Tuesday, May 3, 2016
What factors generate a healthy secondary market in securities? That is my question for this week. I have found myself struggling with this question since I was first called by a reporter writing a story for The Wall Street Journal about a work-in-process written by one of our colleagues, Seth Oranburg (a Visiting Assistant Professor at Chicago-Kent College of Law). The article came out yesterday (and I was quoted in it--glory be!), but the puzzle remains . . . .
Secondary securities markets have been hot topics for a while now. I followed with interest Usha Rodrigues's work on this paper, for example, which came out in 2013. Yet, that project focused on markets involving only accredited investors.
Seth's idea, however, is intended to prime a different kind of secondary market in securities: a trading platform for securities bought by the average Joe (or Joan!) non-accredited investor in a crowdfunded offering (specifically, an offering conducted under the CROWDFUND Act, Title III of the JOBS Act). [Note: I will not bother to unpack the statutory acronyms used in that last parenthetical expression, since I know most of our readers understand them well. But please comment below or message me if you need help on that.] Leaving aside one's view of the need for or desirability of a secondary market for securities acquired through crowdfunding (which depends, at least to some extent, on the type of issuer, investment instrument, and investor involved in the crowdfunding), the idea of fostering a secondary securities market is intriguing. What, other than willing buyers and sellers and a facilitating (or at least non-hostile) regulatory environment, makes a trading market in securities?
Wednesday, April 20, 2016
As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the US Commodity Futures Trading Commission (CFTC) promulgated rules to regulate the swaps marketplace, securities trades that were previously unregulated and a contributing factor in the 2008 financial crisis. The CFTC oversees the commodity derivatives markets in the USA and has dramatically increased regulations and enforcement as a result of Dodd-Frank. As of January 2016, the CFTC finalized Dodd-Frank Rules exemptive orders and guidance actions. Commodity derivatives market participants, whether acting as a commercial hedger, speculator, trading venue, intermediary or adviser, face increased regulatory requirements including:
- Swap Dealer Regulation such as De Minimis Exceptions, new capital and margin requirements to lower risk in the system, heightened business conduct standards to lower risk and promote market integrity, and increase record-keeping and reporting requirements so that regulators can police the markets.
- Derivative Transparency and Pricing such as regulating exchanges of standardized derivatives to increase competition, information and arbitrage on price.
- Establishing Derivative Clearinghouses for standardized derivatives to regulate and lower counter party risks
The full list of CFTC Dodd Frank rulemaking areas is available here. In conjunction with the new regulations, the CFTC has stepped up enforcement actions according to a 2015 CFTC enforcement report detailing 69 enforcement actions for the year. Through these enforcement actions, the CFTC collected $2.8 billion in fines (outpacing SEC collections of $2 billion with a much larger agency budget and enforcement docket).
Tuesday, March 22, 2016
Jet lag prevented me from posting this yesterday. (Yes, I am scheduled to be the BLPB every-Monday blogger going forward.) But at least I am awake enough now to post a bit more on the 7th International Conference on Innovative Trends Emerging in Microfinance (ITEM 7 Conference) I attended last week in Shanghai, China. My initial post on Wednesday provided some information on Chinese microfinance and the initial day of the conference. This week, my post focuses on definitional questions that I have been pondering relating to my participation in this series of conferences. Specifically, I have been sorting through the relationship between microfinance and crowdfunding. My understanding continues to evolve as I become more familiar with the literature on and practice of microfinance internationally.
At the conference, one of the participants noted that while microfinance and crowdfunding appear to be mutually reinforcing, they still do not enjoy comfortable relations in scholarship and practice. After weighing that statement for a moment, I had to agree. I actually have been personally struggling with the nature of the relationship between the two for a few years now. (I often wonder whether folks like co-blogger Haskell Murray who commonly work in the social enterprise space have this issue in talking about the relationship between social enterprise and corporate social responsibility . . . .)
Two years ago at the ITEM 5 Conference, I posited that crowdfunding could be a vehicle for microfinance. The establishment of this point required defining both microfinance and crowdfunding--in each case, no small task. To enable the audience to understand my observation, I used a broad definition of microfinance that focuses on financial inclusion (like the one found here). I believed after my presentation that I had made the point well enough.
Yet, something still niggled at me after the presentation and conference were long gone. I kept feeling as if I had inserted a square peg into a round hole. Something was just a bit off. Part of the issue is, no doubt, the fact that my observation was incomplete. Microfinance is bigger than crowdfunding, and not all crowdfunding is microfinance, even under a broad definition. So, picture a venn diagram like the one below.
The red point of intersection illustrates crowdfunding's place as a means of conducting microfinance. This leaves part of microfinance to be handled through other types of financing (e.g., microcredit). It also leaves part of crowdfunding to other capital-raising uses. This conception of the relatonship between microfinance and crowdfunding is undoubtedly more complete.
