Later this year, anyone will be able to register domain names with the new .xxx gTLD (generic top level domain).  But beginning September 7, 2011 through October 28, 2011 trademark owners will have the right to block their trademarks from .xxx registration.  By paying a $225 fee to a registrar, a trademark owner can have the .xxx domain associated with its trademark removed from the pool of domain names available for registration for ten years and the WHOIS information will list standard registry information.  Persons who visit the blocked .xxx domain will see an informational page indicating the status of the domain name as not available for registration.  Providing an informational page for the blocked domain should prevent “synthetic DNS” or non-DNS resolution systems from hi-jacking queries to these domain names.

Businesses with valuable brands and trademarks, those who rely on Internet searches utilizing their name to direct users to their websites, e-commerce and Internet based businesses, religious, non-profit and political organizations, should consider blocking their trademarks from .xxx registration.  Adult Internet businesses have some of the highest usage and highest search engine rankings on the Internet.  This means that businesses and organizations who rely on the Internet and search engine optimization to acquire customers and promote their brands could shortly find that their homepage is ranked with or below a corresponding .xxx website on searches for their name.  For example, www.”mybusiness”.xxx could eventually be a first page search result or even a higher ranking search result for the term “my business” than your primary www.”mybusiness”.com home page.  Blocking .xxx registration will prevent this possibility.

Here is the procedural schedule for .xxx registration:

Sunrise A – September 7, 2011 to October 28, 20111

During this period, adult businesses with verifiable trademark rights can register .xxx domains.

Sunrise B – September 7, 2011 to October 28, 20111

During this period, non-adult businesses with verifiable trademark rights can block their trademarks from registration as .xxx domains.

Quiet Period – October 29, 2011 to November 7, 2011

Landrush – November 8, 2011 to November 25, 2011

                During this period adult businesses bid at auction to purchase unclaimed .xxx gTLDs.

Quiet Period – November 9, 2011 to December 6, 2011

General Availability – December 6, 2011

                After this date .xxx gTLDs are available to anyone who wants to purchase.

Frustrated entrepreneurs who can’t interest a placement agent sometimes turn to “finders”, which I warned against in “No Free Lunch -Colorado Case Points Out Danger of Using “Finders” in Private Placements“. So what is a founder looking for capital supposed to do?  Assuming you have a good, marketable service or product, and the skill set to make it succeed, then work from a professional business plan and offering documents, build your network, and understand the process from the view of the placement agent and target investors – with those in place, persistence and patience usually pays-off.

The Department of Justice has used these agreements for years in corporate fraud cases.  The infamous “Thompson Memorandum”, written by Larry Thompson of the DOJ in 2003 to help federal prosecutors decide whether to charge a company with criminal offenses, required that a company must

1. turn over materials from internal investigations,
2. waive attorney-client privilege, and
3. not provide targeted executives with company-paid lawyers,

before the company could claim credit for cooperating with the DOJ.   In other words, a company might provide extensive cooperation to the DOJ, but would not get any credit for that cooperation unless it expressly gave up its rights and breached its indemnification contracts.  Nearly every public company has indemnification agreements with its directors and officers, and indemnification is provided in the corporation statutes of Delaware, Colorado, and most other states. While eviscerating the constitutional rights to counsel and against self-incrimination, and the statutory right and contractual obligation to indemnification, the Thompson Memo also provided for the use of non-prosecution agreements for companies that waived their constitutional rights.

The Thompson Memorandum was replaced in December 2006 by the more reasonable “McNulty Memorandum”, which provided some relief from the most offensive portions of the Thompson Memorandum by requiring prosecutors to go through certain procedural requirements and obtain approval from senior supervisors before demanding a waiver of the attorney-client privilege.

The McNulty Memorandum was revised in 2008 (the “Filip Memo”) to prohibit the Department of Justice from coercing companies to breach their indemnification agreements with their directors and officers, to allow credit for cooperation to companies that do not waive the attorney-client privilege or do not disclose attorney-client work product, and to prohibit prosecutors from demanding attorney-client communications or attorney work product.

