ROBS transactions: the Department of Labor and IRS Regulation

Recently, the Department of Labor advised that they are in the process of developing information to provide direction for Rollovers as Business Start-ups known by the IRS as ROBS transactions.

The IRS issued a memorandum on October 1, 2008 warning about potential pitfalls for ROBS transactions particularly related to prohibited transactions. Moreover, the Department of Labor and the IRS have indicated that a large percentage of ROBS transactions do not comply with federal rules and regulations with regard to tax-deferred retirement plans such as qualified 401k plans and IRAs.

According to Louis Campagna, Chief of the Fiduciary Interpretations Division for the Department of Labor’s Employee Benefits Security Administration, the direction being produced by his department shall address the Department of Labor’s apprehension with regard to ROBS transactions initiated with rollovers from employer sponsored qualified plans and individual retirement accounts, such as 401k plans and IRAs, in order to allow a professional to assess whether the ROBS transaction could be a prohibited transaction.

The Department of Labor is concerned with the employer’s intent when the ROBS transaction is initiated.

Specifically, the Department of Labor needs to determine whether the ROBS transaction was initiated to implement a lawful way for employees to save money for retirement or is the ROBS transaction being used to shelter income for taxpayers who want to start a business or capitalize an existing business. The latter would allow for the taxpayer to withdraw funds from the C-corporation with the 401k plan for reasons unrelated to the business. If so, the taxpayer could withdraw funds, which where designated as tax-deferred, before they are allowed to be withdrawn tax free.

The IRS has their own concerns with ROBS transactions such as the valuation of the transaction and their compliance with other rules for qualified retirement plans which invest in employer stock, therefore the IRS may publish their own memorandum with respect to the issues they have concerning ROBS transactions.

Besides the complex rules and regulations governing prohibited transactions, another major concern for the IRS is the ability to “unwind” ROBS transactions which have violated IRS rules and regulations for qualified retirement plans. If a 401k plan participates in a prohibited transaction, the entire 401k plan loses its tax deferred status. Therefore, the entire 401k becomes taxable. Another major issue is deterioration of the initial ROBS valuation. Many small to medium size business holders remove cash from the entity for reasons unrelated to the business. This type of action can cause a decrease in the initial value of the ROBS transaction and violate prohibited transaction rules and regulations.

Time is of the essence with respect to hiring a professional to review your ROBS transaction in order to determine if there have been any violations of federal rules and regulations, such as prohibited transactions. The IRS has a self-correction program for 401ks which taxpayers can take advantage of before an IRS examination.

The End of LIFO/FIFO Loan Participations between Banks?

Loan participations are invaluable to community and regional banks who want to service their borrowers’ needs beyond its legal lending limits or risk tolerance. Loan participations frequently include “LIFO” (Last-in, First-out) and “FIFO” (First-in, First-out) provisions designed to streamline the lending process, simplify monitoring the legal lending limits, and entice banks to participate in a loan they would not otherwise consider.

LIFO loan participations are effective when the originating bank advances funds to its borrower up to its legal lending limit for that single borrower – subsequently the participating bank purchases that amount of the loan which exceeds the originating bank’s lending limit. For the participating bank’s trouble, or relative bargaining power, the participating bank is repaid its principal before the originating bank. The opposite holds true for FIFO loans. Regardless of the loans LIFO or FIFO status, in the event of default losses are shared between the originating bank and the participating bank on a pro-rata basis.

Effective January 1, 2010, FASB Statement No. 166, Accounting for Transfers of Financial Assets (“FAS 166”) altered what constitutes a transfer of a portion of a financial asset, e.g., a loan participation, to be treated as an actual sale. Per FAS 166, LIFO and FIFO participation loans do not qualify for sale accounting treatment. What this means to bankers is that the originating bank is now obligated to report that portion of the loan “sold” to the participating bank as a loan on its balance sheet. So, rather than account for only what the originating bank has outstanding, less what it sold to the participating bank, the originating bank now must include the aggregate balance of a borrower’s debt, which, in turn, is used to determine compliance with legal lending limits (see generally12 USC § 84; Reg O; RSMo § 362.170; and CSR 140-2.080).

