Legal And Other Lessons Learned From The Dotcom Crash

I have a confession to make. I am a recovering dotcommer. There, I said it. The Internet is not the be all and end all that people have made it out to be. It is not the end of the bricks and mortar world as we know it. However, the recent readjustments in expectations of just about everyone carries with it a few lessons to learn for those lawyers seeking an understanding of what the Internet boom and ensuing crash means to them.

In the practice areas of securities, finance, licensing, intellectual property, employment, and consumer protection, among others, there are and will be legal ramifications arising from the developments of the last few years. A comprehensive understanding of how all of these practice areas are impacted is difficult to obtain and maintain. Companies should only retain those legal counsel, relatively few in number, who have a clear insight as to where the new potential potholes and hidden treasure troves may lay. Here are some of the key developments and practice pointers we might all learn from these events:

Intellectual property issues will be fought out in the coming years in, among other things, battles over the controversial web-related business method patent applications that have flooded the U.S. Patent and Trademark Office, some of which this author helped draft. The USPTO is making great headway in enhancing and expediting its review of these applications and it is expected that many will fall by the wayside in the forthcoming years for many reasons, as they have in past eras of great technological innovation.

Nonetheless, there are still many valuable internet-related inventions that will deservedly obtain and sustain patent protection. However, one key issue is whether such protection will really help businesses in a sector where technological progress is often measured in weeks not years. Nonetheless, robust invention "discovery" programs and trade secret protection programs should be instituted at technology companies since the revenues derived from technology either through direct exploitation or from licensing can be extremely significant.

In recent years, the software licensing bar has grown in numbers and sophistication. There is a growing awareness by licensees of the leverage they may have in negotiating for changes in boilerplate pro-seller software licenses. Notwithstanding the growing acceptability of certain of these "pro-purchaser" changes, some of which the author has observed as occurring in as little as two years, software licensors have to be careful to protect themselves from legal and business risks that continue, despite increasingly aggressive stances taken by purchasers in these negotiations. Uniform legislation regarding some of these issues has been proposed and adopted in a number of states that has been criticized as too pro-software vendor, but others see the need for such legislation to help continue to foster a legal environment that fosters technological development and the concomitant assumption of economic risk by developers.

Software licensing law has developed independently of the web for years and the controversy over clickwrap licenses will probably continue for some time. Also, it should be noted that many provisions that deal with the management of legal and business risk in such agreements, such as indemnifications, license scope, limits of liability and IP ownership, do not always depend on the fact that it is the web that is the distribution or access channel for the software, although web-related issues should not be overlooked.

This may sound like a criticism but it really isn’t. Since the Internet came about, experienced and inexperienced venture capitalists and public company investors have thrown billions of dollars at thousands of companies with business plans containing highly speculative or previously nonexistent types of streams of revenue derived from brand new technologies that had never been used before by potential customers. These companies were sometimes led by enthusiastic people with sales, engineering or marketing experience but with no significant operating experience or expertise.

However, we should all first remember that venture capitalists are supposed to allocate risk capital. They and their investors take the risk, reap the rewards when they are to be had, and suffer the consequences when the bubble bursts. We actually should be pretty thankful that there is such a large pool of investment funds available for such incredibly speculative ventures.

Such investors may have made some unfortunate choices (as we all have), but their willingness to risk such substantial sums of capital will be a major reason that our country will sustain its technology lead in this area in the foreseeable future.

The reason there is little management experience, below the CEO level, at many of these startups was because this was a relatively newer area of business with very few people presently available who have a substantial number of years of direct experience in the sector or other industry experience that would be appropriate.

One result entrepreneurs looking for capital should already be experiencing is that venture capitalists are now becoming more aggressive when negotiating the terms of their investments. Participating preferred, full ratchet anti-dilution, and additional directorship demands will rear their head again in such negotiations. Protective provisions will be proposed that are drafted to bring venture capitalists closer to the daily operating decisions of the business.

Some of the major legal risks to be managed are already fairly well-covered to the extent they can be or will fairly quickly evolve under case and legislative law in ways similar to the adjustments our legal system has made when confronting the advent of new technologies in the past.

Private investor protection is largely covered by the fact that many of these deals are privately negotiated with substantial leverage in the hands of many of the investors, existing securities laws, private rights of action, the relative sophistication of the private accredited investors, the awareness they should already have of the risk of total loss of investment, and the sophisticated investment documents prepared by their counsel.

