Sunday, December 23, 2012

FTC’s Report on Privacy Concerns in Kids Apps

On December 10, 2012, the Federal Trade Commission (the “FTC”) issued its second annual report examining the disclosures and information collection practices in kids’ apps. The FTC Staff aimed to determine whether the parents were able to make informed decisions about whether or not to download an app for their kids based on the privacy collection practices used by the app. The short answer is that for the most part, presently parents cannot make such informed decisions. The FTC Staff examined 400 kids’ apps from the Apple and Google Play app stores. The results were alarming. In particular, the survey found that:
  • Only 20% of the apps reviewed disclosed any information about the apps’ privacy practices;
  • Almost 60% of the apps transmitted ID number from the user’s device back to the developers, or more commonly, an advertising network, an analytics company or another party (and 14 of those apps also transmitted geolocation and/or phone number);
  • A small number of third parties receive information from many apps, which means that they can potentially develop children’s profiles based on their behavior in different apps;
  • 58% of apps contained interactive features, such as links to social media or advertising, without first disclosing it to the parents (58% of the apps contained advertising within the app, but only 15% disclosed it to the parents prior to the download; 22% of the apps contained links to social media, but only 9% disclosed this fact prior to the download; 17% of the apps provided ability for kids to purchase virtual goods for $0.99 to $29.99). 
COPPA’s purpose is to safeguard personally identifiable information of children under the age of 13. According to the Act, if apps developers collect, use and/or disclose personal information of children under the age of 13, they must (1) disclose a privacy policy; (2) provide notice to parents about their information collection practices and, with some exceptions, get verifiable parental consent before collecting personal information from children; (3) give parents the choice to consent to the collection and use of a child’s personal information; (4) not condition a child’s participation in the app on the disclosure of more personal information than is reasonably necessary for the activity; and (5) maintain the confidentiality, security and integrity of the personal information collected from children.

The survey makes it clear that the FTC should significantly step up its enforcement efforts against those apps developers that fail to comply with COPPA. In fact, the survey announced that the FTC is launching multiple investigations to determine whether certain apps developers have violated COPPA or engaged in unfair or deceptive trade practices in violation of the FTC Act. Further, the survey shows that COPPA and the current regulations related to COPPA need to be amended soon. The currently proposed amendments seek to expand the definition of personally identifiable information that may be collected from children only upon disclosure and parental consent. The proposed definition includes photos, voice recordings, unique mobile device serial numbers, as well as the geolocation of the mobile device, - information that was not considered as personally identifiable or not considered at all back in 1998, when COPPA was adopted.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Thursday, December 20, 2012

LLCs: do you always need to add the word “LLC” to your company name?


When filing the articles of organization for a limited liability company, the company owners are required to add to the company’s name words such as “LLC”, “L.L.C.” or a “Limited Liability Company”. Often, for marketing purposes, these words are omitted when the company name appears in advertisements, on the business cards or on the website.

Omitting the word “LLC” or its equivalent from a limited liability company’s name may have unintended consequences for the company’s members and managers. If it is not clear that there is a company with limited liability, courts may find that the members have entered into a transaction in individual capacity, and not on behalf of their company. This may result in personal liability for the members and/or managers.

It is advisable to keep the word “LLC” at the end of a limited liability company’s name even on business cards, in advertising or on the website because the word “LLC” indicates the existence of a corporate entity that provides limited liability protection to its members. Additionally, when entering into contracts, members or managers need to sign on behalf of the company as agents for the company and not as individuals.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Monday, December 17, 2012

What is Attorney-Client Privilege and How Does It Apply to Start-Ups?

Attorney-client privilege applies to communications between clients and their attorneys and is believed to be the oldest protection of confidential information in the Anglo-Saxon law. The purpose of this privilege is to encourage the client to talk frankly with his or her attorney, so that the attorney can offer the best legal advice. But, as typical in the law, there are limitations and exceptions. Let’s consider when communications between attorneys and their start-up clients are confidential and when they are not.

During the company formation process, it is important to be clear from the outset who the client is: the individual founder(s) or the company that is being formed. Attorney-client privilege can apply when the client is a company. In such cases, the corporate attorney-client privilege protects the corporation, not its individual owners/employees. Communication between the attorney and the employees, officers or directors of the company is protected so long as such communication (i) was made at the direction of the corporate officials, (ii) the matters discussed were within the employee’s duties and were not available from the upper level employees, (iii) the purpose of the inquiry was to obtain legal advice, and (iv) the communication was intended to be kept confidential. Since corporate attorney-client privilege does not protect the individuals, employees should be careful in communicating with the company counsel if disclosure of certain information may expose them to personal liability.

