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William Carleton, Counsellor @ Law
Average of 14 posts per month.
March 20
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05:45 AM
Senator Dodd's legislation has to change. It simply has to. Otherwise, we have to contemplate that startups will be possible only for those who (a) can bootstrap their way, all the way, with no outside investment, or (b) are very, very rich. BusinessWeek has some data on this, and the numbers are not just sobering, they are devastating. Here are numbers from BusinessWeek on how the angel community will be hit (see the article for better context): - By one measure, the number of accredited investors would drop 77%;
- By another measure, the pool of active accredited investors (people who made a friends-and-family or angel investment in the previous three years) could drop from 528,000 to 756,000 (currently), to to 121,000 to 174,000 people.
Remember: "Most entrepreneurs get their first real investments from angels, not VCs." (The quote is from a post by Fred Wilson on his blog.) Not that VCs will do any better by Sen. Dodd. As I noted yesterday on the Save Reg D site, the BusinessWeek article goes on to describe the negative downstream effects on venture capital financing. The retiring Senator Dodd wants to leave a mark, all right. If someone doesn't take notice, step up and change that bill, Senator Dodd may well lay waste to startup land.
March 19
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05:45 AM
Most folks I know concerned about Senator Dodd's attack on Reg D think it is too early to propose a fallback position or compromise. I agree the best and first line of defense is this: make the case that the self-policing system of exemption and federal preemption under Rule 506 is working; that it is working well; and that it is necessary for entrepreneurship and innovation in America.
But I'm worried the train is leaving the station, and that only the NASAA's views are being heard by Sen. Dodd and the legislators and/or staffers behind the drafting of Sen. Dodd's atrocious proposals to gut angel financing.
At the moment, the only thing approaching a coherent narrative to make sense of the language in Sen. Dodd's bill (and there is no way to make legal or policy sense of the mish mash, as I tried to show yesterday, and as Dennis Brennan and Joe Stansell, in their comments to yesterday's post, did a better job of explaining) is the one put forward by NASAA, and it is this: unscrupulous broker-dealers and placement agents are bilking unsophisticated innocents of their savings, all the while shielding themselves from prospective merit review by filing under Rule 506 of Reg D.
So I think those of us who want to protect seed financings have to brainstorm alternative changes to Reg D that address the problems of which NASAA speaks.
There are other ways to change Reg D, alternative proposals, that would leave the essential system intact for startup technology companies, as well as for other entrepreneurial sectors of the economy that fuel innovation, growth and jobs.
Here are two I can think of:
- Leave everything in Reg D as it is now, but mandate that the SEC refine Rule 506 to say that securites issued in reliance on that rule are not "covered," and thus states may intervene prior to sale, if and only if the issuer sells to non-accredited investors.
- Leave everything in Reg D as it is now, but mandate that the SEC toughen up, by rule, the prohibition against "general solicitation" and/or the "existing business relationship" standard.
And as for the disastrous proposal that could more than double the thresholds for "accredited investor" status, here's one alternative:
Let accredited investors who meet any of the current threshold tests "opt out" and declare themselves as "deemed non-accredited" and in need of state protection. Those who don't earn 6-figure salaries or don't have million dollar net worths are still automatically protected (it's slightly Orwellian, isn't it, to say "protected" where the context requires the word "excluded"), as they are today; and the millionaires who perceive themselves to be unsophisticated can avail themselves of state protection, too.
