A Best Practices Checklist for Issuers of Securities — Featuring the Dark Arts, Magic & Million-Dollar Questions

Introduction: Revisiting the Dark Arts (Or Where Part 1 Left Off..)

You need look no further than the title of Part 1 of my Article to apprise yourself of the underlying proposition behind this article — “The Magical World of Digital Security Tokens and Why You Shouldn’t Characterize Traditional Finance As a Dark Art” available at https://medium.com/@sinha.pooja/the-magical-world-of-digital-security-tokens-and-why-you-shouldnt-characterize-traditional-cf770a82213.

As I have explained in there, the extreme negative perception of traditional finance that many digital token proponents have is both incorrect and potentially also counter-productive. In this article, I follow through on the commitment I made to provide a “real life” example to support my proposition in the form of (drum roll…): A Checklist from the Traditional Finance World to Help Issuers of Securities Mitigate a Key Legal Risk: Managing Disclosure Liability under Global and Local Securities Laws.

Bringing the “Magic” to Securities Laws [Is that even possible?]

Now, I will be the first to admit that this is likely the first time ever on the planet that the words “magic” and “securities laws” have been written in the same sentence…

It is also a relative anomaly to find an interesting topic such as magic mixed into a dry topic such as securities law on a format such as Medium which is filled with some wonderful, truly inspiring articles (My favourite one from the past week : https://medium.com/mind-cafe/7-quotes-by-the-dalai-lama-that-will-change-how-you-see-the-world-and-yourself-7ed31cee855fL).

What I’m drawing upon is the analogy of a magic trick: for a lay person, mastering the trick seems overwhelming, the “how to” often isn’t readily available but once an “insider” shares the “how to” with you , you realize that it may still be difficult to master but much simpler than it initially seems!

This is precisely the core issue in securities law compliance as well- To the “outsider”, securities law compliance seems overwhelming. The reason for this of course is that both global and local securities law apply to each securities offering (Time permitting, I hope to write a separate piece explaining this further for the benefit of lay readers). Each of these are independently both confusing and complex. Even as someone who has practiced securities laws for 15+ years, I continue to grapple with its nuances, complexities and curve-balls.

Within securities laws, managing disclosure liability is another minefield. However, what is often missed is that there are certain universal fundamentals that underpin disclosure liability under securities law across the globe and as a corollary , there are also some handy universally applicable tools that can be deployed by issuers of securities to mitigate the risks of disclosure liability.

Disclosure Liability in a Securities Offering: The Fundamentals

Summarizing, my aforementioned 15+ years of experience in one fell swoop, what matters in securities law in the context of disclosure in a securities offering is as follows:

• What you say and what you don’t say
• Who you say it to
• How you say it
• When you say it

In this article, I focus on the first bullet point- What you say and what you don’t say. i.e. the content of the disclosure which is an all-important component of managing disclosure liability.

For those who want the “legalese”, bear in mind that the disclosure requirement under almost every local securities law anywhere in the world is effectively a variation of the following principles that are regarded as the international “gold standard” for what constitutes adequate disclosure:

• MUST BE “true, accurate and not misleading”
• MUST HAVE “all information necessary to enable investors to make an informed assessment of the issuer and the rights attaching to the securities”
• MUST NOT “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading”

So having set the stage for what generally constitutes adequate disclosure, lets move to the specifics of a risk mitigation strategy for managing liability for the content of a disclosure document.

Disclosure Liability in a Securities Offering: A Risk Mitigation Strategy from the Traditional Finance World

It is all too easy to get lost in the weeds of securities law compliance. One fallout of this is the assumption that any regulatory risk mitigation strategy in respect of securities law will be time-consuming and prohibitively expensive.

Drawing on my experience from the traditional securities world, let me first explain why this assumption is incorrect: Underlying any bespoke risk mitigation strategy in the traditional finance world is a universally applicable best practices framework that has developed over time to help issuers deal with the risk of managing liability for the content of a disclosure document from both a global and a local perspective. This framework can be easily deployed in the digital securities world as well with precious legal dollars therefore saved for customization of the framework to the facts on hand rather than starting from scratch.

Taking a step back, it is useful to know the context in which the best practices framework has developed- For any private placement taking place on a global scale (including one in the traditional securities law space and bearing in mind that even public offerings in a single jurisdiction typically involve concurrent private placements in other jurisdictions), the “perfect” risk mitigation strategy would be to do an individualized survey of local securities laws in each jurisdiction where an investor is based to ascertain the applicable disclosure standards.