So, when hiring a lawyer to form a company, make sure that the engagement letter is between the attorney and the company, not the individual founders. Also, it is helpful to add a paragraph to the engagement letter listing the individual employees who are authorized to communicate with the attorney and give him / her instructions.

Representing the company and an individual founder at the same time may present a conflict of interest, especially if the board of directors of the company later decides to fire the founder. It is advisable for each of the founders to hire their own attorney when negotiating the ownership structure and the operating or the shareholders agreement. Since this can get very expensive, typically founders hire one attorney who serves as the company lawyer during the formation process.

Note that attorney-client privilege only applies to legal and not to business or other type of advice. So, when the attorney is acting primarily as a member of the board of directors of the company or as a human resources manager rather than as an attorney, the privilege does not apply. The privilege protects the communication, not the underlying factual information. Also, there is no protection for any communication made in furtherance of a crime or an illegal act. Finally, the attorney-client privilege may be waived if the communications are shared with other parties (for example, when the founder copies others on the email to the corporate counsel or invites others who are not employees, officers or directors to participate at a meeting with the company’s counsel).

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Monday, December 10, 2012

Leaving Your Current Employer to Start Your Own Company

Earlier this year, I presented a seminar at the Small Business Expo in New York on the top ten mistakes commonly made by start-up founders. Mistake #3 on my list was not paying enough attention to the issues that arise when an entrepreneur starts working on a start-up while still being employed somewhere else. Since these issues continue to come up in my practice frequently, I decided to summarize them in this blog post.

In short, in the absence of an agreement with your employer that contains restrictive covenants (such as non-compete, non-solicit, invention assignment, confidentiality), much depends on two factors: (1) whether the entrepreneur intends to start a competing or a non-competing venture and (2) the entrepreneur’s position with the company. Key employees (such as managers, company officers, directors, group leaders) owe fiduciary duty to the company and its stockholders (see my earlier posts about fiduciary duties: duty of care and duty of loyalty). The duty of loyalty prevents them from taking the company’s opportunities, competing with the company, and soliciting its employees. They have to always act in the best interests of the company and cannot deliberately harm it. So, starting a competing business while still in the company’s employment is out of question. It is likely that skilled employees (such as software engineers or other kind of specialists) owe similar duties. On the other hand, the unskilled employees’ duties to the company are limited to the time when they are actually working. Their off-hours activities are not restricted unless of course their activities are detrimental to the company.

Further, employees (regardless of their position with the company) cannot misappropriate the company’s trade secrets and disclose or use the company’s confidential information during and after the employment. This applies even when there is no confidentiality agreement in place. According to the Uniform Trade Secrets Act, a trade secret is information that has economic value, is not easily ascertainable (means that the information cannot be obtained legally, for example, by searching for it online) and is subject to reasonable efforts to maintain its secrecy.

Finally, even when there is no written invention assignment agreement with the employer, according to the copyright law, all copyrightable material created by an employee for the employer within the scope of employment is deemed to be “work made for hire” and is owned by the employer. So, it is likely that an employee who is writing software code for his new competing venture during regular work hours on the company’s computer at the company’s office does not own the intellectual property rights to it. Some states have limited the application of invention assignments. For example, California’s law limits the employer’s claim on the inventions made during the employee’s own time, not using company equipment and if the invention does not relate to the business of the company and does not result from work for the company.

In addition to these duties and restrictions, employers often ask the employees to sign confidentiality and invention assignment agreements. Typical restrictive covenants found in such agreements are a covenant not to compete and a covenant not to solicit the company’s employees and customers. There may also be a no-moonlighting clause (no outside activities) and a covenant prohibiting any disparaging statements about the company and its customers. Again, several states, such as California, limit the validity of such restrictive covenants.