March 18
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05:00 AM
A spokesperson for the North American Securities Administrators Association (NASAA) is quoted in Investment News as saying that the Association “didn’t get what it wanted” in Monday’s new version of Sen. Dodd's financial regulatory reform bill. The implication is that the language in Sen. Dodd’s substitute proposal, attacking angel financing, is somehow a backing off, a compromise, from language in an earlier version of the bill. That analysis might make sense to the NASAA, but from the perspective of a entrepreneur or an angel investor, Sen. Dodd’s new tack may be worse than his first. What the NASAA wanted was for Sen. Dodd to altogether rescind federal preemption of state regulation over offerings exempt from registration requirements under Rule 506 of Regulation D. Outright repeal of federal preemption appeared to be in the first bill. What happened instead this second go-round looks like one of those mish mashes of incoherence that occurs when someone doesn't understand the underlying purpose of what she or he is messing with. Dodd's new language says the SEC must review filings under Rule 506 of Regulation D within 120 days. If the SEC does not undertake the review in such time, then the states are free to intervene (either because the security is no longer "covered," or because a state regulator undertakes a review and somehow determines that the SEC filing is okay -- it's confusing, but the supposition seems to be that a state may step in and play a review role comparable to the one the SEC failed to play during the 120 days (though it would seem a state might just as well decline that "invitation" and go right to regulating the offering under its own standards)). Alternatively, the SEC can bail on the responsibility altogether, and let states go directly to regulating a certain class of offerings, where the SEC determines that the size and scope of such offerings are too small for SEC consideration (er, make that, "too small to merit federal exemption from state purview"). Depending on SEC rulemaking under Dodd's legislation, this could mean the end of federal preemption over seed financings and smaller offerings that meet Reg D requirements, and a quagmire of uncertainty for offerings that ostensibly are large enough for the SEC to retain authority over. The quagmire is in the 120 day wait. As Joe Wallin put it on his blog, "The concept of waiting 120 days for the SEC to clear an all accredited investor offering is truly an amazing thing to ponder." So how would one plan in this new regime? The prudent issuer that, in the past, would have relied on Reg D, raised initial funds, then filed, will, under Dodd's legislation, probably need to go ahead and comply up front with state requirements. Given the chance that the SEC might default to the states anyway at the end of 120 days, the issuer had better get all relevant state review processes running concurrently. How else can the issuer reasonably hope to get the offering cleared in less than half a year? The only issuers who dare not "cover all bases" in this manner would be those that have all the time in the world to wait for regulatory clearance (there aren't many of those). To summarize, Dodd would now both (a) leave the door open for the SEC, by rule, to gut federal preemption for smaller seed financings or other angel financings, and (b) cripple the self-policing nature of the current exemption regime, even if/where it still would exist, by requiring filers to wait (up to 120 days for SEC review, longer if SEC inaction by default pushes review out to the states). Just how absurd this all is was put well by Dave (no last name given) in a comment to the TechFlash piece from earlier this week: "All this does is massively increase the cost and time burden for rule following companies and it will reduce capital raised. Regardless of the rule changes, federal and state governments do not have the resources to effectively review all public and private offerings of securities. Ultimately, the exemption framework largely sets out the rules for companies that follow the rules and provides the mechanism for recourse when rules were not followed. No exemption typically means a strict liability remedy for violations of state securities or "blue sky" laws in addition to other penalties. That is what the rules do. The system is not designed to have a substantive review of every single financing in the country." Dave goes on to point out that this system for private financing, with self-policing up front and dire consequences and rights of regulatory and private action following just behind, works well, and would appear to be more effective than the system of public registration and disclosure that didn't do anything to stop Madoff or Lehman Brothers. For a future post: what a real compromise might look like.
March 17
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05:45 AM
Much talk in the tech/law blogosphere lately about standardizing financing documents. The Ted Wang seed financing forms are out, and Yokum Taku has a new, long post about them and other financing sets out there. I'm looking forward to finding the time to dig into them (the docs and Yokum Taku's review). I posted recently, too, on Joe Wallin's start up company blog, and earlier this month on this blog, on related subjects. The post on Joe's blog spoke more broadly about a goal of open sourcing all law firm templates. But as I'm getting coffee this morning, thoughts of "templates with agendas" are running through my head. By this phrase, I mean legal documents that present themselves as standard boilerplate, but have tricky, nonstandard language contained within them. Here are two examples: - An employee assignment of inventions that appears to have the statutory notice limiting what the employer can require the employee to assign, but then contains a purported "right of first refusal" on the employee's non-assignable IP!
- An NDA with what at first seems to be a standard "independent development" carve out to the definition of "confidential information," but in fact, with the substitution of just a few little words, effects a cooling off period for any recipient employee with access to the disclosing party's confidential information.
A company can be made or broken over its decision on whether to sign an aberrant form or to confront the proposing party with the issue. There I go again, talking as if a corporation were a person who could make such a judgment. Within startups and emerging companies, anyway, these decisions are made by founders and management who have to weigh the transaction costs and the risks of squelching discussions with bigger players on what by default are going to be seen as "lawyer issues." But the most successful entrepreneurs have a knack for ferreting out when these glitches are something to stop the train for. I still marvel, over a decade later, at the decision one of my clients made to shut down a due diligence visit by a contingent from a Fortune 50 company because the NDA they sent over (some three or four hours before the visit) contained a residuals clause, which we determined effectively acted as a trade secret license. Boy, was his whole team, and his board, p*ssed! That company went on to have a huge IPO.
