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When the United States Congress passed the Foreign Corrupt Practices Act (FCPA) in 1977, its chief concern was deterring off-the-books bribes of foreign officials by domestic corporations. The FCPA authorized the Securities and Exchange Commission (SEC) to issue new rules, including Rule 13b2-2, which imposes civil liability on corporate officers who mislead accountants concerning the corporation’s finances. In SEC v. Das, the Eighth Circuit Court of Appeals addressed the issue of whether civil liability is present in cases where the corporate officer did not knowingly mislead. Splitting from the Ninth Circuit—the only other circuit court that addressed this issue directly—the Eighth Circuit rejected the proposed “knowingly” requirement, holding that a reasonableness standard shall apply in such cases.
Das concerned infoUSA, Inc., a publicly traded, Nebraska-based corporation that sold databases to businesses and consumers. More specifically, the case concerned events involving three corporate officers: Vinod Gupta, who served as chief executive officer and chairman until 2008; Rajnish Das, chief financial officer from 2003 to 2006; and Stormy Dean, chief financial officer from 2000 to 2003 and then again from 2006 to 2008. The SEC claimed, in a 2010 civil enforcement action, that Dean violated provisions of the Securities Exchange Act of 1934. The agency claimed, among other things, that both former chief financial officers, Das and Dean, deceived auditors concerning payments infoUSA had made to Aspen Leasing Services LLC and Annapurna Corporation—two companies owned by Gupta—to pay for Gupta’s homes, yacht, and cars. The SEC’s complaint further alleged that Dean and Das had signed the company’s management letters to external auditors, falsely representing that all related-party transactions had been properly disclosed. At trial, the judge instructed the jury to find that Dean violated the law if he did not act “reasonably” regarding the false statements made to auditors.
The U.S. tax code allows citizens and domestic corporations to credit foreign taxes paid against U.S. taxes owed. A foreign tax paid by a U.S. citizen or a domestic corporation may be creditable against domestic taxes when such tax is considered a levy on income. Although the tax’s “predominant character” controls in determining whether it is an income tax, the effect of a foreign country’s characterization of the tax on such analysis has remained unsettled. In PPL Corp. v. Commissioner, the Supreme Court considered whether a windfall tax paid in the United Kingdom (U.K.), and characterized by the U.K. as a tax on value and not a tax on income, is creditable in the United States. The Court held that the tax formula adopted by the U.K. Labour Party was an income tax in the United States for credit purposes because the economic reality of the levy was a tax on the company’s income.
A Conservative Party-controlled British Parliament privatized certain government-owned companies in the 1980s and 1990s through an initial sale to the public known as a “flotation.” Petitioner PPL Corporation (PPL) was a U.S. company that owned twenty-five percent of one of the privatized companies, South Western Electricity plc (SWE). For the four years after privatization, the British government required certain companies, including SWE, to charge customers the same rates they had charged under the government’s control. The companies became much more efficient during this period and earned large profits.
In Verizon v. FCC,1 the United States Court of Appeals for the District of Columbia, for the second time in four years, reviewed the Federal Communications Commission’s (FCC) authority to impose “net neutrality” rules on broadband service providers’ network management practices.2 In 2005, the FCC issued a policy statement outlining the principles of Internet neutrality applicable to all Internet service providers operating in the United States in an effort to make broadband networks “widely deployed, open, affordable, and accessible to all consumers.”3 After the policy was adopted, the FCC discovered that Comcast Corporation was limiting bandwidth to peer-to-peer sharing websites in contravention of the Internet-neutrality principles. In response, the FCC issued an order requiring Comcast to disclose sufficient details of its network management practices and to create a compliance plan to end the unreasonable practices.4 Following the issuance of the order, Comcast petitioned for judicial review of the FCC’s authority to regulate their broadband network management practices.5 The D.C. Circuit agreed with Comcast, holding that the FCC only had the authority to compel open network practices on common carriers, which broadband providers did not qualify as.6 Shortly after the D.C. Circuit’s 2010 ruling in Comcast, the FCC adopted the Open Internet Order which imposed Internet-neutrality rules of disclosure, antiblocking, and antidiscrimination on broadband providers.7 Verizon then petitioned for judicial review of the FCC’s authority to adopt the Open Internet Order.8
The FCC was established by Congress under the Communications Act of 1934 (Act of 1934) to regulate interstate and international communications transmitted by radio, television, wire, satellite, and cable.9 One of the FCC’s major enforcement provisions under the Act of 1934 mandated that common carriers provide their communications services to the general public on a nondiscriminatory basis.10 Under the Act of 1934, all telecommunications carriers were classified as “common carriers,” with telecommunications defined as the “transmission, between or among points specified by the user, of information of the user’s choosing, without change in the form or content of the information as sent and received.”11 The FCC continues to classify these purely transmission-based services as “telecommunications services.”12
The FCC’s regulatory authority was subsequently overhauled by the Telecommunications Act of 1996 (Act of 1996).13 The Act of 1996, among other things, expanded the jurisdiction of the FCC to intrastate telecommunications and also reinforced the nondiscrimination principles for telecommunications providers. The FCC was also given the power to regulate “information services,” defined as the “offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information via telecommunications.”14 Notably, information services providers were not classified as common carriers and were thus not subject to the same antidiscrimination laws as telecommunications service providers.15 In 2002, the FCC issued a declaratory ruling that classified cable modem service as an “interstate information service” causing those services to fall within its jurisdiction; however, the ruling stated that cable modem services do not contain a separate telecommunications service offering and as a result are not subject to common-carrier regulation.16 Subsequently, many companies petitioned for judicial review of this declaratory ruling. The United States Court of Appeals for the Ninth Circuit held that while cable modem services can be classified as information services, the FCC could not reasonably construe the Act of 1996 as exempting cable modem service carriers from the common-carrier regulations.17 The FCC, in response, petitioned for certiorari to the United States Supreme Court. The Court granted certiorari and overturned the Ninth Circuit’s ruling, holding that the FCC’s conclusion that broadband cable modem companies are exempt from mandatory common-carrier regulation was a lawful construction of the Act of 1996.18
Due to the Brand X ruling, all cable broadband providers in the United States are classified as information services and are not subject to the common-carrier regulations, while dial-up Internet providers are subject to such regulations. Despite the early absence of regulation of information services, the FCC signaled its intention to regulate these services when it issued a policy statement in 2005 containing four principles of Internet neutrality, which aimed at preserving and promoting the open and interconnected nature of the Internet.19 This policy was eventually struck down by the D.C. Circuit when the court determined that the FCC lacked jurisdiction to impose common-carrier regulations on broadband providers.20 The FCC argued that the Act of 1934 gave the Commission ancillary power to impose common-carrier regulation on broadband providers; however, this argument was defeated.21 In response to the Brand X and Comcast rulings—along with the latent ambiguity surrounding the FCC’s ability to regulate information service providers—there have been many proposed bills in Congress attempting to resolve the status quo, most imposing the common-carrier regulation of antidiscrimination on broadband providers.22
In Verizon v. FCC, the D.C. Circuit was aware of the potential ramifications of its holding and began by reviewing whether the FCC had statutory authority to regulate broadband providers pursuant to section 706(a) and (b) of the Act of 1996, which requires the FCC to promote competition in the local telecommunications market.23 The court held that the FCC had statutory authority, in accordance with the FCC’s revised interpretation of section 706. The court then proceeded to review whether the Internet-neutrality rules adopted in the Open Internet Order exceeded the FCC’s scope of authority.24 The court concluded that because the FCC had classified broadband providers as information services without a telecommunications element, and because the Open Internet Order rules relative to antidiscrimination and antiblocking amounted to per se common-carrier regulations, those rules could not be imposed on broadband providers who were otherwise exempt from such regulation.25 The FCC argued that the Open Internet Order rules did not impose common-carrier regulations on broadband providers and that they were not “carriers” as defined in the Act of 1996. Nevertheless, the court found these arguments unpersuasive, reasoning that although broadband providers were not carriers, they were obligated to act like common carriers as a practical result of the Open Internet Order rules.26 All three Judges of the D.C. Circuit in Verizon agreed that the Open Internet Order rules impermissibly imposed antidiscriminatory and antiblocking regulations on broadband providers; however, Judge Silberman, dissenting in part, argued that section 706 of the Act of 1996 did not grant the FCC affirmative authority to promulgate these Internet-neutrality rules.27
Because broadband providers are not subject to antidiscriminatory and antiblocking rules as a result of Verizon, these providers are able to favor certain websites and web services over others.28 This ability to freely discriminate amplifies the impact of web-service and broadband-provider agreements, such as the recent agreement between Netflix and Comcast.29 Though on its face this transaction eliminates the intermediary backbone provider, allowing Comcast to manage the dissemination of data between Netflix and end-users directly, it also permits Comcast to both offer a fast broadband package to web services that can afford it and to slow down, or throttle, data speeds for web services unwilling or unable to pay them for faster speeds.30 This practice will serve not only to stifle competition in the broadband market—as newer companies may not be able to afford a broadband provider’s prices—but will also impose costs on the end-user who will either have to pay more or be forced to use a web service that has its data speeds throttled.31 In addition, Verizon also impacts the looming Comcast and Time Warner merger, in which the resulting organization would be providing broadband to nearly one-third of the country.32 Without any antidiscriminatory or antiblocking rules in effect, a broadband provider covering that much of the country would be in an advantageous bargaining position in the event it decides to implement discrimination and blocking practices against web services; and the web service might only be left with the choice to pay what the broadband provider is asking or risk going out of business.
