Thursday, December 12, 2013
Last week I attended the UN Forum on Business and Human Rights in Geneva. The Forum was designed to discuss barriers and best practices related to the promotion and implementation of the non-binding UN Guiding Principles on Business and Human Rights, which discuss the state’s duty to protect human rights, the corporation’s duty to respect human rights, and the joint duty to provide access to judicial and non-judicial remedies for human rights abuses. This is the second year that nation states, NGOs, businesses, civil society organizations, academics and others have met to discuss multi-stakeholder initiatives, how businesses can better assess their human rights impact, and how to conduct due diligence in the supply chain.
Released in 2011 after unanimous endorsement by the UN Human Rights Council, the Guiding Principles are considered the first globally-accepted set of standards on the relationship between states and business as it relates to human rights. The US State Department and the Department of Labor have designed policies around the Principles, and a number of companies have adopted them in whole or in part, because they provide a relatively detailed framework as to expectations. Some companies faced shareholder proposals seeking the adoption of the Principles in 2013, and more will likely hear about the Principles in 2014 from socially responsible investors. Several international law firms discussed the advice that they are now providing to multinationals about adopting the Principles without providing a new basis for liability for private litigants.
Although the organizers did not have the level of business representation as they would have liked of one-third of the attendees, it was still a worthwhile event with Rio Tinto, Unilever, Microsoft, Google, Nestle, Barrick Gold, UBS, Petrobras, Total, SA, and other multinationals serving as panelists. Members of the European Union Parliament, the European Union Commission and other state delegates also held leadership roles in shaping the discussion on panels and from the audience.
Some of the more interesting panels concerned protecting human rights in the digital domain; case studies on responsible investment in Myanmar (by the State Department), the palm oil industry in Indonesia and indigenous peoples in the Americas; the dangers faced by human and environmental rights defenders (including torture and murder); how to conduct business in conflict zones; public procurement and human rights; developments in transnational litigation (one lawyer claimed that 6,000 of his plaintiffs have had their cases dismissed since the Supreme Court Kiobel decision about the Alien Tort Statute); mobilizing lawyers to advance business and human rights; the various comply or explain regimes and how countries are mandating or recommending integrated reporting on environmental, social and governance factors; tax avoidance and human rights; human rights in international investment policies and contracts; and corporate governance and the Guiding Principles.
As a former businessperson, many of the implementation challenges outlined by the corporate representatives resonated with me. As an academic, the conference reaffirmed how little law students know about these issues. Our graduates may need to advise clients about risk management, international labor issues, corporate social responsibility, supply chain concerns, investor relations, and new disclosure regimes. Dodd-Frank conflict minerals and the upcoming European counterpart were frequently mentioned and there are executive orders and state laws dealing with human rights as well.
Traditional human rights courses do not typically address most of these issues in depth and business law courses don’t either. Only a few law firms have practice areas specifically devoted to this area- typically in the corporate social responsibility group- but many transactional lawyers and litigators are rapidly getting up to speed out of necessity. Small and medium-sized enterprises must also consider these issues, and we need to remember that “human rights” is not just an international issue. As business law professors, we may want to consider how we can prepare our students for this new frontier so that they can be both more marketable and more capable of advising their clients in this burgeoning area of the law. For those who want to read about human rights and business on a more frequent basis, I recommend Professor Jena Martin’s blog.
December 12, 2013 in Business Associations, Corporate Governance, Corporations, Current Affairs, Ethics, Financial Markets, Marcia L. Narine, Securities Regulation, Teaching | Permalink | Comments (1)
Wednesday, December 4, 2013
Earlier this week the SEC released its 2014 rulemaking agenda and excluded from the list is a proposal for public companies to disclose political spending. In 2011, the Committee on Disclosure of Corporate Political Spending, comprised of 10 leading corporate and securities academics, petitioned the SEC to adopt a political spending disclosure rule. This petition has received a historic number of comments—over 640,000—which can be found here.
The Washington Post reported that after the petition was filed,
A groundswell of support followed, with retail investors, union pension funds and elected officials at the state and federal levels writing to the agency in favor of such a requirement. The idea attracted more than 600,000 mostly favorable written comments from the public — a record response for the agency.
Omitting corporate political spending from the 2014 agenda has received steep criticism from the NYT editorial board in an opinion piece written yesterday declaring the decision unwise “even though the case for disclosure is undeniable.” Proponents of corporate political spending disclosure like Public Citizen are “appalled” and “shocked” by the SEC’s decision, while the Chamber of Commerce declares the SEC’s omission a coup that appropriately avoids campaign finance reform.
Included in the 2014 agenda are Dodd-Frank and JOBS Act measures, as well as a proposal to enhance the fiduciary duties owed by broker-dealers. More on the agenda in future posts….
Thursday, November 28, 2013
On Saturday evening I leave for Geneva to attend the United Nations Forum on Business and Human Rights with 1,000 of my closest friends including NGOs, Fortune 250 Companies, government entities, academics and other stakeholders. I plan to blog from the conference next week. I am excited about the substance but have been dreading the expense because the last time I was in Switzerland everything from the cab fare to the fondue was obscenely expensive, and I remember thinking that everyone in the country must make a very good living. Apparently, according to the New York Times, the Swiss, whom I thought were superrich, "scorn the Superrich," and last March a two-thirds majority voted to ban bonuses, golden handshakes and to require firms to consult with their shareholders on executive compensation. Nonetheless, last week, 65% of voters rejected a measure to limit executive pay to 12 times the lowest paid employee at their company. According to press reports many Swiss supported the measure in principle but did not agree with the government imposing caps on pay.
Meanwhile stateside, next week the SEC closes its comment period on its own pay ratio proposal under Section 953(b) of the Dodd-Frank Act. Among other things, the SEC rule requires companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts. It does not specify a methodology for calculation but does require the calculation to include all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees), those employed by the company or any of its subsidiaries, and those employed as of the last day of the company’s prior fiscal year. A number of bloggers have criticized the rule (see here for example), business groups generally oppose it, and the agency has been flooded with tens of thousands of comment letters already.
