Crowd Control.

So … the Jumpstart Our Business Startups Act (aka the “JOBS Act”) has now sailed through the House and Senate with the exuberant nodding of the White House.  I recently posted a ponderous analysis of the House Bill and its component parts - see JOBS One.  After expressly limited debate (i.e., “cloture,” see JOBS Two), last week the Senate sent a revised version of the JOBS Act back to the House for reconciliation and certain approval. 

What’s been revised? 

S. 2190 - The “Crowdfund Act”

What has specifically gone back to the House is the Senate’s revised version of Title III of the JOBS Act, the latter known in House lexicon as H.R. 2930, or the “Entrepreneur Access to Capital Act.”  The new Senate bill – S. 2190 – goes by the burlier name of the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012.”  Wow.  Mercifully, Section 1 thereof also designates an alternative moniker … the “Crowdfund Act.”  Similar to the House bill, S. 2190 adds two new provisions to the Securities Act of 1933: 

A – As with the House bill, the first technical change effected by S. 2190 is to add a new category of exempt transaction enumerated “Section 4(6).”  A financing is exempt from SEC registration under the Section 4(6) Crowdfunding Exemption if:

   1 – The issuer raises no more than $1M in any 12-month period under Section 4(6); and 

   2 – The maximum amount sold to any particular investor under Section 4(6) stays within certain limits based on the investor’s annual income/net worth.  Investors with an annual income (or net worth) of less than $100,000 may not invest more than $2,000 or 5% of annual income (or net worth), whichever is greater, in any 12-month period, and, investors with an annual income (or net worth) of more than $100,000 may not invest more than 10% of annual income (or net worth), in any 12-month period.  For the latter group, there is also a cap on investment of $100,000 in any 12-month period.

The notion of increasing the aggregate limit to $2M if purchasers are provided with the issuer’s audited financials – as articulated in the House Bill – has been eliminated from the new Section 4(6).  A wise change, I think.  As I noted in my prior post, since startups rarely have audited financials, the $2M limit rule was irrelevant in practical terms. 

B - Also like the House bill, the second technical change effected by S. 2190 is to add a new Section 4A to the Securities Act entitled “Requirements With Respect To Certain Small Transactions.”  Section 4A articulates the conditions for the Section 4(6) Crowdfunding Exemption.  The biggest differences between the House Bill and the Senate Bill lie here …

   1 – Intermediary.  Under S. 2190, a Crowdfunding Transaction must be effected through a registered broker or through a “Funding Portal.”  The latter is defined in a proposed new Section 3(a)(80) of the Securities Exchange Act of 1934 and means, in effect, an intermediary that mechanically processes the transfer of investment funds without soliciting purchases or providing investment advice.  Funding Portals will be regulated entities subject to SEC oversight independent of the crowdfunding rules applicable to issuers.

   2 – Information.  Under S. 2190, a considerable amount of information must be made available to prospective purchasers, including information regarding the issuer, its business, management team, capital structure, risk factors, and anticipated use of offering proceeds.  Also required are disclosures regarding the terms of the proposed offering. 

   3 – “Tiered” Financials.  Under S. 2190, how much and what kind of financial information must be provided to prospective purchasers depends on the amount raised by the issuer under Section 4(6) in the prior 12 months.  If, in the prior 12 months, the issuer has raised in a Crowdfunding Transaction …

     ** $100,000 or less, then it must provide a copy of the prior years tax returns (if any) and financial statements certified by an executive officer as correct;

     ** $100,001 to $500,000, then it must provide financial statements “reviewed” by an independent auditor per rules to be promulgated by the SEC; and

     ** more than $500,000, then it must provide audited financial statements per rules to be promulgated by the SEC.

   4 – No Advertising.  Under S. 2190, general solicitation or advertisement of the offering is prohibited, “except for notices which direct investors to the funding portal or broker.”

What I Think

IMO the Senate Bill is a massive improvement for all concerned.  More plainly, S. 2190 converts a proposal to allow willy-nilly sales of unregistered stock over the internet to unsophisticated investors into something relatively well reasoned and in line with established securities laws.  Some supplemental thoughts, in no particular order …

A – Oddly, in the Senate bill there is apparently still no limit on the number of purchasers.  So, the crowd doing the funding is still of theoretically infinite size.  It will be interesting to see if the SEC promulgates regulations in this regard.  IMO a large shareholder base is a bad idea for cash-constrained private issuers in any business sector.

B – Further to the latter point, S. 2190 continues to exclude crowdfund investors from what is known today as the “500-Shareholder Rule.” As it exists today, the “500-Shareholder Rule” subjects a company to the full panoply of SEC “public company” reporting when it reaches $1M in assets and 500 “shareholders of record.”  The JOBS Act dramatically alters this calculus by increasing the absolute number of “shareholders of record” that triggers reporting, and, by excluding both employees and crowdfunders from the count.  While backing employees out of the shareholder count is an important change in line with emerging company business reality, eliminating crowdfunders still strikes me as ill-advised. 

As I queried in my prior post

[Under the new JOBS Act calculus, the] number of all (accredited and non-accredited) holders of capital shares minus employees minus [crowdfunders] must be less than 2,000; and the number of non-accredited holders of capital shares minus employees minus [crowdfunders] must be less than 500. Here’s my question: Since there are no limits on the number of [crowdfunders], can an issuer (1) raise money from, say 10,000 non-accredited [crowdfunders], (2) issue shares to say, 1,000 non-accredited employees, and still (3) be exempt from public company reporting?  (original emphasis). 

Hmmm … I stand by the question.  Just doesn’t sound right to me.

C – Also in my prior post I mentioned that crowdfunding reminded me of the Spring Street Brewing Company story. It still does.  When the SEC dropped in on Spring Street Brewing – recall that it was 1996 and “www” was a brand new concept – one of the things it demanded was an independent intermediary:

Access to and control of investor funds must be handled carefully to provide investors using your system with adequate protections … [W]e suggest you modify your system to eliminate [Spring Street's] control over these funds.  At a minimum, [Spring Street] should use an independent agent, such as a bank or escrow agent, to receive checks from buyers payable to the seller of the security of the bank (rather than payable to Spring Street Brewing Company). Investors should send their checks directly to this independent agent, rather than to Spring Street.  See Letter to Spring Street Brewing (March 22, 1996).

The point … . long ago shades of a “Funding Portal.”

