Monday, July 6, 2015
I have been reading Paul Mahoney’s brilliant new book, Wasting a Crisis: Why Securities Regulation Fails (University of Chicago Press 2015). You should too.
Mahoney attacks the traditional market failure rationale for our federal securities laws. He argues that contrary to the traditional narrative, market manipulation was not rampant prior to 1933 and the securities markets were operating reasonably well. Mahoney concludes that “‘lax’ regulation was not a substantial cause of the financial problems accompanying the Great Depression and . . . most (although not all) of the subsequent regulatory changes were largely ineffective and in some cases counterproductive.”
Mahoney looks at state blue sky laws, the Securities Act, the Exchange Act, the Public Utility Holding Company Act, and, regrettably only briefly, the Investment Company Act. He concludes by discussing the Sarbanes-Oxley and Dodd-Frank Acts. He discusses the rationales for each regulation and whether those rationales are supported by the facts. Mahoney backs up his argument with a great deal of empirical research, some of which has appeared in earlier articles. Warning: Some of that discussion may be a little difficult for those without a background in regression analysis or financial economics, but you can follow Mahoney’s conclusions without understanding all of the analytical detail.
Mahoney’s work is a nice counterpoint to the narrative that prevails in most securities treatises and casebooks. Every law library should have a copy. Everyone interested in securities regulation policy, and certainly everyone who teaches a securities law course, should read this book. Whether or not you ultimately agree with Mahoney (as it happens, I generally do), his arguments must be dealt with.
Monday, June 8, 2015
I was reading an article on securities crowdfunding in China and came across this description of Chinese practice:
Generally, in China, equity-based crowdfunding capital-seekers rely on the strength of experienced, leading investors to advise “follow-up” investors in locating investment projects. Leading investors are usually professionals with rich experience in private offerings and label themselves as holding innovative techniques in investment strategies and possessing sound insights. On the contrary, follow-up investors usually do not have even basic financial skills, but they do ordinarily control certain financial resources for investment. When a leading investor selects a target investment project through an equity-based crowdfunding platform, the leading investor usually invests personal funds into the project. Crowdfunding capital- seekers then take advantage of the leading investor’s funds to market the project to follow-up investors.
(This is from a recent article by Tianlong Hu and Dong Yang, The People’s Funding of China: Legal Developments of Equity Crowdfunding-Progress, Proposals, and Prospects, 83 U. CIN. L. REV. 445 (2014).)
This is not unique to China. Private offerings to accredited investors in the United States often follow a similar path. Smaller investors are more likely to commit once a well-known, sophisticated investor has made a commitment. But the article made me wonder if we could use that structure to create a new securities offering exemption—one that responds to some of the policy concerns people have about the existing exemptions.
Most unregistered primary offerings of securities in the United States are pursuant to Rule 506 of Regulation D, the regulatory safe harbor for the private offering exemption in the Securities Act. Offerings pursuant to Rule 506, either by law [Rule 506(c)] or for practical reasons [Rule 506(b)], are limited to “accredited investors,” a defined term.
Many people have argued that the definition of accredited investor in Regulation D is too broad. Some of the investors covered by the definition are sophisticated institutional investors who clearly can fend for themselves. But the definition also includes many unsophisticated individuals who meet relatively low net worth and income requirements. Many of these investors, it is argued, cannot adequately evaluate the merits and risks of Rule 506 private offerings.
On the other hand, some people have complained that limiting these offerings to accredited investors privileges wealthy people at the expense of “ordinary” investors. Rich people have the opportunity to participate in these sometimes-lucrative offerings, but the rest of us cannot. That was one of the arguments for the not-yet-implemented section 4(a)(6) crowdfunding exemption added by the JOBS Act.
One way to resolve the tension between these two arguments, and deal with both concerns, would be to allow unsophisticated investors to invest in an offering only after a sophisticated investor has made a commitment. Ordinary investors might not be able to protect themselves, but they could free ride on the sophisticated investor’s evaluation of the offering.
We could create a new category of super-accredited investors, consisting only of institutions or individuals who clearly have the sophistication to protect themselves. Once one of those investors purchases a significant stake in an offering, other investors could purchase on the same terms.
For example, if Startup Corporation wanted to raise $50 million in an unregistered offering, it could first sell $10 million of the securities to a large venture capital firm. After that, it would be free to sell the remaining $40 million on the same terms to any investor, accredited or non-accredited, wealthy or not.
The lead investor’s evaluation of the offering wouldn’t completely protect the other investors. In particular, the lead investor’s tolerance for risk might be much higher than most ordinary investors’. But lead investor's evaluation would help protect against fraud and overreaching by the issuer.
