Title III of the JOBS Act, which contains the new crowdfunding exemption, is not a particularly well-drafted statute. It was put together rather quickly in the Senate as a substitute for the crowdfunding exemption that passed the House and never went through a formal committee markup. The resulting exemption contains a number of ambiguities and loopholes. I am happy to report that the SEC’s proposed rules to implement the crowdfunding exemption clear up the major statutory problems.

1. $1 Million Offering Limit Includes Only Crowdfunded Offerings

Section 4(a)(6)(A) of the Securities Act provides that the exemption is available only if

the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, is not more than $1,000,000.

The “including” clause makes it unclear if only securities sold pursuant to the crowdfunding exemption are included, or if securities sold pursuant to other exemptions during the 12-month period must also be subtracted from the $1 million limit. I argued (here, at p. 200) that only crowdfunded securities should count against the limit, but conceded that this statutory language is “a little unclear.” (I vacillated on this; I argued in an earlier draft that other sales should count against the limit, but changed my mind before my article went to press.)

The SEC has accepted my final interpretation. Proposed Rule 100(a)(1) of the new crowdfunding rules only includes securities sold “in reliance on Section 4(a)(6) of the Securities Act.” Securities sold pursuant to other exemptions would not have to be subtracted from the $1 million limit.

2. Ambiguities in the Individual Investment Limits Cleared Up

The statute limits the amount each investor may invest annually in crowdfunded offerings. The maximum amount an investor may invest is based on that investor’s net worth and annual income. Unfortunately, the section of the statute that sets those limits contains a couple of ambiguities.

Ambiguity No. 1: Two Different Limits Applicable to Some Investors

The statute provides for two sets of limits; which limits apply depends on the investor’s annual income and net worth. The lower set of limits, in section 4(a)(6)(B)(i), applies “if either the annual income or the net worth of the investor is less than $100,000.” The higher set of limits, in section 4(a)(6)(B)(ii), applies “if either the annual income or the net worth of the investor is equal to or more than $100,000.”

I and others have pointed out ( here, at  201) that if one of those two figures (annual income and net worth) is less than $100,000 and the other is equal to or greater than $100,000, then the statute says both limits apply.

The SEC has resolved this ambiguity. Under proposed Rule 100(a)(2), if either net worth or annual income are equal to or greater than $100,000, then the higher limit applies. The lower limit applies only if both annual income and net worth are less than $100,000.

Ambiguity No. 2: What Exactly is the Higher Limit?

The higher limit, if applicable, is “10 percent of the annual income or net worth of such investor, as applicable.” Section 4(a)(6)(B(ii). Unfortunately, the statute doesn’t say whether the limit is the greater or the lesser of those two figures. If, for example, 10% of annual income is $15,000 and 10% of net worth is $12,000, is the limit $15,000 or $12,000?

Proposed Rule 100(a)(2)(ii) clarifies this. The limit is the greater of the two numbers.

3. Financial Disclosure Loophole Blocked

The statutory exemption includes a possible loophole in the issuer’s financial disclosure requirements. The financial information to be provided by the issuer depends on the target amount of the crowdfunded offering. The statute sets up three target amount categories ($100,000 or less; $100,000-$500,000; more than $500,000), and imposes a greater burden as the target amount gets larger.

Since nothing in the exemption prevents an issuer from raising more than its stated target amount, this opens a loophole (which I discuss here, at p. 204). An issuer could specify a target amount of $100,000, to minimize its financial disclosure, then raise up to the full $1 million.

The SEC has closed this loophole. Proposed Rule 201(h) requires the issuer to disclose whether it will accept investments in excess of the target amount, and, if so, the maximum amount it will accept. An instruction to proposed Rule 201(t) indicates that, if the issuer is willing to accept more than its target amount, the required financial disclosure is based on “the maximum offering amount that the issuer will accept.” As a result of these rules, the issuer will not be able to specify an artificially low target amount to avoid the more burdensome financial disclosure.

Jennifer Taub has published a new book, “Other People’s
Houses: How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made
Home Mortgages a Thrilling Business.” 
Here is an excerpt from the Yale University Press description:

Focusing new light on the similarities between the savings
and loan debacle of the 1980s and the financial crisis in 2008, Taub reveals
that in both cases the same reckless banks, operating under different names,
received government bailouts, while the same lax regulators overlooked fraud
and abuse. Furthermore, in 2013 the situation is essentially unchanged. The
author asserts that the 2008 crisis was not just similar to the S&L
scandal, it was a severe relapse of the same underlying disease. And despite modest
regulatory reforms, the disease remains uncured: top banks remain too big to
manage, too big to regulate, and too big to fail.

