Airfox SEC Cryptocurrency Alt-Coin Settlement Is Everything Coin Issuers Hoped to Avoid – Securities Act Analysis Applies to Token Issuances

Airfox settles with SEC and treats tokens like the securities they are

CarrierEQ, Inc. (Airfox) did an initial coin offering in October 2017. They raised about $15 million to finance their digital token-denominated ecosystem for playing with ads.

Not bad, right? After all, lots of people were saying how ICOs were a cheap, non-dilutive way to raise money because SEC rules didn’t apply.

The SEC didn’t agree, as it warned in the DAO Report.

For its trouble, Airfox will pay a $250,000 penalty, which is not too bad.

However, they must also:

  • Register the tokens under the Exchange Act; and
  • File periodic reports with the SEC.

So far, expensive but still less than $15 million.

Airfox says they’re pleased with the result:

“We are pleased with these developments. We believe by reaching this resolution with the SEC and MSD, we are removing uncertainty and positioning Airfox to grow our blockchain platform within a regulatory framework,” said Victor Santos, CEO and co-founder, Airfox.

I doubt it. They must also offer rescission rights to everyone who bought their tokens from the Company.

Here we go.

Airtokens were issued at about $0.014 per token (they issued 1.06 billion tokens for $15 million).  They are currently worth about 1/10 of that. If you invested, would you get your money back if you had the chance?

For their sake, I hope Airfox had another source of funding.

Expect more of this from the SEC:

“By providing investors who purchased securities in these ICOs with the opportunity to be reimbursed and having the issuers register their tokens with the SEC, these orders provide a model for companies that have issued tokens in ICOs and seek to comply with the federal securities laws,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division.

Other notes:

  • The Massachusetts Securities Division was also involved, and it has been active in trying to police these activities.
  • Paragon Coin also settled with the SEC.  Paragon wants to integrate blockchain and the cannabis industry.
The Airtoken ecosystem.

Why Startups Fail – Crowdfunded Tech Startup Shuts Down With Open Letter to Backers

Despite successful crowdfunding campaign, tech startup KANOA shuts down after bad product review without sending out products.

KANOA, would-be producer of some sort of wireless earbuds, shut down. They announced their demise with an open letter to their backers.

They began with their founder’s initial capital spent on market research and design study by an engineering firm.

It appears that their crowdfunding may have been a pre-order campaign, but information is scarce at this point.

KANOA, crowdfunded tech startup, describes its demise
KANOA, crowdfunded tech startup, describes its demise

However, KANOA has said that they hired internally and engaged a contract manufacturer.  They began to ship a few units, but they were absolutely savaged by one YouTube review, which seems to have been the knockout blow.  Ironically, according to the reviewer, KANOA reached out to him as an influential personality to review the earbuds and garner publicity.  iTwe4ks has about 486,000 subscribers, and some of his videos have exceeded 1,000,000 views.  He did like the free t-shirt, if that is any consolation.

KANOA claimed in their farewell letter that they are in negotiations with investors for funding or an acquisition, but they do not have enough money to continue operations.  Backers or pre-ordering customers are out of luck.  They will not be fulfilling more orders.

Some farewell letters give a detailed post-mortem explaining what went wrong.  They leave a memorial to what went wrong.

It is difficult to see what happened to KANOA, or at least what KANOA thinks went wrong, other than they ran out of money.  Too many employees?  Ineffective design and manufacturing?  Lack of market?

No.  They were too honest and transparent:

Unlike on typical crowdfunding platforms we allowed backers to ask for refunds at any time. This policy kept us honest, but also added vulnerability once we had made major financial commitments. Setbacks and some bad publicity, like reviews of non-shippable beta units, stirred our audience. Most significantly and to our unpleasant surprise, our investors recently backed out of our funding round. We do not blame them, but this was a pivotal setback since capital was essential for ramping up production.

Perhaps the actual story will be uncovered in the class action lawsuit.  However, a lawsuit is unlikely if there is nothing to go after.

When Innovation Is More Than Technology: Software Company Allows Customers to Steal Their Software

Freakshow Industries implements innovative business model for its music tech software by letting customers “steal” the software.

