March 1

Should You Crowdfund Your Business?

Bunch of different sized piggy banks

For new or would-be entrepreneurs, the central priority is often raising cash. Even when the start-up costs associated with the invention or development of the business idea are low, there is a need for outside capital to market the business to the public. Where can a new business find this funding? In recent years, there has been a push to allow companies to obtain this funding more directly from the public, taking down some of the usual barriers to the public stock markets for early-stage businesses. This concept has coined “crowdfunding” – a process by which the general public (or crowd) funds a new business idea, primarily via an online portal.

What about the stock market?

May 17

The JOBS Act from a Securities Litigation Perspective

Though it is primarily addressed at jumpstarting the initial public offering (IPO) market for startups and emerging growth companies (EGCs), the recently enacted Jumpstart Our Business Startups (JOBS) Act may be a boon for securities litigators.

The Act includes a number of provisions that disrupt the status quo and increase the litigation risk associated with the IPO process. My recent article in the Securities Litigation Report provides a summary of some of the JOBS Act’s provisions that may lead to an increase in filed securities litigation actions.

April 13

A Primer on the JOBS Act

There has been a lot of press recently about the JOBS Act and what it means for small investors and start-ups. The official short title of the act is the “Jumpstart Our Business Startups Act.” The main purpose of the Act is to stimulate business start-ups. Will it work? That depends on the SEC’s interpretation of the intent of the Act and what types of rules it imposes to carry out the Act while fulfilling its duty to protect investors.

What follows is a summary of the JOBS Act.

There are six main sections of the Act:

Title I – Reopening American Capital Markets to Emerging Growth Companies

Title II – Access to Capital for Job Creators

Title III – Crowdfunding

Title IV – Small Company Capital Formation

Title V – Private Company Flexibility and Growth

Title VI– Capital Expansion

Title VII – Outreach on Changes to the Law

Title I –Reopening American Capital Markets to Emerging Growth Companies (IPO On-ramp)

The first section of the Act strips away some of the investor protections that have been added over the years for a category of companies defined as “emerging growth companies.” Under the Act, during a company’s first five years as a public company or before its first year with total annual gross revenues of less than $1 billion (to be indexed for inflation every five years), whichever period is shorter, it is known as an “emerging growth company.” This definition relates back to include all such companies that have gone public since December 8, 2011.

A company loses its “emerging growth company” status if it issues more than $1 billion in non-convertible debt during a 3-year period or it meets the definition of a “large accelerated filer” under the Code of Federal Regulations (Title 17, Section 240.12b-2).

Removal of shareholder approval of executive compensation. Under the law before the JOBS Act, the Securities & Exchange Commission had the authority to exclude small companies from complying with the requirement that shareholders approve executive compensation every three years. The JOBS Act specifically exempts “emerging growth companies” from complying with the shareholder approval of executive compensation rule.

Exemption from Compensation Disclosure. The Securities Exchange Act requires public companies to disclose annually the compensation of certain executives as compared to the financial performance of the issuer. The JOBS Act exempts emerging growth companies from this requirement.

Financial Disclosures and Accounting Pronouncements. Emerging growth companies only need to present 2 years of audited financial statements for the registration statement for an initial public offering.

Emerging growth companies may not be required to comply with new or revised financial accounting standards until nonpublic companies are required to comply with those standards.

Removal of Internal Controls Audit. Emerging growth companies are exempt from the internal controls audit requirement of the Sarbanes-Oxley Act of 2002. Thus, the public accounting firm that prepares the companies audit report does not need to attest to and report on management’s assessment of the company’s internal controls.

Lower Auditing Standards. The Act takes away the discretion previously afforded to the Public Company Accounting Oversight Board to require mandatory audit firm rotation or supplementation to the auditor’s report. Emerging growth companies are specifically exempted from any rules concerning these matters and are also exempt from any additional rules adopted by the board unless the SEC determines that the application of the additional requirements is necessary or appropriate in the public interest.

