NLRB Rules Global Prohibition of Class Actions in Arbitration Agreements Unenforceable

The National Labor Relations Board (“NLRB”) recent ruling in D.R. Horton, Inc. and Michael Cuda makes clear that mandatory arbitration agreements which prohibit employees from asserting class actions in court as well as in arbitration violate the National Labor Relations Act (“NLRA”).

The Mutual Arbitration Agreement (the “Agreement”) contemplated in D.R. Horton, Inc. entirely waived an employee’s ability to resolve an employment-related dispute with D.R. Horton (the “Company”) in court and required resolution of disputes through arbitration. In addition, the Agreement restricted the arbitrator to only hearing individual claims and expressly prohibited the arbitrator from consolidating claims or constructing a class or collective action.  New and current employees were required to enter into the Agreement.

In 2008, a former employee, Michael Cuda, notified the Company that he intended to arbitrate a nationwide class action, based on the allegations that the Company improperly classified superintendents as exempt from the Fair Labor Standards Act.  Mr. Cuda had been a superintendent at the Company from July 2005 to April 2006 and had signed the Agreement, as he was required to do.  When the Company attempted to bar Mr. Cuda’s action pursuant to the Agreement, Mr. Cuda’s attorney filed an unfair labor practice charge with the NLRB.

The NLRB had to consider whether the Agreement violated Section 8(a)(1) of the NLRA, which prohibits employers from interfering with employee rights under the NLRA.  Such interference is deemed an unfair labor practice.  The NLRB determined that the employee’s rights contained in Section 7 to “engage in concerted action for mutual aid or protection” were subjected to inappropriate interference by the Company, thereby violating Section 8(a)(1).  The NLRB also determined that its decision was consistent with the statutory provisions of the Federal Arbitration Act.

In order to provide certainty, the NLRB clearly set forth at the end of its decision what class-action rights may be restricted by an employment arbitration agreement. The NLRB explained, “we hold only that employers may not compel employees to waive their NLRA right to collectively pursue litigation of employment claims in all forums, arbitral and judicial.”  In other words, as long as an arbitration agreement allows employees to pursue class-action claims in at least the arbitral or judicial forum, employee rights under Section 7 the NLRA will not be violated.

It is strongly advised that employers review their employee arbitration agreements to determine whether the agreements permit employees to bring class-action claims in court or through arbitration. If so, the agreements are likely still enforceable. However, if the agreements entirely disregard an employee’s ability to bring a class or collective action, the enforceability of the agreement is likely in question, and the agreement should be reconsidered with the assistance of legal counsel.

All comments contained in this alert are subject to change pending an appeal of the NLRB decision in D.R. Horton to the U.S. Court of Appeals.

This material is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This communication may be deemed advertising under applicable state laws. Prior results do not guarantee a similar outcome.


    IRS Begins Voluntary Employee Classification Settlement Program

    By Raj Grewal

    Spurred by considerations of fair play, the need for higher revenue, and the relaxed compliance records of many businesses, Congress, the IRS, the Department of Labor, and several states have started to take more decisive action with regard to the misclassification of employees.  On September 21, 2011, the IRS began a new Voluntary Classification Settlement Program (“VCSP”) to allow employers who have misclassified their employees as independent contractors in the past to voluntarily reclassify their workers for future tax periods.  Although the VCSP is a promising solution to address the chronic problem of employee misclassification, businesses are best advised to wait for the program to more fully develop before plunging into a new voluntary program fraught with the risk of dissemination of information beyond the IRS, opening taxpayers up to stiff penalties with the Department of Labor and state agencies.

    Background on Employee Classification

    A worker must be classified as an employee if the employer exercises control and direction over her.  The IRS has provided a list of 20 factors in Revenue Ruling 87-41 to help determine whether “control” exists (for convenience, the 20 factors are attached as Exhibit A).  These 20 factors can be sorted into three broad categories: behavioralcontrol (determining time and place of work, training, and other details of the worker’s performance), financial control (business aspects of worker’s job, such as travel and other expenses), and the relationship of the parties (whether evidenced by written contract, benefits such as paid vacation and health coverage, permanency of the position, and extent to which services performed are a key aspect of the company’s regular business).  If workers are properly classified as employees, then the employer must withhold federal income tax under Chapter 24, Medicare tax under the auspices of the Federal Insurance Contributions Act, and Social Security tax under Subchapter A of Chapter 21.  If any employer fails to withhold such taxes, then it risks opening itself up to liability for a deficiency assessment and statutory penalties for the negligent or willful failure to withhold taxes.

    The Voluntary Classification Settlement Program

    From a purely federal employment tax standpoint, the VCSP is a great deal for taxpayers.  A taxpayer who chooses to reclassify its employees will pay only 10% of the amount of employment taxes due under the already reduced rates of Section 3509(a) applied to taxpayers who did not intentionally disregard the requirement to deduct and withhold employment taxes.  The combined effective tax rate under Section 3509(a) for 2011 is 10.28% up to the Social Security wage base.  This covers Social Security and Medicare taxes (employer’s and employee’s share) and federal income tax withholding.  That means the payment required to enter the VCSP in 2012 is a mere 1.28% of the total wages paid to workers in 2011 only, a pittance compared to the amount that would be owed if the misclassification is caught by the IRS in audit.  The taxpayer is not required to pay any interest or penalties.  And, most importantly, the taxpayer can be certain that it will not be liable for past failures to collect employment taxes, as the IRS will agree not to audit the taxpayer for employment tax purposes.

