Search Results

Previously, this Blog wrote about the importance of having a complete record when challenging an arbitration award.  Recently, two claimants in arbitration learned the hard way that an incomplete record will not support vacatur of an award.  See Abbott vs. RBC Dain Rauscher Inc. , No. 1-15-1612, 2016 IL App. (1st) 151612-U (Ill. App., 1Dist., 9/29/16). The Arbitration P roceeding: David James and Michael Abbott (“Plaintiffs”) filed a claim in arbitration against RBC Dain Rauscher Incorporated, now known as RBC Capital Markets Corporation, and Charles Lane, a broker at RBC Capital (“Defendants”), for violating various financial regulations. The Plaintiffs retained RBC Capital and Lane as their financial consultants. Around 2005, the Plaintiffs discovered unsuitable trades in their accounts. In September 2008, the Plaintiffs filed a five-count statement of claim before the Financial Industry Regulatory Authority (“FINRA”). The Plaintiffs asserted violations of the federal securities laws and Illinois consumer laws, and various claims under the common law. The matter went to arbitration for over two years with hearings spanning approximately 57 days. In February 2014, a three-member panel awarded the Plaintiffs almost $200,000 in compensatory damages and $3,000 in sanctions against the Defendants. During the hearing, the Plaintiffs orally moved to submit two FINRA news releases (from 2009 and 2010) and also a “financial industry regulatory letter of acceptance, waiver, and consent,” which is the equivalent of a FINRA settlement, involving RBC Capital. The hearing transcript revealed that counsel for the Plaintiffs briefly described the documents, outlined their contents, and argued they would buttress his expert’s testimony that the Defendants had violated various industry standards and that RBC failed to properly supervise its employees, including Lane. The presiding arbitrator held that the documents did not relate directly to the claims and denied their admission as exhibits. The presiding arbitrator nonetheless reserved the matter for the close of evidence. At the close of evidence, counsel for the Plaintiffs again moved to submit the documents as exhibits. The presiding arbitrator stated that the Plaintiffs could attach the documents to their closing brief and that essentially the arbitrators may or may not review them. The Plaintiffs, however, did not attach the documents. The Motion Court Proceedings: The Plaintiffs moved to vacate the arbitration award, arguing that the arbitrators refused to hear evidence material to the matter, thereby rendering their damages award insufficient. The court denied their motion, holding the matter was within the arbitrators’ discretion. The Plaintiffs filed a motion to reconsider, which was denied. The court thereafter granted the Defendants’ motion to confirm the arbitration award. The Plaintiffs appealed the judgment affirming the arbitration award, contending that the arbitrators did not properly consider the evidence described above. The Appellate Court Ruling: On appeal, the Plaintiffs challenged the motion court’s ruling denying their motion to vacate the arbitration award, arguing the arbitrators erred in declining to admit the news releases and settlement documents. The Plaintiffs maintained that had these documents been admitted, they would have been able to establish liability against RBC for the failure to monitor employee activities, and then been able to obtain punitive damages. The Plaintiffs contended that their expert should have been allowed to testify about the news releases and settlement documents, but inexplicably failed to provide the court with the full transcripts of their expert’s testimony, the Defendants’ expert’s testimony, or that of any other witness. Instead, they only provided the court with snippets of arbitration testimony and transcripts of their interchange with the court and opposing counsel, whereby they argued the evidence at issue should have been admitted. Incredibly, as the Court noted, “ ome of the snippets not even identify by name which witness is testifying.” Slip op. at n.2. The Court held that, even assuming the Plaintiffs had properly sought to admit the documents, “without a record bearing the full hearing testimony, especially that of the competing experts,” it could not say that those documents “were so material to the matter at hand that without them the course of the case would have changed vis a vis RBC.” Id . at 6. Consequently, the Court affirmed the judgment. Takeaway: The teaching of Abbott is simple: a party challenging an arbitral award must file as complete a record as possible to support the motion, taking care to highlight all evidence, not merely snippets and argument among counsel. The importance of this teaching cannot be underscored enough because the party seeking to vacate an arbitral award has the burden of establishing the basis upon which the award should be vacated. Unfortunately for the Plaintiffs in Abbott , they did not learn the lesson. They failed to meet their burden because they “submit a record … woefully insufficient to find prejudice or that plaintiffs were deprived of a fair arbitration hearing.” Slip op. at 7.

Jane is a shareholder in ABC Co. Over the past three years, the company has been losing money, due in large part to an increase in expenses. Jane learns the truth about the company’s financial condition and discovers that senior managers of the company are reporting their personal use of the company’s jet, cars and houses as a business expense. Because of managements’ failure to properly report the use of company property, the company’s expenses have skyrocketed. Jane wants to recover the expenses incurred because of the managers’ misuse of corporate property. Jane can do so by filing a shareholder derivative action. A derivative action is a lawsuit brought by a shareholder of a company, on behalf, and for the benefit, of the company to enforce or defend a legal right or claim. Derivative actions seek the recovery of damages and/or equitable relief arising from unlawful or improper conduct engaged in by officers, directors, or other persons in control of the company. Such conduct includes, but is not limited to: breaches of fiduciary duty; fraud; self-dealing by insiders; conflicts of interest; waste of company assets; insider trading; options backdating; inflated, false, or misleading financial statements; improprieties related to executive compensation; conduct leading to regulatory investigations; and management or board decisions that expose the company to harm or risk ( e.g. , violations of consumer protection laws, environmental violations). A derivative action allows current shareholders to bring an action in the name of the company to redress the harm caused by management where it is unlikely that management will redress the harm itself. In addition to the recovery of damages, which are awarded to the company and not to the individual shareholders that initiate the action, a successful derivative action may include corporate governance reforms that strengthen and protect shareholder value. Any recovery of money or implementation of governance reforms by way of settlement must be approved by the court. Approval must be based on facts and circumstances showing that the result is fair and reasonable to the company and in its best interest. Although a shareholder has the derivative action in his/her arsenal, he/she cannot immediately run to court to redress the alleged wrongdoing. The shareholder must first formally demand the company’s board of directors act in the manner that the shareholder requires, such as suing the wrongdoers. The “demand” requirement, however, can be waived if the suing shareholder can show that such a demand would have been futile. If the shareholder makes a demand on the board, then the board must be allowed time to determine the proper course of action to pursue. To assist it, the board will often seek outside counsel and/or create a committee of disinterested directors who were not involved in the transaction about which the shareholder is complaining. If the board and/or committee recommend legal action, then the board will likely file an action against the wrongdoers who have pursued, or are pursuing, the illegal or improper course of conduct. If, however, the board and/or the committee determine that legal action is not appropriate, then the demanding shareholder may commence an action on his/her own for the benefit of the company. In addition to the demand requirement, many jurisdictions require a shareholder to prove that he/she has standing to bring the action. These laws often require the shareholder to meet certain qualifications, such as maintain a minimum value of the shares held and the hold the shares for a certain period of time. Culligan Soft Water Company v. Clayton Dubilier & Rice, LLC As noted above, any settlement of a derivative action must be approved the court. See , e.g. , Section 626(d) of the New York Business Corporation Law. In June 2015, the Honorable Jeffrey K. Oing, Justice of the Supreme Court, New York County, approved such a settlement.  