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Maintaining Records, Dealing with Fear of an Audit, and Understanding Qualified Investors

February 24, 2023
Maintaining Records, Dealing with Fear of an Audit, and Understanding Qualified Investors

Whether you’re going the Regulation D route or opting for a Regulation A deal or something else, maintaining appropriate records is vital. You could be on the wrong side of an audit without these records. That can lead to fines and fees or mean something worse – jail time.

But what records should you maintain? What sort of information do you need to store? In this post, we’ll delve into maintaining those records and dealing with the fear of facing an audit. We will also touch on qualified investors to help ensure you stay on the straight and narrow.


Maintaining Records: It’s All About the Information You Keep

You’ve structured your deal. You’ve also done your due diligence and built an audience of interested investors who are clamoring to buy what you’re selling. Everything’s going well, but then you receive a notice – someone’s filed a complaint about something you said in an email. How do you protect yourself?

This is just one potential scenario. There is always the chance that someone will take issue with something you’ve said or misinterpret some of your materials and become they’re upset. The only way to protect yourself (and your deal) is to maintain records. But what, when, and for how long? Let’s explore.

1. You Lose Control of the Narrative in Any Outbound Communications

Before anything else, understand this: any information that goes out to investors is automatically out of your control once it leaves your office. Whether we’re talking about an email, an investment memo, or something else, once it goes out to others, you no longer have control over whether someone will misinterpret it.

How do you prevent that? You cannot avoid sending out updates and other written forms of communication, at least not these days. The only logical option is to use a structured form or boilerplate update that allows you to “plug and play” different information within a familiar word structure to minimize misunderstandings and the chance of things being taken out of context.

This is one reason why stockbrokers never take orders over the phone. If you’ve ever worked with one, you know that you cannot call and leave an email telling them “Let’s buy this stock and sell that one”. Instead, you must put it in writing so there can be no misunderstanding and there’s a written record of it.

You must do the same. Anything you send out, any investor communication at all, must be recorded in written form. That way, if someone says that you said something you did not, you can reference that specific communication.


2. Document Changes

Let’s face it – deals evolve. Things change over time. It’s natural and it’s not necessarily a bad thing. However, those changes must be documented.

The problem is that some of your investors might not be happy with specific changes. Depending on the situation, state or federal regulators might also be interested in those changes. To protect yourself, keep a redline version in between changes. Document what’s changing, why, and how.


3. Keep a Standard List of FAQs or Q&A Set

You will have to answer the same questions from multiple investors. However, there’s always the chance that your answers will differ depending on multiple factors, and that can cause wrinkles if you ever face an audit. A better option is to create and then maintain a standardized list of your answers to frequently asked questions (FAQs) or a standardized Q&A set.

This offers several important benefits. One of those is that you can easily answer most questions and you never need to worry that you’re telling an investor something different than what you’ve told every other investor. Another benefit is that it saves you time and hassle. You can include those FAQs as part of the investor packet, or just send it along with other correspondence to head off questions and create more informed investors from the beginning.

Finally, it ties in with one of the requirements of Regulation CF. That is, all communications with your investors must be at the portal and must be maintained there in a way that keeps them from being deleted or removed.


4. Take Precautions When It Comes to Email and Social Media

Email is a big part of modern communication, and you will rely on it during your deals. However, it’s important to take precautions here so that you’re protected in the event of an audit, and you don’t have to worry about things being misconstrued or taken out of context.

The same is true for social media. You need to have pre-approved language that ensures your bases are covered because salespeople may not think the same way about compliance as FINRA does. Everything must be fair, balanced, qualified, and supported.

Just remember that every time you put information out into the world, there’s a risk that it will be taken out of context or misconstrued. Every instance increases the risk of an audit. Working with an experienced attorney can help ensure that you’re protected here.


Audit Fears: You’ve Been Notified, Now What?

Let’s say that the worst-case scenario occurs. You receive a phone call, or maybe it’s a letter from a regulator. It could be that you’ve been subpoenaed.

What do you do now? When allegations arise, it’s natural to hit the pause button. Some firms immediately stop all activities until things are cleared up. Others operate in a limited capacity.

