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Oct. 2013

October 2013
From the Colorado Bar Association
Business Law Section

Ed Naylor, Editor
In this issue...

Crowdfunding Securities Under the CROWDFUND Act

by Andrew A. Schwartz, Associate Professor of Law, University of Colorado

The “crowdfunding” of securities is poised to democratize the financing of startups, small businesses, farmers and others. Securities crowdfunding, defined as the sale of unregistered securities over the Internet to large numbers of retail investors, each of whom contributes a small amount, had previously been banned by federal law, but this prohibition was overturned by Congress in 2012. This new marketplace will go live once the SEC issues regulations to govern it. Although those rules were officially due in late 2012, they were just proposed on Oct. 23, 2013, and are likely to go into effect in 2014.

Securities crowdfunding has its origins in “reward” crowdfunding, practiced on websites like Kickstarter and IndieGoGo. In reward crowdfunding, artists, entrepreneurs and others ask “the crowd” to contribute capital to their ventures, generally in exchange for the fruits of the project, such as a book or CD. The investors never receive stock, bonds or other securities, however, because federal securities law effectively banned the crowdfunding of securities.

This all changed in 2012, when Congress amended the federal securities laws to overturn this prohibition. In Title III of the Jumpstart Our Business Startups (JOBS) Act—the “CROWDFUND Act”—Congress established a new exemption from the registration requirement for crowdfunded securities. President Obama signed the JOBS Act into law in April 2012, and it will go into effect once the SEC completes its rulemaking process.

The purpose of the CROWDFUND Act is twofold. First, it is designed to liberate startup companies, small businesses and others to use peer networks and the Internet to obtain modest amounts of business capital at very low cost. Second, Congress sought to democratize the market for financing speculative startup companies by allowing investors of modest means to make investments that had previously been offered solely to wealthy, “accredited” investors.

The new CROWDFUND Act has important limitations and places significant obligations on participants in this new marketplace. Under the statute, issuers may only raise up to $1,000,000 annually via securities crowdfunding. Issuers also must state a minimum amount and can only collect the proceeds of the offering if they reach or exceed that target.

Issuers must provide some very basic disclosures to the SEC, designated intermediaries, and potential investors. The financial disclosures depend on the size of the offering: For offerings of $100,000 or less, income tax returns for the last fiscal year and unaudited financial statements certified as accurate by the principal executive officer are required. For offerings of between $100,000 and $500,000, financial statements reviewed by an independent public accountant must be provided. And for offerings of between $500,000 and the maximum of $1 million, audited financial statements are mandated. Finally, following a crowdfunding round, an issuer must annually file with the SEC, and make available to investors, a report on the results of operations.

As for investors, the maximum annual aggregate amount of crowdfunded securities that any one investor may purchase depends on her wealth and income: If an investor’s net worth or annual income is under $100,000, she can invest the greater of $2,000, or five percent of her annual income, in crowdfunded securities each year. If her net worth or annual income is over $100,000, she can invest 10% of her annual income each year.

The Act provides that crowdfunding transactions may not be consummated directly between issuer and investor. Rather, they must be executed via a financial intermediary registered with the SEC as either a broker-dealer or a “funding portal,” a creation of the Act. The Act imposes a number of serious obligations on these financial intermediaries, such as a requirement that they take measures to reduce the risk of fraud, including obtaining a background check on officers, directors and substantial investors in crowdfunding issuers.

As for a secondary market, the Act provides that crowdfunded securities may not be transferred or sold by investors for one year after the date of purchase, unless being transferred to the issuer, an accredited investor, a family member of the purchaser, or as part of an offering registered with the SEC.

The CROWDFUND Act expressly pre-empts state law regarding registration or qualification of securities. That said, states must be provided with notice of crowdfunded offerings, and they retain the right to bring enforcement actions for fraud or other violations of state securities law not relating to registration.

To police fraudulent behavior, the Act expressly authorizes civil actions against an issuer, its directors and officers, if they make an untrue statement of a material fact. In addition, the SEC is granted examination, enforcement and other rulemaking authority over funding portals, and presumably retains authority to enforce the various statutory and regulatory mandates for both issuers and intermediaries.

How securities crowdfunding will play out in practice remains to be seen, and depends greatly on the rules that the SEC just proposed on October 23, 2013. Those proposed rules, called “Regulation Crowdfunding,” are available online, and the SEC invites comments from the public before they become final.

