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.
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.
You might think that this amounts to little more than the company being unable offer or sell its securities in Massachusetts, so what? This Consent Order means that Realpha and each of its executive officers and directors will not be able to offer or sell any securities for 10 years under Reg A, Reg CF or any provision of Reg D – and that applies across the United States. I wouldn’t be surprised if other state securities regulators decide to open their own investigations as well. If that happens, the 10-year ban would extend further into the future because the clock would re-start with each subsequent consent order or conviction.
That is a hefty and longstanding consequence that should effectively keep Realpha’s management and board of directors from engaging in any securities offerings at all for a very long time.