As Freakshow says:

We fight crime by legalizing it.  You can’t break an agreement you never made.

Creating products in the digital world can be difficult.  Anyone can steal and reproduce your products at will.  Copy protection is weak and generally only hurts your paying customers by making their experience inconvenient.  I have a pile of license fobs as testament to this.

Some companies provide freeware and simply don’t charge.  Others put out a tip jar.  Freakshow Industries takes it a step further and provides a link for customers to steal their software.

It does not come without a cost.  First, the thief must endure a Q&A with insults around why he or she chooses not to pay, with options including ‘Money is Tight,’ ‘Software Should Be Free,’ ‘I Am A Dick,’ and “I Changed My Mind and I Want to Pay.’  Each provides some additional commentary and ways for the thief to do a little on their part, such as pay less than full price or to provide a tip.  However, the ‘I Am A Dick’ tab replies with “Well there is no fixing that.  Download away asshole.”

Why would Freakshow do this?  Resigned to their fate, perhaps?  As they say:

Stolen product licenses are fully functional, they are just not eligible for any upgrade stuff. We do not otherwise taint these licenses in any way.

Also, if you steal a license then we’ll be using our own discretion around just how much we’re going to support you. Just be a good person and we’ll probably help you out. Yeah.

Don’t get us wrong. We would definitely rather you actually buy our software. But we realize that some people, for whatever reason, just won’t. So, if you’re going to be that person, then we would rather you steal directly from us than catch some shitty computer cancer from whoever else would be hosting our work.

Basically, stealing is inevitable and they don’t want to make life worse for their legitimate users.  They also recognize the risk involved in acquiring pirated software on the streets, or at least through p2p networks.  They probably also recognize that users of cracked software may actually come back and buy stuff if they decide they like it.  Freakshow also provides easy access to links for buying their other merchandise, like t-shirts.  Nonpaying customers may become paying customers, of some sort or another, eventually.

Whatever their reasoning, it is refreshing to see a company that cares about its users, paying and otherwise.  It is refreshing to see a new take on this issue.

Obviously developers want to sell their products, but no amount of wishing is going to offset the reality that the cost to reproduce and distribute digital goods is zero.  If you make your software unwieldy to validate and use, people will crack the copy protection or go elsewhere.  Cultivating these users may actually turn them into paying customers, even if they wind up paying for other goods and services apart from the original software.

Freakshow Industries previews its Backmask plugin.

White Shoe Law Firm Adopting Artificial Intelligence Platform as AI Now Infiltrates BigLaw

Law firms are beginning to adopt artificial intelligence. This could be great news for clients, but young lawyers are most at risk of losing jobs to AI.

Cravath Swaine & Moore has reportedly signed up with Luminance to use its AI technology for due diligence.

Cravath is generally considered one of the most prestigious law firms in the country.  Their adoption of AI will be a big deal since other firms will feel obligated to follow.  For those who don’t know, BigLaw firms tend to be trailblazers . . . when another BigLaw firm paves the trail.

Document review tends to be a big part of how junior associates spend their time and bill their hours.  This applies in due diligence for transactions and discovery for litigation.  For law firms, it serves a valuable purpose of generating fees while these associates learn how to read documents in the context of actual legal work and learn how to do their jobs.  For clients, this feels like paying to train someone else’s employees at premium rates for non-premium work.

The practice of law is changing.  It has the key aspects of any business ripe for disruption: rote work that can be replaced by automation.

When people think of automation, they think of factories and, increasingly, food service.  However, poring over piles of similar documents is subject to machine learning and AI like assembling widgets.

What is Luminance?  It

… is the market-leading artificial intelligence platform for the legal industry. Trained by legal experts, the revolutionary technology is founded on breakthroughs in machine learning at the University of Cambridge.

Luminance understands language the way humans do, in volumes and at speeds that humans will never achieve. It provides an immediate and global overview of any company, picking out warning signs without needing any instruction.

Whether used for due diligence, compliance, insurance or contract management, Luminance adds value to a legal team, freeing lawyers to focus on what matters.

