Search Results

By: Jeffrey M. Haber It is a fact of life that many securities brokers and financial advisors will be the subject of one or more customer complaints during his/her career. To be sure, some of those complaints will be justified. However, many of them will not be. In those latter instances, innocent brokers and financial advisors will have a blemish on his/her record that can be cleared only through an expungement proceeding. Expungement is essentially a three-step procedure. First, the broker or financial advisor must persuade a court or arbitration panel to expunge his/her record of the negative event. Rule 2080(b)(1) promulgated by the Financial Industry Regulatory Authority (“FINRA”) provides the grounds upon which an order of expungement should be granted: (a) the claim, allegation or information is factually impossible or clearly erroneous; (b) the broker or financial advisor was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (c) the claim, allegation or information is false. The process is started by filing an application naming the customer or the firm as a respondent. FINRA is also named as an additional party, unless FINRA waives the requirement. Second, if an expungement award is issued by an arbitration panel, the award must be judicially confirmed. Third, if confirmed, the award and the judgment (confirming the award) are to be sent to the Central Registration Depository (“CRD”) so that the matter can be removed from the broker or financial advisor’s record. In addition to Rule 2080, the process for seeking expungement is governed Rule 12805 of the FINRA Code of Arbitration Procedure for Customer Disputes. Rule 12805 covers the responsibilities of the arbitration panel hearing an application for expungement. The rule requires the panel to “[H]old a recorded hearing session (by telephone or in person) regarding the appropriateness of expungement.” In a case that has gone to hearing on the merits, a panel will often consider a request for expungement as part of its deliberations. Rule 12805 further instructs that if the panel grants expungement, it must “[I]ndicate in the arbitration award which of the Rule 2080 grounds for expungement serve(s) as the basis for its expungement order and provide a brief written explanation of the reason(s) for its finding that one or more Rule 2080 grounds for expungement applies to the facts of the case.” If, however, a customer complaint is settled before a hearing on the merits, the panel must nevertheless hold a hearing on the record to evaluate the expungement application, including “review settlement documents and consider the amount of payments made to any party and any other terms and conditions of a settlement.” The broker or financial advisor must present testimony and evidence to the panel in support of the application, and the customer or other interested party must be given an opportunity to respond and be heard. Upon request of the broker or financial advisor, FINRA will typically keep the arbitration panel intact following the settlement for purposes of holding a hearing limited to the issue of the broker or financial advisor’s expungement request. Expungement Gets Some Bad Press: Royal Alliance Associates, Inc. v. Liebhaber The foregoing expungement process received some adverse press in September of 2014, when The New York Times Dealbook published an article (“A Murky Process” dated September 25, 2014) about an expungement proceeding in which Sandra A. Liebhaber (“Liebhaber”), a customer of Royal Alliance Associates, Inc. (“Royal Alliance”), attempted to oppose an expungement application by her broker, Kathleen Tarr (“Tarr”) (FINRA ID No. 13-01522 (Los Angeles, 9/10/14)), and was rebuffed by the panel, which issued the expungement award. As discussed below, in Royal Alliance Associates, Inc. v. Liebhaber, B264619 (Cal. Ct. App. Aug. 30, 2016), the Court of Appeals of the State of California vacated the expungement award because the arbitrators failed to allow Liebhaber and her counsel the opportunity to present testimony and evidence at the hearing. The Arbitral Proceeding From July 2002 through July 2010, Tarr was employed as a financial advisor with Royal Alliance, a securities broker-dealer and FINRA member. Starting in 2007, Tarr sold high-commission variable annuities and non-traded real estate investment trusts, or REITs, to dozens of AT&T employees who were eligible to receive early retirement offers from the company. By 2010, many of Tarr’s customers complained that she improperly steered them into portfolios of illiquid securities that were unsuitable for their retirement accounts. Liebhaber was a customer service representative for AT&T and one of Tarr’s clients. In May 2013, Liebhaber filed a complaint against Royal Alliance, claiming that Royal Alliance was negligent, breached its fiduciary duty to her, and violated state securities laws by selling her “illiquid, high-risk investments” that were “inappropriate and unsuitable” for her individual retirement account. Slip op. at 3. Liebhaber sought $325,000 in compensatory damages. Royal Alliance settled the action for $30,000, or less than 10% of requested damages, after an arbitration panel was convened but before a hearing was held. Id. Royal Alliance requested that the arbitrators keep the case open so that it could seek expungement of Liebhaber’s claim and settlement from Tarr’s CRD record. Id. at 3-4. On June 9, 2014, Royal Alliance submitted a request for expungement on behalf of Tarr to the previously convened arbitration panel. Liebhaber remained a party to the action; Tarr was not, however, named as a party. Royal Alliance sought expungement because it faced other FINRA arbitrations in which former customers claimed that Tarr had caused them harm. In later briefing, Royal Alliance explained that it wanted to use the expungement award in “ongoing arbitrations and in any later filed arbitration” as evidence of no wrongdoing. Less than a month later, on June 30, 2014, Liebhaber’s counsel advised the arbitration panel that he did not intend to file a pre-hearing brief but planned to call Liebhaber and Tarr as witnesses at the arbitration hearing. According to the Court, the record was devoid of a response by Royal Alliance or the arbitration panel, as well as written evidence and submissions by the parties. Slip op. at 4. On August 12, 2014, the panel held a telephonic hearing to consider the expungement application. Liebhaber and her counsel, Royal Alliance and its counsel, and Tarr participated in the hearing. Royal Alliance argued that expungement was warranted because Liebhaber’s allegations against Tarr were false, stating that the investments Tarr recommended were suitable for Liebhaber, and Liebhaber’s alleged net losses could be attributed to withdrawals from her retirement account and “the 2008 market crash.” Slip op. at 4. Royal Alliance also noted that a complaint similar to Liebhaber’s had been previously expunged from Tarr’s record. (Note: Tarr had 44 customer complaints and a termination on her record.) Tarr also spoke during the hearing, but did so without being sworn in by the panel. Tarr vigorously disputed Liebhaber’s allegations, noting that the allegations against her were inimical to her background as “the daughter and granddaughter of ministers.” Slip op. at 4-5. Tarr spoke uninterrupted and without questions. Id. at 5. Liebhaber’s counsel contended, among other things, that Royal Alliance failed to show that her claims against Tarr were false or factually impossible, and proposed a procedure in which both Tarr and Liebhaber would be asked to respond to questions about Liebhaber’s claims. Tarr’s counsel objected to the proposed procedure. The presiding arbitrator concluded that such questioning was unnecessary. Another panel member, however, wanted to hear such questioning, especially since “the [FINRA] guidelines are pretty clear that we’re supposed to be looking at everything because this was a settled case, and that the more information we have, the easier it is for us to make what I would consider to be a fair and well reasoned decision regarding expungement.” That arbitrator undermined the point, however, by adding that such questioning should not exceed “another two hours.” The third arbitrator agreed with the presiding panel member. Thereafter, the presiding arbitrator denied Liebhaber’s request. Slip op. at 6. Liebhaber’s counsel stated for the record his objection to the panel’s ruling, noting that he had “not been given a full and fair opportunity to respond to … the claims that have been made in the hearing.” Id. at 7. After rebuttal and additional discussion about the panel’s ruling, the panel concluded the proceeding. On September 10, 2014, the panel issued an award recommending expungement. Slip op. at 7. The award tracked the language of Rule 2080, and found that Liebhaber’s “claim, allegation, or information” against Tarr was “factually impossible or clearly erroneous; and … The claim, allegation, or information is false.” Slip op. at 7-8. The panel cited several reasons for its findings, including the difference between the damages Liebhaber sought ($325,000) and the settlement amount ($30,000). Id. at 8. The panel concluded the amount of the payment reflected a business decision by Royal Alliance rather than Liebhaber’s actual net out-of-pocket losses. Id.. The Petition to Confirm the Expungement Award Pursuant to FINRA Rule 2080, Royal Alliance sought confirmation of the expungement award. Liebhaber opposed the petition, and requested that the award be vacated on the grounds that: “(a) Liebhaber’s rights were substantially prejudiced by misconduct of the arbitrators; (b) the arbitrators exceeded their powers in denying Liebhaber’s request to present evidence at the hearing; and (c) Liebhaber’s rights were substantially prejudiced by the refusal of the arbitrators to hear evidence material to her claims.” Slip op. at 10. On May 18, 2015, the trial court held a hearing to consider the petition to confirm the award. In connection with the hearing, the court issued a tentative ruling to vacate the award. Following oral argument, the trial court adopted its tentative ruling and vacated the expungement award. The court did so “on the ground that Liebhaber’s rights were substantially prejudiced by misconduct of the arbitrators, the arbitrators exceeded their powers, and Liebhaber’s rights were substantially prejudiced by refusal of the arbitrators to hear evidence material to the controversy.” Slip op. at 12. The court also found that the arbitrators violated FINRA Rule 2080 “by allowing Ms. Tarr to provide an unsworn statement in support of expungement while also preventing Liebhaber’s attorney from cross-examining Ms. Tarr in order to determine