Last year, the Appellate Division, Second Department, affirmed and modified in part a post-trial judgment against a former minority partner who wrongfully dissolved a general partnership. Congel v. Malfitano , 141 A.D.3d 64 (2d Dep’t May 18, 2016). In a case of first impression in the Department, the Court found that, under Partnership Law § 69(2)(c)(II), a “minority discount” may be applied to the valuation of a minority partner’s interest to reflect the lack of control the partner has in the operations of the partnership. On January 10, 2017, the New York Court of Appeals agreed to review the Second Department’s decision. Factual and Procedural Background : In 1985, the parties to the action entered into a written agreement to form the Poughkeepsie Galleria Company Partnership. The purpose of the partnership was to own and operate the Poughkeepsie Galleria Shopping Center, a 1.2 million square foot shopping mall. The defendant, Marc. A. Malfitano (“Malfitano”), was a general partner who owned a 3.08% interest in the partnership. By letter dated November 24, 2006, Malfitano advised his partners that he was dissolving the partnership due to a fundamental breakdown in their relationship. In 2007, Robert J. Congel (“Congel”) and the other members of the partnership’s executive committee (the “Plaintiffs”) sued Malfitano, alleging that he had wrongfully dissolved the partnership in violation of the partnership agreement, and that he had done so in order to force the partnership “to buy out . . . his interest at a steep premium.” The Plaintiffs sought, among other things, to recover damages for breach of contract, and a judgment declaring that Malfitano wrongfully dissolved the partnership. In his answer, Malfitano asserted a counterclaim against the Plaintiffs pursuant to Partnership Law § 69 (2)(c)(II), which provides, among other things, that in the event of a wrongful dissolution, if the partners who have not caused the wrongful dissolution elect to continue the partnership’s business in the same name, the partner who has caused the wrongful dissolution shall have “the value of his interest in the partnership, less any damages caused to his copartners by the dissolution, ascertained and paid to him in cash . . . .” Thereafter, Malfitano moved to dismiss the complaint for failure to state a cause action, arguing that, under Partnership Law § 62(1)(b), he was permitted to dissolve the partnership because it was dissolvable at-will and indefinite in duration. The Supreme Court, Dutchess County, denied Malfitano’s motion, and the Second Department affirmed, reasoning that the partnership agreement provided that the partnership would be dissolved upon a majority vote of the partners and, therefore, it had a “definite term” within the meaning of Partnership Law § 62(1)(b). As such, the partnership was not dissolvable at-will. In a separate decision, on May 28, 2009, the Supreme Court granted the Plaintiffs’ motion for summary judgment, finding that Malfitano wrongfully dissolved the partnership and breached the partnership agreement, thereby entitling the Plaintiffs to damages. The Second Department later affirmed the ruling, concluding that the terms of the partnership agreement were clear and unambiguous, reiterating that the partnership was not an at-will partnership, and determining that Malfitano dissolved the partnership in contravention of the partnership agreement. See Congel v. Malfitano , 61 A.D.3d 810, 811 (2d Dep’t 2009). Subsequently, the Supreme Court conducted a non-jury trial to determine the amount that Malfitano would be entitled to recover for his partnership interest, and the amount of damages the Plaintiffs incurred as a result of the wrongful dissolution.  After considering expert testimony from both parties, the Supreme Court determined that the value of Malfitano’s interest in the partnership, minus the damages to the Plaintiffs caused by his wrongful dissolution of the partnership, was $857,164.75 – a fraction of the $4,850,000 the parties had stipulated was the unadjusted value of Malfitano’s total interest in the partnership as of November 24, 2006, the date of the wrongful dissolution of the partnership. In reaching this determination, the court applied, among other things, a 15% discount for goodwill, and a 35% discount to account for the limited marketability of Malfitano’s interest. However, the court declined to apply a minority discount (intended to reflect the lack of control that a minority partner holds in the partnership), concluding that it was not permitted to do so based upon case law involving the valuation of a minority shareholder’s stock in a close corporation. See BCL Sections 623 and 1118.  The court also reduced the award by the amount of legal expenses it determined had been reasonably incurred by the Plaintiffs due to Malfitano’s wrongful dissolution of the partnership. The parties appealed and cross-appealed the judgment. The Second Department’s Decision: On appeal, the parties advanced two primary issues: whether the Court should revisit its prior determination that he wrongfully dissolved the partnership in light of a recent New York Court of Appeals decision; and whether the Supreme Court should have applied a minority discount. As discussed below, the Court rejected the former and agreed with the latter. Whether to Revisit the Wrongfulness Determination Malfitano argued that the Court should overturn its prior determination that he wrongfully dissolved the partnership in light of the Court of Appeals’ decision in Gelman v Buehler , 20 N.Y.3d 534 (N.Y. 2013), which was decided after the Court made its determination on this issue. In Gelman , the parties entered into an oral agreement to continue a partnership until the partners found a business with growth potential, acquired it, and increased its value until it could be sold at a profit. The Court of Appeals held that this agreement did not contain a “definite term” of duration or a “particular undertaking” to be achieved within the meaning of Partnership Law § 62(1)(b), and was thus dissolvable at will. The Second Department rejected this argument. The Second Department found that Gelman was distinguishable because it involved an oral agreement that lacked a definite term of duration. By contrast, in Congel , the partnership agreement was written and contained a specific provision that precluded a single partner from dissolving the partnership without a majority vote. Consequently, the partnership was not dissolvable at-will by a single partner. Procedurally, the Court held that its initial determination that the dissolution was wrongful was “law of the case” and foreclosed reexamination notwithstanding the later decided Gelman case. Minority Discount As noted, the Court concluded that the Supreme Court erred by not applying a minority discount to the value of Malfinato’s partnership interest. In rejecting the Supreme Court’s holding, the Court found that the lower court’s reliance on cases concerning the rights of minority shareholders in close corporations was misplaced. It explained that those cases involved claims under Business Corporation Law § 623, which allows minority stockholders to withdraw from a corporation and be compensated for the “fair value” of their shares when the majority takes action that is inimical to the minority shareholder, and Business Corporation Law § 1118, which provides that, following a minority stockholder’s petition for dissolution for oppressive majority conduct, if the corporation elects to purchase the minority stockholder’s interest, it must pay the minority shareholder fair value. The Court reasoned that the concerns expressed in those cases were not implicated in a case involving the wrongful dissolution of a partnership pursuant to Partnership Law § 69(2)(c)(II).  For starters, Congel did not “involve a determination of the ‘fair value’ of a dissenting shareholder’s shares pursuant to Business Corporation Law §§ 623 and 1118, but rather, involve the determination of the ‘value’ of the shares of a partner who has wrongfully caused the dissolution of a partnership pursuant to Partnership Law § 69(2)(c)(II).” Moreover, even if the Business Corporation Law governed the outcome, applying a minority discount to Malfinato’s interest would not contravene any of the objectives provided in the statute – that is, it would not treat holders of the same class of stock differently, undermine the statutory protection for shareholders from being forced to sell at unfair values, or encourage oppressive majority conduct. The Court found support in a decision by the Massachusetts Supreme Judicial Court, Anastos v. Sable , 443 Mass 146, 819 NE2d 587, in which the court interpreted a partnership statute identical in all relevant respects to Partnership Law § 69. In Anastos , the court held that it was proper to apply a minority discount in order to determine the market value of the partner’s minority interest in a going concern, rather than determining the partner’s proportionate share of the liquidation value of the partnership’s assets. In Anastos , the plaintiff and the defendants were members of a partnership formed to own and operate a manufacturing facility. After the plaintiff dissolved the partnership in contravention of the partnership agreement, the defendants elected to continue the partnership business rather than liquidate. In affirming the lower court’s determination to apply a minority discount, the court stated: In this case, the remaining partners chose to exercise their statutory right to continue the partnership business for the remainder of the partnership term, so the partnership business is not winding up and must therefore be treated as a going concern. Because the plaintiff cannot compel liquidation of the business at the point of dissolution, we read as offering a nonliquidation based method of calculating the value of his partnership interest. The statute’s exclusion of good will from the valuation of the wrongfully dissolving partner’s interest supports this reading, as good will is an asset only if the partnership business is a going concern. Were it meant to regard the partnership business as assets to be liquidated, good will need not have been mentioned.” Applying the reasoning from Anastos , the Second Department concluded that since the partnership was a going concern and Malfitano did not have a right to compel the partnership to liquidate its assets, he was not entitled to receive a proportionate share of the liquidation value: Here, as in Anastos , the partnership remains a going concern, and the defendant has no right to compel a liquidation sale of the partnership’s shopping mall and receive a proportionate share of the liquidation value of that