The American Bankers Association has been proactive on this front, authoring a March 3, 2010 letter discussing the regulatory requirements for loan participations effected by FASB Statement No. 166. In its letter to the Federal Reserve and interested parties, the ABA recommends that FAS 166 should not be used to regulate legal lending limits – rather, “[c]ompliance with such limits should apply on the basis of the contractual borrower.”

To be clear, FAS 166 does not apply to loan participations where all cash flows from the entire financial asset are divided proportionately among the participating interest holders in an amount equal to their share of ownership. What is less clear, however, is whether banks must are required to modify accounting methods for loans made pre-2010 but include disbursements post-2009, such as a revolving line of credit.

In sum, until the certain clarifications are made, in order to qualify for sale accounting the originating bank must carefully review its policies and procedures for loan participations, and understand the implications that come with FAS 166.

Raiding Your Competitors’ Salespeople in Missouri: What are Owners’ Key Questions?

Your competition is hurt and bleeding and your industry is down. You own a business and you are in the enviable position of having extra cash. However, barriers to entry are low in your industry and buying your competition’s business may not be a good investment.

An easier strategy, a bit predatory of course, is to hire the salesperson from the failing businesses.

You have searched the internet as to the wisdom of the idea, and you are a bit confused. As fate would have it, the decision is made somewhat easy for you and you are approached by the salesperson in question who lets you know he can bring a substantial book of business given that he is fairly sure his employer’s ship is sinking.

You are aware of the duties that an employee owes an employer, and you intend to stay squarely within the law. The competitor is savvy and you know there has to be a non-competition/non solicitation agreement. You quickly arrange a meeting with the salesperson and you ask her to bring a copy of her non compete/non solicitation for legal review.

So, what are the key questions you should be asking in Missouri during these hard economic times:

1. Has your compensation arrangement been recently unilaterally changed?
2. Has the business changed hands (Roeder v. Ferrell-Duncan, Clinic, Inc.)?
3. Is the employer in the process of being downsized and will you be asked to sign a severance agreement (Carboline v. Lebeck and PPG Industries)?
4. What are the events leading up to the decision to seek new employment-material breach issues (McKnight v. Midwest Eye Institute of Kansas City, Inc.)?

The answers to these questions will help you and your counsel determine whether you need to buy the business, hire the employee or pursue other strategies.

Missouri Historic Tax Credit

Currently, the Missouri legislature is debating on whether to restructure the state’s historic tax credit program given the state’s budget crisis. Governor Nixon apparently believes that the state’s historic tax credit programs are large and have been usurping state funds that could go public schools, colleges and universities. Therefore, his administration believes that these programs need to be reformed to free up cash flow for other state programs. Governor Nixon’s administration has proposed creating new statutes for six separate state historic tax credit programs with discretion on the amount awarded, whether to award any amount at all, whether to award any or all of a particular year’s credits allocation and whether to cap certain tax credits at $314 million a year. No rules or regulations have been set in place for the Missouri Department of Economic Development to even make these types of determinations which will only serve to complicate the process even though the current process has been recognized as a national model.

In 1999, The Wall Street Journal published an article entitled “In St. Louis Developers Bank on Tax Credits” wherein the author called the Missouri Historic Tax Credit program “a national model.” The article explains “the Missouri program provides state income tax credits for 25% of eligible rehabilitation costs of approved historic structures. The credit which has no cap applies to both residential and commercial buildings and can be used in conjunction with the 20% federal historic tax credit. In addition, the state tax credit is transferable: Mercantile Bank (now US Bank) has set up the Missouri Tax Credit Clearinghouse to buy and sell credits.” Rehabilitation construction projects such as Cupples Station, the Chase Park Plaza and projects on Washington Avenue and surrounding areas in downtown St. Louis would not have taken place without these tax credits. Without these tax credits, these properties would most likely continue to be an eye sore for the community and definitely not creating new jobs nor increasing state and local government revenue.

