J.P. Morgan Securities, LLC ("J.P. Morgan") was recently fined $1.25 million by the Financial Industry Regulatory Authority ("FINRA") for how the securities firm handled criminal background checks. In particular, J.P. Morgan failed to conduct timely or adequate background checks on approximately 95 percent of its non-registered personnel, a total of about 8,600 employees.  As noted by FINRA in the announcement of the settlement ( here ), under the federal securities laws, broker-dealers are required to fingerprint certain associated persons working in a non-registered capacity who may present a risk to customers based on their positions. Fingerprinting helps firms identify if a person has been convicted of crimes that would disqualify them from being associated with a firm, absent explicit regulatory approval. Federal banking laws also require banks to conduct such checks on employees using a more limited list of disqualifying events. Section 17(f) (2) of the Securities Exchange Act of 1934 and Rule 17f-2 ( here ) promulgated thereunder require broker-dealer firms to submit fingerprints for all partners, directors, officers, and employees unless they are exempt under certain provisions.  Rule 17f-2 exempts employees from fingerprinting if they do not sell securities or regularly have access to the keeping, handling, or processing of securities, monies, or the original books and records relating to the securities or monies. Employees are also exempt if they do not have direct supervisory responsibility for those who sell securities or access to securities, monies, or the original books and records. FINRA found that for more than eight years (between January 2009 and May 2017), J.P. Morgan failed to fingerprint approximately 2,000 of its non-registered associated persons in a timely manner, preventing the firm from determining whether those persons might be disqualified from working at the firm. In addition, the firm fingerprinted other non-registered associated persons but limited its screening to criminal convictions specified in federal banking laws and an internally created list that included crimes such as kidnapping, rape, murder, manslaughter and sexual assault. In total, J.P. Morgan did not appropriately screen 8,600 individuals for all felony convictions or for disciplinary actions by financial regulators. FINRA also found that four individuals who were subject to a statutory disqualification because of a criminal conviction were allowed to associate, or remain associated, with the firm during the relevant time period. One of the four individuals was associated with the firm for 10 years; another for eight years. FINRA did not disclose the crimes to which the convictions were related. Susan Schroeder, Executive Vice President of FINRA’s Department of Enforcement, said, “FINRA member firms play an important gatekeeper role in keeping bad actors from harming investors. Firms have a clear responsibility to appropriately screen all employees for past criminal or regulatory events that can disqualify individuals from associating with member firms, even in a non-registered capacity.” In addition to paying the $1.25 million fine, J.P. Morgan agreed to review its systems and procedures related to the identification, fingerprinting and screening of non-registered associated persons. The firm cooperated with FINRA in self-reporting and undertaking a plan to address the violations, a factor that FINRA weighed when determining the appropriate monetary sanction, FINRA said. “We self-reported this matter and are pleased it’s now behind us,” said J.P. Morgan spokeswoman Jessica Francisco. In settling the matter, J.P. Morgan neither admitted nor denied the charges, but consented to the entry of FINRA’s findings. In December 2015, FINRA imposed a $1.25 million fine on Merrill Lynch for failing to fingerprint employees. ( Here .) According to FINRA, from January 1, 2009, through October 28, 2013, Merrill Lynch failed to fingerprint or properly screen approximately 4,500 out of 20,000 non-registered associated employees. Of those individuals, 1,115 were not fingerprinted, 240 were not fingerprinted until after they started working, and 3,145 were not screened for felony convictions or regulatory actions. Merrill Lynch also consented to the entry of FINRA’s findings, but neither admitted nor denied the charges. The Takeaway FINRA has stated that it is trying to detect rogue brokers who may have been disciplined for misconduct but who still work in the industry - a number that represents about seven percent of financial advisers. The settlement with J.P. Morgan, though involving non-registered, associated personnel, is an example of that effort. As a result, member firms should ensure that their background check procedures comply with the federal securities laws and rules.

Yellowstone injunctions got their name from First National Stores, Inc. v. Yellowstone Shopping Center, Inc., 21 N.Y.2d 630, 290 N.Y.S.2d 721 (1968) .  A commercial tenant that is faced with the threat of the termination of its commercial lease as a result of a lease default, must follow the procedures set forth in Yellowstone or it runs the risk of losing its lease.  While Yellowstone was decided almost fifty years ago, commercial tenants continue to lose their valuable leases by failing to follow Yellowstone’s relatively simple dictates. By way of background, the plaintiff in Yellowstone was a supermarket tenant in a shopping center owned by the defendant landlord.  The fire department ordered the landlord to install sprinklers in the cellar of the space rented to the plaintiff.  None of the other units in the center were subject to the fire department order.  The landlord and the tenant disagreed as to who was responsible under the lease to pay for the sprinklers.  The tenant urged that the lease obligated the landlord to make repairs to the leased premises required by governmental authorities.  The landlord argued that the same provision relied upon by the tenant shifted to the tenant, the burden of repairs required by governmental authorities if necessitated by the tenant’s particular use of the leased premises. After making numerous unsuccessful requests for the tenant to comply with the fire department’s order, the landlord sent the tenant a default notice pursuant to the lease requiring the tenant to cure within ten days.  The notice was received by the tenant on February 27, 1967.  Instead of curing the noticed default, the tenant commenced a declaratory judgment action on February 28, 1967 by the service of a summons only.  On March 9, 1967, the tenant followed-up with the service of a complaint and an order to show cause (without a stay) for a preliminary injunction (which was returnable on March 13, 1967).  On March 10, 1967 (more than ten days after tenant’s receipt of the default notice), the landlord sent the tenant a notice of termination. The Appellate Division determined that the tenant was indeed responsible under the lease for the sprinkler repairs ordered by the fire department because the sprinklers were necessitated by the tenant’s particular use as the landlord was not ordered to install sprinklers in the cellar of any other tenanted spaces.  Accordingly, the Appellate Division determined that it could have declared the lease terminated.  However, the Court decided not to terminate the lease because the tenant acted in good faith in bringing the declaratory judgment action.  The Appellate Division determined that the lease should remain in force if, within twenty days, the tenant installed a satisfactory fire sprinkler system or reimbursed the landlord if sprinklers were already installed by it. The Court of Appeals in Yellowstone , however, reversed the Appellate Division’s decision and determined that the lease was terminated in accordance with its terms and could not be revived.  Thus, in holding that the Appellate Division was “powerless” to reform the lease absent “a showing of fraud, mutual mistake or other acceptable basis of reformation” ( Yellowstone , 21 N.Y.2d at 637, 290 N.Y.S.2d at 725), the Court of Appeals stated: Here, the lease had been terminated in strict accordance with its terms.  The tenant did not obtain a temporary restraining order until after the landlord acted.  The temporary restraining order merely preserved the status quo as of the date it was obtained.  Once the Appellate Division determined that the tenant had in fact defaulted by not installing the sprinkler system, the conclusion had to be drawn that the lease was terminated in accordance with its terms.  The Appellate Division could not revive it unless it read into the lease a clause to the effect that the tenant could have an additional 20 days to cure is (sic) default before the landlord could commence summary eviction proceedings.  This the court was powerless to do absence a showing of fraud, mutual mistake or other acceptable basis of reformation. ( Yellowstone , 21 N.Y.2d at 637, 290 N.Y.S.2d at 725.) Riesenburger Props., LLLP v. Pi Assoc., LLC , 2017 NY Slip Op 08294, __ N.Y.S.3d __ (2 nd Dep’t November 22, 2017), a case decided almost fifty years after Yellowstone , reiterates the importance of following the procedural requirements of Yellowstone .  The Riesenburger plaintiff, the landlord with respect to a commercial lease, sent the Riesenburger defendant, the tenant, fifteen-day notices of default.  The defaults were disputed by the tenant.  After more than fifteen days passed, the tenant was served with a three-day notice of cancellation of its lease. The Riesenburger landlord commenced an action seeking a judgment of possession.  Thereafter, and more than thirty days after the expiration of the cure period, the tenant moved for a Yellowstone injunction, which the Supreme Court denied the motion as untimely.  The Supreme Court also denied the tenant’s subsequent motion to reargue. On appeal, the Second Department affirmed the decision below because the tenant failed to “move for injunctive relief until after the cure period expired and after the notice of cancellation of the lease had been served”.  ( Riesenburger , 2017 NY Slip Op 08294 (citation omitted).) In succinctly explaining Yellowstone injunctions, the Second Department stated: A Yellowstone injunction maintains the status quo so that a commercial tenant, when confronted by a threat of termination of its lease, may protect its investment in the leasehold by obtaining a stay tolling the cure period so that upon an adverse determination on the merits the tenant may cure the default and avoid a forfeiture of the lease.  To obtain a Yellowstone injunction, the tenant must demonstrate that (1) it holds a commercial lease, (2) it received from the landlord either a notice of default, a notice to cure, or a threat of termination of the lease, (3) it requested injunctive relief prior to both the termination of the lease and the expiration of the cure period set forth in the lease and the landlord’s notice to cure, and (4) it is prepared and maintains the ability to cure the alleged default by any means short of vacating the premises. ( Riesenburger , 2017 NY Slip Op 08294 (citation and internal quotation marks omitted).) The Riesenburger Court also recognized that “ here a tenant fails to make a timely request for a temporary restraining order, a court is divested of its power to grant a Yellowstone injunction.”  ( Riesenburger , 2017 NY Slip Op 08294 (citation omitted).) TAKEAWAY Commercial leases can be an extremely valuable asset of any business.  A commercial tenant that is faced with a default notice, a notice to cure or is otherwise threatened with the termination of its lease, must act quickly to preserve its leasehold interest.  If a commercial tenant waits too long or otherwise fails to follow the relatively easy Yellowstone procedures, the court may be forced to terminate the tenant’s commercial lease.