The exemption would have to include some additional requirements to make sure that the other investors can reasonably rely on the lead investor’s decision to invest:
1. No conflicts of interest. The lead investor could not have a relationship to the issuer. Otherwise, the lead investor’s decision to invest might be due to that relationship, not because it believes the investment is a good one.
2. Minimum Investment. There should be a minimum investment requirement for the lead investor, to give the lead investor sufficient incentive to review the deal. To take an extreme example, a lead investor’s decision to invest $1 in a $50 million offering tells us little about the quality of the deal.
3. Same Terms. The lead investor must be investing on the same terms as the subsequent investors. The lead investor’s decision that an investment is worthwhile offers no protection at all to subsequent investors if those subsequent investors are getting a materially different deal.
4. Exit. If the lead investor’s decision to invest provides a signal to the other investors, so does the lead investor’s decision to exit the investment. At a minimum, the lead investor should have to disclose to the other investors when it sells. And, if the issuer is repurchasing the lead investor’s securities, we might want to impose a requirement that the issuer also offer to repurchase the securities of the other investors who purchased in the exempted offering.
This is just a sketch of what such an exemption would look like, about as far as one can go in a blog post. The proposed exemption would not be perfect. It wouldn’t guarantee that investors were getting a good deal, or even that the offering was not fraudulent. But even registration can’t do that. And I think the proposal is a nice compromise between investor protection and capital formation concerns.
Monday, June 1, 2015
I just read an interesting essay on the debate about creating “practice-ready” graduates: Robert J. Condlin, “Practice Ready Graduates”: A Millennialist Fantasy, 31 TOURO L. REV. 75 (2014), available on SSRN here.
Condlin rejects the notion of making law school graduates practice-ready. He argues that the practice-ready movement is a mistaken response to the downturn in the market for lawyers and that law schools cannot and should not make law students practice-ready. Regardless of your position on this issue, Condlin’s article is definitely worth reading.
Friday, May 29, 2015
A while ago, I noted a New York Times article about the effect of SEC Chair Mary Jo White's recusals from cases because of her husband's work at Cravath. The Times has a follow-up today. Apparently, the 2-2 split that results when Ms. White recuses herself is causing some real enforcement headaches, including missing a statute-of-limitations deadline.
Monday, May 25, 2015
In Flanders fields the poppies blow
Between the crosses, row on row,
That mark our place; and in the sky
The larks, still bravely singing, fly
Scarce heard amid the guns below.
We are the Dead. Short days ago
We lived, felt dawn, saw sunset glow,
Loved and were loved, and now we lie
In Flanders fields.
Take up our quarrel with the foe:
To you from failing hands we throw
The torch; be yours to hold it high.
If ye break faith with us who die
We shall not sleep, though poppies grow
In Flanders fields.
-John McCrae, In Flanders Fields
Today is Memorial Day. Before you run to the beach or the park, or wherever you’re spending the holiday, take a moment to remember those dear soldiers who have fallen. They won’t be going to the beach or park today. They gave their lives so you could live.
You may think, as I do, that some of our more recent battles were better not fought, but that doesn’t make the sacrifices of the soldiers who fought in them any less noble or honorable. The loss of life is even more tragic or regrettable when stupid politicians needlessly send young men and women off to die.
To those of you who have lost loved ones in battle, my heartfelt condolences. To those who have fallen, my eternal gratitude for your sacrifice.
Monday, May 18, 2015
You may recall my blog post this fall about the Delaware Chancery Court opinion in In Re Nine Systems Corporation Shareholders Litigation. That case discusses what happens when a self-dealing transaction results in a fair price, thus causing no damage to the corporation, but the process followed was fair. The court held that the plaintiff could still recover attorneys' fees and costs. I noted that the only people likely to be satisfied with that result were plaintiffs' attorneys. (It makes no difference to the plaintiffs in the case because they had a contingent fee agreement with their attorneys-no recovery, no attorneys' fees to be paid.)
The Chancery Court just entered its order awarding plaintiffs' counsel, Jones Day, $2 million dollars in attorneys' fees and expenses. That's right, the attorneys get $2 million even though, as the Vice Chancellor notes, "the quantifiable benefit obtained in this litigation was $0." Thus, the defendants have to pay $2 million to counsel for helping the court determine that nothing they did harmed the corporation or its shareholders.
It could have been worse; plaintiffs' counsel asked for $11 million.
I'm afraid that this opinion will give plaintiffs' attorneys an incentive to search for problems with the process in conflict-of-interest cases just so they can get in on the Nine-Systems action and collect attorneys' fees. No harm to the corporation? No problem!
Thursday, May 7, 2015
Last year, I blogged about a Fourth Circuit case, Prousalis v. Moore, which held that the Janus Capital definition of “maker” in Rule 10b-5 did not apply in criminal cases. For those who are interested, a short article on wrote on that topic, “Make” Means “Make”: Rejecting the Fourth Circuit’s Two-Headed Interpretation of Janus Capital, is now available on SSRN.
