Saturday, December 27, 2014

Blue Sky Filings Made Easy?

One of the reasons that explains why Rule 506 offerings have been so popular as a means of conducting a private placement is because they are exempt from state regulation.  In 1996, the National Securities Markets Improvement Act stated that securities offered under Rule 506 of Regulation D qualify as "covered securities" under Section 18(b)(4) of the Securities Act.  Consequently, securities sold under Rule 506 enjoy a exemption from the registration requirements of state-level securities laws (blue sky laws).

But states can still ask the issuers to make notice filings and pay filing fees with respect to Rule 506 private placements if any of the investors are their residents.  Most states make it easy for the issuers: they ask for a copy of Form D and a fee that typically ranges around $100-$300.  Some states take it a lot further.  I think New York State blue sky compliance requirements merit a separate blog post (to come).

On December 15, 2014, the North American Securities Administrators Association (NASAA) launched an Electronic Filing Depository system, EFD, that allows issuers to submit Form D and applicable fees to different states at once.  It also allows the public to view blue sky filings made by any issuer in any state that participates in the EFD.  Here is NASAA's training video.  The system provides an electronic receipt as proof of compliance and allows issuers to monitor the progress of states' review of the filing and respond to any deficiencies that may arise.  

Of course, when it comes to blue sky compliance, things cannot be made that simple that fast.  First, not all states participate.  As of now, 41 states and territories participate (New York is not one of them).  Some state regulators want filings to be made only through the EFD, other states accept only hard copies, and yet the third group accepts either.  To confirm what the state regulators expect, attorneys can contact the relevant state regulator using this contact information.  Second, some states may ask for additional documentation (such as consent to service of process or a copy of the offering memorandum) that would need to be sent to them separately.  Third, there is a $150 system use fee for each offering.  The fee covers the issuer's initial Form D filing and all amendment and renewal filings made through the EFD for that offering.

Still, as a lawyer who diligently spends hours (if not days) figuring out each state's blue sky requirements for each private placement I work on, I am thankful for the EFD. Even if it is not perfect, and even if there is a fee to use it, it will save time and will actually increase blue sky compliance.   

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, December 26, 2014

Real Estate Crowdfunding

More about crowdfunding and portals...

When speaking about equity-based crowdfunding, the U.S. securities laws do not differentiate among different uses of proceeds derived from raising funds through crowdfunding portals.  The same securities laws apply to real estate crowdfunding as to crowndfunding campaigns with a goal of investing into technology startups.  The key terms that participants should be aware of are: the JOBS Act, private placements, accredited investors, Rule 506(b) offerings, Rule 506(c) offerings, general solicitation and advertising, intrastate offerings, and broker-dealer registration, among others.  

This guide on real estate crowdfunding prepared by Goodwin Proctor attorneys provides a useful overall summary of applicable laws and may just as well apply to other types of equity-based crowdfunding.  The most useful, in my opinion, is the chart on pages 6-7 of the guide that summarizes how various online crowdfunding portals enable securities offerings.  Interestingly, most if not all, rely on Rule 506(c) that allows conducting private placements that use general solicitation and advertising.  The choice, in my opinion, depends in large part on the amount of information about possible offerings that is available to users of the websites.  Such information can be viewed as general solicitation and advertising if it is easily accessible on the Internet by anybody.  In such cases, reasonable steps must be taken to ensure that only accredited investors participate in the offerings.  

Another interesting fact that can be learned from the chart is that most portals are not registered as broker-dealers.  These are examples of how portals comply with the exemption from registration found in Section 4(b) of the Securities Act that was made possible by the JOBS Act.  I discussed the broker-dealer exemption in my recent blog post available here.  

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Thursday, December 25, 2014

Crowdfunding Portals and the Securities Laws

The SEC has recently intensified its enforcement efforts against crowdfunding portals. The SEC's main focus is on these two legal issues: whether the crowdfunding portals offer and sell securities in unregistered transactions to US persons in violation of the Securities Act, and whether the crowdfunding portals act as unregistered broker-dealers to US persons. A recent example of an enforcement action against Eureeca Capital SPC is a good illustration.

On November 10, 2014, the SEC issued an order instituting administrative and cease-and-desist proceedings against Eureeca Capital SPC (“Eureeca”).  Eureeca was formed in the Cayman Islands in May 2013.  It operated an online equity crowdfunding platform connecting foreign issuers with investors. The offerings posted on the Eureeca website were general solicitation of US persons because they were accessible to the US residents and included information about the offerings, such as amounts and informational videos, that was not restricted or protected by password.  Potential investors were then asked to register to get more information by providing their names, dates of birth, email, country of residence and phone number.  They were not asked to certify that they were accredited investors.  Although Eureeca did have a disclaimer of its website that its services were not being offered to US persons, it did not implement procedures to prevent US investors from using the platform.  As of May 2014, Eureeca permitted over 50 persons who chose “United States” as their country of residence, to register on the platform.  Three of them ended up investing approximately $20,000 in total in four offerings advertised on the platform.  Eureeca sent emails to the registered users with detailed investment status and overview of the offerings and encouraged investment into these offerings.  To invest, registered users had to wire the money into Eureeca’s escrow account.  Then, users could allocate the money among different offerings.  If the offerings were fully funded, Eureeca then completed “the final legal requirements and managed the swap of funds for the equity agreed.”  Eureca received a percentage of the funds of the fully funded offerings of securities as compensation for its services upon closing of a deal. 

First, the SEC concluded that Eureeca violated Section 5(c) of the Securities Act by offering the sale of securities to three US investors because, after generally soliciting them, it did not take reasonable steps to verify that the purchasers of the securities were accredited investors. Two of the three investors self-certified by email that they were accredited investors, although such term was not explained to them. The third investor did not do even that.

Rule 506(c) allows issuers to use general solicitation and advertising in conducting private placements so long as their actual investors are accredited. Companies that conduct 506(c) offerings must take “reasonable steps” to verify that all investors in their offerings are accredited and have a reasonable belief that such investors are accredited at the time of the sale of securities. Before the JOBS Act, and still while conducting Rule 506(b) offerings, companies could rely on investors’ self-certification (for example, questionnaires where investors self-report their income and net worth). This is no longer enough for a successful Rule 506(c) offering. Instead, the companies or someone on their behalf must request and review evidence of investors’ income or net worth. I wrote a detailed blog about how the “reasonable steps” here.

Next, the SEC concluded that Eureeca violated Section 15(a) of the Exchange Act by acting as an unregistered broker-dealer to US persons since it solicited investors and participated in key parts of the transactions.

Although much clarification is still needed, the SEC position with respect to whether crowdfunding portals are expected to register as broker-dealers has been based on the following. First, there is Section 201(c) of the JOBS Act that introduced paragraph (b) to Section 4 of the Securities Act. This exemption states that a person who conducts a Rule 506 offering will not be required to register as a broker-dealer solely because they maintain an online investment portal or engage in general solicitations of securities. Such person may not receive “compensation in connection with the purchase or sale of the security,” have possession of customer funds or securities, or be subject to a statutory disqualification. It is permitted for such person to co-invest in the securities and provide “ancillary services”. I discussed this in more detail here.

Second, the SEC issued FAQs in February 2013, clarifying the broker-dealer exemption described above. Here, the Staff clarified that the prohibition of transaction-based compensation extends to “any direct or indirect economic benefits to the person or any of its associated persons” but that any profits derived from co-investing would be permissible.

