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The Justice Department has joined a whistleblower lawsuit against United Healthcare Group, Inc. ("UHG" or "United") in connection with payments made to the company for its Medicare Advantage Plan. ( Here .) The suit claims the insurer obtained inflated risk-adjusted payments from the Medicare program by providing false and inaccurate information about the health risks of patients enrolled in UHG's largest Medicare Advantage Plan, UHC of California. The original lawsuit was filed by James Swoben, a former employee of Senior Care Action Network (SCAN) Health Plan, under the qui tam provisions of the False Claims Act. "The intervention of the United States in this matter illustrates our commitment to ensure the integrity of the Medicare Part C program," said Acting Assistant Attorney General Chad A. Readler of the Justice Department's Civil Division. What is the Medicare Advantage Program? The Medicare Advantage program is a privately run alternative to the government's Medicare program for the elderly and disabled. Private insurers who participate in this program provide coverage in return for contractual monthly payments. Those payments are determined, in part, on patient-risk scores that are based on their medical conditions in the previous year. United is reportedly the nation's largest Medicare Advantage organization, providing healthcare services and prescription drug benefits to millions of individuals across the country. Currently, about 30 percent of Medicare beneficiaries are enrolled in Medicare Advantage programs. UHG False Claims The suit claims that UHG disregarded information about patients' medical conditions in order to increase the risk-adjusted premiums received from the Medicare program for beneficiaries under the care of a United service provider, Healthcare Partners ("HCP"). In particular, United allegedly funded chart reviews conducted by HCP, and ignored information from these reviews about invalid diagnoses. In short, UHG  received payments to which it was not entitled. "Since 2005, UnitedHealth knew that many diagnosis codes that it submitted to the Medicare Program for risk adjustment were not supported and validated by the medical records of its enrolled beneficiaries," according to the complaint. This lawsuit comes on the heels of another qui tam action the Justice Department joined in February in which the government alleged United defrauded the Medicare program ).  The False Claims Act allows whistle-blowers to file lawsuits against companies on behalf of the government and receive between ten and thirty percent of any recovery. If you know of a violation of the False Claims Act, you should speak with an experienced attorney who can help you understand and explore your options in blowing the whistle on fraud.

On April 26, 2017, the House Financial Services Committee (the “Committee”) held a hearing, entitled “A Legislative Proposal to Create Hope and Opportunity for Investors, Consumers, and Entrepreneurs.” ( Here .) The purpose of the hearing, which lasted over three hours, was to examine the discussion draft of the “Financial CHOICE Act of 2017” (“CHOICE Act 2.0”), which was introduced by Committee Chairman Jeb Hensarling on April 19, 2017. (Discussed here .) The CHOICE Act 2.0 seeks to repeal and make fundamental changes to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) , as well as other financial regulatory laws. On May 4, 2017, the Committee voted to send the CHOICE Act 2.0 to the full House for a vote. ( Here .) Last week, this Blog discussed the proposed change to the SEC Whistleblower program included in the Choice Act 2.0 ( here ); namely, that relators who are non-criminally culpable participants (deemed “co-conspirators” under the discussion draft) in the alleged violation are ineligible to receive a reward for their information. In this installment, this Blog will address the proposed bill’s effort to protect fiduciaries from challenges by those whose interests they are charged with protecting. DOL Fiduciary Rule In May of last year, this Blog wrote about the Department of Labor’s (“DOL” or “Department”) fiduciary rule (“Fiduciary Rule”), which requires financial advisors to put their clients’ interests first when making investment recommendations for retirement accounts, such as 401(k)s and IRAs. ( Here .) The rule, designed to prevent conflicts of interest, had strong support from the Obama administration and investor advocates who argued that inappropriate recommendations cost retirement investors $17 billion a year. On February 3, 2017, President Trump signed a memorandum directing the DOL to determine whether the Fiduciary Rule should be revised or rescinded. (Discussed here .) The memorandum directed the DOL to delay the implementation date of the rule by 180 days. Pursuant to that direction, on March 10, 2017, the DOL filed a notice proposing to delay the start of the Fiduciary Rule from April 10 to June 9, 2017. ( Here .) After a 15-day public comment period, the DOL sent its delay notice to the Office of Management and Budget for review. ( Here .) Following the OMB’s review, the DOL publicly released an official 60-day delay to the effective date of the Fiduciary Rule. Although the DOL has been tasked with reviewing the desirability of, and necessity for, the rule, if enacted into law before June 9, the CHOICE Act 2.0 will effectively take that decision away from the Department. Under the previous version of the CHOICE Act, the DOL was prohibited from issuing a fiduciary duty rule until 60 days after the Securities and Exchange Commission (“SEC”) issues a rule.  