The importance to microfinance of the non-microfinance part of crowdfunding was confirmed at our microfinance site visit last week in Shanghai. Our host for the visit explained, in response to my question about the relationship of microfinance to crowdfunding in China, that crowdfunding typically is seen as an alternative to, rather than a means of, microfinance in China. He noted that equity crowdfunding is uncommon (although growing) in Chinese small business finance overall because the number of shareholders of Chinese limited liability companies is statutorily capped. Specifically, Article 20 of the Companies Law of the People's Republic of China provides that "[a] limited liability company shall be jointly invested in and incorporated by not less than two and not more than fifty shareholders." I made a mental "note to files" that crowdfunding might get crowded out of microfinance or other types of financing--intentionally or unintentionally--by positive regulation.
I invite any readers who are more familiar with world-wide microfinance than I to comment further on its relationship to crowdfunding. Do I have the principal story right, in your view, based on your experience? Can you provide examples from your work or life that help me to see new aspects of the relationship between the two? I invite any related thoughts.
Wednesday, March 16, 2016
Between jet lag and the comprehensive conference proceedings and activities here in Shanghai, it’s all I can do to stay awake to finish this post . . . . But I am not complaining. Shanghai is a wonderful city, and the 7th International Conference on Innovative Trends Emerging in Microfinance (ITEM 7 Conference) has been a super experience so far.
Given my sleep-deprived state, I will just share with you here today a few key outtakes from the presentations we had yesterday (at a pre-conference site visit to the largest microfinance lender in Shanghai) and earlier today (at the conference itself) on microfinance in China. Here goes.
- Chinese microfinance is not really microfinance, in major part. It is SME (small and medium enterprise) lending. MSE loans are loans up to 30,000,000 Yuan RMB (about $4,600,000), and the average single loan amount for MSE lending is about 5,000,000 Yuan RMB (just under $770,000).
- Unlike those in archetypal microfinance and those involved in actual micro-credit lending transactions in many other countries, borrowers in Chinese microfinance lending (such as it is) are largely men rather than women.
- Despite these and other marked differences between Chinese microfinance and global microfinance, Chinese microfinance data does not affect global studies of microfinance in a statistically significant way. However, Chinese microfinance data does influence study results for the East Asia and Pacific region to a statistically significant degree.
Most of this was “new news” to me, given that Chinese microfinance is not at the center of my work. I am sure that I will know even more about it by the end of the conference tomorrow. In the mean time, however, I also enjoyed presentations today about:
- the willingness of rural Ethiopian farmers to pay for insurance to cover the risks of their business (given by an Italian scholar, for which I was an assigned discussant);
- a rural microfinance program in Nigeria (given by a research fellow affiliated with the Central Bank of Nigeria);
- gender-based microfinance lending in Canada (given by a faculty member/Ph.D. student at the University of New Brunswick in Canada);
- the utility of employing joint use of credit scoring and profit scoring in microfinance (given by a Ph.D. student currently serving as the research associate of the Microfinance Chair at the Burgundy School of Business in Dijon, France);
- the relationship between financial and social objectives of microfinance (given by a Ph.D. student from the Centre for European Research in Microfinance at the Université de Mons in Belgium); and
- Participants’ perceptions of two separate microlending programs in Australia, one involving no-interest microloans and the other offering matched savings (given by a Ph.D. student from the University of Queensland in Australia).
I speak tomorrow on crowdfunding intermediation and litigation risk and comment on a paper on crowdfunding and corporate governance. Fingers crossed that I can stay awake long enough to give my presentation . . . . :>)
Monday, February 22, 2016
“[T]he effective date of a registration statement shall be the twentieth day after the filing thereof.” That statement, in section 8(a) of the Securities Act of 1933, makes the process seem so reassuringly quick and simple. If I want to offer securities to the public, I file a registration statement with the SEC and, less than three weeks later, I’m ready to go. But, as every securities lawyer knows, it isn’t really that easy.
It can take months for the registration statement in an IPO to become effective. The statutory deadline is circumvented through the use of a delaying amendment, a statement in the registration statement that automatically extends the 20-day period until the SEC has finished its review. See Securities Act Rule 473, 17 C.F.R. § 230.473.
But wouldn’t it be so much more conducive to capital formation if there really was a hard 20-day deadline? I understand that the SEC doesn’t have the staff to complete a full review in that time frame, but it would force them to focus on the important disclosure issues rather than some of the trivialities one sees in the current comment letters.
I’d like to see someone test that automatic 20-day effectiveness—file a complete registration statement without the delaying amendment and wait to see what happens. The issuer would, of course, be stuck with a price set 20 days before sale, because section 8(a) provides that amending the registration statement resets the 20-day clock. But that’s not the biggest problem.
The biggest problem is that the SEC would undoubtedly seek a stop order under section 8(d) of the Act. It’s only supposed to do that if it appears the registration statement contains a materially false statement or omits a material fact required to be included or necessary to keep the registration statement from being misleading. But I have no doubt that the SEC staff would argue that something in the registration statement was materially misleading, no matter how complete and carefully crafted it was.
Still, it would be nice to see someone try, just to see the SEC scramble to deal with such an unprecedented lack of obeisance. Unfortunately, no one would risk it—unless . . . Mr. Cuban?
