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

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

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

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

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

Being a whistleblower involves personal sacrifice and professional risk.  Many violations of the law go unreported because people who know about them are afraid of being disciplined, losing their job, being demoted, or being passed over for promotion.  Recognizing the financial, reputational and professional risks associated with whistleblowing, Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act” or the “DFA”) strong anti-retaliation provisions to protect whistleblowers who provide information about violations of the securities laws to the Securities Exchange Commission (“SEC”), or violations of any protected activity under the Sarbanes-Oxley Act of 2002 (“SOX”). The Dodd-Frank Act creates a private right of action for employees who have suffered retaliation “because of any lawful act done by the whistleblower – ‘(i) in providing information to the Commission in accordance with ; (ii) in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such information; or (iii) in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002,’” the Securities Exchange Act of 1934 (the “Exchange Act”), and “‘any other law, rule, or regulation subject to the jurisdiction of the .’” Importantly, Congress did not limit the private right of action to employees.  The Dodd-Frank Act extends the cause of action to any individual claiming to have been threatened, harassed or subjected to discrimination because of conduct protected by the Dodd-Frank Act.  A whistleblower may file a retaliation claim in federal court and seek, among other remedies, reinstatement, double back pay (as opposed to just back pay, as under SOX) with interest, litigation costs, expert witness fees and reasonable attorneys’ fees. Since its enactment, there has been a question over whether the whistleblower protections in the Dodd-Frank Act extend to employees who whistleblow internally, rather than to the SEC. The answer to this question has resulted in a split among the circuits. The Fifth Circuit, which was the first to address the issue, strictly applied the DFA’s definition of “whistleblower” to apply only to those who disclose suspected wrongdoing to the SEC. Asadi v. G.E. Energy (USA), L.L.C. , 720 F.3d 620, 621 (5th Cir. 2013). In doing so, the court rejected the SEC’s regulation (17 C.F.R. § 240.21F-2) which extends the anti-retaliation protections to all those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC. Id . at 630. The Second Circuit, by contrast, found that, if the DFA were restricted only to reporting to the SEC, Section 21F(a)(6), subdivision (iii), would protect only those employees who notify the SEC at the same time, or just before, they report internally under SOX.  The court concluded that the language in the DFA was “ambiguous” obligating it to accord Chevron deference ( Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. , 467 U.S. 837 (1984)) to the SEC’s regulation. Berman v. Neo@Ogilvy LLC , 801 F.3d 145, 155 (2d Cir. 2015). On March 8, 2017, the Ninth Circuit joined the Second Circuit in finding that the term “whistleblower” as used in the Dodd-Frank Act did not evince a congressional intent to limit the anti-retaliation protections to those who disclose information to the SEC only. Rather, the anti-retaliation provisions also protect those who were fired after making internal disclosures of alleged unlawful activity under SOX and other laws, rules, and regulations. Somers v. Digital Realty Trust , ___ F.3d ___, No. 15-17352, 2017 WL 908245 (9th Cir. Mar. 8, 2017). Background Paul Somers (“Somers”), a former Vice President of Digital Realty Trust (“Digital Realty”), alleged that Digital Realty fired him after he made several reports to senior management regarding possible securities law violations. Somers only reported these possible violations internally, and not to the SEC.  Somers was unable to report his concerns to the SEC before Digital Realty terminated his employment. Thereafter, Somers sued Digital Realty, alleging violations of state and federal securities laws, including violations of the anti-retaliation protections of the Dodd-Frank Act ( i.e. , Section 21F of the Exchange Act).  