The D.C. Circuit’s conclusion in Verizon was practical and well-rooted in the law when it struck down the FCC’s Internet-neutrality rules for broadband providers because the FCC’s own classification system with respect to information service providers exempted them from such regulations.33Moreover, the FCC’s classification between telecommunication services and information services was upheld by the Supreme Court, and prior attempts to apply common-carrier regulations upon broadband providers have similarly been struck down by the courts.34 Nevertheless, the Court’s decision leaves the future of net neutrality and a free and open Internet uncertain. Congressional action is now the only solution to this problem. Congress must legislate in the area of Internet neutrality or reclassify broadband providers as common carriers. Although previous congressional attempts aimed at achieving this result have been defeated, the looming megamerger of Comcast and Time Warner, as well as the web-service and broadband-provider agreements between key providers such as Comcast and Netflix should have an impact. Indeed, it is clear that the ramifications of not having Internet-neutrality laws are now becoming more apparent to Congress than ever before.
R. Brice Turner, Case Note, D.C. Circuit in Verizon Strikes FCC’s “Net Neutrality” Rules for Broadband Providers, 2 Suffolk U. L. Rev. Online 46 (May 22, 2014), http://suffolklawreview.org/turner-verzion.
The right for a person to be free in his or her body, effects, and property from governmental intrusion serves as the bedrock of the Bill of Rights, as well as the Commonwealth of Massachusetts’s Declaration of Rights.1 As technological advances, such as the creation of smartphones, increasingly allow for the monitoring and tracking of a device owner’s whereabouts, courts are left to reconcile whether and to what extent that information can be used in criminal proceedings.2 In Commonwealth v. Augustine,3 the Supreme Judicial Court of Massachusetts was tasked with deciding whether police may obtain historical cell site location information (CSLI)—which uses signals sent from cell phones to signal towers in order to track a device’s location—from a potential suspect’s cell phone service provider without a warrant.4 The Court held that under the Massachusetts Declaration of Rights, police must obtain search warrants supported by probable cause because defendants are owed a reasonable expectation of privacy in that information.5
Julaine Jules’s body was found in the Charles River on September 19, 2004, nearly one month after she went missing.6 Shortly after its discovery, police began investigating the possible involvement of her former boyfriend, Shabazz Augustine, in her murder.7 In order to “possibly include or exclude” Augustine “as a suspect,” police requested CSLI from his cellular service provider, Sprint Spectrum (Sprint), for a two-week period beginning on the last day Jules was seen alive; police requested this information by means of a court order under § 2703(d) of the Stored Communications Act (SCA),8 but not pursuant to a warrant.9 A Superior Court judge granted an order to Sprint under § 2703(d) of the SCA, and Sprint released sixty-four pages of CSLI records to the Commonwealth.10 Nearly seven years later, Augustine was indicted by a grand jury for the murder of Jules.11
Augustine moved to suppress this CLSI evidence on the grounds that it violated both his Fourth Amendment and Article Fourteen rights to be free from warrantless searches.12 The Superior Court judge agreed that Augustine’s rights under Article Fourteen were violated and ruled that the CSLI information must be suppressed.13 The Commonwealth sought interlocutory review, which a single justice allowed and ordered that the case be heard before the Supreme Judicial Court.14
Under both the Fourth Amendment and Article Fourteen, the government may not search or seize a person, his house, or his effects without a search warrant that is supported by probable cause, with limited exceptions.15 In order to determine whether a search in the constitutional sense has occurred, courts first assess whether the person being searched had a subjective expectation of privacy and then evaluate whether that expectation of privacy is reasonable.16 If both prongs are satisfied but the government did not obtain a warrant for the search (and no exceptions apply), then the search is illegal and the evidence obtained is excluded.17 While courts emphasize that individuals have a manifest reasonable expectation of privacy from the government within the sanctity of their own home, they have likewise held that an expectation of privacy in effects, such as bank statements, transmitted to third parties is not reasonable.18 As technological advances allow individuals to more easily engage in behavior that was typically reserved for protected areas, courts are forced to evaluate whether that information should remain protected now that law enforcement could otherwise obtain it through first-hand observation.19
The SCA was initially created to protect the information transmitted by electronic communications by limiting the circumstances in which service providers could disclose it.20 The SCA allows the government to obtain this information either pursuant to a warrant, which requires a showing of probable cause, or pursuant to a § 2703(d) order, which requires only a showing of reasonable suspicion—a much lower standard.21 While courts remain divided on the issue, many federal courts have held that the lesser “reasonable suspicion” standard mandated by the § 2703(d) order is sufficient to obtain historical CSLI, even though CSLI may reveal information about people while they are at home or engaging in other constitutionally protected conduct.22
While states are required to enforce (and may not abridge) the protections under the Fourth Amendment under the provisions of the Fourteenth Amendment, they are empowered to enlarge those rights23 Accordingly, some states have held that the § 2703(d) process constitutes an illegal search under state constitutions, even though it may comply with the Fourth Amendment.24 Particularly in regard to electronic communications, the Massachusetts Supreme Judicial Court has diverged from the Supreme Court in analyzing searches and seizures under Article Fourteen and afforded Massachusetts residents greater protections than those found under the Fourth Amendment.25
In Commonwealth v. Augustine, the Supreme Judicial Court declined to analyze the release of Augustine’s CSLI records pursuant to the § 2703(d) order under the Fourth Amendment, thus limiting its holding to Article Fourteen of the Massachusetts Declaration of Rights.26 The Court first evaluated whether Augustine’s voluntary use of his cellular telephone, and his knowledge that cellular service providers maintain information about the telephone’s whereabouts, diminishes his expectation of privacy. The Court held that it did not, because of the “indispensable” role cellular telephones play in modern society and the lack of choice people have in cellular service providers transmitting this information.27 The Court next compared CSLI data to GPS tracking and emphasized the likelihood that those records would reveal information about Augustine’s location in constitutionally protected places.28 The Court concluded that Augustine’s expectations of privacy were reasonable, and thus, a search had occurred when the government sought to obtain Augustine’s CSLI. Therefore, police should have obtained a search warrant supported by probable cause.29 Accordingly, the less stringent “specific and articulable facts” standard used in Officer McCauley’s § 2703(d) application was invalid, rendering the search unreasonable.30
Justice Gants, with whom Justice Cordy joined, dissented.31 While they would recognize that certain types of CSLI—namely, registration information—ought to be protected under Article Fourteen, they believed that the more general information of historical CSLI (which only tracks the cell site location when the telephone makes or receives calls) reveals no information that Augustine could reasonably expect to be kept private.32 The dissent reasoned that cellular telephone users would need to make calls constantly in order for the telephone call CSLI to amount to GPS tracking.33 Further, because this type of information is stored only when calls are made or received, the dissent disagreed with the majority’s contention that the information conveyed to the third-party service provider was involuntary.34 Justice Gants would accordingly deny the motion to suppress the CSLI records, which only sought to know the location of the cellular device when it made or received calls for a two-week period.35
The dissent underscores an important question on the distinction between types of CSLI not squarely addressed by the majority opinion: do all types of CSLI deserve the same constitutional treatment?36 Registration CSLI tracks the precise locations of cellular devices every seven seconds, allowing law enforcement officers to reconstruct detailed maps showing where, when, and for how long individuals were at certain locations.37 All justices on the Supreme Judicial Court agree, as do many other jurisdictions, that law enforcement officers should obtain search warrants in order for this type of data to be released.38 However, the type of CSLI at issue in this case—historical CSLI—tracks only the locations of cell sites used in the event calls were made or received.39 This practical difference bears some significance on the court’s third-party analysis, as well as the parallels it draws to GPS tracking.40
The court’s conclusion that Augustine’s transmission of information by his cellular telephone to his service provider violates his reasonable expectation of privacy marks a departure from how many courts have addressed the issue.41 Its departure results from distinguishing the applicability of certain Fourth Amendment precedent.42 Other courts have specifically relied on the Supreme Court case of Smith v. Maryland for the proposition that an individual’s expectation of privacy in the telephone numbers he calls is unreasonable;43 instead, the majority in Augustine emphasized that cellular telephone users do not expect that the telephone numbers they dial remain private, but rather the area in which those calls are made should remain private, now that telephones are portable (noting especially that Smith was penned prior to the development of portable telephones).44 In this regard, location information is not voluntarily given simply because cellular telephones exhibit the feature of portability, since users take no affirmative actions to disclose it.45
Though not directly linked back to its introduction on how cellular telephone technology has evolved, the trend of cellular service providers consistently constructing new cell sites supports the majority’s reasoning that even historical CSLI may eventually operate like GPS tracking, if not more precisely.46 In this regard, the opinion seeks to address future likely events as well as analyzing the facts of the underlying case.47 While historical CSLI is contingent upon calls being made to or from the cellular device, the reality that this information will be transmitted while the device is in constitutionally protected areas cannot be ignored.48 As such, data provided by even historical CSLI may be more invasive than what law enforcement could learn through first-hand observation or GPS tracking.49 Furthermore, the use of GPS tracking provides location information for future movements, but historical CSLI would allow police to recreate an individual’s past movements—“a category of information that never would be available through the use of traditional law enforcement tools of investigation.”50
In Commonwealth v. Augustine, the Supreme Judicial Court ruled, consistent with its Article Fourteen jurisprudence, that in order for police to obtain CSLI from a particular cellular telephone they must first obtain a search warrant. While this holding declines to interpret § 2703(d) applications under Fourth Amendment analysis, it may play an important role in shaping state constitutional analysis in other jurisdictions. Further, the decision may serve as guidance to the Supreme Court in the event that the apparent split between federal courts on the reasonableness of privacy expectations in CSLI is granted certiorari. Because privacy expectations remain a reflection of what society as a whole is willing to accept as reasonable, every individual decision protecting the privacy of CSLI will help demonstrate to the Supreme Court that the government should obtain warrants before infringing upon it.