    The taxpayer must, however, treat the workers or class of workers under consideration as employees for employment tax purposes in future years, making the taxpayer responsible for collecting the full amount of federal income tax withholding, Medicare tax, and Social Security tax going forward.  In addition, the taxpayer must have filed the required Form 1099 for each such worker for the past three years and must also extend the period of limitations on assessment of employment taxes by three years for the first, second, and third calendar years after entering the VCSP.  Taxpayers who have not stayed current in their 1099 filings are not eligible for the VCSP.

    The Problem of State Enforcement and Interaction with the Department of Labor

    The IRS has made a policy decision (conveyed on its website and in statements from its employees, but not in any formal ruling or publication) not to share taxpayer information gathered from the VCSP with the Department of Labor or with state taxing and labor authorities.  This position is in sharp contrast to the memoranda of understanding adopted September 19, a mere two days prior to creating the VCSP, with the Department of Labor and at least thirty states in which the IRS agreed to share similar information gathered in its normal audit process.  Still, it may be very difficult as a practical matter to fully comply with the VCSP and at the same time keep state authorities in the dark about the voluntary disclosure.  The obligation to properly classify employees going forward may in and of itself be problematic for taxpayers not wishing to raise alarm bells with state authorities.

    In New York, Governor Cuomo started a Joint Task Force spanning the New York State Department of Labor, Department of Taxation and Finance, Workers’ Compensation Board, the Attorney General’s office, and the Comptroller of the City of New York to aggressively enforce employee classification rules.  It was his second Executive Order after entering office.  Employers found to have misclassified employees are responsible not only for taxes that should have been withheld, but also for missed payments into the unemployment insurance trust fund, statutory fines for inadequate worker’s compensation contributions, and potential wage disputes related to overtime pay and other pay issues.  One business, a bakery in the Bronx, was even prosecuted criminally by the Task Force for falsifying business records, failure to pay wages, and making false statements or representations pertaining to unemployment insurance.  In addition to paying back wages, taxes, and worker’s compensation related penalties, the defendant was sentenced to thirty days in prison and five years probation.  Participating in the VCSP provides absolutely no protection against such penalties at the state level or even against independent investigations by the federal Department of Labor, which assesses its own penalties.


    The VCSP represents a real step forward in leveling the playing field between compliant and noncompliant businesses as well as providing certainty in an area that affects nearly all employers.  Those businesses in targeted industries, like restaurants and construction companies, or businesses likely to be challenged for unemployment benefits by recently laid off workers, might wish to take advantage of the VCSP considering its low entry cost.  However, many other businesses may wish to wait for a global disclosure regime covering state taxing authorities to develop, much as it did with the Offshore Voluntary Disclosure Program, in which the IRS offered incentives similar to those under the VCSP to taxpayers who came forward voluntarily and reported their previously undisclosed foreign accounts and assets.  Many states created complimentary offshore account and asset disclosure programs.  And, unlike the Offshore Voluntary Disclosure Program, the VCSP is not time limited, making a wait-and-see approach that much more attractive.

    Exhibit A: 20 Factors from Revenue Ruling 87-41

     (1) InstructionsAn employee must comply with instructions about when, where and how to work. The control factor is present if the employer has the right to require compliance with the instructions.

    (2) TrainingAn employee receives on-going training from, or at the direction of, the employer. Independent contractors use their own methods and receive no training from the purchasers of their services.

    (3) IntegrationAn employee’s services are integrated into the business operations because the services are important to the business. This shows that the worker is subject to direction and control of the employer.

    (4) Services rendered personallyIf the services must be rendered personally, presumably the employer is interested in the methods used to accomplish the work as well as the end results. An employee often does not have the ability to assign their work to other employees, an independent contractor may assign the work to others.

    (5) Hiring, supervising and paying assistantsIf an employer hires, supervises and pays assistants, the worker is generally categorized as an employee. An independent contractor hires, supervises and pays assistants under a contract that requires him or her to provide materials and labor and to be responsible only for the result.

    (6) Continuing relationshipA continuing relationship between the worker and the employer indicates that an employer-employee relationship exists. The IRS has found that a continuing relationship may exist where work is performed at frequently recurring intervals, even if the intervals are irregular.

    (7) Set hours of workA worker who has set hours of work established by an employer is generally an employee. An independent contractor sets his/her own schedule.

    (8) Full time requiredAn employee normally works full time for an employer. An independent contractor is free to work when and for whom he or she chooses.

    (9) Work done on premisesWork performed on the premises of the employer for whom the services are performed suggests employer control, and therefore, the worker may be an employee. Independent Contractor may perform the work wherever they desire as long as the contract requirements are performed.

