Crowdfunding and Fiduciary Obligations

The term “fiduciary obligations” sends a chill down the spine of corporate lawyers – although some may object to using the word “spine” and “corporate lawyer” in the same sentence.

A person with a fiduciary obligation has a special legal duty. A trustee has a fiduciary obligation to the beneficiaries of the trust. The executor of an estate has a fiduciary obligation to the beneficiaries of the estate. The fiduciary obligation is not an obligation to always be successful, or always be right, but rather an obligation to try your best, or something close to that. A trustee who fails to anticipate the stock market crash of 2008 has not breached her fiduciary obligation. A trustee who fails to read published reports of a company’s impending bankruptcy before buying its stock probably has.

A person with a fiduciary obligation is required to be loyal, to look out for the interests of those under her care, to put their interests before her own.

By law and longstanding principle, the directors of a corporation have a fiduciary obligation to the corporation and its shareholders. In the classic case, a director of a corporation in the energy business took for his own benefit the opportunity to develop certain oil wells. Foul! cried the court. He has breached his fiduciary obligation by failing to pass the opportunity along to the corporation, to which he is a fiduciary.

Modern corporate statutes allow the fiduciary obligations of directors to be modified, but not eliminated, even if all the shareholders would sign off. If the corporation is publicly-traded, the exchange likely imposes obligations on the director (and the President, and the CEO, etc.) in addition to the fiduciary obligations imposed by state corporate law.

Which takes us to Crowdfunding. crowd funding word cloud

Most deals in the Crowdfunding space are done in a Delaware limited liability company. The Delaware Limited Liability Company Act allows a manager – the equivalent of a director in a corporation – to eliminate his fiduciary obligation altogether. If I’m representing the sponsor of the deal then of course I want to protect my client as fully as possible. And yet, I’m not sure that’s the best answer for the industry overall.

The U.S. public capital markets thrive mainly because investors trust them, just as the U.S. consumer products industry thrives because people feel safe shopping (that’s why securities laws and consumer-protection laws, as aggravating as they can be, actually help business). My client’s investors may or may not pay attention to the fiduciary duty sections of his LLC Agreement, but I wonder whether the Crowdfunding market as a whole can scale if those running the show regularly operate at a lower level of legal responsibility than the managers of public companies. Will it drive investors away?

Part of my brain says that it will, and yet, over the last 25 years or so, as corporate laws have become more indulgent toward management and executive pay has skyrocketed, lots of people have wondered when investors will say “Enough!” It hasn’t happened so far.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

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