The paper is to be included in a symposium honoring the late Alan Bromberg, an outstanding securities scholar, as well as a mentor and friend.
Monday, May 4, 2015
In some European countries, bank interest rates have dropped below zero. (See here and here.) That’s right; it actually costs you to put your money in the bank. You put $1,000 in a savings account and the bank promises to pay you, say, $999, in a year.
I came of age in the Gerald Ford/Jimmy Carter years, when annual inflation rates were in the double digits. Whip Inflation Now! (Yes, children, I’m ancient.) I find it almost unbelievable that nominal interest rate (and bond yields) could drop below zero.
That hasn’t happened in the United States (yet), but what if it did? Set aside the huge macroeconomic issues, and let’s focus on a topic of greater interest to the readers of this blog—the effect on federal securities law, particularly the core notion of what constitutes a security.
The most important case in defining the scope of federal securities law is probably SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Howey says that an investment is an investment contract, and therefore a security, if people invest money in a common enterprise with an expectation of profits coming from the efforts of others.
The “expectation of profits” part of the Howey test is the problem in a negative-interest-rate economy. Assume, for example, that an entrepreneur asks people for money to start a business and promises to return that money, without interest, in two years. In other words, you put in $1,000 and he’ll pay you back $1,000 in two years.
That investment would not ordinarily be treated as a security because there’s no profit. That’s how the Kiva crowdfunding site, which is based on no-interest lending, can avoid federal securities law. But, in a negative-interest world, a mere return of your principal is, in effect, profitable. Considering your opportunity cost, you come out ahead.
If we ever have negative interest rates and the courts hold that no-interest investments are securities, remember that you read it here first.
Monday, April 27, 2015
Many of you have probably heard of bitcoin, the private digital currency that some mainstream merchants are now accepting. (Rand Paul recently became the first presidential candidate to accept donations in bitcoin.)
Bitcoin was developed by a software programmer who used the pseudonym Satoshi Nakamoto. It is built on cryptography software known as the blockchain, which both issues the currency and authenticates transactions using it.
If you haven’t heard of bitcoin or you don’t know much about it, I strongly recommend an interesting, informative new book : The Age of Cryptocurrency: How Bitcoin and Digital Money are Challenging the Global Economic Order, by Paul Vigna and Michael J. Casey.
Vigna and Casey are reporters for the Wall Street Journal. I think they're a little too optimistic about the future of digital currency, but their book is an excellent non-technical introduction to the bitcoin phenomenon and the blockchain software that underlies it. The book isn’t limited to bitcoin; Vigna and Casey talk about other digital currency. They also discuss other potential applications for the blockchain software, such as gambling, self-enforcing “smart” contracts, and currency exchange.
The book’s discussion of regulatory issues is limited. If you’re looking for a discussion of the legal issues, I suggest you look elsewhere. But the book is a very good introduction to digital currency and how it works.
Monday, April 6, 2015
Yesterday was the third anniversary of the JOBS Act. President Obama signed it into law on April 5, 2012. The JOBS Act, as regular readers of this blog know, requires the SEC to adopt rules to enact an exemption for crowdfunded securities offerings. The statutory deadline for the SEC to do so was December 31, 2012. The SEC proposed the required rules on October 23, 2013, but it still has not adopted them.
It is now
- 1096 days since Congress passed the JOBS Act
- 826 days since the deadline for the SEC to adopt the required rules
- 530 days since the SEC proposed the rules
. . . and still no crowdfunding exemption.
If I treated my tax returns like the SEC has treated the crowdfunding rules, I would be in jail.
SEC Chair Mary Jo White has recently said that the SEC hopes to finalize the rules by the end of the year. I certainly hope so.
Monday, March 23, 2015
The JOBS Act requires the SEC to create an exemption for small, crowdfunded offerings of securities. That exemption, if the SEC ever enacts it, will allow issuers to raise up to $1 million a year in sales of securities to the general public. (Don’t confuse this exemption with Rule 506(c) sales to accredited investors, which is sometimes called crowdfunding, but really isn’t.)
The crowdfunding exemption restricts resales of the crowdfunded securities. Crowdfunding purchasers may not, with limited exceptions, resell the securities they purchase for a year. Securities Act sec. 4A(e); Proposed Rule 501, in SEC, Crowdfunding, Securities Act Release No. 9470 (Oct. 23, 2013). Unlike the resale restrictions in some of the other federal registration exemptions, the crowdfunding resale restriction serves no useful purpose. All it does is to increase the risk of what is already a very risky investment by reducing the liquidity of that investment.
