I just finished reading an interesting book on entrepreneurship, and I thought I would share it with the blog. It’s Worthless, Impossible and Stupid: How Contrarian Entrepreneurs Create and Capture Extraordinary Value, by Daniel Isenberg.

Isenberg uses case studies to explode three myths: (1) that entrepreneurs must be innovators; (2) that entrepreneurs must be experts; and (3) that entrepreneurs must be young. He argues that successful entrepreneurship has three elements: (1) perceiving extraordinary value; (2) creating extraordinary value; and (3) capturing extraordinary value. (He obviously likes to group things into triplets.) All three are necessary for success. I, for example, might be able to think of a value creation opportunity but, since I have spent most of my life in the classroom, it’s unlikely I could do much to create that value-turn the idea into reality.

But my favorite part of reading the book was seeing the many examples of successful entrepreneurs being told initially by venture capitalists and others that it just wouldn’t work–that the idea was worthless, impossible, or stupid.

EGCs lead IPOs due to JOBS Act’s relaxed SEC regs, like secret
review filings, exempt exec. compensation and reduced financial disclosures.

For the record as a TWITTER novice, I had to look up the rules pertaining to the 140 character limit and make several attempts to compose a coherent sentence under the limit.  For a more thorough discussion…keep reading.

The latest news on the IPO market is that TWITTER has
announced it has filed with the SEC. 
Last week, Twitter tweeted (a cannibalistic concept in my mind at least),
“We’ve confidentially submitted an S-1
to the SEC for a planned IPO. This Tweet does not constitute an offer of any
securities for sale.”

 The JOBS
Act, passed in April 2012, focused in part on easing access to capital for
“smaller” companies. The JOBS act created a new category of issuer, emerging
growth companies (EGCs), those with revenue
less than $1 billion, and eased the registration regulatory burdens for
IPOs.  (To recap:  “smaller” means less than $1 billion in
revenue.)  The regulatory relief offered
by the JOBS Act allowed for EGCs to (1) submit a confidential draft
registration statement for nonpublic review by the SEC, (2) be exempt from
disclosing for up to 5 years executive compensation and complying with say on
pay votes, and (3) disclose 2 years instead of 3 years of financial statements.

ECG comparison table

 While the number of IPOs in 2013 hasn’t spiked, a
majority of companies participating in IPOs have been EGCs and have taken
advantage of the relaxed regulations available to them. In a report issued by Earnst
& Young on the one-year anniversary of the JOBS Act, it stated that as
of April 2013”

the IPO market has been dominated by EGCs, representing 83% of IPOs that
went effective since April 2012. The majority of EGCs are taking advantage of
the confidential review accommodation and reduced executive compensation
disclosure relief available to EGCs.

The confidential initial
filings have continued to be utilized by nearly every company that qualifies as
an EGC, and Twitter is no exception.  The
confidential draft registration statements have received some criticism for
keeping the IPO pipeline shrouded in mystery and investors in the dark.  Investors will still have an opportunity to review
the financials before Twitter or any EGC goes public, the timetable is just condensed
under the new law.  Considering the speed
with which the market can absorb, distribute, and analyze information, the
condensed timeline shouldn’t pose too much of a problem, and is (according to
an article in the New Yorker) consistent with the timeline previously
applied to IPOs in the 1980’s like when Apple and Microsoft first went public.  If there is any concern for investors it
should be over eliminating the third year of financial disclosures, not the
ability to submit a confidential draft registration statement. 

 With these relaxed
standards for EGCs, Twitter could mark the beginning of a tech-heavy end to the
2013 and start of the 2014 IPO season. 
The market is watching for the following companies to join the ranks:

Square, Dropbox, Box, Living Social, Atlassian, Autotrader.com, and Coupons.com.

2013 IPO
 For more
information on the 2013 IPO record thus far, see:

2013 IPO #2
 -Anne Tucker

Okay, so maybe I am overstating that a bit, but it’s only a
bit.  This is not exactly timely, as the
following case was decided in the December 2012, but I was recently reviewing
it as I taught these cases and helped update Unincorporated Business Entities (Ribstein, Lipshaw, Miller, and Fershee, 5th ed., LexisNexis). (semi-shameless plug).  Despite the passage of time, this case has, apparently, gotten me riled up
again.  So here we go . . .    

