State Blue Sky Laws Not Preempted by NASIMA if Securities Offering does not Actually Qualify for Registration Exemption

In Brown v. Earthboard Sports USA, Inc., the Sixth Circuit Court of Appeals held that securities offerings must actually qualify for a valid federal securities registration exemption in order to enjoy National Securities Markets Improvement Act of 1996 preemption over state blue-sky laws. 2007 US App. LEXIS 6007 (2007).

Earthboard filed for an exemption to federal securities registration pursuant to the Rule 506 of Regulation D limited private placement exemption for 1999; however, it continued to sell subscriptions from 1999 through 2003. Jeffrey Vaughn, a Lincoln Financial Advisor investment advisor, met with Earthboard President Jeffreys -- who was a convicted felon (on a previous fraud charge). Jeffreys told Vaughn that Earthbound was in acquisition negotiations with VANS, a publicly-traded footwear company.

According to the terms of the deal, one share of Earthboard's securities would be exchanged for one share of VANS when the transaction finally closed. At that time, VANS shares were trading at about $12, but Jeffreys offered his company's shares to Vaughn for just $1 apiece.

Vaughn initially purchased $228,000 worth of Earthboard shares and then he purchased several hundred thousand additional shares after inducing some of his friends and acquaintances to invest in Earthboard.

Vaughn introduced Brown, a wealthy prospective client, to Jeffreys and Brown ended up investing in Earthboard. Brown signed the subscription agreement, but he was not provided with the private placement memorandum.

Vaughn then faxed Brown a series of "press releases" from Earthboard that discussed the VANS acquisition and Vaughn and Brown purchased additional Earthboard subscriptions.

Time passed, but the fictitious transaction never closed, and it was finally revealed that the whole scheme was fraudulent.

Brown sued naming Jeffreys, Earthboard, Vaughn, and Lincoln Financial Advisors as defendants. The Federal District Court held Jeffreys and Earthboard jointly and severally liable for the amount that Brown invested, but it dismissed the claims against Vaughn and Lincoln Financial Advisors.

The Sixth Circiut Court of Appeals reversed the lower court's dismissal of Brown's claims against Vaughn (but not against Lincoln Financial Advisors), because the securities were not "covered" becuase they did not actually qualify for a valid federal securities registration exemption and, thus, they were not afforded NASIMA preemption over state blue-sky laws.

Asset Protection: Employment Taxes & LLCs

The Limited Liability Company (LLC) is a flexible legal entity that allows taxpayers to elect how they want to account for their state and federal tax liabilities. Unfortunately many taxpayers do not understand issues surrounding whether they should use the LLC and in what form to achieve their tax and asset protection goals. This article will briefly discuss one issue in this analysis, namely employment or payroll tax liabilities.

The IRS regards a single member LLC (i.e, a LLC owned by one individual or entity) as not being a separate taxable entity distinct from the owner, unless the owner opts to have the LLC treated as a corporation for tax purposes. As a disregarded entity the sole owner of the LLC can simply account for the profits and losses of the LLC on the taxpayer’s personal tax returns (on the taxpayer’s Schedule C).

It is the sole owner of a single member LLC that is personally responsible for employment taxes related to the LLC’s employees. The IRS has the ability to impose a lien or levy or seize the sole owner’s personal assets if the LLC’s employment taxes are not paid, but the IRS cannot levy or seize the LLC’s assets to satisfy this type of liability. This is true regardless of whether the sole owner elected to use his or her name and social security number for the LLC tax reporting or if the sole owner elected to use the LLC name and a separate taxpayer identification number for the LLC tax reporting.

The result for the multi-member LLC (i.e., a LLC owned by more than one individual or entity) may be different depending on the applicable state law. If the state law provides that members of LLC’s are not liable for LLC debts then the IRS’s recourse with regard to the LLC’s unpaid employment taxes lies with the LLC and not with the member owner.

For the most part businesses are started with the aim of making a profit. The thought of incurring a loss is often not planned for in the business formation or start up process. As such, this type of employment tax issue typically does not arise until after the LLC is facing financial difficulties. In these cases the LLC may be unable to meet its state and federal employment tax obligations. If the LLC employment taxes are not timely remitted, the question is whether the state and federal government may collect the employment tax liability from the LLC or the LLC owner or owners.

This issue is most important for LLC’s that employ a number of employees and/or that employ highly paid service employees. In these cases the LLC owners with little or no assets and no expectation of having significant assets or whose only significant assets are those used in their trade or business (e.g., a mechanic whose only assets are his or her tools) may prefer that the IRS pursue him or her individually for the LLC’s employment tax obligations. On the other hand, the financially well off LLC owner may prefer that the IRS only be able to pursue the LLC for the LLC’s employment tax liabilities.

Given this dichotomy it may make sense for single member LLC owners to convert their single member LLCs into multi-member LLCs or to elect to have the LLC be taxed as a corporation once the LLC has achieved some measure of financial success. Of course, the business owner must also consider other tax factors, such as the trust fund recovery penalty and the role of self-employment taxes.

Court Finds No Breach Fiduciary Duty Where Director Has Conflict of Interest

In Kim v. Grover C. Coors Trust the Colorado Court of Appeals upheld a conflicting interest transaction by a corporate director who was also a controlling shareholder. 2007 Colo. App. LEXIS 394.

Jeffrey H. Coors was CEO and the controlling shareholder for Graphic Packaging International Corp., Inc. (GPK). GPK sought to acquire the assets of Fort James Corporation. GPK entered into a credit agreement which required it to pay back $ 525 million of its debt in one year or less.

GPK planned on using the proceeds from the sale of a mill that it also owned to satisfy this obligation; however, the mill sale fell through. GPK then decided to raise revenue to comply with the credit agreement by selling 1,000,000 shares of convertible preferred stock to the Grover C. Coors Trust for $ 100 million. Jeffrey Coors was a trustee of the Trust.

Kim, owner of GPK common shares, filed suit to rescind the sale due to the directors breaching their fiduciary duties in approving the transaction.

The court noted that the “Colorado's corporation code provides that a conflicting interest transaction will not be void or voidable or be enjoined, set aside, or give rise to an award of damages or other sanctions in a shareholder proceeding if the transaction is fair as to the corporation.”

The court balanced the facts and determined that the conflicting interest transaction was fair to the corporation.