asset. Under these circumstances, a minority discount may properly be applied to account for the defendant's lack of control in the partnership as a going concern. Accordingly, the Court remanded the case to the Supreme Court to apply a 66% minority discount – a figure the Court drew from the Plaintiffs’ expert, who was deemed to be credible and supported by the record – to the value of Malfinato’s interest. (Note: At trial, the Plaintiffs’ expert testified that, in determining the fair market value of Malfinato’s 3.08% partnership interest, a minority discount should be applied to reflect the lack of control that a minority owner has in the operations of the partnership and that, based on a variety of factors, including sales of comparable interests and provisions in the partnership agreement restricting the rights of minority owners, the appropriate minority discount was 66%. Malfinato’s expert did not offer any minority discount analysis or computation. As explained in the decision, the expert testified that, although a minority discount “would ordinarily be applied to determine the fair market value of the defendant’s interest, he did not apply a minority discount in his valuation in this case because he ‘was advised, under the relevant statutes, that a minority discount was not applicable.’”) Takeaway: The Court of Appeals has been asked to consider three issues: “Did the Appellate Division’s decision determining that Malfitano engaged in a wrongful dissolution of the Partnership based on its finding that the Partnership Agreement contained a “definite term” conflict with Court of Appeals precedent?” “Did the Appellate Division create a conflict with the other Departments when it ruled that counsel fees were recoverable by a prevailing partnership in a breach of contract action contesting a minority partner’s notice of dissolution under Partnership Law § 62(1)(b)?” “Did the Appellate Division err in applying a minority discount, a marketability discount, and a goodwill reduction when determining the value of a minority partner’s interest under Partnership Law § 69(2)(c)(II)?” If the Court of Appeals agrees with Malfitano that the he did not wrongfully dissolve the partnership, then the damages issue ( e.g. , the attorney’s fees and goodwill reduction) and presumably the minority discount issue would be moot. If, on the other hand, the Court finds that Malfitano wrongfully dissolved the partnership, then it would have to address each of the damages, goodwill, and discount issues. The Court of Appeals will likely hear argument sometime this year.  Whatever the outcome, the decision will have important ramifications for partnership law in the state of New York

Call centers are nothing new to consumers.  Businesses, both large and small, use them to handle their telephone communications with new and existing customers. Brokerage firms also use call centers to service some of their customers – usually those customers with accounts having less than $100,000 - $200,000 in assets. Some firms use financial advisory centers (“FAC”) to provide support for a variety of administrative and customer service issues, while others use call centers to accommodate self-directed investors. As in other industries, these firms use call centers to respond to incoming calls initiated by the investor. Generally, FACs do not solicit investments – that is, they do not call the investor, do not recommend specific investments and, in many instances, do not receive commissions or other transaction-based compensation for selling investment products. Although many firms employ licensed representatives at their FACs, typically there is no fiduciary relationship between the client and the FAC representative. However, there is growing segment of the industry, e.g. , discount brokerage firms, that use call centers as a sales tool. These firms staff their FACs with securities professionals who may provide financial planning services, sell securities products, and receive commissions or other financial incentives for doing so. Often, these firms push their clients with small accounts to FACs without their consent. In 2006, the National Association of Securities Dealers, the predecessor of the Financial Industry Regulatory Authority (“FINRA”), fined Merrill Lynch $5 million for steering clients into unsuitable mutual funds after those clients were reassigned from individual brokers to a call center. Merrill Lynch also improperly held sales contests to favor its proprietary funds and failed to supervise its call-center sales force. On January 19, 2017, FINRA issued an investment advisory to investors about the use of sales-oriented financial advisory centers ( here ). FINRA identified several concerns with these types of FACs.  Among the concerns expressed are: Aggressive sales tactics. Failure to gather customer suitability information. “Free” or “no fees” IRA rollovers. Unsuitable mutual fund switches ( e ., the transfer of money from one mutual fund owned by the investor to a new fund). “No cost” mutual fund switches, when the switch comes with higher annual fees and are subject to contingent deferred sales charges (“CDSC”). Misrepresentations and omissions of key information. Failure to disclose the availability of different classes of mutual fund shares and the different costs and expenses associated with each option. Inadequate supervision of call center representatives. To address these concerns, FINRA recommends the following: Ask questions upon receiving a “welcome” letter or other notice that your account has been, or will be, transferred to a call center or investment center, including: Will I have an individual representative assigned to me that I can contact? Will he or she know me, my account and investment experience and objectives? Will my new representative be permitted to provide recommendations on all types of investments? What services will I receive from the investment or call center? How will these differ from the services I previously received? Will I pay the same commissions and fees for the services I receive? Be wary of calls from FAC representatives that lead to recommendations to move money out of existing investments and into new ones, particularly into a firm’s own mutual funds or other investment products. If a particular investment product is being recommended, ask how the representative will be compensated. Use the FINRA BrokerCheck to make sure the brokerage firm and FAC representative are properly registered and to research the disciplinary history of the firm or registered individual. Make sure each representative understands your risk tolerance, financial circumstances, investment objectives, and any other information pertinent to the recommendation. Understand mutual fund share classes and the different costs and expenses associated with each. If a mutual fund switch is recommended, be aware of the fund’s name, investment objectives, and fees and expenses. Be suspicious of mutual funds that are outside of your existing fund family: Ask if there is a similar fund within your existing fund family and the cost-if any-associated with such an exchange. Ask for a side-by-side comparison of fees and expenses between your existing fund and the recommended fund. Use FINRA’s Fund Analyzer to compare investment objectives, fees and expenses, including a CDSC schedule, and other fund information. Takeaway: FINRA’s investment advisory serves as an important reminder to customers: do your homework and be informed. Thus, customers should ask questions and be suspicious of anything that does not feel right; check the FAC representative’s disciplinary and employment records; ensure that any investments made comport with investment objectives and risk tolerances; read confirmation statements and account statements; understand the costs of the investment products; and know how the FAC representative will be paid. Above all, investors should not hesitate to complain when things don’t look or feel right. If something does not make sense, customers should ask the FAC representative and/or manager about the issue. If the customer remains unsatisfied, s/he should file a complaint online at FINRA’s Investor Complaint Center.  Customers can also seek the advice of an attorney . Finally, customers can transfer their account to another brokerage

What does the SEC have planned for investment advisers and brokers dealers? The Securities and Exchange Commission ("SEC") recently released its list of examination priorities for 2017. In particular, the SEC will be focusing on three areas: matters of importance to retail investors, risks to elderly and retiring investors, and market-wide risks. There are 21 areas of focus on this year's list, including: Money market funds Representatives and employers with prior records of misconduct Wrap-fee programs Exchange-traded funds Multi-branch advisers Senior investors Automated Investment Services The last area is generating a lot of buzz as this is the first year the SEC is making electronic investment advice -- that is advice that is offered through "robo-advisers" -- a priority.  The SEC is hoping to ascertain the risks of digital investment platforms that provide automated advisory services. In fact, automated services that interact with investors online, as well as those that combine automation with access to financial professionals (known as hybrids), will be under enhanced scrutiny. Examinations will zero in on compliance programs, marketing, how investment recommendations are formulated, data security, and conflict of interest disclosures. The agency will also be reviewing compliance oversight of algorithms that generate recommendations. While innovation in the financial services industry historically leads to enhanced regulatory scrutiny, the SEC's plan to focus on automated investment services is part of a growing concern of services that are marketed to fiduciaries. “These priorities make clear we are continuing to focus on a wide range of issues impacting our markets, from traditional areas such as market-wide risks to new forms of technology including automated investment advice,” outgoing SEC Chairwoman Mary Jo White said. Finally, in addition to robo-advisers, the SEC plans enhanced oversight of examinations conducted by the Financial Industry Regulatory Authority. So, broker-dealers can expect visits by examiners of both regulatory bodies. The Takeaway It remains unclear whether examination priorities will change under the Trump Administration, but robo advice will continue to be a hot button issue given the growth of the industry. Nonetheless, securities litigation cases and arbitration matters will continue to require the advice and counsel of an experienced attorney .