if the requirements of Rule 2080 were met.” Id. The Court of Appeals’ Decision The Court of Appeals affirmed the trial court’s ruling. It found that “Liebhaber’s rights as a party to the arbitration proceedings were substantially prejudiced within the meaning of [Code of Civil Procedure] section 1286.2, subdivision (a)(5),” which “provides that the trial court ‘shall vacate’ an arbitration award if ‘The rights of the party were substantially prejudiced by . . . the refusal of the arbitrators to hear evidence material to the controversy or by other conduct of the arbitrators contrary to the provisions of this title.’” Slip op. at 16. Addressing the first question – whether the arbitrators refused to hear evidence material to the controversy or engage in other conduct contrary to the provisions of California law – the Court of Appeals found that the panel in fact had refused to give Liebhaber the opportunity to be heard, present oral evidence, and cross-examine Tarr during the hearing. Slip op. at 16-18. As to the second question – whether Liebhaber’s rights were substantially prejudiced – the Court of Appeals found that they were. In so holding, the Court concluded that “‘the arbitrators might well have made a different award’ if they had allowed Liebhaber to tell her side of the story or question Tarr’s.” Slip op. at 19 (citation omitted). Consequently, the Court held that “the hearing was not fair,” because Royal Alliance received “an unfettered opportunity to bolster its written” submission, while Liebhaber was “denied even a limited chance to do the same.” Id. at 20. Takeaway Royal Alliance teaches the importance of making a record during an arbitration proceeding. As discussed above, Liebhaber’s counsel created a substantial record showing that Liebhaber did not have a fair hearing. He was able to use that record to show prejudice from the arbitrators’ conduct – one of the bases for vacatur of an arbitral award. Since vacatur of an award is very difficult to obtain, as discussed in a July post on this blog, having a detailed record is a good way to persuade a court of entitlement to such relief. Royal Alliance also teaches that, although customers typically remain silent during expungement proceedings, they do not have to remain so, even after settling their claims. As discussed above, Liebhaber felt strongly enough to ensure that other investors would know about Tarr’s behavior notwithstanding the settlement. Of course, customers who believe their broker or financial advisor has been falsely charged with wronging should likewise speak up during an expungement hearing. It should be noted that FINRA participated as a party in the confirmation proceeding and opposed the actions of the arbitrators. At the hearing, FINRA told the trial court that FINRA had “an interest and really a duty here, in protecting the integrity of the [CRD] and the information contained in it.” As such, given the record of proceedings, FINRA argued that the arbitrators broke FINRA’s rules in denying Liebhaber and her counsel the opportunity to testify and be heard. Also, not long after Liebhaber challenged the expungement award, FINRA revised its expungement guidance with respect to customer participation at expungement hearings. The Arbitrators’ Guide now provides, as mentioned above, that arbitrators should “allow customers and their counsel to participate in the expungement hearing in settled cases if they wish to.” Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber, a partner at Freiberger Haber LLP On May 31, 2016, the Appellate Division, First Department, issued MP Cool Investments Ltd. v. Forkosh, 2016 NY Slip Op. 05944, a case involving allegations of fraud in connection with the production and sale of a commercial heating and ventilation system by an Israeli-based company. In the decision, the First Department unanimously affirmed the motion court’s dismissal of the plaintiff’s fraud claims because they were not pleaded with particularity, did not establish justifiable reliance on the defendants’ misrepresentations, and failed to demonstrate scienter or an intent to deceive. The Factual Background of MP Cool The plaintiff, a Manhattan-based private equity fund with $4.3 billion in assets under management, is an admitted sophisticated investor that specializes in capturing value in distressed companies in less efficient markets around the world. In December 2009, MatlinPatterson entered into an agreement with DuCool, Ltd., an Israeli company that claimed to have had breakthrough dehumidification technology, to obtain a majority interest in the company. Pursuant to the agreement, MatlinPatterson invested $30 million in DuCool, giving it an initial 49% interest in the company. By 2012, MatlinPatterson had invested $70 million in DuCool and acquired a 72% majority interest in the company. Subsequent investments brought MatlinPatterson’s equity interest in DuCool to 90%. As permitted under the purchase agreement, MatlinPatterson had a 90-day due diligence period during which it was given full access to DuCool’s business operations, properties, technology data and plans. MatlinPatterson was also given direct access to all of DuCool’s customers, though it only approached one customer. To conduct the agreed upon due diligence, MatlinPatterson, among other things, hired two consultants: QuinetiQ, to perform technical evaluations of DuCool’s technology, manufacturing facility, and installation sites; and McKinsey, to evaluate DuCool’s business model, financial information, and market potential. McKinsey drafted a proposed business plan for the company that was included in the parties’ initial purchase agreements. After the initial investment, but before the second investment, MatlinPatterson appointed three of the seven members of the board of directors and two of McKinsey’s representatives were installed as officers of DuCool. The Allegations and the Motion Court’s Ruling MatlinPatterson claimed that in the period before it purchased any interest in DuCool (pre-investment) and during the two-year period after its first investment (i.e., 2010 through 2012), when it acquired a majority interest in DuCool, the defendants made numerous false representations and provided inaccurate data about DuCool’s air conditioning technology, financial condition and overall successes in the United States and other markets. MatlinPatterson alleged that it relied on the representations and data, inducing it to repeatedly invest in DuCool, believing it was a better performing company than represented. MatlinPatterson also alleged that after it invested in DuCool, the defendants deceived it by intentionally concealing known problems with DuCool’s installations in at least three major sites in the United States and Costa Rica and made numerous false statements about energy cost savings in an April 2011 “study” that touted DuCool products’ performance and cutting edge technology. The defendants moved to dismiss the complaint. The motion court granted the motion and the plaintiff appealed. The Appellate Ruling As an initial matter, the First Department noted that the plaintiff failed to allege fraud with particularity as to each individual defendant and the various time periods involved. The Court observed that the complaint simply “bundled, bare-boned and conclusory allegations” – the type of allegations that do not suffice to plead a fraud claim. Turning to the justifiable reliance element – one of the two elements highlighted by this post – the Court noted that MatlinPatterson is a sophisticated investor that conducted extensive due diligence both before and after its initial investments. Such sophistication and knowledge undermined any claim of justifiable reliance: Plaintiff is an experienced and sophisticated investor. It did not plead facts to support the justifiable reliance element of fraud. Plaintiff had total, unfettered access to every aspect of DuCool’s company information both before and after its initial investment, even before it held a controlling interest in DuCool. Although learning through the due diligence conducted by its own technology and business consultants that there were frequent technological problems with DuCool products, some of them “severe,” plaintiff proceeded to invest in the company. Thereafter, as the 49% shareholder, plaintiff had the largest percentage ownership of any individual shareholder and it had access to information concerning the operations of the business. There is no factual basis on which to conclude that the alleged fraud involved matters peculiarly within defendants’ knowledge, because plaintiff had the means to discover the truth behind any false claims about the condition of the company and whether this was a feasible investment. Slip op. at 3 (citations omitted). Regarding the scienter element – the second element highlighted by this post – the Court found that the due diligence conducted by the plaintiff negated any inference that the defendants knew DuCool would fall short of projections: With respect to the scienter element of its claim, although “most likely to be within the sole knowledge of the defendant and least amenable to direct proof,” plaintiff is still required to allege facts “from which it is possible to infer defendant knowledge of the falsity of statements” when they were made. It has not done so. Plaintiff, based upon its own due diligence, concluded that DuCool presented a profitable, albeit speculative, investment opportunity given its development of new technology and registered patents. Although the company may not have performed as plaintiff expected, this does not support a reasonable inference that defendants knew that DuCool would fall short of its business projections. The parties’ agreement not only contained plaintiff’s express acknowledgment that success was speculative, but also a further acknowledgment that “any business plans prepared by the Company, have been, and continue to be, subject to change and that any projections included in such business plans or otherwise are necessarily speculative in nature. . .” Slip op. at 3-4 (citations omitted). Takeaway Unfortunately, there are times when an acquired business or investment does not live up to expectations. When this happens, the acquiring or investing party sues. MP Cool stands as a reminder that in New York (and some other jurisdictions) an aggrieved party cannot come to court claiming fraud when it has conducted due diligence and obtained information that undermines the strength of its claim. Though sophisticated parties can be the victim of fraud, they cannot complain if they have knowledge of the very fraud of which they complain. MP Cool also reminds us that scienter is a very difficult element to plead. In fact, the scienter element is the hardest to plead because the evidence of intent most often rests solely with the defendant. Because of this difficulty, intent is often inferred from circumstantial evidence. Pludeman v. N. Leasing Sys., Inc., 10 N.Y.3d 486, 488 (N.Y. 2008). Notwithstanding, as the First Department made clear, scienter must be plead with particularity. Slip op. at 3. Conclusory allegations, such as those in MP Cool, will not suffice. The plaintiff must allege facts from which there is some “rational basis for inferring that the alleged misrepresentations were knowingly made.” Houbigant, Inc. v. Deloitte & Touche LLP, 303 A.D.2d 92, 93 (1st Dep’t 2003). As MatlinPatterson learned in MP Cool, the failure to meet this hurdle will result in dismissal. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber On August 30, 2016, the Securities and Exchange Commission (“SEC”) announced that it awarded a company insider $22.5 million for providing “detailed” information about a “well-hidden fraud at the company where the whistleblower worked.” Though not disclosed by the SEC, news outlets reported that the company involved was Monsanto Co. The $22.5 million award is the second-largest the SEC has awarded a whistleblower since the program’s inception in 2011. Among other things, the SEC recognized the “extensive assistance” provided by the whistleblower in “help the agency halt” the fraud. According to the news media, the fraud concerned accounting improprieties involving a rebate program Monsanto used to sell Roundup, a popular weed killer. The SEC accused Monsanto of falsifying its earnings through a corporate rebate program that was designed to increase the product’s sales. The SEC said that Monsanto “lacked sufficient internal controls to account for millions of dollars in rebates that it offered to retailers and distributors. It ultimately booked a sizeable amount of revenue, but then failed to recognize the costs of the rebate programs on its books.” Monsanto neither admitted nor denied the charges. The whistleblower’s attorney told news outlets that the whistleblower, a finance executive at Monsanto, went to the SEC only after first trying to correct the accounting issues internally. Commenting on the award, Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, said: Company employees are in unique positions behind-the-scenes to unravel complex or deeply buried wrongdoing. Without this whistleblower’s courage, information, and assistance, it would have been extremely difficult for law enforcement to discover this securities fraud on its own. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a whistleblower who provides original information to the SEC that leads to a successful enforcement action resulting in over $1 million in monetary sanctions may be awarded an amount not less than 10% and not more than 30% of the monetary sanctions collected. Since 2011, the SEC has awarded more than $107 million to 33 whistleblowers who “provided the SEC with original and useful information that led to a successful enforcement action.” The largest amount awarded to a whistleblower by the SEC was $30 million in 2014. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber, a partner at Freiberger Haber LLP On September 1, 2016, the Commodity Futures Trading Commission (“CFTC” or the “Commission”) announced that it was seeking comment on proposed amendments to the rules governing the Commission’s whistleblower program, its authority to administer the program and issue whistleblower awards, and its authority to implement anti-retaliation enforcement measures. The amendments, if adopted, will make the CFTC’s whistleblower program congruous with that of the Securities Exchange Commission (“SEC”), and would enable the CFTC to initiate enforcement proceedings against employers that retaliate against whistleblowers who engage in lawful whistleblowing activities. The CFTC is seeking comments on the proposed amendments on or before September 29, 2016. Background In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities and commodities laws. The Dodd-Frank Act contains whistleblower provisions that authorize the SEC and CFTC to pay cash rewards to whistleblowers who voluntarily provide the agencies with information about securities and commodities fraud and other violations of the securities and commodities laws. Under the CFTC whistleblower program, the CFTC will pay an award to any individual, or group of individuals, who voluntarily provides “original information” to the Commission about a violation of the commodities laws. If the information leads to a successful enforcement action of more than $1 million, the whistleblower may receive an award of between 10% and 30% of the sanctions collected. The amount of the award is dependent upon a number of factors, including the significance of the information provided and the degree of the whistleblower’s assistance. The CFTC whistleblower program has been around for five years. In that time, there have been only four awards – this blog recently wrote about the latest award – and no enforcement proceedings to protect whistleblowers from retaliation by their current or former employers. The absence of proceedings to enforce the anti-retaliation provisions of the Dodd-Frank Act stand in stark contrast to the more recent actions of the SEC – actions that this blog recently discussed. Since the adoption of the CFTC regulations governing the whistleblower program, the Commission did not view its enforcement authority to cover retaliation against whistleblowers. The proposed amendments indicate that the Commission now intends to promote its whistleblower program and actively protect whistleblowers against activity that chills lawful whistleblowing activity. The Commission made this clear in the notice of the proposed amendments: “Upon reconsideration of its statutory authority on this important issue, and noting that harmonization between the SEC’s and the Commission’s Whistleblower programs would be beneficial to the public by making the consequences of illegal retaliation more uniform, the Commission has decided to join the SEC on that path.” The Proposed Amendments The proposed amendments will make it easier for whistleblowers to seek awards and provide them more opportunity to participate in the awards process. Among other things, if approved, the changes would do the following: enhance the process for reviewing whistleblower claims; assign overall responsibility for administering the whistleblower program to the Director of the Division of Enforcement, and clarify the staff’s authority to administer the whistleblower program; replace the Whistleblower Award Determination Panel with a Claims Review Staff; provide the CFTC with the opportunity to review Proposed Final Determinations; revise the rules governing whistleblower eligibility requirements to make clear that (1) the Commission may consider claims for awards “in a covered action, in a related action, or both,” (2) a claimant may be eligible for an award by providing original information without being the original source of the information, and (3) a claimant will have additional time to submit a TCR by extending the timeframe from 120 to 180 days; revise the award claims review process by (1) replacing the Whistleblower Awards Determination Panel with a review process handled by the Claims Review Staff; (2) assigning responsibility for handling deficient claims with the Whistleblower Office; (3) allowing claimants an opportunity to correct deficiencies or withdraw the claim before finalization of the denial of the claim, (4) allowing the Whistleblower Office to require additional information of the claimant in connection with award applications, (5) allowing claimants an opportunity to demonstrate that they voluntarily provided the same original information to a governmental agency in a related action that led to the CFTC’s successful enforcement action and the successful enforcement action of the related action, and (6) allowing claimants the opportunity to contest the Preliminary Determination, including making available the record supporting the award determination; permit claimants who submitted original information in a related action to receive an award based on the monetary sanctions collected; provided, however, the claimant does not receive more than one award for the same action; and assign responsibility to the Claims Review Staff for the issuance of Preliminary Determinations and Proposed Final Determinations, and issuance of Proposed Final Dispositions to the Whistleblower Office. Whistleblower Protection and Anti-Retaliation Enforcement Authority The proposed changes also include a new emphasis on the protection against retaliation by current or former employers. In the notice of the proposed amendments, the CFTC said that it wants to “set aside” its prior interpretation of whether it has the authority to initiate enforcement proceedings against employers that retaliate against whistleblowers engaged in lawful activity under the Commodity Exchange Act (the “Act”). The Commission previously held that it lacked the statutory authority to bring enforcement proceedings against those who retaliate against a whistleblower in violation of the Act. That interpretation was contrary to that of the SEC. As the CFTC explained, the proposed amendments would end “the incongruous situation where whistleblowers enjoy protection from retaliation through SEC enforcement action under the securities laws, but no such protection through Commission enforcement action under the CEA.” Takeaway The proposed amendments signal the CFTC’s intention to devote more resources and attention to its whistleblower program and the protection of whistleblowers engaged in lawful whistleblowing activities. This new focus should increase the number of tips and awards, as well as guard against the incidence of employer retaliation. It will also encourage employers to adopt compliance programs and related policies that comply with the CFTC’s new regulations, including detecting and preventing retaliation. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