On November 3, 2017, Thrivent Financial for Lutherans (“Thrivent”) obtained a preliminary injunction that temporarily restrains the Department of Labor (the “Department” or the “DOL”) from enforcing an anti-arbitration provision in an exemption to the DOL’s fiduciary duty rule (the “Fiduciary Rule” or the “Rule”) against Thrivent. See Thrivent Financial for Lutherans v. Acosta , Case No. 16-cv-03289 (SRN/DTS) (D. Minn. Nov. 3, 2017). ( Here .) The decision was issued days after the DOL filed a rule with the Office of Management and Budget (“OMB”) for an 18-month delay of the Fiduciary Rule. ( Here .) The anti-arbitration provision, which restricts financial advisers from requiring retirement investors to waive their right to class litigation, is part of the Rule’s best-interest-contract exemption (“BICE” or “BIC Exemption”). An Overview of The Fiduciary Rule Retirement investment advice is governed by different regulatory and supervisory regimes, including the federal securities laws, state insurance regulation, industry self-regulatory bodies, and the Employee Retirement Income Security Act of 1974 (“ERISA”). Among other requirements, ERISA prohibits investment advisers classified as “fiduciaries” from engaging in conduct that constitutes a conflict of interest. Under the ERISA statute, a fiduciary is defined as a person or entity that “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so. . ..” 29 U.S.C. § 1002(21)(A)(ii). Pursuant to statute and executive order, the DOL has been granted interpretive, rulemaking, and exemption authority for the “fiduciary” definition and prohibited transaction provisions, both in ERISA and the parallel provisions of the Internal Revenue Code. On April 8, 2016, pursuant to this rule-making authority, the DOL expanded the definition of “fiduciary,” as well as the type of retirement advice, covered by the ERISA statute with the Fiduciary Rule.  Under the Rule, an advisor provides investment advice if s/he makes “recommendations” about “securities or other investment property,” including recommendations with respect to rollovers, transfers, or distributions from a plan or IRA. See 29 C.F.R. § 2510.03-21(a)(1). Fiduciaries that engage in prohibited transactions are subject to an excise tax equal to fifteen percent of the amount of the prohibited transaction. See I.R.C. § 4975(a). If the prohibited transaction is not corrected within the tax year, however, it is further subject to a tax “equal to 100 percent of the amount involved.” Id . § 4975(b). To ameliorate the harshness of the Rule, the DOL promulgated a number of exemptions that permit qualifying entities to continue to receive certain forms of compensation (such as commissions), and engage in otherwise prohibited transactions, without incurring punitive taxes. One of those exemptions is the BIC Exemption. To qualify for the BIC Exemption, investment advisors and their firms must agree to a number of conditions that comport with fundamental fiduciary standards. With regard to IRA investors, the BIC Exemption mandates that these conditions be contained in a contract between the financial institution and the retirement investor. While the conditions permit these contracts to include individual arbitration agreements, the BIC Exemption is not available for contracts that waive or qualify the investor’s right “to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution.” As originally contemplated by the DOL, investment advisors and their firms wishing to avail themselves of the BIC Exemption must provide such contracts by January 1, 2018. (This Blog has written about the Fiduciary Rule here and here .) The DOL Seeks to Extend the Effective Date of the Rule and Certain Exemptions The Fiduciary Rule was scheduled to become effective in 2017, with the first phase to be implemented on April 10, 2017. However, on March 10, 2017, the DOL filed a notice proposing to delay the start of the Rule from April 10, 2017, to June 9, 2017. ( Here .) On May 22, 2017, Alexander Acosta, the Secretary of Labor, confirmed that the first phase of the Rule would go into effect on June 9, 2017, as scheduled. During the transition period from June 9, 2017, until January 1, 2018, fiduciaries relying on exemptions to the Rule, such as the BIC Exemption, are required to adhere to a “best interest” standard rather than the fiduciary duty standard found in the Rule. On November 27, 2017, the DOL announced ( here ) an 18-month extension from January 1, 2018, to July 1, 2019, for the implementation of the next phase of the Rule and exemptions, and of the applicability of certain amendments to the principal transactions exemption. The extension concluded the process that the Department initiated on November 2, when it sent the proposed rule to the OMB for review. (Note: The Treasury Department said in a report released on October 27, 2017 ( here ) that it supported the effort to delay implementation of the Rule pending further review by the Department, the Securities and Exchange Commission, and the states.) In the press release, the Department said that it needed additional time “to consider public comments submitted pursuant to the Department’s July Request for Information, and the criteria set forth in the Presidential Memorandum of Feb. 3, 2017, including whether possible changes and alternatives to exemptions would be appropriate in light of the current comment record and potential input from, and action by the Securities and Exchange Commission, state insurance commissioners and other regulators.” In the February 3 memorandum, the President directed the Department to prepare an updated analysis of the likely impact of the Fiduciary Rule on access to retirement information and financial advice. (Discussed by this Blog here .) The Department has also announced that during the period June 9, 2017 to July 1, 2019, it would not pursue claims against fiduciaries working in good faith to comply with the Fiduciary Rule and exemptions, or treat those fiduciaries as being in violation of the Fiduciary Rule and exemptions. This decision, which was also contained in the rule sent to the OMB earlier in the month, was relevant to the Court’s decision in Thrivent . Thrivent Financial for Lutherans v. Acosta Thrivent is a not-for-profit, member-owned and governed fraternal benefit society incorporated in Wisconsin. Pursuant to Wisconsin law, Thrivent is required to provide insurance benefits to its members. To meet this requirement, Thrivent offers a broad range of insurance and financial products and services, including traditional life insurance, annuities, disability insurance, long-term care coverage, mutual funds, retirement planning, and money management services.  Several of the products Thrivent offers are proprietary in nature, such as fixed indexed and fixed rate annuities. These latter offerings can be acquired through an IRA, in contrast to traditional life insurance products. Many of Thrivent’s members are individuals and families of modest means. Because most of these members trade infrequently and do not need ongoing financial advice, Thrivent’s financial representatives work under a “transaction-based” compensation model ( i.e. , they receive a commission for each transaction). According to Thrivent, this model is more appropriate for most of its members than a fee-based model, where the investor pays compensation periodically based upon a percentage of the assets under management, or as a flat rate, regardless of whether transactions occur. Since 1999, Thrivent has required disputes with members over insurance products to be resolved through its Member Dispute Resolution Program (“MDRP”). The MDRP provides for a multi-tiered dispute resolution process, escalating (if necessary) to binding arbitration based on the rules of the American Arbitration Association. The MDRP mandates that all mediation or arbitration be individual in nature – representative or class claims, whether arbitral or judicial, are expressly barred. On September 29, 2016, Thrivent filed an action against the Department, asserting that the BIC Exemption’s bar on class action waivers violates the Federal Arbitration Act (“FAA”) and is unenforceable because it exceeds the DOL’s statutory authority. Thrivent sought a declaration that the class action waiver bar is in violation of the Administrative Procedure Act (“APA”) and the FAA and an injunction to enjoin its enforcement. Both parties agreed to proceed with summary judgment. (Note: the parties agreed that Thrivent’s commission-based compensation of its financial representatives and its sale of proprietary insurance products to IRA holders were “prohibited transactions” under the Fiduciary Rule.) Initially, the DOL argued that the ban against class-action waivers did not violate the FAA, and that, pursuant to 28 U.S.C. § 1108(a), the DOL had the authority to condition exemptions on adherence to certain standards, including allowing class actions.  