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The enforceability of a covenant not to compete is an issue that commercial and business lawyers often consider in their practice. Sometimes, the issue arises when an employee leaves a business to open his/her own shop, while other times the issue arises in the sale of a company.  On January 18, 2017, in Shimon v. Paper Enterprises, Inc. , 2017 NY Slip Op. 30101(U) , Justice Sylvia G. Ash of the Supreme Court, Kings County, Commercial Division, issued an injunction enforcing a covenant not to compete in the latter situation. Covenant Related to the Sale of a Business vs. Covenant Related to Employment: Covenant Not to Compete in The Sale of a Business A covenant not to compete, which relates to the sale of a business and its accompanying good will, is enforceable when it is reasonable in scope and duration and is not unduly burdensome. Mohawk Maintenance Co. v. Kessler , 52 N.Y.2d 276, 283-284 (1981). The purpose of the covenant in this context is to protect the purchaser’s acquisition of goodwill in the going concern. Purchasing Assoc. v. Weitz , 13 N.Y.2d 267, 271 (1963). It does so by preventing the seller from starting a new competing business in which the seller could solicit the business of former customers who would voluntarily follow the seller to the new business. Town Line Repairs, Inc. v Anderson , 90 A.D.2d 517, 517 (2d Dept. 1982). New York courts have applied this “sale of a business” rationale in cases where an owner, partner or major stockholder of a commercial enterprise had sold his/her interest for an immediate consideration which was, in part, payment for the good will of the business, in terms of “continuity of place” and “continuity of name”.   Purchasing Assoc. , 13 N.Y.2d at 271. As noted, a covenant not to compete in the sale of a business is reasonable when it is not broader in terms of time, scope and area than is reasonably necessary to protect the buyer’s interest in the going concern. Purchasing Assoc. , 13 N.Y.2d at 271. Three to five year restrictions have generally been held to be reasonable. See , e.g. , Hakakian v. Think Bronze, LLC , 2010 N.Y. Misc. LEXIS 6513; 2010 NY Slip Op 33597(U), *7 (Nassau Cty. Sup. Ct. 2010) (citing FTI Consulting Inc. v. Price Waterhouse Coopers, LLP , 8 A.D.3d 145 (1st Dept. 2004)). Whether a covenant is reasonable depends on the circumstances of each case. Karpinski v. Ingrasci , 28 N.Y.2d 45, 49 (1971). A covenant not to compete will not be declared invalid merely because it is unlimited in duration if the other restrictions on geographic area and scope are limited and reasonable. Thus, if a particular restriction is considered unreasonable, it can be severed and the covenant in its modified form can be enforced. Karpinski , 28 N.Y.2d at 51. Covenant Not to Compete in Employment Covenants not to compete pursuant to the sale of a business are not treated as strictly as those whose sole purpose is to limit employment. In the employement context, a restrictive covenant will only be subject to enforcement to the extent that it is reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee. Courts in New York generally disfavor these covenants because they inhibit a “man’s livelihood” ( Purchasing Assoc. , 13 N.Y.2d at 272), as well as the flow of services, talent and ideas. The courts have determined that employers have a legitimate interest in safeguarding the information and ideas that made the business successful and protecting against commercial piracy. Id . at 274. Thus, covenants not to compete are enforceable only to the extent necessary to prevent the disclosure or use of trade secrets or confidential customer information. However, where the employee’s services are deemed “special, unique or extraordinary”, then the covenant, even if reasonable, may be enforced by injunctive relief though the employment did not involve the possession of trade secrets or confidential customer lists. Shimon v. Paper Enterprises, Inc.: Background The action arose from the purchase of Worldwide Sales & Distributing, Inc. (“WSD”) by Paper Enterprises, Inc. (“PEI”). In connection with the transaction, the parties entered into three agreements: (1) the Asset Purchase Agreement by which PEI purchased certain WSD assets and assumed certain liabilities; (2) the Employment Agreement by which PEI agreed to employ the plaintiff, Barry Shimon (the former owner of WSD), as manager of PEI’s newly formed “Retail Division” for a term of five years; and (3) the Warehousing and Services Agreement by which WSD agreed to allow PEI to store, warehouse, assemble and repackage its merchandise at WSD’s warehouse in Edison, New Jersey. The Asset Purchase Agreement contained a non-compete clause stating, in relevant part, that Shimon agreed that “for a period of five (5) years from and after the Closing Date ... he will not engage in any business similar to or which competes with the Business anywhere in the states of New York, New Jersey, Pennsylvania, Connecticut, Maryland and