Synectic Ventures I, LLC v. EVI Corp., 294 P.3d 478 (Or.
2012):  several investment funds organized as LLCs (the Synectic LLCs or
LLCs).  The LLCs made a loan to the
defendant corporation, EVI Corp. The loan agreement was secured by EVI’s
assets, and provided that EVI would pay back $3 million in loans, plus 8%
interest by December 31, 2004.  The loan
agreement provided that if EVI obtained $1 million in additional financing by
December 31, 2004, the loan amount would be converted into equity (i.e., EVI
shares) and the security interest would be eliminated. If the money were not
raised by the deadline, the LLCs could foreclose on EVI’s assets (mostly IP in
medical devices). 

To make things interesting, the LLCs appointed Berkman the
manager of the LLCs (thus, they were manager-managed LLCs). “At all relevant
times, Berkman—the managing member of plaintiffs—was also the chairman of the
board and treasurer of defendant [EVI].” 
In mid-2003, the Synectic LLCs’ members sought to have Berkman removed, and Berkman signed
an agreement not to enter into new obligations for the LLCs without getting
member approval. 

Continue Reading Oregon Doesn’t Respect Operating Agreements or LLCs As Unique Entities

I (Josh Fershee) will follow up with a post of some (I hope) substance
shortly, but I thought I’d take a moment to briefly re-introduce myself.   When I last wrote for BLPB, I was teaching
at the University of North Dakota School of Law. Last fall, we made the move to
West Virginia University College of Law. 
(I say “we” because my wife (Kendra Huard Fershee) not only moved with me, but because she is
also on the law faculty.)   I joined WVU as part of a university-wide
energy-law expansion and work with the Center for Energy and Sustainable
Development.

I teach business law courses and energy law courses, with
most of my research relating somehow to energy business and regulation.  I teach Business Organizations, Energy Law
Survey, Energy Business: Law & Strategy, and Energy Law and Practice.  I plan to add a Hydraulic Fracturing
Seminar, too, in the near future. 

Of perhaps some interest to our readers, I have taught my Energy Business: Law & Strategy course once, and I plan to do so again in the
spring.  I think it is a unique class,
especially in the law school environment, with its focus on how law comes to be and how businesses are strategic in their use of law and regulation.  (Note: I am of the mind that this reality is important to understand whether you want to work for businesses and employ such strategies or if you want to work to limit businesses in the ability to do so.)  I have the students work in groups, and they draft a written final
project, which they also present to the class. 

Below the jump, I provide the books, course description, goals, and
assessment items for the course. I welcome any comments or suggestions for additional teaching
materials or concepts. 

Continue Reading A Brief Introduction to Me and My Energy Business: Law & Strategy Course

It seems like almost everyone, including the President of the United States, has been offering grandiose ideas to reform legal education. Rather than add to that cacophony, I’m thinking on a micro-level, wondering how I might change my favorite course, Securities Regulation. I think we may be teaching securities registration exemptions backwards.

A very quick overview for those not versed in federal securities law: A company raising money by selling securities must register its offering with the SEC unless it has an exemption from the registration requirement. A number of exemptions are available and companies would prefer an exemption, ceteris paribus, because registration is very expensive.

In securities law practice, the analysis typically proceeds in this order:

Offering Details–Universe of Possible Exemptions–Modification of Offering–Particular Exemption.

The client presents the lawyer with a proposed offering. The client has typically already given some thought to the amount of money needed, the proposed offerees, and perhaps even the manner of offering to those people. The lawyer considers those constraints, considers the universe of possible exemptions and, perhaps after a modification to what the client wants, chooses a particular exemption.

This is also how securities professors like me often test their students on the exemptions. We present students with a proposed offering and ask them to advise the client concerning which exemptions, if any, are available for that offering, and what modifications need to be made to the client’s proposal to fit those exemptions.

This is not, however, how most of us teach the subject. The leading casebooks typically present the material in this way:

Particular Exemption–Offering Details–Modification of Offering.

Each particular exemption is presented separately (except that the Regulation D exemptions are sometimes considered together). Students are then asked if particular offerings would fit within those exemptions.

Consider this alternative to the typical casebook approach. Begin with a very brief overview of each exemption, not more than a paragraph or two, just so students know where to look. Then, organize the material by offering details:

(1) Amount of the Offering. This issuer proposes to sell $2 million of securities. Which exemptions would be available?

(2) Offerees and Purchasers. This issuer proposes to offer to the general public. Which exemptions are available? This issuer proposes to limit its sales to wealthy investors; which exemptions are available?

(3) Manner of Offering. This issuer proposes to publish an advertising on the Internet. Which exemptions are available?

(4) Disclosure Requirements: This issuer doesn’t want any mandatory disclosure. Which exemptions are available?