However, shortly after the submissions, but prior to the hearing on the motions, the DOL requested a stay of the proceedings due to the President’s February 3, 2017, memorandum to the Secretary of Labor, directing him to examine the Fiduciary Rule and to prepare an updated legal and financial analysis concerning certain aspects of the Rule. The DOL stated that as part of its review process, “Plaintiff may be afforded another opportunity to seek an administrative change to the . And the Department could act to revise or rescind the challenged provision.” Shortly thereafter, on March 1, 2017, the DOL informed the Court that, among other things, the Department had proposed an extension of the April 10, 2017, applicability date for the Rule and exemptions, and initiated a 45-day comment period. The Court declined to issue a stay at that time and heard argument on the summary judgment motions. In July 2017, the DOL filed a notice of withdrawal of its cross-motion for summary judgment and its opposition to Thrivent’s summary judgment motion, explaining that “the Department no longer defends the one regulatory provision challenged in this action—the application of Exemption § II(f)(2) to arbitration agreements [ ].” Also, the DOL renewed its request for a stay, arguing that because the challenged provision was not yet applicable to Thrivent, and the DOL was reassessing both the exemption and broader rulemaking, a stay would promote judicial economy and likewise conserve the parties’ resources. Thrivent opposed the motion for a stay, arguing that neither the possibility of future regulatory changes nor the DOL’s change of legal position, supported a stay. Moreover, Thrivent asserted that while the DOJ failed to assert any hardship that it would suffer absent a stay, Thrivent would suffer irreparable harm if the Court granted the stay. Shortly thereafter, Thrivent filed its motion for a preliminary injunction. Thrivent asked the Court to enjoin the Department, as well as all other federal agencies, from implementing or enforcing the BIC Exemption against Thrivent. The Court’s Ruling The Court granted Thrivent’s motion, finding that Thrivent satisfied the requirements necessary to obtain a preliminary injunction against the Department: (1) it was likely to succeed on the merits; (2) it would incur irreparable harm in the absence of injunctive relief; (3) the balance between the irreparable harm and the harm of injunctive relief weighed in Thrivent’s favor; and (4) injunctive relief was in the public interest. Irreparable Harm The Court found that Thrivent sufficiently demonstrated the threat of irreparable harm, “both now and in the future.” Noting the “DOL’s current efforts to extend the BIC Exemption’s applicability date,” the Court found that “the current state of regulatory limbo threatens Thrivent with harm that cannot be remedied monetarily.” The Court found that to comply with the applicability date of the anti-arbitration condition, Thrivent had to change its business model. Such changes, held the Court, “may irreparably disadvantage Thrivent against its competitors and with respect to its members.” As to future harm, the Court found that the “likely harm to Thrivent’s reputation and goodwill,” “also exists in the future.” Thrivent argued that it could not comply with the BIC Exemption (which would allow it to continue paying commissions) because allowing class action litigation – a specific condition of the exemption – would undermine its core Christian values and damage its reputation and goodwill. The Court also found that Thrivent demonstrated the likelihood of future harm with respect to compliance with state regulations, as well as the impact on business operations, due to the uncertainty surrounding the viability of the BIC Exemption. Likelihood of Success The Court found that Thrivent was likely to succeed on the merits because the DOL had conceded that the anti-arbitration condition in the BIC Exemption violated the FAA. Balance of Harms and Public Interest The Court found that these factors also weighed in Thrivent’s favor because the DOL would not suffer any harm, and the public interest would be served if the DOL was enjoined from enforcing an invalid rule. The Court Issues a Stay Given the DOL’s reassessment of the applicability of the BIC Exemption, the Court found that the Department “sufficiently demonstrated the need for a stay.” Granting the stay, said the Court, would “allow the administrative process to fully develop, possibly resolving th dispute, and thereby promoting judicial economy.” And, in light the injunctive relief awarded, the Court noted that “Thrivent would not be prejudiced by the entry of a stay.” Takeaway The combination of the DOL’s rule extending implementation of the Fiduciary Rule and the exemptions, the DOL’s concession that the BIC Exemption cannot be reconciled with the FAA, and Judge Nelson’s grant of a preliminary injunction in favor of Thrivent makes it exceedingly unlikely that full implementation of the Rule or the BICE will occur.  Indeed, Micah Hauptman, financial services counsel at the Consumer Federation of America, stated: “In our view, this is not a delay. It’s an effective repeal of the rule.” If the DOL does not implement the next phase of the Rule and exemptions, then the transition versions of the Rule and exemptions will continue to apply unless other rules are proposed and adopted. Under the transition rules, investment advisers and their firms are required to provide investment advice that is in the best interests of their retirement investors ( i.e. , provide investment advice with skill, care, and prudence, without regard to the financial interests of the advisor, and consistent with the objectives, needs and financial circumstances of the client); charge reasonable compensation; and refrain from making false and misleading statements about investments, compensation, and conflicts of interest. The DOL has cautioned financial advisers and their firms that, notwithstanding the delay and uncertainty surrounding the Rule and exemptions, the Department expects them to “to adopt such policies and procedures as they reasonably conclude are necessary to ensure” compliance with the foregoing standards. This Blog will continue to monitor the implementation of the Fiduciary Rule and related exemptions and provide updates when they become available.

According to a report issued jointly by the New York University Pollack Center for Law & Business and Cornerstone Research, the Securities and Exchange Commission (“SEC” or “Commission”) filed 33% fewer enforcement actions against public companies and their subsidiaries in fiscal year 2017 than in fiscal year 2016. The report ( here ), SEC Enforcement Activity: Public Companies and Subsidiaries, Fiscal Year 2017 Update (the “Report”), analyzes data from the Securities Enforcement Empirical Database (“SEED”) ( here ). SEED tracks and records information for SEC enforcement actions filed against public company defendants. Created by the NYU Pollack Center for Law & Business in cooperation with Cornerstone Research, SEED facilitates the analysis and reporting of SEC enforcement actions through regular updates of new filings and settlement information for ongoing enforcement actions. In fiscal year 2017, the SEC filed 62 new enforcement actions against public companies and their subsidiaries, compared to 92 actions in fiscal year 2016. There were 45 actions filed in the first half of fiscal year 2017, but only 17 in the second half. “The data from SEED show a substantial decline in public company-related enforcement actions, the timing of which corresponds with SEC leadership changes in the new administration,” said Stephen Choi, the Murray and Kathleen Bring Professor of Law at the NYU School of Law and director of the Pollack Center for Law & Business. “For example, only two actions with FCPA allegations have been filed against public company-related defendants since February.” “We also saw major decreases in monetary penalties,” noted David Marcus, senior vice president and head of Cornerstone Research’s finance practice. “Total settlements declined from $1 billion in the first half of FY 2017 to $196 million in the second half.” In fiscal year 2017, the top three categories of cases brought by the SEC involved issuer reporting and disclosure, investment advisers and investment companies, and the Foreign Corrupt Practices Act (“FCPA”). These categories of cases represented 39%, 21% and 16%, respectively, of the total number of cases brought by the Commission in fiscal year 2017. By contrast, in fiscal year 2016, 26% of the cases involved issuer reporting and disclosure, 21% related to investment advisers and investment companies, and 20% were brought under the FCPA. A closer look at the numbers shows a change in enforcement priorities that coincides with leadership changes at the Commission. In the second half of fiscal year 2017, the largest category of cases brought by the SEC involved investment advisers and investment companies, not issuer reporting and disclosure. This change in emphasis comports with Chairman Clayton’s focus on retail investors and the new stated focus of the SEC Enforcement Division. Similarly, in the second half of fiscal year 2017, the number of FCPA cases dropped to 2 from 10 in the first half of the fiscal year. While there may be many reasons for the decline in FCPA enforcement actions, the drop in the number of FCPA actions is consistent with the commitment of the current administration in this area. President Trump has called the FCPA “ridiculous,” and a “horrible law” that makes it difficult for U.S. companies to compete overseas. ( See CNBC interview, here .) In terms of industry, the allocation of enforcement resources has also shifted from finance, insurance and real estate to manufacturing and services. In fiscal year 2016, 59% of the public company actions involved the finance, insurance and real estate sector, while the manufacturing sector accounted for about 18% of the cases, and the services sector accounted for 3%. In fiscal year 2017, however, only 42% of the cases involved the finance, insurance and real estate sector, while manufacturing and services cases increased to 32% and 8%, respectively. In fiscal year 2017, the SEC obtained $1.2 billion in cash settlements. About 89% of the public company settlements involved monetary penalties. That is comparable to the prior two fiscal years. However, a closer examination of the numbers suggests a possible shift due to a change in leadership. In the first half of fiscal year 2017, 94% of the actions settled for money. By contrast, in the second half of fiscal year 2017, the percentage of monetary settlements fell to 78%. Cooperation by a defendant also declined in fiscal year 2017.  In that year, about 54% of the settling defendants cooperated with the SEC, compared to 71% in fiscal year 2015 and 64% in fiscal year 2016. In fiscal year 2017, cooperation was at its highest in actions involving the FCPA (61%) and Municipal Securities/Public Pensions (87%). Finally, actions involving public companies with resolutions that were not concurrent with the filing of a complaint were less likely to have monetary settlements. From fiscal year 2010 through fiscal year 2017, 71% of the actions with non-concurrent resolutions had monetary settlements, compared to 88% of actions with concurrent resolutions. These statistics again raise questions regarding cooperation by defendants in enforcement actions and the settlement approach and tactics employed by the Division of Enforcement. The press release discussing the Report can be found here . The SEC, Division of Enforcement, Annual Report: A Look Back at Fiscal Year 2017 can be found here .