Enforcing the “Come to Rest” Idea
Some of the resale restrictions in other exemptions are designed to enforce the requirement that the securities sold “come to rest” in the hands of purchasers who qualify for the exemption.
Rule 147, the safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act, is a good example. To qualify for the intrastate offering exemption, the securities must be offered and sold only to purchasers who reside in the same state as the issuer. Securities Act sec. 3(a)(11); Rule 147(d). This requirement would be totally illusory if an issuer could sell to a resident of its state and that resident could immediately resell outside the state. Therefore, Rule 147(e) prohibits resales outside the state for nine months.
The resale restrictions applicable to the Rule 505 and 506 exemptions have a similar effect. Rule 506 only allows sales to accredited investors or, in the case of Rule 506(b), non-accredited, sophisticated investors. Rules 506(b)(2)(ii), 506(c)(2)(i). These requirements would be eviscerated if an accredited or sophisticated purchaser could immediately resell to someone who does not qualify.
Rule 505 does not limit who may purchase but, like Rule 506, it does limit the number of non-accredited investors to 35. Rules 505(b)(2)(ii), 501(e)(1)(iv). If an issuer could sell to a single purchaser who immediately resold to dozens of others, the 35-purchaser limitation would be meaningless.
To enforce the requirements of the Rule 505 and 506 exemptions, Rule 502(d) restricts resales in both types of offering.
Preventing an Information-less Resale Market
Rule 504 also includes a resale restriction, Rule 502(d), even though it does not impose any restrictions on the nature or number of purchasers. A resale would not, therefore, be inconsistent with any restrictions imposed on the issuer’s offering.
However, Rule 504 does not impose any disclosure requirements on issuers. See Rule 502(b)(1). Because of that, people purchasing in a resale market would not have ready access to information about the issuer. But the Rule 504 resale restriction does not apply if the offering is registered in states that require the public filing and delivery to investors of a disclosure document. Rules 502(d), 504(b)(1). In that case, information about the issuer is publicly available and there’s no need to restrict resales. People purchasing in the resale market would have access to information to inform their purchases.
The resale restrictions in Rule 505 and 506 offerings could also be justified in part on this basis. If issuers sell only to accredited investors in those offerings, there is no disclosure requirement. If they sell to non-accredited investors, disclosure is mandated, but even then there’s no obligation to make that disclosure public. See Rule 502(b). People purchasing in the resale market therefore would not have ready access to public information about the issuer.
This lack-of-information justification is consistent with the lack of resale restrictions in Regulation A. To use the Regulation A exemption, an issuer must file with the SEC and furnish to investors a detailed disclosure document. Rules 251(d), 252. Because of that, information about the issuer and the security will be publicly available to purchasers in the resale market.
The Crowdfunding Exemption
Neither of these justifications for resale restrictions applies to offerings pursuant to the forthcoming (some day?) crowdfunding exemption.
The come-to-rest rationale does not apply. The crowdfunding exemption does not limit the type or number of purchasers. An issuer may offer and sell to anyone, anywhere, so no resale restriction is necessary to avoid circumvention of the requirements of the exemption.
The information argument also does not apply. A crowdfunding issuer is required to provide a great deal of disclosure about the company and the offering—as I have argued elsewhere, probably too much to make the exemption viable. See Securities Act sec. 4A(b)(1); Proposed Rule 201 and Form C. The issuer is also obligated to file annual reports with updated information. Securities Act sec. 4A(b)(4); Proposed Rule 202. All of that information will be publicly available. Even if one contends that the information required to be disclosed is inadequate, it will be no more adequate a year after the offering, when crowdfunding purchasers are free to resell. Securities Act sec. 4A(e); Proposed Rule 501.
Some people, including Tom Hazen and my co-blogger Joan Heminway, have argued that resale restrictions may be necessary to avoid a repeat of the pump-and-dump frauds that occurred under Rule 504 when Rule 504 was not subject to any resale restrictions. As I have explained, Rule 504, which requires no public disclosure of information, fits within the information rationale. Such fraud is much less likely where detailed disclosure is required. There will undoubtedly be some fraud in the resale market no matter what the rules are, but public crowdfunding will be much less susceptible to such fraud than the private Rule 504 sales in which the pump-and-dump frauds occurred.
The resale restrictions are consistent with neither the come-to-rest rationale nor the information rationale for resale restrictions Forcing crowdfunding purchasers to wait a year before reselling therefore serves no real purpose. The only real effect of those resale restrictions is to make an already-risky investment even riskier by reducing liquidity.
Monday, March 16, 2015
The depth of everyone's knowledge varies from subject to subject. I have a deep understanding of many areas of securities law, but a very shallow understanding of physics. (I’m not even in the wading pool.) But, even in subjects I teach—business associations, securities law, accounting for lawyers—the depth of my knowledge varies from topic to topic.