Wednesday, January 27, 2016
As many of you know, I teach both traditional doctrinal and experiential learning courses in business law. I bring experiential learning to the doctrinal courses, and I bring doctrine to the experiential learning courses. I see the difference between doctrinal and experiential learning courses as a matter of emphasis. Among other things, this post explores the intersection between traditional classroom-based law teaching and experiential law teaching by analogizing business law drafting to yoga practice principles. This turned out to be harder than it "felt" when I first started to write it. So, the post may be wholly or partially unsuccessful. But I persevere . . . .
I begin by noting that we are, to some extent, in the midst of a critical juncture with respect to experiential learning in legal education. Some observers, including both legal practitioners and faculty, criticize the lack of experiential learning, noting that legal education is too theoretical and policy-oriented, resulting in the graduation of students who are ill-prepared for legal practice. Yet, other commentators note that too great an emphasis on experiential learning leaves students without the skills in theory and policy that they need to make useful interpretive judgments and novel arguments for their clients and to participate meaningfully in law reform efforts. Of course, different law schools have different programs of legal education (something not noted well enough, or at all, in many treatments of legal education). But even without taking that into account, many in and outside legal education (including, for example, in articles here and here) advise a law school curriculum that merges the two. I think about and struggle with constructively effectuating this all merger the time.
Now, about the yoga . . . . Most of you likely do not know that, in addition to teaching law, being a wife and mom, and other stuff, I enjoy an active yoga practice. As I finished a yoga class on Sunday afternoon, I realized that yoga has something to say about integrating doctrinal and experiential learning, especially when it comes to instruction on legal drafting in the business law area. Set forth below are the parallels that I observe between yoga and business law drafting. They are not perfect analogs, but they are, in my view, instructive in a number of ways important to the teaching mission in business law. The first two bullet points are, as I see it, especially important as expressions of the idea that law teaching is more complete and valuable when it holistically integrates doctrine, policy, theory, and skills. The rest of the bullets principally offer other insights.
Monday, December 28, 2015
Andrew Schwartz, a professor at the University of Colorado, has recently published an interesting article discussing how crowdfunding deals with the fundamental problems of startup finance: uncertainty, information asymmetry, and agency costs. His article, The Digital Shareholder, 100 MINN. L. REV. 609 (2015), is available here.
Here’s the abstract:
Crowdfunding, a new Internet-based securities market, was recently authorized by federal and state law in order to create a vibrant, diverse, and inclusive system of entrepreneurial finance. But will people really send their money to strangers on the Internet in exchange for unregistered securities in speculative startups? Many are doubtful, but this Article looks to first principles and finds reason for optimism.
Well-established theory teaches that all forms of startup finance must confront and overcome three fundamental challenges: uncertainty, information asymmetry, and agency costs. This Article systematically examines this “trio of problems” and potential solutions in the context of crowdfunding. It begins by considering whether known solutions used in traditional forms of entrepreneurial finance—venture capital, angel investing, and public companies—can be borrowed by crowdfunding. Unfortunately, these methods, especially the most powerful among them, will not translate well to crowdfunding.
Finding traditional solutions inert, this Article presents five novel solutions that respond directly to crowdfunding’s distinctive digital context: (1) wisdom of the crowd; (2) crowdsourced investment analysis; (3) online reputation; (4) securities-based compensation; and (5) digital monitoring. Collectively, these solutions provide a sound basis for crowdfunding to overcome the three fundamental challenges and fulfill its compelling vision.
Andrew was kind enough to share a draft of this article with me earlier this year, and I’ve been waiting for him to make it publicly available so I could bring it to your attention. I’m not quite as optimistic as Andrew that crowdfunding will solve the problems he identifies, but it’s a good piece and worth reading.
Monday, December 21, 2015
I mentioned back in October that I spoke in Munich on Regulating Investment Crowdfunding: Small Business Capital Formation and Investor Protection. I discussed how crowdfunding should be regulated, using the U.S. and German regulations as examples.
If you’re interested, that talk is now available here. I expect this to be the top-rated Christmas video on iTunes.
If you want to know more about how Germany regulates crowdfunding, I strongly suggest this article: Lars Klöhn, Lars Hornuf, and Tobias Schilling, The Regulation of Crowdfunding in the German Small Investor Protection Act: Content, Consequences, Critique, Suggestions (June 2, 2015).
Thursday, December 10, 2015
A few days ago, co-blogger Steve Bradford posted on law professor complaints about grading under the title Warning: Law Professor Whine Season. OK. I typically am one of those whiners. But today, rather than noting that grading is the only part of the semester I actually need to be paid for (and all that yada yada), I want to briefly extoll one virtue of exam season: the positive things one sees in students as they consciously and appropriately struggle to synthesize the material in a 14-week jam-packed semester.
My Business Associations final exam was administered on Tuesday. Like many other law professors, I gave my students sample questions (with the answers), held a review session, and responded to questions posted to the discussion board on our class course management site. Sometimes, I dread any and all of that post-class madness. This year, I admit that there were few of the thinly veiled (and, by me, expressly discouraged and disdained) "is this on the exam?" or "please re-teach this part of the course . . ." types of questions or requests in any of the forums that I offered for post-class review and learning. That was a relief.
The students' final work product for my Corporate Finance planning and drafting seminar was due Monday. I met with a number of students in the course about that drafting assignment and about the predecessor project in the final weeks before each was due. I watched them work through issues and begin to make decisions, uncomfortable as they might be in doing so, that solve real client problems. Satisfying times . . . .
