Silicon Valley Startups: Caught in the Crossfire of the U.S.-China Trade War

President Trump has announced new tariffs on Chinese imports, further escalating the ongoing trade war between the United States and China. On September 17th, the administration released a sprawling list of Chinese products, ranging from food items to industrial machinery. In total, the slew of goods (everything from tuna to fertilizer to cranberries to steam turbines) amounts to roughly $200 billion worth of Chinese products. Each item will be subject to a 10% tariff. Importantly, the extensive list includes circuit boards, semiconductors, cell tower radios, and internet modems. A 10% tax on these items will have devastating effects throughout Silicon Valley. The Valley’s smaller tech startups will be among the first to feel the adverse impacts.

In recent years, fledgling American innovators have managed to carve out their space in the Silicon Valley market largely thanks to cheap Chinese manufacturing. By outsourcing their operations to China, these startups are able to produce goods in much larger quantities, thereby benefitting from economies of scale. Utilizing China’s cheap labor and lax regulations, smaller startups have managed to avail themselves of the advantages that come with mass-production. With these new tariffs, however, small-tech is struggling.

Under the new import restrictions, young businesses will be faced with a 10% tax when they try to import their Chinese-made products back to the Silicon Valley. There are only two ways for companies to deal with this problem: 1) absorb the extra cost by cutting into their profit margins or 2) pass the cost along to consumers, in the form of higher prices. The former option is unavailable to small startups; with thinner margins, many of these nascent companies simply don’t have the ‘wiggle-room’ to take on additional costs. And pursuing the latter option would likely mean being priced out of the market. Thus, startups who rely on outsourcing will struggle to remain afloat. If small businesses truly are the backbone of the American economy, the weight of these tariffs will likely crack some vertebrae.

The tech industry’s larger companies do not face the same existential threat. With massive margins, they are better able to absorb extra costs. Moreover, they are better equipped to reorganize their supply chains. Already, Micron has discussed shifting its production out of China, moving its factories to other low-wage countries within its global supply chain. For smaller companies with limited funds, uprooting an entire production facility is not so simple. Further, large industry titans can exercise lobbying power, thereby insulating themselves against the tariffs. For example, thanks to Apple’s successful lobbying efforts, the administration exempted the Apple Watch and Apple AirPods from the import tax. Of course, smaller startups lack the political influence to have their imports exempted. Thus, while big tech is protected by transferrable supply chains and lobbying, small businesses remain vulnerable.

Although the tariffs may not send Google and Apple plummeting into collapse, the impact on small businesses cannot be ignored. A recent empirical analysis shows that startups account for nearly all net job growth in the U.S. economy. Indeed, that data reveals that, for the past four decades, startups have been responsible for virtually all net job creation. Moreover, beyond their indispensable contributions to employment, startups are also essential to innovation. Research indicates that larger companies tend to invest in ‘incremental technologies’ (i.e. improvements upon existing technologies); this is because improving an existing device—for example, upgrading the camera on a Samsung Galaxy or equipping an iPhone with a thumbprint scanner—involves less risk and a more predictable return. Meanwhile, smaller startups are more amenable to high-risk, high-reward ventures and therefore direct their R&D towards developing groundbreaking innovations.

For these reasons, startup growth is absolutely crucial to economic progress. Currently, Silicon Valley leads the world in startup growth. Between 2012 and 2017, the Valley produced 57 ‘unicorn’ startups (i.e. startups that grew to be worth $1 billion). Over that same time period, China produced only 46. Simply put, the Bay Area alone cultivates more successful startups than the entire nation of China. The Valley’s explosive startup growth is one of the few areas in which we outpace China by leaps and bounds. If these new tariffs undermine the growth of Valley startups, it will threaten a key pillar of our economic dominance, thus undercutting the very objective Trump seeks to achieve.

