After the 2016 presidential election, President Trump promised to dismantle the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), and the regulations promulgated thereunder. ( Here .) The president, however, was silent on whether he intended to alter the Securities and Exchange Commission’s whistleblower program. ( Here .) Last year, House Financial Services Committee Chairman Jeb Hensarling sponsored the Financial CHOICE Act , as a road map for the president’s promised effort to repeal the Dodd-Frank Act. In February of this year, Chairman Hensarling circulated a memo to senior members of the committee in which he outlined changes to the act, which includes a number of provisions that would impact the SEC and its enforcement program. On April 19, 2017, Chairman Hensarling released an updated version of the Financial CHOICE Act (“CHOICE Act 2.0”), a discussion draft that builds on the previous version of the bill (H.R.5983 in the 114th Congress). Large portions of the legislative text remain unchanged from the original version of the act, though the CHOICE Act 2.0 provides more regulatory relief than its predecessor.  Notably, version 2.0 includes a provision that bars “co-conspirators” from recovering whistleblower awards. On April 26, 2017, the Financial Services Committee commenced hearings to discuss the amended and updated version of the act. The bill is expected to be marked-up in early-May. Under the SEC’s whistleblower program, a person who provides “original information” that the SEC uses in furtherance of an enforcement action can recover a reward of between 10% – 30% of the total amount of money collected by the SEC. In creating the whistleblower provisions under the Dodd-Frank Act, Congress recognized that employees with knowledge of a securities or commodities law violation often are participants in that violation.  Consequently, to further the purposes of the program, participants in the violation are eligible to receive an award as long as they are not convicted of criminal conduct relating to the violation. Observers have noted that there is sufficient support in the House Financial Services Committee and the House to pass the CHOICE Act 2.0. However, passage of the bill in the Senate is less certain given Democratic opposition. Takeaway Barring rewards to whistleblowers who may be complicit in alleged wrongdoing is inimical to the SEC’s enforcement objectives.  Indeed, whistleblowers who come forward with original information about a violation of the securities laws should be encouraged, not discouraged, from doing so, even if they may have participated in the wrongdoing. Often, the information possessed by these individuals is valuable to law enforcement authorities, who, without the whistleblower, would not have known of the alleged violation. Therefore, by encouraging individuals who may have participated in the violation, but who are not criminally culpable, to come forward with information, the SEC can further its mission to protect investors and the financial markets. This Blog will continue to monitor developments related to the CHOICE Act 2.0 as the proposed bill moves through the committee and Congress.

The False Claims Act (“FCA” or the “Act”) prohibits businesses and individuals from defrauding the government by knowingly presenting, or causing to be presented, a false claim for payment or approval. The FCA serves as the foundation upon which the states have structured their false claims act statutes. Notably, the FCA does not cover tax fraud and securities/commodities fraud. Blowing the whistle on tax fraud is covered by the Tax Relief and Health Care Act of 2006, and blowing the whistle on securities/commodities fraud is covered by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Both acts offer whistleblowers the opportunity to report violations of the tax and securities/commodities laws and receive a reward for helping the government recover the money lost due to fraud or other illegal conduct. The FCA has proven to be one of the most effective laws to recover money that has been taken from the government through fraud. The Act encourages individuals with knowledge of fraud against the government to come forward by authorizing them to file an action in the name of the government, and by rewarding them with a percentage of any recovery achieved by that lawsuit. A person who brings a successful “qui tam” action can receive between 15% and 30% of the government’s recovery depending upon whether the government intervenes in the action. If the government intervenes, the award generally falls between 15% and 25% of the government’s recovery. If the government declines to intervene and the whistleblower pursues the action alone, the award generally falls between 25% and 30% of the government’s recovery. The New York False Claims Act In 2007, New York passed its own false claims act statute (“NYFCA”). The NYFCA largely tracks the language of the federal FCA. In that regard, it imposes liability on a defendant for knowingly presenting false or fraudulent claims for payment/approval and making or using false records or statements material to a false or fraudulent claim. Like the federal FCA, treble damages are available, the knowledge requirement can be satisfied by showing recklessness, and whistleblowers can receive a portion of any recovery obtained by the state. In 2010, the legislature amended the NYFCA. For relators, the amendments relaxed the pleading requirements. Relators no longer need to allege fraud with particularity. Instead, a complaint will withstand a dismissal motion “if the facts alleged in the complaint, if ultimately proven true, would provide a reasonable indication of one or more violations . . . and if the allegations in the pleading provide adequate notice of the specific nature of the alleged misconduct.” The amendments also simplified the statute of limitations by extending it to 10 years without qualification; previously it had been six years, or three years if the government had actual or constructive knowledge of the violation. Notably, unlike the FCA, which, as noted, excludes false claims related to tax fraud, the New York amendments include such claims. Under the amended act, individuals and businesses with more than $1 million in net income or sales may be liable for tax fraud if the damages resulting from their improper tax filings amount to at least $350,000. $40 Million Settlement with Harbert Management Corporation for Tax Violations On April 18, 2017 ( i.e. , tax day), New York Attorney General Eric T. Schneiderman announced a $40 million settlement with Alabama-based Harbert Management Corporation (“Harbert Management” or “HMC”) and top executives at the firm in connection with allegations that HMC’s investment firm, Harbinger Capital Partners (“Harbinger Capital”), a $26 billion hedge fund based in New York City, failed to pay millions of dollars in New York State tax on performance income for several years. The settlement resolves claims that were brought by a whistleblower under the NYFCA. “Our investigation uncovered a brazen and deliberate decision to avoid paying millions in taxes owed to New York State,” said Attorney General Schneiderman. “Harbert Management made a clear choice to skirt the rules and as a result, ordinary New York taxpayers were left footing the bill. On tax day, this sends a forceful reminder to businesses that if they think they can get away with tax evasion in New York, they should think again.” When businesses operate both inside and out of New York City and New York State, they must apportion for tax purposes the part of their income derived from or connected with New York.  