The Missouri Growth Association (MGA) and St. Louis University performed a ten year study with regard to Missouri’s historic tax credit programs. In March 2010, they released their conclusions which revealed that the Missouri historic tax credit program contributed to the creation of over 43,000 Missouri jobs with average salaries of $42,732, $669 million in newsales, use and income tax revenues which directly benefited the state and local governments as well as $2.9 billion in private investment in Missouri. According to the Missouri Department for Economic Development, Missouri Historic Tax Credit projects created 4,900 Missouri jobs in 2007, which according to David Listokin of Rutgers University Center for Urban Policy Research, equals 38 jobs per $1 million invested or more jobs than highway or new construction projects. Moreover, the Missouri Department of Economic Development noted that from 1998 – 2008 over $4 billion of investment had been leveraged throughout Missouri as a result of the Missouri Historic tax Credit Program as well as $858 million being invested in 2008. In addition, the Missouri Department of Economic Development has concluded that over 66 communities in Missouri have taken advantage of these historic tax credit programs.

According to the Downtown Community Improvement District (2009), St. Louis City alone has 5,000 new residents as a direct result of Missouri’s Historic Tax Credit programs which caused the city to have its first population increase in fifty years. All of these new residents as well as visitors are paying new local taxes to the state and St. Louis City.

The discussion of removing or capping Missouri’s Historic Tax Program would have zero effect on the 2010 budget since historic tax credits have already been approved for this year. Any change to the Missouri Historic Tax Credits programs would only affect future state budgets. If the state historic tax programs are changed, developers would then analyze the cost to renovate a historic building with the potential revenue. In addition, changes to the programs or uncertainty in the programs will cause more problems for developers in terms of financing a project. At this time, developers are having a hard time financing projects as a result of new internal lending policies and procedures. Many lenders are requiring anywhere from 40% percent equity to 100% collateralization in order to obtain a loan. If the state has a stable historic tax credits program, a developer can leverage those funds to aid in financing a project.

While Missouri is debating whether to institute significant changes to the Missouri Historic Tax Credits programs which was deemed “a national model”, Kansas removed its historic tax credits cap. Further, Iowa increased their historic tax credits cap and Illinois is organizing a historic tax credit program. If Missouri wants to continue to grow jobs, grow revenue for state and local governments as well as increase private investment; particularly, when the country and the state are hopefully coming out of a significant economic recession, the Governor and state legislators need to think long and hard about altering a extremely successful state historic tax credit program which is not only the envy of many other states but has been recognized on a national level.

Kaiser and IRS tax shelters

On April 12, 2010, the Department of Justice, Tax Division filed a Complaint in the United States District Court for the Eastern District of Missouri against Philip Kaiser requesting a permanent injunction and other relief. The public record reveals that the Department of Justice, Tax Division is attempting to enjoin Kaiser and all those in active concert or participation with him from allegedly organizing, promoting or selling “tax schemes” known as:

1. a Private IRA Corporation or “PIRAC”,
2. a Charitable Family Limited Partnership or “Char-FLP”,
3. a Real Estate Purchase Option, and
4. Derivium also called a “90% stock loan.”

If you take steps to correct any IRS violations before the IRS begins to investigate your transactions, you can take advantage of IRS correction programs. Once an IRS investigation begins with regard to you, you cannot take advantage of these programs. The IRS has already begun investigations into self-directed Roth IRA accounts or PIRACs as well as the Charitable Family Limited Partnership or Char-FLP. A Justice Department spokesman has already been quoted as stating that the Department of Justice is going to get Kaiser’s client list. Therefore, time is of the essence to contact an attorney to assist you in reviewing your transaction and with any potential IRS examination.

Updated pleading in U.S. Court of Appeals… read more.
Article discussion McGraw Milhaven… read more.

ROBS transactions or “Rollover As Business Start-ups” transactions

Over the last two years, lending institutions have changed internal policies and procedures with regard to loan approval as a result of the global financial crisis. Most domestic lenders require anywhere from forty percent equity to one hundred percent collateralization in order to begin the discussion of obtaining a loan. This has caused many business deals to stall or vanish. These circumstances have given rise to alternative sources of financing for start-up business, franchise purchases and purchases of existing business or assets. One such way is through a Rollovers As Business Start-ups or known by the Internal Revenue Service (IRS) as a ROBS transactions.