In contrast to the Department of Justice, the SEC does not have criminal enforcement powers, only civil enforcement powers, and must refer criminal cases to the Department of Justice.  However, over the years the SEC has sought greater cooperation from companies and people under SEC civil investigation.  For example, the SEC’s equivalent of the Thompson/McNulty/Filip Memorandums is the 2001 “Seaboard Report” describing the criteria it will consider in determining whether, or how much, credit it will give to companies who self-police, self-report, take corrective action or cooperate with the SEC.  Never mind that the “Seaboard Report” is neither about “Seaboard” nor a “report”, it stated that cooperation can result in reduced charges, lighter sanctions or mitigating language in settlements.

Despite the SEC’s more reasonable approach to the rights of companies under investigation, the Seaboard Report, and the SEC’s approach to giving credit for cooperation, were vague, and often applied after-the-fact.  In many cases, a company never really knows where it stands with the SEC, and whether it is actually receiving credit for cooperation, until after the investigation is complete.  While the Justice Department’s rules were originally offensive, at least a defendant signing a non-prosecution or deferral agreement knows exactly what to do, and exactly what treatment it will receive in return for cooperation.

To encourage the type of cooperation the SEC wants, it needs to provide the same type of certainty and fairness to potential witnesses as the DOJ, and so last year the SEC adopted new procedures for rewarding cooperation.

The SEC entered its first non-prosecution agreement in December 2010 with Carter’s Inc. In the Carter’s case the EVP of Sales, Joe Elles, allegedly gave substantial discounts to the company’s largest customer and hid them from the company.  Because the company didn’t know, it did not recognize the discounts until later reporting periods, which caused the company’s results for the quarters in which the discounts were given to be artificially inflated.  The SEC brought an action against Elles, but entered into a non-prosecution agreement with Carter’s. The SEC identified the following factors as relevant to its decision not to bring an action against Carter’s: (1) the “relatively isolated nature” of the unlawful conduct; (2) the company’s “prompt and complete” self-reporting of the misconduct to the SEC; and (3) the company’s “exemplary and extensive” cooperation in the inquiry, including a “thorough and comprehensive” internal investigation.  The SEC did not require Carter’s to waive its attorney-client privilege.

The SEC recently announced its first use of a deferred prosecution agreement, with Tenaris S.A., a manufacturer of steel pipe products from Luxemburg, listed on the New York Stock Exchange.  A world-wide internal investigation conducted by Tenaris’ outside counsel revealed Foreign Corrupt Practices Act violations in Uzbekistan, where Tenaris allegedly bribed Uzbek officials and made $5 million in profits from pipeline contracts.  The company self-reported to the SEC and the Department of Justice, cooperated with the government, and made extensive efforts at correcting the violations.

The SEC said that Tenaris was an appropriate candidate for the first deferred prosecution agreement because of its “immediate self-reporting, thorough internal investigation, full cooperation with SEC staff, enhanced anti-corruption procedures, and enhanced training.”

Under the deferred prosecution agreement, the SEC will not bring civil charges against Tenaris unless the SEC determines that the company has not complied with its obligations under the agreement.  Although Tenaris shared the results of its internal investigation with the government, the agreement does not require it to waive the attorney-client privilege.  Tenaris agreed to pay $5.4 million in disgorgement and interest.

By eliminating the Hobson’s choice of either cooperating and not knowing what will happen, or not cooperating and not knowing what will happen, the certainty provided by deferment and non-prosecution agreements will allow lawyers to better advise their clients on the consequences of self-reporting and corrective actions, and should make it easier for the SEC to secure cooperation from companies and individuals on a fair and reasonable basis.

A few years later, Horner quit and went to work for a competitor, and Lucht’s sought to enforce its non-competition agreement.  The case ended up at the Colorado Court of Appeals, who turned common practice on its head by holding that Horner was not bound by the non-compete agreement he signed with Lucht’s, because he was already employed, his continued employment was “nothing more than he was already promised”, and Lucht’s did not pay him anything for the obligation not to compete.

The Colorado Supreme Court reversed the Court of Appeals, holding that:

“Because an employer may terminate an at-will employee at any time during the employment relationship as a matter of right, its forbearance from terminating that employee is the forbearance of a legal right.  As such, we find that such forbearance constitutes adequate consideration to support a noncompetition agreement with an existing at-will employee.”

Of course, each agreement not to compete in Colorado must still satisfy both

(1)  the requirements of C.R.S. § 8-2-113, which makes non-compete agreements void except

(a)  in connection with the sale of a business,

(b)  to preserve trade secrets,

(c)  to recover expenses of educating the employee, and

(d)  as applicable to executives, management, officers and their professional staff; and

(2)  the common law requirements that the scope of the covenant not to compete be reasonable in both duration and geographic area.

