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On May 31, 2016, the Appellate Division, First Department, issued MP Cool Investments Ltd. v. Forkosh , 2016 NY Slip Op. 05944, a case involving allegations of fraud in connection with the production and sale of a commercial heating and ventilation system by an Israeli-based company.  In the decision, the First Department unanimously affirmed the motion court’s dismissal of the plaintiff’s fraud claims because they were not pleaded with particularity, did not establish justifiable reliance on the defendants’ misrepresentations, and failed to demonstrate scienter or an intent to deceive. The Factual Background of MP Cool : The plaintiff, a Manhattan-based private equity fund with $4.3 billion in assets under management, is an admitted sophisticated investor that specializes in capturing value in distressed companies in less efficient markets around the world. In December 2009, MatlinPatterson entered into an agreement with DuCool, Ltd., an Israeli company that claimed to have had breakthrough dehumidification technology, to obtain a majority interest in the company.  Pursuant to the agreement, MatlinPatterson invested $30 million in DuCool, giving it an initial 49% interest in the company. By 2012, MatlinPatterson had invested $70 million in DuCool and acquired a 72% majority interest in the company. Subsequent investments brought MatlinPatterson’s equity interest in DuCool to 90%. As permitted under the purchase agreement, MatlinPatterson had a 90-day due diligence period during which it was given full access to DuCool’s business operations, properties, technology data and plans. MatlinPatterson was also given direct access to all of DuCool’s customers, though it only approached one customer. To conduct the agreed upon due diligence, MatlinPatterson, among other things, hired two consultants: QuinetiQ, to perform technical evaluations of DuCool’s technology, manufacturing facility, and installation sites; and McKinsey, to evaluate DuCool’s business model, financial information, and market potential. McKinsey drafted a proposed business plan for the company that was included in the parties’ initial purchase agreements. After the initial investment, but before the second investment, MatlinPatterson appointed three of the seven members of the board of directors and two of McKinsey’s representatives were installed as officers of DuCool. The Allegations and the Motion Court’s Ruling MatlinPatterson claimed that in the period before it purchased any interest in DuCool (pre-investment) and during the two-year period after its first investment ( i.e. , 2010 through 2012), when it acquired a majority interest in DuCool, the defendants made numerous false representations and provided inaccurate data about DuCool’s air conditioning technology, financial condition and overall successes in the United States and other markets. MatlinPatterson alleged that it relied on the representations and data, inducing it to repeatedly invest in DuCool, believing it was a better performing company than represented. MatlinPatterson also alleged that after it invested in DuCool, the defendants deceived it by intentionally concealing known problems with DuCool’s installations in at least three major sites in the United States and Costa Rica and made numerous false statements about energy cost savings in an April 2011 “study” that touted DuCool products’ performance and cutting edge technology. The defendants moved to dismiss the complaint.  The motion court granted the motion and the plaintiff appealed. The Appellate Ruling As an initial matter, the First Department noted that the plaintiff failed to allege fraud with particularity as to each individual defendant and the various time periods involved. The Court observed that the complaint simply “bundled, bare-boned and conclusory allegations” – the type of allegations that do not suffice to plead a fraud claim. Turning to the justifiable reliance element – one of the two elements highlighted by this post – the Court noted that MatlinPatterson is a sophisticated investor that conducted extensive due diligence both before and after its initial investments.  Such sophistication and knowledge undermined any claim of justifiable reliance: Plaintiff is an experienced and sophisticated investor. It did not plead facts to support the justifiable reliance element of fraud. Plaintiff had total, unfettered access to every aspect of DuCool’s company information both before and after its initial investment, even before it held a controlling interest in DuCool. Although learning through the due diligence conducted by its own technology and business consultants that there were frequent technological problems with DuCool products, some of them “severe,” plaintiff proceeded to invest in the company. Thereafter, as the 49% shareholder, plaintiff had the largest percentage ownership of any individual shareholder and it had access to information concerning the operations of the business. There is no factual basis on which to conclude that the alleged fraud involved matters peculiarly within defendants’ knowledge, because plaintiff had the means to discover the truth behind any false claims about the condition of the company and whether this was a feasible investment. Slip op. at 3 (citations omitted). Regarding the scienter element – the second element highlighted by this post – the Court found that the due diligence conducted by the plaintiff negated any inference that the defendants knew DuCool would fall short of projections: With respect to the scienter element of its claim, although “most likely to be within the sole knowledge of the defendant and least amenable to direct proof,” plaintiff is still required to allege facts "from which it is possible to infer defendant knowledge of the falsity of statements” when they were made. It has not done so. Plaintiff, based upon its own due diligence, concluded that DuCool presented a profitable, albeit speculative, investment opportunity given its development of new technology and registered patents. Although the company may not have performed as plaintiff expected, this does not support a reasonable inference that defendants knew that DuCool would fall short of its business projections. The parties’ agreement not only contained plaintiff’s express acknowledgment that success was speculative, but also a further acknowledgment that “any business plans prepared by the Company, have been, and continue to be, subject to change and that any projections included in such business plans or otherwise are necessarily speculative in nature. . .” Slip op. at 3-4 (citations omitted). Takeaway: Unfortunately, there are times when an acquired business or investment does not live up to expectations.  When this happens, the acquiring or investing party sues. MP Cool stands as a reminder that in New York (and some other jurisdictions) an aggrieved party cannot come to court claiming fraud when it has conducted due diligence and obtained information that undermines the strength of its claim. Though sophisticated parties can be the victim of fraud, they cannot complain if they have knowledge of the very fraud of which they complain. MP Cool also reminds us that scienter is a very difficult element to plead. In fact, the scienter element is the hardest to plead because the evidence of intent most often rests solely with the defendant. Because of this difficulty, intent is often inferred from circumstantial evidence. Pludeman v. N. Leasing Sys., Inc. , 10 N.Y.3d 486, 488 (N.Y. 2008). Notwithstanding, as the First Department made clear, scienter must be plead with particularity. Slip op. at 3. Conclusory allegations, such as those in MP Cool , will not suffice. The plaintiff must allege facts from which there is some “rational basis for inferring that the alleged misrepresentations were knowingly made.” Houbigant, Inc. v. Deloitte & Touche LLP , 303 A.D.2d 92, 93 (1st Dep’t 2003). As MatlinPatterson learned in MP Cool , the failure to meet this hurdle will result in dismissal.

On August 30, 2016, the Securities and Exchange Commission (“SEC”) announced that it awarded a company insider $22.5 million for providing “detailed” information about a “well-hidden fraud at the company where the whistleblower worked.” Though not disclosed by the SEC, news outlets reported that the company involved was Monsanto Co. The $22.5 million award is the second-largest the SEC has awarded a whistleblower since the program’s inception in 2011. Among other things, the SEC recognized the “extensive assistance” provided by the whistleblower in “help the agency halt” the fraud. According to the news media, the fraud concerned accounting improprieties involving a rebate program Monsanto used to sell Roundup, a popular weed killer. The SEC accused Monsanto of falsifying its earnings through a corporate rebate program that was designed to increase the product’s sales. The SEC said that Monsanto “lacked sufficient internal controls to account for millions of dollars in rebates that it offered to retailers and distributors. It ultimately booked a sizeable amount of revenue, but then failed to recognize the costs of the rebate programs on its books.” Monsanto neither admitted nor denied the charges. The whistleblower’s attorney told news outlets that the whistleblower, a finance executive at Monsanto, went to the SEC only after first trying to correct the accounting issues internally. Commenting on the award, Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, said: Company employees are in unique positions behind-the-scenes to unravel complex or deeply buried wrongdoing. Without this whistleblower’s courage, information, and assistance, it would have been extremely difficult for law enforcement to discover this securities fraud on its own. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a whistleblower who provides original information to the SEC that leads to a successful enforcement action resulting in over $1 million in monetary sanctions may be awarded an amount not less than 10% and not more than 30% of the monetary sanctions collected. Since 2011, the SEC has awarded more than $107 million to 33 whistleblowers who “provid the SEC with original and useful information that led to a successful enforcement action.” The largest amount awarded to a whistleblower by the SEC was $30 million in 2014.

