Separation / Confidentiality Agreements Gone Too Far

It is not a surprise that employees are routinely asked to sign confidentiality agreements at the beginning of their employment as well as separation agreements at the end.  The problem is that sometimes such agreements limit the employees' rights in a way that violates the law.

Here, I am talking about the Dodd-Frank Act and the SEC Rule 21F-17.  The Dodd-Frank Act granted financial incentives to whistleblowers (between 10% and 30% of the penalty that the SEC would collect if their information led to an SEC action).  Rule 21F-17, which became effective in August 2011, prohibits the companies to interfere with the employees reporting potential securities law violations.  It says: "(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications."

NeuStar Inc., a public company, used a non-disparagement clause in its severance agreements that forbade former employees to engage in "any communication that disparages, denigrates, maligns or impugns" the company, including communications with accountants, reporters, investors, customers, and regulators.  A breach of this clause could result in the loss of severance benefits. From August 12, 2011 to approximately May 21, 2015, at least 246 employees signed agreements with such clause, and the SEC order indicates that at least one of them wanted to talk to the SEC but could not because of the agreement.  As a result of settlement, NeuStar amended its nondisparagement clause to exclude federal regulators and paid a penalty in the amount of $180,000.

This is not an isolated enforcement of this Rule.  Earlier in 2015, the SEC brought an enforcement action against KBR, Inc., a public company. KBR required employees who acted as witnesses in certain internal investigations to sign a confidentiality clause that threatened disciplinary actions if such persons discussed the investigations with outside parties without the prior approval of KBR's legal department.  These investigations included possible violations of securities laws.  The company settled with the SEC by agreeing to amend the offending clause and paying a $130,000 penalty.

Yet another enforcement action was brought against BlueLinx, an Atlanta-based building products distributor, in August 2016.  BlueLinx required all departing employees to waive their rights to whistleblower monetary awards should they file a charge or a complaint with the SEC or other federal agencies.   BlueLinx settled with the SEC by agreeing to amend the clause and paying a $265,000 penalty.

The SEC has just brought another enforcement action for violation of Rule 21F-17, this time against Blackrock, Inc., for a clause in its separation agreements that removed the right to claim whistleblower awards from departing employees who chose to become whistleblowers.  Blackrock actually voluntarily stopped using this clause in March 2016, but by then over 1,000 departing employees had already signed it.  BlackRock's penalty was $340,000.

The lesson is an obvious one here: companies should review their separation and confidentiality agreements to ensure they do not violate the employees' rights to file complaints with the SEC and receive financial rewards for doing so.

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 corporate, securities, and intellectual property law.

FundersClub book: Understanding Startup Investments

Just recently, FundersClub, an online venture capital portal open to accredited investors, published a guide on startup investments. The guide is available online at their education center.  It's a great quick read for first time investors and startup founders who are raising capital for the first time.  The guide focuses on common vs preferred equity, SAFEs and convertible notes, - the instruments used to invest into early-stage startups.  To me (and many other lawyers, I am sure) FundersClub is best known as the author of a famous SEC no-action letter  from March 2013 that clarified the SEC's position on activities that did not require broker-dealer registration.

The guide is written in an easy-to-read language and is divided into five chapters. Below are several valuable lessons (but I encourage to read the entire guide):

• Typically, seed and early-stage investors invest into SAFEs or convertible debt, and investors into later-stage startups (Series A or later) invest into preferred stock in priced rounds.
• VC investments are not just about the money; they are also about the much needed connections and advice.
• Convertible debt investors are not really giving a loan to the company, - they are effectively buying a percentage of the company's equity.
• The concept of "total outstanding equity" of the company also includes shares issuable upon conversion of all convertible securities issued by the company, as well as outstanding options given to employees.
• Founders typically hold common stock, investors - preferred stock, and employees - options that give them the right to purchase shares of common stock.
• Preferred stock has a liquidation preference, - i.e., these investors get paid first if a liquidation event occurs (such as acquisition or bankruptcy). Preferred stock holders also typically get pro rata and anti-dilution rights.
• Founders and investors nowadays typically agree on a broad or narrow-based-weighted-average anti-dilution rights rather than the full ratchet anti-dilution formula because they protect the investors while not excessively diluting common shareholders.
• Convertible securities used in startup investing can be either convertible debt or convertible equity (SAFE - invention of Y Combinator, or KISS - invention of 500 Startups).
• Startups prefer to issue convertible securities if they are not ready to establish a valuation.  Also, convertible securities deals are cheaper to execute.  
• SAFEs differ from convertible debt in that there is no maturity date or interest rate, but caps, discounts, and conversion upon next qualified financing are still there (although caps and discounts are optional).

While FundersClub guide is a great read for the first timers, for an in-depth study of these topics, I recommend checking out the following two sources: the blog Startup Company Lawyer  and the book titled "Venture Deals" (note that a new edition of this book is coming out soon).

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 corporate, securities, and intellectual property law. 

Innovation among crowdfunding portals: a PBC that accepts Bitcoin

Innovation in crowdfunding space continues, and I would like to report on two interesting developments.  Both have to do with the crowdfunding portal WeFunder, currently the largest Regulation Crowdfunding portal in the U.S.

First, WeFunder now accepts Bitcoin.  In the announcement in late October, WeFunder explained that the goal is "to make investments easier and cheaper" and to enable investors "to send money from outside the U.S. to bypass having to invest using an international wire transfer."  As confidence in Bitcoin increases, this development can truly facilitate cross border investments and further globalize the investment markets.  Let's see if other portals will follow.   WeFunder is working with BitPay and Silvergate Bank to facilitate this process, and has already had over $50,000 worth of Bicoin come in.

Second, WeFunder is now a public benefit corporation.  Here is an article about it.  WeFunder is the first registered Regulation Crowdfunding portal to do so, but not the first crowdfunding portal all together.  Kickstarter became a PBC in 2015.  WeFunder's charter states that they "aim to increase economic growth and lower wealth disparity, by sharing the rewards of capitalism more broadly, and destroying the barriers that reduce social mobility."  Among its commitments, WeFunder will donate 5% of its profits to programs that mentor more first-time entrepreneurs.  WeFunder is still a for-profit corporation, but now its directors must consider the corporation's public benefit purpose along with its regular corporate goal of generating profit, and report to shareholders regarding its progress in achieving the public benefit purpose.  I previously wrote about Delaware PBC's here.  

Now, a quick update regarding the status of crowdfunding offerings.  According to WeFunder status update, as of November 5, 2016, investors invested $11,782,334 in Regulation CF offerings (that is since May 16, 2016).  So far, there have been 49 successful offerings that reached the minimum funding targets.  Most of the offerings were conducted through WeFunder (34), followed by StartEngine (5) and NextSeed (6).  A total of 13,999 investments have been made.  Three companies raised the maximum of $1 million.

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 corporate, securities, and intellectual property law.