However, on November 29, 2016, the First Department reversed that approval because, among other reasons, the settlement did not confer a benefit on the company. Culligan Soft Water Co. v. Clayton Dubilier & Rice, LLC , 2016 NY Slip Op. 08021. The Motion Court Proceedings : On June 8, 2015, Justice Oing approved the partial settlement of a derivative action brought by minority shareholders of Culligan Soft Water Company (“Culligan”).  The action arose from the $610 million leveraged buyout (“LBO”) of the company by Clayton Dubilier & Rice, LLC (“CD&R”), a private equity firm.  The suing shareholders claimed that after CD&R bought Culligan, it saddled the company with more debt than it could repay. At the same time, CD&R extracted the company’s value for its own benefit through a series of transactions, including a $375 million dividend, and allowed its debt to be sold at a steep discount to investment firms Angelo Gordon & Co., Silver Oak Capital LLC and Centerbridge Partners LP (the “Lenders”). The shareholder plaintiffs reached a settlement with Angelo Gordon, Centerbridge and a related entity.  Under the settlement, the Lenders agreed to pay the shareholders $4 million to be held in trust and used to settle the plaintiffs’ past legal fees, as well as fund the derivative action against CD&R and the current and former Culligan officers and directors. CD&R and the director defendants objected to the proposed settlement, arguing, among other things, that the proposed settlement only benefited the plaintiffs – the minority shareholders – and not the company or its two largest shareholders, both CD&R entities. At oral argument, Justice Oing rejected these arguments, though he expressed skepticism at first, questioning whether it would be better to keep the $4 million in escrow, pending the final resolution of the case.  Justice Oing found that the partial settlement was fair since it resolved the claims against the Lenders (which related to the restructuring and the acquisition of Culligan’s assets pursuant to a 2012 exchange transaction) and provided money for the claims against the remaining defendants, in addition to cooperation from the Lenders in the continued litigation. Justice Oing noted that the proposed partial settlement “compartmentalized” the suit by removing peripheral claims, while keeping the focus on the central allegations of the action – those concerning the LBO and the allegedly illegal distributions paid to CD&R and the Culligan officers and directors. In his bench ruling, Justice Oing underscored the fact that, under the settlement, the minority shareholders would receive $4 million and cooperation from the Lenders to pursue the larger case, which was in the best interest of the broader case: “Those are factors they had to weigh and think about, not only for their benefit but also for the company’s benefit, and at the end of the day, that is something I cannot ignore.” The First Department’s Holding: On November 6, 2016, the First Department heard argument on CD&R’s objections to the partial settlement. As an initial matter, CD&R argued that the plaintiffs, minority holders of beneficial shares of the company, did not have standing to settle the claims. CD&R noted that the plaintiffs were Culligan franchisees and “business partners” with the defendant investment firms that bought Culligan’s debt after CD&R’s $610 million LBO. Additionally, CD&R argued that the settlement provided no benefit to Culligan. According to CD&R, the settlement benefited the minority shareholders and not the corporation. “The money is going straight into the pockets of the dealers, their trade association and its attorneys,” said CD&R’s counsel. “ hey haven’t obtained anything except cash for their trade association.” Notably, the minority shareholders did not disagree, stating: “The $4 million is to be used for legal fees and to the extent that there’s anything left, it would go to the company.” Neither the trade association nor the dealers would receive any money outside of what they had spent on legal fees. Approximately three weeks later, the First Department agreed with CD&R and the company defendants and reversed the approval of the partial settlement. In a unanimous, terse opinion, the Court accepted the reasons advanced by these defendants for vacating the judgment below: The settlement does not provide for payment to the company. Plaintiffs are to receive the bulk of the $4 million settlement in reimbursement for their legal fees in this case, and the remainder is to be turned over to their franchisee organization for future legal fees or for distribution, at the organization's discretion, to plaintiffs. Moreover, because they have not obtained a substantial benefit for the company, but have accomplished only getting their lawyers paid, plaintiffs, who, after four attempts, have yet to plead properly that they have standing to sue derivatively, are not entitled to legal fees. It was an abuse of discretion to approve the settlement of a derivative action purporting to bind the company and all shareholders that was obtained by plaintiffs who had not established — and may never establish — their standing to bring the action. Contrary to plaintiffs' argument, defendants, as shareholders in the company who received notice of the settlement and had an opportunity to and did object to the settlement, have standing. Internal citations omitted. Takeaway: It is well-established that the fundamental purpose of a derivative action is to vindicate a wrong done to the company. Because that is the purpose of the derivative action, New York courts have long held that any recovery obtained in a derivative action should be for the benefit of the injured company. Thus, any monetary payment recovered and/or non-monetary benefit obtained in the action must be paid and/or flow to the company whose claims are at issue. The settlement before the Court in Culligan , however, did not comport with these principles. The record showed that in exchange for a broad release of Culligan’s claims against the settling parties, the minority plaintiffs would receive: (1) $4 million to be paid directly to their franchise dealers association, which was given complete discretion –without court review– to distribute attorney’s fees, hold “up to $1 million” in trust “to fund future legal expenses,” and to pay the balance “directly to Plaintiffs” in proportion to their fundraising efforts for the association; and (2) cooperation in the continued litigation ( i.e. , the ability to subpoena documents and testimony from the settling parties) – consideration that was opposed by the company and its majority shareholder because it only conferred a benefit on the plaintiffs and their attorneys. The Court rightly found that neither form of consideration provided any benefit to Culligan or its majority shareholder. Where derivative actions are concerned, courts must be vigilant in protecting the interests of the corporation and shareholders, especially in the context of settlement. The reason courts are given such a responsibility is “to discourage the private settlement of a derivative claim under which a shareholder-plaintiff and his attorney personally profit to the exclusion of the corporation and the other shareholders....”  Mokhiber on Behalf of Ford Motor Co. v. Cohn , 783 F.2d 26, 27 (2d Cir. 1986). By examining the substance of the proposed settlement in Culligan , the Court fulfilled its role as gatekeeper and ensured that the relief obtained was fair and reasonable and would go to the company. As the Court found, however, the partial settlement did not provide a real or substantial benefit to the company but, instead, allowed the plaintiffs to negotiate fees in exchange for illusory benefits to the corporation and broad general releases for the alleged wrongdoers.