This is obviously an expensive and time-consuming exercise. Also, such a survey may not even be practically useful: given that despite the issuer’s best efforts, communication of information in respect of the offering is often through a range of channels (although when i–banks typically run a traditional securities law deal, they have internal procedures in place to control the dissemination of information). In addition, given investments are typically made through a chain of intermediaries, it is typically impossible to pin-down the location of the “actual” investor (or “beneficial owner” as it is known in securities law parlance) at the time of its investment.

It is to tackle these constraints that a universally applicable best practices framework has developed over time in the traditional finance world. What token enthusiasts therefore fail to recognize is that the compliance challenges that they face are the same as those in the traditional securities space: But by sheer dint of being around longer, the traditional finance industry has had a head start in developing the risk mitigation tools to deal with these challenges.

In relation to managing disclosure liability, one risk mitigation tool is a universally applicable “best practices” framework that has developed in the traditional finance world to evaluate the adequacy of the content of disclosure from a legal perspective: this is the Number 1 thing that issuers can can do to manage disclosure liability. At the end of the article , I will go on to share some aspects of this “best practices” framework -in the form of an easily digestible checklist to help issuers with this evaluation exercise.

It is this “best practices” framework that I liken to the “magic trick” of a securities lawyer -in that this know-how is not readily found in one place and effectively exists inside the head of those such as I who have had the chance to practice the “dark arts” of traditional finance in many real-world scenarios over the years and has been honed by our deal experience.

Now like any “best practices” framework , this framework too is not a bullet-proof risk mitigation strategy- However, these should generally go a long way in keeping the issuer on the right side of the law.

Bonus Freebie 1: Do I Need Lawyers to Draft My Disclosure Document?

Now, if only I had a penny for every time I was asked this question, I would be chilling out on my own private island on a sunny shore somewhat like the pic below…… Unsurprising though given that “Needing lawyers” is no doubt likely to be one of the least popular phrases on the planet.

However, given the complexities of securities law, I would strongly suggestion that your international lawyers play an anchor role in drafting your disclosure document. At a minimum, they should “vet” your disclosure document to ask you the “hard” questions on what is the back-up behind any sentences that sing praises of your products or services and help flesh out the “what ifs” that go onto become risk factor disclosure [2].

To save costs, you can take a stab at preparing an advanced draft of the disclosure document internally for which the Checklist will serve as a useful reference point.

If you’re struggling with where to even start in terms of the overall structure of a disclosure document, feel free to send me a private message on LinkedIn and I would be happy to share a free sample table of contents for a disclosure document.

Bonus Freebie 2: When Do I Need “Local” Counsel on my securities offering?

Note that your local lawyers will also have a role: They general guidelines in the checklist should be supplemented with specific local advice in those jurisdictions where it is known the issuer would have a higher risk exposure. Examples include:

• jurisdictions which are known to be “difficult” and/or have active securities regulators (eg. the United States by dint of both its extra-territorial laws and its proactive securities regulator in the form of the SEC);
• jurisdictions where a business has a more proximate exposure to a regulator (eg. its jurisdiction of incorporation); and/or
• jurisdiction in which the issuer proposes to conduct extensive marketing reach-outs.

Finally, some national regulators tend to have a “knee-jerk” dislike of any securities offering involving a digital token as they see it as an attempt to evade traditional laws (however compliant your offering might actually be). Therefore, you must take particular care to stay apprised of the changing trends in regulatory focus in your relevant jurisdictions and be prepared to adjust your marketing strategy accordingly.

Coming Up Next

In the next edition of this series, I plan to provide some practical tips on putting in place certain internal processes to manage your liability.

If you want to make sure you don’t miss the next part of my piece when its published, watch out for my updates on LinkedIn (https://sg.linkedin.com/in/pooja-sinha-singapore).

Checklist To Review the Content of Your Disclosure Document(s)

[1] The views expressed herein are in my individual capacity and do not represent the views of my firm. The contents herein are purely informational and should not be construed as legal advice or opinion. Please contact me or another lawyer for advice on the specific risks that may apply to your fact situation.

[2] The importance of having risk factor disclosure that is customised to your business and industry should not be underestimated- You may start with boilerplate risks but this should be adapted to your context.