Deeply concerned by the tariffs’ impacts on our economy, some have called for legal action against the Trump administration. President Trump has been levying these tariffs pursuant to 19 U.S.C. § 2411. In a recent statement, the Consumer Technology Association (CTA) argued that President Trump and the United States Trade Representative have not conformed to the stringent requirements of the law. Specifically, the CTA alleges that President Trump has failed to meet certain statutory deadlines and, moreover, is acting outside the scope the authority conferred upon him by 19 U.S.C. § 2411.

Silicon Valley Startups: Caught in the Crossfire of the U.S.-China Trade War

Provision Designed to Protect Consumers from Unreasonable Airline Fees Dropped by Congress

The American airline industry celebrated this past Saturday as Congress decided to drop a provision that would have given the Department of Transportation the authority to determine if airline fees were “reasonable and proportional.”  Congress will be voting on the measure this week, before the September 30 deadline.

The “reasonable and proportional” fee provision had been supported by consumer groups, celebrated as a bipartisan effort.  The provision was part of a compromise between chairman of the Commerce, Science and Transportation Committee, Republican Senator John Thune (R-SD) and chairman of the Transportation and Infrastructure Committee, Representative Bill Shuster (R-PA), Democrat leaders, and Republicans in other committees.

The Trump administration’s Department of Transportation told Congress it opposed the measure, going so far as to say that many new consumer protections were deemed to be “unnecessary and wasteful.”  The Department of Transportation’s deputy general counsel, James Owens, said the provision was a “giant step backwards” and presented a risk of wider regulation that would hurt both consumers and air carriers.

Airlines make significant profits from fees that are largely seen as unreasonable by consumers.  In 2017, airlines charged passengers $4.6 billion in fees related to baggage, seat assignment, and flight changes.  Given how much they stood to lose, it is no surprise that airlines heavily lobbied against the provision.  Airlines for America, an airline trade group that represents United, Southwest, and American among others, publicly stated that the provision should be rejected, arguing that it would result in “government-mandated price controls.”

It is also worth noting that the airline industry is heavily involved in politics, having contributed $2.4 million to incumbents in Congress for the November 6 election cycle and over $12.4 million to incumbents in the last ten years.  In 2017, Airlines for America spent $8.59 million on lobbying efforts, likely due to the FAA reauthorization bill as well as the viral video of a United passenger being violently removed from his flight.

Provision Designed to Protect Consumers from Unreasonable Airline Fees Dropped by Congress

Amazon’s Trillion-Dollar Question: Monopoly or Not?

Last week Amazon became the second U.S. company in history to climb to one trillion dollars in market value. The feat underscores Amazon’s continued upward trajectory as well as the sheer magnitude of its business. Nevertheless, this unprecedented growth might bring with it an increased risk of regulatory scrutiny.

The question of whether or not Amazon should fear antitrust claims is not a new one. To date, the e-commerce and cloud computing giant has avoided such claims because its influence on market price and output have not negatively affected consumer welfare. While monopolistic companies use their dominance to inflate price, Amazon’s prices are consistently lower than those of its competitors. Consequently, Amazon does not raise substantial red flags under current antitrust doctrine.

Some scholars are calling for an alternative approach to antitrust regulation that accounts for how technology companies are disrupting traditional economic principles. Just this week, the Federal Trade Commission began a series of public hearings on “Competition and Consumer Protection in the 21st Century.” The hearings are part of the FTC’s active evaluation of its policy agenda and heightened concern for these issues.

In a strategic move to minimize the potential for these hearings to affect its current mode of business, Amazon released a memo asserting that its core mission aligns with that of the FTC. It said, “Our corporate philosophy is firmly rooted in working backwards from what customers want and continuously innovating to provide them better service, more selection, and lower prices.”

While a definitive conclusion may not be reached in the near-term, it is safe to say that as Amazon continues to grow beyond the trillion-dollar mark, it will also continue to garner attention from these regulators.

Amazon’s Trillion-Dollar Question- Monopoly or Not?

Theranos and Startup Culture: Vision or Fraud?

As ravaged startup giant, Theranos, begins dissolution after a series of lawsuits alleging “massive fraud” and a default on its last $65 million loan, spectators all seem to be asking the same question: how did a company fraudulently raise $700 million before finally being unmasked?

