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Checkbook IRA

Checkbook IRA – Checkbook LLC

Whatever You Call It –There’s Trouble Ahead

A recent case has shed light on one of the riskiest retirement plan strategies put forth by promoters. In McNulty v. Commissioner (157 T.C. 10) a U.S. Tax Court brought clarity to the scheme of using self-directed IRAs for personal investments. While the rules are strict, they had become lax and unenforced in recent years. The McNulty case brings the requirements back into line, and serves as a warning of what may come.

If you have a checkbook IRA or LLC you may want to speak with your lawyer immediately.

The facts in McNulty are fairly common. We have seen such promoters at investment conferences for years.

In August 2015 Mrs. McNulty purchased services from Check Book IRA, LLC (Check Book), through its website, that included assistance in establishing a self-directed IRA and forming an LLC to which she would transfer IRA funds though purchases of membership interests and then purchase American Eagle (AE) gold coins using IRA funds. During 2015 Check Book’s website advertised that an LLC owned by an IRA could invest in AE coins and IRA owners could hold the coins at their homes without tax consequences or penalties so long as the coins were “titled” to an LLC.

So, Mrs. McNulty used the company to set up Green Hill Holdings, LLC (Green Hill) to own the coins. Green Hill was then owned by her IRA.

There were a few problems with this. First, an IRA trust must be administrated by an independent trustee, not the beneficiary of the retirement assets. The trustee is responsible for storing the coins in an adequate vault. In this case, Mrs. McNulty, following the promoter’s advice, took personal possession of the coins herself and held them in her own safe at home.

McNulty and the IRS made numerous arguments and counterarguments as to why the whole chain of events was either appropriate or amiss. The court could have decided the case on a number of issues but chose just one — this is important and we will come back to it.

The Tax Court noted that an owner of a self-directed IRA is entitled to direct how her IRA assets are invested without forfeiting the tax benefits of an IRA, and that a self-directed IRA is permitted to invest in a single-member LLC.

However, IRA owners cannot have unfettered command over the IRA assets without tax consequences. The Tax Court stated that it was on the basis of Mrs. McNulty’s control over the American Eagle coins that she had taxable IRA distributions.

A qualified custodian or trustee is required to be responsible for the management and disposition of property held in a self-directed IRA. A custodian is required to maintain custody of the IRA assets, maintain the required records, and process transactions that involve IRA assets.

The presence of such a fiduciary is fundamentally important to the statutory scheme of IRAs, which is intended to encourage retirement saving and to protect those savings for retirement.

The Tax Court emphasized that independent oversight by a third-party fiduciary to track and monitor investment activities is one of the key aspects of the statutory scheme; that when coins or bullion are in the physical possession of the IRA owner (in whatever capacity the owner may be acting), there is no independent oversight was clearly inconsistent with the statutory scheme; and that personal control over the IRA assets by the IRA owner was against the very nature of an IRA.

The Tax Court concluded Mrs. McNulty had complete, unfettered control over the American Eagle coins; that she was free to use them in any way she chose; and that this was true irrespective of Green Hill’s purported ownership of the American Eagle coins and her status as Green Hill’s manager.

Once Mrs. McNulty received the American Eagle coins, there were no limitations or restrictions on her use of the coins, even though she asserted that she did not use them. While an IRA owner may act as a conduit or agent of the IRA assets, an owner of a self-directed IRA may not take actual and unfettered possession of the IRA assets. It is a basic axiom of tax law that taxpayers have income when they exercise complete dominion over it. Constructive receipt occurs where funds are subject to the taxpayer’s unfettered command and she is free to enjoy them as she sees fit.

The Tax Court concluded that Mrs. McNulty’s possession of the American Eagle coins was a taxable distribution. Accordingly, the value of the coins was includible in her gross income. The Tax Court noted that the McNultys’ arguments to the contrary would make permissible a situation that was ripe for abuse and that would undermine the fiduciary requirements of the act. Mrs. McNulty took position of the American Eagle coins and had complete control over them. Accordingly, she had taxable distributions from her IRA in excess of $300,000 — a painful financial mistake.

We have long warned about the risks of the check book scheme. In my 2015 book Finance Your Own Business the hazards were enumerated with the conclusion being “The safer course is to stay away from Checkbook IRAs.”

Interestingly, some promoters claim that the McNulty case is limited to situations in which gold coins were taken into personal possession. But that narrow view misreads the whole case. (Indeed, if they argue otherwise ask for a legal opinion letter on the viability of the Checkbook LLC.)

Remember when we said the court chose just one issue as a discussion point? The court mentioned numerous prohibited transactions (rule violations) and problems with the Checkbook scheme. But it focused on just the physical possession of the coins in this specific case.

The court may be doing everyone else using a Checkbook IRA a huge favor. The court may be signaling that future limitations on the scheme are coming. The court may be giving everyone a head’s up that its time to change your Checkbook IRA structure.

Be sure to talk to your own attorney about this. But here is a scenario to consider: Let’s say you are the manager of the LLC that controls your IRA investments. As such, you have management control over your IRA assets. You are keenly aware that the court in the McNulty case stated: “Personal control over the IRA assets by the IRA owner is against the very nature of an IRA.”