Digital Realty moved to dismiss on the ground that Somers was not a “whistleblower” under Dodd-Frank because he only reported the possible violations internally and not to the SEC. The district court denied the motion, deferring to the SEC’s interpretation that internal whistleblowers are also protected from retaliation under the Dodd-Frank Act. Like the Second Circuit, the court analyzed the statutory text, the DFA’s legislative history, and the procedural and practical implications of harmonizing the narrow definition of “whistleblower” with the broad protections of the anti-retaliation provision.  Somers v. Dig. Realty Tr. Inc. , 119 F. Supp. 3d 1088, 1100–05 (N.D. Cal. 2015). The court observed that “ t bottom, it is difficult to find a clear and simple way to read the statutory provisions of Section 21F in perfect harmony with one another.” Id . at 1104.  Having analyzed the tension between the definition and anti-retaliation provisions, the district court deferred to the SEC’s interpretation that individuals who report internally only are nonetheless protected from retaliation under DFA. Id . at 1106. The district court certified the question for interlocutory appeal pursuant to 28 U.S.C. § 1292(b), id . at 1108, and the Ninth Circuit granted Digital Realty’s petition for permission to appeal. The Ninth Circuit’s Decision As noted by the court, “ he underlying issue” in the case was “whether, in using the term ‘whistleblower,’ Congress intended to limit protections to those who come within DFA’s formal definition, which would include only those who disclose information to the” SEC. The issue arises because of the tension between the definition of who qualifies as a “whistleblower” under Section 21F(a)(6) and the anti-retaliation provisions of Section 21F(h)(1)(A)(iii). The former defines “whistleblower” as “any individual who provides . . . information relating to a violation of the securities laws to the Commission,” while the latter protects individuals who make “‘disclosures that are required or protected under’ Sarbanes-Oxley, the Exchange Act, 18 U.S.C. §1513(e), ‘and any other law, rule, or regulation subject to the jurisdiction of the Commission.’” The court concluded, like the Second Circuit, that Congress intended Section 21F(h)(1)(A) (iii) to broaden the anti-retaliation protections to include internal reporters.  The majority found that “ y broadly incorporating, through subdivision (iii), Sarbanes-Oxley’s disclosure requirements and protections, necessarily bars retaliation against an employee of a public company who reports violations to the boss, i.e. , one who ‘provide information’ regarding a securities law violation to ‘a person with supervisory authority over the employee.’” The court noted that “ strict application of ’s definition of whistleblower would, in effect, all but read subdivision (iii) out of the statute.”  The court also noted that there are provisions in SOX and the Exchange Act that mandate internal reporting before external reporting in certain instances.  Therefore, “ eaving employees without protection for that required preliminary step would result in early retaliation before the information could reach the regulators.” The court also found support in King v. Burwell , 135 S. Ct. 2480, 2489 (2015), the Supreme Court’s Affordable Care Act decision, for the proposition that a statutory term can have different operative consequences in different contexts.” Thus, it was reasonable to conclude that the term “whistleblower” “may mean different thing[]” in a different part” of the statute”. Id . at 2493 n.3. The majority concluded that a narrow ruling applying protections only to those reporting to the SEC “would make little practical sense and undercut congressional intent” to protect whistleblowers from retaliation. For all these reasons, we conclude that subdivision (iii) of section 21F should be read to provide protections to those who report internally as well as to those who report to the SEC. We also agree with the Second Circuit that, even if the use of the word “whistleblower” in the anti-retaliation provision creates uncertainty because of the earlier narrow definition of the term, the agency responsible for enforcing the securities laws has resolved any ambiguity and its regulation is entitled to deference. In a brief dissent, Judge John Owens sided with the Fifth Circuit.  Judge Owens criticized the majority for relying, in part, on King , and advocated for a “quarantine” of “ King and its potentially dangerous shapeshifting nature to the specific facts of that case to avoid jurisprudential disruption on a cellular level.” Takeaway Given the split in the circuits, it is likely the issue will reach the Supreme Court for review. This is especially so in light of the implications of extending the DFA anti-retaliation protections to internal whistleblowers.