    (10) Order or sequence setA worker who must perform services in the order or sequence set by an employer is generally an employee.  Independent Contractor performs the work in whatever order or sequence they may desire.

    (11) Oral or written reportsA requirement that the worker submit regular or written reports to the employer indicates a degree of control by the employer.

    (12) Payments by hour, week or monthPayments by the hour, week or month generally point to an employer-employee relationship.

    (13) Payment of expensesIf the employer ordinarily pays the worker’s business and/or travel expenses, the worker is ordinarily an employee.

    (14) Furnishing of tools and materialsIf the employer furnishes significant tools, materials and other equipment by an employer, the worker is generally an employee.

    (15) Significant investmentIf a worker has a significant investment in the facilities where the worker performs services, the worker may be an independent contractor.

    (16) Profit or lossIf the worker can make a profit or suffer a loss, the worker may be an independent contractor.  Employees are typically paid for their time and labor and have no liability for business expenses.

    (17) Working for more than one firm at a time. If a worker performs services for a multiple of unrelated firms at the same time, the worker may be an independent contractor.

    (18) Making services available to the general publicIf a worker makes his or her services available to the general public on a regular and consistent basis, the worker may be an independent contractor.

    (19) Right to dischargeThe employer’s right to discharge a worker is a factor indicating that the worker is an employee.

    (20) Right to terminateIf the worker can quit work at any time without incurring liability, the worker is generally an employee.


    This information has been prepared by GC LLC  for general informational purposes only.  It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with GC LLC or its affiliates.  The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.

    IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein. For more information on this disclaimer, please see the Gibbons website.


      NYT Highlights Shift Away from High-Overhead Big Law Firms

      The front page of this week’s Sunday New York Times makes an elegant case for the demise of Big Law. Though the diagnosis has been clear to legal insiders for years, the Times article demonstrates that clients have lost patience with padded billable hours, subsidizing associate learning curves, and paying top dollar for mediocre legal results. Link to NYT Article, Sunday Times, page 1, November 20, 2011

      We launched The Forefront Law Group earlier this year as an antidote to this antiquated, broken model. Unlike Big Law, Forefront is dedicated to the needs of the entrepreneurial economy. We have assembled a team of experienced, talented lawyers to serve as counsel to entrepreneurs, growth stage companies, and their investors. With seasoned experts in intellectual property, employment, tax, commercial contracts, real estate, equity structures and financing transactions, we are a very efficient full service law firm. We serve as general counsel for the majority of our clients, partnering closely with them on business and legal strategy.

      Forefront itself is a start-up with a unique structure — one that does not rely on a pyramid of leverage built on the backs of green associates. We serve clients with a core group of knowledgeable in-house attorneys supported by a network of legal experts in their respective disciplines. This novel structure allows us to run a very lean and efficient shop, with virtually no overhead and no need to support armies of associates and their learning curves. The way we practice law is shaped by the fact that every one of our founders and lawyers is an entrepreneur at heart (and often in practice). We have a passion for problem-solving and finding ways to help our clients grow their business.

      As the Times obituary for Big Law concluded:

      “[F]or decades, clients have essentially underwritten the training of new lawyers, paying as much as $300 an hour for the time of associates learning on the job. But the downturn in the economy, and long-running efforts to rethink legal fees, have prompted more and more of those clients to send a simple message to law firms: Teach new hires on your own dime.

      ‘The fundamental issue is that law schools are producing people who are not capable of being counselors. . . . They are lawyers in the sense that they have law degrees, but they aren’t ready to be a provider of services.’”

      Many Big Law firms are making patchwork adjustments to accommodate the new legal realities.  At Forefront, we believe the model needs to be created anew.  Our partner-level experts work directly with clients to provide seamless, efficient counsel on matters from tactical to strategic – with no layers of churn to pad the bills. Through flexible and creative fee arrangements, we try hard to align our interests with those of our clients. It’s time for lawyers to be as creative and entrepreneurial as our clients . . . on the Forefront of the profession.

      Link to NYT Article, Sunday Times, page 1, November 20, 2011


        Understanding the Venture Capital Deal – Anatomy of a Term Sheet

        Understanding the VC Deal
        Anatomy of a Term Sheet

        Jason D. Gabbard, Founding Partner

        Entrepreneurs and financiers must understand that venture capital deals are complicated, dynamic and hugely important to the life cycle of a business in that they scribe a strategic circumference around the company in terms of its current and future financing opportunities.

        Step one in most VC and angel deals is the term sheet.  Term sheets really run the gamut in terms of both content and style.  One of my early mentors at Cravath always told me that a term sheet is “nothing but an agreement to agree, and therefore worth about as much as the paper on which it’s written.”  I tend to agree and for that reason do not get too worked up about term sheets.  50 years ago “term sheets’ were scratched out on dirty napkins over cigars and bourbon.  The premise of a highly detailed and negotiated term sheet is that it saves work (and hard feelings) on the back-end when parties turn to definitive documentation.  In the end, an entrepreneur will probably find they get exercised, or not, about the term sheet to the extent the capital provider does.

