The level of diligence required in presenting the facts in a private placement is not as well fleshed out in the cases and authorities as in the case of a public offering. A defective-disclosure document in a public offering is scrutinized against the background of §11 of the '33 Act, where liability for misstatements can be close to absolute. The principal federal provision governing private placements is found in Rule l0b-5, promulgated under the '34 Act, which talks in terms of fraud and deceit and thus has been held to require proof of some form of scienter, a legal term entailing knowing violations of the appropriate standard. The sections of the securities laws governing liability for faulty disclosure in nonregistered offerings, state and federal, vary in the standards of diligence required, but the burden is less than the duty of active investigation imposed by §11 of the 33 Act.
In the final analysis, the private placement memorandum is a compromise document, entailing a trade-off between the durability of a bulletproof statutory prospectus versus the expense entailed in preparing such a presentation to investors. Founders and their advisers have to face the problem squarely. If the financing involves no more than, say, $750,000, there is a line which counsel cannot cross in spending time drafting the private placement memorandum. A business plan coupled with prudential caveats, which "bespeak caution" for example the risk factors, may be the best anyone can do in the circumstances. The tradeoff issue should not be read to suggest the problem of antifraud liability is insignificant. Many of the built-in comforts and safeguards for the issuer in a public offering–the SEC staff's letter of comment, the use of Regulation S-K as a guide, the existence of audited financial statements, and other expertise portions of the registration statement, are not available in a private placement. Moreover, even the lawyers keep their heads below the lip of the trench. Most law firms take the view that issuers and placement agents are not entitled to an opinion that a private placement does not violate the antifraud provisions of the securities laws and a so-called 106-5 opinion is rarely requested and too expensive.
Investor Exculpatory Representations
Prudence suggests that each purchaser be required to fill out and file with the issuer documents in aid of the issuer's ability to claim an exemption from the requirement that the securities be registered under federal and state law. The statements made by the purchaser also serve to stop him from claiming he was deceived in the course of the offering. The inclination of issuers, and it appears to be sound, is to load up the subscription documents with a combination of exculpatory language, concessions by the investor as to his status as a "smart and rich" investor and representations that he has in fact done the sort of things (i.e., read the memo, consulted his own advisers) the private placement memorandum urges him to do. In light of the few cases of any relevance, there does not appear to be harm in going overboard, despite the fact that investors routinely sign the subscription agreement and questionnaire without reading them and the language is rarely an item for negotiation.