Kathryn Acello, Case Note, SJC Requires Search Warrants To Obtain Defendants’ Cellular Site Location Information in Augustine, 2 Suffolk U. L. Rev. Online 37 (May 19, 2014), http://www.suffolklawreview.org/acello-augustine.
This distinction between privacy interests in public and private spaces makes CSLI especially problematic, because cellular telephones give off signals from within both spaces, and when the government seeks to obtain CSLI from a cellular service provider, it has no way of knowing in advance whether the CSLI will have originated from a private or public location.
Id. at 864. ↩
Police officer testimony during OUI (operating a motor vehicle while under the influence of alcohol) trials in Massachusetts often reads like a script from an all too familiar play, with indicators of alcohol intoxication largely the same across police reports and police officer testimony. Police reports are almost certain to include phrases such as, “odor of alcohol on the [driver’s] breath” and “eyes were bloodshot.”1 Indeed, these are common—albeit accurate—indicators of alcohol consumption and intoxication. There are also many other indicators, which are generally important factors in a police officer’s determination of whether he or she has probable cause to arrest a suspected OUI offender.2 When any of these common indicators of intoxication are observed by a police officer, it is a safe bet that it will be listed in the police report. Likewise, when an officer writes something in his or her police report, they almost certainly will testify to it at trial as if it were a fact and not merely one of their observations. This is a common practice, as police officers arrest countless citizens during the course of their duties and there is no prohibition against testifying to alleged facts recorded in a police report.
It is also recognized in Massachusetts that police officers may offer their opinion, as lay witnesses, regarding a defendant’s level of intoxication and may even offer their opinion that a defendant was indeed “drunk.”3 However, the Massachusetts Supreme Judicial Court (SJC) recently decided in Commonwealth v. Canty that a police officer testifying in an OUI trial “may not opine as to the ultimate question whether the defendant was operating while under the influence, but they may testify to his apparent intoxication.”4 This Case Note will examine the SJC’s decision in Canty, briefly outlining the legal theories relied upon by the court in making its decision, and focusing on the court’s analysis. Moreover, this Case Note will also discuss the implications of the SJC’s decision on OUI trials going forward, emphasizing the suggested proper lines of questioning posed to police officers by prosecutors, the proper instructions to police officers by prosecutors before trial, and various strategies and approaches defense attorneys should take in light of the Canty decision.
II. Police Officer Testimony In OUI Trials
A police officer rarely qualifies, except in limited circumstances that specifically pertain to knowledge gained through specialized police work, as “a witness qualified as an expert by knowledge, skill, experience, training, or education.”5 Therefore, police officers are usually deemed lay witnesses, which limits their opinion testimony to observations that are: “(a) rationally based on the witness’s perception; (b) helpful to clearly understanding the witness’s testimony or to determining a fact in issue; and (c) not based on scientific, technical, or other specialized knowledge within the scope of Rule 702.”6
As lay witnesses at OUI trials, police officers are permitted to offer their lay opinion regarding a person’s level of intoxication, but while their training and experience teaches them to look for specific signs of drunkenness, intoxication, or inebriety, their opinion that a person is intoxicated remains that of a lay person, just as any other person may offer such testimony.7 Police officers receive training on what to look for in order to determine a person’s level of intoxication and gain experience in making such determinations and testifying on what factors lead them to make those determinations while performing their duties. Nevertheless, their training, knowledge, and experience does not reach the level of an expert with regard to the level of intoxication or the effects of alcohol on a person.8
On the other hand, an expert qualified “by knowledge, skill, experience, training, or education” regarding the effects of alcohol on human beings may testify on that subject, if such “scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence.”9 In order for a qualified expert to do so, however, the expert’s testimony must be “based upon sufficient facts or data, . . . [be] the product of reliable principles and methods, and . . . the witness [must apply] the principles and methods reliably to the facts of the case.”10 This permits experts to offer a greater degree of opinion testimony than that of lay witnesses, as expert witnesses are permitted to rely upon and explain in greater detail what facts, data, principles, and methods helped them arrive at their ultimate conclusion. Regardless, expert witnesses still may not offer their opinion as to the ultimate issue in any case, such as a specific element of an offense at trial, because the purpose of expert testimony is only to assist the factfinder in determining a fact at issue.11
As long as witnesses do not directly testify that they believe a defendant is guilty or innocent in a criminal case, there is no explicit rule in Massachusetts that prevents them from offering an opinion on the ultimate issue in a case. What courts must do in such circumstances is weigh the probative value of such opinion testimony against the threat of unfair prejudice to the defendant, in order to determine whether the testimony was improper.12 In OUI trials specifically, allowing police officers to testify as to their opinion on what effect a defendant’s consumption of alcohol had on a particular defendant’s ability to operate a motor vehicle safely, presents a significant danger of prejudicing a jury against the defendant because juries may view the opinion as that of an expert, although a police-officer witness, in such circumstances, is not qualified to give such an opinion.13 Allowing this testimony at OUI trials comes dangerously close to the ultimate issue of guilt, and because juries tend to view police officers as experts on determining a defendant’s ability to drive after consuming alcohol, the admission of this evidence diminishes the jury’s role in the fact-finding process.14 Therefore, police officers at OUI trials may—as lay witnesses—offer their opinion regarding whether the defendant was intoxicated; however, in order to do so, they must offer testimony about the observations they made of the defendant that helped them reach their conclusion.15
III. Commonwealth v. Canty
There is no explicit rule in Massachusetts that prevents witnesses from offering opinion testimony regarding the ultimate issue of guilt or innocence in a criminal case. Prior to the SJC’s decision in Canty, as long as testimony did not directly concern the defendant’s guilt, nothing prevented police officer’s from improperly offering opinion testimony regarding the ultimate issue of impairment during OUI trials. Accordingly, the police officer in Canty was allowed to testify that “[he] believed that [the defendant’s] ability to drive was diminished,” and that he believed this was due to “alcohol consumption.”16 Another officer testified that “[b]ased on what I observed, yeah, in my opinion [the defendant] was probably impaired.”17 After the jury returned a guilty verdict on the OUI charge and the judge denied the defendant’s motion to vacate his conviction on an indictment that was not before the jury, the SJC granted the defendant’s application for direct appellate review.18
The significant issue on appeal in Canty was whether a police officer may “offer testimony that, in his opinion, the defendant’s ability to drive was diminished by the consumption of alcohol, or that the defendant was probably impaired by alcohol?”19 The court noted that they were required to balance the tension between two well-established evidentiary principles that are specific to OUI trials: the admissibility of lay witness opinion testimony regarding whether a person was intoxicated from the consumption of alcohol and the long-recognized Massachusetts common-law principle that “[n]o witness, including a police witness, may testify as to a defendant’s guilt or innocence.”20 Indeed, the defendant’s contention that police officer’s testified to his guilt is sensible because having been charged with an OUI, a police officer testified that “[Canty’s] ability to drive was diminished by the consumption of alcohol and that he was ‘probably impaired.”21 Although the SJC had previously stated in Commonwealth v. Jones22 that opinion testimony as to the ultimate question of whether an OUI defendant was operating under the influence of alcohol is inadmissible, testimony regarding the defendant’s intoxication remains admissible. The court declined to provide further explanation, which left the door open for prosecutors to elicit—and for police officers to offer—opinion testimony on whether a defendant’s ability to drive was impaired from alcohol.23 In Canty, The SJC was presented with the opportunity to explain its reasoning in Jones and to create a concrete rule for police officer opinion testimony regarding a defendant’s impaired ability to drive as a result of alcohol consumption.
The SJC began its discussion by noting that “an opinion regarding a defendant’s sobriety is a lay opinion, not an expert opinion.” The court continued, stating that “the reasons for admitting a lay opinion are wholly different from the reasons for admitting an expert opinion,” as “the principal objective symptoms” of intoxication are well known to the average person, which gives such opinion testimony probative value.24 The court explained that because there are many subtle observations that any percipient witness can use to form an opinion as to a person’s level of intoxication, lay opinion testimony on a person’s level of intoxication is highly probative, and thus admissible.25 The court then noted that such lay opinion testimony regarding a defendant’s ability to safely operate a motor vehicle comes close to an opinion on the defendant’s guilt or innocence, which poses a significant danger of unfair prejudice.26 This danger is especially significant when the percipient lay witness is a police officer because when an influential witness, such as a police officer, offers an opinion on the ultimate issue of guilt or innocence, it may cause a jury to take the witnesses opinion as truth rather than independently analyze the facts.27 The SJC in Canty recognized that if the opinion testimony is a direct opinion regarding the guilt or innocence of a criminal defendant, then it is inadmissible.28
The SJC’s holding in Canty finally created an explicit prohibition on testimony as to “whether the defendant’s consumption of alcohol diminished his ability to operate a motor vehicle safely.”29 After applying this new rule to the police officer’s testimony at trial, the court concluded that the admission of the police officer’s testimony that the defendant’s “ability to drive was diminished” was improper. Nevertheless, the court held that the admission of the police officer’s testimony that the defendant was “probably impaired” was not prejudicial error.30 Justice Gants disagreed with the defendant’s assertion that the jury would reasonably understand the phrase “probably impaired” to refer to the defendant’s ability to drive because the “opinion was proffered in response to a question asking whether the officer had an opinion ‘as to [the defendant’s] sobriety.’”31 The court refused to limit the use of particular words or phrases in an opinion offered by a witness (lay or expert), recognizing that “[t]he rule that witnesses in describing conduct should tell what they saw and heard does not foreclose the use of words of summary description.”32 Reasoning that “‘[p]robably impaired’ . . . is no worse than many of the alternatives (e.g., ‘buzzed,’ ‘tipsy’) to describe a modest level of inebriation,” the court refused to exclude the police officer’s testimony that the defendant was probably impaired.33
First, “the risk of prejudice arising from the admission of an opinion that closely touches on the ultimate issue of guilt is less with lay opinion than with expert opinion, even where the lay opinion is offered by a police officer.”34 Second, the trial judge mitigated the risk of the jury giving the police officer’s opinion testimony too much weight by specifically instructing the jury that “they ultimately must determine whether the defendant was under the influence of alcohol, and that they may consider any opinion they heard about the defendant’s sobriety.”35 Third, there was overwhelming evidence of the defendant’s guilt, besides the police officer’s improper opinion testimony, which allowed the court to conclude that “the jury’s judgment was not substantially swayed by the error.”36
While the SJC correctly concluded that the police officer’s opinion testimony that the defendant’s “ability to drive was diminished” was improper, it declined to adequately address the issue of whether the police officer opinion testimony that the defendant was “probably impaired” should be admitted at trial.37 This not only presents problems for defendants and their counsel, but also presents significant problems for prosecutors who hope to try their cases correctly and avoid mistrials and overturned convictions. The risk is that police officers may be able to offer opinion testimony that a defendant was impaired while responding to questions other than those regarding a defendants’ sobriety; such a risk is not covered in the court’s opinion, and may, therefore, still constitute improper opinion testimony as to a defendant’s ability to operate a motor vehicle. Defense attorneys will likely challenge the admission of such opinion testimony, potentially resulting in mistrials, appeals, and overturned convictions.
