Mgmt 520

PART A

Paul and Thomas Franklin, brothers, are college students and web designers. While at the University of Megalopolis, a private, for-profit college in the “Quad State” area, they started an online chat service called FaceLinked. Paul attended and resided at the college’s campus in the State of Quadrahenria. Thomas, who was on probation during college for a low level felony drug conviction, could not be a resident student and took classes at the campus in the Commonwealth of New Guernsey campus. The chat service began by putting information from the school’s student directory online, and offering blog, chat, and message board features. FaceLinked was such a hit that within a year, the school advised the brothers that they had to remove FaceLinked from the university’s server as it was utilizing too many resources. This was not a problem as the Franklins found advertisers, so they were able to move FaceLinked to a private server without charging user fees. In fact, FaceLinked was earning so much revenue that the Franklin brothers were able to pay themselves and the six friends who helped them start and operate it salaries. The Franklin brothers are graduating from the University of Megalopolis and will be attending separate graduate programs. Paul will attend Quadrahenria State University, and Thomas the College of New Guernsey. As FaceLinked is so successful, the brothers not only plan to expand it to the two new colleges that they are attending, but to as many other colleges within the four states comprising the “Quad State” area as possible. They even have hopes of “going national.” As part of their plan to expand to other campuses, they expect to recruit a student from each of the new schools “to get them in.” They wish to formalize FaceLinked by organizing it as a proper business. The brothers would like to maintain a majority interest in the business, give about 20 percent to the six friends from their undergraduate days who helped them run the service, and use the remaining interest in the business to attract other investors and use employee incentives.

They seek your advice on (a) the form of business they should use, (b) who might have a claim on the business, and (c) how they might protect themselves from claims regarding a computerized internet platform?



PART B

FaceLinked has been a phenomenal success for over ten years. They are now a worldwide social networking phenomenon. Over the years and the various incarnations of the business enterprise, they are now a corporation with just under 100 shareholders. In anticipation of a public offering, they have just completed a private stock offering and allowed several of the initial equity owners to exercise stock options. The Franklin brothers each exercised options to purchase 10,000 shares for $5 a share. Also in anticipation of the public offering, pursuant to the early intervention drug plea he made while in college, Thomas Franklin had his conviction expunged. In addition, FaceLinked sold $10 million in two year advertising contracts, which would allow the clients to back out for a 90 percent refund. These unusual contracts increased their current revenue by 15%. As FaceLinked is such a phenomenon, the hype regarding the public offering has been enormous. Even college students are attempting to buy the stock. Days before the public offering, the following occurred: (a) a broker at their underwriter, Silversmith & Baggs, showed a pension fund director a draft version of the prospectus; (b) Paul sold 1000 shares of the stock that he purchased through the stock option plan for $45 a share, telling the private investor that the issue price for the public offering would be at least $60 a share; and (c) several of the people who bought stock in the private offering sold it at a nice profit. The initial public stock offering had many problems. The NASDAQ computer system, which was implemented pursuant to a recent regulation change by the Securities And Exchange Commission (SEC), could not keep up with the demand. The system could not accurately report the price, and many day traders, including Big Profit Hedge Fund, lost money. Big Profit had formally filed its opposition to the SEC’s regulation when it was proposed. After the public offering was completed, FaceLinked stock stabilized at $40 a share, well below the initial offering price of $70 a share. In light of the fiasco of the public offering and the bad press that it generated, users began to drop FaceLinked in favor of a new, upstart rival service offered by TronCom. Fearful that the new advertisers would back out of their contracts, the Franklin brothers sold a great deal of their stock.

What issues does FaceLinked, its officers, and stockholders face under (a) state securities law, (b) the Securities Act of 1933, and (c) the Securities and Exchange Act of 1934? (Points : 60)