The SEC must take some action because Congress has dictated a mandate through Dodd-Frank. It can’t just listen to the will of the people (many of whom support the rule) like the Swiss government did. It will be interesting to see what the agency does. After all two of the commissioners voted against the rule, and one has publicly spoken out against it. But the SEC does have some discretion. The question is how will it exercise that discretion and will the agency once again face litigation as it has with other Dodd-Frank measures where business groups have challenged its actions (proxy access, resource extraction and conflict minerals, for example). More important, will it achieve the right results? Will investors armed with more information change their nonbinding say-on-pay votes or switch out directors who overpay underperforming or unscrupulous executives? If not, then will this be another well-intentioned rule that does nothing to stop the next financial crisis?
Sunday, November 17, 2013
A quick review of the top 10 Papers for Corporate, Securities & Finance Law eJournals on SSRN for the period of September 18, 2013 to November 17, 2013 (here), led me to Utpal Bhattacharya’s paper “Insider Trading Controversies: A Literature Review.” Here is the abstract:
Using the artifice of a hypothetical trial, this paper presents the case for and against insider trading. Both sides in the trial produce as evidence the salient points made in more than 100 years of literature on insider trading. The early days of the trial focus on the issues raised in the law literature like fiduciary responsibility, the misappropriation theory and the fairness and integrity of markets, but the trial soon focuses on issues like Pareto-optimality, efficient contracting, market efficiency, and predictability raised in the financial economics literature. Open issues are brought up. A jury finally hands out its verdict.
Saturday, November 16, 2013
Congratulations to Eric Chaffee, former BLPB contributing editor & friend of the blog, for taking over the Securities Law Prof Blog reins from Barbara Black. Barbara has left some big shoes for Eric to fill, having single-handedly built the Securities Law Prof Blog into one of the staple blogs for business law folks, but if anyone is up to the task it's Eric. Make sure you add the Securities Law Prof Blog to your personal blogroll.
Thursday, November 14, 2013
This week two articles caught my eye. The New York Times’ Room for Debate feature presented conflicting views on the need to “prosecute executives for Wall Street crime.” My former colleague at UMKC Law School, Bill Black, has been a vocal critic of the Obama administration’s failure to prosecute executives for their actions during the most recent financial crisis, and recommended bolstering regulators to build cases that they can win. Professor Ellen Podgor argued that the laws have overcriminalized behavior in a business context, and that the “line between criminal activities and acceptable business judgments can be fuzzy.” She cited the thousands of criminal statutes and regulations and compared them to what she deems to be overbroad statutes such as RICO, mail and wire fraud, and penalties for making false statements. She worried about the potential for prosecutors to abuse their powers when individuals may not understand when they are breaking the law.
Charles Ferguson, director of the film “Inside Job,” likened the activity of some major financial executives to that of mobsters and argued that they have actually done more damage to the economy. He questioned why the government hadn’t used RICO to pursue more criminal cases. Former prosecutor and now private lawyer Allen Goelman pointed out rather bluntly that prosecutors aren’t cozy with Wall Street—they just won’t bring a case when the evidence won’t allow them to win. He also reminded us that greed and stupidity, which he claimed was the cause of the “overwhelming majority of the risky and irresponsible behavior by Wall Street,” are not crimes. Professor Lawrence Friedman wrote that the law “announces the community’s conceptions of right and wrong,” and if we now treat corporations like people under Citizens United then we should likewise make the executives who run them the objects of the community’s condemnation of wrongdoing.
Finally, Senator Elizabeth Warren concluded that if corporations know that they can break the law, pay a large settlement, and not admit any guilt or have any individual prosecuted, they won’t have any incentive to follow the law. She also argued for public disclosure of these settlements including whether there were tax deductions or releases of liability.
This brings me to the second interesting article. Former SEC enforcement chief and now Kirkland & Ellis partner Robert Khuzami recently said, “I didn’t think there was much doubt in most cases that a defendant engaged in wrongdoing when you had a 20-page complaint, you had them writing a big check, you may well have prosecuted an individual in the wrongdoing.” While not endorsing or rejecting current SEC Chair Mary Jo White’s position to require certain companies to admit wrongdoing in settlements, he raised a concern about whether this change in policy would place undue strain on the agency’s limited resources by forcing more cases to go to trial. He also raised a valid point about the legitimate fear that firms should have in that admitting guilt could expose them to lawsuits, criminal prosecution, and potential business losses. Chair White did not set out specific guidelines for the new protocol, but so far this year 22 companies have benefitted from the no admit/no deny policy and have paid $14 million in sanctions. But we don’t know how many executives from these companies lost their jobs. On the other hand, would these same companies have settled if they had to admit liability or would they have demanded their day in court?
Should the desire to preserve agency resources trump the need to protect the investing public—the stated purpose of the SEC? If neither the company nor the executive faces true accountability, what will be the incentive to change? In a post-Citizens United world, will Congressmen strengthen the laws or bolster the power and resources of the regulators to go after the corporations that help fund their campaigns? Have we, as Dostoyevsky asserted, become “used” to the current state of affairs where drug dealers and murderers go to jail, but there aren’t enough resources to pursue financial miscreants?
What will make companies and executives “do the right thing”? Dostoyevksy also wrote “intelligence alone is not nearly enough when it comes to acting wisely,” and he was right. Perhaps the fear of the punishment for clearly enumerated and understood crimes, and the fear of the admission of wrongdoing with the attendant collateral damage that causes will lead to a change in individual and corporate behavior. I agree with Professor Podgor that there is clearly room for prosecutorial abuse of power and that the myriad of laws can lead to a no-mans land for the unwary executive forced to increase margins and earnings per share (while possibly getting a healthy bonus). While I have argued in the past for an affirmative defense for certain kinds of corporate crimial liability, I also agree with Professor Black and Senator Warren. At some point, people and the corporations (made up of people) need more than “intelligence” to act “wisely.” They need the punishment to fit the crime.
Wednesday, November 13, 2013
We live in a world where most working individuals have some retirement savings invested in the stock market. The stock market funds, in part, college educations, and serve as the primary wealth accumulator for post-baby boom generations. My parents—an elementary school teacher and a furniture salesman—lived in Midwestern frugality and invested their savings from the mid-80’s until 2006 when they pulled out of the market. They retired early, comfortably (so I believe), and largely because of consistent gains in the stock market over a 30 year period. The question is whether this story is repeatable as a viable outcome for working investors now.
