Recently, Credit Suisse (the "Bank"), the multinational financial services holding company based in Switzerland, was hit with two  class action lawsuits , one from investors over the Bank's writedown of more than $1 billion and the other from U.S.-based brokers who refused or were unable to move to Wells Fargo & Co. ("Wells Fargo") after their private banking unit was closed in 2015 .   Both lawsuits come at a time when the Bank has been in the news for legal challenges and inquiries linked to it or former employees. Credit Suisse Writedowns The investor class action lawsuit was brought by the City of Birmingham Firemen’s and Policemen’s Supplemental Pension System (“Birmingham”) on behalf of all persons or entities that purchased or otherwise acquired Credit Suisse's American Depositary Receipts (“ADRs”) on the New York Stock Exchange (“NYSE”) between March 20, 2015, and February 3, 2016 (the “Class Period”). Birmingham seeks relief under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et. seq. The Complaint alleges that, throughout the Class Period, Credit Suisse and certain of its officers ("Defendants") made false and/or misleading statements, as well as failed to disclose material adverse facts about the Company's business, operations, and risk controls.  In particular, Birmingham maintains that Defendants made false and/or misleading statements and/or failed to disclose that: (1) Credit Suisse's risk protocols and control systems were routinely disregarded; (2) the Company was accumulating billions of dollars of risky, highly illiquid securities in violation of those risk protocols; and (3) as a result of the foregoing, Defendants' statements about Credit Suisse's business, operations, and risk controls were false and misleading and/or lacked a reasonable basis. According to Birmingham, throughout the Class Period, Defendants represented in SEC filings that Credit Suisse maintained “comprehensive risk management processes and sophisticated control systems” – a notable component of such systems was the Bank’s high-level Capital Allocation and Risk Management Committee (“CARMC”) – which established and allocated appropriate trading and risk limits for the Bank’s various businesses.  Birmingham alleges that Credit Suisse’s trading and risk limits routinely increased to allow the Bank to accumulate billions of dollars in extremely risky, highly illiquid investments. According to the complaint, the Bank “surreptitiously accumulate nearly $3 billion in distressed debt and U.S. collateralized loan obligations (“CLOs”), which were … difficult to liquidate and required significant capital investments.”  This investment position, says Birmingham, was undisclosed, "violated Credit Suisse’s represented risk protocols and rendered the Bank highly susceptible to losses when credit markets contracted.” On February 4, 2016, Credit Suisse announced its fourth quarter and year-end financial results, which included a $633 million writedown from the sale of the Bank’s illiquid distressed debt and CLO positions. That amount, says Birmingham, “swell to nearly $1 billion in the ensuing weeks.” The complaint notes that Defendant Tidjane Thiam, Credit Suisse’s recently-appointed CEO, “admitted that these risky and outsized investments were only allowed because trading limits were continuously raised, which enabled traders to take larger positions in violation of the Bank’s risk policies. The complaint notes that market analysts and former Credit Suisse insiders were “incredulous that the position went unreported,” and doubted that the bank’s senior executives did not know about the illiquid positions sooner. Some said it was “inconceivable” that the CARMC was unaware of the holdings. Birmingham alleges that as a result of the announcement, the price of the Bank’s ADRs declined from a close of $16.69 on February 3, 2016, to a close of $14.89 on February 4, 2016—an 11% drop that "wiped out" approximately $230 million in market capitalization. Credit Suisse said in a recent statement that “the claim is unfounded and without merit.” “In the last three years, Credit Suisse has analyzed these allegations and responded to information requests from supervisory bodies.  All regulatory reviews were closed without any action against Credit Suisse,” the Bank said. The shareholder class action is not the only legal challenge facing the Bank. As noted, former U.S.-based brokers have accused the Bank of withholding up to $300 million of deferred compensation after their private banking unit was shuttered in 2015. The Broker Class Action In a class action complaint filed last month in the United States District Court for the Northern District of California, Christopher Laver (“Laver”), a former Credit Suisse Securities broker of 13 years who joined UBS Financial Services in 2015, alleges that the Bank intentionally entered into a recruiting transaction with Wells Fargo rather than a sale to avoid triggering a change-of-control provision in brokers’ employment agreements that would have accelerated deferred compensation payments. Brokers who joined Wells Fargo collected their deferred shares. Wells Fargo is not a named defendant and was not accused of wrongdoing. Laver also alleges that many brokers turned down offers from Wells Fargo out of concern over its ability to serve their customers.  In that regard, Laver maintains that Credit Suisse knew many brokers would not join Wells Fargo because its business and client base was different but entered the recruiting deal because a sale of the unit would have constituted a “change of control” requiring the payments. “Wells Fargo was incapable of and/or ill-suited to handle certain significant portions of Credit Suisse advisers’ business, and Wells Fargo maintained a different type of client base than Credit Suisse advisers,” the complaint says. “At the time it entered into the ‘recruiting agreement’ with Wells Fargo, Credit Suisse knew and expected that many of the Credit Suisse financial advisers would not and/or could not work for Wells Fargo.” The class-action lawsuit supplements dozens of arbitration proceedings that former Credit Suisse brokers commenced to collect back pay and to avoid repaying balances on promissory notes that the Bank is demanding. Credit Suisse has maintained that it can keep the deferred compensation, which the complaint says may be as much as $300 million because the brokers “resigned” rather than joined Wells Fargo. “Credit Suisse should not be able to avoid its obligation to compensate the advisers fully and fairly by claiming they ‘resigned’ when, in fact, Credit Suisse simply ceased operating this business,” the complaint says. Karina Byrne, a Credit Suisse spokeswoman, said that if the brokers had accepted Wells Fargo’s offers they would have received all their deferred compensation. She also disputed the allegation that a change of control would have triggered accelerated awards of the deferred shares. “Those who chose not to accept those offers had negotiated equally or more lucrative compensation packages from competing institutions that also covered the same contingent deferred compensation at issue here, consistent with standard industry practice,” she wrote in an e-mail. “Simply put, the plaintiff here is looking to be paid the same money twice.” The class-action lawsuit was filed on behalf of brokers with unvested compensation awards who were effectively “terminated” between October 20, 2015, and March 31, 2016, because their “private bank” went out of business. Laver seeks unspecified damages for roughly 200 brokers.

Ameriprise Settles with The SEC for Overcharging Retirement Account Customers for Mutual Fund Shares On February 28, 2018, just a few weeks after launching its Share Class Selection Disclosure Initiative (discussed below), the Securities and Exchange Commission (“SEC”) announced (here) that Ameriprise Financial Services Inc. (“Ameriprise”), the Minnesota-based broker-dealer and investment adviser, agreed to settle charges for recommending and selling higher-fee mutual fund shares to retirement account customers and for failing to provide sales charge waivers. According to the SEC, Ameriprise disadvantaged certain retirement customers by failing to ascertain their eligibility for less expensive mutual fund share classes. As set forth in the SEC’s order (here), Ameriprise recommended and sold retirement customers more expensive mutual fund share classes when less expensive share classes were available. Ameriprise also failed to disclose that it would receive greater compensation from the purchases and that the purchases would negatively impact the overall return on the customers’ investments. The SEC said that approximately 1,791 customer accounts paid a total of $1,778,592.31 in unnecessary up-front sales charges, contingent deferred sales charges, and higher ongoing fees and expenses (also known as 12b-1 fees) as a result of Ameriprise’s practices. “Ameriprise generated greater revenue for itself but lower returns for its retirement account customers by recommending higher-fee share classes,” said Anthony S. Kelly, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “As evidenced by our recently announced Share Class Selection Disclosure Initiative, pursuing these types of actions remains a priority for the Division as we seek to get money back in the hands of harmed investors.” As noted in the announcement, Ameriprise cooperated with the SEC and voluntarily identified the affected accounts, issued payments including interest to the affected customers, and converted eligible customers to the mutual fund share class with the lowest expenses for which they are eligible, at no cost. The SEC’s order instituting a settled administrative and cease-and-desist proceeding finds that Ameriprise violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933. Without admitting or denying the findings, Ameriprise consented to the cease-and-desist order, a censure, and a $230,000 civil penalty. The Share Class Selection Disclosure Initiative Conflicts of interest can arise in the sale of mutual funds that offer different share classes and fee structures. Because each share of a mutual fund represents an interest in the same portfolio of securities regardless of the share class, to the extent that multiple share classes are available to an investor, it is in the investor’s best interest to purchase the share class with the lowest fees. By contrast, an adviser, its affiliates, and/or its associated persons has a financial incentive to recommend the share class that results in the client paying higher fees. To the extent a conflict exists, it must be fully disclosed by the adviser so that its clients have the information necessary to make an informed investment decision. The SEC created the Share Class Selection Disclosure Initiative (“SCSD Initiative”) to address the foregoing (e.g., undisclosed conflicts of interest). (Here.) The SEC Asset Management Unit is leading the SCSD. Under the SCSD Initiative, the SEC will not recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to mutual fund share class selection issues and promptly return money to harmed clients. The SEC has been focused on the conflicts of interest associated with mutual fund share class selection for a long period of time. In the past several years, the SEC has charged nine firms with failing to disclose such conflicts of interest. These actions have resulted in the imposition of significant penalties against the advisers and the return of millions of dollars to the affected clients. In addition, the SEC’s Office of Compliance Inspections and Examinations has repeatedly cautioned investment advisers and other market participants to examine their share class selection policies and procedures and disclosure practices. “This focused initiative reflects our effort to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors,” said Stephanie Avakian, Co-Director of the Division of Enforcement. “The legal and regulatory requirements in this area are clear, and the Commission will continue to pursue securities violations associated with mutual fund share class selection disclosure failures. We strongly encourage advisers to take advantage of the favorable terms we are offering; these terms will not be available to advisers who do not self-report under this initiative, and we will continue to proactively seek to identify and pursue investment advisers that fail to make the necessary disclosures,” said Steven Peikin, Co-Director of the Division of Enforcement. In addition to requiring the adviser to disgorge its ill-gotten gains and pay those amounts to affected clients, under the SCSD Initiative, the SEC will recommend favorable settlement terms to advisers that self-report their failure to disclose conflicts of interest associated with the recommendation to purchase a higher-cost mutual fund share class when a lower-cost share class of the same mutual fund is available for advisory clients. The SEC has warned, however, that it will impose stronger sanctions against advisers that fail to take advantage of the SCSD Initiative. “Proper disclosure of conflicts of interest is of utmost importance, and a necessity for any investment adviser to ensure that it is satisfying its obligations as a fiduciary to its clients,” said C. Dabney O’Riordan, Co-Chief of the Asset Management Unit in the Division of Enforcement. “This initiative is designed to promote compliance with these obligations with respect to mutual fund share class selection, while at the same time quickly returning money to harmed clients.” The SCSD Initiative was explained in a detailed announcement issued by the SEC’s Enforcement Division on February 12, 2018 (here). The deadline for investment advisers to avail themselves of the SCSD Initiative is June 12, 2018.