Third, there is a series of no-action letters on the topic: IPOnet (July 26, 1996), Lamp Technologies, Inc. (May 29, 1997), Angel Capital Electronic Network (October 25, 1996), FundersClub Inc. and FundersClub Management LLC (March 26, 2013) and AngelList LLC and AngelList Advisors LLC (March 28, 2013). I discussed the latter two no-action letters here.

Overall, the SEC position with respect to the need for a crowdfunding portal to register as a broker-dealer appears to be as follows. There may not be a need for registration so long as the following restrictions are observed:

1. There is no transaction-based compensation (i.e., fees are not contingent upon the outcome or success of the offerings).

2. The portals do not participate in any negotiations between the companies and the investors or structuring of the deals.

3. The portals do not handle funds or securities involved in the transactions.

4. The portals do not hold themselves out as providing any securities-related service other than a listing or a matching service.

5. The portals do not provide advice about the merits of a particular opportunity or investment.

Clearly, Eureeca violated a number of these provisions. Eureeca’s compensation was based on the success of the offerings. It handled investors’ money and the securities. Finally, it encouraged investors to invest in the offerings.

In conclusion, it seems advisable for entrepreneurs who are interested in setting up a crowndfunding portal to engage the services of an experienced attorney who specializes in securities laws.  If Eureeca had done it, its legal troubles would have been avoided.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Monday, October 6, 2014

CPOs Can Now Engage in General Solicitation

The big legal news in September was that the staff at the Commodity Futures Trading Commission (CFTC) published an exemptive letter No. 14-116 (available here) that allows certain commodity pool operators (CPOs) to engage in general solicitation and advertising in private offerings of pool interests under Rule 506(c) of the Securities Act.  This long-awaited relief comes over a year after the SEC adopted its Rule 506(c) that provides for general solicitation and advertising in private placements pursuant to the JOBS Act.

Fund managers have to register as CPOs if they operate or solicit funds for a commodity pool (with limited exceptions).  A commodity pool is a fund that trades in futures contracts, options on futures, retail off-exchange forex contracts or swaps, or invests in another commodity pool.  Registering as a CPO is not an easy process.  It requires associated persons to take a Series 3 exam, among other requirements.  All CPOs must become members of the National Futures Association (NFA).  You can find more information about this here.  

The exemptive relief is available to those CPOs  that are exempt from registration under the CFTC Regulation 4.13(a)(13) or are registered but exempt from certain disclosures under Regulation 4.7(b).  Previously, such CPOs were expressly constrained by applicable regulations from engaging in general solicitation or advertising.  Now, all these CPOs need to do is file a notice by email with the CFTC's Division of Swap Dealer and Intermediary Oversight providing basic identifying information about the CPO and the fund, indicating reliance on Rule 506(c) and promising to comply with all other applicable requirements. The exact content requirements are in the Letter.

So, will we now see an increase in the use of general solicitation and advertising by private fund managers?  So far, only a minority of funds have relied on Rule 506(c) in raising capital, in part due to the lack of conforming changes to the CFTC rules.  It is possible that now more funds will resort to general solicitation and advertising.  However, it is still unlikely that the use of general solicitation and advertising in raising capital by funds will become the norm.  There are several reasons.  First, established funds prefer to raise capital from either the existing investors or those with whom they have pre-established relationships, so there is no need for them to advertise to the general population.  Second, there is a concern over the SEC proposed rules that seek to further regulate Rule 506(c) offerings, potentially making them overly burdensome.  Finally, all Rule 506 private placements are now subject to "bad actor" rules that bar any issuer disqualified under these rules from relying on Regulation D (including for failed offerings).

In conclusion, considering the uncertainty surrounding the proposed SECs rules and the increased risks of a failed Rule 506(c) offering, fund managers should carefully consider whether engaging in an offering involving general solicitation and advertising is really worth it.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, August 22, 2014

New Seed Financing Documents (500 Startups and Y Combinator)

The startup industry keeps on coming up with new innovative solutions to seed financing.  The latest trend is convertible equity.  Two startup venture funds and incubators, 500 Startups and Y Combinator, recently released their versions of convertible equity documents.

SAFE

In 2013, Y Combinator, a well-known seed incubator and venture fund, released its own version of equity securities that it refers to as SAFE (simple agreement for future equity).

Benefits of SAFE

SAFE securities are not convertible notes because they don't have the common features of debt instruments: maturity and interest rate.  This means that there is no debt on the startup's balance sheet.  Since this investment does not mature, it removes the risk of startup insolvency in the case of non-repayment and non-conversion into equity.  Terms are simple, with valuation cap being the only negotiated item.  By investing in a SAFE security, the investor gives money to the startup in exchange for a promise to receive preferred stock in the event of future equity financing.  There is no deadline and there is typically no minimum size of equity financing.  SAFE securities terminate either at IPO or change of control or conversion into equity.

Different Types of SAFE Securities

There are essentially four types of SAFE securities proposed by Y Combinator.

1.  SAFE with a cap and a discount.
2.  SAFE with a discount, but no cap.
3.  SAFE with a cap, but no discount.
4.  SAFE without a cap or a discount, but with an MFN provision, which says that if the company were to issue another SAFE with more favorable terms, this SAFE documents will be amended to benefit from similar terms.  However, there is no automatic conversion into equity unless the amount of equity financing is at least $250,000.

 So, if the SAFE valuation happens to be higher than the valuation at the time of a priced equity round, then SAFE converts into the preferred stock at the same lower valuation of the preferred stock.  If the SAFE valuation is lower than the valuation of the company right before the equity financing, then the holder of SAFE securities gets shares of preferred stock calculated using its own valuation cap, not the higher valuation of the equity financing.  Then, SAFE securities convert into a Series SAFE preferred (also referred to as "shadow preferred" or "sub-series preferred", which has the same features as the preferred stock that the company is issuing except for the conversion price, liquidation preference (which still equals to the original investment amount into SAFE securities) and dividend rate.  In the event of the company sale, the SAFE security holders get a choice of either converting its securities into shares of common stock based on its valuation cap, or having the investment returned.

However...

However, investors may still feel weary of using SAFE equity or other convertible equity structures because they are too favorable to the companies.  There is just too little protection for the investors in the event that the company fails to raise any equity financing.  There is no maturity and no interest rate, so it is not possible for the investors to declare default.

KISS

On July 3, 2014, a well-known business incubator and fund 500 Startups released its own deal documents named KISS (keep it simple security) for convertible debt and convertible equity financings developed in collaboration with Gunderson Dettmer.

KISS Convertible Debt

I personally like their convertible note document.  It is clear and simple, and has no surprising terms.  Its maturity is 18 months, and the notes accrue interest at 5% that can be paid by the Company in cash.  It provides for an automatic conversion to preferred stock if the company raises a qualifying priced round ($1 million).  Conversion occurs at the lesser of a cap and a discount.  At a change of control event, investors have an option of either cashing out at a multiple of 2X or converting into common stock at the cap.  I particularly like that the KISS convertible note agreement addresses what happens at maturity in case of non-payment.  It provides for an option to convert into a newly created series seed shares using model documentation or explore other options (for example, extension of maturity).  This is not mandatory and is decided by the majority of note holders.  All KISS investors receive an MFN treatment and major investors (those who invested more than $50,000) receive basic information and participation rights.  