The “This is Not a Pipe” Provision Otherwise Titled “Availability of Information about Emerging Growth Companies.” (Section 105 of the Act). This part of the Act eviscerates the research/investment bank firewall established by the Spitzer-banking industry settlement of 2003. If a broker provides a potential investor with a research report about an emerging growth company that is the subject of an IPO, the provision of that information is not considered to be an offer to sell that company’s stock, even if the broker will participate in the IPO. Thus, even if the report is clearly a suggestion that the investor should consider buying stock in the company, the law no longer deems it to be such so that the protections afforded a stock offering do not apply. UPDATE (9/12): The SEC has issued FAQs that state that the JOBS Act does not affect the Spitzer “Global Settlement” —

The Act also provides that neither the SEC nor any national securities association registered under section 15A (e.g. FINRA) may impose regulations restricting, based on a person’s job function (such as research v. banking), who at a broker-dealer may arrange for communications between a securities analyst and a potential investor. Nor may the SEC or FINRA restrict a securities analyst from participating in communications with management of an emerging growth company that are also attended by another non-analyst member of the broker-dealer (i.e. banker).

No More Quiet Period for Emerging Growth Companies. Prior to or following the filing of a registration statement with respect to a securities offering, an emerging growth company or anyone authorized to act on its behalf may engage in communications with potential investors that are qualified institutional buyers or institutions that are accredited investors. After the IPO, neither the SEC nor any national securities association registered under 15A of the Securities Exchange Act of 1934 (i.e. FINRA) may adopt rules preventing any broker/dealer from issuing research or making a public appearance concerning the company.

Submission of Confidential Draft Registration Statements. Prior to an IPO, an emerging growth company may submit its registration statement to the SEC in draft form for review so long as the initial confidential submission and all amendments are publicly filed not later than 21 days before the road show.

Tick Size Study. Within 90 days of the enactment of the Act, the SEC shall submit a report on the findings of a study examining the transition to trading and quoting securities in one penny increments. If the SEC determines that emerging growth companies should be traded and quoted using a minimum greater than one cent, the SEC may, by rule, no later than 180 days after the enactment of the Act, designate a minimum increment that is greater than one penny and less than ten cents for quoting and trading of securities.

Emerging Growth Companies May Opt in to Greater Regulation. An emerging growth company may choose to forgo any exemption provided by the Act, but if an emerging growth company chooses to comply with new or revised financial accounting standards required of all non-emerging growth company issuers, it must make this choice when it is first required to file a registration statement, periodic report or other report with the SEC under Section 13 of the Securities Exchange Act. It must comply with all such standards if it opts to comply with any of them and it must continue to comply with the standards for as long as it remains an emerging growth company.

SEC must undertake a review of Regulation S-K. The SEC is required to analyze current registration requirements and to issue a report including specific recommendations on how to streamline the registration process.

Title II – Access to Capital for Job Creators

This section of the law provides that private offerings made to accredited investors or qualified institutional investors may be generally advertised so long as the company offering the securities takes reasonable steps to verify that the purchasers of the securities are accredited investors or qualified institutional investors.

Although this section refers to the companies taking advantage of this rule as “job creators,” nothing in the new rule requires the company to use the capital acquired in reliance on the rule for job creation.

No general solicitation nor advertising prohibition. The Act requires the SEC to revise its rules to provide that the prohibition against general solicitation or general advertising does not apply to offers and sales made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. The rules to be issued by the SEC must require the issuer to take reasonable steps to verify that the purchasers of the securities are accredited investors.

No general solicitation nor advertising prohibition for Section 230.144A exemption. The Act requires the SEC to revise subsection (d)(1) of Section 230.144A of title 17, Code of Federal Regulations, to provide that securities sold under the private sale exemption may be offered to persons other than qualified institutional buyers, including by means of general solicitation or advertising, so long as the seller reasonably believes that the sale is to a qualified institutional buyer.

