Should I make a Rescission Offer?

Should I make a Rescission Offer? What effect will it have? How involved is the process?
Here is the scenario. A client comes to you and tells you that a year ago he raised a few million from a number of investors in different states. The offering was not registered at the federal or state level. The investors were provided with a business plan. The sponsor is not sure if they were all accredited investors. Another round of investors come in and wants to put in additional capital. The new investors discover the possible securities law violations and want to rid the balance sheet of the potential future liability. The issuer asks you about a rescission offer. How involved is it? What protection from future liability will the issuer get from doing one?

What is a Rescission Offer?
A rescission is an offer to rescind a transaction in which the seller has or may have violated the securities laws. The purpose is to put the purchaser in the same position he was in prior to the transaction by offering to give him back his money plus interest.

What is the effect at State law?
If a rescission offer is made in accordance with the state laws the effect is to release the offeror from civil liability under state securities laws. However, the offeror may not necessarily be insulated from common law fraud or anti fraud provision of state securities laws.

What is the effect at Federal Law?
Under federal securities laws when company issues securities without registering the securities or having an available exemption, the purchaser can bring an action and if successful can recover the consideration paid for the security with interest (less the amount of any income received thereon) or damages if he no longer owns the security. The purpose is to put the purchaser in the same position he was in prior to the transaction. Purchaser must bring action within 1 year of the violation and no later than three years after the security was offered to the public.

It is unclear whether a rescission offer cuts off the right of rescission described above. The SEC staff is of the opinion that a person’s statutory right of rescission survives. However, federal courts in the past have ruled that a person who rejects or fails to accept a rescission offer is precluded from later seeking similar relief. Arguably it should be the case that an investor who accepts a rescission offer will have given up his rights under federal law since he will have received a return of his original investment plus interest and thus was put in the same position he was in prior to the transaction which is the purpose of the right of rescission under federal law.

Complying with State Law
Most states have rescission offer statutes for violations of state securities statutes. The policy behind the statutes is that if an issuer is willing to rescind a transaction within the terms of the statute an investor should not be able to reject the offer and bring a civil action later if the investment later further declines. That would be tantamount to giving the investor a put option on the deal.

Most states have their own specific regulations as to how a rescission offer is to be conducted. The generally require that the offer be held open for 30 days, the seller be returned the purchase price and be paid statutory interest (ranges from for 6 to 12% depending on the state). Some states require that the funds be held in escrow. Some states (such as California) have specific rescission offer forms (California). Some states (again like California) require that the rescission offer materials be pre-approved before they are mailed out to investors.

It is important to remember that if the issuer does not comply with the state rescission offer statute you will not have extinguished the investor’s right to later bring an action for rescission for damages at a later date if he does not accept the rescission offer. Thus the contingent liability will continue to exist until the statute of limitations under the applicable state law runs out.

It is also important to bear in mind that the rescission offer itself may need to be registered or qualified under state securities laws unless an exemption is otherwise available. For example if the offer itself cannot be made under Rule 506 of Regulation D then the rescission offer will not be pre-empted and may itself required the registration or qualification with the state blue sky authorities. A few states (including California) require the rescission offer comply with the registration requirements of the blue sky laws.

Complying with Federal Law
As the rescission offer is a new offer and essentially a new investment decision the rescission offer must be registered under the Securities Act or applicable exemption must be relied on. In addition, if the issuer is publicly traded then the tender offer provisions of Rule 13E -4 (if the offer is made by the issuer) and Regulation 14D (if the offer is made by an affiliate of the issuer of a third party) must be complied with.

Conclusion
Rescission offers can be very expensive and time consuming particularly those involving many states, those requiring registration under the Securities Act or those conducted by publicly traded companies.

Written by Mark P. Cawley | Download v-card