Parties to commercial/business transactions are no doubt familiar with “term sheets”, “letters of intent”, “memoranda of understanding” and “agreements in principle”. As the parties to these documents know, they outline the fundamental terms of the transaction being negotiated. Terms sheets and the like have a number of advantages: they can be drafted without the expense of hiring a lawyer; they reduce later renegotiation and lapses in memory; they can facilitate discussions with financial institutions, as well as debt and equity financing providers; they can create deal momentum; and, where applicable, they allow filings with antitrust and other regulators. These documents also can have a number of disadvantages: they can cause business owners/corporate executive to pass on alternative strategic opportunities because of the desire to conclude the transaction; they can cause business owners/corporate executives to kick the can down the road on more difficult terms for which agreement may never come; and they can cause business owners/corporate executives to lose focus on the operations of the company. Perhaps the biggest disadvantage of these documents is the possibility that they can be considered enforceable contracts. McGowan v. Clarion Partners, LLC –  Enforcing A Term Sheet: On January 6, 2017, Justice Scarpulla of the New York County, Supreme Court, Commercial Division, held in McGowan v. Clarion Partners, LLC , 2017 NY Slip Op. 30019(U) that a term sheet was a binding contract because it contained all the material terms of the proposed joint venture that would reasonably have been expected to be included under the circumstances. Background Facts : In February and March 2012, Clarion Partners, LLC (“Clarion Partners”), a real estate investment management firm, and Barry McGowan (“McGowan”), formerly the chief investment officer and managing director of non-party GLL Real Estate Partners (“GLL”), a multi-national real estate fund manager, held numerous discussions and meetings at Clarion Partners’ New York offices concerning the creation of Clarion Partners Europe (“CPE”), a real estate investment management business. As originally planned, CPE would maintain headquarters in Munich, Germany, where McGowan lived at that time. On March 9, 2012, McGowan, non-party Steve Furnary (“Furnary”), the chairman and chief executive officer of Clarion Partners, and non-party Florian Winkle (“Winkle”), a former GLL colleague of McGowan, executed a document entitled, “A Term Sheet for Clarion Partners — Europe” (the “Term Sheet”). The Term Sheet set forth the terms concerning, among other things, the identity of the CPE management team, the management team’s income, funding for CPE, and the team’s investment in Clarion Partners, and provided that all terms are “ greed amongst the parties but subject to signed documentations.” No additional documentation was executed by the parties. Following execution of the Term Sheet, and at Clarion Partners’ request, McGowan formally ceased discussions with other potential joint venture partners, such as non-party Legal & General Group plc (“Legal & General”), a multi-national insurance company, in reliance upon Furnary’s assurances that the Term Sheet was binding on Clarion Partners. McGowan also asked certain GLL colleagues to resign from GLL, and join him at CPE. On March 12, 2012, Clarion Partners stated that the management team would invest €1 million into Clarion Partners, instead of the $1million provided in the Term Sheet. This was a significant change because in 2012, the prevailing exchange rate from dollars to euros meant that Clarion Partners was increasing the management team’s investment by approximately 30%. Clarion Partners also stated that the investment would be made in a Clarion Partners entity, rather than in Clarion Partners directly. At that time, the Clarion Partners entity was less valuable than Clarion Partners. Although the changes were unilateral, McGowan decided to honor the Term Sheet, as modified by Clarion Partners. Winkle declined to accept the modification, and formally withdrew from the joint venture. In March and April 2012, McGowan continued his efforts to move forward with the formation of CPE, and continued to correspond and meet with Furnary. McGowan sought office space in Munich. McGowan also developed a business plan as referenced in the first paragraph of the Term Sheet, and a revised start-up budget for CPE. On May 13, 2012, McGowan emailed Furnary a copy of the “CPE Business Plan — Restructure/Delay (1 yr)” (the “Business Plan”). On May 24, 2012, Furnary advised McGowan for the first time that Clarion Partners would not perform under the Term Sheet, that the Term Sheet was not a binding agreement, and that Clarion Partners was no longer interested in forming CPE with McGowan. The Complaint : In 2015, McGowan commenced the action, asserting two causes of action: breach of contract and specific performance. In the contract claim, McGowan alleged that the Term Sheet was a binding contract, and that by its actions Clarion Partners breached the Term Sheet and the covenants of good faith and fair dealing implied in that document. McGowan also alleged that Clarion Partners usurped his opportunity to form a European fund manager by opening a London office without McGowan, in order to take advantage of the European investment opportunities. In addition, McGowan alleged that he lost the salary, benefits, and investment opportunities promised him by Clarion Partners in the Term Sheet, and was forced to remove his children from private school in Germany, put his house in Germany up for sale, and return to the United States, where he began renting a property in Rye, New York, at great personal cost and expense. McGowan alleged that he lost more than $3 million in compensation that he would have earned had Clarion Partners kept its side of the bargain. In the specific performance claim, McGowan alleged that the opportunities guaranteed in the Term Sheet could not be obtained anywhere else, and sought a 30% ownership interest in Clarion Partners’ European business, an opportunity to invest $1 million in Clarion Partners, and ownership of 1% of Clarion Partners’ income units and performance units. Clarion Partners moved to dismiss both causes of action. The Court’s Decision: As noted above, the Court held that the Term Sheet was a legally enforceable agreement and not a mere “agreement to agree” that “lack the material terms essential to the formation of CPE,” as Clarion Partners had contended. The Court found that the Term Sheet embodied “all essential terms” of a contract – that is, “an offer, acceptance of the offer, consideration, mutual assent, and an intent to be bound” sufficient to find a meeting of the minds: The Term Sheet and the Business Plan referenced therein set forth the material terms of the proposed CPE joint venture. *   *  * The Term Sheet includes identification of the purpose and form of the proposed joint venture — the creation of a Clarion Partners entity in Europe headed by a management team comprised of McGowan, nonparty Oliver Kachele, and Winkle. The Term Sheet specifies the initial funding for CPE's operations by the management team and Clarion Partners, and the management team's salary, salary increase, and bonus calculations. It also specifies the percentages of CPE ownership interests — Clarion Partners would own 70% of CPE's equity, and the management team would own 30%, and what will happen to those interests, in the event of a sale of Clarion Partners. It also provides that the management team will be given income units and performance units in Clarion Partners. The Business Plan referenced in the Term Sheet projects CPE’s expected cash flow, expenses, and number of employees during a six-year period, from 2012 through 2018. That Plan provides target start dates for CPE’s CEO (July 1, 2012), CFO (January 1, 2013), and fund managers and researchers. It also projects business expenses, including office rent, travel, entertainment, and attorneys’ fees. The Court concluded that the Term Sheet and the actions of the parties, manifested their intent “to be associated as joint venturers,” to mutually contribute “to the joint undertaking through a combination of property, financial resources, effort, skill, or knowledge,” to maintain “a measure of joint proprietorship and control over the enterprise,” and an agreement “for the sharing of profits and losses.” The Court was not persuaded by Clarion Partners’ argument that “even if the Term Sheet a binding agreement, it did not breach that agreement because an express condition precedent to the formation of CPE — the execution of additional documentation — never occurred.”  The Court found that the parties’ actions spoke louder than words. In this regard, the Court noted that “Clarion Partners clearly signaled … that it considered the Term Sheet itself to be a binding agreement.” In fact, Furnary “expressly assured McGowan that the Term Sheet was binding on Clarion Partners, and requested that he cease negotiations with Legal & General.” With that assurance, McGowan formally terminated those negotiations. Additionally, the Court declined to accept Clarion Partners’ argument that the language in the Term Sheet itself – “ greed amongst the parties but subject to signed documentations” – demonstrated that the Term Sheet was not intended to be a binding agreement. That language did not “conclusively” change the result, said the Court, because the use of “subject to” language and the reference to the execution of a formal agreement at a later date, did not amount to a reservation of the right not to be bound. Finally, the Court refused to accept the emails exchanged between the parties and non-parties to the venture to be conclusive proof of the parties’ intention to be bound by the Term Sheet, given the stage of proceedings: “At this juncture, it would be premature to hold that these emails conclusively demonstrate McGowan’s understanding that that essential material terms of the joint venture were still in negotiation.” Takeaway: McGowan is illustrative of most litigation concerning the enforceability of term sheets and similar documents.  Disputes arise when one side of the transaction argues that the term sheet does not clearly reflect the intent of the parties on the issue of enforceability. As McGowan shows, a court will find a term sheet binding if it includes the material provisions of the agreement and the parties conduct themselves as though they have a firm agreement. So, what can business owners/corporate executives do to minimize the risk of the unintended enforcement of a letter of intent or term sheet? For starters, the parties should consider using language that expressly imposes a duty to negotiate a final agreement in good faith.  They should also: (a) state their intent that neither subsequent communications nor course of conduct will give rise to binding obligations before a definitive agreement is signed; (b) identify material contingencies and conditions precedent for completing the transaction, such as obtaining financing, required permits or consents, and satisfactory completion of due diligence; and (c) state that neither party is relying on, or is entitled to rely on, the term sheet or letter of intent for any purpose. In the end, business owners/corporate executive should proceed with caution when drafting term sheets or letters of intent and in their course of conduct surrounding the negotiation of a final agreement to ensure that they are not later bound to their non-binding term sheet or letter of intent.