When parties negotiate the terms of a contract, they cannot account for every contingency or event that may affect performance. To be sure, they try. But, it is simply not possible to account for every occurrence that might arise during the course of the contract. This inability, therefore, gives the parties wide latitude in the performance and enforcement of their contractual obligations. Underlying this discretion is the duty to act in good faith and with fair dealing. As set forth in the Restatement (Second) of Contracts, “[E]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” Restatement (Second) of Contracts § 205 (1981). A party to a contract breaches these duties when his/her conduct frustrates the purpose of the contract, e.g., by failing to perform the things necessary to carry out the purpose for which the contract was entered and to refrain from destroying or injuring the other party’s right to receive the fruits of the contract. Such conduct is often described as bad faith, and is identified by, among other things, “evasion of the spirit of the bargain,” “abuse of a power to specify terms,” “interference with or failure to cooperate in the other party’s performance,” and willful rendering of imperfect performance. E.g., Restatement (Second) of Contracts § 205 cmt. d. It is widely recognized that New York was the first jurisdiction to identify the duty of good faith and fair dealing as an implied covenant that made a contract enforceable. See Wood v. Lucy, Lady Duff - Gordon, 222 N.Y. 88 (1917). Wood involved an endorsement and licensing agreement in which the parties agreed that the plaintiff could sell or license the defendant’s fashion designs in exchange for the payment of one half of all the profits and revenues generated under the agreement. A dispute arose and the defendant argued that there was no agreement between the parties. The court rejected the defendant’s argument, stating: The defendant insists, however, that it lacks the elements of a contract. She says that the plaintiff does not bind himself to anything. It is true that he does not promise in so many words that he will use reasonable efforts to place the defendant’s endorsements and market her designs. We think, however, that such a promise is fairly to be implied. The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract. Id . at 90-91 (citations omitted). New York Law: In the 1933, the New York Court of Appeals expressed the duty found in Wood as an implied covenant of good faith and fair dealing. In Kirk La Shelle Co. v. Paul Armstrong Co., a case involving a dispute between parties to a settled copyright litigation, the Court held that “in every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.” 263 N.Y. 79, 87 (N.Y. 1933). Since Kirk La Shelle, the courts in New York have implied a covenant of good faith and fair dealing in the course of the performance of all contracts. See, e.g., Van Valkenburgh, Nooger & Neville v. Hayden Publ. Co., 30 N.Y.2d 34, 45 (N.Y.), cert. denied, 409 U.S. 875 (1972); Dalton v Educational Testing Serv., 87 N.Y.2d 384, 389 (N.Y. 1995). While the duties of good faith and fair dealing do not imply obligations “inconsistent with other terms of the contractual relationship” (Murphy v. American Home Prods. Corp., 58 N.Y.2d 293, 304 (N.Y. 1983)), they do include “any promises which a reasonable person in the position of the promisee would be justified in understanding were included.” Rowe v. Great Atl. & Pac. Tea Co., 46 N.Y.2d 62, 69 (N.Y. 1978) (citation omitted). When the contract contemplates the exercise of discretion by the parties, it includes a promise not to act arbitrarily or irrationally in exercising that discretion. Tedeschi v. Wagner Coll., 49 N.Y.2d 652, 659 (N.Y. 1980). New York law does not, however, “recognize a separate cause of action for breach of the implied covenant of good faith and fair dealing when a breach of contract claim, based upon the same facts, is also pled.” Harris v. Provident Life and Acc. Ins. Co., 310 F. 3d 73, 81 (2d Cir. 2002). Therefore, when a complaint alleges both a breach of contract and a breach of the implied covenant of good faith and fair dealing based on the same facts and seeks the same relief, the latter claim will be dismissed as redundant. JFK Holding Co. LLC v. City of New York, 98 A.D.3d 273 (1st Dep’t 2012); MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287 (1st Dep’t 2011); Logan Advisors, LLC v. Patriarch Partners, LLC, 63 A.D.3d 440, 443 (1st Dep’t 2009). Rebecca Broadway L.P. v Hotton Recently, the Appellate Division, First Department had the opportunity to once again consider the covenant of good faith and fair dealing. On August 16, 2016, the First Department decided Rebecca Broadway L.P. v Hotton, NY Slip op. 05839, a case that arose “from an unsuccessful effort to produce a Broadway musical about a ghost.” Id. at 1. As the New York Law Journal observed, the facts of the case “offer[ ] enough twists and turns to rival a stage play.” Jason Grant, Appellate Ruling Sets the Stage for Trial in Broadway Scandal, NYLJ, Aug. 18, 2016, available here. Distilled to their essence, the facts of the case are as follows: After it was reported that a major foreign investor in the production had died, it emerged that the supposedly deceased backer had never been more than a ghost himself —the man had never existed, except as a deceptive construct conjured up by a dishonest fundraiser, who has since been incarcerated for this wrongdoing. The publicity agent for the show, when he began to suspect the truth about the supposedly deceased foreign investor, expressed his concerns to the producer's principal, who essentially told him to keep quiet about it. Apparently stung by this dismissive treatment, the publicity agent sent four anonymous emails to another potential investor (this one an actual, living person), who had wished to remain anonymous. The last of these emails, sent under a fictitious name, made various highly negative allegations about the producer and the show's prospects, and urged the potential investor not to back the play. After receiving this email, the potential investor promptly withdrew from involvement in the production, preventing it from going forward. Slip op. at 1-2. The plaintiff, Rebecca Broadway Limited Partnership (“RBLP”), sued Marc Thibodeau (“Thibodeau”) a publicity agent for breach of contract, tortious interference with business relations and defamation. The motion court granted RBLP’s motion for summary judgment as to Thibodeau’s liability for breach of contract and denied RBLP’s summary judgment as to RBLP’s causes of actions for tortious interference with business relations and defamation. The motion court also denied Thibodeau’s cross motion for summary judgment for, among other things, breach of contract. Thibodeau appealed the motion court’s order. The First Department affirmed. “As to the breach of contract cause of action,” the First Department found that the motion court “properly granted RBLP summary judgment as to liability on that claim.” Slip op. at 4. The Court found that the “record establishes that Thibodeau, without RBLP’s authorization, and using confidential information he had obtained as a result of his employment as RBLP’s press representative,” caused “a key potential investor” “to withdraw his financial commitment,” to the show, “which resulted in the cancellation of rehearsals and the play’s failure to open.” Id. That sufficed to breach the terms of the agreement with RBLP. The First Department noted that “[E]ven assuming that his conduct did not violate the express terms of his agreement to act as the play’s press representative, Thibodeau breached the implied duty of good faith and fair dealing by essentially defeating the purpose of the agreement by his actions.” Slip op. at 4 (citation omitted). In so holding, the Court found that "Thibodeau was hired by RBLP to use his public relations skills to facilitate the production of a play; his actions, in which he made use of confidential information that RBLP had entrusted to him in the course of his employment, made it impossible for RBLP to produce the play as planned. It is difficult to imagine a plainer case of a party to a contract utterly defeating the purpose for which the other party had entered into that contract, or a more blatant example of an agent's disloyalty to his principal." Id. Having affirmed the motion court’s decision, the First Department turned to the denial of Thibodeau’s cross motion for summary judgment. Thibodeau claimed that RBLP breached the covenant of good faith and fair dealing by instructing him to answer all questions about the project, notwithstanding the direction to refrain from discussing possible foreign investors. The First Department rejected this claim: Although Thibodeau might well have felt uncomfortable in meeting the press while under orders not to give them the information they sought, RBLP did not breach the covenant of good faith and fair dealing by giving him those instructions. Again, while the record establishes that RBLP — as was its right — directed Thibodeau not to respond substantively to questions concerning the Abrams (i.e., foreign investor) issue, Thibodeau does not allege that RBLP ever directed him to respond falsely to press inquiries. He could have responded to questions about Abrams, both truthfully and consistent with RBLP’s directives, by stating that RBLP was investigating the matter. RBLP, as Thibodeau’s principal, was entitled to limit the subjects that Thibodeau, as RBLP’s agent, was authorized to discuss substantively with the press and public; if Thibodeau was uncomfortable with that limitation on his authority, he was free to resign. Slip op. at 5. The Court went on to observe that even if RBLP breached the covenant of good faith and fair dealing before Thibodeau breached his covenant, the result would remain unchanged. As the Court noted, Thibodeau could have resigned and terminated the agreement with RBLP: Even if RBLP could be deemed to have somehow breached its implied duty to Thibodeau of good faith and fair dealing before he committed his own breach of that covenant by sending the anonymous emails, we would not reach a different result. Any such material breach by RBLP, before the breach by Thibodeau, would have given Thibodeau grounds to suspend his own performance and, absent a timely cure by RBLP of its breach, to terminate his contract with RBLP (and then, perhaps, to seek damages for breach) …. But a first material breach of the parties’ agreement by RBLP, if there was one, would not have justified Thibodeau’s remaining in RBLP’s employ while using confidential information entrusted to him to sabotage the production. A party to a bilateral contract, when faced with a breach by the other party, must make an election between declaring a breach and terminating the contract or, alternatively, ignoring the breach and continuing to perform under the contract. Such a party has no right to represent himself as continuing to perform under the contract —and continuing to receive the other party’s performance in exchange — while at the same time surreptitiously breaching his own duty by flouting his own implied duty of good faith and fair dealing. Slip op. at 5-6 (citations and quotations omitted). Takeaway: The implied duty of good faith and fair dealing has long been accepted as a judicial tool of contract analysis. It is aimed at ensuring that the parties to a contract do not interfere with the other party’s performance or destroy the other party’s expectations with respect to the benefits of the contract. Rebecca Broadway serves as a recent example of the duty and how it can serve as the basis for a separate cause of action. Rebecca Broadway is also notable for its admonition to contracting parties about how to conduct themselves when there is a breach. In this regard, the Court made it clear that when a party to a contract breaches the agreement, the non-beaching party must make an election of remedies between declaring a breach and terminating the contract or, ignoring the breach and continuing to perform under the contract. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber New York, NY (Law Firm Newswire) August 10, 2016 - The Legal 500 USA, a leading legal ranking and referral guide, has again recognized Mr. Haber, co-founding partner of Freiberger Haber LLP, for his work as a plaintiff’s attorney in securities litigation. Mr. Haber was identified in the 2016 edition as a “recommended” lawyer in the “Dispute Resolution: Securities Litigation – Plaintiff” category. Mr. Haber was also “recommended” in the 2011–2012 and 2014–2015 editions of The Legal 500 USA. The Legal 500 is an independent guide that ranks law firms and individual lawyers around the world. It spends several months each year conducting in-depth research into the legal market, using information provided by law firms and “feedback from peers and clients.” The purpose of the guide is “to assess … overall visibility and reputation … buyers of legal services with an objective analysis of the U.S. market….” About Freiberger Haber LLP Located in New York City, Freiberger Haber LLP is dedicated to representing corporations, small businesses, partnerships and individuals involved in a broad range of complex business and commercial litigation matters. Freiberger Haber LLP combines the sophistication and counsel of a large national law firm with the economy, flexibility, commitment and personal attention of a small firm. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber How many awards has the Commodity Futures Trading Commission ("CFTC") made under its whistleblower program? The CFTC awarded a whistleblower $50,000, the second such award this year. The $50,000 award comes on the heels of a $10 million award earlier in 2016, the largest award under its program to date. Authority Under the Dodd-Frank Act The whistleblower award program created under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") in 2010 authorized the commodities watchdog, along with the Securities and Exchange Commission ("SEC"), to reward whistleblowers who report violations of the commodities and securities laws. The CFTC program rewards individuals for voluntarily providing original information about Commodity Exchange Act ("CEA") violations, provided that the information leads to an enforcement action that results in monetary sanctions greater than $1 million. The whistleblower gets an award of between 10 and 30 percent of the amount collected by the CFTC. Under the law, the CFTC cannot identify the whistleblower, or the enforcement action on which the award is based. The $50,000 award is based on monetary sanctions collected by the CFTC thus far, and the whistleblower will receive between 10 and 30 percent of any additional sanction collected. CFTC Whistleblower Awards in 2016 Since the program was rolled out, the CFTC has made four awards for a total of $10.6 million, which is far less than awarded under the SEC's whistleblower program in which 32 awards of more than $85 million have been made - the largest being $30 million. While the CFTC was slow in rolling out its program - the first award was in 2014 - the program is said to be picking up steam. Protection Against Retaliation The Dodd-Frank Act also protects whistleblowers under the CFTC program, whether or not the individual is eligible for an award. Employers are prohibited from terminating, demoting, suspending, threatening, harassing (directly or indirectly), or in any manner discriminating against a whistleblower for any lawful act taken by the whistleblower under the CFTC program. These protections apply to any whistleblower who reasonably believes the information provided is related to possible violations of the CEA. Whistleblowers can also file a lawsuit in federal court in the event that they are discharged or discriminated against by an employer. The Takeaway The $10 million award earlier this year and the latest $50,000 award are an indication that the CFTC is becoming more aggressive in its enforcement activities. If you have knowledge of a violation of the CEA, an experienced attorney can help you report your concerns and obtain compensation. For related coverage, see our posts on IRS Whistleblowers Win Big as Court Ruling Stands and Former Employee Sued by Tesla Claims Whistleblower Status. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jeffrey M. Haber What is a FINRA arbitration? The Financial Industry Regulatory Authority ("FINRA") issued a Regulatory Notice in July 2016 reminding member firms that customers have a right to request arbitration "at any time." In addition, the self-regulator stated that customers do not forfeit their right to a FINRA arbitration by signing an agreement that calls for another venue. The notice also reiterated that FINRA members cannot require registered representatives and certain employees to waive their right to arbitration in a pre-dispute arbitration agreement. FINRA Arbitration at a Glance The FINRA arbitration forum protects customers from a wide range of practice violations, such as unsuitable investment advice, churning, breach of fiduciary duty, and the like. Arbitration is a more expedient and cost-effective approach to dispute resolution than a court trial. The process involves selecting a neutral third party, the "arbitrator," to resolve the dispute. By pursuing arbitration, a customer waives the right to pursue the matter in court, and the arbitrator's decision is final and binding. The Regulatory Notice is a reminder that failing to comply with the rules concerning arbitration agreements, or failing to submit disputes to a FINRA forum, are rules violations that could result in disciplinary action. The notice serves as a warning to firms that have reportedly been including restrictive provisions regarding dispute forums in their arbitration agreements. While these restrictions are more common in disputes between member firms and registered representatives, the real issue in customer disputes tends to be the selection of law. In a related development, FINRA has also filed a proposed rule with the SEC to amend its Code of Arbitration Procedure for Customer Disputes. The goal is to provide a more efficient arbitration process that is also less costly, while maintaining the rights of the parties involved in a dispute. Some observers believe the process could be made more efficient, but argue that any cost savings should be passed through to the customers involved in the proceeding. FINRA has continued to refine its arbitration and dispute-resolution procedures since; see our post on FINRA's proposed changes to the expungement process for a related development. Notwithstanding FINRA's July 2016 notice, brokers and investment advisors have a duty to act in a reasonable and prudent manner when acting as a fiduciary, and are required to put their customers' interests first. A registered representative who becomes embroiled in a dispute with a customer or employer should engage the services of an experienced securities arbitration attorney. For a broader look at how the process works, see our post, In Focus: Securities Arbitration. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jonathan H. Freiberger Deadlines are a big part of litigation. When a litigant serves a late paper, they may receive a notice of rejection in response. What happens if a notice of rejection is not timely served? If the rejection is made after fifteen days, the objection is deemed waived pursuant to CPLR 2101(f), which provides: A defect in the form of a paper, if a substantial right of a party is not prejudiced, shall be disregarded by the court, and leave to correct shall be freely given.  The party on whom a paper is served shall be deemed to have waived objection to any defect in form unless, within fifteen days after the receipt thereof, the party on whom the paper is served returns the paper to the party serving it with a statement of particular objections. In Gorgia v. Dolan, 250 A.D. 3d 809 (2d Dept. 2026), was an employment discrimination case. Pursuant to CPLR 3012(b) a complaint must be served within twenty days of demand. The motion court dismissed the complaint because it was served thirty days after the defendant’s demand. The Second Department reversed holding that the defendant waived the right to argue that the complaint was served late. The defendant was untimely in rejecting same and a “party is deemed to have waived late service where it retains the paper without rejecting to late service.” Gorgia, 250 A.D.3d at 813 (citations omitted). In Lyles v. Nassau County, 213 A.D.3d 921 (2d Dept. 2023), the plaintiff served the defendant with a copy of the summons and complaint on March 15, 2019. More than two months later, defendant served and filed an untimely answer. The answer was never rejected, and, instead, the plaintiff moved for a default judgment five months later. The defendant cross-moved to dismiss the complaint as time-barred. The motion court denied plaintiff’s motion and granted the cross-motion. On plaintiff’s appeal, the Court affirmed holding that the retention of the answer without rejection waived the late service and default. Aron Law, PLLC v. New York City Health and Hospitals Corp., 232 A.D.3d 528 (1st Dept. 2024), involved a petition regarding FOIL records. When petitioner’s response to a FOIL request contained numerous redactions, he brought an article 78 Proceeding seeking the production of unredacted documents. The motion court granted the petition and directed that the agency produce unredacted copies. On the agency’s appeal, the Court unanimously reversed. The Court found that the agency submitted, with the records, a detailed explanation of its redactions, in evidentiary form that should not have been disregarded by the motion court. In addition, the Court held that “petitioner waived any objections to any procedural deficiencies in the answer by raising them for the first time in reply, instead of returning the answer to respondent with a statement of objections within 15 days pursuant to CPLR 2101(f).” Aron