Theranos promised to revolutionize the diagnostic-lab industry by delivering one innovation: finger prick blood tests. Health care companies, venture capitalists, and even government officials poured huge investments into the company – on one occasion, $100 million was sent over a single wire transfer. As investors waited for years for Holmes to deliver, she was raking in money for a product that never even existed. Whenever investors would try to peek behind the curtains to find out more about her company’s “secret sauce,” she shrouded herself behind flagrantly vague and often outright untruthful statements.

In many ways, Theranos is the embodiment of Silicon Valley startup culture. The startup entrepreneurial spirit is selling a vision of a fictional product – a product that does not yet exist. This is how Theranos’s huge valuation was birthed and where a critical legal problem lies. With the advent of Sarbanes-Oxley Act in 2002 that promised to safeguard investors against fraud like in the Enron scandal, startup companies have purposefully opted to stay private due to the myriad of regulations imposed by the Act, such as disclosure of financial statements. The problem is, companies like Theranos, Uber, WrkRiot, and more, have often construed this to mean that they are exempt from the rules that public companies play by and thus often cross the delicate line between merely selling a visionary product and committing massive fraud.

In many ways, Theranos was exactly the case the SEC was looking for. The SEC exists in an opportune moment to not only establish a clearer distinction of that oft-straddled line while also sending a strong signal that startup companies will have to play by the rules. While investment and fraud more generally will likely always be a feature in the magical Valley, the SEC must ensure that these fictional visions are kept honest through litigation.

Theranos and Startup Culture – Vision or Fraud?

Nike Leans into Controversy and Wins Big

Nike’s stock has reached a record high a week after unveiling its new ad campaign featuring Colin Kaepernick, the former San Francisco 49ers quarterback best known for protesting racial injustice by kneeling during the National Anthem ceremony preceding NFL games.

Nike unveiled the ad on September 3rd, releasing a portrait of Kaepernick’s face overlaid with, “Believe in something. Even if it means sacrificing everything.”

Kaepernick began kneeling during the Anthem in 2016. Since, many have either vehemently denounced his form of protest or rallied to support his message. President Trump weighed in at an Alabama rally in September 2017, calling Kaepernick a “son of a bitch” and urging the NFL to fire him.

After opting out of his contract with the 49ers in March of 2017 and becoming a free agent, Kaepernick remained conspicuously unsigned despite his widely recognized talent. Kaepernick brought suit against the NFL in November in an ongoing case alleging collusion.

In the first day of trading after the ad’s release, Nike’s stock dipped nearly 3%, leading many to think Nike had bet wrong by going all in with Kaepernick. But other sports brands—including Nike’s rival, Adidas—fell by similar margins, proving an industry-wide dip. Nike’s sales have since skyrocketed, with its stock closing at a record $83.47 on Thursday.

To explain the boon, many have pointed to Nike’s young and urban customers, noting Nike’s long history of “selling rebellion.” Others, even if fundamentally aligned with Kaepernick’s message, have decried Nike’s commodification of protest.

Kaepernick’s protests aimed to ignite conversation about America’s structural racism. The ensuing controversy has only amplified Kaepernick’s message. Nike has taken a page from Kaepernick’s book, leaning into the controversy it is sure to have anticipated, while ultimately achieving increased visibility. Not only is the move smart business, it’s right on brand.

Nike Leans into Controversy and Wins Big

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

In the wake of further developments by the SEC, many key players in the industry are currently combining efforts to petition federal authorities to see certain virtual currencies in a “different light.” The Venture Capital Working Group is led by Andreessen Horowitz, which includes another significant VC firm, Union Square Ventures, and lawyers from Cooley LLP, McDermott Will & Emery LLP, and Perkins Coie LLP.

The primary purpose of the Group is to deter regulators from categorizing cryptocurrencies, such as Bitcoin and Ether, as securities. On March 28th, the Group met with the U.S. Securities Exchange and proposed a “safe harbor” for some cryptocurrencies.