In conclusion, my general advice for the entrepreneurs who have started working on their new venture while still being employed elsewhere is to (1) review all signed agreements with their present employer; (2) not compete with the employer, (3) not use the employer’s confidential information; (4) avoid working on the new venture during business hours, on the employer’s premises and using employer’s equipment; and (5) if possible (and this depends on the particular circumstances), disclose the new venture to the employer and negotiate the applicability of restrictive covenants, if any. Who knows, the employer may become the new venture’s first investor.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Sunday, December 9, 2012

Examining Duty of Care of Corporate Directors

In addition to the duty of loyalty that corporate directors owe to the corporation and its shareholders, the directors also owe the duty of care.  As I mentioned in my earlier post, the duties of loyalty and care are the so called “fiduciary duties”.  Judges will respect the decisions of the directors (even if they turned out to be wrong) if the directors acted on an informed basis, in good faith and in the best interests of the corporation. This is called the "business judgment rule". Pursuant to it, courts will not question the directors’ decisions unless they have breached their fiduciary duties: a duty of loyalty or a duty of care.

Duty of care can be summarized as requiring the directors to make informed decisions and consider carefully all of the available information before arriving at a decision. This seems like an obvious thing to do, but you would be surprised to learn how often this requirement is disregarded. In particular, directors should:
  • Obtain all relevant information 
  • Have sufficient time to consider such information 
  • Hire experts if necessary (accountants, lawyers, financial experts) 
  • Understand the terms of the proposed transactions, understand the corporation’s finances and closely monitor the performance of executive officers 
  • Institute and supervise a set of policies that would ensure the corporation’s compliance with applicable laws and regulations. 
Typically, directors will not be found liable if they simply failed to follow the best practices. Courts will find a breach of fiduciary duty of care only in cases where directors engage in gross negligence or act with reckless disregard for the shareholders’ interests.

For example, in Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), the court found that the directors breached their duty of care because (1) they did not know prior to the board meeting that there was a pending merger and that the deadline was the next day, (2) they approved the merger in a 2-hour meeting without even reviewing the merger agreement or questioning the purchase price, (3) they relied on the CEO’s oral report without questioning the CEO’s role in bringing the merger about and did not know that he had suggested the purchase price to the buyer. In another case, In re Abbott Labs Derivative Shareholders Litigation, the court found that the directors breached their duty of care because the FDA repeatedly over a period of six years served safety violations notices to the corporation, the directors knew about this, and took no steps to ensure that the corporation changed its practices.

Directors are not the only persons with fiduciary duties. Executive officers also owe fiduciary duties to the corporation and its shareholders. Additionally, controlling shareholders owe the duty of loyalty to the minority shareholders. The activities (such as a vote) by the controlling shareholders will be respected by the Delaware courts as long as their activities had a rational business aim and the controlling shareholders were not involved in “self-dealing”.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Saturday, December 1, 2012

Which Instruments are Included in a Commodity Pool?


It is challenging times now for those investment managers who have recently launched hedge funds. It is due to the change in regulations by the Commodities Futures Trading Commission (CFTC) enacted in February of 2012.  Operators of potential commodity pools are required to determine whether they operate a "commodity pool", and if yes, then they must register with the CFTC by December 31, 2012 or rely on an exemption from registration.  It is not an easy task to determine whether the hedge fund is a commodity pool.  In particular, potential commodity pool operators should check to see whether any of the agreements they have entered into are swaps.  All Title VII instruments that are swaps will, effective December 31, 2012, be included into the definition of a commodity pool along with other instruments, such as futures contracts, security futures products, commodity options, and many others.  Previously, many funds relied on Rule 4.13(a)(4) exemption from registration.  This exemption is no longer available and the transition period expires on December 31, 2012.  Now, unless investment managers qualify for other exemptions, they only have one month to register as CPOs with the CFTC.

For a closer analysis of what is a "commodity pool", I'd like to refer to an excellent blog post by Doug Cornelius.  The full version is found here.

"In looking closer at the statutory definition of “commodity pool” it seems that single swap should not turn a private fund into a commodity pool.