In short, the CROWDFUND Act represents an opportunity for enterprising and creative practitioners to shape a brand new market for securities.

The Denver District Court Decides: Joint Venture Interests are Not Securities

by Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

This newsletter has published several articles discussing whether interests in oil and gas drilling joint ventures are “securities” for the purposes of federal and state securities laws. Recent articles included a discussion in the May 2012 newsletter of the Colorado Court of Appeals’ affirmation of a cease and desist order issued by the Colorado Securities Commissioner in Joseph v. Mieka Corporation, 282 P.3d 509 (Colo. App. 2012) (“Mieka”) and the September 2012 newsletter article discussing the Colorado federal district court’s dismissal of a similar case brought by the Securities and Exchange Commission in SEC v. Shields, 2012 WL 3886883 (D. Colo. 9/6/2012) (“Shields”).

The Hon. Michael A. Martinez of the Denver District Court issued his opinion and final judgment in Joseph v. HEI Resources, Inc., et al. (Case No. 09 CV 7181) on Oct. 17, 2013. In his order, Judge Martinez reviews a number of drilling ventures formed by HEI Resources, Inc. (“HEI”) and specifically focuses on the character of the venturers who contributed funds for the drilling of the promised wells. Judge Martinez’s order followed an earlier opinion by the Hon. Morris B. Hoffman in Joseph v. HEI Resources, Inc. (Case no. 09CV7181, 1/6/2011).

Both Judge Martinez and Judge Hoffman applied the Fifth Circuit case of Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981) to determine whether the joint venture interests offered by HEI were “securities” under Colorado law. Judge Martinez went on to consider whether the Commissioner’s alternative argument, the “economic realities test,” would change the analysis. In the end, Judge Martinez found that the joint venture interests offered were not securities, and that such finding was “dispositive of all claims raised by Plaintiff” and vacated the May 2014 trial.

The Oil and Gas Drilling Joint Ventures

HEI, along with many other oil and gas operators, have developed working interest programs by which persons can invest money and become working interest owners in a drilling venture. The joint ventures formed by HEI were formed as general partnerships subject to Texas law. The documentation generally provided that the venturers had to vote at material steps along the way, and the documentation included the warning:

Participants in this Joint Venture are provided extensive and significant management powers. Participants are expected to exercise such powers and are prohibited from relying on the Managing Venturer for the success or profitability of the Venture.

In their investor questionnaires and applications, the prospective venturers acknowledge “under penalties of perjury” that their participation will be required and that they have the necessary sophistication and experience to participate. Many of the investors were found by solicitors making “cold calls” “without regard to their experience or interest in oil and gas exploration.” If the person called expressed interest, HEI provided the prospective venturers with a confidential information memorandum containing a turnkey drilling contract, a separate contract for completion, and a significant amount of other disclosure.

In the eight joint ventures which Judge Martinez reviewed, there were more than 500 venturers from at least 30 states. Seventeen venturers testified at trial, ranging in age from 48 to 78. Judge Martinez concluded that, “[a]s a group, the joint venture partners possessed significant knowledge and experience in business affairs” and that the “partners in the Joint Ventures were capable of intelligently exercising the partnership powers granted to them in the joint venture agreements.”

During the operation of the joint ventures, HEI (and in some cases, the venturers) called meetings and the venturers voted. HEI kept records of the votes and presented them as evidence that in fact the venturers (including those who testified) participated. Judge Martinez also noted that some of the venturers continued to invest in subsequent ventures even after receiving little or no return on earlier joint ventures.

Presumption in Williamson v. Tucker

An important analysis in both Judge Hoffman’s 2011 opinion and the October 2013 opinion by Judge Martinez is the presumption from Williamson v. Tucker. In Williamson, the Fifth Circuit held that there is a strong presumption that interests in general partnerships were not securities. The Court held that the presumption can be overcome, and an interest in a general partnership can be a security, if the investor can establish any one of three factors:

  1. The agreement among the parties leaves so little power in the hands of the partner that the arrangement in fact distributes power as would a limited partnership;
  2. The partner is so inexperienced and unknowledgeable in business affairs that he is incapable of exercising his partnership powers; or
  3. The partner is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership powers.