On February 23, 2018, the U.S. Supreme Court set oral argument in Lucia v. SEC, 17-130, a case involving the use of administrative law judges (“ALJ”) by the Securities and Exchange Commission (“SEC” or the “Commission”) as hearing officers in administrative proceedings. The issue presented to the Court concerns whether the use of ALJs violates the constitutional limitations of the Appointments Clause on “Officers of the United States” (here). U.S. Const., art. II, § 2, cl. 2. Resolution of the issue is important because there is a conflict among the circuits over the meaning of the Appointments Clause and the interpretation of the Court’s precedents addressing that provision (e.g., Freytag v. Comm’r, 501 U.S. 868, 881-82 (1991) (holding that non-Article III adjudicators, such as ALJs, who exercise discretionary powers are Officers of the United States who must be appointed pursuant to the Appointments Clause). Lucia v. SEC Background The case arose from an administrative proceeding brought by the SEC against Raymond J. Lucia and his investment company (collectively, “Lucia”). Lucia marketed a wealth-management strategy, which they called “Buckets of Money,” under which retirement savings were divided among assets of different risk levels ( e.g. , bonds, fixed annuities, and stocks) and periodically reallocated as those assets changed in value. The Commission instituted administrative proceedings against Lucia based on allegations that they had used misleading slideshow presentations to deceive prospective clients about how the Buckets of Money strategy would have performed under historical market conditions. The Commission charged Lucia with violating the Securities Exchange Act of 1934, the Investment Advisers Act of 1940 (“IAA”), and the Investment Company Act of 1940. An ALJ conducted the initial stages of the proceeding. During a nine-day hearing, the ALJ presided over witness testimony and cross-examinations, admitted documentary evidence, and ruled on objections. After the hearing, the ALJ issued an initial decision finding that Lucia had made fraudulent misrepresentations related to one of their investment strategies. After the Commission directed the ALJ to make additional factual findings with respect to other alleged misrepresentations, the ALJ issued a revised initial decision finding that Lucia had willfully and materially misled investors, in violation of the IAA. The ALJ ordered a variety of sanctions to be imposed on Lucia, including revocation of his registration as an investment adviser; a permanent bar on associating with investment advisers, brokers, or dealers; a cease-and-desist injunction against future violations; and $300,000 in civil penalties. Lucia appealed. On appeal, the Commission conducted “an independent review of the record, except with respect to those findings not challenged on appeal.” Exchange Act Release No. 73,857, at 3, 2015 WL 5172953 (SEC Sept. 3, 2015) (here). The Commission determined that the ALJ had correctly found that Lucia had willfully made fraudulent statements and omissions in violation of the IAA. The Commission also largely “affirm ,” with limited exceptions, “the sanctions imposed” by the ALJ. Two Commissioners dissented with respect to one aspect of the Commission’s liability determination. Lucia argued before the Commission that the proceeding against him was unlawful because the ALJ who had conducted the hearing and issued the initial decision was an “Officer[ ] of the United States” within the meaning of the Appointments Clause. Id . at 28. As such, the ALJ had not been appointed, in accordance with that provision, “by the President, the head of a department, or a court of law.” Id . at 29. The Commission rejected Lucia’s argument. In the Commission’s view, its ALJs were mere employees rather than constitutional officers because they do not exercise “significant authority independent of the supervision.” Id. Among other things, the Commission explained, its ALJs “issue ‘initial decisions’ that are … not final”; a person aggrieved by an initial decision may seek review before the Commission, which “grant virtually all petitions for review”; the Commission may review any ALJ decision sua sponte ; review of an ALJ’s decision is de novo ; and under the Commission’s rules, “no initial decision becomes final simply on the lapse of time by operation of law,” but instead becomes final only upon “the Commission’s issuance of a finality order.” Id . at 30 (citation and internal quotation marks omitted). The Commission also distinguished the Freytag decision, finding that “ Freytag inapposite here.” Id . at 32. On appeal of the Commission’s order, a panel of the Court of Appeals for the D.C. Circuit denied the petition for review. Lucia v. SEC , 832 F.3d 277 (D.C. Cir. 2016). The court rejected Lucia’s Appointments Clause challenge, holding that the Commission’s ALJs are mere employees rather than officers under the Constitution because they do not exercise “significant authority pursuant to the laws of the United States.” Id . at 284. For that conclusion, the court relied on its prior decision in Landry v. FDIC , 204 F.3d 1125, 1133-1134 (D.C. Cir.), cert. denied , 531 U.S. 924 (2000). In Landry , the court held that the ALJs used by the Federal Deposit Insurance Corporation (“FDIC”) were not officers of the United States because they could not issue final decisions on behalf of the agency – i.e. , they could not exercise significant authority to bind third parties, or the government itself, for the public benefit. Id . at 1333; see also Lucia , 832 F.3d at 285. The Lucia court determined that an SEC ALJ’s initial decision is similarly non-final, and it rejected Lucia’s attempts to distinguish Landry . Lucia , 832 F.3d at 285. The court also rejected Lucia’s argument that the SEC’s ALJs “exercise greater authority than FDIC ALJs in view of differences in the scope of review of the ALJ’s decisions.” Id . at 288. The court acknowledged that “the Commission may sometimes defer to the credibility determinations of its ALJs,” but it concluded that “the Commission’s scope of review is no more deferential than that of the FDIC Board.” Id . The court further rejected Lucia’s attempt to equate the SEC’s ALJs with the special trial judges of the Tax Court who were held to be officers in Freytag . In the court’s view, the special trial judges were distinguishable because, as “members of an Article I court,” they “could exercise the judicial power of the United States” and “issue final decisions in at least some cases.” Id . at 284-85. The court also found special trial judges to be different than SEC ALJs because “the Tax Court in Freytag was required to defer to the special trial judge’s factual and credibility findings unless they were clearly erroneous.” Id . at 288 (citation and internal quotation marks omitted). The Commission, by contrast, “is not required to adopt the credibility determinations of an ALJ.” Id . On the merits, the court determined that substantial evidence supported the Commission’s finding that Lucia, acting with the requisite scienter, had made material misstatements and omissions in violation of the IAA. The court also concluded that the Commission had not abused its discretion in ordering sanctions against Lucia. Lucia sought rehearing en banc , which the court of appeals granted on February 16, 2017. The order granting rehearing en banc vacated the panel’s judgment but not its opinion. The court directed the parties to limit their briefs to two issues: (1) whether “the SEC administrative law judge who handled this case an inferior officer rather than an employee for the purposes of the Appointments Clause”; and (2) whether the court should “overrule Landry.” On June 26, 2017, an equally divided en banc court issued a per curiam judgment denying the petition for review. Appeals Courts are Split on Administrative Proceedings Since the original opinion of the three-member panel of the D.C. Circuit remains controlling, it is at odds with the ruling of the Tenth Circuit, which expressly disagreed with that decision. In Bandimere v. SEC , 844 F.3d 1168, 1170 (10th Cir. 2016), the court ruled that SEC ALJs are Officers of the United States within the meaning of the Appointments Clause. In Bandimere , an ALJ issued an initial decision finding that the respondent had violated antifraud and registration provisions of the federal securities laws by operating as an unregistered broker and by failing to disclose potentially negative facts to investors. In re David F. Bandimere , Securities Act Release No. 9972, 2015 WL 6575665, at *1 (Oct. 29, 2015). On review of the ALJ’s initial decision, the Commission upheld the liability finding and imposed disgorgement and civil-penalty sanctions. Id . at *2. The Commission also rejected the respondent’s argument that its ALJs are officers under the Appointments Clause. Id . at *19-*21. The Tenth Circuit granted the respondent’s petition for review, holding that the Commission’s ALJs are invested with powers that require their appointment as inferior officers under the Appointments Clause. Bandimere , 844 F.3d at 1179-1182. In reaching that conclusion, the court relied on Freytag , which it interpreted as turning on the significance of the special trial judges’ duties, not on their authority to render final decisions of the Tax Court. Id . at 1182-1185; see also id . at 1179. The Tenth Circuit expressly “disagree ” with the D.C. Circuit’s decisions in Landry and Lucia , which, the court determined, had “place undue weight on final decision-making authority.” Id . at 1182. Judge Monroe G. McKay dissented, arguing that Freytag does not “mandate[ ] the result proposed here.” Bandimere , 844 F.3d at 1194. Like the panel in Lucia , Judge McKay distinguished the special trial judges at issue in Freytag because of their authority to enter final decisions in a number of cases and because “the Tax Court was required to defer to its special trial judges’ findings.” Id . at 1197. Judge McKay emphasized that the Commission’s ALJs, by contrast, “possess only a ‘purely recommendatory power.’” Id . (quoting Landry , 204 F.3d at 1132). In May 2017, the Tenth Circuit denied the Commission’s petition for rehearing en banc , with two judges dissenting. See Bandimere v. SEC , 855 F.3d 1128, 1128-1133 (10th Cir. 2017). On September 29, 2017, the government filed a petition for a writ of certiorari urging the Court to resolve the question whether the Commission’s ALJs are inferior officers rather than employees. SEC v. Bandimere , No. 17-475. But the government explained that Lucia , rather than Bandimere , presented the Court with the preferable vehicle for addressing the question. The government accordingly “request that the Court hold th petition” in Bandimere “pending its consideration of the petition” in Lucia . On July 21, 2017, Lucia filed his petition for a writ of certiorari. The Court granted the petition on January 12, 2018. As the docket shows, numerous amici filed briefs in connection with the petition. (Here.) The Takeaway Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Commission has increased both the number and proportion of enforcement actions brought in administrative hearings before its ALJs. There are more than 100 cases currently under review by SEC ALJs, as well as a dozen on appeal in the federal courts. Given the foregoing, it is clear that the fact-finding and credibility determinations of the SEC’s ALJs are important to its ability to enforce the federal securities law. Congress created the ALJ position pursuant to the Administrative Procedure Act ("APA") (Pub. L. No. 79-404, 60 Stat. 237 (1946), codified at 5 U.S.C. §§ 551-559). In doing so, Congress sought a mechanism by which federal agencies could provide for due process in administrative adjudications. Since the enactment of the APA, numerous federal agencies use ALJs in adjudicating administrative proceedings ( e.g. , the Commodities Futures Trading Commission, Federal Energy Regulatory Commission, the FDIC, the Consumer Finance Protection Bureau, National Labor Relations Board, the Environmental Protection Agency, and the Social Security Administration). Therefore, the decision by the Court will impact administrative proceedings beyond those conducted by SEC ALJs. This Blog will be following the case as developments occur. Stay tuned for additional posts.

