The SEC recently settled charges against two prominent celebrities in connection with the promotion of initial coin offerings. Boxer Floyd Mayweather Jr. and music producer and social media star DJ Khaled were charged in separate incidents with failing to disclose that they had received payments for promoting ICOs. While the SEC has provided prior guidance
SEC issues guidance on cybersecurity disclosure obligations (and more)
On February 21 the SEC issued a “Commission Statement and Guidance on Public Company Cybersecurity Disclosures”. The Release contains new guidelines and requirements regarding public companies’ disclosure responsibilities for cybersecurity situations. No new rules or regulations have been issued at this point, but the Release contains some valuable guidance. It is also clear that cybersecurity is a hot button for the SEC and for Chair Clayton, and I believe that cybersecurity disclosure issues will be subject to more rigorous scrutiny going forward. All public companies should carefully review the Release and evaluate their disclosure obligations in connection with cybersecurity.
The Release updates the SEC’s position on cybersecurity. The SEC’s previous guidance in this area was primarily a Corporation Finance Division Release issued in 2011 that did not contain specific disclosure requirements. The cybersecurity landscape has changed radically since then. The substantial increases in the number and severity of cybersecurity incidents, coupled with the growing dependence of businesses on cyber systems and the associated problems that arise in a cybersecurity incident, have clearly convinced the SEC that additional disclosure is required.
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Cryptocurrency crackdown
The SEC took two strong steps this week toward increased regulation of the cryptocurrency markets and specifically regulation of Initial Coin Offerings (“ICOs”). These steps included the halting of an ongoing ICO and a strong statement by the SEC’s chairman regarding ICOs and their status under the Federal securities laws. These steps were the SEC’s strongest actions to date regarding ICOs, but what is the probable long-term result here? This is getting very interesting as you pit the regulators and their application of traditional securities law concepts against an increasing strong demand in the investment community to invest in these cryptocurrency vehicles.
An ICO involves the offering of a token, “coin” or other digital product. In exchange for their investment, investors receive these tokens or coins. The company then uses the proceeds of the ICO for various corporate purposes similar to a regular offering of securities. ICOs have generally not been registered with the SEC.
On December 11, 2017, the SEC halted the ICO that was being conducted by Munchee Inc., a company that developed a restaurant review app. This action was based on the fact that the company had not registered this offering with the SEC. This ICO involved the issuance of MUN Tokens by Munchee, which the company said might increase in value. Munchee planned to raise about $15 million in this ICO. The SEC said that an investor could reasonably expect to earn a return on these Tokens, and accordingly the Tokens issued in the ICO were “securities” and should have been registered under the Federal securities laws. Munchee accepted the SEC’s findings without admitting or denying anything. The company agreed to halt the offering and to return all proceeds that it had received from investors in the offering.
The investigation of this matter was conducted in part by the SEC’s new Cyber Unit (a division of its Enforcement Section). The SEC had also issued other materials regarding concerns with cryptocurrencies and ICOs, including an Investor Bulletin issued on July 25, 2017 and a Report of Investigation issued on the same date.
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It’s a good time to be a VC fund
Things are looking pretty good for the venture capital industry. Potential VC investors have a lot of money available, and industry and geographical trends show a positive outlook for VC investing in the near term. There are numerous factors that could negatively affect the outlook for VC investments, but it certainly appears that substantial VC investment activity could occur over the next twelve months.
The most significant positive factor for VC activity in the near term is the supply of available cash. According to a recent report, VC funds currently have approximately $120 billion available for investment. Even though this is a composite number that is applied across the whole VC industry, it is a huge amount of available investment funds.
Another positive factor is the increase in corporate VC investment. In a relatively short time (aided by large amounts of cash on corporate balance sheets), corporate investors have begun to play a key role in the VC industry, especially in larger deals. Last year corporate VC deals comprised 25% of total VC deals, and this percentage will continue to increase. See my prior blog post on the rise of corporate VC investors (Corporate Venture Capital Investments – Good for Startups?).
New federal law provides additional protection for trade secrets
President Barack Obama signed into law Wednesday, May 11th, a bill that will provide protection for trade secrets on the federal level.
This new legislation, called the Defend Trade Secrets Act of 2016, or DTSA, has been hailed by commentators as an extremely significant addition to federal intellectual property law. The DTSA was created as an amendment to the Economic Espionage Act of 1996 to provide civil remedies for trade secret violations under federal law. While some potential issues exist, I believe that this new law should be beneficial to many companies because of the possible increased trade secret protection and aggressive potential remedies that it will provide.
Trade secret protection in the U.S. has primarily been available under applicable state law. The Uniform Trade Secrets Act provides some consistency, and it has been adopted by 48 states. The trade secret laws of the various states are not totally uniform, however, and this has sometimes made it difficult for companies to protect their trade secrets under the various state laws. Legal actions involving trade secret protection have generally been brought in state courts. Since the DTSA is a federal law, more trade secret actions will now be able to be brought in federal court, providing an additional potential venue for these actions.
