Improving Legal Documents In Crowdfunding: New Risk Factor For Supreme Court Ruling

It appears the Supreme Court is about to strike down Roe v. Wade, allowing states to regulate or outlaw abortion. Many states are poised to do so with varying degrees of severity. 

In his draft opinion in Dobbs v. Jackson Women’s Health Organization, Justice Alito states that the decision would not affect other rights, like the right to gay marriage (Obergefell v. Hodges), the right to engage in homosexual relationships (Lawrence v. Texas), or the right to contraception (Griswold v. Connecticut). In my opinion, you should take Justice Alito’s assurance with a large spoonful of salt.. Theoretically, all these cases rest on a constitutional right to privacy. If you knock that pillar down for one right it falls for all of them. On a practical level, Justice Alito himself voted against gay marriage and I have little doubt that there are at least five votes to overturn all these precedents.

Some states are already considering bans on contraception and surely challenges to gay marriage are close on the horizon.

When the COVID-19 pandemic swept the country, companies raising capital had to add one or more risk factor to their offering materials, describing how the pandemic could harm their businesses. I believe the Supreme Court’s opinion in Dobbs v. Jackson Women’s Health Organization calls for the same thing.

Imagine a SAAS company in Austin, Texas, looking to recruit talented young engineers. Imagine the company’s ideal candidate:  a woman who just graduated from Stanford with a specialty in AI. If she has one job offer from the company in Austin and another from a company in Oregon it isn’t hard to see why the Texas company would have a competitive disadvantage, all other things being equal.

Companies are already trying to mitigate the risk. For example, Starbucks has announced free travel to employees to states where abortion is legal. But even that might not eliminate the risk. Do women want to travel out of state for medical care? And, in any case, many states where abortion is or will be illegal are trying to make it illegal to travel out of state for an abortion

Whatever the realities of the marketplace, our job as securities lawyers is to make investors aware of risks so our clients can’t be sued afterward. I suggest the following or something like it in the offering materials of any company where recruitment is important

State Laws Might impair the Company’s Ability to Recruit: The U.S. Supreme Court [seems poised to overturn] [has recently overturned] women’s privacy rights in health care decisions set forth in Roe v. Wade. Moreover, the reasoning used by the Court in overturning Roe v. Wade suggests that other constitutional rights could also become subject to restriction by the states, including the right to gay marriage and use of contraception. Texas, where the Company’s headquarters are located, has enacted strict laws regulating abortion and its political climate is such that it might seek to limit or take away other rights as well. These state laws could impair the Company’s ability to recruit and retain personnel and could put the Company at a competitive disadvantage with companies in other states.

Questions? Let me know.

Improving Legal Documents in Crowdfunding: Get Rid of the State Legends!

I see lots of offering documents like this, with pages of state “legends.” The good news is that in Crowdfunding offerings – Title II (Rule 506(c)), Title III (Regulation Crowdfunding), and Title IV (Regulation A) – you can and should get rid of them.

The legal case is pretty simple:

  • Before 1996, states were allowed to regulate private offerings. Every state allowed exemptions, but these exemptions often required legends, differing from state to state.
  • The National Securities Market Improvement Act of 1996 added section 18 to the Securities Act of 1933. Section 18 provides that no state shall “impose any conditions upon the use of. . . .any offering document that is prepared by or on behalf of the issuer. . . .” in connection with the sale of “covered securities.”
  • The securities sold under Title II, Title III, and Title IV are all “covered securities.”
  • Hence, section 18 prohibits states from imposing any conditions regarding the issuer’s offering documents, including a condition that requires the use of a state legend.

If the capitalized legends just take up space, why not include them anyway just to be safe? Take Pennsylvania’s legend as an example:

These securities have not been registered under the Pennsylvania Securities Act of 1972 in reliance upon an exemption therefrom. any sale made pursuant to such exemption is voidable by a Pennsylvania purchaser within two business days from the date of receipt by the issuer of his or her written binding contract of purchase or, in the case of a transaction in which there is not a written binding contract of purchase, within two business days after he or she makes the initial payment for the shares being offered.

If you include the Pennsylvania legend “just to be safe,” you’ve given Pennsylvania investors a right of rescission they wouldn’t have had otherwise!

Two qualifications.

First, the North American Securities Administrators Association –the trade group of state securities regulators – suggests including uniform legend on offering documents. I include this or something similar as a matter of course:

IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THESE SECURITIES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THESE SECURITIES ARE SUBJECT TO RESTRICTIONS ON TRANSFERABILITY AND RESALE AND MAY NOT BE TRANSFERRED OR RESOLD EXCEPT AS PERMITTED UNDER THE ACT, AND THE APPLICABLE STATE SECURITIES LAWS, PURSUANT TO REGISTRATION OR EXEMPTION THEREFROM. INVESTORS SHOULD BE AWARE THAT THEY WILL BE REQUIRED TO BEAR THE FINANCIAL RISKS OF THIS INVESTMENT FOR AN INDEFINITE PERIOD OF TIME.

Second, some states, including Florida, require a legend to appear on the face of the offering document to avoid broker-dealer registration. Because Section 18 of the Securities Act doesn’t prohibit states from regulating broker-dealers, some lawyers recommend including those legends, while others believe those requirements are an improper “back door” way for states to avoid the Federal rule. I come out in the latter camp, but opinions differ.

Questions? Let me know.

Improving Crowdfunding Legal Documents

I don’t know much about videos or marketing, but I know a lot about legal documents. In a series of posts I’m going to suggest improvements to some of the legal documents used in Crowdfunding. Most of the time, I’ll suggest actual language a portal or issuer can cut and paste – after talking with a lawyer, of course.

By and large, the legal documents you see on Crowdfunding websites were pulled from other deals. For example, the Operating Agreement you see on a real estate Crowdfunding website is usually the same document the lawyer used for pre-Crowdfunding deals. And in many respects that’s okay because legal documents are pretty agnostic as to industry.

But in other respects it’s not okay. Sometimes you have to tailor the legal document to the industry.

An example is the section of the Operating Agreement that talks about an investor’s right to information. The provision from one well-known site says that the records of the company “. . . shall be available at the Company’s principal office for inspection and copying by any Member at any and all reasonable times during normal business hours at such Member’s expense.” Another says “A Member and the Member’s authorized representative shall, upon reasonable request and for purposes related to the interest of that Member, have reasonable access to, and may inspect and copy, during normal business hours all books, records and other materials pertaining to the Company or its activities.”

No! These provisions were typical in the pre-Crowdfunding world, but they don’t work with Crowdfunding.

You might have 218 investors in a Crowdfunding deal. You have to limit the right of investors to come to your office to inspect the books, and you have to limit what they can see. Under the Delaware limited liability company statute, if you don’t provide otherwise, your investors have the right to see basically everything, including a list of all the other investors. With one or two unscrupulous or irrational investors, that’s a recipe for losing sleep.

We want to:

  • Be fair to investors and provide all the information they need
  • Avoid spending an inordinate amount of management time dealing with bad apples
  • Protect your confidential information
  • Avoid dealing with 218 investors each asking for the same information
  • Give you discretion to protect your business and the interests of your investors

For an example of actual legal language that does just that while, I believe, fully complying with the Delaware Limited Liability Company Act, click here.

Questions? Let me know.