So to clean things up you need to step aside as manager of the Checkbook LLC. You appoint your CPA or attorney or other fiduciary as the manager so that you no longer have any personal control over your retirement assets.

If the IRS ever later questions you on such a move you tell the truth. You had initially been led to believe that the Checkbook IRA scheme was acceptable. But then you learned of the McNulty case. And in an attempt to follow IRS guidance you appointed a new, non-related fiduciary to serve as the LLC manager overseeing your personal IRA investments. You have made a good faith effort to be compliant with their rules in light of new information. Instead of doing nothing, by taking prompt corrective action you are in a much better position to ask for forgiveness.

The McNulty case is not the only challenge to the Checkbook LLC. Proposed legislation in Congress also seeks to crack down on IRA abuses. Talk to your professionals now to stay ahead of what is coming.  

Piercing the Corporate Veil – How to Avoid It

50% of piercing the veil court cases nationwide succeed because owners are failing to properly follow corporate formalities. This exposes business owners to personal liability – meaning they can lose their possessions.

What is the Corporate Veil?

What is the corporate veil? How can it protect me and what does it mean when it is pierced? We’ll cover these ideas critical to liability, wealth and asset protection. By properly forming a corporation, LLC or Limited Partnership (LP) and taking the steps required of corporate formalities, a corporate veil is raised that may protect shareholders, officers and directors from personal liability and provide tax benefits. However, to ensure that the corporate veil remains intact and business meets its potential, all persons involved in the corporation must follow certain corporate formalities. (While we refer to corporations in this article, the concepts and issues apply to LLCs and LPs as well. Don’t be misled by those who claim that the need for following formalities only applies to corporations.)

If you fail to follow the requirements of corporate formalities, you could be vulnerable to court decisions which pierce the corporate veil. Today, 50% of piercing the veil court cases succeed because owners are failing to properly follow corporate formality requirements.

This topic is so important, I wrote a book on it!

Veil Not Fail

Upcoming book!

When protective entities like LLCs and corporations fail and businesses risk piercing of the corporate veil, experienced legal guidance is imperative. In Veil Not Fail, the author explores potential risks and weak spots in LLCs and corporations and helps readers better prepare for what he considers an inevitability in a sue happy society ― it isn’t if you’ll be sued…it’s when.

Ebook prelaunch, April 2022 at

RDA-Press.com

 

Definition of Piercing the Corporate Veil

A situation in which courts put aside limited liability and hold a corporation’s shareholders or directors personally liable for the corporation’s actions or debts. Veil piercing is most common in close corporations. While the law varies by state, generally courts have a strong presumption against piercing the corporate veil, and will only do so if there has been misconduct like abuse of the corporate form (e.g. intermingling of personal and corporate assets) or undercapatitalization at the time of incorporation. (Undercapatitalization would apply if the corporation never had enough funds to operate, and was not really a separate entity that could stand on its own).

If corporate formalities such as annual corporate filings and meeting minutes are not maintained in a timely and proper manner, courts can hold YOU, the entity’s owner, personally responsible for claims filed against the company. You need to keep your corporation filings current, and your legal protections intact.

How to Prevent Piercing the Corporate Veil

Limited liability and tax benefits are not a right granted to every business person, but privileges earned by following corporate formalities. The following nine rules provide general guidance for maintaining the corporate veil while conducting business through a corporation:

  • Perform all annual filings;
  • Maintain internal formalities, including having a resident agent in their state of formation and in any state the company qualifies to do business in;
  • Maintain a written record of corporate decisions;
  • Provide the world with corporate notice;
  • Ensure the corporation is sufficiently capitalized;
  • Maintain the distinction between corporate assets and personal assets;
  • Use caution when distributing corporate profits;
  • Separate bank accounts; and
  • Separate tax returns

Although the burden of maintaining corporate formalities may not be appealing, the consequences of neglecting corporate formalities are great. Whether the corporation has followed the foregoing rules becomes important when a creditor seek to receive payment through the assets of the corporation’s individual shareholder, director or officer. Each rule and its various implications are discussed more in depth below.

If you are unsure if you are in compliance or would like hire Corporate Direct to ensure that you are, we offer a service to assist.

Get Our Corporate Clean-Up Service

  • We prepare your first Corporate Minutes.
  • We perform the research and analyze if you are current in all areas of the corporate formalities and whether or not your entity is positioned for full protection.
  • We do all the work necessary to bring your affairs current to verify you are legally compliant and you save time.

We have helped clients become compliant after as much as 23 years of improper record keeping. But remember, it’s important to have the corporate veil properly maintained before a lawsuit or claim is brought against a corporation. Once that happens, its too late and personal assets can be jeopardized.

How to Raise the Corporate Veil

Once you have decided that a corporation, LLC or Limited Partnership (LP) is the right entity for your business or asset holding purpose and you have decided which state to incorporate in, corporate formalities begin. Events occurring immediately after formation must be performed properly to maintain the corporate veil and ensure the corporation’s longevity and flexibility.

