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Jonathan B. Wilson Archives

Judge Sanctions Porn Troll
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In a victory for corporate defendants that often face baseless suits intended to extort a quick settlement, a judge this week imposed sanctions on so-called "porn troll" Prenda.

Prenda had filed multiple suits against Comcast, AT&T and other internet service providers, claiming copyright infringement arising from the downloading of copywritten pornographic materials. The defendants claimed that the claims were baseless and that Prenda had brought the claims in hopes of extorting a quick settlement from corporations looking to avoid an association with pornography.

U.S. District Judge Patrick Murphy did not mince words:

"These men have shown a relentless willingness to lie to the court on paper and in person, despite being on notice that they were facing sanctions in this court, being sanctioned by other courts and being referred to state and federal bars, the United States Attorney in at least two districts, one state attorney general and the Internal Revenue Service."

Judge Murphy ordered Prenda to pay more than $260,000 in attorneys' fees and litigation costs to the defendants. Earlier this year a federal judge in California also ordered Prenda to pay defendants' attorneys' fees based on similar reasoning.

Because of the high cost of defending litigation, plaintiffs willing to aggressively plead cases can often extort settlements from defendants who are willing to settle at a price they think will be less than their cost of litigation. I covered this phenomenon and described the high economic costs resulting from the practice in my 2005 book, Out of Balance.

The CFPB, the consumer protection watchdog created by the Dodd-Frank Act, is coming after debt collectors.

Early this month the agency issued a notice of proposed rule making on the topic of debt collection practices.

The CFPB views debt collection as a significant part of the economy with substantial effects on consumers, noting that, "The use of debt collection litigation to recover on debts has grown to become a critical part of the debt collection industry, with collection law firms having an estimated $2.4 billion in revenues from collections in 2011."

Debt collection, however, is already the subject of extensive federal regulation through the Fair Debt Collection Practices Act, or "FDCPA". The CFPB, however, views consumers complaints and lawsuits against debt collectors under this law as indicating the need for additional regulation:

"Despite the enactment and enforcement of the FDCPA and other measures, protection problems related to debt collection have persisted. For many years, consumers have submitted more complaints to the FTC about debt collectors than any other single industry."

According to the CFPB, "Consumers most commonly complain to the FTC that collectors harass them, demand amounts that consumers do not owe, threaten dire consequences for non-payment, or fail to send required notices."

The CFPB writes that, "Not only do consumers complain about debt collectors, but they also file thousands of private actions each year against debt collectors that allegedly have violated the FDCPA. The number of these actions filed in Federal district court increased from 3,215 in 2005 to 11,811 in 2011, with increases observed each year."

With an administration that is struggling to change the topic away from healthcare and towards topics that can be managed without further Congressional action, look for the administration to shine a light on the CFPB's rulemaking activity and its emphasis on additional consumer protection regulations.

Wisconsin Governor Scott Walker is reportedly heading to Madison, Wisconsin to sign that state's crowdfunding bill.

With this new law Wisconsin will become the third state in the U.S. (along with Georgia and Kansas) to permit intrastate crowdfunded securities offerings.

On October 23, 2013 the Securities and Exchange Commission (the "SEC") issued proposed regulations (the "Proposed Rules") with respect to crowdfunding as contemplated by Title III of the Jumpstart our Business Startups Act of 2012 (the "JOBS Act"). The Proposed Rules are open for comment for 90 days from the date of publication in the federal register (a period that will likely run to the end of January, 2014).

While the Proposed Rules will not be effective until adopted by the SEC, and the SEC may change the Proposed Rules before adopting them, if adopted in their present state the Proposed Rules will make it possible for privately-owned company to sell securities to investors over the Internet through registered "crowdfund portals." Under the Securities Act of 1933 (the "1933 Act"), companies may not sell securities to investors unless the securities are either registered (generally requiring an initial public offer or "IPO") or exempt from registration. The crowdfunding authorized by Congress through the JOBS Act creates a new exemption from registration (now contained at Section 4(a)(6) of the 1933 Act) and the Proposed Rules, if adopted, would make it possible for sales of securities under this new exemption to commence.

I have posted here a lengthy analysis of the provisions of the Proposed Rules applicable to issuers of securities under the new Section 4(a)(6) exemption. My firm is planning a second publication shortly to cover the provisions of the Proposed Rules applicable to crowdfund portals.