Law students with BigLaw ambitions should take note.  Unless BigLaw finds another way to finance their training, entry-level opportunities at BigLaw may be going away.

Cravath Swaine & Moore adopts Luminance for law firm artificial intelligence (AI) and machine learning platform.
Luminance: Artificial Intelligence (AI) for the legal industry, adopted by white shoe law firm, Cravath Swaine & Moore

SEC Warns of SAFE Investment Instrument Popular in Equity Crowdfunding Campaigns

The SEC issued a bulletin warning investors about SAFE securities used in equity crowdfunding offerings.

Issuers in equity crowdfunding campaigns have offered various types of securities since it became legal to do so, such as various classes of stock, notes and instruments known as SAFE instruments.  ‘SAFE’ stands for ‘Simple Agreement for Future Equity.’

SAFEs were originally designed to be an alternative to convertible notes for early-stage technology investments.  The idea was that they would become simple, standardized vehicles for investing in very young companies without dealing with a lot the terms needed to make a convertible note or stock investment.

As the SEC points out, a SAFE is not like investing in common stock.  It is an agreement that converts into issuer securities in the event of future triggering events, such as a future investment round, an IPO, a change of control or a liquidation.

Some people seem to think of them like convertible notes.  However, convertible notes have maturity dates, among other terms.  SAFEs do not and may never convert.  SAFEs are more like derivative contracts with springing conversion based on listed events.

SAFEs have been increasing in use in the venture capital and angel investing worlds, and more recently other investors have gained some exposure and comfort with them.  However, the SEC wants investors to know that:

  • SAFEs do not represent a current equity stake in the company in which you are investing.
  • SAFEs may only convert to equity if certain triggering events occur.
  • Depending on its terms, a SAFE may not be triggered.

To the people who have seen them before, none of this is a surprise.  To a new investor, the SEC is concerned that these terms may be unexpected.  As the SEC said:

SAFEs were developed in Silicon Valley as a way for venture capital investors to quickly invest in a hot startup without burdening the startup with the more labored negotiations an equity offering may entail.  Oftentimes, for the venture capital investor, it was more important to get the investment opportunity, and possible future opportunities, with the startup than it was to protect the relatively small investment represented by the SAFE.  In addition, the various mechanisms of the SAFE, from the triggering events to the conversion terms, were designed to best operate in the context of a fast growing startup likely to need and attract additional capital from sophisticated venture capital investors.  This may or may not be the case with the crowdfunding investment opportunity you are exploring.

SAFEs can make a lot of sense to particular parties in particular deals, but investors such as crowdfunding investors should make sure to understand exactly what rights they have in what they are purchasing.

SEC issues warning about SAFE instruments in equity crowdfunding campaigns.
SEC issues warning about SAFE instruments in equity crowdfunding campaigns.

Equity Crowdfunding Risks and Liabilities – Yes, They Do Exist

Sorry startups, you actually have to be careful with equity crowdfunding disclosures. There is substantial risk of liability for securities fraud.

Based on discussions with the equity crowdfunding-curious, people seem to believe that equity crowdfunding is the wild west where anything goes.  Raise lots of money and do it cheaply! Do what you want, say what you want and the SEC does not care!  Look at the Form C’s, there were probably no lawyers anywhere near them.  Think of the savings!!!!

None of that is true.

Done correctly, an equity crowdfunding offering should be done with as much care as any private placement.  The actual information requirements are more extensive than a typical Rule 506 offering.  Most importantly, crowdfunding issuers are subject to the same liability as any other securities selling issuer.

Securities Act Section 4A(c) provides that an issuer will be liable to a purchaser of its securities in a transaction exempted by Section 4(a)(6) if the issuer, in the offer or sale of the securities, makes an untrue statement of a material fact or omits to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading . . .

Sound familiar?  What is the difference between this liability and private placements?  Equity crowdfunding is done publicly to more people who are potential claimants.

What does this mean for issuers?  It means the Form C and the offering page on the platform site need to be done carefully and in compliance with SEC rules.  Those rules sound a lot like watered down Regulation S-K rules for MD&A, description of securities, related party transactions, etc…  If you have never complied with them, good luck doing this without experienced help.

