Two months later you decide to do another securities offering under Rule 504 and your raise another $950,000.

Chances are, you will have violated the requirements of Rule 504.  Why?  Because the SEC will integrate the two offerings into one and you will have raised $1.9 million total which exceeds the $1 million maximum of Rule 504.

How can you prevent two separate securities offerings from being integrated?

The SEC looks at the following factors when determining whether two offerings should be integrated:

1. Whether the two offerings are part of a single plan of financing
2. Whether the two offerings are for the same class of securities
3. How close together the two offerings are in time
4. Whether the same type of payment for the securities is being received in both offerings
5. Whether the two offerings are for the same general purpose

It may be difficult to tell whether two offerings are likely to be integrated by the SEC.  Luckily, there is a “safe harbor” rule you can use to make sure that two offerings will not be integrated.  As long as the end of one offering is separated by at least six months from the beginning of another offering, they will not be integrated.

We have discussed the definition of an accredited investor elsewhere.

A recent change in the law has narrowed the definition.  The recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act adjusted the “accredited investor” definition to exclude the value of an investor’s primary residence from the current $1 million net worth threshold.  This change went into effect immediately upon passage of the Act.

What will be the main activities of the co-op?  How will it earn revenue?

Does it need to raise capital?  If so, how will it raise capital?  Through member contributions and/or through outside investors?

Will all the workers be members?  (in other words will there be employees that never become members?)

Will there be a probationary period before a worker can become a member?  If so, how long?

Can the co-op pay all the workers at least minimum wage from the very beginning and pay all the other costs associated with having employees like employment tax, workers comp, etc.?

Will all the workers have the legal right to work in the United States?

Will the workers be more like employees or independent contractors?

How do you want the co-op to be governed?  By a board elected by the members, by the members themselves, by one or more managers?

Would it bother you to have to observe certain “formalities” (such as holding regular governance meetings, complying with rules about meeting notice, keeping meeting minutes, having elections, having officers)?

How will decisions be made?  Majority vote, super-majority, consensus, modified consensus?  Will different decisions be made in different ways?

If you will have a board, what do you want the term of office to be?  Do you want term limits?  Do you want to have any qualifications for who can serve on the board?  Can only members serve on the board?  How many board members do you want?  Do you want staggered terms?

If you have officers, what officers do you want to have and what will be their duties and qualifications?

Do you want to have committees?  If so, what powers do you want them to have?

How do you want to distribute excess revenues?  Do you want some of it to be able to be held within the co-op and not become the property of the members?  Do you want to pay dividends to the members?  Do you want to pay dividends to investors?  How will you decide how much of excess revenues to allocate to various uses?  How will you decide how much of the patronage dividend to pay in cash versus an allocation to the member’s capital account?

How will you allocate losses?

How will you set member capital contributions?  Do you want there to be a limit on how much they can increase from year to year?

Do you want to have member capital accounts?  If so, do you want to pay “interest” on the balance in the member accounts?  How often do you want to redeem member accounts?

When a member leaves the co-op how will their capital account be redeemed?

What do you want to happen with the assets of the co-op upon dissolution?

Given your business plan, what are your biggest concerns about taxes?  Dividends being taxed twice (at the entity and investor level)?  Having to pay a tax on gross receipts?  Having to pay employment tax on distributions?  Having to deal with “pass through” tax treatment?

Who will have check signing authority?  Who will have the authority to sign contracts on behalf of the co-op?

Would it bother you to have an entity that is not well understood by most lawyers and accountants?

Is it important to you to use the word “cooperative” in your name?

How will you decide whether to admit new members?

How will you decide whether to remove members?  How will you decide whether to remove managers, directors, officers?

Do you want the founders to receive some sort of extra benefit to compensate them for the risks they took?

How will you decide on amending your governing documents – a majority of members, 2/3 of members . . . .?

What is and is not general solicitation can get tricky!  Especially if you decide to make your private offering of securities using a third party web-based platform.  Beware!  Don’t assume that these services know what they are doing and are in compliance with the law.  If they screw up, you could be on the hook to return the money you raised using their platform.