When I’m teaching the Securities Act registration exemptions, my knowledge base is very deep. I research and write primarily in that area. I know the law. I know the lore. I know the policy.
In other areas, my knowledge is much shallower. In some cases, I know just enough to teach the class. My business associations class sometimes touches on entity taxation issues, but I’m far from an expert on entity taxation. (My tax colleagues would say “far, far, far.”)
One’s knowledge deepens over time, of course. That’s one of the great joys of becoming an expert, whether you’re a law professor or a practitioner. I know more now about every topic I teach (including entity taxation) than I knew when I began teaching 27 years ago.
Several years ago, I decided to teach a course on investment companies and investment advisers. I started from scratch. I had no such class in law school and I didn’t practice in that area, so I had to learn the details myself before teaching the class. Now, having taught the class many times and having written two articles that deal with issues in the area, my knowledge base is much deeper.
All law professors have shallow and deep areas of knowledge. Over time, all of us should try to deepen our knowledge in the shallower areas. This improves our teaching and, less obviously, improves our scholarship. I tell my students that a broad education benefits the specialist, and my own experience confirms that. I have often drawn on what I learned in one of my shallower areas while writing an article in a deep area.
Professors also need to be careful that our teaching isn’t negatively affected by our shallow and deep areas.
- Be sure your course coverage (and your exam coverage) is based on the importance and relevance of the topics and the needs of the students, not on your knowledge base. There’s a natural psychological tendency to focus on what we know best, which is usually also what we’re most interested in. Don’t minimize a topic just because your knowledge of the topic is shallow. Don’t stress a topic just because your knowledge is deep. I would like to spend my entire securities regulation course talking about Securities Act exemptions, but I don’t.
- Be careful to maintain the same classroom atmosphere in shallow and deep areas. When I’m teaching in a deep knowledge area, I’m often just scratching the surface of what I know. I sometimes have to fight to stay excited about the material and avoid going on autopilot. When I’m teaching in a shallow area, the discussion is fresher and more exciting to me. I’m more likely to learn from my students and I can empathize with their struggles to master the material. The key is to keep an even keel—to keep the discussion equally fresh and exciting, no matter how deep or shallow your knowledge.
- Don’t overwhelm the students with your deep knowledge. They need to spend some time in the shallow end before you can take them into the depths. It’s taken you years to develop your deep knowledge; you can’t replicate that for your students in an hour or two.
- Admit when your knowledge is shallow. “I don’t know” is a perfectly appropriate response even when your knowledge is deep, even more so when your knowledge is shallow. And “I don’t know” is much better for you and your students than trying to fake it. Use these opportunities to deepen your knowledge and get back to the students with your answer. I can’t count how many times in my career I have faced situations like that.
I apologize for disillusioning any readers who, based on this blog, believed I was omniscient and had deep knowledge of everything.
Monday, March 2, 2015
As many of you know, both I and my co-blogger Joan Heminway have written several articles on crowdfunding. My articles are available here and Joan’s are available here. I think that a properly structured crowdfunding exemption (unfortunately, not the exemption Congress authorized in Title III of the JOBS Act) could revolutionize the finance of very small businesses.
Professor Darian M. Ibrahim, of William & Mary Law School, has posted an interesting and important new paper on crowdfunding, Equity Crowdfunding: A Market for Lemons? It’s available here.
Professor Ibrahim discusses two types of “crowdfunding” approved by the JOBS Act: (1) sales to accredited investors pursuant to SEC Rule 506(c), adopted pursuant to Title II of the JOBS Act; and (2) sales to any investors pursuant to the crowdfunding exemption authorized by Title III of the JOBS Act, but not yet implemented by the SEC. I don’t think the former should be called crowdfunding, but many people call it that, so I’ll excuse Professor Ibrahim.
Title II “Crowdfunding”
Professor Ibrahim points out that traditional investing by venture capitalists and angel investors is characterized by contractual controls and direct personal attention to the business by the investors. This allows the investors to monitor the investment and control misbehavior, and the investors’ participation and advice also provides a benefit to the business.
Ibrahim argues that Title II (506(c)) “crowdfunding” has been successful because it mimics what angel investors have been doing all along. It’s not really revolutionary, just making the existing model of angel investing more efficient by moving it to the Internet.
Title III Crowdfunding
Title III crowdfunding, on the other hand, is revolutionary; it doesn’t resemble anything that currently exists in the United States. If the SEC ever adopts the required rules, issuers will be selling to unaccredited investors who lack the knowledge and sophistication of venture capitalists and angel investors. It’s less obvious how they will judge among the various offerings and protect themselves from misbehavior by the entrepreneur.