The Wall Street Journal ran a story on Monday “Stocks Regain Appeal” documenting the number of dollars flowing into markets from retail investors as well as the anecdotal confidence of investors. The WSJ reports that:
“U.S. stock mutual funds have attracted more cash this year than they have in any year since 2004, according to fund-tracker Lipper. Investors have sent $76 billion into U.S. stock funds in 2013. From 2006 through 2012, they withdrew $451 billion.”
This seems indisputably good right? Maybe. The real question for me is why is more money flowing into the markets and confidence high? Is this behavior driven by information, emotion, or herd mentality? Robert Shiller, recent Nobel Prize winner and author of Irrational Exuberance, wrote in March in a column for the NYT that investors were confident, but who knows why. Shiller’s conclusions were based on data from the cyclically adjusted price-earnings ratio, CAPE, of 23 suggesting that the market was priced high, which is interesting when compared with his data that 74% of individual investors did not think that the market was overpriced. Shiller strengthened his cautionary stance on the market last month when the CAPE held at 23.7, and Shiller warned that stocks were the “most expensive relative to earnings in more than five years.”
This is business law blog, not a market blog, yet the role of the market interests me greatly. As corporate law scholars, we teach students and write about the legal limits, obligations and assumptions that establish the market and dictate how individuals and institutions interact with the market and corresponding corporate-level controls. In 2007 the market collapsed (self-corrected if we want to use the economists’ terms) and what was the result? Dodd-Frank and a series of legislation aimed at policing the market. If we are interested in the laws that govern the market, surely some attention must be paid to how and why the market works the way that it does.
Monday, November 11, 2013
The SEC’s crowdfunding proposal offers small, startup businesses a new way to raise capital without triggering the expensive registration requirements of the Securities Act of 1933. But the capital needs of small businesses are often uncertain. They may need to raise money again shortly after an exempted offering. Or they may want to sell securities pursuant to another exemption at the same time they’re using the crowdfunding exemption. How do other offerings affect the crowdfunding exemption? The proposed crowdfunding rules are unexpectedly generous with respect to other offerings, but they still contain pitfalls.
Other Securities Do Not Count Against the $1 Million Crowdfunding Limit
The proposed rules make it clear that the crowdfunding exemption’s $1 million limit is unaffected by securities sold outside the crowdfunding exemption. As I explained in an earlier post, only securities sold pursuant to the section 4(a)(6) crowdfunding exemption count against the limit.
Crowdfunding and the Integration Doctrine
But the integration doctrine, the curse of every securities lawyer, poses problems beyond determining the offering amount.
Briefly, the integration doctrine defines what constitutes a single offering for purposes of the exemptions from registration. The Securities Act exemptions are transactional; to avoid registration, the issuer must fit its entire offering within a single exemption. It cannot separate what is actually a single offering into two or more parts and fit each part into different exemptions.
Unfortunately, the application of the integration doctrine is notoriously uncertain and unpredictable, making it difficult for issuers who do two offerings of securities at or about the same time to know whether or not those offerings qualify for an exemption. (For a critical review of the integration doctrine, see my article here.)
The SEC’s crowdfunding proposal begins with what appears to be absolute protection from integration. The proposal says (p. 18) that “an offering made in reliance on Section 4(a)(6) should not be integrated with another exempt offering made by the issuer, provided that each offering complies with the requirements of the applicable exemption that is being relied on for the particular offering.”
However, the SEC giveth and the SEC taketh away. First, this isn’t really a rule, just a pledge by the SEC. The anti-integration language does not appear anywhere in the rules themselves; it’s only in the release discussing the rules. Other integration safe harbors, such as Rule 251(c) of Regulation A and Rule 502(a) of Regulation D, appear in the rules. It’s not clear why the SEC was unwilling to write an integration provision into the crowdfunding rules, but an actual rule would provide much more comfort to issuers than the SEC’s bare promise.
And, unfortunately, the SEC doesn’t stop with the broad anti-integration pledge. It adds (pp. 18-19) that
An issuer conducting a concurrent exempt offering for which general solicitation is not permitted, however, would need to be satisfied that purchasers in that offering were not solicited by means of the offering made in reliance on Section 4(a)(6). Similarly, any concurrent exempt offering for which general solicitation is permitted could not include an advertisement of the terms of the offering made in reliance on Section 4(a)(6) that would not be permitted under Section 4(a)(6) and the proposed rules.
These qualifications may prove particularly mischievous. Assume, for example, that an issuer is offering securities pursuant to section 4(a)(6) and, around the same time, offering securities pursuant to Rule 506(b), which prohibits general solicitation. The issuer would have to verify that none of the accredited investors in the Rule 506(b) offering saw the offering on the crowdfunding platform. Since crowdfunding platforms are open to the general public, that might be difficult.
As a result of the second sentence quoted above, there’s also a potential problem in the other direction. Assume that an issuer is simultaneously offering the same securities pursuant to both section 4(a)(6) and Rule 506(c). Rule 506(c) allows unlimited general solicitation, but the crowdfunding rules severely limit what an issuer and others may say about the offering outside the crowdfunding platform. The SEC seems to be saying that a public solicitation under Rule 506(c) would bar the issuer from using the crowdfunding exemption to sell the same securities. Since the same securities are involved in both offerings, the 506(c) solicitation would arguably “include an advertisement of the terms of the offering made in reliance on Section 4(a)(6).”
Double-Door Offerings Redux
Before the SEC released the crowdfunding rules, I questioned whether “double-door” offerings using the crowdfunding exemption and the new Rule 506(c) exemption were viable. I posited a single web site that sold the same securities (1) to accredited investors pursuant to Rule 506(c) and (2) to the general public pursuant to the crowdfunding exemption. I concluded that, because of the integration doctrine, such offerings were impossible. The SEC anti-integration promise may change that result, if the SEC really means what it says.
The anti-integration promise doesn’t exclude simultaneous offerings, even if those offerings involve the same securities. And I don’t see anything in the rules governing crowdfunding intermediaries that would prevent both 506(c) and crowdfunding offerings on a single web platform, with accredited investors funneled to a separate closing under Rule 506(c). Funding portals could not host such a double-door platform, because they’re limited to crowdfunded offerings, but brokers could.
However, both the issuer and the broker would have to be careful about off-platform communications. Ordinarily, an issuer in a Rule 506(c) offering may engage in any general solicitation or advertising it wishes, on or off the Internet. But the SEC crowdfunding release, as we saw, warns that “any concurrent exempt offering for which general solicitation is permitted could not include an advertisement of the terms of the offering made in reliance on Section 4(a)(6) that would not be permitted under Section 4(a)(6) and the proposed rules.” To avoid ruining the crowdfunding exemption, any off-platform communications would have to be limited to what the crowdfunding rules allow, and that isn’t much.