Following months of hinting that the Department of Justice (“DOJ” or “Department”) would change its qui tam policies, Michael Granston (“Granston”), Director of the Civil Fraud Section, announced that the DOJ will now move to dismiss qui tam actions brought under the False Claims Act when it concludes that the actions lack merit.  The announcement was made during a presentation at the Health Care Compliance Association’s Health Care Enforcement Compliance Institute on October 30, 2017, rather than through official channels. (The announcement was covered by the RAC Monitor, here .) This policy shift represents a significant departure from the government’s past practice, which typically involved allowing meritless cases to be litigated by the relator. Under the False Claims Act (“FCA”), when a relator files a qui tam action, the government has 60 days to decide whether to intervene, decline to intervene, move to dismiss, or try to settle the action.  If the government intervenes, it controls the action and has the primary responsibility for prosecuting the case. Notably, the government intervenes in only a small percentage of qui tam actions. If the government declines to intervene, which it does in roughly 78 percent of the cases, the relator may continue to prosecute the action. However, the government may intervene at a later date upon a showing of good cause. The government typically declines to intervene if there is no merit to the case, or the action conflicts with the government’s statutory or policy interests. A discussion of the process can be found here . Over the years, defendants and trade groups have encouraged the DOJ to seek dismissal in declined cases, in an effort to avoid the costs associated with defending meritless qui tam lawsuits. These groups have argued that the government is not only in the best position to evaluate a qui tam case ( e.g. , it has myriad tools at its disposal to gather facts and evaluate evidence before deciding whether to intervene), it has the statutory authority to stop them. Given such authority, they argue, the government has a responsibility to seek dismissal of meritless cases, even when to do so occurs over the objections of the relator. Although the DOJ has the statutory authority to seek dismissal of qui tam actions, the DOJ has rarely exercised this right. By choosing not to seek dismissal, the DOJ has allowed many questionable qui tam actions to go forward, costing companies millions of dollars in legal fees and over $2.2 billion in judgments and settlements. At the conference, Director Granston explained that the government’s rationale for developing the new policy was to ease the burden created by frivolous litigation (in terms of time and resources) on the courts and the defendant companies. Takeaway Only time will tell whether the new policy will materially shift the Department’s decision making.  At this point in time, however, this Blog is skeptical. First, aggressive implementation of the policy would bite the hand that feeds the government. Since the majority of qui tam recoveries come from cases initially brought by relators, the government has an economic interest in allowing relators to pursue their actions – even when the DOJ believes the merit of the claim to be dubious. Nearly 95 percent of the money recovered under the False Claims Act is obtained in cases initiated by a whistleblower. If the DOJ implements this policy, it is more likely the Department will do sparingly, reserving dismissal motions only for cases where it is clear that the relator’s allegations are baseless and sanctionable. Second, while defendants will no doubt welcome the support of the DOJ, in cases where the absence of merit is abundantly clear ( e.g. , the type of cases Director Granston referred to), the DOJ’s intervention will be of little assistance – in such cases, defendants will likely achieve dismissal on their own. Under such circumstances, it raises the question why expend the resources to seek dismissal? This Blog will monitor whether the DOJ increases the instances in which it moves to dismiss relator claims.

During the past year, Wells Fargo has faced a number of scandals. In addition to the bank account scandal ( here ) in which millions of accounts were set up under customers’ names without their permission, the bank forced thousands of customers into car insurance they did not need, and also charged improper rate-lock fees to mortgage applicants. Now, in a recent filing ( here ), Wells Fargo has disclosed that a number of employees have filed retaliation claims after they were fired for voicing their concerns over the bank’s practices. In one case, a former employee alleged “retaliation for raising concerns regarding automobile lending practices.”  In other cases,  former Wells Fargo mortgage employees have claimed that they were terminated for complaining about improper mortgage rate-lock fees. The bank has denied the claims. The employment retaliation claims originally surfaced last year in connection with the bank account scandal when several employees alleged they were terminated after reporting the activities to the bank’s ethics hotline. According to some observers, this pointed to a pattern in which the scandals were followed by employee retaliation claims. ( Here .) While current Chief Executive Officer Tim Sloan has stated that employees would not face retribution for reporting unethical behavior, the recent filing noted that a number of employment litigation lawsuits have been filed against Wells Fargo, including class action lawsuits brought by former employees alleging adverse employment actions for raising sales practice misconduct issues.  The bank also faces numerous single plaintiff Sarbanes-Oxley Act complaints and state law whistleblower actions filed with the United States Department of Labor or in various state courts alleging retaliation for raising sales practice misconduct. Earlier this year, the Labor Department ordered the bank to pay $5.4 million and reinstate a whistleblower who was fired after reporting suspected fraud to the ethics hotline. The Auto Insurance Scandal The auto insurance scandal is also more extensive than was previously reported. That scandal involved improper sales practices concerning the origination, servicing, and/or collection of consumer automobile loans, including related insurance products. Wells Fargo initially acknowledged last July that since 2012 as many as 570,000 customers were charged for auto insurance that they did not need. The recent filing reported that the bank is now accepting refund requests related to this matter dating back to October 2005. The estimated cost of the scandal is now $130 million, up from the previously reported amount of $80 million.  Multiple class action lawsuits alleging, among other things, unfair and deceptive trade practices have been filed against the bank in connection with the auto insurance scandal. Allegations related to the bank's auto insurance programs are among the subjects of two shareholder derivative lawsuits filed in California state court. These and other issues related to the origination, servicing and/or collection of consumer automobile loans, including related insurance products, have subjected the bank to formal or informal inquiries, investigations or examinations from federal and state government agencies. What is whistleblower retaliation? Whistleblower retaliation occurs when an employee is terminated, demoted, threatened, intimidated, harassed or subjected to a hostile work environment for engaging in the following protected activity: Reporting - Making a complaint about an alleged violation of law or company policy to an employer or government agency. Filing - Pursuing a claim, lawsuit or other legal proceeding. Testifying - Providing written affidavits or giving oral statements or testimony relative to a  legal proceeding. Opposing - Refusing to perform a task or activity that the individual reasonably believes is illegal.  Takeaway Being a whistleblower involves personal sacrifice and professional risk.  Many violations of the law go unreported because people who know about them are afraid of being disciplined, losing their job, being demoted, or being passed over for promotion. To address these concerns, Congress has passed numerous pieces of legislation that protect whistleblowers from retaliation, including the Whistleblower Protection Act, the Dodd-Frank Act, and the Sarbanes-Oxley Act. These laws are intended to encourage individuals to come forward with information about violations of law. As Congress recognized long ago, “few individuals will expose fraud if they fear their disclosures will lead to harassment, demotion, loss of employment, or any other form of retaliation.” Consequently, there should be a mechanism “to halt companies and individuals from using the threat of economic retaliation to silence whistleblowers, as well as assure those who may be considering exposing fraud that they are legally protected from retaliatory acts.”

Many leases provide for a tenant’s option to purchase the subject real property.  The recent case of Blackburn Food Corp., et. al. v. Ardi, Inc., et. al ., (Sup. Ct. Suffolk Co. October 25, 2107), illustrates the importance of, inter alia , careful drafting when dealing with real property purchase option agreements. The plaintiffs in Blackburn entered into a ten-year lease for real property.  The lease contained an option, which, if exercised within the first three years of the lease, permitted plaintiffs to purchase the property for $975,000 provided they were not in default of their lease obligations.  A rider to the lease provided that if the option was exercised, the plaintiffs would receive as a credit against the purchase price, a sum equal to the amount paid in base rent for the first three years of the lease ($144,000) and the purchase price paid by plaintiff for the ongoing restaurant business operated at the property ($150,000) (the “Credits”). The option provides: Provided tenant is not default of this Lease Agreement, it shall have the Option to Purchase the Premises for the purchase price of Nine Hundred Seventy Five Thousand ($975,000) Dollars subject to the terms herein.  Tenant shall receive a credit against the purchase price in the amount of base rent actually paid for years 1, 2 and 3, exclusive of taxes, insurance and utilities…together with the total “Key Money” paid ($150,000.00).  The option to purchase shall terminate thirty days prior to the end of Year 3 unless earlier terminated by Tenant’s default under this Lease Agreement. Thereafter, the parties executed a supplemental rider extending the option period by one year making the option exercisable for the first four years of the lease.  The supplemental rider, which did not address whether the Credits would be applied to the purchase price if the option was exercised in the fourth year of the option period, provides: Landlord/seller and Tenants/purchasers agree that the option to purchase is an exclusive option of tenants/purchasers and this exclusive option period shall expire 30 days prior to Year five (5) of the Lease Agreement . (Emphasis supplied by the Court.) When plaintiffs exercised their purchase option in year four and requested Credits totaling almost $300,000, the defendants balked; arguing that while the option period was extended for one year, the right to receive the Credits expired at the end of year three.  Plaintiffs brought suit against Defendants based on their refusal to sell the property to the plaintiffs for anything less than the full purchase price.  Plaintiffs complaint contained a cause of action for specific performance of the contract at the option price of $681,000 and a cause of action to recover any rent paid after exercising the option. The case was tried after summary judgment was denied to both parties because the “option language was reasonably susceptible of more than one meaning.”  At trial, plaintiffs presented several witnesses and defendants presented none.  The Court credited the unrebutted testimony of plaintiff Blackburn that he believed that “the option extended to five years the credit for rent paid in the first three years.”  The Court found plaintiff’s interpretation to be “consistent with the written agreement” because the supplemental rider “merely extended” the original option for an additional period of time and that “ here is no language in the supplemental rider regarding the purchase price for the redits, and nothing in the supplemental rider regarding the purchase price or the redits, and nothing in the supplemental rider indicates that the Blackburns would not receive the redits if they exercised the option in year four or five of the lease.” The Court found defendants’ interpretation of the lease riders related to the options to be inconsistent with some of the exhibits introduced at trial as well as with accepted principals of contract interpretation, holding that: A lease, like any other contract, is to be enforced in accordance with the expressed intention of the contracting parties.  In the context of real property transactions, where commercial certainty is a paramount concern and where, as here, the instrument was negotiated at arms length between sophisticated, counseled business people, courts should be extremely reluctant to interpret the agreement as impliedly stating something that the parties have neglected to specifically include.  