On March 29, 2018, the New York Court of Appeals decided Kolchins v. Evolution Markets, Inc. , a case that addresses several important practice issues. Plaintiff in Kolchins was a commodity trader who, in 2005, joined defendant as a commodity broker.  In 2006, and again in 2009, the parties entered into three-year employment agreements.  The 2009 agreement, which had an end date of August 31, 2012, provided for various forms of compensation including a base salary, a “sign on” bonus, a production bonus and minimum guaranteed compensation.  In June of 2012, in anticipation of the expiration of the 2009 agreement, defendant’s CEO sent plaintiff an e-mail stating that the terms of a new employment offer were the same as those under the parties’ 2009 contract, but for a minor issue that was not challenged by plaintiff.  Plaintiff replied to the CEO one month later with an e-mail that stated, “I accept, pls send contract”.  The happy CEO then responded by e-mail stating, “Mazel. Looking forward to another great run.” Thereafter, defendant’s general counsel unsuccessfully attempted to “reduce the parties’ mutual understanding to a more formal written instrument.”  On September 1, 2012, plaintiff was notified that his employment ceased upon the expiration of the 2009 agreement. Litigation ensued in which plaintiff alleged that his breach of contract claim was supported by the parties’ e-mails, which constituted a “valid and binding contract setting forth the terms of continued employment with defendant.”  Defendant, relying on the parties’ e-mails, letters and prior employment agreements, moved to dismiss the complaint pursuant to CPLR 3211(a)(1).   The Kolchins Supreme Court denied the motion to dismiss.  Among other things, Supreme Court held that e-mails are not the types of documents that can be considered “documentary evidence” under CPLR 3211(a)(1) and that, even if considered documentary evidence, such documents in this case, did not conclusively refute that the parties entered into a binding contract. Defendant appealed.  Appellate Division, First Department, found that Supreme Court properly denied defendant’s motion, while rejecting Supreme Court’s conclusion that e-mails cannot be considered documentary evidence for the purposes of a CPLR 3211(a)(1) motion.  In this regard the Kolchins Appellate Division stated: Preliminarily, we reject Supreme Court’s conclusion that correspondence such as the emails here do not suffice as documentary evidence for purposes of CPLR 3211(a)(1).  The Court has consistently held otherwise…. his Court found drafts of an agreement and correspondence sufficient for purposes of establishing a defense under the statute.  Similarly,… this Court found documentary evidence in the form of emails to be sufficient to carry the day for a defendant on a CPLR 3211(a)(1) motion.  Likewise,… this Court granted a CPLR 3211(a)(1) motion on the basis of a letter from the plaintiff’s counsel that contradicted the complaint.  Therefore, there is no blanket rule by which email is to be excluded from consideration as documentary evidence under the statute. The Kolchins Court of Appeals recognized the Appellate Division’s holding in this regard and agreed that, based on the documentary evidence supporting its motion, defendant failed to “meet its burden to conclusively refute the allegations of the complaint that the parties entered into a new contract.” The Court of Appeals noted that the first level of analysis in determining if the parties entered into a contract is whether “there is a sufficiently definite offer such that its unequivocal acceptance will give rise to an enforceable contract.”  The Court also reiterated that: when faced with determining the issue of whether the parties’ course of conduct and communications created an enforceable contract, “it is necessary to look to the objective manifestations of the intent of the parties as gathered by their expressions, words and deeds” (citations and internal quotation marks omitted);  and, that certainty as to material terms is also critical to the finding that a contract exists. Against this backdrop, the Court of Appeals concluded that a reasonable fact-finder could determine that the documentary evidence presented on the motion could support the finding that a binding contract was formed by the parties.  The CEO’s initial e-mail stated that the terms of the new contract offer were largely the same as under the prior contract.  This, the Court concluded, “could reasonably be inferred constitute[] a valid offer by defendant.”  As to the acceptance and the parties’ intent to be bound, the Court stated: In response to that email, plaintiff wrote "I accept. pls send contract," to which Ertel replied, "Mazel. Looking forward to another great run." Affording plaintiff the benefit of every favorable inference, this exchange — in essence, we "offer" and "I accept," followed by an arguably congratulatory exclamation, coupled with a forward-looking statement about the next stage of the parties' continuing relationship — sufficiently evinces an objective manifestation of an intent to be bound for purposes of surviving a motion to dismiss. TAKEAWAY As technology advances, folks tend to become increasingly more informal.  Care should be taken to ensure that one or more informal communications cannot be pieced together to create a binding agreement where none was intended. This Blog previously addressed the issue of e-mails and contract formation here and here .

JEFFREY M. HABER, CO-FOUNDING PARTNER OF FREIBERGER HABER LLP, IS AGAIN RECOGNIZED BY SUPER LAWYERS MAGAZINE New York, NY (Law Firm Newswire) April 5, 2018 – Freiberger Haber LLP is pleased to announce that co-founding partner, Jeffrey M. Haber , has been named by Super Lawyers Magazine® to be among the top lawyers in the New York metropolitan area for the seventh consecutive year. Mr. Haber was recognized for his work in business litigation . As part of his history of professional achievements, he was also recognized as a Super Lawyer in 2008-2010 and 2012-2017. Super Lawyers Magazine® is an affiliate of Thomson Reuters. The publication recognizes attorneys who have distinguished themselves by both a high degree of professional achievement and by peer recognition. Each year, no more than 5 percent of lawyers are recognized as Super Lawyers by the magazine. The annual selection involves a survey of lawyers, independent research evaluation of candidates, and peer reviews within each practice area. The magazine publishes its lists nationwide, as well as in leading city and regional magazines and newspapers across the country. A description of the selection process can be found on the Super Lawyers website (here). About Freiberger Haber LLP Located in New York City and Melville, Long Island, Freiberger Haber LLP is dedicated to representing corporations, small businesses, partnerships and individuals in a broad range of complex business, securities, real estate, construction and commercial litigation matters. Founded by Jonathan H. Freiberger and Jeffrey M. Haber, Freiberger Haber leverages more than 50 years of combined experience to deliver sophisticated and creative representation to its clients. The firm’s approach is results oriented and client-centric, providing clients with the sophisticated counsel expected from larger firms with the flexibility and agility of a small firm. ATTORNEY ADVERTISING. © 2018 Freiberger Haber LLP. The law firm responsible for this advertisement is Freiberger Haber LLP, 105 Maxess Road, Suite S124, Melville, New York 11747, (631) 574-4454. Prior results do not guarantee or predict a similar outcome with respect to any future matter. Contact: Jeffrey M. Haber Freiberger Haber LLP Melville Office (Main Office): 105 Maxess Road, Suite S124 Melville, New York 11747 Tel: (631) 574-4454 Fax: (631) 390-6944 New York Office: 708 Third Avenue, 5th Floor New York, N.Y. 10017 Tel: (212) 209-1005 Fax: (212) 209-7101 Email: info@fhnylaw.com

What is a Trade Secret? At its core, a trade secret is information of commercial value. It can be anything, such as a formula, strategy, device, process, or recipe. It is not generally known to others and is not readily ascertainable by proper means. Since a trade secret is a thing of commercial value, it gives the owner an advantage over competitors who do not know the secret and cannot use it to compete for business.  New York Law vs. The UTSA At the state level, the protection of trade secrets is generally governed by the  Uniform Trade Secrets Act ("UTSA") . To date, 48 states, including the District of Columbia, Puerto Rico and the U.S. Virgin Islands, have adopted the UTSA in one form or another.  (There is some debate about whether Alabama or North Carolina adopted the UTSA; the  Uniform Law Commissioners maintain that Alabama has adopted it, while North Carolina has not .)  Only New York and Massachusetts have not enacted the UTSA.  New York courts define a trade secret as any “formula, pattern, device or compilation of information which is used in one’s business, and which gives an opportunity to obtain an advantage over competitors who do not know or use it.”  Ashland Mgt. v. Janien , 82 N.Y.2d 395, 407 (1993). To determine if a “trade secret” exists, New York courts examine: "'(1) the extent to which the information is known outside of business; (2) the extent to which it is known by employees and others involved in business; (3) the extent of measures taken by to guard the secrecy of the information; (4) the value of the information to and competitors; (5) the amount of effort or money expended by in developing the information; (6) the ease or difficulty with which the information could be properly acquired or duplicated by others.'" Id . (quoting Restatement of Torts § 757, Comment b). The UTSA defines a trade secret as “information … that (i) derives independent economic value … from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” UTSA § 1(4). The UTSA both narrows and broadens the common-law definition of trade secret. It narrows the definition by making a) the difficulty in independently ascertaining the information, and b) reasonable efforts to maintain secrecy, prerequisites to the finding of a “trade secret.”  It broadens the definition by eliminating the factor concerning the expense or difficulty involved in developing the information. Consequently, commercial information discovered at minimal cost, or even by accident, may be considered a trade secret.  In addition to the definition of a trade secret, New York common law and the UTSA differ over what it takes to qualify as a trade secret. In New York, to qualify as a trade secret, there must be “a process or device for continuous use in the operation of the business.”  Softel, Inc. v. Dragon Med. & Scientific Commc’ns, Inc. , 118 F.3d 955, 968 (2d Cir. 1997). A single, discrete event will not do.  In contrast, the UTSA does not require a process or continuous use. The standard concerning the efforts necessary to protect a trade secret is similar under the UTSA and the common law. Under New York law, for example, if a trade secret is disclosed to an individual who is not under an obligation to protect the confidentiality of the information, the trade secret loses its protection.  See, e.g., Big Vision Private Ltd. v. E.I. DuPont De Nemours & Co. , 1 F. Supp. 3d 224, 267-69  (S.D.N.Y. 2014). Similarly, the UTSA provides that disclosure may be made only to individuals who are associated with the company and thus have a duty of loyalty not to disclose the information, or to those who have signed a confidentiality agreement and/or non-disclosure agreement. Confidentiality agreements and/or non-disclosure agreements are considered to be “reasonable precautions” for maintaining secrecy under the UTSA and New York law -- both agreements create an obligation by the third party to protect the confidentiality of the information. Misappropriation of Trade Secrets Generally, trade secret owners have recourse only against the “misappropriation” of a trade secret. Misappropriation is the use of a trade secret without permission.  Under the UTSA, misappropriation occurs when a trade secret is acquired by "improper means" or from someone who has acquired it through "improper means." Theft, bribery, and misrepresentation are among the acts considered to be "improper means." Under New York common law, a trade secret is misappropriated if it was obtained through corporate spying or other improper manner.  In addition, a person or company can be guilty of misappropriation if the information was obtained through a breach of trust, e.g. , an employee steals trade secrets from his employer, gives the information to another company, and that company uses the secrets even though it has obtained the information without permission. Remedies and Fees If a trade secret is misappropriated, the injured person may seek injunctive relief and damages. Damages include actual loss and unjust enrichment. If the misappropriation is done willfully or maliciously, the plaintiff may obtain exemplary damages -- which are limited to twice the actual damages. Seeking emergency injunctive relief plays an important role in trade secret litigation. The reason: once a trade secret has been disclosed, its value diminishes. Waiting for trial and a final judgment to prevent or stop the misappropriation rarely provides the protection needed to maintain the value of the trade secret. For this reason, plaintiffs often seek emergency injunctive relief prior to trial. The most common types of emergency relief are temporary restraining orders and preliminary injunctions. Under the UTSA, a plaintiff also may seek a “royalty injunction.” A royalty injunction provides that “ n exceptional circumstances, an injunction may condition future use upon payment of a reasonable royalty for no longer than the period of time for which use could have been prohibited.” UTSA § 2(b). The provision allows a court to impose a royalty instead of a conduct-based injunction, typically in circumstances involving a person's reasonable reliance upon acquisition of a misappropriated trade secret in good faith and without reason to know of its prior misappropriation.  Id . §2 at cmt.¶5 Finally, under the UTSA, a court may award reasonable attorneys' fees to a prevailing party in specified circumstances as a deterrent to specious claims of misappropriation, to specious efforts by a misappropriator to terminate injunctive relief, and to willful and malicious misappropriation. Under New York law, in contrast, attorneys’ fees are unavailable in the absence of specific contractual or statutory provisions.  Levine v. Infidelity, Inc. , 2 A.D.3d 691, 692  (2d Dep't 2003). New York courts recognize a limited exception to this rule, and award attorneys' fees to prevailing parties where the plaintiff’s damages “have been proximately related to the malicious acts and the acts themselves entirely motivated by disinterested malevolence on  part.” Brook Shopping Ctrs., Inc. v. Bass , 107 A.D.2d 615 (1st Dep't 1985).  As a practical matter, in a trade secrets litigation, this exception is unlikely to arise because the defendant’s motivation is to profit from the theft, not just to harm the plaintiff. Federal Statute: Defend Trade Secrets Act On May 11, 2016, President Obama signed the Defend Trade Secrets Act ("DTSA") into law. (18 USC §§ 1836 et seq.) The DTSA creates a federal, private cause of action for trade-secret protection. Before the DTSA, in the absence of diversity jurisdiction, or an independent federal cause of action, trade secret owners seeking relief ( e.g. , damages or injunctions) for misappropriation had recourse in state court only. The DTSA provides a uniform statutory scheme to be applied in federal court; it does not pre-empt state law. In many respects, the DTSA is modeled after the UTSA. Accordingly, the substantive provisions under the DTSA are similar to state regimes modeled after the UTSA, though some material differences exist.