In fact, there have been a number of moments over the past week in which I was exceedingly proud of the learning that had gone on and was continuing to go on during the post-class exam-and-project-preparation phase of the semester. I offer a few examples here to illustrate my point. They come from both my Business Associations course, for which students take a comprehensive written final examination, and my Corporate Finance planning and drafting seminar, for which students solve a corporate finance problem through planning and drafting and write a review of a fellow student's planning and drafting project.
Wednesday, December 9, 2015
Divestment campaigns have been a popular form of corporate activism. With divestment pensions, institutions, endowments and funds withdraw investments from companies to encourage and promote certain social/political behaviors and policies.
Erik Hendey in his article Does Divestment Work (in the Harvard Political Review) recounted recent divestment campaigns including:
"sweatshop labor, use of landmines, and tobacco advertising. But undoubtedly the best known example of divestment occurred in the 1970s and ’80s in response to the apartheid regime of South Africa. Retirement funds, mutual funds, and investment institutions across the country sold off the stocks of companies that did business in South Africa."
A current divestment campaign is focused on guns. In the wake of the San Bernardino, California mass shooting, this issue is poised to gain momentum. The widespread investment in gun manufacturers will also make this campaign relevant to many investors. Andrew Ross Sorkin at the NYT DealBook writes in Guns in Your 401(k)? The Push to Divest Grows:
"If you own any of the broad index funds or even a target-date retirement fund, you’ve got a stake in the gun industry. Investments in gun makers, at least over the past five years, have performed well. Shares of Smith & Wesson are up nearly 400 percent since 2010. On Monday, shares of Smith & Wesson reached their highest price since 2007 after President Obama called for more gun control laws, leading investors to anticipate a rush of gun sales ahead of any restrictions."
If you are curious/concerned, Unload Your 401(k) is a website where you can check and see if you are personally invested, through your retirement savings plan, in one of the three major gun manufacturers.
Individuals may allocate their personal 401(k) money to socially responsible investment funds or in traditional funds that do not include gun manufacturers. A traditional fund is a hard bet because even if the fund doesn't currently invest in a gun manufacturer at the time of the individual's investment, it could become a part of the portfolio. Only funds with investment parameters that specifically exclude gun manufacturers can provide such a guarantee.
But what about endowments and pension funds-- large institutional investors who are often the target of divestment campaigns because when they choose to divest (or simply not to invest in the first place) this is where the real pressure can be applied to companies. Many stewards of such funds manage them according to certain social principles, especially if those principles are advocated by the beneficiaries of the funds (as is the case with student activists behind the fossil fuel divestment campaigns). Applying social pressure through such funds and on behalf of beneficiaries raises question of whether such actions are in appropriate fidelity to the trust position over the money (not the morals) the trustees are appointed to preserve. Bradford Cornell, at California Institute of Technology published a 2015 paper estimating the cost of fossil fuel divestment of major educational endowments, which for Harvard he figured to be over $100 million.
Friday, November 27, 2015
Please accept my apologies for not posting this notice sooner. I received the call for papers a few weeks ago and meant to post it then. But I now see that the deadline for abstract submissions is Monday! Mea culpa. Please feel free to post a comment here or contact me by email for more information if you want to submit. I have a more full-blown version of the call for papers that I can send by email to those who are interested in more information. (I omitted here prior conference locations as well as the names and affiliations of members of the conference academic and practice review boards and organizing committee.)
I have participated in this conference for the past two years. While there are few law academics in attendance, I have found the work of our international colleagues from the business side of the aisle to be both very informative to my work and interesting in many other respects. This conference also has enabled me to forge new relationships that have positively impacted my scholarship.
Call for Papers
7th Conference on Innovative Trends Emerging in Microfinance (ITEM-7)
Pumping up Innovations In and Around Microfinance
(Microfinance, Crowdfunding and Community Development Finance)
Organized by the
Banque Populaire Chair in Microfinance of the Burgundy School of Business, Dijon, France
In collaboration with
The Chinese Association of Microfinance
Shanghai Jiao Tong University Centre for Financial Inclusion
March 15-17, 2016
In Shanghai, China
Poverty is a deep-rooted problem. Science magazine has published research indicating that poverty is even associated with cognitive problems. One hope to eradicate poverty is to provide the poor with the resources necessary to cope with it, the resources being specific to their situation. One possible resource is microfinance. Today, more and more researchers are getting involved in research that makes a difference to practitioners who want to create a new world of hope for the poor. Although it is too early to prove either a positive or a negative impact of financial leverage on the poor, other financial products are being offered to the poor so that they are financially included.
The international conference on Innovative Trends Emerging in Microfinance (ITEM) is aimed at researchers, both from academic field and from the industry, who are looking at institutional and technological environmental factors that could increase outreach or reduce costs or both. Previous editions of this conferences have been held in India, France and Morocco.
The 7th edition brings together researchers from three areas: Microfinance, Crowdfunding and Community Development Finance. However, the conference is open to other closely related microfinance fields and papers on impact measures, social governance, innovation, and sustainable development are welcomed.