Another problem presented by the SJC’s holding in Canty is that such language mirrors the jury instructions given regarding the under-the-influence element of OUI offenses.38 When opinion testimony that parallels jury instructions is admitted at trial, jurors may become confused regarding their role as the finder of fact. Rather than determine the credibility of trial testimony on their own, jurors who hear police officer opinion testimony that resembles the language the judge reads to them during jury instructions, may defer to the police officer’s opinion testimony because they hear this language from the officer, prosecutor, and judge.39 Because it is natural for jurors to trust judges more than any other participant in a trial, when the instructions given by a judge before deliberations closely resemble the terminology used by the prosecution and its witnesses, they are likely to give this testimony more weight, which may result in unfair prejudice.
While the SJC in Canty declined to recognize this danger, the circumstances in the case did not present the ideal opportunity to confront these problems.40 First, the police officer’s opinion testimony that the defendant was probably impaired was given in response to a question by the prosecutor regarding the defendant’s sobriety, rather than his ability to safely operate a motor vehicle. Second, the judge gave the jury a curative instruction regarding its role as the finder of fact. Lastly, the other evidence of the defendant’s guilt, besides the police officer’s testimony, was overwhelming.41 For these reasons, the risk of unfair prejudice was minimized.
In the wake of the SJC’s decision in Canty, prosecutors and defense attorneys should adjust their trial strategies in order to reach just results in OUI trials. Prosecutors must now better prepare their police officer witnesses before they testify to ensure that they do not offer opinion testimony regarding a defendant’s ability to safely operate a motor vehicle as a result of consuming alcohol. If they do not, they may risk mistrials and overturned convictions in cases where OUI defendants should otherwise be convicted. On the other hand, defense attorneys must be aware of prosecutors and police officers who attempt to slip such improper opinion testimony into evidence at trial and vehemently object and call for a mistrial when this occurs. While ideally the SJC would have recognized the significant risk of unfair prejudice when the language used in opinion testimony offered by police officers closely resembles the jury instructions, the court was correct in declining to do so in Canty. Nevertheless, defense attorneys in OUI trials should continue to present this argument in hopes of one day bringing this issue up on appeal in a case where the factual circumstances better allow the SJC to reach this decision.
Timothy Rodden, Case Note, SJC in Canty Addresses Police Officer Testimony at OUI Trials, 2 Suffolk U. L. Rev. Online 29 (May 12, 2014), http://www.suffolklawreview.org/rodden-canty.
Even where a witness has described the defendant’s appearance, manner, and conduct (e.g., bloodshot eyes, slurred speech, and unsteady gait), a lay opinion by a percipient witness regarding the defendant’s intoxication is still of probative value because such an opinion, especially as to the level of intoxication, may be shaped by observations too numerous or subtle to mention.
Canty, 998 N.E.2d at 329. ↩
To state the obvious, we live in a world that is awash in information. Discoveries of new scientific information occur daily in the laboratories of the world. The Facebook accounts of millions of teenagers contain information about the love lives of their friends. Google traces the search information of its subscribers. Supermarkets use personalized discount cards to trace the purchasing preferences of their customers. The National Security Agency (NSA) has been building a one-million-square-foot data and supercomputing center in Utah, which is expected to intercept and store much of the world’s Internet communication for decryption and analysis. States maintain driver, tax, and voter records. All of these records contain information that can yield profit for some and embarrassment for others.
The First Amendment to the U.S. Constitution dictates access to and dissemination of this information, whereas the Fourth Amendment limits such access and dissemination. Additionally, common-law doctrines of privacy, publicity, and defamation apply to this information, as do copyright, patent, and trademark law. State and federal legislatures race to regulate the collection, storage, and dissemination of this data and information in the public interest. This Article will review recent developments in the constitutional treatment of access to data and information, will comment on an illustrative group of statutory and common-law developments, and will discuss a number of current noteworthy controversies. . . .
Ernest Willis was convicted of various sexual assault offenses that occurred in 1997.1 He appealed those convictions in State v. Willis, by arguing that the court erred in admitting certain portions of a police interrogation recording into evidence.2 The conviction arose from Willis’s interactions with a fifteen-year-old girl who attended his church. On one occasion, Willis had sexual contact with the victim during a driving lesson. About one month later, he had sexual intercourse with the victim at her home.3 In October 1997, the victim disclosed to a neighbor, who was a member of her and the Willis’s church, that she was pregnant with his child. The neighbor notified both the victim’s mother and church pastor. The pastor investigated and met privately with Willis, who acknowledged his relationship with the victim. After receiving confirmation from Willis, the pastor informed the police and the New Hampshire Division for Children, Youth and Families (DCYF).
The investigation stalled in 1997, but was reopened by a detective in 2010. The investigation led to Willis meeting with detectives and participating in a recorded interview. During the interview, an officer told the defendant that he did not “see the motivation for [the victim] to lie.”4 The prosecution sought to admit the tape into evidence and play it for the jury. Willis submitted a pretrial motion to exclude portions of the recorded interrogation from evidence, along with other items, which included the officer’s “motive to lie” statement.5 Willis argued that the statement was the officer’s opinion as to the victim’s—and thus Willis’s—credibility. That is, the recording of the officer’s statement exposed the jury to the officer’s view that the victim had no motive to lie, and thus implied that she was truthful. Willis also argued that the statement should have been excluded because its prejudicial effect substantially outweighed its probative value. The prosecution countered that the officer was not attempting to convince anyone that the defendant was lying; rather, it was an interrogation technique utilized to convince Willis to tell the truth.
The trial court denied the part of Willis’s motion concerning the motive-to-lie statement, but issued a limiting instruction informing the jury that “‘the question part of the tape that you have just heard is only being admitted for the purpose of . . . context, what elicited a particular response of the Defendant,’ and not for the truth of any assertions contained within the officers’ questions.”6 This issue of first impression was appealed to the New Hampshire Supreme Court.
The Admissibility of Statements Made During Police Interrogations Relating to Witness Credibility
At the center of evidence law is the principle of relevance.7 In New Hampshire—like most states—evidence is “relevant” when it has “any tendency to make the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence.”8 Generally, evidence can only be admissible if relevant, but this is subject to many exceptions.9 One such exception is Rule 403 of the New Hampshire Rules of Evidence, which allows relevant evidence to be excluded if its “probative value is substantially outweighed by the danger of unfair prejudice, confusion of the issues, or misleading the jury, or by considerations of undue delay, waste of time, or needless presentation of cumulative evidence.”10 Unfair prejudice typically would lead a jury to reach a verdict based on evidence that triggers horror, outrage, or some other strong emotion, as opposed to a logical evaluation of all the evidence presented.11 For example, New Hampshire courts largely prohibit questions regarding a witness’s opinion about the credibility of another witness.12 The courts reason that such questioning is not probative and “such questioning interferes with the jury’s obligation to determine the credibility of witnesses.”13 Nevertheless, whether recorded police interviews implicate the same concerns that underlie the prohibition on witness testimony regarding the trustworthiness of other witnesses is subject to much debate.
There is a chance that by admitting such evidence jurors may confuse an officer’s statement as being submitted to prove the truth of the matter asserted—i.e., that the victim is not lying—instead of just providing context in the case. Presenting these interviews with only the defendant’s responses, however, may harm the recording’s effectiveness by requiring it to be redacted and therefore making it confusing.