Last year, this Blog wrote a number of articles about the Securities and Exchange Commission’s (“SEC” or the “Commission”) efforts to stop companies from impeding whistleblowers from reporting violations of the securities laws to the Commission. ( See here , here , and here .) It looks like 2017 is picking up where 2016 left off. Last week, the SEC announced the settlement of two enforcement actions ( here and here ) against companies that impeded protected whistleblower activity. Both actions involved the use of separation agreements that required departing employees to waive their right to recover whistleblower awards for reporting violations of the law to the Commission; the SEC also alleged that one of the companies took other actions to impede its employees from communicating with the Commission. The SEC has repeatedly sanctioned companies that use such agreements as violating Section 21F of the Dodd-Frank Act and Rule 21F-17 promulgated thereunder by, among other things, “removing the critically important financial incentives” intended to encourage current and former employees to report violations of the securities laws to the SEC. Blackrock, Inc. : On January 17, 2017, BlackRock Inc. (“Blackrock”), the New York-based asset manager, agreed to pay the SEC a $340,000 penalty to settle charges that it forced more than 1,000 exiting employees to waive their right to obtain whistleblower awards for reporting violations of the law in order to receive their severance payments. According to the SEC’s order , more than 1,000 departing BlackRock employees signed separation agreements containing language stating that they “waive any right to recovery of incentives for reporting of misconduct” in order to receive their monetary separation payments from the firm. Notably, BlackRock added the waiver provision in October 2011 after the SEC adopted its whistleblower program rules.  The asset manager continued using this language in its separation agreements through March 2016. Commenting on the settlement, Anthony S. Kelly, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, stated: “BlackRock took direct aim at our whistleblower program by using separation agreements that removed the financial incentives for reporting problems to the SEC. Asset managers simply cannot place restrictions on the ability of whistleblowers to accept financial awards for providing valuable information to the SEC.” BlackRock consented to the SEC’s order without admitting or denying the findings that it violated Rule 21F-17.  The order notes that BlackRock voluntarily revised its separation agreement and took a number of remedial actions, including the implementation of mandatory yearly training to summarize employee rights under the SEC’s whistleblower program. HomeStreet Inc. : Two days later, on January 19, 2017, Seattle-based HomeStreet, Inc., a commercial and financial lender that serves customers in the Western United States and Hawaii, agreed to settle allegations that it conducted improper hedge accounting and later took illegal steps to impede employees from talking to the SEC about it. The bank agreed to pay a $500,000 penalty, and Darrell van Amen, the company’s chief investment officer and treasurer, agreed to pay a $20,000 penalty, to settle the charges.  Both agreed to the settlement without admitting or denying any wrongdoing. According to the SEC’s order , HomeStreet originated approximately 20 fixed rate commercial loans and entered into interest rate swaps to hedge the exposure – the swaps were designed to guard against a change in interest rates that would make those loans more costly for HomeStreet. The company elected to designate the loans and the swaps in fair value hedging relationships, which can reduce income statement volatility that might exist absent hedge accounting treatment.  Companies are required to periodically assess the hedging relationship and must discontinue the use of hedge accounting if the effectiveness ratio falls outside a certain range. The SEC found that in certain instances from 2011 to 2014, van Amen saw to it that unsupported adjustments were made in HomeStreet’s hedge effectiveness testing to ensure the company could continue using the favorable accounting treatment.  The test results with altered inputs to influence the effectiveness ratio were provided to HomeStreet’s accounting department, which resulted in inaccurate accounting entries. The SEC also found that after HomeStreet employees reported concerns about the accounting errors to management, the company concluded the adjustments to its hedge effectiveness tests were incorrect.  When the SEC contacted the company in April 2015 seeking documents related to hedge accounting, HomeStreet presumed it was in response to a whistleblower complaint and began taking actions to determine the identity of the whistleblower.  It was suggested to one individual considered to be a whistleblower that the terms of an indemnification agreement could allow HomeStreet to deny payment for legal costs during the SEC’s investigation.  HomeStreet also required former employees to sign severance agreements waiving potential whistleblower awards or risk losing their severance payments and other post-employment benefits. “Companies that focus on finding a whistleblower rather than determining whether illegal conduct occurred are severely missing the point,” said Jina Choi, Director of the SEC’s San Francisco Regional Office. Jane Norberg, Chief of the SEC’s Office of the Whistleblower, added, “This is the second case this week against a company that took steps to impede former employees from sharing information with the SEC.  Companies simply cannot disrupt the lines of communications between the SEC and potential whistleblowers.” Takeaway: Last week’s enforcement actions underscore, as Norberg said, the SEC’s continued “commitment to ensure the lines of communication between whistleblowers and the SEC remain unimpeded.” This commitment should influence how companies deal with potential whistleblowers in their severance agreements, internal policies and confidentiality agreements. Therefore, the key takeaway from these enforcement actions is, as Norberg stated, for companies to “review and revise their agreements that stifle whistleblowers from reporting to the SEC.”

On January 23, 2017, the SEC announced that it awarded more than $7 million to three whistleblowers who came forward with information that led to a successful SEC enforcement action.  One whistleblower provided information that the SEC considered to be the primary impetus for the start of the Commission’s investigation.  Consequently, the SEC awarded more than $4 million to that whistleblower.  The other two whistleblowers split more than $3 million for jointly providing new information during the SEC’s investigation that significantly contributed to the success of the enforcement action. The whistleblowers are the 39 th , 40 th and 41 st relators to receive an award under the SEC whistleblower program. Since 2011, the SEC has paid approximately $149 million to whistleblowers who provided information resulting in the collection of monetary sanctions against violators of the securities laws. To date, the SEC has recovered more than $935 million from enforcement actions resulting from whistleblower tips. The SEC declined to identify the whistleblowers or the wrongdoers. By law, the SEC protects the confidentiality of whistleblowers and does not release information that might directly or indirectly reveal the whistleblower’s identity. Commenting on the award, Jane Norberg, Chief of the SEC’s Office of the Whistleblower, stated: “Whistleblowers played an important role in the success of this case as they helped our agency detect and prosecute a scheme preying on vulnerable investors. Whistleblowers not only helped us open the investigation but provided critical information after the investigation was already underway.” Under the program, whistleblowers are eligible for an award if they voluntarily provide the SEC with original information that leads to a successful enforcement action that exceeds $1 million. The award can range from 10 percent to 30 percent of the money collected. All payments come from an investor protection fund established by Congress that is financed through monetary sanctions paid to the SEC by securities law violators.  No money is taken or withheld from harmed investors to pay whistleblower awards. Takaway: As noted by this Blog earlier in the month, the SEC rang in the New Year with a whistleblower award of more than $5.5 million to a relator who helped stop an ongoing fraud. With this award, the SEC is reiterating its commitment to encourage whistleblowers to come forward with information about violations of the securities laws.

In December 2016, UBS lost an $18.5 million arbitration brought by two former clients, a husband and wife, in connection with the sale of close-end funds that were collateralized by Puerto Rican bonds. The controversy arose in the wake of the collapse of the island nation's bond market in 2013 during which time UBS allegedly increased the local demand for the bonds artificially and misled the clients about the potential risks associated with the investments. In 2014, the couple filed a complaint in arbitration, claiming breach of fiduciary duty, unsuitability, and other misconduct. During the arbitration proceeding, UBS claimed the clients maintained investments in the bonds with rival firms and rejected the recommendations of UBS financial advisors to diversify. While the arbitration transcript showed that this recommendation was in fact rejected, the couple argued that UBS profited from the sale of artificially  inflated bonds. After numerous hearing sessions, the couple was awarded damages, plus attorney's fees. Finra Arbitrator Disclosure Requirements Now, UBS is seeking to overturn the award in federal court, claiming that two of the three arbitrators were not impartial judges of the merits of the case because they failed to disclose key material facts before the proceeding began. One arbitrator did not disclose her involvement as a plaintiff in a securities fraud class action seeking to recover personal investment losses. The second arbitrator failed to disclose that she had committed fraud, and denied she had previously filed for bankruptcy. In sum, UBS claims that those who have committed fraud or who have made material misrepresentations, are barred from acting as arbitrators by FINRA rules. In addition, UBS argues that the claims should have been dismissed because one of the clients is a Harvard educated attorney and a savvy investor who made his own investment decisions and rejected UBS financial advisors’ recommendation to sell his bond positions. Some observers believe that UBS will prevail in overturning the award since potential arbitrators are required to disclose certain information about their professional and personal histories. Nonetheless, there are reportedly hundreds of other claims against UBS related to its sale of the Puerto Rican bonds. The Takeaway While it is unclear what the outcome of this case will be, it does illustrate the importance of financial advisors fulfilling their fiduciary obligations to their clients. The case also shows the importance of selecting the right arbitrators for a case and the arbitrators' obligation to comply with the rules and regulations that govern them. These issues, among others, are important for investors who have a dispute with their broker or financial advisor to understand. Accordingly, if they find themselves in such a dispute, they should engage the services of an experienced arbitration attorney.