The parties in Stravroulakis v. Pelakanos , 58 Misc.3d 1221(A) (Sup. Ct. N.Y. Co. Feb. 13, 2018), are the owners of Bareburger.  The majority owners attempted to oust a shareholder by improper means and the court thought otherwise. The oversimplified facts of Stravroulakis are as follows.  Plaintiff and some of his buddies (the “Owners”) owned a dive bar in Brooklyn called Sputnik, in which they started to sell organic hamburgers.  The hamburgers became so popular that the Owners, with the help of some investors (collectively, the “Founders”), decided to form a corporation to own the first “Bareburger” restaurant.  A few of the “buddies” worked at the restaurant and drew salaries while the remainder of the shareholders, who had full time jobs, did not. The first restaurant was so successful that the Founders decided to franchise Bareburger and formed Bareburger, Inc. (the “Company”) for that purpose.  Each of the six Founders invested $6,000 and received 16.666% of the Company.  The Company received its Bareburger trademark from the PTO in 2010. The Founders and some additional investors formed another corporation and entered into a franchise agreement with the Company to own a second Bareburger restaurant.  Prior thereto, however, all of the Founders (with the exception of plaintiff) (the “Shareholder Defendants”) began discussing terminating plaintiff’s interest in the Company (but not the two restaurants in which he had an ownership interest) because he was not working for the Company (as he was a passive investor that had no obligation to work – as the court pointed out many times throughout the Stravroulakis decision).  In this regard, in a letter from one Founder to the remaining Shareholder Defendants, it was written, among other things: …After repeated attempts to work and motivate we have not seen the results expected by this company.  As per our conversation with him, he was granted a probationary period that has now lapsed.  At this time, I propose we terminate our good friend but inattentive partner …. (Emphasis added by court.) Similarly, meeting minutes reflect that the Shareholder Defendants discussed the hours they worked while plaintiff was absent and the fact that the “money invested is minimal compared to the amount of labor and time involved….”  According to the minutes: ptions discussed include (1) removing (2) giving back the $6,000 invested plus interest (3) start over with those willing to do the work required.   Members/shareholders agree that they will either remove or take other measures to the same effect.  should receive fair value for the amount he contributed.  Any interests has in the actual physical restaurant will not be affected.  (Emphasis supplied by court; footnote omitted.) Thereafter, and after some internal disputes as to how to deal with plaintiff, the five Shareholder Defendants formed Bareburger Group (“Group”) and each received a 20% interest in same.  Eventually, all the Company’s assets (the right to royalties under the franchise agreements, cash and the Bareburger trademarks) were transferred, without plaintiff’s knowledge, to Group without consideration.  Almost a year later, and after repeated requests for his K-1 from the Company, plaintiff was advised that the Company had no income, the Company’s assets were transferred to Group and he had no interest in Group. An assignment of the Bareburger trademark from the Company to Group was filed with the PTO indicating “that it was for good and valuable consideration no actual cash or other assets of value were paid by Bareburger Group to the Company.”) (Emphasis supplied by the court; some internal quotation marks and brackets omitted.)  On the same day, Group filed a trademark application for the word “Bareburger” based on its ownership of the “Bareburger Organic” trademark, which application contained numerous misrepresentations. In its franchise agreements, Group permitted franchisees to use the Bareburger trademarks although it was not the true owner of the trademarks and “did not have the power or authority to license their use.” Plaintiff asserted twenty causes of action in his complaint and moved for summary judgment on the following seven: breach of fiduciary duty (corporate waste and self-dealing); breach of fiduciary duty (shareholder oppression);  breach of fiduciary duty (corporate waste, self-dealing and usurpation of a corporate opportunity); trademark infringement under the Lanham Act; fraud on the trademark office; fraudulent conveyance (constructive and intentional); and, aiding and abetting breach of fiduciary duty. The court granted summary judgment to plaintiff on the breach of fiduciary duty claims. In so deciding, the court reasoned that the “business judgment rule” does not apply where the challenged “acts not further the interest of the corporation, especially when the directors have a personal stake in the corporation” and where “the board acted in bad faith, e.g., deliberately singled out an individual for harmful treatment. ”  (Emphasis added by court; some internal quotation marks and citations omitted.)  Because of the inapplicability of the “business judgment rule” to “create a presumption of legality”, the burden shifted to the interested directors or shareholders to prove their good faith and the “entire fairness” of the transaction.  Because the subject transactions were not fair to a minority shareholder in terms of “price” and “process” and because the transactions could not be ratified by the Shareholder Defendants because they were not “disinterested,” the Shareholder Defendants do not pass the “entire fairness” test. The court also found that there was corporate waste because assets were transferred without consideration.  The court also found that corporate opportunities were diverted.  This occurs when directors divert opportunities “to other companies in which neither the corporation nor its minority shareholder has an interest.”  (Citation omitted.)   The court noted that “ his doctrine is violated where, as here, a director secretly forms a new entity and transfers the corporation’s entire business to that entity.” (Citation omitted.)   The court explained: imply put, where the defendants are either conflicted or have engaged in corporate waste, they have the burden of establishing entire fairness.  Here, the Shareholder Defendants (or their wholly owned LLCs) are members of Bareburger Group, which owns Be My Burger.  Hence, the subject transfers of the Company’s assets are interested transactions.  That, in addition to the discussed evidence of waste and theft of corporate opportunities, makes entire fairness the applicable the standard of review.  (Footnote omitted.) The court found that the Shareholder Defendants did not meet their burden and, to the extent that they invoked the fairness concept by urging that plaintiff refused to work for the Company, the argument was rebuffed by the court.  In rebuking the Shareholder Defendants for justifying their subjective belief that their actions were warranted because of plaintiff’s “lack of contributions” coupled with the fact that they were not lawyers, the court stated in footnote 26: Defendants note that they are not corporate lawyers.  However, the subject transactions were done with the aid of a lawyer and accountant.  Leaving aside the court’s dismay that a lawyer could agree to help structure an illegal transaction, defendants cannot hide behind ignorance of corporate law to claim a lack of bad faith.  Their contemporaneous emails demonstrate a clear intent to steal plaintiff’s interest in the business, which recognized was problematic. The court, in recognizing that many businesses have passive investors, whose interest may be worth far more than the amount invested, stated: his is a good thing, and is an aspirational outcome in the minds of many who decide to chance their money on a fledgling business.  If investors intend to condition an equity grant on the requirement of further contribution (either labor or capital), they must expressly agree to that condition.  The majority investors may not, as here, later decide that pari passu treatment of active and passive investors is not fair.  Likewise, to the extent a majority believes a business would be better off without a problem shareholder, there is legal recourse available to them, such as a buyout or a freeze-out merger.  (Emphasis in original; citations omitted.) Summary judgment was also granted on plaintiff’s claim that one of the defendants aided and abetted the Shareholder Defendants in their respective breaches of fiduciary duty.  The elements of such a claim are: “(1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) that plaintiff suffered damage as a result of the breach.”  (Citation omitted.)  As to the first prong, the court found that the Shareholder Defendants breached their fiduciary duty to plaintiff.  The second prong requires “substantial assistance”, which exists where “(1) a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed, and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated.”  (Citations and internal quotation marks omitted.)  The court found that the aider/abettor “knowingly and intentionally” participated in the fiduciary breaches by, inter alia , helping to transfer assets, crafting audited financial statements that hid the illicit formation of Group from plaintiff, and preparing Group tax returns and operating agreements that excluded plaintiff.  Plaintiff clearly suffered damage from defendant’s actions. The court also granted summary judgment on plaintiff’s trademark infringement claim and stated: There is no question of fact that…Bareburger Group used the Trademark without authorization and without providing any consideration to the Company.  This is trademark infringement…. Indeed, the very reason why they executed the Trademark Assignment Agreement was because they recognized that Bareburger Group…needed to obtain the rights to the Trademark to validly use and license it to the franchisees.  (Citations omitted.) The court did not dismiss the infringement claim as duplicative because plaintiff may be entitled to treble damages under the Lanham Act – a quantum of damages unavailable under the other causes of action subject to the plaintiff’s summary judgment motion. The court did, however, did dismiss plaintiff’s fraudulent conveyance and fraud on the PTO causes of action to the extent that the damages in those causes of action are duplicative of the damages to which plaintiff would be entitled for the fiduciary duty breach and/or the trademark infringement claims. TAKEAWAY There are appropriate ways to excise unwanted shareholders/members from a business.  The court in Stravroulakis was not pleased with the way that defendants proceeded to remove plaintiff.