The SEC has formally announced that it will hold a public meeting on October 23 to determine whether to release proposed crowdfunding rules.

(Update: Coverage on Washington Post).

A bi-partisan group of Senators consisting of Jeff Merkley (D-OR), Jerry Moran (R-KS), Michael Bennet (D-CO), Mark Warner (D-VA), Kelly Ayotte (R-NH), Jon Tester (D-MT), Pat Toomey (R-PA), and Mary Landrieu (D-LA) has written an open letter to SEC Chair Mary Jo White, asking that the SEC adopt regulations to implement crowdfunding as contemplated by the 2012 JOBS Act.

As the letter points out, the law required the SEC to adopt regulations within 270 days after enactment. It has been more than 530 days and the SEC has not completed the task.

Business writer Dave Michaels, writing in Bloomberg's Businessweek has penned a piece under the headline, "SEC to Issue Crowdfunding Proposal Easing Investor Verification."

The article explains that "Small businesses raising money by selling shares over the Internet wouldn't have to verify that their backers comply with individual investment limits under a U.S. regulatory proposal set for a vote as soon as next week."

The article is potentially confusing to those trying to follow the numerous changes now being rolled out that affect capital formation for emerging growth companies. My hope in writing this is to eliminate that potential confusion.

The 2012 JOBS Act, among its other efforts, was intended to make possible securities-based crowdfunding on a nationwide basis. Title III of the JOBS Act created a comprehensive system by which private companies could sell securities (equity or debt) to investors in the U.S. on licensed "crowd-fund portals". Investors would be limited in the amount of money they could invest in a crowdfunded offering based upon their income levels.

Congress directed the SEC to adopt regulations implementing Title III within 270 days after the law's enactment. More than 1.5 years have elapsed and the SEC still has not adopted those necessary regulations, although SEC Chair Mary Jo White has been quoted to say that she expects those regulations out by the end of 2013.

The Bloomberg article describes a "regulatory proposal" that would expressly relieve issuers of securities in crowdfunded offerings from having to verify the income levels of participating investors.

Importantly, no regulatory proposal has yet been released to the public, and Dave Michaels notes that he is relying on unnamed sources within the SEC "with direct knowledge of the matter who asked not to be named because the proposal hasn't been made public." Assuming that the rumor is true, however, it is also important to understand what this proposal would, and would not, cover.

Although crowdfunding under Title III of the JOBS Act prohibits investors from making investments greater than their income-related levels, that prohibition is only one of several requirements. Even if the rumored proposal were adopted, that would not allow companies to start issuing securities in crowdfunded offerings any time soon. The SEC would still need to adopt all of the other regulations required to implement crowdfunding, including a comprehensive description of the licensing requirements for the yet-to-be-defined "crowd-fund portals". Because the licensing of the crowdfund portals is likely to fall within FINRA's purview, even the completion of the SEC's rules will not be enough to implement crowdfunding because FINRA would also be required to adopt procedures for portal licensing. Once adopted, potential portals would need to complete the FINRA licensing process before launching, a process that would likely take months.

So, while a proposed rule that relieved issuers from a duty to verify an investor's income would be a step forward, it would not come anywhere close to completing the regulatory work needed to implement crowdfunding under the JOBS Act.

It's also important for those following these issues to understand how investor income verification is a separate topic from accredited investor status as it relates to Regulation D.

Before the advent of crowdfunding, private offerings under Regulation D were the primary means of capital formation for emerging growth companies. Under the mandates of the JOBS Act the SEC has recently adopted regulations making it possible for private companies to issues securities under Regulation D through public solicitations under Rule 506(c). One of the requirements of these new "public/private" offerings is that all of the participating investors be accredited investors (a category that is defined by either the investor's income or net worth). A key element of the new Regulation D rules is that securities issuers must take additional steps to verify the status of each investor as an accredited investor through a process that might require the issuer to verify the issuer's income.

The proximity of Dave Michael's rumored income verification rule for crowdfunding with the accredited investor status verification rule under Regulation D could become confusing for some. Even if the rumored proposal eliminated a duty on the part of an issuer to verify income for compliance with Title III of the JOBS Act, that proposal would have no bearing on the issuer's duty to verify accredited investor status (via income or net worth) for purposes of an exempt private offering under Regulation D.