D – Buried in the issuer disclosure requirements of S. 2190 is, for lack of a better description at the moment, a sort of “quasi-cooling-off period.”  Specifically, the proposed statute says that “prior to [consummating the sale of securities] each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities …”  (emphasis added).  Unusual for a securities transaction, but since we are talking about unregistered offerings to the general public, apropos IMO.


Despite its remarkably swift passage, sometimes it’s hard to tell from the rhetoric if pundits and politicians are talking about the same subject.  In the final analysis, of all the opinions floating about, I think Steve Case gets it right:  the Crowdfund Act “democratizes … access to [venture capital] investments.” 

What remains to be seen is whether that is a good thing … (1) for the army of “unpreferred retail investors” looking for the next big thing, or (2) for issuers newly owned by the crowd, or (3) for mainline venture capital investors who now have a supplemental due diligence item (i.e., was the company crowdfunded, how big is the crowd, who’s in the crowd, are there actual or de facto voting blocks within the crowd, and can management control it/them?).

Lots of things to look for in the coming months …

  ** Companies lining up to act as Funding Portals;

  ** Correspondence from Funding Portals and lawyers about how to do a Crowdfunding Transaction; and 

   ** Last but hardly least, a wave of SEC rules putting meat to the bones of S. 2190.  The Senate Bill includes a lot of enabling language directing the SEC to promulgate regs necessary “for the protection of investors and in the public interest.”  No doubt they will.  All things considered, not a bad thing in this instance.

Well, that’s what I think anyway …

© david jargiello 2012  all rights reserved

“Point of parliamentary procedure” on the JOBS Act.

Today, the U.S. Senate invoked cloture on the JOBS Act, or to use the parliamentary term more appropriate these days, the “guillotine” has dropped.  Whatever parliamentary verbiage you prefer, it means that debate is now officially time constrained and a vote on JOBS Act passage is imminent.  Despite rumblings from consumer advocates, White House support of the measure makes passage about as swift and certain as such things can be.  See Politico.

In that regard, two quotes today caught my eye …

These bills on their own certainly won’t solve the jobs crisis, but they will make it a lot easier for entrepreneurs and innovators to get the capital they need to build businesses and create jobs.  Senate Minority Leader Mitch McConnell (R-Ky).


This is not a bill which will allow new opportunities for American workers but one which will create new opportunities for fraudsters, [and] carries the false label of a jobs bill.  Sen. Carl Levin (D-Mich.).

Why noteworthy?  Because both quotes are, IMHO, exactly correct.

After a painful slog through the proposed legislation and the source House Bills, here’s what I had to say in my prior post:

The JOBS Act variously tinkers with and takes a hammer to two pillars of the New Deal – the Securities Act and the Securities Exchange Act. Most of the tinkering – such as the IPO On-Ramp and the proposal to exclude employees from the 500-Shareholder Rule – represents thoughtful, intelligent adjustment of the regulatory framework to emerging company business reality. By contrast, “hamfisted” is how I would characterize the rulemaking that enables (1) unfiltered, unlimited solicitation of unregistered investments, (2) Crowd Funding, and (3) creation of private-company behemoths with thousands of “unpreferred retail” shareholders trading in a murky online world of secondary sales. As to the latter changes, John Coates’ JOBS Act testimony was correct IMO … any decrease in the transactional costs of raising capital effected by these changes is illusory.

I stand by that analysis.  The JOBS Act is neither good nor bad.  Rather, by mixing good, important law with bad law it is both at once.  Legislative sausage in the truest sense of the term. 

So, what to do?  Pass it of course … we are in a presidential election year, and the economy still teeters on the brink, and a dysfunctional Congress is unlikely to reach any other deal.  Therefore, the best available move is to (1) pass it to secure the immediate advantages of the IPO On-Ramp, and (2) deal with the debris from the rest of it later.  Democracy is a contact sport and rarely pretty.  Of course, I can’t help but wonder if this is the reasoning Bill Clinton used when he signed away Glass-Steagall with a stroke of a pen in 1999 … .

For film buffs wondering where you may have heard “point of parliamentary procedure … ! ” before, See Animal House.

© david jargiello 2012 all rights reserved

Lawyering up for the JOBS Act.

So, the Jumpstart Our Business Startups Act (aka the “JOBS Act” … nice touch) is afloat and headed to the Senate for almost certain approval.  In mechanical terms, the “JOBS Act” is a “legislative package,” i.e., a series of six interrelated bills affecting startup businesses.  If (when) approved, private companies will be able to (1) have a lot more shareholders and therefore stay private longer, (2) raise money from more people with fewer securities law restrictions, and (3) when ready, go public and be public with less regulatory hassle from the SEC. 

Terrific political theater, but is it good law and/or good business?

IMHO, parts of the JOBS Act are well done and overdue (principally the “IPO On-Ramp”).  As to other parts, well, we’ll see.  One thing is for sure … after you get past the political chaff there is a lot of complex lawyering afoot in all of this.  Whether or not the JOBS Act stimulates the economy as its supporters say remains to be seen, but one thing is certain … it will create a lot of jobs for lawyers.  My thoughts follow below.  Of course, this post is based on the JOBS Act as proposed, not as finally enacted.  Further, much of the proposed statutory language instructs the SEC to promulgate enabling regulations.  Thus, while the broad strokes below are probably correct, details will change as the statute is finalized.  Stay tuned.

My thoughts …

Title 1

“IPO On-Ramp” - The Reopening American Capital Markets to Emerging Growth Companies Act.   

A – Technical.  Title I of the JOBS Act began as H.R. 3606.  The core technical change enacted by Title I is to amend Section 2 of the Securities Act of 1933 to create a new defined term … the “Emerging Growth Company.”  In short, an issuer has “Emerging Growth Company” status for five years after its IPO, or until it exceeds $1 billion in annual gross revenue, or until it becomes a “large accelerated filer,” whichever comes first.  A “large accelerated filer” is one with a public float of $700M.  See Rule 12b-2(b).  Thereafter, to effect the contemplated business result(s), the term “Emerging Growth Company” cascades through the Securities Act of 1933, the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 with the net effect of exempting such entities from a host of regulatory requirements.  Here’s the scoop …

     1 - Quiet Filings.  Section 6 of the Securities Act articulates the statutory architecture for filing a registration statement with the SEC.  As proposed, Title I would amend Section 6 to allow – for the first time - submission of a registration statement by an Emerging Growth Company for “confidential nonpublic review” by the SEC staff.  Though recently limited (see SEC), such “quiet filing” has long been available to foreign issuers.  By contrast, in domestic practice “quiet filing” has meant filing a registration statement without issuing a press release, an anachronism given the availability of information today.  Since a filed S-1 is almost instantaneously available online - allowing a deep dive into an issuer’s technology, business strategy and financials by global competitors months before there is market certainty - a “quiet filing” takes some of the competitive risk out of an IPO filing for U.S. issuers.  Net:  Good stuff.