For the last year we have been advising clients that new non-compete agreements with existing eligible employees should only be signed in connection with a bonus, raise or other tangible consideration.  However, in light of the Supreme Court’s decision in Lucht’s Concrete v. Horner, employers may now return to the common practice of requiring eligible employees to sign non-compete agreements in due course.

Last fall I was voted by my peers – “The People’s Court” – as the “Best Sports Lawyer” for the Barrister’s Best 2010 issue of Law Week Colorado.  I am flattered by this recognition, no doubt partially attributable to my efforts many years ago helping rescue our local major league baseball team from the scandal of its original ownership from Ohio.  More recently, I was involved in the television production, broadcast and streaming media business, which included putting together deals to broadcast a variety of high-profile entertainment, athletic and Olympic events.

Upon the pronouncement that I was a “best sports lawyer”, the response from my clients, contacts and colleagues was mostly: “Congratulations!  What is a “sports lawyer?”  Herein, my answer.

Notwithstanding the impassioned exclamations of millions of sports-fans around the world everyday that sports has a deeper meaning, unless you are a professional participant, sports is entertainment, and entertainment is very big business.  We are entertained and invigorated through our participation in sports, and we buy billions of dollars of  equipment and toys to support our participation.  We are likewise entertained and occasionally infuriated by our observations of sports as a spectator, and our spectating generates billions of dollars of revenue in advertising, merchandise sales, food and beverage and related products.

A “sports lawyer” is a business lawyer who has clients in the business of sports.  Like every business, sports businesses must be financed and protected; their risks managed and business deals documented in well negotiated and drafted contracts.  However, some aspects of the sports business are unique:

• contract negotiations involve unions, players associations, and in some leagues, salary cap rules;
• league and association rules govern both player conduct and team activities such as trades, revenue sharing, merchandising and broadcast agreements;
• stadiums and arenas are often financed with special tax districts and government supported bonds, and stadium leases and use agreements need to keep the teams in place so as not to leave the taxpayers paying for an empty building;
• teams are awarded through the “franchise” processes, involving federal and common law relating to franchisee’s rights and team movement restrictions;
• whenever rules limit the movement of teams or players, pricing, use of revenues or limits on pay, antitrust laws apply.

Personnel issues in the sports business are highly concentrated compared to a regular business, partly because of the amount of money paid to the most productive players, and the short time span of the average career.  Employment contracts are highly negotiated, and may include morals clauses, payment guarantees, incentive payments, and highly complex amortizations to fit under a league salary cap.  They may also address trade rights.

The financial and legal interests of players, while not necessarily unique from other highly compensated occupations, are far more concentrated.  The average professional athlete has an even shorter professional life than a teen pop star; most of the revenue earned by the athlete comes in a very short period of time.  Like a lottery winner, claims to a share of that money may come from likely and unlikely sources – estranged relatives, former paramours, casual acquaintances, managers and agents, business partners and brand new “friends”.  The athlete has less time to create, build, protect and preserve his or her value and assets than most people, and to be effective the lawyer’s efforts in that regard must come early.

The list of famous and not so famous athletes who have filed bankruptcy or gone broke is a long one.  It includes Johnny Unitas, Dorothy Hamill, Bjorn Borg, Lawrence Taylor and Scottie Pippen, who unsuccessfully sued his own law firm for giving him bad investment advice. Almost all of these people have lost their fortunes to “bad investments”, which usually includes at least one restaurant.

And all of these activities are conducted under the glare of the media, bloggers, fans and even the government and its politicians.

Nevertheless, it’s business.  Whether the lawyer represents a team, a facility, a broadcast network, an equipment manufacturer or an athlete, it involves many of the same issues that impact most other businesses:

• Are the right legal entities being used to maximize protection from liability and to minimize taxes?
• Is the brand and goodwill on a safe foundation, and protected from infringement?
• Are business agreements documented in well written contracts, appropriate for the arrangement and related risks?
• Are capital finance arrangements compliant with federal and state securities laws; are lending agreements properly documented and secured?
• Does the business/athlete have and use procedures, including checks and balances, to reduce the risk of loss due to theft, embezzlement or liability to third persons?
• And perhaps most importantly, does the athlete’s investment portfolio have the right balance between risk and conservative, self-sustaining investments that will provide long-term growth?