According to Schneiderman, in 2001, Harbert Management sponsored and organized the New York-based Harbinger Capital Partners Master Fund I Limited hedge fund (“Harbinger Fund”), and hired Philip Falcone as its primary investment decision-maker. Harbinger Capital Partners Offshore Manager LLC (“Offshore Manger”) served as the investment manager for the Harbinger Fund from 2002 through 2009. As investment manager, Offshore Manager earned a performance fee income equal to 20 percent of the Harbinger Fund’s net profits. Offshore Manager’s members, which included several senior executives at Harbert Management, were required to pay New York State income tax on this performance fee income. According to the New York AG, they did not. Schneiderman noted that in 2005, the individuals at issue were advised by outside accounting professionals that New York tax would be due on the fee income earned during 2004, despite the fact that some of them lived and worked in Alabama. Notwithstanding, Offshore Manager apportioned all performance fee income to the lower-tax state of Alabama, where Harbert Management’s headquarters were located and where back office and support functions for the Harbinger Fund were conducted. During the ensuing tax years (in particular, 2005, 2008 and 2009), Offshore Manager continued to file returns that failed to report any nexus to, or performance income derived from, activities performed in New York. Not surprisingly, Offshore Manager did not correct any of these tax filings, even as the Harbinger Fund became more successful, and the New York investment team grew larger. As noted, the settlement resolves claims that were initially brought by a whistleblower. The whistleblower, whose identity remains protected, will receive 22 percent of the settlement ($8.8 million), the largest amount and percentage share ever for a whistleblower in a NYFCA case not involving Medicaid. A copy of the settlement can be found here .

Litigants and their attorneys who fail to comply with discovery demands and/or discovery orders do so at their peril. Such non-compliance can lead to penalties and sanctions, especially when the non-compliance arises from deliberate behavior. When a party deliberately fails to comply with discovery demands and/or discovery orders, the requesting party may file a motion to compel compliance pursuant to Section 3124 of the Civil Practice Rules and Procedure (“CPLR”) or a motion to preclude evidence pursuant to CPLR 3126. A motion under CPLR 3126 may result in an order against the recalcitrant party, including preclusion of evidence in support of, or in opposition to, a claim or defense, or striking all or part of a pleading. While striking a pleading is a drastic remedy, the courts in New York will do so when the non-compliant party demonstrates a willful or contemptuous pattern of behavior. New York appellate courts have repeatedly granted preclusive relief under CPLR 3126 as a means of addressing recalcitrant parties who fail to comply with discovery demands and/or discovery orders. E.g. , Flax v. Standard Sec. Life Ins. Co. of N.Y. , 150 A.D.2d 894 (3d Dept. 1989) (holding that the plaintiff’s failure to comply with a preclusion order requiring him to file a verified and responsive bill of particulars entitled the defendants to a dismissal of the entire complaint); Neveloff v. Faxton Children’s Hospital & Rehabilitation Center , 227 A.D.2d 457, 458 (2d Dept. 1996); Figdor v. City of New York , 33 A.D.3d 560 (1st Dept. 2006); Brandenburg v. County of Rockland Sewer Dist. #1, State of N.Y. , 127 A.D.3d 680, 681 (2d Dept. 2015); Shah v. Oral Cancer Prevention Intl., Inc. , 138 A.D.3d 722 (2d Dept. 2016); Lucas v. Stam , 147 A.D.3d 921 (2d Dept. Mar. 29, 2017). In doing so, they have “encourage the courts to employ a more proactive approach … upon learning that a party has repeatedly failed to comply with discovery orders. . . .” Figdor , 33 A.D.3d at 560. This “more proactive approach” comports with the concerns expressed by the New York Court of Appeals not too long ago about the impact of dilatory tactics on the functioning of the court system and the adjudication of claims: …there is also a compelling need for courts to require compliance with enforcement orders if the authority of the courts is to be respected by the bar, litigants and the public.                                                      *** As this Court has repeatedly emphasized, our court system is dependent on all parties engaged in litigation abiding by the rules of proper practice. The failure to comply with deadlines not only impairs the efficient functioning of the courts and the adjudication of claims, but it places jurists unnecessarily in the position of having to order enforcement remedies to respond to the delinquent conduct of members of the bar, often to the detriment of the litigants they represent. Chronic noncompliance with deadlines breeds disrespect for the dictates of the Civil Practice Law and Rules and a culture in which cases can linger for years without resolution. Furthermore, those lawyers who engage their best efforts to comply with practice rules are also effectively penalized because they must somehow explain to their clients why they cannot secure timely responses from recalcitrant adversaries, which leads to the erosion of their attorney-client relationships as well. For these reasons, it is important to adhere to the position we declared a decade ago that “ f the credibility of court orders and the integrity of our judicial system are to be maintained, a litigant cannot ignore court orders with impunity.” Gibbs v. St. Barnabas Hosp. , 16 N.Y.3d 74, 81 (2010) (quoting Kihl v. Pfeffer , 94 N.Y.2d 118, 123 (1999). On April 12, 2017, the Appellate Division, Second Department continued the trend of sanctioning willful and contumacious behavior. In Mears v. Long , 2017 NY Slip Op. 02782 , the Court affirmed the order of the motion court granting the plaintiffs’ motion to strike the defendants’ answer and for leave to enter a default judgment against them based on their failure to comply with court-ordered discovery. In doing so, the Court explained: The nature and degree of the sanction to be imposed on a motion pursuant to CPLR 3126 is within the broad discretion of the motion court. The striking of a pleading may be appropriate where there is a clear showing that the failure to comply with discovery demands or court-ordered discovery is willful and contumacious. The willful and contumacious character of a party’s conduct can be inferred from the party’s repeated failure to comply with discovery demands or orders without a reasonable excuse. Here, the defendants’ willful and contumacious conduct can be inferred from their repeated failures, without an adequate excuse, to comply with discovery demands and the Supreme Court’s discovery orders. Accordingly, the court providently exercised its discretion in granting the plaintiffs’ motion pursuant to CPLR 3126 to strike the defendants’ answer and for leave to enter a default judgment against the defendants. Internal citations omitted. Takeaway As the Court of Appeals observed in Gibbs , the legal system depends upon the parties’ compliance with the rules of practice and the court’s orders. A party’s failure to comply with deadlines and orders “not only impairs the efficient functioning of the courts”, but also jeopardizes a party’s ability to support or oppose the claims and defenses in the action. Mears reinforces these principles and warns that willful and contumacious behavior will not be countenanced by the courts.