What questions should you ask before deciding whether to use one of these platforms?

1. Is the operator of the platform a licensed broker-dealer?  If not, it can be risky to post your private placement on their site.

Section 15 of the 1934 Exchange Act requires persons that effect securities transactions on behalf of others to register as broker-dealers.  However, if the web-based platform is merely serving as a passive intermediary that facilitates the introduction of buyers and sellers, it may be able to operate legally without a broker-dealer license.  The types of activities to watch out for if the platform does not have a license include offering advice and information, handling funds, assisting with negotiations, and receiving fees based on a percentage of the purchase price.

2. How is the operator of the platform finding investors for the site?  Is it being done in a way that could look like general solicitation?  For example if the public web site invites potential investors to view specific offerings, this could be a general solicitation and all un-registered offerings on the site would be illegal.

3. Is access limited to accredited investors?  If not, it is necessary to provide an extensive private placement memorandum to potential investors and there is more risk of runnning afoul of the law.

4. How are investors screened?  How does the platform ensure that investors are really accredited and are making other required representations such as a statement that they are not purchasing for re-sale?  Generally speaking a lengthy questionnaire is required to determine whether the potential investor is suitable – having them check a box stating that they are accredited is not enough.

5. Once investors are given access to the site, are they allowed to view offerings that were already listed?  If so, this could be deemed general solicitation.

6. Are detailed records kept to ensure that the requisite pre-existing relationships can be documented if necessary?

7. Has the platform secured a “no action letter” from state and/or federal regulators assuring that the regulators will not bring an action against them?

Under the intrastate exemption (Section 3(a)(11) of the Securities Act of 1933), an issuer is exempt from the federal securities registration requirements.  To be eligible for the exemption, all investors must reside in a single state and the issuer must be incorporated in and doing most of its business in that state.

If the securities are offered, sold, or re-sold within nine months of the initial offering to even one out-of-state investor, the exemption may be lost.  Losing the exemption means the issuer could be required to return all the investors’ money.

The best way to ensure compliance with Section 3(a)(11) is to take advantage of the safe harbor provision in SEC Rule 147.  A safe harbor is a set of conditions that, if you comply with them, you can be assured that you will meet the requirements of an exemption.  However, it is not necessary to comply with the safe harbor conditions to comply with the exemption.  The conditions required to meet the safe harbor are as follows:

1. 80% of the company’s assets are located in the state in which the offering is made;
2. 80% of the company’s revenue comes from the state in which the offering is made; and
3. 80% of the proceeds from the offering will be used within the state in which the offering is made.

The intrastate exemption is self-executing.  The issuer is not required to file any paperwork with the SEC.

To prevent the inadvertent loss of the exemption, the issuer should do the following:

1. Place a legend on the certificate evidencing the security stating that the securities have not been registered under the Act and setting forth the limitations on resale;
2. Issue stop transfer instructions to the issuer’s transfer agent or make a notation in the appropriate records of the issuer; and
3. Obtain a written representation from each purchaser as to his residence.

Even if an offering qualifies for the intrastate exemption to federal registration, it is still necessary to comply with the securities regulations of the state in which the offering is made.

Example of the Use of the Intrastate Offering Exemption

Saranac Lake Community Store

After the town’s general store closed, members of the Saranac Lake community decided to open their own store.  They are offering shares to the public using the federal intrastate exemption and a special New York state registration process designed for issuers using the federal intrastate exemption.

Investors can purchase as little as one share for $100, with a maximum purchase of 100 shares. As of June 24, 2010, the Community Store has raised $442,900 from over 400 investors all over the state of New York.  The offering will close when $500,000 has been raised.  The Community Store organization has engaged the local community by holding “share parties” – small gatherings in homes and other intimate venues where potential investors can discuss the business plan with the interim Board of Directors and invest in shares if they choose.

Although raffles can be a great fundraising opportunity for some nonprofits, most states consider raffles to be a type of illegal gambling. Many states, including California, carve out an exception for nonprofits. The following is a brief summary of the California exception.

