We’ve covered crowdfunding extensively in our previous posts “Crowdfunding: Is It Right for My Business,” “Is It Time To Do Crowdfunding To Raise Money?: SEC Releases Federal Crowdfunding Rules,” and “An Easy Way for Texas Companies To Raise Money? A Discussion of the Texas Crowdfunding Exemption.” As crowdfunding gains popularity, not only has it proved to be a process of trial and error (see, for example, our previous posts “Eureeca: A Cautionary Tale on How Not To Do Crowdfunding” and “Update on Eureeca Capital”), but schemes to defraud unsophisticated investors with the allure of crowdfunding also seem to have been on the rise.
On October 13, 2015, the Securities and Exchange Commission (SEC) filed an emergency action against Ascenergy LLC (Ascenergy), a Nevada limited liability company, and its CEO Joseph Gabaldon. In the complaint, the SEC alleged that the defendants, which purported to be an oil and gas company, solicited investors on crowdfunding websites and its own website to purchase overriding royalty interests (ORRI), i.e., fractional, undivided interest in oil and gas or the sale of proceeds of oil and gas, in undeveloped wells. Specifically, the SEC said, in July 2014, Ascenergy filed a Form D notice with the agency seeking to offer ORRI investment contracts under the Rule 506(c) exemption. As we explained in our previous post on exempt offerings, Rule 506(c) allows companies to engage in general solicitation, so long as all purchasers are accredited investors. According to the SEC, Ascenergy made general solicitations on various websites and told investors that for each $100,000 invested, the investor would receive a 1% ORRI in the production from one of Ascenergy’s initial five wells, and described the investment as having “exceptionally low risk” and being “profitable as long as there is oil and gas to sell regardless of price.”
The SEC alleged that Ascenergy posted numerous false and misleading statements on its website and the crowdfunding sites to spur interest in the offering and to inflate the company’s credibility, including the following statements that: its team of geologists, engineers, and experts has secured its top 20 properties, when in fact it had not evaluated a single property at that time; it will be “profitable even at $20 per barrel” and “as an investor you will receive monthly income that [Ascenergy projects] will result in a 8X return . . . at a price of $40/barrel for oil,” when in fact these stated economics are not reasonable or realistic; the investment is “highly liquid,” when in fact ORRI in undeveloped properties are typically hard to sell and there is likely no market for resale of those interests; it recently discovered $40 million in proven reserves and has produced more than a million dollars in oil and gas revenue, which figures related to an entirely different company called Southern Star in which Gabaldon may have an interest; it has assembled a team with 150 years of industry experience, when in fact at least one of the persons referenced has done no work for the company and did not authorize Ascenergy to use his bio; and it is “partners” with several established industry participants, when in fact those “partners” did not have any relationship with Ascenergy and never authorized Ascenergy to use their respective names and trademarks, among other things. The SEC said that Ascenergy’s written offering materials contained similar false and misleading statements and failed to properly disclose the risk of the investment. The SEC further alleged that, rather than using the funds raised from investors to acquire and develop oil and gas properties, the defendants have diverted most of the proceeds to a company apparently unrelated to the oil and gas business and spent substantial amounts on payments to Gabaldon and on other inappropriate items, such as foreign travels, dietary supplements, and Apple stores and iTunes.
The SEC claimed that the ORRI investment is a security within the meaning of federal securities law and, thus, the defendants’ conduct violated federal securities laws, which prohibit fraud and misrepresentations in the offer or sale of securities. The SEC requested that the court enjoin the defendants from committing further securities law violations, freeze the assets of the defendants, and order the defendants to disgorge all ill-gotten gains, among other things.
The story is a cautionary tale making clear that, even though crowdfunding transactions may have an exemption from federal securities law in some cases, the SEC is watching and it is very important to make sure that all factual representations made to investors are accurate.
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This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
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About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Firm, PLLC, which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: (214) 418-0258; email@example.com, or www.mcbrideattorneys.com.
 See generally Complaint, SEC v. Ascenergy LLC, Civil Action No. 2:15-cv-01974-GMN-PAL (D. Nev. Oct. 13, 2015). Unless otherwise noted, all references to the SEC’s allegations in this posting are from the complaint.