On March 29, 2018, the Department of Justice (“DOJ”) announced ( here ) that it had reached agreement with Barclays Capital, Inc. and several of its affiliates (together, “Barclays” or the “Bank”) to settle a civil action in which the United States sought civil penalties for alleged conduct related to Barclays’ underwriting and issuance of residential mortgage-backed securities (“RMBS”) between 2005 and 2007. Under the settlement, Barclays will pay the United States two billion dollars ($2,000,000,000) in civil penalties in exchange for dismissal of the Amended Complaint. A copy of the settlement agreement can be found here . The settlement follows a three-year investigation into allegations that Barclays caused billions of dollars in losses to investors by engaging in a fraudulent scheme to sell 36 RMBS deals, and that it misled investors about the quality of the mortgage loans backing those deals. Those allegations, violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), and the predicate acts of mail fraud, wire fraud, bank fraud, and other misconduct, were set forth in the DOJ’s initial complaint, which it filed in December 2016. The lawsuit also names as defendants two former Barclays executives: Paul K. Menefee (“Menefee”), who served as Barclays’ head banker on its subprime RMBS securitizations; and John T. Carroll (“Carroll”), who served as Barclays’ head trader for subprime loan acquisitions. The DOJ also reached agreement with Menefee and Carroll. In exchange for dismissal of the claims against them, Menefee and Carroll agreed to pay the United States the combined sum of two million dollars ($2,000,000) in civil penalties. “This settlement reflects the ongoing commitment of the Department of Justice, …, to hold banks and other entities and individuals accountable for their fraudulent conduct,” stated Richard P. Donoghue, United States Attorney for the Eastern District of New York. “The substantial penalty Barclays and its executives have agreed to pay is an important step in recognizing the harm that was caused to the national economy and to investors in RMBS.” “The actions of Barclays and the two individual defendants resulted in enormous losses to the investors who purchased the Residential Mortgage-Backed Securities backed by defective loans,” stated Laura S. Wertheimer, Inspector General, of the Federal Housing Finance Agency Office of the Inspector General (“FHFA-OIG”). “Today’s settlement holds accountable those who waste, steal or abuse funds in connection with FHFA or any of the entities it regulates.” The scheme alleged in the complaint involved 36 RMBS deals in which over $31 billion worth of subprime and Alt-A mortgage loans were securitized, more than half of which loans defaulted. The complaint alleged that in publicly filed offering documents and in direct communications with investors and rating agencies, Barclays systematically and intentionally misrepresented key characteristics of the loans it included in these RMBS deals. In general, the borrowers whose loans backed these deals were significantly less creditworthy than Barclays represented, and these loans defaulted at exceptionally high rates early in the life of the deals. In addition, as alleged in the complaint, the mortgaged properties were systematically worth less than what Barclays represented to investors. In a statement, Barclays Chief Executive Officer, Jes Staley, called the settlement a “fair and proportionate settlement.” Staley said that, because of the settlement and a 2017 restructuring, Barclays was “well positioned” to ramp up profits and return a greater share of its profit to shareholders. The settlement amount is less than market analysts had expected and less than the penalties paid by other banks, such as by Goldman Sachs and JPMorgan Chase, facing similar claims involving the underwriting and issuance of residential mortgage-backed securities.

Simply stated, the “Voluntary Payment Doctrine” bars recovery of payments voluntarily made with full knowledge of the facts, and in the absence of fraud or material mistake of fact or law.  Dubrow v. Herman & Beinin , 157 A.D.3d 620 (1 st Dep’t 2018) (citation and quotation marks omitted).  The Doctrine has been around for quite some time.  In 1898, the First Department recognized that “ voluntary payment of money under a claim of right cannot in general be recovered back.  To warrant such recovery there must be a compulsion, -- actual, present, potential, -- and the demand must be illegal.  In the absence of such compulsion a mere protest is not sufficient.  The element of coercion is essential to the right.” ( Lesster v. City of New York , 33 A.D. 350.  The Lesster Court went on to reiterate the rule as follows: If a party, with full knowledge of all the facts, voluntarily pays money in satisfaction of a demand made upon him, he cannot afterwards allege such payment to have been unjustly demanded, and recover back the money. The Plaintiff in Lester was a property owner in New York City who paid real property taxes without knowing that the subject property had been condemned and acquired by the City for a street widening project.  When the City refused to return the tax payment, Lester sued and prevailed in light of the mistake. Others have not been so fortunate, as was the case in Gimbel Brothers, Inc. v. Brook Shopping Centers, Inc. , 118 A.D.2d 532.  There, plaintiff leased its retail store from defendant. The subject lease was drafted when New York’s “Sunday Blue Laws” prohibited businesses from operating on Sunday.  After the “Blue Laws” were declared unconstitutional, defendant started invoicing Gimbel Brothers for a $10.00 per week “Sunday charge”.  The charge was later increased to $825.00 and Gimbel Brothers paid a total of $19,800.00 in such charges before stopping.  The lease did not provide for “Sunday charges”. Gimbel Brothers commenced suit against its landlord seeking, inter alia , a declaration that it could offset the previously made “Sunday charges” against future rents. Relying on the “Voluntary Payment Doctrine”, the Gimbel Brothers court held that the “Sunday charges” should not be returned and, in so doing, stated: Indeed, we find that the weight of the evidence supports the conclusion that Gimbels was not operating under an actual mistake of law but, instead, made the subject payments voluntarily, as a matter of convenience, without having made any effort to learn what its legal obligations were….When a party intends to resort to litigation in order to resist paying an unjust demand, that party should take its position at the time of the demand, and litigate the issue before, rather than after, payment is made.  Gimbels displayed a marked lack of diligence in determining what its contractual rights were, and is therefore not entitled to the equitable relief of restitution.  (Citations omitted.) In Dillon v. U-A Columbia Cablevision , 100 N.Y.2d 525 (2003), plaintiff brought a purported class action lawsuit against her cable provider alleging that a $5 late fee/administrative fee was an impermissible penalty and she would not have made the payments “had she known the true facts”.  The Dillon Court of Appeals, agreeing with “both lower courts that the voluntary payment doctrine bars plaintiff’s complaint,” stated: Here, no fraud or mistake is alleged in that, according to the complaint, plaintiff knew she would be charged a $5 late fee if she did not make timely payment.  Alleged mischaracterization of a $5 late fee as an administrative fee does not overcome application of the voluntary payment doctrine. Yesterday, the First Department decided The Law Offices of Paul Chin, P.C. v. Seth A. Harris, PLLC ; presumably the most recent New York decision applying the Voluntary Payment Doctrine.  The parties in Chin are law firms.  Defendant hired plaintiff for six months, on a part-time basis, commencing in August.  The terms of the relationship were set forth in a memorandum that the defendant sent to plaintiff and, as presently germane, provided that plaintiff’s part-time work could not exceed 350 hours for the relevant time period.  Plaintiff, however, worked and was paid for 460 hours.  Plaintiff also worked past the six-month term of the relationship. The Chin plaintiff sued defendant when defendant refused to pay plaintiff for all hours billed.  The Chin defendant asserted a counterclaim to recover over $20,000 in payments made to plaintiff.  Relying on the court’s decision in Dillon , supra , the Chin court found that defendant’s counterclaim was “barred by the voluntary payment doctrine, since defendant fails to present any evidence that it made the payments while laboring under any material mistake of fact or law concerning the invoiced services or the basis for the billing. TAKEAWAY A lesson to be learned from these cases is that payors should not “pay now and ask questions (or litigate) later”, lest they run the risk that a court will not permit the recovery of such payments from the payee.  Known rights should be asserted promptly.