And so on. This may not be the best sequence, but you get the general idea.

I think this organization would force students to think more like securities lawyers: consider the facts (offering amount; characteristics of the offerees, etc.), look at the universe of possible exemptions, and determine which exemptions, if any are available.

The substance covered would be the same under each approach, but the alternative approach would be truer to the type of analysis required in practice (and on the exam). We would be teaching students how to do the analysis, instead of forcing them to learn it on their own.

This is all tentative thinking on my part, so I would be interested in your views. It always worries me when I disagree with the way everyone else is doing something. (I don’t change my mind, but it does worry me.)  It may be that the best solution is just to buy each student one of these. (If my mother had bought one of these, my first reaction would have involved an ax. To the study carrel, not to my mother. I’m no Lizzie Borden.)

In my next post, I will discuss why I think the way we’re teaching business associations may also be backwards.

 

 

This is a “thinking out loud” post, which means I’m not sure
I’ve got the analysis correct, but feel it’s worth floating by readers in
draft form in an attempt to generate some discussion (which may include the
comment: “you are obviously wrong, and here’s why”).  I realize not all academic bloggers agree
this is an appropriate use of the blogosphere, but you now know my current
position on that issue.  (By the way, if
you do post a comment, please consider also emailing me directly at
spadfie@uakron.edu because I’m not clear on what sort of comment alerts we get
when comments are posted and I’d hate to miss one.)  So, with disclaimers firmly in place:

A few weeks ago, The CLS Blue Sky Blog posted a piece by
Pepper Hamilton on Round Two of Shareholder Say-on-Pay Litigation. Here is a relevant excerpt:

The third proxy season of the Dodd-Frank Act’s mandatory shareholder
“say-on-pay” advisory votes is well underway, and “round two” of shareholder
say-on-pay litigation is in full swing. Unlike the first round of say-on-pay
lawsuits, which were based on negative advisory votes that had already
occurred, this second wave of shareholder litigation, which began in 2012,
seeks to enjoin advisory votes on executive compensation based on allegedly
deficient proxy disclosures…. The Dodd-Frank Act expressly states that
shareholder say-on-pay votes … may not be construed as … (2) creating or
implying any change to the fiduciary duties of the company or its board; or (3)
creating or implying any additional fiduciary duties for the company or its
board…. Generally speaking, the complaints in these lawsuits do not allege that
the defendants violated any disclosure statute, rule or regulation. Instead,
the complaints aver that the directors breached their state law fiduciary
duties (e.g., duty of candor) ….

Further on, the piece quotes from a relatively recent
relevant case, Noble v. AAR Corp., 12 C 7973, 2013 WL 1324915 (N.D. Ill.
Apr. 3, 2013), wherein the court dismissed one of these cases:

Plaintiff does not dispute that Defendants have complied
with the federal disclosure requirements under the Dodd–Frank Act nor does he
point to any statutes, regulations, or case law that require corporations to
disclose more than the federal disclosure requirements. Indeed, Plaintiff does
not identify how the alleged omissions are even arguably covered under Item 402
or Item 407. Instead, Plaintiff attempts to create additional disclosure
obligations for “say on pay” votes without citing legal precedent other than
case law involving the required disclosures for shareholder actions outside of
the context of executive pay.

What strikes me as interesting about this analysis is that
it seems to suggest Dodd-Frank’s say-on-pay provision implicitly has preempted
state fiduciary duty law on what disclosures satisfy the duty of candor, which
seems wrong.  Cf. Robert E. Scully
Jr., Executive Compensation, the Business Judgment Rule, and the Dodd-Frank
Act: Back to the Future for Private Litigation?,  Fed. Law., January 2011, at 36, 38 (“the act
does not pre-empt state fiduciary duty law”). In other words, requiring
disclosures made in connection with say-on-pay votes to satisfy the duty of
candor should not be deemed to create improper additional disclosure
obligations, or change or add to existing fiduciary duties.  Rather, it should merely be understood as
applying existing duties to new disclosures, which strikes me as perfectly
consistent with the text of say-on-pay. 
In light of this, it should be possible to state a claim for a violation
of the duty of candor without alleging a violation of the federal disclosure
requirements.