On September 1, 2016, the Commodity Futures Trading Commission (“CFTC” or the “Commission”) announced that it was seeking comment on proposed amendments to the rules governing the Commission’s whistleblower program, its authority to administer the program and issue whistleblower awards, and its authority to implement anti-retaliation enforcement measures. The amendments, if adopted, will make the CFTC’s whistleblower program congruous with that of the Securities Exchange Commission (“SEC”), and would enable the CFTC to initiate enforcement proceedings against employers that retaliate against whistleblowers who engage in lawful whistleblowing activities. The CFTC is seeking comments on the proposed amendments on or before September 29, 2016. Background In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities and commodities laws.  The Dodd-Frank Act contains whistleblower provisions that authorize the SEC and CFTC to pay cash rewards to whistleblowers who voluntarily provide the agencies with information about securities and commodities fraud and other violations of the securities and commodities laws. Under the CFTC whistleblower program, the CFTC will pay an award to any individual, or group of individuals, who voluntarily provides “original information” to the Commission about a violation of the commodities laws. If the information leads to a successful enforcement action of more than $1 million, the whistleblower may receive an award of between 10% and 30% of the sanctions collected. The amount of the award is dependent upon a number of factors, including the significance of the information provided and the degree of the whistleblower’s assistance. The CFTC whistleblower program has been around for five years. In that time, there have been only four awards – this blog recently wrote about the latest award – and no enforcement proceedings to protect whistleblowers from retaliation by their current or former employers.  The absence of proceedings to enforce the anti-retaliation provisions of the Dodd-Frank Act stand in stark contrast to the more recent actions of the SEC – actions that this blog recently discussed . Since the adoption of the CFTC regulations governing the whistleblower program, the Commission did not view its enforcement authority to cover retaliation against whistleblowers. The proposed amendments indicate that the Commission now intends to promote its whistleblower program and actively protect whistleblowers against activity that chills lawful whistleblowing activity. The Commission made this clear in the notice of the proposed amendments: “Upon reconsideration of its statutory authority on this important issue, and noting that harmonization between the SEC’s and the Commission’s Whistleblower programs would be beneficial to the public by making the consequences of illegal retaliation more uniform, the Commission has decided to join the SEC on that path.” The Proposed Amendments The proposed amendments will make it easier for whistleblowers to seek awards and provide them more opportunity to participate in the awards process. Among other things, if approved, the changes would do the following: enhance the process for reviewing whistleblower claims; assign overall responsibility for administering the whistleblower program to the Director of the Division of Enforcement, and clarify the staff’s authority to administer the whistleblower program; replace the Whistleblower Award Determination Panel with a Claims Review Staff; provide the CFTC with the opportunity to review Proposed Final Determinations; revise the rules governing whistleblower eligibility requirements to make clear that (1) the Commission may consider claims for awards “in a covered action, in a related action, or both,” (2) a claimant may be eligible for an award by providing original information without being the original source of the information, and (3) a claimant will have additional time to submit a TCR by extending the timeframe from 120 to 180 days; revise the award claims review process by (1) replacing the Whistleblower Awards Determination Panel with a review process handled by the Claims Review Staff; (2) assigning responsibility for handling deficient claims with the Whistleblower Office; (3) allowing claimants an opportunity to correct deficiencies or withdraw the claim before finalization of the denial of the claim, (4) allowing the Whistleblower Office to require additional information of the claimant in connection with award applications, (5) allowing claimants an opportunity to demonstrate that they voluntarily provided the same original information to a governmental agency in a related action that led to the CFTC’s successful enforcement action and the successful enforcement action of the related action, and (6) allowing claimants the opportunity to contest the Preliminary Determination, including making available the record supporting the award determination; permit claimants who submitted original information in a related action to receive an award based on the monetary sanctions collected; provided, however, the claimant does not receive more than one award for the same action; and assign responsibility to the Claims Review Staff for the issuance of Preliminary Determinations and Proposed Final Determinations, and issuance of Proposed Final Dispositions to the Whistleblower Office. Whistleblower Protection and Anti-Retaliation Enforcement Authority The proposed changes also include a new emphasis on the protection against retaliation by current or former employers. In the notice of the proposed amendments, the CFTC said that it wants to “set aside” its prior interpretation of whether it has the authority to initiate enforcement proceedings against employers that retaliate against whistleblowers engaged in lawful activity under the Commodity Exchange Act (the “Act”). The Commission previously held that it lacked the statutory authority to bring enforcement proceedings against those who retaliate against a whistleblower in violation of the Act. That interpretation was contrary to that of the SEC. As the CFTC explained, the proposed amendments would end “the incongruous situation where whistleblowers enjoy protection from retaliation through SEC enforcement action under the securities laws, but no such protection through Commission enforcement action under the .” Takeaway The proposed amendments signal the CFTC’s intention to devote more resources and attention to its whistleblower program and the protection of whistleblowers engaged in lawful whistleblowing activities. This new focus should increase the number of tips and awards, as well as guard against the incidence of employer retaliation. It will also encourage employers to adopt compliance programs and related policies that comply with the CFTC’s new regulations, including detecting and preventing retaliation.

When parties negotiate the terms of a contract, they cannot account for every contingency or event that may affect performance.  To be sure, they try.  But, it is simply not possible to account for every occurrence that might arise during the course of the contract.  This inability, therefore, gives the parties wide latitude in the performance and enforcement of their contractual obligations.  Underlying this discretion is the duty to act in good faith and with fair dealing. As set forth in the Restatement (Second) of Contracts, “ very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” Restatement (Second) of Contracts § 205 (1981). A party to a contract breaches these duties when his/her conduct frustrates the purpose of the contract, e.g. , by failing to perform the things necessary to carry out the purpose for which the contract was entered and to refrain from destroying or injuring the other party’s right to receive the fruits of the contract.  Such conduct is often described as bad faith, and is identified by, among other things, “evasion of the spirit of the bargain,” “abuse of a power to specify terms,” “interference with or failure to cooperate in the other party’s performance,” and willful rendering of imperfect performance. E.g. , Restatement (Second) of Contracts § 205 cmt. d. It is widely recognized that New York was the first jurisdiction to identify the duty of good faith and fair dealing as an implied covenant that made a contract enforceable. See Wood v. Lucy, Lady Duff - Gordon , 222 N.Y. 88 (1917).   Wood involved an endorsement and licensing agreement in which the parties agreed that the plaintiff could sell or license the defendant’s fashion designs in exchange for the payment of one half of all the profits and revenues generated under the agreement. A dispute arose and the defendant argued that there was no agreement between the parties.  The court rejected the defendant’s argument, stating: The defendant insists, however, that it lacks the elements of a contract. She says that the plaintiff does not bind himself to anything. It is true that he does not promise in so many words that he will use reasonable efforts to place the defendant’s endorsements and market her designs. We think, however, that such a promise is fairly to be implied. The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract. Id . at 90-91 (citations omitted). New York Law : In the 1933, the New York Court of Appeals expressed the duty found in Wood as an implied covenant of good faith and fair dealing.  In Kirk La Shelle Co. v. Paul Armstrong Co. , a case involving a dispute between parties to a settled copyright litigation, the Court held that “in every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.” 