November 11, 2022

Understanding Audits and Investigations

If you find yourself facing an upcoming audit or are expecting to deal with that scenario in the future, it’s important to anticipate how things may go. Any scenario where you're dealing with problems from the SEC is one you should prepare for. Every state has its own division that deals with audits and investigations. If you have a project that goes wrong, it’s practically inevitable that you’ll have these issues with regulators.

One Possible Scenario

The following is a scenario to illustrate what this can look like and how it can happen. This is what I experienced, and I’ve dealt with it quite a few times. My law firm represented several real estate deals in Las Vegas that went belly up within a couple of years (2008-2010).

All the investigations that I went through tended to begin the same way. An investor is dissatisfied and complains because they've lost money that they are looking to recoup. The investor reaches out to their financial advisor to complain or to their attorney because they want to file a lawsuit. The first step is the same for either of those people, and then the investor, advisor, and legal counsel are all involved.

It's taken to the state securities division or the SEC. The SEC tends to focus on larger, more significant issues and concerns. The state will handle more minor infractions, localized issues, and smaller concerns. Regardless of who attends to it, a complaint is filed. It then goes to some attorney's or investigator's desk.


When any type of investigation or audit is launched, everybody gets a subpoena. It’s the first step in the process. The investigative body wants to gather as much information as possible that they can get about this particular investment and everything you’re doing with investors.

Because they’re investors, they’re never going to look at only one problem. A problem with one single project will prompt them to ask what else you’re doing and they’ll try to find out. This is a “one bad apple can spoil the bunch” kind of situation. Investigators will start opening up whatever can of worms they can find. This all amounts to a very good reason to keep your investors happy and to do everything you can to ensure that you’re protecting them. That’s your duty.

The next step is to provide the subpoena to the regulators – not just the PPM and not just the bank statements. You want to provide every communication that goes to the investors. They'll ask about other contracts. They'll look at bank statements. They want to see if you transferred money anywhere that you weren't supposed to or whether you failed to disclose it.

One of the quickest ways to find yourself with securities issues is by having plenty of reserves in one investment and no reserves in another. Although it might seem to make sense to loan from one to the other, that’s massively misleading the investor. It’s also a potential securities fraud. It can result in minor penalties, like disclosing everything you’ve received and paying a substantial fine, or major consequences such as the right of rescission being awarded to investors. This can send you toward bankruptcy if you owe millions of dollars to investors that you can’t afford. It’s also possible to serve jail time by acting so egregiously.

No matter the outcome, it always starts with the subpoena. You'll provide information to the regulators. They'll go through absolutely everything, including all the other projects you've been doing.


Typically, you’ll get a subpoena to meet with the state or whichever regulator is handling the case. They may start deposing people beyond just the primary sponsor or salesperson. They could begin deposing other investors or vendors, acting like a grandma who wants to talk to everybody because there’s still information to gather. Once investigators have every document and feel confident that they have all the information they would expect to find, they move on to information gathering via depositions.

Following that, the regulator has a real decision and hundreds of hours put into the investigation. At that point, there’s a substantial risk. They can easily begin filing lawsuits. Often, they will file a lawsuit without providing any notice. Think of it as an effort to surprise you or get you rattled enough to open up settlement discussions.

Nobody wants to deal with the pain and cost of a trial, including the state. If it's a minor infraction or issue, your attorney and the regulators should be able to negotiate and come to a good solution. If they fail to do so, you could go to either civil or criminal court. Which court you’re sent to depends on the claims and problems that regulators uncovered.

The securities division bringing civil actions doesn’t stop them from referring the case to the FBI, local criminal law enforcement, or district attorneys to begin pursuing it as a criminal act. This should be avoided at all costs, and the best way to do that is to perform your duties. Treat your investors like family, and make sure you do everything you can to protect them. Institute the best communications practices, even when things are not going as planned. Be transparent and be open with the investors if you start stealing from Peter to pay Paul. It creates an enormous problem to do something without disclosing it to investors. What starts with a subpoena for information depositions may spiral into a concern of whether or not you’re going to be sued for everything.

Final Thoughts

Earlier, you saw an example of a scenario where a client and several people who worked with him ended up in prison. Ultimately, multiple trials were involved in that situation and many people were brought in. The outcomes for some were bleak. One man got 90 years in prison. Another gentleman in his 70s ended up with 200 years in prison and will not see the light of day again. This information hopefully illustrates how unbelievably important all of this is and that the punishments can sometimes be severe.

Lawyers would love for you to work with crowdfunding. Our primary goal is to make sure that you know and understand the best practices. We act as guides to help and inform. If it's not our firm, that's no problem. Make sure that whatever securities attorney you choose to work with provides the same level of guidance. It can be a problem when they're billing by the hour because you don't want to call with a problem. After all, it's going to cost you. Nevertheless, it's incredibly important that you do so. Sometimes you must pay the price to ensure that you're always out of trouble.

If you have additional questions, reach out to us at anytime. Our information can be found on the Contact Page under Resources.


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