UPDATE: The book will be in bookstores in May, but can be
pre-ordered now.

Bill Black takes down claims of a “victory for the
government in its aggressive effort to hold banks accountable for their role in
the housing crisis.”  (HT: naked
capitalism.)  The full piece is available here, and
I highly recommend you go read the whole thing. 
What follows is a brief excerpt:

The author of the most brilliantly comedic statement ever
written about the crisis is Landon Thomas, Jr…. 
Everything worth reading is in the first sentence, and it should trigger
belly laughs nationwide. “Bank of America, one of the nation’s largest banks,
was found liable on Wednesday of having sold defective mortgages, a jury
decision that will be seen as a victory for the government in its aggressive
effort to hold banks accountable for their role in the housing crisis.” … Yes,
we have not seen such an aggressive effort since Captain Renault told Rick in
the movie Casablanca that he was “shocked” to discover that there was gambling
going on (just before being handed his gambling “winnings” which were really a
bribe)…. The jurors found that BoA (through its officers) committed an orgy of
fraud in order to enrich those officers…. The journalist’s riff is so funny
because he portrays DOJ’s refusal to prosecute frauds led by elite BoA officers
as “aggressive.”  Show the NYT article to
friends you have who are Brits and who claim that Americans are incapable of
irony…. I’m not sure whether the DOJ consciously deciding not to investigate,
bring civil suits, or prosecute the most destructive frauds in history
represents “aggressive” or “accountable” to the DOJ.  We do know, however, the fantasy that caused
DOJ to give these control frauds a free pass. Benjamin Wagner, a U.S. Attorney
who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points
out that banks lose money when a loan turns out to be fraudulent. “It doesn’t
make any sense to me that they would be deliberately defrauding themselves,”
Wagner said. “They” refers to the CEO. 
“Themselves” refers to the bank. 
“They” are not “defrauding themselves.” …  The game being played out in all the corporate
settlements, like the JPMorgan deal, is that the controlling officers, even
when they grew wealthy by looting the shareholders, use corporate funds to cut
deals that protect them from being prosecuted or having to return their
fraudulent proceeds.  We all know who
pays for this – the shareholders.  Only a
comic genius would have the mastery of irony necessary to call the ability of
elite bankers to become wealthy through fraud with immunity “accountability.” …
The self-congratulations that DOJ press flacks regularly issue to attempt to
con journalists and the public into believing that DOJ is aggressively holding
elite bankers accountable for their frauds make “Baghdad Bob” seem credible by
comparison.

I blogged yesterday about the SEC’s release of proposed rules to implement the JOBS Act crowdfunding exemption.

Both the JOBS Act and the proposed rules require that crowdfunding offerings be made through either registered securities brokers or registered funding portals. “Funding portal” is a new category of regulated entity created by the JOBS Act specifically for exempted crowdfunded offerings. The Act requires non-broker funding portals to belong to a national securities association subject to rules “written specifically for registered funding portals.” (See section 3(h)(2) of the Exchange Act, as amended by the JOBS Act.) Because of that requirement, non-broker funding portals cannot engage in crowdfunding until those rules are in place.

Somewhat overlooked in the hoopla surrounding the SEC rules proposal was the release of proposed rules by the Financial Industry Regulatory Authority (FINRA) to regulate funding portals. The FINRA notice is here and the proposed rules are here.

I hope the SEC and FINRA are careful to coordinate final adoption of the crowdfunding rules and the FINRA rules. Funding portals cannot engage in crowdfunding until they have registered under the FINRA rules. If the crowdfunding rules go into effect before funding portals can register with FINRA, brokers will be able to begin operating crowdfunding platforms before funding portals, giving registered brokers a competitive advantage.

 

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. 

 

The SEC has finally released its long-awaited proposal for rules to implement the crowdfunding exemption in the JOBS Act. It’s available here. The 585-page proposal is substantial, even by SEC standards.

The statutory deadline for the SEC to adopt these rules was Dec. 31, 2012, but almost no one with a sophisticated knowledge of securities law, including me, expected the SEC to meet that deadline. I wish I had bet with some of the people in the crowdfunding community who naively expected that deadline to be met; I could have cleaned up.

There’s a 90-day comment period. (Giving people 90 days to comment on a 585-page proposal that it took 18 months to draft is chutzpah.) Because of that, adoption before the end of this year is impossible. [I corrected this. The original post said 60 days.]