Last year, this Blog wrote about the importance of assigning title to, or ownership in, a claim, when assigning the right to pursue an action to another party. ( Here .) Recently, the issue arose in connection with an action alleging, among other things, fraud and negligent misrepresentation in connection with the purchase and sale of residential mortgage-backed securities (“RMBS”). On April 12, 2017, in Royal Park Investments SA/NV v. Morgan Stanley ( here ), Justice Charles E. Ramos of the Supreme Court, New York County, Commercial Division, dismissed with prejudice four complaints filed by Royal Park Investments SA/NV (“Royal Park”) against Morgan Stanley and other investment banking firms because the tort claims alleged by Royal Park had not been properly assigned to it. Background The action arose out the purchase of RMBS by Fortis Bank (“Fortis”) and certain affiliates of the bank between January 12, 2005 and July 27, 2007. Fortis Bank was a sophisticated financial institution that extensively invested in the RMBS market. In 2007, Fortis began to experience significant financial trouble, as a result of its exposure to U.S. structured credit assets. On May 12, 2009, Royal Park acquired Fortis and, in connection with the transaction, entered into a Portfolio Transfer Agreement (“PTA”), pursuant to which Royal Park acquired from Fortis the RMBS that were structured, marketed, and/or sold by the defendants between 2005 to 2007. Royal Park maintained that in the offering documents provided to Fortis, Morgan Stanley (and the other banks) failed to disclose and affirmatively misrepresented material information regarding the nature and credit quality of the loans underlying the RMBS and used the offering documents to defraud it and its assignors into purchasing “investment grade” securities at inflated prices. The defendants moved to dismiss the complaints on the ground that Royal Park lacked standing to sue because the PTA did not assign Royal Park any non-contractual claims. The Motion Court’s Ruling Justice Ramos granted the motions to dismiss, holding that the PTA lacked any language transferring tort claims to Royal Park: It is well settled in New York, that the right to assert a fraud claim related to a contract or note does not automatically transfer with the respective contract or note. There must be some language that evinces an intent to transfer fraud claims. *** Here, it is undisputed that the PTA transfers to RPI all rights, title, and interest in and to the Portfolio Property, which is expressly limited to contractual rights and obligations. *** There is simply no language in the documents evidencing an outward expression of an intent to assign the tort claims at issue. Contrary to RPI’s assertions, the above-mentioned language of rights, title, and interest in and to the Portfolio Property reveals no verifiable intention to include tort claims. Internal citations omitted. Since the Court found the PTA to be clear and unambiguous, it refused to examine any extrinsic evidence to demonstrate the intent of the parties, especially since the purpose of doing so was “to create an ambiguity in the PTA when none exists.”  As the Court noted, given the sophistication of the parties and their counsel, if the parties “intended to assign non-contractual claims, they would have done so through express language.” Justice Ramos found that they had not done so. Takeaway Two lessons flow from Royal Park : 1) the right to assert a fraud claim related to a contract or note does not automatically transfer with the respective contract or note. There must be some language that evinces an intent to transfer fraud claims; and 2) where the assignment pertains to a contract or note, the court will examine the contract or note to determine whether it is complete, clear, and unambiguous, and if so it will enforce the agreement according to the plain meaning of its terms.