Being a whistleblower is not easy. It involves personal sacrifice and professional risk. Many violations of the law go unreported, especially in the workplace, 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”) strong anti-retaliation provisions to protect whistleblowers who provide information to the SEC or the CFTC about violations of the securities and commodities laws, or violations of any protected activity under the Sarbanes-Oxley Act of 2002 (“SOX”). The Dodd-Frank Act created a private right of action for employees who have suffered retaliation ( e.g. , threats, harassment or discrimination) “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, and “‘any other law, rule, or regulation subject to the jurisdiction of the .’” 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. Under SOX, employees of publicly traded companies are protected from retaliation by their employers for reporting certain types of fraud and other securities violations. An employee seeking relief from retaliation under SOX must file the claim with the Occupational Safety and Health Administration (“OSHA”) of the Department of Labor, which investigates the claim and issues a determination. A claim brought under SOX is adjudicated by administrative law judges or by judges in federal district court. If successful, the employee is entitled to recover back pay, front pay, compensatory damages for emotional distress, and attorneys’ fees. In order to state a retaliation claim, both SOX and the Dodd-Frank Act require plaintiffs to demonstrate, among other things, that they engaged in protected whistleblowing activity, that their employer knew they engaged in protected activity, and that there was a causal connection between the protected activity and an adverse employment action. With the foregoing in mind, consider Feldman-Boland vs. Morgan Stanley , No. 15-CV-6698 (S.D.N.Y. July 13, 2016), where whistleblowers notified their supervisor of their concerns about unlawful activities and were terminated from their employment for blowing the whistle. Feldman-Boland vs. Morgan Stanley and the Importance of Complying With All Pleading Requirements: Facts : The plaintiffs, Jamie Feldman-Boland (“Feldman”) and James Boland (“Boland”), worked at Morgan Stanley & Co. (“Morgan Stanley”). Feldman joined Morgan Stanley as a financial advisor in 2008. At that time, she executed an agreement requiring her to split commissions from high-net-worth clients with a more senior Morgan Stanley advisor, Michael Silverstein (“Silverstein”). In 2010, Boland joined Morgan Stanley as a trainee. In March 2011, Feldman and Boland witnessed Morgan Stanley employees violating the federal securities laws and mail and wire fraud statutes. Among other things, they observed: (1) unlicensed employees executing trades; (2) cold calling clients using deceitful practices (such as promising unrealistic annual returns to entice individuals to transfer 401(k) retirement plans into risky mutual funds); (3) retroactive alterations of clients’ risk profiles to permit riskier investments; and (4) employees working without branch office supervision. In April 2011, Feldman met with her supervisor David Turetzky (“Turetzky”) to complain about a variety of problems with Silverstein, her senior advisor. She also raised concerns regarding the fraudulent activity she had observed. Turetzky dismissed Feldman’s concerns and instructed her to leave his office. Later, he requested a list of Feldman’s clients and prospects. Feldman claims that Turetzky sought permission to fire her on the pretext of substandard performance. In May 2011, Feldman had an altercation with Silverstein that she reported to Turetzky. She also reiterated her complaint that Silverstein failed to supervise brokers. Rather than investigate her complaints, Morgan Stanley rejected a profitable commodities deal that she had proposed without any explanation. In June 2011, Boland wrote to Morgan Stanley’s CEO, alerting him to “discriminatory, unethical and perhaps illegal practices” that could “escalate a very negative, public perception of the Firm.” Boland reiterated those concerns in follow-up communications with the human resources department. In July 2011, Feldman and Boland submitted identical complaints to the SEC regarding fraudulent conduct. In response, FINRA investigators met with the plaintiffs for six hours in early August. Later that month, FINRA audited the Morgan Stanley branch where the plaintiffs worked. FINRA’s investigation focused on allegations of unsupervised employees and deceptive cold calling. Feldman and Boland overheard Morgan Stanley risk officers discussing their concerns about the specificity of FINRA’s investigation. Morgan Stanley’s Regional Risk Officer concluded that the Plaintiffs’ complaints were “unsubstantiated,” even though she never interviewed them. In late August, Turetzky fired Feldman for substandard performance, despite the fact that she had just signed a $1.8 million account. Boland claims that, thereafter, Morgan Stanley undermined his ability to develop business. In September 2011, Boland informed Morgan Stanley risk officers that he had filed complaints with the SEC and FINRA. In early November 2011, Boland was permitted to take medical leave to care for Feldman, who was scheduled to undergo surgery. Less than 48 hours after he returned to work, Morgan Stanley fired Boland under the pretext of substandard performance. In February 2012, Feldman filed a complaint with OSHA against Morgan Stanley, alleging that she was fired in retaliation for her complaints to regulators. Three months later, Boland filed a complaint with OSHA mirroring his wife’s allegations. Those complaints were assigned to an investigator, but no findings had been made at the time the plaintiffs filed their complaint in federal court. The Allegations in the Complaint and The Motion to Dismiss : Feldman and Boland sued Morgan Stanley and their former supervisor Turetzky for $20 million on the grounds that they were fired for reporting improper and unlawful broker practices to the SEC and FINRA, in violation of the whistleblower protection provisions of SOX and the Dodd-Frank Act. These practices included, among others, cold calling employees at large companies, such as Pfizer Inc. and Verizon Communications Inc., who were near retirement and had 401(k) plans at Fidelity Investments to solicit them to roll over their account to Morgan Stanley with the enticement of a 15% annual return; and changing the client’s risk profile to allow for investments in riskier closed-end funds. This was the second time that this Morgan Stanley branch had been sued under the anti-retaliation provisions of the Dodd-Frank Act. In 2012, Clifford Jagodzinski, a risk officer mentioned in the plaintiffs’ complaint, sued Morgan Stanley for $1 million, claiming he was told by Turetzky not to report alleged violations, including improper Treasury trades, drug use by an adviser and advisers working from home without registering their home office as an alternative work location. The defendants moved to dismiss all claims on the grounds that: (1) the claims were barred by collateral estoppel; (2) the complaint failed to state a claim under SOX or the Dodd-FrankAct; and (3) the plaintiffs failed to exhaust their administrative remedies under SOX. The defendants also moved to strike the claim for emotional distress damages under SOX and claims for special damages under the Dodd-Frank Act. The Court’s Decision: Collateral Estoppel : The defendants argued that the plaintiffs were collaterally estopped from bringing their claims because the New York City Commission on Human Rights (“NYCCHR”) had determined that they were “terminated for legitimate non-discriminatory reasons and not because of discrimination.” Prior to filing the action in federal court, Feldman filed a gender-discrimination complaint with the NYCCHR, and Boland filed a Family Medical Leave Act complaint with the same agency. The Court rejected this argument, holding that the plaintiffs were not precluded by collateral estoppel, because there was no identity of issues – the two cases involved different sets of claims and standards of proof. To establish a prima facie case under SOX, Plaintiffs need only establish that whistleblower retaliation was a contributing factor to their termination. Likewise, under Dodd-Frank, Plaintiffs need only establish that their termination was causally connected to protected whistleblower activity. Defendants would then need to demonstrate by clear and convincing evidence that Plaintiffs’ employment would have been terminated in the absence of any protected activity. The issue of whether it was more likely than not that Plaintiffs were fired for reasons other than gender discrimination, or retaliation for taking family leave, is plainly not identical to the issue of whether Defendants can demonstrate by clear and convincing evidence that Plaintiffs would have been fired without engaging in activities under the whistleblower protections of SOX and Dodd-Frank. In dicta , the Court found that “ ven if there were an identity of issues, Plaintiffs did not have a full and fair opportunity to litigate the issue before the NYCCHR.” The Court explained that the plaintiffs “were not afforded an evidentiary hearing where they could confront witnesses against them, nor did they have the benefit of discovery. Moreover, … had no opportunity, and certainly no apparent reason, to introduce issues of retaliation under SOX or Dodd-Frank before the NYCCHR.” Accordingly, the Court concluded that the plaintiffs were not collaterally estopped from asserting their claims. Failure to State a Claim : As noted