In an article entitled “Why You Won’t Get Your Day in Court” appearing in The New York Review of Books, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York, tried to explain why this is so. According to Judge Rakoff, there are several reasons for this occurrence. These include: the “cost of hiring a lawyer”; “the increased expense, apart from legal fees, that a litigant must pay to pursue a lawsuit to conclusion”; the “increased unwillingness of lawyers to take a case on a contingent-fee basis when the anticipated monetary award is modest”; “the decline of unions and other institutions that provide their members with free legal representation”; “the imposition of mandatory arbitration”; “judicial hostility to class action suits”; “the increasing diversion of legal disputes to regulatory agencies”; and “in criminal cases, … the … increased risk of a heavy penalty in going to trial.” Judge Rakoff observed that there are a number of “disturbing trends” that illustrate the consequences of these factors. For example, “as many as two thirds of all individual civil litigants in state trial courts are representing themselves, without a lawyer,” including “people of moderate means” who “cannot afford a lawyer.” As Judge Rakoff noted, this trend has had a negative impact on such litigants because “ nividuals not represented by lawyers lose cases at a considerably higher rate than similar individuals who are represented by counsel, … even when the judge tries to compensate for counsel’s absence.” The inability to afford a lawyer goes beyond simply affording attorney’s fees. It goes to the costs of litigation, which have “proved to be excessively expensive.” As Judge Rakoff observed, these costs “not only place[] impecunious parties at a disadvantage but, again, also discourage[] ordinary people from bringing meritorious lawsuits in the first place.” Even the contingent-fee arrangement does not adequately cure the problem, according to Judge Rakoff. For starters, “contingent-fee arrangements only benefit those … who are suing rather than being sued.” Under most state rules of professional responsibility, the plaintiff who has a contingent-fee arrangement “is still personally responsible for paying for the costs of the lawsuit,” which “frequently amount to thousands of dollars.” “Most importantly,” said Judge Rakoff, “the time-consuming nature of modern litigation means that most contingent-fee lawyers will simply refuse to take on a case that does not promise an award or settlement of at least several hundred thousand dollars, leaving those tort victims who cannot sue for large amounts unable to have a day in court.” If the fees and expenses don’t impede access to the courts, then “one-sided contracts” requiring arbitration will, said Judge Rakoff. These agreements, drafted by counsel for employers and the seller of goods and services, require disputes to be decided in arbitration rather than in court. Even though these agreements are rightly called “contracts of adhesion”, “ i.e. , one-sided contracts imposed on weaker parties who have no realistic ability to negotiate, let alone contest the terms,” they nevertheless have been upheld and enforced by the courts, including the United States Supreme Court. So, What is the Solution? Judge Rakoff offered a few suggestions to open the courthouse doors to ordinary Americans.  These solutions, which Judge Rakoff believes will not “come easily”, include legislative responses, “state-sponsored legal insurance”, “a guarantee of counsel to indigent civil litigants” and a “lawyer-subsidized provision of cheaper legal services.” Perhaps the most immediate solutions, said Judge Rakoff, should come from the courts: But while the larger solutions to this denial of access must await a change in the legislative climate, there is, I am convinced, no reason short of ignorance or ideology for judges to continue to give their approval to devices that effectively deny Americans access to their courts…. And lower court judges, state and federal, could take a harder look at some of the practices described here that have the same effect. This would require a considerable change of thought on the part of many judges. Indeed, it is hardly surprising that judges who often have substantial dockets tend to look favorably on arrangements that will lessen their work burden, whether by mandatory arbitration, denial of jurisdiction, reliance on prosecutors and administrators, or similar measures. Too often, however, such relief morphs into an effective reduction of judicial responsibility, with dire consequences for the long-term ability of the courts to serve as an effective check on the power of the legislature and the executive. Arguably even worse, the situation I’ve described reinforces the belief of citizens that the courts are not an institution to which they can turn for justice, but are simply a remote and expensive luxury reserved for the rich and powerful. If the judges themselves do not take steps to counter this insidious trend, who will? This Blog’s Takeaway: Judge Rakoff makes several strong points, especially with regard to the costs of litigation. For this reason, Freiberger Haber LLP (the “Firm”) has been dedicated to making litigation and consultation services efficient and affordable.  The Firm understands that clients are concerned about cost certainty.  Therefore, the Firm uses flexible fee arrangements to deliver value to its clients for all types of legal matters, from the routine to the complex. At Freiberger Haber LLP, we work with our clients to develop risk-sharing solutions and alternative fee arrangements to help them address their business and litigation challenges. Whether through hourly fees, fixed fees, collared fees, contingent fees, success fees/holdbacks, or any combination of approaches, the Firm crafts fee arrangements that reduce overall costs, improve predictability, share risks and align incentives. In this way, the Firm can provide the best value and result to its clients.

The Securities and Exchange Commission (“SEC”) will tell anyone who listens that reporting violations of the securities laws is an important part of its anti-fraud/anti-corruption whistleblower program.  This is especially so when the violations are difficult to detect.  For this reason, among others, the SEC has encouraged company insiders with knowledge of wrongdoing to come forward with information about the violations. The carrot used to encourage such whistleblowing is the reward mechanism provided under the SEC program. Over the year, this Blog has written about awards given to whistleblowers under the SEC and CFTC whistleblower programs – the anti-fraud/anti-corruption programs created under the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). See here , here , here , and here . Yesterday, the SEC issued another award to a whistleblower. On December 5, 2016, the SEC announced that it awarded $3.5 million to a whistleblower who came forward with information that led to a successful SEC enforcement action.  The whistleblower is the 36 th relator to receive an award under the SEC whistleblower program. In total, since 2011, the SEC has paid approximately $135 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 $874 million from enforcement actions resulting from whistleblower tips. The SEC declined to identify the whistleblower or the wrongdoers. By law, the SEC protects the confidentiality of whistleblowers and does not release information that might directly or indirectly reveal the whistleblower’s identity. Commenting on the award, Jane Norberg, Chief of the SEC’s Office of the Whistleblower, stated: “Whistleblowers do a tremendous service to the investing public and we will continue to reward those who come forward with valuable tips that help us bring successful cases against those who violate the securities laws.” 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: The SEC’s whistleblower program is, by all accounts, a success. Announcements like this one serve as important reminders to potential whistleblowers that they will be rewarded if they come forward and provide information that results in a successful enforcement action. This Blog hopes that whistleblowers will heed these reminders, especially since the program is under the microscope of the new administration (discussed by this Blog here ).