Friday, November 8, 2013
The Economist has an interesting piece on how “[a] mutation in the way companies are financed and managed will change the distribution of the wealth they create.” You can read the entire article here. A brief excerpt follows.
The new popularity of the [Master Limited Partnership] is part of a larger shift in the way businesses structure themselves that is changing how American capitalism works…. Collectively, distorporations such as the MLPs have a valuation on American markets in excess of $1 trillion. They represent 9% of the number of listed companies and in 2012 they paid out 10% of the dividends; but they took in 28% of the equity raised…. [The] beneficiaries, though, are a select class. Quirks in various investment and tax laws block or limit investing in pass-through structures by ordinary mutual funds, including the benchmark broad index funds, and by many institutions. The result is confusion and the exclusion of a large swathe of Americans from owning the companies hungriest for the capital the markets can provide, and thus from getting the best returns on offer….
Another booming pass-through structure is that of the “business development company” (BDC). These firms raise public equity and debt much like a leveraged fund.… What they all share is an ability to do bank-like business—lending to companies which need money—without bank-like regulatory compliance costs….
Andrew Morriss, of the University of Alabama law school, sees the shift as an entrepreneurial response to a century’s worth of governmental distortions made through taxation and regulation. At the heart of those actions were the ideas set down in “The Modern Corporation and Private Property”, a landmark 1932 study by Adolf Berle and Gardiner Means. As Berle, a member of Franklin Roosevelt’s “brain trust”, would later write, the shift of “two-thirds of the industrial wealth of the country from individual ownership to ownership by the large, publicly financed corporations vitally changes the lives of property owners, the lives of workers and …almost necessarily involves a new form of economic organisation of society.” … Several minor retreats notwithstanding, the government’s role in the publicly listed company has expanded relentlessly ever since.
November 8, 2013 in Business Associations, Books, Corporate Governance, Corporations, Current Affairs, Financial Markets, LLCs, Partnership, Securities Regulation, Stefan J. Padfield, Unincorporated Entities | Permalink | Comments (0)
Thursday, November 7, 2013
In 2011, I met with members of the SEC and Congressional staffers as part of a coalition of business people and lawyers raising concerns about the proposed Dodd-Frank whistleblower provision. Ten days after leaving my compliance officer position and prior to joining academia, I testified before a Congressional committee about the potential unintended consequences of the law. The so-called “bounty-hunter” law establishes that whistleblowers who provide original information to the SEC related to securities fraud or violations of the Foreign Corrupt Practices Act are eligible for ten to thirty percent of the amount of the recovery in any action in which the SEC levies sanctions in excess of $1 million dollars. The legislation also contains an anti-retaliation clause that expands the reach of Sarbanes-Oxley. Congress enacted the legislation to respond to the Bernard Madoff scandal. The SEC recently awarded $14 million dollars to one whistleblower. To learn more about the program, click here.
I argued, among other things, that the legislation assumed that all companies operate at the lowest levels of ethical behavior and instead provided incentives to bypass existing compliance programs when there are effective incentive structures within the existing Federal Sentencing Guidelines for Organizations. Although they are no longer binding, judges use the Guidelines to sentence corporations that plead guilty or are so adjudicated after trial. Prosecutors use them as guideposts when making deals with companies that enter into nonprosecution and deferred prosecution agreements. I recommended: (1) that there be a presumption that whistleblowers report internally first unless there is no viable, credible internal option; (2) that the SEC inform the company that an anonymous report has been made unless there is legitimate reason not to do so and (3) that those with a fiduciary duty to report be excluded from the bounty provisions of the bill and be required to report upward internally before reporting externally.
Fortunately, the final legislation does make it more difficult for certain people to report externally without first trying to use the compliance program, if one exists. Nonetheless, the Wall Street Journal reported yesterday that a growing number of compliance personnel are blowing the whistle on their own companies, notwithstanding the fact that they must wait 120 days under the rules after reporting internally to go to the SEC. One of the attorneys interviewed in the WSJ article, Gregory Keating, is a shareholder Littler Mendelsohn, a firm that exclusively represents management in labor matters. His firm and others are seeing more claims brought by compliance officers.
This development leads to a number of questions. What about compliance officers who are also lawyers, as I was? NY state has answered the question by excluding lawyers from the awards, and I am sure that many other states are considering it or will now start after reading yesterday’s article. What does this mean for those forward thinking law schools that are training law students to consider careers in compliance? I believe that this is a viable career choice in an oversaturated legal market because the compliance field is exploding, while the world of BigLaw is contracting. Do we advise students considering the compliance field to forego their bar licenses after graduation because one day they could be a whistleblower and face a conflict of interest? I think that’s unwise. What about compliance personnel in foreign countries? Courts have already provided conflicting rulings about their eligibility for whistleblower status under the law.
Most significantly, in many companies compliance officers make at least an annual report to the board on the activities of the compliance program in part to ensure that the board fulfills its Caremark responsibilities. These reports generally do and should involve detailed, frank discussions about current and future risks. Will and should board members become less candid if they worry that their compliance officer may blow the whistle?
Could the Sentencing Commission have avoided the need for compliance officers to blow the whistle externally by recommending that compliance officers report directly to the board as the heads of internal audit typically do? This option was considered and rejected during the last round of revisions to the Sentencing Guidelines in 2010. Compliance officers who do not report to general counsels or others in the C-Suite but have direct access to board members might feel less of a need to report to external agencies. This is why, perhaps, in almost every corporate integrity agreement or deferred prosecution agreement, the government requires the chief compliance officer to report to the board or at least to someone outside of the legal department.
To be clear, I am not opposed to the legislation in principle. And for a compliance officer to report on his or her own organization, the situation internally was probably pretty dire. Gregory Keating and I sit on the Department of Labor’s Whistleblower Protection Advisory Committee, which will examine almost two dozen anti-retaliation laws in the airline, commercial motor carrier, consumer product, environmental, financial reform, food safety, health care reform, nuclear, pipeline, public transportation agency, railroad, maritime and securities fields. During our two-year term we will work with academics, lawyers, government officials, organized labor and members of the public to make the whistleblower laws more effective for both labor and management.