263 N.Y. 79, 87 (N.Y. 1933). Since Kirk La Shelle , the courts in New York have implied a covenant of good faith and fair dealing in the course of the performance of all contracts. See , e.g. , Van Valkenburgh, Nooger & Neville v. Hayden Publ. Co. , 30 N.Y.2d 34, 45 (N.Y.), cert . denied , 409 U.S. 875 (1972); Dalton v Educational Testing Serv. , 87 N.Y.2d 384, 389 (N.Y. 1995). While the duties of good faith and fair dealing do not imply obligations “inconsistent with other terms of the contractual relationship” ( Murphy v. American Home Prods. Corp. , 58 N.Y.2d 293, 304 (N.Y. 1983)), they do include “any promises which a reasonable person in the position of the promisee would be justified in understanding were included.” Rowe v. Great Atl. & Pac. Tea Co ., 46 N.Y.2d 62, 69 (N.Y. 1978) (citation omitted). When the contract contemplates the exercise of discretion by the parties, it includes a promise not to act arbitrarily or irrationally in exercising that discretion. Tedeschi v. Wagner Coll ., 49 N.Y.2d 652, 659 (N.Y. 1980). New York law does not, however, “recognize a separate cause of action for breach of the implied covenant of good faith and fair dealing when a breach of contract claim, based upon the same facts, is also pled.” Harris v. Provident Life and Acc. Ins. Co ., 310 F. 3d 73, 81 (2d Cir. 2002). Therefore, when a complaint alleges both a breach of contract and a breach of the implied covenant of good faith and fair dealing based on the same facts and seeks the same relief, the latter claim will be dismissed as redundant. JFK Holding Co. LLC v. City of New York , 98 A.D.3d 273 (1st Dep’t 2012); MBIA Ins. Corp. v. Countrywide Home Loans, Inc. , 87 A.D.3d 287 (1st Dep’t 2011); Logan Advisors, LLC v. Patriarch Partners, LLC , 63 A.D.3d 440, 443 (1st Dep’t 2009). Rebecca Broadway L.P. v Hotton Recently, the Appellate Division, First Department had the opportunity to once again consider the covenant of good faith and fair dealing. On August 16, 2016, the First Department decided Rebecca Broadway L.P. v Hotton , NY Slip op. 05839, a case that arose “from an unsuccessful effort to produce a Broadway musical about a ghost.” Id . at 1. As the New York Law Journal observed, the facts of the case “offer[ ] enough twists and turns to rival a stage play.” Jason Grant, Appellate Ruling Sets the Stage for Trial in Broadway Scandal , NYLJ, Aug. 18, 2016, available at http://www.newyorklawjournal.com/id=1202765487538/Appellate-Ruling-Sets-the-Stage-for-Trial-in-Broadway-Scandal .  Distilled to their essence, the facts of the case are as follows: After it was reported that a major foreign investor in the production had died, it emerged that the supposedly deceased backer had never been more than a ghost himself —the man had never existed, except as a deceptive construct conjured up by a dishonest fundraiser, who has since been incarcerated for this wrongdoing. The publicity agent for the show, when he began to suspect the truth about the supposedly deceased foreign investor, expressed his concerns to the producer's principal, who essentially told him to keep quiet about it. Apparently stung by this dismissive treatment, the publicity agent sent four anonymous emails to another potential investor (this one an actual, living person), who had wished to remain anonymous. The last of these emails, sent under a fictitious name, made various highly negative allegations about the producer and the show's prospects, and urged the potential investor not to back the play. After receiving this email, the potential investor promptly withdrew from involvement in the production, preventing it from going forward. Slip op. at 1-2. The plaintiff, Rebecca Broadway Limited Partnership (“RBLP”), sued Marc Thibodeau (“Thibodeau”) a publicity agent for breach of contract, tortious interference with business relations and defamation. The motion court granted RBLP’s motion for summary judgment as to Thibodeau’s liability for breach of contract and denied RBLP’s summary judgment as to RBLP’s causes of actions for tortious interference with business relations and defamation.  The motion court also denied Thibodeau’s cross motion for summary judgment for, among other things, breach of contract. Thibodeau appealed the motion court’s order. The First Department affirmed. “As to the breach of contract cause of action,” the First Department found that the motion court “properly granted RBLP summary judgment as to liability on that claim.” Slip op. at 4. The Court found that the “record establishe that Thibodeau, without RBLP’s authorization, and using confidential information he had obtained as a result of his employment as RBLP’s press representative,” caused “a key potential investor” “to withdraw his financial commitment,” to the show, “which resulted in the cancellation of rehearsals and the play’s failure to open.”   Id . That sufficed to breach the terms of the agreement with RBLP. The First Department noted that “ ven assuming that his conduct did not violate the express terms of his agreement to act as the play’s press representative, Thibodeau breached the implied duty of good faith and fair dealing by essentially defeating the purpose of the agreement by his actions.” Slip op. at 4 (citation omitted). In so holding, the Court found that "Thibodeau was hired by RBLP to use his public relations skills to facilitate the production of a play; his actions, in which he made use of confidential information that RBLP had entrusted to him in the course of his employment, made it impossible for RBLP to produce the play as planned. It is difficult to imagine a plainer case of a party to a contract utterly defeating the purpose for which the other party had entered into that contract, or a more blatant example of an agent's disloyalty to his principal." Id . Having affirmed the motion court’s decision, the First Department turned to the denial of Thibodeau’s cross motion for summary judgment. Thibodeau claimed that RBLP breached the covenant of good faith and fair dealing by instructing him to answer all questions about the project, notwithstanding the direction to refrain from discussing possible foreign investors. The First Department rejected this claim: Although Thibodeau might well have felt uncomfortable in meeting the press while under orders not to give them the information they sought, RBLP did not breach the covenant of good faith and fair dealing by giving him those instructions. Again, while the record establishes that RBLP — as was its right — directed Thibodeau not to respond substantively to questions concerning the Abrams < i.e. , foreign investor> i.e., foreign investor> issue, Thibodeau does not allege that RBLP ever directed him to respond falsely to press inquiries. He could have responded to questions about Abrams, both truthfully and consistent with RBLP’s directives, by stating that RBLP was investigating the matter. RBLP, as Thibodeau’s principal, was entitled to limit the subjects that Thibodeau, as RBLP’s agent, was authorized to discuss substantively with the press and public; if Thibodeau was uncomfortable with that limitation on his authority, he was free to resign. Slip op. at 5. The Court went on to observe that even if RBLP breached the covenant of good faith and fair dealing before Thibodeau breached his covenant, the result would remain unchanged.  As the Court noted, Thibodeau could have resigned and terminated the agreement with RBLP: Even if RBLP could be deemed to have somehow breached its implied duty to Thibodeau of good faith and fair dealing before he committed his own breach of that covenant by sending the anonymous emails, we would not reach a different result. Any such material breach by RBLP, before the breach by Thibodeau, would have given Thibodeau grounds to suspend his own performance and, absent a timely cure by RBLP of its breach, to terminate his contract with RBLP (and then, perhaps, to seek damages for breach) …. But a first material breach of the parties’ agreement by RBLP, if there was one, would not have justified Thibodeau’s remaining in RBLP’s employ while using confidential information entrusted to him to sabotage the production. A party to a bilateral contract, when faced with a breach by the other party, must make an election between declaring a breach and terminating the contract or, alternatively, ignoring the breach and continuing to perform under the contract. Such a party has no right to represent himself as continuing to perform under the contract —and continuing to receive the other party’s performance in exchange — while at the same time surreptitiously breaching his own duty by flouting his own implied duty of good faith and fair dealing. Slip op. at 5-6 (citations and quotations omitted). Takeaway : The implied duty of good faith and fair dealing has long been accepted as a judicial tool of contract analysis. It is aimed at ensuring that the parties to a contract do not interfere with the other party’s performance or destroy the other party’s expectations with respect to the benefits of the contract. Rebecca Broadway serves as a recent example of the duty and how it can serve as the basis for a separate cause of action. Rebecca Broadway is also notable for its admonition to contracting parties about how to conduct themselves when there is a breach. In this regard, the Court made it clear that when a party to a contract breaches the agreement, the non-beaching party must make an election of remedies between declaring a breach and terminating the contract or, ignoring the breach and continuing to perform under the contract.