Delaware, directly or indirectly ....” After two years, Shimon left PEI’s employ and formed a new company in New York called “Great $ Deal Inc. (“Great Deal”). Great Deal competes with PEI. Shimon sought a preliminary injunction to prohibit PEI “from taking any action that would prevent, inhibit and/or otherwise impede ability to obtain employment and/or engage in commerce in order to support himself and his family.” Shimon claimed that PEI breached the three agreements discussed above, thereby relieving him of his performance obligations. In addition, Shimon argued that the non-compete clause was unenforceable because it was overbroad – that is, the five-year restrictive covenant contained in the Asset Purchase Agreement was unreasonable in light of the two-year restrictive covenant contained in the Employment Agreement. PEI also sought a preliminary injunction.  PEI sought to enjoin Shimon from soliciting or attempting to pursue, market or solicit the business of any PEI customers or prospective customers for a five-year period beginning with date of the transaction closing. The Court’s Decision Justice Ash denied Shimon’s motion and granted PEI’s cross-motion only to the extent that Shimon, either directly or indirectly, individually or through any person or entity, was prohibited from soliciting or attempting to pursue, market or solicit the business of any of PEI customers or prospective customers until August 27, 2017 (five years after the deal closed). In so ruling, the Court found: Here, given the undisputed facts, the Court finds that PEI has established entitlement to the injunctive relief that it seeks. First, Shimon’s contention that he is not bound by the Asset Purchase Agreement is without legal support and is otherwise without merit. Secondly, Shimon fails to provide support for his argument that the geographic scope or duration of the subject restrictive covenant is overly broad. He fails to dispute that PEI’s business extends into the six-state Territory. Accordingly, there is no basis to deem the subject restrictive covenant unenforceable. Conversely, Shimon’s application for injunctive relief must fail. Takeaway: Shimon is instructive for two reasons.  First, it demonstrates the ease with which the courts will enforce a covenant not to compete related the sale of a business. Second, it underscores the requirement that the covenant must be reasonable in scope, time and geographic location.

Last month, this Blog wrote about the uncertainty surrounding implementation of the Department of Labor’s (“DOL”) fiduciary rule.  On February 3, 2017, that uncertainty was reinforced with the issuance by President Trump of a memorandum directing the DOL to determine whether the fiduciary rule should be revised or rescinded. The memorandum directs the DOL to delay the implementation date of the rule by 180 days. What is the Fiduciary Rule? The regulations in question expanded the universe of persons who would be considered a fiduciary under the Employment Retirement Income Security Act of 1974. (Click here for this Blog’s discussion of the fiduciary rule.) In general, these regulations, which were to become effective on April 10, 2017, would have imposed a fiduciary duty on registered brokers, financial advisers, and other investment professionals (collectively, “Financial Advisors”), who provide investment recommendations for retirement accounts, such as 401(k)s, IRAs and health savings accounts. Currently, Financial Advisors have no legal obligation to act in their client’s best interest, except for those professionals who are registered as investment advisers with the Securities and Exchange Commission (“SEC”) or in individual states. Instead, Financial Advisors only have to recommend investments that are “roughly suitable” for their customer. This means, for example, that a Financial Advisor, who has a choice between two similar mutual funds, can put a customer in the higher commission and fee investment even though the other fund has lower fees and could generate higher returns. While commissions and other fees are permissible under the regulations, Financial Advisors must commit to charging “reasonable compensation” and cannot receive financial incentives to make inappropriate recommendations. This commitment is set forth in a contract provided to the client in which the advisor promises to put the client’s interests first — the “best-interest contract exemption”. Firms that employ the Financial Advisors would also have to disclose their compensation and incentive arrangements. Conflicted advice costs retirees approximately $17 billion a year, according to a 2015 report from the Obama administration. Notwithstanding, the Trump administration has indicated that it wants to keep the old system in place, arguing that the fiduciary rule will limit investment choices and burden the industry with unnecessary regulations. The President’s February 3, 2017 Memorandum: In addition to directing the DOL to delay implementation of the fiduciary rule, the memorandum