This blog previously wrote about Universal Health Services, Inc. v. United States ex rel. Escobar , a Medicaid case involving the “implied certification” theory of liability under the False Claims Act (“FCA”). In Escobar , the Court held that implied certification liability under the FCA may exist where the following two conditions are satisfied: (1) the defendant does not merely request payment, but also makes specific representations about the goods or services provided; and (2) the defendant’s failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading. Since the Supreme Court decided Escobar , the district courts have been split on whether satisfaction of the two-part test is the only basis on which a relator can establish implied certification liability. Some courts have determined that the two-part test is the exclusive means of establishing implied certification liability, while other courts and the Department of Justice (“DOJ”) have argued that liability under the implied certification theory may be found, under certain circumstances, without satisfying the first part of the test – that is, without establishing “specific misrepresentations” about the goods or services provided. The courts that have found the two-part test to be the exclusive means of establishing implied certification liability left no room for debate.  Each court found that the plaintiff “must” allege the two conditions set forth in Escobar . See , e.g. , United States ex rel. Handal v. Ctr. for Emp’t Training , No. 2:13-cv-01697-KJMKJN, 2016 U.S. Dist. LEXIS 105158, at *12 (E.D. Cal. Aug. 8, 2016) (“To establish implied false certification, a plaintiff must show < escobar ’s two conditions> escobar’s two conditions>.”); United States ex rel. Doe v. Health First, Inc. , No. 6:14-cv-501-Orl-37DAB, 2016 U.S. Dist. LEXIS 95987, at *8 (M.D. Fla. July 22, 2016) (“< escobar ’s> escobar’s> two conditions must exist to impose liability . . . .”); United States ex rel. Creighton v. Beauty Basics Inc. , No. 2:13-CV-1989-VEH, 2016 U.S. Dist. LEXIS 83573, at *9 (N.D. Ala. June 28, 2016) (“ he plaintiff must allege < escobar ’s two conditions> escobar’s two conditions>.”). The courts that have found that the two-part test is not the exclusive means of establishing implied certification liability argue for a more expansive view of the Supreme Court’s holding. For example, last month, in United States ex rel. Panarello v. Kaplan Early Learning Co. , No. 11-cv-00353 (W.D.N.Y. Nov. 14, 2016), the court held that “ Escobar cannot be read to impose the ‘specific representations’ requirement in every case.” Slip op at 8.  The court reasoned that the Supreme Court merely identified “‘some’ of the circumstances” that create implied certification liability, thereby “suggest that compliance with the conditions it discussed is not necessarily a prerequisite to implied false certification liability in every case.” Id . at 9. Consequently, the court permitted the implied certification claim to proceed even though the defendant did “not use payment codes” or “contain specific representations about the goods or services provided.”  Id . at *8. In permitting the claim to proceed, the Panarello court relied on the court’s decision in Rose v. Stephens Institute , No. 9-cv-05966-PJH, 2016 U.S. Dist. LEXIS 128269 (N.D. Cal. 2016), which reached the same conclusion. There, the court rejected the defendant’s exclusivity argument “as a matter of law”, finding that “Escobar . . . does not purport to set out, as an absolute requirement, that implied false certification liability can attach only when these two conditions are met.” It should be noted that both courts recognized that their decision was contrary to that of other courts. Consequently, the Rose court certified the issue to the Ninth Circuit, and the Panarello court recommended certification to the Second Circuit. The DOJ, for its part, has argued that the two-part test is not the exclusive means of establishing implied certification liability under Escobar . In statements of interest filed throughout the country, the DOJ has relied on the portion of the Supreme Court’s decision in which it expressly declined to decide whether a claim for payment could itself constitute an implicit representation of entitlement to payment. In that regard, the DOJ has relied on the Court’s refusal to “resolve whether all claims for payment implicitly represent that the billing party is legally entitled to payment,” noting that the claim before the Court contained “specific representations” that were “misleading half-truths.” Universal Health Services, Inc. v. United States and Massachusetts, ex rel. Julio Escobar and Carmen Correa , 579 U.S.___, 136 S. Ct. 1989, 1999-2001 (2016). Takeaway: This blog will continue to follow this post- Escobar debate.  One thing is for certain, there is a split of opinion that will make its way through the circuit courts, and perhaps even the Supreme Court.  Stay tuned.

Arbitration is an alternative form of dispute resolution, meaning it is an alternative to a court proceeding. In arbitration, the parties have their dispute resolved by neutral persons (known as arbitrators) knowledgeable in the areas in dispute, rather than by a judge or jury. Arbitration has been a form of dispute resolution within the securities industry for many years, primarily because it is generally considered to be faster, inexpensive and less complex than litigation.  Since 1987, investors with claims against their stockbroker or financial advisor have been required to assert them in an arbitration before the Financial Industry Regulatory Authority (“FINRA”) and its predecessors, the National Association of Securities Dealers and the New York Stock Exchange Regulation, Inc., the regulatory arm of the New York Stock Exchange.  Thanks to the Supreme Court, investors who sign customer agreements containing an arbitration clause must bring their claims against their broker or financial advisor in an arbitration proceeding instead of a state or federal court. Shearson/American Express v. McMahon , 482 U.S. 220, 226 (1987). By agreeing to arbitrate, “a party does not forgo substantive rights …; only submits to their resolution in an arbitral, rather than a judicial, forum.” Id . at 229-230, 238 (citation omitted). For years after Shearson/American Express , investors and commentators criticized the securities arbitral process as unfair to individual investors, primarily because of a perceived bias towards broker/dealers. See , e.g. , Susanne Craig, New York Times, Investors Opt for Arbitration Panels Without Ties to Wall Street (Oct. 27, 2011). This perceived bias was based, in part, on the fact that arbitral panels were comprised of members of the securities industry – that is, members of FINRA and its predecessors. Over the past several years, FINRA has tried to address the perception of unfairness by improving the efficiency and fairness in its arbitration program, from revising its rules on who is eligible to serve as a public arbitrator to expanding the number of potential arbitrators provided to parties during the panel selection process. Recently, FINRA took another step in its efforts to preserve the integrity and fairness of the arbitration process. FINRA Fines Oppenheimer for Discovery Abuse On November 17, 2016, FINRA announced that it had “fined Oppenheimer & Co. Inc. $1.575 million and ordered the firm to pay $1.85 million to customers for failing to report required information to FINRA, failing to produce documents in discovery to customers who filed arbitrations, and for not applying applicable sales charge waivers to customers.” In addition to identifying various sales practices, supervisory lapses, and CRD reporting violations, the release and the underlying Acceptance, Waiver & Consent (“AWC”) identified various discovery abuses engaged in by the firm in arbitrations involving a former Oppenheimer broker, Mark Hotton (“Hotton”). FINRA found that between 2010 and 2013, Oppenheimer failed to produce documents during discovery to seven sets of claimants who asserted claims against Oppenheimer for failing to supervise Hotton. In this regard, Oppenheimer failed to provide spreadsheets showing that Hotton had excessively traded multiple customer accounts. The spreadsheets also showed that in four accounts Hotton had churned the accounts – that is, the commissions charged exceeded the total account value – and in two accounts there were insufficient funds to execute trades causing Oppenheimer to place the accounts on ninety-day restrictions. According to the AWC, these spreadsheets were prepared in 2007 and 2008. In the seven arbitration proceedings, the claimants resolved their disputes through settlement or awards without the receipt of those documents. Incredibly, in March 2015, FINRA announced that it had fined Oppenheimer $2.5 million and ordered the firm to pay restitution of $1.25 million for failing to supervise Hotton, who stole money from his customers and excessively traded their brokerage accounts during the period 2005 through 2009. FINRA permanently barred Hotton from the securities industry in August 2013. In the recent AWC, FINRA censured Oppenheimer, fined the firm $1,575,000, and ordered remediation payments totaling $703,122 to be paid to the seven sets of claimants affected by the firm’s failure to supervise.  Oppenheimer accepted and consented to FINRA’s findings, though it did so without admitting or denying them. Takeaway: Failure to comply with FINRA’s discovery rules hinders the efficient and cost-effective resolution of disputes and undermines the integrity and fairness of FINRA’s arbitral forum. FINRA’s action against Oppenheimer is an important step in ensuring those purposes are realized.