From 1992 – 2007, many employees built up their retirement funds through qualified 401k plans. As a result of the global economic and financial crisis, typical losses in a 401k plan ranged from thirty percent to forty percent of retirement assets. Despite these losses, these individuals still have significant sums of money in these accounts which have been assisted by an increase, from the DOW’s low of about 6,547 in 2009, in the United States securities exchanges. Many United States employees have a substantial percentage of their entire savings locked up in a 401k account which cannot be touched unless the taxpayer is willing to pay a penalty for an early withdrawal before 59 and one-half years old. Over the last several few years, the IRS has seen an increase in ROBS transactions which are being promoted by various entities across the United States as a significant method to capitalize a start-up business, to buy a franchise, capitalize an existing business or buy the assets of an existing business. Essentially, a promoter is a company or individual who markets and sells a tax shelter. A tax shelter is an investment, agreement or plan that is established for the purpose of avoiding or evading federal income taxes.

A ROBS transaction is a tax shelter whereby an individual uses pre-tax passive retirement assets, such as funds in a 401k, to capitalize new or existing businesses without paying taxes on the retirement assets. Typically, the promoter assists the individual through the process by initially incorporating a C-corporation for the taxpayer. The same corporation adopts a qualified 401k profit sharing plan which the promoter markets. The newly established 401k is a plan which includes an uncommon plan election allowing 401k participants to invest their entire account balance in the employer’s stock. At this point, the promoter typically then executes a rollover of retirement money into the new 401k plan. The promoter then directs the 401k to purchase employer stock in the C-corporation. The promoter’s client then transfers existing 401k funds to the C-corporation in order to capitalize the C corporation. The promoter’s client does not pay any taxes or penalties for this distribution or early withdrawal of the existing 401k funds.

Throughout the process, the promoter advises their client that the ROBS transaction meets the requirements of federal law under an ERISA exemption. The promoter typical informs their client that the client will receive a (advisory) letter from the IRS indicating that the ROBS transaction with withstand an IRS review. In addition, the promoter may advise the client that any outside attorney will not be able to advise them that the ROBS transaction is illegal or unable to withstand an IRS review. Given the circumstances surrounding a ROBS transaction, we are not aware of any official opinion letter from the IRS which addresses the issue of whether there is a violation of federal law under ERISA or the prohibited transaction rules with regard to the form or structure and operation or administration of a business, such as a C-corporation, under a ROBS transaction.

While the IRS has not officially deemed the ROBS transactions illegal, they have coined the term “ROBS” for these transactions, are vigorously investigation these transactions with the Department of Labor, have only stated the form may not be a violation “per se” of federal law but at no time has the Department of Labor or the IRS ever stated that these transactions from the structure through the operations will withstand an IRS review. In fact, the answer is that nobody knows whether the ROBS transaction is legal. The fact that the federal government is running massive deficits as well as the IRS :

1. calling these transactions ROBS,
2. having targeted these transactions, and
3. having issued a stern memorandum for these transactions, should raise red flags with regard to how the Department of Labor and the IRS will treat ROBS transactions in the future.

On October 1, 2008, the Director of Employee Plans for the United State Department of the Treasury issued a Memorandum with regard to guidelines regarding Rollovers As Business Start-ups. The Memorandum reveals that the IRS does not believe that the form of all of these transactions may be challenged by the IRS as being non-compliant “per se” but each case is to be considered on a case by case basis. The problem with a ROBS transaction might not be so much with the form or the structure of the deal but more so with operating and administering the deal after the transaction is completed. Two primary issues raised by the IRS are:

1. violations of the nondiscrimination requirements, in that benefits shall not satisfy the benefits, rights and features test of Treasury Regulations,
2. prohibited transactions as a result of deficient valuations of stock,
3. promoter fees,
4. “permanent” retirement program,
5. exclusive benefit of the retirement plan,
6. the retirement plan not communicated to the employees, and
7. inactivity in cash or deferred arrangement.

