Thursday, June 30, 2011

Corporate Policies Regarding Employees’ Social Media Activities

All companies need to have employee handbooks containing corporate policies, such as anti-discrimination policy, vacation/sick leave policy and others. Recently, employers started amending their employee handbooks to include a new policy: that governing the employees’ use of the Internet during work.

Concerns that gave rise to such policies include:

- Can employees spend time on the Internet during business hours?
- Can the company regulate what employees say about it online?
- Is there a danger that employees’ postings/blogs will be attributed to the company?
- Is there a risk that the employees disclose company confidential information through the social media?

In my opinion (and feel free to disagree) is that every company needs to set clear boundaries regarding its employees’ use of the Internet for personal purposes during business hours. However, this policy should not be too restrictive. Much of marketing is done nowadays online, through Facebook, twitter, and other social media sites. Preventing employees from going on these sites during work can take away a great marketing tool, if such (satisfied) employees have positive things to say about their employers and the products/services they offer. What a better marketing tool than let the employees “spread the word” through their informal social networks!

So, regulation rather than restriction, seems to be what is needed. For example, the social media policy can include these guidelines:

- Start with the warning that any violation of these rules can result in termination of employment;
- Say that employees may not post knowingly false information about the company, its employees and customers;
- Ask employees to limit use of the Internet during business hours to essentially business purposes (but employers need to understand that even blocked sites can be accessed by employees during business hours through their personal smart phones);
- Ask employees to put disclaimers on their personal blogs that views they express there are their own;
- Prohibit (here I use the strong word) any disclosure of proprietary confidential information of the employer;
- Say that employees cannot put anything on the Internet that would disparage, embarrass, insult, harass any of the other employees or damage the reputation of the company, its products or its customers.
- On the other hand, encourage employees to write about the company in the social media in a way that would benefit the company. This is a great way to fortify your brand and increase your company’s visibility.

Please keep in mind that views expressed here are my own personal views and do not constitute legal or any other advice. Each company is different, and should follow its own view on how its employees can/should use the Internet during business hours.

Thursday, June 23, 2011

Legal Aspects of Crowdfunding

Today, I would like to discuss regulatory aspects of crowdfunding. There are several proposals now that aim to change existing regulation to provide small businesses with easier access to capital markets.

One such proposal comes from the Sustainable Economies Law Center (SELC). In July 2010, SELC proposed to the SEC to exempt from registration requirements of Section 5 of the Securities Act securities offerings up to $100,000 in total amount raised with a $100 maximum investment limit per investor. Investors can be only individuals and must be either U.S. citizens or permanent residents. Investors cannot participate in multiple offerings at the same time. Petition is available at

In my opinion, the SELC proposal is not practical in limiting investment amount to only $100 per investor. A $10,000 limit is much more reasonable, and if lost, would unlikely lead to investor’s bankruptcy. Also, the rationale for limiting investors only to one offering at a time is unclear. After all, if they are choosing to participate in risky investments, then they have to be prepared to bear the risks (especially, if the investments are limited to $100).

Another proposal is called the “Startup Exemption”. The petition (that presently has 1,803 signatories) is based on an idea by a group of entrepreneurs led by Sherwood Neiss. It calls for creating a “funding window” to raise up to $1 million over the life of a business, to be used by small businesses with less than $5 million in revenues during the last three years. Each individual investment would be limited to a maximum of $10,000. Investors would be required to fill out a questionnaire demonstrating their willingness to accept risks related to the investment. The Startup Exemption also proposes to eliminate the 500-shareholder rule limitation and the broker-dealer licensing requirements and preempt state regulation of such offerings similarly to Rule 506. Finally, the petition calls to repeal the ban on general solicitation if the offering is conducted through one of registered platforms, where like on crowdfunding sites, ideas can be vetted, discussed, and peer reviewed. Such platforms would then report to the SEC regarding their customers and offerings. More information is available at

This seems to be a better proposal as it addresses important issues like state regulation, the 500 shareholder rule, and proposes a more reasonable $10,000 per investment limit. Also, reporting requirements by registered platforms that would be reviewed by the SEC, as well as review of companies and offerings by peers, provide some investor protection and transparency.