The public investor risk should be already well-addressed by the existing securities disclosure rules. Failures to comply in that area, including recent cases of alleged accounting and securities fraud, will probably be effectively handled by the SEC, other law enforcement agencies, and the class action bar.

The SEC has done an admirable job of addressing the impact of the Internet on the sales and offering of securities (including public and private offerings), and issues regarding online brokerages and stock price manipulation through the use of chatrooms, bulletin boards and websites.

Other cutting-edge securities law issues still being addressed include how or if the plethora of information on the Internet should inure to the benefit of publicly traded companies through the truth on the market doctrine, stock picking and trading software, and virtual mutual fund registration issues.

Current criminal statutory schemes, with some tweaking, will hopefully help to address the new forms of crime enabled by the web, although many would argue that most of these crimes are just old wine in new bottles. Trademark and domain name issues are being fought out in the regular course of court business and arbitration.

There will be new battles fought over the ways the Internet sometimes allows unsuspecting members of the public to be tracked and targeted. It is to be expected that new laws will eventually emerge that will govern the collection, use and ownership of such information, especially when it is personally identifiable, similar to the laws recently enacted or proposed regarding children’s privacy, and health care and financial data.

The recent resurfacing in the media of revelations of the capabilities of html email tracking (internal company discussions could be essentially bcc’d back to the vendor without knowledge of company personnel) implicates email wiretap law and poses new risks in this area.

Companies would be wise to carefully assess third party technologies, especially where the use of such technologies have become public relations nightmares for other companies. However, advances could occur in the consensual monetization of such data, where a customer allows their personal information to be shared if they receive certain benefits in return.

Use of technology such as web bugs, clear gifs, and cookies, and the linking of anonymous and personal identifiable information may be regulated or suffer consumer backlash. However, new technologies currently in development might soon allow easy screening and automatic opting out of user data collection schemes that consumers may find objectionable for whatever reasons.

Most of all, company lawyers might want to look again at their contracts to see if they provide that customer and user data ownership resides in the company itself and that privacy policies are to be adhered to in the utilization of such data. It should be noted that a company’s reputation is not only enhanced by the Internet’s ability to gather such data and more effectively serve customers but also risked by the Internet’s ability to alienate customers in brand new ways.

The Internet sector is infamous for mercurial neophyte CEOs who fly off the handle at a whim and lay off people with no notice. The problem is that the bricks legal world still applies to that and other company conduct. Layoff notices with little or no lead time may violate certain labor laws and are bad for the public reputation of the business. Sexual harassment and discrimination statutory protections are not just for old economy businesses. They also make good business sense and they are the law.

Good administrators are able to spot these risk areas and prepare ahead of time by seeking legal counsel but, as evidenced by recent headlines, some of the dotcommers have already running afoul of these statutory protections.

What many an internetcentric business model ignored is that no business ever survived and thrived by just building a great store, online or not. And giving away a product at or below cost is usually to be called a loss leader, not a path to profitability, notwithstanding the fact that gaining early market share is essential in any new technology business.

Any real world proprietor will tell you that first you have to get the customer in the door, then you have to keep him there, sell him something, and then make him want to come back. If you are setting up a web channel of distribution of your product it also doesn’t hurt if you already have a customer base in the real world.

The internet is sometimes better understood not only as just another means of distribution (the conventional wisdom) but also as a self-service communications channel to the customer – not only should you seek to sell goods to the customer but you need to give them product and other information that enables the customer to answer her own questions.

Many clicks and mortar companies would probably do better to have cheap but effective data intensive (yet easily navigable) sites that allow such self-service. It is important to understand, however, that web-based customer service can create friction with customers if, for instance, emails are not responded to on a timely basis or relevant information is more than 2 or 3 clicks away.

Many internet divisions of real-world companies are now being rolled back into the parent because they found out that their internet strategy was an essential extension of their marketing and customer service functions, not just an overly expensive sales channel to spin off in a future, allegedly lucrative, IPO.

Real world employees must want to use the Internet software that claims to make their job easier. The data gathered by the new breed of customer relationship management software products being offered is useless to a company if it’s employees see it more as a burden than a boon. Therefore, sophisticated CRM offerings may not be right for all organizations.

The dotcom party may be over but the legal and business education has just begun. Although many Internet based businesses will continue to shut their doors over the coming year, the legal and business lessons to be learned from their failures and sometime successes will definitely help create a more effective and resilient clicks and mortar business environment.