A corporation is born when the Articles of Incorporation are properly filed. The corporate veil provided Shareholders with limited liability and is raised and maintained by management and ownership that treats the corporation like a corporation. As indicated above, a corporation is considered to be a legally distinct entity, capable of incurring its own debts and obligations. This protection is frequently referred to as the corporate veil. When creditors or others seek to obtain a judgement from a court that makes the corporations shareholders, directors or officers personally liable, they are seeking to pierce the corporate veil. This article will focus mostly on maintaining the corporate veil once it has been established, but briefly here are the requirements needed to set it up:

  • File the Articles of Incorporation
  • Hold organizational meetings to empower the corporation to conduct business and provide limited liability.
  • Provide the corporation with competent initial management
  • Issue the corporation’s shares of stock

Maintaining the Veil by Maintaining Corporate Formalities

Performing Annual Filings

Annual filings are required to protect and ensure the longevity of the corporation. In addition to the permits, licenses, or approvals that are unique to the corporation’s business, every corporation must obtain and maintain a corporate charter in good standing. In many states, a corporation must file an annual report, providing the names and addresses of Officers and Directors, and annual fees. If such filings are not completed in a timely fashion, the state may revoke the corporate charter and the corporation will cease to exist. The time, energy, and expense expended organizing the corporation will be wasted if the state revokes the corporate charter. While it may be possible to have the charter reinstated, the best way to maintain the corporate veil and ensure that the corporation serves its purpose is to simply perform annual filings in a timely manner.

Maintaining Internal Formalities

Bylaws adopted by the Directors in their organizational meeting provide the guidelines for the corporation’s future actions and corporate policy. Specifically, the Bylaws should provide the following:
1. Notice requirements for Directors meetings;
2. The minimum number of annual Directors meetings;
3. The date for annual Shareholders meetings;
4. The requirements for special Shareholders meetings;
5. The responsibilities of each Officer and Director; The procedures for removing Officers or Directors;
6. The procedures for Shareholders’ inspection of the corporation’s records; and
8. The name and address of the corporation’s resident agent.

Although they shape the internal operations of the corporation, Bylaws should not be complicated or provide intricate procedures. Necessity determines the extent and detail provided in the corporation’s Bylaws, which may be amended, altered, or repealed by the Board of Directors.

All decisions the corporation makes and all actions the corporation takes should be in compliance with the rules established by the Bylaws. Compliance with the Bylaws indicates that the corporation’s Directors, Officers, and Shareholders treat the corporation as a separate entity with its own rights and limitations. If the Directors, Officers, and Shareholders treat the corporation as a separate entity, courts will be less likely to ignore the division between corporate property and the rights of the individual Directors, Officers, and Shareholders. The corporate veil will be maintained.

As well, in most states it is imperative to have a current resident agent to accept service of process. Failure to have a resident agent in place can lead to arguments that the corporate veil should be pierced.

Maintain a Written Record of Corporate Decisions

Even if a small group of people or a single person controls the corporation, it should conduct meetings and prepare records of such meetings. Shareholders and Directors conduct three types of meetings, which should each be recorded through minutes of meetings. As provided above, immediately following incorporation, organizational meetings should be conducted. During the corporation’s life, regular meetings must be conducted annually pursuant to the corporation’s Bylaws to reflect elections and the corporation’s other decisions. Additionally, a corporation may hold special meetings when called by the Directors or Shareholders. Special meetings are held to discuss urgent items of business or to approve any legal or tax issues. The general procedure for conducting Directors or Shareholders meetings is provided below.

Prior to a meeting of Shareholders, all Shareholders must receive or waive notice of the meeting. Prior to a Directors’ meeting, all Directors must receive or waive notice of the meeting. In meetings of Shareholders or Directors, corporate formalities require voting and an official record of actions taken at the meeting. The official record of actions taken in regular meetings, as well as the organizational meetings, is provided as the minutes of the meeting. Minutes provide a record of the corporation’s resolutions. A resolution is a document that records actions that the Directors or Shareholders “resolve” to take on the corporation’s behalf. The nature and timing of the corporation’s decisions dictate whether a resolution or minutes of a meeting provide an appropriate record of a decision.

An alternative in most states to conducting actual meetings and preparing minutes for those meetings is for the corporation to authorize action by written consent. This is the quickest and easiest way to document formal corporate action. Directors and/or Shareholders sign a document that contains the language of the corporation’s decision or resolution. By signing the document, the Directors and/or Shareholders approve the decision or resolution. To ensure that an action by written consent is adequately documented, all Directors and/or Shareholders must sign the consent form. The corporation should keep signed consent forms in the corporate minute book.

By conducting the necessary meetings and preparing adequate records, a corporation provides documentation to protect the corporate veil. Should a creditor seek to pierce the corporate veil at a later date, the corporation’s records will serve as evidence of its separate existence. In addition, maintaining proper records may help to avoid future miscommunications and misunderstandings within the corporation.

Although many people believe that preparing annual meeting minutes is difficult, the minor inconvenience is greatly outweighed by the potential problems that failing to prepare such records could cause. If necessary, a service provider may prepare the required minutes for the corporation for a reasonable fee. Our firm charges $150 per year to prepare minutes. You may call toll free 1-800-700-1430 for more information.