Some have argued that the new crowdfunding exemption will appeal only to those companies that are too low quality to obtain traditional VC or angel funding, leaving unaccredited investors with the bottom of the barrel. Ibrahim disagrees, arguing that Title III crowdfunding will appeal to some high-quality entrepreneurs—those who need less cash for their businesses or are unwilling to share control with VCs or angel investors.
But how are we to avoid a “lemons” problem if the unsophisticated investors likely to participate in crowdfunding cannot distinguish good companies from bad? Ibrahim poses two possible answers. The first is the “wisdom of crowds,” the idea that the collective decision-making of a large crowd can approximate or even exceed expert judgments. Possibly, although I’m not completely sure. Collective judgments by non-experts can equal or surpass the judgments of experts, but I'm still unsure that the necessary conditions for that to happen are met on crowdfunding platforms. At best, I think the wisdom of the crowd is only a partial answer.
Ibrahim’s second answer is for the funding portals who host crowdfunding offers to curate the offerings—investigate the quality of the offerings and either provide ratings or limit their sites to higher-quality offerings. I think this is a good idea, but, unfortunately, the SEC’s proposed regulations would prohibit funding portals from doing this. Funding portals required to check for fraud, but that’s all they can do. Any attempt to exclude entrepreneurs for reasons other thanfraud or to provide ratings would go beyond what the proposed regulations allow and subject the portals to regulation under the Investment Advisers Act. Ibrahim has the right solution, but it’s going to require congressional action to get there.
Abstract of the Paper
Here’s the full abstract of Professor Ibrahim’s article:
Angel investors and venture capitalists (VCs) have funded Google, Facebook, and virtually every technological success of the last thirty years. These investors operate in tight geographic networks which mitigates uncertainty, information asymmetry, and agency costs both pre- and post-investment. It follows, then, that a major concern with equity crowdfunding is that the very thing touted about it – the democratization of investing through the Internet – also eliminates the tight knit geographic communities that have made angels and VCs successful.
Despite this foundational concern, entrepreneurial finance’s move to cyberspace is inevitable. This Article examines online investing both descriptively and normatively by tackling Titles II and III of the JOBS Act of 2012 in turn. Title II allows startups to generally solicit accredited investors for the first time; Title III will allow for full-blown equity crowdfunding to unaccredited investors when implemented.
I first show that Title II is proving successful because it more closely resembles traditional angel investing than some new paradigm of entrepreneurial finance. Title II platforms are simply taking advantage of the Internet to reduce the transaction costs of traditional angel operations and add passive angels to their networks at a low cost.
Title III, on the other hand, will represent a true equity crowdfunding situation and thus a paradigm shift in entrepreneurial finance. Despite initial concerns that only low-quality startups and investors will use Title III, I argue that there are good reasons why Title III could attract high-quality participants as well. The key question will be whether high-quality startups can signal themselves as such to avoid the classic “lemons” problem. I contend that harnessing the wisdom of crowds and redefining Title III”s “funding portals” to serve as reputational intermediaries are two ways to avoid the lemons problem.
It’s definitely worth reading.
Andrew Schwartz at the University of Colorado is also working on a paper that addresses the problems of uncertainty, information asymmetry, and agency costs in Title III crowdfunding. I have read the draft and it’s also very good, but it’s not yet publicly available. I will let you know when it is.
Tuesday, February 24, 2015
The New York Times has an interesting article today about SEC Chair Mary Jo White. Her husband is a partner at Cravath, Swaine, & Moore, so she has to recuse herself from any cases, enforcement actions, or investigations involving the firm's clients. The Times claims that the resulting 2-2 split has given the Republican commissioners a little more control over some settlements than they otherwise would have had.
Monday, February 23, 2015
I’m a big fan of Ernest Hemingway. I love his writing style. I’m currently rereading all of his novels, and I ran across a quote that I think every lawyer and law professor should read and take to heart.
I don’t think Hemingway was a fan of lawyers. The only lengthy portrayal of a lawyer in his fiction is in To Have and Have Not, and that lawyer is a crooked, double-crossing sleaze. I’m reasonably sure he never wrote or said anything specifically about legal writing. But the following passage from The Garden of Eden captures the essence of good legal writing:
Be careful, he said to himself, it is all very well for you to write simply and the simpler the better. But do not start to think so damned simply. Know how complicated it is and then state it simply.
No legal writing instructor could have said it better than Papa.
Monday, February 16, 2015
Happy Presidents’ Day.
Sometimes, this holiday gets overlooked. In fact, it’s not even treated as a holiday by my university. Originally the Washington’s Birthday holiday, it was renamed and broadened to include other Presidents, primarily Lincoln, who also has a February birthday. This isn’t business law, but I think it’s important to remember the greatness of those two men. Compared to many of today’s politicians, their intelligence and integrity is astounding. Their voices remain relevant today.