Last month, the Fifth Circuit issued U.S. ex rel Abbott v. BP Exploration and Production, Inc . , --- F.3d ---, 2017 WL 992506 (5th Cir. Mar. 14, 2017), a decision in which it applied the materiality standard set forth by the Supreme Court in Universal Health Services, Inc. v. United States ex rel. Escobar , 136 S. Ct. 1989 (2016) (discussed here ), to dismiss a qui tam action using the implied certification theory as the basis for liability. In doing so, the Fifth Circuit joined the First ,  Seventh ,  Eighth , and  Ninth  Circuits in issuing post- Escobar rulings. Background Kenneth Abbott (“Abbott”), a former BP administrative employee, claimed that BP falsely certified compliance with various safety regulations applicable to the construction and maintenance of its Atlantis Platform (“Atlantis”), a semi-submersible oil production facility in the Gulf of Mexico. Abbott alleged that without the false certifications, the Atlantis would not have been approved. Abbott filed a complaint under the False Claims Act (“FCA”) and sought over $200 billion in damages. The government declined to intervene. As a result of his lawsuit, the Department of the Interior (“DOI”) began reviewing BP’s compliance with the regulatory requirements identified by Abbott. In a detailed report, the DOI found Abbott’s claims to be both “unfounded” and “without merit.” Consequently, the DOI concluded that there “no grounds for suspending the operations of the Atlantis . . . or revoking BP’s designation as an operator . . ..” Despite the DOI’s findings, Abbott continued with his qui tam action. Following discovery, the district court granted summary judgment in BP’s favor on all claims, describing BP’s alleged misconduct as “paperwork wrinkles,” which could not have affected the government’s decision to pay. U.S. ex rel. Abbott v. BP Exploration and Production, Inc. , Case No. 4:09-CV-01193 (S.D. Tx. Aug. 21, 2014) (ECF No. 431). Abbott appealed. The Fifth Circuit’s Ruling In affirming the district court’s ruling, the Fifth Circuit found that the regulatory violations cited by Abbott were immaterial to the government’s decision to pay the claims. In doing so, the Court explained that the FCA’s materiality standard is “demanding” and noted that the Supreme Court “debunked the notion that a Governmental designation of compliance as a condition of payment by itself is sufficient to prove materiality.” Consequently, it was necessary to consider whether the government’s payment was dependent upon regulatory compliance – that is, for example, whether the government paid the claim with knowledge of the regulatory violation. Applying the foregoing analysis, the Court found that although the government did not know of BP’s alleged regulatory violations when it paid the claims, compliance with the regulations was not material to the government’s decision to pay: hen the DOI decided to allow the Atlantis to continue drilling after a substantial investigation into Plaintiffs’ allegations, that decision represents “strong evidence” that the requirements in those regulations are not material. These “strong facts” have not been rebutted by Plaintiffs’ evidence such that Plaintiffs have failed to create a genuine dispute of material fact as to materiality. The district court therefore correctly granted summary judgment on the FCA claims in favor of BP. Takeaway At the time of its issuance, Escobar was largely considered to be a victory for the United States and whistleblowers using the implied certification theory of liability to fight fraud under the FCA. Though the Supreme Court recognized the viability of the theory, it nevertheless limited the reach of the theory by instructing the lower courts to strictly enforce “the ’s materiality and scienter requirements.” Although the Supreme Court did not provide a test for materiality under the FCA, it reminded the lower courts that the standard was “familiar and rigorous,” “demanding” and not “too fact intensive”. In the short time since the Supreme Court decided Escobar , many circuit courts have applied Escobar to limit the reach of implied certification cases by rejecting claims asserted by relators who cannot establish materiality or satisfy the scienter requirement. Abbott falls within this trend. Apart from falling in line with other circuit courts, Abbott is important for its use of post-payment evidence to show that that alleged noncompliance was not material to the government’s decision to pay claims. As such, FCA Defendants should find Abbott to be a powerful resource to secure dismissal of implied certification cases brought against them.

The limited liability company (“LLC”) is a relatively new business form that combines features of a corporation (a separate legal entity and limited liability) and those of a partnership (pass-through taxation and contractual flexibility). This Blog previously wrote about the advantages and disadvantages of this business structure. ( Here .) In the past several years, the LLC has become the business structure of choice for entrepreneurs and small business owners. Unfortunately, many entrepreneurs and business owners enter contracts with third parties before the LLC is formed. When this happens, they expose themselves to personal liability. The Law in New York A person contracting in the name of a proposed (or non-existent) corporation is personally liable on the contract, unless the parties have agreed otherwise. Such liability is based upon the principle that one who acts for a non-existent principal is himself/herself liable on the contract in the absence of an agreement to the contrary. See , e.g. , Clinton Invs. Co., II v. Watkins , 146 A.D.2d 861, 862-63 (3d Dept. 1989); Universal Indus. v. Lindstrom , 92 A.D.2d 150, 151 (4th Dept. 1983); Tarolli Lbr. Co. v. Andreassi , 59 A.D.2d 1011, 1012 (4th Dept. 1977). Whether a person is personally obligated on a pre-incorporation transaction depends on the intention of the parties. It is important to note that ratification or adoption of the contract by the LLC (once formed) will not remove the liability of the individual; instead, it “gives rise to corporate liability in addition to any individual liability” so that the individual remains obligated unless there has been a novation ( i.e. , the substitution of a new contract for the old one) between the corporation and the third party. Universal Indus ., 92 A.D.2d at 152. The foregoing principles were at play in Eastern Consolidated Properties, Inc. v. Waterbridge Capital LLC , 2017 NY Slip Op. 02731 (1st Dept. April 