Since the summer of 2015, the Delaware Chancery Court has issued a series of rulings in which disclosure-only settlements in merger objection lawsuits have been rejected. Those rulings culminated with the decision by Chancellor Andre Bouchard in January 2016, in which he confirmed that parties submitting disclosure-only settlements to Chancery Court judges should expect enhanced scrutiny of such settlements.  In In Re Trulia, Inc. Stockholder Litigation , 129 A.3d 884 (Del. Ch. 2016) ( here ), Chancellor Bouchard rejected a proposed disclosure-only settlement of a shareholder lawsuit arising from the February 2015 acquisition of Trulia, Inc. by Zillow, Inc. In doing so, Chancellor Bouchard found that because “none of the supplemental disclosures were material or even helpful to Trulia’s stockholders,” the proposed settlement did “not afford them meaningful consideration to warrant providing a claim release.” In rejecting the settlement, Chancellor Bouchard reviewed “the dynamics that have led to the proliferation of disclosure settlements.”  “ oting the concerns that scholars, practitioners and members of the judiciary have expressed” about these settlements – they “rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with rigor” –  Chancellor Bouchard warned practitioners to expect the Court to “be increasingly vigilant in scrutinizing the ‘give’ and the ‘get’ of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.” 129 A.3d at 887. In the wake of the Chancery Courts’ hostility to disclosure-only settlements, shareholders have sought redress in other jurisdictions, namely in federal court and/or the courts in other states. But, most of those courts have not been as receptive as shareholders expected. For instance, in In Re: Walgreen Co. Stockholder Litigation , 832 F.3d 718 (7th Cir. 2016), the Seventh Circuit overturned the approval of a disclosure-only settlement, while referencing with approval Chancellor Bouchard’s opinion in Trulia . Writing for the court, Judge Richard Posner expressed skepticism about merger objection litigation and of disclosure-only settlements. Other jurisdictions have applied a less hostile approach to disclosure-only settlements. In New York, for example, the Appellate Division, First Department, reaffirmed, with some refinement, its more lenient standard for reviewing disclosure-only settlements in Gordon v. Verizon , 148 A.D.3d 146 (1st Dep’t 2017) (citing Matter of Colt Indus. Shareholder Litig ., 155 A.D.2d 154, 160 (1st Dep’t 1990), mod on other grounds , 77 N.Y.2d 185 (1991)). In Gordon , the First Department held that “a court conducting a settlement review in a putative shareholders’ class action has a responsibility to preserve the viability of those nonmonetary settlements that prove to be beneficial to both shareholders and corporations, while protecting against the problems with such settlements recognized trulia court and other courts in new york> trulia court and other courts in new york> …, in order to promote fairness to all parties.” The court identified seven factors for the trial courts to consider in reaching a determination as to whether it is appropriate to approve a disclosure-only settlement. These factors are: the likelihood of success, the extent of support from the parties, the judgment of counsel, the presence of bargaining in good faith, the nature of the issues of law and fact, whether the proposed settlement is in the best interests of the class ( i.e. , whether the supplemental disclosures provide “some benefit to the shareholders”), and whether the proposed settlement is in the best interest of the corporation. 148 A.D.3d at 156, 158-59, 161. City Trading Fund v. Nye Applying the seven Gordon factors, Justice Shirley Werner Kornreich of the Supreme Court, New York County, Commercial Division, recently rejected a proposed disclosure-only settlement of a shareholder lawsuit challenging Martin Marietta’s 2014 acquisition of Texas Industries. In a scathing opinion ( here ), Justice Kornreich rejected the proposed settlement as “utterly useless to shareholders.” City Trading Fund v. Nye , 2018 N.Y. Slip Op. 28030 (Sup. Ct. N.Y. County Feb. 8, 2018). Background The case arose from the acquisition of Texas Industries, Inc. by Martin Marietta Materials, Inc. (the “Company”). The plaintiffs, shareholders of the Company, sought to enjoin the merger on the grounds that the disclosures regarding the transaction were inadequate.  The plaintiffs alleged that the Company breached its fiduciary duties to its shareholders by making material misstatements and omissions in the definitive proxy, which was provided to shareholders for the purpose of evaluating and voting on the proposed merger. The plaintiffs moved for a preliminary injunction, and on the eve of the hearing, the parties settled the action for a “peppercorn and a fee.” “In other words, they entered into a ‘disclosure-only’ settlement that provides no monetary relief to the stockholders, but which calls for a significant payment of attorneys’ fees to plaintiffs’ counsel (here, $500,000).” The “supplemental disclosures” purportedly remedied the alleged deficiencies in the proxy statement by providing shareholders with additional information sufficient to allow them to make a more informed decision about the merger. In January 2015, Justice Kornreich rejected the plaintiff’s motion for preliminary approval of the settlement, based on, among other things, her analysis of the “immateriality” of the additional disclosures. She also noted “the public policy concerns that arise from worthless disclosure-only settlements of strike suits that seek to enjoin mergers of publicly traded corporations,” and the decisions from other courts that “have addressed worthless disclosure-only settlements.” (Citing Trulia ). The plaintiffs appealed. The First Department “reversed court’s denial of preliminary approval, remanded the case, and directed court to hold a fairness hearing to determine whether final approval of the settlement should be granted.” In reversing the court’s ruling, the First Department found that “the shareholders obtained a number of additional disclosures reflected in the supplemental proxy statement, including disclosures of additional information regarding the investment banks’ conflicts of interest and the projections upon which they relied in rendering their fairness opinions, that were arguably beneficial .” (Emphasis added.) The February 8, 2018 Opinion After discussing the choice of law, Judge Kornreich turned to the change in judicial attitudes toward disclosure-only settlements since her January 2015 ruling rejecting preliminary approval of the proposed settlement.  Describing the Trulia decision as “a thorough and compelling decision,” and “the culmination of the Chancery Court’s negative experience with such strike-suits,” Justice Kornreich noted that Delaware courts would approve disclosure-only settlements only when the supplemental disclosures were “plainly material” and the releases “narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.” Citing Trulia , 129 A.3d at 888. By “plainly material,” Justice Kornreich noted that Delaware courts leave no room for disclosures that are “‘arguably beneficial’” or “provide ‘some benefit.’” “In using the term ‘plainly material,’” the Chancellor explained that he meant “that it should not be a close call that the supplemental information is material as that term is defined under Delaware law .” Id . (emphasis added). In other words, approval requires a clear showing that the supplemental disclosures were more than “arguably beneficial” or that they may provide “some benefit.” Rather, it must be clear that the new disclosures would clearly aid shareholders in deciding whether to vote on the merger by significantly altering the “total mix” of available information. Citing Trulia , 129 A.3d at 899. In contrast to the Delaware courts, and the Fifth and Seventh Circuits, which followed the lead of Chancellor Bouchard in Trulia , the First Department adopted what Justice Kornreich described as a “more lenient approval standard” in Gordon . Though less exacting than the Delaware materiality standard, Justice Kornreich explained that Gordon’s “some benefit test” required the court “to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger.” Thus, “ f the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders.” That being said, regardless of whether Gordon’s some benefit test was intended to mirror the Delaware mootness fee standard, the only reasonable way to interpret “some benefit” is that while the plaintiff need not (as under Trulia ) rule out all doubts as to the materiality of the supplemental disclosures, the court must be able to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger. If the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders. After all, the whole point of a lawsuit challenging the sufficiency of pre-merger disclosures is to ensure that shareholders have all the information they need to make an informed vote on the merger’s wisdom. For the relief in such a suit to be beneficial, the procured new disclosures must actually be useful to the shareholders — that is, the disclosures must aid them in the decision-making process. If the disclosures reveal information that has no bearing on the wisdom of the merger — such as a disclosure of the CEO’s favorite baseball team — no one would contend such revelation makes a shred of difference to … voting shareholders. There is no benefit to such disclosure. Analyzing the supplemental disclosures against the Gordon factors, Justice Kornreich found that the disclosures were “utterly worthless — because they would not matter to any reasonable shareholder and provide no benefit to the class….” The Court noted that it was “not a close call” reaching that conclusion. After finding the settlement to be of no benefit, Justice Kornreich concluded with a policy discussion about “utterly worthless” disclosure-only settlements, such as the one before her. In that regard, she explained that such settlements were detrimental to shareholders and benefited only the lawyers who propose them. The supplemental disclosures, at best, are of the “tell me more” sort that countless courts have recognized are of little to no value, and which certainly do not substantially alter the total mix of available information. In other words, after having received the supplemental disclosures, the universe of information upon which shareholders decided whether to vote in favor of the merger did not meaningfully change …To be sure, under controlling ( i.e. , Gordon) and persuasive ( i.e. , Delaware) authority, a stockholder’s counsel deserves at least some reward if he can procure information that, while not landscape changing ( i.e. , material), is of some benefit to the stockholders. Plaintiffs’ counsel has not done so in this case. The shareholders are not better off. In fact, the shareholders are net losers here, for at least two reasons. The first, obvious reason, is the payment of counsel fees in exchange for worthless supplemental disclosures. The second, less obvious reason is that there is a cost to the shareholders if, in fact, management concealed material facts about the merger. Even though the settlement only calls for a release of disclosure violations ( i.e. , it is not a galactic release), there is no reason the shareholders should lose the right to eventually file a post-closing action alleging inadequate disclosures if, in fact, some subsequent revelation makes clear that, unlike those at issue in this case, there were material facts withheld from them. To be clear, the court has no reason to believe that is the case here. However, shareholders do not benefit from giving up the right to pursue future meritorious claims in exchange for relief from patently baseless ones. In other words, settling a baseless claim should not create immunity for a related, but currently unknown meritorious claim. Takeaway In Trulia , Chancellor Bouchard expressed “hope” that courts outside of Delaware will apply a materiality standard to the consideration of disclosure-only settlements. While the First Department in Gordon chose not to follow suit, it remains to be seen whether the other appellate courts in New York, including the Court of Appeals, will adopt the Gordon standard. Whatever happens going forward on the appellate level in New York, City Trading makes it clear that disclosure-only settlements providing no value for shareholders will face heightened judicial scrutiny, even under the “more lenient settlement approval standard” set forth in Gordon . In light of such scrutiny, “utterly worthless” disclosure-only settlements will not be tolerated. Therefore, practitioners presenting a disclosure-only settlement for approval in New York should ask: “Are the company and its shareholders better off if the court permits plaintiffs’ disclosure claims to be settled in consideration for the supplemental disclosures and a substantial attorneys’ fees award?” If “ he answer is no,” they should expect enhanced scrutiny from the reviewing judge.