directs the DOL to review and analyze the rule and prepare an economic and legal analysis “concerning the likely impact” of the rule on, among other things: “access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice”; the retirement services industry and whether the rule “has resulted in dislocations or disruptions … that may adversely affect investors or retirees”; and litigation and the costs borne by investors and retirees “to gain access to retirement services”. If the DOL finds any of the foregoing points to be impacted by the rule, or if it concludes “for any other reason” that the rule “is inconsistent with the priority identified” in the memorandum, then the DOL is to issue a new proposed rule that revises or rescinds the fiduciary rule. Political and Industry Opposition to the Rule: Republican lawmakers, Financial Advisors and some financial advisory firms have maintained that the fiduciary rule will restrict investment options for investors and retirees. President Trump echoed this sentiment in the memorandum, stating: “One of the priorities of my Administration is to empower Americans to make their own financial decisions, to facilitate their ability to save for retirement and build the individual wealth necessary to afford typical lifetime expenses.…” Republican lawmakers have also argued that the SEC, not the DOL, should oversee and regulate any changes related to financial firms. Many Financial Advisors and financial advisory firms have been opposing the fiduciary rule since the DOL’s approval of the final regulations, arguing the regulations could raise the costs of compliance and the costs of providing advice, thereby making it more difficult to serve lower-income clients. Some have also argued that the increase in costs will price out smaller Financial Advisors who will not be able to service smaller accounts. The Securities Industry and Financial Markets Association, the industry’s top lobby group, estimated the fiduciary rule would cost Financial Advisors and their financial service companies $5 billion to implement and another $1.1 billion annually to maintain. Additionally, business groups, including the U.S. Chamber of Commerce, the National Association for Fixed Annuities, and American Council of Life Insurers have sued to try to block implementation of the rule. (This Blog discussed these and other lawsuits here and here .) Industry Best Practices: Despite the industry’s opposition to the regulations, representatives of some financial service companies have publicly stated that they plan to change their practices to meet the standards contained in the regulations even if the rule is rescinded.  For example, Bill Morrissey, managing director of business development at LPL Financial Holdings Inc., said before the President signed the memorandum, “What investors want is more transparency and lower fees.” On January 26, 2017, Morgan Stanley said that it plans to continue with changes designed to comply with the rule, despite uncertainty over whether the regulation will be implemented. Insurers, including American International Group Inc. and Principal Financial Group Inc., previously stated that they would continue to operate as though the regulations would be implemented. Takeaway: Given the new administration’s position on regulations, it seems likely the DOL will decide to modify or rescind the fiduciary rule. To do so, however, will require new rule making – a process that could take years not months, according to some observers. In the meantime, as noted above, some financial advisory companies recognize that best practices demand compliance with the rule even if it never gets implemented. As these firms note, a fiduciary standard of care is good for the industry despite the costs, because clarity and transparency around compensation builds faith and credibility with investors and retirees. Consequently, the President’s memorandum may prove to be much ado about nothing.

Arbitration is an alternative dispute resolution mechanism that enables parties to resolve disputes without going to court. Arbitration is similar to a trial without the formalities. It is an adversarial proceeding where the parties can call witnesses and present evidence to a neutral arbitrator or panel of arbitrators. The rules of discovery and evidence are relaxed to make it a shorter and more cost-efficient process.  An attorney or retired judge, who works for a private ADR firm, conducts the proceeding.  