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FTC’s Strict New Guidelines for Digital Advertising

Posted on Mar 30th, 2013

On March 12, 2013 the Federal Trade Commission (FTC) released new guidelines covering digital advertising. They are stricter for advertisers and call for digital marketers to review their current practices for compliance.

The original guidelines from 2000 merely demanded that disclosures be in close “proximity” to ads whereas the new guidelines must be “as close as possible,” clear and conspicuous, and hyperlinked only when their meaning is easily understood by consumers. These changes are largely the result of mobile and social media advertising.

The impact is important for digital marketers to understand. The FTC explains in the guidelines that tweets with the hashtag “#Sponsored” are probably acceptable as this is would be easily understood by consumers to be an ad. However, the FTC distinguishes the example tweet “#spon” and says it is probably not acceptable and possibly deceptive.

The FTC also addressed the problems presented by digital advertising on mobile devices. The new guidelines point out that many platforms may not be appropriate for digital advertising based on their incapability of the kinds of conspicuous disclosures now mandated by the FTC. For example, the FTC advises against the use of Flash media now for digital advertising.

The new guidelines specifically address disclosures within social media and mobile platforms. The FTC makes clear that “space-constrained” platforms (like Twitter, for example) are not exempt from the disclosure rules. In fact, the FTC recommends that advertisers actually make their disclosures within the ads despite the lack of space. If they are linked, they must be linked conspicuously. The Guidelines also advise that ads be mobile-optimized, to avoid the problem of ads with clear and conspicuous disclosures on a regular-sized screen becoming ambiguous on a mobile screen or requiring scrolling. Pop ups are also discouraged, since so many people use blockers or simply disregard them completely.

The takeaway here is that digital advertisers need to ensure their compliance with the new guidelines. Mobile optimization and better social media advertising are good business anyway, but the FTC will be making sure that marketers toe the line.

If you have any questions about this topic, please feel free to email us.


ZIP Codes Constitute “Personal Identification Information” According to Recent Massachusetts Supreme Judicial Court Holding

Posted on Mar 27th, 2013

Overview

On March 11, 2013, the Massachusetts Supreme Judicial Court (SJC) followed courts in California* and many other jurisdictions, holding that ZIP Codes constitute personal identification information (PII). While this cases arises in the context of point of sale data collection by off-line brick and mortar retailer, the implications for this are significant for offline and online companies engaged in any collection of data from their customers and end users.

Case Summary

This case arises from the common practice by retailers of collecting customers’ zip codes at the time of purchases. Mass. General Laws Section 105(a) prohibits any business from recording or demanding that a credit card holder write “personal identification information, not required by the credit card issuer, on the credit card transaction form.” The PII contemplated in the section includes address and telephone number as they are explicitly listed but it also states that those are not the only PII it refers to. Any violation of Section 105(a) is considered to be “an unfair and deceptive trade practice” which means it is also in violation of Massachusetts General Laws, chapter 93A, section 2. 93A allows a plaintiff to claim treble damages and attorney’s fees, which can significantly up the ante in the event of potential violation.

The Tyler case was filed after the similar Pineda decision from California (see below) and was based on a complainant’s argument that she provided her ZIP Code to defendant Michael’s over the course of a year believing she had to in order to make her purchases. The plaintiff also alleged that Michael’s employees recorded her ZIP code information in an electronic transaction form and that Michaels was then able to get her address and phone number from commercial databases using her name and ZIP Code to send her unwanted, unsolicited marketing materials. The plaintiffs asserted that this was tantamount to writing PII on a credit card transaction form. Ergo, according to Massachusetts law, the practice should be considered a deceptive or unfair trade practice. Michaels moved to dismiss.

The district court agreed that ZIP codes are PII and that Section 105(a) may apply to the Michaels electronic credit card transaction forms. However, the district court dismissed because it found that, absent identity theft, there was no cognizable injury stated by the plaintiffs under chapter 93A of the General Laws. Thus, the district posed the following three questions to the SJC to answer under Massachusetts law:

(1) Do ZIP Codes constitute personal identification information (PII); (2) Absent identity fraud, can a violation of the Massachusetts General Laws, chapter 93, section 105(a) give rise to an action concerning PII; and (3) Third, does the phrase “credit card transaction form” covers both electronic and paper transaction forms equally. These three questions originated within a class action lawsuit citing violation of Section 105(a) on the part of Michaels who had allegedly asked for and stored customers’ credit cards’ ZIP codes.

The Court first clarified that “based on the text, title and caption, and legislative history of § 105,” the purpose of the statute was not in fact to protect against identity theft; rather, this section’s purpose is to protect consumer privacy with regard to credit card transactions. Because ZIP codes could allow other PII about consumers to be discovered using public databases (PII like addresses and phone numbers) the court reasoned that ZIP codes must also be PII. The court further observed that Section 105(a) is not specifically limited to identity theft and thus refused to limit it in this way. Finally, the statute explicitly states that it applies to “all credit card transactions”, so the court found that electronic credit card transaction forms would be included within its purview.