Law, 232 A.D.3d at 529. Against this backdrop we discuss PNC Bank, N.A. v. Kane, 2026 WL 2336292 (2d Dept. 2026). The defendant in PNC Bank made a pre-answer motion to dismiss the plaintiff’s foreclosure complaint. The motion was denied in June 2023. Pursuant to CPLR 3211(f), the defendant’s answer was due “ten days after service of notice of entry of the order” denying the motion. Instead, the defendant served her answer in October. Twenty days later the plaintiff rejected the answer as untimely. Thereafter, the defendant moved for an order compelling the plaintiff to accept a late answer and the plaintiff cross-moved for a default judgment. The motion court denied defendant’s motion and granted the cross-motion. On defendant’s appeal, the Second Department reversed holding that: Pursuant to CPLR 2101(f), “[t]he party on whom a paper is served shall be deemed to have waived objection to any defect in form unless, within fifteen days after the receipt thereof, the party on whom the paper is served returns the paper to the party serving it with a statement of particular objections.” Here, the plaintiff’s undisputed failure to reject the defendants’ answer within the 15-day statutory time frame constituted a waiver of the late service and the default (see Globalized Realty Group, LLC v Crossroad Realty NY, LLC, 239 AD3d 950, 952; U.S. Bank N.A. v Lopezv, 192 AD3d 849, 850; Glass v Captain Hulbert House, LLC, 103 AD3d 607, 608-609). Accordingly, the Supreme Court should have granted the defendants’ motion to compel the plaintiff to accept their late answer and denied the plaintiff’s cross-motion for leave to enter a default judgment against the defendants (see U.S. Bank N.A. v Lopez, 192 AD3d at 850-851; Glass v Captain Hulbert House, LLC, 103 AD3d at 609). Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By: Jeffrey M. Haber The Securities and Exchange Commission (the “Commission”) regulates investment advisers, primarily under the Investment Advisers Act of 1940 (“Advisers Act”) and the rules adopted under that statute. One of the central elements of the regulatory program is the requirement that an investment adviser under the Advisers Act register with the Commission, unless exempt or prohibited from registration. Generally, only larger advisers that have $100 million or more of regulatory assets under management, or that provide advice to investment company clients, are permitted to register with the Commission. Smaller advisers register under state law with state securities authorities. Exempt Reporting Advisers (“ERAs”) are a category of private fund advisers under the Advisers Act that are not required to register with the Commission. ERAs include advisers to venture capital funds, and advisers to private funds with less than $150 million in assets under management in the United States. The registration exemption for advisers to venture capital funds is Advisers Act Section 204(l); the registration exemption for private fund advisers is Advisers Act Section 204(m). While ERAs are exempt from the registration requirements, any books or records they do maintain are subject to examination by the Commission under Section 204(a) of the Advisers Act. Section 204(a) of the Advisers Act provides that all records of investment advisers are “subject at any time, or from time to time, to such reasonable periodic, special, or other examinations by representatives of the Commission as the Commission deems necessary or appropriate in the public interest or for the protection of investors.”[1] Form ADV is the form used by investment advisers to register with the Commission and with state securities authorities. It consists of two parts, both of which are required to be filed with the Commission, and both of which are publicly available once filed: Form ADV Part 1 and Form ADV Part 2. ERAs, while exempt from registration, are still required to file certain items in Form ADV Part 1. ERAs do not complete Part 2. Part 1 asks for information about, among other things, an adviser’s business, amount of assets under management, ownership, and clients. Form ADV is filed electronically with the Commission through the Investment Adviser Registration Depository (“IARD”), a secure Internet-based filing system that collects and maintains the registration, reporting, and disclosure information for investment advisers. The Financial Industry Regulatory Authority (“FINRA”), under contract with the Commission, is the developer and operator of the IARD system. Once filed, the Form ADV is available to the public through the Commission’s Investment Adviser Public Disclosure database (“IAPD”), located at https://adviserinfo.sec.gov. The importance of the Form ADV disclosure regime and the Commission’s authority to examine records maintained by advisers and exempt reporting advisers were highlighted in Securities and Exchange Commission v. Wisdom Capital Management Group Ltd., an enforcement action filed by the Commission in 2024 in which a final judgment was recently entered. Securities and Exchange Commission v. Wisdom Capital Management Group Ltd. According to the Commission’s complaint, Wisdom Capital Management Group Ltd. (“Wisdom”) filed a Form ADV in December 2023 claiming that it qualified as an ERA under both of the Advisers Act’s principal private-fund exemptions. Specifically, Wisdom represented that it both advised only venture capital funds and acted solely as an adviser to private funds with less than $150 million in assets under management in the United States. The filing contained information concerning Wisdom’s business operations and organizational structure. Wisdom identified a Wall Street address in New York City as its principal office and place of business and designated an individual, “Ricardo Jobity”, as both its Chief Executive Officer and Chief Operating Officer. It also reported that it had $10 million in private fund assets under management in the United States and disclosed two private funds that it purportedly advised. In addition, the filing represented that Wisdom was a public reporting company and supplied a Central Index Key (“CIK”) number typically associated with entities that make periodic filings with the SEC. The Commission’s investigation allegedly revealed multiple inconsistencies with those representations. According to the Commission’s complaint, the occupant of the Wall Street address identified in the Form ADV had been located there for more than seven years and had no knowledge of either Wisdom or “Ricardo Jobity”. The Commission further alleged that a third-party registered investment adviser identified in Form ADV as providing information about Wisdom’s private funds did not report those funds in its own filings. Nor, according to the Commission, were the funds or their listed identification numbers found elsewhere in the SEC’s records. The Commission also alleged that searches of the SEC’s public-company database produced no information corresponding to either Wisdom or the CIK number provided in the filing. According to the Commission, the matter was compounded by its inability to verify the information directly with the firm. The telephone number listed for Wisdom’s New York office used a San Antonio, Texas area code, and when Commission attorneys called the number on two occasions, the calls allegedly went unanswered and resulted only in a busy signal. The Commission also sent requests seeking books and records relating to the information reported on the Form ADV, including organizational records and information relating to the firm’s reported private-fund assets under management. According to the complaint, neither Wisdom nor “Jobity” responded to those requests. By engaging in the conduct described in the Complaint, the Commission alleged that Wisdom violated Sections 204(a) and 207 of the Advisers Act of 1940. The Commission sought injunctive relief and civil monetary penalties. On August 3, 2026, the court entered a final judgment by default. Pursuant to the judgment, (1) Wisdom was enjoined from future violations of Sections 204(a) and 207 of the Advisers Act, (2) Wisdom, its owners, and its executive officers were enjoined from filing a Form ADV as an Exempt Reporting Adviser, and Wisdom was ordered to pay a civil penalty of $1,152,316. Takeaway Wisdom Capital serves as a reminder that Exempt Reporting Adviser status relieves an adviser of the obligation to register with the SEC, but it does not remove the adviser from the Commission’s oversight authority. ERAs remain subject to the Advisers Act’s examination provisions and must be prepared to substantiate the information they disclose in Form ADV filings. The enforcement action underscores that the Commission views Form ADV as a critical regulatory disclosure document and expects advisers relying on registration exemptions to provide accurate and verifiable information concerning their business operations, assets under management, personnel, and fund activities. The enforcement action also demonstrates the breadth of the Commission’s authority under Section 204(a) of the Advisers Act. According to the Commission, when questions arose regarding the accuracy of Wisdom’s disclosures, the Commission’s staff requested books and records supporting the firm’s representations. The alleged failure to respond to those requests became an important aspect of the case. Wisdom Capital therefore illustrates that an adviser cannot rely on its exempt status as a shield against regulatory inquiry; records maintained by an ERA remain subject to SEC examination, and a failure to cooperate with those examination efforts can itself form the basis for enforcement action. Finally, Wisdom Capital highlights the risks associated with inaccurate or unsupported Form ADV disclosures. The Commission alleged that multiple representations in Wisdom’s filing, including information concerning its address, management, assets under management, private funds, and public-company status, could not be verified and were inconsistent with information available from other sources. By pursuing claims under Section 207, which prohibits untrue statements of material fact in filings made under the Advisers Act, the Commission reinforced the principle that advisers claiming an exemption from registration must provide truthful and complete information in the filings that the statute requires them to make. __________________________________ Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes only and is not intended to be, and should not be, taken as legal advice. Unless otherwise stated, Freiberger Haber LLP’s articles are based on recently decided published opinions or litigation releases and not on matters handled by the firm. ___________________________________ [1] 15 U.S.C. § 80b-4(a).