Prior to its decision in Willis, the New Hampshire Supreme Court had not considered whether a police officer’s statement during an interrogation was admissible if it concerned a witness’s credibility.14 Several other state and federal courts have addressed the issue and there is no consensus.15 The Kansas Supreme Court has held that a trial court erred by showing the jury a video recording of a police officer commenting on the defendant’s credibility.16 That court concluded that “[a] jury is clearly prohibited from hearing such statements from the witness stand in Kansas and likewise should be prohibited from hearing them in a videotape, even if the statements are recommended and effective police interrogation tactics.”17 In contrast, although the Washington Supreme Court acknowledged that such video recordings are generally inadmissible without a limiting instruction, it held that the lack of a limiting instruction by the trial court was harmless error and thus affirmed the defendant’s conviction.18 Similarly, the Ninth Circuit has held that recordings of police commentary on credibility do not deprive defendants of due process because limiting instructions cure any errors.19 Further, Missouri courts have allowed this type of evidence, reasoning that the recordings are simply part of an interrogation technique.20 Pennsylvania courts, on the other hand, have held the opposite, deciding that explicit or implicit police accusations of untruthfulness must be redacted from a tape before the jury views it.21
Despite this split, most courts have recognized that interrogations are an effective investigatory tool and officers’ statements during interrogations provide context to understand defendants’ responses.22 Few courts, however, have drawn the very fine distinction between statements that claim a witness is lying and those statements or questions that ask a person to comment on a witness’s motive to lie. While the former directly comments on someone else’s truthfulness, which is prohibited by New Hampshire law, the latter explores whether someone else may have a potential bias, which is permissible.
The Willis Court’s Decision
The New Hampshire Supreme Court affirmed Willis’s conviction, and drew different conclusions regarding the admissibility of the various challenged pieces of evidence.23 Regarding the officer’s statement about the victim’s motive to lie, the court held that the danger of unfair prejudice did not substantially outweigh its probative value. Therefore, the trial court’s admission of the statement was not an “unsustainable exercise of discretion.”24 In reaching its decision, the court reasoned that the motive-to-lie statement was probative because it provided context for Willis’s explanations of the victim’s conduct and bias.25 The court further reasoned that the risk of prejudice was minimal because the officer’s statements were not an appeal to the jury’s emotion or an opinion as to the victim’s credibility; instead, they merely posed questions that explored a witness’s potential bias.26
The New Hampshire Supreme Court’s decision initially appears to provide clear guidelines for the admissibility of recorded interrogations. That is, recorded interrogations are admissible when the defendant’s statements may reveal consciousness of guilt or explore a witness’s potential bias, and officers’ statements are necessary to provide context for the defendant’s statements.27 Notwithstanding this guideline, the court’s decision in Willis may have created a slippery slope by characterizing the officer’s statement as exploring bias, rather than as commenting on the victim’s credibility. In Willis, all of the officer’s statements suggested that he could not understand what would motivate the victim to lie.28 However, one could conclude that the officer was explicitly suggesting that he did not believe the victim had a motive to lie, and thus had no bias.29 By permitting this type of evidence, the court allowed an inference that the victim was truthful, and therefore Willis was guilty. A limiting instruction that an officer’s statement is only offered for context—and not for the truth—may assist in eliminating the risk of unfair prejudice. Nevertheless, a law enforcement officer’s statement carries with it an aura of reliability and trustworthiness, which could unduly prejudice a jury.
Courts will surely continue to grapple with whether an officer’s comment on a witness’s credibility should be admissible with a limiting instruction. Some argue that could be enough to taint a jury and render the proceedings fundamentally unfair. Others contend, as the Willis court did, that such evidence provides important context, and that juries can be trusted to heed limiting instructions. Courts should decide these questions on case-by-case bases, utilizing the discretion evidence law provides to the trial judge. Future litigation should continue to address the potential prejudice that defendants may encounter under such circumstances, and provide further guidance to avoid unjust results.
Julianne Campbell, Case Note, Providing Context: New Hampshire Supreme Court Allows Recording of Officer’s “Motive to Lie” Statement into Evidence, 2 Suffolk U. L. Rev. Online 24 (Apr. 20, 2014), http://suffolklawreview.org/campbell-Willis.
In Commonwealth v. Winfield,1 the Massachusetts Supreme Judicial Court (SJC), in a matter of first impression, held that the First Amendment right of access to a criminal trial—as applied to the states through the Fourteenth Amendment—and the common-law right of access to judicial records did not extend to a backup room recording that was not the official record of the trial.2 In 2007, Keith Winfield was convicted of two counts of forcible rape of a child under the age of sixteen, indecent assault and battery of a child under the age of fourteen, and assault and battery of a child causing serious bodily injury.3 The Massachusetts Appeals Court affirmed the convictions.4 Steve Audette, a film producer, is making a documentary film concerning the defendant’s prosecution and convictions.5 Audette says that the documentary “will examine, among other things, Winfield’s continued assertion of innocence in light of the evidence presented at trial.”6
The court reporter during the trial was a “voice writer,” which means that she creates a “voice-over recording” on to a tape recorder by wearing a special mask and repeating everything that is said at the trial.7 The court reporter then created the official transcript of the trial from the voice-over recording.8 In addition to the voice-over recording, the court reporter had a separate audio room recording during the trial as a backup, which presumably recorded everything said at the trial, including inflections, nuances, and pauses made by each speaker.9 Audette purchased a copy of the trial transcript from the court reporter, but also requested a copy of the audio room recording.10 The court reporter would not release a copy of the room recording unless she was directed to by the court; accordingly, Audette filed a motion asking the court to order the reporter to provide him with a copy of the audio room recording arguing that his First Amendment and common-law rights of access to judicial records guaranteed him access to the audio recording.11 The trial judge concluded that when a transcript of the trial is available an individual is not entitled to the backup room recording because the room recording is not a judicial record subject to the right of public access under the First Amendment or common law.12 The judge reported her decision to the Appeals Court and the SJC took the case on their own motion.
Common-Law Right of Access to Judicial Records
There is a long-standing right of public access to judicial records in Massachusetts that “is governed by overlapping constitutional, statutory, and common-law rules.”13 The long-recognized common-law right of access to judicial records is not restricted to a certain class of persons, but rather is available to the entire public.14 The Supreme Court first considered the common-law right to inspect and copy judicial records in Nixon v. Warner Communications, Inc.15 The Court in Nixon established a presumption in favor of public access to judicial records, but went on to explain that it was only a presumption.16 This presumption of public access both allows the public to keep a watchful eye on the government and to make sure its public servants are properly carrying out their duties.17
The presumption of public access, however, only applies to judicial records. Thus, the threshold question when determining if a document should be open to the public is whether it constitutes a “judicial record.”18 Under Massachusetts case law, if a document or recording is kept in the court file then it is considered a judicial document accessible to the public, unless it is impounded.19 The court has the power to impound the files of a case and deny the public access to them “when justice so requires.”20 In determining when the right of access to judicial records should be overridden, courts analyze all relevant factors, including the public’s interest in understanding the trial and whether the disclosure of the information would allow for improper use such as scandalous or libelous purposes.21
First Amendment Right of Access to Criminal Trials
The First Amendment inherently grants the public, along with the press, the right of access to criminal trials.22 This right under the First Amendment also acts as an “effective check” on the judiciary.23 The First Amendment right only applies to judicial documents. Whether a document is a judicial document hinges on whether the document was filed in court, or was otherwise integrated into the court’s adjudicatory proceedings.24 This right of access also inherently includes the right to purchase a transcript of the proceeding that was open to the public. The Supreme Court in Press-Enterprise, Co. v. Superior Court25 equated the right to attend a hearing with the right to obtain a transcript of the hearing, and reasoned that any denial of a transcript request “would frustrate what [the Court has] characterized as the ‘community therapeutic value’ of openness.”26 Further, the First Amendment right of access to the courtroom provides a strong presumption that those that cannot attend the trial may still learn what happened during the proceedings by purchasing a copy of the transcript.27
The First Amendment right of access, like the common-law right of access, is not absolute. There is a strong constitutional presumption in favor of a public trial. Other important interests, however, may overcome this presumption.28 A judge may find on a case-by-case analysis that closing the courtroom is “essential to preserve higher values and is narrowly tailored to serve that interest.”29 The party that opposes the right of access has the burden of proving that the overriding interest is narrowly tailored to serve that interest.30
Massachusetts Rules and Statutes Enabling Right of Access
Massachusetts has its own statutes, rules, and standing orders that require official transcripts be made available to the public. Massachusetts superior courts require that a court reporter, where available, create a transcript of the case.31 Under Massachusetts law, a court reporter is a shorthand reporter or voice reporter who is a sworn officer of the court appointed by the justices of the superior court to make a “verbatim record” of the trial.32 The court reporter then, upon request “shall furnish a transcript of his notes, or any part thereof, taken at a trial or hearing.”33 The transcript, once it has been “verified by the certificate of such stenographer,” is then admissible as evidence of the testimony given at the trial or the hearing and is what is ultimately used as the “record” on appeal.34 In Massachusetts, if there is no certified transcript than an electronic recording of the trial or hearing is the official record of the proceeding.35
The SJC’s Holding
The SJC held that Audette did not have a constitutional, common-law, or statutory right to the backup room recording when a certified transcript was the official record of the trial.36 The court reasoned that if Audette had attended the trial he would have had no constitutional right to make an audio recording of the trial and the court saw no reason to extend the First Amendment right of access to include unofficial electronic recordings where there is an official record of the trial.37 The court further explained that the common-law right to judicial records did not extend to the backup room recording because this right only applies to judicial records, which in this case included only the official transcript.38
The court held that in this case they only needed to determine whether the presumption of public access should apply to the backup room recording. The question that must be answered to make this determination is “whether a record that is not kept in the court file is nonetheless so important to public understanding of the judicial proceeding that it should be presumed to be public.”39 The court ultimately decided that where there is an official transcript available to the public, the backup room recording does not pass this test because it is more likely to create public confusion than aid public understanding.40 The SJC, however, clarified that this does not mean the public may not request access to the room recording, but rather that the “burden is not on the opponent of the motion to overcome the presumption of public access by showing good cause to impound the presumptively public recording.”41 The burden rests on the proponent of the motion to show why the interests of justice, in the particular case at hand, would be served by making a document that is not inherently available to the public.42 In the end, the judge decided in this case that the room recording was not a judicial record, but found that even if it were, if the Commonwealth had to show just cause to impound it, the burden would have been met. Taking all factors into consideration, the SJC found that preventing the disruption to the peace of mind of the victim and victim’s family from hearing the recording again outweighed Audette’s interest in giving a meaningful presentation to his viewers.43
The SJC conveyed a prudent tone in their holding and left room for other scenarios to arise where a backup room recording may be available to the public. The court did not determine whether the presumption of public access could apply to any document or recording that is the property of the court but is not referenced in the court file.44 Rather, the court only decided that when a verified transcript is available in the court file, making it a judicial document, a backup room recording would not be considered a judicial document, and is thus not presumptively available to the public. Indeed, the document may still be available to the public as long as the party seeking the recording can show why the interests of justice are being served by making it public.45 This leaves the court with possible outcomes where a document or recording that is not in the court file could still be made public. Yet, the SJC’s distinction between a presumption for access to “judicial records” and a presumption against access to recordings of trial proceedings that are court property raises important legal questions. The Supreme Court has held that “[w]hat transpires in the court room is public property.”46 The SJC conceded that the backup recordings at issue are indeed “the property of the court.”47 Thus, by holding that the backup recordings are not “judicial records” because an official transcript exists, the court’s holding draws a line in the sand, marking where the presumption of access shifts away.