State bars, government agencies, boards, general counsels, plaintiffs’ lawyers and defense lawyers need to watch these developments of the compliance officer as whistleblower closely. I will be watching as well, both as a former compliance officer and for material for a future article.
Monday, November 4, 2013
I support crowdfunded securities offerings, but I have criticized the crowdfunding exemption in the JOBS Act. I won’t repeat those criticisms here, but, after wading through the 585-page SEC rules proposal, I am happy to report that some (but not all) of the proposed rules would significantly improve the exemption.
1. The proposed rules clear up the statutory ambiguities relating to investment limits and the amount of the offering
Title III of the JOBS Act includes a number of ambiguities relating to the investment limits and the amount of the offering. The proposed rules clear up those ambiguities. I have already discussed this aspect of the proposed rules and won’t repeat that discussion here.
2. Both issuers and intermediaries can rely on information provided by investors to determine if the investment limits are met.
The amount that an investor may invest in a crowdfunded offering depends on that investor’s net worth and annual income and also on how much that investor has already invested in section 4(a)(6) offerings in the last 12 months. I have argued that crowdfunding issuers and intermediaries should not be required to verify these numbers--that investors should be able to self-certify.
I am happy to report that the SEC’s proposal recognizes the substantial burden that verification would impose and allows both issuers and crowdfunding intermediaries to rely on the number furnished by investors.
Proposed Rule 303(b)(1) allows crowdfunding intermediaries to rely on an investor’s representations as to net worth, annual income, and previous investments unless the intermediary has reason to question the reliability of the investor’s representations. And Instruction 3 to proposed Rule 100(a)(2) allows the issuer to rely on the intermediary to ensure that investors don’t violate the limits, unless the issuer knows an investor is exceeding the limit.
3. The proposed rules include a “substantial compliance” rule that preserves the exemption in spite of immaterial violations.
The crowdfunding exemption’s requirements are detailed and extensive, and the availability of the exemption is conditioned on the issuer’s and intermediary’s compliance with all of those requirements. Most crowdfunding issuers will be relatively inexperienced small businesses and often won’t have sophisticated securities counsel, so violations are likely. The exemption could be lost due to a relatively minor technical violation of the exemption’s requirements.
The SEC solved this problem in Regulation D by adding a “substantial compliance” rule, Rule 508, that sometimes preserves the Regulation D exemptions even when issuers are not in full compliance.
The SEC has included a similar rule in the proposed crowdfunding rules. Proposed Rule 502 provides that a failure to comply with a requirement of the exemption will not result in loss of the exemption as to a particular investor if the issuer shows:
(1) The failure to comply was insignificant with respect to the offering as a whole;
(2) The issuer made a good faith and reasonable attempt to comply with all of the exemption’s requirements; and
(3) If it was the intermediary who failed to comply, the issuer was unaware of the noncompliance or the noncompliance was solely in offerings other than the issuer’s.
4. The proposed rules require the intermediary to provide communications channels for issuers and investors.
As I have discussed elsewhere, the statutory exemption
omits a crucial element of crowdfunding—an open, public communications channel allowing potential investors to communicate with the issuer and each other. Openness of this sort would allow crowdfunding sites to take advantage of “the wisdom of crowds,” the idea that “even if most of the people within a group are not especially well-informed or rational . . . [the group] can still reach a collectively wise decision.” Open communication channels can help protect investors from both fraud and poor investment decisions by allowing members of the public to share knowledge about particular entrepreneurs, businesses, or investment risks. Open communication channels also allow investors to monitor the enterprise better after the investment is made. [C. Steven Bradford, The New Federal Crowdfunding Exemption: Promise Unfulfilled, 40 SEC. REG. L. J. 195 (2012)]
(For more on why I think open communications channels are a good idea, see here, at pp. 134-136.)
Proposed Rule 303(c) requires crowdfunding platforms to provide “communication channels by which persons can communicate with one another and with representatives of the issuer about offerings made available on the intermediary’s platform.” Those communications channels must be accessible by the general public, although only investors who have opened an account with the crowdfunding platform may post.
Thursday, October 31, 2013
I have argued that, because of excessive regulatory costs, the new crowdfunding exemption in section 4(a)(6) of the Securities Act is unlikely to be as successful as hoped. (Rule 506(c) is another story; I expect that to be wildly successful.)
We now know what the SEC anticipates. Hidden deep within the SEC’s recent crowdfunding rules proposal is the Commission’s own estimate of the likely impact of the new exemption. (It’s on pp. 427-428, in the Paperwork Reduction Act discussion, if you want to look at it yourself.)
How Many Crowdfunded Offerings?
The SEC estimates that there will be 2,300 crowdfunded offerings a year once the new section 4(a)(6) exemption goes into effect, raising an average of $100,000 per offering. That’s a total of $230 million raised each year.
How Many Crowfunding Platforms?
The SEC estimates, “based, in part on current indications of interest” (p. 380) that 110 intermediaries will offer crowdfunding platforms for section 4(a)(6) offerings. Sixty of those will be operated by registered securities brokers and the other fifty will be operated by registered funding portals. (Non-brokers may act as crowdfunding intermediaries only if they register as funding portals.)
The Fight to Survive
If the SEC’s figures are correct, and who really knows, that’s an average of approximately $2 million raised per crowdfunding platform. I would expect many of those 110 platforms to fail rather quickly. Given the regulatory and other costs involved, crowdfunding intermediaries won’t survive for very long on 10-15% of $2 million a year. The SEC doesn’t appear to think so, either. They note (p. 380) that “it is likely that there would be significant competition between existing crowdfunding venues and new entrants that could result in . . . changes in the number and type of intermediaries as the market develops and matures.”
Of course, as the proposal itself indicates, it’s impossible to predict exactly what will happen when the rules become effective. But it’s at least interesting to see the SEC’s own guesses.
Wednesday, October 30, 2013
I have a new article, Retirement Revolution: Unmitigated Risks in the Defined Contribution Society, which describes citizen shareholders--individual investors who enter the stock market through defined contribution plans--and examines the overlapping corporate and ERISA laws that govern their investments.