Often, the parties select the arbitrator or panel of arbitrators. Arbitration can be binding, in which the arbitrator renders a decision that can be enforced by the courts, or non-binding, in which the arbitrator renders an advisory opinion that the parties can accept or reject. In New York, arbitration, like other alternative dispute resolution mechanisms, is valid and enforceable. Westinghouse v. New York City Tr. Auth ., 82 N.Y.2d 47, 54 (1993) (“Considerable authority thus supports the validity and enforceability of alternative dispute resolution mechanisms.”). Like many jurisdictions, New York has a strong public policy that favors arbitration. In fact, arbitration is not only favored, but encouraged “as an effective and expeditious means of resolving disputes between willing parties desirous of avoiding the expense and delay frequently attendant to the judicial process.” Id . Because of the strong public policy favoring arbitration, courts give considerable deference to arbitrators and their awards. Tullett Prebon v. BGC Fin. , 111 A.D.3d 480, 482 (1st Dept. 2013) (“awards are subject to very limited review in order to avoid undermining the twin goals of arbitration, namely, settling disputes efficiently and avoiding long and expensive litigation”). In fact, judicial review of arbitration awards is severely limited in New York. Id .  As this Blog previously noted , setting aside arbitral awards are difficult. Grounds for The Review of Arbitral Awards Upon receiving a motion to confirm an arbitration award, New York courts must confirm the award unless the movant satisfies one of the statutory reasons for modification or vacatur provided by New York Civil Practice Law and Rules Section 7511. See CPLR 7510; see also Bernstein Family Ltd. P’ship v. Sovereign Partners , 66 A.D.3d 1, 7-8 (1st Dept. 2009) (confirmation is mandatory in the absence of grounds for vacatur). The grounds for modification or vacatur under CPLR 7511 are limited.  These include: (1) “corruption, fraud, or misconduct in procuring the award”; (2) partiality of the arbitrator; (3) the arbitrator exceeded his power or imperfectly executed it; (4) failure to follow the procedures of Article 75 of the CPLR. CPLR 7511(b)(1)(i)-(iv).  Only when the record demonstrates one of the foregoing will a New York court vacate or modify an award under the CPLR. (This Blog previously wrote about the importance of a record in the context of vacating an award, here and here .) Corruption, Fraud, Or Misconduct in Procuring the Award: Under CPLR 7511(b)(1)(i), an arbitral award may be vacated or modified when the movant can demonstrate “corruption, fraud, or misconduct in procuring the award.” The party challenging an award on these grounds must establish through clear and convincing evidence that the fraud or corruption was material to the proceeding such that the challenging party could not have discovered the fraud or corruption through the exercise of diligence. See , e.g. , Matter of Klikocki (New York Dept. of Corr., Mount McGregor) , 216 A.D.2d 808, 809 (3d Dept. 1995). Vacatur is also warranted under CPLR 7511(b)(1)(i) where, for example, the arbitrator or parties engage in misconduct. For example, vacatur is appropriate when the arbitrator refuses to hear material evidence ( Goldfinger v. Lisker , 68 N.Y.2d 225, 231 (1986) (“Arbitrators must afford the parties the opportunity to present evidence”)) or conducts an ex parte communication with a party that was substantial and material to the arbitrator’s decision. Id . at 227. Partiality of the Arbitrator: CPLR 7511(b)(1)(ii) permits vacatur or modification when the arbitrator was bias or maintained an undisclosed personal relationship to one of the parties, resulting in a prejudiced decision. J.P. Stevens & Co. v. Rytex , 34 N.Y.2d 123, 129-130 (1974) (“all arbitrators before entering upon their duties should make known any relationship direct or indirect that they have with any party to the arbitration, and disclose all facts known to them which might indicate any interest or create a presumption of bias”). The mere inference of impartiality, however, is insufficient to warrant interference with the arbitrator’s award; the evidence must be stronger; it must be clear and convincing. Matter of Provenzano , 28 A.D.2d 528 (1st Dept. 1967), aff’d , J.D.H. Rest. Inc. v. New York State Liquor Auth. , 21 N.Y.2d 846 (1968). The Arbitrator Exceeded His Power or Imperfectly Executed It: Under CPLR 7511(b)(1)(iii), a movant can vacate or modify an arbitral award when the arbitrator exceeded his or her authority under the arbitration agreement. To succeed under CPLR 7511(b)(1)(iii), the movant must demonstrate that the arbitration agreement limited the arbitrator’s authority to act, and the arbitrator subsequently violated that limitation. New York City Tr. Auth. v. Transport Workers’ Union of Am. Local 100, AFL-CIO , 6 N.Y.3d 332 (2005). The same is true with regard to arbitration mandated by statute.  