     2 - “Testing the Waters” And Other Talk.  Section 2(a)(3) of the Securities Act sets forth a long list of actions that are deemed to constitute a “sale” of securities for regulatory purposes.  As proposed, Title I would amend Section 2(a)(3) to exclude therefrom “research reports” about an Emerging Growth Company both prior to and immediately after its IPO, even if the analyst works for a bank that is underwriting the offering (i.e., such a report would not be deemed a “prospectus”).  Further, Title I would amend Section 5 of the Securities Act and Section 15D (“Securities Analyst and Research Reports”) of the Securities Exchange Act to increase the range of allowable communication between an Emerging Growth Company, prospective institutional investors, and analysts, again both before and after an IPO.  The theory behind these changes is that they will allow a company to “test-the-waters” with certain qualified purchasers before incurring the costs of registration.  Likewise, the loosening of rules regarding research and analyst communication is intended to increase the amount of information available to the investing public and thus – theoretically – the success of the offering.  Net:  This is the only part of the On-Ramp that gives me pause.  No specific objection I can articulate, but nearly 80 years of securities jurisprudence has focused on limiting the pre-effective chat.  In the final analysis, I think this will prove more complex in practice than it appears on paper.  We’ll see.

     3 - Limited SOX.  Section 404(b) of the Sarbanes-Oxley Act requires that public companies retain an outside auditor to attest to its internal controls and procedures. See AICPA.  As proposed, Title I would amend Section 404(b) to exclude Emerging Growth Companies.  The purpose of this exemption is to reduce the cost of “being public” for companies that have just undertaken an IPO by eliminating this (expensive) audit requirement.  Notably, management liability is unchanged in that Emerging Growth Company executives would still have to certify to the public that their controls are adequate.  Net:  Continuing liability of executives (which protects the public) while eliminating the gigantic accounting bill (providing cash flow relief to the business) is, IMO, a nice balance of real world practicalities.  Good stuff.

     4 - No “Say-On-Pay.”  A web of federal laws, including Section 14A and Section 14(i) (“Disclosure of Pay Versus Performance”) of the Securities Exchange Act require shareholder votes on executive compensation arrangements, including golden parachutes.  See SEC and NYTimes.  Existing Section 14A(e) of the Securities Exchange Act creates a regulatory “placeholder” pursuant to which the SEC has authority to exempt issuers from such obligations specifically including when deemed to “disproportionately [burden] small issuers.”  Title I drives Emerging Growth Companies through that gap by expressly exempting them from shareholder advisory votes on executive compensation in proposed new Sections 14A(e)(1) and (2).  Likewise, the disclosure of pay-vs-performance under Section 14(i) - added to the Securities Exchange Act only recently (as Section 953(a) of the Dodd-Frank Act) – is amended by Title I to expressly exclude Emerging Growth Companies.  Net:  I personally don’t think the risk in newly public investments is on the executive comp side.  At this stage management is playing for massive stock appreciation just like the investing public.  So, with the phase-in as the company matures, IMO another good balance of real world practicalities.  Good stuff.

     5 - Financials – Not So Much.  Finally, Title I would amend Section 7(a) of the Securities Act (regarding information required in the IPO registration statement) and in Section 13(a) of the Securities Exchange Act (regarding information required in post-public periodic reports) such that no more than two years of audited financials be required to be disclosed.  This change is intended to reduce audit costs relative to the current requirement (five year look back on financials).  Net: Good stuff.

B – Practical.  There is a tremendous groundswell of support in the business and venture capital communities, and in both political parties, for the passage of the IPO-On Ramp.  See NVCA(1) and NVCA(2).  Not surprising.  As noted above I think that these are logical edits to real world regulatory pressure points for emerging companies.  Overall, the IPO On-Ramp is also a vast improvement on (or, depending on your point of view, a logical extension of) the awkward “smaller reporting company” regime created by the SEC in 2008.  See Release 33-8876.  A “smaller reporting company,” under those rules, was one with less than $75M in public equity float, or less than $50M in annual revenue.  See Interpretations.  In mechanical terms, the “smaller reporting company” rules poured Regulation SB “small business issuers” into a scaled version of the Regulation SK disclosure requirements applicable to all public companies.  Confusing verbiage and rules structure, IMO.  The “Emerging Growth Company” moniker of the On-Ramp is a vastly more understandable and practicable rules regime.

Title 3

“Crowd Funding” – The Entrepreneur Access to Capital Act.

A – Technical.  Title III of the JOBS Act began as H.R. 2930.  As proposed, Title III adds two new provisions to the Securities Act:

The first of these is a new category of exempt transaction enumerated “Section 4(6)” whereby issuers may sell up to $1M in any 12-month period without registration.  The aggregate limit is increased to $2M in any 12-month period if purchasers are provided with the issuer’s audited financial statements.  Since startups rarely have audited financials, the $2M limit rule is largely irrelevant.  In contrast to the extensive jurisprudence surrounding the Section 4(2) exemption (access to information, sophistication of purchasers, etc.), under the new Section 4(6) the sole purchaser qualification would be a limitation on amount invested, i.e., $10,000 or 10 percent of the investor’s annual income, whichever is less.  Oddly, there is apparently no limit on the number of purchasers.  So, the Crowd doing the Funding is of theoretically infinite size … ? 

The second new provision is a new Section 4A entitled “Requirements With Respect To Certain Small Transactions.”  As proposed, Section 4A articulates the conditions for a Section 4(6) transaction, including specific risk factors that must be stated, specific questions that must be directed to prospective purchasers (in short … “do you understand that this is risky stuff?”), an SEC notice requirement, and, notably, a requirement that a third party custodian manage the inflow of investment funds from the offering.  Look for lots of marketing pamphlets from law firms on “how to do a 4(6) deal.”  Ditto a jostling for custodial duties.  As a legal practice point, query whether law firms will look to step into this void.  Bad idea, IMO, but that’s another post for another day.