I am happy to report that SEC staff members have read my two articles on crowdfunding and the JOBS Act crowdfunding exemption (available here and here). Those articles are cited several times in the release. I will be interesting to see if the staff actually acted on any of my recommendations or accepted any of my interpretations in drafting the rule. But the JOBS Act itself puts significant restrictions on the content of the exemption, so it’s not clear there’s much they can do to cure some of the problems.

A few bloggers began chiming in shortly after the release of the proposal with summaries and instant analysis. The blogosphere is becoming like the race to the courthouse for shareholder litigation, often with similar quality. I will be offering some comments on the proposal, but only after I have had time to absorb and analyze it.

Yesterday, the Executive Director, James Leipold, of
NALP (the National Association of Law
Placement) presented data regarding law graduate hiring trends from 2000
through 2012, both nationally and for my school (Georgia State University
College of Law).  It provided an
understanding of the changes to the legal market as a whole, and for our graduates
specifically.  I wasn’t aware of the data
compiled by NALP and available on their website prior to this presentation, and
man was I impressed.  As a faculty member
who frequently counsels students on job searches, the data paints a very
interesting story about HOW a majority of law graduates find jobs and WHERE
they find them.  The data also tells a
very compelling story of how the 2008 financial crisis/Great Recession has
impacted the legal hiring market.  (In
short:  big law jobs are down
significantly which was created downward pressure on alternative career paths
as students who would have traditionally pursued big law jobs compete for other
positions.) 

On the HOW question, the data confirmed a suspicion
of mine about how a majority of students find jobs.  Of course these statements will be either
more or less true depending on the reputational capital of your school.  Before the Great Recession approximately 20%
of students found their post-graduation job through on campus interviewing
(OCI) and that number is now approximately 14%. 
This means that even before the Great Recession, but certainly today, a
vast majority of students find jobs through other means such as networking/personal
referral, self-initiation such as inquiring about job opportunities and sending
out resumes, and responding to postings on sites like Monster.com.   In
thinking about HOW law students find jobs, this information provides a powerful
narrative that students who are working hard to find a job are not alone, and
not the outlier now, or even in the past. 
This information will shape the advice that I give students about where
and how to place their energy during their three years in law school.  If in-school activities do not land a student
on law review and the top 10% of their class, then focusing on external opportunities
to network and gain professional contacts in law practice and law-related
fields should be a top priority for students.

NALP numbers

And now for the WHERE part, private practice job
placement is down from a steady 55%
to approximately 50% of
post-graduation jobs.  One of the
sectors that has absorbed this shift is JD hiring by businesses, which is up to
almost 18% of new graduate jobs (from historic
percentages of 12-13%).   The NALP report on 2012 graduates 9 months after graduation concludes that:

“Employment in business was
17.9%, down a bit from the historic high of 18.1% reached in 2011, but still
higher than the 15.1% for the Class of 2010. The percentage of jobs in business
had been in the 10-14% range for most of the two decades prior to 2010, except in
the late 1980s and early 1990s, when it dipped below 10%. About 29% of these
jobs were reported as requiring bar passage, and about 39% were reported as
jobs for which a JD was an advantage.”

Out of a presentation that included a host of facts
and figures, I want to highlight one other part of the picture painted by the
data.  Feedback from legal employers
(mostly private practice law firms) said that in new-JD hires, they were
looking for students who understand that practicing law in a firm is a business
and how they fit into that business model. They also want students to have a
basic understanding of financial literacy skills.   I plan
on sharing this information with our students who are turning their attention
to scheduling classes for their spring semester. I see this as a clear
justification for emphasis on business-related classes.

-Anne Tucker

Yesterday, the New York Times published what I consider a medicocre criticism of law reviews.  Not that some criticism isn’t valid.  It is.  I just think this one was poorly executed.  Consider, for example, these thoughtful responses from Orin Kerr and Will Baude.

As I have thought about it, one thing that struck me was about the Times article was the opening:

 “Would you want The
New England Journal of Medicine to be edited by medical students?” asked
Richard A. Wise, who teaches psychology at the University of North Dakota. 

Of course not. Then why are law reviews, the primary
repositories of legal scholarship, edited by law students?

I don’t disagree with the premise, but note how limiting it is.  First, it talks about one journal, one that is highly regarded.  I know some people hate all law reviews, but I humbly suggest that most people consider elite journals like the Yale Law Journal a little differently.  (It’s also true that some journals like the Yale Law Journal happen to use some forms of peer review in their process.) 

