Articles

Olufunmilayo B. Arewa, Securities Regulation of Private Offerings in the Cyberspace Era: Legal Translation, Advertising and Business Context, 37 U. Tol. L. Rev. 331 (2006).

Abstract (from author): Evaluating the application of existing securities laws and regulation in a cyberspace context requires an understanding of how existing legal structures accommodate changing societal or other conditions, including changes resulting from technological innovation and changing business culture and practice, which both encompass and extend beyond changes resulting from technological innovations. Understanding the application of securities regulation in such circumstances represents a distinct response to the familiar problem of applying and borrowing from existing legal frameworks in new contexts. However, since existing securities laws and regulations were originally crafted during an earlier time period, the translation of such frameworks in new contexts leads at times to questionable outcomes, at least partly because such frameworks represent a response to a particular historical context involving specific business practices that might not be as relevant in the business climate of today. This is particularly true with respect to non-public offerings, which were recognized in the Securities Act of 1933 from its inception. This Article assesses the translation of existing securities laws and regulation in the cyberspace context of non-public offerings, focusing specifically on restrictions on general solicitations and advertising in non-public offerings, as well as whether and how structures that exist in "real" space can be adapted in the cyberspace context.

Francesco Bova et al., The Sarbanes-Oxley Act and Exit Strategies of Private Firms (2011), available at http://ssrn.com/abstract=1730242.

Abstract (from author): The costs and benefits of the Sarbanes-Oxley Act of 2002 (SOX) have been oft-debated since the inception of the Act. Much of the extant literature has assessed the costs and benefits of SOX to publicly-traded companies. We focus on the costs of SOX compliance for private firms wanting to exit the private market via either an acquisition by a public firm or an IPO. Consistent with our predictions we establish three principal findings. First, SOX appears to have shifted the incentive for firms to exit the private market via IPO to exit via acquisition by a public acquirer. Second, private target deal multiples are increasing in variables that proxy for a private target’s level of pre-acquisition SOX compliance. For our median-sized private target, the estimated dollar value decrease in deal proceeds when one moves from a high level to a low level of pre-acquisition SOX compliance is $1.3 million. Finally, public target deal multiples are not affected by a public target’s level of pre-acquisition SOX compliance. These findings suggest that SOX-related costs have both restricted the action space of possible exit strategies for private firms and led to lower deal multiples for those private acquisition targets that are less likely to be SOX compliant prior to acquisition. We believe that the implications from our tests will be relevant to regulators in the U.S. and many countries outside the U.S. that are attempting to improve their country’s governance and listing standards and potentially seeking alternatives to SOX-like standards, especially with respect to internal controls. International regulators need to assess the total costs of SOX, including costs imposed on private company shareholders, when contemplating the net benefits of SOX-like regimes.

C. Steven Bradford, Crowdfunding and the Federal Securities Laws, 2012 Colum. Bus. L. Rev. 1 (2012).

Abstract (from author): Crowdfunding -- the use of the Internet to raise money through small contributions from a large number of investors -- could cause a revolution in small-business financing. Through crowdfunding, smaller entrepreneurs, who traditionally have had great difficulty obtaining capital, have access to anyone in the world with a computer, Internet access, and spare cash to invest. Crowdfunding sites such as Kiva, Kickstarter, and IndieGoGo have proliferated, and the amount of money raised through crowdfunding has grown to billions of dollars in just a few years. Crowdfunding poses two issues under federal securities law. First, crowdfunding sometimes involves the sale of securities, triggering the registration requirements of the Securities Act of 1933. Registration is prohibitively expensive for the small offerings that crowdfunding facilitates, and none of the current exemptions from registration fit the crowdfunding model. Second, the web sites that facilitate crowdfunding may be treated as brokers or investment advisers under the ambiguous standards applied by the SEC. This article considers the costs and benefits of crowdfunding and proposes an exemption that would free crowdfunding from the registration requirements, but not the antifraud provisions, of federal securities law. Securities offerings for an amount less than $250,000-500,000 would be exempted if (1) each investor invests no more than the greater of $500 or 2% of the investor's annual income; and (2) the offering is made on an Internet crowdfunding site that meets the exemption's requirements. To qualify for the exemption, crowdfunding sites would have to: (1) be open to the general public; (2) provide public communication portals for investors and potential investors; (3) require investors to fulfill a simple education requirement before investing; (4) prohibit certain conflicts of interest; (5) offer no investment advice or recommendations; and (6) notify the SEC that they are hosting crowdfunding offerings. Sites that meet these requirements would not be treated as brokers or investment advisers.