March 16
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05:45 AM
Yesterday, TechFlash ran a guest post Joe Wallin and I wrote about draft legislation that would gut Reg D and angel financing as we know it. This is part of Senator Dodd's revamped financial regulatory reform bill. Joe Stansell had a comment that notes the irony this way: "It would be incredibly unfortunate if in combatting too-big-to-fail we implement a rule that ensures too-small-to-succeed."
The who, what, when, where and why, such as we know, are in the TechFlash piece. If you are an entrepreneur, an angel investor, or a VC, you should look at the TechFlash piece, and you should email it to everyone you know.
What is at stake is still summed up best by a paragraph Fred Wilson wrote last December:
"The angel funding mechanism is potentially the single most important funding mechanism in startup land. Most entrepreneurs get their first real investments from angels, not VCs. If you lower the amount of angel capital in startup land, you'll end up lowering the number of entrepreneurs who can get their projects off the ground."
How real is this threat? I am no expert on how legislation is made, but I read that Senator Dodd intends to have hearings on the bill next week, and to get it out of committee and to the full Senate in as short as two weeks time. So I presume it makes sense to act now.
Last month, I had a phone conversation with a candid state securities administrator about his position on Reg D. He and his colleagues in other states are very frustrated that fraudulent broker-dealers utilize Reg D to try to shield themselves. This is NOT an exact quote but instead a loose paraphrase of his position, assembled from different moments in our conversation: "The problem is, there is no gatekeeper at the front end. No one looking at the bad boy provisions. We put the micro-cap scams out of business in the 90s, but now they've been replaced by broker dealers who file dozens of Reg D filings simultaneously. We've had six years of the SEC saying, 'this looks like fraud, you can see it just looking at the form it on its face,' but they just file it in a drawer anyway."
In retrospect, I would have to say this gentleman knew where Sen. Dodd's language would be going. Dodd's bill essentially tells the SEC, "review the Form D's, or let the states have at 'em!"
The problem is, Dodd's bill would have us clearcut the entire, healthy forest, just to cull the occasional thicket of poison ivy.
If you want to call Senator Dodd's office, here is a tweet that Joe Wallin sent out last week, with the right phone number. And if you want to call a number for the staff of the Senate Banking Committee, here is another tweet from Joe. 
March 11
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10:11 AM
Have you noticed a slate of stories in the news lately about blogging fatigue? For example, here and here. Some of the stories talk about how time consuming it is to blog (as opposed to micro-blog on Twitter or Facebook) on a consistent basis. Though not fatigued by any means, Fred Wilson and Glenn Kelman have also blogged recently about some drawbacks to being publicly overexposed, suggesting that zones of privacy might sometimes be appropriate and even efficient. It might be reaching too far to say that there is a reassessment of personal transparency in the air, but it is interesting. Around the same time, Mark Suster published a long post explaining why and how to blog, and even what to blog about. It's very nuts and bolts. He even shares his production method, down to the time it takes generate a typical post, and his thoughts on building a backlog of posts. Mark is pro blogging, for sure, but his post is not a "rah rah, everyone's doing it, let's all jump in" promo piece. Just a non-patronizing, relatively sober and practical "why" and "how-to." I am slightly out of sync with all of the above as I am yet in the mode of discovering the unexpected joys of blogging. And I have a post about this, too, of course. I wrote it last week, but am holding it in reserve to publish at the end of the month, on March 28, the anniversary of this blog. In the meantime, however, I want to share a self-discovery that occured last week after I clicked on a link to an article from a major periodical. Not more than a paragraph into it, I realized, holy sh*t, this thing is written like a magazine article. And for the first time, I was conscious that my prejudices had shifted. That is, instead of imbuing the article with credibility because of the brand banner under which it was published, I was skeptical, for the lack of accountability, lack of a genuine voice, the traces of oversimplification and a condescending, affected tone of authority. For the first time, I was fully conscious of a new predisposition, newly wired, that if one really wants to know something, one is going to have to start by finding those in the know blogging about it.
March 10
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09:56 PM
March 8
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06:38 PM
 Editor's note: This is a guest post authored by patent attorney Micah Stolowitz of Stolowitz Ford Cowger LLP. Micah explains how Apple was able to receive its iPhone “TUI” (US Pat. No. 7,479,949) in less than a year under the Patent and Trademark Office's "Accelerated Examination" program. The iPhone “TUI” patent is among many that Apple is suing to enforce, in a move widely seen as an attempt by Apple to thwart Google's ambitions in the phone market.
