Thursday, July 14, 2016

The Wit and Wisdom of Commissioner Gallagher

I doubt that comments from SEC Commissioners are often dubbed "witty," but Commissioner Daniel M. Gallagher had a real zinger in connection with the SEC's adoption of pay ratio rules last year.

As a bit of background, among the many half-baked ideas in the Dodd-Frank Act of 2010 was the requirement that the SEC adopt rules requiring public companies to disclose the median annual compensation of all employees of the company (excluding the Chief Executive Officer) as well as the ratio of the median salary to the total compensation of the CEO.

Of course, this disclosure would be virtually meaningless to any rational investor.  The sole goal of this new disclosure requirement was to try to embarrass CEOs by making their compensation appear unreasonably high when compared to rank-and-file employees.  Did you think the goal of the SEC disclosure regime was to inform shareholders so that they can make rational investment decisions? So did I, but apparently the 111th Congress of the United States, which passed the Dodd-Frank Act, disagreed.

Anyway, the SEC was tasked with coming up with regulations to implement Dodd-Frank's disclosure requirement.  The task of determining the median annual compensation of employees was not as easy as it might initially seem. What about part-time workers? Seasonal workers? Non-U.S. based workers?  What about employees with different cost-of-living circumstances? Etc.

Ultimately, the SEC passed a controversial set of rules by a 3-2 vote, which included part-time and foreign workers in the median compensation calculation. At the meeting in which the vote was taken, Commissioner Gallagher objected to the adoption of the rule, noting that the disclosure was outside the SEC's core mission, and explaining that since the SEC was required to adopt the rule, he would have at least used the SEC's definitional and interpretive authority to limit the phrase "all employees" in the Dodd-Frank Act to full-time, U.S. based workers.

And here's the part I really like.  Commissioner Gallagher described his proposed disclosure rule as "marginally less useless" than the rule the SEC ultimately adopted. Classic.

I had the honor of introducing Commissioner Gallagher at the 2015 UT-CLE Conference on Securities Regulation and Business Law, and I can confirm that his prepared remarks were as thoughtful as his comment of pay ratio rules was witty.

Thursday, June 23, 2016

Reward-Based Crowdfunding Forum

Earlier this week, I was in the audience for a terrific roundtable discussion on reward-based crowdfunding at IDEA Works FW.  The discussion was led by Hayden Blackburn, the Director of IDEA Works FW, and included an interview with Stephen and Carrie Fitzwater, the founders of Modern Lantern, a designer and retailer of battery-operated cordless lamps (here is their website). Modern Lantern have raised over $15,000 in crowdfunding on Kickstarter to help bring their lamps to life.  

I learned a lot about rewards-based crowdfunding at the event.  For those that don't know, crowdfunding involves seeking funding for a project through small contributions from a large number of people, typically over the internet using websites such as Kickstarter.  Importantly, rewards-based crowdfunding does not involve an investment in securities, such as stock of a company (that's called "equity crowdfunding"). Contributors to a reward-based crowdfunding effort typically expect to receive something in return for their contribution, however, such as a discounted purchase price for a product under development, an extra role in a movie under development, a t-shirt or other swag from the company, and certainly some psychic benefit of knowing you have helped get a young company or project off the ground.

Below are a few take-aways  from the discussion, in no particular order:

  • DON'T EXPECT TO RAISE BIG BUCKS. Reward-based crowdfunding is generally not a way to raise a lot of funds. According to Kickstarter's statistics (available here), although their site has raised of $2.4 billion for over 100,000 projects, about 70% of the projects that successfully used the website for fundraising raised less than $10,000. Less than 0.2% of all successful Kickstarter projects raised $1 million or more.   
  • CHOOSE THE RIGHT PLATFORM. There are more than 190 websites that offer crowdfunding platforms, with more being added all of the time. Some of the more well-known crowdfunding platforms are Kickstarter, Indiegogo and GoFundMe. Different platforms focus on different types of crowdfunding projects (tech, movies, music, medical expenses, etc.), so a company seeking crowdfunding will want to make sure its project fits into the general focus of the crowdfunding platform it chooses to use.
  • MAKE A GREAT VIDEO ABOUT YOUR PROJECT. Kickstarter permits (and strongly encourages) you to prepare a video (perhaps 1-3 minutes long) describing your project. This is where potential crowdfunding contributors are likely to go first to learn about you, your project, your funding needs, and why they should care, so putting together a compelling video is an important part of the crowdfunding process.  It should tell your story in a way that makes the viewer care about and get invested in your success.
  • DRIVE TRAFFIC TO YOUR PROJECT PAGE. Do not expect Kickstarter to do any advertising for you. Getting a project accepted by Kickstarter (yes, they must approve your project before you can use their platform - other platform (such as Indiegogo) have a less rigorous admission process) is only part of the battle for funding.  You should plan to have a robust campaign to drive traffic of potential contributors to your Kickstarter project page.  E-mail blasts and social media "likes" to a broad range of potentially interested contributors is critical to a successful crowdfunding campaign. Media contacts who might help you promote your project and/or a coordinated series of press releases can also enhance your visibility. 
  • FOLLOW UP TO BUILD SUPPORT AND LOYAL CUSTOMERS. Perhaps more important than the funds that can be raised through crowdfunding, is the core of customers, supporters and fans of your product or service that can be grown and cultivated through an effective crowdfunding campaign and thoughtful interaction and follow-up throughout and after the crowdfunding campaign. An earlier contributor to your project is likely to feel invested in your success (literally and figuratively!) much more than a traditional customer.
  • COOL SUCCESS STORY. One interesting reward-based crowdfunding success story is Rocketbook, which has raised over $500,000 on Kickstarter for its cloud-connected, microwavable notebook.  The product allows you to take notes, store your notes on the cloud, then erase your notes in the microwave and re-use the notebook!  You can read more about it here.
Thanks to Hayden and his team for putting on a very interesting and informative event.      

Wednesday, June 1, 2016

German Efficiency?

If you have ever wondered why it is necessary to sign so many sheets of paper when buying or selling a house in the United States, just know that entering into a contract could be worse in other parts of the world.

I've been enjoying reading "Working with Contracts - What Law School Doesn't Teach You," by Charles M. Fox.  The book provides a really good summary of what we corporate lawyers do every day.  It also includes some interesting tidbits, such as this nugget on contractual formalities on page 159:

"[M]any German agreements must be read aloud from beginning to end (including schedules) by a notary, and some must be bound by a ribbon which is affixed to both the cover page and the back page with a waxed seal."

Apparently, the efficiency famously exhibited by German engineers is not shared by German lawyers!

Monday, May 23, 2016

Regulation Crowdfunding Investment Limit

The SEC's Regulation Crowdfunding sets forth the rules pursuant to which companies may raise capital through the SEC's equity crowdfunding exemption.  One of those rules sets limits on the amount of crowdfunding investments by any one investor in crowdfunding offerings (by all companies conducting crowdfunding offerings) in any 12-month period.

Specifically,  Rule 100(a)(2) of Regulation Crowdfunding provides:

"The aggregate amount of securities sold to any investor across all issuers in reliance on [the equity crowdfunding exemption] during the 12-month period preceding the date of such transaction, including the securities sold to such investor in such transaction, shall not exceed: 

(i) The greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net
worth if either the investor’s annual income or net worth is less than $100,000; or

(ii) 10 percent of the lesser of the investor’s annual income or net worth, not to exceed an
amount sold of $100,000, if both the investor’s annual income and net worth are equal to or more
than $100,000."

The investment limit (for all crowdfunding investments) for a crowdfunding investor always results in a number:

  • between $2,000 and $5,000; or 
  • between $10,000 and $100,000. 
Put another way, the investment limit for a crowdfunding investor can never be:

  • less than $2,000;
  • more than $5,000 but less than $10,000; or 
  • more than $100,00.
I have developed a handy calculator for determining the investment amount limit for a particular equity crowdfunding investor based upon their income, net worth, and prior crowdfunding investments in the past 12-months. Feel free to contact me if you'd like a copy of the investment limit calculator.

Tuesday, May 17, 2016

Equity Crowdfunding under Federal Law has Arrived!

It's finally here.  Four years after the JOBS Act of 2012 was signed into law which required the SEC to adopt rules permitting equity crowdfunding, the SEC's final rules titled "Regulation Crowdfunding" have gone effective.

Effective May 16, 2016, U.S. companies may now offer and sell shares of stock and other securities via crowdfunding and qualify for an exemption from securities registration requirements under Section 4(a)(6) of the Securities Act of 1933, as amended.

I'm still wading through the SEC's 685-page final rule release adopting Regulation Crowdfunding, which is available here.  I plan to blog about this matter further in the coming days, but in the meantime, you can read "Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers" written by the SEC, which is available here.