In his 2011 opinion, Judge Hoffman reviewed the facts presented by the Commissioner and determined that the Commissioner could not prove Williamson factors 1 or 3, that the agreements provided significant power and authority to the venturers, and that the oil and gas industry is not dependent on some unique entrepreneurial or managerial ability of any person (which Judge Martinez later determined as well). Judge Hoffman had left for determination by subsequent trial whether the Commissioner could prove Williamson factor 2 (that the individuals were incapable of exercising their powers through a lack of experience or knowledge) and whether the “economic realities” test proffered by the Commissioner would lead to a different conclusion.

In determining that the Commissioner had not met his burden of showing the applicability of Williamson factor 2, Judge Martinez looked at federal authority which reflected that “a partner in a general partnership must have experience and knowledge in business affairs generally, and a partner is not required to have industry specific knowledge in order to preclude a finding that a joint venture interest is a security.” [Emphasis in original.] As noted above, Judge Martinez found that the venturers as a group, and each of the venturers who testified, were sufficiently experienced and knowledgeable business people to withstand that application of the second Williamson factor.

The Economic Realities Test

The Commissioner has argued a number of times that the courts should not apply the Williamson presumption but should apply the “economic realities test”. This was discussed in Mieka as well as in the earlier cases of Joseph v. Viatica Mgmt, LLC, 55 P.3d 264, 266 (Colo. App. 2002) and Toothman v. Freeborn & Peters, 80 P.3d 804, 811 (Colo. Ct. App. 2003). The key question in performing an economic realities analysis is whether the enterprise is promoted primarily as an investment or as a means whereby participants could pool their own activities, money, and the promoter’s contributions. Toothman, 80 P.3d at 811. In the former case, a security would be involved; in the latter case, arguably not. In the May 2012 Business Law Section newsletter I argued that the two tests were similar:

It can be expected that the Commissioner will continue to oppose application of the Williamson presumption on the basis that the presumption increases the Commissioner’s burden of proof that a participation in a general partnership entity (including in some cases a joint venture) is a security. On the other hand, the Williamson presumption is a rational approach toward determining whether a transaction involves a security. The Williamson factors are also relevant to performing an economic realities analysis. Since the burden of proof should be on the Commissioner when bringing an enforcement action in a civil or administrative setting, whether or not the Williamson presumption applies does not shift the Commissioner’s ultimate burden of proof.

In reaching his conclusion that the joint venture interests in Joseph v. HEI Resources, Inc. were not securities under the catch-all economic realities test, Judge Martinez focused on Colorado Supreme Court guidance in Cagle v. Mathers Family Trust, 295 P.3d 460, 467 (Colo. 2013) (discussed in the March 2013 newsletter) that provisions of the Colorado Securities Act should be coordinated with federal securities law. In applying applicable precedent, Judge Martinez said that the Commissioner, as plaintiff, “has simply failed to carry its heavy burden of establishing that the joint venture interests … are securities under any catch-all economic realities.”


Of course, this is not necessarily the conclusion of this question inasmuch as the Commissioner has the ability to file a Rule 59 motion for reconsideration or an appeal to the Colorado Court of Appeals.

Furthermore, and perhaps more importantly, different facts might lead to different results. Where the documentation of another joint venture may be the same as the HEI documentation described in Judge Martinez’s opinion but the investors are inexperienced and unknowledgeable about business affairs, the second Williamson factor to overcome the presumption might be met. Where the managing venture simply made decisions without providing the venturers the opportunity to exercise their right to vote, the first Williamson factor might be found to exist.

Cases and their decisions are always fact-specific. Given the facts of this case as determined by the Court, I believe it was the correct decision.

Adding Value to Public Data: The Business Intelligence Center

From the Colorado Secretary of State’s Office

Colorado government agencies possess large volumes of business and economic public data. This data can help businesses with strategic planning, but it exists in so many different places and formats that most businesses cannot effectively use it. The Secretary of State’s office, in collaboration with the Governor’s office and other state agencies, is addressing this opportunity through the creation of the Business Intelligence Center (BIC).

The BIC project will grow the use of one of our most underutilized resources—public data. Colorado government agencies collect volumes of public business and economic data during the normal course of business. BIC will streamline access to public data by consolidating it in one place online and by providing resources to make the data more useful.