        Whether your term sheet is closer to a whisky-soaked napkin with notes or a $25,000 Cravath term sheet, set forth below are many of the important metrics about which you should be thinking when it’s time to think about a term sheet.


          SBJA Provides Tax Free Gains on Growth Company Stock Acquired Before Year-End 2011

          By Alfia Catapano

          Investors have a unique opportunity to purchase tax-advantaged equity in entrepreneurial companies before year-end 2011.  For qualified stock purchases and grants held for more than five years, all gains are tax-free – and exempt from alternative minimum tax provisions as well.

          The Small Business Jobs Act of 2010 provides unique opportunities and incentives for investors through changes to various provisions in the tax code.  Of particular note as we approach the end of 2011 are the amendments the SBJA made to Internal Revenue Code Section 1202.  That section provides a partial exclusion from gross income on gain from transfers of certain qualified small business stock and is likely to be of importance to our clients with investments in eligible small businesses.

          The amendment to §1202 expands the exclusion from 50% to 100% of gain.

          Prior to the enactment of the Small Business Jobs Act, §1202 provided that 50% of gain on the sale or exchange of certain qualified small business stock would be excluded from the gross income of the transferor, provided the transferor met certain requirements and held the stock for more than five years.  While the SBJA makes no change to the original requirements for eligibility or the necessary holding period, it adds a new provision that will allow taxpayers to exclude 100% of such gain on stock that was acquired between September 27, 2010 (the enactment date of the Small Business Jobs Act) and December 31, 2011.

          Gain on stock acquired before January 1, 2012 will not be subject to Alternative Minimum Tax.

          In addition to expanding the exclusion to 100% of gain on such transfers, the SBJA repealed the application of IRC §57(a)(7) which would otherwise make a percentage of the excluded gain an item of AMT preference.  The AMT preference would often negate much of the benefit otherwise derived from §1202. Under the amended provision however, any gain is completely excluded from both regular taxable income and Alternative Minimum Taxable Income.  Exclusion from AMTI can be a significant additional benefit.

          Qualified Small Business Stock

          Section 1202 provides these benefits only for gains on qualified business stock and the requirements for qualification remain unchanged by the SBJA amendments.  In order to qualify, stock must be:

          • Acquired by the taxpayer/transferor at original issue
          • Acquired by the taxpayer/transferor in exchange for money or other property (not including stock) or as compensation for services provided to such corporation.

          Additionally, the small business issuing the qualified stock also must meet several criteria.  The business must:

          • Be a domestic C-corporation
          • Be an active business or a “specialized small business investment company”
          • Have gross assets that do not exceed $50,000,000
          • Be engaged in a qualified trade or business as set out by §1202(e)3

          The requirements for qualifying small businesses listed above are a brief summary of those detailed in §1202(d)-(e).  The statute should be consulted when making a determination of qualification on a per-taxpayer basis.

          Year End Planning Opportunity

          As December 31, 2011 approaches, we advise any clients who may have options to purchase qualifying small business stock to consider doing so before year-end.  Acquiring the options themselves will not suffice; instead, taxpayers must actually exercise those options in order to fall under the provisions of the statute.  The unique benefit provided by the SBJA amendment to §1202 will not be available on stock acquired on January 1, 2012.  Gain on after-acquired stock will again be limited to a 50% exclusion as well as subject to AMT at applicable rates.  In order to take advantage of the benefit provided by the Small Business Jobs Act, taxpayers will need to acquire eligible small business stock prior to 2012.


          This information has been prepared by GC LLC  for general informational purposes only.  It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with GC LLC or its affiliates.  The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.

          IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein. For more information on this disclaimer, please see the Gibbons website


            Preparing for Early Stage VC Deals

            Preparing for Early Stage Venture Capital Deals

            By Jason D. Gabbard

            November 2011

            After two decades of successful operations, one of my clients recently decided to pursue an outside source of capital.  Her decision was one founded in need and opportunity.  It was now apparent that she needed to upgrade assets and add personnel in order to satisfy a business that had grown from her basement to one with global reach.  Similarly, her ability to manage the growing enterprise and the network through which she was acquiring raw materials, buyers and distributions channels are both stretched thin.  Only with more purchasing power, tighter controls and more reasoned strategy will she be able to maximize her ROI and realize her brand’s full value.  In short, she needs capital and expertise.

            The deal strikes me as one more suited for a strategic buyer/partner, but my client has several financial investors on her list of potential investors.  For purposes of this article, I’m not sure that distinction has significance, but in other contexts, especially moving forward with a deal, it will.  For instance, a financial investor will negotiate harder for the preferences associated with preferred shares, such as protective rights, anti dilution and registration rights, while a strategic, viewing the investment as a long-term, synergistic partnership, may be willing to drop some of those more onerous provisions.

            The following abbreviated list of pre-deal issues should be helpful in this context.  Assuming you have moved beyond the preliminary paper review[1] by the investor, this list may guide the entrepreneur in his or her preparation for discussions with potential investors, and help both sides understand critical levers in the pre deal process.

            Practice your pitch.  Rehearse your presentation over and over.  But don’t plan for your meeting to be a rote recitation.  It should and likely will be a dialogue about your business.  Be prepared to have a conversation, articulate your strategy and assumptions, and defend the same.