Impact of Tyler

It is possible that, as with the older Pineda case, the Tyler case might lead to additional class action lawsuits. In any event, given the Massachusetts SJC’s strong stand on consumer rights in Tyler, businesspeople and retailers (local or national) doing business in the Commonwealth of Massachusetts should re-evaluate their own practices to make certain they are in compliance with Section 105(a). This practice should also be taking place in the other states that have similar laws on the books.

It is possible, within the confines of Tyler, that collecting this kind of information for internal use only, and not for marketing or to sell or make a profit on the information, might not give rise to enough of an actual “harm” to support a cause of action. Any plaintiff still must prove an actual injury to some extent. Still, the decision makes collecting information beyond what is required by credit card issuers risky.

* (For a related case see the California Supreme Court decision Pineda v. Williams-Sonoma Stores which also holds that ZIP codes are personal identification information according to California’s Song-Beverly Credit Card Act, Civil Code section 1747.08. In excess of 15 states, Massachusetts and California among them, have laws that regulate the type of customer personal identification information that retailers may legally collect and store.)

If you have any questions about this topic, please feel free to email us.


Some Thoughts on Convertible Notes vs. Straight Equity

Posted on Mar 15th, 2013

In today’s early stage fundraising market, most seed investments come in several flavors: common stock, convertible notes (or “converts” as they are sometimes called) and a simple preferred stock investment. There are a lot of interesting posts on this topic on Quora and elsewhere so we thought that we would provide our take.

Common Stock

If you are looking for a simple and inexpensive process and you are raising a small amount of money ($250,000 or less), common stock may be a good choice. The documentation can be very simple – a short subscription agreement (with an investor questionnaire), shareholder agreement, stock certificates and you may be done. Typical terms include basic information rights, rights of first refusal and co-sale (or tag along) rights and a pro-rata right to participate in the next round of financing of the Company. From the company’s standpoint, it is generally a good idea to keep these deals as simple as possible, both to keep costs down and to avoid a complicated structure that could impact future investment rounds. If the company is an S-corporation, a common stock round (assuming all investors are eligible S-corp shareholders) also helps the company to keep its S-corp status, which can create tax benefits for active investors and founder shareholders.

The downside of an early common stock round is that it can lock the company into a fixed valuation that has not been really tested by the market. If the valuation is set too high, it will be difficult for the company to issue cheap stock and options. Since this is often a key attraction in joining a company at an early stage before they raise a larger capital round, an excessively high valuation could prejudice the company in attracting key talent at this formative stage. Another downside to a fixed price is that follow-on investors may challenge the valuation that was reached and try to impose a lower valuation—a down round—later. This potentially puts the company in the awkward position of mediating between the original investors and the new money. The original investors, of course, put their money in at a higher risk and may insist on their negotiated deal. The new money may want to pay less and thereby substantially dilute the original seed investors. Unlike a preferred stock or convertible note structure, common stock usually does not offer a simple price protection (like a weighted average broad based anti-dilution adjustment).

If the common stock value is too low, it may be unfair to the founders and key employees. This issue may take awhile to germinate, but by the first or second venture round, there may be pressure from management and the new investors to try to “reshuffle the deck” to get the key players more of a stake in the Company’s long term outcome.

Convertible Notes

There a lot of variations on this deal structure. Over the last several years, the most prevalent terms include an unsecured note carrying a 24-36 month term, interest ranging from 5-10%, and a conversion price based on the next “Qualifying Financing” of the Company (usually $1-2MM of new money). The conversion price is now often subject to two outside conditions that help reduce some of the uncertainty of the valuation of the Qualified Financing by subjecting it to a cap and a discount of the price in that round. The cap can range from $1-2MM on low end (considered low) to $7-8MM on the higher end (this range is usually seen where the Company already has some traction or where the founders are known players and therefore able to command better terms). The discount ranges from zero to 30%, usually being in the realm of 10-20%. Similar to common stock terms, investors usually get basic information rights and pro-rata participation rights for the company’s next financing round.

The documentation for these deals also tends to be pretty light, and while a bit more than the common stock offering, a lot less than a preferred stock investment. Typical documents involve a subscription or purchase agreement and some form of convertible note. Deals can also include warrants, although this seems a bit less common in today’s market. Similar to a common stock round, these deals can be closed quickly and cost-efficiently.

Like the common stock deals, a downside of convertible notes for the company can arise at the time of the next round, if the new investors see the terms as being too rich and do not want the old investors converting into the same security as them, and at a lower price. This issue has caused many sophisticated investors to opt for more set terms on valuation, resulting in the recent popularity of preferred seed rounds, discussed below.

