The Private Securities Litigation Reform Act and the Entrepreneur: Protecting Naïve Issuers from Sophisticated Investors
25 Pages Posted: 7 May 2009
Date Written: March 5, 2008
The purpose of U.S. securities laws is to protect investors by requiring full disclosure on the part of the issuers of securities. The intent is to increase the efficiency and integrity of the nation’s capital markets by ensuring that all material information is publicly available. Thus, the laws were created and have been amended to provide legal redress for investors who were not provided with sufficient information to make a reasoned decision. In most respects, these laws presume relative naïveté on the part of the investors and relative knowledge and power on the part of the issuers.
There is evidence suggesting, however, that in the sphere of new ventures, the balance of power may be tipped in favor of the investors and away from the issuers. Indeed, it is often the case that entrepreneurs, though expert in their substantive field, tend to be naïve in financial and business matters. Investors, particularly venture capitalists, on the other hand, tend to be experienced and knowledgeable in financial matters. In these circumstances, there was a threat that securities laws could exacerbate the power imbalance in favor of the investors and leave the entrepreneurs vulnerable to unfair dealing. Specifically, because of the tenuous financial position of new ventures, any heavy-handedness on the part of investors could kill the venture, regardless of the merits of the investors’ claims. Indeed, any threat of litigation, regardless of how spurious, could paralyze a new venture.
This article first examines the current research regarding control mechanisms used by investors in new ventures and conflicts that arise between investors and entrepreneurs. The legal environment associated with private securities litigation is then examined in detail. Specifically, this article examines court interpretations of the language within the Private Securities Litigation Reform Act regarding allegations of fraud; finding that the Act, though intended to address other perceived abuses, may actually benefit entrepreneurs accused of securities fraud in new venture financing. This article then briefly examines additional non-legal attributes that may also favor entrepreneurs when dealing with new venture financiers.
Keywords: securities litigation
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