Month: July 2017

Ziyen Inc- Another Reg. A+ Question Mark

Investors, Issuers, Law , , ,

I have written several articles about specific Reg. A+ offerings. These offerings are targeted at small investors who are ill-equipped to judge their value as an investment, let alone, the accuracy of the disclosures.

I recently got a call from a colleague who works at a reputable brokerage firm.  He suggested that I look at the Reg. A+ offering of a company called Ziyen Inc.  He thought that it might be the grist for a blog article. He was not wrong.

Ziyen Inc. was incorporated in April 2016 to provide a suite of “cutting edge digital business intelligence, marketing and software services.”  By business intelligence it means information about available government procurement contracts, initially in Iraq and eventually globally.

The offering circular states: “Ziyen currently operates the B2B Procurement Portals “Rebuilding Iraq.net” and “Cable Contracts.net”.  “Rebuilding Iraq is our first B2B Procurement Portal, and the flagship service for the company. We are currently the number one international source for information on tenders, contracts, news and marketing services in Iraq.”

As far as I can tell, Rebuilding Iraq.net lists tenders for contracts that might be found elsewhere and does not charge for the information. It claims that 200,000 people visit the site every month.  When I checked Cable Contracts.net, which does charge for usage on a monthly subscription basis, I did not find any tenders listed. According to the financial statements in the offering circular the company has no revenue and roughly $7000 in the bank.

The company is selling up to 64,000,000 shares at $.25 per share. It is self-underwriting, meaning that there is no brokerage firm involved or even an established crowdfunding platform.  The offering circular mentions two crowdfunding platforms by name and the subscription agreement mentions a third, but I could not find this offering on any of them.

It appears that shares are being sold directly from the company website. The website actually uses shopping carts into which you can put a bundle of shares and check out using a credit card. And before you say that the shares are only $.25 a piece, the bundles go up to $25,000 so this is a serious offering of securities.

The subscription agreement also mentions an escrow agent where investors can deposit their funds, except that no escrow agent is being used.  According to the offering circular, “Subscription amounts received by the Company will be deposited in the Company’s general bank account, and upon acceptance of the subscription by the Company, the funds will be available for the Company’s use.”

No competent securities attorney would permit these types of inconsistencies. In truth, it appears that no competent securities attorney was involved in the preparation of this offering.  None is disclosed and no funds are allocated to pay an attorney to prepare the offering or deal with the Securities and Exchange Commission’s Division of Corporate Finance which reviewed it.

It appears the offering was prepared by the company’s principal, Alastair Caithness, a Scottish-American businessman.  You can tell he wrote the offering circular because he refers to himself in the first person – “I was Head of Sales in a company in the UK” although he never discloses the name of that company.

The offering circular also obliquely refers to other employees and a Board of Directors, none of whom are named. The Company does business in Iraq and for all you know the Company might have people on its Board of Directors whom the US government might not look upon favorably.

I did find six other Board members on the Company’s website, but their backgrounds were short on the type of detail I would have expected to see in an offering circular. The disclosures give incomplete employment histories and several fail to disclose where they were educated.  Nothing negative was disclosed about any of them and I am not suggesting that there was anything negative to disclose. I am only questioning whether Mr. Caithness would have known what disclosures the rules required.

For a little perspective, back in the late 1970s when I was writing registration statements I took some flak from the Division of Corporate Finance because one of the executives at an issuer had claimed to have a Bachelor’s degree and did not. It seems he got his draft notice right before his senior year final exams and decided that graduating was not that important. When he took the job at the company years later his resume said that he had graduated and no one had ever checked. The Division of Corporate Finance told me at the time that was a misstatement of a material fact.

I must have missed the memo where they subsequently decided that not disclosing the names of the members of the Board of Directors in an offering circular was not an omission of a material fact.  Nowhere in the offering circular does it suggest that investors should review every page of the company’s website or every subsequent press release.

