9. DERIVATIVE LIABILITY
Embedded feature of
equity-linked financial instrument:
In June 2008, the FASB
finalized ASC 815-15, "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock".
ASC 815-15 lays out a procedure to determine if an equity-linked financial instrument (or embedded feature) is indexed to its own
common stock. ASC 815-15 is effective for fiscal years beginning after December 15, 2008. 9,034,800 of Bluegates outstanding
warrants that were previously classified in equity were reclassified to derivative liabilities on January 1, 2009 as a result of
ASC 815-15. Bluegate estimated the fair value of these liabilities as of January 1, 2009 to be $84,000 by recording a reduction
of $4,600,000 to Additional Paid In Capital and $4,516,000 to Accumulated Deficit. The effect of this adjustment is recorded as
a cumulative effect of change in accounting principle in our consolidated statement of stockholders deficit. On December
29, 2011 we received notification that the remaining 6,000,000 warrants with an anti-dilutive provision issued to related party,
SAI Corporation, were to be canceled. Due to the cancelation, there were no derivative financial instruments outstanding at December
31, 2011 and therefore, the fair value of these liabilities was -0- at December 31, 2011. The $22,000 change in fair value from
2010 is reported in our statement of operations as a gain on derivative financial instruments.
Bluegate used the Black-Scholes
option pricing model to value the embedded feature of the liability using the following assumptions: number of options as set forth
in the option agreements; no expected dividend yield; expected volatility of 340%; risk-free interest rates of 5.0%; and expected
terms based on the contractual term.