Second, the implication is that medical journals have it all figured out.  That’s apparently not true, either.  An article from the Journal of the Royal Society of Medicine, What errors do peer reviewers detect, and does training improve their ability to detect them?, had the following goal:

Objective

To analyse data from a trial and report the frequencies with which major and minor errors are detected at a general medical journal, the types of errors missed and the impact of training on error detection.

The study concluded: 

Editors should not assume that reviewers will detect most major errors, particularly those concerned with the context of study. Short training packages have only a slight impact on improving error detection.  

Consider also, for example, this article from National Geographic, Fake Cancer Study Spotlights Bogus Science Journals: 

A cancer drug discovered in a humble lichen, and ready for testing in patients, might sound too good to be true. That’s because it is. But more than a hundred lower-tier scientific journals accepted a fake, error-ridden cancer study for publication in a spoof organized by Science magazine.

Finally, the problem for all kinds of journals is hardly new.  This study, Peer-review practices of psychological journals: The fate of published articles, submitted again, from 1982, determined that the problem can also run in the other direction. From the Abstract: 

A growing interest in and concern about the adequacy and fairness of modern peer-review practices in publication and funding are apparent across a wide range of scientific disciplines. Although questions about reliability, accountability, reviewer bias, and competence have been raised, there has been very little direct research on these variables.

The present investigation was an attempt to study the peer-review process directly, in the natural setting of actual journal referee evaluations of submitted manuscripts. As test materials we selected 12 already published research articles by investigators from prestigious and highly productive American psychology departments, one article from each of 12 highly regarded and widely read American psychology journals with high rejection rates (80%) and nonblind refereeing practices.

With fictitious names and institutions substituted for the original ones (e.g., Tri-Valley Center for Human Potential), the altered manuscripts were formally resubmitted to the journals that had originally refereed and published them 18 to 32 months earlier. Of the sample of 38 editors and reviewers, only three (8%) detected the resubmissions. This result allowed nine of the 12 articles to continue through the review process to receive an actual evaluation: eight of the nine were rejected. Sixteen of the 18 referees (89%) recommended against publication and the editors concurred. The grounds for rejection were in many cases described as “serious methodological flaws.” A number of possible interpretations of these data are reviewed and evaluated.

In the interest of full disclosure, I admit I have a fondness for law reviews. I am a former editor in chief of one, have served as an advisor to another, serve as the current president of our law review alumni association, and serve on the review’s Advisory Board of Editors. The things I learned, from (usually) patient and careful authors, were exceedingly valuable and help guide me to do what I do now.  I also have worked with several journals and reviews from the author side, and I have been usually impressed, and sometimes very frustrated, which is also true of almost every job experience I have ever had.  And I am confident every editor in chief of a law review has worked with an author or two who drove them nuts.  

I understand the frustrations, and the criticisms are often valid, at least to a point.  But let’s not undercut the efforts of committed and careful, if not experienced, student editors, who usually work their tails off.  And let’s not assume that every other discipline has it all figured out.  I think it’s clear they don’t.  There may be a better system (and I suspect there is), but let’s not keeping dumping on a system (and students who work hard) without proposing some alternatives that we have a reason to believe will actually be better.  

Sarah C. Haan has posted “Opaque Transparency: Outside
Spending and Disclosure by Privately-Held Business Entities in 2012 and Beyond”
on SSRN.  Here is a portion of the
abstract:

In this Article, I analyze data on outside spending from the
treasuries of for-profit business entities in the 2012 federal election – the
very spending unleashed by Citizens United v. FEC. I find that the majority of
reported outside spending came from privately-held, not publicly-held
companies, including a significant proportion of unincorporated business
entities such as LLCs, and that more than forty percent of spending by
privately-held businesses was characterized by opaque transparency: Though
fully disclosed under existing campaign finance disclosure laws, something
about the origin of the money was obscured. This happened when political
expenditures were spread among affiliated business-donors, typically donating
similar amounts to the same recipient(s) on similar dates, and when for-profit
business entities were used as shadow money conduits. I also argue that, due to
differences between access-oriented and replacement-oriented electoral
strategies, for-profit businesses engaged in outside spending in a federal
election are likely to be experiencing insider expropriation. The expropriation
of a business entity’s political voice by a controlling person is another
potential way in which voters are misled in our current disclosure regime. In
light of these spending patterns, and evidence of insider expropriation of the
political voice of many privately-held business donors, I argue that
privately-held business entities that engage in federal election-related
spending should be compelled to reveal the individual(s) who control them.