The offering circular is dated mid-October of 2016. In mid-April 2017, the Company announced separately that it had established a “new investment division in the company to focus on financing unfunded construction projects in Iraq”.  It claimed to have “the capabilities to provide the finance for long-term projects.”  Financing for long-term projects?  According to the offering circular the company has $7000 in cash in the bank.

In June 2017, the Company announced that Ziyen Energy, a division of Ziyen Inc., had just secured over $36 million dollars of oil reserves in Indiana in the United States.  The deal includes 7 existing oil producing wells worth over $6 million dollars of proven reserves along with a support water injection well and a water producing well for injection purposes with a further potential for 20 new oil producers on undeveloped reserves on the site worth over $30 million.

That would certainly be big news, except the offering circular does not mention Ziyen Energy nor any intention to be in the oil production business, much less in the oil production business in the US. If you were to download and review the offering circular today you would have no idea you were investing in an oil company. Even if you tracked down the press release, it does not disclose how much the company paid for these reserves, whether they were financed, how much the wells are producing or if contracts are in place to sell the production.

As I was researching this article I was prepared to give Mr. Caithness the benefit of the doubt. I thought he was just a businessman trying to raise some money for his own company on the cheap, i.e. without hiring a competent securities attorney.

Then I found this offering on a crowdfunding platform that specializes in Reg. A+ offerings called Wall Street Capital Investment. It is owned by Mr. Caithness who holds himself as an expert and offers to help raise money for others.

Ziyen Inc. is actually the second offering on that platform. The first is a company called Novea Inc. which shares the same address in Cheyenne, Wyoming as Ziyen. (Mr. Caithness is actually in California and presumably operates Ziyen from there. I have no reason to believe that Novea is actually in Cheyenne either.) The offering circulars for the two are remarkably similar and no attorney was apparently paid to prepare the Novea offering either.

Novea Inc. also has neither revenue nor cash in the bank and is in the business of offering warranties that “disrupt” the warranty industry.  One of its largest shareholders is Mr. Carlos Arreola who is Mr. Caithness’ partner in Wall Street Capital Investment. As an aside, the advertising for both companies feature the same actor and the marketing plan and press releases are also very similar.

I also suspect that this is about more than just saving some money on legal fees. Had Mr. Caithness come to me I would have suggested that he raise his funds through a Reg. D offering to accredited investors. He would have spent about the same as he anticipated (the offering budgets $20,000 for crowdfunding and related expenses) whereas the average cost of a Reg. A+ offering is in the neighborhood of $150,000 and much of that is for the lawyers.

Personally I think this offering might have been difficult to sell to accredited investors given that its business plan is weak. But if its Rebuilding Iraq.net website gets 200,000 views per month there would be a steady stream of non-accredited potential investors who are pre-disposed to the idea that Iraq needs rebuilding and might put a few shares in their shopping cart, even though they would actually be investing in a US domestic oil producer.

And that is really the point. Since there is neither a competent securities attorney nor broker/ dealer involved with this offering it is up to the individual investors to investigate this offering and make their own decision. No one has vetted this offering and no one can say whether every material fact is disclosed or accurate. The crowdfunding industry needs to stop deluding itself into thinking that small investors can actually perform due diligence.

Given the internal inconsistencies and inaccuracies, the failure to disclose the names of the Board of Directors and the fact that this was a DIY Reg. A+ offering I would have expected a little more scrutiny by the SEC’s Division of Corporate Finance before it was approved. But that no longer matters.

I know that about two dozen senior staffers at the SEC receive this blog through Linked-in, as do people at FINRA and the offices of state securities administrators in more than a dozen states. I know that people in a few Congressional offices that have oversight on the SEC and crowdfunding receive it as well. This one is a no-brainer.

From the company’s own press releases it is obvious that the information being disseminated to prospective investors in the offering circular does not reflect the current state of the company’s affairs. If a cease, desist and disclose order is not appropriate here, I cannot imagine that it will ever be appropriate anywhere.