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

This Blog previously wrote about a case involving a whistleblower’s claim, under the “alternate remedy” provision of Section 3730(c)(5) of the False Claims Act (“FCA”), to settlement proceeds obtained in a later-filed action brought by the government even though the whistleblower had voluntarily dismissed his earlier qui tam action. Earlier this month, Judge William H. Pauley, III had the opportunity to address the issue in United States ex rel. Kolchinsky v. Moody’s Corp ., 12-cv-1399 (S.D.N.Y. Mar. 2, 2017), a qui tam action brought by a former Moody’s Corp. (“Moody’s”) managing director who claimed that Moody’s sold subscriptions for its ratings delivery service to the government, which contained false ratings. Kolchinsky filed the action in February 2012, asserting numerous violations of the FCA. The common thread among the claims was that, prior to 2009, Moody’s issued credit ratings that a) were improperly inflated or deflated; b) entered the financial markets through various channels; and affected certain governmental entities relying on the quality of those ratings. After two years of investigation, the government declined to intervene. Following protracted settlement discussions, Kolchinsky amended his complaint in May 2015. The amended complaint largely tracked the original complaint. The Court granted Moody’s motion to dismiss, finding that all but one of the claims alleged in the amended complaint failed to establish that Moody’s sought payment from the government, as opposed to payment from private entities. As to the surviving claim ( i.e. , the ratings delivery service claim), the Court gave Kolchinsky leave to replead it. Thereafter, Kolchinsky filed a second amended complaint, which was essentially the same as his prior complaints. Judge Pauley once again dismissed the complaint. In doing so, the court found that the government was on notice of the facts Kolchinsky relied upon to support the fraud alleged in his second amended complaint. And, as that complaint established, the government nonetheless continued to pay Moody’s for its credit-ratings products. “Such allegations plead Kolchinsky out of court, because,” as the Supreme Court explained in Universal Health Servs., Inc. v. United States , 136 S. Ct. 1989, 1996 (2016) (discussed here ), “when the ‘Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements are not material.’” (quoting Escobar , 136 S. Ct. at 2003–40). Judge Pauley found that Kolchinsky failed to allege any facts giving rise to an inference that any listed agency could have been unaware of the alleged fraud during the proscribed time period. Having disposed of the second amended complaint, Judge Pauley addressed Kolchinsky’s claimed entitlement to a portion of a $864 million settlement among Moody’s, the Department of Justice, several states, and the District of Columbia relating to violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) and parallel state laws. Noting the harshness of the result, Judge Pauley found that the absence of a viable complaint at the time of the “related” action negated any entitlement to alternate-source relief: No alternate remedy is available here, however, because the Second Amended Complaint fails to state a valid FCA claim as a matter of law. Nor is the alleged “overlap” between Kolchinsky’s allegations and those described in the settlement agreement a basis for recovery by Kolchinsky. Even if a timely variant of Kolchinsky’s Ratings Delivery Service theory could have formed a basis for the settlement, that theory did not appear in his initial pleading, which was the basis on which the Government declined to intervene. Indeed, at least two of the “state cases” that formed the basis for the Government’s settlement occurred in the years before Kolchinsky’s first complaint was filed under seal. Kolchinsky is not entitled to the proceeds of a settled action he did not initiate. This Court acknowledges that this a harsh result. The role of a whistleblower is never an easy one. Kolchinsky provided enormously helpful information to various congressional committees and government investigators. This Court is particularly sympathetic to Kolchinsky’s position in light of the serious and far-reaching effects that Moody’s conduct had on the American economy. This observation does not, however, cure the deficiencies in Kolchinsky’s pleadings or enable him to collect a share of the FIRREA settlement. Internal citations omitted.