I identify two paramount issues in all the discussions about the need for new exemptions. First, there is an acute need to protect investors from scams and fraud that may be directed at them once/if general solicitation on the Internet is allowed. It seems inevitable that at some point in the future the SEC will relax the ban on solicitation and advertising given the proliferation of social media and the current state of technological progress. However, this also may open a floodgate of fraudulent offerings and schemes, and the SEC needs to put safeguards in place before it relaxes rules relating to solicitation and advertising.

Second, one of the main complaints regarding the current private placement exemptions is the onerous state regulation of private offerings. The only private offerings that are preempted from state regulation by the National Securities Markets Improvement Act of 1996 (the “1996 Act”) are the Rule 506 offerings. State regulation is based on the number of investors in each state. So, a private offering of securities to investors from ten or so states may fall under regulation of all ten states, thus leading to high legal fees which may make a small offering cost-prohibitive. There is a need to expand the reaching of the 1996 Act to other Regulation D offerings (Rule 504 and 505 offerings) as well as other private placement exemptions.

In the April 6, 2011 26-page long letter to the Chairman of the Committee on Oversight and Government Reform, Mary Shapiro, the Chairman of the SEC, expressed the understanding and the urgency for legal reform to enable small company investing. The SEC is currently reviewing the impact of the regulations on capital formation for small business, with the focus on (i) restrictions on communications in IPOs, (ii) adequacy of a ban on solicitation and advertising in light of current technologies and capital-raising trends, (iii) the 500 shareholder trigger for public reporting, and (iv) the questions presented by new capital raising strategies. The SEC staff is familiar with crowdfunding and the desire by many startups to use it to conduct securities offerings (i.e., offer equity or profit sharing or another arrangement to investors).

So, stay tuned, as the Congress and the SEC address issues relating to capital formation of small businesses.

Friday, June 10, 2011

Rules are Still Rules: Even with Novel Crowdfunding Approaches, the Current SEC Rules Have to be Respected

On June 8, 2011, the SEC entered a cease and desist order against two individuals, Michael Migliozzi II and Brian William Flatow, who launched a crowdfunding campaign at their website to raise $300 million to buy Pabst Brewing Company. Migliozzi and Flatow solicitated investors through Facebook and Twitter and actually received $200 million worth of pledges. The offering never closed because it did not reach the $300 million funding goal and because of the SEC action. The site was shut down in April 2011. The SEC press release is copied below.

Cases like this inevitably bring negative publicity to crowdfunding. The first question that comes to mind is whether these individuals ever consulted a securities attorney prior to starting their venture. There is a plethora of resources now available on the Internet (including this blog) that continuously discuss the issues relating to compliance with the securities laws and the SEC regulations. Unless a securities offering qualifies for one of the available exemptions, it must be registered with the SEC, regardless of whether this is an Internet offering and whether it comes under the aegis of a fashionable trend called “crowdfunding.”

My second reaction to this case was the astonishment with the amount of money that these individuals were able to raise (in pledges). Many seasoned companies have trouble raising a lot less. But in their case, there was not even a company, - just two people with an idea to buy a beer company. Was their “success” due clever online marketing and reaching out to the potential investors through their social networks? This approach, propagated by crowdfunding, seems to work. However, one still needs to balance the need to raise money with the necessity to remain compliant with the securities laws directed at protecting investors from fraud, deception and monetary loss.

SEC Enters Cease and Desist Order in Connection with Online Campaign to Buy Beer Company
Washington, D.C., June 8, 2011 — The Securities and Exchange Commission today announced a settlement with two advertising executives who launched a campaign to buy a beer company through a solicitation of investors on Facebook and Twitter without first registering with securities regulators and making the necessary disclosures.
Additional Materials
Administrative Proceeding
Michael Migliozzi II and Brian William Flatow consented to a cease and desist order after directing investors to their website,, and soliciting pledges for a hoped-for $300 million purchase of the Pabst Brewing Company.

Under federal securities laws, the two men were required to register their offering before seeking to sell shares to the public. The registration requirements include publicly disclosing a company's financial condition and other information that could help investors determine whether to invest.

"All investors are entitled to know certain basic information about a company before being asked to invest," said Scott Friestad, Associate Director in the SEC's Division of Enforcement. "Just because would-be investors are being solicited online doesn't make them less deserving of the protections under our securities laws."
The SEC's order found that Migliozzi and Flatow intended to solicit funds in two stages. In the first stage, the two sought pledges and required that pledgors only supply an e-mail address, first name, last name, and pledge amount. If they received $300 million in pledges, the second stage would consist of collecting the pledges and undertaking to purchase Pabst.