KISS Convertible Equity

KISS Equity securities have no interest rate (company-friendly feature) BUT have a maturity date of 18 months.  Just like the KISS convertible notes, they automatically convert into equity at the next round of equity financing but only if the financing is for $1 million or more (unlike SAFE securities that do not have a minimum financing amount unless this is SAFE with the MFN clause).  KISS Equity securities have both the discount and the valuation cap, and convert at the lesser of the two.  SAFE, on the other hand, has options in terms of how to structure the security (cap and discount or either cap or discount or none of the above but with an MFN treatment).  Treatment of KISS Equity in the case of a change in control or at maturity is the same as KISS Debt.  Like with convertible debt, the convertible equity securities offer the same MFN protection and major investors receive additional information and participation rights.  The convertible equity securities are treated on pari passu with other KISS securities and convertible debt securities, including in terms of repayment.

So, as far as I can see, the main difference between KISS Equity and KISS Debt is that KISS Equity securities do not have an interest rate.  Is it sufficient to treat these securities as "equity"?

Conclusion

In conclusion, I would like to thank 500 Startups for developing a solid convertible debt purchase agreement.  I would definitely resort to it in the future. However, as of now, I am unlikely to recommend to my clients to use convertible equity structures, although it is good to know that this option exists.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.


Unregistered IPOs of Bitcoin Companies Do Not Go Unnoticed By the SEC

As I previously discussed in my blog here, the SEC does not have a mandate to regulate Bitcoin. Not unless it is used in a securities offering, especially in an unregistered initial public offering conducted over the Internet in violation of the securities laws. As Andrew J. Ceresney, director of the SEC's Division of Enforcement said, "We will continue to focus on enforcing our rules and regulations as they apply to digital currencies."

This was the case when the SEC issued a cease-and-desist order on June 3, 2014 against Erik T. Voorhees, a 29-year old Bitcoin activist, for "publicly offering shares in the two [Bitcoin-related] ventures without registering them."  The SEC's press release is here.

What Mr. Voorhees did was pretty straight forward: he published prospectuses on the Internet and solicited the general public to buy shares of his online ventures, SatoshiDICE and FeedZeBirds.  The only problem was that Mr. Voorhees neglected to register the offerings with the SEC or conduct them in compliance with an available exemption from registration.  It looks like Mr. Voorhees never bothered with retaining a securities lawyer (or any corporate lawyer for that matter) to advise him.  I used to give a talk to the entrepreneurs awhile back, listing the top ten legal mistakes that many of them make.  Conducting a securities offering without even realizing it was #8 on my list.  It appears that Mr. Voorhees did just that.

The first unregistered offering took place in May 2012, when FeedZeBirds issued 30,000 shares in exchange for 2,600 bitcoins.  The price per bitcoin was around $5 back then, so overall he received $15,000.  FeedZeBirds promised to pay bitcoins to Twitter users who would forward its sponsored text messages. The shares of FeedZeBirds were listed on an entity known as the Global Bitcoin Stock Exchange, which operated the Bitcoin stock exchange.  Although Mr. Voorhees published a prospectus for this offering, it was never filed with the SEC.  Mr. Voorhees also engaged in general solicitation to sell the FeedZeBirds shares over the Internet (on website BitcoinForum, Facebook and other Bitcoin-related websites).

Then, SatoshiDICE sold 13 million shares for 50,600 bitcoins ($722,659 in total) in offerings conducted from August 2012 through February 2013.  SatoshiDICE was a gaming site that paid winnings in bitcoins.  The shares of SatoshiDICE were listed on MPEx, a Bitcoin trading platform based in Romania.  Mr. Voorhees issued a prospectus for these offerings, and it was broadly disseminated over the Internet.  Mr. Voorhees again engaged in general solicitation by advertising the offering on various websites.  However, in July 2013, Mr. Voorhees announced that SatishiDICE was being sold, and that prior to the sale it would buy back all outstanding shares from investors.  Given that the exchange ratio between Bitcoin and USD had significantly appreciated, the repurchase price that was offered was at 277% premium over the original share sale price.  So, investors who in aggregate invested $722,659 just a year or so before were paid back approximately $3.8 million.  Not a bad return.

As a penalty for violating securities laws, Mr. Voorhees agreed to pay back $15,000 from the FeedZeBirds offering and a fine of $35,000.  In addition, he agreed not to participate n any issuance of any security in an unregistered transaction in exchange for any virtual currency including Bitcoin for five years.

According to the new rule 506(d) that I described here, the entry of the SEC cease-and-desist order makes Mr. Voorhees a "bad actor" and disqualifies him from relying on Rule 506(b) and 506(c) of Regulation D.  That, in my opinion, is worse than the financial penalties as it prevents Mr. Voorhees from participating in any Rule 506 private placement for at least a year.

In conclusion, it is clear that the SEC is paying particular attention to the investment funds or ventures that involve Bitcoin or other virtual currencies.  Only last year, the SEC  charged Trendon Shavers with defrauding investors in a Bitcoin-related Ponzi scheme.  I wrote about it here.  Founders of Bitcoin-related enterprises should be aware of this attention, and should make sure that they are in full compliance with the U.S. federal securities laws.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Wednesday, August 6, 2014

Crowdfunding Right Now (Fund Model, Broker-Dealer Model, Lending Platforms and Intrastate Offerings)

We are still waiting for the SEC to issue final rules with respect to the Title III crowdfunding that will allow the U.S. companies to issue up to $1 million in securities to non-accredited investors through the online funding portals. So, while we are all waiting, crowdfunding in the U.S. is alive and happening. And I am not talking here about rewards-based crowdfunding like campaigns on Kickstarter. I am referring to the equity / debt crowdfunding.

In the U.S., it is currently being done in several different ways. Here is a short summary of each.

Crowdfunding through the accredited investor portals: the fund model

This crowdfunding model came out of the two no-action letters: the AngelList LLC and the FundersClub Inc., both issued in March 2013. I previously wrote about them here. Essentially, both are online platforms that aim to invest accredited investors’ money in the startup companies. However, they do so indirectly. Each aims to pool investors’ money into a separate investment fund that in turn invests into the startup. A new fund is formed for each investment. Accredited investors become members (or limited partners) of the fund in a Rule 506(b) offering. Only accredited investors can participate in these types of offerings. Both FundersClub and AnglelList operate as investment advisers, which means that they either have to register with the SEC as such or comply with an available exemption. They receive carried interest (a share of profits distributed at the termination of an investment) from their funds. However, since they are not broker-dealers, they cannot accept any transaction-based fees.

Crowdfunding through the accredited investor portals: the broker-dealer model

Alternatively, funding portals can partner with registered broker-dealers in order to be able to receive transaction-based compensation (a percentage of the total offering proceeds). A good example is CircleUp Network, Inc. CircleUp itself is an online portal, but all securities-related activities are conducted through Fundme Securities LLC, a wholly owned subsidiary of CircleUp Network, Inc., which is a registered broker-dealer and a member of FINRA/SIPC.  In this model, securities of the startup itself, not the fund, are sold to accredited investors in a Rule 506 offering. This crowdfunding model can be used for any type of startup, irrespective of its industry. However, this model has its challenges, beginning with the need to find an interested broker-dealer and having to compete with the more established platforms and broker-dealers.

Lending platforms

LendingClub Corporation and Prosper Marketplace, Inc. have adopted a different crowdfunding model, that of the peer-to-peer lending. Each company is an online platform that enables individuals to borrow up to $35,000 from a large number of lenders each of whom commits only a very small amount. These platforms have been tremendously successful. However, these offerings are not exempt from registration with the SEC. Each platform has filed a registration statement on Form S-1 that allows them to engage in a continuous offering to the general public .  The LendingClub investors do not invest directly in loans (the minimum investment is only $25) but instead purchase Member Dependent Notes from LendingClub.  Loans are issued by WebBank, an FDIC insured Utah-chartered bank, that then assigns the loans to the LendingClub in exchange for money received from the investors.  The platforms earn a transaction-based fee on each loan as well as servicing fees while payment are made on the loans.