The proposal suggests that digital tokens should generally be exempt from securities laws if they achieve “full decentralization” or “full functionality.” It adds that full decentralization could occur under several conditions, including when the token creator no longer has control of the network based on its ability to make unilateral changes to the functionality of the tokens. It can also be used, not just as a speculative investment, but for its intended purpose on a computer network.

The group notes that these definitions are only suggestions, but the “proposed safe harbor has been vetted by, and has the support of, many of the key players in the industry.” People briefed on the meeting said that regulators did not immediately embrace the safe harbor proposal.

Many entrepreneurs and law firms have been creating new ways for virtual currency projects to issue their tokens as securities and some exchanges have talked about getting registered as official securities exchanges. It is still unclear what will happen to tokens that did not register as securities but are later categorized as securities.

Furthermore, on April 26, a congressional hearing with testimony from the SECs Division of Corporation Finance took place to develop more reasonable approaches toward token sales and their classifications. The discussion marked a new attitude amongst SEC members and addressed how certain utility tokens could not be securities if purchased with no investment intention.

In the hearing, the SEC division head, William Hinman, stated:

“They can certainly imagine a token where the holder is buying a token for its utility, not as an investment; especially if it’s a decentralized network where it’s used, and not central actors where there would be information asymmetries where they would know more than token investors.”

Hinman — likely referring to the Venture Capital Working Group — replied that one of the steps that the SEC was taking was “meeting with participants that have these ideas of a token that shouldn’t be regulated as a security” and working with them on how they should be structured. Hinman pointed out that the SEC is heavily engaged with academics and other departments to better explore how everything might work, and that in the long run, the U.S. is “pragmatic” in its support of new technology.

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

U.S. Top Court Rules That Microsoft Email Privacy Dispute is Moot

Microsoft Corp. v. United States is a recent data privacy case concerning the extraterritorial reach of the Electronic Communications Privacy Act’s (of 1986) Stored Communications Act (the “SCA”).

In 2013, the US federal government issued Microsoft a warrant, asking it to turn over the email of a target who was being investigated in a drug-trafficking case. The warrant, issued by a US magistrate judge in the US District Court for the Southern District of New York, was issued under SCA. Pursuant to this warrant, Microsoft was to produce all emails and information associated with the target’s account. Microsoft denied the government’s request, arguing that the SCA precluded an extraterritorial application of a warrant for information stored on servers in Ireland.

After multiple failed attempts to block the government’s order, Microsoft appealed to the Second Circuit. A three-judge panel of the Second Circuit overturned the lower court’s ruling in July 2016, invalidating the government’s warrant. Relying on the US Supreme Court’s 2010 ruling in Morrison v. National Australia Bank, which held that the “longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States,” the Second Circuit found no mention of extraterritorial application in the SCA.

In June 2017, the US Department of Justice appealed to the Supreme Court, arguing that the Second Circuit’s decision allows large, data-laden companies to deny law enforcement officials with requested information stored on servers outside the US and warned that such prohibitions could hamper criminal investigations. The Supreme Court granted certiorari in October 2017 and the case, United States v. Microsoft Corp., was heard on Feb. 27, 2018.

The Supreme Court’s ruling was to be expected by June 2018, but in the time between the oral arguments in February and the expected decision in June, Congress passed the Clarifying Lawful Overseas Use of Data Act (the “Cloud Act”) on March 22, 2018. The Cloud Act allows US judges to issue warrants with an extraterritorial reach to obtain data such as the one at issue here; if the warrant’s scope conflicts with foreign law, then companies have means to object under the Cloud Act.

In response to the Cloud Act, the DOJ requested that the Court vacate the case and remand it to the Second Circuit. On April 17, 2018, the Court issued a per curium that per the passage of the Cloud Act, the case was rendered moot, vacating the case and remanding it.

While it may seem strange, Microsoft actually backed the Cloud Act. In its support for the Cloud Act, Microsoft stated that legislators, rather than the courts, are best situated to resolve such extraterritorial disputes, in that comprehensive legislation as opposed to “repeated court visits and legal battles” is proper. Microsoft’s hope is that legislation such as the Cloud Act will motivate “governments to move forward quickly to put new international agreements in place…a set of agreements that create an accepted model and establish clear international legal rules that satisfy law enforcement and privacy advocates alike.”