A good business lawyer will provide advice and assistance on specific issues, while remaining mindful of the bigger picture – and that is true whether the business is football, or making footballs, or making televisions that show football games.

Consequently, no one person can really be a “best sports lawyer”, since no one person could be the best at all of the different areas of law and business that are involved in the business of sports and entertainment.

In the final analysis, a “sports lawyer” is a lawyer involved in any of the broad array of legal, finance and risk areas that affect his clients, some of whom happen to be in the business of sports.

I did a re-financing a few years ago for a very profitable client.  The loan was a large number, but small compared to the value of the company; the lenders were very secure and over-collateralized.  The loan was complex because it involved 7 countries.  It should have taken about 3 months from inception to close – but because of the personalities of some of the characters involved, it took nearly 10 months to negotiate, document and close the transaction, and the client almost defaulted on the loan.  There were 5 law firms on the deal, some late, late nights, an unexpected 4 day emergency trip to the coast without luggage, nasty letters, and weekly heated negotiations.

That deal was by far the most fun I had that year.  We counseled the clients through difficult situations, providing the benefit of decades of doing deals like this, and frequently answered the question “is this normal”?  When we were done, we all flew to a tropical country and celebrated the closing on a beautiful beach. If I don’t have at least one or two of those “difficult” deals a year, I feel like I’ve missed something.

Doing deals has taken me around the globe, from the deserts of Mongolia to the capitals of Europe to frozen Siberia to the restaurants of Shanghai and the discos of Moscow. Being a deal lawyer can be invigorating, infuriating and exciting, but it is almost always satisfying – and fun.  If it’s not fun, it’s not the right career choice.  Oh the stories we could tell, if we were allowed to tell stories.

Yesterday Ronald Barusch, a retired deal lawyer from Skadden Arps, published an article in the Deal Journal, the Wall Street Journal’s deal blog, about his experiences as a deal lawyer.  If you’re curious, and want a better description of what keeps a transactional lawyer going (and going, and going, and going), read Barusch’s An M&A Junkie Kicks His All-Consuming Habit.  I never did a deal with Ron Barusch, but I congratulate him on his career, and on his article, which captures very well the allure of the deal, and the next deal, and the next.

This is Part 2 of 2 articles on the Small Business Jobs Act of 2010.  This article summarizes the tax changes and incentives, and Part 1 summarizes the loan incentives and benefits of the Jobs Act.

On September 27, 2010 President Obama signed into law the Small Business Jobs Act of 2010, P.L. 111-240 (the “Jobs Act”). The Act, attempting to ease credit lending, has $12 billion in tax cuts, including

• extension and expansion of the SBA Recovery Loan program,
• increase in asset expensing, and
• a continuation of bonus depreciation.

Some of the most important tax breaks and incentives for small businesses are summarized below:

Health Insurance Deduction for Self-Employed

The Jobs Act provides that self-employed taxpayers can deduct the cost of health insurance for themselves and their family members in calculating their self-employment taxes. The Act creates a special rule for taxable years beginning in 2010 that allows the deduction under Code §162(l) for health insurance costs of self-employed individuals to be taken into account in determining net earnings from self-employment, for purposes of the tax on self-employment income. This provision is estimated to provide over $1.9 billion in tax cuts for the self-employed.

Temporary End of Capital Gain Tax on Certain Small Business Stock

The Jobs Act allows individuals to exclude 50% (60% for certain empowerment zone businesses) of the gain from the sale of certain small business stock, if it was acquired at original issue and held for at least five years. The percentage exclusion for qualified small business stock acquired after February 17, 2009, and before January 1, 2011, is increased to 75%.  But for qualified small business stock acquired the rest of this year (after September 27, 2010 and before January 1, 2011), the percentage exclusion is increased to 100%.  To qualify as a small business, when the stock is issued, the gross assets of the corporation may not exceed $50 million – more than one million businesses in the United States meet this criteria.  The business also must meet certain active trade or business requirements.

This means that if you start a new business, or invest in an existing small business, between now and January 1, 2011, and hold the stock for more than 5 years, when you sell your stock you will not have to pay any capital gains on the sale – your profit will not be taxed either as ordinary income or taken into AMT (up to $10 million or 10 times your investment).

• It must be stock of a corporation, not a limited liability company or a partnership,
• You must purchase the stock from the corporation, for cash or property, or for services,
• The corporation has to be an active business; it can’t be a holding company,
• Certain businesses are excluded – banking, farming, hotels, mining and resources.