New York, NY (Law Firm Newswire) August 10, 2016 - The Legal 500 USA, a leading legal ranking and referral guide, has again recognized Mr.  Haber, founder of The Law Office of Jeffrey M. Haber, for his work as a plaintiff’s attorney in securities litigation. The Law Office of Jeffrey M. Haber was identified in the 2016 edition as a “recommended” lawyer in the “Dispute Resolution: Securities Litigation – Plaintiff” category. The Law Office of Jeffrey M. Haber was also “recommended” in the 2011–2012 and 2014–2015 editions of The Legal 500 USA. The Legal 500 is an independent guide that ranks law firms and individual lawyers around the world. It spends several months each year conducting in-depth research into the legal market, using information provided by law firms and “feedback from peers and clients.” The purpose of the guide is “to assess … overall visibility and reputation buyers of legal services with an objective analysis of the U.S. market….” About The Law Office of Jeffrey M. Haber Located in New York City, The Law Office of Jeffrey M. Haber is dedicated to representing corporations, small businesses, partnerships and individuals involved in a broad range of complex business and commercial litigation matters . The Law Office of Jeffrey M. Haber combines the sophistication and counsel of a large national law firm with the economy, flexibility, commitment and personal attention of a small firm. For more information, please contact The Law Office of Jeffrey M. Haber at (212) 209-1005 The Law Office of Jeffrey M. Haber 708 Third Avenue, 5th Floor New York, N.Y. 10017 Tel: (212) 209-1005 Fax: (212) 209-7101 Email: info@jhaberlaw.com

How many awards has the Commodity Futures Trading Commission ("CFTC") made under its whistleblower program? The CFTC awarded a whistleblower $50,000, the second such award this year. The $50,000 award comes on the heels of a $10 million award earlier in 2016, the largest award under its program to date. Authority Under the Dodd-Frank Act The whistleblower award program created under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") in 2010 authorized the commodities watchdog, along with the Securities and Exchange Commission ("SEC"), to reward whistleblowers who report violations of the commodities and securities laws. The CFTC program rewards individuals for voluntarily providing original information about Commodity Exchange Act ("CEA") violations, provided that the information leads to an enforcement action that results in monetary sanctions greater than $1 million. The whistleblower gets an award of between 10 and 30 percent of the amount collected by the CFTC. Under the law, the CFTC cannot identify the whistleblower, or the enforcement action on which the award is based. The $50,000 award is based on monetary sanctions collected by the CFTC thus far, and the whistleblower will receive between 10 and 30 percent of any additional sanction collected. CFTC Whistleblower Awards in 2016 Since the program was rolled out, the CFTC has made four awards for a total of $10.6 million, which is far less than awarded under the SEC's whistleblower program in which 32 awards of more than $85 million have been made - the largest being $30 million. While the CFTC was slow in rolling out its program - the first award was in 2014 - the program is said to be picking up steam. Protection Against Retaliation The Dodd-Frank Act also protects whistleblowers under the CFTC program, whether or not the individual is eligible for an award. Employers are prohibited from terminating, demoting, suspending, threatening, harassing (directly or indirectly), or in any manner discriminating against a whistleblower for any lawful act taken by the whistleblower under the CFTC program. These protections apply to any whistleblower who reasonably believes the information provided is related to possible violations of the CEA. Whistleblowers can also file a lawsuit in federal court in the event that they are discharged or discriminated against by an employer. The Takeaway The $10 million award earlier this year and the latest $50,000 award are an indication that the CFTC is becoming more aggressive in its enforcement activities. If you have knowledge of a violation of the CEA, an experienced attorney can help you report your concerns and obtain compensation.

What is a FINRA arbitration? The Financial Industry Regulatory Authority ("FINRA") issued a Regulatory Notice in July reminding member firms that customers have a right to request arbitration "at any time." In addition, the self regulator stated that customers do not forfeit their right to a FINRA arbitration by signing an agreement that calls for another venue. The notice also reiterated that FINRA members cannot require registered representatives and certain employees to waive their right to arbitration in a pre-dispute arbitration agreement. FINRA Arbitration at a Glance The FINRA arbitration forum protects customers from a wide range of practice violations, such as unsuitable investment advice , churning , breach of fiduciary duty and the like. Arbitration is a more expedient and cost effective approach to dispute resolution than a court trial. The process involves selecting a neutral third party, the "arbitrator," to resolve the dispute. By pursuing arbitration, a customer waives the right to pursue the matter in court and the arbitrator's decision is final and binding. The Regulatory Notice is a reminder that failing to comply with the rules concerning arbitration agreements or submitting disputes to a FINRA forum are rules violations that could result in disciplinary actions. The notice serves as a warning to certain firms that have reportedly been including restrictive provisions regarding dispute forums in their arbitration agreements. While these restrictions are more common in disputes between members firms and registered representatives, the real issue in customer disputes tends to be the selection of law. In a related development, FINRA has also filed a proposed rule with the SEC to amend its code of Arbitration Procedure for Customer Disputes. The goal is to provide a more efficient arbitration process, as well as one that is less costly while maintaining the rights of the parties involved in a dispute. While some observers believe there is a need to make the process more efficient, they also argue that any cost saving should be passed through to customers involved in a dispute resolution proceeding. Notwithstanding FINRA's July notice, brokers and investment advisors have a duty to act in a reasonable and prudent manner when acting as a fiduciary and are required to put their customers' interests first. In the end, a registered representative who becomes embroiled in a dispute with a customer or employer should engage the services of an experienced securities arbitration attorney .

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities.  The Dodd-Frank Act contains whistleblower provisions that authorize the Securities and Exchange Commission (“SEC” or the “Commission”) to pay substantial cash rewards to whistleblowers that voluntarily provide the SEC with information about violations of the securities laws. The Act further empowers whistleblowers to report corporate fraud or illegal conduct by prohibiting retaliation against individuals who blow the whistle under the SEC whistleblower program. In 2011, the SEC adopted Rule 21F-17 to implement the whistleblower-protection provisions of the Act.  The rule provides that “ o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications.” Rule 21F-17 applies to any policy or procedure, or agreement, such as confidentiality, severance, and non-disclosure agreements, that may impede an employee or former employee from providing information to the SEC about a securities law violation. The SEC Begins To Enforce Rule 21F-17 Since the rule’s adoption, whistleblowers and their counsel have complained that employers have used confidentiality and non-disclosure agreements to harass and intimidate employees and former employees from reporting a violation of the securities laws to the SEC. The problem from the whistleblower’s perspective was that following adoption, the SEC was not enforcing the rule.  That changed, however, in March 2014, when the SEC whistleblower office promised to police confidentiality agreements, and punish those companies that used such agreements to impede whistleblowing communications with the Commission. A year later, in February 2015, the SEC laid the foundation to make good on that promise.  According to numerous media reports, the SEC asked dozens of public companies for nondisclosure agreements, employment contracts, severance agreements, and other similar documents as part of an investigation into whether there were efforts to suppress lawful whistleblowing activities. See , e.g. , Rachel Louise Ensign, “SEC Probes Companies’ Treatment of Whistleblowers,” The Wall Street Journal , Feb. 25, 2015. The KBR Administrative Action : In April 2015, the SEC made good on its promise to crackdown on agreements and policies that restrict whistleblowing activities, when it issued a cease-and-desist order against KBR Inc. (“KBR”) for using confidentiality agreements that could chill the whistleblower process. According to the SEC, KBR, a global technology and engineering firm based in Houston, required employees participating in internal investigations to sign confidentiality statements containing language warning that the employee could be disciplined and/or fired if he/she discussed the investigation and its subject matter with outside parties without the approval of KBR’s legal department. The SEC acknowledged that it was “unaware of any instances in which (i) a KBR employee was in fact prevented from communicating” with the Commission, or “(ii) KBR took action to enforce the form confidentiality agreement or otherwise prevent such communications,” but nonetheless found that the agreement “impedes such communications.” KBR agreed to pay a $130,000 penalty to settle the SEC’s charges and amend its confidentiality statement by adding language making it clear that employees could report securities law violations to the SEC and other federal agencies without KBR approval or fear of retaliation. Commenting on the settlement, Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, underscored the vigor with which the SEC would pursue companies for violating Rule 21F-17: By requiring its employees and former employees to sign confidentiality agreements imposing pre-notification requirements before contacting the SEC, KBR potentially discouraged employees from reporting securities violations to us. SEC rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC.  We will vigorously enforce this provision. The KBR order was the first reported enforcement action by the SEC that was based solely on the language of a confidentiality agreement.  