Series Seed or Series A-1 Lite Preferred Stock

Because preferred stock investments are significantly more complicated to close than the other deal formats, a number of national law firms and investor syndicates have tried to develop a simple set of deal documents to make this structure more attractive. (See Fenwick & West Series Seed Docs for example.) While we commend these authors for trying to establish an open-source library to streamline this process and reduce expenses, these documents are basically a watered down version of other more comprehensive VC form documents, such as the NVCA Model Documents, and leave a lot of details out that could be material. For a small amount of investment — $500,000 or less — it would seem hard to justify this structure. Also, if the Company is an S-corp, it will automatically blow the Company’s S-corp election, something that may be better delayed until the investment amount is substantial and merits losing the single-tax structure. The creators behind the Series Seed argue that those documents can be just as fast and cost-effective as convertible notes, with the added benefits of giving “investors more clear definition around rights, more stability and less potential squabbling in the next round.”

The bottom line is that no structure is perfect and there are tradeoffs for all of the parties involved. While there are lots of free (and freemium) resources available to help educate entrepreneurs on these issues, experienced counsel should be sought to help document any transaction and ensure that it is done properly. All of these structures are designed to be cost efficient, to reduce the inevitable temptation for clients to do it themselves, and to allow folks with little or no money to establish the right foundation for their investment that will facilitate their growth and future investment potential.

If you have any questions about this topic, please email us.


Delaware Court of Chancery Holds that a Reverse Triangular Merger is not a Transfer or Assignment by Operation of Law

Posted on Mar 13th, 2013

 

Last month the Delaware Chancery Court allayed the concerns of corporate transactional lawyers by ruling under Delaware law that a reverse triangular merger (RTM) does not constitute a transfer or assignment by operation of law. The decision, Meso Scale Diagnostics, v. Roche Diagnostics, C.A. No. 5589-VCP (Del. Ch. 2013), involved a restriction on assignments and transfers in a license agreement, which the Court held as a matter of law was not triggered by the RTM.

In brief, a reverse triangular merger structure involves a merger of a selling company (Target) with a subsidiary of the buyer company (Buyer), which is often a special purpose entity created just for the transaction. The transaction is referred to as a “reverse” type of merger because the acquired entity here ends up being the surviving entity in the merger and becomes a subsidiary of the Buyer. This structure is desirable because it resembles a stock acquisition in its final result, but has the added advantages of (1) requiring less than unanimous approval from the Target’s stockholders and (2) allows for more flexibility than a stock swap under the tax laws relating to what are called “tax free” reorganizations.

For years, corporate lawyers have taken the position that a RTM does not trigger anti-assignment provisions in contracts. That’s because in this structure, just like in a stock acquisition, no contracts are being assigned or transferred per se. The acquired entity remains in place and the only change is that its stockholders before the deal have been replaced with a single stockholder, which is either the Buyer or one of its subsidiaries. However, starting with a somewhat obscure 1991 California court decision involving Oracle, there has been a growing national trend of courts calling this line of reasoning into question. The Oracle court reasoned that a change of stock ownership in a target was a change of its legal form, which resulted in an impermissible transfer of intellectual property rights. Most recently, an earlier Chancery Court decision in 2011 in this same case created ambiguity under Delaware law – previously thought to be safe territory by most Delaware practitioners – by refusing to dismiss the case based on the stock acquisition cases cited by the defendants.

The recent Meso Scale holdings resolve these issues. The Chancery Court rejected the Oracle decision as persuasive authority on this issue. The Court reasoned that the California court’s holding that a RTM constitutes an assignment by operation of law conflicts with Delaware’s jurisprudence regarding stock acquisitions. This is because Delaware courts have consistently found over time that when a corporation lawfully acquires the ownership of another corporation and with it the corporation’s stock, this change of ownership does not imply any assignment of the contractual rights of the corporation whose securities the buying corporation purchased. Therefore, the Court of Chancery held that because both stock acquisitions and RTMs are changes in legal ownership, and not in the underlying interest of that entity, they should produce parallel legal results.

The lessons from this case are two-fold:

1.   For contracts governed by Delaware law, parties can continue to rely on stock acquisitions and RTMs as a structure where third party consents should not be required to a “transfer” or “assignment” type of contractual clause. For contracts governed outside Delaware, such as in California, the doubt still remains, so it may be prudent to get the third party consent for those contracts just in case.

2.   For Delaware-governed contracts, parties that want the right to consent to a RTM (or other similar transaction) should include a “change of control” provision in their contracts. While this is common in more complex agreements, such as financing agreements and real estate leases, commercial agreements such as software license agreements and customer and vendor contracts generally do not go to this level of drafting.

If you have any questions about this topic, please feel free to email us.