Vacatur will be warranted where the arbitrator fails to follow the standards and requirements of the subject statute. Forest River, Inc. v. Stewart , 34 A.D.3d 474, 474 (2d Dept. 2006). Absent an agreement or statute, however, as long as an arbitrator addresses the issue(s) submitted for resolution, vacatur will not be granted, unless the award is completely irrational – that is, the resulting award goes beyond the issues before the arbitrator . Rochester City Sch. Dist. v. Rochester Teachers Ass’n , 41 N.Y.2d 578, 583 (1977). In addition to exceeding one’s authority, an award will be vacated when the decision is irrational or is violative of a public policy. See Board of Education of the Dover Union Free Sch. Dist. v. Dover-Wingdale Teachers Ass’n, 61 N.Y.2d 913 (1984); Matter of City of Johnstown , 99 N.Y.2d 273, 278 (2002). In essence, the court must conclude, without any fact-finding or legal analysis, that arbitration of the matter is prohibited by law. Stated differently, “a court must stay arbitration where it can conclude…that the granting of any relief would violate public policy.” Matter of New York City Tr. Auth. , 6 N.Y.3d at 284 (“where a court examines an arbitration agreement or an award on its face and concludes that the granting of any relief would violate public policy without extensive fact-finding or legal analysis, courts may then intervene and stay arbitration”). Failure to Follow the Procedures of Article 75: Finally, vacatur or modification is permitted under CPLR 7511(b)(1)(iv) when the arbitrator fails to follow the procedures set forth by Article 75 of the CPLR. Article 75 affords the parties due process rights, such as: the right to be heard, the right to cross-examine witnesses, and the right to present evidence. Article 75 of the CPLR does not bind an arbitrator to the rules of evidence because arbitrators are not bound by substantive rules of law. There must be some clear, egregious, and evident prejudice to the arbitration participant in vacating under CPLR 7511(b)(iv). Mere errors of law or fact do not suffice. Kalyanaram v. New York Inst. of Tech. , 79 A.D.3d 418, 419-420 (1st Dept. 2010) (“Challenges to the sufficiency or adequacy of the evidence to support an award are not grounds for vacating the award.”). Error of Law by Arbitrator Insufficient Basis to Vacate Award: Matter of Yarmak v. Pension Financial Services Inc. On January 24, 2017, the Appellate Division, First Department issued a decision in Matter of Yarmak v. Penson Financial Services Inc. , 2017 NY Slip Op. 00433, in which the Court held that mere errors of law are insufficient grounds to vacate an arbitral award. Background Facts: The petitioner, Sarah J. Yarmak (“Yarmak”), then a customer of ChoiceTrade, a securities brokerage firm, claimed that ChoiceTrade and the respondent, Penson Financial Services, Inc. (“Penson”), an independent execution, clearing, settlement and technology firm, engaged in a number of activities that caused her financial harm, including: unauthorized withdrawals from her brokerage account; churning; failure to provide the best execution price, failure to supervise, and the failure to disclose material information. On October 28, 2011, six years after the events that gave rise to the dispute, Yarmak initiated an arbitration against ChoiceTrade, Penson, and others. Pension filed motions to dismiss on February 14 and 15, 2012. Following extensive briefing and oral argument on the motions, the arbitration panel unanimously granted the motions. Yarmak filed a motion for reconsideration, and the Panel reversed itself with respect to ChoiceTrade (finding that Yarmak’s claims against ChoiceTrade were not barred by the statute of limitations), but the Panel “decided to uphold the Dismissal of Claims against Penson Financial Services, a Texas entity . . . based on a Texas Statute of Limitations.” On January 11, 2013, while the dismissal motions were pending, Penson filed for bankruptcy protection and, in accordance with that filing, all claims against Penson were automatically stayed. The Panel did not know about the bankruptcy filing or the automatic stay at the time it issued its February 1, 2013 order or when it issued its March 28, 2013 order. Later, when the Panel learned about Penson’s bankruptcy filing, it withdrew its ruling dismissing Penson. Yarmak continued the arbitration to final hearing against the other respondents (including ChoiceTrade). Following four days of evidentiary hearings in August 2013, and another three in March 2014, the panel issued a final order dismissing the claims against all remaining respondents on the merits. It also granted ChoiceTrade’s counterclaim against Yarmak for $348,885.62 plus costs and attorneys’ fees. On December 11, 2014, upon Penson’s application, the United States Bankruptcy Court issued an order retroactively annulling the automatic stay, thereby deeming effective all FINRA orders, including the Panel’s February 1, 2013 order dismissing Penson, and its March 28, 2013 order reaffirming the dismissal of Penson on statute of limitations grounds. On January 2, 2015, Yarmak filed another motion for reconsideration with the FINRA panel and finally, on February 27, 2015, “ fter considering the pleadings, the testimony and evidence presented at the hearing, and post-hearing submissions,” the panel denied Yarmak’s claims in their entirety and reaffirmed Penson’s dismissal from the case. On May 27, 2015, Yarmak filed a petition to vacate the arbitration Award.  