Access to the data by itself is not enough. Businesses also need tools to analyze, and compare and contrast the data, making it more valuable for decision-making. Gov. John Hickenlooper and Secretary Scott Gessler announced during Denver’s Startup Week the Colorado Innovation Challenge. The Challenge will solve real business decision-making problems through the use of public data with web or mobile applications created by Colorado’s technology development community.

With the help of the Colorado business community, we have identified five key challenge problems that business decision-makers face on an on-going basis. Over the next few months, we will better define these challenges with the help of business leaders. Then in early 2014, we will ask the tech community to build applications designed to address these opportunities. The applications will give businesses of all sizes access to sophisticated decision-making tools based on public data. Challenge participants will be eligible to receive $100,000 in financial incentives and other services, like office space and mentorships.

BIC is moving beyond government transparency to creating valuable business intelligence. Learn more about the BIC program, the Innovation Challenge, and sign up for e-mail updates online.

Business Law Section Activities
Bankruptcy Subsection

Bankruptcy Litigation: Knowing and Navigating the Differences from Other Litigation—Thursday, Dec. 5

Co-Sponsored by the Bankruptcy Subsection of the CBA Business Law Section

This program is suitable not only for bankruptcy attorneys, but for attorneys who periodically litigate in Bankruptcy Court; attorneys who are about to step into the bankruptcy arena; and trial attorneys. Every litigator can benefit from knowing the ins and outs and hot topics of bankruptcy litigation.

Join us and receive invaluable perspectives from the Bankruptcy Court Judges, the Bankruptcy Court Clerk’s Office, and seasoned Bankruptcy court practitioners, and other court litigators. Offered for 7 CLE credits.

Bankruptcy Subsection Co-Chairs and Program Planners are Leigh Flanagan, Kutner Brinen Garber, PC; and Andrew Johnson, Onsager, Staelin & Guyerson, LLC.

Program location is at the CBA-CLE Classroom—1900 Grant Street, Ste. 300, Denver, CO. Learn more and register online, or call 303-860-0608 (toll free 888-860-2531).

Financial Institutions Subsection

UCC Article 9 Professionals: Participate in CSC’s Survey of UCC Article 9 Best Practices and Trends

Anyone who manages UCC searching and filing transactions under Article 9 is invited to participate in the Corporation Service Company (CSC) survey. CSC’s goal with the survey is to assemble a comprehensive overview of UCC Article 9 best practices and insights. UCC professionals at all levels with lenders, leasing enterprises, factoring companies, and law firms can provide valuable feedback that may help answer the question: What are your peers doing in terms of best practices and trends?

The survey addresses: (a) What is the demographic profile of the typical UCC professional? (b) How have the 2010 Amendments to UCC Article 9 impacted organizations? (c) What are the most common types of UCC transactions and how are they managed? (d) How are UCC filers choosing the correct debtor names? (d) How are organizations managing their UCC portfolios? (e) Which associations, conventions and publications are the best source of UCC news and information?

The survey takes less than 15 minutes to complete and participants will be be entered into a random drawing for one of four tablets: the Amazon® Kindle Fire, the Apple® iPad, the Google® Nexus, or the Samsung® Galaxy.

Click here to complete the survey online.

This Newsletter is expected to contain survey results in the January issue.

What to Do When the SEC Comes Knocking—Wednesday, Nov. 20

Co-sponsored by the Financial Institutions Subsection of the CBA Business Law Section

Get an overview of the SEC’s enforcement and examination programs, particularly as they pertain to financial crisis cases. Learn about individual and company cooperation tools. Get up-to-speed on whistleblowing. Be ready when the SEC comes knocking. Available for one general CLE credit.

Program location is at the CBA-CLE Classroom—1900 Grant Street, Ste. 300, Denver, CO. Learn more and register online, or call 303-860-0608 (toll free 888-860-2531).

Save the Date: OFAC’s Sanctions Programs: Financial Institution Compliance—Wednesday, Dec. 18

Co-sponsored by the Financial Institutions Subsection of the CBA Business Law Section

Attend this program to receive updates on the Sanctions Programs of the US Office of Foreign Assets Control (OFAC). Learn recent developments, including recent enforcement actions and trends, and the requirements of these Sanctions Programs as they pertain to banks and hear strategies for compliance. Register today to be prepared! Available for one general CLE credit.

