The seventeenth issue of the Michigan Business & Entrepreneurial Law Review has been published! Our subscribers will find the following works inside.
9 Mich. Bus. & Entrepreneurial L. Rev. ___ (2020)
Published: Spring 2020
Jeff Thomas, Redefining Accredited Investor: That’s One Small Step for the SEC, One Giant Leap for Our Economy
Abstract: It may sound trivial, yet how we define accredited investor (AI) is critical. Among other things, U.S. securities laws and regulations make it easier for AIs to invest in privately held companies through “exempt offerings,” which are offerings not “registered” under the 1933 Securities Act. This results in AIs having investment opportunities that are unavailable to non-accredited investors (non-AIs). Moreover, the amount raised in exempt offerings has been increasing both absolutely and relative to the amount raised in registered offerings. In fact, the Director of the SEC’s Division of Corporate Finance recently indicated that “[c]ompanies raised $2.9 trillion in private markets [in 2018], compared to $1.4 trillion in public markets . . . .” The importance of making more exempt offerings available to current non-AIs is frequently noted. Further, the pool of capital available to new ventures is essentially limited to the amount AIs are willing and able to invest. This is because it is too expensive for new ventures to participate in registered (i.e., public) offerings. It is also well established that these entrepreneurial ventures, which frequently need additional capital, have a significant impact on our economy. Thus, converting current non-AIs into AIs would create new investment opportunities, provide a much needed source of capital for entrepreneurial ventures, and have an economic impact.
To date, the AI definition has ignored the sophistication of individual investors. Instead, it has focused solely on one’s net worth and income. Commentators, including the SEC, have repeatedly noted potential shortcomings with this approach. But, the need to protect investors has provided the justification for tolerating these shortcomings. This Article argues that AI should be redefined to welcome investors who demonstrate an ability to fend for themselves by passing a relevant exam. More specifically, Part II of this Article reviews the current AI definition and population. Part III provides examples of how the AI definition impacts investments in private companies and the secondary trading of such securities. Part IV summarizes recent proposals to expand the current AI definition. Finally, Part V takes an in-depth look at one of the proposals: letting investors test into AI status. Part V also explains how such an exam could be linked to two other responsible ways to expand the AI pool: putting investment limits on AIs and recognizing the value of experience gained by actually investing in exempt offerings.
Matthew A. Melone, Pub. L. No. 86-272 and the Anti-Commandeering Doctrine: Is This Anachronism Constitutionally Vulnerable After Murphy v. NCAA?
Abstract: State taxing authority suffers from little of the structural impediments that the Constitution imposes on the federal government’s taxing power but the states’ power to tax is subject to the restrictions imposed on the exercise of any state action by the Constitution. The most significant obstacles to the states’ assertion of their taxing authority have been the Due Process Clause and the Commerce Clause. The Due Process Clause concerns itself with fairness while the Commerce Clause concerns itself with a functioning national economy. Although the two restrictions have different objectives, for quite some time both restrictions shared one attribute—a taxpayer physical presence test.
Business practices evolved in response to technological developments and the ability of enterprises to avail themselves of a forum state’s markets with little or no traditional physical presence in the state resulted in the elimination of the physical presence test for Due Process purposes almost thirty years ago. The subsequent exponential growth of electronic commerce finally led to the demise of the physical presence test for Commerce Clause purposes as a result of the Court’s recent decision in South Dakota v. Wayfair. However, a six decades old statute remains an impediment to the states’ ability to exercise income tax jurisdiction over the income earned by remote sellers of tangible personal property.
In a case unrelated to state taxing authority during the same term, the Court in Murphy v. National Collegiate Athletic Association struck down a federal law that prohibited states from authorizing sports gambling. According to the Court, the federal law impermissibly commandeered state legislatures. A critical holding in that case was that a federal law that prohibits state action is subject to the anti-commandeering doctrine similar to federal laws that mandate state action. The federal statute that limits the states’ ability to tax is very similar to the gambling statute that the Court struck down—it prohibits states from enacting otherwise permissible legislation without establishing a corresponding federal regulatory regime. In short, the statute commandeers the states similarly to the gambling statute. As a result, the statute is an impermissible encroachment of state sovereignty.