A revolution in the retirement landscape over the last several decades shifted the predominant savings vehicle from traditional pensions (a defined benefit plan) to self-directed accounts like the 401(k) (a defined contribution plan) and has drastically changed how people invest in the stock market and why. The prevalence of self-directed, defined contribution plans has created our defined contribution society and a new class of investors — the citizen shareholders — who enter private securities market through self-directed retirement plans, invest for long-term savings goals and are predominantly indirect shareholders. With 90 million Americans invested in mutual funds, and nearly 75 million who do so through defined contribution plans, citizen shareholders are the fastest growing group of investors. Yet, citizen shareholders have the least protections despite conventional wisdom that corporate law and ERISA protections safeguard both these investors and their investments. As explained in an earlier paper, citizen shareholders do not fit neatly within the traditional corporate law framework because their investment within a defined contribution plan restricts choice and their indirect ownership status dilutes their information and voting rights, as well as exacerbates their rational apathy as diffuse and disempowered “owners.”
Thursday, October 24, 2013
Now that juries and the DOJ have spoken, will boards be more active in shaping ethical culture in the C-Suite?
CEOs and executives just can’t get a break in the news lately. A jury found both former Countrywide executive Rebecca Mairone and Bank of America liable for fraud for Countrywide’s “Hustle” loans in 2007 and 2008 (see here). Martha Stewart has had to renegotiate her merchandising agreement with JC Penney to avoid hearing what a judge will say about that side deal in the lawsuit brought against her by Macy’s, with whom she purportedly had an exclusive merchandising deal (see here). JP Morgan Chase is in talks to pay $13 billion to settle with the Department of Justice over various compliance-related failures, but the company still faces billions in claims from angry shareholders. The company isn’t out of the woods yet in terms of potential criminal liability (see here). CEO Jamie Dimon isn’t personally accused of any wrongdoing, and in fact has been instrumental in achieving the proposed settlements. But in the past he has faced questions from institutional shareholders about his dual roles as chair of the board and CEO. Those questions may come up again in the 2014 proxy season.
The Bank of America verdict and the recent JP Morgan Chase settlement may herald a new age of prosecutions and settlements both for institutions and executives for compliance failures and criminal activity. With the recent announcement of a $14 million dollar award for an SEC whistleblower coupled with the SEC's pronouncements about getting its "swagger" back, we can expect more legal actions to come as employees feel incentivized to come forward to report wrongdoing.
So what is the role of the board in directing, managing, and shaping corporate culture? In my former life as a compliance officer this issue occupied much of my time. My peers and I scoured the newspapers looking for cautionary tales like the ones I recounted above so that we could remind our internal clients and board members of what could happen if they didn’t follow the laws and our policies.
Bryan Cave partner Scott Killingsworth has written a white paper on the importance of the board in monitoring the C-Suite. He examines the latest research in behavioral ethics citing Lynne Dallas, Lynn Stout, Krista Llewellyn, Maureen Muller-Kahle, Max Bazerman and Francesca Gino, among others. It’s definitely worth a read by board members in light of recent headlines. The abstract is below:
The C-suite is a unique environment peopled with extraordinary individuals and endowed with the potential to achieve enormous good – or, as recent history has vividly shown, to inflict devastating harm. Given that senior executives operate largely beyond the reach of traditional compliance program controls, a board that aspires to true stewardship must embrace a special responsibility to support and monitor ethics and compliance in the C-suite.
By themselves, the forces at large in the C-suite would challenge the ability of even the most conscientious and rational executives to make consistently irreproachable decisions. The C-suite environment is characterized by the presence of power, strong incentives and huge temptations (financial and other), high ambition, extreme pressure, a fast pace, complex problems and few effective external controls. The problem of C-suite ethics has a deeper dimension, though, than the mere impact of strong pressures upon rational decision-makers. Recent behavioral research brings the unwelcome news that the subversive effects of these pressures are magnified by systematic, predictable human failings that can prompt us to slip our moral moorings and overlook when others do so. We are just beginning to understand the insidious power that such factors as motivated blindness, attentional blindness, conflicts of interest, focused "business-only" framing, time pressure, irrational avoidance of loss, escalating commitment, overconfidence and in-group dynamics can exert below the plane of conscious thought, even over people who have good reason to consider themselves ethically strong. and behaviorally upright.
But we also know that organizational culture can
dramatically affect both ethical conduct and reporting of misconduct, by
establishing workplace norms, harnessing social identity and group loyalty and
increasing the salience of ethical values. How can these learnings inform the
board’s interaction with, and monitoring of, the C-suite? And how can the board
help forge a stronger connection between the C-Suite and the organization’s
compliance and ethics program? This paper suggests several key strategies for
dealing with different aspects of this complex problem.
Saturday, October 19, 2013
Stephen Davidoff recently posted a piece on DealBook entitled “A Push to End Securities Fraud Lawsuits Gains Momentum,” in which he notes that “Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “’fraud on the market.’” He goes on to provide a lot of interesting additional details, so you should definitely go read the whole thing, but I focused on the following:
In its argument, Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “fraud on the market.” The doctrine has its origins in the 1986 Supreme Court case Basic v. Levinson. To state a claim for securities fraud, a shareholder must show “reliance,” meaning that the shareholder acted in some way based on the fraudulent conduct of the company. In the Basic case, the Supreme Court held that “eyeball” reliance — a requirement that a shareholder read the actual documents and relied on those statements before buying or selling shares — wasn’t necessary. Instead, the court adopted a presumption, based on the efficient market hypothesis, that all publicly available information about a company is incorporated into its stock price…. A group of former commissioners at the Securities and Exchange Commission and law professors represented by the New York law firm Wachtell, Lipton, Rosen & Katz have also taken up the cause. In an amicus brief, the group argues that, in practice, the Basic case has effectively ended the reliance requirement intended by the statute, something that is not justified. They rely on a forthcoming law review article by an influential professor, Joseph A. Grundfest of Stanford Law School. Professor Grundfest argues that the statute on which most securities fraud is based — Section 10(b) of the Exchange Act — was intended by Congress to mean actual reliance because the statute is similar to another one in the Exchange Act that does specifically state such reliance is required.
This got me to thinking about how I might introduce the fraud-on-the-market reliance presumption to students the next time I teach it. This is what I came up with as a possibility:
Assume you know that a particular weather app is 100% accurate. Assume also that you know all your neighbors check the app regularly. If in deciding whether you need an umbrella you simply look out your window to see whether any of your neighbors are carrying one, rather than checking the weather app, are you not still actually relying on the weather app? The fraud-on-the-market presumption of reliance effectively answers that question in the affirmative. In the securities context it provides that instead of reviewing all publicly available disclosures when deciding to buy or sell securities, it is enough for you to simply “look out your window” at the market price because we assume the market price reflects the consensus equilibrium of all publicly available information.