Crowdfunding within a single state (intrastate offerings)

It is permissible under Section 3(a)(11) and Rule 147 of the Securities Act to conduct an offering of securities to the general public that is not registered with the SEC so long as the securities are only offered to the residents of a single state by an issuer that is registered and doing business in that state.  These exemptions were available even before the JOBS Act.  However, now these exemptions are being actively used by intrastate crowdfunding portals.  All intrastate offerings must comply with the applicable state registration and offering requirements (which vary from state to state).

On April 11, 2014, the SEC issued new Compliance and Disclosure Interpretations ("CDIs") relating to intrastate securities offerings made pursuant to Rule Section 3(a)(11) and Rule 147 of the Securities Act.  The new CDIs provided guidance and clarification with respect to the recent numerous state crowdfunding exemptions that are rapidly increasing in number.  One aspect in particular was previously unclear: how and whether the use of general solicitation and advertising, including social media and online crowdfunding portals, in intrastate offerings could be reconciled with the requirement that offers only be made to persons resident in the issuer's home state.  You can find a good analysis of the new CDIs here.

According to this blog, as of June 2014, 12 states (Alabama, Colorado, Georgia, Idaho, Indiana, Kansas, Maine, Maryland, Michigan, Minnesota, Tennessee, Washington and Wisconsin) have intrastate crowdfunding exemptions in place and 14 states (Alaska, Arkansas, California, Connecticut, Florida, Illinois, Missouri, North Carolina, New Jersey, Pennsylvania, South Carolina, Texas, Utah and Virginia) are in various stages of enacting/considering sponsored legislation regarding such intrastate crowdfunding.

It may, in fact, be easier for the companies to comply with such intrastate requirements than to comply with the much expected crowdfunding rules. The disadvantages of such offerings include (i) the fact that the offers can only be made to made to residents of a single state; (ii) resales to out-of-state residents are restricted; (iii) if the offerings are subject to that state’s regulatory approval, if such approval is not obtained, the offering will never take place.

In conclusion, I find that the crowdfunding industry is not waiting in one place for the enactment of the SEC rules relating to Title III of the JOBS Act.  The crowdfunding is already taking place now, whether it is done through a broker-dealer portal, as a lending platform or in instrastate offerings.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Tuesday, July 22, 2014

Should Startups Have Boards of Directors?

All corporations are required to have a board of directors by law. LLCs are not. However, an LLC can be structured so as to have a board of managers (some even refer to managers as directors). At formation, founders become the sole directors of their startup corporation. They alone are responsible for the long-term vision and the daily management of their company. Creating a real board of directors may be viewed as giving up control. However, at some point the board composition is likely to change. The question is: do all startups need to have a board of directors? And if yes, then at what time should they create one?

In my opinion, not every company needs to have a board (or, if it is a corporation, then a board that has outside members). If a founder prefers to closely manage the affairs of his or her company, then having a board of advisors may be sufficient. A board of advisors is an informal body that usually consists of industry experts. A CEO may consult any of the advisors throughout the year on an informal basis, through a series of meetings or conversations, but ultimately, all decisions are the CEO’s.

A start-up may, however, be asked to create a board regardless of how the founders feel about it. This typically happens if the startup is about to receive an investment and the investor wants a seat on the board. This is not an unusual request. So, if a board of directors were to be created, what would the ideal board look like?

An ideal board would be (mostly) independent and active. Its members would have a lot of experience and advice to share with the founders. A perfect board would have a financial expert, a marketing expert, persons who have previous startup experience, connections in the industry, and connections with potential investors. The perfect board would be there to help, not judge. The majority of its members would be outsiders, and would not be influenced by other motives (such as, for example, the need to make a successful exit in 7-10 years).

A startup does not need to have a large board. Typically, 5-7 members is perfect. Personalities of directors are also important. The board has to function well and efficiently as a unit, and get along well with the management. A board should meet monthly (or quarterly) and discuss the long-term strategy of the company. The day-to-day operations are left to the management. The board reviews the management’s performance and determines their bonuses on a yearly basis. This means that, if the board is not satisfied with the performance of any of the managers (including the founders), it can fire them. Unfortunately, this does occasionally happen. It recently happened to one of my clients, who originally created a board comprised of industry experts and then the board voted to fire him. Of course, this created a ton of emotions and negative feelings. All I can say is that founders should ensure that their vesting accelerates if they are fired for “no cause” or are asked to leave for a “good reason.”

The board members do not receive much compensation. This is not why they serve on the board. They typically get reimbursed for expenses incurred in attending board meetings and are given restricted stock or stock options.

Directors in a corporation owe fiduciary duties to the corporation and its shareholders. These are duties of care and loyalty. I previously wrote about them, and the business judgment rule, here and here. The corporation should ensure that, when creating the board, its articles of incorporation are amended to limit directors’ liability to the maximum extent allowed by law. Also, the corporation should consider getting a D&O insurance (although it can be expensive and cost prohibitive for a startup).

In conclusion, I would note that creating a helpful, independent and active board can certainly bring your company to the next level. This is the necessary step in transitioning from a startup to a “grown up” corporation.  Last, but not least, read this book "Startup Boards: Getting the Most of Your Board of Directors" by Brad Feld.  He really knows what he is talking about.  

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Saturday, July 19, 2014

The SEC Will Likely Update its Definition of “Accredited Investors” Very Soon

Most of the startup capital comes from accredited investors through investments made in reliance upon Rule 506 of Regulation D.  According to a study by the University of New Hampshire’s Center for Venture Research, in 2013, almost 71,000 benefited from $24.8 million in investments made by accredited investors.

So, who are these “accredited investors”? The definition of “accredited investors” is found in Rule 501 of Regulation D and includes the following individuals:

1. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; or

2. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

Section 413(b)(2)(A) of the Dodd-Frank Act requires the SEC to review the definition as it relates to the natural persons every four years to determine whether "it should be modified for the protection of investors, in the public interest and in light of the economy.” Now is the time for the SEC to do so. The last review of the “accredited investor” definition by the SEC was done in July 2010.  At that time, the definition was amended to exclude the value of a primary residence from the calculation of investor’s net worth.

In a letter to Representative Scott Garrett in November 2013, the SEC Chair Mary Jo White described potential changes to the accredited investor definition and factors that the SEC is considering.  It indicates that this time the changes to the definition may go beyond merely adjusting the net worth minimum requirements for inflation.

In particular, Ms. White’s letter states that the SEC is examining:
  • "whether the existing net worth and income tests are appropriate measures that should continue to be used (presumably this also includes consideration of whether and how the net worth and income thresholds could or should be adjusted);
  • whether financial professionals, such as registered investment advisers, consultants, brokers, traders, portfolio managers, analysts, compliance staff, legal counsel, and regulators should be considered accredited investors without regard to net worth;
  • whether individuals with certain educational backgrounds focused on business, economics, and finance should be considered accredited investors without regard to net worth;
  • whether an expanded pool of accredited investors would help provide liquidity in private placement investments and thereby reduce the risk profile of those investments;
  • whether reliance on a qualified broker or registered investment adviser should enable ordinary investors to participate in private placements; and
  • whether reducing the pool of accredited investors would harm U.S. GDP."
If the SEC were merely to adjust the amounts for inflation, according to the Angel Capital Association press release, the “inflation-based adjustments would increase the net worth standard to about $2.5 million and the annual income to $450,000."  This increase would “eliminate about 60 percent of current accredited investors.” Also, the Association said that such inflation-based adjustments would reduce its membership by 25%.

