SEC Brings First Enforcement Action Involving Crowdfunding Regulations

Crowdfunding can be an effective way to raise funds for your business...

Crowdfunding can be an effective way to raise funds for your business. However, as highlighted in a recent enforcement action brought by the Securities and Exchange Commission (SEC), you have to play by the rules.

According to the SEC, its enforcement action against two cannabis companies is the first involving the agency’s crowdfunding regulations. The SEC also brought charges against the registered funding portal and its CEO, who placed the offerings on the portal’s platform.

“Crowdfunding offerings enable issuers to cast a wide net for potential investors, emphasizing the importance of full and honest disclosure,” Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, said in a press statement. “As companies continue to raise funds through crowdfunding offerings, we will hold issuers, gatekeepers, and individuals accountable and enforce the protections in place for all investors.”

Regulation Crowdfunding

In 2012, the JOBS Act authorized everyday citizens (non-accredited investors) to participate in equity crowdfunding. However, the SEC did not publish final implementing regulations until four years later. Under Regulation Crowdfunding, crowdfunding transactions must take place through an SEC-registered intermediary, which can be either a broker-dealer or a funding portal. Funding portals relying on the crowdfunding exemption must register with the SEC and become a FINRA member. 

Securities purchased in a crowdfunding transaction generally can’t be resold for one year. The regulation also requires disclosure of information in filings with the SEC and to investors and the intermediary facilitating the offering.

Regulation CF also sets limits on how much companies can raise and individuals can invest. The most recent amendments to Regulation CF raised the offering limit from $1.07 million to $5 million. They also amended the investment limits for investors in Regulation CF offerings by removing investment limits for accredited investors and using the greater of their annual income or net worth when calculating the investment limits for non-accredited investors.

SEC Crowdfunding Enforcement Action

On September 20, 2021, the SEC charged three individuals and one issuer with conducting a fraudulent scheme to sell nearly $2 million of unregistered securities through two crowdfunding offerings. In its complaint, the SEC alleges that Robert Shumake, alongside associates Nicole Birch and Willard Jackson, conducted fraudulent and unregistered crowdfunding offerings through two cannabis and hemp companies, Transatlantic Real Estate LLC and 420 Real Estate LLC.  

According to the SEC, Shumake, with assistance from Birch and Jackson, concealed his involvement in the offerings from the public out of concern that his prior criminal conviction could deter prospective investors. The complaint alleges that Shumake and Birch raised $1,020,100 from retail investors through Transatlantic Real Estate, and Shumake and Jackson raised $888,180 through 420 Real Estate. Shumake, Birch, and Jackson allegedly diverted investor funds for personal use rather than using the funds for the purposes disclosed to investors. 

The SEC’s complaint charges Shumake, Birch, Jackson, and 420 Real Estate with violating the antifraud and registration provisions of the Securities Act of 1933 and Securities Exchange Act of 1934. It seeks disgorgement plus pre-judgment interest, penalties, permanent injunctions, and officer and director bars.

The SEC’s enforcement action also brings charges against TruCrowd Inc., a registered funding portal, and its CEO, Vincent Petrescu. As set forth in the complaint, the Transatlantic Real Estate and 420 Real Estate offerings were hosted on TruCrowd’s platform. According to the agency, Petrescu allegedly failed to address red flags including Shumake’s criminal history and involvement in the crowdfunding offerings, and otherwise failed to reduce the risk of fraud to investors. The SEC complaint charges TruCrowd and Petrescu with violating the crowdfunding rules of the Securities Act and seeks disgorgement plus pre-judgment interest, penalties, and permanent injunctions.

Key Takeaway

While the SEC has gradually expanded the availability of crowdfunding, it has also warned that it will take swift action against those who use it to defraud investors. For businesses seeking to use crowdfunding to raise funds, it is imperative to work with knowledgeable counsel who can help ensure that your offering complies with Regulation CF and any other applicable securities regulations.

For investors, the SEC’s enforcement action serves as a reminder that securities-based crowdfunding comes with risks. Accordingly, it is imperative to conduct due diligence regarding the investment opportunity and the company offering it. The SEC’s Office of Investor Education and Advocacy has issued an investor bulletin on crowdfunding, which is available here.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Michael Sheppeard, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.