Drafting Disclosure Documents to Protect Against Material Omissions in Securities Offerings

Happy Halloween to all our readers!

Earlier this month, we wrote about the dangers of material omissions in private placement offerings. Basically, if you’re selling stock in your company, you need to disclose all information necessary for an investor to make an informed decision. For example, if you forget to mention that your company is about to lose half its customer base, your investors can sue for rescission, allowing them to get all their money back plus interest.

How do you make sure that you don’t forget to disclose important information to your investors? Well, the short answer is, your best option is to hire a lawyer. Disclosures need to be tailored for each industry and each company. There is no magic set of words that will protect you against material omissions.

That said, there are some general guidelines and a handful of issues that will always need to be addressed. If you’re trying to go without legal counsel or are trying to inform yourself so that you can have a more fruitful discussion with your attorney, here is some basic information about drafting documents to protect against material omissions in securities offerings:

General Guidelines

1. Provide your disclosures in writing. Technically oral disclosures could be sufficient, but written disclosures are much easier to prove.
2. The clarity of the communication is as important as substance. It is important that your disclosures are not so filled with jargon or written so poorly that they cannot be understood by your investors.
3. Technical or complex matters should be simplified as much as possible. This point is similar to the previous one–make sure that your investors can understand your disclosures.
4. It almost goes without saying, but the disclosures need to be complete. Half truths aren’t going to serve you well.
5. Don’t fail to disclose something because you assume that your investors already have knowledge about the assumed fact.

Areas of Primary Disclosure Concern

1. Risk Factors
   Risk factors are extremely important disclosures. Your investors need to be made aware of all material risks. Every company has risks; investors will not be scared away from promising companies merely because it faces many risks. For example, check out risks Google listed in its public disclosures (pages 9-21). Risk factors are usually listed in a separate section, but should be crossed referenced where appropriate in the remainder of the disclosure documents. The following are common examples of risks:
   • The untested nature of the product or service
   • The lack of a developed market
   • Foreseeability of near-term operating losses
   • Management inexperience
   • Dependence upon major suppliers
   • Dependence upon major customers
   • Dependence upon key company personnel
   • Competitive aspects of the industry or market
   • Uncertainty of dividends
   • Transferability limitations imposed by securities laws and lack of trading market
   • Regulatory concerns such as tax, environmental, foreign trade and other relevant laws
   • Pending or threatened litigation
   • Anticipated future capital requirements
   • Conflicts of interest between management and company
2. Description of Business
   A description of past, present, and future operations along with related matters such as business assets, marketing programs, major contracts, etc.
3. Management
   A description of the background of each key company member.
4. Use of Proceeds
   A description of the anticipated use of the funds you are trying to raise.
5. Marketing of Securities
   A description of the process used to market the current offering.
6. Nature of Securities Offered
   A description of the rights, powers, and attributes of the securities being offered.
7. Control
   An identification of the individual shareholders controlling the entity.
8. Financial Statements
   For companies with an operating history, balance sheets and profit and loss statements are material information.
9. Legal Opinion
   An opinion from an attorney stating that the securities are properly authorized, the issuer is in good standing and qualified to do business, is frequently included in the disclosure documents.

The adequacy of disclosures depends on the facts and circumstances surrounding a given offering and not on any technical disclosure rules.