The ITEM conference provides a forum for both researchers and practitioners to discuss and exchange on financial inclusion. The conference in March 2016 seeks quantitative, qualitative and experience-based papers from industry and academia. Case studies and PhD research-in-progress are also welcomed. It encourages reflections on the potential and use of technology in microfinance in developed and developing countries.
Papers can be in English, French and Chinese. Normally, there is no provision for translations. So, English is preferred.
The conference invites both professional presentations and research papers. Since we are all aiming for high level publications, we do not publish books or copyrighted proceedings. It is expected that the review process and the partnerships developed would help the researchers develop the paper towards a high impact journal and that, perhaps, they would think of acknowledging their participation in the conference. However, if researchers want, their papers are directly considered for journal special issues or books that the organizers or other participants may be associated with. These journals include Strategic Change (Wiley) and Cost Management (Thomson-Reuters).
Proposals: All contribution types require a proposal in the first instance, including a short abstract between 300 and 500 words, up to five keywords, the full names (first name and surname, not initials), email addresses of all authors, and a postal address and telephone number for at least one contact author.
The abstract should indicate:
Title of the paper
Track of the paper (see below)
Authors and affiliations
Impact: (on new research or on new practices, policies)
Stream 1: Microfinance
Track 10: Microfinance (all other)
English / French
Track 11: Communication and Microfinance
Track 12: Experiments in Microfinance
Track 13: Market research in microfinance
Track 14: Microfinance in China
Stream 2: Crowdfunding
Track 20: Crowdfunding (all other)
English / French
Track 21: Communication et crowdfunding
Track 22: Regulation in Crowdfunding
English / French
Track 23: Engaging the crowd
Track 24: Strategies of crowdfunding
Track 25: Governance in Crowdfunding
English / French
Stream 3 : Community Development Finance
Track 30: Community Development (all other)
English / Chinese
Track 31: Impact Investment Funds
Track 32: Community Development Funds
Track 33: Slow Money / Agricultural Investment
Full Papers are only required after acceptance of abstract. Papers should not to be more than 5000 words including abstract, keywords and references. Submission period for the full papers is till December 31st, 2015. These will be sent for review after the registration fee has been paid. Each author of a full paper will also be required to review a paper and be a discussant at the conference.
Deadline / Timeline
November 30, 2015: Submission of abstract of proposals
December 10, 2015: Confirmation of acceptance
December 31, 2015: Early-bird registration ends
January 15, 2015: Full papers for those who want their papers reviewed
January 31, 2016: Normal registration ends
March 15-17, 2016: Conference
Registration and Payment: instructions will be sent at the time of confirmation of acceptance of abstract.
There are special discounts available for early-bird registration and for students. These will be posted on the conference website.
Web site: http://www.bmicrofinance.org/item7.html
Monday, November 16, 2015
One final post on the SEC’s proposed changes to Rule 147 and I promise I’m finished—for now. Today’s topic is the effect the proposed changes will have on state crowdfunding exemptions. If the SEC adopts the proposed changes to Rule 147, many state legislatures will have to (or at least want to) amend their state crowdfunding legislation.
As I explained in my earlier posts here and here, the SEC has proposed amendments to Rule 147, currently a safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act. If the proposed amendments are adopted, Rule 147 would become a stand-alone exemption rather than a safe harbor for section 3(a)(11). There would no longer be a safe harbor for intrastate offerings.
That creates some issues for the states. Many states have adopted state registration exemptions for crowdfunded securities offerings that piggyback on the federal intrastate offering exemption. That makes sense, because, if the offering isn’t also exempted at the federal level, the state crowdfunding exemption is practically worthless. (An offering pursuant to the federal crowdfunding exemption is automatically exempted from state registration requirements, but these state crowdfunding exemptions provide an alternative way to sell securities through crowdfunding.)
The SEC’s proposed amendments would actually make it easier for a crowdfunded offering to fit within Rule 147. (In fact, the SEC release says that’s one of the purposes of the amendments.) Most importantly, the SEC proposes to eliminate the requirement that all offerees be residents of the state. That change would facilitate publicly accessible crowdfunding sites which, almost by definition, are making offers to everyone everywhere. The securities would still have to be sold only to state residents, but it’s much easier to screen purchasers than to limit offerees.
Problem No. 1: Dual Compliance Requirements
Unfortunately, many state crowdfunding exemptions require that the crowdfunded offering comply with both section 3(a)(11) and Rule 147 in order to be eligible for the state exemption. Here, for example, is the relevant language in the Nebraska state crowdfunding exemption: “The transaction . . . [must meet] . . . the requirements of the federal exemption for intrastate offerings in section 3(a)(11) of the Securities Act of 1933 . . . and Rule 147 under the Securities Act of 1933.” (emphasis added).
Currently, that double requirement doesn’t matter. An offering that complies with the Rule 147 safe harbor by definition complies with section 3(a)(11). That would no longer true if the SEC adopts the proposed changes. Since Rule 147 would no longer be a safe harbor, an issuer that complied with Rule 147 would still have to independently determine if its offering complied with section 3(a)(11). Because of the uncertainty in the case law under 3(a)(11), that determination would be risky. (But see my argument here.) The leniency the SEC proposes to grant in the amendments to Rule 147 would not be helpful unless state legislators amended their crowdfunding exemptions to eliminate the requirement that offerings also comply with section 3(a)(11).
