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May 15, 2015 – On April 13, 2015 Governor Hickenlooper of Colorado signed the Colorado Crowdfunding Act. The Crowdfunding Act becomes law on August 5, 2015, and on May 7, 2015 Colorado Securities Commissioner Gerald Rome said that he anticipates the regulations will be final by that date so that Colorado businesses will be able to raise money in a crowdfunded offering beginning August 5, 2015. Under the Crowdfunding Act, offers can be made solely in Colorado, under the federal intrastate offering exemption. This means that the offers may be made only to Colorado residents, and only Colorado residents may invest. In addition, the offering must comply with the federal intrastate exemption, which means, among other things, ownership of the stock must not leave Colorado for 9-months after it is purchased.

I discussed the requirements for crowdfund offerings in Part 1 of this article; this Part 2 discusses the role and requirements for “intermediaries” who provide the Internet website for offerings.

Before the JOBS Act was passed three years ago, “crowdfunding” in the U.S. comprised only donations, or pre-sale purchase of goods or services, through websites such as gofundme, KickStarter, and indiegogo, and not the sale of securities. The JOBS Act required the SEC to establish a procedure for small securities offerings to a large number of investors, and in 2013 the SEC published proposed “crowd funding” rules, but they have not yet been approved and adopted. As a result states have begun to adopt their own laws and regulations to enable businesses to raise money by offering securities to “the crowd,” and now Colorado has followed suit.

In a private placement, the issuer may, and often does, sell its securities directly to investors. However, the issuer cannot sell its securities directly to the public in a crowdfund offering, for example, through its own website. In Colorado securities can be sold in a crowdfund offering by a registered broker-dealer, a registered sales representative (stockbroker) or an online “intermediary.”

An online intermediary is a website that is not a broker-dealer or stockbroker, and does not offer securities except for crowdfund offerings. Before offering online intermediary services, the intermediary must:

  1. File a statement or form with the Colorado Division of Securities disclosing the following:
    • identity, address, contact information, and names of the officers, directors, managers, or other persons who control the company;
    • a consent to service of process; and
    • an undertaking to provide investors the offering information required by the Crowdfunding Act.
  2. Comply with reporting and filing rules of the Securities Division. The rules have not been published yet, but the Crowdfunding Act says the Securities Commissioner may require intermediaries to file financial information, make and retain specified records for 5 years, and establish written supervisory procedures to prevent and detect violations of the Crowdfunding Act and rules. I anticipate the rules will include all of these requirements
  3. Maintain records of all its offers, which must be available to the Securities Division on request and subject to division examination at any time.
  4. Not have any ownership or financial interest in, or be affiliated with, any issuer it conducts offerings for.

Intermediaries cannot charge commissions on securities sold. Under both federal and state securities laws, only registered and regulated persons such as broker-dealers and stockbrokers can be paid commissions. Since intermediaries are not registered, they cannot be paid based on the amount of securities sold. Intermediaries have two fee options, and they can use one or a combination. They may charge (1) a fixed fee for each offering, or (2) a variable amount based on the length of time the securities are offered. As a result, intermediaries will have several fee options. For example:

• a flat fee unless the offering is not sold within a number of weeks, and then an additional fee for every week the offering remains open;
• or a fee for every week the offering remains open, but not less than a fixed amount, which will guaranty the intermediary a minimum fee even for offerings that sell out very quickly.

No Advertising?

An intermediary cannot promote a crowdfund offering – the Act says: “An on-line intermediary shall not identify, promote, or otherwise refer to any individual security offering by it in any advertising for or on behalf of the on-line intermediary.”

An issuer cannot promote its crowd fund offering either, because issuers are restricted to distributing a notice that can only state the company is conducting an offering, the name of the intermediary, and a link to the intermediary’s website.