In addition to starting a new corporation, or investing in an existing small business, any of the following type of transactions might benefit from this 100% exclusion if they are done by the end of this year (2010):

• Exercising a stock option, warrant, convertible note or other convertible security
• Granting stock or warrants for compensation
• Converting a partnership or LLC into a corporation
• Converting debt to stock

Before implementing any of these transactions, work with your lawyer and tax accountant – these are complex tax code provisions.

Expensing Capital Investments

For 2010 and 2011 small businesses can immediately write off $500,000 in capital investments (reduced by the amount of the cost above $2 million). For taxable years beginning after 2011, the amount is $25,000, with a phase out reduced by the amount of the cost above $200,000.

The Jobs Act provides an election, available for tax years beginning in 2010 or 2011, to treat (1)  qualified restaurant property, (2) qualified retail improvement property, and (3) qualified leasehold improvement property, as IRS Code §179 property that may be expensed in the year it is purchased, instead of depreciated over a period of years.

The cost of qualified real property that may be expensed is limited to $250,000 per year, and excess amounts would not be carried over to tax years beginning after 2011.  According to the Senate Finance Committee, § 179 expensing makes it cheaper for small businesses to invest in new equipment because expensing in the current year decreases the net cost to the business compared to long-term depreciations.

Extension of 50% Bonus Depreciation to Encourage Capital Investment

The Jobs Act extends the Recovery Act’s 50% “bonus depreciation” benefit through 2010, allowing small businesses to continue accelerating the rate at which they deduct capital expenditures. Specifically, the Act extends for one year the IRS Code §168(k) special allowance of first-year depreciation equal to 50% of the adjusted basis of qualified property to include qualified property acquired before January 1, 2011, or acquired pursuant to a written binding contract which was entered into after December 31, 2007, and before January 1, 2011. Qualified property would have to be placed in service before January 1, 2011 (before January 1, 2012 for certain property).

Cell Phone Deductions Made Easier

The Jobs Act changes rules for cell phones and similar telecommunications equipment so that they can be deducted without burdensome extra documentation – by removing this communications equipment from the definition of listed property, the heightened substantiation requirements and special depreciation rules that apply to listed property no longer apply to cell phones.

Increase in the Deduction for Start-Up Expenses

For 2010, entrepreneurs can deduct $10,000 of start-up expenses (but the deduction is reduced by the amount by which the cumulative cost of start-up expenditures exceeds $60,000).  This means that the deduction, which was $5,000, is increased to $10,000 for small 2010 start-ups. Unless it is extended, this increased deduction only applies to the 2010 tax year.

Carryback of General Business Credits Extended from One year to 5 Years

Eligible small businesses will be able to carryback eligible small business credits five years, instead of only one year.  Only corporations whose stock is not publicly traded, or partnerships, whose average annual gross receipts do not exceed $50 million, are eligible. In the case of a sole proprietorship, the gross receipts test is applied as if it were a corporation. Credits determined with respect to a partnership or S corporation are not treated as eligible small business credits by a partner or shareholder unless the partner or shareholder meets the gross receipts test for the taxable year in which the credits are treated as current year business credits. This credit carryback allows the small business owner to use the credit to offset both regular and alternative minimum tax liability.

Makes it Easier for a Corporation to Convert from a C Corporation to an S Corporation by Providing “Built-in Gain” Relief

A “small business corporation” (as defined in IRS Code §1361(b)) may elect to be treated as an S corporation. Unlike C corporations, S corporations generally pay no corporate-level tax. Instead, income and loss of an S corporation is passed-through to its shareholders to report on their individual tax returns.

It is difficult to convert a C corporation to an S corporation because after the conversion, corporate level tax, at the highest marginal rate applicable to corporations (currently 35%) is imposed on an S corporation’s gain that arose prior to the conversion, and is recognized by the S corporation for 10-years after the conversion.  In other words, if the S corporation had property that appreciated in value, and thus has a “gain”, for 10-years after converting the corporation will pay taxes on that gain (if it sells the property) as though it was a C corporation.

The built-in gains tax also applies to net recognized built-in gain attributable to property received by an S corporation from a C corporation in a carryover basis transaction.  For these built-in gains, the capture period begins when the asset was acquired by the S corporation instead of the first tax year of conversion to an S corporation.

