suffice it to say that raising $17 million when you need $250 million and claiming most of the rest will come from a government program for which the company does not qualify is a business plan that is “impractical”.

Secondary market liquidity is an important aspect of Reg. A offerings. Companies that register their shares under Reg. A can also list those shares for trading in the OTCQX market. Investors who take a chance on these small companies have a way of selling their shares which investors in private placements cannot.

As of last Friday, the bid and asked for Elio shares was over $8 despite the fact the financial statements have been public for 2 months. Regulators might reasonably look at the liquidity and efficiency of that market as well.

Some people will tell you that crowdfunding is for start-ups most of which will fail anyway, so why bother to follow the rules and do it right? That is like saying everybody dies sometime, so why not drive around drunk.

The capital markets work because they are regulated. Regulation gives investors confidence.  If Elio turns into a well publicized scandal it is likely to scare investors away from the entire crowdfunding marketplace.

If you are operating a crowdfunding platform or portal and are too ignorant or too arrogant to follow the rules that keep scam artists out, please find another business. Neither the issuers nor investors want them around.

Stopping Elder Financial Abuse

Investors, Law

What happens to retirees in the financial markets is a national disgrace. It was so in 2015 when I wrote a book on the subject (the one with the shark on the cover in the right margin of this blog). It is still available on Amazon.com and I still give the proceeds that I receive to cancer research. Little has changed since…but it could.

Retirees who have been fortunate enough to put away $500,000 or more to cover their retirement expenses know that very few of their contemporary baby-boomers will have as much.

Much of the discussion about elder fraud centers on caregivers or relatives who help themselves to a senior’s checkbook. To a lesser extent, it is about educating seniors to avoid scam artists, phony charities and telemarketers.

Very little time or money is spent focusing on how the mainstream financial industry acts to rip off seniors and retirees. I suspect this may be because many of the not-for-profit organizations that are active in this area also count banks and mainstream financial firms among their donors and advisors.

The financial services industry offers no real training for financial professionals on how to spot cognitive impairment in potential customers who are senior citizens. The general attitude of the industry towards seniors is that if they have money and want to invest then the financial services industry is here to assist them.

Most retirees (and most investors) purchase the investments that their brokers or advisors recommend. We acknowledge that financial professionals know more about the financial markets and about any particular investment that they are recommending than we do.

Post-retirement investing is not that complicated. For most people it is absolutely essential that they get it right. For everyone, it should be absolutely essential that they do not get it very wrong.The person from whom you seek financial advice is the key person who will be responsible for determining exactly how much money you will have to spend between the time that you retire and the time that you die.

Unfortunately, there is a lot of bad information about the cost of retirement living that is built into many retirement planning models. The financial services industry is the source of much of this misinformation which skews the conversation about investing retirement funds and has become imbedded in the mainstream mindset.

For example, standard retirement calculators will tell you that inflation is a big problem for anyone on a fixed income. They suggest that a retiree’s expenses will continue to grow, year after year until they die, even if they live into their 90s.

Actually, studies show that most retirees spend less each year after a certain age as they slow down. In many cases, there is no need to take on the risk to try to make the portfolio continue to grow and grow.

Whether or not you will need long-term care and for how long is much more likely to impact your retirement lifestyle and retirement finances than anything else. Many people consider long term care insurance but you will only have a conversation about it if the financial professional whom you consult has an appropriate license to sell it to you.

Retirees frequently hear a sales pitch that seems pretty benign. Retirees are told that they can get a dependable monthly or quarterly check at a rate several percentage points higher than they might get if they kept their money in a bank or if they invested their money in bonds. The risks are often minimized, if they are considered at all.

Actual portfolio construction for a retired income investor is neither difficult nor complicated. If you need to draw a check from the account every month or every quarter, any competent financial professional should be able to help you earn anywhere between 4% (with less risk) and 8% (with more risk) per year. You should be able to peg your return with a high degree of specificity.

Investments and strategies that pay a higher return to investors generally have a higher risk of loss. Investments and strategies that have a higher risk of loss generally pay higher commissions and fees to the financial professionals who sell them.

There are no secrets here. The financial services industry, its regulators and just about every stockbroker who sells them knows that two financial products in particular, private placements and variable annuities, are too risky and inappropriate for most senior investors. These two products pay among the highest commissions of any products that a stockbroker can offer.

Even traditional asset allocation ideas are suspect given that the government has artificially reduced interest rates for so long. Many retirees are sold “high yield” or junk bond funds because the interest rates and therefore the distributions are higher.

But there is a reason that they call junk bonds “junk”. It is because the risk that they will default is higher. If they do default investors lose their investment.

All bond funds are a problem when interest rates are rising as they are now. If you have bond funds in your portfolio and your advisor has not advised you to sell them and purchase higher rated individual bonds, it is because your advisor is lazy.

There is an old saying that a rising tide raises all boats. When this market turns down (and they always have in the past) many seniors will have losses that they never expected to have. It is often because they took risks that they never intended to take.

The typical retort of the financial services industry is always the same, that they did not see the downturn coming.  Actually, it is not that they do not see it coming; it is that they do not want to see it. A market down turn is bad for business and stockbrokers seem to think that something as simple as a stop loss is too difficult to apply.

The simple fix for this vexing problem is for the compliance departments at the brokerage firms to start acting like they want to fix it. People nearing retirement age should not be permitted to purchase variable annuities or private placements unless they can afford to lose the money that they are investing. That fact should be verified before the order for one of these products is processed. This is one area where a little common sense and effort will go a long way and could help a lot a seniors avoid significant financial problems.