It is well-settled that a plaintiff asserting a derivative claim seeks to recover for injury to the business entity. A plaintiff asserting a direct claim seeks redress for injury to himself/herself individually. Sometimes, the distinction between the two types of actions is not readily apparent. Yudell v. Gilbert , 99 A.D.3d 108, 113 (1st Dept. 2012). In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go. Tooley v. Donaldson, Lufkin & Jenrette, Inc. , 845 A2d 1031, 1039 (Del. 2004). See also Yudell , 99 A.D.3d at 114; Higgins v. New York Stock Exch., Inc. , 10 Misc. 3d 257, 264 (Sup. Ct. N.Y. County 2005) (citation omitted). Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation. Tooley , 845 A2d at 1039. Derivative claims that are improperly alleged as direct claims must be dismissed for lack of standing. Abrams v. Donati , 66 N.Y.2d 951, 953 (1985) (“ complaint the allegations of which confuse a shareholder’s derivative and individual rights will, therefore, be dismissed.”) (internal citations omitted). New York Courts have held that, because derivative actions bind absent interest holders, they take on “the attributes of a class action” and a “plaintiff must therefore demonstrate that will fairly and adequately represent the interests of the shareholders and the corporation, and that is free of adverse personal interest or animus.” Steinberg v. Steinberg , 106 Misc. 2d 720, 721 (Sup. Ct. N.Y. County 1980) (citation omitted); see also Gilbert v. Kalikow , 272 A.D.2d 63, 63 (1st Dept. 2000) (“ erivative causes of action were properly dismissed on the ground that plaintiff has failed to demonstrate that he will fairly and adequately represent the interests of the .”). As noted in a recent article posted by this Blog ( here ), these standing requirements are strictly enforced. Earlier this month, the Appellate Division, First Department, considered the foregoing in a case involving the business breakup of two managing partners of a general partnership. Pokoik v. Norsel Realties , 2018 NY Slip Op. 01534 (1st Dept. Mar. 8, 2018) ( here ). Pokoik v. Norsel Realties Background Leon Pokoik (“Pokoik”), among others, commenced the action in 2014, asserting direct and derivative claims against, among others, Norsel Realties (“Norsel”), Michael Steinberg (“Steinberg”) and Jay Lieberman (“Lieberman”) for breaches of fiduciary duty in connection with their management of a closely held real estate business. Norsel, a New York partnership, owns the land under an office building located on Madison Avenue in midtown Manhattan (the “Property”). Defendants Norsel, 575 Realties, Inc. (“575 Realties”) and 575 Associates, LLC (“575 Associates”), an affiliated operating company of 575 Realties, are owned by the Steinberg and Pokoik families, and their children. 575 Realties leases the Property from Norsel, and net leases the Property to 575 Associates. The dispute centered on the ground rent agreed to between Norsel and 575 Realties for the Property. Plaintiffs claimed that the rent was improperly calculated, notwithstanding the fact that it was based on two independent appraisals. The rental terms for the applicable extension periods of the ground lease were approved by 90% of Norsel’s partners. Pokoik and his family hold approximately 11% of the partnership interests in Norsel and slightly different percentages in their affiliates. In July 2015, Justice Oing dismissed the initial complaint based solely on the application of the business judgment rule. By order dated April 12, 2016, the Appellate Division, First Department affirmed Justice Oing’s order in part and reversed it in part ( Pokoik v. Norsel Realties , 138 A.D.3d 493 (1st Dept 2016) ( here ). The First Department affirmed the dismissal with prejudice as to the defendant business entities on the ground that there was no allegation that any of those entities owed Plaintiffs a fiduciary duty, or that those entities engaged in any misconduct. The First Department, however, reversed and remanded the remaining claims against Norsel and the individual defendants (Steinberg and Lieberman), finding that the complaint was sufficient with respect to these defendants to overcome the presumptive application of the business judgment rule in view of the limited record at that stage of the proceeding. Notably, the First Department did not address the issue of whether Plaintiffs’ alleged conflicts of interest prevented them from fairly and adequately representing Norsel’s interests. Plaintiffs subsequently filed an amended complaint in which they named thirty-nine additional defendants, including all of the approving partners, as well as eleven individuals, who either were never partners, or were no longer partners when the new ground rent was approved. As to all defendants, Plaintiffs alleged that “by arranging and/or agreeing” to the ground rent, each of the defendant mangers/general partners breached their fiduciary duties under New York law. The amended complaint also contained a cause of action against all defendants, relating to the transfer of the Property from Norsel to Norsel LLC, a newly formed single­member limited liability company, the sole member of which is Norsel. Plaintiffs alleged that, after they filed their initial complaint, Steinberg, Lieberman and possibly other defendants arranged for Norsel to transfer its interests in the Property to Norsel LLC, which transfer was conducted without their knowledge or consent. Plaintiffs alleged that this transfer was made so as to defeat the terms of Norsel’s partnership agreement. Plaintiffs further alleged that Norsel’s managers refused their demands to protect Norsel and its partners against the transfer. As a result, Plaintiffs sought to set aside and void the deed transferring Norsel’s interest in the Property to Norsel LLC, the assumption of the ground lease, and all other instruments in connection therewith. Defendants moved to dismiss the amended complaint, primarily arguing that Plaintiffs lacked standing to assert their direct and derivative claims. In that regard, they argued that Plaintiffs’ claims were all derivative in nature, and that as such, they lacked standing to assert the claims because of Plaintiffs’ “conflicts of interest,” which prevented them from “fairly and adequately” representing the partnership. Justice Oing held ( here ) that Plaintiffs lacked standing to bring the claims asserted in the amended complaint directly, finding that the alleged injuries were suffered by Norsel: Here, a review of all of plaintiffs’ claims in a light most favorable to them unequivocally demonstrates that they are based on alleged injuries to Norsel purportedly caused by the decisions to adopt an apparently below­market ground lease rent, and to transfer its interest in the Property to Norsel LLC, as well as the transfer of the ground lease from Norsel Realties to Norsel LLC. In fact, plaintiffs allege that the acts underlying the amended complaint were directed at Norsel as an entity, repeatedly asserting that such acts were “not in the best interests of Norsel,” and that “Norsel Realties as a whole is damaged $131,000,000.” Plaintiffs also rely on the purported injury to Norsel as the basis for their individual claims in which they assert that they have been injured in an amount equal to their ownership percentage multiplied by the $131,000,000 allegedly loss to Norsel. Under these circumstances, plaintiffs’ direct claims, which are based on allegations that their interests in Norsel have been diminished through the adoption of the ground rent at issue, are inherently derivative claims. Plaintiffs’ remaining allegations that defendants mismanaged Norsel for their own benefit, i.e., by transferring ownership to Norsel LLC, are similarly derivative in nature. Accordingly, to the extent that plaintiffs attempt to bring direct claims against Norsel or its partners, they do not have standing to do so because the claims asserted in the amended complaint are strictly derivative in nature — the claims and damages alleged result from purported injuries to Norsel. Having determined that the claims were derivative in nature, Justice Oing turned to the question of whether Plaintiffs had standing to represent the partnership’s interests. Justice Oing found that, for a number of reasons, Plaintiffs did not “fairly and adequately represent the interests” of the partnership because they were not “free of adverse personal interest or animus.” Citations omitted. As an initial matter, the court found that because Plaintiffs sued all of Norsel’s partners, there were no beneficiaries of the action. “This presents a prototypical conflict of interest,” said Justice Oing. The court also found that Plaintiffs had an “inherent conflict of interest” because of their 12.788% ownership interest in 575 Associates. Since 575 Associates net leases the Property from 575 Realties, the court found that the “plaintiffs are attempting to double dip — they are simultaneously receiving funds from 575 Associates in the form rental income while suing Norsel over the same ground rent.” The court further found that Plaintiffs were harming Norsel rather than benefitting the partnership, finding that they did not “have any genuine concern for Norsel or its related entities.” In addition, plaintiffs do not appear to have any genuine concern for Norsel or its related entities. While plaintiffs seek to extract monetary damages from their partners based upon their extremely high property appraisals, they do not request any relief, such as the revision of the subject ground lease rent or court oversight of the appraisal process, that would benefit Norsel. Indeed, plaintiffs ignore the fact that their $20 million proposed annual rent, an almost 90% increase, would make business operations more difficult for 575 Associates which, in turn, would jeopardize Norsel itself. Last, but not least, Justice Oing found that Leon Pokoik, the lead plaintiff in the action, was not “free from personal animus” when it came to his business partners. According to the court, Pokoik’s “litigious nature” demonstrated that he was using the litigation as “a weapon” “to gain leverage in the other disputes” with his business partners and family. “Having named all of the Norsel partners with whom plaintiffs disagree as defendants in this action, and given Leon Pokoik’s demonstrated animus,” concluded the court, “plaintiffs’ self-interest is palpably obvious to the point that they are unable to show that they will adequately represent the interest of these defendants.” The Court granted Defendants’ motion and dismissed the amended complaint in its entirety. Plaintiffs appealed. First Department Ruling The Court unanimously modified the decision, vacating the dismissal of the individual defendants, reversing the dismissal of Plaintiffs’ first three of the causes of action and affirming the remainder of the motion court’s decision. Relevant to the motion court’s finding that Pokoik was not “free from personal animus,” the Court disagreed, finding that the record was devoid of “any indication of an especially acrimonious relationship between the parties.” We perceive no conflict of interest that would prevent plaintiffs from fairly representing Norsel’s interests. In a separate derivative action by plaintiff Leon Pokoik against other Pokoik family members, who are also defendants in this action, we found that Pokoik’s relationship with defendants had not been shown to be “so acrimonious or emotional as to demonstrate that plaintiff cannot act as an adequate representative for the companies” ( Pokoik v Pokoik , 146 AD3d 474, 475 <1st dept 2017> ). Nor is there in the present record any indication of an especially acrimonious relationship between the parties. Takeaway Breaking up a business relationship is hard to do. It can be acrimonious and/or emotional. The First Department’s decision in Pokoik shows that the degree of acrimony alleged is important, especially on a motion to dismiss. Although the facts in Pokoik – namely, Pokoik’s “litigious nature” and his improper use of the lawsuit as leverage in other cases against the defendants – showed some acrimony, it was not enough on the pleadings to demonstrate a conflict of interest sufficient to defeat derivative standing. The lesson of Pokoik , therefore, is that acrimony and/or personal animus alone is not be enough to defeat derivative standing, no matter how intensely expressed they may be. More facts are needed. Without such facts, defendants will be unable to demonstrate that a plaintiff cannot, and will not, “fairly and adequately represent the interests of the shareholders and the corporation.…”