Consider the following story.  John Smith has worked for Jane Doe for 15 years. Doe runs a small, but profitable, media consulting business.  Smith has been one of Doe’s most productive account executives, generating significant business over the 15 years of his employment. Though compensated well, Smith decides that he wants to open his own media consulting firm. Smith secretly advises Doe’s clients that he intends to strike out on his own and requests that they follow him.  Shortly thereafter, Smith opens his business a few miles from Doe’s firm with a substantial number of Doe’s clients.  Not surprisingly, Doe sues Smith. Unfortunately, this story is not uncommon. Employees misappropriate confidential, proprietary information and trade secrets all too often. Some use the information for profit; others do nothing with the information. When an employee uses misappropriated information, an employer has an arsenal of claims that he/she can assert against the employee, including, among other others, the misappropriation of proprietary information and trade secrets, breach of contract, and breach of fiduciary duty.  But, perhaps, the most potent weapon, at least in New York, is the faithless servant doctrine. The Faithless Servant Doctrine In New York: The doctrine first appeared in New York in the late nineteenth century as part of a one-two-punch adopted by the Court of Appeals to address employee misconduct. Grounded in contract and fiduciary duty, respectively, each claim could result in the forfeiture of compensation. Under the former, an employee guilty of violating his/her employment agreement could be ordered to forfeit his/her compensation if the violation was found to be substantial. See Turner v. Kouwenhoven , 100 N.Y. 115, 120 (1885).  Under the latter ( i.e. , the faithless servant doctrine), an employee who acted adversely to the employer or failed to disclose any interest that conflicted with that of the employer ( i.e. , breaches a duty of loyalty or good faith) could be ordered to forfeit his/her compensation. See Murray v. Beard , 102 N.Y. 505, 508 (1886) (“ n agent is held to uberrima / fides in his dealings with his principal, and if he acts adversely to his employer in any part of the transaction, or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of the employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.”). The faithless servant doctrine, also known as equitable forfeiture, is based on agency principles, and has been applied to brokers, salaried employees, attorneys, arts and entertainment representatives, and executors of estates.  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. Violating the Doctrine Can Result in A Harsh Result: 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. Some recent decisions by the lower courts in New York, however, have relaxed the severity of the penalty by endorsing the principle that a faithless servant forfeits all compensation from the date of the first disloyal act. See e.g. , Herman v. Branch Motor Express Co. , 67 Misc.2d 444, 446 (N.Y. Civ. Ct. 1971) (finding that a faithless employee is deprived of his right to compensation “only for the period of his faithlessness”); Maritime Fish Products, Inc. v. World Wide Fish Products, Inc. , 100 A.D.2d 81, 91 (1st Dep’t 1984) (employer is entitled to return of compensation paid to employee “during the period of disloyalty”); St. James Plaza v. Notey , 95 A.D.2d 804, 806 (2d Dep’t 1983) (“an employee may forfeit his right to compensation for services rendered by him during such periods of disloyalty”). The Law in New York Since 1886: Notwithstanding the few decisions that apportion forfeiture relative to the period of disloyalty, the faithful servant doctrine has remained relatively unchanged in New York since its origin. In 1977, for example, the Court Appeals reconfirmed the doctrine, noting that an employee “faithless in the performance of his services ... is not entitled to recover his compensation” even if “his services were beneficial to the principal” or the employer “suffered no provable damage as a result of the breach of fidelity by the agent.” Feinger v. Iral Jewelry, Ltd. , 41 N. Y.2d 928, 929 (1977). On September 26, 2006, the First Department rejected attempts by the defendant to escape the harshness of the doctrine by trying to reverse the motion court’s ruling requiring complete forfeiture of his compensation, including that which was untainted by the disloyal acts. In Matter of Blumenthal , 32 A.D.3d 767, 768 (1st Dep’t 2006), the Court affirmed the motion court’s ruling, holding that “ n light of respondent’s repeated disloyalty throughout his tenure , there is no merit to his assertion that there should have been an apportionment of his salary or of Wise Acre commissions as to which disloyalty was not found.” In William Floyd Union Free School District v. Wright , 61 A.D.3d 856, 859 (2d Dept. 2009), the Second Department reversed the decision of the motion court, finding that the lower court erred “in limiting the defendants’ forfeiture of insurance benefits to a period of 10 years.” In doing so, the Second Department made clear that “complete and permanent forfeiture of compensation, deferred or otherwise, warranted under the faithless servant doctrine.” Beach v. Touradji Capital Management, LP – The Doctrine is Alive and Well: On November 22, 2016, the First Department had another opportunity to consider the doctrine. In Beach v. Touradji Capital Management , LP, 2016 NY Slip Op. 07852 , the Court held that the faithless servant doctrine could be used to recover the compensation paid to the disloyal employees (former employees who formed a competing company), regardless of whether damages could otherwise be proven: Although plaintiffs were at-will employees, they could be found to have breached a fiduciary duty to their employer if they acted directly against the employer’s interests. Plaintiffs do not dispute that they were employed by TCM …. Plaintiffs contend that the breach of fiduciary duty counterclaim should have been dismissed in its entirety because TCM failed to show that their actions caused it damage. They submitted evidence that investors withdrew from TCM for reasons other than their actions. However, counterclaim defendants’ damages are not limited to the loss of investors. For example, under the faithless servant doctrine, TCM could seek to recover the compensation it paid to plaintiffs. Takeaway: Beach shows that the faithless servant doctrine is alive and well in New York and remains a potent weapon for employers faced with an employee who acts disloyal during his or her employment.  The question, however, is whether the doctrine is fair? To be sure, a faithless servant should not benefit from his/her acts of disloyalty. But, should the employer benefit too by strict application of the doctrine?  That is, should the employer recoup compensation paid to the employee for activities and contributions untainted by acts of disloyalty? That too seems to be unfair. Perhaps there is a middle ground, where the court could look at the nature of the employment relationship, the severity of the disloyal action engaged in and the benefits received by the employer from the employee during the period of disloyalty to determine the amount of forfeiture.  Such an approach would still penalize an employee who is guilty of disloyal conduct, but it would also recognize his/her achievements or contributions to the employer. Notably, the Second Circuit has advanced this middle ground approach in applying New York law, at least under certain circumstances; namely: a) the employer and employee agree that the latter would be compensated on a “task-by-task basis”; the employee was disloyal as to only certain tasks; and the employee was otherwise loyal with regard to other tasks. See Design Strategy, Inc. v. Davis , 469 F.3d 284, 300-02 (2d Cir. 2006). Some lower courts in New York have applied the Second Circuit’s approach, finding that it comports with the Restatement (Second) of Agency, which calls for apportioning forfeitures when an agent’s compensation is allocated to periods of time or to the completion of specified items of work. E.g. , G.K. Alan Assoc., Inc. v. Lazzari , 44 A.D.2d 95, 103-04 (2d Dep’t 2007). The Court of Appeals has not weighed in on the Second Circuit’s less draconian approach. Thus, until the Court reviews that approach, employers and employees are reminded that the faithless servant doctrine is alive and well.