Hence, courts may not by construction add or excise terms, nor distort the meaning of those used, and thereby make a new contract for the parties under the guise of interpreting the writing. (Citations omitted.) The Court recognized the settled principal that strict adherence to the to the terms and conditions of the option agreement is necessary to validly exercise an option to purchase real property and found that plaintiffs so complied.  The Court also found that plaintiffs proved that they had the financial wherewithal to purchase the property and, thus, were “ready, willing and able” purchasers.  Accordingly, the plaintiffs prevailed on their specific performance cause of action. The plaintiffs, however, failed on their second cause of action, which was to recover such rent as was paid after exercising the purchase option.  The Court explained the law in this regard as follows: When, as here, a tenant exercises an option to purchase real property pursuant to a lease, the relationship between the parties is converted to that of a vendor and vendee, and the landlord-tenant relationship merges with the vendor-vendee relationship.  When a merger has occurred, the owner of the property is not entitled to an award for use and occupancy of the premises from the vendee in possession unless the parties clearly intended a contrary result.  An intention to deviate from the general rule and to avoid a merger may be directly expressed in the agreement or may be inferred from a medley of factors such as the terms of the agreement, the circumstances of its making, and the subsequent behavior of the parties.  (Citations omitted.) The Court found that numerous provisions in the lease and certain language in the parties’ “stipulated statement of the facts”, were sufficient to establish that the merger was avoided and, accordingly, the landlord-tenant relationship survived the plaintiffs’ exercise of the option. TAKEAWAY Great care must be taken when negotiating and drafting leases and option agreements to ensure that the signed documents clearly reflect the agreement of the parties.  The Court in Blackburn found the parties’ option agreement to be ambiguous and, thus, a trial was required to determine the contract’s meaning.  The fact that the supplemental rider did not specifically state that the Credits would not be applied to the purchase price if plaintiff exercised the option between years three and four cost the defendant/seller almost $300,000.00.  The Court’s decision indicates that the result could have been avoided by simply incorporating language into the supplemental rider stating that while the option period was extended by one year, the Credits would not be applied if the option was exercised between years one and three. Similarly, specific language within the lease was sufficient to avoid the merger of the landlord-tenant and vendor-vendee relationships that would have otherwise operated to relieve plaintiffs of their obligation to pay rent once they exercised their right to the option.  While it remains unclear to what extent the relevant language was negotiated, vendees and their counsel should be mindful of the merger issue and refrain from incorporating into option agreements, language that may operate to avoid the merger and, therefore, continue vendee’s rental payment obligations subsequent to exercising any rights under option.

It has been some time since this Blog has written about the False Claims Act (“FCA”). In today’s post, this Blog looks at the Seventh Circuit’s recent embrace of the proximate cause standard for claims arising under the FCA. In United States v. Luce ( here ), the Seventh Circuit overruled its longstanding precedent for alleging causation in cases arising under the FCA. In doing so, the Seventh Circuit joined its sister circuits in holding that the government and whistleblowers must prove that the false claim was the proximate ( i.e. , foreseeable), as opposed to the “but-for”, cause of the government’s loss. Background Facts Luce arose from allegations that Robert S. Luce (“Luce”), the president and owner of MDR Corporation, a mortgage loan correspondent, submitted false certifications regarding his criminal history in order to participate in the Housing and Urban Development (“HUD”) mortgage insurance program. In particular, the government alleged that following his indictment in an unrelated matter, MDR filed Yearly Verification Reports (“V-form”) certifying that none of MDR’s officers, including Luce, were involved in any criminal proceedings. According to the government, those certifications violated applicable program rules. As a result of the false certifications, the government claimed that it had incurred substantial damages. For example, in the three years during which the false V-forms were submitted, MDR originated 2,500 loans. Approximately ten percent of those loans were in default, causing the government to pay millions of dollars under the insurance program. Upon learning of the false certifications, HUD’s Office of the Inspector General initiated an investigation into MDR and Luce. Following the investigation, Luce was debarred from the HUD program. District Court Proceedings The government filed an action under the FCA, seeking treble damages and civil penalties for HUD’s net loss on the loans that MDR originated since Luce’s indictment and that subsequently went into default. After both parties moved for summary judgment on liability, the district court entered judgment for the government. The court held that Luce violated the FCA in connection with the V-forms, finding that since Luce signed the forms aware of his criminal indictment, the certification in the forms was knowingly false when made. The district court concluded that “ ecause the certification on the V-forms constituted fraud in fulfilling a prerequisite to receiving government funds,” it was material as a matter of law. Thereafter, the government moved for summary judgment on the issue of damages. In its motion, the government argued that it was entitled to “three times HUD’s net loss on the 237 loans that Luce’s MDR Mortgage Corporation originated between the relevant dates.” Luce opposed the motion on various grounds, including that the government was required to establish “the foreseeability of the damages it claims” and that “ reasonable jury could conclude that it was not foreseeable … that he would be responsible for future borrower defaults on 237 loans because of his misrepresentations on the V forms.” Before the district court ruled on the government’s motion, the Supreme Court decided Universal Health Services, Inc. v. United States ex rel. Escobar , 136 S. Ct. 1989 (2016) (“ Escobar ”), which addressed the question of materiality in FCA cases. (This Blog wrote about Escobar , here and here .)  As a result, the district court ordered additional briefing on “the Court’s ruling as to liability.” In response, Luce contended that his V-form certifications were not material under Escobar . With regard to the causation issue, Luce argued that the Supreme Court’s instruction in Escobar to apply common-law fraud principles required the application of proximate, rather than but-for, causation. The district court granted the government’s motion, finding that Luce’s false certifications were material under Escobar’s heightened materiality standard and the “but-for” cause of the government’s losses. In ruling for the government on causation and damages, the district court rejected Luce’s argument that Escobar impliedly overruled Seventh Circuit precedent ( i.e. , United States v. First National Bank of Cicero ) concerning the standard for causation in FCA cases. The Seventh Circuit’s Ruling On the issue of materiality, the Seventh Circuit affirmed the district court’s finding that the government satisfied Escobar’s heightened pleading standard. Under Escobar , when a defendant submits a claim for government payment, the defendant must not “merely request payment”; it must “make[ ] specific representations about the goods or services provided.” 136 S. Ct. at 2001. When the submission involves an omission – that is, the defendant’s “failure to disclose noncompliance with material statutory, regulatory, or contractual requirements” – it must rise to the level of “misleading half-truths.” Id .  In Luce , the rules applicable to the insurance program affirmatively prohibit program participation by loan correspondents who have had a principal “indicted for, or … convicted of, an offense” bearing on the loan correspondent’s integrity. The Court noted that the false certifications materially violated these rules. In fact, “they were lies that addressed a foundational part of the Government’s mortgage insurance regime, which was designed to avoid the systemic risk posed by unscrupulous loan originators.” Proof of materiality, said the Court, was further shown by the government’s reaction upon learning the truth about Luce’s background and false certifications – HUD instituted debarment proceedings to end Luce’s participation in the program so that no future payments could be made. In affirming the district court’s materiality finding, the Court rejected Luce’s arguments that: (1) the government approved insurance on new loans after learning of the false V-forms; (2) the government allowed MDR to continue operating as a loan correspondent for two years when no V-forms were on file; (3) the V-forms were not considered when making the decision to insure any specific loan; and (4) HUD stopped regulating loan correspondents entirely. In this regard, the Court found: First, the Government’s actions following its discovery of his fraud support, rather than undercut, a finding of materiality. Although new loans were issued, the Government also began debarment proceedings, culminating in actual debarment. There was no prolonged period of acquiescence. Second, Mr. Luce’s contention that HUD allowed MDR to operate without V-forms for two years is simply not supported by the evidence. Although the V-form for 2006 could not be located, the Government submitted undisputed evidence that, had MDR failed to submit the V-form, HUD would have terminated MDR’s FHA-approval. Third, Mr. Luce’s argument that the certification was not tied to any particular loan misses the mark; the V-form certification was a threshold eligibility requirement that, by extension, was tied to every loan. That is to say, without the V-form, he could not have originated a single mortgage. Finally, the contention that HUD stopped regulating loan correspondents in 2010 is simply inaccurate. Rather, the 2010 amendments required that loan correspondents seek a sponsorship relationship with approved mortgagees, who in turn assume responsibility for the loan correspondents. This structural shift in no way suggests that the actions of loan correspondents are not material; if anything, it demonstrates that their actions are of sufficient import that further supervision by an intermediary is required. Emphasis added; footnotes omitted. On the issue of causation, which was “at the heart of appeal,” the Court reversed the district court, holding that FCA plaintiffs must prove that the false claim was the proximate cause of the government’s losses. The Court noted that although the Supreme Court did not specifically address causation in Escobar , it nevertheless instructed the courts to interpret the FCA consistently with common-law fraud principles absent an indication that Congress intended otherwise. At common law, a fraudulent misrepresentation is the legal cause of a monetary loss “only if the loss might reasonably be expected to result from” reliance on the misrepresentation. The Court explained that this analysis “comports with the FCA’s statutory purpose” because it “separates the wheat from the chaff, allowing FCA claims to proceed against parties who can fairly be said to have caused a claim to be presented to the government, while winnowing out those claims with only attenuated links between the defendants’ specific actions and the presentation of the false claim.” (Citation omitted.)  Consequently, the Court overruled its longstanding precedent and joined its sister circuits (including the Third, Fifth, Tenth, and D.C. Circuits), which had adopted proximate causation as the standard for proving causation. Having ruled on the causation standard to apply, the Court remanded the matter to the district court to decide whether the government could establish that Luce’s false certifications, as opposed to the defaults by mortgagors that would have occurred regardless of the certifications, proximately caused the government’s harm. Takeaway In Luce , the Seventh Circuit abandoned its longstanding causation standard for proving damages under the FCA. The decision comes 25 years after the Court adopted its “but-for” standard, which required only a showing that damages would not have occurred if not for the alleged fraudulent conduct. As the Court noted in Luce , it had been the outlier among the circuits that had addressed the question. Now, all circuits addressing the issue agree that the plaintiff must demonstrate a causative link between the defendant’s alleged fraudulent conduct and the requested damages – specifically, that the “conduct was a material element and substantial factor in bringing about the injury” and that “the injury is of the type a reasonable person would see as a likely result of the conduct.” By joining the other circuits on the issue, the Seventh Circuit has shifted the pendulum in favor of defendants, making it more difficult for the government and whistleblowers to survive pre-trial motion practice.