There would be others, albeit more than a year later. The BlueLinx Holdings Administrative Action : On August 10, 2016, the SEC announced that BlueLinx Holdings Inc. (“BlueLinx”), a building products distributor based in Atlanta, agreed to pay $265,000 in settlement of charges that it violated Rule 21F-17 by using severance agreements that required outgoing employees to waive their rights to a monetary recovery if they filed a complaint with the SEC or other federal agencies. According to the SEC, BlueLinx used several forms of severance agreements “that prohibited the employee from sharing with anyone confidential information concerning BlueLinx that the employee had learned while employed by the company, unless compelled to do so by law or legal process,” but which failed to exempt the employee from providing “information voluntarily to the Commission or other regulatory or law enforcement agencies.” Even though BlueLinx’s severance agreements did not prohibit former employees from reporting violations to the SEC, the SEC nevertheless claimed that the company unlawfully restricted outgoing employees from participating in the SEC’s whistleblower program. According to the SEC, “by requiring its departing employees to forego any monetary recovery in connection with providing information to the Commission, BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” The SEC also objected to the requirement that outgoing employees notify the company’s legal department prior to disclosing information to third parties, because the agreement did not expressly exempt the SEC from the restriction. The SEC determined that “BlueLinx forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.” Although the company did not admit or deny the findings, BlueLinx agreed: “(1) to amend its severance agreements to make clear that employees may report possible securities law violations to the SEC and other federal agencies without BlueLinx’s prior approval and without having to forfeit any resulting whistleblower award, and (2) to make reasonable efforts to contact former employees who had executed severance agreements after Aug. 12, 2011 to notify them that BlueLinx does not prohibit former employees from providing information to the SEC staff or from accepting SEC whistleblower awards.” In the announcement of the settlement, the SEC made it clear that the Commission would continue to aggressively enforce Rule 21F-17.  Stephanie Avakian, Deputy Director of the SEC’s Enforcement Division underscored this point, stating “We’re continuing to stand up for whistleblowers and clear away impediments that may chill them from coming forward with information about potential securities law violations.” Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, added, “Companies simply cannot undercut a key tenet of our whistleblower program by requiring employees to forego potential whistleblower awards in order to receive their severance payments.” The Health Net Inc. Administrative Action : On August 16, 2016, the SEC announced that Health Net Inc. (“Health Net”), a health insurance provider based in California, agreed to pay a $340,000 penalty for using severance agreements that required outgoing employees to waive their right to obtain monetary awards for blowing the whistle under the SEC’s whistleblower program. Health Net provided a severance package pursuant to an agreement that outgoing employees signed when leaving the company. These agreements included a Waiver and Release of Claims that listed various potential claims against the company that an outgoing employee waived as a condition of receiving severance payments and other consideration from Health Net. In August 2011, Health Net amended the Waiver and Release of Claims to specify that, while not prohibited from participating in a government investigation, the outgoing employee who executed the Waiver and Release of Claims was prohibited from filing an application for, or accepting, a monetary award from the SEC. In June 2013, Health Net further amended the Waiver and Release of Claims by removing the language “expressly prohibiting employees from applying for whistleblower awards pursuant to Exchange Act Section 21F,” and added an exemption for “communicating directly with, cooperating with or providing information to any government regulator.” However, Health Net “retained restrictions in the Waiver and Release of Claims that removed the financial incentive for its former employees who executed that agreement to communicate with Commission staff concerning possible securities law violations at Health Net.” On October 22, 2015, Health Net amended its severance agreements to remove the prohibition described above. Notably, the SEC acknowledged that it found no evidence of any instances in which an outgoing Health Net employee who executed the severance agreements did not communicate directly with the SEC about potential securities law violations, nor did the SEC find any evidence that Health Net enforced the waiver provisions or otherwise prevented such communications.  Nonetheless, the SEC concluded that both the 2011 and the 2013 provisions violated Rule 21F-17 by removing the financial incentive to communicate with the SEC concerning possible securities law violations at Health Net. In addition to paying the penalty, Health Net agreed to make reasonable efforts to contact former employees who signed the Waiver and Release of Claims, and provide those employees with a link to the SEC’s order and a statement that “Health Net does not prohibit former employees from seeking and obtaining a whistleblower award from the Securities and Exchange Commission pursuant to Section 21F of the Exchange Act.” In the announcement of the settlement, the SEC continued to emphasize its effort to enforce Rule 21F-17.  In this regard, Antonia Chion, Associate Director of the SEC Enforcement Division, stated, “Financial incentives in the form of whistleblower awards, as Congress recognized, are integral to promoting whistleblowing to the Commission.  Health Net used its severance agreements with departing employees to strip away those financial incentives, directly targeting the Commission’s whistleblower program.” Takeaway : The foregoing administrative actions demonstrate the SEC’s intention to make good on its promise to crack down on agreements and policies that impede whistleblowers from reporting securities fraud to the Commission. Whistleblowers should take comfort knowing that the SEC is aggressively enforcing Rule21F-17 so that there are no contractual or policy impediments to blowing the whistle on securities fraud. Companies should review their severance agreements and policies to ensure that they are compliant with Rule 21F-17.  Even companies that have previously reviewed their severance agreements and company policies should undertake such a review in light of the SEC’s recent enforcement actions.

In the commercial world, parties to a transaction often allocate the risk of economic loss in the event the transaction is not fully executed by including a sole remedy clause in their agreement. New York courts have long upheld such contractual provisions. However, as the First Department of the New York Supreme Court, Appellate Division, recently held, there are exceptions.  One such exception pertains to a party’s grossly negligent conduct. As explained in Morgan Stanley Mortgage Loan Trust 2006­13ARX v. Morgan Stanley Mortgage Capital Holdings LLC , 2016 NY Slip Op. 05781 (1st Dep’t. Aug. 11, 2016), a party cannot “insulate itself from damages caused by its grossly negligent conduct.” Id . at *4 (internal quotations omitted). THE CASE The case arose from the securitization and sale of residential mortgages.  The underlying mortgage loans originated with an affiliate of the defendant, Morgan Stanley Capital Holdings LLC (“Morgan Stanley”). The mortgage loans were pooled together and sold to the Morgan Stanley Mortgage Loan Trust 2006­13ARX (the “Trust”), which, through the plaintiff, U.S. Bank National Association (the “Trustee”), issued certificates representing ownership shares in the combined assets. These assets were then offered for sale, by prospectus, to investors as residential mortgage backed securities (“RMBS”). The Trustee sued Morgan Stanley to recover the losses sustained by investors who purchased the RMBS after a massive number of the loans defaulted. Facts: In 2006, Morgan Stanley sold debt, in the form of 1,873 residential mortgage loans, to a Morgan Stanley affiliate, Morgan Stanley Capital I, Inc. The sale, which represented an unpaid principal balance of more than $600,000,000, was largely effectuated through two integrated agreements, a Mortgage Loan Purchase Agreement (“MLPA”) and a Pooling and Servicing Agreement (“PSA”). These residential mortgage loans were pooled together and sold to the Trust, which issued certificates representing ownership shares in the combined assets. These RMBS were then offered for sale, by prospectus, to investors. Mortgage payments were the anticipated source of revenues that the Trustee would use to pay investors.  However, when hundreds of the borrowers defaulted in making their mortgage payments, the RMBS became virtually worthless. The Proceedings Below: The Trust alleged that it incurred more than $140 million in damages due to Morgan Stanley’s false representations and warranties. According to the Trustee, Morgan Stanley acted with reckless indifference by failing to adhere to minimum underwriting standards.  The Trustee claimed that when it notified Morgan Stanley of the defective loans, demanding that Morgan Stanley repurchase them, Morgan Stanley refused to do so. The Trustee claimed that a forensic examination of the RMBS showed that there were hundreds of loans that were of lesser quality than what Morgan Stanley had represented. The complaint alleged that many of the underlying borrowers obtained their loans by providing inaccurate, if not outright false, information on their applications that Morgan Stanley failed to verify. The Trustee maintained that Morgan Stanley should have notified the Trustee of these conditions because it knew of them, or could have discovered them with due diligence, given its access to documents and information about the loans. The Trustee alleged that Morgan Stanley made representations to make the loans appear less risky than they were. Despite the sole remedy provision, the Trustee alleged that contractual damages would not adequately compensate the Trust for its losses. Morgan Stanley moved to dismiss the complaint. The trial court dismissed the cause of action alleging a breach of contract based on Morgan Stanley’s alleged failure to notify the Trustee about the defective loans. The court rejected the Trustee’s argument that Morgan Stanley’s inaction constituted an independent breach of contract claim, finding that the requirement was not a contractual obligation, but merely a notification remedy. The court also dismissed the Trustee’s claims that it was entitled to damages caused by Morgan Stanley’s gross negligence on the basis that “the relief available to plaintiff is limited by the sole remedy provisions in the and the ....” Slip Op. at *4 (internal quotations omitted). Alternatively, the court held that “even if, legally, the sole remedy limitations in the MLPA and PSA could be rendered unenforceable by Morgan Stanley’s willful misconduct or gross negligence,” the Trustee’s complaint “did not contain facts to sufficiently support that claim.” Id . The Court’s Decision: In dismissing the Trustee’s failure to notify cause of action, the trial court observed that the issues raised by the Trustee were substantially the same as those raised in Nomura Asset Acceptance Corp. Alternative Loan Trust v Nomura Credit & Capital, Inc ., an RMBS case that was pending before it, and that its ruling was consistent with that earlier case.  