B – Practical.  It is hard to overstate the enthusiasm for Crowd Funding.  See Forbes (“The potential for [Crowd Fund] investing to transform that [sic] way startups access capital is staggering.”), Inc.(1) (“[Crowd Funding is] the grease that keeps the gears in the American economy churning.”), and Inc.(2) (“Imagine … [t]he next Steve Jobs being held back by rules from the age of the typewriter. When are we going to give the tools and resources to our job creators? [Crowd Funding] is an innovative way to look outside the box and get up with the times to open up capital markets to new businesses and existing small businesses. It has the potential to be a powerful venture capital model.”).


Nevertheless, IMO the Crowd Funding legislation is ill-advised.   As proposed, it strikes me as a quasi-private version of the Spring Street Brewing Company saga.  Founded by former Cravath associate Andrew Klein, Spring Street Brewing completed what is generally considered the first internet direct public offering, or “DPO,” in February 1996.  For a terrific analysis, see Hass (SoCalLawRev).  Though a groundbreaking use of the then brand new “world wide web,” the real success of the Spring Street Brewing DPO is that it opened the world of online investing; in fact, the very next year Mr. Klein shifted his efforts to Wit Capital, the first online investment bank (“fat-cat investing at the click of a mouse”).  The microbrewery?  Well, as Klein said in a 1999 interview:

[A]lthough we had around 500,000 people who came and saw the [Spring Street] prospectus on our site, only 3,500 of them invested.  Yeah, we raised nearly $2 million, but the conversion rate - that is, the rate at which people who heard about the offering and looked at the prospectus were willing to buy in a direct offering - was very, very small.  [Why?]  Because people aren’t that stupid.   I mean, our beer company was a very decent offering, a perfectly legitimate effort to raise capital.  But the average investor is smart enough to know that if there’s not an intermediary who’s in the business of evaluating the company, doing due diligence, and putting its reputation on the line with the company’s reputation, that investors should beware.


So … what about the idiots investors who put $2M into Spring Street Brewing?  According to Crowd Funding evangelist Scott Brown (R-MA):

[S]ome have voiced concerns that [Crowd Funding] is an avenue for fraud and abuse.  But, consider this: Americans are allowed to gamble unlimited amounts at casinos, and can send donations to charities halfway around the world with one tap of a trackpad. Yet, we are legally prevented from making even modest investments in job-creating small businesses.

Casinos?  Hoo boy.

Putting aside the merits of targeting an unlimited number of unsophisticated investors (“unpreferred retail investors” in Crowd Funding parlance), for a financing capped in practical terms at $1M, as a business matter there is the inconvenient truth that shareholders (1) have legal rights, and (2) create administrative cost/hassle.  The online platforms cited as evidence of Crowd Funding power – Peerbackers, IndieGoGo, Kickstarter, PledgeMusic and RocketHub – solicit donations.  “Micro-patronage” in industry-speak.  Others, like Prosper, broker loans.  Thus, missed in the exuberance of selling equity to the general public is the fact that the Crowd doing the Funding thereafter owns the business.  As owners …

     ** They have statutory rights to records and information. 

     ** They have statutory authority to sue in the name of the company (aka a “derivative” suit). 

     ** They have voting rights, and their votes may or may not be needed to undertake various future corporate actions.   You have to think that Crowd Funded startup essentials will include:  drag alongs (are they enforceable?), voting agreements, and a super-voting class of Common held by solely management (per Facebook).  Said another way, some expensive lawyering will be needed to offset the risk that the Crowd will want too much of a say in corporate affairs.

     ** They are owed a fiduciary duty by both management and majority shareholders.  Think Board of Directors and management control group - of a startup with limited resources - vis-à-vis hundreds (thousands? … remember, no cap on numbers) of mom-and-pop, general public, minority shareholders. 

     ** Finally, the Crowd is going to (reasonably) expect management to communicate with them, answer questions and keep them informed.  In my view, the Crowd Funding evangelists are ignoring the practical, in-the-trenches administrative burden of carrying a shareholder base of hundreds (thousands?). 

Net:  IMO, bona fide control issues arising from a large, unsophisticated shareholder base plus the administrative cost of managing same plus management liability exposure to same plus likely disinterest of mainline venture investors in all of the foregoing … together offset the advantages of $1M in funding.  Thus, I would say that the proposed Crowd Funding legislation is ill-advised in practical, real world business terms.  My guess is that most venture backed startups will avoid the process, rendering the law largely irrelevant to mainstream business backed by professional money. 

Title 5 and Title 6

“500-Shareholder Rule” - The Private Company Flexibility and Growth Act and The Capital Expansion Act.

A – Technical.  Title V and Title VI of the JOBS Act began as H.R. 2167 and H.R. 4088, respectively. I have no opinions on the latter, which deals with the number of shareholders permitted to invest in a community bank.  The former, however, directly impacts emerging company practice.  As proposed, Title V amends Section 12(g)(1)(B) of the Securities Exchange Act – aka the (in)famous “500-Shareholder Rule.” As it exists today, the “500-Shareholder Rule” subjects a company to the full panoply of SEC “public company” reporting when it reaches $1M in assets and 500 “shareholders of record.”  H.R. 2167 appears to be the simplest of the proposed amendments, i.e., it amends Section 12(g)(1)(B) by increasing the asset threshold to $10M (non-controversial), and, the shareholder threshold from 500 to (a) 2,000 total or (b) 500 non-accredited “shareholders of record,” whichever comes first.  The real action, however, lies in how the new rule defines “shareholders of record.”  Under existing law the term has its plain English meaning (essentially holders of outstanding securities).  The JOBS Act dramatically alters this calculus in two ways:  First, under Title V, employees are excluded if they receive their securities under equity compensation plans (Query:  what’s a “plan” for this purpose?).   Second, hidden in Section 302 of Title III (Crowd Funding), is the nuance that persons who purchase shares in a Section 4(6) Crowd Funding transaction are not counted either.  In technical terms, Title III (not Title V) amends Section 12(g)(5) of the Securities Exchange Act to exclude Crowd Funding shares.

So … Putting that all together:  The number of all (accredited and non-accredited) holders of capital shares minus employees minus Crowd Funders must be less than 2,000; and the number of non-accredited holders of capital shares minus employees minus Crowd Funders must be less than 500.  Here’s my question:  Since there are no limits on the number of Crowd Funders, can an issuer (1) raise money from, say 10,000 non-accredited Crowd Funders, (2) issue shares to say, 1,000 non-accredited employees, and still (3) be exempt from public company reporting?  Sounds crazy, but that’s how I read it … .