Well, at least the platforms are safe, right?  They are just dumb pipes for crowdfunding deals and have no responsibility for what the issuers do on their site, right?

Well, no.  While the SEC did not impose issuer liability on the platforms, it specifically declined to exempt the platforms from liability under Section 4A(c).  Why?  So investors could bring suits against the platforms to make sure that the platforms take steps to keep from becoming conduits of fraud.

The SEC believes that the platforms should take steps to protect themselves.  Congress provided them a defense if they could not have known of an untruth or omission in the exercise of reasonable care.  In other words, the “head in the sand” defense will not work.  In addition, I have seen them provide and even require standard language and provisions in their issuers Form Cs and offering pages.  I doubt the SEC will ignore this if this becomes misleading.

As the SEC stated:

These steps may include establishing policies and procedure that are reasonably designed to achieve compliance with the requirements of Regulation Crowdfunding, and conducting a review of the issuer’s offering documents, before posting them to the platform, to evaluate whether they contain materially false or misleading information.

We are coming up on the one year anniversary of equity crowdfunding.  It is still very early in the equity crowdfunding world to see where the liability issues will shake out.  However, it is clear that the SEC and the state securities regulators take these liability issues seriously, and the issuers and platforms should too.

Equity Crowdfunding. Missing Category: Liability
Equity Crowdfunding. Missing Category: Liability

Equity Crowdfunding Publicity, Or What Not To Do

Rules on marketing and advertising your equity crowdfunding campaign are more restrictive than you think.  Startups accostomed to blogging your every thoughts and feelings beware.

When the SEC adopted the crowdfunding rules under Regulation CF, it included severe restraints on a company’s ability to publicize its crowdfunding campaign.  Many people think the SEC allows general solicitation and it applies to everything.  Wrong.  It does not apply to crowdfunding.

You know those cool tombstone ads in the Wall Street Journal showing off an IPO?  That shows the type of information that your crowdfunding notices can include.

A crowdfunding advertising is limited to:

  • a statement that the issuer is conducting a crowdfunding offering in reliance on section 4(a)(6) of the Securities Act of 1933
  • the name of the platform
  • a link directing the investor to the intermediary’s platform;
  • the terms of the offering; and
  • factual information about the legal identity and business location of the issuer, limited to:
    • the name of the issuer of the security
    • the address of the issuer
    • phone number of the issuer
    • website of the issuer
    • the e-mail address of a representative of the issuer and
    • a brief description of the business of the issuer.

The description of the terms of the offering must be limited to:

  • the amount of securities offered;
  • the nature of the securities;
  • the price of the securities; and
  • the closing date of the offering period.

That’s it.  Some short bullet-pointy info dots.

There’s no “this is the Internet and I can say whatever I want.”  There’s no “This is the new world and old rules don’t apply.”

Is it limiting?  Yes.

Is there a reason?  Yes.

As with public offerings, there is a required disclosure document, in this case Form C.  The SEC wants to make sure you have access to it before you make an investment decision.  The SEC does not want a hyped-up ad to entice you to purchase before you have the ability to review 50 to 100 pages of required disclosure.

Any good news?  Well, the company does not have to file the notices with the SEC.  The company is not limited to newspapers.  The notices can go anywhere, such as social media or the company’s website.

Also, the company can communicate with investors through the crowdfunding platform.  The SEC believes that this ability will facilitate the wisdom of the “crowd” in crowdfunding.  The company must identify itself as the company and not as “Random Guy Who Believes Company Will Be the Next UBER x Google.”

Old timey Ford tombstone. Crowdfunding companies need to get used to this.
Old timey Ford tombstone. Crowdfunding companies need to get used to this.

JPMorgan Beating Startups to the AI Revolution. Artificial Intelligence to Eat White Collar Jobs – Is Going Solo in the Freelance Economy the Answer?

It is not just startups shaking up the AI world.  JPMorgan discusses its artificial intelligence program. Going Solo in the Freelance Economy starts looking better.