The United States government encourages the use of retirement plans. In order for an employer to take advantage of these legal tax shelters for their employees, the employer shall adopt the retirement plan for the exclusive benefit of its employees. A lawful use of a 401k is to provide a way for employees to save funds for their retirement. After the plan is adopted, the administrator chooses investments which the employees can choose to invest their savings. With regard to a ROBS transaction, the 401k is being used to shelter income for taxpayers who want to start a business or capitalize an existing business. In this scenario, the 401k is not being used as a way for employees to save money for retirement but as means to capitalize a business.

The Department of Labor and the IRS are currently examining ROBS transactions and have targeted these transactions for review. The IRS Memorandum referenced-above has declared that ROBS transactions “may violate law in several regards.” The IRS has noted that each transaction will be reviewed on a case by case basis as opposed to issuing a blanket letter indicating that all of these transactions are legal. If you have engaged in a ROBS transaction, time is of the essence to contact an experienced attorney to have the transaction reviewed to determine if there have been any violations of federal law. If so, these violations can typically be corrected. If you take steps to correct any violations before the Department of Labor and the IRS begin to investigate your transaction, you can take advantage of the Department of Labor and IRS correction programs.

Once an investigation into your ROBS transaction has begun, you cannot take advantage of their correction programs. If an investigation begins and violations of federal law have been found, the taxpayer can be subject to their entire 401k being taxed, excise taxes, back taxes, penalties, and any other taxes that your ROBS transaction incurred. Moreover, the taxpayer may have a civil lawsuit against any individual or firm who assisted and counseled the taxpayer with regard to the ROBS transaction.

U.S. Energy Policy, Intangible Drilling Costs (IDCs) and Income Tax Deductions

Since 1913, the intangible drilling costs (IDC) tax deduction has allowed oil and gas companies to obtain capital for the huge risk of exploring and developing new locations of oil and gas. This tax deduction is critical when it comes to providing an incentive for oil and natural gas companies to continue to explore and develop new sites for oil and gas. For tax purposes, IDCs get special treatment. Usually, costs that benefit periods in the future must be capitalized and recovered over those periods as opposed to being expensed in the period they are realized.

Under the special rules, an operator or working owner can either expense or capitalize these costs if they pay for or incur IDCs in association with the exploration and development of gas or oil on property located in the U.S. IDCs include all payments made by an operator or working owner for wages, fuel, repairs, hauling, supplies, drilling or development work done by contractors under any contract which is necessary for the drilling of a well including drilling, shooting, cleaning, clearing, roads, surveying, geological work, and in the construction of tanks, pipelines, and any other physical structure necessary for the drilling and preparation of the well which are incidental and necessary to the drilling and preparation of a well for oil and gas.

If elected to expense these items, the owner or working operator deducts the amounts of the IDCs as an expense in the taxable year the cost is paid or incurred. If IDCs are not expensed but capitalized, they can be recovered via depreciation. If the well is dry, the IDCs can be deducted.

The ability to expense IDCs is critical for the exploration and development of new sources of oil and gas. Natural gas and oil is a key component with respect to U.S. demand for sources of energy. Currently the Obama Administration wants to repeal the expensing of IDCs.

This could crush the domestic U.S. oil and gas industry.

There would no longer be any incentive for small to medium sized oil and gas companies in the U.S. to explore and develop new wells. Moreover, the repeal would essentially wipe out millions U.S. jobs associated with this industry at a time when many state governments are bankrupt, unemployment levels are high and revenues for state governments and the federal government are declining.

In addition, some estimates have indicated that a repeal of IDCs could wipe out $3 billion of U.S. business investments in oil and gas development and exploration at a time when the U.S. needs these types of investments. Moreover, a repeal of IDCs would destroy corporate financial value which would directly impact securities such as mutual funds as well as 401(k) plans or other retirement plans.

There is no doubt that America must develop alternative sources of energy including renewable sources but oil and gas remains a key ingredient for the U.S. energy policy including national security. Repealing the tax benefit for IDCs would put a significant dent in America’s security and ability to compete in a global economy during a severe economic downturn which does not appear to be showing any signs of quick recovery.

ERISA, FEHBA, Medicare (CMS) and Personal Injury claims

Whether you are a plaintiff or defendant with regard to a personal injury claim, it is important to determine whether there are any issues with respect to ERISA, FEHBA and Medicare.