Charitable Raffles in California

California Penal Code section 320.5 carves out an exception to the general prohibition against gambling in California. This exception allows “eligible organizations” to “conduct raffles for the purpose of directly supporting beneficial or charitable purposes or financially supporting another private, nonprofit, eligible organization that performs beneficial or charitable purposes if the raffle is conducted in accordance with this section.”

Definition of an eligible organization

Generally, an eligible organization is a private nonprofit organization that is exempt from California income tax and has been qualified to conduct business in California for at least one year prior to conducting a raffle.

Definition of a raffle

A raffle is a scheme to distribute prize(s) by chance among people who purchase paper tickets that provide the opportunity to win the prize(s). The paper tickets must have a detachable stub/coupon. Each paper ticket and its corresponding stub/coupon must have a unique and matching identifier. The prizes are awarded by a random drawing from all the purchased tickets; the drawing must be conducted under the supervision of a natural person who is at least 18 years old.

Note: California law prohibits raffles from being operated or conducted over the Internet, although the organization conducting the raffle may advertise the raffle over the Internet. Also, federal law prohibits multi-state raffles, so a nonprofit should only sell tickets inside California.

The 90/10 rule

At least 90 percent of the gross revenue from the sale of raffle tickets must be used to benefit or provide support for beneficial or charitable purposes. “Beneficial purposes” excludes purposes that are intended to benefit officers, directors, or members of the eligible organization. The funds may not be used to fund any beneficial, charitable, or other purpose outside of California.

Registration and reporting requirements

Unless specifically exempted, nonprofits that want to conduct raffles must register with the California Department of Justice. They also have to comply with annual reporting requirements to disclose information such as gross raffle ticket sales, expenses, and how the revenue was spent. Registration and reporting forms are available at http://ag.ca.gov/charities/raffles.php.

Educational institutions, religious institutions, and hospitals are exempt from raffle registration and raffle reporting requirements but must otherwise comply with all the other regulations.

Taxes and withholding

A raffle ticket purchase is not tax-deductible. Prizes are considered taxable income to the winners.

Mailings and advertisements

The Federal Deceptive Mail Prevention and Enforcement Act prohibits deceptive mailing practices for sweepstakes, contests, and raffles. If the nonprofit plans to use the U.S. Postal Service to mail advertisements or raffle tickets, it must comply with this act, which requires certain disclosures on each mailing. When drafting the raffle rules, it is helpful to include these disclosures in the raffle rules. For more information, see http://www.dmaresponsibility.org/Sweepstakes/.

Here are some examples of provisions that would be void under California law:

Employee shall not directly or indirectly solicit any current customers to transfer any account or relationship from Employer to any business other than Employer.

For 18 months after termination of employment Employee shall not render services, directly or indirectly, to any competitor in which such services could enhance the use or marketability of a competing product.

These kinds of provisions are very common in employment and independent contractor agreements even though they are unenforceable.  An employee should not sign an agreement that contains a clause like this.  Even though it’s unenforceable, a new employer might refuse to hire an employee that has signed such an agreement unless the former employer releases its rights under this agreement.  Why?  The new employer does not want to take a chance that the former employer will litigate the issue even though the chance of success is basically nil.

While employers should not put any non-solicitation or non-compete provisions into their agreements, they can and should include provisions to protect any secret information such as a prohibition on employees and former employees from revealing company secrets to any third party.

First, it rewards companies that affirmatively serve the public interest in the state. The proposed legislation effectively creates and strengthens a brand for good corporate behavior.  The B-Corporation label recognizes companies that are committed to undertaking their business with high labor, environmental, and community standards, even if this commitment reduces its profitability.  HB-1009 effectively rewards a company embracing these goals by helping consumers also motivated by these values to find and selectively purchase their goods and services.  It similarly rewards socially responsible businesses by attracting like-minded investors.