Here, for your enjoyment, quotes from Washington and Lincoln:
If benefits have resulted to our country from these services, let it always be remembered to your praise, and as an instructive example in our annals, that under circumstances in which the passions, agitated in every direction, were liable to mislead, amidst appearances sometimes dubious, vicissitudes of fortune often discouraging, in situations in which not unfrequently want of success has countenanced the spirit of criticism, the constancy of your support was the essential prop of the efforts, and a guarantee of the plans by which they were effected. Profoundly penetrated with this idea, I shall carry it with me to my grave, as a strong incitement to unceasing vows that heaven may continue to you the choicest tokens of its beneficence; that your union and brotherly affection may be perpetual; that the free Constitution, which is the work of your hands, may be sacredly maintained; that its administration in every department may be stamped with wisdom and virtue; that, in fine, the happiness of the people of these States, under the auspices of liberty, may be made complete by so careful a preservation and so prudent a use of this blessing as will acquire to them the glory of recommending it to the applause, the affection, and adoption of every nation which is yet a stranger to it.
This is from Washington’s Farewell Address. The full text is available here.
The brave men, living and dead, who struggled here, have consecrated it, far above our poor power to add or detract. The world will little note, nor long remember what we say here, but it can never forget what they did here. It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us -- that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion -- that we here highly resolve that these dead shall not have died in vain -- that this nation, under God, shall have a new birth of freedom -- and that government of the people, by the people, for the people, shall not perish from the earth.
This is from the Gettysburg Address. The full text (in its many versions) is available here.
Tuesday, February 3, 2015
Last Wednesday, I reported on a New York Times story that, prior to Alibaba's registered public offering this fall, a Chinese government agency secretly contacted Alibaba about allegedly illegal practices on its shopping web sites. Not surprisingly, the U.S. securities litigation industry has swung into action and filed a securities class action lawsuit against Alibaba. Details here. Welcome to America!
Monday, February 2, 2015
Students, want to learn more in law school? Look back, not just forward. As the semester begins, instead of focusing solely on the new classes you’re taking, review the exams you took last semester. Those exams aren’t just for assigning you a grade; you can also use them as a learning tool.
Read the exam questions and your answers. Look at the professor’s comments on your exam and any model answers the professor has provided. What did you get wrong? What in the course did you misunderstand? If some areas are still unclear to you, make an appointment with the professor and review the exam with him or her.
If you do that, you’ll have a much better understanding of the courses you took than if you let your learning stop at the end of your final moment of exam preparation. Professors constantly reevaluate what we know and whether we’re right; you should too. You don’t want to carry that B grade into your legal career; you want to be an A lawyer. If you review your exams, you emerge from that review process with a better understanding of the subject matter.
You might think you’ll never use that material again, but it’s surprising what you draw on in practice. When I was in law school, back when we were chiseling our exam answers on stone tablets, I took a conflict of laws course just because I thought it was interesting. I didn’t think I would ever use it in practice. To my surprise, two years out of law school, I was faced with a major choice-of-law research question. Don’t assume you can leave those old courses behind when you graduate. And, if it comes up, you want to understand it as well as you possibly can.
Few of my students take advantage of the opportunity to review exams. I have never had more than a handful of students stop by to review their exams or even ask me questions about something on the exam. Some semesters, I see no students at all. I don’t even see students who did badly on my Business Associations exam and are taking more advanced courses from me. You would think those students especially would want to clear up where they went wrong.
I provide model answers, so it’s possible students are reviewing those, but I doubt it. My guess is that most students are thankful to have the past semester’s exams behind them and don’t look back as they breeze on to the next semester’s classes.
If students are interested only in earning the credit required for their eventual graduation, that attitude is understandable. But I hope that most of my students are interested in more than just obtaining a credential required to practice. I hope they’re interested in learning as much as they can to be the best lawyers they can be. If that’s their goal, they ought to be reviewing their exams.
Monday, January 26, 2015
For the last three years, I have been teaching my Accounting for Lawyers course as a distance education course. It’s only available to students at my law school, but everything except the final exam is online; there are no in-person classes. I think it’s worked well, better than the in-person accounting class I used to teach, but that’s a topic for another day. Today, I want to talk about four things I’ve learned teaching the course.
1. Law students are not used to “learning as they go.”
The typical law school class involves a single end-of-semester exam, and law students get used to pulling things together by cramming at the end of the semester. Almost all of my students read the daily assignments, but many of them, even some of the most conscientious students, really haven’t actively wrestled with the material.
I usually teach by the problem method, and I use books with a large number of problems. I strongly urge students to answer those problems before class. Almost all of my students read the problems before class; many of them think about the problems before class; but it’s clear that few of them have thoroughly worked their way through the problems .