In that regard, the act would have blocked the Fiduciary Rule from becoming effective until 60 days after the SEC initiates a fiduciary rule governing the standards of conduct for brokers when providing personalized investment advice about securities to a retail customer. The CHOICE Act 2.0 abandons the 60-day time limit, instead requiring the DOL to issue a fiduciary rule that is “substantially similar” to the SEC’s rule.  Since the SEC has not issued a fiduciary duty rule, the CHOICE Act 2.0 effectively prevents the Fiduciary Rule from becoming effective. Fiduciary Duty Under Section 36(b) of The Investment Company Act of 1940 The Investment Company Act of 1940 (“ICA”) regulates investment companies, including mutual funds. See Jones v. Harris Assocs. L.P. , 559 U.S. 335, 338 (2010). “Congress adopted the because of its concern with the potential for abuse inherent in the structure of investment companies.” Id. at 339 (citing Daily Income Fund, Inc. v. Fox , 464 U.S. 523, 536 (1984)). The ICA provides various safeguards for shareholders in response to the risk of abuse, including limitations on affiliations of fund directors with investment advisors and a requirement that fees for advisors be approved by the directors and shareholders of the funds. Id . In 1970, Congress amended the ICA to “strengthen the ‘cornerstone’ of the Act’s efforts to check conflicts of interest, the independence of mutual fund boards of directors, which negotiate and scrutinize advisor compensation.” Id . (citation omitted). In that regard, the ICA includes a broad provision empowering the SEC to bring actions in a federal district court to seek civil penalties or injunctive relief against individuals or entities that violate the ICA. 15 U.S.C. § 80a-41(d)-(e). In creating Section 36(b), Congress imposed a fiduciary duty on investment advisors with respect to the receipt of compensation for services. Section 36(b) provides shareholders with a private right of action to enforce this obligation. Section 36(b) does not, however, give plaintiffs the right to sue for alleged breaches of general fiduciary duties. Case law makes clear that a breach may be shown only where the fee charged is “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.” Jones , 559 U.S. at 346. The court’s function is to use “the range of fees that might result from arm’s-length bargaining as the benchmark for reviewing challenged fees” and “identify the outer bounds of arm’s length bargaining.” Id . In applying this standard, courts consider the following factors: (1) the nature and quality of the services provided to the fund and shareholders; (2) the profitability of the fund to the adviser; (3) any “fall-out financial benefits,” those collateral benefits that accrue to the adviser because of its relationship with the mutual fund; (4) comparative fee structure (meaning a comparison of the fees with those paid by similar funds); and (5) the independence, expertise, care and conscientiousness of the board in evaluating adviser compensation. Id . at 1426, n.5 (citing Gartenberg v. Merrill Lynch Asset Mgmt., Inc. , 694 F.2d 923, 929-32 (2d Cir. 1982)). These factors are non-exclusive. Therefore, courts are to consider “all relevant circumstances.” Gartenberg , 694 F.2d at 929); see also Sivolella v. AXA Equitable Life , Civ. A. No. 11-cv-4194 (PGS)(DEA), 2016 WL 4487857, at *4 (D.N.J. Aug. 25, 2016) (“The Court weighs all of the evidence presented and the gravity of each factor to adjudicate the case.”) (citation omitted). Plaintiffs have the burden of proving a breach of fiduciary duty under Section 36(b).  Jones , 559 U.S. at 340 (internal citations omitted); 15 U.S.C. § 80a-35(b). This means that plaintiffs must meet the burden of proving their case by a preponderance of the evidence. Kasilag v. Hartford Inv. Fin’l Servs., LLC , 2:11-cv-01083, at *7 (D.N.J. Feb. 28, 2017). The CHOICE Act 2.0 seeks to change the foregoing by requiring private plaintiffs to state their claim with particularity and prove it by clear and convincing evidence. By imposing these requirements, the CHOICE Act 2.0 seeks to treat the ICA’s breach of fiduciary duty claim like a fraud claim. Under the Federal Rules of Civil Procedure, fraud claims must be pled with particularity. Most states require the plaintiff to prove fraud with clear and convincing evidence, rather than a preponderance of the evidence generally applicable to civil claims. Some jurisdictions also apply the higher pleading standard to breach of fiduciary claims, in effect treating them as fraud claims. By imposing a heightened pleading standard and burden of proof, the CHOICE Act 2.0 will make it even more difficult for a plaintiff to sustain breach of fiduciary duty claims against officers, directors or other specified fiduciaries of the investment company.