However, based on the November letter, it appears that the SEC is undertaking a more comprehensive review of the definition than just adjusting it for inflation. In my opinion, simply relying on net worth or income amounts is not enough to determine the investors' suitability for high-risk investments into startups.  I have come across many individuals who, although they satisfy the net worth or the income test of the current accredited investor definition, entirely lack financial sophistication and can be easily talked into investing into the most unbelievable schemes.   On the other hand, I have met financial industry professionals, who are quite able to "fend for themselves," although technically they do not satisfy the income or net worth tests.  

I also believe that it is important to keep a fairly large pool of accredited investors, because they help fuel the growth of our economy.  While the crowdfunding rules are still pending, it is essential to keep or even increase the angel community in order to provide continued support to the startups and entrepreneurs.  After all, today's startups are tomorrow's Fortune 500 companies.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, July 11, 2014

How to Verify That Your Investor is Accredited - The SEC Provides New Explanations Regarding Rule 506(c) Offerings

On July 3, 2014 (right on my birthday), the SEC issued six compliance and disclosure interpretations (“CD&Is”) regarding the use of verification methods for determining whether a prospective investor is accredited.

First, a bit of background information. Effective September 23, 2013, the SEC introduced Rule 506(c) that allows issuers to use general solicitation and advertising in conducting private placements so long as their actual investors are accredited (meaning wealthy and sophisticated individuals and/or certain entities). Companies that conduct 506(c) offerings must take “reasonable steps” to verify that all investors in their offerings are accredited and have a reasonable belief that such investors are accredited at the time of the sale of securities. Before the JOBS Act, and still while conducting Rule 506(b) offerings, companies could rely on investors’ self-certification (for example, questionnaires where investors self-report their income and net worth). This is no longer enough for a successful Rule 506(c) offering. Instead, the companies or someone on their behalf must request and review evidence of investors’ income or net worth.

An issuer may satisfy the verification requirement of Rule 506(c) by either using the principles-based method of verification or by relying upon one of the specific, non-exclusive verification methods listed in Rule 506(c)(2)(ii). Since these methods are non-exclusive, the issuers are not required to use any of them. However, if they do, then they must meet all of the requirements of the chosen method, including that the documents provided are current. Regardless of what steps the issuer takes, it is important to retain adequate records of the verification steps they took.

Next, let’s review the acceptable methods of verification before discussing the new CD&Is.

Under the principles-based verification method, “the determination of what constitutes reasonable steps to verify is an objective determination based on the particular facts and circumstances of each purchaser and transaction.” CD&I 260.07. Here, the issuers should consider factors such as the nature of the purchaser and the type of accredited investor it claims to be; the amount and type of information the issuer has about the investor; the nature of the offering and the manner of solicitation.

Specific, non-exclusive verification methods for natural personal include the following methods:

1. If the person’s accredited investor status is based on income:
  • reviewing any IRS form that reports the person’s income for the two most recent years; and
  • obtaining a written representation that the person reasonably expects to reach the income level required to qualify as an accredited investor in the current year.
2. If the person’s accredited investor status is based on net worth:
  • as to the person’s assets, reviewing one or more of certain documents (including bank statements, brokerage statements and tax assessments) dated within the past three months; and 
  • as to the person’s liabilities, reviewing a report from one of the national consumer reporting agencies and obtaining a written representation that the person has disclosed all liabilities necessary to make a net worth determination.
3. Obtaining a written confirmation from a certain type of third party (a registered broker-dealer or investment advisor, a licensed foreign or domestic attorney in good standing or a foreign or domestic CPA registered and in good standing) that the third party has taken reasonable steps to verify the person’s AI status within the past three months and has determined that the person is an accredited investor.

There is also a fourth safe harbor that relates to individuals who invested in an issuer's Rule 506(b) offering as accredited investors prior to the effective date of Rule 506(c).

And now, let’s finally discuss the new CD&Is.

The new CD&I 260.35 discusses the use of the income-based verification method and the requirement to rely on an IRS form that reports the person’s income for the two most recent years. This method becomes unavailable during the first part of the year until the tax returns for the previous year have not yet been filed. According to the CD&I, the issuer then has to resort to other verification methods.

The new CD&I 260.36 explains that if the investor is not a US taxpayer and therefore does not have income tax returns, the income-based verification method is not available. So, the issuer has to resort to other verification methods.

The new CD&I 260.37 refers to the second, net worth-based, verification method. It underlines the importance that all documents provided by the investor regarding its assets and liabilities be dated within the prior three months. So, an annual tax assessment, if not dated within that time frame, would not be acceptable.

The next new CD&I 260.38 is also about the net worth-based verification method. It clarifies that a consumer report from one of the “nationwide consumer reporting agencies” means that such agency must be U.S.-based.

And finally, there are two new CD&Is (255.48 and 255.49) about the accredited status of an investor. Question 48 says that if the purchaser’s annual income is not reported in the U.S. dollars, the issuer may use either the exchange rate that is in effect on the last day of the year for which income is being determined or the average exchange rate for that year. Question 49 states that if the assets in an account are owned jointly with another person who is not the purchaser’s spouse, then it is still fine to include the assets in the calculation for the net worth test, but only to the extent of the purchaser’s percentage ownership of the account or property.

Overall, the new CD&Is are undoubtedly helpful in providing guidance to the issuers that are conducting a Rule 506(c) offering. At the same time, the verification methods required of the issuers are becoming more complex and nuanced. Clearly, a careful study of all SEC guidance, the Rule itself, and the accompanying releases, is required before attempting to conduct a successful Rule 506(c) offering.

More recent developments

The SEC is not the only entity that is making navigation of Rule 506(c) requirements more difficult.  On June 23, 2014, SIFMA issued guidance for registered broker-dealers and investment advisers regarding verification methods that they should use if a client asks for a written confirmation of their accredited investor status. In short, the guidance includes two general conditions: (i) that the client has maintained an account with them for at least six months; and (ii) the client makes a representation that it is making the investment for his or her own account or a joint account with the spouse, is not borrowing money to make this investment and is an accredited investor. The guidance then discusses specific verification methods that broker dealers or investment advisers are encouraged to use. Note that according to the guidance, only the existing clients can ask for the verification letter, and not just any prospective investor. This narrows the universe of potential investors seeking to prove their accredited status through third party verification method.

In conclusion, I want to caution anyone using Rule 506(c) to conduct a private placement. This Rule is an exclusive safe harbor, and non-compliance with the verification requirements may jeopardize the whole offering. Also, I’d like to say that for attorneys, it would be helpful to have some guidance from the Bar Association that, similarly to the SIFMA one, provides advice on attorney-issued written confirmation letters of accredited investor status.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, April 25, 2014

Elusive Bitcoin: Regulation of Bitcoin in the U.S. Part III

In this third chapter of my blog about Bitcoin regulation, I am going to focus on regulation of Bitcoin by the CFTC and the SEC.

The U.S. Commodity Futures Trading Commission (the "CFTC") is an independent federal agency that regulates derivative products tied to interest rates and commodities, such as swaps, options and futures.  Currently, the CFTC does not regulate Bitcoin or transactions involving Bitcoin.  However, as this article indicates, this may change quickly.