Title III – Crowdfunding

The short title of this section is “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” or the “CROWDFUND Act.”

The CROWDFUND Act exempts certain small transactions of securities from the registration statement requirement of Section 5 of the Securities Act of 1933.

The CROWDFUND exemption applies if the aggregate amount of securities sold to all investors is not more than $1 million and if the aggregate amount sold to any one investor is not greater than (1) $2,000 or 5 % of the investor’s annual income or net worth if the annual income or net worth of the investor is less than $100,000 or (2) 10 % of the annual income or net worth of the investor, not to exceed $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000. The exemption only applies if the transaction is conducted through a broker or funding portal that complies with new registration and disclosure requirements, including certain measures meant to reduce fraud, and the company selling the securities files certain information with the SEC, including details on ownership, nature of the business, financial condition of the business, intended use of the proceeds, target offering amount, etc.

Section 12(b) liability specifically reaches offers or sales of securities made pursuant to the CROWDFUND exception.

Securities purchased pursuant to the CROWDFUND exemption may not be transferred for one year after the date of purchase unless the transfer is to the issuer, to an accredited investor, is part of a registered offering, or is made to a family member of the purchaser or equivalent. The SEC may impose additional limitations on transfers by rule.

Companies must be organized under and subject to the laws of a state or territory of the United States or the District of Columbia to take advantage of the CROWDFUND exemption.

Investment companies may not use the CROWDFUND exemption to sell securities.

Within 270 days of the Act’s enactment, the SEC must issue rules for the protection of investors to carry out sections 4(6) and 4A of the Securities Act of 1933, created by the CROWDFUND exemption.

Shareholders who hold securities pursuant to the CROWDFUND exemption are excluded when calculating the number of shareholders to determine the applicability of Section 12(g) of the Securities Exchange Act, which requires that an issuer file a registration statement once certain shareholder caps are met.

Funding portals are exempted from registering as a broker or dealer under Section 15(a)(1) as long as certain requirements are met.

The SEC must issue rules to carry out this new legislation not later than 270 days after the enactment of the Act.

The rule also limits state regulation of registered funding portals.

Title IV – Small Company Capital Formation

The SEC previously had authority to exempt companies issuing less than $5 million in securities from enforcement under the Securities Act of 1933. The Act requires the SEC to create a new class of securities exempt from the Securities Act.

Small Company Capital Exemption

  • Aggregate offering of all securities offered and sold within the prior 12-month period based on the exemption shall be no greater than $50 million.
  • Securities may be offered and sold publicly.
  • The securities cannot be restricted securities.
  • 12(a)(2)’s civil liability shall apply.
  • Interest in the offering may be solicited prior to the filing of any offering statement, on terms and conditions that the SEC prescribes.
  • Audited financial statements may be required to be filed with the SEC.
  • The SEC may impose other terms, conditions, or requirements that it determines to be necessary in the public interest for the protection of investors.
  • Only equity securities, debt securities, and debt securities convertible or exchangeable to equity interests, including any guarantees of such securities may be exempted under this provision.
  • The SEC may also require companies using this exemption to make certain periodic disclosures.

Within 3 months of enactment of the Act, the Comptroller General is required to conduct a study on the impact of state laws regulating securities offerings and send a report on the study to the Committee on Financial Services of the House of Representatives and the Committee on Banking, Housing, and Urban Affairs of the Senate.

Title V – Private Company Flexibility and Growth

This provision allows a company to have a greater number of investors before it is required to register as a public company.

Previously, within 120 days after the last day of a fiscal year in which a company has total assets greater than $10 million dollars and a class of security (other than exempted securities) held by 500 or more people, the company would be required to file a registration statement.

Under the JOBS Act, a company does not need to file a registration statement until it has a class of equity security held of record by either 2,000 people or 500 people who are not accredited investors.

