September 27, 2010
SEC Charges: True Facts and Misleading Positive Spin
The SEC announced charges on September 21 against a Minnesota attorney (who left his partnership to run the fund) and two Bay Area fund promoters for misleading investors. (Complaint here.)
The SEC asserts that, initially, the fund's sole business was to make real estate loans to one business partner. After that business partner defaulted, the SEC alleges that the defendants continued to raise money, even though they "had no meaningful income" and were instead using the new investor funds to pay their original fund investors. The defendants raised this money by claiming that they were in a position to take advantage of the real estate market collapse, but the SEC asserts there was no such possibility. In a statement, the SEC's Chicago Regional Director explained: "Investors were entitled to know true facts rather than the misleading positive spin that [was] provided."
I don't love the phrasing, but it's an interesting way to frame the case. It's certainly reasonable that the the SEC would want to ensure investors have access to "true facts" (as opposed to any other kind of facts). And I suppose the SEC is trying to send a message that what might be (in the mind of some business people) justified as "positive spin" can, nonetheless be "misleading" under Rule 10b-5. I see the point; when we discuss disclosures in my course BA courses, I often borrow Dwight Drake's recommendation (see his book here) to lay out all risk factors for the offering and to "stay clear of bold adjectives." As he puts it, "You are protecting here, not selling."
Further, it seems to me that a "misleading positive spin" on the investment implies that the SEC will be taking a hard line on those soliciting investors, expanding beyond just those, for example, who "lied" to investors. The only concern I would have is that "misleading positive spin" also seems to imply an argument that the positive spin was not knowing or reckless. That is -- positive spin implies that there's some truth there, it's just truth with the best possible framing. I haven't forgotten that Rule 10b-5 also covers material omissions; I'm just saying it's kind of soft language and might elicit sympathy in some corners.
Personally, I'd go for something stronger in my statement: "The investors were entitled to all the necessary facts, not a deliberately misleading set of cherry-picked items designed to hide the realities of the investment." Just a thought.