B – Practical.  As with Crowd Funding, it is hard to overstate the excitement about changing the 500-Shareholder Rule.  See Bloomberg (The 500 shareholder rule is outdated, overly restrictive, and limits U.S. job creation and American global competitiveness.”).  Google, Twitter, Zynga and Facebook – variously forced to go public, structure contorted beneficial ownership arrangements and/or seek an SEC exemption – are generally cited as the poster children for rule’s negative impact.  See Deal and DealBook.  Much is made of the fact that the 500-Shareholder Rule was first articulated in 1964, the year in which Section 12(g) was added to the Securities Exchange Act.  Since then, as the argument goes, the size of the stock market, the number of corporations and the number of investing shareholders have all grown substantially, thus changing the meaning of what constitutes a “public market,” thus driving a need to increase the 500 shareholder threshold.

Hmmm …

     ** First, obviously the stock market is bigger today than in 1964, as is the size of a now global investing public.  Try watching television for any particular 30 minute period without seeing an ad for online investment services.  That said, I personally don’t see a straight line between that data and the number of shareholders in a privately-held company that indicates an investor footprint of sufficient size to warrant public reporting.  So, the “1964 = old = bad” argument?   I don’t get it.

     ** Second, by focusing on the “old = bad” angle, I think much of the debate in the blogosphere misses the core issue, i.e., how many shareholders does a private company have to have before it should be deemed to have a public market for its shares?  In this regard, the JOBS Act properly takes a hatchet to employee shares.  This is the Google, Twitter, Zynga and Facebook problem:  companies growing at meteoric speed and issuing gobs of employee stock and options that “count” in the “public market” calculus.  To this extent, Title V is good stuff and overdue. 

     ** Third, while I can’t say that 500 shareholders is the correct standard, I also don’t know how or why 2,000 total holders or 500 non-accredited holders is right either.  The new number choices strike me as arbitrary as the old one.  I will say this, however:  After you factor out the employees, 500 shareholders is a lot of people.  2,000 is a lot more.  Managing 1,999 non-employee shareholders – answering their questions, responding to their requests for information, keeping them informed of events as corporate laws require, soliciting their vote(s) when necessary and generally managing their expectations – is a big job.  If a privately-held company has so many shareholders that it requires an internal investor relations function isn’t it, like, “public-ish”?  Just a thought.

     ** Finally, assuming you back the employees out of the calculation, who benefits from massive 2,000+ shareholder, privately-held companies loathe to dive into the public markets?  Certainly not mainline venture capital investors with presumptively extended liquidity paths.  In that regard, it’s no surprise that some of the biggest supporters of a “2,000-Shareholder Rule” are the purveyors secondary markets (SecondMarket and SharesPost).  The secondary market phenomenon is a topic for another day, but two comments are apropos here:  (1) many people – myself included – believe that much secondary market activity defies the spirit if not the letter of the federal securities laws, and (2) the way venture capital documents are drafted companies generally have an effective veto over who can and cannot sell into the secondary market and as a result some issuers are “gaming” who “gets” to “cash out.”  Regarding the former (securities laws), the word on the street has long been that the SEC is aware of the abuses but under orders from the Obama Administration to let it slide – for now.  To my knowledge, only one investigation has transpired to date (see Bloomberg).  Regarding the latter (issuers letting “friends” cash out), this is almost certainly actionable on a variety of legal theories.  No one has sued anyone (yet) because for the time being everyone wants to play nice and get liquid.  However, with 2,000 shareholder companies floating around – with active secondary markets - look for that legal ground to be plowed sooner rather than later.

Title 2 and Title 4

Reg D and Reg A – The Access to Capital for Job Creators Act and The Small Company Capital Formation Act.

A – Technical.  Title II and Title IV of the JOBS Act began as H.R. 2940 and H.R. 1070, respectively.  The latter is noncontroversial and probably not greatly relevant to tech startups; as proposed Title IV amends Regulation A under the Securities Act to increase the offering threshold for companies exempted from SEC registration from $5M to $50M.  Conversely, Title II plows new securities law ground … As proposed, the core change effected by Title II is to amend Regulation D under the Securities Act to say that (1) offerings exempt under Rule 506, in which (2) all purchasers are accredited investors, can (3) be effected without regard to the general advertising and general solicitation restrictions of Rule 502(c).  Various conforming changes then ripple through the Securities Act.  So, in English … 35 accredited purchasers, no dollar limit on the offering, with general advertising/solicitation = OK under Rule 506.

B – Practical.  Personally, I’m hard pressed to see the merits of abolishing the general solicitation rule in any context.   Remember, the latter is there to protect investors and issuers (the former from fraud, and the latter from lawsuits for failure to disclose material information in said solicitations).  Barry Silbert, CEO of SecondMarket explained it thus in a House Subcommittee hearing on September 21, 2011:

[T]he general solicitation prohibition unnecessarily limits the pool of potential investors, thereby restricting companies’ ability to raise capital to fuel growth …  [I]f only accredited investors are eligible to purchase unregistered securities, shouldn’t we strive to maximize the pool of accredited investors that have access to the offering?  [S]ophisticated, accredited individual and institutional investors have greater capacity for risk and do not require the enhanced protections provided to the average retail investor.


The phrase “the devil is in the details” was created for situations like this.  Should it be adopted as proposed, abuse of the new rule as well as increased instances of outright fraud are, IMO, a given.  Ditto hand-wringing by lawyers for legitimate offerings on the subject of what must be disclosed in a “Rule 506 General Solicitation” to minimize issuer and management liability.  Does issuer’s counsel hold a sort of quasi-drafting session for solicitation material, or just wash his or her hands of it as a non-legal business matter?  Since it goes to the exemption, hard to imagine the latter.  Further, what happens to third party legal opinion practice?  Rote for 506 deals today, but if the rule goes through as proposed look for much rumbling over exceptions and assumptions in what were once routine transactions.  Net:  By allowing unregistered general solicitation Congress is cutting to the core of the federal securities law regime.  IMO, this will create more problems than it will solve and create more jobs in the legal industry than any other sector.  Crank up the legal budget for these deals. 

Final Note:  Erosion of the New Deal

In 1932 Roosevelt swept to power with an electoral victory that is stunning by today blue state/red state standards.  In 1936, the electoral map was even more so.   Roosevelt used his electoral mandate (control of Congress helped) to usher in the “New Deal,” a cluster of legislative activity intended to deal with the national financial debacle of the time. 