Gains recognized in the recognition period are not built-in gains if they are shown to have arisen while the S election was in effect or are offset by recognized built-in losses. The amount of the built-in gains tax is treated as a loss taken into account by the shareholders in computing their individual income tax.

However, under the Jobs Act for the 2009 and 2010 tax years, the built-in gain capture period is reduced to 7 years. Therefore, for gain that arose prior to the conversion of a C corporation to an S corporation, for taxable years beginning in 2009 and 2010, no tax is imposed under §1374 after the seventh taxable year the S corporation election is in effect.

For taxable years beginning in 2011, the Jobs Act provides that for purposes of computing the built-in gains tax, the “recognition period” is 5 years beginning with the tax year of the conversion to an S corporation.

The Small Business Jobs Act also

• Limits the penalty on small businesses for errors in tax reporting, changing the penalty from a fixed dollar amount to a percentage of the tax reduction achieved by the error, with a minimum ($5,000 individual, $10,000 business) and maximum penalty ($100,000./ $200,000),

• Changes the information reporting requirements for rental property expense payments,

• Increases the information reporting penalties, and

• For large corporations (with assets of at least $1 billion) increases the required estimated tax payments by 36 percentage points.

For help in understanding how the tax benefits provided by the Small Business Jobs Act of 2010 apply to your business or investments, contact your lawyer or tax accountant.

Circular 230 Disclosure

The following disclosure is provided in accordance with the Internal Revenue Service’s Circular 230. Any tax advice contained in this alert is intended to be preliminary, for discussion purposes only, and not final. Any tax advice is not intended to be used for marketing, promoting or recommending any transaction or for the use of any person in connection with the preparation of any tax return.  THE TAX INFORMATION IN THIS ARTICLE MAY IS NOT INTENDED TO BE USED, AND MAY NOT BE USED, BY ANY TAXPAYER, FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE TAXPAYER BY THE INTERNAL REVENUE SERVICE.  FOR INFORMATION ABOUT THIS STATEMENT CONTACT JONES & KELLER, PC.  (The foregoing legend has been attached pursuant to U.S. Treasury Regulations governing tax practice.)

On September 27, 2010 President Obama signed into law the Small Business Jobs Act of 2010, P.L. 111-240 (the “Jobs Act”). The Act, attempting to ease credit lending, has $12 billion in tax cuts, including

• extension and expansion of the SBA Recovery Loan program,
• increase in asset expensing, and
• a continuation of bonus depreciation.

Extension of SBA Recovery Loan Provisions

The American Recovery Capital Loan Program was started in the summer of 2009 to help small businesses facing temporary financial hardship by providing loans of up to $35,000 over six months.  Borrowers do not have to begin loan repayments until 12 months after the end of the lending period, and the business can take as long as five years to repay.  The loans have no fees, are interest free and SBA guaranteed.  The loans are intended to be used to pay off existing debt, giving the small business a “debt service holiday” for up to 18 months, allowing the business to use cash flow that would otherwise go to pay debt, for investment, hiring, growth and other purposes. In spite of initial lender resistance to the loan program, it gained momentum during the year after enactment, providing $30 billion in lending to over 70,000 small businesses.

With funds provided in the Jobs Act, the SBA is funding new Recovery loans and clearing out 1,400 applications in the loan queue by businesses requesting more than $730 million in loans. The extension provided by the Jobs Act provides the capacity to support $14 billion in new loans to small businesses.

Increase SBA Loan Size

The Jobs Act permanently increases the maximum loan size for legacy SBA loan programs, raising the maximum size for the 7(a) Loan Program and the CDC – 504 Loan Program from $2 million to $5 million, and the maximum 504 manufacturing related loan from $4 million to $5.5 million.  In addition, the Jobs Act temporarily increases the maximum loan size for the SBA Express loan program from $350,000 to $1 million; the Express loan program is primarily used to fund working capital loans that small businesses use to purchase new inventory.

Small Business Lending Fund for Community Banks

The Jobs Act also creates a new $30 billion Small Business Lending Fund to fund capital investment into community banks – banks with less than $10 billion in assets.  Qualified community banks can get capital investment from the Treasury administered fund at an initial dividend rate of 5%, which can go as low as 1% depending on qualified lending volumes, but increases to 9% after four and 1/2 years; “community development” banks that lend to small businesses in low-income neighborhoods can get capital at a 2% rate for eight years.  Community banks with less than $1 billion in assets can apply for capital investment up to 5% of risk-weighted assets, and community banks with between $1 billion and $10 billion in assets can apply for up to 3% of risk-weighted assets.  Certain application requirements must be met – these are well summarized at the Iowa Banking Law Blog.