However, after the parties briefed the appeal, the First Department modified the Nomura decision, “holding that under similar RMBS agreements, a seller’s failure to provide the trustee with notice of material breaches it discovers in the underlying loans states an independently breached contractual obligation, allowing a plaintiff to pursue separate damages.” Slip Op. at *4 (citing Nomura Home Equity Loan, Inc. v Nomura Credit & Capital, Inc. , 133 A.D.3d 96, 108 (1st Dep’t 2015) ( lv granted 1st Dep’t Jan. 5, 2016)). Consistent with the First Department’s Normura decision, the Court reinstated the failure to notify claim. In connection with the Trustee’s claims of gross negligence, the Court held that although the courts in New York will honor “the remedies that the parties have contractually agreed to,” they will not allow a party to “insulate itself from damages caused by its grossly negligent conduct.” As a general principle of law, damages arising from a breach of contract will ordinarily be limited to those necessary to redress the wrong ( see e.g . Rocanova v Equitable Life Assur. Socy. of U.S. , 83 NY2d 603, 613 <1994> ). Where parties contractually agree to a limitation on liability, that provision is enforceable, even against claims of a party's own ordinary negligence ( Sommer v Federal Signal Corp ., 79 NY2d at 553, 554) …. There are exceptions to this rule of law, however, and as a matter of long standing public policy, a party may not insulate itself from damages caused by its "grossly negligent conduct ( Sommer at 554). Looking at the complaint, the Court found that the Trustee sufficiently alleged that Morgan Stanley acted with reckless indifference. In that regard, the Court noted that: alleged there were widespread breaches across the loans being held by the Trust and that Morgan Stanley failed to adhere to even minimal underwriting standards or to verify basic and critical information about potential buyers; it further alleges that Morgan Stanley had access to the underlying loan files and that more than half of the loans later reviewed by plaintiff's forensic analysts revealed rampant breaches of the warranties Morgan Stanley made. It further alleges that Morgan Stanley simply ignored its contractual obligations, disregarded the known or obvious risks that the loans sold to the Trustee were defective and then failed to notify the Trustee of any breaches or effectuate a cure/repurchase. We hold that these allegations are sufficient to withstand dismissal at the pleading stage. Takeaway: Agreements limiting the remedies available to parties for the failure to perform the terms of their agreement are enforceable under the law.  In fact, such provisions are an accepted means to allocate risk between the parties. Morgan Stanley teaches that despite the parties’ attempt to contractually limit the remedies available for a breach, they cannot limit the remedies available for their fraudulent or reckless misconduct.

Did Tesla violate securities laws by not disclosing a fatal accident? In May, the driver of a Tesla Model S was killed after colliding with a truck while the Autopilot feature, which is designed to assist drivers in steering, braking and avoiding collisions, was engaged. Since October 2014, Tesla Motor Co. has installed autopilot software in all of its cars, even though the feature is still being tested in a public beta. Now, the Securities and Exchange Commission ("SEC") is said to be probing the matter to determine if Tesla violated the federal securities laws by failing to disclose the fatal accident. Tesla claims it immediately reported the crash to the National Highway Traffic Safety Administration ("NHTSA"), however. The overarching issue is whether the company should have also disclosed the crash to the SEC. Some observers argue that the accident was a material event, and the electric car maker breached its corporate duty by not informing the agency, and its investors. While the SEC has not confirmed that an investigation is underway, the NHTSA and the National Transportation Safety Board are looking into the crash. For its part, Tesla said it has not received any communication from the SEC, and also noted that this is the first fatality in 130 million miles of travel with the Autopilot mode activated. While the company acknowledges the system has not been perfected, the system is designed to reduce drive workload and improve safety. However, there have recently been other non-fatal accidents in Montana and Pennsylvania in which Tesla drivers were in the self-driving mode. The accidents come at an inopportune time for Tesla, and its founder, Elon Musk, who until this time has been the darling of investors. The company recently announced shipments of Tesla models missed second quarter projections after previously announcing a first quarter miss and has been forced to revise its projected shipments downward for the year. On the other hand, it remains to be seen whether the accident was material to Tesla's future. Shares of the company's stock rose after news of the crash first became public on July 1. Investors in the electric car maker are said to view this as developing technology and that errors are inevitable. Questions have also been raised as to whether the driver was using the Autopilot feature as intended. Drivers are required to maintain control of the vehicle, keeping both hands on the wheel at all times. The system alerts the driver if hands are not detected and the car is designed to slow down until the driver responds. Whether the SEC will find that this accident was a material event that should have been disclosed is uncertain, but any company being probed by the agency needs to engage the services of an experienced attorney.

The False Claims Act (“FCA” or the “Act”) prohibits businesses and individuals from defrauding the government by knowingly presenting, or causing to be presented, a false claim for payment or approval. Currently, violations of the Act can result in a judgment equal to three times the losses sustained by the government, plus civil penalties of $5,500 to $11,000 for each false claim. The Act rewards whistleblowers (also known as “relators”) who successfully recover funds on behalf of the government. A person who brings a successful “ qui tam ” action can receive between 15% and 30% of the government’s recovery depending upon whether the government intervenes in the action. To start a qui tam action, the relator must file a complaint under seal in federal court – i.e. , it will be kept from public view. Copies of the complaint are served on the United States Department of Justice (“DOJ”), including the local United States Attorney, and delivered to the judge assigned to the action. The complaint is not served on any of the named defendants until ordered by the court. The complaint must satisfy multiple pleading requirements under the Federal Rules of Civil Procedure (“Fed. R. Civ. P.”).  For example, the relator must satisfy Fed. R. Civ. P. 8(a)(2), which requires the complaint to provide “a short and plain statement of the claim showing that the pleader is entitled to relief.”  In doing so, the complaint must “possess enough heft” by demonstrating with “sufficient factual matter” that the relator has “state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly , 550 U.S. 544, 570 (2007); see also Ashcroft v. Iqbal , 556 U.S. 662, 678 (2009). The relator must also plead with particularity the circumstances constituting the alleged fraud on the government. Fed. R. Civ. P. 9(b).  See also U.S. ex rel. Lucas Matheny v. Medco Health Solutions, Inc ., 671 F.3d 1217 (11th Cir. 2012). This requirement “demands a higher degree of notice than that required for other claims,” and “is intended to enable the defendant to respond specifically and quickly to the potentially damaging allegations . ”   U.S. ex rel. Joshi v. St. Luke’s Hosp., Inc. , 441 F.3d 552, 556 (8th Cir. 2006) (internal citations omitted).  “To satisfy the particularity requirement of Rule 9(b), the complaint must plead such facts as the time, place and context of the defendant’s false representations, as well as the details of the defendant’s fraudulent acts, including when the acts occurred, who engaged in them, and what was obtained as a result.”  Id .  In other words, the relator must identify the “who, what, where, when and how of the alleged fraud.” Id . See also Hopper v. Solvay Pharms., Inc. , 588 F.3d 1318, 1324 (11th Cir. 2009); Rombach v. Chang , 355 F.3d 164, 170 (2d Cir. 2004). In addition to filing a complaint, the relator must serve a disclosure statement on the government containing substantially all the evidence in his/her possession about the alleged fraud. 31 U.S.C. § 3730(b)(2). The disclosure statement is not filed in court, and is not available to the named defendants. The primary purpose of the disclosure requirement “‘is to provide the United States with enough information on alleged fraud to be able to make a well reasoned decision on whether it should participate in the filed lawsuit or allow the relator to proceed alone.’” United States ex rel. Bagley v. T.R.W. Inc ., 212 F.R.D. 554, 556 (C.D. Cal. 2003) (quoting United States ex rel. Woodward v. Country View Care Ctr ., 797 F.2d 888, 892 (10th Cir. 1986)); United States ex rel. Calilung v. Ormat Indus., Ltd. , No. 3:14-cv-00325-RCJ-VPC (D. Nev. Dec 23, 2015). To many, including government attorneys, the disclosure statement is the most important document submitted at the outset of a qui tam action. As noted, Section 3430(b)(2) requires the relator to provide the government with “substantially all material evidence and information” that the relator possesses. 