I am older than most of my readers. I was around and litigated matters involving Stratton Oakmont and before them Blinder, Robinson and First Jersey Securities, so I think I have a pretty good idea of what a micro-cap fraud looks like. I was not certain that I was looking at one here until I got to the press release about the potential for 20 new producing oil wells. There have been quite a few micro-cap frauds involving oil stocks over the years. Mr. Caithness and his partner are registering a lot of their own stock. My gut tells me that there will be an enforcement action here sooner or later.

I am not a whistle blower. I know a lot of lawyers and others who are trying to navigate the Reg. A+ waters specifically because they believe that more companies need access to capital and that smaller offerings should be open to smaller investors. Their hard work will go for naught if the investors are drawn into scam after scam.

I am not the world’s biggest fan of government regulators. But if you want the fire department to show up and put out a fire, you need to scream FIRE at the top of your lungs. That is really all that I am trying to do.  I am optimistic that some securities regulator will hear me. There have already been far too many examples of fraudulent Reg. A+ offerings that the crowdfunding industry does not want to talk about.  Here is an opportunity for the SEC to re-enforce the need for compliance with the rules. Investors should be able to look at an offering circular and at the very least get accurate disclosures of all of the facts.

 

Classifying Crypto-Currency

Investors, Issuers, Law , ,

Is a Bitcoin a currency or a security?

This is a question that may interest only a small number of geeks and lawyers, but there is a lot of money already in the crypto-currency market and a lot more on the sidelines waiting to jump in if this question is answered satisfactorily.

The key concern is regulation especially if crypto-currencies are ruled to be securities. The securities markets are regulated in virtually every country and the penalties for issuing securities without following those regulations can be severe.

The history of crypto-currencies traces back to Bitcoins which were introduced in Japan in 2009. The coder who introduced them wanted Bitcoins to be considered to be a currency and used as such, hence the name “coins”.  Had he called them “Bitcode” many of the questions about what they are might never have been asked. At the same time much the market for Bitcoins might not have developed.

Part of the allure of crypto-currencies is the fact that some people see them as part of an alternative financial universe. These people seem to believe that crypto-currencies are part of a trend to replace traditional banks and banking.

Bitcoins store value and are a medium to exchange value,which are two prime attributes of currencies.  But having attributes of currencies does not make them currencies.  That point seems lost on many of the people who are insistent that Bitcoins and similar crypto-currencies are currencies. They are not.

Historically, most people who hated fiat currency preferred to use precious metals such as gold or silver for trade, although other commodities, most notably salt have been used over the centuries. But the simple fact is that fiat currencies work because they are almost universally accepted.

Proponents of crypto-currencies argue that they are becoming more and more accepted and that acceptance will increase.  But accepting crypto-currencies as an exchange of value will not make them currencies in the strictest sense. Salt, after all is just salt, no matter how it is used.

If we accept the fact that Bitcoins were mislabeled to give them the appearance that they were currency that is “mined” and kept in electronic “wallets” strictly is a marketing ploy we can free our thoughts for the real issue; are crypto-currencies a security?

The US Securities and Exchange Commission (SEC) has issued several Investor Alerts warning people to avoid investments and especially Ponzi Schemes that are funded by or which purchase Bitcoins and other crypto-currencies.  But the SEC has not come out and said the coins themselves are securities and that is significant.

The SEC has statutory jurisdiction over securities and the securities markets but not all investments are securities. Your home, for example, or other real estate can be a good investment, but is not a security. The same is true of gold bars or bullion; works of art or collectables and all commodities that trade on commodity exchanges.  All are investments, just not securities or the SEC’s problem.

I wrote a blog article about Bitcoins a few weeks back that got a lot more views than most of my articles because crypto-currency is a very hot topic. Several people forwarded legal opinions to me that specifically addressed the issue of whether or not crypto-currencies were a security.  Several of those legal opinions were written by excellent lawyers at excellent law firms. I was not really surprised to see that they reached opposite conclusions; some thought the coins were securities; some thought they were not.