            Utilize available resources.  Your company accountants, lawyers, and other entrepreneurs can serve as a discerning audience to assist your preparation.

            Diligence the investor.  This point should be axiomatic, but it’s not.  Too often entrepreneurs want to jump at the first sign of green, but the diligence process is a two-way street.  Entrepreneurs need to feel comfortable with the style, attitude, track record and resources the investor brings to the table.   For example, does the investor have experience in your industry?  What, aside from money, does the investor bring to the table?  These questions are important, as some entrepreneurs will accept less-than-ideal terms and valuations if the investor brings expertise or an expansive network.  Make the investment round opportunistic and strategic at once.  Many resources are now available on the Internet to assist this process.  See

            In this vein, consider a diligence request list for the investor.  For instance, request from the investor information as to:

            • how many current portfolio companies; how many exits, their type and success; average time to exit;
            • regional focus of the fund, if any;
            • average size of portfolio company (do you fit in);
            • examples of how the investor works hand in hand with companies; and
            • aspects of the fund itself, if it is a fund (availability of follow-on financing, how much cash is available, etc.

            Understand the critical challenges facing your business, including with your weaknesses.  Don’t be uncomfortable with questions related to challenges and weaknesses, in fact, address them head-on.  Be prepared to articulate in a reasoned manner how your business will address these issues going forward and with the assistance of your investor (and its capital).  Also, preemptively identify your key competitors and differentiate your company and its strategy.


            Vet your strategy. Review your strategy and business plan to confirm that you have a big and expanding market, and that there are barriers to competitors entering that market.  A strong brand name helps, or some other IP, such as patents.  Can you demonstrate a sustainable competitive advantage?

            Don’t forget your most important resource – your human capital.  Have the potential investor into your office to meet key personnel, along with the rank and file.  The investment decision may very likely hinge on the strength of the entrepreneurial founder, but without a strong team and corporate infrastructure, the Company’s growth will be prematurely capped.

            Formulate an exit strategy.  Be prepared to show the investors how they are getting their investment and return out of the Company.  When I think about exit, I think about either an IPO or a sale to a PE fund.  Be prepared to stress test the potential scenarios and to provide industry-specific examples when available.

            In advance of your discussions with VCs, I also suggest that the Company compile a due diligence file containing key contracts, litigation papers and financial statements and projections, at a minimum.  Review that file to assure that you understand the company’s contractual position at a general level, along with potential issues.  Additionally, you should think about common representations and warranties and the potential pitfalls therein – organization and good standing; intellectual property; litigation and contingent liabilities; employee matters; and taxes, to name a few.  If your company will have difficulty in making any of the representations and warranties, proactively think about a strategy for eliminating your risk.


            [1] Incidentally, during the meeting that prompted me to pen this note, my client dropped an 80-page business plan in front of me, asking for my thoughts.  My personal view, and one I’ve  heard echoed time and again from my investor-side clients, is that investors, especially institutional ones, simply do not have time to wade through epic-sized business plans.  I prefer to keep them short.  Assume you have five minutes of the investor’s time.


            This information has been prepared by GC LLC  for general informational purposes only.  It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with GC LLC or its affiliates.  The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.


              Broker-Dealer Regulation of Finders and Intermediaries

              Are Intermediaries and Finders Required to Register as Broker-Dealers?

              By Jason D. Gabbard

              The Forefront Law Group

              Today, many financial services businesses are seeking to expand into new areas and to provide additional services to their customers.  These businesses need to be aware that many activities, however innocuous they may appear, may have serious regulatory implications, just one of which may be the need to register with the Securities Exchange Commission (“SEC”) as a broker-dealer.  This article will discuss the actions undertaken by a business that may require registration with the SEC, and specifically whether certain activities undertaken by “finders” require registration.  It should be noted at that outset that this determination is a very fact-specific analysis that may require consultation with the SEC, and any business that engages in activities similar to those discussed here should consult an attorney.

              Section 15(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) requires broker-dealers to register with the SEC, and Section 15(b)(8) of the Exchange Act requires broker-dealers to be members of a qualifying self-regulatory organization.  Section 3(a)(4)(A) of the Exchange Act defines a “broker” generally as, “any person engaged in the business of effecting transactions in securities for the account of others,” and Section 3(a)(5)(A) of the Exchange Act generally defines a “dealer” as, “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.”  These definitions are not self explanatory, yet their interpretation and application in individual cases can have an enormous impact on the operation of a business.  Registration as a broker-dealer can be an onerous, expensive and time-consuming process that subjects the business to a complicated regime of rules and regulations as well as ongoing compliance requirements.  However, conducting activities that require registration with the SEC when not registered may subject the business to regulatory actions and fines, and can also result the rescission of bilateral contracts with third parties.  Thus, it is extremely important to analyze these definitions thoroughly in relation to the activities of a particular business.