On November 2, 2017, the Securities and Exchange Commission (“SEC” or the “Commission”) announced (here) that it had charged Osiris Therapeutics, Inc. (“Osiris” or the “Company”), a Maryland-based biotech company, and four former senior executives with inflating reported revenue growth, improperly recognizing revenue and misleading investors. In its complaint (here), the SEC alleged that Osiris routinely overstated Company performance and issued fraudulent financial statements for a period of nearly two years. According to the SEC, Osiris and its former senior officers artificially inflated the Company’s reported revenue and results of operation, entered into undisclosed side agreements with distributors, improperly recognized revenue in direct contravention of the Company’s accounting policies, lied to Osiris’ independent public accounting firm, and backdated and falsified documents. As alleged, the fraudulent actions complained of were carried out by former Company officers, including Phillip R. Jacoby, Jr. who served as Osiris’ chief financial officer and, subsequently, vice president of finance and principal accounting officer; Gregory I. Law who served as Osiris’ vice president of finance and principal accounting officer and, subsequently, chief financial officer; Lode B. Debrabandere who served as Osiris’ chief executive officer; and Bobby Dwayne Montgomery, who served as Osiris’ general manager of orthopedics and sports medicine and, subsequently, its chief business officer. According to the SEC, throughout 2014 and the first three quarters of 2015, the defendants repeatedly mislead the investing public about Osiris’ financial condition and results of operations. Osiris did so by: (i) prematurely recognizing revenue in periods before sales had been made and critical agreement terms were finalized; (ii) recognizing revenue using higher, inaccurate prices, while disregarding data explicitly showing lower, actual revenue numbers; (iii) recognizing revenue on consignment inventory, directly contradicting Osiris’ disclosed accounting policies; and (iv) prematurely recognizing revenue involving transactions with distributors despite the fact that the Company already had significant accounts receivable with them. As alleged, these accounting practices led to misstatements about Osiris’ revenue, a key financial metric for the Company, which was reported in Osiris’ periodic filings, current reports, and earnings calls. According to the SEC, the fraudulent misstatements and omissions were driven by Osiris’ corporate culture, which was set and communicated by Debrabandere and embraced by Jacoby, Law, and Montgomery. During at least 2014 and the first three quarters of 2015, Osiris was focused on recognizing gross revenue, which Osiris executives and employees often referred to as “top line” revenue. In particular, Debrabandere was focused on demonstrating consistent revenue growth quarter over quarter. When the defendants realized that Osiris’ actual sales were not meeting Debrabandere’s aggressive targets, they engaged in a variety of improper accounting practices to artificially inflate reported revenue. “As alleged in our complaint, Osiris Therapeutics falsely portrayed to investors that its revenue was growing so rapidly that its performance was consistently exceeding expectations,” said Julie Lutz, Director of the SEC’s Denver Regional Office. “Corporate cultures cannot be so fixated on higher revenues that they use illegal accounting gimmicks to meet the financial numbers they desire.” Osiris agreed to settle the charges without admitting or denying the allegations by consenting to the entry of a final judgment, subject to court approval, that permanently restrains and enjoins the Company from violating certain provisions of the federal securities laws, and by agreeing to pay a $1.5 million civil penalty. “We are very pleased to have reached the resolution announced today, which relates to activities that occurred during the tenure of the Company’s former management team,” said Peter Friedli, Chairman of the Board of the Company. “We have instituted broad remedial measures designed to detect and prevent the issues that led to the matter being resolved, and this resolution allows us to continue moving forward with the Company’s critical mission of making advances in the area of cellular and regenerative medicine.” Although the Company settled the charges with the SEC, the litigation continues against Debrabandere, Jacoby, Law, and Montgomery. The SEC is seeking disgorgement of ill-gotten gains plus interest and penalties along with officer-and-director bars. In addition to the SEC action, there is an ongoing investigation by the U.S. Attorney’s Office for the Southern District of New York relating to matters that were also investigated by the SEC. Finally, there are multiple shareholder actions involving the matters resolved by the Company and the SEC: a securities class action pending in the United States District Court for the District of Maryland (Kiran Kumar Nallagonda v. Osiris Therapeutics, Inc., Case No.: 1:15-cv-03562-JFM), alleging violations of the federal securities laws; and a shareholder derivative action pending in the Circuit Court for Howard County in the State of Maryland (Kevin Connelley v. Lode Debrabandere et al ., Case No. 13C16106811), alleging that, in connection with the matters subject to the class action, each of the individual directors and officers named as defendants: (i) violated their fiduciary duties to the Company’s shareholders; (ii) abused their ability to control and influence the Company; (iii) engaged in gross mismanagement of the assets and business of the Company; and (iv) was unjustly enriched at the expense of, and to the detriment of, the Company. This Blog previously wrote about derivative actions here. Takeaway The SEC’s stated mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” (Here.) Although each mission should be a priority, the SEC’s focus is often based on its chair and commissioners and the politics of the day. Former Chair Mary Jo White and Enforcement Division Director Andrew Ceresney viewed enforcement and investor protection to be the agency’s top priority. Based upon his background and pro-business disposition, Jay Clayton, the new chair of the agency and a mergers & acquisitions attorney, is more likely to focus on capital formation as the Commission’s priority. Notwithstanding, there is little reason to believe that the Enforcement Division will stop investigating violations of the federal securities laws. (Here.) The federal securities laws are, after all, intended to protect investors. To that end, they are based on the principle that all investors, whether institutions or individuals, should have access to full and complete material information about a company before they buy its securities, as well as during the period of time in which they hold them. Public company reporting requirements are, therefore, designed to ensure that such information is publicly disseminated so that investors can make an informed decision as to whether to buy, sell or hold a particular security. The SEC charged Osiris and its former executives for failing to provide the transparency required under the federal securities laws.