The Wisconsin crowdfunding bill has passed the state Senate and now moves to the desk of Wisconsin Governor Scott Walker.

Quoting the Milwaukee Business Journal:

"Where the federal government has delayed, Wisconsin has acted," said Rep. David Craig, (R-Vernon), one of the bill's lead co-authors, in a prepared statement. "Where other states have failed to allow small business to harness the power of the Internet, Wisconsin has embraced it. Sen. (Leah) Vukmir, Rep. (Chad) Weininger and I have put our joint time and efforts into crafting this important legislation, and with the overwhelming support of the Legislature we look forward to Gov. Walker signing this important jobs bill in the near future."

The Wisconsin bill, if passed into law, would make Wisconsin the third state to permit intrastate crowdfund offerings (along with Kansas and Georgia).

Citing a "large amount of public interest" the SEC has extended the comment period by an additional thirty days (counting from the date the notice of the extension is published in the federal register).

Publication in the federal register generally takes a few business days, so the extended comment period will probably run until sometime in early November.

An informal survey of the comments submitted so far can be summarized as "339 opposed, 9 in favor and 30 irrelevant or incomprehensible."

The extended comment period (probably intended to buy the SEC more time to figure what to do with the mess it has created) will unfortunately tend to increase the confusion already present in the market place. For those keeping score, there were three related releases on July 23rd, two became effective on September 23rd and the third (regarding amendments to Form D) has had its comment period extended. So, if you are an issuer engaged in a Rule 506 offering you need to think through the decision to stay private (Rule 506(b)) or engage in public solicitations (Rule 506(c)).

If you opt for public solicitations, you should expect that the SEC is going to require you to do something on your Form D, but, because those rules are not yet adopted, we can't know for certain what that will be.

Wisconsin Crowdfunding Bill
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Following the lead of Georgia and Kansas, lawmakers in Wisconsin have proposed a bill that would adopt a form of intrastate securities-based crowdfunding in that state. Wisconsin Crowdfunding Bill

Assembly Bill 350, known as the Crowdfunding Securities Exemptions for JOBS Act (or "CASE for JOBS Act") aims to bypass the delay caused by the SEC's failure to implement regulations to permit crowdfunding as required by the federal JOBS Act passed by Congress in 2012. While nationwide interstate crowdfunding remains stuck behind the SEC's inaction, states like Georgia and Kansas have leapt ahead with intrastate rules that permit crowdfunding by companies organized in their states to investors residing in their states.

The Wisconsin bill would combine many of the features of the Georgia and Kansas rules (which are nearly identical) with some of the features of crowdfunding as envisioned by the federal JOBS Act.

Like Georgia and Kansas, the Wisconsin bill would exempt securities issued in purely intrastate transactions in Wisconsin where both the issuer and the investor were residents in that state.

Also like Georgia and Kansas, the Wisconsin bill would allow investments by non-accredited investors up to a maximum dollar amount per issue ($5,000). Accredited investors, however, could invest any amount.

In a strange twist, however, the Wisconsin bill would adopt a unique definition of "accredited investor" (which is generally defined under Rule 501 of the SEC's Regulation D as either (i) an individual with $200,000 or more in adjusted gross income ($300,000 if married filing jointly) for each of the past two years (and the reasonable expectation of achieving the same outcome in the current year), or (ii) an individual with a net worth of $1 million or more (excluding the individual's principal residence). Under the Wisconsin bill, however, the income prong of the definition would be reduced to $100,000 (for single investors) and $150,000 (for married investors) while the net worth prong would be reduced to $750,000. The proponents of the bill have said that this twist is for the purpose of sweeping more Wisconsin residents into the accredited investors definition.

The Wisconsin bill is also noteworthy because it would require its crowdfunded offerings to take place on licensed web portals, much in the way contemplated by the federal JOBS Act. (In contrast, the Georgia and Kansas rule have no provision for licensing crowdfunding web portals.)

The Wisconsin bill would exempt intrastate offerings of up to $1 million (increasing to $2 million if the issuer has audited financial statements). Issuers are required to make a notice filing with the Wisconsin Department of Financial Institutions.

As of this writing the bill has been introduced but not yet acted upon.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.