6, 2017), where the Court held that a person who signs an agreement on behalf of an LLC prior to its formation can be held personally liable under the agreement. Background The case arose from the $92.25 million sale of 103 North 3rd Street in Williamsburg, Brooklyn to the investment firm Waterbridge Capital in 2014. Eastern Consolidated Properties, Inc. (“Eastern”) claimed that it was denied a commission from the transaction, and sued Waterbridge Capital LLC (“Waterbridge”) the following year. Eastern alleged that, after Waterbridge agreed to pay it a 1% commission in connection with the transaction, Waterbridge’s chief executive, Joel Schreiber (“Schreiber”), verbally asked Eastern to accept a 1/2% commission because another broker claimed entitlement to a commission on the transaction. Eastern agreed to the revised agreement. Thereafter, WB Berry Street LLC (“WB Berry”), an affiliate of Waterbridge, acquired the property. The defendants refused to pay any commission. Eastern sued for, among other things, breach of contract and quantum meruit. The defendants moved to dismiss, and Eastern cross moved to add Schreiber as a defendant. Justice Charles Ramos of the Supreme Court, New York County, Commercial Division, denied the defendants’ motion as to these causes of action and granted Eastern’s cross motion. The First Department unanimously affirmed the decision. As to the cross motion, the Court found that Schreiber could be found liable under the principles discussed above: Supreme Court properly granted plaintiff’s cross motion to add Schreiber as a party defendant. As a member of Waterbridge, Schreiber could not be held personally liable for an agreement made on Waterbridge’s behalf. However, at the time of the oral agreement, WB Berry was not yet formed. To the extent that Schreiber acted on WB Berry's behalf before its formation, he is presumed personally liable as an agent of the nonexistent corporate principal. Citations omitted. Addressing the merits of the appeal, the Court found that Eastern adequately plead a breach of contract claim, stating that the agreement to pay Eastern half of the commission was valid “even if claim was doubtful or would ultimately prove to be unenforceable.” The Court noted that the revised agreement was essentially a settlement agreement. As such, it was not necessary to determine whether Eastern was the “procuring cause” of the transaction, as the defendants contended. Moreover, since the parties disputed the validity of the oral settlement agreement, the Court held that Eastern could seek, “in the alternative”, “to recover its full commission in quantum meruit, in order to prevent unjust enrichment.” This was especially so since Eastern alleged “that it performed valuable services in good faith, including providing confidential information concerning the property to Waterbridge, that the services were rendered with an expectation of compensation, and that they were accepted by defendants.” Takeaway All too often, entrepreneurs and business owners engage in too many activities during the formation of their LLC. While some of these activities are benign, others, such as entry into agreements with vendors, creditors and other third parties, are not. Eastern Consolidated serves as a good lesson for these individuals – do not enter into any contracts until the LLC is formed, especially if personal liability is to be avoided.

Did Wells Fargo retaliate against whistleblowers who complained about sales pressure? In the wake of the sale's scandal last September that led to the ouster of Wells Fargo & Co.'s CEO John Stumpf, the bank's Board of Directors has been conducting an independent investigation to determine if retail bank employees who complained about sales pressure or practices were retaliated against. With an assist by a New York-based law firm, the bank recently released its findings, writing that the investigation did not identify a pattern of retaliation to date, based on what it called a "limited review." Nonetheless, the investigation is ongoing, and it remains to be seen if the bank has been retaliating against whistleblowers. However, Wells Fargo was recently ordered by the Department of Labor to reinstate and compensate a former bank manager in the wealth management group who was terminated after complaining about fraudulent conduct, albeit that incident is unrelated to the retail bank scandal. The Whistleblower Investigation The bank's counsel said that its independent review consisted of five steps, starting with creating a spreadsheet of 115 potential whistleblower cases from 2011 to 2016. Ten cases were gleaned from that list from the 2011-2103 period since they were connected to sales practice misconduct. A review of those cases did not reveal evidence of "purposeful" retaliation. Next, Wells Fargo identified 11 former employees to interview based on these cases. Of the three who agreed to be interviewed, and a review of related documents, no evidence of retaliation was found. Then, the law firm analyzed the bank's EthicsLine and whistleblower reports dating back to 2011. Nine incidents of "potential" retaliation were found, and those reviews are continuing. A further review was also conducted of files regarding 885 employees who called the EthicsLine between 2011 and 2016. These employees were reportedly subjected to "corrective action" within 12 months of their calls or claimed in media reports that Wells Fargo had retaliated against them for complaining about sales practices. Of those files, eight "raised concerns" and are being independently reviewed in addition to 10 other files of employees who were among the 5,367 terminated in the 2016 settlements. Finally, the law firm is reviewing a handful of whistleblower files connected to complaints filed by the bank's shareholders. The Takeaway Although the investigation has yet to identify a pattern of retaliation, Wells Fargo continues to face scrutiny over the sales practice scandal that centered on the creation of approximately 2 million bogus accounts that were set up in customers' names without their knowledge or permission. In fact, Congressional lawmakers have been calling on the Securities and Exchange Commission to investigate whether the bank has engaged in prohibited retaliatory practices. In the meantime, it is important to note that whistleblowers are protected against retaliation under federal law. For this reason, if you believe you were retaliated against for blowing the whistle, you should engage the services of an experienced attorney .