A FINRA arbitration panel recently awarded an investor over $1 million in compensatory and punitive damages related to claims that a Wilbank Securities Inc. broker misled her about the performance of a variable annuity. The investor alleged fraud, breach of contract, negligent supervision and breach of fiduciary duty in connection with the underperforming investment. The investor purchased the variable annuity at a Wilbanks branch in Colorado in 2008, and claims she was promised a 7 percent compounded annual return. She sold the investment in 2012 and received a rate of return that was far less, according to her attorney. The $536,720 in compensatory damages was designed to help the investor recoup those losses. In addition, she was awarded the same amount in punitive damages, which were attributed to the bank's pattern of harming a group of variable annuity investors who experienced similar problems. Variable Annuities at a Glance A variable annuity is a tax-deferred retirement vehicle that allows an investor to select a variety of investments, and then pays out a level of income in retirement that is determined by the performance of the chosen investments. Variable annuities are designed to boost savings by providing investors with long-term capital growth.   Although advocates believe fixed, indexed and variable annuities are a critical component of retirement security because they provide a guaranteed income stream, critics contend that variable annuities are too complex for ordinary investors. The Wilbanks Arbitration In this proceeding, the arbitration award says Wilbanks denied the allegations and filed a counterclaim. The investment adviser argued that the investor's claim was brought more than seven years after she bought the annuity, which did not meet the requirements of FINRA Rule 12206 or state law statutes of limitations. The investor's claim was filed in January 2016. The three-member panel denied Wilbank's counterclaim but awarded the investor less than she originally sought. In any event, this story highlights the importance of the FINRA arbitration process in protecting investors from losses due to misconduct, or sales practice violations. Most brokerage agreements between investors and financial advisors include a mandatory arbitration clause. These proceedings are a faster and less expensive method of resolving disputes than a court trial.  If you are an investor who is seeking to bring a claim, or an investment adviser in need of representation before a FINRA review panel, you are well advised to engage the services of an  experienced securities arbitration attorney.

One remedy the Securities and Exchange Commission ("SEC" or "Commission") has long relied upon in cases involving broker misconduct is disgorgement. In a nutshell, disgorgement is a remedy that requires a party who profits from illegal conduct to pay back any ill-gotten gains obtained from that conduct. On April 18, the U.S. Supreme Court heard oral argument in  Kokesh v. Securities and Exchange Commission , a case involving a New Mexico-based investment adviser who was sued in federal district court by the SEC in 2009 for misappropriating investors' money. The adviser was ordered to pay $2.4 million in penalties, plus $34.9 million in disgorgement of ill-gotten profits. The disgorged amounts, however, did not go to the victims, instead, it went to the U.S. Treasury. The U.S. Court of Appeals for the 10th Circuit upheld the disgorgement award as not time-barred by 28 U.S.C. §2462, the statute of limitations requiring that “enforcement of any civil fine, penalty, or forfeiture” be “commenced within five years from the date when the claim first accrued.” Although the 10th Circuit’s opinion comported with that of other courts of appeals (including the First Circuit and the District of Columbia Circuit), it conflicted with the 11th Circuit, which broke from its sister circuits in Securities and Exchange Commission v. Graham . As noted, under 28 U.S.C. §2462, the SEC has five years to seek penalties, forfeitures, and other punitive remedies, in civil enforcement matters. The Commission, therefore, is incentivized to commence enforcement proceedings seeking such relief within this time frame, especially given the Supreme Court's 2013 decision in Gabelli v. Securities and Exchange C ommission , in which the Court held that the limitations period set forth in Section 2462 begins to run when the fraud occurs, not when it is discovered -- a point raised by the SEC during the argument. The issue in Kokesh is whether disgorgement is a penalty governed by the five-year limitation period. The Commission argued that the statute of limitations did not apply to disgorgement, claiming that disgorgement is equitable relief, which is not a form of punishment but restores the defendant to the position s/he was in prior to the misconduct occurring, while Kokesh argued that disgorgement is either a “forfeiture” or a “penalty” and thus subject to the five-year limitation period. During the argument, the justices questioned how the SEC applies disgorgement and whether it has the legal authority to force the disgorgement of profits for conduct occurring more than five years from the date of the enforcement action. For example, Justices Alito, Sotomayor and Kennedy questioned the source of authority for the Commission to pursue disgorgement remedies, while newly-seated Associate Justice Neil Gorsuch raised concerns that there is no statute in place governing the remedy and whether the government keeps the money or if it is paid to the victims. "We kind of have a special obligation to be concerned about how far back the government can go when it's something that Congress did not address because it did not specify the remedy," Chief Justice John Roberts said. Justice Kennedy suggested that perhaps there was a “non-categorical” approach, characterizing disgorgement as non-penal and not subject to any statutory definition ( e.g. , a civil fine, penalty, or forfeiture) when the only objective of the remedy is victim compensation: "The case is presented to us as if disgorgement is this category we must adopt. … It’s always a penalty or it’s always not a penalty. It seems to me that maybe we can give guidance on when it is a penalty." A ruling is expected in June. Takeaway At this juncture, some observers of the Court believe it will likely rule against the SEC. If the SEC loses, it could impact cases in the pipeline, as well as those in which the defendants were ordered to disgorge profits for conduct dating beyond the five-year statute of limitations. In light of Justice Kennedy's “non-categorical” suggestion, it is possible that the Court could create an alternative to the positions advanced by the SEC and Kokesh that is based on that suggestion. In that event, Kokesh could declare victory, while the possibility that the statute of limitations would not apply to enforcement actions that only seek victim compensation would remain open. Regardless of how the Court rules, many believe it will take an act of Congress to determine whether the five-year statute of limitations applies to disgorgement.

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.