The DTSA does not replace or preempt existing state laws. As a result, this could be an advantage to companies as it may provide a separate method of protecting their trade secrets. The DTSA also defines trade secrets a little more broadly, using “public economic value” as the heart of the trade secret definition. This broader definition of what constitutes a trade secret may expand the range of information that a company can claim as a trade secret.
That said, there is a potential problem here: the DTSA does not provide a uniform system of trade secret law and instead establishes a federal level of trade secret law on top of the existing states’ trade secret laws. This could increase the number and the complexity of legal actions involving trade secrets. Therefore, a company that wishes to assert a trade secrets action will need to analyze which court — state or federal — will be more advantageous, and this will likely vary with the different circumstances of each situation.
One-sided seizures
The DTSA contains fairly aggressive potential remedies that may be advantageous to companies which believe that a trade secret violation has occurred. The provision that has drawn the most interest is the ability of a court to issue an ex parte seizure order in certain extraordinary circumstances.
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What’s up with Crowdfunding? So far, not much (but a fix may be coming)
The SEC’s crowdfunding rules (under Regulation Crowdfunding) became effective earlier this week. From the legal and legislative perspectives this was a big day since it marked the effective date of
one of the most heavily anticipated and promoted components of the JOBS Act. It is also the last provision of the JOBS Act to be put into practice. Reward-based crowdfunding has been operational for a long time and has had some pretty positive results, but the SEC’s equity crowdfunding rules were going to be a way for small investors to make equity investments in small companies and help foster the growth of the tech and innovation economies.
Unfortunately, as reported in my prior blog post and just about everywhere else, the execution of the final crowdfunding rules has resulted in a system that is probably not viable for most situations. While the new rules may work in some cases, they create barriers that I believe will prevent widespread use of equity crowdfunding as a financing vehicle. One of the best summaries of Regulation Crowdfunding problems and deficiencies can be found in this post which quotes Jeff Lynn, the CEO of Seedrs (a prominent crowdfunding platform). He is certainly a guy who believes in the crowdfunding concept, but he says that the crowdfunding regulations in their current form are not workable. Lynn also advises US regulatory authorities to study the UK crowdfunding model, which he believes allows companies to raise funds while still providing investor protection.
The main problems with the new crowdfunding regulations are practical ones. First, the funding limit of $1 million each year is just too low for most companies. This is similar to the problem that we saw with Regulation A for a long time – essentially no one used it because the limit was too low in relation to the costs (although the old Regulation A limit was $5 million, substantially higher than the current crowdfunding limit). Regulation A+ has fixed this problem for Regulation A offerings, but the low limit remains a huge challenge for crowdfunding offerings. This low limit problem is made worse by the costs associated with a crowdfunding offering, which will be substantial for a small company. Legal and accounting work will be required. Companies must also use a registered funding portal in connection with the offering, and this will add to the cost burden. Finally, companies cannot “test the waters” before beginning an offering to see if the offering is even viable for them. The combination of all of these factors creates significant practical roadblocks for crowdfunding that cannot be overcome without some adjustments (as discussed below).
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Corporate venture capital investments – Good for startups?
Corporate venture capital has quickly developed into a major funding source for startup companies. This type of startup funding is available to some innovative startups and early stage companies, and the dollars involved are significant. This all sounds great, but is this type of funding right for your startup?
According to the National Venture Capital Association and PWC’s Money Tree survey, 905 corporate venture capital deals were closed during 2015 with $7.5 billion invested (primarily in high growth startup companies). These transactions comprised 21% of the total number of venture capital deals closed in 2015 and represented 13% of the total venture capital funds invested in that year. Not surprisingly, the biggest chunk of these investments went to software companies ($2.5 billion in 389 deals, which represented 33% of all corporate venture deals in 2015), while biotech deals were second ($1.2 billion in 133 deals, which represented 16% of all corporate venture deals that year).
Many large and familiar companies have implemented venture capital programs. Some of the most well-known corporate venture funds are Alphabet’s GV (formerly Google Ventures), Microsoft Ventures, and Salesforce Ventures. Most of these corporate venture funds are sponsored by large technology companies, but Airbus Group Ventures is an example of a fund established by a non-technology company in a specific industry space. While each of these programs has some independent characteristics, the commonalities are a strong desire to foster innovation (either generally or in specific industry segments) and an ability to step out of the normal corporate mold and commit funds to situations with higher risk profiles when compared to normal corporate investments like real estate and straightforward corporate industry acquisitions.
There are a number of significant potential advantages associated with corporate venture capital. For me, two of the biggest potential advantages are the broader investment scope and the more long-range expectations which may result in a corporate venture investment as compared to a normal external venture investment. A corporate venture capital investor can
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SEC adopts final crowdfunding rules – Last gasp of the JOBS Act (plus some bonus proposed new rule amendments)
After much anticipation, the SEC adopted final crowdfunding rules on October 30, 2015. These rules (called Regulation Crowdfunding) will become effective 180 days after they are published in the Federal Register. Here are links to the SEC’s press release and a helpful summary of these new rules as well as some good background commentary from Chair White. Click here for the final rules. VentureBeat also recently posted a helpful and practical summary of Regulation Crowdfunding.