Problem No. 2: State-of-Incorporation/Organization Requirements
There’s another potential issue. Many state crowdfunding exemptions include an independent requirement that the issuer be incorporated or organized in that particular state. That’s inconvenient, and reduces the value of the state crowdfunding exemption, because corporations and LLCs are often incorporated or organized outside their home states. But, until now, that state requirement hasn’t mattered because both section 3(a)(11) and Rule 147 also impose such a requirement.
The SEC proposes to eliminate that requirement from Rule 147, so it now matters whether the state crowdfunding exemption independently imposes such a requirement. Issuers won’t be able to take full advantage of the proposed changes to Rule 147 unless states eliminate the state-of-incorporation/organization requirements from their state crowdfunding exemptions as well.
On to More Important Things
That’s the end of my Rule 147 discussion for now. I promise! Now, we can turn to more important questions, such as why your favorite team belongs in the college football playoff. (I know for sure that my college football team won't be there. I would be happy just to have my college football team in a bowl game.)
Wednesday, November 11, 2015
My recent article: Locked In: The Competitive Disadvantage of Citizen Shareholders, appears in The Yale Law Journal’s Forum. In this article I examine the exit remedy for unhappy indirect investors as articulated by Professors John Morley and Quinn Curtis in their 2010 article, Taking Exit Rights Seriously. Their argument was that the rational apathy of indirect investors combined with a fundamental difference between ownership of stock in an operating company and a share of a mutual fund. A mutual fund redeems an investor’s fund share by cashing that investor out at the current trading price of the fund, the net asset value (NAV). An investor in an operating company (a direct shareholder) exits her investment by selling her share certificate in the company to another buyer at the trading price of that stock, which theoretically takes into account the future value of the company. The difference between redemption with the fund and sale to a third party makes exit in a mutual fund the superior solution over litigation or proxy contests, they argue, in all circumstances. It is a compelling argument for many indirect investors, but not all.
In my short piece, I highlight how exit remedies are weakened for citizen shareholders—investors who enter the securities markets through defined contribution plans. Constrained investment choice within retirement plans and penalties for withdrawals means that “doing nothing” is a more likely option for citizen shareholders. That some shareholders are apathetic and passive is no surprise. The relative lack of mobility for citizen shareholders, however, comes at a cost. Drawing upon recent scholarship by Professors Ian Ayres and Quinn Curtis (Beyond Diversification), I argue that citizen shareholders are more likely to be locked into higher fee funds, which erode investment savings. Citizen shareholders may also be subsidizing the mobility of other investors. These costs add up when one considers that defined contribution plans are the primary vehicle of individual retirement savings in this country aside from social security. If the self-help remedy of exit isn’t a strong protection for citizen shareholders, then it is time to examine alternative remedies for these crucial investors.
Wednesday, November 4, 2015
The Department of Labor issued new interpretive guidelines for pension investments governed by ERISA. A thorny issue has been to what extent can ERISA fiduciaries invest in environmental, social and governance-focused (ESG) investments? The DOL previously issued several guiding statements on this topic, the most recent one in 2008, IB 2001-01, and the acceptance of such investment has been lukewarm. The DOL previously cautioned that such investments were permissible if all other things (like risk and return) are equal. In other words, ESG factors could be a tiebreaker but couldn't be a stand alone consideration.
What was the consequence of this tepid reception for ESG investments? Over $8.4 trillion in defined benefit and defined contribution plans covered by ERISA have been kept out of ESG investments, where non-ERISA investments in the space have exploded from "$202 billion in 2007 to $4.3 trillion in 2014."
The new guidance admits that previous interpretations may have
"unduly discouraged fiduciaries from considering ETIs and ESG factors. In particular, the Department is concerned that the 2008 guidance may be dissuading fiduciaries from (1) pursuing investment strategies that consider environmental, social, and governance factors, even where they are used solely to evaluate the economic benefits of investments and identify economically superior investments, and (2) investing in ETIs even where economically equivalent."
Under the new interpretive guidelines, the DOL takes a much more permissive stance regarding the economic value of ESG factors.
"Environmental, social, and governance issues may have a direct relationship to the economic value of the plan's investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary's primary analysis of the economic merits of competing investment choices. Similarly, if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote. Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors."
In other words, ESG factors may be economic factors and such investments are not automatically suspect under ERISA fiduciary duty obligations.
Monday, November 2, 2015
Here’s something everyone who has ever taken Securities Regulation should know: Section 3(a)(11) of the Securities Act, the intrastate offering exemption, has a safe harbor, Securities Act Rule 147.
As Lee Corso would say, “Not so fast, my friend.” The SEC is proposing to overturn that longstanding wisdom. If the SEC’s proposed changes to Rule 147 are adopted,Rule 147 would no longer be tied to section 3(a)(11) and section 3(a)(11) would no longer have a safe harbor. The intrastate nature of Rule 147 would be preserved, but the proposed changes would be adopted under the SEC’s general exemptive authority in section 28 of the Securities Act.