On March 20, 2018, the United States Supreme Court decided Cyan, Inc. v. Beaver County Employees Retirement Fund , No. 15-1439, in which it unanimously held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) does not strip state courts of subject-matter jurisdiction over class actions involving claims exclusively brought under the Securities Act of 1933 (the “1933 Act”), and does not allow for the removal of those cases to federal court. ( Here .) The Court resolved a split among state and federal courts that has spanned nearly two decades concerning state court jurisdiction over securities class actions that exclusively allege claims under the 1933 Act. Some courts have held that, after SLUSA, federal courts have exclusive jurisdiction over class actions alleging only 1933 Act claims. Other courts, by contrast, have concluded that SLUSA did not remove state courts’ concurrent jurisdiction over such actions. Legal Background In the 1930s, Congress passed sweeping legislation to regulate the offer and sale of securities – the 1933 Act and the Securities Exchange Act of 1934 (the “Exchange Act”). Prior to the legislation, the states primarily regulated the purchase and sale of securities. The 1933 Act requires companies that offer securities to the public (known as issuers) to make accurate disclosures of material information. Under the statute, violations of the 1933 Act are actionable in state and federal court. Notably, and relevant to the Court’s decision in Cyan , Congress barred removal of actions filed in state court to federal court. By contrast, the Exchange Act, which regulates the trading of securities (on the national exchanges), deprives the states of jurisdiction over claims arising under that statute. In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”) over President Clinton’s veto. The PSLRA included a number of procedural and substantive provisions affecting the prosecution and defense of securities class action litigation. To avoid the application of these provisions, plaintiffs filed their class action lawsuits in state court, asserting claims under state law only. Congress passed SLUSA to pre-empt state court jurisdiction, requiring “covered” class action lawsuits ( i.e. , a lawsuit on behalf of 50 or more people) to proceed in federal court only. In passing SLUSA, Congress amended Section 16(b) of the 1933 Act, which prohibits securities class actions based on state law in both state and federal courts that allege false or misleading practices in the purchase or sale of a covered security – i.e. , a security traded on the national exchanges. That provision is known as the “state-law class-action bar.” Congress added a new provision, Section 77p(c), which permits the removal of state-law class actions to federal court: “Any covered class action brought in any State court, as set forth in subsection (b) of this section, shall be removable to the Federal district court … and shall be subject to subsection (b) of this section.” The purpose of this provision, as the Supreme Court concluded in another case, is to ensure that the district court promptly dismisses the action. Finally, Congress made conforming amendments to Section 22(a) of the 1933 Act, making clear that the grant of concurrent jurisdiction over 1933 Act claims is limited: “except as provided in with respect to covered class actions.” The district courts of the United States … shall have jurisdiction …, concurrent with State and Territorial courts, except as provided in section 77p of this title with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter. This provision is known as the “except clause.” Cyan addressed the question what does SLUSA mean when it refers to “covered class actions” in the “except” clause. Cyan argued – relying on the definition of “covered” in Section 77p(f) – that SLUSA bars state courts from hearing large securities class actions ( e.g. , class actions having more than 50 class members), based on state or federal law. The plaintiffs, on the other hand, argued that SLUSA prohibits state courts from hearing securities class actions barred by Section 77p(b) only. Cyan also addressed the question whether a covered securities class action alleging only 1933 Act claims can be removed to federal court. Factual Background The case arose from the initial public offering (“IPO”) of Cyan, Inc. (“Cyan”) shares in May 2013. The plaintiffs/respondents, three pension funds and an individual (together, the “Investors”), purchased shares of Cyan stock in the IPO. After the stock declined in value, the Investors brought a damages class action against Cyan in California Superior Court. The Investors alleged that Cyan’s offering documents contained material misstatements in violation of the 1933 Act. The Investors did not assert any state law claims. Cyan moved to dismiss the Investors’ suit for lack of subject matter jurisdiction. It argued that the “except clause”— i.e. , the amendment made to §77v(a)’s concurrent-jurisdiction grant —stripped state courts of the power to adjudicate 1933 Act claims in “covered class actions.” The Investors did not dispute that their lawsuit qualified as such an action under SLUSA’s definition. But they maintained that SLUSA left intact state courts’ jurisdiction over all suits — including “covered class actions”— alleging only 1933 Act claims. The California Superior Court agreed with the Investors and denied Cyan’s motion to dismiss. The state appellate courts denied review of that ruling. The Supreme Court granted Cyan’s petition for certiorari to resolve the split among state and federal courts about whether SLUSA deprived state courts of jurisdiction over “covered class actions” asserting only 1933 Act claims. The Supreme Court’s Opinion In a unanimous decision, the Court held that state courts have concurrent jurisdiction over federal securities class actions asserting claims exclusively brought under the 1933 Act. Although SLUSA bars certain securities class actions based on state law, and expressly authorizes removal of such actions so that they may be dismissed by federal courts applying SLUSA, the Court concluded that “SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations.” In reaching that conclusion, Justice Kagan noted that the language used by Congress was clear: “SLUSA’s text, read most straightforwardly, leaves in place state courts’ jurisdiction over 1933 Act claims, including when brought in class actions.” Put another way, said Justice Kagan, “ he statute says what it says—or perhaps better put here, does not say what it does not say. State-court jurisdiction over 1933 Act claims thus continues undisturbed.” The Court made it clear that the “except clause” “does not” limit “state-court jurisdiction over class actions brought under the 1933 Act.” Section 16(b) “bars certain securities class actions based on state law … nd as a corollary of that prohibition, it authorizes removal of those suits so that a federal court can dismiss them.” “But,” said Justice Kagan, “the section says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule of §77v(a)—under which a state court may hear the Investors’ 1933 Act suit—continues to govern.” Citations omitted. Justice Kagan rejected Cyan’s attempt to “cherry pick” a sub-paragraph in a larger section of the statute to reach a result that is incompatible with that larger provision: … Cyan thus concludes that the except clause exempts all sizable class actions—including the Investors’ suit—from §77v(a)’s conferral of jurisdiction on state courts. But that view cannot be squared with the except clause’s wording for two independent reasons. To start with, the except clause points to “section 77p” as a whole—not to paragraph 77p(f)(2). Cyan wants to cherry pick from the material covered by the statutory cross-reference. But if Congress had intended to refer to the definition in §77p(f)(2) alone, it presumably would have done so—just by adding a letter, a number, and a few parentheticals.… And “ hen Congress want to refer only to a particular subsection or paragraph, it sa so.…” It said no such thing in the except clause. Justice Kagan explained that Cyan’s reliance on the definitional paragraphs of the statute to give meaning to Section 77p(f)(2) could not withstand scrutiny because the former does not do latter: In any event, the definitional paragraph on which Cyan relies cannot be read to “provide[ ]” an “except ” to the rule of concurrent jurisdiction, in the way SLUSA’s except clause requires. A definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.… If Congress had wanted to deprive state courts of jurisdiction over 1933 Act class actions, it had an easy way to do so: just insert into §77p an exclusive federal jurisdiction provision (like the 1934 Act’s) for such suits. That rule, when combined with the except clause, would have done the trick because it would have “provided” an “except ” to §77v(a)’s grant of concurrent jurisdiction; by contrast, a mere definition of “covered class action” (as a damages suit on behalf of 50-plus people) does not so provide. Finally, Justice Kagan rejected Cyan’s argument that the except clause was merely a “minor tweak” or a “conforming amendment”: And finally, Cyan’s take on the except clause reads too much into a mere “conforming amendment.” The change Cyan claims that clause made to state court jurisdiction is the very opposite of a minor tweak. When Congress passed SLUSA, state courts had for 65 years adjudicated all manner of 1933 Act cases, including class actions. Indeed, defendants could not even remove those cases to federal court, as schemes of concurrent jurisdiction almost always allow. State courts thus had as much or more power over the 1933 Act’s enforcement as over any federal statute’s. To think Cyan right, we would have to believe that Congress upended that entrenched practice not by any direct means, but instead by way of a conforming amendment to §77v(a) (linked, in its view, with only a definition). But Congress does not make “radical—but entirely implicit—change ” through “technical and conforming amendments.” In short, quoting a metaphor from an opinion written by Justice Antonin Scalia, Justice Kagan concluded that “Congress does not ‘hide elephants in mouseholes.’” As to defendants’ ability to remove class actions alleging 1933 Act claims to federal court, the Court held that the removal provision applies to only “covered class actions,” which are “state-law class actions.” Section 77p(b) does not preclude federal-law class actions. So under our decision, §77p(c) does not authorize their removal. Takeaway Class action plaintiffs asserting claims only under the 1933 Act will most likely file their complaints exclusively in state court. After Cyan , such exclusivity could subject defendants to litigating 1933 Act cases in state court while at the same time litigating in federal court Exchange Act claims arising under substantially the same facts and circumstances as the 1933 Act claims. Cornerstone Research recently noted that this phenomenon is already being played out, albeit on a small scale. See here (noting that there were seven 1933 Act actions pending in state court since 2014, all of which have parallel actions in federal court.) here.=">here."> Class action defendants litigating in state court will likely find that the procedural safeguards of the PSLRA will not be available to them, unless the state court decides to apply them anyway. These safeguards include, among others, the lead plaintiff provisions, which are intended to ensure that investors with the largest financial interest in the litigation will direct the lawsuit. On the other hand, as the Cyan Court emphasized, the substantive provisions of the PSLRA, including the safe harbor protection for forward-looking statements, will apply in both federal and state courts. The Court did not, however, address whether other protections, such as the automatic stay of discovery during the pendency of a motion to dismiss, will apply in state court actions. The applicability of those protections will likely be litigated in the state courts. After Cyan , companies may try to dictate the forum in which shareholders litigate their 1933 Act claims. This approach adds to the law in some states, notably Delaware, in which corporations are permitted to include in their by-laws a choice of forum provision establishing the state’s courts as the exclusive forum for litigation involving the internal affairs of the company. Stanford Law Professor Joseph Grundfest, for example, has advocated for forum-selection by-laws involving 1933 Act claims. The limitation imposed by that approach, however, might be prohibited by Section 14 of the 1933 Act. Section 14 provides that: “Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title … shall be void.” Whether the courts will consider a by-law designation of forum exclusivity to be the same as a waiver of compliance remains to be seen. Regardless, after Cyan , companies may be more inclined to include such forum selection designations in their by-laws. In addition, companies may be inclined to adopt corporate by-laws requiring shareholder disputes, including those arising under the 1933 Act, to be arbitrated. For the past few years, companies have been adopting arbitration by-laws.  In the few cases in which these by-laws have been addressed by the courts, they have been upheld. E.g. , Delaware Cty. Employees Ret. Fund v. Portnoy , Civil Action No. 13-10405-DJC (D. Mass. Mar. 26, 2014). Just as the approach advocated by Professor Grundfest may be prohibited by Section 14 of the 1933 Act, so too may the foregoing solution. This Blog will continue to watch for material developments after Cyan and report on the impact the decision has on class action litigation alleging claims arising under the 1933 Act.