In prior posts, this Blog has written about the financial exploitation and abuse of vulnerable investors ( here and here ). The financial exploitation and abuse of vulnerable investors ( e.g. , senior citizens and the disabled) takes many forms. The most common involves: churning, unauthorized trading, unsuitable investing, over-concentrating an investor’s portfolio in a single type of investment or industry segment, and misrepresenting the risk or potential returns of an investment product for the purpose of generating high commissions. Unscrupulous investment professionals (such as, stockbrokers, financial advisors and insurance brokers) often exploit the fact that many elder and disabled investors are not market savvy and financially sophisticated or are trusting of those in a position of knowledge and authority. They prey on the fact that elder and disabled investors are often hesitant to admit they do not understand what is being presented to them. Vigilence by family members and trusted individuals in overseeing and monitoring the assets of the elderly and disabled is one way to help prevent and stop the incidence of financial exploitation and abuse. Contacting a lawyer is another. Sometimes, a criminal proceeding or an enforcement action is the most appropriate way to stop an abuser. On March 27, 2017, the Securities and Exchange Commission (“SEC”) announced that it had sought and received an emergency asset freeze and temporary restraining order against Daniel H. Glick (“Glick”), a Chicago-based investment adviser and his financial management company, who were accused of scamming elderly investors out of millions of dollars. According to the SEC, Glick and his unregistered investment advisory firm Financial Management Strategies (“FMS”) provided clients with false account statements to hide Glick’s use of client funds to pay personal and business expenses, purchase a Mercedes-Benz, and pay off loans and debts among other misuses. As noted in the SEC complaint , Glick is no stranger to run-ins with regulators. In 2014, Glick was barred by FINRA and had his Certified Financial Planner designation and Certified Public Accountant license revoked for engaging in misconduct – conduct that included stealing money from elderly family members. “As alleged in our complaint, Daniel Glick raised millions of dollars from elderly clients by claiming that he would pay their bills, handle their taxes, and invest on their behalf.  In reality, Daniel Glick used much of their money to do what was best for Daniel Glick,” said David Glockner, Director of the SEC’s Chicago Regional Office. The SEC also named Glick Accounting Services, Glick’s business partner David B. Slagter, and Glick’s business acquaintance Edward H. Forte as relief defendants for purposes of recovering client funds that Glick transferred or paid them in the form of advances or loans. The court issued a temporary restraining order against Glick and FMS at the SEC’s request, and issued an order freezing the assets of Glick, FMS, and Glick Accounting Services. Takeaway Despite recent legislative and regulatory efforts to protect senior and disabled investors, financial exploitation and abuse of vulnerable investors remains an all too common fact of life. Enforcement actions, like the one discussed in this article, are important reminders to the unscrupulous investment professional that financial exploitation and abuse of the elderly and disabled will be prosecuted to the fullest extent of the law.

Financial exploitation and abuse is all too common in today’s day and age.  In fact, it is one of the fastest-growing forms of abuse of seniors and adults with disabilities. According to a recent MetLife study, titled “ Broken Trust: Elders, Family & Finances ,” about one million seniors lose an estimated $2.6 billion annually from financial exploitation and abuse. Last October, the Financial Industry Regulatory Authority (“FINRA”) announced that it had submitted proposed rule changes to the Securities and Exchange Commission (“SEC”) to help member firms detect and prevent the abuse and financial exploitation of senior and vulnerable adult customers. (This Blog wrote about the proposed rule changes here .) On March 30, 2017, FINRA announced that the SEC approved the proposed rule changes. In connection with the announcement, FINRA issued Regulatory Notice 17-11 , and set February 5, 2018, as the effective date for the new rules. The changes approved by the SEC involve two key protections for seniors and other vulnerable investors. First, member firms will be required to make reasonable efforts to obtain the name and contact information of a trusted contact person for a customer’s account. Second, member firms will be permitted to place a temporary hold on the disbursement of funds or securities when there is a reasonable belief of financial exploitation and abuse. “These rules will provide firms with tools to respond more quickly and effectively to protect seniors from financial exploitation. This project included input and support from both investor groups and industry representatives and it demonstrates a shared commitment to an important, common goal – protecting senior investors,” said Robert W. Cook, FINRA President and CEO. The trusted contact person is intended to be a resource for member firms in handling customer accounts, protecting assets and responding to possible financial exploitation and abuse of any vulnerable investors. The new rule allowing firms to place a temporary hold provides them and their associated persons with a safe harbor from certain FINRA rules. This provision will allow member firms to investigate the suspected exploitation and reach out to the customer, the trusted contact and, when appropriate, law enforcement or adult protective services, before disbursing funds. Prior to the implementation date, FINRA will amend its New Account Application Template, a voluntary model brokerage account form that is provided as a resource to member firms when they design or update their new account forms, to capture trusted contact person information. Takeaway Financial exploitation and abuse of seniors and persons with disabilities is a problem that spans every community and social condition. It is underrecognized, underreported, and underprosecuted. FINRA’s effort to empower member firms to detect and prevent the financial exploitation of seniors and other vulnerable adults is an important step in addressing the problem. Though the amendments to Rule 4512 and new Rule 2165 do not go as far as some commentators have urged , they will, nevertheless, provide member firms with the tools to respond to situations in which they have a reasonable basis to believe that financial exploitation and abuse has occurred, is occurring, has been attempted or will be attempted.

