When do companies need to tell investors about criminal proceedings that allege their officers and directors have engaged in fraud? According to the Commonwealth of Massachusetts, it may be sooner than companies expect.
In a settlement that it made public, Realpha Assets Management, Inc. (“Realpha”) was found liable by Massachusetts for failing to disclose in its Reg A offering the ongoing criminal proceeding involving allegations of cheating, fraud and forgery against their CEO even though there had not been a conviction. Further, the criminal proceedings at issue were outside the United States, in India.
The Form 1-A, which sets forth the SEC’s disclosure requirements for Reg A offerings, requires disclosure of any legal proceeding material to the business or financial condition of the issuer, as well as any convictions in a criminal proceeding (except for traffic violation or minor offenses) within the past 5 years for its control persons. The latter requirement is U.S. focused. Here, Realpha’s CEO had not yet triggered this disclosure requirement pending a conviction (and, technically, may never because the incident was outside the U.S.). However, Massachusetts has taken a much broader view in that any criminal proceeding involving cheating, fraud or forgery that isn’t disclosed amounts to a material omission that is actionable under Section 101 of Chapter 110A of its Uniform Securities Act.
It probably didn’t help that the Massachusetts Securities Division also alleged that Realpha, whose business was to acquire single-family homes at a discount and then list them on short-term rental sites after renovation, acted fraudulently by posting stock images of properties that the company did not own on rental platforms. Allegedly Realpha would also include “Realpha Scores” and purchase dates alongside the stock photos for the purpose of inflating the size and quality of its real estate holdings and giving it the appearance of a profitable enterprise. It also didn’t help that Realpha was using multiple stock photos for the same address on different apps. These are potential facts that would invite scrutiny by any regulator.
It would appear this scrutiny led to numerous additional allegations involving other violations of Massachusetts law, such as a failure to disclose a conflict of interest, failure to make notice filings and related fee payments to Massachusetts in connection with the Reg A offering, and failure to file a consent to service of process.
Under the terms of the disclosed Consent Order, Realpha neither admitted nor denied the allegations. Nevertheless, the company was required pay a fine of $375,000 and undertake a written rescission offer, overseen by the Securities Division, to each of the 14 Massachusetts investors who had purchased securities in Realpha’s Reg A offering for a total of $19,500. Realpha has also been permanently barred from engaging in offerings of securities in Massachusetts.
The company was able to negotiate that the offering did not amount to a disqualification under the SEC's bad actor rules. But other companies may not be able to avail themselves of that outcome as well, and similar circumstances may resulted in disqualification to offer or sell any securities for 10 years under Reg A, Reg CF or any provision of Reg D.