November 4, 2022

How to Protect Yourself From Breaching Fiduciary Duty

If there’s a concern that you’ve been part of something that could result in legal action being taken against you, which could ultimately lead to serving time in prison, there are a few things to keep in mind. Poor or neglectful management of an LLC will most likely not result in a prison sentence. There are other areas and crimes, like fraud, when that outcome is less certain.

At this point, securities laws must be addressed. Below is a quick recount of the securities laws in the United States. Use this as a brief guide to understanding the risk and responsibility associated with involvement in securities.

United States Security Laws

The United States has two pillars of security laws – The Securities Act of 1933 and the Securities Exchange Act of 1934. From these laws come three main points or requirements. You’ll find them below, along with a brief explanation of what each of them means.

  1. Registration of securities or an exemption therefrom.
  2. Licensing to sell securities or an exemption therefrom.
  3. Full disclosure. Essentially, if there is a question or doubt about whether it should be disclosed, disclose it.

Registration

Concerning registration, the Securities Act of 1933 says all securities must be registered with the SEC by unethical state regulators or that they must qualify for an exemption. It goes on to say that it is unlawful to sell unregistered securities unless an exemption applies. Take note of the word “unlawful” in this context.

Licensing

This is similar for anyone engaged in affecting transactions and securities and selling securities. If you’re working with an account belonging to others, you are not selling shares of yourself. You’re selling shares of a corporation or units of an LLC, thus selling on account of another. In this case, you must be registered with the SEC unless there is an exemption, as it is unlawful for an unlicensed broker to induce the purchase or sale of a security.

Furthermore, except in cases where an exemption does apply, there are certain exemptions we advise our clients against taking. This is to avoid having to be licensed as a broker. The bottom line is, it’s unlawful to sell securities if you don’t have that exemption or are not a licensed broker.

Full Disclosure

This means what it says and is aimed at providing full, honest disclosure. When purchasing securities, it's unlawful to employ any device, scheme, or artifice with the intent to defraud. This includes making any untrue statement of a material fact that sounds like a fraud to omit to state a material fact necessary to render other statements not misleading. It’s not only what you say, but what you don’t say as well. It also applies if you engage in any act or practice that appears as fraud or deceit.

This is a rule called rule 10B-5 Under the Exchange Act, which is very similar to the Securities Act, which says the offer or sale of securities is unlawful. It's unlawful to employ any advice, scheme, artifice, or fraud to obtain money or property using an untrue statement or any omission to state a material fact necessary to make other statements not misleading.

To illustrate this, look at a great bit from the comedian Mitch Hedberg. He said, “I used to do drugs. I still do. But I used to.” Omitting the “I still do” would make the first statement misleading. You need the “I still do.” Even if you state that you used to engage in any transaction, practice, or course of business, without the “I still do” it would operate as fraud. The language of the Securities Act and the Securities Exchange Act are similar.

The bottom line is that it’s very important to fully disclose what you’re doing. Be honest, and don’t try to be sneaky.

Risks for Those Not Selling Securities or Directly Involved

If you’re not the one selling securities, aren’t the issue, or aren’t even involved, can you still get into trouble under securities laws? The answer can be illustrated through a situation that Kim Kardashian recently faced regarding a post she made on Instagram. The post read as follows:

"This is not financial advice, but I just wanted to share what I was told about this Aetherium Max token. They burned 400 trillion tokens, literally half of their admin wallet, to give back to the community. Swipe up to join and check these people out."

Kim was not selling the audience anything herself, and the statements that she made were true. The content of the post was not misleading. Assuming the information is accurate, and they did burn 400 trillion tokens, there is no false information being presented with what she wrote or claimed. The legal problems come because of the following:

"It's unlawful for any person to give publicity to or circulate an advertisement or communication, though not purporting to offer security for sale. But that just describes the security without fully disclosing the receipt of consideration and the amount they're up."

The issue with Kim’s post is that she failed to disclose that she received $250,000 to make it. This violated the concept of “full disclosure” as explained above, even though she didn’t post anything untruthful, to the best of her knowledge. The SEC pursued action, ultimately fining Kim approximately 1.2 million dollars. While that might not be a considerable amount of money for this particular person, it is still a notable penalty for something as innocent as an Instagram post. This is something that can be pursued and is punishable.

Your Risks and Liabilities

The situation with Kim Kardashian shows one way to get into hot water, but when it comes to your personal risks and liabilities there are a few things to keep in mind.

Investors that are harmed by your securities violations are going to have a cause of action against you. They can sue you and collect damages. They can also get a rescission, which would involve returning all the money you received from them plus interest. Under the Securities Act, they have a private right of action for other damages as well. These things can stack together to form a considerable sum.

Investors who were not personally harmed but were taken off can choose to work with the SEC. If they have information about what you’re doing, or what they suspect is being done, nothing is stopping them from taking that to the SEC. This tattletale method might get the SEC to look your way.

If the SEC pursues you, you will likely still have to return your ill-gotten gains in addition to any penalties they charge. In Kardashian’s case, she was forced to return the original payment of $250,000 in addition to the $1.2 million fine levied against her.

Consider the consequences of injunctive relief as well. Injunctive relief prohibits you from selling securities or advertising. The situation with Kim Kardashian resulted in her not being allowed to post about cryptocurrencies for three years. You stand to lose more than just what you’re paying out in penalties and damages.

The SEC has levied almost $4 billion in fines over the last year, which is an incredible sum of money. These fines are not just being brought against big operators, billionaire celebrities, or all the ones that make headlines, either. Just because you haven’t heard it reported doesn’t mean they’re not going after others, too. They pursue small operators as well, who are not equipped with the war chest to take on the SEC and battle with them. Small, average-sized operators are low-hanging fruit and there have been occasions when the SEC has acted even in the absence of investor losses or other securities violations.

Penalties and fines, as well as a permanent ban on raising capital, can also happen with state regulators, meaning that you can be banned from raising capital in a certain state. In other cases, you may even be banned from raising capital nationwide.

Who Should Be Concerned?

It is possible to serve prison time for securities violations. In some cases, securities violations are not even necessary to warrant that type of action. Department of Justice charges concerning wire fraud, mail fraud, money laundering, conspiracy, Rico cases regarding the sale of securities, etc., are all other examples of crimes that can earn a sentence. There are things to consider beyond just dealing with the risks that come with securities.

The Securities Act, Section 24, says any person who willfully violates any of the conditions of this title shall, upon conviction, be fined no more than $10,000 or imprisoned for no more than five years. “Willful violation” is the takeaway from this. Kim Kardashian could have received a prison sentence for her violation, but likely, it was not willful and was simply ignorance surrounding what was allowed. Those typically aren’t the types of cases that will result in serving time. If something is done accidentally, you will likely not face a sentence in jail or prison. Willfully violating the Securities Act, however, could warrant it.

Possible Outcomes

Under the Exchange Act, upon conviction, you can be fined up to $5 million and imprisoned for up to 20 years or both. There is a potential for very serious consequences. The DOJ may not pursue run-of-the-mill investors in favor of targeting the more egregious, blatant fraud, but the risks are still present. It is impossible to know when their attention may turn to you instead. Hoping you won’t get their attention is a large risk to take.

Legal Aid

The best way to protect yourself is to hire legal counsel. When dealing with securities and the surrounding laws, a standard-issue lawyer will not be able to help you. You need a securities attorney. Since securities insurance is expensive, it’s not typically carried out by attorneys unless it is in line with the work they do.

Before you begin selling or issuing securities, consult with a securities lawyer. The internet and other sources will not match their level of expertise.

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