Here are the most significant changes that the SEC has proposed:
Tied to State Regulation
The premise of section 3(a)(11) and its Rule 147 safe harbor is to relegate purely intrastate offerings to state regulation. But there’s currently nothing in Rule 147 to enforce that premise; federal exemption does not depend on state regulation of the offering.
The SEC proposal would expressly tie the federal Rule 147 exemption to state regulation. An offering would qualify for the federal exemption only if it was (1) registered at the state level or (2) sold pursuant to a state exemption that imposes investment limits on purchasers and limits the amount of the offering to $5 million in any 12-month period. (This second possibility is clearly aimed at the crowdfunding exemptions that many states have recently enacted.)
Rule 147 does not currently limit the amount of the offering. The SEC proposal would limit the offering amount to $5 million in any 12-month period, unless the offering is registered at the state level.
State of Incorporation
Rule 147 currently requires that the issuer be incorporated or organized in the state in which the securities are sold. Because of that, even a corporation or LLC with all of its business in a single state cannot use Rule 147 if it happens to be incorporated or organized in another state, such as Delaware.
The SEC proposes to eliminate the focus on state of incorporation or organization, and require instead that the issuer’s “principal place of business” be within the state in which the offering is made. This would be defined as the state where “the officers, partners or managers . . . primarily direct, control and coordinate” the issuer’s activities.
Doing Business in the State
Under the current rule, the issuer must meet four requirements to establish that it is doing business in the state:
- It must derive at least 80% of its gross revenues from operations within the state;
- At least 80% of its assets must be located within the state;
- It must intend to use and actually use at least 80% of the offering proceeds in connection with operations in the state; and
- Its principal office must be located in the state.
All four of those requirements must be met.
The proposed rule is much less restrictive. An issuer only has to meet any one of the following requirements:
- It derives at least 80% of its gross revenues from operations in the state;
- At least 80% of its assets are located in the state;
- It intends to use and uses at least 80% of the offering proceeds in connection with operations in the state; or
- A majority of its employees are based in the state.
(Notice the addition of the new fourth test.) It will obviously be easier to satisfy a single one of the new requirements that it is to satisfy all four of the requirements under the current rule.
Intrastate Offers and Sales
Rule 147 currently provides that the securities must be offered and sold only to state residents. In other words, it’s not enough to screen out non-residents before sale. You can’t even solicit non-residents.
The SEC proposes to eliminate the restriction on offerees. An issuer could make a general public solicitation to the world, as long as it only sells the securities to state residents. This obviously makes it much easier to make Rule 147 offerings on the Internet.
Reasonable Belief Standard
The current rule requires that all of the purchasers (and offerees) be residents of the state. If one of them is a non-resident, the exemption is lost, even if the issuer thought the person was a resident.
The proposed rule adds a reasonable belief standard. The exemption is protected as long as the issuer had a reasonable belief that the non-resident purchaser was a resident.
Resales and the Issuer’s Exemption
Both the current rule and the SEC’s proposal limit resales to non-residents. However, there’s a crucial difference between the two.
The current rule makes the exemption dependent on meeting all of the terms and conditions of the rule, including the resale limit. Thus, if a purchaser immediately resold to a non-resident, the issuer could lose the exemption.
The proposed rule, like the current rule, requires the issuer to take certain precautions to prevent resales to non-residents, but the prohibition on resales is no longer a condition of the issuer’s exemption. Thus, if the issuer took the required precautions and a purchaser resold to a non-resident anyway, the issuer would not lose the exemption.
Protection from Integration
Rule 147 currently has a provision that protects the Rule 147 offering from integration with sales pursuant to certain other exemptions six months prior to or six months after the Rule 147 offering.
The SEC proposal offers a much broader anti-integration safe harbor, similar to the integration safe harbor included in Regulation A. Offers or sales under the amended Rule 147 exemption would not be integrated with any prior offers or sales. And Rule 147 offerings would not be integrated with subsequent offers or sales that are (1) federally registered; (2) pursuant to Regulation A; (3) pursuant to Rule 701; (4) pursuant to an employee benefit plan; (5) pursuant to Regulation S; (6) pursuant to the crowdfunding exemption in section 4(a)(6); or (7) more than six months after completion of the Rule 147 offering.
There is also some protection against integration when an issuer begins an offering under Rule 147 and decides to register the offering instead.
Section 3(a)(11) Remains Available
As I mentioned earlier, the amended Rule 147 would no longer be a safe harbor for section 3(a)(11) of the Securities Act. But Section 3(a)(11) would remain available. It just wouldn’t have a safe harbor.
An issuer would be free to use the section 3(a)(11) statutory exemption, but I wouldn’t recommend it unless everything is unquestionably intrastate. It was the uncertain interpretations of section 3(a)(11) that led to Rule 147 in the first place.
A Move in the Right Direction
I think the proposed exemption is a move in the right direction. Rule 147, one of the SEC’s earliest surviving safe harbors, was a little long in the tooth. The proposed changes will make it a little more viable.
Friday, October 30, 2015
Tuesday, October 27, 2015
This hit my mailbox this morning. If the report is correct, we'll know in a few days whether we have a path to unregistered, broad-based securities crowdfunding in the United States. More as news is reported . . . .