On March 29, 2017, Sen. Chuck Grassley and Sen. Ron Wyden, the founding members of the Senate Whistleblower Protection Caucus, introduced the IRS Whistleblower Improvements Act of 2017 , bipartisan legislation intended to improve communication between the IRS and whistleblowers and strengthen the protections for whistleblowers against workplace retaliation. “Whistleblowers are a crucial line of defense against waste, fraud and abuse,” said Wyden in a joint statement . “This legislation will strengthen protections for employees of companies who come forward to report tax evasion.  Empowering these whistleblowers is key to rooting out bad actors who are breaking the law by dodging their taxes.” The bill was originally introduced last year as an amendment to the Taxpayer Protection Act of 2016. The Senate Finance Committee approved the amendment last April, but it failed to receive the approval of the full Senate. “Whistleblowers have helped the IRS recover more than $3 billion for the taxpayers that otherwise would have been lost to fraud,” Grassley said in the statement. “Whistleblowers have the potential to help even more. They need assurances that putting their jobs at risk carries protections. They also need better communication about where their cases stand so they’re not sitting in limbo. This bill will offer a welcome mat to those who are too often treated like skunks at a picnic.” If passed, the bill would: (1) increase communication between the IRS and whistleblowers, while protecting taxpayer privacy; and (2) provide legal protections to whistleblowers from employers retaliating against them for disclosing tax abuses. To increase communication, the bill would allow the IRS to exchange information with whistleblowers where doing so would be helpful to an investigation.  It would further require the IRS to provide status updates to whistleblowers at significant points in the review process and allow for further updates at the discretion of the IRS.  It does this while ensuring that the confidentiality of this information is maintained. To protect whistleblowers from employer retaliation, the bill extends anti-retaliation provisions to IRS whistleblowers that are currently afforded to whistleblowers under other whistleblower laws, such as the False Claims Act and the Sarbanes-Oxley Act of 2002. “Tax whistleblowers may be easily identified within their firms as having specific knowledge of tax fraud.  Extending the protections to tax whistleblowers that apply to whistleblowers in other fields is a matter of fairness and in the interest of U.S. taxpayers who benefit from such whistleblowing,” Grassley and Wyden said. According to the IRS, “since 2007, information submitted by whistleblowers has assisted the IRS in collecting $3.4 billion in revenue, and, in turn, the IRS has approved more than $465 million in monetary awards to whistleblowers.” See IRS Whistleblower Program Fiscal Year 2016 Annual Report to the Congress . Takeaway: If enacted, the bill will strengthen the power of the IRS to fight tax fraud under its whistleblower program and protect whistleblowers from workplace retaliation. Given the number of submissions the IRS considers per year, and the concerns whistleblowers have about reporting fraud to the IRS, this bill is much needed.

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.  Recognizing the financial, reputational and professional risks associated with whistleblowing, Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act” or the “DFA”) strong anti-retaliation provisions to protect whistleblowers who provide information about violations of the securities laws to the Securities Exchange Commission (“SEC”), or violations of any protected activity under the Sarbanes-Oxley Act of 2002 (“SOX”). The Dodd-Frank Act creates a private right of action for employees who have suffered retaliation “because of any lawful act done by the whistleblower – ‘(i) in providing information to the Commission in accordance with ; (ii) in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such information; or (iii) in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002,’” the Securities Exchange Act of 1934 (the “Exchange Act”), and “‘any other law, rule, or regulation subject to the jurisdiction of the .’” Importantly, Congress did not limit the private right of action to employees.  The Dodd-Frank Act extends the cause of action to any individual claiming to have been threatened, harassed or subjected to discrimination because of conduct protected by the Dodd-Frank Act.  A whistleblower may file a retaliation claim in federal court and seek, among other remedies, reinstatement, double back pay (as opposed to just back pay, as under SOX) with interest, litigation costs, expert witness fees and reasonable attorneys’ fees. Since its enactment, there has been a question over whether the whistleblower protections in the Dodd-Frank Act extend to employees who whistleblow internally, rather than to the SEC. The answer to this question has resulted in a split among the circuits. The Fifth Circuit, which was the first to address the issue, strictly applied the DFA’s definition of “whistleblower” to apply 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). In doing so, the court rejected the SEC’s regulation (17 C.F.R. § 240.21F-2) which extends the anti-retaliation protections to all those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC. Id . at 630. The Second Circuit, by contrast, found that, if the DFA were restricted only to reporting to the SEC, Section 21F(a)(6), subdivision (iii), would protect only those employees who notify the SEC at the same time, or just before, they report internally under SOX.  The court concluded that the language in the DFA was “ambiguous” obligating it to accord Chevron deference ( Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. , 467 U.S. 837 (1984)) to the SEC’s regulation. Berman v. Neo@Ogilvy LLC , 801 F.3d 145, 155 (2d Cir. 2015). On March 8, 2017, the Ninth Circuit joined the Second Circuit in finding that the term “whistleblower” as used in the Dodd-Frank Act did not evince a congressional intent to limit the anti-retaliation protections to those who disclose information to the SEC only. Rather, the anti-retaliation provisions also protect those who were fired after making internal disclosures of alleged unlawful activity under SOX and other laws, rules, and regulations. Somers v. Digital Realty Trust , ___ F.3d ___, No. 15-17352, 2017 WL 908245 (9th Cir. Mar. 8, 2017). Background Paul Somers (“Somers”), a former Vice President of Digital Realty Trust (“Digital Realty”), alleged that Digital Realty fired him after he made several reports to senior management regarding possible securities law violations. Somers only reported these possible violations internally, and not to the SEC.  Somers was unable to report his concerns to the SEC before Digital Realty terminated his employment. Thereafter, Somers sued Digital Realty, alleging violations of state and federal securities laws, including violations of the anti-retaliation protections of the Dodd-Frank Act ( i.e. , Section 21F of the Exchange Act).  