Employee Retirement Income Security Act of 1974 (ERISA)is federal law which establishes minimum standards for pension plans in private industry and includes extensive rules with regard to federal income tax effects of transactions associated with employee benefit plans. Congress established this law with the intent to protect the interests of participants in employee benefits plans and their beneficiaries by requiring financial disclosure to them, establishing fiduciary duties with respect to the plans and allowing access to federal courts to obtain remedies. ERISA addresses pension plans in detail but also effects health care plans. Thus, ERISA applies to all employee welfare benefit plans offered by private sector employers or unions whether offered through insurance or a self-funded arrangement. ERISA’s preemption clause states that ERISA “shall supersede any and all state laws insofar as they relate to any employee benefit plan” which would include a health care plan.

Under an ERISA plan such as a self-funded health and welfare fund, i.e. union health insurance, a plaintiff can recover benefits due under the terms of the plan, enforce rights under the plan and receive a clarification of rights to future benefits under a plan. These health care plans outline when a participant must repay them. These plans typically include language such as when “you or your Dependent achieve any recovery whatsoever, through a legal action or settlement in connection with any sickness or injury alleged to have been caused by a third-party, regardless of whether or not some or all of the amount recovered was specifically for medicalor dental expenses for which Plan benefits were paid.” Moreover, it is not uncommon for the ERISA plan fiduciaries to require a beneficiary to sign additional documents before making any payment to a health care provider with respect to medical care for alleged injuries from a personal injury claim. These additional documents typically contain language which includes “I understand that the Fund must be reimbursed for medical benefits or for any benefits paid as a result of an injury or illness if any recovery is made for that injury or illness.” For example, a plaintiff in a state claim may have health insurance through a self-funded health and welfare fund. Continue reading »

Toyota: Business Decisions Based on Economics, the Law and Ethics

Recently, Toyota executives were hauled before Congress to explain growing questions regarding quality and safety issues for their vehicles. Within the last three months, Toyota has recalled over 8 million cars worldwide for gas pedal accelerator problems in several models and break pedal issues with regard to the 2010 hybrid Prius. Moreover, the car manufacturer announced a voluntary safety recall for 8,000, 2010 Tacomas to inspect the front drive shaft. Businesses, such as Toyota, are economic organizations which are required to operate pursuant to certain laws. Moreover, businesses have a fiduciary duty to attempt to produce as much profit as possible in order to create value for their shareholders while staying within the law. On the flip side, businesses have a fiduciary to refrain from destroying shareholder value. Therefore, economics and the law are critical when it comes to making business decisions. A view that economics and the law are the only key aspects with regard to making business decisions can be toxic. The relationship of ethics to economics and the law is complicated but crucial when making business decisions.

With respect to economics, the sole choice is to maximize profits to create shareholder value. Firms attempt to maximize output for the least amount of input which can lead to deficiencies in quality, safety and reliability. In addition to economic issues, quality, safety and reliability also create shareholder value, which assist in the process of increasing profits. Ethics considers many other kinds of reasons outside of economics including rights, justice and non-economic issues such as social issues. With respect to the law, businesses must operate within a certain framework in order to remain in business. Some believe that the law operates within pubic life while ethics operates solely within private life. Laws are clearly defined and necessary to establish a common framework for a level playing field for all entities. Meanwhile, many believe ethics are personal ideas which tend to reveal how a person operates their life. Laws are not enough when it comes to making business decisions. It can be extremely dangerous when business executives only consider economics and the law when making business decisions; especially, when the product in question is a motor vehicle which can injure or kill a person even when there is no operator error. One reason why a business manager should not be making business decisions based solely on the law is because not everything that is considered to be immoral is illegal under the law.

Every dangerous product can be made at a cheaper cost which can ultimately impact quality and safety. Therefore, manufacturers of dangerous products have an ethical duty to ensure product safety; especially, if they built their reputation on quality, reliability and safety such as Toyota has done. In order to keep their reputation Toyota has to be able to walk the talk.