Part I of this Article discusses the Due Process and Commerce Clause limitations on states’ taxing powers and the eventual demise of the physical presence test as a result of Court’s holdings in Quill Corp. v. North Dakota and, more recently, South Dakota v. Wayfair. This part also discusses Pub. L. No. 86-272, the longstanding prohibition imposed on states with regard to the taxation of income derived by remote sellers of tangible personal property. Part II discusses the anti-commandeering doctrine. This doctrine has surfaced as a significant bulwark for federalism over the past three decades and led to the demise of the federal sports gambling legislation as a result of the Court’s recent decision in Murphy. This part concludes with an analysis of the case and its potential application to the tax statute.
Leah Duncan, The Proxy Problem: Using Nonprofits to Solve Misaligned Incentives in the Proxy Voting Process
Abstract: Proxy advisory firms and their influence on the proxy voting process have recently become the subject of great attention for the Securities and Exchange Commission (“SEC”) among other constituencies. A glance at recent proxy season recaps and reports, many of which devote space to discussing proxy advisory firm recommendations, reveal the significance of this influence on institutional voting. As Sagiv Edelman puts it, “proxy advisory firms exist at the nexus of some of the most high-profile corporate law discussions—most notably, the shareholder voting process, which has recently been the subject of much scholarly and legal debate.” The SEC has responded by announcing that it intends to reform the regulations, or lack thereof, surrounding proxy advisory firms.
Recently, the SEC issued proposed amendments to Exchange Act Rule 14(a)-1 which would effectively codify their earlier interpretation of solicitation under this rule. The proposed amendment would “condition the availability of certain existing exemptions from the information and filing requirements . . . for proxy voting advice businesses upon compliance with additional disclosures and procedural requirements.” Furthermore, the amendments would clarify when a lack of disclosure of certain information in proxy voting advice compromises the accuracy of the advice and misleads within the meaning of the rule. The SEC believes that these extra requirements will “help ensure that investors who use proxy voting advice receive more accurate, transparent, and complete information on which to make their voting decisions.” Based on this proposal, it is apparent that the SEC is intent on rectifying some of the problems of transparency and conflicts of interest associated with proxy advisory firms.
Given the increasing influence of proxy advisory firms, the misalignment of incentives between proxy firms and the institutional shareholders who use proxy firm services is troubling. This Note identifies inherent problems and concerns with proxy advisory firms and offers solutions to these issues with a focus on eliminating conflicts of interest. Using Henry Hansmann’s theory of ownership, this Note argues that nonprofit ownership of proxy advisory firms eliminates both information asymmetry and conflicts of interest inherent to the current ownership structure.
Part I provides a brief overview of the problems and concerns associated with proxy advisory firms. Part II suggests two potential solutions: that Rule 206(4)-6 of the Investment Adviser Act of 1940 should be repealed or alternatively, that nonprofit ownership through investment company associations is a more effective way for investment management companies to comply with their fiduciary duties. Because profit incentive has created conflicts of interest that lead to proxy advice that may not always be in the best interest of investment manager clients, nonprofit ownership promotes transparency that allows parties who rely on the advice to make more independent decisions. Part III argues that nonprofit ownership is the most viable alternative to the status quo.
Nick Worden, Gatekeeping the Gatekeepers: The Need for a Licensing Requirement for Crowdfunding Portals in the Wake of the DreamFunded Decision
Abstract: Most people are familiar with crowdfunding sites such as Kickstarter and GoFundMe—sites that allow users to part with their money in exchange for products or donate their capital to organizations they believe in. However, these sites have one trait in common: they do not offer contributors equity or a promise for future profits. For a long time, selling equity meant complying with the costly requirements of federal securities laws, which was cost-prohibitive for many small businesses; it was illegal for businesses to offer equity over a site in the way businesses on Kickstarter offered products. The Jumpstart Our Business Startups (JOBS) Act changed that. Small businesses, initially precluded from raising capital through the promise of equity, could do so now. However, the passage of the JOBS Act came with a number of requirements for businesses trying to sell equity via crowdfunding. In particular, these businesses could not offer their equity through just any Internet site. They had to do so through a registered intermediary—a gatekeeper to the equity crowdfunding scene. These intermediaries came in two types: broker-dealers (a familiar party in securities law) and a new statutorily created entity called a “funding portal.” Funding portals have many requirements imposed on them, but unlike broker-dealers, they are not required to be licensed to act as an intermediary.
The absence of a licensing requirement for funding portals is problematic. The first litigated case involving a funding portal, Department of Enforcement v. DreamFunded Marketplace, LLC, presented that the lack of a licensing requirement threatens the twin purposes of the JOBS Act: capital formation and investor protection.