By: Jeffrey Haber In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities. The Dodd-Frank Act contains whistleblower provisions that authorize the Securities and Exchange Commission (“SEC” or the “Commission”) to pay substantial cash rewards to whistleblowers that voluntarily provide the SEC with information about violations of the securities laws. The Act further empowers whistleblowers to report corporate fraud or illegal conduct by prohibiting retaliation against individuals who blow the whistle under the SEC whistleblower program. In 2011, the SEC adopted Rule 21F-17 to implement the whistleblower-protection provisions of the Act. The rule provides that “o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications.” Rule 21F-17 applies to any policy or procedure, or agreement, such as confidentiality, severance, and non-disclosure agreements, that may impede an employee or former employee from providing information to the SEC about a securities law violation. The SEC Begins To Enforce Rule 21F-17 Since the rule’s adoption, whistleblowers and their counsel have complained that employers have used confidentiality and non-disclosure agreements to harass and intimidate employees and former employees from reporting a violation of the securities laws to the SEC. The problem from the whistleblower’s perspective was that following adoption, the SEC was not enforcing the rule. That changed, however, in March 2014, when the SEC whistleblower office promised to police confidentiality agreements, and punish those companies that used such agreements to impede whistleblowing communications with the Commission. A year later, in February 2015, the SEC laid the foundation to make good on that promise. According to numerous media reports, the SEC asked dozens of public companies for nondisclosure agreements, employment contracts, severance agreements, and other similar documents as part of an investigation into whether there were efforts to suppress lawful whistleblowing activities. See, e.g., Rachel Louise Ensign, “SEC Probes Companies’ Treatment of Whistleblowers,” The Wall Street Journal, Feb. 25, 2015. The KBR Administrative Action: In April 2015, the SEC made good on its promise to crackdown on agreements and policies that restrict whistleblowing activities, when it issued a cease-and-desist order against KBR Inc. (“KBR”) for using confidentiality agreements that could chill the whistleblower process. According to the SEC, KBR, a global technology and engineering firm based in Houston, required employees participating in internal investigations to sign confidentiality statements containing language warning that the employee could be disciplined and/or fired if he/she discussed the investigation and its subject matter with outside parties without the approval of KBR’s legal department. The SEC acknowledged that it was “unaware of any instances in which (i) a KBR employee was in fact prevented from communicating” with the Commission, or “(ii) KBR took action to enforce the form confidentiality agreement or otherwise prevent such communications,” but nonetheless found that the agreement “impedes such communications.” KBR agreed to pay a $130,000 penalty to settle the SEC’s charges and amend its confidentiality statement by adding language making it clear that employees could report securities law violations to the SEC and other federal agencies without KBR approval or fear of retaliation. Commenting on the settlement, Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, underscored the vigor with which the SEC would pursue companies for violating Rule 21F-17: By requiring its employees and former employees to sign confidentiality agreements imposing pre-notification requirements before contacting the SEC, KBR potentially discouraged employees from reporting securities violations to us. SEC rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC. We will vigorously enforce this provision. The KBR order was the first reported enforcement action by the SEC that was based solely on the language of a confidentiality agreement. There would be others, albeit more than a year later. The BlueLinx Holdings Administrative Action: On August 10, 2016, the SEC announced that BlueLinx Holdings Inc. (“BlueLinx”), a building products distributor based in Atlanta, agreed to pay $265,000 in settlement of charges that it violated Rule 21F-17 by using severance agreements that required outgoing employees to waive their rights to a monetary recovery if they filed a complaint with the SEC or other federal agencies. According to the SEC, BlueLinx used several forms of severance agreements “that prohibited the employee from sharing with anyone confidential information concerning BlueLinx that the employee had learned while employed by the company, unless compelled to do so by law or legal process,” but which failed to exempt the employee from providing “information voluntarily to the Commission or other regulatory or law enforcement agencies.” Even though BlueLinx’s severance agreements did not prohibit former employees from reporting violations to the SEC, the SEC nevertheless claimed that the company unlawfully restricted outgoing employees from participating in the SEC’s whistleblower program. According to the SEC, “by requiring its departing employees to forego any monetary recovery in connection with providing information to the Commission, BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” The SEC also objected to the requirement that outgoing employees notify the company’s legal department prior to disclosing information to third parties, because the agreement did not expressly exempt the SEC from the restriction. The SEC determined that “BlueLinx forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.” Although the company did not admit or deny the findings, BlueLinx agreed: “(1) to amend its severance agreements to make clear that employees may report possible securities law violations to the SEC and other federal agencies without BlueLinx’s prior approval and without having to forfeit any resulting whistleblower award, and (2) to make reasonable efforts to contact former employees who had executed severance agreements after Aug. 12, 2011 to notify them that BlueLinx does not prohibit former employees from providing information to the SEC staff or from accepting SEC whistleblower awards.” In the announcement of the settlement, the SEC made it clear that the Commission would continue to aggressively enforce Rule 21F-17. Stephanie Avakian, Deputy Director of the SEC’s Enforcement Division underscored this point, stating “We’re continuing to stand up for whistleblowers and clear away impediments that may chill them from coming forward with information about potential securities law violations.” Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, added, “Companies simply cannot undercut a key tenet of our whistleblower program by requiring employees to forego potential whistleblower awards in order to receive their severance payments.” The Health Net Inc. Administrative Action: On August 16, 2016, the SEC announced that Health Net Inc. (“Health Net”), a health insurance provider based in California, agreed to pay a $340,000 penalty for using severance agreements that required outgoing employees to waive their right to obtain monetary awards for blowing the whistle under the SEC’s whistleblower program. Health Net provided a severance package pursuant to an agreement that outgoing employees signed when leaving the company. These agreements included a Waiver and Release of Claims that listed various potential claims against the company that an outgoing employee waived as a condition of receiving severance payments and other consideration from Health Net. In August 2011, Health Net amended the Waiver and Release of Claims to specify that, while not prohibited from participating in a government investigation, the outgoing employee who executed the Waiver and Release of Claims was prohibited from filing an application for, or accepting, a monetary award from the SEC. In June 2013, Health Net further amended the Waiver and Release of Claims by removing the language “expressly prohibiting employees from applying for whistleblower awards pursuant to Exchange Act Section 21F,” and added an exemption for “communicating directly with, cooperating with or providing information to any government regulator.” However, Health Net “retained restrictions in the Waiver and Release of Claims that removed the financial incentive for its former employees who executed that agreement to communicate with Commission staff concerning possible securities law violations at Health Net.” On October 22, 2015, Health Net amended its severance agreements to remove the prohibition described above. Notably, the SEC acknowledged that it found no evidence of any instances in which an outgoing Health Net employee who executed the severance agreements did not communicate directly with the SEC about potential securities law violations, nor did the SEC find any evidence that Health Net enforced the waiver provisions or otherwise prevented such communications. Nonetheless, the SEC concluded that both the 2011 and the 2013 provisions violated Rule 21F-17 by removing the financial incentive to communicate with the SEC concerning possible securities law violations at Health Net. In addition to paying the penalty, Health Net agreed to make reasonable efforts to contact former employees who signed the Waiver and Release of Claims, and provide those employees with a link to the SEC’s order and a statement that “Health Net does not prohibit former employees from seeking and obtaining a whistleblower award from the Securities and Exchange Commission pursuant to Section 21F of the Exchange Act.” In the announcement of the settlement, the SEC continued to emphasize its effort to enforce Rule 21F-17. In this regard, Antonia Chion, Associate Director of the SEC Enforcement Division, stated, “Financial incentives in the form of whistleblower awards, as Congress recognized, are integral to promoting whistleblowing to the Commission. Health Net used its severance agreements with departing employees to strip away those financial incentives, directly targeting the Commission’s whistleblower program.” Takeaway: The foregoing administrative actions demonstrate the SEC’s intention to make good on its promise to crack down on agreements and policies that impede whistleblowers from reporting securities fraud to the Commission. Whistleblowers should take comfort knowing that the SEC is aggressively enforcing Rule 21F-17 so that there are no contractual or policy impediments to blowing the whistle on securities fraud. Companies should review their severance agreements and policies to ensure that they are compliant with Rule 21F-17. Even companies that have previously reviewed their severance agreements and company policies should undertake such a review in light of the SEC’s recent enforcement actions. Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

In the commercial world, parties to a transaction often allocate the risk of economic loss in the event the transaction is not fully executed by including a sole remedy clause in their agreement. New York courts have long upheld such contractual provisions. However, as the First Department of the New York Supreme Court, Appellate Division, recently held, there are exceptions. One such exception pertains to a party’s grossly negligent conduct. As explained in Morgan Stanley Mortgage Loan Trust 2006-13ARX v. Morgan Stanley Mortgage Capital Holdings LLC, 2016 NY Slip Op. 05781 (1st Dep’t. Aug. 11, 2016), a party cannot “insulate itself from damages caused by its grossly negligent conduct.” Id. at *4 (internal quotations omitted). THE CASE The case arose from the securitization and sale of residential mortgages. The underlying mortgage loans originated with an affiliate of the defendant, Morgan Stanley Capital Holdings LLC (“Morgan Stanley”). The mortgage loans were pooled together and sold to the Morgan Stanley Mortgage Loan Trust 2006-13ARX (the “Trust”), which, through the plaintiff, U.S. Bank National Association (the “Trustee”), issued certificates representing ownership shares in the combined assets. These assets were then offered for sale, by prospectus, to investors as residential mortgage backed securities (“RMBS”). The Trustee sued Morgan Stanley to recover the losses sustained by investors who purchased the RMBS after a massive number of the loans defaulted. Facts: In 2006, Morgan Stanley sold debt, in the form of 1,873 residential mortgage loans, to a Morgan Stanley affiliate, Morgan Stanley Capital I, Inc. The sale, which represented an unpaid principal balance of more than $600,000,000, was largely effectuated through two integrated agreements, a Mortgage Loan Purchase Agreement (“MLPA”) and a Pooling and Servicing Agreement (“PSA”). These residential mortgage loans were pooled together and sold to the Trust, which issued certificates representing ownership shares in the combined assets. These RMBS were then offered for sale, by prospectus, to investors. Mortgage payments were the anticipated source of revenues that the Trustee would use to pay investors. However, when hundreds of the borrowers defaulted in making their mortgage payments, the RMBS became virtually worthless. The Proceedings Below: The Trust alleged that it incurred more than $140 million in damages due to Morgan Stanley’s false representations and warranties. According to the Trustee, Morgan Stanley acted with reckless indifference by failing to adhere to minimum underwriting standards. The Trustee claimed that when it notified Morgan Stanley of the defective loans, demanding that Morgan Stanley repurchase them, Morgan Stanley refused to do so. The Trustee claimed that a forensic examination of the RMBS showed that there were hundreds of loans that were of lesser quality than what Morgan Stanley had represented. The complaint alleged that many of the underlying borrowers obtained their loans by providing inaccurate, if not outright false, information on their applications that Morgan Stanley failed to verify. The Trustee maintained that Morgan Stanley should have notified the Trustee of these conditions because it knew of them, or could have discovered them with due diligence, given its access to documents and information about the loans. The Trustee alleged that Morgan Stanley made representations to make the loans appear less risky than they were. Despite the sole remedy provision, the Trustee alleged that contractual damages would not adequately compensate the Trust for its losses. Morgan Stanley moved to dismiss the complaint. The trial court dismissed the cause of action alleging a breach of contract based on Morgan Stanley’s alleged failure to notify the Trustee about the defective loans. The court rejected the Trustee’s argument that Morgan Stanley’s inaction constituted an independent breach of contract claim, finding that the requirement was not a contractual obligation, but merely a notification remedy. The court also dismissed the Trustee’s claims that it was entitled to damages caused by Morgan Stanley’s gross negligence on the basis that “the relief available to plaintiff is limited by the sole remedy provisions in the [PSA] and the [MLPA]” (2014 NY Slip Op 32520[U], *1-2 [2014]). Alternatively, the court held that “even if, legally, the sole remedy limitations in the MLPA and PSA could be rendered unenforceable by Morgan Stanley’s willful misconduct or gross negligence,” the Trustee’s complaint “did not contain facts to sufficiently support that claim.” Id. The Court’s Decision: In dismissing the Trustee’s failure to notify cause of action, the trial court observed that the issues raised by the Trustee were substantially the same as those raised in Nomura Asset Acceptance Corp. Alternative Loan Trust v Nomura Credit & Capital, Inc., an RMBS case that was pending before it, and that its ruling was consistent with that earlier case. However, after the parties briefed the appeal, the First Department modified the Nomura decision, “holding that under similar RMBS agreements, a seller’s failure to provide the trustee with notice of material breaches it discovers in the underlying loans states an independently breached contractual obligation, allowing a plaintiff to pursue separate damages.” Slip Op. at *4 (citing Nomura Home Equity Loan, Inc. v Nomura Credit & Capital, Inc., 133 A.D.3d 96, 108 (1st Dep’t 2015) (lv granted 1st Dep’t Jan. 5, 2016)). Consistent with the First Department’s Nomura decision, the Court reinstated the failure to notify claim. In connection with the Trustee’s claims of gross negligence, the Court held that although the courts in New York will honor “the remedies that the parties have contractually agreed to,” they will not allow a party to “insulate itself from damages caused by its grossly negligent conduct.” As a general principle of law, damages arising from a breach of contract will ordinarily be limited to those necessary to redress the wrong (see e.g. Rocanova v Equitable Life Assur. Socy. of U.S., 83 NY2d 603, 613 [1994]). Where parties contractually agree to a limitation on liability, that provision is enforceable, even against claims of a party's own ordinary negligence (Sommer v Federal Signal Corp., 79 NY2d at 553, 554). There are exceptions to this rule of law, however, and as a matter of long-standing public policy, a party may not insulate itself from damages caused by its “grossly negligent conduct” (Sommer at 554). Looking at the complaint, the Court found that the Trustee sufficiently alleged that Morgan Stanley acted with reckless indifference. In that regard, the Court noted that: “It alleges there were widespread breaches across the loans being held by the Trust and that Morgan Stanley failed to adhere to even minimal underwriting standards or to verify basic and critical information about potential buyers; it further alleges that Morgan Stanley had access to the underlying loan files and that more than half of the loans later reviewed by plaintiff's forensic analysts revealed rampant breaches of the warranties Morgan Stanley made. It further alleges that Morgan Stanley simply ignored its contractual obligations, disregarded the known or obvious risks that the loans sold to the Trustee were defective and then failed to notify the Trustee of any breaches or effectuate a cure/repurchase. We hold that these allegations are sufficient to withstand dismissal at the pleading stage.” Takeaway: Agreements limiting the remedies available to parties for the failure to perform the terms of their agreement are enforceable under the law. In fact, such provisions are an accepted means to allocate risk between the parties. Morgan Stanley teaches that despite the parties’ attempt to contractually limit the remedies available for a breach, they cannot limit the remedies available for their fraudulent or reckless misconduct. This article was written by Jeffrey M. Haber, a partner at Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.