Digital Realty moved to dismiss on the ground that Somers was not a “whistleblower” under Dodd-Frank because he only reported the possible violations internally and not to the SEC. The district court denied the motion, deferring to the SEC’s interpretation that internal whistleblowers are also protected from retaliation under the Dodd-Frank Act. Like the Second Circuit, the court analyzed the statutory text, the DFA’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. Dig. Realty Tr. 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 DFA. Id . at 1106. The district court certified the question for interlocutory appeal pursuant to 28 U.S.C. § 1292(b), id . at 1108, and the Ninth Circuit granted Digital Realty’s petition for permission to appeal. The Ninth Circuit’s Decision As noted by the court, “ he underlying issue” in the case was “whether, in using the term ‘whistleblower,’ Congress intended to limit protections to those who come within DFA’s formal definition, which would include only those who disclose information to the” SEC. The issue arises because of the tension between the definition of who qualifies as a “whistleblower” under Section 21F(a)(6) and the anti-retaliation provisions of Section 21F(h)(1)(A)(iii). The former defines “whistleblower” as “any individual who provides . . . information relating to a violation of the securities laws to the Commission,” while the latter protects individuals who make “‘disclosures that are required or protected under’ Sarbanes-Oxley, the Exchange Act, 18 U.S.C. §1513(e), ‘and any other law, rule, or regulation subject to the jurisdiction of the Commission.’” 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.  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 Exchange Act 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 court also found support in King v. Burwell , 135 S. Ct. 2480, 2489 (2015), the Supreme Court’s Affordable Care Act decision, for the proposition that a statutory term can have different operative consequences in different contexts.” Thus, it was reasonable to conclude that the term “whistleblower” “may mean different thing[]” in a different part” of the statute”. Id . at 2493 n.3. The majority concluded that a narrow ruling applying protections only to those reporting to the SEC “would make little practical sense and undercut congressional intent” to protect whistleblowers from retaliation. For all these reasons, we conclude that subdivision (iii) of section 21F should be read to provide protections to those who report internally as well as to those who report to the SEC. We also agree with the Second Circuit that, even if the use of the word “whistleblower” in the anti-retaliation provision creates uncertainty because of the earlier narrow definition of the term, the agency responsible for enforcing the securities laws has resolved any ambiguity and its regulation is entitled to deference. In a brief dissent, Judge John Owens sided with the Fifth Circuit.  Judge Owens criticized the majority for relying, in part, on King , and advocated for a “quarantine” of “ King and its potentially dangerous shapeshifting nature to the specific facts of that case to avoid jurisprudential disruption on a cellular level.” Takeaway Given the split in the circuits, it is likely the issue will reach the Supreme Court for review. This is especially so in light of the implications of extending the DFA anti-retaliation protections to internal whistleblowers.

As many investors know, the securities industry settles securities transactions ( e.g. , the purchase and sale of equities, as well as corporate and municipal bonds) on the third day after a transaction is executed by sending payment for the transaction to the seller and the securities to the buyer. This settlement cycle is known as “T+3” – shorthand for “trade date plus three days.” Prior to 1995, the financial markets operated on a longer settlement cycle – “T+5”. In 1995, however, the Securities and Exchange Commission (“SEC”) reduced the settlement cycle from five business days to three business days, or “T+3”. This move lessened the amount of money needed to be collected at any one time, reduced risk ( e.g. , credit, market, and liquidity risk) and strengthened the financial markets for times of stress. In early 2012, the Depository Trust & Clearing Corporation (“DTCC”) commissioned an independent study to analyze the costs, benefits, opportunities, and challenges associated with reducing the settlement cycle to T+1 or T+2 from T+3. This study confirmed the risk reduction benefits, operational efficiencies, and feasibility of reducing the settlement cycle to T+2 for equities, corporate bonds, municipal bonds, and unit investment trusts. Following the 2012 study, the industry, led by various associations, including the Securities Industry and Financial Markets Association (“SIFMA”) and the Investment Company Institute (“ICI”), expressed support for the migration to a T+2 settlement cycle. In 2014, DTCC, in collaboration with representatives from the financial services industry, including SIFMA and the ICI, established an Industry Steering Committee (“ISC”) comprised of a broad range of firms and trade associations. The ISC was tasked with directing the scope, requirements, and changes needed to facilitate the implementation of the T+2 settlement cycle. In June 2015, the ISC released a white paper outlining the timeline and industry-level actions required to move to a two-day settlement cycle by the end of the third quarter of 2017. Notably, the industry found strong support from the SEC, which adopted changes to Rule 15c6-1 on March 22, 2017, to facilitate the move to a T+2 settlement cycle. The changes do not, however, affect any other portions of the rule, including the existing exemptions for government securities, municipal securities and certain other securities and provisions allowing issuers and their underwriters to agree on a different settlement cycle for securities being sold for cash in firm commitment underwritten public offerings. The changes will align the U.S. with other T+2 settlement markets across the globe. “As technology improves, new products emerge, and trading volumes grow, it is increasingly obvious that the outdated T+3 settlement cycle is no longer serving the best interests of the American people,” said SEC Acting Chairman Michael Piwowar.  “The SEC remains committed to ensuring that U.S. securities regulation is reflective of modern times, and in shortening the settlement cycle by one day we aim to increase efficiency and reduce risk for market participants.” Broker-dealers are required to comply with the amended rule by September 5, 2017. Takeaway : Shortening the settlement cycle to T+2 is expected to enhance market efficiency, improve operational process, reduce credit and counterparty risk, improve cash deployment, increase market liquidity, lower collateral requirements, and enhanced global settlement operations. If these expected benefits are realized, the shortened settlement cycle will promote financial stability, improve capital efficiency, and reduce the costs incurred by the industry and investors.