According to the order, Migliozzi and Flatow also created a Facebook page and Twitter account in order to advertise their offering. Would-be investors visiting the website were told that each investor would receive a certificate of ownership as well as beer of a value equal to the amount invested.

The order further states that in February 2010, the two men said they had received more than $200 million in pledges from more than five million pledgors, and that Migliozzi and Flatow were searching for a firm to assist in the acquisition. The website, which the two men launched in November 2009, continued to solicit pledges until it was taken down in April 2010.

In the end, the two never received the $300 million in pledges, and never collected any money.

The SEC's order finds that Migliozzi and Flatow violated Section 5(c) of the Securities Act of 1933. As a result, it directs Migliozzi and Flatow to cease and desist from committing or causing any violations and from committing or causing any future violations of Section 5(c) of the Securities Act. Migliozzi and Flatow consented to the issuance of the order without admitting or denying any of the findings in the order except jurisdiction, which they admitted.

While federal laws require the registration of solicitations or "offerings," some offerings are exempt. Some of the most common exemptions from the registration requirements include private offerings to a limited number of accredited investors or institutions, as well as offerings of limited size. For information about the securities registration process and the types of information to be disclosed in offering documents, see the SEC's online publication Registration Under the Securities Act of 1933.

# # #
For more information about this enforcement action, contact:
Scott W. Friestad
Associate Director, SEC Division of Enforcement
(202) 551-4962
Nina B. Finston
Assistant Director, SEC Division of Enforcement
(202) 551-4961

Friday, June 3, 2011

Small Company Capital Formation Act of 2011 – Much Needed but At What Cost?

There is a new bill in the House that aims to facilitate capital raising by private companies (H.R. 1070). The bill was introduced in March 2011 by Representative David Schweiker and is currently being considered by the House Committee on Financial Services.

The bill proposes to amend Section 3(b) of the Securities Act of 1933. Section 3(b) of the Act authorized the Securities and Exchange Commission (the “SEC”) to create Regulation A, an exemption for private companies to conduct public offerings of their securities in the amount not exceeding $5 million in a 12-month period. Companies relying on Regulation A need to file an offering statement with the SEC and get it approved. The securities are offered publicly, are not “restricted” (i.e., freely tradable), and solicitation and advertising (“testing the waters”) is allowed. Advantages of Regulation A (as opposed to the full-blown registration) include the following: simplified financial statements, which need not be audited, there are no Exchange Act reporting obligations after the offering is concluded unless the company has more than $10 million in total assets and more than 500 shareholders, and companies may file a simplified version of the offering statement. Disadvantages are: that the Regulation A offering is still very expensive in terms of legal and accounting costs, and such offerings are not exempt from state “blue sky” laws.

The new bill H.R. 1070 proposes to introduce an additional exemption under Section 3(b), allowing companies to raise between $5 million and $50 million. Similarly to the existing exemption for offerings under $5 million, the securities could be offered and sold publicly and would not be considered “restricted”. “Testing the waters” would be permitted. Companies would need to file with the SEC an offering statement. However, companies raising up to $50 million would be required to file audited financial statements with the SEC. The SEC could also require the company issuing such securities to make periodic disclosures available to the investors. According to the May 2nd amendment of the bill, such securities would not be exempt from state regulation unless offered through brokers and dealers.

The requirements for audited financial statements and the possibility of ongoing periodic disclosures make the exemption look more like an initial public offering. Continued state regulation may render it unpopular due to high compliance costs, just like the Regulation A offerings. But it is too early to judge, as the bill may be amended substantially before being voted on by both the House and the Senate.

Generally, if a bill is reported favorably by a committee to the House, it will be considered by the full House and then move to being considered in the Senate. However, most bills are never considered by the committees, and thus never move forward. Since its introduction in March 2011, bill H.R. 1070 was already reviewed by a subcommittee of the Committee on Financial Services and on May 4 was forwarded to the full Committee for consideration. Although only at the initial step in the legislative process, it already has 17 cosponsors (2 Democrats and 15 Republicans). It appears to be on the “fast track”, as the lack of access to capital is seen by many as a major impediment to growth in the U.S. economy.