Each of the opinions was interpreting one US Supreme Court case, SEC v. Howey, which basically defines a security as the “investment of money in a common enterprise with an expectation of profits predominantly from the efforts of others.” Law school students studying securities law spend a considerable amount of time with this case and later cases that applied it.  Any legal opinion asking the question “is this a security” will certainly review Howey and apply its reasoning to the facts at hand.

Personally, I do not think that the Howey test applies to crypto-currencies at all.

Let me take a step back and re-frame the question. If a crypto-currency is not a security, what is it?  I think that if a crypto-currency is clearly something other than a security, especially if it is something already regulated under different statutes, it should go a long way to settling the question. So what, exactly, are we dealing with?

Any crypto-currency is nothing more or less than multiple lines of computer code; a long string of ones and zeros.  Computer code is recognized by law as intellectual property which can be copyrighted and is covered by a substantial body of law both in the US and internationally. No one classifies computer code as a security.

The shares of Microsoft Corp. are a security, not the operating system that it sells. That distinction is why I believe that the coins themselves are not a security.

The last time that I heard so many securities lawyers asking the question “is this investment a security” was in the late 1970s.   At that time the marginal tax rate on the highest earners in the US was 50%-70%. If you earned over a certain amount you would pay one-half of the overage to the IRS.  Perhaps not surprisingly, there seemed to be a lot of doctors, business owners and entertainers with this problem.

An industry grew up to provide this group with a series of “tax sheltered” investments.  These transactions were intended to take advantage of IRS rules that provided tax credits and accelerated depreciation when certain physical items were purchased in a business context.  To qualify for the favorable tax treatment, the item purchased had to have a business purpose, be placed in service during the calendar year and not be a security.

In many cases leverage was employed. A doctor would put down $20,000 and sign an $80,000 non-recourse note for the item.  If the tax credit was 50% of the purchase price, then the doctor would save $50,000 from his tax bill for his $20,000 investment; more in subsequent years when he depreciated the value of his $100,000 item over time.

One of the more famous of these tax shelters was a company that sold lithographic masters of artwork from famous artists.  If you bought the master that had been created by an artist such as Andy Warhol, you might make 500 prints from the master before it wore out. If you could sell the lithographs for $200 a piece you could pay back your note, recoup your $20,000 down payment and still save $50,000 on your taxes.

If you sold those lithographs over a period of years, the price might fluctuate. A Warhol lithograph would likely at least retain its value and it could be exchanged for other works of art if you dealt with the right gallery or broker. That did not make the lithographs into a currency even though they had these key attributes of a currency.

Most of these investment programs came with an opinion letter written by a securities attorney that attested to the fact that selling a physical “item” did not involve the sale of securities because the sale did not satisfy the Howey test.  I wrote a few of those opinion letters back in the day because the law was pretty clear that a “thing” was not a security. As far as I can remember the SEC never brought a regulatory action against one of these investment programs taking the position that the items were securities.

The IRS did, however, take issue with a number of these tax sheltered investment programs. They disallowed the credits and deductions that the programs offered and ultimately changed its rules to close the loopholes.  The IRS is not bound to legal opinions and frequently judges the tax treatment of any investment long after the investment is made.

A key issue was whether you were buying a thing or a business. The same is true today. A coin offering might be a security if the coin owner receives a portion of the profits of that company when they purchase the coin.

The SEC is not bound by a legal opinion on the question “is this a security “.  As I said I read several opinions regarding crypto-currencies that went both ways, albeit on slightly different facts. What I did find surprising is that none of the opinion letters that I read, mentioned the fact that the IRS categorized crypto-currency tokens as “property”, not a “security” back in 2014.