Medicare and Medicaid fraud costs taxpayers billions of dollars each year.  In 2016, the Government Accountability Office (“GAO”) estimated that in fiscal year 2015, taxpayers lost almost $90 billion to improper payments from Medicare and Medicaid providers.  The GAO defines an improper payment to be any payment that should not have been made or that was made in an incorrect amount (including overpayments and underpayments) under statutory, contractual, administrative, or other legally applicable requirements. It is estimated that fraud and abuse account for approximately 10% of all Medicare and Medicaid expenditures annually. Unfortunately, the government’s resources dedicated to anti-fraud enforcement are limited. However, whistleblowers – those willing to risk career, financial security, reputation and sometimes personal safety to report fraud on the government – can increase the power and impact of those resources significantly. Earlier this month, the Department of Justice (“DOJ”) announced the filing of criminal and civil actions relating to a 12-year scheme to defraud Medicaid, Medicare, and private health insurance companies out of more than $50 million. The DOJ civil action joins (through intervention) a pending qui tam action that was previously filed under seal. According to the DOJ, Dr. Asim Hameedi (“Hameedi”), a New York cardiologist, and Dr. Emad Soliman (“Soliman”), a New York neurologist, were arrested and charged in the scheme to defraud. Also charged were four employees or associates of City Medical Associates, P.C. (“CMA”), a clinic operated by Hameedi. All defendants are facing criminal charges for their roles in submitting false insurance claims to defraud Medicaid, Medicare and private health insurance companies. According to the DOJ, between 2003 and 2015, the defendants perpetrated their fraud by, among other things: (1) making false representations to insurance providers, including providers paid through Medicaid and Medicare, about the medical condition of patients in order to obtain pre-authorization for medical tests and procedures; (2) submitting false claims to insurance providers for tests and procedures that were not performed and/or medically unnecessary, as well as for drug items not used or provided; (3) paying kickbacks to local primary care medical offices in exchange for referrals from these offices; and (4) accessing, without authorization, electronic health records of patients at a hospital based on Long Island, New York (“Hospital-1”), in violation of the Health Insurance Portability and Accountability Act of 1996, in order to identify patients to be recruited to CMA. In furtherance of the scheme, and to hide from the insurance companies the huge volume of claims, including fraudulent claims, being submitted by CMA, Hameedi, and others submitted claims to the insurance companies falsely representing that medical tests had been ordered or performed by doctors who did not work at CMA and who had not ordered or performed the tests.  These doctors included Soliman, who knowingly participated in the scheme to allow CMA to submit false claims to the insurance companies in his name, as well as two other doctors who did not know that their identities were being used to further the fraud. In addition, Hameedi and others used various unlawful means to obtain and maintain a high volume of patients for use in the fraudulent scheme, including, among other things, paying kickbacks to local primary care offices and practitioners in exchange for referrals of patients by those offices and practitioners to CMA.  Moreover, Hameedi and employees of CMA repeatedly, and without authorization, accessed information in electronic health records of patients of Hospital-1 to identify and recruit them to CMA and Hameedi’s practice. “Public health insurance programs, like Medicare and Medicaid, are not a personal pocketbook for criminals seeking to exploit a program designed to help those who need these programs the most,” FBI official William F. Sweeney Jr. said in a statement. HHS-OIG Special Agent-in-Charge Scott J. Lampert added: “Health care fraud schemes like the one alleged here loot government health programs, compromise patient well-being, and undermine the public’s trust in the health profession.  You can bet our agents will continue to thoroughly investigate such allegations and hold fraudsters accountable for their crimes.” In the fraud action filed against CMA and Hameedi, among others, the government is seeking treble damages and civil penalties under the False Claims Act for the fraudulent claims submitted to Medicare and Medicaid for reimbursement by CMA. The criminal case is U.S. v. Asim Hameedi et al. , No. 17-cr-00137 (S.D.N.Y.). The civil case is U.S. ex rel. Dr. Patricia A. Kelley et al. v. City Medical Associates et al. , No. 1:15-cv-07261 (S.D.N.Y.).