When I left Big Firm, it was for personal reasons.  I did not leave shaking my fist at a horrible culture and history of injustice.  I did not experience that.  I started thinking about a professional life staring at a different set of walls.  I began to question my place in the Big Firm ecosystem and whether I could succeed without the safety net.  Lucky me, I could.

For many attorneys, the choice will not be theirs to make.  Technology is coming for their jobs.

Junior attorneys in bigger firms spend most of their time in some sort of document review and document processing roles.  This is necessary grunt work, and it is how junior attorneys learn, when they pay attention.

Billable rates have continued to increase, and clients push back when they can.  However, discovery in litigation and due diligence in transactional work must get done.  What happens when software can take the place of expensive junior associates?

It is about to happen.

There have been a number of articles lately about first generation artificial intelligence tools for this type of work and their early adopter law firms.

Last week, Bloomberg reported on JPMorgan’s COIN, or Contract Intelligence, program.  It reviews commercial loan agreements, something that consumed 360,000 hours of work by lawyers and loan officers each year.  That task now takes seconds, has fewer errors, does not ask for vacations or have the other baggage associated with human employees.

In addition, JPMorgan’s machine learning and big data system helps automate software coding.

In legal circles, litigation document review was seen as the low-hanging fruit for AI software.  However, any white collar position that provides a service that is based on rote activities can and will be replaced by software.  It may not be tomorrow, but it is sooner than you think.  JPMorgan is already planning to license its service to its bigger clients who are staffed to the rafters with white collar “thought employees” who are about to be replaced by code.

Many people believe their job cannot be at risk to computers because computers do not have the judgement capabilities of humans.  But:

As for COIN, the program has helped JPMorgan cut down on loan-servicing mistakes, most of which stemmed from human error in interpreting 12,000 new wholesale contracts per year, according to its designers.

The software is doing other tasks that lots of humans now perform:

For simpler tasks, the bank has created bots to perform functions like granting access to software systems and responding to IT requests, such as resetting an employee’s password, Zames said. Bots are expected to handle 1.7 million access requests this year, doing the work of 140 people.

I am not writing this as a doom-and-gloom article about lost employment.  I think this is ultimately a good thing.  No one knows about the opportunities that will arise from this shift.

It does mean that people should recognize the shift and their place in it.  Stability, comfort and complacency in large organizations has been an antiquated notion for a while.  Maybe Going Solo and finding your place in the Freelance Economy is a path forward.

Artificial intelligence drives the Freelance Economy, eats white collar jobs.
Artificial intelligence drives the Freelance Economy, eats white collar jobs.  Some large enterprise companies are beating startups to the AI revolution.

Monster Books and Records; Unrequited Demands and Other Lessons for Startups and Seasoned Companies

Everyone from startups to seasoned companies and their shareholders can take a lesson from the Monster books and records demand debacle.

I know what you’re thinking:  “How lucky am I to have two books and records articles in two weeks!”

Monster Worldwide (of job board fame) was acquired and merged out of existence.  A shareholder had made a books and records demand prior to the merger but did not bring suit to enforce it until after the merger.  The demand letter said it would assume Monster would not take certain actions unless Monster said otherwise by a deadline.  Monster did nothing. Former shareholder loses.

Here’s a timeline that will be helpful:

  • August 8 – Monster and Acquiror enter into a merger agreement
  • September 6 – Acquiror commences a tender offer to Monster shareholders under the merger agreement
  • October 19 – Shareholder sends demand letter to Monster seeking access to books and records
  • October 26 – Monster rejects demand in current form but offers to cooperate on limited access
  • October 26 – Shareholder emails about the limited offer and stating that if the merger closes before he files a complaint, he expects that the company will refrain from asserting any argument that he lost standing to inspect documents because the merger closed before he filed his complaint. If the company will not refrain from making any such argument, please tell me by 10:00 a.m. Eastern time tomorrow.”
  • October 28 – Withdrawal rights for the tender offer expire; Monster responds to Shareholder refusing to refrain from anything
  • November 1 – Merger completed
  • November 4 – Monster notifies Shareholder that its request was moot since the merger occurred
  • November 22 – Shareholder files complaint

The Shareholder claimed he still had standing according to some policy arguments based on the timing of his demands to Monster, but the court noted that this was simple:

The language of Section 220(c) is plain and unambiguous. By requiring that a plaintiff under Section 220, to seek relief from this Court, demonstrate both that it “has”—past tense—complied with the demand requirement, and that it “is”—present tense—a stockholder, the legislature has made clear that only those who are stockholders at the time of filing have standing to invoke this Court’s assistance under Section 220.