Securities held by employees pursuant to an employee compensation plan in transactions exempted from the registration requirements of section 5 of the Securities Act are not included in the definition of “held of record.”

The SEC is required to revise the definition of “held of record” to implement this amendment and is also required to adopt safe harbor provisions in connection with the definition.

The SEC is also required to determine if new enforcement tools are needed to enforce against improper evasion of the registration requirement by the holding of securities by exempt investors for the benefit of others.

Title VI – Capital Expansion

This provision provides that companies issuing securities that are either banks or bank holding companies do not need to register until 120 days after the last day of its first fiscal year on which the issuer has total assets exceeding $10 million and a class of equity security (other than exempted security) held of record by 2,000 or more persons. There is no requirement that banks or bank holding companies register if its securities are held by 500 or more investors who are not accredited.

For banks or bank holding companies, registration is terminated within 90 days of the submission of a certification that the number of investors is less than 1200. For every other type of entity, registration may only be terminated if the number of investors drops to less than 300.

The SEC is required to issue final regulations to implement this provision within 1 year of the date of enactment.

Title VII – Outreach on Changes to the Law

The SEC shall provide outreach to inform small- and medium-sized businesses, women-owned businesses, veteran-owned businesses, and minority-owned businesses of the changes made by this Act.


**Note: This is a summary. If you need specific advice about your situation, contact Felicello Law or another lawyer.**

February 7

Basic Healthcare Coverage in the U.S. Will Continue to be a Patchwork Stitched by Politicians and Insurers.

The Patient Protection and Affordable Care Act (PPACA) gave the Department of Health and Human Services (DHHS) the power to update minimum healthcare coverage nationwide to bring it up to date with current best medical practices by directing the Secretary of DHHS to define the “essential health benefits,” (EHB) which would be the minimum coverage provided by the PPACA and would help to alleviate the gaps in medical coverage and treatment seen from state to state. The Secretary of DHHS has ignored the mandate by deciding not to provide a uniform definition of EHB.

Instead, after a year of meetings, an extensive report by the Institute of Medicine, and nationwide “listening sessions,” the DHHS announced in an Essential Health Benefits Bulletin dated December 16, 2011 (December 16 Bulletin) that it intended to allow the States the “flexibility” to choose one of the following four benchmark approaches:

1. The largest plan by enrollment in any of the three largest small group insurance products in the State’s small group market;

2. Any of the largest three State employee health benefit plans by enrollment;

3. Any of the largest three national FEHBP plan options by enrollment; or

4. The largest insured commercial non-Medicaid Health Maintenance Organization (HMO) operating in the State.

In other words, the states are allowed to choose one of four status quo approaches as the definition of EHB. Instead of aiming for a nationwide standard of care based on evidence-based and population-based medicine, the DHHS has fallen back to relying on the standards built up over years of political wrangling and insurer lobbying. The science has fallen out of the discussion.

Not only is this approach inconsistent with Section 1302(b) of the PPACA, which directs that the Secretary of Health and Human Services define essential health benefits, it is also merely reflective in that it allows a state to choose a benchmark consistent with what the state already provides. It adds no new mandate to what is covered by any state, despite the letter and spirit mandate of the PPACA.

Second, the proposed approach also seemingly ignores the findings of the October 6, 2011 IOM report, “Essential Health Benefits—Balancing Coverage and Cost” (EHB Report). The EHB Report proposes that HHS embrace a framework for establishing EHB that considers “the population’s health needs as a whole,” “encourage[s] better care by ensuring good science is used to inform coverage decisions,” “emphasize[s] the judicious use of resources,” and “carefully use[s] economic tools to improve value and performance.” The EHB Report also encourages public involvement in defining the EHB and, although it suggests “some flexibility” at the state level, does not suggest that merely looking to current coverage by large state healthcare plans is the best approach.