State Small Business Credit Initiative

Another part of the Act, the State Small Business Credit Initiative, will provide Colorado up to $17.2 million to support state small business lending programs and collateral support programs, which is expected to support approximately $172 million in new lending.

More detailed information about taking advantage of these programs is available at the SBA website linked throughout this article, and also by speaking with your community banker.

The Dodd-Frank Act was primarily crafted to reduce the exposure of the U.S. banking system to a repeat of the 2008 melt-down, and end the potential for “too big to fail” government bail outs.  However, the Act goes well beyond the initial intent, addressing broad changes in securities laws, capital markets, banking and consumer finance.

47 Studies (or is it 67 Studies?)

Depending on whom you ask, and how you count parts and sub-parts, the exact number of studies commissioned by the Dodd-Frank Act varies.  The best estimate may be “scads”.  Studies will be conducted and reports published by the Financial Stability Oversight Council, the FDIC, the GAO, the FTC, the Federal Reserve, Treasury, the new Bureau of Consumer Financial Protection, and the SEC, among others.  In particular, the SEC will have one of the biggest roles in implementing Dodd-Frank.   The SEC has begun ramping-up to implement its role.  Compliance Week reports that the SEC will hire roughly 800 new employees, create five new offices, and revamp its internal reporting and technology processes in implementation of its broader reporting and enforcement role.

The following studies may be of interest to our clients:

• Accredited Investors. The GAO will study and report on the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.  As I reported recently, the Dodd-Frank Act already increased the asset value required for individual investors to be “accredited” by excluding the value of the investor’s primary residence.  This report is due in 3 years.

• Short Selling and Swaps. The SEC must report on several studies on different aspects of short selling and swap transactions.  Particularly, reporting and regulation of certain aspects of short selling are likely to be forthcoming.  While selling stock you don’t own, gambling that the price will go down, can be an effective hedge (insurance) strategy for persons with substantial and complex stock positions, short selling for speculation often vexes public companies.  Management of public companies who watch their stock go down for no apparent reason in the face of growing short positions often believe that speculators are conducting a “short and distort” campaign – taking a short position, then spreading negative rumors or false information about the company to insure a profit from the short position, or that the existence of the short position itself causes other investors to sell their stock, driving the price down and hurting the company.

• Information on Broker-Dealers, Investment Advisers and Registered Reps. The SEC must study and recommend ways to improve investor access to registration information (including disciplinary actions, regulatory, judicial, and arbitration proceedings, and other information) about registered and previously registered investment advisers, associated persons of investment advisers, brokers and dealers and their associated persons.  This report is due by January 21, 2011.

• Aiding and Abetting Violations of Securities Laws. The GAO must study and report on the impact of authorizing a private right of action against any person who aids or abets another person in violation of the securities laws. This is of particular interest to securities lawyers, accounting firms, and their insurers.  At common law, aiding and abetting occurs through “knowing participation” in the illegal conduct. Although knowing participation is required, wrongful intent by the defendant is not necessary.  Nor is it necessary that the plaintiff establish that an agreement existed between the defendant and the guilty party.  There is a fine evidentiary line between participating in someone else’s conduct, and knowing the conduct was illegal. Thus, when a fraudster commits securities fraud and heads for the border with the money, the aggrieved investors look for people to sue – the lawyers who prepared the offering documents, the accountants who prepared the financial statements, the financial printer, the broker dealer who sold the securities, the investment banker who advised on the deal.

Under current law the SEC may bring action against aiders and abettors, but individuals may not. In addition, the Dodd-Frank Act provides for the SEC to impose aiding and abetting liability on persons who “recklessly” provide substantial assistance to someone who violates the Exchange Act.  Previously, the SEC was required to show that such assistance was provided “knowingly.”  Private plaintiffs have been unable to bring such claims since the Supreme Court’s Central Bank of Denver decision in 1994, and the 2008 decision in Stoneridge Investment Partners blocked plaintiffs from bringing similar “scheme” liability claims.