The Department of Justice ("DOJ") recently announced that CA Technologies ("CA") has agreed to pay $45 million to resolve allegations under the False Claims Act related to a General Services Administration ("GSA") contract awarded to the company for software licenses and maintenance services. CA is an international information technology management software and services company with headquarters on Long Island, New York.  The government alleged that CA made false statements and claims in connection with the negotiation and administration of the GSA contract. Under Multiple Award Schedule contracts, like the one at issue, prices and contract terms for subsequent orders by federal agencies are pre-negotiated. In order to negotiate a fair price, the GSA required CA to fully and accurately disclose how it conducted business in the commercial marketplace. In addition, the contract included a price reduction provision that required CA to reduce the prices charged to the government if prices charged to commercial customers fell. The settlement resolves allegations that CA did not fully and accurately disclose its discounting practices to GSA contracting officers. In particular, the agreement resolves claims that CA provided false information about discounts given to commercial customers when the contract was first negotiated in 2002, as well as when it was subsequently extended in 2007 and 2009. Additionally, the settlement resolves claims that CA violated the price reduction clause in the contract by not providing government customers with additional discounts when commercial discounts improved. The allegations initially surfaced in a whistleblower lawsuit brought by a former employee of CA Software Israel. “Today’s settlement demonstrates our continuing vigilance to ensure that contractors deal forthrightly with federal agencies when seeking taxpayer funds,” said Acting Assistant Attorney General Chad A. Readler of the Justice Department’s Civil Division.  “We will take action against contractors who withhold information and cause the government to pay more than it should for commercially available items.” What is the False Claims Act? The False Claims Act ("FCA") is a federal law that prohibits businesses or individuals from knowingly submitting false or fraudulent claims to the federal government for payment. The FCA also rewards whistleblowers, referred to as "relators," who successfully recover funds on behalf of the government. In this case, the CA whistleblower is set to receive about $10.2 million under the settlement. In addition, the FCA includes an anti-retaliation provision that protects whistleblowers from workplace retaliation, including acts such as termination, suspension, demotion, and discrimination. If you are aware of a violation under the False Claims Act, an experienced attorney can help you understand and explore your options in blowing the whistle on fraud.

The Financial Industry Regulatory Authority, Inc. ("FINRA") has proposed a rule change that will allow broker-dealers to project the performance of investment strategies or asset allocations, but not specific stocks, in communications with clients. If approved, the new rule would put brokers on an equal footing with registered investment advisers that are currently allowed to use these projections in their communications. The self-regulatory organization ("SRO") is currently accepting comments on the proposed rule. The objective of the rule is to allow firms that are not dually registered, or those that do not employ dually-registered persons, to compete more effectively by providing this service to clients. "FINRA anticipates that these benefits would largely accrue to clients that do not have investment advisory accounts and, as a result, are not already receiving projections-related communications," the SRO wrote in its proposal. Under the proposed rule change, brokers would need a "reasonable basis" for all assumptions, conclusions and recommendations made in investment planning illustrations that are designed for clients. Moreover, the illustration must clearly and prominently disclose that the projection is hypothetical and that there is no guarantee that a projected performance or event will occur. All material assumptions and applicable limitations would also have to be disclosed. There are a number of ways to establish a reasonable basis, such as referring to the historical performance and volatility of asset classes, the duration of fixed income investments, anticipated contribution and withdrawal rates by clients, and the impact of a variety of other factors. Nonetheless, "hypothetical back-tested performance" or reliance on a particular asset manager's performance would not be permitted. Lastly, the projections would need to be approved by a principal of the firm or supported by a reliable software package. The proposed rule change stems from a recent self-assessment of current disclosure rules, and it has the support of brokers and industry groups. Ultimately, industry observers believe the rule change will harmonize FINRA's oversight of brokers with the standards that govern investment advisers. FINRA has requested comment about the proposed rule change, particularly concerning its potential impact on member firms, and whether there are alternative approaches that should be considered. Whether the amendment will be approved remains to be seen, but any member firm that needs advice and counsel on FINRA rules or that may be involved in a dispute should speak with a FINRA arbitration attorney.