What is the amount of fines assessed by Finra this year? Thus far, 2016 has been a banner year for the Financial Industry Regulatory Authority ("FINRA"). Buoyed in part by a handful of large penalties, the self-regulatory watchdog is on pace for a record year as fines could be up by 70 percent when all is said and done. In the first six months of this year, FINRA assessed $79.4 million in fines against member broker-dealers. For the similar period in 2015 that figure was $37.5 million. If this clip continues, FINRA could net $159 million in fines, a 69 percent spike over 2015. This is not without precedent, however, because the previous record was in 2014, when the total amount of fines assessed was $134 million. That said, this year's total could eclipse that mark by 19 percent. Large Finra Fines in 2015 As we have previously reported  in May, FINRA fined two units of Raymond James a total of $17 million over compliance breakdowns related to its anti-money laundering programs. At that time, FINRA also slapped MetLife with a $25 million fine, the second largest by the SRO,  for misleading thousands of its variable annuity customers. We also reported on the $6 million penalty assessed to Deutsche Bank over blue sheet lapses. Combined, these fines account for more than 60 percent of the fines assessed in the first 6 months of 2016, in addition to 8 other supersized fines (those exceeding $1 million). However, there has been a slight decline in the total number of disciplinary actions taken by FINRA this year even though smaller fines on broker-dealers are having a cumulative effect. Finra Sanctions Guidelines According to some observers, FINRA has taken a very aggressive approach since it published the 2015 sanctions guidelines, and is sending a message to the Street. However, FINRA has not been as busy on the restitution front so far. It is on pace to order a return of $28 million to customers, far less than the $96 million in restitution ordered in 2015. These figures are bound to change as FINRA is reportedly gearing up for larger restitution awards this year. While not offering specific details, there could also be a greater emphasis on variable annuity cases this year. It is unclear if these cases are connected to the efforts to step up enforcement activity with respect to elder financial abuse. The Takeaway Given that the Dodd-Frank regime has continued to unfold, the spike in fines assessed by FINRA this year should come as no surprise. At this juncture, it is unclear if and to what extent that regulatory framework will be scaled back under a new presidential administration. (This Blog recently discussed possible implications with respect to the SEC whistleblower program here .) In the meantime, broker-dealers and other member financial services providers should proceed with caution.

The Financial Industry Regulatory Authority ("FINRA") recently announced that the new Capital Acquisition Broker ("CAB") Rules will become effective April 14, 2017. While CABs still must be registered with the Securities and Exchange Commission, they will be subjected to a reduced series of FINRA rules and compliance obligations. Capital Acquisition Brokers at a Glance Capital Acquisition Brokers are those involved in private placements and mergers and acquisitions involving institutional investors and qualified purchasers. CABs are barred from engaging in both proprietary trading and secondary sales and limited to the following activities: Advising companies on mergers and acquisitions Advising issuers on raising debt and equity capital in private placements Acting as placement agent Providing strategic and financial advisory services It is important to note that FINRA emphasized the word "solely" in its announcement, which means for all intents and purposes that a CAB may engage only in business activities related to the securities industry and not other businesses, such as insurance or real estate. Moreover, in its capacity as a placement agent, a CAB can make offerings only to institutional investors, including: Any bank, savings and loan association, insurance company or registered investment company Any governmental entity or subdivision of a governmental entity Certain employee benefit, stock bonus or profit-sharing plans Any individual or entity having total assets of at least $50 million Any “qualified purchaser” as defined under Investment Company Act Broker-dealers that carry customer accounts, accept purchase and sale orders, hold or handle customer funds or that engage in a range of other activities specified in FINRA's rule do not meet the definition of a CAB. At the same time, CABs may engage in activities in the normal course of conducting business, such as such as opening bank accounts, renting or owning office space and entering into arrangements with third-party vendors. The Takeaway While the FINRA By-Laws and other core rules will still apply to CABs, certain other rules will be tailored to the specific activities, dealings and communications with institutional investors. For example, CABs will be permitted to provide forecasts and projections in offering materials and there is no requirement to file advertising or sales literature with FINRA. Lastly, CABs will have reduced supervisory requirements with respect to annual meetings and internal inspections. While the rule does not become effective until April 14, 2017, FINRA will begin accepting applications beginning January 3, 2017. If you further questions about the CAB rules or need assistance with the application process, you should engage the services of an attorney with expeience in FINRA rules and regulations.