If a contracting party intends for the obligations under a contract to be executed by a business entity, it is critical that the person executing the contract on behalf of the entity clearly indicate that the contract is being signed in a representative capacity.  This point was recently reiterated in James E. Cayne v. Alexandra Lebenthal , (Sup. Ct. New York Co. October 30, 2017) (the “Action”).  The Defendant in Cayne is Alexandra Lebenthal, CEO of Lebenthal Holdings, LLC f/k/a Alexandra & James LLC (“Holdings”), a wealth management firm, and the daughter of Jim Lebenthal, the former chairman of Lebenthal & Company, a municipal bond brokerage firm. The facts of the Action are simple.  As a result of financial troubles experienced by Holdings, Ms. Lebenthal reached out to an old family friend, plaintiff, James E. Cayne, the former CEO and Chairman of the Board of Bear Stearns, and asked for a $1,000,000 loan, which request Mr. Cayne obliged (the “Loan”).  The Loan proceeds were delivered to Ms. Lebenthal by way of a check made payable to “Alexandra Lebenthal” (the “Check”).  Shortly thereafter, Ms. Lebenthal executed a promissory note in the amount of $1,000,000 (the “Note”).  Underneath the signature line of the Note, was Ms. Lebenthal’s name and Holdings’ address. After numerous payments were made on the Loan by check drawn on Holdings’ account, the payments ceased.  After Mr. Cayne agreed to several requests for payment accommodations, Ms. Lebenthal stated that no further payments under the Loan were forthcoming.  Ms. Lebenthal further advised that she deemed the repayment of the Loan to be the sole obligation of financially strapped Holdings.  Shortly thereafter the Action was commenced by Mr. Cayne. Mr. Cayne moved for summary judgment, arguing that Ms. Lebenthal defaulted under the Loan.  The Court found that Mr. Cayne satisfied the burden of proof on his prima facie case, by submitting to the Court: a copy of tPhe written “Instruction to Pay” form by which Mr. Cayne requested that a $1,000,000 check made payable to “Alexandria Lebenthal” be drawn on his Bear Stearns brokerage account; a copy of an invoice for accrued interest, listing “Alexandria Lebenthal” as borrower; and, a copy of a check for quarterly interest (drawn on Holdings’ account). In opposition, Ms. Lebenthal argued, among other things, that at all times she was acting in a representative capacity as the Loan was made to Holdings as evidenced by the fact that: in her initial discussions about the Loan, Ms. Lebenthal advised Mr. Cayne that Holdings was in the need of capital; initially, when the funds were going to be wire transferred, the instructions indicated that the deposit was to be made to Holdings’ operating account (although the Loan was ultimately funded by the Check); the Check was deposited into Holdings’ bank account; the address under the signature line of the Note was that of Holdings; interest invoices were sent by Mr. Cayne to Ms. Lebenthal at Holdings’ business address; the payments that were made on the Loan were made checks drawn on Holdings’ bank account; and, Cayne sent a Loan related letter addressed to “Alexandra Lebenthal, Lebenthal Holdings, LLC” at Holdings’ new offices. In granting summary judgment to Mr. Cayne, the Cayne Court stated: To bolster claim, submits a copy of the … ote with her signature affixed to the bottom noting that the address listed on the … ote is that of .  It is notable that no part of this document indicates that is signing on behalf of the or in her capacity as the company’s CEO. In looking at the four corners of all the documentary evidence, the oan was made to and by in her personal capacity and not as … one to her business.  offers no evidence to support the position that the oan was a corporate debt rather than a personal one.  The language of all documents evidencing the oan are clear and unambiguous, and defendant’s parole evidence that parties agreed that the oan was for the company is inadmissible to vary its terms. Accordingly, the Cayne Court entered judgment against Ms. Lebenthal in the amount of $438,680.69, plus interest and costs, and set the matter down for a hearing on reasonable attorney’s fees. TAKEAWAY No one wants to be held personally liable for the obligations of a business entity, whether as an owner or employee.  It is of critical importance, therefore, that anyone entering into a contract on behalf of a business entity make clear that they are acting in a representative capacity.  This objective easily can be accomplished by including in the signature block of a contract, the entity’s name and the signatory’s title with the entity.  In many situations, a personal guaranty may be requested from a business owner.  In such circumstances, an informed decision can be made as to whether the business owner is prepared to be exposed to personal liability for the obligations of the entity.  A business owner or employee should not, however, unwittingly be exposed to personal liability through inadvertence or a lack of attention to detail (as may have been the case in Cayne) by failing to enter into a contract in a representative capacity. Similar issues were addressed in the following article previously appearing on this Blog: https://fhnylaw.com/third-parties-beware-agent-not-disclose-identity-principal/

Preliminary injunctions can be an important and potent weapon in business and commercial litigation.  In New York, “ preliminary injunction may be granted … where it appears that the defendant threatens or is about to do … an act in violation of the plaintiff’s rights” with regard to the subject matter of the action, and which “render the judgment ineffectual ….” CPLR 6301. Whether to grant a preliminary injunction lies within the sound discretion of the court.  Doe v. Axelrod , 73 N.Y.2d 748, 750 (1988); Zoller v. HSBC Mtge. Corp. (USA) , 135 A.D.3d 932, 933 (2d Dept. 2016). The movant must, therefore, show entitlement to preliminary injunctive relief by demonstrating (with clear and convincing evidence) satisfaction of the following: (1) probability of success on the merits; (2) irreparable harm absent the injunction; and (3) the balance of the equities favoring the relief sought. Zoller , 135 A.D.3d at 933; W. T. Grant Co. v. Srogi , 52 N.Y.2d 496, 517 (1981). “ bsent extraordinary circumstances, a preliminary injunction will not issue where to do so would grant the movant the ultimate relief to which he or she would be entitled in a final judgment.” SHS Baisley, LLC v. Res Land, Inc. , 18 A.D.3d 727, 728 (2d Dept. 2005); see also Board of Mgrs. of Wharfside Condominium v. Nehrich , 73 A.D.3d 822, 824 (2d Dept. 2010). Likelihood of Success on the Merits Success on the merits does not mean certainty of success. Indeed, certainty of success is not the standard; instead, the movant must establish that it is likely to succeed on the merits of the claim. In this regard, the movant must demonstrate its right to the relief, though the evidence submitted need not be conclusive. Terrell v. Terrell , 279 A.D.2d 301 (1st Dept. 2001); McLaughlin, Piven, Vogel v. Nolan & Co. , 114 A.D.2d 165, 172-173 (2d Dept.) (“ s to the likelihood of success on the merits, a prima facie showing of a right to relief is sufficient; actual proof of the case should be left to further court proceedings”), lv. denied , 67 N.Y.2d 606 (2d Dept. 1986). Notably, issues of fact are insufficient to defeat the motion. See CPLR 6312(c) (providing that issues of fact identified in opposition to the application are insufficient to defeat the motion and “shall not in itself be grounds for denial of the motion.”). But, the movant must nevertheless show a clear right to relief which is plain from the undisputed facts. Matter of Related Prop., Inc. v Town Bd. of Town/Village of Harrison , 22 A.D.3d 587 (2d Dept. 2005). Irreparable Harm Irreparable injury, for purposes of the second prong, means an injury for which money damages are insufficient. Walsh v. Design Concepts, Ltd. , 221 A.D.2d 454, 455 (2d Dept. 1995); McLaughlin , 114 A.D.2d at 174. See also Sterling Fifth Assoc. v. Carpentille Corp., Inc. , 5 A.D.3d 328, 330 (1st Dept. 2004)). The injury claimed must be direct and concrete . Rowland v. Dushin , 82 A.D.3d 738 (2d Dept, 2011) (noting that preliminary injunctive relief is not appropriate where the irreparable harm claimed is remote or speculative); Family-Friendly Media, Inc. v. Recorder Tel. Network , 74A.D.3d 738 (2d Dept. 2010). Satisfying this prong can be the most difficult of the three because most plaintiffs seek monetary damages. Consequently, courts will deny a motion for a preliminary injunction where the movant has an adequate remedy at law. E.g. , Dana Distr., Inc. v. Crown Imports, LLC , 48 A.D.3d 613 (2d Dept. 2008) (“Where, as here, a litigant can fully be recompensed by a monetary award, a preliminary injunction will not issue.”). There are two exceptions to the general rule. First, when the subject matter of the case concerns a specific fund, courts will find irreparable injury even though the plaintiff seeks monetary relief. In these cases, the courts grant the injunction because there is harm to the property, not to the value of the property. Genger v. Genger , 2010 NY Slip Op. 33929 (Sup. Ct. N.Y. County July 2, 2010); Ma v. Lien , 198 A.D.2d 186, 604 N.Y.S.2d 84 (1st Dept. 1993) (holding that if “the requested relief is not granted, a substantial amount of money may be dissipated or otherwise unavailable for recovery”). Second, courts will issue a preliminary injunction when such relief is authorized by statute and is in the public interest. People v. Empire Prop. Solutions, LLC , 2012 NY Slip Op. 30346 (Sup. Ct. Nassau County Jan. 27, 2012); Spitzer v. Lev , ___ Misc.3d. ___, 2003 WL 21649444, at *2 (Sup. Ct. N.Y. County 2003) (noting that “when the Attorney General is authorized by statute to seek injunctive relief to enjoin fraudulent or illegal acts, no showing of irreparable harm is necessary.”); State of New York v. Terry Buick Inc. , 137 Misc. 2d 290 (Sup. Ct. Dutchess County Oct. 9, 1987). As the Empire Prop . court noted, “the irreparable injury to be enjoined is an injury to the public, which need not be focused upon an individual to be actionable.” Balance of Equities To satisfy the third prong of the preliminary injunction standard, the movant must establish that the injury it would sustain is more burdensome to it than the harm that would be caused to the non-movant through the imposition of the injunction. Winter Bros. Recycling Corp. v. Jet Sanitation Serv. Corp. , 23 Misc. 3d 1115 , 2009 NY Slip Op. 50753 (Sup. Ct. Nassau County Mar. 13, 2009); Fischer v. Deitsch , 168 A.D.2d 599, 601 (2d Dept. 1990). Conclusory assertions will not suffice to satisfy this prong. A fact-based, client affidavit is critical to the success of the application. Posting an Undertaking CPLR 6312(b) requires the movant to post a bond contemporaneously with the issuance of a preliminary injunction order. The amount to be posted is a matter within the sound discretion of the court. Lelekakis v. Kamamis , 303 A.D.2d 380, 380 (2d Dept. 2003). However, the amount of the undertaking must be rationally related to the amount of