above, to state a claim for retaliation under both SOX and the Dodd-Frank Act, a plaintiff must demonstrate, among other things, that s/he engaged in protected whistleblowing activity, that his/her employer knew s/he engaged in protected activity, and that there was a causal connection between the protected activity and the adverse employment action. The defendants sought dismissal on the grounds that Morgan Stanley and Turetzsky were not aware that Feldman and Boland had engaged in whistleblowing activities – that is, they filed complaints with the SEC about violations of the securities laws. The Court rejected this argument. According to the Court, the facts alleged by the plaintiffs were sufficient to infer “that Morgan Stanley knew, or had sufficient reason to know, that Plaintiffs had filed a complaint with regulators precipitating the audit.” These facts included, among others: (a) Feldman and Boland each raised concerns about violations of the securities laws with Turetzky in April 2011 and June 2011, respectively; (b) the August 2011 FINRA audit addressed some of the same issues raised by the plaintiffs in their complaints to the SEC; (c) Morgan Stanley co-workers observed the FINRA audit team documenting regulatory violations; and (d) Boland alleged that he informed Morgan Stanley risk officers, prior to his termination, that he filed complaints with the SEC and FINRA. Exhaustion of Administrative Remedies Under SOX : As noted, SOX requires an employee to file a complaint with OSHA when complaining about violations of the anti-retaliation provision of the act. The failure to comply with this requirement deprives the court of subject matter jurisdiction. The defendants sought dismissal, arguing that the plaintiffs failed to exhaust their administrative remedies as to both Morgan Stanley and Turetzky. The Court rejected the argument as to Morgan Stanley, but not Turetzky. As to Morgan Stanley, the Court held that the plaintiffs exhausted their administrative remedies by filing their complaints with OSHA, “given that the OHSA complaints pled allegations concerning Defendants’ “improper and unlawful broker practices.” (Internal quotation and citations omitted.) This finding was reinforced by the fact that the law does not require a “particular form of complaint” “to trigger a claim before OSHA.” (Internal quotation and citations omitted.) As to Tureztky, the Court found that the plaintiffs had not exhausted their administrative remedies. In that regard, the Court noted that although their OSHA complaints mentioned Turetzky, simply mentioning someone is insufficient to put that person on notice that they are the subject of a complaint: t is not sufficient to merely mention an individual in the body of an administrative complaint without specifically listing as a defendant . . . the particular named person. Plaintiffs therefore failed to exhaust . . . administrative remedies as against Turetzky, by failing to include Turetzky as a named person in the administrative complaint. Accordingly, the SOX claim against Turetzky is dismissed. The Motion to Strike : The Court denied the defendants’ motion to strike the emotional distress damages and special damages, finding that such damages are recoverable under SOX and the Dodd-Frank Act.   The court’s decision can be found here .

On January 13, 2017, the United States Supreme Court agreed to consider whether, under American Pipe & Construction Co. v. Utah , 414 U.S. 538 (1974) (“ American Pipe ”), the filing of a securities class action lawsuit tolls the statute of repose found in Section 13 of the Securities Act of 1933 (the “Act”).  In American Pipe , the Court held that “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” 414 U.S. at 554.  This was the second time, the Court granted certiorari to consider the issue. In Public Employees’ Retirement System of Mississippi v. IndyMac MBS, Inc. , 134 S. Ct. 1515 (2014), cert . dismissed as improvidently granted , 135 S. Ct. 42 (2014), the Court granted certiorari to decide whether the tolling doctrine established under American Pipe applies to securities claims subject to the three-year repose period set forth in Section 13 of the Act. The issue was never decided by the Court because the case was settled. The Supreme Court’s January 13, 2017 order granting the petition for a writ of certiorari in California Public Employees’ Retirement System v. ANZ Securitites Inc . can be found here . Background: ANZ Securities arose out of the collapse of Lehman Brothers. Prior to its bankruptcy in 2008, Lehman Brothers operated as a global investment bank whose stock traded on the New York Stock Exchange. Between July 2007 and January 2008, Lehman Brothers raised over $31 billion through debt offerings. The California Public Employees’ Retirement System (“CalPERS”), the largest pension fund in the United States, purchased millions of dollars of those securities. On June 18, 2008, a putative class action complaint was filed in the Southern District of New York (the “Class Action”), alleging that the defendants, who were involved in underwriting the debt offerings, were liable under Section 11 of Act for making false and misleading statements in the registration statements. Among other things, the Class Action alleged that the registration statements contained untrue statements and omitted material facts concerning Lehman’s accounting practices (including improperly removing tens of billions of dollars from its balance sheet), risk-management activities (including its accumulation of illiquid assets), and exposure to risky mortgage and real estate-related assets. In February 2011, more than three years after the securities were offered to the public, but before the district court had decided whether to certify the class, CalPERS decided to file its own complaint against the defendants in the Northern District of California. Cal. Pub. Emps.’ Ret. Sys. v. Fuld , No. 3:11-cv-00562-EDL (N.D. Cal. Feb. 7, 2011). CalPERS also alleged violations of the Act. The case was subsequently transferred to the Southern District of New York and consolidated with the Class Action for pretrial purposes. Later that year, the parties to the Class Action reached a settlement and the district court preliminarily certified a class for settlement purposes. Upon receiving the court-ordered notice of the settlement, CalPERS opted out to pursue its own claims individually.  The district court, however, dismissed CalPERS’ individual suit as untimely. In so doing, it rejected CalPERS’ tolling argument that the pendency of the Class Action rendered CalPERS’ individual lawsuit timely. CalPERS appealed. On July 8, 2016, the Second Circuit affirmed.  In a summary order ( here ), the Second Circuit held that the timely filing of the Class Action had not tolled the statute of repose for CalPERS. CalPERS had argued that because the Class Action “was commenced by a named plaintiff with proper standing,” its claims were timely filed.  The Second Circuit rejected this argument as “inconsistent with the reasoning of IndyMac .” IndyMac made no reference to the standing of named plaintiffs when it concluded that American Pipe tolling did not apply to section 13’s statute of repose; its conclusion was instead derived from two longstanding principles. First, if American Pipe is grounded in equity, its tolling rule cannot affect a legislatively enacted statute of repose. Second, if American Pipe establishes a “legal” tolling principle grounded in Rule 23, to apply it to a statute of repose would violate the Rules Enabling Act by permitting a procedural rule to abridge the substantive rights created by statutes of repose. Accordingly, under IndyMac ’s reasoning, the inapplicability of American Pipe tolling to a statute of repose turns on the nature of the tolling rule and its ineffectiveness against statutes of repose, not whether the named plaintiffs have proper standing to assert claims on behalf of a class. Notably, the Second Circuit acknowledged that there is a split among the circuits on the issue, stating that the tolling question “may be ripe for resolution by the Supreme Court.”  Presently, the Tenth, Seventh and Federal Circuits hold that the filing of a putative class action tolls the statute of repose, while the Second, Sixth and Eleventh Circuits hold that such a filing does not toll the Act’s statute of repose. The Second Circuit emphasized that “unless and until the Supreme Court informs us that our decision was erroneous, IndyMac continues to be the law of the Circuit and its reasoning controls the outcome of the case.” The Cert. Petition: On September 22, 2016, CalPERS filed a petition to the Supreme Court for a writ of certiorari ( here ), seeking to have the Court reverse the Second Circuit’s decision.  CalPERS presented two questions for the Court’s review, the first of which was presented in the dismissed IndyMac petition: 1) “Does the filing of a putative class action serve, under the American Pipe rule, to satisfy the three-year time limitation in Section 13 of the Securities Act with respect to the claims of putative class members? (Question granted in IndyMac )”; and 2) “May a member of a timely filed putative class action file an individual suit on the same causes of action before class certification is decided, notwithstanding the expiration of the relevant time limitations?” To invite review, CalPERS cited the split of authority among the circuits. On January 13, 2017 the Supreme Court granted CalPERS’ petition, but only as to the first of the two questions presented, e.g. , whether American Pipe tolls the Act’s statute of repose. The Court denied the writ on the second question presented.