New York, NY ( Law Firm Newswire ) November 22, 2016 - Freiberger Haber LLP is pleased to announce that Freiberger Haber LLP, the firm’s principal, has been quoted in a two-part series appearing in the ctnews.com blog, “Getting Personal About Business.” The article is about the importance of business owners retaining legal counsel before a dispute arises and the available methods of dispute resolution once dissension occurs. In part one, Freiberger Haber LLP discusses how significant it is for a business owner to establish a relationship with a capable attorney before disputes arise. He points out that the attorney consulted should be skilled in strategic approaches and able to assist the business owner in prioritizing and achieving his or her personal goals. In part two, Freiberger Haber LLP discusses the available methods of dispute resolution, as well as the advantages and disadvantages of each. To read the articles, visit http://blog.ctnews.com/zahn/2016/11/15/ounce-of-prevention/ and http://blog.ctnews.com/zahn/2016/11/15/adr-is-a-ok/ . About Freiberger Haber LLP Located in New York City, Freiberger Haber LLP is dedicated to representing corporations, small businesses, partnerships and individuals engaged in a broad range of business and litigation matters. For over 25 years, Freiberger Haber LLP has 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. Freiberger Haber LLP’s 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. © 2016 Freiberger Haber LLP. The law firm responsible for this advertisement is Freiberger Haber LLP, 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 Freiberger Haber LLP Freiberger Haber LLP 708 Third Avenue, 5th Floor New York, N.Y. 10017 Email:info@jhaberlaw.com Tel: (212) 209-1005 Fax: (212) 209-7101

What are the seal provisions in a complaint? The U.S. Supreme Court is weighing the conditions under which a federal court should dismiss lawsuits brought by whistleblowers who violate the law's non-disclosure requirements. In short, a complaint must be filed and remain under seal for sixty days. During this period, the government investigates the allegations and decides whether to intervene while the plaintiff is barred from publicly disclosing the suit. In November, the Court heard argument in over the Act's seal provision. The case involves a complaint brought by plaintiffs Cori and Kerri Rigsby against State Farm. The Rigsbys, sisters and former claims adjustors for Allstate, claimed the company fraudulently mischaracterized wind damages caused by Hurricane Katrina as flood damages. Instead of Allstate being responsible for paying the damages, the cost would be covered by the government's flood insurance program. While the plaintiffs filed the lawsuit under seal, it was allegedly disclosed shortly thereafter to several news outlets by the Rigsby's prior counsel. State Farm then moved for a dismissal which was declined by the district court (which also awarded the plaintiffs 30 percent of the $758,250 award against State Farm and $2.9 million in attorney fees and costs). On appeal, the Fifth Circuit rejected the insurer's argument that a seal violation mandated dismissal and affirmed the trial judge's discretion in rejecting a "per se" dismissal rule. The court also applied a balancing test in finding that the disclosures were not revealed by the media and that the government's investigation had not been compromised. The overarching issue before the Supreme Court is whether all violations of the seal requirement should be dismissed or if a balancing test similar to that of the Fifth Circuit's should be adopted. The Court must also consider a number of other factors such as the plaintiff's intent, whether the disclosure was limited or inadvertent, and the potential harm to the defendant or to the government's investigation. Why This Matters This case amplifies the high stakes of claims brought under the False Claims Act. While it is unclear at this time how the Supreme Court will rule, claims are unlikely to be rolled back. That being said, it is crucial for parties who bring claims under the Act to be aware of the seal requirement and that a violation of this provision could lead to a case being dismissed. If you are considering bringing a claim of fraud against the government, you should consult with an experienced whistleblower attorney .

On November 4, 2016, a judge sitting in the United States District Court for the District of Columbia upheld the Department of Labor’s (“DOL”) fiduciary duty rules that were adopted to curtail conflicts of interest by financial advisors providing investment recommendations for retirement accounts.  In a 92-page ruling, Judge Randolph Moss rejected arguments that the new rules would have “catastrophic consequences” for the fixed indexed annuities industry, that the DOL exceeded its authority in promulgating the rules, and that the industry could not meet the April 2017 effective date. The rules, which took six years to craft, require financial advisors to act in the “best interest” of their client when, among other things, they provide investment recommendations for retirement accounts.  (This Blog wrote about the new rules in May 2016.  See here .) In the National Association for Fixed Annuities v. Perez , No. CV 16-1035 (RDM) (D.D.C. Nov. 4, 2016), Judge Moss granted the DOL’s motion for summary judgment and dismissed the claims brought by the National Association for Fixed Annuities (“NAFA”).  The ruling can be found here . In granting summary judgment, Judge Moss reviewed the legislative history of the Employee Retirement Income Security Act of 1974 (“ERISA”), 29 U.S.C. § 1001 et seq., and the DOL’s rulemaking authority.  The court ruled that, among other things, the DOL’s decision to hold financial advisors who recommend retirement investments to a fiduciary standard was reasonable considering the growth of IRAs (since first introduced in 1974) and other retirement plans as a future source of income. NAFA has announced that it will appeal the decision. The Challenges and Ruling: NAFA brought its action under the Administrative Procedures Act, the Regulatory Flexibility Act (“RFA”) and the Due Process Clause of the Fifth Amendment to challenge three rules promulgated by the DOL on April 8, 2016. NAFA argued that: (i) the DOL exceeded its authority by replacing an established regulation that, among other things, made a financial advisor a “fiduciary” only if she or he rendered “investment advice” for a fee “on a regular basis”; (ii) the DOL improperly applied the new rules to IRAs and other retirement plans that are not subject to Title I of the ERISA statute; (iii) the written contract requirement contained in the Best Interest Contract (“BIC”) Exemption impermissibly created a private right of action; (iv) the “reasonable compensation” condition set forth in the BIC Exemption is constitutionally vague; (v) the decision to move fixed indexed annuities (“FIAs”) to the BIC Exemption was improper; and (vi) the DOL failed to conduct a regulatory impact analysis required by the RFA. Judge Moss rejected each of the foregoing challenges. The DOL Did Not Exceed its Authority by Replacing a 1975 Regulation with the New Rules and the Definitions Set Forth Therein The court rejected NAFA’s argument that the DOL exceeded its rule-making authority by, among other things, discarding the limitations set forth in a 1975 regulation. The regulation in question created a five-part test to determine whether an advisor “renders investment advice” to a plan or IRA. The test limited the fiduciary duty reach of ERISA to only those advisors who rendered investment advice “on a regular basis.” The new rules eliminate that limitation “in favor of a definition that encompasses, among other activity, ‘ recommendation as to the advisability of acquiring . . . investment property’ that is rendered ‘pursuant to . . . understanding that the advice is based on the particular investment needs of the advice recipient.’” The new rules define “investment advice” to include advice even if not given “on a regular basis.” In ruling against NAFA, the court held that the DOL was entitled to deference in its interpretation of the term “investment advice” under the two-step framework established in Chevron, USA, Inc., v. Natural Resources Defense Council, Inc. , 467 U.S. 837 (1984), and that nothing in the ERISA statute foreclosed the DOL’s interpretation.  In fact, the court concluded that the DOL’s interpretation hews closer to the text and purpose of ERISA than the 1975 rule. As to step one of the Chevron analysis, the court held that there is nothing in the ERISA statute that “forecloses the Department’s current interpretation.” Indeed, the court found that “ he statute does not define the phrase ‘investment advice,’ and the ERISA statute expressly authorizes the Secretary to adopt regulations defining ‘technical and trade terms used’ in the statute.”  