C. Steven Bradford

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Federal and state securities regulation is the personification of what conservatives refer to pejoratively as “big government.” Businesses can’t raise money unless they first get permission from the government and, in many states, that permission turns on a regulator’s determination of whether the offer is fair. The cost of compliance is a serious drag on capital formation, especially small business capital formation. Federal and state securities laws also generate a tremendous amount of plaintiff’s litigation, another conservative bugaboo.

We’ve seen conservative efforts at the federal level to limit securities regulation and litigation—for example, the Private Securities Litigation Reform Act and the JOBS Act. But, unless things are going on at the state level that I’m not aware of, there doesn’t seem to be a corresponding effort at the state level.

That’s surprising, because the Republicans have greater control at the state level than they do at the federal level. There are 31 Republican governors and the Republicans control both chambers of the state legislature in 30 states, plus Nebraska’s unicameral legislature. Republicans control both the governorship and the state legislature in 24 states.

Why hasn’t there been a push to change state securities regulation? Are Republicans satisfied with state regulation?

Andrew Vollmer, a law professor at the University of Virginia and a former SEC deputy general counsel, has written two excellent papers on SEC enforcement.

The first, SEC Revanchism and the Expansion of Primary Liability under Section 17(a) and Rule 10b-5, is a critical look at the SEC’s decision in the Flannery administrative proceeding. If you’re a securities lawyer and you’re not familiar with Flannery, you should be. It stakes out a number of broad interpretations of liability under Rule 10b-5 and section 17(a) of the Securities Act. I (and Professor Vollmer) believe some of those positions are inconsistent with Supreme Court precedent, but the SEC’s is clearly trying to set up an argument for judicial deference under Chevron.

Professor Vollmer’s second article is Four Ways to Improve SEC Enforcement. He discusses the problems with SEC administrative proceedings and how to fix them.

Both articles are definitely worth reading.

Recent news brings us two reminders that crowdfunding is an amoral fundraising tool. It can be used for evil as well as for good.

Crowdfunding War

First, the New York Times reports that Russian nationalists are using crowdfunding to fund the rebellion/invasion in eastern Ukraine. One website even allows donors to direct contributions to specific militia units. The Russian separatists claim to have raised millions of dollars. (Of course, they have also claimed there’s no Russian government involvement in the rebellion, so take these claims with a grain of salt.)

Not much can be done about the groups themselves, which are located in Russia. But, as the Times points out, the payment intermediaries who help facilitate these payments are at legal risk.

Crowdfunding Fraud

Second, Inc. magazine reports that the Federal Trade Commission has taken action against a man who raised $122,000 on Kickstarter to produce a board game, then used the money to pay his rent and move. The man, Erick Chevalier, agreed to a settlement that orders him to repay the money, but the judgment has been suspended because he no longer has any money.

A copy of the FTC’s complaint is here. The agreed order is …

I was reading an article on securities crowdfunding in China and came across this description of Chinese practice:

Generally, in China, equity-based crowdfunding capital-seekers rely on the strength of experienced, leading investors to advise “follow-up” investors in locating investment projects. Leading investors are usually professionals with rich experience in private offerings and label themselves as holding innovative techniques in investment strategies and possessing sound insights. On the contrary, follow-up investors usually do not have even basic financial skills, but they do ordinarily control certain financial resources for investment. When a leading investor selects a target investment project through an equity-based crowdfunding platform, the leading investor usually invests personal funds into the project. Crowdfunding capital- seekers then take advantage of the leading investor’s funds to market the project to follow-up investors.

(This is from a recent article by Tianlong Hu and Dong Yang, The People’s Funding of China: Legal Developments of Equity Crowdfunding-Progress, Proposals, and Prospects, 83 U. CIN. L. REV. 445 (2014).)

This is not unique to China. Private offerings to accredited investors in the United States often follow a similar path. Smaller investors are more likely to commit once a well-known, sophisticated investor has made a commitment. But…

When I write a law review article, I usually include in the author’s footnote a brief note of thanks to the student research assistants who helped me on that article. When I write a book, I thank my research assistants in the preface.