Non-securities crowdfunding offers, like the recently extremely successful effort by Alan Tudyk and Nathan Fillion to raise funding for the series Con Man on indiegogo, can use social media to publicize the opportunity. Tudyk and Fillion used their extensive Twitter and facebook followers to gain momentum and attention for the Con Man fund raise. Companies selling securities in a crowd funded offering through an intermediary will not be able to undertake any similar advertising, promotion, or sales campaigns, and will instead have to rely on investors who follow intermediaries looking for investment opportunities.

Although the Colorado Crowdfunding Act has several advantages over the proposed SEC rules, it is still a very expensive option when compared to a traditional private placement, and only time will tell if it presents a viable funding option for companies who cannot raise the needed funds through traditional private placements.

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Law Week Colorado, April 20, 2015   LW-CannabisBanking

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In Gantler v. Stephens, C.A No. 2392, 2009 WL188828 (Del. Jan. 27, 2009), the Delaware Supreme Court held that officers of Delaware corporations owe the same fiduciary duties of care and loyalty to the company and its shareholders as directors owe.  Prior Delaware court decisions have implied that officers might have the same fiduciary duties as directors, but no Delaware Supreme Court case had explicitly applied those duties to company officers before Gantler v. Stephens.  The Court also held that shareholder ratification of director action is limited to approval of matters that are not required to be approved by shareholders in the first place. 

In Gantler the board of directors of First Niles Financial, Inc., a bank holding company, retained a financial advisor to pursue a sale.  Three parties made bids, but company management failed to respond to bidder, and the remaining bidder proposed a stock-for-stock merger, which the board rejected without discussion.  The board then voted to proceed with a going private restructure and reclassification proposed by company management.  The shareholders voted to approve the reclassification.

Normally a board’s decision not to pursue a merger is reviewed under the business judgment standard, which entitles the board to a strong presumption in its favor and prevents a court from second guessing directors’ business decisions.  However, in this case the court found that two directors provided services to the bank that were likely to be terminated in the event of a merger, and that the Chairman failed to communicate with a bidder who he know intended to replace the board. The board’s rejection of the merger was therefore subject to entire fairness review, and was not granted the benefit of the doubt provided by the business judgment rule.  Since the competing offer was made by company management, and because management actions obstructed progress with the outside bidders, the Court then examined the disloyalty claim against the defendant officers, clarifying what had been implied in prior cases:  corporate officers owe the same duties of care and loyalty as directors do.  The Court found that the Chairman may have sabotaged the third-party due diligence process, and the treasurer may have assisted him, for which they each could be liable. 

The Court also clarified that common law shareholder ratification is only valid when the fully informed shareholders vote to approve director action that does not legally require shareholder approval to become effective.  However, this holding applies only to common law ratification and does not affect shareholder ratification under Section 144 of the Delaware General Corporation Law, which provides a process for approving transactions with a corporation in which directors or officers have a conflict of interest.

Gantler is important for several reasons:

  • Disgruntled shareholders who commonly sue directors for breach of fiduciary are now more likely to name officers as defendants in these lawsuits.  However, most state corporate laws protect directors from liability for breach of fiduciary duty, but do not provide any protection for officers.  That is not the case in Colorado.  Colorado Revised Statutes § 7-109-107 states that officers are entitled to the same mandatory indemnification as directors are under § 7-109-103.  Many companies doing business in Colorado are not Colorado corporations, but are formed in Delaware of other states.  I recommend that Companies, particularly those incorporated outside Colorado, review their articles of incorporation and directors and officers liability insurance policy for officer protection. Gantler is likely to result in more fiduciary duty claims against officers.

 

  •  States whose corporation law is based on the Model Corporate Act, such as Colorado, already impose fiduciary duties on company officers.  Colorado Revised Statutes § 7-108-401 states that directors and officers have fiduciary duties to the company.

 

  •   If your company seeks a shareholder vote to ratify board action, Gantler permits shareholder ratification only of matters that do not statutorily require shareholder approval to be effected.  For example, shareholder ratification of director action that requires shareholder approval, such as a merger or amendment to the certificate of incorporation, will not provide any additional protection if the shareholders were required to approve the action before it occurred. 

 

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