The Law and Other Anomalies

The FDA has a Task Force with focus on companies subject to FDA regulation/clearances.  It should be remembered that while the SEC regulates, and monitors disclosure by, public companies, much of what they do also covers private enterprises which raise capital, including early-stage med-tech and bio companies.  The focus of SEC activity is to prevent misstatements and over-statements made to new investors or (for public companies) into the public marketplace.

Many investigations arise by reason of inaccuracies in materials utilized by emerging companies in private fund-raising, whether for stock offerings or other “securities” such as SAFEs and Convertible Notes.  These misstatements can arise in connection with oral presentations, offering “decks,” private placement memoranda or other written material. This includes articles or studies prepared by third parties, based on misstatements or exaggerations made by companies and which are repeated by third party sources.  Companies offering securities of any sort need to centralize and review disclosures of all types by all personnel; which  includes scientists and researchers who may not be attuned to the impact and scope of the laws concerning sale of securities.

The types of typical misstatements often relate to a misstatement of the science, the status and success of trials, the existence and scope of customer base, failure to clarify that certain “sales” are really beta tests, and particularly ambiguous or misleading statements concerning company status vis-a-vis FDA guidance or approval.

While one might expect that most complaints come from ultimately dissatisfied investors and arise many months (or years) later, overly enthused senior management should note that very often the SEC is “tipped” by inside whistleblowers who are uncomfortable with what is being said about the company offerings which seem excessive to scientific employees who are finely attuned to the granular accuracy of data concerning the science.

Having company disclosure substantively reviewed by outside counsel prior to its use is an excellent way, absent actual intent to defraud, to protect against an SEC criminal action based on material misstatement; the SEC may well take civil action and also cause corrective disclosure or a rescission offer to investors, but such is far more palatable than a criminal charge.

Finally, and this relates to public companies, the SEC focuses on trading upon material non-public information, whether through formal trading programs (so-called 10b5-1 plans or otherwise), and trading in shares of companies other than one’s own company based on insights obtained (by example) by reason of inter-company collaboration or trade group disclosures.

With so much funding going into med-tech of all sizes, it is not surprising that the SEC has a specific Task Force in this vertical, and companies should be aware of the particular SEC focus  which does not make different rules for med-tech but does create heightened scrutiny.

The SEC has a Small Business Capital Formation Advisory Committee (“Committee”)  to propose regulation that would make it easier for small business to raise investment capital.  A recent survey found that 89% of small businesses feel capital-limited, but only 6% of small business sought equity investment to meet that shortfall.

With such an unfulfilled need in the small business community, a bedrock of American capitalism and a highly favored cohort in the view of the general public, you would think that the SEC would have taken major steps  to ease capital formation for small business.  But it ain’t so!  Materially similar rules apply to small business capital raises as to larger VC-type raises.  One recent effort to afford easier access to capital has been the SEC system for crowd-funding, and while deals have been done, compliance with that method is formal and requires legal guidance (or the surrender of the small busienss to the crowdfunding platforms established under the SEC Crowdfunding Regulation (with related risk, expense and formalities).

This week, at a meeting of the Committee, two SEC commissioners spoke about the need to make capital formation easier for “underrepresentated” entrepreneurs. They were focusing upon entrepreneurs in rural areas  and others less sophisticated, both without access to knowledgeable lawyers.

But no specific proposals were suggested; that is the task of the Committee.  Will there be success where in the past the capital formation process has remained technical and requires, often, what one commissioner described as “a game of  ‘gotcha’ that requires $1,000 per hour lawyers to navigate”?

Making progress here will be difficult.  The problem fundamentally is the risk of fraud.  Scams abound, we read about them all the time whether through the internet or telephone or in person.  By definition, underrepresented founders are not likely to be attuned to legal formalities which are, indeed, sometimes arcane.  And the fundamental task of the SEC is to prevent fraud, not to engineer social policy for economic justice and growth.  Mechanisms to reach these two goals, as a practical matter, seem inherently contradictory.

The SEC website has posted advice addressing methods of capital formation but it is not enough; I suspect that protection against fraud does require legal assistance (unless AI can be trained to uncover fraud, which I would not count on).  The answer, however impractical it may be, is that the Congress can create an independent agency of lawyers to represent the underrepresented entrepreneur in compliance with SEC (and indeed State) securities regulations, with fees based on ability to pay and upon success.  We have the SBA for general business advice and funding, and free lawyers for the criminally indigent.  I hate to suggest it, but we could use government lawyers to help fund small business through legally compliant capital investment.

Otherwise, I fear that this is a real issue that will not be solved– as it has not been since the SEC was formed almost a century ago….