Since the merger had occurred, the Shareholder was no longer a shareholder at the time of the complaint.  Therefore, he did not have standing under DGCL Section 220(c) to file a suit to enforce his right to books and records.

As we mentioned in our previous post, all corporations are bound by the books and records requirements of their jurisdiction of incorporation.  Startups are not exempt just because they like confidentiality and “stealth mode.”

Likewise, shareholders making a demand must conform to strict requirements of the statute.  A company can refuse and delay access on the basis of an improper request.

–Joe Weingarten v. Monster Worldwide, Inc.

Monster denies books and records request since it doesn't really exist anymore in its old form.
Monster Worldwide – You can have our job listings, but not our books and records

 

Do Startups and Other Private Companies Have to Provide Info to Employees?

If the employee is a stockholder, private companies, including secretive tech startups and other private emerging growth companies, must provide some company information, as confirmed by old law and new case.

Some ink is being spilled regarding the Biederman v. Domo case about a former employee and current stockholder suing Domo for financial information.  Some of the ink tells the story, but some get it wrong.  Let’s take a look.

I’m using news reports since I could not find an opinion or ruling, so accuracy may vary as we will see.

Domo usually keeps its financial information secret, like most companies.  Domo also pays its employees in stock and options, like many tech and startup companies.  Domo was richly valued in VC rounds, like many tech and startup companies.  Domo’s value may have declined, like many tech and startup companies that were richly valued in VC rounds.

Biederman wanted information about Domo’s financial condition, Domo wanted a confidentiality agreement.  Biederman refused.  According to the Information, this

“highlighted an obscure Delaware law that gives investors the right to financial information of private tech firms in which they hold stock.”

The San Francisco Business Times (the “SFBT“) misreports the Information by stating that

“The Information reports that a Delaware law applies to any privately held company that has issued more than $5 million in stock awards in a year and is incorporated in the state. The rule allows employees of any U.S. private company a right to detailed financial information — even if they work for the famously opaque and sometimes secretive tech sector.”

Let’s unpack this a bit.

First, Section 220 of the Delaware General Corporation Law is not obscure.  It is commonly invoked by stockholders who demand information.  The universe of documents available to the stockholder is limited and related to the stockholder’s purpose for requesting the information.

Second, with respect to the SFBT, Delaware law cannot apply “to any privately held company,” only those subject to Delaware’s jurisdiction.  The $5 million figure refers to SEC Rule 701, which exempts certain compensation benefit plans from SEC registration requirements and has nothing to do with Delaware law.  Basically, certain disclosure requirements are triggered if the value of equity awards in a 12-month period exceeds $5 million.

None of this is new.  There are those, particularly in the tech world, who don’t understand that old rules apply to them.  You can’t force a stockholder to sign an agreement as a condition to exercising statutory rights.  I suppose you can try, but a court may disagree.  In some states, a company may be subject to penalties for refusing access to books and records.

Generally speaking, private companies do not have to make disclosures to stockholders (employee or otherwise).  However, there are circumstances where statutes and regs require opening up, such as:

  • pursuant to a proper books and records inspection request (most states have statutes requiring this, and the request has to be in proper form);
  • while there are usually no specific disclosure requirements for stockholder meetings, fiduciary considerations apply when asking for stockholder vote, such as M&A transactions; and
  • state and federal antifraud and registration/exemption rules apply when securities are involved.
Probably a different Domo, but Domo wants his stockholder books and records information.
Probably a different Domo, but Domo wants his Biederman stockholder books and records information.