Provide the World with Corporate Notice

Whenever the corporation enters into a contract or engages in any business activity whatsoever, it must do so clearly as a corporation. Individual Officers or Directors may be subject to personal liability if they act on the corporation’s behalf, but fail to clearly indicate that they are acting in their capacity as the corporation’s Officer or Director. To avoid creditors or others from piercing the corporate veil and attacking individual members of the corporation’s management or Shareholders, it must be clear that the corporation, and not an individual, is acting. Business cards, letterhead, invoices, company checks, brochures, etc … must identify the corporation. The full name of the corporation should be provided (not XYZ, but XYZ, Inc.). All contracts and correspondences signed by Directors or Officers for the corporation should be signed with reference to their corporate designation. If the corporation takes steps to ensure that others know that the corporation, and not an individual Officer or Director is acting, the corporate veil will be more resistant to attack.

Avoid Under-Capitalization

Although most jurisdictions will not allow creditors to pierce the corporate veil solely because the corporation had insufficient assets, the risk of veil piercing provides reason to ensure that the corporation is sufficiently capitalized. California and few other states have relied on under¬capitalization in piercing corporate veils. A corporation should have sufficient resources to meet its short-term obligations whether it is just starting, is part of a cooperative project, or is merely one element in a greater corporate strategy. If the corporation is undercapitalized, a creditor may argue, and a court could accept the argument, that the corporation exists simply to help its owners shelter their assets. As is discussed further below, this may be enough reason for a court to pierce the corporate veil and find personal liability for Officers, Directors, and/or Shareholders.

Maintain the Distinction between Corporate and Personal Assets

A common but fatal mistake for developing corporations occurs when its management and/or Shareholders fail to maintain the distinction between corporate and personal assets. Whether arising from loans from the corporation to individuals, shared bank accounts, shared tax returns, or individual use of corporation property, failure to separate corporate assets from personal assets negates the corporation’s separate identity. To prevent creditors from piercing the corporate veil, the corporation must maintain a separate bank account, file separate tax returns, and use corporate assets only for corporate purposes.

The corporation should not be used as a lender for its Officers, Directors or Shareholders. An air of impropriety is created when a corporation loans money to members of management, even if management genuinely intends to repay the loan. The infamous chain of corporate scandals in spring and summer 2002 highlighted the dangers involved in loaning to management, as such loans were often cited in allegations that a Director or Officer breached their fiduciary duties. The best way for the corporation to avoid potential problems is to refuse to lend money to its Directors and Officers.

Regardless of their personal interest or role in the corporation, nobody should treat the corporation’s property as personal property. By clearly distinguishing between corporate and personal assets, the corporation may indicate and retain its separate identity. By reporting and maintaining the corporate assets separately from management’s or Shareholders’ personal assets, the corporation will reduce the potential for successful lawsuits against Officers, Directors, and individual Shareholders.

Cautiously Distribute Corporate Profits

Whether a corporation distributes its profits through dividends paid to shareholders or compensation paid to employees, the corporation’s distribution of profits may provide a basis for creditors to pierce the corporate veil. The veil that limits the liability of Shareholders, Directors, and Officers also creates limitations on the corporation’s ability to pay such corporate actors from the corporation’s profits. If the corporation fails to obey established rules for the distribution of corporate profits, a creditor may use such failure as an indication that the corporate actors are not treating the corporation as a separate legal entity. To reduce creditors’ ability to pierce the corporate veil, the corporation must exercise caution in distributing its profits.

Every state authorizes a corporation’s Board of Directors to issue dividends to its Shareholders. However, the Directors’ decision to declare dividends may result in substantial fines assessed against the individual Directors if the dividend is found to be illegal. Dividends from surplus cannot exceed limits established by reference to the corporation’s assets. “Nimble” dividends, or dividends paid from profits, may be issued when the corporation’s surplus is insufficient. However, such dividends may only be paid when such payment does not impair the capital representing preferred stock. Directors must determine whether the corporation has sufficient funds legally available to pay dividends to protect themselves from potential liability. To avoid liability arising from the issuance of dividends, corporations should consult with legal counsel before deciding to issue dividends.

Keep a Separate Bank Account

A corporate veil will be pierced in cases where the company founders use a personal bank account for business affairs. You cannot consistently pay business expenses from a personal account and, conversely, you cannot pay personal expenses from a company bank account. Failure to follow these simple guidelines can be catastrophic, so as soon as you incorporate obtain an EIN (Employer Identification Number) from the IRS and use it to open a corporate bank account.

Prepare a Separate Tax Return

Because you have obtained an EIN for your entity you must now file a separate tax return with the IRS. Fear not, this is your chance to take all the deductions you may be entitled to take. But failure to file a separate return can lead to claims that you are not following corporate formalities. So file – and take advantage of the tax benefits you are entitled to in the first place.