31 U.S.C. § 3730(b)(2). However, there are “few reported decisions constru the nature and extent of the relator’s disclosure obligation under section 3730(b)(2).” Bagley , 212 F.R.D. at 556 (citing United States ex rel. Made in the USA Found. v. Billington , 985 F. Supp. 604, 608 (D. Md. 1997)). “As such, the statute affords the drafter the discretion to include a recitation of facts that support an allegation or analysis of how the facts coalesce to support an allegation—or both—as long as it contains ‘substantially all material evidence and information the person possesses.’” Bingham v. Baycare Health Sys ., Case No: 8:14-cv-73-T-23JSS (M.D. Fla. Apr. 15, 2016) (citing Bagley , 212 F.R.D. at 556). Given the discretion afforded to a relator under Section 3430(b)(2), it is generally recommended that the relator do more than provide a basic overview of the alleged fraud. See generally Robert Salcido, The Government Declares War on Qui Tam Plaintiffs Who Lack Inside Information: The Government’s New Policy to Dismiss These Parties in False Claims Act Litigation , 13 Health Law 1, 4 (2000) (explaining the pros and cons of filing a full disclosure statement versus a sparse disclosure statement). As a practical matter, a threadbare disclosure statement will more likely be rejected by the government – that is, the government will more likely decline to intervene in the action. However, the DOJ will be more likely to intervene when the relator provides documentary evidence supporting the allegations of fraud.  Consequently, relators are “encourage … to make as complete, detailed, and thoughtful as possible.” Bagley , 212 F.R.D. at 557. How then does a relator provide the government with the quantum of evidence needed to support his/her allegations of fraud and increase the likelihood of government intervention in the action? One method often used is self-help discovery. Self-help discovery occurs when an employee uses his/her position to access company files for the purpose of collecting documents and information relating to his/her qui tam claims. Often, the documents and information that a whistleblower takes are confidential.  Sometimes, the documents include trade secrets, and others times attorney-client privileged information. Almost always, the self-help discovery violates company policy and/or a confidentiality agreement. Consequently, self-help discovery exposes the employee to a counterclaim for breach of contract, sanctions, or worse. Whether such claims can survive depends on the court in which the claim is brought and the facts underlying the self-help discovery. Some courts have dismissed claims against a relator holding that in the context of a qui tam action, public policy voids confidentiality agreements and company policies. E.g. , United States v. Cancer Treatment Centers of America , 350 F. Supp. 2d 765, 773 (N.D. Ill. 2004); Head v. Kane Co. , 668 F. Supp. 2d 146 (D.D.C. 2009); Ruhe v Masimo Corp ., 929 F Supp. 2d 1033, 1039 (C.D. Cal. 2012). Cf . X Corp. v. John Doe , 805 F. Supp. 1298, n. 24 (E.D. Va. 1992) (noting that a confidentiality agreement would be void as against public policy if, when enforced, it would prevent “disclosure of evidence of a fraud on the government”).  Other courts have held that claims against a relator who has availed himself/herself of documents and information through self-help discovery turns on the reasonableness of the relator’s conduct in relation to the need for the documents and information. E.g. , Aldrich v. Rural Health Servs ., 579 Fed. Appx. 335 (6th Cir. 2014); U.S. v. Boston Scientific Neuromodulation Corp. , 2014 WL 4402118 (D.N.J. Sept. 4, 2014); Cafasso v General Dynamics C4 Systems, Inc ., 637 F.3d 1047, 1062 (9th Cir. 2011) (recognizing “some merit” in a public policy exception, but finding that such an exception would have limits); JDS Uniphase Corp. v. Jennings , 473 F. Supp. 2d 697, 702-03 (E.D. Va. 2007); Niswander v. Cincinnati Ins. Co. , 2007 WL 1189350 (N.D. Ohio Apr. 19, 2007); Laughlin v. Metropolitan Washington Airport Auth. , 149 F.3d 253 (4th Cir. 1998). These courts balance the need of the relator to provide the government with substantially all the evidence in his/her possession ( see 31 U.S.C. § 3730(b)(2)) against the company’s expectation that its confidential and privileged information will be protected. Courts that engage in the balancing approach often note that there is a strong public policy that protects whistleblowers from retaliation for actions taken in connection with their qui tam complaint. But in doing so, they also note that this policy has its limits, stating that relators cannot purloin documents for reasons other than in pursuit of their qui tam action. Consequently, these courts examine whether the self-help discovery went beyond the scope of what was necessary to demonstrate qui tam liability by considering a number of factors, including, but not limited to: (1) the manner in which the employee obtained the evidence; (2) whether the evidence contained trade secrets, proprietary information or attorney-client privileged information; (3) what the employee did with the evidence; (4) whether the employee’s conduct was prohibited by a company policy or confidentiality agreement; (5) the impact on the company of the disclosure of the evidence – that is, whether disclosure of the evidence was made public or to competitors; (6) whether the evidence is relevant to the relator’s qui tam claims; (7) the effect of allowing or disallowing use of the evidence on the rights of the employee and the employer; and (8) whether there was a risk that the evidence would be destroyed if the employee did not remove or retain it. Often, the courts using the balancing approach have found that the factors mentioned above favor the company rather than the public policy interest.  E.g. , Cafasso , 637 F.3d at 1062 (public policy exception “would not cover conduct given her vast and indiscriminate approach of files.”); U.S. ex rel. Wildhirt v. AARS Forever, Inc. , No. 1:09-cv-01215, 2013 WL 5304092 (N.D. Ill. Sept. 19, 2013) (finding that the public policy exception did not shield the relator from liability since the relator took documents with no intention of filing a qui tam action and disclosed them to the public); U.S. ex rel. Walsh v. Amerisource Bergen Corp. , No. 2:11-cv-07584, 2014 WL 2738215 (E.D. Pa. June 17, 2014) (denying a relator’s motion to dismiss counterclaims and emphasizing that the relator “took ‘a large variety of confidential, proprietary and privileged information…’”) (citation omitted).  Sometimes, however, the factors mentioned above favor the relator.  One such case is discussed below. Recent Use of the Balancing Approach On May 9, 2016, the U.S. District Court for the Northern District of Illinois dismissed a counterclaim brought by a defendant company against a whistleblower for providing the government with confidential information in violation of the company’s privacy policy and a confidentiality agreement. In United States ex rel. Cieszynski v. Lifewatch Services, Inc. , No. 13 CV 4052, 2016 WL 2771798 (N.D. Ill. May 13, 2016), the court balanced the public policy and company interests and found that the whistleblower had not taken any more information than necessary to report the alleged fraud to the government. The Facts Matthew Cieszynski (“Cieszynski”), a certified technician for the defendant LifeWatch Services, Inc. (“LifeWatch”), brought a qui tam action against LifeWatch under the Act and related state false claims statutes, alleging that LifeWatch collected reimbursements for medical services that were performed by non-U.S.-based technicians and/or non-certified technicians, in violation of Medicare and other federal and state insurance laws and regulations. After the court denied LifeWatch’s motion to dismiss, LifeWatch answered the complaint and filed a one-count counterclaim alleging that Cieszynski breached both a confidentiality agreement and privacy policy he signed as part of his employment with LifeWatch.  According to LifeWatch, Cieszynski took and disclosed to his attorney and the government confidential information in connection with the pursuit of his qui tam action. All parties agreed that the information taken was covered by the confidentiality agreement and privacy policy. The Court’s Decision Breach of Contract Must Be Independent from Any FCA Investigation After balancing the public policy that protects whistleblowers from retaliation for the actions they take to investigate and report a fraud on the government against the privacy rights of companies that claim independent damages from the theft of confidential information, the court held that LifeWatch “failed to state a claim for breach of contract.” In dismissing the counterclaim, the court found that LifeWatch failed to “create a plausible claim that plaintiff’s actions deprived him of the public policy protections afforded qui tam relators who must collect and disclose documentary evidence to support their suspicions of fraud against the government.” At the heart of the dismissal was the court’s conclusion that LifeWatch’s claim derived from the FCA claims Cieszynski alleged against it.  LifeWatch did not contend that Cieszynski had retained or disclosed the information “for any reason other than to support his FCA claim.” Nor did LifeWatch contend that Cieszynski provided the documents to anyone “other than the government or his counsel.” In fact, LifeWatch did not allege any “damages resulting from relator’s actions other than the fees and costs associated with pursuing the counterclaim” – which the court considered to be “a self-inflicted wound.” According to the court, Cieszynski’s actions were far different than in other cases in which the plaintiffs had taken documents with no intention to file a qui tam action, made the documents public, disclosed trade secrets that could damage the business, and/or convinced other employees to take documents. The Retention and Disclosure Did Not Go Beyond the Scope of Necessity Next, the court rejected LifeWatch’s argument that Cieszynski “took many more documents than were necessary to support his claim.” In doing so, the court declined to impose a burden on relators to know in hindsight “precisely how much information to provide the government” in order to support their case, fearing that to do so would have a chilling effect of their “willingness to report suspected fraud.” It is unrealistic to impose on a relator the burden of knowing precisely how much information to provide the government when reporting a claim of fraud, with the penalty for providing what in hindsight the defendant views as more than was needed to be exposed to a claim for damages.  Given the strong public policy encouraging persons to report claims of fraud on the government, more is required before subjecting relators to damages claims that could chill their willingness to report suspected fraud. Takeaway Cieszynski is a good decision for relators. It represents a fair and reasonable approach to evaluate self-help discovery in furtherance of a qui tam action.  It firmly recognizes the importance of protecting whistleblowers against retaliation and incentivizes them to investigate and report fraud against the government as intended by the Act. But, it also recognizes that whistleblowers cannot overreach by haphazardly and indiscriminately taking documents that are unrelated to their  qui tam  action, disclosing them to the public, or disclosing trade secrets, proprietary information and/or attorney-client privileged documents to competitors and/or third parties. Counsel on both sides of the case should consider this approach in their qui tam representation.