[Additional information: Based on the link to the SEC's notice of meeting in Steve Bradford's comment to this post, it also appears that the SEC is considering amendments to Rules 147 (intrastate offerings) and 504 (limited offerings under Regulation D of up to $1,000,000).]
Wednesday, October 21, 2015
As Steve Bradford mentioned in his post on Monday (sharing his cool idea about mining crowdfunded offerings to find good firms in which to invest), our co-blogger Haskell Murray published a nice post last week on venture capital as a follow-on to capital raises done through crowdfunding. He makes some super points there, and (although I was raised by an insurance brokerage executive, not a venture capitalist), my sense is that he's totally right that the type of crowdfunding matters for those firms seeking to follow crowdfunding with venture capital financing. I also think that, of the types of crowdfunding he mentions, his assessment of venture capital market reactions makes a lot of sense. Certainly, as securities crowdfunding emerges in the United States on a broader scale (which is anticipated by some to happen with the upcoming release of the final SEC rules under Title III of the JOBS Act), it makes sense to think more about what securities crowdfunding might look like and how it will fit into the cycle of small business finance.
Along those lines, what about debt crowdfunding as a precursor to venture capital funding? Andrew Schwartz has written a bit about that. Others also may have taken on this topic. Professor Schwartz may be right that issuers will prefer to issue debt than equity--in part because it may prove to be less of an impediment to later equity financings. But I don't necessarily have a warm feeling about that . . . .
And what about the crowdfunding of investment contracts (e.g., what I have previously called "unequity" in this article (and elsewhere, including in this further article) and perhaps even the newly popular SAFEs)? There is no equity overhang with unequity and some other types of investment contract, but crowdfunded SAFEs, which are convertible paper, may be viewed negatively in later financing rounds--especially if the conversion rights are held by a wide group of investors. While part of me is surprised that people are not taking the investment contract part of the potential securities crowdfunding market seriously (since folks were crowdfunding investment contracts before the JOBS Act came along--not knowing it was unlawful), the other part of me says that crowdfunded investment contracts would have a niche market at best.
So, thanks, Haskell, for the food for thought. No doubt, more will be written about this issue as and if the market for crowdfunded securities develops. Coming soon, says the SEC . . . .
Wednesday, October 7, 2015
As some of you may know, I have been focused on crowdfunding intermediation in my research of late. My articles in the U.C. Davis Business Law Journal and the Kentucky Law Journal both touch on that topic, and a forthcoming chapter in an international crowdfunding book and several articles in process follow along that trail. (I also have the opportunity to look into gatekeeper intermediary issues outside the crowdfunding context at an upcoming symposium at Wayne State University Law School, about which I will say more in a subsequent post.) The underlying literature on financial intermediation is super-interesting, and it continues to grow in breadth and depth as I research and write.
Given my interest in this area, I was delighted to see that Larry Cunningham is contributing to the debate, following on his already-rich work relating to Warren Buffett and Berkshire Hathaway. As you may recall, Larry was our guest here at the Business Law Prof Blog back in 2014. You can read my Q&A with him here and his posts here and here.
Larry recently posted an essay responding to Kathryn Judge's Intermediary Influence, 82 U Chi L Rev 573 (2015). In her article, Professor Judge shows "how intermediaries acquire influence over time and how they have used that influence to promote high-fee arrangements." She then uses this descriptive analysis both to explain existing phenomena in the financial markets and to identify significant implications for the same.
Forthcoming in the University of Chicago Law Review Dialogue, Larry's responsive essay, Berkshire versus KKR: Intermediary Influence and Competition, compares the infamous private equity firm Kohlberg Kravis Roberts to his beloved Berkshire Hathaway. His focus? The M&A market. His bottom line?
I have extended Judge’s insights with an illustration from the acquisitions market, depicting one firm (KKR) that epitomizes intermediary influence, in contrast to a rival (Berkshire)—the anti-intermediary par excellence. The juxtaposition affirms the portrait of intermediary influence that Judge paints as well as the potential for correction through lower-priced competition and fee disclosure she posits.
I have given Larry's essay a skim, and that quick pass has enticed me into giving both it and Professor Judge's article a good, thorough read in the not-too-distant future.
Monday, October 5, 2015
Alicia Plerhoples (Georgetown) has the details about the first benefit corporation IPO: Laureate Education.*
She promises more analysis on SocEntLaw (where I am also a co-editor) in the near future.
The link to Laureate Education's S-1 is here. Laureate Education has chosen the Delaware public benefit corporation statute to organize under, rather than one of the states that more closely follows the Model Benefit Corporation Legislation. I wrote about the differences between Delaware and the Model here.
Plum Organics (also a Delaware public benefit corporation) is a wholly-owned subsidiary of the publicly-traded Campbell's Soup, but it appears that Laureate Education will be the first stand-alone publicly traded benefit corporation.
*Remember that there are differences between certified B corporations and benefit corporations. Etsy, which IPO'd recently, is currently only a certified B corporation. Even Etsy's own PR folks confused the two terms in their initial announcement of their certification.
October 5, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, CSR, Delaware, Haskell Murray, Research/Scholarhip, Securities Regulation, Social Enterprise | Permalink | Comments (0)