Edan Burkett, A Crowdfunding Exemption? Online Investment Crowdfunding And U.S. Securities Regulation, 13 Transactions: Tenn. J. Bus. L. 63 (2011).

Abstract (from author): In recent years, artists, entrepreneurs, and nonprofits (collectively “promoters”) have tapped the collaborative power of the online crowds to fund a wide range of charities, creative projects, and even investment opportunities. This phenomenon is called “crowdfunding,” or sometimes “crowd financing” or “crowd-sourced capital.” This Article first examines the intractable conflict between investment crowdfunding and traditional U.S. securities laws and then explores possible solutions that would enable small companies to more easily raise capital through the online crowds.

Abraham J.B. Cable, Fending for Themselves: Why Securities Regulations Should Encourage Angel Groups, 13 U. Pa. J. Bus. L. 107 (2010).

Abstract: This article argues that securities law has not kept up with the needs of today’s entrepreneurs and their investors, artificially lowering the potential for new companies to find financing, especially from angel groups.

Cécile Carpentier & Jean-Marc Suret, Entrepreneurial Equity Financing and Securities Regulation: An Empirical Analysis, 30 Int'l Small Bus. J. 41 (2012).

Abstract (adapted from authors): To protect investors, securities regulation generally restrains entrepreneurial ventures from entering the stock market. Scholars and regulators contend that strong rules and requirements for listing are essential to prevent the market from failing. However, these constraints can also unduly impede the growth of new ventures. The authors use the Canadian case to examine the effects of the relaxation of the regulatory constraints. Unlike in other countries, firms in Canada can list at a very early stage, without revenues, with a minimal size and even without writing a prospectus using the reverse merger technique. This provides a unique opportunity to examine entrepreneurial ventures listed on a public market. The quality of firms, their post-listing operating performance and strategy, and their fate largely support the opinion that strong listing requirements are essential to prevent the emergence of a lemon market. Investors involved in this market obtain very poor returns. This indicates that they are neither able to set correct prices in this market nor deal with the high level of information asymmetry therein. The reluctance of most regulators to relax the requirements for small business finance can, therefore, be justified.

Stephen J. Choi, Gatekeepers and the Internet: Rethinking the Regulation of Small Business Capital Formation, 2 J. Small & Emerging Bus. L. 27 (1998).

Abstract (from author): This Article argues that reduced communication costs through the Internet will both make it more difficult for countries to impose mandatory securities regulatory regimes and increase the value of regulatory competition. Both issuers and investors will value regulations that reduce the incidence of fraud. Securities market participants, therefore, will voluntarily bind themselves to value-increasing securities regulations. Private sources of investor protection, including third party certifiers of information, will also flourish over the Internet. This Article argues that the Internet will make it possible for issuers and investors to pick and choose among both public and private sources of protections, leading to the best combination of protections for each particular securities offering.

Stuart R. Cohn & Gregory C. Yadley, Capital Offense: the Sec's Continuing Failure to Address Small Business Financing Concerns, 4 N.Y.U. J. L. & Bus. 1 (2007).

Abstract: This article reviews the criticisms leveled by small business advocates against the Securities and Exchange Commission efforts to lighten the legal and regulatory burden on small companies that are raising capital.  It provides a review of SEC proposals aimed at small business financing and concludes that these proposals, while somewhat helpful, fall short of addressing the capital formation problems faced by small businesses. The authors discuss the primary hurdles confronting small businesses under the securities laws and offer a critique informed by the twin goals of protecting investors while providing realistic opportunities for small businesses to raise capital in compliance with the regulatory scheme.

Alexander E. Csordas, Note, Funding Entrepreneurial Ventures in China: Proposals to More Effectively Regulate Chinese Foreign Private Issuers, 38 Brook. J. Int'l L. 373 (2012).