So, what could the CFTC regulate? It could treat Bitcoin as a “commodity” and regulate certain spot transactions involving it pursuant to its anti-manipulation rules in the spot market (although the CFTC jurisdiction over spot transactions is limited). As Bitcoin derivative market develops (and according to this article, it certainly is developing), the CFTC could also regulate certain Bitcoin transactions as swaps, options or futures. Check out also this article as well that goes into depth regarding the CFTC potential regulation.

However, as of now, the CFTC does not regulate Bitcoin or any transactions involving it.

The Securities Exchange Commission (the "SEC"), a federal agency charged with regulation of the U.S. securities markets, also currently does not regulate Bitcoin.

The definition of a “security” under the U.S. Securities Act of 1933  includes an investment contract. According to the well-known to all U.S. legal professionals case, SEC v. W.J. Howey Co.,  “an investment contract, for purposes of the Securities Act, means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party …”.

Bitcoin in itself is not an investment contract. Bitcoin users do not invest their money into a common enterprise with an expectation to derive profits solely based on the efforts of others.  They typically use bitcoins to pay for goods or services.  However, investments into funds or other investment vehicles that transact in Bitcoin are securities, and the SEC does have authority to regulate those offers and sales.

This was settled in August 2013, when a U.S. magistrate judge stated in a published memorandum opinion that investment in Bitcoin-related fund is an investment contract, and therefore, a security.  This ruling gave the SEC the mandate to charge Trendon T. Shavers, founder and operator of Bitcoin Savings and Trust (“BTCST”), with defrauding investors in a Bitcoin-related Ponzi scheme. Shavers advertised in 2011 that he was in the business of “selling Bitcoin to a group of local people” and offered investors "up to 1% interest daily.” He offered and sold Bitcoin-denominated investments through the Internet. Shavers raised at least 700,000 Bitcoin in BTCST investments, which amounted to more than $4.5 million based on the average price of Bitcoin in 2011 and 2012. According to the SEC, BTCST was a sham and a Ponzi scheme in which Shavers used bitcoins from new investors to make purported interest payments and cover investor withdrawals on outstanding BTCST investments. Shavers also diverted investors’ bitcoins for day trading in his account on a Bitcoin currency exchange, and exchanged investors’ bitcoins for U.S. dollars to pay his personal expenses. The SEC complaint can be found here.

Shavers main argument was that the BTCST investments were not securities because Bitcoin is not money, and is not part of anything regulated by the United States. The judge disagreed.  He said that 
“It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in BTCST provided an investment of money.”
The judge then reviewed other requirements of an investment contract. He determined that there was a common enterprise and that the investors were dependent on Shavers’ expertise in Bitcoin.  Also, investors clearly expected profits to come solely from Shavers’ efforts.

Contemporaneously with this case, the SEC issued an investor alert warning people about fraudulent investment schemes involving Bitcoin.

Interestingly, the same judge said that “Bitcoin is an electronic form of currency unbacked by any real asset and without specie.” However, as of now, neither the Federal Reserve Board, nor the U.S. Treasury, nor the CFTC stepped in to regulate Bitcoin exchanges or currency exchange-related transactions involving Bitcoin (although I think this is imminent).

The next, and final, post about Bitcoin regulation will focus on the treatment of Bitcoin by the IRS, and regulation by the states.

Thursday, April 17, 2014

Elusive Bitcoin: Regulation of Bitcoin in the U.S. Part II

Today, I am going to summarize FinCEN’s regulations relating to Bitcoin.

The Financial Crimes Enforcement Network (FinCEN) is an agency within the US Treasure Department. Its mission is to safeguard the financial system from illicit use, combat money laundering and promote national security. Among other things, it regulates money services businesses (MSBs). All MSBs have registration requirements and a range of anti-money laundering, recordkeeping, reporting, and know-your-client responsibilities.

On March 18, 2013, pursuant to the authority granted to it by the US Bank Secrecy Act, FinCEN published guidelines about the applicability of the US Bank Secrecy Act to virtual currencies.

The guidelines list circumstances when virtual currency users may fall under the definition of MSB. FinCEN concluded that a user of virtual currency is not an MSB, but an administrator or an exchanger is. Specifically, administrators and exchangers are money transmitters (a category of MSB), and therefore, are subject to the requirements applicable to all MSBs. Bitcoin exchanges fall under the definition of “exchangers” and therefore are MSBs. The definition of an “administrator” is less clear. An “administrator” is a “person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.” “An exchanger or an administrator that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter.” It is not clear how this definition of an administrator would apply to the Bitcoin network.

So, to clarify things, FinCEN issued two rulings on January 30, 2014. The first ruling relates to the activities of “miners” and states that a user who “mines” a convertible virtual currency solely for its own use, not for the benefit of another, is not an MSB because these activities involve neither “acceptance” nor “transmission” of the currency. So, without registration, miners can use the bitcoins they mined to purchase goods or services for their own use, covert bitcoins into a real currency, pay debts incurred in the ordinary course of business, or, if the miner is a corporate entity, make distributions to shareholders. However, “any transfers to third parties at the behest of sellers, creditors, owners, or counterparties involved in these transactions should be closely scrutinized, as they may constitute money transmission.”

The second ruling titled “Application of FinCEN’s Regulations to Virtual Currency Software Development and Certain Investment Activity” deals with two things. First, it addresses the question of whether the production and distribution of software to facilitate purchases of bitcoins would make developers “money transmitters.” According to the ruling, “the production and distribution of software, in and of itself, does not constitute acceptance and transmission of value, even if the purpose of the software is to facilitate the sale of virtual currency.”

Second, the ruling clarifies that a company purchasing and selling convertible virtual currency exclusively as an investment for its own account is not considered to be a money transmitter but is rather a user within the meaning of the guidance. However, if the company were to provide any investment-related or brokerage services to others that involve accepting and transmitting virtual currency, or if it transferred money to third parties at the behest of the company’s counterparties, creditors or owners entitled to direct payments, then it may be subject to regulation and additional analysis by FinCEN would be necessary.

This seems to suggest that investment funds that invest in Bitcoin can do so without registration with FinCEN, as long as all transactions in Bitcoin are done for the Fund’s own account, and not the accounts of individual investors. If, however, the fund engages in brokerage services, then it needs to investigate not just registration with FinCEN as an MSB, but also registration as a broker-dealer with the Securities and Exchange Commission.

As you can see, the FinCEN guidance and rulings are all very recent as the laws and regulations relating to Bitcoin develop. I strongly recommend for everybody who is involved with Bitcoin to monitor the Bitcoin regulatory landscape closely, since it changes “as we speak.”

More to follow in Elusive Bitcoin: Part III.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Wednesday, April 16, 2014

Elusive Bitcoin: Regulation of Bitcoin in the U.S. Part I

The phenomenon of Bitcoin (and virtual currency in general) presents an interesting legal conundrum. It is still not clear for many where does Bitcoin fit within our legal system, and whether and how to regulate it. Today, I would like to take a closer look at the Bitcoin network, the recent legal developments in the U.S. relating to the classification of Bitcoin, and its (non)-regulation.

Background

First, let’s take a look at Bitcoin itself. Bitcoin is a peer-to-peer convertible digital currency and payment system. There is no central authority that issues bitcoins or tracks transactions in bitcoins (i.e., no central bank). The Bitcoin network is based on open source code and is managed by an army of volunteers. All Bitcoin transactions are anonymous and get recorded on the public ledger called a “block chain” by people or entities referred to as “miners”. Miners get compensated for their efforts in new bitcoins and transaction fees. Users keep bitcoins in their own “digital wallets”, which are essentially virtual uninsured bank accounts. If the digital wallet gets accidentally deleted, stolen or lost, all bitcoins in it will be irretrievably gone. Users can obtain bitcoins in four ways: (i) by purchasing bitcoins on a Bitcoin exchange; (ii) accepting bitcoins as payment for goods or services; (iii) earning bitcoins through competitive mining process; or (iv) exchanging bitcoins with others.

