Sponsor Obligations and Securities Violations – TBD with TLG #7

Duties, Obligations, and Potential Liabilities for Sponsors

In this episode, securities attorneys Jonathan Nieh and Gene Trowbridge discuss the duties, obligations, and potential liabilities for sponsors.


JN Hi, everybody. Welcome back to another episode of TBD with TLG where your host is Jonathan Nieh and my partner, Gene Trowbridge. How are you doing Gene?
GT I'm doing fine. How are you today, Jonathan?
JNI'm doing great. I'm doing great.
GT Good, good, good, good. You notice anything new in the background, Jonathan?
JN Oh yeah, you got a nice, cool, what is it?
GTSmart board.
JN Smart board, yeah.
GT I got it, it's called the Vibe smart board. Tim at the office and I have been working on this and we brought this in and it kinda, it's a computer. What it is, it communicates with your computer and I can, this is a PowerPoint slide that's up there right now. I can do PowerPoints. I can do, I can write on there. I can make diagrams and email them to people.
GTIt's all going to be part of our new education
GT We'll figure it out, we'll figure it out.
GT So far, I've got this. I've got this so far.
JNIt looks great. It's great.
GTWe've got the logo up there. So that's great. So Jonathan.
JNMm hmm.
GT Fill me in, what is the topic today?
JN So the topic for this week, I know it's TBD. So I guess I'm determining it right now but what we're gonna be talking about today is sponsor, you know, the syndicator, his duties, his obligations to his investors and potential securities law liabilities. Right? And the reason why I want to talk about it is because recently there was a Supreme Court case that came out that, it's kind of controversial, but I guess they limited the SECs ability to go after fraudulent sponsors, to go after their ill gotten gains, right? They limited the amount of money that the SEC can go after as far as, you know, the profits that the sponsor made from defrauding investors. I guess before it was, they were kind of allowed to do punitive damages. They were allowed to get a lot more money from, you know, sponsors who were doing fraudulent stuff. So a lot of people were kind of upset, you know, saying that, oh, no, like, you know, now, you know, sponsors can kind of get away with more than they were before. But I mean, when you think about it, you know, that's just one aspect of a sponsor's liability to their investors, right? It's not just the SEC's ability to go after disgorgement. They also have rescission and there's also the criminal aspect of it too. Right? There's the securities law, there's the criminal law. So you could be prosecuted in a criminal proceeding, but I guess
GT I can tell you we didn't rehearse this because it's TBD but I can tell you when the time is right. I'll tell you this story of a guy in LA who did something that was totally against the rules and how it, how disgorgement and prison and everything worked for him. And all you're going to see after I tell you the story is, that guy was dumb. Okay. So don't, don't do that. Well, okay. Let's get started. You know, when you're going to talk about the liabilities that a sponsor has, there's a couple of ways you can figure out what that is. One of the things is you can read my book. My book on page nine through ten talks about the duties that the sponsor has. And Jonathan don't we also enumerate these duties in the PPM?
JN It's in the PPM and the operating agreement as well. But should we also point out that if someone wants a free copy of the book they should subscribe to our YouTube channel, right Gene?
GT That's right. Subscribe to the YouTube channel, and I'll put a free copy in the book, of the book, in the mail to you. It doesn't help if in fact, I don't know where to send it. So I'm not so up on what happens when you subscribe. But somehow you got to, you've got to let me know where to send it. Okay, I'll let you and Tim work on it, work on that one, okay?
GT Luckily, we got a team that could reach out to you, to our subscribers to figure out how to send the free book to you guys.
JN Oh, okay. Let's do that.
GTWe'll figure it out.
GT Yeah, this is, this is great. So, there are a number of them and I'll just cover... I'll cover, then you can cover, and we'll go back and forth. But overall, the issue is you have a fiduciary duty to the investors, not just an agency duty, you have a fiduciary duty because you're taking the investors money. You're in charge of the investor's money. So, broadly a fiduciary duty means that you're supposed to use your best efforts when working on behalf of your client. You're not supposed to work in any way that's adverse to your client's interest. Not necessarily, you're not supposed to work in your own interest instead of your client's interests which you'll hear about my story in a minute. And you're committing to use all of your exercise, to use all of your skills in whatever you said to your clients you were going to do for them in the practice of your business. Now, when we...
JNWhen you say clients I think you really mean investors Right?
GT The investors. Okay. Yeah, that's right.
JNCause we have clients.
GTWe have clients. We do?
JN Yeah, I'd hope so.
GT We have one this month, right? So anyhow, when we're doing our full day training, Jonathan, you and I always talk about the fact that we compare agency duty with fiduciary duty. And we do that because so many of our people are in the real estate business and have real estate licenses and have agency duty. When you sign a listing agreement or selling contract or property management agreement, you have an agency duty and that's contractual and sure, that's laid out in what the state law is but when you actually take people's money it moves over into the fiduciary area. And fiduciary starts with F and fraud starts with F so they kind of got you coming and going both ways. So that's my opening salvo about fiduciary duty. What else, Jonathan?
GT So, I mean, you normally see it in like a corporation setting. That's when I first learned about fiduciary duties is when I took business entities in law school, you know talked about corporations and directors of the corporation have a fiduciary duty to the shareholders. It's very similar to when you're doing a syndication, the LLC, the manager has the fiduciary duties to the members of the LLC, or if you're doing a partnership, right, the general partner has fiduciary duties to the limited partners. And it's only that direction, right? It doesn't go the other direction. Limited partners don't have any duties to the general partner. Your investors don't have duties to the sponsor. It's only, you know, it's burdensome on the sponsor only. Right? So should we...
GT Okay. So we're talking about the duties that the sponsor has. One of the duties I enumerate in the book is the duty of care. It says here that group sponsors are required to perform their duties with the care, skill, diligence and prudence of like persons in like positions. So how are you going to be judged as a sponsor when you're sitting in the witness chair? You're going to be judged based on, are you, did you use the duty of care that other sponsors of syndications like yours would use? So that's kind of broad, right? But that's the standard of care we have with the duty of care. What's another one Jonathan, we spell out in the PPM?
JN There's the duty of loyalty. So it's, you know, kind of like your duty to not have conflicts of interests with your investors. Right? So an example I can kind of think of is say you're a sponsor with a business of doing construction, right? And you do syndication. You have a fee
GT A premium, right?
JN Yeah exactly. You're basically taking money that should have gone to your investors, should have gone to the company and paying it to yourself, putting it in your own pockets. So that would be a violation of the duty of loyalty, right?
GT Yep. We, one of the duties of loyalty is to avoid conflict of interest. And one of the things I say is to enter into contracts with the company that benefit you more than the company and not profit from opportunities that are presented to the company. For example, you've got a whole bunch of money sitting in your account. You've been raising money. You're getting ready to break impounds and you go out and look at a property and you like the property. And you say, you know instead of the company buying that property, maybe I'll write an offer. And the seller asks you to prove up funds. So you show them the bank account of the syndication. You show them the bank account of your offering and say, well, I have $2 million in the bank. Well, first of all, that's fraud on the seller cause it's not your money. But if in fact you were to go ahead and buy that property for yourself using that type of a presentation that would be a breach of the duty of loyalty. And don't we have a section in the PPM where we go through the conflicts? Cause there's always conflicts.