Some pieces of New Deal legislation served their purpose and were repealed (e.g., rules creating the Civilian Conservation Corps and Public Works Administration).  Some were doomed by the politics of the day (e.g., the Civil Works Administration, see Slate).  Others were ruled unconstitutional by the Supreme Court (e.g., the Agricultural Adjustment Act of 1933 and the National Industrial Recovery Act of 1933), leading to FDR’s ill-advised and doomed “court packing” maneuver.  Finally, a lot of the “New Deal” still exists today … the Banking Acts of 1933 and 1935 (creating the Federal Deposit Insurance Corporation), the  Securities Act of 1933, the Securities Exchange Act of 1934, the Social Security Act of 1935, the National Labor Relations Act of 1935, the Investment Company Act of 1940, and the Investment Advisers Act of 1940. 

Notable by its absence in the above discussion is the “Glass-Steagall Act,” a confusing term that variously refers to (1) 1932 legislation put forth by Henry Glass (D-VA) and Henry Steagall (D-AL) related to the Federal Reserve, or (2) the entire Banking Act of 1933, or (3) Sections 16, 20, 21 and 32 of the Banking Act of 1933 dealing broadly with the separation of commercial and investment banking, or (4) Sections 20 and 32 of the Banking Act of 1933 dealing specifically with the ability of commercial banks to participate in securities underwriting and investment.  Historically, references to “Glass-Steagall” and the “Glass-Steagall Act” have meant the four provisions of the Banking Act drawing a line between commercial and investment banking.  However, it was Sections 20 and 32 thereof – federal statutes expressly forbidding commercial banks from underwriting activity - that were (dubiously) repealed by the Gramm-Leach-Bliley Act of 1999.  Consumer advocates draw a straight line between the repeal of Glass-Steagall and the financial crisis of the late 2000’s.  See Kuttner and Weissman.  Some – primarily those in the banking industry – dismiss the assertion.  Me?  I’m with Elizabeth Warren:  FDIC insurance, Glass-Steagall’s separation of investment banking and SEC regulations provided “50 years without a crisis,” and generally kept banks from doing “crazy things.”

What’s the point? 

The JOBS Act variously tinkers with and takes a hammer to two pillars of the New Deal – the Securities Act and the Securities Exchange Act.  Most of the tinkering – such as the IPO On-Ramp and the proposal to exclude employees from the 500-Shareholder Rule – represents thoughtful, intelligent adjustment of the regulatory framework to emerging company business reality.  By contrast, “hamfisted” is how I would characterize the rulemaking that enables (1) unfiltered, unlimited solicitation of unregistered investments, (2) Crowd Funding, and (3) creation of private-company behemoths with thousands of “unpreferred retail” shareholders trading in a murky online world of secondary sales.  As to the latter changes, John Coates’ JOBS Act testimony was correct IMO … any decrease in the transactional costs of raising capital effected by these changes is illusory.  See Coates.

For reasons that I personally don’t understand, there seems to be a groundswell of belief that the New Deal was a bad thing.  “Bad for business” is an oft articulated point of view and one that permeates JOBS Act political discussion.  My view is that the 1929 Crash and ensuing Great Depression was bad for business.  So was the S&L crisis, Enron, and the subprime mortgage meltdown.  All failures to regulate properly, not failures of over-regulation.  My view is that the federal securities laws should be bad for bad business and short-term profiteering.  They should also prevent people from doing crazy things.  Some parts of the JOBS Act qualify … others don’t.

Stay tuned … .

© david jargiello 2012 all rights reserved

File-or-Die; Ugly New Law Afoot in California.

California Senate Bill No. 978 was recently introduced by Senators Juan Vargas (D) (District 40, San Diego) and Curren D. Price, Jr. (D) (District 26, Los Angeles) and is apparently threading its way through the legislative process. SB 978 is lawmaking at its worst, IMHO, at least as far as the venture capital and legal industries are concerned.

1 - What It Does. SB 978 would change two longstanding securities law exemptions used in venture capital financings – Sections 25102(e) and 25102(f) of the California Securities Law – to say that failure to timely file a notice of transaction with the state Commissioner of Corporations would result in loss of the exemption. Under current law failure to file this form can result in penalties but not loss of the exemption. Why is that bad? Because the proposed new law converts a ministerial failure to make a one-page “notice” filing into a material violation of California Securities Law that (a) triggers the full panoply of enforcement horribles, most notably, rescission rights, and (b) will inevitably result in claims against lawyers for legal malpractice and/or invalid third party closing opinions. In short, it’s a “file-or-die” rule and an ugly victory of form (no pun intended) over substance.

2 – Technically Speaking. In purely technical terms, venture financings that rely on Rule 506 should be unaffected by SB 978 by virtue of the continuing preemption by the National Securities Markets Improvement Act of 1996 (“NSMIA”). By its terms, NSMIA applies to Rule 506 transactions, but not to transactions effected under Rule 504, Rule 505 or Section 4(2) of the Securities Act of 1933. Thus, only financings done in reliance on any of the latter exemptions would feel the wrath of SB 978.

3 – In Practical Terms. So, what does all of that mean, exactly, in the real world? Well, not much as far as Rule 504 is concerned. Rule 504 has never been a significant exemption for venture capital financing purposes because of its $1M aggregate offering limit. Ditto Rule 505 with its $5M aggregate offering limit. Rule 506 and Section 4(2), on the other hand, are the workhorses of nearly all venture capital financings and the impact here is significant for issuers, investors and their respective lawyers alike.

     » 506 Traps. As noted, SB 978 should be irrelevant to valid Rule 506 transactions by operation of NSMIA. However, the key word here is “valid.” I’ve seen more than a few venture financings done with a hand wave toward that rule and the filing of a Form D. What sometimes gets lost is that lurking in Rule 506 is a trap for the unwary. As the SEC itself says:

Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that are generally the same as those used in registered offerings. (emphasis added).

So, Rule 506 transactions that involve only accredited investors … all good. But, Rule 506 transactions with a handful of the proverbial non-accredited “friends and family” … not so much. Why? Because the information and financial statement requirements are rarely met or even practicable to meet by a start-up comprised of the proverbial two engineers, an idea, a dog and no money. The point: A lot of “Rule 506” transactions are technically not for failure to comply with the information delivery requirements.