How did Apple get a patent in 10 months? Wait a minute! Everyone knows the PTO has a huge backlog of
patent applications (well over a million last I checked). And everyone knows that in IT/ Internet and
software related technologies, it takes something like three to six years to
get a patent granted. OK, how did Apple
file an application on the iPhone touchy user interface (TUI) on April 11, 2008
and receive a granted patent on January 20, 2009, less than 10 months later? Political influence? No, it’s called Accelerated Examination, and
in that program the PTO actually is granting applications in under a year. The PTO Accelerated Examination Program. The Acclerated Examination
program FAQs are here. Briefly, the AE program
requires an applicant to conduct a thorough search of the prior art, and then
cite to the PTO, “any reference that establishes, by itself or in combination
with other information, a prima facie case of unpatentability of a claim” of
the patent application. - Applicant
is required to cite the reference that discloses the most limitations in the
independent claim.
- Applicant
is required to cite any reference that discloses a limitation of an independent
claim that is not shown in the other references.
- Applicant is required to cite any reference
that discloses a limitation of a dependent claim that is not shown in the other
references.
The Accelerated Examination Support Document (AESD). And here's the clincher: "For each reference cited in the IDS of the
AESD, the AESD must include an identification of all the limitations in the
claims that are disclosed by the reference specifying where the limitation is
disclosed in the cited reference. The
AESD must also include a detailed explanation of how each of the claims are
patentable over the references cited with the particularity required by 37 CFR
§1.111 (b) and (c).” (As an example, the AESD for the Apple iPhone "TUI" patent, followed by the patent application itself, is here.) Applicant Does the Work.
Thus, under this program, the applicant conducts the prior art search,
provides the detailed search report, identifies the closest art, applies the
closest prior art to each claim limitation, and then demonstrates how each
claim is patentable over that art. In
other words, the applicant carries
out the examination before even filing the application. This is why most patent
practitioners advise their clients to avoid this program. Practitioners are loathe to fill the record
with all these admissions as to the prior art, and how it applies to their
claims. Only a few thousand applications
have been filed under the program (see below), out of several hundred thousand total applications
filed over the past few years. The PTO thinks this fear is
misguided (or exaggerated). One person I
spoke with at the PTO pointed out that the AESD is presenting facts, not
conclusions of law. That line can get
blurred however, especially in litigation. Still, some of my clients, for certain applications, would rather take that
risk than wait five years to get a patent. They are not alone, as the number of petitions for AE is on the
rise. After the Petition for Accelerated Examination is
Granted. If the applicant meets all of these requirements (and
some others) (and the PTO is very exacting on these requirements), then the
petition for accelerated examination should be granted. This initial step takes about two to four
months, depending on the technology center. After the petition is granted, the applicant can expect not the usual
“official action” (rejection), but instead a telephone call from the assigned
examiner, within a month! The examiner
is to point out and discuss what issues need to be addressed in the case. An amendment to the claims may follow, and if
agreement was reached, a Notice of Allowance comes back shortly
thereafter. Even after spending the
initial few months deciding the petition, the PTO still aims to finish
examination with one year, total, from filing. Here are some statistics. Of 2811
Petitions filed through 12/31/2009, 76% or 2131 have been granted so far (including Apple’s petition), and 10%
have been denied. Note that refers to
the petitions for accelerated examination, not allowance of patents. The (cumulative) statistics
also show, for those 2131 applications undergoing AE, 23.8% are still pending,
17.7% are abandoned, and 1246 or 58.5% have been allowed. That compares to an overall PTO allowance
rate somewhere around 42%. An allowance
rate of 42% was reported for the first quarter 2009. The graph
below is from here. 