An agency relationship occurs when a principal gives legal authority to an agent to act on the principal’s behalf when dealing with a third party, and obtains the agent’s consent to be subject to the principal’s control.   See Restatement (Third) of Agency §1.01. An agency relationship is a fiduciary one, meaning the agent, acting within the scope of his/her authority, has to act in the best interests of the principal. Under such circumstances, the acts and deeds of the agent will bind the principal, making the principal liable for the consequences of the acts that the agent has been authorized to perform. There is a significant body of law governing the principal-agent relationship, including liability for wrongs committed against third parties. As a general matter, the liability of an agent for wrongs committed against a third party depends upon a number of factors, including whether the agent discloses the existence of the principal.  The inquiry is often focused on the type of principal that is present in the deal or transaction: (1) a “disclosed” principal; (2) a “partially disclosed” principal; or (3) an “undisclosed” principal. Disclosed Principal A disclosed principal is a person whose existence and identity is made known to the third party through words or the performance of an authorized act.  As explained in the Restatement (Third) of Agency, the “third party has notice that the agent is acting for a principal and has notice of the principal’s identity.” Restatement (Third) of Agency § 104(2)(a). Under these circumstances, any contract or agreement executed between the agent and a third party is deemed to be a contract or agreement between the principal and the third party. The agent is not a party to the contract or agreement. Therefore, in the event the contract or agreement is breached in any way by the principal, the agent cannot be held personally liable for any damages incurred by reason of the breach. Partially Disclosed Principal A partially disclosed principal or “unidentified principal” is a person whose existence but not identity is made known to the third party through words or the performance of an authorized act. As explained in the Restatement (Third) of Agency, the “third party has notice that the agent is acting for a principal but does not have notice of the principal’s identity.” Restatement (Third) of Agency § 104(2)(c). Under these circumstances, any contract or agreement executed between the agent and a third party is deemed to be a contract or agreement between the agent and the third party unless the parties agree otherwise ( i.e. , the principal is responsible for performing under the contract or agreement). Without the third party’s consent and agreement that the principal is the contracting party, the agent may be held personally liable for any breach of the contract or agreement. Undisclosed Principal An disclosed principal is a person whose existence and identity are not made known to the third party through words or the performance of an authorized act. As explained in the Restatement (Third) of Agency, the “third party has no notice that the agent is acting for a principal.” Restatement (Third) of Agency § 104(2)(b). Under these circumstances, any contract or agreement executed between the agent and a third party is deemed to be a contract or agreement between the agent and the third party.  Thus, the agent may be held personally liable for any breach of the contract or agreement. Holding the Agent Liable It goes without saying that an agent does not want to be held liable for the transactions he/she enters on behalf of another person. With this truism in mind, let’s consider the following scenario: Jane buys a condo that needs renovation.  After two months of research, Jane meets with John, a contractor and home designer.  John tells Jane that he is the owner of XYZ Design and Renovation, maintains an affiliation with ABC Home Designs (a high-end home design company), and can handle the work required to renovate the apartment. Jane tells John that she will think it over and get back to him if she decides to go forward. A few weeks later, Jane emails John to express her interest in hiring him. Over the next few months, Jane and John exchange emails about designs and construction plans. Thereafter, John sends Jane a contract, which lists all of the improvements to be done and the corresponding cost for supplies and labor.  Jane finds the terms and conditions acceptable and hires John. Not long after John begins the work, Jane becomes concerned with John’s workmanship and the quality of the supplies that John is using for the renovation.  After paying over $25,000 in parts and labor, Jane fires John and files suit against him for breach of contract. John denies any liability, arguing that he is not a party to the contract with Jane. John claims that the actual contracting party is Bella Inc. d/b/a XYZ Design and Renovation and that XYZ Design and Renovation is a trade name for Bella Inc. Can Jane sue John personally for breach of contract? In Tecchia v. Bellati , 2016 NY Slip Op. 31311(U), the case upon which the foregoing fact pattern is based, Justice Scarpulla of the Supreme Court, New York County, Commercial Division, answered the question with an unequivocal yes. The Facts Sara Tecchia (“Tecchia”) purchased an apartment in lower Manhattan that needed substantial home improvements.  Tecchia met with Bartolomeo Bellati (“Bellati”) in his New York showroom, “where he represented that he was the owner of Minimal USA, that he was affiliated with Minimal Cucine, an Italian bespoke kitchen designer, and that he could perform the construction improvements that Tecchia sought.” During the following year, Tecchia and Bellati met and exchanged multiple emails concerning the construction plans. Bellati sent a contract (the “Contract”) to Tecchia, which Tecchia countersigned several months later.  Among other things, the Contract listed the work to be performed and the corresponding price for parts and labor. Tecchia was not satisfied with the work that Bellati performed and the quality of the supplies that he installed.  Consequently, Tecchia terminated the Contract, after paying Bellati $593,808.29 under the Contract, and sued for, among other things, breach of contract. Bellati moved to dismiss the complaint on the grounds that he was the agent for another company, Canova Inc. (“Canova”), and that Canova was responsible for any damages Tecchia claimed she incurred. The Holding Justice Scarpulla denied the motion, finding that Bellati failed to disclose Canova as the principal: Here, the Contract was signed by individual defendant Bellati over a line that bore the name “Minimal USA” and there is no indication that it was disclosed to Tecchia that Bellati was acting on behalf of corporate entity Canova instead of individually or on behalf of non-corporate entity Minimal USA. None of the documents submitted by Defendants “conclusively” establish a defense to the claims asserted against Bellati. (Internal quotations and citations omitted.) In rejecting Bellati’s argument, Justice Scarpulla made it clear that the third party must have actual knowledge of the principal.  Mere suspicion is insufficient “to relieve the agent from liability”: Defendants argue that an invoice bearing the name “Canova Inc.” gave reason to suspect that Bellati was acting on Canova’s behalf. However, the fact that a plaintiff has reason to suspect that an individual is acting as an agent in and of itself is insufficient to relieve the agent from liability. Knowledge of the real principal is the test, and this means actual knowledge, not suspicion. Indeed, nothing short of full disclosure of the principal’s status will relieve an agent from personal liability. (Internal quotations and citations omitted.) TAKEAWAY : Tecchia teaches that disputes between principals/agents and third parties can be avoided through the use of a well-written contract.  Such agreements can be drafted to make it clear who the transacting parties are ( e.g. , a third party and the principal) and who will be responsible for any breaches of the agreement. A business lawyer and/or a commercial litigator can help draft such an agreement and/or represent the principal or agent in a dispute with a third party.