What is a forum selection clause?  Corporations and other business entities are all too familiar with them. In its simplest form, a forum selection clause is a provision in a contract that designates a specific location (or a particular court within a specific location) for litigation in the event of a dispute. Forum selection clauses are common in commercial contracts because they “provide certainty and predictability in the resolution of disputes.” Boss v. American Express Fin. Advisors, Inc. , 6 N.Y.3d 242, 247 (2006), quoting Brooke Group Ltd. v. JCH Syndicate , 87 N.Y.2d 530, 534 (1996). They come in two forms: mandatory and permissive. In the former, the parties are “required to bring any dispute to the designated forum,” while the latter “only confers jurisdiction in the designated forum, but does not deny plaintiff his choice of forum, if jurisdiction there is otherwise appropriate.” Phillips v. Audio Active Ltd. , 494 F.3d 378, 383, 386 (2d Cir. 2007). Under New York law, “parties to a contract may freely select a forum which will resolve any disputes over the interpretation or performance of the contract.” Brooke Group , 87 N.Y.2d at 534. Such clauses “are prima facie valid” and “are not to be set aside unless a party demonstrates that the enforcement of such would be unreasonable and unjust or that the clause is invalid because of fraud or overreaching, such that a trial in the contractual forum would be so gravely difficult and inconvenient that the challenging party would, for all practical purposes, be deprived of his or her day in court.” Sterling Nat. Bank as Assignee of Norvergence, Inc. v. Eastern Shipping Worldwide, Inc. , 35 A.D.3d 222 (1st Dep’t 2006) (citations and quotations omitted). In Atlantic Marine Construction Co. v. United States District Court for the Western District of Texas , 134 S.Ct. 568, 583 (2013), the United States Supreme Court provided the contractual basis for the enforcement of forum selection clauses: When parties have contracted in advance to litigate disputes in a particular forum, courts should not unnecessarily disrupt the parties’ settled expectations. A forum-selection clause, after all, may have figured centrally in the parties’ negotiations and may have affected how they set monetary and other contractual terms; it may, in fact, have been a critical factor in their agreement to do business together in the first place. In all but the most unusual cases, therefore, ‘the interest of justice’ is served by holding parties to their bargain. Prospect Funding Holdings L.L.C v. Maslowski: Last week, the Appellate Division, First Department, issued a decision concerning the enforceability of a forum selection clause. In Prospect Funding Holdings L.L.C v. Maslowski , 2017 NY Slip Op. 00253 (1st Dep’t Jan. 12, 2017), the Court held that a forum selection clause should not have been enforced because it was unreasonable and unjust to do so. Facts and Proceedings in The Motion Court : The defendant, Pamela Maslowski (“Maslowski”), was involved in an automobile accident that left her with brain trauma and facial lacerations. The accident occurred in Minnesota, where Maslowski was a long-time resident. Maslowski brought a personal injury lawsuit in Minnesota against the tortfeasors responsible for the accident. In need of money, and unable to await the completion of her lawsuit, Maslowski entered into a sale and repurchase agreement with the plaintiff, Prospect Funding Holdings L.L.C. (“Holdings”). Holdings is a limited liability company established under the laws of New York, but maintains its principal place of business in Minnesota. Pursuant to the agreement, Holdings advanced a small amount of money to Maslowski. Notably, the agreement had a mandatory forum selection clause that provided: The parties irrevocably agree that all actions or proceedings in any way, manner or respect, arising out of or related to this agreement shall be litigated only in courts having situs in New York County, New York, each party consents and submits to personal jurisdiction in the state of New York and waives any right such party may have to transfer venue of any such action or proceeding. Maslowski eventually filed an action in Minnesota challenging the validity of the agreement. The courts in Minnesota determined that the agreement (which charged her a fee of 19%, and required that she pay an interest rate at 60% per annum) was void as against public policy. Shortly thereafter, Holdings filed the action in New York alleging, among other things, that Maslowski breached the agreement. Maslowski moved to dismiss the complaint on forum non-conveniens grounds. The motion court denied Maslowski’s motion.  Maslowski appealed. The First Department’s Ruling : The Court reversed, holding that enforcement of the forum selection clause was unreasonable and not in the interests of justice because Maslowski had no contacts with New York: The New York action should have been dismissed pursuant to CPLR 327(a). “ n the interest of substantial justice,” the parties’ dispute should be heard in Minnesota (CPLR 327 ;  Islamic Republic of Iran v Pahlavi , 62 NY2d 474, 478-479 <1984> ,  cert denied  469 US 1108 <1985> ). Ms. Maslowski demonstrated that the choice of forum provision in the parties’ agreement is unreasonable and should not be enforced ( see Brooke Group v JCH Syndicate 488  , 87 NY2d 530, 534 <1996> ). Every aspect of the transaction at issue occurred in Minnesota, the parties, documents, and witnesses are located in Minnesota, and defending this action in New York would be a substantial hardship to Ms. Maslowski. Takeaway: Prospect Funding teaches that forum-selection clauses are not automatically enforceable. They can be found to be unenforceable when: it is unreasonable or unjust to do so; it is against public policy; or it is the result of fraud or overreaching. In addition, a forum selection clause can be set aside when a party can demonstrate “that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court.” Chiarizia v. Xtreme Rydz Custom Cycles , 43 A.D.3d 1353, 1354 (4th Dep’t 2007). Finally, and perhaps more significant in today’s world of e-commerce, a forum selection clause can be invalidated when its existence was not reasonably communicated to the plaintiff – that is, it was unreasonably masked from the view of the prospective purchaser. Jerez v. JD Closeouts, LLC , 36 Misc. 3d 161, 170 (Nassau Dist. Ct. 2012). The lesson of Prospect Funding therefore is that forum selection clauses, while prima facie valid, are not iron-clad, and can be found unenforceable if a litigant is not careful.

A breach of contract comes in two primary varieties: a material breach and a minor breach.  The former is substantial, goes to the very heart of the agreement and prevents the contract from being performed. When a material breach occurs, the non-breaching party can cease performing under the agreement and sue to collect the damages caused by the breach.  The latter, also known as a partial breach, occurs when a party fails to complete a less important part of a contract. Importantly, the contract can still be completed. Thus, the non-breaching party remains obligated to complete his/her performance under the agreement, but has the right to sue for damages. In deciding whether a breach is material, courts often look to the Restatement (Second) of Contracts, as well as to other court decisions that arose from contract disputes. In New York, “courts generally consider the extent to which the non-breaching party will be prejudiced or damaged by lack of full performance.” Awards.com v. Kinko's, Inc. , No. 603105/03, 2006 WL 6544391, at *5 (Sup. Ct. N.Y. Cnty. 2006) (quoting Callanan v. Powers , 199 N.Y. 268, 284 <1910> , aff’d as modified , 42 A.D.3d 178 (3d Dept. 2007)).  This determination is not as easy as it seems. The Restatement (Second) of Contracts provides a list of circumstances that help determine whether a breach is material – that is, whether the non-breaching party is prejudiced by the breach.  These circumstances include: “(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected; (b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived; (c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture; (d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; (e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.” Restatement (Second) of Contracts § 241 (1981).  These factors are discussed below. The extent to which the injured party will be deprived of the benefit which he reasonably expected: An example of this factor can be seen from the Volkswagen emissions scandal. Volkswagen marketed and sold its turbocharged direct injection (“TDI”) diesel engines as “clean diesel” vehicles. Purchasers of these vehicles believed that they were buying vehicles that met or exceeded emissions requirements in the United States. However, Volkswagen intentionally programmed its TDI diesel engines to activate emissions controls only during laboratory emissions testing. Thus, the vehicles were not environmentally clean as represented. For millions of environmentally conscious consumers, the purpose of buying the TDI diesel engine vehicles was denied – that is, they were deprived of the clean diesel vehicles they agreed to buy. The extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived : If the breach can be corrected with reasonable effort or expense, while keeping the contract in effect, it is less likely to be a material breach. Consider the Volkswagen TDI diesel engine example. Volkswagen did not have the technology to make the TDI diesel engine clean. Because the manufacturer could not fix the problem, a court would consider Volkswagen to have breached the contract in a material way. The extent to which the party failing to perform or to offer to perform will suffer forfeiture : This factor looks at the amount or degree of performance by the breaching party to fulfill his/her end of the bargain? In the Volkswagen example, the company failed to deliver at inception. It did not expend the time and resources needed to deliver a clean diesel engine vehicle. Under that circumstance, the breach is material. There are other more common, everyday examples of this factor.  For instance, consider the homeowner who hires a contractor to replace his roof with modern tiling. About sixty percent of the way into the job, the homeowner discovers that the contractor is not using the modern tile as agreed upon, though the material used is considered to be comparable. If the homeowner declares a breach of contract, the contractor will have lost a significant amount of time and money than if the breach was declared before the job commenced. If most of the contractual obligations have been completed, the homeowner would be less likely to claim a material breach of contract. The likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances: This factor considers whether breaching party can and will correct the problem. The more likely the breaching party can and will fix the problem, the less likely the breach will be deemed to be material. In the Volkswagen case, the technology for “clean diesel” engines did not exist.  