the non-movant’s potential liability if the preliminary injunction later proves to be unwarranted. Id . at 381. The purpose of the undertaking therefore is to secure for the non-movant the actual losses and costs – not theoretical losses, “if it is later finally determined that the preliminary injunction was erroneously granted.” Id . at 380. Mere conclusory assertions of potential monetary loss are insufficient to justify anything more than a minimal bond. 7th Sense, Inc. v. Liu , 220 A.D.2d 215, 217 (1st Dept. 1995). JSC VTB Bank v. Mavlyanov As noted above, demonstrating irreparable injury can be the most difficult of the three prongs to satisfy. In JSC VTB Bank v. Mavlyanov , 2017 NY Slip Op. 07339 (1st Dept. Oct. 19, 2017), decided by the Appellate Division, First Department, on October 19, 2017, the plaintiff learned this lesson the hard way. JSC VTB Bank involved an alleged fraudulent conveyance by the defendant Igor Mavlyanov (“Mavlyanov”) in violation of New York Debtor and Creditor Law Article 10 (N.Y. DCL §§ 270, et seq.). The plaintiff, JSC VTB Bank (“VTB” or the “Bank”), a Russian bank, alleged that Mavlyanov transferred real and/or personal property in the United States while purportedly owing more than $30 million to the Bank. VTB sought to set aside and void the alleged fraudulent transfers between Mavlyanov and his immediate family and close associates or, alternatively, for money damages. According to the Bank, VTB had extended loans to a non-party under two facility agreements (the “Facility Agreements”). Mavlyanov personally guaranteed all principal and interest due under the Facility Agreements (the “Guarantees”). The recipient of the loans defaulted on its obligations and Mavlyanov refused, upon demand by VTB, to honor his obligations under the Guarantees. VTB commenced an action against Mavlyanov on the Guarantees in Russia. The Russian court ruled in favor of VTB and judgments on the Guarantees were issued, which awarded VTB rub. 2,245,899,146.78 (approximately $34,000,000) in damages and court costs. Thereafter, VTB filed the action in New York, alleging that Maylyanov took a number of actions to thwart collection under the Russian judgment. In this regard, the Bank alleged that unbeknownst to it, Mavlyanov transferred all of his real property located in New York and California after executing the Guarantees. Mavlyanov also transferred numerous properties located in Russia to his wife, Defendant Stella Mavlyanova, all within a four-week period just prior to the default under the Facility Agreements. According to VTB, the conveyances involved, among other things, transfers to immediate family and close associates, a lack of fair consideration, knowledge of VTB’s claims under the Guarantees, suspicious transfers not within the usual course of business, Mavlyanov’s continued retention and use of the properties, and the use of “dummy” or “sham” entities. VTB alleged that the Defendants’ conduct had placed the properties outside the reach of VTB as a creditor and a judgment creditor. As a result, VTB sought a temporary restraining order, preliminary injunction and an attachment of the property claiming that there was a significant risk that the Defendants would continue to transfer or encumber the transferred properties and that Mavlyanov or the other Defendants would divert additional assets to avoid paying on the Russian judgments or on an ultimate judgment in the New York action. The motion court, which had previously granted VTB’s motion for a temporary restraining order, granted in part the Bank’s motion for a preliminary injunction and attachment, but fixed the amount of the undertaking at $25 million, which at the time of the appeal had not been posted. The Defendants’ appealed, arguing that the motion court’s order should be reversed on the grounds that, among other things, VTB failed to establish: (1) a likelihood of success on the merits of its underlying fraudulent conveyance claims; (2) the irreparable injury required for an order granting injunctive relief or an attachment; and (3) a balance of equities in its favor. The First Department’s Ruling The First Department unanimously modified the motion court’s ruling, reversing the grant of the preliminary injunction, vacating the attachment of properties, and reducing the undertaking ordered in connection with the temporary restraining order to $1 million. With regard to the preliminary injunction, the Court held that “on the merits, the court should not have granted” it, “because the primary relief sought in this action is money damages.” The Court noted that “ ven if this were an appropriate case for an injunction, the injunction should not be granted, because the fact that plaintiff can be fully compensated by damages shows that he would not suffer irreparable injury absent the injunction.” Takeaway “Preliminary injunctive relief is a drastic remedy and will only be granted if the movant establishes a clear right to it under the law and the undisputed facts found in the moving papers.” Koultukis v. Phillips , 285 A.D.2d 433, 435 (1st Dept. 2001). Because it is “a drastic remedy” it “should be used sparingly.” Fischer v. Deitsch , 168 A.D.2d 599, 601 (2d Dept. 1990). For this reason, the showing of irreparable harm is the most difficult element to demonstrate for obtaining injunctive relief under New York law. And in this regard, the courts are clear that the harm will not be considered irreparable if it can be redressed with monetary damages. As noted above, VTB learned just how hard it is to demonstrate irreparable harm.

Parties to commercial and business disputes frequently encounter and litigate the threshold question whether their dispute must be arbitrated rather than litigated in court. But, before this question can be answered, there is an even more fundamental question that must be resolved: who decides whether a dispute is subject to arbitration – the court or the arbitrator? Courts have struggled with this question for years and continue to do so today. Generally, whether a claim is subject to arbitration is a decision for the court, not the arbitrator. See Primex Int’l Corp. v. Wal-Mart Stores, Inc. , 89 N.Y.2d 594, 598 (1997) (affirming trial court ruling that “whether there is a clear, unequivocal and extant agreement to arbitrate the claims, is for the court and not the arbitrator to determine . ”); Smith Barney Shearson Inc. v. Sacharow , 91 N.Y.2d 39, 45-46 (1997) (noting “well-settled proposition that the question of arbitrability is an issue generally for judicial determination in the first instance.”) (citing cases). Notwithstanding, the U.S. Supreme Court has held that “parties can agree to arbitrate ‘gateway’ questions of ‘arbitrability.’” Rent-A-Center, West, Inc. v. Jackson , 561 U.S. 63, 68-9 (2010). (For a discussion of Rent-A-Center, see here .) Such “delegation clauses” are enforceable where “there is ‘clea and unmistakabl ’ evidence” that the parties intended to arbitrate arbitrability issues. First Options of Chicago, Inc. v. Kaplan , 514 U.S. 938, 943, 944 (1995), quoting AT&T Technologies, Inc. v. Communications Workers , 475 U.S. 643, 649 (1986). “When deciding whether the parties agreed to arbitrate a certain matter (including arbitrability), courts generally . . . should apply ordinary state-law principles that govern the formation of contracts.” First Options of Chicago, Inc. , 514 U.S. at 944. Courts in New York follow the foregoing principles and will not take the issue of arbitrability away from the arbitrator when the parties specifically provide as such. Matter of Monarch Consulting, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA , 26 N.Y.3d 659, 676-677 (2016); Life Receivables Trust v. Goshawk Syndicate 102 at Lloyd’s , 66 A.D.3d 495, 495 (1st Dep’t 2009). This approach reflects the “overarching principle of law ‘that arbitration is a matter of contract’” and that “courts must rigorously enforce arbitration agreements according to their terms.” Monarch Consulting , 26 N.Y.3d at 675, quoting American Express Co. v. Italian Colors Restaurant , 133 S.Ct. 2304, 2309 (2013). Thus, where a contract contains a valid delegation to the arbitrator of the power to determine arbitrability, such a clause will be enforced absent a specific challenge to the delegation clause by the party resisting arbitration.   Monarch Consulting , 26 N.Y.3d at 675-76. This Blog previously discussed the issue here . On October 12, 2017, the New York Court of Appeals issued Garthon Bus. Inc. v. Stein , 2017 NY Slip Op. 07160 , in which it held, in a tersely written decision, that the gateway issue of arbitrability should be determined by the arbitrator where “the terms of the parties’ final agreements . . . incorporated the rules of the” arbitral forum. In Garthon , the parties incorporated into their agreement the rules of the London Court of International Arbitration (“LCIA”), which provides, in pertinent part, that “ he Arbitral Tribunal shall have the power to rule upon its own jurisdiction and authority, including any objection to the initial or continuing existence, validity, effectiveness or scope of the Arbitration Agreement.” In so holding, the Court reversed the decision of the Appellate Division, First Department, which held (with two justices dissenting) that the parties’ incorporation of the LCIA Rules was insufficient to demonstrate a “clear and unmistakable” intent to have the arbitrator determine the arbitrability of the parties’ dispute. Garthon Bus. Inc. v. Stein , 138 A.D.3d 587, 593 (1st Dept. 2016). The First Department reasoned that under the circumstances, where the “agreements containing … arbitration clauses…, directly clash with an enforceable forum selection clause in a separate agreement relevant to the parties’ dispute,” it could not be said “with any degree of certainty that the parties clearly and unmistakably intended for the chosen arbitral body to decide the particular issue presented to us.” As a consequence, the court declined to let the arbitrators decide the issue of arbitrability even though the agreement to arbitrate incorporated the arbitral body’s rules which reserved the gateway issue of arbitrability to itself. (A copy of the First Department’s decision can be found here .) Takeaway Since First Options of Chicago , arbitration associations have amended their rules to provide that the arbitrator has the power to decide whether a given dispute is arbitrable. When parties incorporate the rules of the arbitration association into their contract, they are, therefore, delegating to the arbitrator the jurisdiction to decide the issue of arbitrability of the matter. Garthon confirms that broadly worded arbitration clauses, which incorporate a set of arbitration rules and confers upon the arbitrator the power to determine his/her own jurisdiction, will be enforced according to their terms. Garthon also teaches that unless parties want to arbitrate whether a given dispute is arbitrable, they should specifically address in the arbitration clause the question of who will determine whether the dispute is arbitrable. Failure to do so can lead to expensive litigation or lead to results the parties never intended.