One might protest that the plaintiff should still have to prove that all the neighbors are in fact checking the weather app, and this is in fact the case when we require plaintiffs seeking the benefits of the FOM presumption to prove the relevant market is efficient. Alternatively, one might protest that the idea that the actions of your neighbors reflect well-enough the information provided by the weather app is questionable, but since Eugene Fama just won the Nobel prize in economics it might be an uphill battle to overturn the presumption on that basis. Another objection might be that we don’t need the presumption because there are enough alternative mechanisms to hold corporate actors accountable for fraud, and it is certainly the case that when the Supreme Court adopted the FOM presumption, a large part of the rationale was the perception that there was a need for the presumption in order to facilitate actions that would otherwise never be brought in any form. What I see as a possible obstacle to this approach is that, while one may debate whether the Roberts Court is in fact pro-business, I do believe it is concerned about appearing overly so – and authoring a decision that states we no longer need the FOM presumption because alternative corporate accountability mechanisms are working so efficiently strikes me as just throwing fuel on that fire when the Court could arguably reach the same result by continuing to tighten up class-action law generally. Finally, one might object that the FOM presumption actually allows folks who just run out of the house without either checking the app or looking out their window to claim the presumption, but at least a partial answer to this objection is that the Basic decision itself provides that: “Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance,” Basic Inc. v. Levinson, 485 U.S. 224, 248 (1988), and this is typically understood to at least include plaintiffs who are, to continue the analogy, rushing out of the house because they don’t have time to grab an umbrella.
Obviously, the issues are ultimately more complicated than the foregoing suggests, but it is just intended to serve as an introduction, which can be expanded to account for more complicated matters as the discussion proceeds. I’d be curious to hear what readers think needs to be added/amended to make this introduction work.
Wednesday, October 16, 2013
The 2013 Nobel Prize in Economics winners were announced earlier this week and the award was shared by three U.S. Economists for their work on asset pricing. Eugene Fama of the University of Chicago, Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University share this year’s prize for their separate contributions in economics research.
The work of the three economics is summarized very elegantly in the summary publication produced by The Royal Swedish Academy of Sciences titled “Trendspotting in asset markets”. The combined economic contribution of the three researchers is described below:
The behavior of asset prices is essential for many important decisions, not only for professional investors but also for most people in their daily life. The choice on how to save – in the form of cash, bank deposits or stocks, or perhaps a single-family house – depends on what one thinks of the risks and returns associated with these different forms of saving. Asset prices are also of fundamental importance for the macroeconomy, as they provide crucial information for key economic decisions regarding consumption and investments in physical capital, such as buildings and machinery. While asset prices often seem to reflect fundamental values quite well, history provides striking examples to the contrary, in events commonly labeled as bubbles and crashes. Mispricing of assets may contribute to financial crises and, as the recent global recession illustrates, such crises can damage the overall economy. Today, the field of empirical asset pricing is one of the largest and most active subfields in economics.
This year’s award has several implications for those of us interested in the legal side of law and economics. First, Fama is the grandfather of the efficient capital market hypothesis, the foundation for fraud on the market, a economics elements incorporated into securities fraud litigation.
Second, Fama’s inclusion in the award is being heralded by some as a win, or vote of confidence, for free marketers whose regulatory view (that markets should be largely unregulated) rests on the fundamental assumption that markets are efficient. On the other hand, Shiller’s inclusion in the award challenges the coup that can be claimed by free marketers because Shiller has long questioned the efficiency of the markets. John Cassidy at The New Yorker writes “Shiller, in showing that the stock market bounced up and down a lot more than could be justified on the basis of economic fundamentals such as earnings and dividends, kept alive the more skeptical and realistic view of finance that Keynes had embodied in his “beauty contest” theory of investing.” Market efficiency, or lack thereof, are key arguments against and for market regulations. Trends in support for either theory or validation of one could signal future approaches to regulation.
Finally, the focus on asset pricing, particularly Fama’s work has some potential implications for the mutual fund industry. Fama’s efficiency view of the markets largely discounts the value of actively managed funds, once costs and annual fees are deducted because the market, if efficient, cannot consistently be beaten. This last thread regarding fund management is a theme woven into some of my more recent research on the regulations, risks, and ownership anomalies facing retirement investors. More on this later, with links to newly published papers of course, but for now read the Nobel summary document included above and briefly contemplate taking the time to audit an economics course next semester—I am going to browse the b-school catalogue now.
Monday, October 14, 2013
The JOBS Act offers two new opportunities to offer securities on the Internet without Securities Act registration. Both the Rule 506(c) exemption and the new crowdfunding exemption could be used to sell securities on web sites open to the general public. But could a single web site offer securities pursuant to both exemptions at the same time (assuming the SEC eventually proposes and adopts the regulations required to implement the crowdfunding exemption)?
Background: The two exemptions
Rule 506(c) allows an issuer to publicly advertise a securities offering, as long as the securities are only sold to accredited investors. Rule 506(c) is not limited to Internet offerings, but it could be used by an issuer to advertise an offering on an Internet site open to the general public—as long as actual sales are limited to accredited investors.
The new crowdfunding exemption, added as section 4(a)(6) of the Securities Act, allows issuers to sell up to $1 million of securities each year. The offering may be on a public Internet site, as long as that site is operated by a registered securities broker or a “funding portal,” a new category of regulated entity created by the JOBS Act.
Could a single intermediary do both 506(c) and crowdfunded offerings?
Yes, but only if the intermediary is a federally registered securities broker.
Rule 506(c) does not limit who may act as an intermediary, but the crowdfunding exemption says that only registered brokers or funding portals may host crowdfunded offerings. By definition, funding portals appear to be limited to offerings under the crowdfunding exemption. A funding portal is “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to section 4(6).” Exchange Act section 3(a)(80), as amended by the JOBS Act. Thus, funding portals could not act as intermediaries in Rule 506(c) offerings.
The JOBS Act does not impose a similar limitation on brokers, so brokers could act as intermediaries in both Rule 506(c) and crowdfunded offerings.