     » The Final Frontier. That leads us to Section 4(2) – the longstanding private offering exemption with the wonderfully vague guidelines as to purchaser sophistication, the number of purchasers, dollar amount of stock sold, and information provided. Whether used as the primary exemption for a securities offering or as the “back up” for an invalid Rule 506offering, Section 4(2) has been a backbone of Silicon Valley capital raising for decades on end. With respect to SB 978, this is where the rubber meets the road. The California Commissioner of Corporations has long called out the fact that Section 4(2) transactions are not preempted by NSMIA – see Release 103-C. Thus, Section 4(2)transactions are subject to regulation by the State of California, and would be expressly affected by SB 978. In real world terms, here’s how things go bad … . Classic bootstrapped start-up does a “friends and family” round of financing in reliance on Section 4(2) and therefore California Section 25102(f). Oops, accidently miss that one page notice filing, even by one day? Sorry, no exemption, the entire offering is unlawful for lack of a valid California exemption, the purchasers have recission rights, and the issuer is, at least potentially, a “bad boy” (aka a “disqualified bad actor”). Welcome to California.

4 - Bad Timing. Putting aside the wisdom of complicating the capital raising process in the current economic environment, the timing of SB 978 is also unfortunate vis-à-vis two other recent legislative developments: First, it is “harder” to be an “accredited investor” today. As a result of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the value of one’s primary residence does not count as an asset for purposes of calculating “net worth” to determine “accredited investor” status. Second, under a still proposed rule driven by Dodd-Frank, “bad boys” would be barred from participation in any Rule 506 offerings. Barred forever? I don’t know. It’s a proposed rule, so stay tuned. Notably, the existing federal “bad boy” rules are triggered by federal bad acts (e.g., acts before the SEC) and not by state-level misconduct. At least theoretically, the proposed Rule 506(c) sweeps in the “final orders of certain state regulators” as a “disqualifying event.” The broad point is that, juxtaposed against concurrent federal rulemaking, SB 978 comes at a time when (a) the pool of accredited investors is smaller and issuers are more likely to rely on Section 4(2) as a primary exemption, and (b) the federal consequence of being a state-level “bad boy” is in flux.

5- Ignoring History. One of the remarkable things about SB 978 is that we’ve been down this path before with unhappy results. Section 25102(o) of the California Securities Law articulates the standard exemption for sales of securities pursuant to a compensatory benefit plan (i.e., the issuance of stock and options to employees and consultants). When Section 25102(o) was first enacted, failure to make a similar “notice filing” was fatal to the availability of the exemption. This led to a host of problems, and the simple fact that many start-ups engaged in expensive (and largely pointless) employee rescission offers on the eve of their initial public offering in order to cure a ministerial dysfunction. In recognition of the “undue burden on businesses creating jobs … in California” imposed by Section 25102(o) generally, a wave of changes in 2007 brought it into line with corresponding federal securities law. Among those changes was the elimination of the “file-or-die” element … . “The failure to file the notice of transaction within the time specified in this subdivision [Section 25102(o)] shall not affect the availability of this exemption” (emphasis added). Precisely the language to be deleted from Sections 25102(e) and 25102(f) by the backward looking SB 978.

6– Risk Management. If SB 978 actually becomes law, then failure to timely file Section 25102(f) notices would be material and legal malpractice claims inevitable. For knowledgeable start-up lawyers, think Section 83(b) elections. Under SB 978, the stakes would be similar. Failure to file, even by one day … . Investors with buyers’ remorse will have a rescission right that the issuer will look to the lawyers to make good on. Company unable to raise additional capital because it is a “bad boy” with a documented unlawful issuance? Try on the consequential damages for size. Ditto lawyers who render third party legal opinions to the investors at the closing of venture financings. The customary opinion regarding the availability of an exemption? Suddenly much riskier to give. Expect a good deal of hand-wringing, theorizing and negotiated exceptions on that stead.

Net: SB 978 – as proposed - is the worst sort of regulatory sausage … . (1) a punishment vastly out of context for the violation, (2) guaranteed to generate a wave of socially useless litigation in order to sort out the debris field that such punishment will leave in its wake, all for (3) zero actual benefit to the investing public it is presumably intended to aid.

Here’s to hoping that cooler heads prevail.

© david jargiello 2012 all rights reserved

First Posted February 23, 2012, Re-Posted March 7, 2012

Venture Capital Board Politics: Fiduciary Duty of “Stockholder Control Groups.”

Lots of recent blogging about this Q4 case out of the Court of Chancery (Dubroff v. Wren Holdings, LLC (Del. Ch. Oct. 28, 2011 (“Dubroff II” in the lexicon of court cases, to distinguish it from an earlier case in the same matter), which has some terrific language and useful reminders.

Among the latter:

First, the Court of Chancery reaffirmed that (1) individual stockholders without individual control positions can combine to form a “control group” working together to control corporate affairs, and (2) that such a “control group” owes a fiduciary duty to minority stockholders. Venture investors and angels in operating in concert can easily fall into the control group rubric.

Second, minority stockholders can sue a control group directly (as opposed to derivatively) for a breach of such duties if their interests have been diluted in favor of the group. As the Court of Chancery put it …

… minority stockholders may have a direct equity dilution claim when their holdings are diluted, and those of the [control group] are not. In other words, as long as the [control group’s] holdings are not decreased, and the holdings of the minority shareholders are, the latter may have a direct equity dilution claim … .

In holding that the minority held a direct claim against the Dubroff II control group, the Court of Chancery noted – eloquently IMO - that the transaction in question was an “extraction” of “economic value and voting power” from the minority and a “redistribution” thereof to the control group.

Finally, the contours of DGCL §228(e) (regarding “prompt” disclosure of actions taken by majority stockholder written consent) remain elusive. Certainly it would appear that in the dilutive transaction at issue in Dubroff II, mere disclosure of the fact of the recapitalization - without mention of the redistribution of economic and voting power effected - was insufficient.

Net: Some good learning here. The pleading and disclosure items are useful technical points. More nuanced, however, is the control group point. Dubroff II is an interesting read/reminder that there are an array of shifting fiduciary duties afoot as board and stockholder politics unfold in any rapidly growing company.

© david jargiello 2012 all rights reserved

First Posted January 31, 2012, Re-Posted March 6, 2012

Business Judgment Rule Protection for Corporate Officers? We’ll See.

A recent case out the Central District of California is getting some attention and caught my eye. In Federal Deposit Insurance Corp. v. Perry (C.D. CA December 13, 2011), the district court held that the business judgment rule does not apply to decisions of corporate officers as a matter of California law. After a rather laborious reading of §309 of the California Corporations Code (codifying the BJR) and its legislative history, the Central District concluded that the architects of the California statutory BJR intended to expressly exclude corporate officers from its benefits. Fair enough.

Here’s what I found interesting … .