Last November, this Blog discussed the faithless servant doctrine under New York law. ( Here .) As explained, the courts have applied the doctrine to a wide variety of misconduct, including, but not limited to, conflicts of interest, stealing money or goods, and secretly starting a competing business. Any act that can give rise to a claim for breach of fiduciary duty will trigger the doctrine. The penalty for violating the doctrine is harsh: the employee must forfeit all compensation earned since the first date of employment, even though the employee’s services may have otherwise benefitted the employer or the employer suffered no damages. Indeed, any value provided by the employee through loyal service is irrelevant. Thus, if an employee, even an otherwise valuable employee, is found to have been disloyal, then the employee will be required to disgorge all compensation even if the harm caused by the misconduct was minimal and the employee otherwise provided valuable service during the period of employment. Recently, Justice Ramos of the Supreme Court, New York County, Commercial Division, had the opportunity to rule on a summary judgment motion involving the doctrine. On February 27, 2017, Justice Ramos issued a decision in  Schulhof v. Jacobs , 2017 NY Slip Op. 50264(U), where he found the defendant, an art dealer, liable for fraud and breach of fiduciary duty and held that she not only had to account for the fraud, but also had to forfeit her commission on a sale of art work under the faithless servant doctrine. Background The action arose from a written agreement dated October 25, 2011 between the plaintiff, Michael P. Schulhof (“Schulhof”), and the defendant, Lisa Jacobs (“Jacobs”) (a private curator and art consultant) (“October Agreement”), pursuant to which Jacobs was to locate a buyer for a painting in the Schulhof Collection (the “Work”) for a minimum purchase price of $6 million in exchange for a $50,000 fee. The October Agreement required Jacobs to contact Schulhof prior to approaching any prospective purchaser, and prohibited her from presenting or seeking offers below $6 million without written confirmation of the lower price. Additionally, Jacobs could not “accept any fee from the purchaser, in cash or in kind". On November 1, 2011, Jacobs met with Amy Wolf (“Wolf”), an art dealer, to discuss the sale of the Work. Jacobs informed Wolf that the asking price for the Work was $6.5 million. By November 2, 2011, Jacobs and Wolf reached an agreement for the sale of the Work at the asking price. Shortly thereafter, on November 4, 2011, Wolf invited Jacobs to send her an invoice for the Work. The next day, on November 5, 2011, Jacobs informed Schulhof that she had a potential purchaser for the Work. On November 7, 2011, Jacobs informed Schulhof by email that she “was able to get the up to 5.5 million. We have a firm deal.” Schulhof accepted the deal. Jacobs suggested that the transaction be structured as a two-step process, stating that the buyer wanted to remain anonymous. Honoring the request, Schulhof sold the Work to Jacobs for $5,450,000, and Jacobs immediately resold it to Wolf for $5.5 million. On November 11, 2011, Jacobs executed a contract with Wolf for the sale of the Work for $6,500,000 (“November Agreement”). After receiving the $6.5 million from Wolf, Jacobs wired $5,450,000 to Schulhof on November 16, 2011. Jacobs never informed Schulhof that she received a $1 million profit in connection with the sale of the Work or that the buyer had accepted the $6.5 million offer. Approximately one year later, Schulhof discovered that the purchase price for the Work was actually $6.5 million and that Jacobs kept not only her agreed $50,000, but also an additional $1 million from the sale of the Work. The Complaint On August 26, 2013, Schulhof filed a complaint against Jacobs asserting causes of action for breach of fiduciary duty, fraud, breach of contract, restitution, and unjust enrichment. The complaint sought compensatory damages in excess of $1 million, as well as punitive damages. Following the completion of fact discovery, each party filed a motion for summary judgment. The Court’s Decision The court granted Schulhof’s motion for summary judgment, finding that Jacobs had “misrepresented” the terms of the sale of the Work knowing “that the buyer was actually willing and ready to pay” more than was represented by Jacobs ( e.g. , $6.5 million). In addition, the court found that the fraud occurred in the context of a fiduciary relationship, which obligated Jacobs “to disclose the $6.5 million offer prior to entering into the November Agreement.”  Given Jacobs “disloyalty” and breach of fiduciary duty, the court considered Jacobs to be a faithless servant, requiring her to account “for the $1 million of secret profits earned for the sale of the Work,” and “forfeit the $50,000 in compensation” she had earned under the October Agreement. Takeaway The faithless servant doctrine is a potent weapon for employers faced with an employee who acts with disloyalty during his/her employment. Although this Blog queried whether the doctrine was too draconian last year, it is hard to disagree with its application in Schulhof .  After all, the defendant was found to have secretly profited from the sale of goods, at the expense of the plaintiff, in breach of her fiduciary duties.