Abstract (adapted from author): Over the past thirty years, the People's Republic of China has emerged into an economic juggernaut. China has leveraged its population of 1.3 billion people to industrialize at an incredible rate. Three decades of 9 percent average annual growth in gross domestic product (“GDP”) resulted in China supplanting Japan as the world's second largest economy in 2010. Moreover, by focusing on infrastructure spending and the export of consumer goods to drive economic growth, China has managed to largely avoid the financial turmoil that has roiled developed economies, particularly the United States and the European Union, since late 2007. The vibrancy of China's economy has led to the emergence of a middle class and a generation of “budding entrepreneurs” who seek to build new businesses and raise capital. Western investors have been eager to seek investment opportunities in these fast-growing Chinese businesses and to enter a market that, a generation ago, was off-limits to outsiders. Foreign investment in Chinese firms, however, has been plagued with problems. Regulators have discovered numerous instances of corruption and fraud, often perpetrated through deceptive accounting practices, within Chinese companies publicly listed in the United States. These revelations have resulted in international finger pointing between the United States Securities and Exchange Commission (“SEC”) and the China Securities Regulatory Commission. This Note explores the issues raised by such tainted firms and suggests policy changes that may result in more effective regulation of Chinese public companies. Specifically, this Note argues that by implementing legislation that mirrors provisions of the United States' Sarbanes-Oxley Act of 2002, China may be able to develop and, more importantly, enforce a stricter regulatory regime that will reduce corporate fraud.

Andrew C. Fink, Protecting the Crowd and Raising Capital Through the Crowdfund Act, 90 U. Det. Mercy L. Rev. 1 (2012).

Abstract (adapted from author): You are an entrepreneur with an innovative business idea, but you have no assets. You need cash to bring your idea to the production line, but no bank or wealthy investor will listen. Would you think it possible to raise over $200 million from five million strangers using just your idea, a website, and social media? That is exactly what happened in 2009 when marketing executives Michael Migliozzi II and Brian Flatow solicited individual investors using their website, BuyABeerCompany.com, to fund a potential purchase of beer company Pabst Blue Ribbon. The average pledge from individuals was just $40, and in return, investors were promised “a certificate of ownership as well as beer of a value equal to the amount invested.” The Securities and Exchange Commission (SEC) stepped in to halt the campaign because it violated securities law, but the message was clear: business ideas can be funded by connecting the entrepreneur to the masses through the Internet and social media platforms. Entrepreneurs and investors took notice of the event, and in July 2010, the Sustainable Economies Law Center sent a petition to the SEC requesting a federal securities exemption for small businesses seeking up to $100,000 in funding with individual investments of $100. Congress could not ignore the economic potential of this untapped resource, and (for once) is attempting to position itself in front of social media transformations. The Jumpstart Our Business Startups Act, commonly referred to as the JOBS Act, is an amalgamation of prior proposals. Title III of the JOBS Act is called the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012,” or in shorter form, the CROWDFUND Act. The bill was signed into law on April 5, 2012, and stands to revolutionize small business and entrepreneurial capital-raising by permitting any individual to invest in private companies over the Internet with limited regulatory hurdles. While crowdfunding in the form of charitable contribution and political fundraising is not a new concept, the notion of equity crowdfunding, where investors have an expectation of profit, is a young solution to the financing problems that small businesses and entrepreneurs face. Lawmakers have spent the last two years brainstorming ways to promote crowdfunding investing as a responsible capital raising avenue and potential jumpstart to the economy. The JOBS Act, as cemented into law, will create a new and largely unexplored market for raising capital. Part I of this Article introduces the Crowd and the crowdfunding concept, and also discusses the U.S. legal framework that has yet to account for the global influence of the Crowd. Part II analyzes the JOBS Act and the proposals that led to its creation. Part III analyzes crowdfunding concerns and the efforts to balance investor protection with capital raising.

Jill E. Fisch, Can Internet Offerings Bridge the Small Business Capital Barrier?, 2 J. Small & Emerging Bus. L. 57 (1998).

Abstract (from author): Internet technology offers the potential to reduce the search and information costs associated with capital formation. Commentators have suggested that the Web will enable small business to achieve better access to the capital markets. To facilitate this access, they have suggested regulatory reforms to make Internet offerings cheaper and easier. At the same time, small business offerings have been identified as among the most risky, offering a caution to those who counsel regulatory reform. This Article examines the existing regulatory climate. State and federal regulators have adopted a number of recent reforms to facilitate the use of the Internet and to reduce the regulatory burden on small business offerings. The Article explores proposals for further reform and evaluates the existing evidence on the extent to which previous regulatory changes have affected the use of the Internet for small business capital formation. The Article observes that, despite these reforms, small business have had limited success to date in using the Internet as a substitute for traditional financing methods. The Article goes on to consider the effect of substituting public capital markets for traditional small business financing sources, such as bands, angel investors, and venture capital, if technological and regulatory change makes this substitution possible. In particular, the Article indentifies nonfinancial benefits that banks and private equity provide to small businesses through active managing and monitoring. Shifting the source of small business capital may sacrifice these benefits, at the cost of future business performance.