A mechanic’s lien is an encumbrance on the title to the real property. Contractors and subcontractors, among others (collectively, “Contractors”), whose work improves real property, are entitled to place a mechanic’s lien on the real property so improved to secure the payment of the amounts due to them.  Oftentimes, mechanic’s liens are problematic for real property owners.  For example, the filing of such a lien could be an event of default under a mortgage or a lease. Under New York’s Lien Law, there are numerous ways to discharge a mechanic’s lien for a private improvement.  For example, an action must be commenced to foreclose a lien, or the lienor must obtain an order to continuing the lien, within one year of its filing or the lien will be discharged.  (See Lien Law §§17 and 19(2) .)  Before or after a lien foreclosure action is commenced, but after a lien is filed, a lien can also be discharged by procuring and filing with the clerk of the county in which the lien is filed, a bond or undertaking in an amount equal to 110% of the amount of the lien.  (See Lien Law §19(4).) A mechanic’s lien for a private improvement can also be discharged by paying money into court.  ( See Lien Law §20 .)  If the payment is made before an action to foreclose the lien is commenced, the deposit must equal the amount of the lien plus interest to the time of the deposit.  (See Lien Law §20.)  If the payment is made after the commencement of a foreclosure action, the lien will be discharged upon payment into court “of such sum of money, as, in the judgment of the court or a judge or justice thereof, after at least five days' notice to all the parties to the action, will be sufficient to pay any judgment which may be recovered in such action.”  (See Lien Law §20.) Section 37 of the Lien Law permits an owner or contractor to obtain a bond either before or after the commencement of the improvement in an amount as directed by the court “which shall not be less than the amount then unpaid under such contract, conditioned for the payment of any judgment or judgments which may be recovered in any action brought for the enforcement of any and all claims, notices of which may be filed as in this section provided, arising by virtue of labor performed or materials furnished in or about the performance of any such contract.”  (See Lien Law §37.)  Once a Section 37 bond is approved by the court and filed with the county clerk an order shall be made by such court, judge or justice discharging such property from the lien of each and every Contractor, who, thereafter, “shall have a claim, which shall attach against and be secured by such bond, for the principal and interest of the value, or the agreed price, of such labor and materials”.  (See Lien Law §37(4) and (5).) The Lien Law sets forth the necessary parties defendant to a mechanic’s lien foreclosure action.  ( See Lien Law §44. )  Among others, lien law §44(3) requires that “ ll persons appearing by the records in the office of the county clerk or register to be owners of such real property or any part thereof” be named as a defendant. In the event that a bond or cash deposit is made to discharge a lien, does the owner of the real property remain a necessary party to a mechanic’s lien foreclosure action?  There is presently a split among the Departments on this issue.  The law in the Second Department is that the owner need not be named as a party defendant.  In Bryant Equipment Corp. v. A-1 Moore Contr. Corp. , 51 A.D.2d 792 (1973), the Bryant   Court held that the subject bond “replace the real property as the security to be attached and attacked” and, therefore, Lien Law Section 37(7) controls and “sets forth the classes of persons who shall be joined as parties defendant, namely the principals and surety on the bond, the contractor, and all claimants who have filed notices of claim prior to the date of the filing of such summons and complaint.”  (Internal quotation marks omitted.) The Third Department shares this view and held that “ here the lien no longer attaches to real property due to the filing of a bond under the Lien Law…the owners of the real property are no longer necessary parties to the action.”  ( M. Gold & Son, Inc. v. A.J. Eckert, Inc. , 246 A.D.2d 746 (1998).) The First Department, however, does not share the view of the Second and Third Departments.  In Harlem Plumbing Supply Co., Inc. v. Handelsman , 44 A.D.2d 768 (1972), a tenant was building out space leased from the landlord owner of the property.  A materials supplier filed a lien, which, before the commencement of a foreclosure action, was discharged by deposit into court made by the tenant pursuant to Lien Law §20.  The property owner, who was named as a defendant in the action, moved to dismiss.  The Court recognized that the “effect of the deposit was to discharge the lien upon the real estate and shift it to the fund.”  Nonetheless, relying on Lien Law §44(3), the Harlem Court in holding that the owner was a necessary party to a mechanic’s lien foreclosure action stated: The fact that this lien was discharged by a deposit (Lien Law s 20) rather than by an undertaking (id. s 19(4)) is of no consequence. Where, as here, the lienor has elected to proceed in equity to enforce its lien, both sections envision the establishment of the validity of such lien before further rights accrue. Under such circumstances, the owner of the property is a necessary party defendant, although the prior owners are not. The Supreme Court, New York County, in Doma Inc. v. 885 Park Avenue Corp. (March 13, 2018), was faced with the very issue decided by the Harlem Court, but adopted the reasoning of the Second and Third Departments after recognizing that “ he law on this question is not settled.”  The plaintiff in Doma was a contractor that performed renovation work for defendant Gilman, a tenant/shareholder in a cooperative apartment in a building owned by defendant 885 Park Avenue Corp.  Owner defaulted in answering the complaint.  In response to plaintiff’s motion for a default judgment, Owner cross-moved to dismiss the complaint “on the ground that a bond discharging the lien has been filed ensuring full payment of the lien amount.” The Doma court, accepted the cross-motion as timely made in lieu of an answer and addressed the merits of Owner’s position.  The Doma court characterized the reasoning of the Harlem Court as being “very technical” and recognized that some motion courts in New York County have followed Harlem .  Relying on the authority set forth above, the Doma court stated that the First Department “appears to stand alone in the view that the owner is a necessary party following the posting of a bond discharging the lien.”  Accordingly, the Doma court, in refusing to follow the First Department in Harlem , stated: Since the owner of the building ceases to have a stake in an action by a contractor against a tenant following the posting of a bond, wherein any subsequent action deals with the surety and not the real property, from a public policy perspective, there is no purpose in keeping the owner in the caption.  Indeed, to keep the owner of the building in the action would only serve to needlessly increase the costs associated with the ownership and management of real property in this State….Given, however, that two other departments of the Appellate Division have disagreed with technical reasoning, relying on Lien Law §37(7); that other motion courts in New York County have followed the Second and Third Departments and avoided the technical problem; inasmuch as this Court can discern no public policy reason to keep the owner in the action under these circumstances; and noting that the First Department has not had occasion to revisit this proposition in many years; this Court follows the rule that, upon the filing of a bond discharging a mechanic’s lien, Lien Law §37(7) supplants Lien Law §44(3) in prescribing the necessary parties to the action, and causes the owner to no longer be a necessary party. Notice of entry of the Doma order was filed on March 16, 2018, and no notice of appeal has been filed as of yet.