U.S. Top Court Rules That Microsoft Email Privacy Dispute is Moot

Starbucks Response to Arrest of Two Men

A Philadelphia Starbucks manager called the police after having a disagreement with two patrons waiting for a friend. The episode unfolded after one of the men was refused access to the restroom since neither of the pair made a purchase. After the two men were asked to leave and refused to do so, they were arrested on charges of disturbance and trespassing. The men were freed later that night and the charges against them were dropped.

The two men, Rashon Nelson and Donte Robinson, are entrepreneurs that were at the Starbucks that afternoon to discuss a project which they had apparently been working on for months. The men claimed that the project was in its final stages and could potentially “change [their] lives.”

The arrest of the two men, both black, was captured on video and generated millions of views within days. The video reveals the two men being placed in handcuffs after being approached by police. Also appearing in the video is the friend they were waiting for, who is white, questioning the police’s intentions for the arrest, asking, “Is it because they’re black?”

Shortly after the video went viral, the hashtag “#Boycottstarbucks” started trending on Twitter. Shortly after that, Howard Shultz, Starbuck’s Executive Chairman, said that he felt “ashamed,” adding that he “had no doubt in [his] mind” that the police were called because the men involved were black. Starbuck’s new CEO, Kevin Johnson, also called the ordeal “reprehensible” and arranged to fly to Philadelphia to personally apologize to the two men.

In the aftermath of the incident, Starbucks announced that it will be closing more than 8,000 of its locations in order to train some 175,000 of its employees on racial bias. The closure will occur on May 29th and according to Schultz “will cost millions of dollars,” which he nonetheless views as “an investment in our people and community.”

Notwithstanding the appropriateness of Starbucks’s swift response, which many figures in the PR world applauded, one has to question, was the hideous event, at its core, really a Starbucks problem? Whether or not Starbucks’s response was sincere or merely a product of excellent crisis management, the company undoubtedly made the right call by going above and beyond just issuing a statement. With the plethora of instances of people of color being wrongfully arrested, many of which are captured on video, is it really that shocking that something like this could happen at a Starbucks? Black people shouldn’t be arrested for being black. The Starbucks arrests should serve as a wakeup call that a lot more than training Starbucks employees needs to be done in order to curtail these sadly not so unfamiliar occurrences.

Starbucks Response to Arrest of Two Men

PayPal Attempts to Enter the Traditional Banking World

PayPal, a leading global payment company, has recently announced that it is piloting some banking service models similar to those that traditional banks typically provide to customers. In addition to its primary money transfer service, the new feature services will be made available through the PayPal digital wallet. Under this scheme, PayPal is offering the option to make a mobile check deposit or have direct-deposit paychecks, an ATM-compatible debit card for cash withdrawals, and pass-through Federal Deposit Insurance Corp. (FDIC) insurance for the account balances.

According to Bill Ready, PayPal’s Chief Operating Officer, PayPal just wants to offer banking options to customers who may not be able to access fundamental financial services, but it has no interest in becoming a traditional bank at this moment. Ready emphasized that “if you already have a bank account connected to your PayPal account, this isn’t an account for you.” This is because PayPal claims that it aims to provide the service to promote financial access to a person who may not have an existing traditional bank account, also known as people who are “unbanked”. Ready pointed out that there are more than 30 million underserved people in the U.S. who basically spend 9.5% of their income on service charges or fees for alternative financial services. They are forced to turn to prepaid cards, check cashiers, or payday lenders to afford their basic needs of financial services.

In terms of serving those who are “unbanked,” on one hand, PayPal will not charge a monthly fee nor require the customers to maintain a minimum balance on their account. However, on the other hand, it will impose fees on cash withdrawals from out-of-network ATMs as well as take 1% of the deposited checks done through the smartphone camera system. This may not be so attractive to those with existing bank accounts but it would be a helpful option for some customers who are being ignored by big banks.