In Massachusetts, the most immediate impact of the SJC’s decision will be felt by filmmakers or artists, such as Audette, who wish to have access to backup room recordings of highly contentious or troubling cases. These are the types of cases that interest filmmakers because the stories being captured usually generate great public interest. A documentary by its own definition is “a work, such as a film, presenting its subject matter factually, often with news films, interviews, and narration.”48 Filmmakers and artists best portray the actual happenings at trials by using the witnesses’ own words, in their own voices. This has the most impact on the audience. Using the recording also allows the filmmaker to preserve the trial, as it happened through the eyes of those that decided the defendant’s fate, for future audiences to experience as if they were there. Without access to the backup room recording, the documentary could lose a measure of its authenticity.
The SJC did allow Audette to purchase a copy of the transcript from the court. However, the SJC did not reverse the lower court’s holding that even if the backup room recording was considered a judicial record the prosecution would have met its burden of showing good cause to have the record impounded. Future litigation will likely raise the difficult question of whether a backup recording that is the judicial record of a public trial can still be concealed from the public in the interest of protecting a child victim. The constitutional question raised would certainly be a difficult one to answer. Indeed, Massachusetts has a history of providing special protections, which conflict with the U.S. Constitution, to the victims of crimes.49 Thus, a court confronted by this scenario, keeping in line with Winfield, may find that the interests of justice are better served by allowing the filmmaker access to the recording.
Mary C. Ambacher, Case Note, Back It Up: Massachusetts Supreme Judicial Court Holds First Amendment and Common-Law Rights of Access to Criminal Trial Do Not Extend to Backup Room Recording, 2 Suffolk U. L. Rev. Online 18 (Feb. 18, 2014), http://suffolklawreview.org/ambacher-winfield.
In United States v. Wurie,1 a police officer, while performing routine surveillance, observed what he believed was an illegal drug transaction between Fred Wade and defendant Brima Wurie.2 After brief questioning about the drug transaction by two officers, Wade admitted to buying the drugs from “B.”3 The officers then notified a third officer, who was following Wurie in his car, and that officer arrested Wurie for distributing crack cocaine.4 At the police station, officers took, among other things, two of the defendant’s cellular phones; one of the phones repeatedly received calls from a number identified by the phone as “my house,” which could be seen in plain view by the officers.5 The officers then opened the phone, revealing a “wallpaper” of a young woman holding a baby, and pressed a button to access the call log on the defendant’s cellular phone, which, in turn, revealed the specific phone number labeled as “my house.”6
The officers suspected that the defendant was lying about his address and involvement with the sale of drugs, so they researched the address associated with the phone number labeled as “my house” and went to that location. They arrived at an apartment and saw the young woman and baby that were pictured on the “wallpaper” of the cellular phone.7 Officers eventually entered the apartment in an attempt to “freeze” it while they acquired a warrant, which ultimately led to the seizure of drugs, guns, and money.8
Wurie was charged with possession of crack cocaine with intent to distribute, distribution of crack cocaine within 1,000 feet of a school, and being a felon in possession of a firearm and ammunition.9 Wurie filed a motion to suppress the evidence obtained as a result of the warrantless search of his cellular phone. The district court denied the defendant’s request, however, and the jury subsequently found Wurie guilty on all three counts.10 Wurie appealed the lower court’s decision, contending that the warrantless search of his cellular phone violated his Fourth Amendment rights because the search conducted by the officers unjustifiably intruded upon his right to privacy.11
The Fourth Amendment protects individuals from “unreasonable searches and seizures.”12 Opposition to the British search and seizure methods inspired the Amendment; it served to protect the privacy rights of citizens against the discretionary powers employed during the colonial period.13 Today, courts have continuously held that warrantless searches are per se unreasonable, unless one of the few exceptions applies.14 The Supreme Court carved out one of these exceptions in Chimel v. California,15 holding that a search-incident-to-a-lawful-arrest permits an arresting officer “to search for and seize any evidence on the arrestee’s person in order to prevent its concealment or destruction” and to search “the area into which an arrestee might reach in order to grab a weapon or evidentiary items.”16 The Court affirmed this principle in United States v. Robinson,17 holding that a warrantless search of a cigarette package on the defendant was valid and did not violate his Fourth Amendment rights.18 The underlying policy justifications for this exception remained the same: officer safety and the preservation of evidence.19
The warrantless search-incident-to-lawful-arrest exception has been applied to most, if not all, of the objects that can be found on one’s person.20 In New York v. Belton,21 the Supreme Court held that police may search a container on the arrestee’s person because the lawful custodial arrest justifies the infringement of the arrestee’s privacy rights.22 The Court reasoned that a “container” includes any object capable of holding another object, such as luggage, boxes, or bags.23 This definition, however, is quite broad and includes more than just objects that can hold an arrestee’s personal belongings.24
Courts are split regarding the constitutionality of warrantless searches of cellular phones incident to a lawful arrest, with a majority of decisions upholding the searches.25 In People v. Diaz,26 the Supreme Court of California held that, under Robinson, a cellular phone could be searched incident to a lawful arrest without any further justification; the lawful arrest justified the search.27 In United States v. Murphy,28 the Fourth Circuit held that the warrantless search of the defendant’s cellular phone was constitutional because of the need for officers to preserve evidence.29 The Seventh Circuit, in United States v. Flores-Lopez,30 agreed with this position, and held that officer safety justified a warrantless search of the defendant’s cellular phone.31 Conversely, in United States v. Park,32 a federal judge in California likened the search of a cellular phone to a Chadwick-type search; the court held that once the police gain control of the phone, they no longer have the ability to search it without a warrant, absent exigent circumstances, because the defendant is no longer in possession of the object and it is not within his immediate control.33 Moreover, the Supreme Court of Ohio held similarly in State v. Smith,34 deciding that a cellular phone is unlike other closed containers because of the high expectation of privacy in one’s phone.35 Lastly, the Florida Supreme Court in Smallwood v. State36 utilized the approach in Arizona v. Gant and declared that once a cellular phone is removed, there is neither a need for officer safety nor a chance that the defendant can destroy the evidence.37
Applying these factors to Wurie, the First Circuit reversed the district court’s decision and held that a warrantless search of a cellular phone, incident to a lawful arrest, violated Wurie’s Fourth Amendment rights.38 The court determined that a cellular phone was unlike any other container because of its ability to hold and store highly personal information, such as addresses, photographs, videos, and messages.39 The court wrote that the government did not prove that officers needed to search the cellular phone under either of the two underlying policy justifications of the exception—officer safety and the preservation of evidence.40 There was no officer safety justification because once officers realized the phone—as well as the data inside it—was not, in fact, a weapon or could harm them, officers had no reason to further inspect it.41 There was no evidence preservation justification, according to the court, because officers could have protected the phone from outside interference without accessing it.42 Indeed, the court reasoned that if there were a genuine threat that the phone’s content could be wiped or overwritten, then the police would routinely use methods of preservation to counteract such threats. Thus, the court saw the risk of evidence destruction as only “theoretical.”43 The court then recognized that the Supreme Court insists on “bright-line rules in the Fourth Amendment context.”44 Based upon this, the court developed a bright-line rule that warrantless searches of cellular phone data are “categorically unlawful” under the search-incident-to-arrest exception.45
The creation of the Fourth Amendment was spurred by its drafters’ intent to create a system that protects privacy interests and personal freedom, a system that, in current times, shields citizens from general warrants and unreasonable searches and seizures. A warrantless search of a cellular phone intrudes upon these essential civil liberties. Although capable of holding something else—under the loose Belton definition of a “container”—a cellular phone has many more capabilities and implicates unique and different privacy concerns. The Supreme Court in Belton could not have imagined the technological developments the future would bring: electronic devices are capable of containing someone’s entire personal life, for example, many today hold pictures of loved ones, videos of friends and family, access to home security cameras, and private messages. As Justice Brandeis once wrote, constitutional provisions must have the “capacity of adaptation to a changing world.”46 Once a cellular phone is accessed, police officers are no longer searching a container; rather, they are entering into the heart of a person’s private life, areas that the founding fathers intended to protect through the Fourth Amendment. With the rapid change and evolution of technology, allowing warrantless searches of cellular phones today could lead to similar searches of future devices with capabilities and privacy concerns far beyond today’s cellular phones. A line must be drawn somewhere, and the court correctly drew it at the warrantless search of a cellular phone under these factual circumstances. The alternative to the First Circuit’s decision in Wurie—allowing courts to apply multi-factor, fact-specific tests to determine the validity of such searches—would be very difficult for police officers to apply in the field.