HereHe

As I mentioned in my opening post, I’m a big fan of Jay
Brown.  So, I plan on routinely passing
on what he’s blogging about.  This week,
I’ve got two items:

In Corporate Governance, the SEC, and the Declining
Importance of Delaware Law, Jay suggests that “the SEC, rather than Delaware,
may increasingly be the driving force behind the development of substantive
duties for directors.”  Here’s an
excerpt:

[In] In re Alderman … the Commission settled an action
against directors of a mutual fund.  The
Commission first found a duty — 
“Under the Investment Company Act, directors had an obligation to
make good faith efforts to ensure that certain below-investment grade debt
securities for which market quotations were not readily available were valued at fair
value.”  The Commission then
concluded that this duty had not been fulfilled…. Likewise, the Commission has
sanctioned companies and boards for failing to adequately disclose the process
used in reaching a decision…. Unlike the law in Delaware where less board
involvement usually reduces the risk of liability (and encourages the ostrich
approach to governance), these cases suggest that greater involvement by
directors will in fact reduce the risk of an enforcement proceeding by the
SEC.  

In Wall Street, Risk Reduction and the Case for Glass
Steagall, Jay opines:

In reducing the amount of risk taking, bank regulators are
focusing on the protection of deposits not the collateral consequences to the
capital markets. Perhaps the US capital markets permitted too much risk
taking.  Certainly the financial crisis
demonstrated that independent investment banks required some additional oversight.  But the steps taken by bank regulators are
not done with the interests of the capital markets in mind. A re-separation of
investment and commercial banking (some form of Glass Steagall) would allow for
the rise of independent intermediaries that are regulated not as banks but as
brokers.  This in turn would allow some
of the lost risk at places like Morgan Stanley to remain in the capital
markets.

I encourage you to check out both posts in their entirety. 

Ronald Coase died this past Monday, and Stephen Bainbridge posted some related commentary here, as well as an excerpt of his review of Coase’s book The Firm, the Market, and the Law (here).  What follows are two of my favorite Coase quotes, taken from pages 3-4 of that book:

  • The rational utility maximizer of economic theory bears no resemblance
    to the man on the Clapham bus or, indeed, to any man (or woman) on any
    bus. There is no reason to suppose that most human beings are engaged in
    maximizing anything unless it be unhappiness, and even this with
    incomplete success.
  • In mainstream economic theory, the firm and the market are, for the most part, assumed to exist and are not themselves the subject of investigation.  One result has been that the crucial role of the law in determining the activities carried out by the firm and in the market has been largely ignored.

For those who have followed
the shareholder activism debate between Harvard Professor Lucian Bebchuk
(see a recent op-ed
piece here), corporate lawyer Martin Lipton from Wachtell, Professor
Stephen Bainbridge of UCLA  (see here for
example) and others, a new article provides some additional data
points.  In their article,
Professors Paul Rose of Ohio State and Bernard Sharfman of Case Western use the
work of Kenneth Arrow as a basis to discuss offensive shareholder activism. The
abstract is below:

Under an Arrowian
framework, centralized authority and management provides for optimal decision
making in large organizations. However, Arrow also recognized that other
elements within the organization, outside the central authority, occasionally
may have superior information or decision making skills. In such cases, such
elements may act as a corrective mechanism within the organization. In the
context of public companies, this article finds that such a corrective
mechanism comes in the form of hedge fund activism, or more accurately,
offensive shareholder activism. 

Offensive shareholder activism exists in the market for corporate influence,
not control. Consistent with a theoretical framework where the value of
centralized authority must be protected and a legal framework in which
fiduciary responsibility rests with the board, authority is not shifted to
influential but unaccountable shareholders. Governance entrepreneurs in the
market for corporate influence must first identify those instances in which
authority-sharing may result in value-enhancing policy decisions, and then
persuade the board and/or other shareholders of the wisdom of their policies so
that they will be permitted to share the authority necessary for the policies
to be implemented. Thus, boards often reward offensive shareholder activists
that prove to have superior information and/or strategies by at least
temporarily sharing authority with the activists by either providing them seats
in the board or simply allowing them to directly influence corporate policy.
This article thus reframes the ongoing debate on shareholder activism by
showing how offensive shareholder activism can co-exist with—and indeed, is
supported by—Arrow’s theory of management centralization which explains and
undergirds the traditional authority model of corporate law and governance. 

Empirical studies have repeatedly shown that certain types of offensive
shareholder activism lead to an increase in shareholder wealth. However, the
results of empirical studies must be interpreted carefully so as not to
overstate their informational value. Empirical research supports the argument
that certain types of offensive shareholder activism have value, but it does
not provide conclusive proof that they have value at any specific company at
any specific time. Instead, the use of empirical evidence supporting offensive
shareholder activism should be understood as providing proof that offensive
shareholder activists may on occasion successfully rebut the presumption of the
superiority of existing managerial strategies.