The IRS’s classification is also not binding on the SEC.  But given the fact that the IRS had made this determination that the sale of a crypto-currency would be treated as property for tax purposes and the US Copyright Office will issue a copyright on computer code (but not on a stock certificate) I think any legal opinion regarding the classification of a crypto-currency under securities law should mention both.

Several of these opinions were rendered in connection with specific Initial Coin Offerings (ICO). Again this term is intended to create the look and feel of an initial public stock offering (IPO).  This is marketing and it is intended to create the impression (falsely) that an ICO is just like the offering of a security. Of course, if the SEC should assert that these ICOs were actually selling securities because they had the look and feel of securities and attempt to sanction the people behind them, these same people would be screaming that they did no such thing.

In most of the offerings that I reviewed, buying a coin in the ICO neither conferred ownership of the project nor did it promise any payments, so it would not be difficult to opine that all you were getting was a digital coin, not a security. If coin purchasers receive anything other than just the digital coin, then the issue gets murky.  Given that there have already been close to 1000 coin offerings, some very different from others, it can get very murky.

Just to be clear, this article is my opinion of a fairly new legal issue. It is not intended to be specific legal advice as regards one coin offering or another.

If someone came to me with a proposed ICO and sought my opinion I would probably counsel them as follows, just to keep them out of potential legal difficulty.

1) If you intend to use the proceeds of your coin offering to fund your new business then call the coins what they are: “Great New Tech Company Start-up Commemorative Digital Medallions”. This is just truth in packaging. Why call them coins or currency when they are not?

2) Account for the sale proceeds on your books as if you were selling any intellectual property.  If you wrote and sold a book about writing computer code and used the proceeds to fund your code writing business, you would not enter the sale proceeds on your books as an investment.

3) Go about your business and stay under the radar. There are certainly regulators who believe that the whole idea of crypto-currency is a scam.  At the same time, it does not seem to be difficult to raise money using these digital coins. There are multiple reports of multi-million dollar raises being accomplished within hours.  I can see no reason why anyone trying to raise money in this market would write numerous articles or give interviews bashing banks or Wall Street firms or proclaiming crypto-currencies as the new form of unregulated capitalism.  The best way to attract regulators is often to publicize how much money you are making in an “unregulated” business.

If you do want a formal legal opinion letter that your ICO is not the offering of securities, I would be happy to review the facts and prepare one for you. I probably charge a little less than the big Wall Street law firms.  I know that you will understand that I will need to be paid in US dollars not whatever coin you are issuing.  I cannot use your coins at the market, gas station or movies and it is probably going to be a long, long time before I can.

 

 

The Economics of Healthcare

Economics

I suspect that I am like a lot of people who have boxes of old documents in storage. I recently began cleaning mine out and I came across some of the lecture notes that I used when I was teaching Economics back in the 1990s.

One particular set of notes originated from a panel discussion I was asked to join about healthcare reform in 1993 or 1994.  Not unlike today, there was a substantial and partisan discussion about healthcare reform in the early years of the Clinton Administration.

There were two main topics covered by the panel. The first was should the government follow the British model and simply provide healthcare to all citizens. The second was a general discussion on what could be done to reduce the cost of healthcare for everyone.

As to the first, I was and continue to be an advocate of free markets.  I thought that if government provided healthcare and paid the providers it would necessarily do so at the lowest common denominator of care.  I have to admit that I was wrong on this point.

In the interim years, I became a large consumer of healthcare. In 2011 I was diagnosed with a very deadly type of leukemia. I had 5 rounds of nasty chemotherapy, two stem cell transplants and spent a total of 148 nights in the hospital. I beat the cancer only because I got world class treatment at the University of California San Francisco Medical Center (UCSF).

Every one of the doctors, nurses, technicians, kitchen staff and parking attendants at UCSF is an employee of the State of California. This is government provided healthcare at its best and I am certain that it is the same at UCLA or UC Davis. I will not dwell on whether or not the government can provide high quality healthcare because I witnessed it firsthand.