On February 21, 2018, the United States Supreme Court ruled that the anti-retaliation protections passed by Congress after the 2008 financial crisis extend only to individuals who report suspected violations of the securities laws to the Securities and Exchange Commission (“SEC” or “Commission”). In Digital Realty Trust, Inc. v. Somers , 583 U.S. _____ (2018) ( here ), the Court held that individuals who blow the whistle through internal means only are precluded from the anti-retaliation protections enjoyed under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank” or the “Act”). This Blog has written about Digital Realty here , here , here and here . The Court, in an opinion authored by Justice Ruth Bader Ginsburg, resolved a circuit court split over whether individuals are required to report alleged violations of the securities laws to the SEC to qualify as a whistleblower under Dodd-Frank. The Ninth and Second Circuits held that Dodd-Frank did not limit the anti-retaliation protections of the Act to those who disclose information to the SEC only.  Digital Realty Trust, Inc. v. Somers , 850 F.3d 1045 (9th Cir. 2017); Berman v. NEO@OGILVY LLC , 801 F.3d 145 (2d Cir. 2015). Rather, the anti-retaliation provisions also protect those who were fired after making internal disclosures of alleged unlawful activity under the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley” or “SOX”) and other laws, rules, and regulations. By contrast, the Fifth Circuit, which was the first to address the issue, held that the Act’s definition of “whistleblower” applied only to those who disclose suspected wrongdoing to the SEC. Asadi v. G.E. Energy (USA), L.L.C. , 720 F.3d 620, 621 (5th Cir. 2013). The court rejected the SEC’s regulation (17 C.F.R. § 240.21F-2), which extends the anti-retaliation protections to those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC. Id . at 630. In reversing the Ninth Circuit decision, the Court held that a “plain-text reading” of Dodd-Frank controlled because the statute unequivocally limited the definition of “whistleblower” to only those individuals who provide “information relating to a violation of the securities law to the commission.” 15 U.S.C. §78u-6(a)(6). The Court held as such notwithstanding the anti-retaliation provision of Sarbanes-Oxley, which applies to all “employees” who report misconduct to the SEC, any other federal agency, or their internal supervisors. In giving Section 21F(a)(6) its plain meaning, Justice Ginsburg refused to give deference, under Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc. , 467 U. S. 837 (1984), to the SEC’s interpretation of Dodd-Frank – that is, the Court refused to ascribe different meanings to “whistleblower” in the reward and anti-retaliation provisions of the Act. Because “Congress has directly spoken” to the matter, she wrote, the SEC is precluded from a more expansive interpretation. Background Paul Somers (“Somers”), a former Vice President of Digital Realty Trust (“Digital Realty”), a real estate investment trust specializing in properties for data centers, alleged that he was fired after reporting possible securities law violations to senior management. Somers was an executive in the company’s Singapore office when he reported that his boss had hidden millions of dollars in cost overruns, granted no-bid contracts and made payments to friends, among other things. Although nothing impeded Somers from reporting the suspected wrongdoing to the SEC prior to his termination, he failed do so. Additionally, Somers failed to file an administrative complaint within 180 days of his termination, rendering him ineligible for relief under Sarbanes-Oxley. Thereafter, Somers sued Digital Realty, alleging violations of state and federal securities laws, including violations of the anti-retaliation provisions of the Act ( e.g. , Section 21F(h)(1)(A) of the Act).  Digital Realty moved to dismiss on the ground that Somers was not a “whistleblower” under Dodd-Frank because he only reported the wrongdoing internally and not to the SEC. In May 2015, the district court denied the company’s motion to dismiss. In denying the motion, the district court deferred to the SEC’s interpretation of “whistleblower” to include internal whistleblowers. The court analyzed the statutory text, the Act’s legislative history, and the procedural and practical implications of harmonizing the narrow definition of “whistleblower” with the broad protections of the anti-retaliation provision.  Somers v. Digital Realty Trust, Inc. , 119 F. Supp. 3d 1088, 1100–05 (N.D. Cal. 2015). The court observed that “ t bottom, it is difficult to find a clear and simple way to read the statutory provisions of Section 21F in perfect harmony with one another.” Id . at 1104.  Having analyzed the tension between the definition and anti-retaliation provisions, the district court deferred to the SEC’s interpretation that individuals who report internally only are nonetheless protected from retaliation under Dodd-Frank. Id . at 1106. The district court certified the question for interlocutory appeal pursuant to 28 U.S.C. § 1292(b), and the Ninth Circuit granted Digital Realty’s petition for permission to appeal. The court concluded, like the Second Circuit, that Congress intended Section 21F(h)(1)(A) (iii) to broaden the anti-retaliation protections to include internal reporters.  Digital Realty Trust, Inc. v. Somers , 850 F.3d 1045 (9th Cir. 2017).  The majority found that “ y broadly incorporating, through subdivision (iii), Sarbanes-Oxley’s disclosure requirements and protections, necessarily bars retaliation against an employee of a public company who reports violations to the boss, i.e. , one who ‘provide information’ regarding a securities law violation to ‘a person with supervisory authority over the employee.’” The court noted that “ strict application of ’s definition of whistleblower would, in effect, all but read subdivision (iii) out of the statute.”  The court also noted that there are provisions in SOX and the Securities Exchange Act of 1934 that mandate internal reporting before external reporting in certain instances.  Therefore, “ eaving employees without protection for that required preliminary step would result in early retaliation before the information could reach the regulators.” The Ninth Circuit found that Dodd-Frank’s anti-retaliation provision “unambiguously and expressly protects” whistleblowers of both types: those who report matters to the SEC and those who only make internal reports to their employer. 850 F.3d at 1050. In a brief dissent, Judge John Owens sided with the Fifth Circuit.  Judge Owens maintained that the statutory definition of whistleblower was clear, left no room for interpretation, and plainly governed. Id . at 1051. Sommers appealed to the Supreme Court. The Supreme Court’s Decision In reversing the Ninth Circuit decision, the Court held that the plain text of the statute, in conjunction with the Act’s anti-retaliation provision, as well as the intent of Congress in enacting the statute, negated the Ninth Circuit’s expansive reasoning. The Court found that the definition of “whistleblower” under Section 21F(a)(6) plainly “describes who is eligible for protection” from retaliation, i.e. , someone who “‘provides … information relating to a violation of the securities laws to the Commission.’” (Citation omitted; orig’l emphasis.) This definition, Justice Ginsburg found, applies “throughout” the statute. The definition section of the statute supplies an unequivocal answer: A “whistleblower” is “any individual who provides . . . information relating to a violation of the securities laws to the Commission .” §78u–6(a)(6) (emphasis added). Leaving no doubt as to the definition’s reach, the statute instructs that the “definitio shall apply” “ n this section,” that is, throughout §78u–6. §78u–6(a)(6). Having determined “who” is a whistleblower, the Court turned to the conduct protected under the Act – that is, “what” conduct is protected by Dodd-Frank. The Court explained that such conduct can be found in the three clauses of Section 21F(h)(1)(A). The three clauses of §78u–6(h)(1)(A) then describe what conduct, when engaged in by a whistleblower, is shielded from employment discrimination. See §78u–6(h)(1)(A)(i)–(iii). Reading the “who” and the “what” provisions together, Justice Ginsburg explained how an individual can obtain the anti-retaliation protections of the Act. An individual who meets both measures may invoke Dodd-Frank’s protections. But an individual who falls outside the protected category of “whistleblowers” is ineligible to seek redress under the statute, regardless of the conduct in which that individual engages. Justice Ginsburg noted that “Dodd-Frank’s purpose and design corroborate our comprehension of §78u–6(h)’s reporting requirement,” noting that Congress enacted Dodd-Frank “to motivate people who know of securities law violations to tell the SEC,” and, in connection with this purpose, Congress granted such individuals “immediate access to federal court, a generous statute of limitations … and the opportunity to recover double backpay.” The Court, however, found that the reason for such incentives was to effectuate Dodd-Frank’s narrow objective of motivating individuals to “tell the SEC,” and not (as with SOX) to “disturb the ‘corporate code of silence’” and embolden employees to report fraudulent behavior “not only to the proper authorities … but even internally.” The “core objective” of Dodd-Frank’s robust whistleblower program, as Somers acknowledges is “to motivate people who know of securities law violations to tell the SEC .” By enlisting whistleblowers to “assist the Government identify and prosecut persons who have violated securities laws,” Congress undertook to improve SEC enforcement and facilitate the Commission’s “recover money for victims of financial fraud.”  To that end, §78u–6 provides substantial monetary rewards to whistleblowers who furnish actionable information to the SEC. See §78u–6(b). Financial inducements alone, Congress recognized, may be insufficient to encourage certain employees, fearful of employer retaliation, to come forward with evidence of wrongdoing. Congress therefore complemented the Dodd-Frank monetary incentives for SEC reporting by heightening protection against retaliation. While Sarbanes-Oxley contains an administrative-exhaustion requirement, a 180-day administrative complaint-filing deadline, and a remedial scheme limited to actual damages, Dodd-Frank provides for immediate access to federal court, a generous statute of limitations (at least six years), and the opportunity to recover double backpay. Dodd-Frank’s award program and anti-retaliation provision thus work synchronously to motivate individuals with knowledge of illegal activity to “tell the SEC.” When enacting Sarbanes-Oxley’s whistleblower regime, in comparison, Congress had a more far-reaching objective: It sought to disturb the “corporate code of silence” that “discourage employees from reporting fraudulent behavior not only to the proper authorities, such as the FBI and the SEC, but even internally.” (Citations omitted; orig’l emphasis; internal quotation marks omitted.) The Court concluded that, given the unambiguous definition of whistleblower, because “Somers did not provide information ‘to the Commission’ before his termination,” “he did not qualify as a ‘whistleblower’ at the time of the alleged retaliation.”  Therefore, he was “ineligible to seek relief under §78u–6(h).” In a concurrence, Justice Clarence Thomas, joined by Justices Samuel Alito and Neil Gorsuch, agreed with the Court’s conclusion, but declined to adopt Justice Ginsburg’s argument that the purpose and design of Dodd-Frank and its legislative history supported the Court’s decision. Justice Thomas maintained that even if “a majority of Congress read the Senate Report, agreed with it, and voted for Dodd-Frank with the same intent, ‘we are a government of laws, not of men, and are governed by what Congress enacted rather than by what it intended’” (quoting Justice Antonin Scalia’s concurring opinion in Lawson v. FMR LLC ). Justice Sonia Sotomayor, joined by Justice Stephen Breyer, filed a separate concurrence that supported Justice Ginsburg’s use of legislative history, noting that “ ust as courts are capable of assessing the reliability and utility of evidence generally, they are capable of assessing the reliability and utility of legislative-history materials.” Takeaway As Justice Ginsburg observed, Congress “complemented the Dodd-Frank monetary incentives for SEC reporting by heightening protection against retaliation.” In this regard, the Act “provides for immediate access to federal court, a generous statute of limitations (at least six years), and the opportunity to recover double backpay.” (Citation omitted.) Thus, “Dodd-Frank’s award program and anti-retaliation provision … work synchronously to motivate individuals with knowledge of illegal activity to “‘tell the SEC.’” (Citation omitted.) In light of this synchronicity, giving the term “whistleblower” a consistent meaning makes sense. It not only comports with the plain text of the Act, but also the legislative history and “purpose and design” of the statute. After Digital Realty , whistleblowers will no longer have a reason to blow the whistle internally, even where the company has a strong and robust compliance program. Instead, to avail themselves of the Act’s anti-retaliation protections, employees will likely report their concerns of suspected wrongdoing directly to the SEC – before any adverse action occurs, but also before employers have had the chance to hear, investigate, and address their concerns – notwithstanding the fact that they may receive a higher bounty for participating in internal compliance programs in the first instance. See Rule 21F-6, 17 C.F.R. § 240.21F-6 (listing as a factor that may increase an award whether the individual reported internally before, or at the same time, as any report to the SEC). Whether the incentive to report wrongdoing to the SEC in the first instance trumps the financial incentive to report internally remains to be seen. No doubt, the number of filings with the SEC after Digital Realty will be watched closely by practitioners and the Commission. Finally, although Digital Realty eliminates the ability of individuals who report suspected violations of the securities laws only internally to bring retaliation actions under Dodd-Frank, internal whistleblowers still have protections under Sarbanes-Oxley.