              The SEC has not published a list of all of the business types and models that may require registration with the SEC as a broker-dealer, but the following are just a few of the businesses that may be deemed a broker-dealer, depending on a number of factors:  “Finders,”  “business brokers,” “placement agents,” investment advisors, financial consultants, businesses that operate electronic trading platforms, businesses that market real estate investment interests that are securities and businesses that effect securities transactions for the account of others for a fee.

              As previously noted, my focus here is solely on the activities of “finders.” This term is not defined in the Exchange Act, but is understood to describe a business that engages in one or more of the following activities:  finding investors or customers for, or making referrals to, broker-dealers, investment companies, mutual funds, hedge funds or other securities intermediaries; finding investors for issuers of securities, even in a “consultant” capacity; engaging in, or finding investors for, private equity of venture capital financings, including private placements; and introducing buyers and sellers of businesses.

              The SEC’s determination as to whether a particular business should be treated as a finder as opposed to a broker-dealer requiring registration depends on a number of factors, including whether the business: receives transaction-based compensation as opposed to a flat fee for its services; renders advice about the structure, price or desirability of a securities transaction; seeks investors actively rather than passively; advertises or solicits on behalf of an issuer of securities; is actively involved in negotiations between an issuer and investors; and possesses client funds and securities.  See Torsiello Capital Partners, LLC v. Sunshine State Holding Corp., 2008 NY Slip Op. 30979, April 7, 2008.  While all of these factors are relevant to the determination, the SEC will likely focus on two primary elements: the type of fee charged by the business for its services and the specific services provided by the business to its customers.

              Regarding the type of fee charged, a business that charges a flat or hourly fee for its services, as opposed to a commission type fee that varies with the size or success of a transaction, is more likely to be deemed by the SEC to be a finder not requiring registration (the SEC has noted that “transaction-based compensation [is] one of the hallmarks of being a broker-dealer.”  John R. Wirthlin, SEC No-Action Letter (January 19, 1999)).  For example, in Hallmark Capital Corporation, SEC No-Action Letter (February 26, 2007), the SEC noted that Hallmark Capital (“HallCap”), a self-described “financial consultant and finder for small businesses” that assists owners of small businesses in raising capital and facilitating mergers and acquisitions, that was “compensated with a modest upfront retainer and a fee based on the outcome of the transaction,” would likely be required to register with the SEC as a broker-dealer.  This was true even though HallCap always informed clients that it was not a broker-dealer, did not act as an agent for its clients and it did not effectuate transactions for the account of others.  In addition, in Brumberg, Mackey & Wall PLC, SEC No-Action Letter (May 17, 2010, the SEC stated, “Any person receiving transaction-based compensation in connection with another person’s purchase or sale typically must register as a broker-dealer.”)

              Regarding the services provided by the business, in general, the more actively involved the business is in the negotiation of a particular transaction, the more likely the SEC is to find that the business must be registered as a broker-dealer.  Some factors to consider in making this determination are whether the business: provides valuations; negotiates or advises as to the structure or terms of the transaction; participates substantively in negotiations; performs due diligence; and/or helps to prepare the transaction documents.  No single factor is dispositive.  Rather the activities of a business need to be analyzed as a whole.  The SEC summarized this position in IMF Corp., SEC No-Action Letter (May 15, 1978) where it stated:  “Individuals who do nothing more than act as finders by bringing together merger or acquisition-minded persons or entities and who do not participate in subsequent negotiations probably are not brokers or dealers in securities and would not be required to register with the SEC. On the other hand, persons who play an integral role in negotiating and effecting mergers or acquisitions that involve transactions in securities generally are deemed either a broker or a dealer depending upon their particular activities, and are required to register with the SEC pursuant to Section 15(a).”

              Section 15(a)(1) of the Exchange Act generally prohibits any unregistered broker or dealer to use any means of interstate commerce (the mails, the internet, the telephone, etc.) to “effect any transaction in, or induce or attempt to induce, the purchase or sale of any security,” and Section 29(b) of the Exchange Act provides that “[e]very contract” made in violation of the Exchange Act or the performance of which involves such violation “shall be void.”   Thus, a business must know whether the activities in which it engages require registration with the SEC as a broker-dealer, or run the risk of violating the securities laws and being the subject of private litigation.  If found to be in violation of the securities laws, a business can be subject to the issuance of cease and desist orders, the levying of monetary penalties and the denial of future registration.

              Finally, though it is beyond the scope of this article, it is also important to note that each state has its own registration requirements that may be applicable to broker-dealers having a presence in that state. Even if a broker-dealer has fully complied with the federal registration requirements, failure to properly register in each in state in which registration is required can result in fines, denial of the right to continue to do business in the state and even rescission of transactions with residents of that state. 

              The bottom line is that, to avoid running afoul of the SEC, businesses and their counsel must at the very least ask themselves the following questions (and this list is not exhaustive):

              • Does the business participate in important parts of securities transactions, including solicitation, negotiation, or execution of transactions?
              • Does the business’ compensation for participation in a transaction depend upon, or is it related to, the outcome or size of the transaction?
              • Does the business receive trailing commissions?
              • Does the business receive any other transaction-related compensation?
              • Is the business otherwise engaged in the business of effecting or facilitating securities transactions?
              • Does the business handle the securities or funds of others in connection with securities transactions?