March 5
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09:15 PM
I've been critical in recent months about what in my opinion were the misplaced legislative priorities of the National Venture Capital Association. Well, I now happily withdraw that critique. The NVCA has put its logo, and its President, Mark Heesen, has put his signature, on a letter to Sen. Christopher Dodd, the (now lame-duck) Chairman of the Senate Finance Committee, asking that federal preemption of state regulation over Reg D "accredited investor" offerings be preserved, and expressing concern over a precipitous increase in the accredited investor thresholds. The letter was a joint effort of the NVCA and the Angel Capital Association, whose Executive Director, Marianne Hudson, also signed the letter. Legislation to end federal preemption over "accredited investor" offerings was introduced last year by Sen. Dodd. Not that the issue took center stage in the bill that was introduced; the attack on Reg D surfaced in just a few lines within a bill whose ostensible purpose was the comprehensive reform of the nation's financial regulatory system. Nevertheless, pertinent language in that bill would end federal preemption of the ability of states to regulate private securities offerings that are exempt from registration requirements by virtue of Rule 506 under Regulation D. It may be the case that Sen. Dodd's original bill is no longer viable, given the Obama administration's endorsement of the Volcker rule and other refinements to administration proposals for financial regulatory reform. But the NVCA and the Angel Capital Association, at least, would appear to think that the issue is still timely, and I have presupposed that Senator Dodd's next bill might well recycle the Reg D and accredited investor threshold provisions of his initial bill. (Google research note: Senator Dodd blogged this week that his legislative efforts are alive and well.) I became aware of the NVCA/Angel Capital Association letter through Jason Mendelson's blog. Jason posted this week that he knew that the NVCA had taken a position, and in the comment stream to that post, Marianne Hudson of the Angel Capital Association responded to a comment I had made with a link to the letter. I mean to connect with Marianne and compare notes; she may know the current status of the attack, whether it remains in the earlier bill, or whether it has been reintroduced somewhere else. (I should also mention: I had a background conversation with a prominent state securities regulator recently, and he told me he believed there was a House counterpart to the language in Sen. Dodd's bill. He could not identify it for me, however, and I have not found it yet.) Tremendous credit for raising consciousness on this issue has to go to Marcelo Calbucci and Seattle 2.0. Last November, Marcelo invited Joe Wallin and I to author a guest post to publicly announce a letter that some two dozen entrepreneurs, angel investors and attorneys in Washington State wrote to Senator Patty Murray and Senator Maria Cantwell about the importance of angel financing. Amazingly, neither Senator wrote back; but the Seattle 2.0 post made that letter available publicly (in fact it is quoted in the NVCA/Angel Capital Association letter). Fred Wilson also blogged about the issue in a post about public policy priorities for venture capital, and I know this caused some VCs I have spoken with to realize that this was not simply an "angel issue." And Jason Mendelson blogged about this back in November when one of our group notified him of the effort in Washington State. I have no idea if we'll be successful, but it's pleasing to see the effort going national and including more of the startup ecosystem. Final note for this post: at the 30th Annual Northwest Securities Institute put on by the Washington State Bar Association, I had the opportunity to ask (publicly) a question of Michael Stevenson, the former director of Washington State's Securities Division, about whether it was true or not that all the cases of abuse and fraud that state securities regulators worry about involve broker dealers or placement agents (and thus can be distinguished from the kinds of angel financing that is typical in the startup community). He answered that in his opinion that was not the case. I go back to the conference in the morning and may try to collect my notes on his additional remarks, for a follow up post.
March 5
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09:26 AM
Vivek Kundra, Federal Chief Information Officer of the United States of America, is an impressive guy.
He was in Seattle yesterday participating in public and private events that Todd Bishop and Marcelo Calbucci cover here and here, respectively.
I was able to attend a public event on the University of Washington campus, and have a few impressions to share, in the general category of style-as-statecraft. The CIOs of federal agencies focus on the wrong things, Kundra said. Instead of concentrating their time and resources on improving user (read, "citizen," or "taxpayer," or, to extend the metaphor even a bit further, "stakeholder") experience, federal agency CIOs distract themselves -- and waste taxpayer dollars -- by building siloed data centers. It gets worse: Kundra thinks federal agencies do not adequately leverage best industry practices and that they miss opportunities to improve processes. One example: at the Patent and Trademark Office, federal employees print out patent applications that are submitted online, and manually key them into an antiquated computer system. The standards Kundra would have the federal government set for IT are commercial ones. To symbolize this, government IT projects are going online. Pictures of agency CIO's, he said, are being posted next to the IT projects they are responsible for! Kundra talks as if it's reasonable for the taxpayer to bring a tech consumer's quenchless thirst for innovation and access to her expectations of government. Getting real time text alerts when your application status changes, or comparing the response times of different regional offices performing the same function -- those are simple examples of how the government might emulate online commerce. Marcelo is a better judge on his substantive qualifications, and Todd moves more deftly to the implications of Kundra's policies (government meets cloud computing) for industry, but take it from me that this man has his messaging down. It's disarming, to hear the guy billed as having the mandate of the POTUS say government should be as accessible as a social media site. We're on your side, Sir! Does the IRS have an iPhone app yet? Our nation state has a President but no CEO per se. Kundra, however, has a C-level title. Think of him as working for the United States of America, Inc.? 
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