In her petition, Yarmak argued that vacatur was appropriate because the panel: exceeded its authority by ruling on the statute of limitations issue before the conclusion of her case in chief; exceeded its authority by applying the Texas statute of limitations as opposed to the FINRA limitations period; and failed to provide a sufficient explanation for its decision. The Supreme Court, New York County rejected each of her arguments. First, the court found that panel properly considered the statute of limitations as a basis for dismissal at the outset of the arbitration under FINRA rules. In doing so, the court noted that FINRA’s rules only discourage rulings on motions to dismiss before the conclusion of the petitioner’s case in chief, they do not prohibit a panel from considering a motion to dismiss. Second, the court found that the panel properly applied the shorter statute of limitations set forth under Texas law, noting that the abbreviated period was contractually agreed upon by the parties. “As arbitration is entirely a creature of contract law,” said the court, “the panel was free to consider … a shortened limitations period such as the one provided under Texas law pursuant to respondent’s Customer Agreement.” Finally, the court rejected the argument that the panel failed to provide a sufficient explanation for its decision. “ review of the award,” said the court, “demonstrates that the reasons provided were sufficient in that the panel explained it was applying the Texas three year statute of limitations to the claims against respondent, a Texas entity, and the six year statute of limitations to the claims against ChoiceTrade.”  The Court concluded that “ he fact that petitioner is not satisfied with explanation or would like more detail is not a basis to vacate the award.” Not surprisingly, Yarmak appealed. The Appeal: In a unanimous decision, the First Department tersely affirmed the Supreme Court’s decision. Applying the legal principles discussed above, the Court held: Even if the arbitrators’ dismissal of petitioner’s claims prior to the completion of her case in chief violated Financial Industry Regulatory Authority (FINRA) Manual rule 12504, which provides that dismissals at such an early juncture are “discouraged,” the arbitrators were entitled to interpret the rule (FINRA Manual rule 12409). In any event, any error in interpretation is a mere error of law that does not provide a basis for vacatur ( see Wien & Malkin LLP v Helmsley-Spear, Inc. , 6 NY3d 471, 479 <2006> , cert dismissed 548 US 940 <2006> ). The same holds true with respect to the arbitrators’ application of the Texas statute of limitations pursuant to the choice of law clause in the parties’ agreement. Takeaway: Yarmak exemplifies the deferential treatment given to arbitrators under New York law and the narrow grounds under which vacatur or modification is permitted under CPLR 7511.  As the title of this article says, overturning an arbitral award is not easy.

New York, NY ( Law Firm Newswire ) February 3, 2017 -  The Law Office of Jeffrey M. Haber is pleased to announce that Mr. Haber, the firm’s principal, has been published in the December 2016 edition of the Wall Street Lawyer (Vol. 20, No. 12), a West LegalEdcenter publication, ©Thomson Reuters. The article, entitled “Will the Public Disclosure Bar Be the Next Provision of the False Claims Act to Be Reviewed by the U.S. Supreme Court?”, covers the basics of the False Claims Act public disclosure bar and the split of authority among the circuits about the test used to determine whether the public disclosure bar should apply to the actions of a would-be relator. The article also discusses United States ex rel. Advocates for Basic Legal Equality v. U.S. Bank , a case that is currently before the United States Supreme Court on a petition for a writ of certiorari. Advocates for Basic Legal Equity involved the dismissal of a qui tam because of the public disclosure bar. A copy of the article is available here . About The Law Office of Jeffrey M. Haber Located in New York City, The Law Office of Jeffrey M. Haber is dedicated to representing corporations, small businesses, partnerships and individuals engaged in a broad range of business and litigation matters. For over 25 years, Mr. Haber have been involved in high-profile complex litigations and arbitrations. He has served in various roles in both individual and class action lawsuits resulting in million and multimillion-dollar settlements and awards. His practice combines the sophistication and counsel of a large national law firm with the economy, flexibility, commitment, and personal attention of a small firm. ATTORNEY ADVERTISING. © 2017 The Law Office of Jeffrey M. Haber. The law firm responsible for this advertisement is The Law Office of Jeffrey M. Haber, 708 Third Avenue, 5th Floor, New York, New York 10017, (212) 209-1005. Prior results do not guarantee or predict a similar outcome with respect to any future matter. Contact: The Law Office of Jeffrey M. Haber 708 Third Avenue, 5th Floor New York, N.Y. 10017 Tel: (212) 209-1005 Fax: (212) 209-7101 Email: info@jhaberlaw.com

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 .