The Financial Industry Regulatory Authority (“FINRA”) is the largest independent, non-governmental regulator of broker-dealer firms doing business in the United States. See UBS Fin. Servs., Inc. v. W. Va. Univ. Hosps., Inc. , 660 F.3d 643, 648 (2d Cir. 2011).  FINRA was formed in 2007, pursuant to Section 15A of the Securities Exchange Act of 1934 (“Exchange Act”), through the merger of the National Association of Securities Dealers (“NASD”) and the New York Stock Exchange Regulation, Inc., the regulatory arm of the New York Stock Exchange ( see 15 U.S.C.A. § 78o-3). The Securities and Exchange Commission regulates FINRA. FINRA is involved in almost every aspect of the securities industry. Among other things, FINRA registers and educates industry participants, examines securities firms, promulgates rules and enforces them, enforces the federal securities laws, and educates the investing public. FINRA also provides regulatory services for the equities and options markets, as well as trade reporting and other utilities for the industry. Significantly, FINRA administers nearly all securities-related arbitrations in the country. FINRA has a uniform set of rules for arbitrating disputes between Member firms and their customers and between Member firms and Associated Persons. Among these rules are FINRA Rule 12200, which requires Member firms, at a customer’s request, to arbitrate disputes that arise in connection with their business activities, and FINRA Rule 13200, which requires Member firms and Associated Persons to arbitrate their employment disputes. Despite the requirement to arbitrate under Rules 12200 and 13200, customers and Associated Persons may avoid arbitration by including non-exclusive judicial forum selection clauses in their agreements with Member Firms. FINRA Rules 12200 and 13200 FINRA Rule 12200 Rule 12200 requires FINRA members to submit to arbitration if the following factors are met: Arbitration is either required by a written agreement or requested by the customer; The dispute is between a customer and a member or an associated person of a member; and The dispute arises in connection with the business activities of the member or associated person, with certain exceptions for insurance company members. Under Rule 12200, customers are given the unilateral right to demand arbitration even in the absence of a pre-dispute arbitration agreement. FINRA Rule 13200 Under Rule 13200, disputes between Member firms and Associated Persons arising out of the business activities of a Member or an Associated Person must be arbitrated through FINRA. Rule 13200 does not permit waiver by the Member firm. A dispute must be arbitrated under the rule and administered in the FINRA forum. There is no provision for contractual waiver or modification of this requirement. The purpose of Rule 13200 is to encourage market participants, both Members and their Associated Persons, take advantage of arbitration in the FINRA forum. In promulgating the rule, FINRA wanted to make it clear that it has the authority, expertise, and Congressional mandate to resolve intra-industry disputes in a manner that fairly and efficiently protects the markets, market participants, and the public. Although the rule is mandatory, as with Rule 12200, Associated Persons may waive their right to a FINRA arbitration in a pre-dispute agreement. Judicial Forum Selection Clauses Judicial forum selection clauses – contractual provisions in which the parties agree to resolve their disputes in court – are intended to supersede or waive the right to arbitration under Rules 12200 and 13200. In 2014, the Court of Appeals for the Second Circuit held that forum selection clauses in contracts between Members and customers supersede Rule 12200, permitting the parties to submit their disputes in state and federal court rather than in a FINRA arbitration. Goldman, Sachs & Co. v. Golden Empire Sch. Fin. Auth. , 764 F.3d 210, 217 (2d Cir. 2014). The Ninth Circuit took the same view in Goldman, Sachs & Co. v. City of Reno , 747 F.3d 733, 747 (9th Cir. 2014).  Like the Second Circuit, the Ninth Circuit did not apply the presumption in favor of arbitration because the forum selection clause cast doubt on whether the agreement to arbitrate remained in effect at all. Applying state-law contract interpretation principles, the court held that the mandatory nature of the forum selection clause superseded the default obligation under FINRA’s rules to arbitrate, and that by agreeing to that clause, the customer waived any right to a FINRA arbitration. Id . at 741-46. The Fourth Circuit, likewise, has held that Members can contract with their customers to resolve their disputes in court. UBS Fin. Servs., Inc. v. Carilion Clinic , 706 F.3d 319, 328 (4th Cir. 2013). Hyuncheol Hwang v. Mirae Asset Sec. (USA) Inc. On February 28, 2018, Justice Saliann Scarpulla of the Supreme Court, New York County Commercial Division, issued a decision in Hyuncheol Hwang v. Mirae Asset Sec. (USA) Inc. , 2018 N.Y. Slip Op. 30368(U) ( here ), in which she held that a forum selection clause in a broker’s employment contract trumped an arbitration clause in the broker’s later-signed Form U-4. Background Hwang involved an employment dispute in which Hyuncheol Hwang (“Hwang”) sought to stay the arbitration of his claims on the grounds that his employment agreement with Mirae Asset Securities (USA) Inc. (“Mirae”), a broker-dealer firm registered with FINRA, contained a forum selection clause directing the parties to litigate their disputes under the agreement in a New York court, notwithstanding his later signed Form U-4, which contained a mandatory arbitration provision. Hwang was hired to serve as Mirae’s Head of Prime Brokerage Services and Capital Markets Business, unless Mirae terminated his employment with or without cause, or if Hwang resigned with or without cause. The employment agreement included an exclusive judicial forum selection clause that required the parties to litigate any disputes relating to the terms of the agreement, including any counterclaims, in either a state or federal court sitting in New York County. The employment agreement also contained a standard provision requiring any amendments or modifications of the agreement to be signed in writing by both parties. Immediately after entering into the employment agreement, Hwang applied to become a registered representative by filling out a Form U-4. The Form U-4 included a mandatory arbitration clause. Less than a year after signing the employment agreement, Mirae terminated Hwang’s employment for cause. Thereafter, Hwang sent Mirae a draft complaint that outlined the claims he intended to assert against the broker-dealer. The complaint was to be filed in federal court. In response, Mirae filed a statement of claim with FINRA, asserting the following claims: 1) declaratory award that Hwang was terminated for cause; 2) breach of employment agreement; 3) fraudulent inducement and misrepresentation, seeking rescission of the agreement and recoupment of the compensation paid to Hwang under the agreement; and 4) breach of the duties of good faith and loyalty, seeking disgorgement of the compensation paid to Hwang under the agreement. The same day that Mirae filed its complaint, Hwang filed his complaint in state court. Hwang alleged that he was terminated without cause and was therefore entitled to his base salary for the remainder of his employment term, the remainder of his sign-on bonus, his retention bonus, his annual bonuses, his additional annual bonuses, and his benefits for the remainder of his employment term. He asserted causes of action for: (1) breach of contract; (2) violation of NYLL Section 193; (3) a declaratory judgment that he did not breach the agreement; (4) a declaratory judgment that the employment agreement should not be rescinded; and (5) a declaratory judgment that he did not breach any duty of good faith and loyalty. Hwang moved to stay the arbitration and Mirae cross moved to compel arbitration and stay the action pending the resolution of the arbitration. Hwang argued that the dispute should not be arbitrated because his employment agreement contained a forum selection clause directing the parties to litigate any disputes relating to the terms of the agreement in a New York court. He also contended that the Form U-4 did not amend or supersede the forum selection clause in his employment agreement, because any amendment would have required both parties to enter into a signed written agreement to modify its terms. Mirae argued that Hwang agreed to arbitrate any employment related claims with Mirae when he signed his Form U-4, which replaced his earlier employment agreement to resolve his claims in a different forum. Further, Mirae argued that under Rule 12200, Mirae and Hwang were required to submit any disputes arising under the employment agreement to FINRA for arbitration. The Court’s Decision The court granted the motion to stay arbitration. The court found that the evidence presented “demonstrate that the parties intended to be bound by the forum selection clause in the employment agreement.” “Mirae present no evidence,” said the court, “to show that the parties intended the arbitration clause in the U4 to supplant the forum selection clause in the employment agreement.” The court found dispositive the fact that “the forum selection clause, was negotiated and executed” a few weeks before Hwang signed the Form U-4: Hwang avers in his affidavit in support that, when he signed the employment agreement, both he and Mirae understood that Hwang’s position at Mirae would require him to sign the FINRA U4. As such, his signing of the U4 — which was done a few weeks after the employment contract was executed — was contemplated when the employment agreement, and specifically the forum selection clause, was negotiated and executed. Mirae submits no evidence to the contrary. In a footnote, the court noted that the law in the Appellate Division, First Department (to which the motion court is bound), confirmed that “specific contract terms can supersede FINRA’s arbitration rules.” Bortman v. Lucander , 150 A.D.3d 417 (1st Dept. 2017) (citing Golden Empire Schs. Fin. Auth. , 764 F.3d at 215). Finally, the court rejected Mirae’s argument that the Form U-4 amended the employment agreement, finding that Mirae failed to proffer any evidence that the parties “knowingly agreed, in a written employment contract modification, to eliminate the forum selection clause in Hwang’s employment agreement.” Further, Hwang’s employment contract contains a clause requiring any changes to the agreement be set forth in a signed written agreement. Mirae submits no evidence to show that both parties knowingly agreed, in a written employment contract modification, to eliminate the forum selection clause in Hwang’s employment agreement. If the parties intended to change the forum for disputes concerning Hwang’s employment, they would have had to indicate such in a signed written agreement, but they did not do so. Takeaway In the briefing of the motions, the parties addressed whether FINRA Regulatory Notice 16-25 (the “Notice”) mandated arbitration of their dispute. The Notice clarified FINRA’s position that its mandatory arbitration rules cannot be waived by Member firms in customer and industry disputes, notwithstanding the existence of a pre-dispute agreement to a different forum. See FINRA Regulatory Notice 16-25 ( here ). The Notice expressed the view that FINRA’s rules prohibit Member firms from precluding customers and Associated Persons, as the case may be, from pursuing arbitration at a FINRA arbitration, but do not prohibit customers and Associated Persons from agreeing to forego FINRA arbitration. The Notice specifically recommends that if Member firms wish to use a forum-selection provision in pre-dispute agreement, they are permitted to use a “non-exclusive forum selection provision” leaving the choice as to whether to proceed before FINRA to the customer or the Associated Person. The Hwang court did not address the Notice directly. However, the result comports with the purpose of the Notice. Although the forum selection clause in Hwang was an exclusive one, and therefore subjected Mirae to FINRA scrutiny, it was Hwang, the Associated Person, not Mirae, the Member firm, that sought to enforce the clause. Hwang also highlights the point that courts use state-law principles of contract interpretation to decide whether a contractual obligation to arbitrate exists. Thus, as in Hwang , where the parties’ agreement is clear on its face, courts will enforce it as written. Greenfield v. Philles Records, Inc. , 98 N.Y.2d 562 (2002) (“ written agreement that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms.”).