Interestingly, PayPal is hoping to pilot these services even though it has never obtained a U.S. banking license. The industrial loan company charter states that nonfinancial companies are allowed to engage in the banking business without being subject to banking regulations, including the Federal Reserve’s oversight authority in some states. To this end, PayPal has developed financial technological tools and has affiliated itself with small financial institutions who work behind the scenes for particular services from different locations. Namely, they use the debit card connecting to customers’ PayPal accounts issued by a Delaware bank, retain instant check depositing and clearing from another bank in Georgia, and engage with a bank in Utah to make loans to consumers. Such partnership agreements not only help PayPal bypass several financial regulations and FDIC deposit insurance but also allows PayPal to conform with the rules of card issuer companies, like Visa and MasterCard, which require their debit/credit cards to be issued by banks.

PayPal is not the only non-traditional bank firm trying to explore the banking field. There are other players, including startups such as Square Inc., Stripe Inc., Social Finance Inc. and TransferWise, or even one of the world’s biggest online marketplaces like Amazon, that are eager to seek the lucrative business opportunity in bank-like services too.

In the near future, we could see a lot of next-generation momentum in disruptive technologies and changes in the relationship between banks and customers. Fintech companies will likely go the extra mile to offer user-friendly services in the growing digital economy. In the end however, it would be a real nightmare for traditional banks if they cannot respond to these rapid changes.

PayPal Attempts to Enter the Traditional Banking World

Bayer’s sale of its Contraception Device Essure Faces New FDA Restrictions

On April 9, the United States Food and Drug Administration placed restrictions on Bayer’s implantable, contraception device Essure. The FDA’s order specifies that Bayer must restrict the sale and distribution of its contraceptive implant to “only health care providers and facilities that provide information to the patient about the risks and benefits of this device.” These new restrictions stem from a history of rising complaints that the agency has received about the device and the concern that women were not being apprised of its risks adequately.

Essure is a permanent, implantable birth control device made up of two small coils that operates via placement into the fallopian tubes to create scar tissue by triggering an inflammatory response. This resultant scar tissue created by the inflammatory response creates a physical barrier that isolates the eggs and prevents contact with sperm. Essure is a non-hormonal and non-surgical form of birth control. It is estimated that 750,000 Essure devices have been sold throughout the world with a majority of devices being sold in the United States.

In 2016, due to thousands of complaints regarding the use of the device, the FDA ordered Bayer to place the most serious health advisory warning on the label of Essure, warning that the device could cause certain injuries or health problems. The agency also ordered that Bayer conduct a new safety study. The concerns and complaints raised about the use of the device include depression, rash, hair loss, hives, fatigue, weight loss, perforation of the uterus or fallopian tubes, debilitating pain, and more. Many of the patients who complained suffered from more than one condition possibly caused by the device, and other serious problems reported include “deaths, pregnancy loss, and ectopic pregnancies.” In 2017, the FDA received almost 12,000 medical reports related to Essure. In addition to complaints filed with the FDA, Bayer itself has received about 10,600 U.S. lawsuits alleging Bayer gave insufficient warning to providers and regulators regarding the risks of the device.

Under the FDA’s order, before implantation of the device, an acceptance of risk form needs to contain the signatures of both the patient and the health care provider. The form can only be signed after the health care provider has discussed all the potential risks with the patient by reviewing a brochure together.

The burden lies with Bayer to ensure that medical providers follow the restrictions imposed by the FDA. If Bayer fails to implement the restrictions properly, and fails to ensure that physicians comply with the restrictions, the FDA has said that it will “take appropriate action against Bayer,” which can include criminal and civil penalties.

Essure entered the market in 2002. After the FDA required the most serious warning label to be placed on Essure’s box and ordered Bayer to conduct a new safety study in 2016, the sales of the contraceptive device have declined approximately 70% in the United States.

In light of these developments, Bayer maintains that the device’s “benefit or risk profile has not changed.

Bayer’s sale of its Contraception Device Essure Faces New FDA Restrictions