Many developing corporations do not have sufficient assets or profits to distribute dividends to Shareholders, but they must compensate Officers, Directors, or other employees for their services. Especially in start-up businesses, the compensation a corporation pays to Officers, Directors, and other employees may determine the corporation’s ability to succeed. Equity compensation (using shares of the corporation’s stock, stock options, or other alternative forms of compensation) may be attractive. Compensation based in part on the corporation’s profits may also be appealing. However, all forms of compensation should be based primarily upon the market value of the employee’s services. The Internal Revenue Service may scrutinize excessive compensation paid to Directors, Officers, or employees and decide to tax excessive compensation as dividends.
Corporations that over-compensate their employees may create liability for the Directors based on Shareholders’ claims of mismanagement, breach of fiduciary duties, self-dealing, or waste of corporate assets. Through a derivative action, the Shareholders may regain control of the corporation and its assets. The corporation may then assert legal claims against former Directors, creating personal liability for such Directors. To avoid potential liability based on employee compensation and excessive tax liability, Directors must ensure that compensation paid by the corporation is reasonable.

All decisions regarding the distribution of a corporation’s profits or compensation for employees is subject to the discretion of the Board of Directors. However, to avoid potential liability for the corporation and for themselves, Directors must carefully consider the effects of every use of the corporation’s assets. Caution and the advice of legal counsel may be necessary to prevent the Board’s distribution decisions from creating unwanted liability.

State Differences

Some states are more likely to pierce the corporate veil than others. As well, in some states veild piercing cases are brought more often. The top five states in order of most cases filed are:

  1. New York,
  2. California,
  3. Texas,
  4. Ohio and
  5. Pennsylvania.

As you would expect, the filings reflect population density. But they also reflect the states in which the strategy may be successful.

On a national basis, nearly 50% of veil piercing cases were successful, which is all the more reason to be cautious when dealing with corporate formalities.

The Wyoming DAO LLC

Is a Decentralized Autonomous Organization (DAO) Right For You?

A DAO is an organization operated by a smart contract, which is a computer code running within the blockchain. The ‘A’ for Autonomous refers to the self-executing nature of it all. If a condition is met the computer code executes the transaction. There is no need for human managers, with all their failings, to be involved. The contract provides management certainty.

The DAO concept is advocated as a benefit for those from around the world with common goals who may not know or trust each other. You come together for a common project and the smart contract guides the beneficial way.

But there is one big problem with an ordinary DAO: There is no asset protection. Essentially, you and all of your like-minded DAO compatriots are operating as general partners, with unlimited personal liability.

Hence, the Wyoming DAO LLC.

The state of Wyoming is on a mission to be the best jurisdiction for all things blockchain. And in realizing that a DAO had a legal gap, they had their legislature provide a legal solution. A DAO can now be organized as a Wyoming LLC. You and your partners can now autonomously operate with the solid protection of Wyoming’s very strong LLC laws.

The requirements aren’t difficult. You need to have a Wyoming registered agent and pay the annual state fees. Your official LLC name must include the wording ‘DAO LLC,’ as in Betty’s Plumbing DAO, LLC. You can list yourself, a human, as a manager or you can choose to be algorithmically managed. Meaning your DAO LLC can be managed by artificial intelligence – or AI. Who thought science fiction would ever come to corporate governance?

Wyoming DAO Chart

But therein lies the largest detraction to the DAO LLC. By being algorithmically managed via a smart contract (which is your own LLC’s Operating Agreement) you are giving up some privacy.
Smart contracts operate on the blockchain. And the blockchain is out there for all to see. So by knowing the entity name – Betty’s Plumbing DAO, LLC – for example, someone can go online to read Betty’s Operating Agreement. They can access her operational road map and internal strategies.

Many of our clients prefer their entity’s governance to remain confidential. So when it comes to balancing autonomous with anonymous, privacy wins. A human manager following a confidential Operating Agreement is preferred by most.

To date, we have not formed any DAO LLCs due to this privacy limitation. It will be interesting to see if and when the state of Wyoming deals with this gap in an otherwise unique and useful corporate structure.

Has The Time Come For Cyber Bounty Hunters?

The Colonial Pipeline shutdown last week raised troubling questions. How vulnerable is our own infrastructure to  cyber attacks? Should cyber pirates be paid, as they were by the Colonial Pipeline authorities?

Most importantly: What can we do to prevent such attacks?

Incentives usually work.

I wrote about this in Chapter 13 of my newest book, Scam-Proof Your Assets: Guarding Against Widespread Deception

A bounty hunter is someone who captures criminals for a “bounty,” a payment for providing a public service.

In the Old West, local sheriffs were sometimes unable to track down outlaws alone. They couldn’t do that and protect their town at the same time. So they put up wanted posters offering rewards for an outlaw’s capture, Dead or Alive. Bounty hunters responded, and tracked down the outlaws for the reward. For example, the reward for the capture of Jesse James was $5,000, an enormous amount of money at that time, equal to over $112,000 in today’s dollars.

Although the term “bounty hunter” evokes images of vigilantes in the Old West, the term “bounty hunter” was not in use in this context in the 1800s. Rather, the term relating to “one who tracks down and captures outlaws” arose around the 1950s in pulp fiction and Hollywood westerns. In 1954, Elmore Leonard published The Bounty Hunters. In the same year, The Bounty Hunter, a 1954 western film was released by Warner Brothers. The movie, starring Randolph Scott, was the first film to feature a bounty hunter as its hero. Have Gun-Will Travel was an American Western series that was broadcast by CBS on both television and radio from 1957 through 1963. The TV series featured Richard Boone as Paladin, a gentleman gunfighter who typically charged $1,000 per job and traveled around the Old West working as a mercenary for hire. Similarly, Wanted Dead or Alive was a CBS bounty hunting Western airing from 1958 through 1961. Recently, Leonardo DiCaprio played Rick Dalton, the fictional TV star of Bounty Law in Quentin Tarantino’s Once Upon a Time…in Hollywood.