This is a distinction that makes a difference in the lives of many Americans. The science of medicine is evolving at a rapid rate and state-mandated insurance coverage has not kept up with the advances in medical treatment. For instance, individuals born with Phenylketonuria (PKU) and similar inborn errors of metabolism must maintain strict low protein diets and consume medical formula in order to thrive. Untreated PKU and similar disorders leads to severe mental retardation, neurological problems and other physical and mental complications. Current medical practice dictates that individuals with PKU remain “on diet” and on formula for their entire lives. Prior medical practice was to take individuals off diet and formula when they had reached a certain level of development.  Under this approach, many PKU patients suffered severe intellectual, emotional, and medical setbacks. Many state laws are outdated and do not require coverage of medical foods or formula for life. Thus, the insurance plans in those states do not provide this coverage.  Under the “intended approach” outlined in the December 16 Bulletin, those with PKU and related disorders may not receive coverage of their medical formula and low protein foods.

The approach to defining EHB as set out in the EHB Report supports defining EHB to include coverage for formulas and low protein foods to treat inborn errors of metabolism:

  • It is good science to provide coverage for medical foods and formulas to treat inborn errors of metabolism.  The science shows that medical formulas and a low protein diet work to allow children and adults born with inborn errors of metabolism to lead productive lives. Decades of evidence support treating individuals with PKU and other inborn errors of metabolism with medical foods.  Failing to ensure coverage for PKU and other inborn errors of metabolism will lead to severely damaged infants and children. Further, public policy already supports the need to identify these disorders (as reflected in mandatory newborn screening for PKU and related inborn errors of metabolism). This same policy supports mandating coverage for treatment of these disorders.


  • It is consistent with a “population-based” healthcare approach to provide coverage for medical foods and formulas for the entire population of individuals who suffer from inborn errors of metabolism.  All of those who suffer from inborn errors of metabolism should have the same access to the state of the art treatment for the condition, i.e. diet and treatment for life. For those who suffer from inborn errors of metabolism, medical foods and formulas are akin to insulin for individuals who suffer from diabetes.


  • It is consistent with ethics to provide coverage for medical foods and formulas for individuals who suffer from inborn errors of metabolism.  We know that inborn errors of metabolism can lead to catastrophic outcomes if they are not treated. We also, thankfully, know how to treat them. We know that the use of medical foods works to allow people with inborn errors of metabolism to lead normal, productive lives. It would be unethical not to provide coverage for these foods.


  • Finally, basic economics also supports coverage of medical foods for inborn errors of metabolism. Yes, the foods are expensive (and more expensive for those without insurance), but the burden to society at large is even greater if these individuals do not receive treatment (a treatment that we know works). They may require more care, including more frequent trips to the emergency room. And many will eventually need to be institutionalized if they are unable to afford the medical foods they need to develop properly.

It is incorrect to suggest that that the EHB Report by the IOM supports the DHHS’s intended approach as set out in the December 16 Bulletin.  As explained above, the intended approach ignores the framework suggested by the EHB Report and substitutes the current lowest common denominator approach.  Because current coverage for medical foods and formulas for those with inborn errors of metabolism is a patchwork among the states, if the DHHS implements its intended approach, many individuals with PKU and related disorders will be left without coverage for their necessary formula and medical foods. This is an unacceptable result when we know that the medical foods and formulas work to improve outcomes and cost less than the outcomes that result if we do not provide treatment.

PKU and related inborn errors of metabolism is just one example of medical problems that may not be properly addressed if the DHHS moves forward with its proposed approach of allowing the States to define EHB by what is currently covered under their large health plans.  The DHHS will have squandered an opportunity to ensure that all Americans have access to healthcare that is consistent with accepted medical practices and, in fact, will cause many Americans to be treated in accordance with what we now know to be bad medicine (such as those Americans who have PKU who are forced to go off-diet without coverage for formula and medical foods).

Disclosure: This issue is a personal one for my family. My 20-month old daughter, Juliana, was born with PKU.