Could a broker include both types of offerings on the same web site?
The answer to this is probably yes.
Rule 506(c) does not limit the content of the web site, so any limitations are going to come from the crowdfunding exemption. Crowdfunding intermediaries are subject to a number of requirements, but the crowdfunding exemption does not appear to prohibit the inclusion of other offerings on the same web site.
Operating a dual site could be cumbersome. For example, Rule 506(c) offerings could appear on the site's main page, but no investor may see crowdfunded offerings until they satisfy the crowdfunding exemption’s investor education requirements. But unless the SEC rules implementing the crowdfunding exemption prohibit it, dual-exemption sites should be possible.
Could an issuer do a double-door offering, using a single web site to simultaneously sell the same securities in both types of offerings?
I have heard that some ill-advised fledgling intermediaries have plans to do this, but the answer to this question is no. The integration doctrine would not allow it.
Rule 506(c) incorporates the requirements of Rule 502(a) of Regulation D, and Rule 502(a) indicates that “[a]ll sales that are part of the same Regulation D offering must meet all of the terms and conditions of Regulation D.” Section 4(a)(6) of the Securities Act, the crowdfunding exemption, exempts “transactions” that meet the criteria of the exemption.
Under that transactional language, as consistently interpreted by the SEC and the courts over the years, the entire offering must comply with the requirements of the exemption, or none of the sales is exempted. An issuer cannot sell parts of a single offering pursuant to two separate exemptions.
Unless an integration safe harbor is available, and none would apply here, the SEC uses a five-factor test to determine whether ostensibly separate offerings are part of the same transaction. This test considers (1) whether the sales are part of a single plan of financing; (2) whether the sales involve issuance of the same class of securities; (3) whether the sales are made at or about the same time; (4) whether the issuer receives the same type of consideration; and (5) whether the sales are made for the same general purpose.
Under this test, an issuer could not sell a security pursuant to the Rule 506(c) exemption and at the same time sell the same security on the same web site pursuant to the crowdfunding exemption. Those two ostensibly separate offerings would be integrated and would have to fit within a single exemption. (There is vague language in the crowdfunding exemption that might arguably protect against integration, but the argument is a weak one. For a discussion of that argument see pp. 213-214 of my article here.)
Thursday, October 10, 2013
US Chamber of Commerce Event on the State of Corporate Governance and the 2014 Proxy Season-October 16
On October 16th, the US Chamber of Commerce’s Center for Capital Markets Competitiveness will host a half-day event to examine trends from the 2013 proxy season and look ahead to 2014. The day will start with a presentation from the Manhattan Institute about the 2013 season and then I will be on a panel with Tony Horan, the Corporate Secretary of JP Morgan Chase, Vineeta Anand from the Office of Investment of the AFL-CIO, and Darla Stuckey of the Society of Corporate Secretaries and Governance Professionals. Our panel will look back at the 2013 proxy season and discuss hot topics in corporate governance in general. Later in the day, Harvey Pitt and other panelists will talk about future trends and reform proposals, and depending on the state of the government shutdown, we expect a member of Congress to be the keynote speaker. The event will be webcast for those who cannot make it to DC. Click here to register.
Dodd-Frank requires the SEC to issue rules barring national exchanges from listing any company that has not implemented a clawback policy that does not include recoupment of incentive-based compensation for current and former executives for a three-year period. Unlike the Sarbanes-Oxley clawback rule, Dodd-Frank requires companies to recover compensation, including options, based on materially inaccurate financial information, regardless of misconduct or fault.
Although the SEC has not yet issued rules on this provision, a number of companies have already disclosed their clawback policies, likely because proxy advisory firms Glass Lewis and Institutional Shareholder Services have taken clawback policies into consideration when making Say on Pay voting recommendations. Equilar has reviewed the proxy statements for Fortune 100 companies filed in calendar year 2013 for compensation events for fiscal year 2012. The organization released a report summarizing its findings, which are instructive.
Of the 94 publicly-traded companies analyzed by Equilar, 89.4% publicly disclosed their policies; 71.8% included provisions that contained both financial restatement and ethical misconduct triggers; 29.1% included non-compete violations as triggers and 27.2% had other forms of triggers. 68% of the policies applied to key executives and employees including named executive officers, while only 14.6% applied to all employees. 7.8% of clawback policies applied only to CEOs and/or CFOs. 35.9% of policies covered a range of compensation types including deferred compensation, sales commissions, flexible perquisite accounts and/or supplemental retirement plans.
The Equilar report provides language and links to the filings for Wal-Mart, Ignite Restaurant Group, CVS Caremark, Johnson & Johnson, AIG, Supervalu, Apple, IBM, Johnson Controls and ConocoPhilips. The report also notes that despite the early disclosures, they tend to fall short of the Dodd-Frank standard in that only 37.9% mention outstanding options. This will surely change once the SEC finalizes the rule.
Saturday, October 5, 2013
Michael B. Dorff has posted “The Siren Call of Equity Crowdfunding” on SSRN. Here is the abstract:
The JOBS Act opened a new frontier in start-up financing, for the first time allowing small companies to sell stock the way Kickstarter and RocketHub have raised donations: on the web, without registration. President Obama promised this novel form of crowdfunding would generate jobs from small businesses while simultaneously opening up exciting new investment opportunities to the middle class. While the new exemption has its critics, their concern has largely been confined to the limited amount of disclosure issuers must provide. They worry that investors will lack the information they need to separate out the Facebooks from the frauds. This is the wrong concern. The problem with equity crowdfunding is not the extent of disclosure. The problem is that the companies that participate will be terrible prospects. As a result, crowdfunding investors are virtually certain to lose their money. This essay examines the data on angel investing – the closest analogue to equity crowdfunding – and concludes that the majority of the issuers that sell stock to the middle class over the internet will lose money for investors, with many failing entirely. The strategies that help the best angels profit will not be available to crowdfunders. Plus, the losses most issuers inflict will not be offset by a few huge winners. Investors will not find tomorrow’s Googles on crowdfunding portals because they will not be there; instead, start-ups with real potential will continue to use other programs, such as the newly expanded Rule 506 exemption. This outcome is the inevitable result of the nature of start-up investing and crowdfunding. No amendments to the Act or rule-making by the SEC can prevent it. The only solution that will protect investors is to abolish equity crowdfunding for the unaccredited.