There is a lot of optimism regarding these crowdfunding rules and their potential positive impact on capital raising, and there is certainly a high degree of good intent behind these rules. I continue to doubt, however, that crowdfunding will have a major impact on capital raising for many companies because of the associated regulatory requirements and high costs (particularly the costs associated with audited financial statements and the use of an intermediary).
The most important components of these crowdfunding rules are:
- Issuers can raise up to $1 million during each 12 month period in crowdfunding offerings.
- There are substantial limits on the amounts that an investor can invest. If an investor has less than $100,000 in either annual income or net worth, that investor can only invest the greater of $2,000 or 5% of their annual income or net worth in all crowdfunding transactions over a 12 month period. Investors whose annual income and net worth are both at least $100,000 can invest up to 10% of their annual income or net worth in all crowdfunding transactions over a 12 month period. It is important to note that during this 12 month period the aggregate amount of securities sold to an investor in all crowdfunding transactions cannot exceed $100,000.
- Certain entities, such as Exchange Act reporting companies, non-U.S. companies, “blank check” companies and certain disqualified companies, are not eligible to use Regulation Crowdfunding.
- Issuers must submit detailed reports to the SEC and to investors in connection with each crowdfunding transaction and also annually. These reports must contain, among other things, information about the issuer’s officers, directors and principal shareholders, related party transactions and the use of proceeds. Audited financial statements (prepared by an independent accounting firm) are generally required, although there is some relief from the audit requirement for certain issuers who are utilizing Regulation Crowdfunding for the first time. In these cases the financial statements must be reviewed. The issuer’s principals may be required to disclose certain personal financial information.
- Securities purchased in a crowdfunding transaction can generally not be resold for one year.
- Holders of securities obtained in a crowdfunding transaction will generally not be counted in the determination of whether an issuer must register under Section 12(g) of the Exchange Act.
- An intermediary (called a funding portal) must be used. The requirements for an intermediary under Regulation Crowdfunding are complex and contain numerous important provisions and restrictions that are specific to crowdfunding transactions.
The SEC’s press release also described some interesting proposed
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SEC charges unlicensed broker/dealers in EB-5 Program
The SEC continued its program of enforcement actions in connection with the Federal EB-5 Program by bringing charges against two firms which raised approximately $79 million for EB-5-related situations. This matter is a little different in that it is the first SEC action to be brought in connection with unregistered broker-dealer activities in the EB-5 context. This action is important and should be reviewed by all participants in the EB-5 arena because it demonstrates the SEC’s willingness to exercise its enforcement powers in connection with these immigration-related matters. It also shows the SEC’s willingness to partner with other regulatory agencies (in this case the U.S. Citizenship and Immigration Services (CIS)). The SEC’s action is summarized in its June 23 press release.
The Federal EB-5 Immigrant Investor Program is designed to provide a way for foreign nationals to achieve legal residency in the U.S. by investing in certain approved U.S.-based businesses or designated regional economic development centers. The requirement for investment in a regional economic development center is generally less than the amount required to invest in a U.S. business under this program.
According to the SEC’s Order, Ireeco LLC and a successor company, Ireeco Limited, acted as unregistered broker-dealers in raising funds from a number of foreign investors. According to the Order, these companies promised to help investors locate the best regional center in which to make their investments, but they allegedly only directed these investors to a small number of regional centers. These regional centers allegedly made payments to the Ireeco companies once the CIS granted certain approvals for conditional residence to the investors. The SEC alleged that the two Ireeco companies raised approximately $79 million in this manner
First crowdfunding fraud enforcement action
The first enforcement action involving a crowdfunding project was recently brought by the Federal Trade Commission. It involved the development of a board game which did not go well despite a successful crowdfunding campaign. This matter is interesting and instructive not only because it is the first such case, but also because it highlights some of the significant risks inherent in the crowdfunding process. The FTC’s official press release on this matter contains a good summary of the relevant events.
According to the FTC complaint, Erik Chevalier discovered an idea for a board game called The Doom that Came to Atlantic City! This game was designed to be a dark fantasy take on the traditional Monopoly board game. The game had originally been developed by two designers, but Chevalier planned to take their concept and produce and distribute a finished game. To raise money for this venture, Chevalier turned to Kickstarter, probably the best known crowdfunding platform. According to the FTC complaint, Chevalier represented to investors that the funds raised would primarily be used for the development, production, completion, and distribution of this game, and that participants would receive certain rewards, such as copies of the final game and action figures, in return for their participation in this campaign.
This crowdfunding campaign was very successful. Chevalier’s original goal was to raise $35,000, but this campaign raised more than $122,000 for the development of this game. Unfortunately, things went bad as the game development process encountered delays.
According to the FTC complaint,
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