              A “yes” answer to any of these questions indicates that the business may need to register with the SEC as a broker-dealer.  As this article has hopefully highlighted, this analysis is very fact intensive and may require consultation with the SEC.  If you are currently engaging in any finder-type activities, you may want to consult a qualified attorney.


              Jason Gabbard is a Founding Partner at The Forefront Law Group.  Jason has a diverse set of legal skills, including significant exposure to broker-dealer and other regulatory matters, and has represented a variety of companies and financial institutions.


              The contents of this article are for informational purposes only. Neither this article nor the lawyers who authored it are rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of this article to any person constitute the establishment of an attorney-client relationship. The Forefront Law Group assumes no liability in connection with the use of this publication.


                FBT Productions – understanding the Eminem case




                The Supreme Court recently declined to hear a Universal Music Group appeal in its years-running fight with Eminem’s former production group.  The decisioncould have substantial monetary implications for the industry and older artists.  In late 2010, in a somewhat strained decision, the Ninth Circuit court held in FBT Productions, LLC. v. Aftermath Records, 621 F.3d 958 (2010), that permanent downloads via Apple’s iTunes and other digital download purveyors constitutes a license for the purposes of calculation of royalties under a particular music distribution agreement.  The facts at issue in the case were briefly as follows:

                • Plaintiff FBT had signed rapper Eminem to an exclusive agreement in 1995.
                • Plaintiff FBT entered into a deal with defendant Aftermath Records three years later that provided, among other things, that:
                  • FBT would receive between 12% and 20% of the adjusted retail price of all “full price records sold in the United States through normal retail channels”; and
                  • FBT would receive 50% of Aftermath’s net revenues on masters licensed for the manufacture and sale of records.
                • Five years later, as the digital music revolution began to take firm hold, Aftermath’s parent signed a deal with Apple that, in the words of the court, “enabled…the Eminem masters, to be sold through Apple’s iTunes store as permanent downloads.”  Emphasis added.
                • Shortly thereafter, in 2003, FBT and Aftermath entered into a new agreement that terminated the prior one.  The new agreement increased royalty rates and included many of the terms from the prior agreement.  The court notes one substantive addition to the agreement: it provided that “’Sales of Albums by way of permanent download shall be treated as [US Normal Retail Channel] Net Sales for purposes of escalations.’”
                • For three years thereafter, Aftermath sold Eminem records through iTunes (and similar channels) and Aftermath paid, and FBT accepted, royalties at the lower license rate on such sales.

                In overturning the lower court, the appeals court issued a curious decision.  While in its factual summary of the case the court states that iTunes enabled the Eminem masters to be sold, it forces its own hand when it later decides that these sophisticated industry participants used the term license in its “ordinary and popular sense, rather than…a technical sense.”  Grasping to support its position the court goes on to say that “Aftermath was at all relevant times the owner of the copyrights to the Eminem recordings at issue in this case…Aftermath did not “sell” anything to the download distributors….the ownership of those files remained with Aftermath, Aftermath reserved the right to regain possession of the files at any time.”

                The somewhat perplexing opinion leaves unanswered questions:

                • Will this case which clearly analyzes the language of one particular contract, have precedential  applied in the context of other agreements?
                • So does the test turn on the relationship between Apple and Aftermath or that between Apple and its customer?
                • If iTunes and its ilk “enabled [the masters] to be sold”, why is this transaction now considered a license?
                • Why did the court turn a blind eye to the contract clause providing for the payment of lower royalties in the event of sales by way of permanent download?  Wasn’t the iTunes download surely what the parties had in mind when including that provision?
                • Since the court holds that Aftermath reserved the right to regain possession, can Aftermath cancel my “license” of Stan (ft Dido)?
                • If an iTunes transaction doesn’t represent a sale, what does – in a world where disc sales have become nearly extinct?
                • Was the court simply trying to reach an equitable result in the wake of a dramatic shift in the economic realities of the music industry?

                This case will have little impact on artists signed to labels in the 2000s and later.  But it could have substantial impact for older artists and their estates.  It could also be applied in other segments of the entertainment industry.  We eagerly look forward to the next case to interpret FBT Productions and to more clarity on many of the questions presented above.

                Our firm regularly advises clients on how to approach and analyze music production, distribution and license deals.


                This information has been prepared by GC LLC  for general informational purposes only.  It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with GK.  The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.


                  Impact of Dodd-Frank on Hedge and Private Equity Funds

                  Impact of Dodd-Frank on Hedge and Private Equity Funds

                  By Mark Shaffer and Don Snyder

                  The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Pub. L. 111-203 (2010)), enacted on July 21, 2010 (the “Act”), will affect every financial institution in the country, big and small.  Financial institutions and other entities face new regulations in the fields of banking, securities, derivatives, executive compensation and others.  While the reach of the Act is clearly very broad, this article will focus on the Act’s impact on hedge funds and private equity funds (“Funds”), which will experience government regulation in ways they have not previously.  Except where otherwise specified, the Act’s provisions take effect on July 21, 2011.