Theresa A. Gabaldon, Love and Money: An Affinity-Based Model for the Regulation of Capital Formation by Small Businesses, 2 J. Small & Emerging Bus. L. 259 (1998).

Abstract (from author): The focus of the Forum is the impact of technology and innovation on the financing of small business. The significance of love and friendship to this topic may not be obvious. One could, I suppose, posit a family Web site as the securities-offering vehicle posing the problems described below. The authorial intent, however, was to alleviate, without criticizing, the quite possibly disembodied nature of the forum discussion -- to interject some flesh and blood. Real people borrow money from their sisters. They always have and, on or off the Internet, I hope they always will.

Kathleen Weiss Hanley & Gerard Hoberg, Litigation Risk, Strategic Disclosure and the Underpricing of Initial Public Offerings (FEDS Working Paper No. 2011-12, 2011), available at http://ssrn.com/abstract=1810084.

Abstract (adapted from author): Using word content analysis on the time-series of IPO prospectuses, we find evidence that issuers trade off underpricing and strategic disclosure as potential hedges against litigation risk. This tradeoff explains a significant fraction of the variation in prospectus revision patterns, IPO underpricing, the partial adjustment phenomenon, and litigation outcomes. The authors find that strong disclosure is an effective hedge against all lawsuits. Underpricing, however, is an effective hedge only against the incidence of Section 11 lawsuits, those lawsuits which are most damaging to the underwriter. Underwriters who fail to adequately hedge litigation risk experience economically large penalties including loss of market share.

Joan MacLeod Heminway & Shelden Ryan Hoffman, Proceed at Your Peril: Crowdfunding and The Securities Act of 1933, 78 Tenn. L. Rev. 879 (2011).

Abstract (adapted from author): This article first analyzes the circumstances under which crowdfunding interests are securities under the definition provided in Section 2(a)(1) of the Securities Act. After situating crowdfunding interests as potential investment contracts governed by the Howey test (or, in the alternative, debt interests governed by the Reves test), this part of the article explains the elements of an investment contract and compares and contrasts them, in pertinent part, to the attributes of crowdfunding interests. This analysis reveals that some crowdfunding interests are likely classifiable as securities. Given that some crowdfunding interests may be securities, the article then focuses on the consequences of that legal conclusion. It describes the regulatory ramifications of security status under the Securities Act's key operative provisions (which require, in significant part, that the offer and sale of a security must be registered or exempt from registration) and the policies underlying both the registration requirement and relevant exemptions. The article explains why the offer and sale of crowdfunding interests under certain conditions should not require registration, and suggests the principles and potential parameters of a new registration exemption for crowdfunding interests, which could be adopted by the SEC under Section 3(b) of the Securities Act.

Jennifer J. Johnson, Private Placements: A Regulatory Black Hole, 35 Del. J. Corp. L. 151 (2010).

Abstract (from author): Many investors, including vulnerable senior citizens, are victimized each year in dubious securities offerings yet governmental regulators can do little to intervene. Utilizing the Rule 506 private placement exemption, promoters today can escape regulatory review by both federal and state securities officials. While states at one time served as “local cops on the beat” to protect their citizens, Congress in 1996 preempted state authority, thus creating a situation in which suspect investment schemes can proliferate below any governmental radar screen. This article questions the continued wisdom of this regulatory vacuum, especially in light of recent financial events.

This article reviews the legislative history of this preemptive statute, the National Securities Markets Improvements Act of 1996 (NSMIA), and concludes that the preemption of private placements either resulted from congressional misconceptions, back room politics arising from the conservative deregulatory agenda of the decade, or both. After analyzing the regulations and the private placement market as it existed in 1996, and as it operates today, the article concludes that NSMIA’s cogent preemptive force primarily impacts state authority over the smaller, most risky private placements. Combined with the lack of federal oversight, this statutory preemption creates a regulatory abyss that permits many questionable offerings to take place. In its zeal to deregulate, Congress left many investors with little, if any, governmental protection. This article proposes a return to state supervision of designated private placements. This modest proposal would foster capital formation, protect investors, and provide for a more rational and efficient legislative framework to regulate private securities transactions.