In Dormitory Authority of the State of New York v. Samson Construction Co. (Feb. 15, 2018) , the New York Court of Appeals was called on to address, inter alia, the question of whether the City of New York “is an intended third-party beneficiary of the architectural services contract between…Dormitory Authority of the State of New York (DASNY) and…Perkins Eastman Architects, P.C. (Perkins)….” The facts of Dormitory are relatively simple and typical of many construction projects. The City was interested in building a forensic biology laboratory for the Office of the Chief Medical Examiner (OCME) next to Bellevue Hospital (the “Project”). The City entered into a Project Management Agreement with DASNY, pursuant to which DASNY was to finance and manage the design and construction of the Project. DASNY entered into a contract with Perkins to provide design, architectural and engineering services. The Perkins contract provided that “Perkins would ‘indemnify and hold harmless’ DASNY and the ‘Client’ (that is, OCME…) from any claims arising out of Perkins’ negligent acts or omissions and that extra costs or expenses incurred by DASNY and the Client as a result of Perkins’ ‘design errors or omissions shall be recoverable from and/or its Professional Liability Insurance carrier.’” Samson Construction Co. was also retained by DASNY to perform excavation and foundation work for the Project. The Court of Appeals emphasized that “the contract executed between DASNY and Samson provides that the Client - i.e., the City - ‘is an intended third party beneficiary of the Contract for the purposes of recovering any damages caused by Samson.’” (Brackets omitted.) Conversely, the Court noted that “ though there are passing references to the Client in the Perkins Contract, no analogous language providing that the City is an intended third-party beneficiary appears there.” During the prosecution of the foundation work, the failure to properly install an excavation support system led to significant problems, including severe damage to neighboring Bellevue buildings. As a result, the Project was delayed by more than 18 months and $37 million in additional costs were incurred. In the ensuing litigation, the City asserted, inter alia, a breach of contract claim against Perkins. In granting Perkins’ motion for summary judgment on that claim, Supreme Court held that the City was not an intended third-party beneficiary of the Perkins contract with DASNY. The Appellate Division, holding that there were factual issues as to the City’s status as a third-party beneficiary, modified Supreme Court’s order by denying that portion of Perkins’ motion for summary judgment. The Court of Appeals reversed the Appellate Division and held that the City failed to raise any factual issues concerning its status as a third-party beneficiary and, therefore, Perkins was entitled to summary judgment. In so holding, the Court generally described the relevant law as follows: A third party may sue as a beneficiary on a contract made for its benefit. However, an intent to benefit the third party must be shown, and, absent such intent, the third party is merely an incidental beneficiary with no right to enforce the particular contracts. We have previously sanctioned a third party’s right to enforce a contract in two situations: when the third party is the only one who could recover for the breach of contract or when it is otherwise clear from the language of the contract that there was an intent to permit enforcement by the third party. (Citations, internal quotation marks and brackets omitted.) When construction contracts are at issue, the Court noted that in order to be a considered a third-party beneficiary, “express contractual language stating that the contracting parties intended to benefit a third party by permitting that third party to enforce a promisee’s contract with another.” (Citations, internal quotation marks and brackets omitted.) Absent express language, “such third parties are generally considered mere incidental beneficiaries.” (Citations, internal quotation marks and brackets omitted.) The Court explained that “ his rule reflects the particular nature of construction contracts and the fact that - as is the case here - there are often several contracts between various entities, with performance ultimately benefitting all of the entities involved.” In applying the previously quoted “two-situation” analysis to the facts of Dormitory, the Court found that the City was not a third-party because “the City is not the only entity that can recover under the Perkins Contract” and “the Perkins Contract does not expressly name the City as an intended third-party beneficiary nor authorize the City to enforce any obligations thereunder….”

Through the years, numerous class action lawsuits have been brought involving securities fraud, corporate misconduct, unfair business practices and other claims. This article provides a brief overview of class action lawsuits . What is a class action lawsuit? A class action is a procedural device in which one or more persons sue on behalf of a larger group of persons, referred to as the “class.” The class action lawsuit started in the courts of equity in seventeenth-century England as a Bill of Peace. A Bill of Peace allowed the Court of Chancery to hear the dispute of a group of persons – known as the “multitude” – in one lawsuit. The Bill of Peace provided the means by which a court could resolve legal disputes affecting numerous people with similar claims in one lawsuit rather than in separate actions. To bring a Bill of Peace, the number of persons affected had to be so numerous that joining their claims in one lawsuit would be impractical; the members of the group had to possess a common interest in the issues to be adjudicated; and the persons named in the lawsuit had to adequately represent the interests of persons who were absent from the action but whose rights would be affected by the outcome. If a court allowed a Bill of Peace to proceed, the judgment that resulted would bind all members of the group. In the early nineteenth century, the Bill of Peace came to the United States. Justice Joseph Story, then serving on the United States Court of Appeals for the First Circuit, advocated the use of the Bill of Peace in courts of equity. In that regard, Justice Story wrote that “all persons materially interested, either as plaintiffs or defendants in the subject matter of a bill ought to be made parties to the suit, however numerous they may be,” so that the court could “make a complete decree between the parties prevent future litigation by taking away the necessity of a multiplicity of suits.” West v. Randall , 29 F. Cas. 718, 2 181 <1820> . Initially, a class action could be brought only in actions in which the plaintiffs sought equitable, as opposed to monetary, relief.  In 1938, with the adoption of Rule 23 of the Federal Rules of Civil Procedure, plaintiffs were permitted to seek monetary damages using the class action device. In 1966, Rule 23 was amended to provide that absent class members would be bound by a final judgment so long as their interests were adequately represented by the class representative. There are three categories of actions that fall within the scope of Rule 23. The first category involves the commencement of separate actions that may adversely affect members of the class or the defendant in one of two ways: it may impose inconsistent rulings on the defendant, or it may “impair or impede” class members from protecting their interests. The second category involves non-monetary relief, where the party against whom the class seeks relief “has acted or refused to act on grounds generally applicable to the class” so that injunctive or declaratory relief as to class would be appropriate. The third category involves cases seeking monetary relief in which there are questions of law or fact common to the class that predominate over questions specific to each class member, and the class action device is a more efficient means to resolve the controversy – that is, it is “superior to other available methods” for resolving the dispute. Regardless of the category of class action, a plaintiff, known as the class representative, who seeks class certification, must demonstrate that: (1) the number of class members is too numerous making it impracticable to join them in the action; (2) there are common questions of law and fact shared by members of the class; (3) the claims or defenses of the proposed class representative are typical of the class; and (4) the proposed class representative will adequately protect the interests of the class. Defendants can object to class certification. For instance, defendants can argue that the proposed class representative does not satisfy the adequacy and typicality requirements of Rule 23(a)(3) and (4). Defendants can also argue that the proposed class representatives have injuries that are different or more severe than those suffered by the class. If a class is certified, then members of the class must receive notice of the action. The notice includes information about the lawsuit and informs class members that their rights may be affected by the outcome of the litigation. The notice also provides information about how class members may opt out of, or exclude themselves from, the class if they do not want to be bound by the outcome of the litigation. If class members remain in the class, they give up their right to sue the defendants individually on the same claim after the class action concludes. If the named plaintiff and defendants reach a resolution, all members of the class must receive notice of the settlement. The court must approve the settlement to ensure that it is fair, reasonable and in the best interests of the class. Many, but not all, states permit class action lawsuits. The states that permit class actions have rules that mirror the Federal Rules of Civil Procedure. One notable exception is California, which has materially different rules for class actions in its state courts. Virginia does not allow class actions – there are no procedural rules or statutes permitting the commencement of a class action lawsuit in Virginia state courts. Here.=">Here."> The Benefits and Criticisms of Class Actions The Benefits Class action lawsuits advance important public policy goals. Such lawsuits often provide an oversight function for misconduct the government may be unable or unwilling to police, whether because of deregulation or resource conservation. A class action is often the only way average Americans with limited means can remedy wrongs committed by powerful, multi-million-dollar corporations and institutions. As noted by Justice William O. Douglas, “The class action is one of the few legal remedies the small claimant has against those who command the status quo.” Class action lawsuits have a deterrent effect on bad actors.  It forces those within the defendants’ industry or sector to change their behavior, product or procedures. In short, because a class action lawsuit combines and disposes of numerous claims that may not be practical to litigate individually, the process is more efficient. Additionally, aggregating small claims into a collective action can reduce the cost of litigation. A class action lawsuit can also ensure that all the plaintiffs obtain some compensation, even though the award may not cover all of the damages. The Criticisms Many critics consider the plaintiffs’ lawyers, not the class, to be the only “winners” in a class action lawsuit – if successful, the plaintiffs’ lawyers receive a percentage of any recovery achieved for the class. Proponents of the class action device, in particular, those from the plaintiffs’ bar, contend that this perception ignores the risk that class action attorneys take in starting such lawsuits. Indeed, not every class action results in a successful outcome. Without a financial incentive, attorneys will not handle class action lawsuits, thereby depriving average Americans the ability to recover damages for their injuries and losses. Proponents of the device also note that contingent fee attorneys receive large percentages of the awarded damages through their fee agreements. Class action lawyers should not be treated differently. Critics maintain that there is no salutary purpose to class actions, especially in small claims actions, in which individual class members have very small stakes. These critics argue that such actions are lawyer-driven – because the class representatives have so little at stake, they do not exercise any control over the litigation. With the class action lawyer in complete control, the economics of the lawsuit change. The lawyer has the largest financial interest in the outcome of the litigation, leading to settlements that produce high attorneys’ fees and minimal payouts to class members. Some critics argue that class action attorneys are more interested in securing a lucrative fee than advancing social justice. These critics claim that if social justice was the driving force behind the lawsuit, then class action lawyers would let the government perform its regulatory and oversight functions. Instead, by filing a class action lawsuit, private lawyers are substituting their judgment for that of a government agency charged with overseeing the conduct at issue. This usurpation of the government function is significant when the agency concludes that the conduct at issue and the injuries sustained by the plaintiff are immaterial and do not warrant prosecution of the defendant. Finally, as to the deterrence factor, critics maintain that state and federal law enforcement organizations have the ability to investigate and punish cases involving fraud and other wrongdoing regardless of its size and scope and offer an alternative means of addressing wrongful conduct. Private enforcement through a class action, they say, reduces the accountability of the law enforcement effort and delegates to the plaintiffs’ attorney control over enforcement priorities.  Since payouts to class members are often insignificant, class actions wind up being the cost of doing business rather than a deterrent to future conduct.