Bitcoin is a relatively recent phenomenon. It all started in early 2007, when an anonymous user or group named “Satoshi Nakamoto” began working on a cryptographic-based network. In January 2009 (just slightly over five years ago), the first Bitcoin block was mined, and the first transaction in Bitcoin occurred. In February 2010, the first Bitcoin exchange was created. In September 2012, the Bitcoin foundation was created, and this foundation is presently the core development team behind the Bitcoin network. Since the Bitcoin software is open source, any developer can contribute to the Bitcoin code. You can read about how to do it here.

Presently, Bitcoin is by far the most popular virtual currency. As of today, its market capitalization is approximately $6.7 billion, whereas the market for the second largest currency, Litecoin, is only $373 million, followed by Peercoin at $63 million. You can check the current market cap here.  The value of Bitcoin (here I mean the Bitcoin-USD exchange rate) fluctuates greatly. Just within the past six months, the exchange rate changed from under $200 per Bitcoin to over $1,000 and currently it is at $512.  You can view the chart here.

It remains uncertain whether the Bitcoin will become widely accepted by retail merchants around the world although the list of entities accepting Bitcoin as payment is broadening. For example, the first university (University of Nicosia in Cyprus) announced in November 2013 that its students can now pay tuition in bitcoins. In February 2014, a medical marijuana dispensary in Washington State started accepting bitcoins as payment.  For full story, click here.

For now, many governments are battling with the issue of whether and how to regulate Bitcoin. Many believe that some type of regulation is necessary due to the potential of Bitcoin being used to fund illegal activities. Known to many as the currency of choice for the online black marketplace called Silk Road, Bitcoin has attracted a lot of negative attention and concerns over it being used for illegal purposes and terrorism.

Now, let’s review current regulation of Bitcoin by the federal governmental agencies such as FinCEN, the CFTC, the SEC and the IRS, and the states.

Now, please continue reading Elusive Bitcoin: Part II.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Saturday, February 1, 2014

Could Your Update on LinkedIn Violate a Non-Compete Agreement?

Today, I am re-posting a blog post of a colleague of mine (with his permission) that I found to be particularly interesting and relevant for those of you who are looking to leave your present employers to start your own businesses or to just go work elsewhere. It has to do with announcing your new job on LinkedIn, and whether this act alone could be viewed as a violation of the prior employer’s non-complete policy. I have to be honest here, this possibility never occurred to me before. But now, the more I think about it, the more it makes sense: considering that so many people are connected and active on LinkedIn, you may solicit people to follow you to your new job by simply announcing your new job on LinkedIn.  Especially, if you are a recruiter.  Hmm…

About the author: James Hunt is a business litigator and a partner at Slater, Tenaglia, Fritz & Hunt, P.A., a commercial litigation and personal injury firm with offices in NJ and NY.

“It has been said in a wide variety of contexts that you must think twice before you post anything on social media websites. This may hold true when it comes to announcing your new job if you are still bound by a non-compete agreement.

In the recent case of KNF&T Inc. v. Muller, filed in Suffolk, Mass., Superior Court, KNF&T alleged its former vice president Charlotte Muller violated her non-compete contract in a variety of ways, including her announcement of her new job on LinkedIn. KNF&T is in the business of providing staffing resources and Ms. Muller’s new employer, Panther Global Group Inc., recruits in the field of information technology. When Ms. Muller updated her place of employment via LinkedIn, more than 500 contacts, including some she made during her employment with KNF&T, were notified.

KNF&T alleged the LinkedIn notification constituted a solicitation of business, which directly violated her non-compete agreement. In rendering its decision, the court focused on the fact that Ms. Muller’s new position in information technology recruiting did not constitute direct competition with KNF&T’s recruitment of administrative support specialists. Thus, the court held that there was not a violation of the non-competition contract.

The result? Since the Massachusetts court based its decision on the difference in the services provided by the two companies, the issue of whether a simple social media notification can constitute a solicitation of business remains unresolved. Thus, if you or your new employee is bound by the terms of a valid non-compete agreement, it is extremely important to be careful when announcing the new position.

What should you consider? You should have your attorney review the terms of the non-compete contract to determine what constitutes a violation of it. Typically, if the new position directly competes with the business of the former employer or the employee is connected with former clients on the social media website, you may have an issue.

If you have questions regarding non-compete agreements, contact an experienced business litigation attorney at Slater, Tenaglia, Fritz & Hunt, P.A. for a free initial consultation.”

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Thursday, January 30, 2014

Startup-NY - an Amazing New York Initiative for Tech Startups

I have been following the development of this exciting new program in New York State that, if successful, can really turn New York into the next Silicon Valley. The program became effective on January 1, 2014.

All of the details are at www.startupny.com. The program aims to provide major incentives for businesses to relocate, startup or expand in New York State through affiliations with academic institutions (both private and public). Qualifying businesses will be able to operate without paying state or local taxes on or near academic campuses in so-called "tax-free" zones. What's more, the employees of these businesses will be exempt from paying state and local taxes.

Hard to believe! But it is true. It is, in fact, the reality, for already one whole month. So, here is how it should work.

According to startupny.com, in addition to the benefits that come with being affiliated with an academic institution, the participating businesses will get 10 years (!) of tax elimination credit for their state and local tax liabilities (to be pro rated for businesses that operate only partly out of NY tax-free areas). Additionally, the participating businesses will be exempt from paying certain other state and local taxes. The employees pay no NY state or local income tax on their wages for the first five years of enrollment in the program (it is pro rated among businesses and then gradually phases out after five years).

This sounds great. So, who is eligible? The eligible companies include those who are somehow align (or are affiliates with) academic institutions. This affiliation or alignment can take on different forms, such as offering internships, jobs, teaching, offering seminars or other company resources.

The businesses must also create "net new jobs" within their first year of operation. The business cannot be relocating or transferring jobs from another state.

Importantly, at the time of application, the business must be a new business in New York, an out-of-state business moving into NYS, an existing NYS business that is expanding and creating net new jobs, or an existing NYS business that has attended and graduated from a NYS incubator program. A new business is one that has not been operating or located in the state at the time of application, is not moving existing New York jobs into the tax-free NY area, and is not substantially similar in operation or ownership to a taxable or previously taxable business entity within the previous five years. Certain types of businesses are all together excluded from participation.

A company may still be granted permission to participate even if it does not meet all the eligibility requirements, at the discretion of the Commissioner of Economic Development and the NYS Department of Economic Development.

One of the conditions of participating in this program is that the business occupies property or land in NYS affiliated with public and private academic institutions or certain State-owned property, designated for use in the program as the tax-free NY area. There are currently three facilities that are in the process of being designated as tax-free NY areas in New York City: the Downstate Biotechnology Incubator, for startup and early-stage biotech companies, BioBAT at the Brooklyn Army Terminal, for second-stage and growth stage tech and biotech companies, and the Downstate Synthetic Chemistry Facility for mature companies.

Business that want to participate should apply with the specific academic institution. Their contact information is on the website. Once the institution has been accepted in the Start-Up NY program, it can begin accepting applications from different businesses. There is really no need to rush, - the program will go on until December 31, 2020. However, wouldn't you agree that first comers hold the advantage?