Those terms, which the new rules define, the court held, comport with their ordinary usage: “Indeed, if anything, it is the five-part test—and not the current rule—that is difficult to reconcile with the statutory text. Nothing in the phrase ‘renders investment advice’ suggests that the statute applies only to advice provided ‘on a regular basis.’” As to step two of the Chevron analysis, the court deferred to the DOL’s interpretation of the ERISA statute. The court found that the DOL’s interpretation was “reasonable and reasonably explained.” The new interpretation, rather than the five-part test embraced by NAFA, fit comfortably with the text and purpose of ERISA to protect the interests of retirement plan participants. The court rejected NAFA’s contention that market changes alone could justify the change in the definition of “fiduciary”, finding that the DOL did not distort the statutory meaning of “rendering investment advice” simply to achieve a regulatory end. In fact, the DOL supported the change with an extensive explanation of the relationship between advisers and investors and how that relationship has changed. Further, citing to the commentary accompanying the new rules, the court further rejected NAFA’s argument that the definition of “rendering investment advice” is too broad, sweeping up “relationships that are not appropriately regarded as fiduciary in nature and that the Department does not believe Congress intended to cover as fiduciary relationships.” (Internal quotation marks omitted.) The DOL Did Not Exceed its Authority By  Requiring Financial Advisers Who Provide Advice Regarding Investments Held in IRAs and other Non-Title I Plans to Comply with the Duties of Loyalty and Prudence to Qualify for the BIC Exemption The court rejected NAFA’s argument that the DOL exceeded its rule making authority by extending the duties of loyalty and prudence found in Title I of ERISA to individuals who advise IRAs and other non-Title I plans.  The court determined that the DOL had the authority to condition prohibited transaction exemptions on compliance with ERISA’s duties of loyalty and prudence. The court reasoned that “the mere fact that title I imposes certain duties or obligations on employee benefit plans does not, as a matter of logic or the rules of statutory interpretation, mean that Congress intended to preclude the Department from imposing a similar duty or obligation as a condition of granting an exemption under 26 U.S.C. § 4975(c)(2).” Indeed, the ERISA statute authorizes the DOL to adopt non-statutory exemptions and limitations on those transactions. Subjecting financial advisers who recommend Title II plans to ERISA duties only if they are paid commissions is the point of the exemption, since the DOL is concerned about conflicted advice resulting from commission arrangements: “Importantly, there is also a clear nexus between the risk that commission-based compensation will skew investment advice and the condition that advisers paid on a commission basis must provide advice that satisfies the duties of loyalty and prudence.” Although it “may be difficult and costly for financial institutions to move away from that model of compensation, the prospect of alternative compensation methods is not illusory. The choice may not be pleasant one, but it is real.” The Written Contract Requirement Contained In The BIC Exemption Does Not Create a Private Cause Of Action The court rejected NAFA’s argument that the new rules “impermissibly creates a private right of action” for violations of the BIC Exemption.  The court found that the BIC Exemption “merely dictates terms that otherwise conflicted financial institutions must include in written contracts with IRA and other non-title I owners in order to qualify for the exemption.” Enforcement of these contractual terms “would be brought under state law,” which both parties agreed during oral argument would occur. As such, the court concluded that “although the BIC Exemption dictates what must be included in the contract, the cause of action and right to recover are dictated by state law. Federal law merely requires the inclusion of specific contractual terms as a condition of the prohibited transaction exemption.” The “Reasonable Compensation” Condition in the BIC Exemption is not Void for Vagueness The court rejected NAFA’s argument that the “reasonable compensation” requirement of the BIC Exemption was void for vagueness under the Due Process Clause of the Constitution. “Under that condition, a financial institution must agree in writing that ‘ he recommended transaction will not cause , dviser or their ffiliates or elated ntites to receive, directly or indirectly, compensation for their services that is in excess of reasonable compensation within the meaning of <29 u.s.c. § 1108(b)(2)> and <26 u.s.c. §> 4975(d)(2).’” The court found that the concept of “reasonable compensation” is commonly used throughout the U.S. Code, including in the ERISA statute, and “is sufficiently clear to provide financial institutions with ‘fair warning of what the regulations require.’” (Citation omitted.) Indeed, the phrase is one that “a reasonably prudent person, familiar with the conditions the BIC Exemption is meant to address and the objectives the exemption and conditions are meant to achieve, would have fair warning of what the regulations require.” The Industry Had Ample Time to Comment on The New Rules The court rejected NAFA’s argument that the DOL failed to give it an opportunity to comment on the decision to make FIAs ineligible for PTE 84-24.  PTE 84-24 created a limited exemption to the prohibited transaction rules set forth in Title I and Title II of the ERISA statute.  Under PTE 84-24, it was permissible to compensate investment advisors and their employees and agents “on a commission basis for sales of variable and fixed annuity products held in ERISA employee benefit plans and IRAs, as long as either (1) the relevant investment advice was not provided ‘on a regular basis,’ or (2) the terms of the transaction were at least as favorable as those offered in arm's-length transactions and the relevant fees and commissions were reasonable.” NAFA challenged the new rules on the grounds that the decision to subject FIAs to the BIC Exemption was different than originally proposed. The court dismissed this challenge noting that the DOL “expressly requested comment on its decision to ‘continue to allow IRA transactions involving’ fixed indexed annuities ‘to occur under the conditions of PTE 84-24,’ while requiring that similar transactions involving variable annuities occur under the conditions contained in the proposed BIC Exemption.” In fact, to remove any doubt about the bankruptcy of NAFA’s argument, the court observed that “NAFA, along with other industry groups, provided comments on that very issue.” The DOL Did Not Violate the RFA The court rejected NAFA’s argument that the DOL failed to accompany the final rule with a “final regulatory flexibility analysis” required by the RFA – that is, an assessment of the impact of the new rules on small businesses.  According to the court, the final regulatory flexibility analysis is only a procedural requirement, not a substantive one. In any event, the court found that DOL put forth a reasonable good-faith effort to comply with the statute, as evidenced by the DOL’s “382-page final Regulatory Impact Analysis.” Takeaway: The NAFA decision is thoughtful and well-reasoned. It is not only a win for the DOL, but also a victory for investors looking for retirement investment opportunities.  As such, it could influence and inform the decisions of other courts that are also considering the legality of the new rules. To date, there are six cases filed by industry professionals and state attorneys general against the DOL’s new rules. Three were consolidated into one case in the United States District Court for the Northern District of Texas. Oral argument was heard the Texas consolidated action and in the Kansas action (one of the remaining cases). Decisions are likely in the coming months. As the NAFA action shows, whatever the results in those cases, appeals will likely follow, ultimately creating an opportunity for the Supreme Court to weigh. All though the DOL has won round one in the courts, there is also a legislative fight that could spell the end of the new rules. The Republican-controlled Congress previously passed legislation to nullify the new rules; President Obama vetoed that legislation. It stands to reason that the newly elected Republican-controlled Congress will do same once Donald J. Trump is inaugurated. Though there is no indication of what the new president will do, he has already expressed an interest in reducing jobs-killing regulations during the campaign and transition. ( See , e.g. , https://www.greatagain.gov/policy/regulatory-reform.html.) One thing is for certain: despite the win, the DOL’s new fiduciary duty rules remain in jeopardy.