Program speaker is Frank Schuchat, who has practiced in the area of international trade and business for three decades, in both Washington DC and Denver. He advises clients on export controls, sanctions, Foreign Corrupt Practices Act compliance, import rules, and transnational business and investment transactions. Mr. Schuchat is a director of the World Trade Center Denver and he serves by appointment of the U.S. Secretary of Commerce as a member of the Rocky Mountain District Export Council.

Program location is at the CBA-CLE Classroom—1900 Grant Street, Ste. 300, Denver, CO, or attend via webcast.

Mergers and Acquisitions Subsection

Busted M&A Deals—Perspectives from an Investor and an Operator—Tuesday, Nov. 12

Co-Sponsored by the M&A Subsection of the CBA Business Law Section

Derek Pilling of Meritage Funds provides a unique perspective on M&A transactions, including busted M&A transactions, as he had the opportunity to live such transactions from both the perspective of an institutional investor and in the trenches as an operator. Derek discusses his thoughts, suggestions and ideas based upon his position as an institutional investor in companies undertaking an M&A transaction. Available for one general CLE credit.

Program location is at the CBA-CLE Classroom—1900 Grant Street, Ste. 300, Denver, CO, or attend via webcast. Learn more and register online, or call 303-860-0608 (toll free 888-860-2531).

Securities Subsection

General Solicitation in Action and Novel Ways to Raise Capital Under the JOBS Act—Monday, Nov. 11

Live in Denver at Noon at the Brown Palace Hotel, 321 17th Street, Denver, CO

This panel will address two aspects of the JOBS (“Jumpstart Our Business Startup”) Act: General solicitation in action and innovative crowdfunding potentials.

Title II of the JOBS Act allows companies to generally offer their securities to the public—including through advertising—while still maintaining the benefits of a non-public offering, so long as the securities sales are made solely to accredited investors. Jim Carroll, a partner at Faegre Baker Daniels who practices in this area, will report on how Title II is working so far. Jim will address questions such as:

  • How are issuers taking advantage of general solicitation?
  • How should issuers plan ahead to use general solicitation?
  • What lessons have been learned so far?

Title III of the JOBS Act authorizes the “crowdfunding” of securities, defined as the online sale of small amounts of unregistered securities to all adults, accredited or not. Andrew Schwartz, an Associate Professor of Law at the University of Colorado Law School who recently published on the subject, will address how Title III may play out once the SEC issues final rules, and how issuers can use crowdfunding in ways that they may not realize, including issue debt.

Call 303-860-1115, ext. 727 (toll free 800-332-6736), email, or view the detailed agenda and register online. The deadline for registration is Thursday, Nov. 7 at noon. If calling and leaving a message, please spell your name, specify that you would like to attend the Securities Subsection Luncheon, and include your phone number.

One general CLE credit is available.

CBA-CLE Information

Unless otherwise noted, all programs are at the CBA-CLE offices, 1900 Grant St., Ste. 300, Denver

Upcoming CBA-CLE Ethics Programs

Ethics Revue at Lannie’s Clocktower Cabaret 2013—Starring The Law Club—Nov. 4 or 5
Offered for 3 ethics credits

2013 Ethics 7.0—Friday, Nov. 22
Offered for 7 Ethics Credits - Learn More!

Spend the Day with Sean Carter—Comedic Professional Education—Friday, Dec. 20
Offered for 6 Ethic Credits

Recent Homestudies

2013 Business Law Institute —Original program date Oct. 16–17

Annual Tort Law Update 2013—Original program date Sept. 20

Ethics and Professionalism in the Practice of Law—Original program date Oct. 4

CBA-CLE Featured Publications

CBA-CLE carries an extensive catalog of business law ABA publications—and CBA members always get a 15% discount on the ABA regular price! Check out just some of the books available:

  • Advising the Small Business: Forms and Advice for the Legal Practitioner, 2nd Ed.
  • Business Bankruptcy Essentials, 1st Ed.
  • Business Torts Litigation, 2nd Ed.
  • Contract Drafting: Powerful Prose in Transactional Practice, 1st Ed.
  • Intellectual Property Deskbook for the Business Lawyer—A Transactions-based Guide to Intellectual Property, 3rd Ed.
  • Model Jury Instructions—Business Torts Litigation, 4th Ed.
  • A Manual of Style for Contract Drafting, 3rd Ed.

Check out the CBA-CLE library!

Contributions for future newsletters are welcome —
Contact Ed Naylor at or 303-292-2900

This newsletter is for information only and does not provide legal advice.

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