This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Wednesday, January 29, 2014

New York employers - don't forget to give yearly wage notice to your employees

I received a helpful reminder today from my friends employment attorneys Joseph Harris and Evan White at White Harris PLLC that all New York private sector employers must give an annual written notice of wage rates to their employees. The deadline is February 1st.

The New York Department of Labor has wage notice templates available on its website here. The wage notices must include:
  • an employee's rate of pay, including the overtime rate, if applicable;
  • how the employee is paid (salary, hour, commission, etc.);
  • the regular payday;
  • the official name of the business as well as any DBAs;
  • the address and telephone number of the main office; and
  • any allowances taken as part of the minimum wage.
Wage notices must be in English and in the employee's primary language. The notice must also include an affirmation by the employee that s/he identified his or her primary language, and that a wage notice in the correct primary language was provided. Employees must sign and date the notice and they must receive a copy for their records. The company must keep a copy for six years.

Employers must provide new employees with wage notices at the time of hire. During the year, when there is an increase in an employee's wage rate and the new rate is shown on the next wage statement, employers do not need to provide an additional wage notice. However, employees must be notified in writing seven days before any reduction in their wage rate takes effect. (Wage notices must be given to all employees, even those who are exempt from overtime or who have previously received notice.)

For more information about the wage notice requirement, here is a FAQ and a fact sheet from the Department of Labor: http://www.labor.ny.gov/workerprotection/laborstandards/PDFs/wage-theft-prevention-act-faq.pdf; http://www.labor.ny.gov/formsdocs/wp/P715.pdf.

Monday, January 27, 2014

Are You a Broker or a Finder? Does It Really Matter?

I previously covered regulations relating to those who broker securities transactions and get compensated a "success" fee (a recurring question that comes up periodically in my practice).  Such persons have to register with the SEC as broker-dealers prior to conducting any such activities.  Here is my earlier blog about it.  Today I decided to bring it up again because I came across a comprehensive and well-written blog post "Finders Are Not Always Keepers"(found here) and wanted to share it with you.

Individuals who make introductions, identify potential investors, help structure the deal, and who get compensated a fee that is based on the amount of capital raised are considered to be "brokers" and are required to register as broker-dealers with the SEC.  The SEC has consistently viewed the presence of transaction-based compensation as one of the key attributes of a broker's activity.  According to the blog post, there is really no "finder" exemption to the rule.  Using unregistered broker-dealers presents risks to the companies as well as to the unregistered broker-dealers themselves.  If a sale of securities of a company was done through such unregistered "finders," investors may get the right to rescind the entire transaction, which can have disastrous consequences for the company.

To all companies out there raising capital:  beware of using the services of unregistered broker-dealers or finders.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, January 24, 2014

How Much Should a Startup Pay in Legal Fees?

A fair percentage of my legal practice consists of representing early stage companies (i.e., startups).  Many founders approach me because they want to form Delaware corporations and seek funding from VCs or angel investors.  The question of legal fees is often a painful one for these clients.  Many of them have already left their full-time jobs to dedicate themselves to their startups, others have switched to part-time work and make just enough to pay their bills.  Legal costs often come as a shock.

I fully understand the predicament of my clients, and yet here I am, trying to run a business (i.e., my legal practice).   So, this is what I think about the legal fees involved in representing startups.

First, I want to applaud those startups that understand that they should seek legal representation and not do it all themselves (for example, through Legal Zoom). Although many documents are standard, there are always modifications and special situations to account for.  Also, the value of a lawyer comes from advice rather than the preparation of documents that have already become pretty standardized.  A fair number of law firms and incubators have released their model startup and funding documents, so as I said, the value of legal representation is not in the documents, but in the legal advice that takes into account specific situations.

In case you are interested, here are several sources:

Startup documents - Docracy, Upcounsel, VentureDocs.
Financing documents - Y Combinator, NVCA, TechStars.      

Second, I believe that startup lawyers should offer fixed fee packages.  For example, I offer four.  There is a basic package that takes care of the incorporation and related matters, stock issuance, IP transfer agreements and invention assignment agreements, etc.  There is another package that includes the basic package plus employee incentive compensation plan and related documents (although not clear to me why a startup would need it right away).  The third package is the basic plus trademarks.  And the final, fourth package, includes all of the above. Offering fixed fee packages enables founders to control legal costs and takes away ambiguity.

Third, I agree with Fred Wilson here that basic incorporation and a seed financing round should not cost more than $5,000-$6,000 (unless of course the lawyer bills on an hourly basis at $600+/hour and/or there are complicated negotiations).  The $5K-$6K price is fair if the parties agree to use one of the sets of model documents I referred to above and if the investors do not have separate representation.  I was recently involved in a deal where the company had to pay a $20,000 fixed fee for a seed round of financing (below $1 million) that was done based on one of these model documents.  I think they overpaid.

Finally, I just want to say that not all deals and startups are cookie-cutters. Many companies face their specific issues (whether these are tensions among co-founders or something else) that do not fit into any fixed fee package.   I think of good business lawyers as "preventive care" specialists, who can anticipate and avert a problem and help ensure that your startup survives and succeeds.  In that case, legal costs are worth the expense.

 This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

How to Choose the Best Name for Your Company (Legal Perspective)

Marketing and other experts will undoubtedly have pages of advice for you on how to choose the best name for your business. Given my background, I’ll approach it from the legal perspective. My advice is essentially two-fold: choose a business name that (i) is available and (ii) you can use as a trademark (should you decide to). Below are some considerations:

1. Descriptive name vs unique name. A business owner may be attracted to a business name that describes the services or products that the company provides. For example, names such as “Joe’s Pizza” or “Murray Street Cleaners” let the others know immediately what that company does. However, beware: descriptive names are not protected as trademarks, so others can use the same or similar names to provide similar services or products.

2. Name availability in the state of incorporation. Check with the Department of State of your state of incorporation whether the name is available. Typically, the Division of Corporations (or a similar entity) of the Department of State keeps a list of all business names that are already in use, and will reject the filing if the name is not available. When checking name availability, typically disregard words such as “the,” “company,” or “corporation.” Different states may have different rules regarding name availability. For example, in California, disregard all geographic names and numerals. So, the business name “Clearview America, Inc.” would conflict with “Clearview, Inc.” because the word “America” is a geographic location and therefore is disregarded. Also, “First Web Solutions, Inc.” will be deemed to be conflicting with “Web Solutions, Inc.”

3. Name availability in other states. Next, check with the Departments of State of every other state where your company will be doing business regarding whether the name is available there.

4. Trademark report. Finally, determine if the name is available to be used as a trademark. This rule does not apply to every business. Building a brand calls for a unique name that is also available as a trademark (i.e., available to be used as an identifier of the source of goods or services). If another company already owns a trademark on the name you chose for your business, you may not be able to use it as a trademark (especially if your business is offering similar goods or services) although you may still be able to form your company under that name with the Department of State. Therefore, before committing to any name, check whether it is available as a trademark. The easiest way to do it is by searching for the name in the U.S. Patent and Trademark Office’s database.  However, this will only search federally registered or pending trademarks. A comprehensive search should also include a search of databases of state trademark offices as well as a “common law” search that includes the Internet and state business registrations. A comprehensive trademark search is typically ordered from trademark research companies, and then reviewed by a trademark attorney. Government Liaison Services, Inc. is one such company. Another one is Thomson Compumark.

Choosing a good business name takes time and effort, but is an important step in business formation. It is an exercise in balancing the creation of a unique brand identity, on one hand, and the need for the name to identify your business and carry a message about it, on the other hand.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.