Since the summer of 2016, this Blog has written about the Fiduciary Rule (the “Fiduciary Rule” or the “Rule”), which the Department of Labor (“DOL”) promulgated in April 2016. ( See , e.g. , here , here , here , here , here , here , here .) Readers of this Blog know that the implementation of the Rule has not gone smoothly. The Rule has been the subject of congressional and industry attacks and legal challenges. On March 15, 2018, one of the legal challenges succeeded – the Court of Appeals for the Fifth Circuit struck down the Rule in its entirety, finding that the DOL exceeded its authority in promulgating the Rule. A Primer on The Fiduciary Rule The Fiduciary Rule provides that an individual “renders investment advice for a fee” whenever s/he is compensated in connection with a “recommendation as to the advisability of” buying, selling, or managing “investment property.” 29 C.F.R. § 2510.3-21(a)(1) (2017). A fiduciary duty arises when the “investment advice” is directed “to a specific advice recipient . . . regarding the advisability of a particular investment or management decision with respect to” the recipient’s investment property. 29 C.F.R. § 2510.3-21(a)(2)(iii) (2017). The Rule encompasses virtually all financial and insurance professionals who do business with ERISA plans and IRA holders. An important component of the Fiduciary Rule is the “Best Interest Contract Exemption” (“BIC Exemption” or “BICE”), which, if adopted by “investment advice fiduciaries,” allows them to avoid prohibited transaction penalties. The BICE and related exemptions were promulgated pursuant to the DOL’s authority to approve prohibited transaction exemptions (PTEs) for certain classes of fiduciaries or transactions. 29 U.S.C. § 1108(a), 26 U.S.C. § 4975(c)(2). To qualify for a BIC Exemption, providers of financial and insurance services must enter into contracts with clients that, inter alia , affirm their fiduciary status; incorporate “Impartial Conduct Standards” that include the duties of loyalty and prudence; “avoid[] misleading statements;” and charge no more than “reasonable compensation.” In addition, the contracts may not include exculpatory clauses such as a liquidated damages provision or a class action waiver. Another significant component of the Fiduciary Rule is the amended Prohibited Transaction Exemption 84-24 (“PTE 84-24”). Since 1977, that exemption had covered transactions involving insurance and annuity contracts and permitted customary sales commissions where the terms were at least as favorable as those at arm’s-length, provided for “reasonable” compensation, and included certain disclosures. As amended in the Fiduciary Rule, PTE 84-24 subjects these transactions to the same Impartial Conduct Standards as in the BIC Exemption. The Long and Winding Road of the Fiduciary Rule Shortly after taking office in 2017, President Trump instructed the DOL to perform an “economic and legal analysis” of the potential impact of the Rule on retirement investors and the market before its effective date. In late March 2017, following demands by industry participants, such as Vanguard and Blackrock, for a delay in the implementation of the Rule, and after a 15-day public comment period, the DOL decided to delay implementation of the Rule. The DOL sent its decision to the Office of Management and Budget (“OMB”) for review and approval. After the review by the OMB, the DOL delayed implementation of the Rule by 60-days. In the announcement, the DOL explained that “it would be inappropriate to broadly delay application of the fiduciary definition and Impartial Conduct Standards for an extended period in disregard of its previous findings of ongoing injury to retirement investors.” In late May 2017, Alexander Acosta, the newly-appointed Secretary of Labor, wrote in an opinion piece for the Wall Street Journal , that the Fiduciary Rule would not be delayed beyond June 9, 2017, though the DOL was still seeking “additional public input” about the Rule. On June 30, 2017, the DOL reopened the public comment period for another 30 days. In early August 2017, the DOL decided to delay implementation of the Rule to 2019. In a court filing, the DOL proposed an 18-month delay in the implementation of the Rule, changing the final deadline for compliance from January 1, 2018, to July 1, 2019. The proposed delay was approved by the OMB in August 2017. Court Rulings Prior to and during the first year of the Trump presidency, trade groups, among others, challenged the legality of the Rule in court. For the most part, the DOL scored many victories. Some of those cases made it to the appellate courts. In one case, the Rule survived; in another, the Rule was struck down. The Tenth Circuit Affirms The Rule On March 13, 2018, the Court of Appeals for the Tenth Circuit ruled that the DOL did not “arbitrarily treat fixed indexed annuities differently from fixed annuities” under the Fiduciary Rule. The plaintiff, Kansas-based Market Synergy Group (“MSG”), argued that the DOL arbitrarily threw fixed indexed annuities (“FIA”) under the BICE without notice, and therefore without any opportunity for public comment. The Tenth Circuit was “unpersuaded” by the argument, noting that “ he clearly asks for comment on whether removing variable annuities from PTE 84- 24 but leaving FIAs and fixed rate annuities struck the appropriate balance.” Thus, the DOL’s decision to include FIAs under PTE 84-24 was “not arbitrary or capricious.” Market="Market" Synergy="Synergy" Group,="Group," Inc.="Inc." v.="v." United="United" States="States" Department="Department" Labor, ="Labor," et="et" al. ,="al.," No.="No." 17-3038="17-3038" (10th="(10th" Cir.="Cir." Mar.="Mar." 13,="13," 2018),="2018)," can="can" be="be" found="found" here .=">here."> Micah Hauptman, financial services counsel for the Consumer Federation of America, said the decision “is yet another concluding that the DOL acted properly in promulgating the rule. The DOL’s careful analysis in promulgating the rule stands in stark contrast to the agency’s more recent arbitrary and capricious actions in delaying the rule’s full implementation.” The Fifth Circuit Strikes Down The Rule On March 15, 2018, the Court of Appeals for the Fifth Circuit vacated the Rule in a 2-1 decision, overturning a Dallas district court opinion that rejected the attacks on the Rule and the DOL’s authority to promulgate it. The case was brought by several industry groups, including the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Institute. Chief Judge Barbara M.G. Lynn of the United States District Court for the Northern District of Texas, granted summary judgment to the DOL in 2017. Chamber of Commerce of the United States of America, et al. v. Hugler, et al. , 231 F. Supp. 3d 152 (N.D. Tex. Feb. 8, 2017). ( Here .) In doing so, the court rejected each of the arguments advanced by the plaintiffs; namely, that the DOL did not exceed its authority, did not create a private right of action for clients and did not violate rulemaking authority. In fact, Chief Judge Lynn endorsed the DOL’s analysis of how the Rule would affect investors and financial firms, finding that “the DOL adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers.” “In doing so,” said the court, “the DOL conducted a reasonable cost-benefit analysis.” That finding struck at the heart of President Trump’s directive to the DOL to perform an analysis to determine whether the Fiduciary Rule harms investors and/or the market. The plaintiffs appealed. The Fifth Circuit ruled that the DOL exceeded its authority in extending the reach of the Fiduciary Rule to IRAs. In so holding, the Court found that the DOL improperly attempted “to rewrite the law that is the sole source of its authority.” “This it cannot do,” said the Court. The Court observed that the “DOL’s principal policy concern about the lack of fiduciary safeguards in Title II” was one that should be addressed by Congress, not by “de facto statutory amendments” or rule: That times have changed, the financial market has become more complex, and IRA accounts have assumed enormous importance are arguments for Congress to make adjustments in the law, or for other appropriate federal or state regulators to act within their authority. A perceived “need” does not empower DOL to craft de facto statutory amendments or to act beyond its expressly defined authority. On the merits, the Court found that the Rule’s definition of an “investment advice fiduciary” did not comport with ERISA Titles I and II, was not “reasonable” under Chevron U.S.A., Inc. v. NRDC, Inc. , 467 U.S. 837 (1984), and was violative of the Administrative Procedures Act (“APA”), 5 U.S.C. § 706(2)(A) (2016). In holding that the Rule is unreasonable and violative of the APA, the Court found that the DOL ignored the distinction between its authority over employer-sponsored plans and IRAs: By statute, ERISA plan fiduciaries must adhere to the traditional common law duties of loyalty and prudence in fulfilling their functions, and it is up to DOL to craft regulations enforcing that provision. 29 U.S.C. §§ 1001(b), 1104. IRA plan “fiduciaries,” though defined statutorily in the same way as ERISA plan fiduciaries, are not saddled with these duties, and DOL is given no direct statutory authority to regulate them. As to IRA plans, DOL is limited to defining technical and accounting terms, 11 U.S.C. § 1135, and it may grant exemptions from the prohibited transactions provisions. 26 U.S.C. § 4975(c)(2), 29 U.S.C. § 1108(a). Hornbook canons of statutory construction require that every word in a statute be interpreted to have meaning, and Congress’s use and withholding of terms within a statute is taken to be intentional. It follows that these ERISA provisions must have different ranges; they cannot mean that DOL may comparably regulate fiduciaries to ERISA plans and IRAs. Loughrin v. United States , 134 S. Ct. 2384, 2390 (2014). Despite the differences between ERISA Title I and II, DOL is treating IRA financial services providers in tandem with ERISA employer-sponsored plan fiduciaries. The Fiduciary Rule impermissibly conflates the basic division drawn by ERISA. The Court also found that the Fiduciary Rule’s definition of “investment advice fiduciary” was overbroad, illogical and otherwise internally inconsistent, characteristics of “arbitrary and unreasonable agency action.” Moreover, the Court found that the BIC Exemption is overbroad and “inconsistent” with an exemption specifically provided by ERISA: Another such marker is the overbreadth of the BIC Exemption when compared with an exception that Congress enacted to the prohibited transactions provisions. 26 U.S.C. § 4975(d)(17) exempts from “prohibition” transactions involving certain “eligible investment advice arrangements” for individually directed accounts. 26 U.S.C. § 4975(e)(3)(B); 26 U.S.C. § 4975(f)(8)(A), (B). Moreover, in describing the transactions not prohibited by Section 4975(d)(17), Congress distinguished two activities: “the provision of investment advice” and “the . . . sale of a security . . . .” 26 U.S.C. § 4975(d)(17)(A)(i), (ii). Congress further distinguished the “direct or indirect receipt of fees” “in connection with the . . . advice” from fees “in connection with the . . . sale of a security . . . .” 20 U.S.C. § 4975(d)(17)(A)(iii). That Congress distinguished sales from the provision of investment advice is consistent with this opinion’s interpretation of the statutory term, “render investment advice for a fee,” 29 U.S.C. § 1002(21)(A)(ii), and inconsistent with DOL’s conflating sales pitches and investment advice. Perhaps “ ven more remarkable,” said the Court, the “DOL had to exclude Congress’s nuanced § 4975(d)(17) exemption from the BICE exemption’s onerous provisions.” This was critical because “ ut for this exclusion, the BIC Exemption would have brazenly overruled Congress’s careful striking of a balance in the regulation of ‘prohibited transactions’ concerning certain self-directed IRA plans.” The Court concluded: “When Congress has acted with a scalpel, it is not for the agency to wield a cudgel.” Most significantly, the Court found that the BIC Exemption exploited the “DOL’s narrow exemptive power in order to ‘cure’ the Rule’s overbroad interpretation of the ‘investment advice fiduciary’ provision.” The Court noted that the “DOL admitted that without the BIC Exemptions, the Rule’s overbreadth could have “serious adverse unintended consequences.” “That a cure was needed,” said the Court, “should have alerted that it had taken a wrong interpretive turn.” (Citation omitted.) The Court concluded that “ ecause is independently indefensible, this alone dooms the entire Rule.” In dissent, Chief Judge Carl Stewart concluded that “the DOL acted well within the confines set by Congress in implementing the challenged regulatory package, and said package should be maintained so long as the agency’s interpretation is reasonable.” “DOL has acted within its delegated authority to regulate financial service providers in the retirement investment industry — which it has done since ERISA was enacted — and has utilized its broad exemption authority to create conditional exemptions on new investment-advice fiduciaries,” Stewart wrote. “That the DOL has extended its regulatory reach to cover more investment-advice fiduciaries and to impose additional conditions on conflicted transactions neither requires nor lends to the panel majority’s conclusion that it has acted contrary to Congress’ directive.” Micah Hauptman said that the “case was wrongly decided. The industry opponents went forum shopping and finally found a court that was willing to buy into their bogus arguments. This is a sad day for retirement savers.” The opinion, Hauptman added, “is extreme by any measure. It strikes at the essence of the DOL’s authority to protect retirement savers under ERISA. It’s not only an attack on the rule, it’s an attack on the agency.” A spokesman for the DOL said, “Pending further review , the department will not be enforcing the fiduciary rule.” Chamber="Chamber" Commerce="Commerce" the="the" United="United" States="States" America,="America," et="et" al.="al." v.="v." Department="Department" Labor, ="Labor," al. ,="al.," No.="No." 17-10238="17-10238" (5th="(5th" Cir.="Cir." Mar.="Mar." 15,="15," 2018),="2018)," can="can" be="be" found="found" here .=">here."> What’s Next? The Fiduciary Rule may not be dead . . . at least as of now. The DOL can seek an en banc review or it can seek certiorari from the United States Supreme Court. As noted, the Tenth Circuit upheld the Rule, although on a much narrower question than the broader one resolved by the Fifth Circuit.  Also, the Court of Appeals for the D.C. Circuit is slated to hear an appeal involving the Rule. That court is not bound by either circuit court ruling. With a split among the circuits, the Supreme Court may grant a petition for certiorari. Supreme Court review may also occur because the Fifth Circuit decision materially curtails the ability of the DOL to regulate through its rulemaking authority. Letting the Fifth Circuit’s decision stand could impact the DOL’s ability to promulgate rules going forward. Review by the high court will clarify the scope of the DOL’s ERISA rule-making authority. Additionally, the Securities and Exchange Commission (“SEC”) has been considering and working on its own fiduciary rule, which the SEC may release over the next 12 months. Many experts believe that the SEC rule would likely supersede the Fiduciary Rule in some areas and achieve many of the same outcomes that were envisioned by the DOL when it created the Rule. Further, Congress may wait to legislate the end of the Rule now that the Fifth Circuit has acted. In the proposed Choice Act 2.0, House Republicans have sought to end the Fiduciary Rule.  (For a discussion of congressional action, see here .) Finally, there is activity on the state level that is likely to continue. Over the past few years, the states have been proposing their own fiduciary rules for financial advisors. This trend could continue and even be accelerated now that the federal rule has been vacated in toto . Stay tuned for more updates on the Rule as they develop.