My research assistant also helps me from time to time with research related to this blog. (Yes, I actually research some of the things I write on this blog. Hard to believe, isn’t it?) Blogs don’t have prefaces or author’s footnotes, so there’s no convenient way to acknowledge his help. I decided to give him his own blog post.

My thanks to Stephen Knudsen, University of Nebraska College of Law Class of 2015, for the assistance his has given me over the past year on this blog. (He is, of course, totally responsible for anything I wrote that you found objectionable or wrong.) The two or three people who read what I write here are now aware of his contribution and he can provide the link to his parents, almost doubling my usual readership.

I saw this in Utah over spring break and I just had to share it with our readers: the Supreme Court building made out of Legos.

Supreme Court Lego Edited

This was part of an extensive Lego exhibit that also included the White House, the Capitol, and the Washington Monument, among other familiar D.C. monuments. If you have a child that likes Legos, a lot of time, and a lot of money for the Legos, feel free to try this at home. What better way for a lawyer or law student to teach a child about the Supreme Court?

The darling model next to the building is my five-year-old granddaughter Payton, something of a Lego expert herself. Thanks to Sandy Placzek for the photography. (Grandpa has too much fun playing with the grandchildren to spend time taking pictures.)

The JOBS Act requires the SEC to create an exemption for small, crowdfunded offerings of securities. That exemption, if the SEC ever enacts it, will allow issuers to raise up to $1 million a year in sales of securities to the general public. (Don’t confuse this exemption with Rule 506(c) sales to accredited investors, which is sometimes called crowdfunding, but really isn’t.)

The crowdfunding exemption restricts resales of the crowdfunded securities. Crowdfunding purchasers may not, with limited exceptions, resell the securities they purchase for a year. Securities Act sec. 4A(e); Proposed Rule 501, in SEC, Crowdfunding, Securities Act Release No. 9470 (Oct. 23, 2013). Unlike the resale restrictions in some of the other federal registration exemptions, the crowdfunding resale restriction serves no useful purpose. All it does is to increase the risk of what is already a very risky investment by reducing the liquidity of that investment.

Enforcing the “Come to Rest” Idea

Some of the resale restrictions in other exemptions are designed to enforce the requirement that the securities sold “come to rest” in the hands of purchasers who qualify for the exemption.

Rule 147, the safe harbor for the intrastate offering exemption in section…

The depth of everyone's knowledge varies from subject to subject. I have a deep understanding of many areas of securities law, but a very shallow understanding of physics. (I’m not even in the wading pool.) But, even in subjects I teach—business associations, securities law, accounting for lawyers—the depth of my knowledge varies from topic to topic.

When I’m teaching the Securities Act registration exemptions, my knowledge base is very deep. I research and write primarily in that area. I know the law. I know the lore. I know the policy.
In other areas, my knowledge is much shallower. In some cases, I know just enough to teach the class. My business associations class sometimes touches on entity taxation issues, but I’m far from an expert on entity taxation. (My tax colleagues would say “far, far, far.”)

One’s knowledge deepens over time, of course. That’s one of the great joys of becoming an expert, whether you’re a law professor or a practitioner. I know more now about every topic I teach (including entity taxation) than I knew when I began teaching 27 years ago.

Several years ago, I decided to teach a course on investment companies and investment advisers. I started…

Sergei Magnitsky. Remember that name any time you’re considering doing business in Russia or any other country in which the "rule of law" is a meaningless masquerade for the uncontrolled whims of the powerful.

Magnitsky was a young Russian accountant working for the Hermitage Capital Management firm created by Bill Browder to invest in Russia. When Browder stepped on the toes of some of the Russian business oligarchs, Magnitsky was thrown into prison, beaten, refused essential medical care, and basically murdered.

I learned Magnitsky’s story in a new book by Bill Browder, Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice. Browder created Hermitage Capital shortly after the breakup of the Soviet Union. The book details Hermitage’s dramatic rise and, when Browder publicly fought the attempts by the Russian oligarchs to dilute his minority investments, Hermitage’s eventual fall. Browder and almost everyone else associated with Hermitage managed to flee Russia, some after being detained, but Magnitsky, the firm's young accountant, refused to leave. When he was imprisoned and questioned, he refused to tell his captors the lies they wanted to hear, and his refusal eventually resulted in his death.

The story is…