In my online course, assignments are due every week. Students must learn the material as they go, or they won’t be able to do the assignments. Cramming at the end is not an option. They learn in the first couple of weeks that the shallower daily preparation that works in many law school classes won’t work in Accounting. As their study habits change, they learn more, but it requires a real adjustment on their parts.
2. Regular practice and feedback is important.
The educational literature stresses the value of regular practice and feedback (or even regular practice without feedback). I use the problem method in all of my classes because of that. It forces students to apply the materials on a daily basis, with in-class feedback from me. Seeing how much more students learn in my Accounting course, with its regular assignments and feedback, just reinforces that point.
3. If there’s an ambiguity in anything, at least one student will find it.
I didn’t really learn this lesson teaching the online course. It’s obvious every time I grade an exam. No matter how good the casebook, no matter how careful I am in class, some students will manage to misinterpret something. Law students are experts at finding ambiguity. This shouldn’t surprise us; it’s one of the things we teach them to do. The problem is often not due to a failure to read or listen, but a single-minded focus on some isolated statement taken out of context.
In a course like Accounting that has weekly assignments, I don’t have to wait until the final exam to see those misunderstandings, and I can correct them before they do too much damage. But seeing misunderstandings like this on a weekly basis has also made me much more careful in my other classes, more aware of possible ambiguities in the readings and what I say. I would rather over-explain than risk a semester-long misunderstanding.
4. Oral communication is better than written communication, especially for criticism.
In an online course, I’m forced to communicate with my students almost exclusively in writing. Writing, unlike direct, oral communication, is very bad at conveying nuance or sentiment. That difference is especially important when my communication is primarily critical, correcting and evaluating student work.
Students, like most of us (including me), are sensitive to criticism. And, unless one is very careful, they tend to see critical comments as more negative and personal than they are intended to be. As I’m not a particularly careful person when it comes to criticism or anything else (the word “blunderbuss” is relevant), this is problematic.
In person, my true intent comes through more easily. I recently heard, second-hand, a comment from a student who had taken Accounting and was now in one of my in-person classes. He reportedly said, “I thought Professor Bradford was really mean after Accounting, but I like him in this course.”
Monday, January 19, 2015
Every U.S. law school, or at least every law school I’m aware of, offers a securities regulation course. But those courses usually focus on the Securities Act of 1933 and the Securities Exchange Act of 1934. A typical securities regulation course covers the definition of security, materiality, the registration of securities offerings under the Securities Act, and liability issues under both the Securities Act and the Exchange Act. If the professor is ambitious, those courses may also cover the regulation of securities markets and broker-dealers.
Almost none of those basic securities regulation courses spends any significant time on the 1940 Acts—the Investment Company Act and the Investment Advisers Act. It’s not because those two statutes are unimportant. A good proportion of American investment is through mutual funds and other regulated investment companies, not to mention hedge funds which depend upon Investment Company Act exemptions. And the investment advisory business is booming. When I attend gatherings of securities lawyers, I’m always amazed at how many of the lawyers present are dealing with issues under the 1940 Acts.
The lack of coverage of the 1940 Acts in the basic securities law course would be acceptable if law schools offered separate, stand-alone courses dealing with those issues, but many of them do not. I began teaching a course on the 1940 Acts in 1997. (I subsequently expanded the course to include a segment on the regulation of brokers.) At that time, you could count the number of law schools offering 1940 Act courses on one hand. Since then, more law schools have begun to offer such courses, but many law schools still do not.
Why are law schools not offering such an important business law course? One problem may be staffing. Many schools, including my own, have only one securities law professor. That person often also has to teach Business Associations, Mergers and Acquisitions, and other such courses, leaving no time for a second securities course. I have been able to offer my course only by rotating it with Mergers and Acquisitions on a biennial basis.
The lack of 1940 Act courses may also be due to the backgrounds of people teaching securities law. Some (certainly not all) securities law professors come from the litigation side of practice. Securities litigation centers on the 1933 and 1934 Acts. Litigation is a less important part of practice under the 1940 Acts, so many securities litigators aren’t exposed to it much.
A third problem is a lack of teaching materials. There isn’t much available on the 1940 Acts. I was lucky when I began teaching the course to discover a set of materials put together by Larry Barnett at Widener University. Those materials, supplemented with my own handouts and problems, have worked well. Unfortunately, Larry just retired and will no longer be updating his materials, so I’m not sure what I’m going to do now. I suspect more people would teach the course if more books were available, but there’s a chicken-and-egg problem. The major publishers aren’t interested in offering materials for a course that few schools teach.
Whatever the reason, the lack of such courses is a serious deficiency at any school preparing students for a securities law practice.
I'm interested to hear from commenters: are there any other courses law schools aren't teaching that are crucial to business law practice?