The New York Court of Appeals rules that a litigant must produce information from her Facebook account notwithstanding her chosen “privacy” settings.  The plaintiff in Forman v. Henkin (February 13, 2018) was injured after falling from a horse owned by defendant and alleges she suffered “spinal and traumatic brain injuries resulting in cognitive deficits, memory loss, difficulties with written and oral communication, and social isolation.”  During the litigation, plaintiff revealed she was a frequent Facebook user, but deactivated her account within six months of her accident.  Plaintiff claims that, after her accident, she had “difficulty using a computer and composing coherent messages” and that her e-mails were riddled with grammatical and spelling errors and took too long to compose. During discovery, defendant “sought an unlimited authorization to obtain plaintiff’s entire ‘private’ Facebook account, contending the photographs and written postings would be material and necessary to his defense of the action under CPLR 3101(a).”  Defendant moved to compel disclosure when plaintiff refused to provide the requested authorization. Plaintiff opposed the motion arguing that defendant failed to establish a basis to access the “private” portion of the Facebook account.  Defendant argued that the information sought would lead to relevant evidence – such as the amount of time it took plaintiff to write posts. Supreme Court granted the motion and directed plaintiff to “produce all photographs of herself privately posted on Facebook prior to the accident that she intends to introduce at trial, all photographs of herself privately posted on Facebook after the accident that do not depict nudity or romantic encounters, and an authorization for Facebook records showing each time plaintiff posted a private message after the accident and the number of characters or words in the message.”  The content of any of plaintiff’s written Facebook posts, whether authored before or after the accident, were not directed to be produced. The Court of Appeals pointed out several times that although defendant was denied some of the discovery it sought, only plaintiff appealed to the Appellate Division.  The Appellate Division modified Supreme Court’s decision by “limiting disclosure to photographs posted on Facebook that plaintiff intended to introduce at trial (whether pre- or post-accident) and eliminating the authorization permitting defendant to obtain data relating to post-accident messages, and otherwise affirmed.” The Court of Appeals reversed the Appellate Division and reinstated Supreme Court’s Order.  In its opinion, the Court generally reiterated the liberal discovery rules that permit the disclosure of “material and necessary” information that “bear on the controversy which will assist preparation for trial by sharpening the issues and reducing delay and prolixity.”  (Citations omitted.)  The Court also recognized that there are limitations to discovery and that when faced with “onerous” demands “competing interests must always be balanced; the need for discovery must always be weighed against any special burden to be borne by the opposing party.” (Citations omitted.) The Court recognized that when faced with discovery disputes, discovery requests must be evaluated on a “case-by-case basis.” The Court of Appeals found that there is no reason to apply any different standard to the disclosure of social media materials and, thus, stated that “ hile Facebook-and sites like it-offer relatively new means of sharing information with others, there is nothing so novel about Facebook materials that precludes application of New York’s long-standing disclosure rules to resolve this dispute.” Thus, the Court rejected the ruling of the First Department in Tapp v. New York State Urban Dev. Corp., 102 A.D.3d 620 (2013) , that “ o warrant discovery, defendants must establish a factual predicate for their request by identifying relevant information in plaintiff’s Facebook account –that is, information that ‘contradicts or conflicts with plaintiff’s alleged restrictions, disabilities, and losses, and other claims.’” (Quoting Tapp , emphasis in original.) The Court also rejected Tapp’s progeny, relied upon by the plaintiff in Forman , which “conditioned discovery of material on the ‘private’ portion of a Facebook account on whether the party seeking disclosure demonstrated there was material in the ‘public’ portion that tended to contradict the injured party’s allegations in some respect.”  (Citations omitted.) The Court agreed with defendant’s argument that the “Appellate Division erred in employing a heightened threshold for production of social media records that depends on what the account holder has chosen to share on the public portion of the account.”  The rule employed by the Appellate Division would permit the account holder “to unilaterally obstruct disclosure merely by manipulating ‘privacy’ settings or curating the materials on the public portion of the account.” In applying the general concepts of disclosure to social media discovery, the Court stated: New York discovery rules do not condition a party’s receipt of disclosure on a showing that the items the party seeks actually exist; rather, the request need only be appropriately tailored and reasonably calculated to yield relevant information.  Indeed, as the name suggests, the purpose of discovery is to determine if material relevant to a claim or defense exists.  In many if not most instances, a party seeking disclosure will not be able to demonstrate that items it has not yet obtained contain material evidence.  Thus, we reject the notion that the account holder’s so-called “privacy” settings govern the scope of disclosure of social media materials. The Court, however, tempered its decision by rejecting the notion that “commencement of a personal injury action renders a party’s entire Facebook account automatically discoverable”, holding that “ ather than applying a one-size-fits-all rule…, courts addressing disputes over the scope of social media discovery should employ our well-established rules – there is no need for a specialized or heightened factual predicate to avoid improper “fishing expeditions.” When judicial intervention is necessary in cases involving social media discovery disputes, the Court instructed lower courts to: 1. consider the nature of the event giving rise to the litigation, the injury claimed and any other case specific information to assess whether relevant information is likely to be found on Facebook; and, 2. “balanc the potential utility of the information sought against any specific ‘privacy’ or other concerns raised by the account holder… tailor to the particular controversy that identifies the types of materials that must be disclosed while avoiding disclosure of nonrelevant materials.”  In issuing such a ruling, the Court recognized that “private” materials, such as medical records, are discoverable in litigation if relevant. Among other things, the Court found that Supreme Court’s order was consistent with the principals espoused in Forman because, for example: 1. the request for photographs was “reasonably calculated to yield evidence” related to plaintiff’s claim that she was unable to engage in previously enjoyed activities; and, the request for the data revealing the timing and number of characters in posted messages would be relevant to plaintiff’s claim cognitive injuries caused difficulty writing and using a computer.   Because defendant did not appeal Supreme Court’s order, the Court of Appeals could not decide whether said order barring access to the content of the messages on plaintiff’s Facebook account (as opposed data revealing the timing and number of characters in posted messages) was appropriate. _____________________________________ <1>   Because defendant did not appeal Supreme Court’s order, the Court of Appeals could not decide whether said order barring access to the content of the messages on plaintiff’s Facebook account (as opposed data revealing the timing and number of characters in posted messages) was appropriate.

Last November, this Blog wrote about an announcement Michael D. Granston (“Granston”), Director of the DOJ Commercial Litigation Branch, Fraud Section, made at a health care conference concerning the DOJ’s intention to seek dismissal of meritless qui tam cases. ( Here .) Since the speech was not accompanied by a policy memorandum, there was skepticism within the False Claims Act (“FCA”) bar that there would be any material change in policy. That skepticism was met last month with a memo, titled “Factors for Evaluating Dismissal Pursuant to 31 USC 3170(c)(2)(A),” that Granston sent to all attorneys in the Fraud Section and all Assistant U.S. Attorneys handling FCA cases that encourage the DOJ to “seek[ ] dismissal” of non-intervened qui tam cases that “lack substantial merit” and discusses the factors that should guide the exercise of dismissal discretion (the “Granston Memo”).  A copy of the Granston Memo can be found here . Under the FCA, whistleblowers, also known as relators, can sue persons or entities believed to have engaged in a fraud against the government. A relator can recover a reward equaling up to 35% of the damages and penalties (up to $21,916 per fraudulent filing) recovered by the government. Such an economic benefit serves as a powerful incentive for whistleblowers to come forward and report fraud on the government.  Critics (and the FCA defense bar) claim, however, that this economic incentive too often results in the filing of costly, meritless qui tam actions. When a qui tam action is commenced, the complaint is filed under seal, to provide the Department of Justice (“DOJ” or “Department”) with time to investigate the allegations and decide whether to intervene and join the lawsuit. The FCA also provides that if the government determines its interests are not served by the lawsuit, it may seek dismissal, over the relator’s objections, provided the relator has an opportunity to be heard. 31 U.S.C. § 3730(c)(2)(A). “Historically,” the DOJ has used Section 3730(c)(2)(A) “sparingly,” in large part because the FCA permits relators to pursue their claims even when the government declines to intervene in the action. And, because declination can be based on factors other than the merit of the claim, the government has been “circumspect” in its use of Section 3730(c)(2)(A). Nevertheless, in order to fulfill its “gatekeeper role in protecting the False Claims Act,” and “to advance the government’s interests, preserve limited resources, and avoid adverse precedent,” the Granston Memo encourages Department attorneys to exercise their “authority to dismiss cases” under certain circumstances. The memo identifies a number of factors, gleaned from cases in which the government has sought dismissal, that Department attorneys should consider in determining “whether the government’s interests are served” by the qui tam action. These factors, which are intended to “ensure consistency across the Department,” and “serve as a basis for evaluating whether to seek to dismiss future matters,” include: (1) “curbing meritless cases,” “where a qui tam complaint is facially lacking in merit-either because relator’s legal theory is inherently defective, or the relator’s factual allegations are frivolous”; (2) “preventing parasitic or opportunistic qui tam actions,” where the relator only provides the government with “duplicative information” or “adds no useful information to the investigation”; (3) “preventing interference with agency policies and programs,” “where an agency has determined that a qui tam action threatens to interfere with an agency’s policies or the administration of its programs and has recommended dismissal to avoid these effects”; (4) “controlling litigation” and “avoid the risk of unfavorable precedent,” “to protect the Department’s litigation prerogatives,” such as to “avoid interference with the government’s ability to litigate the intervened claims”; (5) “safeguarding classified information and national security interests,” “particularly” in cases “involving intelligence agencies or military procurement contracts”; (6) “preserving government resources” in cases “when the government’s expected costs are likely to exceed any expected gains”; and (7) addressing “procedural errors” by relators, when they “frustrate the government’s efforts to conduct a proper investigation.” The Granston Memo notes that “the factors identified above are not mutually-exclusive,” and are not “intended to constitute an exhaustive list.”  Indeed, “there may be other reasons for concluding that the government’s interests are best served by the dismissal of a qui tam action.” Having said that, the Granston Memo contains an important qualifier, noting that “to maximize its resources” the DOJ typically only investigates a whistleblower action to the point needed to decide whether to decline intervention. Since that level of investigation “may not equate to a conclusion that no fraud occurred,” the relator should be afforded “an opportunity to further develop the case” before dismissal is considered. Of the foregoing factors, perhaps the most interesting for defendants is the third – “preventing interference with agency policies and programs.” In discussing this factor, the Granston Memo recognizes that weak qui tam actions can be costly to entities that do business with the government: “ here may be instances where an action is both lacking in merit and raises the risk of significant economic harm that could cause a critical supplier to exit the government program or industry.” In support, the memo cites to a recent decision coming out of the Fifth Circuit, United States ex rel. Harman v. Trinity Industries , 872 F.3d 645 (5th 2017), in which the court reversed a $680 million judgment because the government agency had decided that the relator’s purported violations were not material to the government’s decision to pay. The memo’s citation to Harman suggests that the DOJ would be more inclined to dismiss cases where liability hinges on a minor contractual or regulatory violation that would not pass muster under   Universal Health Services, Inc. v. United States ex rel. Escobar , 136 S. Ct. 1989 (2016), but which could cost significant resources to defend in a qui tam action. Under Escobar , an alleged false certification must be material to a federal agency’s decision to pay the claim for the claim to become an FCA violation. escobar.> escobar.> This Blog has written about Escobar and its progeny here , here , here , here , here , here and here . In a nod toward allowing relators the opportunity to decide whether to proceed with a qui tam action, the Granston Memo recommends that “to the extent possible,” Department attorneys should “consider advising relators of perceived deficiencies in their cases as well as the prospect of dismissal so that relators may make an informed decision regarding whether to proceed with the action.” Such information can save time and resources, especially when the agency affected by the qui tam action opines on “whether dismissal is warranted.” As noted in the memo, “ n many cases, relators … choose to voluntarily dismiss their actions, particularly if the government has advised the relator that it is considering seeking dismissal under section 3730(c)(2)(A).” Takeaway “Of the more than $3.7 billion in FCA settlements and judgements reported by the Department in 2017, $3.4 billion came from cases initiated by whistleblowers, who received nearly $393 million in whistleblower rewards.” ( Here .)  In light of these statistics, this Blog remains skeptical that the Granston Memo will result in a material departure from past Department practice. Indeed, this Blog expects government attorneys to remain resistant to aggressively dismissing qui tam actions. Notwithstanding, the Granston Memo provides useful guidance for relators and defendants to consider in cases in which the strength of the action is in question – guidance that can save the parties, and the government, significant costs in prosecuting or defending the action. For defendants, it is reasonable to expect they will use the Granston Memo to persuade the DOJ that the qui tam complaint in which they are the subject lacks merit and should be dismissed following the initial meeting with the DOJ while the case remains under seal. For relators, it means that, while the case is under seal, they should be given the opportunity to use the factors to further develop their claims before the government acts – either by declination or a motion to dismiss. In any event, whether the Granston Memo portends a sea change in Department policy or is simply a reminder for government attorneys to exercise their statutory authority to dismiss a qui tam action remains to be seen.  One thing is certain, however, even a small shift in the DOJ’s willingness to exercise its dismissal authority would be welcome by FCA defendants.