Recently, Toyota executives announced that their current problems were a direct result of the company growing to big to fast. Over the last several years, Toyota knew American car manufacturers were vulnerable. Toyota sensed a prime opportunity to grab market share to increase overall revenue and value for their shareholders. In order to do this, Toyota had to quickly increase production which resulted in a worldwide expansion. Prior to the massive global expansion, Toyota would try to minimize quality issues by not building a new vehicle in a new building with new labor. In the mid part of this century, Toyota was building new vehicles in new buildings with new labor which resulted in quality control issues. It appears Toyota had sacrificed some of their own principles with respect to quality, safety and reliability to grow revenues. The growing too big too fast excuse can easily be interpreted as though Toyota sacrificed quality, safety and reliability (ethical standards) for economic issues such as growth or essentially market share and revenue.

So did Toyota make business decisions on how to grow the firm based solely on economic and legal issues? Regarding economics, Toyota noticed the competition was having problems so that moved into rapid expansion which generated more worldwide sales, i.e. increasing overall revenue. Regarding the law, Toyota may have performed a cost benefit analysis to compare overall profit to the cost of recalls and personal injury or class action lawsuits whereby they chose overall revenue. Whatever the case may be, Toyota clearly left behind some of their core beliefs and values with regard to manufacturing processes when they decided to rapidly expand the company. Although, Toyota does deserve some credit for announcing a production shut down along with recalls even if Toyota was experiencing quality issues in 2006 and 2007 with respect to gas pedals in at least one of their vehicles. Going forward, Toyota would be best served to refrain from making business decisions solely based on economics, laws or a combination of both if they truly want to be a world leader in quality, safety and reliability and avoid being associated with the Pinto or other quality and reliability issues which played a significant role in the downfall of the American car industry over the last twenty years.

A Primer — Legal Considerations When Raising Capital From Individuals

On occasion, entrepreneurs seek to raise capital from individual investors. But whenever an entrepreneur sells an interest in his company, whether it is common stock (equity/ownership) or notes (debt) or any other investment, that interest is a security, and the securities laws apply, even if he is offering only to FF & F (family, friends and fools).

Federal law and the law of all but two or three states, separately, include securities laws which must be complied with when making requests for investments. However, all those laws, as a class, have some common general principles.

First, every offering of a security must either be registered under both federal and state law, and an exemption from federal law, and the law of every state where any investor resides, must be available and provable by the entrepreneur. To prove that an entrepreneur is liable, an investor only needs to show that he was sold investments in the company, and that the company did not register the sale with both the federal government and with the state where he resides. And registration is almost always impossible for entrepreneurs. Therefore, the entrepreneur must prove he has exemptions under federal and all the relevant state laws.

General Principles for an Offering to be Exempt: Both federal and almost all state laws have their own securities exemption requirements. They usually fall into common categories. For an offering to be exempt, the federal law and/or laws of almost all states:

1. Require smallness! The company must place limits on the number:
   a. of persons who purchase shares;
   b. sometimes, of persons contacted.
2. Require the company to have reasonable grounds to believe, before it contacts a prospect, that the prospect is wealthy and investment-sophisticated (“suitability”).
3. Forbid “general solicitation,” i.e., advertising, mass mailings, large group meetings, telephone campaigns, etc.

In addition to these restrictions, both the federal government and almost every state have additional requirements and filings which are unique to them.

Is a Private Placement Memorandum (“PPM”) Required? To meet the requirements for an exemption, if raising less than $1,000,000 in a twelve month period, a PPM is generally not required to meet exemption requirements. However, if the entrepreneur seeks to raise more money and to do so from any unaccredited investors (this usually means persons with less than $1,000,000 net worth) a PPM is required and it must meet specific, sometimes expensive, requirements.

However, even if a PPM is not required to qualify for an exemption, the offering entrepreneur must be able to show that he has told the investor everything which the investor reasonably needs to know in making his investment (in order to meet the “anti-fraud” securities law requirements. Therefore, it is best to have a disclosure document for all offerings in order to establish that the company has informed all offerees of all material risks. Frequently this need not be a long, involved document, and may consist largely of materials which already exist, such as financial statements, descriptions of the company, etc.