First, Perrywas decided on a Motion to Dismiss, and in any event is not your average, run-of-the-mill corporate dispute. The officer in question was the CEO of Indymac, accused by the FDIC of driving said bank into receivership via massive subprime mortgage losses. Not exactly a poster child for the application of the business judgment rule to corporate officer decision making. On the theory that bad facts make bad law, I’m personally going to take a wait-and-see approach as to how California law develops on this front.

Second, it’s interesting that Delaware law is only modestly more developed on this issue. In Delaware - by proclamation of the Delaware Supreme Court just two years ago in Gantler v. Stephens (965 A.2d 695 (Del. 2009)) – corporate officers owe the same fiduciary duties (care and loyalty) as directors. While the notion of officers’ fiduciary duties had long been presumed through a labyrinth of dicta and conventional wisdom, Gantler was actually the first statement of this principle as a matter of Delaware law. As I recall, Gantler was – at the time - perceived as leaving a something of a debris field in its wake: For example, the Delaware statutory liability shield applied (and still applies) only to directors. Further, the dearth of Delaware case law regarding the fiduciary duty of officers created (and still creates) doubt as to how those duties are to be interpreted and discharged. To the latter point, officers follow the directions of the board and/or superior officers, setting the stage for a conflict between self-preservation (i.e., following orders and keeping your job) and the affirmative duty to act in the corporation’s best interests.

So what’s an officer to do?

Well, in Delaware, Gantler implies but does not hold that corporate officers enjoy the protections of the business judgment rule. IMO, a terrific pre-Gantler piece from The Business Lawyer gets it right: The BJR … (1) protects the actions of officers within the scope of their “delegated discretionary authority” (my emphasis), but (2) does not protect mutiny, i.e., actions of officers in derogation of their job responsibilities. In other words, the board is primary, the BJR protects its good faith judgments in pursuit of legitimate corporate interests, and corporate officers are the implementers of those judgments. To the extent officers have discretionary authority in that implementation, the BJR applies.

In California, there’s not much to be said beyond “consider moving the corporate domicile to Delaware.” And there are a lot of reasons to do that …

© david jargiello 2012 all rights reserved

First Posted January 27, 2012, Re-Posted March 6, 2012

Going Dark: Portco Radio Silence to Venture ‘Storm Warning.’

Recent Case (Strategic Diversity v. Alchemix Corp., 9th Cir., January 20, 2012).

Interesting case out of the 9th Circuit. In May 2001, Angel investor loans Start-Up $500,000 under a convertible note. Angel gets what sounds like “series next” conversion rights, a security interest in Start-Up’s intellectual property, and a board seat. In May 2002, various new investors come along, and the (normal) process of negotiating away Angel’s board seat and security interest begin. In June 2002, New Corporate Investor puts in a first tranche of money, and in connection therewith Angel: (1) gets his $500,000 note paid in full, (2) surrenders his board seat, (3) releases his security interest, and (4) pays $250,000 in cash for new stock.

Unfortunately, in July 2002, New Corporate Investor becomes “strapped for cash.” Only $3M of a promised $30M comes in. That same month, Start-Up’s CEO/Founder is sued for securities fraud in connection with an unrelated business. Start-Up then goes radio silent vis-à-vis investors, including Angel. Two years later - in 2007 - Angel sues CEO/Founder and Start-Up for securities fraud. Angel loses on Summary Judgment in the District of Arizona on grounds that his claim was time barred, but prevails in this appeal to the 9th Circuit.

My thoughts …

1 - Sitting on your hands is (still) a bad idea: Financially distressed companies often go dark vis-à-vis investors, creditors or even an inattentive board. More commonly, they leak just enough sanitized information to keep potential claimants at bay. So, if you are a venture investor, when does the limitations period for securities fraud begin to run … . When the splashy newsletters stop? When compliance with contractual information rights becomes spotty? When compliance with such rights stops altogether? When your emails/calls go unanswered? The good news – sort of – for claimants is that the 9th Circuit held in Strategic Diversity that after a two year information hiatus, Angel’s securities fraud claim was not time barred per se. That said, IMO the proper reading is not that the 9th Circuit somehow endorsed sitting on your hands in the face of a dearth of information, but rather sent the case back for proper application of Merck & Co., Inc. v. Reynolds, 130 S.Ct. 1784 (2010). How that plays out is not at all clear given the facts at hand. For example, from Merck come some terrifically descriptive terms - “Inquiry Notice,” aka a “Storm Warning” - that denote a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. Contrary to some of the analysis I have read, Merck does not say that sitting around while a portco remains dark is “OK.” Rather, in Merck the Supreme Court held that the moment of “Inquiry Notice” does not by itself start the limitations clock; instead, the limitations period for a securities fraud claim begins to run when plaintiff discovers or should have discovered the facts constituting the violation. The point is that maybe plaintiff should have discovered the subject facts at the time of Inquiry Notice, thus triggering the period, or … maybe the plaintiff should have discovered those facts a day, a month or a year after Inquiry Notice.

2 – A unrelated fraud lawsuit against a founder is material to an investment decision: In the facts underlying Strategic Diversity, Angel investor was unaware of a securities fraud lawsuit brought against Start-Up’s CEO/Founder regarding an unrelated business (the “Unrelated Fraud Suit”) at the same time as Angel was making his investment decision. On this point and citing Basic v. Levinson, the 9th Circuit stated that it was …

… not convinced that [CEO/Founder’s] omission concerning the [Unrelated Fraud Suit] was material to [Angel’s] investment decision. An omitted fact is material if there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available… . [T]here is no reason to conclude that this affected the “total mix” of information available or that any reasonable investor would consider this material. [CEO/Founder] was the civil defendant in another securities fraud case involving a completely different company. The company was in no way related to [Start-Up] … and it was not connected to the instant transaction.

Hmmmm … With respect, I don’t think this is even close to correct. Does anyone know a venture capitalist that would NOT want to know - immediately - that the CEO of a portco is a securities fraud defendant?

That’s what I think, anyway …

© david jargiello 2012 all rights reserved

First Posted January 22, 2012, Re-Posted March 6, 2012

Liability of Corporate Counsel to Founders; IMO a Nebraska Court Misses the Mark

Recent Case (Sickler v. Kirby, Neb. Ct. App., No. A-10-965, 11/8/11).

An extraordinarily dangerous precedent for corporate counsel. In my view, a misguided and incorrect analysis that misses the realities of corporate representation. For the better analysis see Alok Singhania v. Venture Law Group (2002).

© david jargiello 2011 – 2012 all rights reserved

First Posted November 27, 2011, Re-Posted March 6, 2012