Thus, there was no likelihood that Volkswagen could fix the emissions problem. The extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing : If the breach was intentional or resulted from bad faith or unfair dealing, a court is more likely to presume a material breach of contract. In the Volkswagen case, the facts showed that in order to deceive the buying public and government regulators about compliance with emissions standards, Volkswagen intentionally programmed its TDI diesel engines to activate emissions controls only during laboratory emissions testing. These controls were automatically turned off once the emissions testing concluded. The extent to which the Contract Defines A Material Breach : Often, the parties to a contract will include provisions in their agreement stating that certain events will constitute a material breach of the agreement. For example, a clause may state that certain activities, such as a failure to make payments, a failure to maintain insurance, or a failure to achieve certain sales goals, will constitute a material breach under the contract. Notably, because a delay in performance and/or payment may not be material, parties often include a “time is of the essence” clause, to signify that a delay will be considered a material breach of the agreement. Matter of Buffalo Schools Renovation Program: On December 8, 2016, the Supreme Court, Commercial Division, in Erie County issued a decision in the  Matter of Buffalo Schools Renovation Program , 2016 NY Slip Op. 51846(U), in which it dismissed a breach of contract and rescission claim because the breach alleged was not material. Facts : Buffalo Schools arose out the renovation of 48 schools for the City of Buffalo City School District (“District”), formerly known as the Buffalo Schools Renovation Program (the “Program”). The general framework of the Program was governed by a Comprehensive Program Packaging and Development Services Provider Agreement, signed by the City of Buffalo Joint Schools Construction Board (“JSCB”) and LPCiminelli, Inc. (“LPC”) in 2002 (“PPDSA”). JSCB acted as the District’s agent in implementing and overseeing the Program. LPC served as the “Program Provider”. Pursuant to the PPDSA, the Program was implemented over five (5) phases; each phase was governed by separate phase agreements (the “Phase Agreements”). The Phase Agreements set out the delivery model for the phase and the specific schools to be renovated pursuant to that delivery model. While substantially all of the Program was financed with state funds (not the District’s or the City of Buffalo’s), the District, the JSCB, and the bond insurers and underwriters insisted that LPC agree to commit to fixed-priced construction agreements for each phase of the renovations, pursuant to which LPC assumed virtually all of the risk of cost overruns and time delays. The Phase Agreements required that amounts due LPC were to be determined by the Program’s architects, based upon the percentage of completion of the stipulated sum, not the actual cost of construction and administration. For more than a decade (and five phases of the Program) the JSCB approved and paid 265 of LPC’s Program payment requisitions, without reservation — until late 2014. At that time (and at the behest of certain members of the District’s Board of Education), the JSCB failed to process certain of LPC’s payment requisitions for completed portions of the Program, totaling in excess of $3.1 million (the “Disputed Payment Requisitions”), and the District insisted that it — not the JSCB, was solely responsible for considering them. For the first time, the JSCB and the District demanded that LPC produce documentation of, inter alia , LPC’s Program-related overhead and administration costs, construction expenses and profit (the “Disputed Information”). The Motion Court’s Rulings : The District filed a complaint against LPC on January 29, 2016, alleging, among other things, breach of contract. On February 17, 2016, LPC filed a verified petition and complaint against the District and the JSCB, alleging, among other things, the failure to act on the Disputed Payment Requisitions. Each side moved to dismiss the complaints pursuant to CPLR § 3211; the District and the JSCB also moved to dismiss pursuant to Section 3813 of the New York Education Law, and by way of cross-motion to direct LPC to preserve any documentation related to the construction program at issue. The Court (by decision rendered on the record on August 15, 2016) disposed of some, but not all aspects of the motions. Instead, it invited further submissions on the remaining issues that were the subject of the Court’s decision. The Court found that LPC did not breach any provision of the PPDSA. Nevertheless, the Court addressed the allegation that the breach ( i.e. , the failure to provide certain documentation required under the PPDSA) was material and, therefore, permitted the District and the JSCB to cease performing under the contract.  The Court found that, “even if accepted as true,” LPC’s failure “to provide required information” was not material “as a matter of law and, in any event, justify the District’s refusal to pay LPC for the work approved and accepted.” The Court explained that: Only a material breach of contract gives rise to a cause of action or a right to rescind. A material breach is generally regarded as a breach which substantially defeats the purpose of an agreement in such a fundamental way as to defeat the object of the parties in making the contract, and otherwise occurs where a party fails to perform a substantial part of the agreement performance of which was the initial inducement for entering the agreement. For a breach to be material, it must go to the root of the agreement between the parties. A party to a contract will not be excused from paying for the other party’s services absent such material breach. In determining whether a breach is material, courts generally consider the extent to which the non-breaching party will be prejudiced or damaged by lack of full performance. Whether a breach is material is a question of law to be decided by the Court. * * * Here, any alleged breach by LPC’s purported failure to provide certain information was not material. The purpose of the Program and its contracts was to renovate forty-eight (48) District schools for a stipulated sum. That purpose was fully accomplished. The District does not dispute this. It accepted the work, occupied the buildings, and received the certifications of the Architects of Record, who signed off on the outstanding payment applications. For twelve (12) years, the District never claimed that LPC failed to provide it with regular reports or required information. The District’s claim, raised at Program completion, does not go to the “root” of the contracts; it was not so substantial that it defeated the object of the parties in making the contracts; and, equally important, the provision of information was never an inducement for the District to enter into the contracts at issue. The District wanted schools renovated, at a fixed priced, and that is what it received. Under a fixed-price contract, the actual cost to the design-builder is irrelevant and immaterial. The provision that the District relies most heavily on – PPDSA § 11.05 – predates the entry of the Phase Agreements, meaning it had even less materiality once the fixed-price model was agreed on. (Internal quotations and citations omitted). Takeaway: Buffalo Schools stands as a reminder that parties to an agreement that want to cease performing because of an alleged breach better be sure that the breach goes to the root of the agreement such that performance cannot be made. Otherwise, that party is exposing itself to a claim of breach of contract that may in fact be material.

On January 6, 2017, the SEC announced that it awarded $5.5 million to a whistleblower who came forward with information that led to a successful SEC enforcement action.  The whistleblower is the 38 th relator to receive an award under the SEC whistleblower program. In total, since 2011, the SEC has paid approximately $142 million to whistleblowers who provided information resulting in the collection of monetary sanctions against violators of the securities laws. To date, the SEC has recovered $904 million from enforcement actions resulting from whistleblower tips. According to the Order Determining Whistleblower Claim , the relator came forward “while still employed with the company … and … provided critical information that helped end an on-going fraud that preyed predominantly on a more vulnerable investor community.” The Commission agreed to make the award notwithstanding the fact that the relator failed to comply with Rule 21F-9(d), which requires tips to be in writing “if the information was first submitted to the Commission during the interim period between the enactment of the whistleblower program— i.e. , July 21, 2010, when the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) was signed into law—and the effective date of the Commission’s whistleblower rules.”  The Commission found that, among other things, the relator “was already actively working with before the enactment of the Dodd-Frank Act, and … it would have been counter-productive and unreasonable to require … the revert to providing information to the Commission staff in writing.” The SEC declined to identify the whistleblower or the wrongdoers. By law, the SEC protects the confidentiality of whistleblowers and does not release information that might directly or indirectly reveal the whistleblower’s identity. Commenting on the award, Jane Norberg, Chief of the SEC’s Office of the Whistleblower, stated: “Whistleblowers play a key role in bringing wrongdoing to the SEC’s attention, and this whistleblower helped prevent further harm to a vulnerable investor community by boldly stepping forward while still employed at the company.” Under the program, whistleblowers are eligible for an award if they voluntarily provide the SEC with original information that leads to a successful enforcement action that exceeds $1 million. The award can range from 10 percent to 30 percent of the money collected. All payments come from an investor protection fund established by Congress that is financed through monetary sanctions paid to the SEC by securities law violators.  No money is taken or withheld from harmed investors to pay whistleblower awards. Takaway: This Blog has repeatedly noted that the SEC’s whistleblower program is, by all accounts, a success.  In Fiscal Year 2016 (ended September 30, 2016), the SEC awarded more than $57 million to whistleblowers under the program. As the SEC rings in the new year with this award, the SEC is clearly signaling that it wants whistleblowers to continue to come forward with original information regarding alleged violations of securities laws.