A lot of the real problem with healthcare costs in the US can be laid at the feet of the insurance companies. Insurance companies are entitled to make a profit meaning that they will charge consumers as much for coverage as they can while at the same time negotiating the lowest price from the service provider.

During the course of my treatment, when I was not in the hospital I got my blood drawn and tested often.  If I did not want to drive to San Francisco, I could have my blood drawn at the county hospital nearer to my home.  The bill for the same blood test was several hundred dollars more at UC than at the county hospital. How much the insurance company paid either provider for the same test is a different matter. Still, a blood test is a blood test and the cost of one should not vary from location to location as much as it does.

The real focus should be on reducing the cost of providing medical care and services. Economics teaches that basic price theory applies. The cost of healthcare is largely determined by supply and demand, just like the price of anything else.

The supply of doctors and nurses has not kept pace with population growth. Just about everyone agrees that there is a significant shortage of both doctors and nurses.

There are roughly 1,250,000 licensed physicians in the US. Some do not practice or practice part time. Many specialize; some do research.  Overall it works out to about 400 licensed physicians per 100,000 people.  We add about 12,000 net new physicians every year (new graduates minus retirees).

We could add an additional 5000 new doctors per year if we wanted to do so. That comes out to an average of 100 more per state with perhaps 150 from New York and California and fewer from Montana and Alaska.

Medical school is very expensive but does not need to be as expensive as it is. Much of the first year curriculum (anatomy, immunology, genetics) are lecture courses that can be given on-line freeing up classroom space and faculty salaries.  Not that much more laboratory space is needed to accommodate an additional 100 students, especially if there was more than one medical school in the state. Clinical courses and research require patients and supervision and there are enough of both to go around.

Most medical students graduate with piles of debt. We could arrange to let them work that debt off after they become doctors by working part-time over a period of years at free or low cost clinics in rural or inner city areas where they are needed.  That way people without insurance could still get care and a lot of doctors would not have to be concerned about having to charge as much as they can to pay off their debt.

There has also been a shortage of nurses in the US since I first looked in the early 1990s. Current estimates seem to be between 250,000-500,000 unfilled nursing jobs by 2025.  These are good paying, middle class jobs in a rewarding albeit challenging profession. A shortage of this magnitude necessarily increases what nurses earn. If we want the cost of care to decrease, we need to train a lot more nurses.

The demand for healthcare is rising at the same time. More people are becoming insured with the Affordable Care Act and the population of baby-boomers is getting older. The best way to reduce the cost of healthcare might be to reduce the demand.

If we wanted the population to be healthier over all we could, for example, outlaw smoking and tobacco products altogether. We could make a first offense for drunk driving punishable by a permanent loss of driving privileges. Drunk drivers add significantly to healthcare costs every year.

We could reduce diabetes and obesity by imposing a hefty surtax on fried foods or sugared beverages. We could outlaw vending machines that sold potato chips and require that they sell fruit instead.  We could also require school children to spend part of their lunch hour walking around the block a few times. Healthcare costs will not come down in the long term if 30% of school age children are already obese.

I am not suggesting that any of this will happen. We did, however, get rid of asbestos, lead paint and DDT for health reasons and we require seat belts for the same reason. Each action reduced healthcare costs. Somehow sugary drinks and fried food seem a lot harder to regulate.

Perhaps health insurance companies could take a page from auto insurers who offer discounts for good drivers.  If you get a physical every year (which itself leads to early detection of many diseases and reduces the costs of treatment) and are not significantly over weight, you get a discount on your premium.  Economics teaches that incentives usually work better than penalties.

The one place you will never find a solution to the costs of healthcare is the US Congress.  The lobbyists who represent the industries that receive our healthcare dollars will see to that. As I said, Congress has been “fixing” healthcare since at least the early 1990s.  A market driven solution may be our best bet.