In modern times, bounty hunters generally are known as bail enforcement agents, and they mostly carry out arrests of criminal defendants who have skipped bail and failed to appear at their trials. In some states there is no formal training for bail enforcement agents, and they are unlicensed. In other states, there are varying standards of training and licensing. The state of Nevada has very strict statutory and administrative requirements for bail enforcement agents. The risks can be great.

Local law enforcement agencies also offer rewards in high-profile cases. Funding sometimes comes from outside private donors who provide money to help solve specific crimes. As well, some cities and towns have set up Crime Stopper programs for anonymous tips.

Incentives also work in the field of cyber security. Governments and private companies offer “bug bounty” programs where monies are paid to ‘white hat hackers’ to identify weaknesses within a security or computer system.

A white hat hacker, or ethical hacker, is a good guy. They operate with the system owner’s permission to conduct penetration testing, vulnerability assessments and the like. Black hat hackers also harken back to TV Westerns, where the bad guy was easily identifiable by the black hat he wore. Black hatters are motivated by financial gain, anger at the system, the thrill of cybercrime, among other reasons. As we have learned throughout this book, the black hats wreak havoc in every corner of society.

Since not everything in life is just black and white there are also grey hat hackers. As an example of their work, they will search for system vulnerabilities without an owner’s permission. If they find an issue, they will ask the owner for a fee to fix it. If the owner won’t pay, they sometimes post the vulnerability for the web to see. While not black hat pernicious in their intent their hat is grey since they didn’t have the owner’s permission to begin with.

 

White hat hackers can be well compensated. In recent years the Department of Defense has paid out over $500,000 annually to white hatters for uncovering thousands of vulnerabilities under the Hack the Army, Hack the Air Force and Hack the Marine Corps programs. The Department of Homeland Security has established a bug bounty program to minimize internet security problems within their own systems.

Private companies also fund their own bug bounty programs. Apple offers a maximum payout of $1.5 million. In 2019, Google paid out $6.5 million to 461 researchers for their vulnerability assessments.

HackerOne is a founding member of Internet Bug Bounty (IBB), a bug bounty program designed for core internet infrastructure projects. IBB was started by hackers and security providers who were interested in making the internet safer. IBB partners with the global hacker community in order to discover security issues for its customers before these issues can be exploited by cyber criminals.

HackerOne claims to be the number one hacker-powered bug bounty platform in the country. They have launched more federal programs, including Hack the Pentagon, than any other service.

If bounty programs work for tech savvy hackers, why not for sophisticated hunters? Incentives work. The government could certainly expand existing bounty programs to bring in cyber criminals. To be certain there are legal issues to be worked out, but when compared to the lawlessness and impunity with which internet crime is committed, the legal issues seem small.

In fact, the U.S. Constitution allows for bounty hunters. Article 1, Section 8 gives Congress the power in Clause 11 to grant Letters of Marque and Reprisal. At the founding many sovereign nations issued such letters, which allowed private parties (or “privateers”) to engage in hostile, for profit acts against state enemies. In many cases, the state and the privateer shared the spoils. The most successful team was Sir Francis Drake, who scored lucrative hits on Spanish shipping, and Queen Elizabeth, who both feigned innocence to other monarchs and gladly took her cut of all the gold and silver. The difference between piracy, a hanging offense, and privateering (or benefitting from private ships of war) was having “letters of marque” sanctioning the bounty.

Article 1, Section 8, Clause 11 is often referred to as the War Powers Clause. It vests in Congress the power to declare war and grant letters of marque and reprisal. So Congress would have to approve the bounties.

But in a new world of extraterritorial threats, including terrorism and cyber havoc, the Constitution clearly allows a mechanism for the country to defend itself using sanctioned private actors. Letters of marque against a broad profile of hostile individuals, organizations and cyber bad actors would save the nation trillions in fighting undeclared wars and occupying countries that don’t want to be occupied. Letters of marque would target bad actors wherever they are found, offering great tactical flexibility. The U.S. has plenty of trained individuals to perform the work, privately defending the country and its citizens for a just reward.

Some commentators are adamantly against the idea of cyber bounty hunters. They note that active hacking, or going on the offense, is illegal under the Computer Fraud and Abuse Act. Even if someone in the private sector has been hit by a black hatter, opposing commentators claim there is no legal authority to hack back. As well, they ask who decides what is ethical, just and legally binding? A cyber bounty hunter with a financial incentive to find and accuse could destroy lives of innocents.

These commentators also argue that the government is already engaged in their own shadow form of bounty hunting. A majority of the personnel at the CIA’s National Clandestine Service are independents. They claim that 80% of the National Security Agency’s budget goes to paying private contractors. Are they privateers?