The First Circuit’s approach not only comports with the underlying policy rationales of the search-incident-to-lawful-arrest exception, it also provides easy to follow guidelines for the police. First, when neither officer safety nor evidence preservation is an issue, officers must obtain a warrant under the search-incident-to-arrest exception. Second, if the police have probable cause that a cellular phone contains evidence of a crime and have an immediate and compelling need to act quickly and are unable to obtain a warrant, then the exigent circumstances exception is applicable and they can proceed with the warrantless search. Gant and its progeny have stated these principles time and time again, and there is no need to depart from such a rule, especially as it applies to highly personal and intimate information containers, to wit, cellular phones. The categorical approach leaves officers with a readily administrable rule to get a warrant first and search later. People’s privacy interests vastly outweigh this undemanding step. Thus, the First Circuit’s holding in Wurie was correct, and courts should continue to require that police officers go through the requisite legal strictures in order to break the seal of privacy.
A cellular phone is not analogous to a container. People are increasingly reliant on cellular phones to communicate, research, and plan their lives, and access to cellular phones’ contents paints a “subjective picture of our life.”47 Because the privacy interests people have in the containers and cellular phones they carry are so different, this is a case where the law has to “[adapt] to a changing world.”48
The Wurie case will by no means end the debate on warrantless searches of cellular phones. In fact, the government filed a petition for writ of certiorari, and the Supreme Court recently granted certiorari on January 17, 2014.49 Currently, police officers have to resolve conflicting constitutional rulings based on the region in which they are policing. Until the Supreme Court resolves these issues, courts will continue to decide these types of Fourth Amendment cases without uniformity.
Anthony J. Gambale, Case Note, First Circuit Prohibits Warrantless Search of Cellular Phones, 2 Suffolk U. L. Rev. Online 12 (Feb. 7, 2014), http://suffolklawreview.org/gambale-wurie.
On October 23, 2013, the SEC released its proposed equity crowdfunding rules.1 The proposed rules, which come over a year and a half after the Jumpstart Our Business Startups Act (JOBS Act) was signed into law, outline the details of how the legislation’s new crowdfunding provisions will function. While many have lauded the new rules as potentially useful for capital-seeking startup companies, this new financing mechanism has two serious limitations. First, crowdfunding will require companies to incur significant costs in order to comply with the annual reporting requirements of the law.2 Second, crowdfunded companies may also face difficulty in acquiring traditional venture capital. This Essay discusses the potential pitfalls of crowdfunding and explores measures that crowdfunded companies can take to avoid them.
Equity crowdfunding is a method of financing in which, generally, large numbers of individuals purchase relatively small dollar amounts of equity in a private company through an online intermediary.3 Unlike other private-placement methods, such as those under Rules 505 and 506 of Regulation D, companies that sell equity through crowdfunding will be able to sell to an unlimited number of unaccredited investors without filing a registration statement.4 Consistent with the JOBS Act, the proposed rules allow companies to sell up to $1,000,000 worth of securities through crowdfunding within a one-year period,5 so long as the offering is conducted through a broker or a funding portal6 and the company meets a number of requirements.7 These requirements include, among other things, making initial and annual disclosures to investors and the SEC,8 and not advertising the terms of the offering except for notices that direct investors to the online intermediary.9
The legislation limits the amount that individual investors may contribute. Investors with an annual income and net worth of less than $100,000 are limited to the greater of $2000 or 5% of their annual income or net worth.10 Investors with an annual income or net worth equal to or exceeding $100,000 are allowed to invest 10% of either their annual income or net worth (whichever is greater) up to $100,000.11
III. Disclosures and De-Crowding
A. Disclosure Requirements
Under the proposed rules, an issuer relying on the crowdfunding provisions of the JOBS Act must make certain initial disclosures to the SEC, investors, and the crowdfunding intermediary.12 These disclosures include the names of the issuer’s directors, officers, and major equity holders;13 a description of the issuer’s business and its capital structure; the risk factors of the business; the terms of the securities being offered; the intended use of the offering proceeds; and the manner in which the offering will be conducted.14 The initial disclosures must also include the company’s financial statements.15 For an issuer raising less than $100,000, the financial statements must be certified by the company’s principal executive officer,16 while issuers raising between $100,000 and $500,000 must have their financial statements reviewed by a public accountant.17 For amounts over $500,000, the financial statements must be audited by a public accountant.18
In addition to these initial disclosures, crowdfunded companies will also be subject to ongoing reporting requirements. A company that raises capital through the crowdfunding provisions will have to file an annual report of its operations and financial statements with the SEC.19 Under the proposed regulations, the annual report must include most of the materials required in the initial filing, except for the information relating to how the offering was originally made.20 Also, the annual financial statements will have to be reviewed in the same manner as they were for the initial disclosures, based on the amount of the offering.21 An issuer will have to continue to comply with these ongoing reporting requirements until the company repurchases all of the securities issued through crowdfunding, becomes a reporting company under the Exchange Act, or liquidates or dissolves the business.22
While the initial disclosures may not be a heavy burden for startup companies because they are a one-time event, the ongoing reporting requirements could become particularly onerous for some enterprises. Indeed, as the SEC noted in the report accompanying the proposed rules, the cost of audited financials alone could be $28,700 per year.23 If a company raises just over $500,000, for example, it could pay over half of that amount just for its audited financials over the course of ten years. As one commentator has noted, companies raising smaller amounts could end up paying more for crowd capital than they would with a credit card.24 Thus, under the current proposal, the ongoing compliance costs may not be worth it for some companies in the long run.
Of course, a high long-term cost does not mean that a company will not crowdfund. Given the difficulty of getting traditional venture capital or angel financing and the near impossibility of receiving a bank loan without substantial cash flow, many companies may ignore the long term and crowdfund anyway. Moreover, there may be some companies whose later-stage growth did not pan out, making the disclosures relatively more costly than anticipated. We could see a whole generation of crowdfunded companies strangled by the reporting requirements and looking for a way out.
How will these companies terminate their disclosures? As previously mentioned, there are only three ways: buy back all of the crowd shares, go public, or go broke.25 Going public would, of course, be the most desirable option. But it is not a viable one for most companies, even if they have decent growth potential and cash flow. This leaves a share repurchase as the only other way. However, a share buy-back could present a serious issue: there is a potential holdout problem. Because the company will have to repurchase all of its crowdfunded shares26—and there could be thousands of shareholders—one stubborn shareholder could keep a company from de-crowding.
C. Share Buy-Back Rights
The easiest way to get around the holdout problem is to ensure that crowdfunded companies have the right to repurchase crowd shares. This can be done contractually or through a provision attached to preferred shares.27 Because of the difficulty of having potentially thousands of crowdfunders sign shareholder agreements, however, the better route will likely be the latter. Under this approach, the company would issue preferred shares to crowdfunders with an optional redemption right attached in favor of the company. This right would be written into the company’s certificate of incorporation and would carry over to any person who subsequently purchased the preferred shares.
The provision itself would likely be structured to give the company the right to purchase the crowdfunded shares for their fair market value28 only upon the occurrence of a particular event. For example, the right could be conditioned on the total number of crowdfunding shareholders falling below a certain threshold. Using this provision, the company could conduct a voluntary buy-back to acquire the majority of the crowd shares. Then, once the threshold has been reached, the company could exercise its optional redemption rights to eliminate any dissenting crowd shareholders.29
D. Squeeze-Out Mergers
Assuming a company’s crowd shares are not subject to an optional redemption right, the traditional way of getting around this problem is through a squeeze-out merger. Under this approach, a group of noncrowd shareholders would purchase as many crowd shares as possible. Afterwards, they would attempt to affect a merger with a newly created shell company to squeeze out the remaining crowd shareholders. Assuming the noncrowd shareholders acquire a sufficient number of the company’s shares,30 they would be able to effect the merger over the dissent of holdout shareholders. Under the merger agreement, the remaining crowd shareholders would receive at least the fair market value31 of their shares in cash, and the shell company would merge into the crowdfunded company. As a result, the shell would disappear, leaving only the formerly crowdfunded company with only noncrowd shareholders.
E. Potential Problems
Unfortunately, both of these approaches to reacquiring shares have potential problems. In the case of an optional redemption right, the inclusion of such a provision in a preferred share issuance would likely chill the initial sale to crowdfunders. Investors, hoping to achieve a high upside on their investment, may be wary of granting the company the right to buy back their shares prematurely. Regarding squeeze-out mergers, the risk of shareholder litigation and the cost of the associated legal legwork would be quite high. While the hurdles would not be as numerous as those for a public company going private, state corporate law would still present challenges. Because the directors of a company and any controlling shareholders owe fiduciary duties to minority shareholders,32 a company would need to take precautionary steps to ensure the transaction was conducted in a fair manner and on fair terms.33 If going-private transactions are any indication, we could see crowdfunded companies attaining fairness opinions and creating special committees,34 both of which are time consuming and expensive.