The Dodd-Frank Act also extends aiding and abetting liability for the first time to the Securities Act, the Investment Company Act and the Investment Advisers Act. The Act also clarifies that the SEC may pursue enforcement actions against so-called “control” persons – those found to “directly or indirectly control” a violator – unless they acted in “good faith” and did not “directly or indirectly induce” the violative conduct.  This report is due in 1 year.

• Lessen Impact of Sarbanes-Oxley on Medium-Sized Companies. The SEC will study how the SEC could reduce the burden of complying with Section 404(b) of the Sarbanes-Oxley Act for companies whose market capitalization is between $75,000,000 and $250,000,000 while maintaining investor protections for such companies, including whether any such methods of reducing the compliance burden or a complete exemption for such companies from compliance with such section would encourage companies to list on exchanges in the United States in their initial public offerings.  See Sarbanes-Oxley discussion below. This study is due in 9 months.

• Core and Brokered Deposits.  The FDIC will conduct a one year study to evaluate:

- the definition of core deposits for the purpose of calculating the insurance premiums of banks;

- the potential impact on the Deposit Insurance Fund of revising the definitions of brokered deposits and core deposits to better distinguish between them;

- an assessment of the differences between core deposits and brokered deposits and their role in the economy and banking sector of the United States;

- the potential stimulative effect on local economies of redefining core deposits; and

- the competitive parity between large institutions and community banks that could result from redefining core deposits.

Current FDIC policy strongly discourages acceptance of brokered deposits by charging an FDIC insurance premium if brokered deposits exceed a specified percentage, and by very broadly interpreting the definition of brokered deposit.

What the Dodd-Frank Act Does Today

• Makes it Harder to Qualify as an Accredited Investor.  As detailed in my earlier article, effective immediately, the definition of an individual accredited investor under the SEC’s Regulation D for private placements now excludes the value of the investor’s primary residence. This reduces the number of people eligible to participate in many private placements, which are often offered only to accredited investors.

• Sarbanes-Oxley Relief. After six compliance extensions by the SEC, including a couple of “final extensions”, the matter is taken out of the SEC’s hands.  The Dodd-Frank Act provides immediate relief from the onerous Sarbanes-Oxley internal control audit provisions for approximately 5,000 smaller public companies.  Smaller public companies, (non-accelerated filers – companies with a market cap less than $75 million) are now exempt from Sarbanes-Oxley 404(b) compliance. Sarbanes-Oxley 404(a) requires a management report on internal controls, which smaller public companies must still provide – 404(b) requires external audit of internal controls. Based on a 2007 study by Financial Executives International, the average filer incurred outside audit and legal fees associated with Sarbanes-Oxley compliance of $846,000. The costs of compliance with 404(b) were clearly beyond the reasonable reach of smaller public companies.  Smaller public companies comprise approximately 50% of all public companies in the United States.

Stay tuned – the real financial reform will be published over the next few months and years.

Most U.S. based companies seeking to raise money from investors do so through a “private placement” authorized under Regulation D of the Securities and Exchange Commission.  Reg D provides several exemptions from SEC registration of a securities offering, the most popular of which (Rule 506) allows unlimited investment and participation by “accredited investors”.  If the offering includes non-accredited investors, the issuer must meet required disclosure obligations by providing information of the same kind that would be provided in a registration statement for a public offering.  If only accredited investors participate in the offering, there are no specific disclosure requirements mandated by Reg D (although thorough disclosure is still recommended as a risk management practice).  Therefore, many issuers chose to limit their offerings only to “accredited investors”.

With the enactment of Dodd-Frank, effective July 21, 2010, and for at least the next four years, the definition of “accredited investor” has changed.  The net worth part of the accredited investor test, which specifies that a natural person is an accredited investor if his or her net worth is at least $1 million, now excludes the value of that person’s primary residence.   Before July 21, the net worth test included the investor’s primary residence.

There was no transition period or future effective date, so that issuers conducting private placements on July 21, 2010 had to amend and re-document their private placements in process to comply with the change.   Fortunately, the other portions of the accredited investor definition, including the net income tests for natural persons, remain unchanged for now.

The Comptroller General is required to study the appropriate criteria for accredited investor status and report back to Congress within three years.  On July 20, 2014 and every four years thereafter the SEC must review the definition of accredited investor as it applies to natural persons and make adjustments in the rules if appropriate.

The Race to the Bottom has a discussion of the history of the definition of accredited investor, as well as some thoughts about the SEC’s role in developing the standards in the past and the future.