Governments will not warmly embrace digital vigilantism as they are already engaged in their own covert cyber criminality. A notable example of this, never confirmed, is the American and Israeli use of the Stuxnet computer worm to damage Iran’s nuclear program in 2010. While limiting an angry nation’s access to atomic capabilities seems worthwhile, it was also technically a violation of international law.

China’s military plans do not involve confronting the U.S. military directly. Instead, in what they call ‘systems destruction warfare,’ they will undermine American operations. At this point, no one will be arguing about technical violations of international law.

Christian Brose is the author of The Kill Chain: Defending America in the Future of High-Tech Warfare. In the May 23, 2020 edition of the Wall Street Journal, Mr. Brose wrote:

We must…redefine our objectives. If China continues to grow in wealth, technology and power, it will become a peer competitor to the U.S. Recovering our global military primacy is no longer a practical goal. We must instead pursue a more limited and achievable goal: denying military dominance to China. The U.S. military will have to focus less on projecting power and controlling territory than on preventing China (and other competitors) from projecting power themselves and committing acts of aggression beyond their borders. We must create defense without dominance.

This will require us to think differently about modernizing the U.S. military. The goal cannot be to accumulate more and better versions of traditional platforms in expensive pursuit of a 355-ship Navy or a 386-squadron Air Force. We must focus instead on developing networks of systems that enable U.S. commanders to understand the battle- space, make decisions and act – the process that our military calls “the kill chain” – and to do so better, faster and more dynamically than our adversaries. This battle network, not platforms alone, creates real military advantage.

Similarly, the Wall Street Journal reported in their June 2, 2020 edition:

The International Committee of the Red Cross in a letter last week signed by international political and business leaders called for governments to take “immediate and decisive action” to punish cyber attackers.

“There are more and more cyberattacks…on the healthcare sector and unless there are really strong measures taken, they will continue,” said Cordula Droege, chief legal officer at ICRC. “What we’re seeing at the moment are still indications of how devastating it could be.”

The next war or triggered economic collapse will involve taking out critical infrastructure, as well as military capabilities. The electric grid, telecommunications, healthcare, transportation, finance, water and waste water treatment, among other key resources are targets that will be attacked and must be defended. Having a corps of certified and licensed defenders may provide a crucial edge toward military advantage. They may also provide an immediate advantage to every American now suffering from the financial and emotional onslaught of scams.

The scamster in some small country who believes they are free to disrupt and ruin the lives of millions without consequence must see that other cyber criminals are being caught in the act, extradited to the United States, prosecuted and sent to jail for a very long time. When boastful American scamsters learn their friends not only dislike their criminality but like being paid for a tip off or learn that lesser confederates are now more likely to turn on them, a positive disrupting factor is introduced. These criminals must know that the new sheriff is willing to pay millions to trained, sophisticated hunters to bring order and justice to the Wild West of the internet. When criminals have to think twice about their criminality, when they witness other bad actors going to jail, crime does go down.

But the question remains: How can a government act against cyber bad actors when they also engage in cyber bad acts?

Other questions will arise. What if a cyber bounty hunter tries to collect on a government? And what if a government, in failing to pay, turns a white hat to black hat perdition? (Hopefully that last one is just an action adventure movie). To be certain, the issues will be complicated. But they pale in comparison to the billions in losses and social risks of not addressing widespread deception. Failing to act now only allows the monster to grow. Citizens will accept the cognitive dissonance that protecting the country with cyber criminality is different than protecting citizens from cyber criminality. Helping individuals to scam proof their assets is not inconsistent with collectively scam proofing the country. You can do both at the same time.

So either governments admit (as sheriffs in the Wild West did) that they can’t do the job and let the bounty hunters in. Or they step it up and actively protect their citizens from cyber criminality. Whatever course the people’s representatives choose it must be acted upon immediately. The threat to our country is great. The damage being inflicted upon millions of innocent Americans every day hollows out our core.

Cyber bounty hunters (either in house or contracted) will be utilized by all government in the future. Their citizens will demand it. The only question is what will come first: The real thing, or the TV show?

Scam-Proof Your Assets: Guarding Against Widespread Deception

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Bylaws and Operating Agreements

Corporations

A corporation must have bylaws. Bylaws are the road mapby which the corporation operates. Bylaws set forth how annual and special meetings are called and held, and how officers and directors are elected or removed. Bylaws provide a framework. A lack of bylaws creates uncertainty in which only the arguing lawyers win.

For good reason, all states require corporations to have bylaws. Corporate Direct provides this important corporate document as part of its incorporation package.

Limited Liability Companies

An Operating Agreement is a key foundational document for your Limited Liability Company. It sets out the rights and restrictions for each owner and provides an operational road map for how to govern your LLC.

Why on earth wouldn’t you have one?

Because there are promoters who want to sell you the cheapest possible package – a bundle of forms that technically set you up as an LLC but leaves you open to a piercing the veil of limited liability claim which, by court order, can lead to your personal liability for everything.

These promoters don’t care about protecting you into the future. They care about getting a few hundred dollars from you today and moving on to the next victim.