Title 7 of the US Code Section 1(a)
(10) Commodity pool
(A) In general
The term ‘‘commodity pool’’ means any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any—
(i) commodity for future delivery, security futures product, or swap;
(ii) agreement, contract, or transaction described in section 2(c)(2)(C)(i) of this title or section 2(c)(2)(D)(i) of this title;
(iii) commodity option authorized under section 6c of this title; or
(iv) leverage transaction authorized under section 23 of this title.
From the statutory definition, the fund needs to operated for the purpose of trading in commodity interests.
One argument is that the fund is an end user and therefore not organized for the “purpose of trading in commodity interests.” Under the new end user exception to the swap clearing requirement, the key test is whether the entity is “using the swap to hedge or mitigate commercial risk.”
What is a swap used to hedge or mitigate commercial risk?
(c) Hedging or mitigating commercial risk.
For purposes of section 2(h)(7)(A)(ii) of the Act and paragraph (b)(1)(iii)(B) of this section, a swap is used to hedge or mitigate commercial risk if:
(1) Such swap:
(i) Is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise, where the risks arise from:
(A) The potential change in the value of assets that a person owns, produces, manufactures, processes, or merchandises or reasonably anticipates owning, producing, manufacturing, processing, or merchandising in the ordinary course of business of the enterprise;
(B) The potential change in the value of liabilities that a person has incurred or reasonably anticipates incurring in the ordinary course of business of the enterprise;
(C) The potential change in the value of services that a person provides, purchases, or reasonably anticipates providing or purchasing in the ordinary course of business of the enterprise;
(D) The potential change in the value of assets, services, inputs, products, or commodities that a person owns, produces, manufactures, processes, merchandises, leases, or sells, or reasonably anticipates owning, producing, manufacturing, processing, merchandising, leasing, or selling in the ordinary course of business of the enterprise;
(E) Any potential change in value related to any of the foregoing arising from interest, currency, or foreign exchange rate movements associated with such assets, liabilities, services, inputs, products, or commodities; or
(F) Any fluctuation in interest, currency, or foreign exchange rate exposures arising from a person’s current or anticipated assets or liabilities; or
(ii) Qualifies as bona fide hedging for purposes of an exemption from position limits under the Act; or
(iii) Qualifies for hedging treatment under:
(A) Financial Accounting Standards Board Accounting Standards Codification Topic 815, Derivatives and Hedging (formerly known as Statement No. 133); or
(B) Governmental Accounting Standards Board Statement Accounting and Financial Reporting for Derivative Instruments; and
(2) Such swap is:
(i) Not used for a purpose that is in the nature of speculation, investing, or trading; and
(ii) Not used to hedge or mitigate the risk of another swap or security-based swap position, unless that other position itself is used to hedge or mitigate commercial risk as defined by this rule or Sec. 240.3a67-4 of this title.
I think most private equity funds and real estate private equity funds would be using interest rate derivatives to hedge or mitigate commercial risk.
The tough part of this argument is that a “financial entity” is not an end user.
2(h)(7)(C)(i)‘‘financial entity’’ means—
(I) a swap dealer;
(II) a security-based swap dealer;
(III) a major swap participant;
(IV) a major security-based swap participant;
(V) a commodity pool;
(VI) a private fund as defined in section 80b–2(a) of title 15;
(VII) an employee benefit plan as defined in paragraphs (3) and (32) of section 1002 of title 29;
(VIII) a person predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature, as defined in section 1843(k) of title 12.
In case you have forgotten about the definition of private fund under Dodd-Frank:
The term “private fund” means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a–3), but for section 3(c)(1) or 3(c)(7) of that Act.
The end user exemption excludes private funds. That seems bad and is going to kick all of the newly registered private equity and real estate private equity funds out of the end-user exemption.
On top of that, there is a de minimis exemption from registration under the terms of Rule 4.13(a)(3). Under these requirements, either:
  • Initial margin and premiums for commodity interest transactions must be less than 5% of the liquidation value of the fund; or
  • Aggregate net notional value of commodity interest transactions must be less than 100% of the liquidation value of the fund.
That still leaves me stuck with trying to figure out when an entity becomes a commodity pool. The regulations provide no further guidance. One case that addresses the definition is Lopez v. Dean Witter Reynolds 805 F.2d 880 1986. Unfortunately for my purposes it focuses on whether separate accounts are aggregated enough to be a pool.
In CFTC v. Heritage Capital Advisory Services, Ltd. (Comm. FUT. L. REP. (CCH) 21,627, 26,377 (N.D. Ill. 1982).) the ruled that a fund investing in Treasuries and hedging the risk was a commodity pool. The defendants had solicited and pooled public funds with the stated intention of investing approximately 97% of the proceeds in United States Treasury bills, and using the remainder to hedge the account by trading futures contracts on Treasury bills. The ruling concluded that “[t]he risk to the funds of the defendants’ investors far exceeded the 3% discount which was supposedly to be committed to the futures markets” because of the possibility of a rapid decrease in the applicable market or of the pool being required to take delivery of costly Treasury bills pursuant to a future contract.
That does not provide much help for private equity funds and real estate private equity funds."