Friday, May 13, 2016

Little Known Facts: LLCs and Statutory Attorney's Fees in Texas

Here's a Little Known Fact about an advantage of operating as a limited liability company (LLC) in Texas.

LLC's are not subject to Section 38.001 of the Texas Civil Practice and Remedies Code, which permits statutory recovery of reasonable attorney's fees from individuals and corporations for certain claims, including claims for an oral or written contract.

Section 38.001 of the Texas Civil Practice and Remedies Code provides as follows:

"A person may recover reasonable attorney's fees from an individual or corporation, in addition to the amount of a valid claim and costs, if the claim is for:
(1) rendered services;
(2) performed labor;
(3) furnished material;
(4) freight or express overcharges;
(5) lost or damaged freight or express;
(6) killed or injured stock;
(7) a sworn account;  or
(8) an oral or written contract."

A 2014 case decided by the Houston Court of Appeals (Fleming v. Barton) has confirmed that the statute means what it says - that only individuals and corporations (not LLCs, limited partnerships (LPs), limited liability partnerships (LLPs) and other entities) may be liable under Section 38.001. Relying upon the plain language of the statute, that court denied a claim for legal fees under Section 38.001 against Fleming & Associates, L.L.P. because it was a limited liability partnership.

But wait a second, why wouldn't a limited liability company, limited liability partnership, or limited partnership who lost a breach of contract lawsuit face the same liability as a natural person or a corporation that was guilty of the exact same breach?

It arises as a quirk of Texas's statutory codification process.  When the Civil Practice and Remedies Code was adopted in 1986, it replaced the existing Article 2226 of the Texas Revised Civil Statutes, which permitted recovery of legal fees against “a person or corporation.”  The then-recently adopted Texas Code Construction Act had defined "person" broadly to include any legal entity, including governmental entities.  So in seeking to avoid substantive changes to Article 2226, the drafters chose the word "individual" instead of "person" to clarify that governmental entities could not be subject to liability under Section 38.001.

This strikes me as a great area of the law for the Texas legislature to step in and clarify that LLCs, LPs, LLPs, and other business entities (perhaps excluding governmental entities) should face the same liability under Section 38.001 as individuals and corporations.

Note that the issue discussed above relates only to statutory attorney's fees provided for by Section 38.001 of the Texas Civil Practice and Remedies Code.  Nothing in that section prevents an LLC or other entity to agreeing to cover another party's attorney's fees pursuant to a contract.

Thursday, April 21, 2016

Does Big Board = Big Problem for Texas LLC?

Texas limited liability companies have tremendous flexibility in choosing how they may be governed. That can be a blessing and a curse.  Let me explain.

Each Texas LLC must elect to be member-managed or manager-managed in its certificate of formation.  Then the LLC's company agreement generally determines if the company may or may not have officers representing the company and how the management rights will be allocated among the officers (if any), managers (if any), and members.  The benefits of this flexibility are easy to see: the LLC can choose to slice-and-dice the management and control functions of the company in any number of ways that suit its interests.  For example:

  • officer(s) might be responsible for day-to-day management of the company in the ordinary course; 
  • manager(s) approval might be required for more substantial matters, such as taking out a loan or entering into a material contract; and
  • member(s) approval might be required for major decisions, such as entering into a merger, accepting a new member, or amending the company agreement.    
LLCs often seek to establish a Board of Managers which would be analogous to a Board of Directors of a corporation. In that case, it is not unusual for the LLC's company agreement to provide that no individual manager has the power or authority to bind the company (much like a single director of a corporation with multiple directors would not be able to bind the corporation).  Such a provision would be effective to deny any particular manger the actual authority to bind the company.

But might a rogue manager nonetheless have apparent authority to bind the LLC? Probably so. Recall that a manager-managed Texas LLC must identify its initial managers in its certificate of formation. So the world would be on notice as to the identity of the mangers - but not necessarily the scope of their authority, which in this example is limited by the company agreement which is not publicly filed. The default presumption under the Texas Limited Liability Company Law is that a manager is an agent that may bind the LLC (see Section 101.254 of the Texas Business Organizations Code).

Bottom line, a Texas LLC has at least some risk that a rogue manager might act without actual authority (but with apparent authority) to bind the company.  That's a risk a Texas corporation does not face - a director of a corporation generally does not have apparent authority to bind a corporation because corporations generally act through their officers, not their directors.

Thanks to Allen Sparkman for highlighting this issue in a paper he presented to the UT-CLE Securities Regulation and Business Law Conference.