Most importantly, both of these techniques for de-crowding assume that the company and/or a group of noncrowd shareholders have sufficient funds on hand to effect the repurchase.35 In the startup space, this is a big assumption. These techniques will likely only be used by more established companies with substantial cash flow but not strong growth potential.36 Thus, of the companies that would want to de-crowd, only a very small section of those may be able to. Indeed, the companies most burdened by the costs of complying with the law would be the least likely to have the cash to afford such a repurchase.
IV. Acquiring Venture Funding
A. Potential Problems
Another problem with crowdfunding is that it may inhibit a company’s ability to acquire subsequent financing because venture capitalists are apprehensive about investing in companies with large numbers of unaccredited investors.37 Large numbers of shareholders can mean an investor relations nightmare and a substantial increase in the risk of shareholder litigation.38 These are both issues that venture capitalists would rather avoid.
Of course, this begs the question: why would a crowdfunded company want a subsequent round of venture financing? There are several reasons. First, one million dollars per year may not be enough to properly grow the business. Indeed, in the first quarter of 2013, the average venture capital investment was four million dollars.39 And for some industries, such as biotech, the capital demands tend to be even higher.40 Second, even if one million dollars per year is enough, a crowdfunded company may believe it can get a more favorable and less dilutive price per share from a venture deal than from another round of crowdfunding. Lastly, there are certain nonfinancial benefits to working with venture capitalists. Venture firms can provide guidance on how to run and grow the business and can introduce companies to valuable contacts, such as suppliers, customers, and potential acquirers.41
B. Potential Solutions: No Preemption and the Two-Entity Structure
A crowdfunded company that wants to raise a round of venture capital cannot simply de-crowd the company using the methods previously discussed. A crowdfunded company that is looking for additional capital likely would not have the cash to repurchase crowd shares. Moreover, venture capitalists are unlikely to make any capital injection for the purpose of cashing out crowd shares because they want their investment to be put towards growing the company. Thus, crowdfunded companies looking for funding will need to find other ways to soothe venture capitalists’ concerns.
The first and most important measure that companies should take is ensuring that crowdfunded shares do not have preemption rights.42 If the crowd shareholders have been granted preemption rights, this will likely be a deal breaker for venture funds because of the nature of Rules 505 and 506 under Regulation D. Per Rules 505 and 506, the number of nonaccredited investors allowed to participate in a private placement is limited to thirty-five.43 Should more than thirty-five nonaccredited crowd shareholders hold preemptive rights and want to participate in a round of funding, Rules 505 and 506 could not be used. This would severely hamper a company’s ability to raise capital through a private placement, presenting an unacceptable risk for most venture funds.
The second issue that companies will need to address is regarding the sheer number of shareholders. In order to deal with this, startup companies will want to carefully consider their capital structure before engaging in a round of crowdfunding. In particular, startups will want to consider ways of grouping and separating crowdfunders.
One way startup companies could do this is by assuming a two-entity structure. Under this approach, the founders would initially create a holding company—either a corporation or a LLC—which would, in turn, create a wholly-owned subsidiary to actually run the business (i.e., the operating company). After creating the subsidiary—a corporation44—the founders would cause the holding company to sell shares to crowdfunding investors. Once the holding company receives the cash from the crowfunding round, it would then make a capital contribution to the subsidiary through a share purchase. As a result, the subsidiary would hold all the proceeds from the crowdfunding round and be entirely owned by the holding company, while the holding company would be owned by a combination of the founders and the crowdfunders.
This arrangement would leave the company in a more venture-friendly structure than a single-entity arrangement because all the crowdfunders would be isolated to the holding company and represented as one large shareholder of the operating company. A venture fund looking to invest would simply purchase shares in the operating company, leaving it with only one shareholder to deal with: the holding company. The director(s) of the holding company would be responsible for crowdfunder relations, leaving the venture-appointed directors of the operating company to focus on growing the business. Moreover, this arrangement could simplify the de-crowding techniques discussed in Part III. Should the operating company want to de-crowd at any time in the future, it would only need to repurchase the shares of one shareholder, which would eliminate the potential holdout problem.
Is this type of arrangement (see Figure 1) allowed under the proposed crowdfunding rules? It appears so. Under the SEC’s proposal, the crowdfunding exemption does not apply to, inter alia, companies without business plans or whose only plan is to engage in an acquisition with an unidentified company.45 Also, the exemption does not apply to investment companies.46 This arrangement, however, does not fall within either of these categories because the company whose shares are to be acquired is known, and the holding company would not qualify as an investment company.47
C. Potential Problems with a Two-Entity Arrangement
Of course, this arrangement is not without its drawbacks. The holding company would add complexity as well as additional costs for annual filings and franchise taxes. Also, having two entities makes a future exit transaction more complicated than it otherwise would be, because it may be necessary to merge the holding and operating companies before an IPO or buyout. The two-entity arrangement could also impact the success of the crowdfunding round. Crowd-investors may not understand the need to corral them into a separate entity. Even if they do, individual crowdfunders may be concerned that they are more susceptible to being squeezed out under the two-entity arrangement, a risk that would need to be explained in the initial disclosure.48 This could mean less money or more founder dilution during the initial crowdfunding round.
Regarding the tax implications, a two-entity structure could be more costly for crowdfunders and founders. Depending on how much of the operating company is owned by the holding company, shareholders of the holding company could be taxed at the shareholder, holding company, and operating company levels.49 Fortunately, however, the triple taxation issue likely would not be a problem for most startups. Generally, even if a startup is profitable, all of its excess revenue is reinvested to grow the company and not distributed through dividends. Thus, the holding company and its shareholders would not be receiving any dividends to be taxed. Even if the company needed to make a cash dividend in the future, it could affect a tax-free merger50 beforehand to put the company back into a one-entity structure. Alternatively, the founders could simply structure the holding company as a LLC, making it a tax-transparent entity.51
Perhaps most importantly, this iteration of the two-entity arrangement would have the unintended effect of corralling the founders along with the crowdfunders. This could be problematic because the company would be unable to cash out crowdfunders through a repurchase of the holding company’s shares without also cashing out the founders at the same time. Also, the arrangement could complicate founders’ relationships with venture financiers and create potential conflicts of interest.
The corralling problem, however, could be avoided by tweaking the two-entity structure. This could be done by having the operating company initially owned by the founders instead of the holding company. Once the entities were set up, the founders would cause the holding company to sell shares to crowdfunders and dilute their holdings effectively to zero.52 After that, the holding company would use all of the proceeds to purchase newly issued shares in the operating company. The terms of the issuance could be governed by a contract between the holding company and the operating company that was executed before the crowdfunding and was disclosed to crowdfunders. Thus, the price and percentage of equity that the holding company would be purchasing would be known before the crowdfunding. The result of this arrangement would be that the operating company would hold all the cash and be owned by both the founders and the holding company. The operating company could then bring on venture investors in the same manner as in the first iteration.
It is less clear whether this second iteration (see Figure 2) is allowed under the proposed crowdfunding regulations. Under the SEC’s proposal, investment companies or companies that would be investment companies but-for the exemptions of Sections 3(b) and 3(c) of the Investment Company Act53 may not use the crowdfunding exemption.54 Investment companies, in turn, include any issuer which (1) “is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities” and (2) “owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets.”55 Under the second prong of the definition, “investment securities” do not include securities issued by majority-owned subsidiaries of the owner.56 This means the first iteration would be okay because, at the time of the crowdfunding, the operating company would be wholly-owned. Under the second iteration, however, the operating company would be owned by the founders, not the holding company. Thus, the holding company would arguably be in the business of owning the securities of the operating company, and it would certainly be proposing to acquire “investment securities” with a value of greater than 40% of its assets.
As discussed in Part III, the costs of annual reporting for crowdfunded companies could be quite high. As a result, it is likely that we will see some companies in the future looking to de-crowd. Doing so, however, will present challenges. Large numbers of relatively small investors and the SEC’s proposed rules mean that holdout shareholders could be a serious problem. In order to get around them, companies seeking crowdfunding will need to act with foresight and ensure they have a repurchase right. If not, they may be forced to undertake the more risky and costly approach of a squeeze-out merger.
Of course, because the SEC’s proposed rules are not final, the difficulty of de-crowding might still be mitigated. If the SEC changes its rule by terminating ongoing reporting requirements once the number of crowdfunders falls below a certain threshold—for example, thirty-five—this would greatly lower the risk of a holdout and make it easier for companies to de-crowd. However, even if the SEC adjusts the termination conditions, companies will still need to have the cash on hand to buy back crowd shares. This means many startups, short on cash, will likely be stuck eating the cost of annual disclosures.
As discussed in Part IV, crowdfunded companies who are seeking venture capital will need to act proactively to make themselves more appealing. Most importantly, crowdfunded companies should ensure that they do not grant crowdfunders preemption rights. Also, companies may want to consider isolating crowd shareholders in a separate legal entity before seeking venture financing. This will decrease the number of shareholders the venture fund has to deal with, allowing them to focus on growing the company. As far as what the structure should look like, it appears that the first iteration discussed would be allowed under the proposed regulations, but it has the draw-back of lumping founders in with crowd shareholders. The second iteration, while it eliminates this problem, may not be allowed under the proposed rules.
What does all this mean for startups? Companies considering crowdfunding should evaluate their options very carefully. Once crowd shareholders are brought on board, they will be costly and difficult to get rid of. Moreover, crowd shareholders could prevent some companies from acquiring the venture financing they need. While crowdfunded companies can adopt a two-entity structure to make themselves more venture-friendly, this arrangement comes with a number of costs.
Byron Crowe, Essay, After Online Equity: De-Crowding and Accommodating Venture Capital, 2 Suffolk U. L. Rev. Online 1 (Jan. 31, 2014), http://suffolklawreview.org/crowe-crowdfunding.