Directors and officers of publicly traded companies have a fiduciary duty to their shareholders. In the face of corporate misconduct, executives are often reluctant to take legal action against their peers. However, shareholders may bring a derivative lawsuit against the board of directors and other responsible parties. The goal is to compel the board to remedy the damages sustained by company and to protect the interests of investors. Nonetheless, a successful claim depends on the skills of an attorney with experience handling complex litigation. What is a derivative lawsuit? A shareholder derivative lawsuit may arise when a company’s value is diminished because of mismanagement or unlawful conduct by directors and officers. A derivative lawsuit is filed by an investor, or a class of investors, for the benefit of both the corporation and the shareholders. The plaintiffs are not seeking compensation. Instead, the objective is to protect their investment by imposing management changes and corporate governance reforms. Any proceeds of a successful action are awarded to the corporation, not the shareholders. Before filing a lawsuit, a shareholder must demand that the board take legal action. If the board rejects the demand or refuses to act, then the lawsuit is permitted to proceed. Shareholders may file lawsuits to remedy all types of corporate misconduct, including: Breach of Duty of Care - Directors and officers have a duty of care to act responsibly, and in good faith, when managing the company’s affairs. Examples of breaches include a director or officer not exercising rational judgment, acting in bad faith, or not being reasonably informed when making a decision. Breach of Duty of Loyalty - Directors and officers cannot profit at the expense of the corporation and have a duty to put the financial interests of the shareholders first. A breach this duty may involve self-dealing, misuse or waste of corporate assets, or abuse of corporate privileges, such as using a corporate jet for personal travel. Accounting Malpractice - Financial statements must be prepared in accordance with generally accepted accounting principles (GAAP). Corporate executives are prohibited from using aggressive accounting techniques and overstating or manipulating earnings. A derivative lawsuit can be brought to remove the directors and officers who had knowledge of any improprieties. Shareholders may also seek to compel the company to establish stricter governance measures that will prevent similar activities in the future. Improper Mergers and Acquisitions - Shareholders can also pursue legal action to challenge proposed mergers or acquisitions. If the directors and officers approve a deal that fails to maximize shareholder value, a breach of fiduciary duty may have occurred. Other Misconduct - A derivative lawsuit can also be filed if a company’s executives fail to address violations of environmental regulations, wage and hour laws, workplace safety guidelines, or other state and federal regulations. The Takeaway A successful shareholder derivative lawsuit can result in corporate governance reforms, prevent future wrongdoing, and increase shareholder value. In some cases, the court may also approve an incentive reward to compensate the plaintiffs for the time and inconvenience associated with pursuing a legal action. In the end derivative lawsuits and class actions give shareholders power legal recourse to protect their interests.

On January 31, 2018, the Second Department decided 159 MP Corp. v. Redbridge Bedford, LLC.   The Court in 159 MP , recognized that the “appeal raises an issue of first impression in the appellate courts of New York…” to the extent that it “address the question of whether written leases negotiated at arm’s length by commercial tenants may include a waiver of the right to declarative relief that is enforceable at law or, alternatively, whether such a waiver is void and unenforceable as a matter of public policy.” The plaintiffs in 159 MP are related entities that leased from the defendant landlord commercial retail and storage space in Brooklyn for use as a supermarket and related purposes.  The commercial leases executed by the parties contained provisions that reads as follows: waives its right to bring a declaratory judgment action with respect to any provision of this Lease or with respect to any notice sent pursuant to the provisions of this Lease.  Any breach of this paragraph shall constitute a breach of substantial obligations of the tenancy, and shall be grounds for the immediate termination of this Lease.  It is further agreed that in the event injunctive relief is sought by Tenant and such relief shall be denied, the Owner shall be entitled to recover the costs of opposing such an application, or action, including its attorney’s fees actually incurred, it is the intention of the parties hereto that their disputes be adjudicated via summary proceeding <(the “waiver provisions”)> .  Four years into a twenty-year lease (with an additional ten-year renewal option), tenants received from landlord a “Ten (10) Day Notice to Cure Violations” (the “Notice”).  In response, and prior to the cure period in the Notice (the “Cure Period”), tenants commenced an action in the Supreme Court for declaratory and injunctive relief and for breach of contract.  Also before the end of the Cure Period, tenants moved by order to show cause for a Yellowstone injunction staying and tolling the Cure Period and enjoining defendant landlord from terminating the leases.  ( Yellowstone injunctions are fully discussed in Freiberger Haber LLP’s December 1, 2017 Blog Post: “Commercial Tenants Must Remain Aware of Yellowstone Injunctions” .) Defendant landlord answered the complaint and, inter alia , asserted an affirmative defense that plaintiff tenants’ right to seek injunctive relief was contractually waived.  Landlord also cross-moved for summary judgment dismissing the complaint based on the Waiver Provision. The Supreme Court denied tenants’ request for a Yellowstone injunction finding “that all the plaintiffs’ claims were actual or disguised causes of action for declaratory relief…”, and granted landlord’s cross-motion for summary judgment. A divided Appellate Division, Second Department, affirmed the Supreme Court’s decision.  First, the Court held that tenants timely obtained Yellowstone injunctive relief.  However, in finding that such relief was unavailable to tenants in 159 MP, the Court stated that: By nature and definition, a Yellowstone injunction is inextricably intertwined with the court’s role in resolving whether a tenant has breached provisions of the lease and, if so, whether any such breach shall be cured.  As here, a tenant’s preemptive action to have the court determine that the lease has not been breached is in the nature of declaratory judgment.  (Citations omitted.) The Court rejected tenants’ argument that there was a distinction between the declaratory relief prohibited by the Waiver Provision and permissible Yellowstone relief because “ y nature and definition, a Yellowstone injunction springs from the declaratory judgment action that gives rise to it.”  Because “plaintiffs expressly waived both declaratory and Yellowstone relief pursuant to the ”, the Court held that the Supreme Court properly denied the Yellowstone relief sought by tenants and granted landlord’s cross-motion for summary judgment dismissing the causes of action seeking declaratory relief. Although tenants’ argument that the Waiver Provisions were void as against public policy was raised for the first time on appeal, the Court nonetheless addressed those arguments because “where a contract provision is arguably void as against public policy, that issue may be raised for the first time at the Appellate Division by a party, or by the court on its own motion.”  (Citation omitted.)  Upon consideration, the Court determined that the Waiver Provisions were not void.  Among other things, the Court relied on the fact that “ bedrock principle of our jurisprudence is the right of parties to freely enter into contracts” and that “our jurisprudence provides citizens with the freedom and opportunity to abandon rights and privileges.”  The Court also stated that while “ aivers of rights should not lightly be presumed,” the “parties were sophisticated entities that negotiated at arm’s length and entered into lengthy and detailed leases defining each party’s rights and obligations with great apparent care and specificity.” The plain language of the Waiver Provisions were found to “reflect[] the parties’ mutual intent to adjudicate disputes by means of summary proceedings.” Ultimately, the Court held that “ eclaratory and Yellowstone remedies are rights private to the plaintiffs that they could freely, voluntarily, and knowingly waive.” The Court, in issuing its ruling, considered that notwithstanding the subject waivers plaintiffs had other remedies available to them to protect their interests.  For example, plaintiffs could have cured the breaches that were the subject of the Notice and sued landlord for breach of contract or otherwise.  Also, plaintiffs could have asserted defenses in any summary proceeding brought against them by landlord and, if successful, they would remain in possession. In a lengthy dissent, Justice Connolly urged that the Waiver Provisions were void as against public policy and, therefore, unenforceable because their “enforcement…would deprive the plaintiffs of any meaningful means of accessing the courts….”