Second, it increases market efficiency. Some argue that whenever companies sacrifice profits for other goals like high labor or environmental standards, efficiency is lost.  This, however, springs from an incorrect definition of efficiency, since it focuses exclusively on whether or not consumers are being offered the cheapest goods and services.  A better definition of efficiency focuses on whether consumers are getting the best value for goods and services. Value includes quality of the product and quality of the company, and decisions about value depend entirely on consumer choice.  It is an axiom of a market economy that it functions more efficiently when consumers have the best information possible to make their market choices.  The B-Corporation label does this, effectively matching consumers and investors committed to improving the state’s public interest with companies that share these values.

Third, it boosts the state economy. In addition to the benefits that flow from greater market efficiency, the legislation will tend to drive more Maryland residents to buy goods and services from local companies and drive more investors to place money in local companies.  Local purchasing and local investing boosts local jobs.

Fourth, it supports the broad objectives of economic development. There is a growing body of evidence that locally owned companies, compared to absentee owned businesses, generate for every dollar spent in them higher economic multipliers.  That means more income, wealth, jobs, tax receipts, and charitable contributions for the state.  Additionally, the evidence also suggests that these businesses are particularly good a promoting smart growth, tourism, entrepreneurship, and low-carbon footprints—all goals officially embraced by the state of Maryland.

Finally, it accomplishes all these worthy objectives at virtually no cost. All that is required by the bill is voluntary action by companies who wish to apply and comply, and minor administrative declarations and paperwork by the state.  It would be difficult to identify another proposed measure that would deliver as much “economic stimulus” at as small a cost.

The only reservation I have about this bill—a minor one—is that I would like to see it go further.  I would like the bill explicitly to embrace the carefully nuanced criteria for social performance designed by B-Lab (the architects of the B-Corporation label).  And I would like to see explicit preferences in state procurement and in disbursement of economic-development incentives for B-Corporations.

The sections of the Health and Safety Code listed include sanctions for possession (11357), cultivation (11358), possession for sale (11359), transportation or furnishing marijuana (11360), maintaining a location for unlawfully selling, giving away, or using controlled substances (11366), managing a location for the storage or distribution of any controlled substance for sale (11366.5), and nuisance caused by selling, storing, manufacturing, and distributing a controlled substance (11570).

In People v. Urziceanu (2005), the California Court of Appeal said that this section of the MMPA “indicates it contemplates the formation and operation of medicinal marijuana cooperatives that would receive reimbursement for marijuana and the services provided in conjunction with the provision of that marijuana.”

But is this the same thing as selling?

Los Angeles City Atty. Carmen Trutanich has said that state law authorizes collectives only to grow marijuana and recover their actual costs, not to sell it.

This sounds like splitting hairs to me – what is the difference between selling and recovering costs when it is clear in the MMPA that this all needs to be done without profit?

One thing that further muddies the water is that the Attorney General’s medical marijuana guidelines seem to urge collectives to pay sales tax.  But if they are not selling and just recovering their costs, why do they have to pay sales tax?  This puts collectives in a difficult position – if they pay sales tax, are they admitting they are selling which is not clearly legal?  And if they don’t pay sales tax, will the Board of Equalization come after them?

One possible solution is to pay sales tax but submit a letter to the BOE stating that the collective is paying under protest because it does not believe that a collective set up by patients to share marijuana is selling anything.

The following are characteristics that will make it more likely that a court will consider an instrument to be a security, and therefore subject to securities regulations:

1. the right to receive dividends contingent upon an apportionment of profits;
2. negotiability (i.e., transferability);
3. the ability to be pledged or hypothecated (i.e. used as collateral);
4. the conferring of voting rights in proportion to the number of shares owned;
5. the capacity to appreciate in value;
6. the motivations of the seller and buyer – the seller’s purpose is to raise capital and the buyer’s purpose is to earn a profit;
7. the plan of distribution - there is “common trading for speculation of investment” and the instrument is offered and sold to a broad segment of the public;
8. public perception – the public reasonably perceives the instrument as an investment;
9. the instrument poses a risk to the investing public.