Here’s the thing: if you stop doing business, there’s a very real chance that you’ll go bankrupt. It can take years to clear up regulatory issues and if you stop operations during that time, there’s no income generation.

However, that does not mean that you need to press forward like nothing has changed, either. You cannot expect to emerge from the other side of an audit completely unscathed. It can also annoy the regulators and that’s not something you want to do.

You need to strike a middle ground. Don’t stop operations, but don’t barrel ahead like it’s just another day, either. Slow things down. Make sure you’re still generating profit but put the brakes on so that the regulators know you’re taking them seriously. It’s also a good idea to tone down any boiler room environment and ensure you’re qualifying investors before you talk to them about a program, even it’s a 506 C or RIA is involved.

Why does it matter if you’re qualifying investors? Regulators try to catch you doing things you shouldn’t. it happens year after year – someone sounds like a qualified investor, but if you don’t qualify them, you miss the fact that it’s a regulator plant. This also happens when someone says they were referred to you but cannot give you the name of the referrer. Always view these interchanges as suspicious and follow through with your due diligence.


Qualifying Investors: What Does It Mean?

Doing your due diligence is critical. Otherwise, you could end up on the wrong side of the law by allowing unaccredited investors into your deal. Even if you’re allowed to market your deal to unaccredited investors, it’s always wise to ensure that you get to know the people to whom you’re selling just to cover your bases and protect against regulators. You need to be asking:

  • Who are you?
  • Who referred you?
  • What have you invested in?
  • What do you do for a living?
  • What kind of investments do you prefer?
  • What kinds of returns have you seen?

Build a profile for all your investors. Questions like these also help build rapport, which can help with investment sales. The last thing you want to do is give just enough information so that potential investors only hear what they want. That route leads to the little old lady down the road giving you her pension check and then her children call the regulators and report you.

Almost every audit or investigation begins with an investor complaint. Sure, some start because a regulator caught someone doing or saying something they shouldn’t in a phone call or email, but it’s usually because an investor was unhappy. When an investor complains, it’s like tipping that first domino. A chain reaction follows, and it could mean bad things for the deal and you, personally.

That chain reaction will eventually engulf other investors, too. It’s never just one. Regulators are interested in everything you’re doing and will eventually start contacting other investors. In some cases, they may be happy with how things have worked out, but what if they’re not? At least a few might want their money back.

Where do regulators get the contact information for your investors? From your office. They have the right to subpoena that from you, as well as a great deal more. If you don’t provide that data, you violate the document request order. And remember, there’s an implication that you must comply with all securities laws no matter the specifics of your situation. It’s a lot like driving a car. You might not know all the laws, but you’re still expected to comply with them.


The Golden Rule

Ultimately, it comes down to this: do what you say you will and document everything. Sometimes investors complain. It happens. However, if you’re doing what you say you will and have the documentation to back that up, then you have nothing to worry about even if you are audited.

Also, remember that investor fears are heightened during times of economic uncertainty. As the economy continues to teeter between recession and growth, some of your investors may regret their decision and complain about it. If you’ve held up your end and have everything documented, though, you need not worry.


Legal Help Along the Way

Can you go it alone if you’re facing an audit? You can, but it’s not recommended. It can be hard to read between the lines when it comes to regulator letters and requests. You must comply with what they ask for, nothing more and nothing less. An experienced securities attorney can help you define what that is so you’re able to deliver what’s required and nothing more.

A securities attorney can also help in other ways, including guiding your responses, understanding what auditors are trying to find, communicating with your investors, and so much more.


In Conclusion

Documentation is everything when it comes to deals. It’s all too easy for things to be taken out of context or misconstrued. By documenting all communications, creating formal responses to investor queries, and ensuring that you have a set of predefined FAQs and Q&As, you can limit the potential for those issues.

It’s also important to understand that anyone can be audited. Regulators are actively looking for you to put a foot out of line. And your investors may use their uneasiness about the economy to try to get their money back even if everything you’re doing is aboveboard, so watch for those warning signs.

The best defense is having an experienced securities attorney on your side. With legal help, you can put policies and procedures in place that ensure all communication is documented. You also get help dealing with investors, handling regulator inquiries, and guidance during an audit should worse come to worse.

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