How can they get away with this? They assert a single statute without thinking through the larger consequences. Most of these promoters are not lawyers, and therefore in dealing with only one aspect of a statute they fail to appreciate the bigger legal picture.

Many states sought flexibility in setting up their LLC statutes. In doing so they allowed for the Operating Agreement to be optional. The members (owners) could prepare one if they wanted to do so. If they decided not to, then the State’s default rules would apply.

Of course, when you ask the promoters what the default rules are you will either get a blank rabbit in-the-headlights look or a glib, totally nonsensical answer.

The default rules do matter. As filmmaker Louis Mayer once stated, “Oral contracts aren’t worth the paper they’re written on.” Why set yourself up for a bitter battle that is so easily avoided with a written Operating Agreement?

 Many states allow for oral understandings to serve as an Operating Agreement. Can you see the danger in this? Do you know people who conveniently forget important facts? This may be why the state of New York requires a written Operating Agreement.

But for the other states, let’s consider an arrangement where three friends form an LLC. Their oral and unwritten deal is that they will split the profits three ways. One can hope that everyone will live up to the deal.

But what if the oral understanding provides that a departing member will be entitled to earn payouts over a six year period? Or provides for other arrangements performed over one year in length?

A recent Delaware case dealt with this exact issue. The holding is as you would expect: Oral understandings are much better enforced if they are instead written and signed by all parties.

The heart of the matter is the Statute of Frauds – an old English rule which sensibly holds that contracts for real estate transactions and agreements that are to be performed over one year must be in writing.

The point being that those old English judges (and today’s modern judges) don’t want people coming into their courtrooms and arguing there was an oral deal to sell real estate or an oral understanding for a multi-year payout. From a judge’s standpoint, it is very difficult to sort out a “he said/she said” argument. You’d better get your important agreements in writing or you won’t get far in court.

In the Delaware case, the claimed oral understanding was a six year payout for a departing member. The court relied on the rule of the Statute of Frauds, contracts to be performed over one year in length must be in writing, to deny the plaintiff their request for relief.

The lesson is, you should make sure your Operating Agreement is in writing. Then you must make certain that everyone signs it. A written and executed document can easily be reviewed by a court. Or, better yet, you won’t have to go to court because your written agreement will be clear to all.

Another very practical matter is that Banks and Lenders expect to see an Operating Agreement. When you borrow money, the lender is going to want to certify that you are real and properly established. In an area where you want to put your best foot forward, create a good first impression, you want to confidently hand over that Operating Agreement to your lender.

Imagine instead telling the lender that your state statute does not require an Operating Agreement. The lender politely states that may be true but lender policy requires one. You firmly state that the promoter who set up your entity swore you didn’t need one. You argue that you don’t need an attorney and you don’t need an Operating Agreement.

You can see where this is going. Banks and Lenders have their own default rules. Either you do it the right way and have an Operating Agreement or, by default, you don’t get the loan. Is it worth saving a few hundred dollars to be technically right and then lose your financing? Ask yourself – Is it your intent to operate in the real world?

Then, by failing to follow the corporate (or LLC) formalities, a creditor can claim that your entity is a sham and therefore not entitled to protection and may seek to pierce the corporate veil. If the claim is successful (and they are successful almost half the time) all of your personal assets are exposed to satisfy a judgment. It is not a good position to be in. And you will find yourself in it very quickly if you don’t have an Operating Agreement.
Judges can be prickly and juries can be fickle. You can argue that a state does not require an Operating Agreement all you want. To most people, running a business without some sort of agreement or roadmap means you are not a real business. Courts can overrule statutes. And when your veil is pierced for that reason, it means all of your assets are at risk. Are you starting to understand the issues and see the bigger picture?

It is interesting to note that one of the major sources of this idea, that no Operating Agreement is necessary in the U.S., comes from Australia. Many Aussies are now investing in U.S. real estate, which is great. Our doors are open. The Australians are being told they need an LLC to protect their investment real estate and themselves in litigious America. But the promoters are counseling them to file the initial Articles of Organization and that’s it. No Operating Agreement or other supporting paperwork is required, these poor Aussies are told.

It is bad enough to have American non-lawyers counsel the unsuspecting on legal issues. Now we have Australian non-lawyers counseling folks on American law. Has globalization blinded some to the continuing existence of unique legal systems and the need for local counsel?

Any Australian who walks into a U.S. court and testifies that a non U.S. attorney Down Under advised them how to set up their incomplete, bare bones U.S. entity is going to lose. Hands down, you’re done. A good American attorney will have a field day with those facts.

On the other hand, the Australian (or other foreign national) who follows not only the letter, but the spirit of the law, and who runs their business and investments as a business in conformance with American standards, will receive the respect and fairness of both Judge and jury. Doing it right without cutting corners means a lot in this context.

One last point must be made: Some states actually do require a written Operating Agreement. It is a wise position that, over time, other states will also follow this position.

So, do it right at the start. Ensure you have prepared an Operating Agreement for your LLC.

It may be well to note, if you form an entity with Corporate Direct, the appropriate written Operating Agreement is included in your formation fee so everybody in your company will be on the same page from the start. If you are ready to form your company, schedule a free 15-minute consultation with an Incorporating Specialist today!