Yes, the SEC is Interested In Your Friends & Family Investing In Your Film

SECPart of what I love about my job is that I get to advise clients in the film industry from the inception of the project through execution and then distribution. When does a film project really start going? Often, once the financing is secured. And for independent film producers, at some point, there will be private investors in the film, whether they are friends and family or institutional investors. To everyone’s surprise, even if your mom or friend invests – as distinct from gifting – only a couple of thousand dollars in the film project, that still qualifies as a sale of a “security” and therefore, the investment will fall under the purview of federal and state securities laws.

When I first apprise clients of this issue, some of them are greatly surprised – they’ve done other projects before (film or otherwise) with investments from friends and family without any involvement of securities laws, so why bother now? Usually, there was no attorney involved in the prior scenario – any attorney with a modicum of experience or knowledge in basic financing issues will instantly recognize an investment as creating a securities issue. And, should the SEC or investors find out that the prior project did not comply with securities regulations, the project and the owners are in jeopardy…the last thing you want to do is be on the SEC’s radar (thus potentially triggering parallel inquiries by the Department of Justice, state authorities and civil lawsuits).

Sometimes producers try to circumvent securities issues by structuring the capital infusion as a “promissory note.” Them and everyone else. It doesn’t matter how you label the transaction. The SEC has battalions of attorneys whose only job is to examine financial transactions to determine whether they are, in fact, issuances of securities that fall under the auspices of securities laws.

Here is the basic rule: if your friend/family member/investor is giving you money – no matter how small – for your film/project and he/she expects a profit derived solely from others’ efforts, in other words, he/she has no management involvement in the film/project, then the transaction is an issuance of a security and you must now comply with federal and applicable state securities regulations including all of their disclosure and reporting requirements.

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SUSIE YOO
Email: SYoo@KHSLaw.com
Phone: (310) 551 – 0600
Practice Areas
Fashion & Apparel
Entertainment Law
Intellectual Property Law
Business & Corporate Law

What about crowd-funding? Couldn’t you try to circumvent securities laws by going that route?

Good try, I love that you’re thinking out of the box. But crowd-funding has been legally permitted as an exception to the SEC rules only because there is a quid pro quo built into the process, it is expressly disallowed for investments. I.e., people who put up money on the site must receive something in return, it is never an investment where the person giving the money is given a percentage of the return. See e.g., the Rules for Kickstarter at: https://www.kickstarter.com/rules.

So to receive an investment in your film, you will need to comply with federal securities regulations. But here’s the good news. The SEC rules provide for an exemption from its registration requirements to small companies for certain types of “offerings” (i.e., a funding or investment round) through its Regulation D. Rules 504, 505 and 506 of Reg D permit different amounts of financing ranging from $1 million (a Rule 504 offering) to an unlimited amount (under Rule 506) with varying requirements for each type of offering. Even if you are planning on raising substantially less than $ 1 million – say, your parents are investing $100,000 in your project – you still must go through one of these offerings. In all, one of the easiest ways to raise investment money in accordance with the SEC rules is to do an offering under Reg D to “accredited” investors (which generally means investors with whom you have a preexisting personal or business relationship and who meets certain financial – or what the SEC labels “sophistication” – requirements).

What are the primary requirements with any of these offerings? Keep in mind that our federal securities regime is one predicated on disclosure. With all of these offerings come different types of disclosure requirements that must be given to the investor(s); the greater the amount to be raised, the greater the amount of details to disclose. These include, at a minimum, a detailed description of risk factors, capitalization structure of the project, subscription agreement, audited financials and the LLC operating agreement.

Disclosure and reporting does not have to be daunting and, in fact, it may help you get organized and provide structure to your project. A good attorney will help you organize your investment rounds and find the most efficient and cost-effective way to ensure compliance with the SEC.