                  The Act’s changes affect several aspects of private fund activity.  For example, several types of products commonly used by Funds, such as swaps, derivatives and asset-backed securities, are now subject to greater government oversight, rulemaking and future regulation.  However, no change will be a dramatic as the new registration requirements for Funds and their corresponding recordkeeping and reporting obligations.

                  Prior to the Act, most fund advisors relied upon the “private investment adviser” exemption contained in the Investment Adviser’s Act to avoid registration as an investment advisor.  Pursuant to this exemption, an advisor who had fewer than 15 clients during the course of the preceding 12 months (under this exemption, each fund is counted as a single client) and did not hold itself out to the public was exempt from registration.  The Act eliminates this exemption and specifically states that “private fund” advisors – those advising a fund that would be an investment company but for the exemptions contained in sections 3(c)(1) or 3(c)(7) of the Investment Company Act – are no longer exempt from registration unless they meet a further exemption under the Act.

                  The Act then details certain advisors who may remain exempt from registration.  These advisors include: foreign private advisors, venture fund investment advisors (to be defined by the SEC), investment advisors to “family offices” (to be defined by the SEC) and investment advisors who “solely” advise private funds with an aggregate amount (per such advisor) of less than $150 million in assets in the United States (these advisors will be required to keep certain records, and will periodically have to provide informational records to the SEC).

                  The elimination of this exemption will require many previously exempt advisors to register.  While it is true that exempt advisors were always required to comply with the Investment Advisers Act’s anti-fraud provisions, registered advisors have to comply with additional compliance obligations, including, among others:  appointing a chief compliance officer, establishing a compliance program and complying with certain advertising restrictions.  In addition to these new obligations resulting from registration, the Act imposes new recordkeeping and reporting requirements on registered advisers.  For example, among other things, registered advisers must report to the SEC:  their assets under management; their use of leverage (including off-balance sheet); counterparty credit risk exposure; trading and investment positions; valuation policies; trading practices and types of assets held.

                  In addition to these potentially onerous new registration, recordkeeping and reporting requirements imposed on Funds by the Act, the Act also changes the definition of an “accredited investor.”

                  In order to avoid registering its offering and its securities pursuant to the Securities Act and having to comply with the requirements that attach to such registration, most Funds rely upon one of the exemptions from registration found in Regulation D of the Securities Act, the most common being the exemption under Rule 506.  Pursuant to this exemption, a company can raise an unlimited amount of money from an unlimited number of investors so long as, among other criteria, each investor is an “accredited investor” as defined in Rule 501.  The Act modifies this definition as applied to an individual investor, excluding the value of a primary residence for the purpose of calculating whether an individual has a net worth of $1 million or more.  The SEC is also required to revisit the definition of an “accredited investor” every 4 years, reviewing and modifying the standard “as appropriate for the protection of investors, in the public interest, and in light of the economy.”  This change may not be a problem for large Funds, whose investors are generally institutional investors, but could be very relevant for employee investments in Funds and for “friends and family” type funds.

                  So, the bottom line is that previously exempt advisors of private funds need to determine whether they meet any of the new exemptions provided by the Act, or whether they now need to register.  And if they do need to register, they need to ensure that that have in place the appropriate policies and procedures to comply with the governance, recordkeeping and reporting obligations that come with such registration.

                  *          *          *          *

                  Mark Shaffer is counsel with Gabbard & Kamal LLP.  Don Snyder is a law clerk with the firm, and is not yet admitted to the Bar.

                  Dodd-Frank Article – link to article


                    Ending Internet Anonymity

                    Commentators and scholars alike have been calling for an end to Internet anonymity for years now.  The Internet is a powerful tool for communicating with others and for formulating ideas.  It encourages the flow of information in a manner of epic proportions, to be sure.  But when loose and careless tongues have access to such a powerful means of publishing and disseminating information, it can serve as a recipe for disaster.  Consider the case of our client, Michael Bolla.  The NY Post featured Mr. Bolla’s case recently in their Sunday edition.  The full article can be found here:


                    This case follows the lead set by the somewhat famous “Skanks of New York” case in which a young lady took action after one anonymous blogger defamed her character.  Under the common law, per se categories of defamation included allegations of being unchaste or engaging in sexual improprieties (a somewhat dated and sexist category that applies almost entirely to women).  They also included remarks aimed at a person’s profession and professional reputation, as in the case of Mr. Bolla.  The Petitioner in that case, like Mr. Bolla, was successful in persuading the court to pull the mask off the anonymous pen.

                    While I certainly would never advocate against the protection of free speech, I do not think bloggers should have the luxury of hiding behind their URLs.  Surfing anonymously is one thing.  Maliciously destroying another person’s reputation from your armchair with zero accountability is another.

                    If you’ve found yourself on the business end of one of these “anonymous blogs”, don’t take for granted that it’s a lost cause.

                    I encourage you to stay tuned to this exciting and dynamic area of the law, as we all contribute to a mounting body of precedent that may lead to a US Supreme Court case.

                    For reference, I attach the actual Order in the Michael Bolla case below.

                    New York, NY

                    August 3, 2010