According to a new report by Cornerstone Research (“Cornerstone”), titled Securities Class Action Settlements—2017 Review and Analysis (the “Report”) ( here ), total settlement dollars from securities class action lawsuits declined “dramatically” in 2017, even as the number of settlements remained relatively steady. Cornerstone’s March 14, 2018 press release about the Report can be found here . In 2017, the total value of court-approved securities class action settlements was $1.5 billion, a substantial decline from the $6.1 billion tallied in 2016. According to the Report, the $1.5 billion in total value is the second-lowest since 2008. There were 81 court-approved securities fraud class action settlements in 2017, down slightly from 85 settlements in 2016. The average settlement value, however, decreased 75 percent from $72.0 million in 2016 to $18.2 million in 2017. This decrease represents a 70% decline from the 1996-2016 average of $57.7 million. According to the Report, for the first time in more than five years, no settlement exceeded $250 million. The Report found that the median settlement amount in 2017 was $5.0 million, over 40 percent lower than both the 2016 median ($8.7 million) and the median for all prior post-Reform Act settlements ($8.5 million). “More than half of 2017 settlements were for $5 million or less. We also saw a significant decline in mid-range to large settlements,” said Dr. Laura E. Simmons, a co-author of the Report and a Cornerstone Research senior advisor. “A combination of lower estimates of the proxy for plaintiff-style damages and smaller issuer defendant firms contributed to this decrease.” The authors of the Report “largely” attributed the decline in settlement value to the size of the cases – they are smaller than in previous years (as measured by Cornerstone’s own estimate of the plaintiff-style damages in the filed cases) – a combination of market volatility and shorter class periods, and “considerably smaller issuer defendants.” Also affecting settlement value was the decline in institutional representation. According to the Report, institutional investors served less frequently as lead plaintiffs, even in large cases.  The authors found that public pension funds served as lead plaintiffs in 32 percent of settled cases in 2017, compared to 41 percent in 2016 and 46 percent in 2012. Recent literature, they said, provided a possible explanation for the decline in institutional representation: there were fewer economic incentives for them, “other than the potential benefit … from political contributions by plaintiff attorneys.” In 2017, there were only four settlements valued at $100 million or more, amounting to 43 percent of total settlement dollars during the year. By contrast, during the period 2008–2016, 70 percent of total settlement dollars were attributable to settlements of over $100 million. Compared to the four settlements over $100 million in 2017, there were ten settlements over $100 million in 2016. “These data suggest that plaintiff counsel have recently been going after smaller fry claims where the issuers are not as large and there is less at stake. The mega-cases involving large firms appear to be in the rearview mirror for the moment,” observed Professor Joseph A. Grundfest of Stanford Law School, and a former Commissioner of the Securities and Exchange Commission. The Report found that the proportion of shareholder derivative actions accompanying settled securities class actions “was among the highest … in more than 15 years.” The Report noted that nearly one-half of all settled cases, and more than one-half of all settlements valued at $5 million or less, were accompanied by a shareholder derivative lawsuit. The authors explained that these results were “unexpected” since shareholder derivative actions are most often associated with “larger class actions and larger settlement amounts.” Not only were the settlement amounts smaller in 2017, but the cases also tended to settle more quickly than in the past. The Report found that 23 percent of the cases that settled in 2017 were resolved within the first two years of filing, compared to less than 16 percent during the period 2008-2016. The Report found that the average time to settlement from filing during 2017 was at its lowest level in ten years. The authors noted that the median settlement involving cases taking more than two years was more than double the median for cases that settled within two years. Moreover, the proportion of settled cases alleging violations of Generally Accepted Accounting Principles was 53 percent in 2017, continuing a three-year decline from a high of 67 percent in 2014. Of the accounting cases settling in the preceding nine years, 23 percent involved named auditor co-defendants. In 2017, this dropped to 13 percent. Finally, approximately 20 percent of the cases that settled in 2017 involved an accompanying enforcement action by the Securities and Exchange Commission (“SEC”), a modest increase over the percentage recorded in 2016 (18 percent). The authors noted that “ ompared to 2011-2014, the relatively high level of class actions settled over the last three years with corresponding SEC actions is consistent with the SEC’s stated focus on financial reporting and disclosure matters during this period.” Cases with corresponding SEC actions tended to involve larger issuer defendants. For approved settlements during the period 2008-2017, the average assets for issuer defendant firms were $135 billion for cases with corresponding SEC actions, compared to only $31 billion for cases without a corresponding SEC enforcement action. The Report also noted that corresponding SEC actions are “frequently associated with delisted firms.” Out of the total 159 settlements during 2008-2017 involving cases with corresponding SEC actions, 63 cases (40 percent) involved issuer defendants that had been delisted. Looking forward, the authors opined that the number of cases filed in the prior two years suggested that “the high volume of settlements continue.” However, the data also suggested that with the higher number of filings there may be a higher number of dismissals, which could offset the increase in settlement activity. The authors also noted that the continued reduction of institutional investor involvement in securities class actions could translate into lower overall settlement values in the foreseeable future.

“Timing is everything”, it is often said.  A fine illustration of this often-uttered phrase can be found in Reverend C.T. Walker Housing Dev. Fund Corp. v. City of New York (E.D.N.Y. March 5, 2018), an appeal from the United States Bankruptcy Court for the Eastern District of New York. The Reverend C.T. Walker Housing Dev. Fund Corp. (“Walker”) owned property on 135 th Street in New York City (the “Property”).  The New York City Department of Housing Preservation and Development (“HPD”) agreed to fund the development of the Property, but the funding was conditioned on certain restrictive covenants that required Walker to use the Property for low-income, rent-stabilized housing for twenty years.  The financial success of the development would have been greatly enhanced by certain property tax exemptions offered by the City.  Unfortunately, the exemption expired before Walker filed its petition to receive same.  Accordingly, Walker fell behind in its property tax payments and the resulting tax lien certificates were sold to Bank of New York Mellon (“BONY”).  BONY assigned its rights to two trusts. The trusts initiated state court foreclosure proceedings in which a judgment of foreclosure and sale was issued and a foreclosure sale was held.  The Property was knocked down to the highest bidder at the sale and a $1.15 million deposit was delivered to the foreclosure sale referee.  The winning bid was assigned to 181 West 135 th LLC (“West”).  The closing of the sale was adjourned twice at West’s request because it was having difficulty obtaining title insurance, but a third request for an adjournment was denied. West filed for bankruptcy protection one day prior to the scheduled closing and the closing was postponed due to the automatic stay.  The trusts, Walker and the City moved to lift the automatic stay imposed by West’s bankruptcy filing. Thereafter, Walker filed its own bankruptcy petition in which it moved the bankruptcy court for an order permitting a sale of the Property to West for $9 million. The bankruptcy court denied Walker’s motion to sell the Property, holding that, under New York law, the Property was not part of the estate because the foreclosure sale extinguished Walker’s equity of redemption prior to the filing of Walker’s bankruptcy petition.  The bankruptcy court did, however grant relief from the automatic stay in the West bankruptcy because, inter alia , West had no equity in the $1.15 million bid deposit because it failed to close on the Property.  Walker appealed to the United States District Court for the Eastern District of New York. The District Court affirmed the bankruptcy court’s order.  In addressing that portion of the appeal relating to the sale of the Property, the Court found that the Property was not property of the estate under 11 U.S.C. §541 and, therefore, a sale could not be ordered under §363 in Walker’s bankruptcy proceeding.  The Court relying on In re Rodgers , 333 F.3d 64 (2003), in which the Second Circuit, applying New York law, found that the subject “property did not become part of the debtor’s bankruptcy estate when it was subject to a tax lien foreclosure auction before the bankruptcy petition was filed.” For a variety of reasons, the Walker court found that, at the time it filed its petition, Walker “had no cognizable legal or equitable interests in the Property” and, therefore, the Property was not part of Walker’s bankruptcy estate.  (Internal quotation marks omitted.)  First, the judgment of foreclosure and sale (the “JF&S”) extinguished any interest Walker had in the Property.  Second, assuming that the JF&S left Walker with an equity of redemption, same was cut-off by the foreclosure sale.  Section 1194 of the Real Property Tax Law permits the owner of a tax lien to “foreclose the lien as in an action to foreclose a mortgage”.  “In such an action, the equity of redemption allows property owners to redeem their property by tendering the full sum at any point before the property is actually sold at a foreclosure sale.”   (Citation and internal quotation marks omitted; emphasis supplied by the Walker court.)  The court further recognized that, under New York law, it is the foreclosure sale, and not the delivery of the deed to the sale purchaser, that operates to extinguish the equity of redemption. The Court also found that the stay was properly lifted in the West bankruptcy.  Pursuant to 11 U.S.C. §362(d)(2) , after notice and a hearing, the stay can be lifted if the debtor has no equity in the property and the property is not necessary for an effective reorganization.  The Court found that West “abandoned all equity in the roperty by failing to close the sale. And because…West is left with only the bid deposit as an asset, there is no reorganization necessary.” TAKEAWAY Frequently bankruptcy actions are filed immediately before a foreclosure sale so that the sale will be stayed.  Once the referee at the sale says “going, going, gone” and knocks down the property to the highest bidder, the foreclosed prior owner no longer has rights to the property itself and cannot generally unwind the foreclosure sale by filing a bankruptcy petition.