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Since the summer of 2016, this Blog has written about the Fiduciary Rule (the “Fiduciary Rule” or the “Rule”), which the Department of Labor (“DOL”) promulgated in April 2016. ( See , e.g. , here , here , here , here , here , here , here .) Readers of this Blog know that the implementation of the Rule has not gone smoothly. The Rule has been the subject of congressional and industry attacks and legal challenges. On March 15, 2018, one of the legal challenges succeeded – the Court of Appeals for the Fifth Circuit struck down the Rule in its entirety, finding that the DOL exceeded its authority in promulgating the Rule. A Primer on The Fiduciary Rule The Fiduciary Rule provides that an individual “renders investment advice for a fee” whenever s/he is compensated in connection with a “recommendation as to the advisability of” buying, selling, or managing “investment property.” 29 C.F.R. § 2510.3-21(a)(1) (2017). A fiduciary duty arises when the “investment advice” is directed “to a specific advice recipient . . . regarding the advisability of a particular investment or management decision with respect to” the recipient’s investment property. 29 C.F.R. § 2510.3-21(a)(2)(iii) (2017). The Rule encompasses virtually all financial and insurance professionals who do business with ERISA plans and IRA holders. An important component of the Fiduciary Rule is the “Best Interest Contract Exemption” (“BIC Exemption” or “BICE”), which, if adopted by “investment advice fiduciaries,” allows them to avoid prohibited transaction penalties. The BICE and related exemptions were promulgated pursuant to the DOL’s authority to approve prohibited transaction exemptions (PTEs) for certain classes of fiduciaries or transactions. 29 U.S.C. § 1108(a), 26 U.S.C. § 4975(c)(2). To qualify for a BIC Exemption, providers of financial and insurance services must enter into contracts with clients that, inter alia , affirm their fiduciary status; incorporate “Impartial Conduct Standards” that include the duties of loyalty and prudence; “avoid[] misleading statements;” and charge no more than “reasonable compensation.” In addition, the contracts may not include exculpatory clauses such as a liquidated damages provision or a class action waiver. Another significant component of the Fiduciary Rule is the amended Prohibited Transaction Exemption 84-24 (“PTE 84-24”). Since 1977, that exemption had covered transactions involving insurance and annuity contracts and permitted customary sales commissions where the terms were at least as favorable as those at arm’s-length, provided for “reasonable” compensation, and included certain disclosures. As amended in the Fiduciary Rule, PTE 84-24 subjects these transactions to the same Impartial Conduct Standards as in the BIC Exemption. The Long and Winding Road of the Fiduciary Rule Shortly after taking office in 2017, President Trump instructed the DOL to perform an “economic and legal analysis” of the potential impact of the Rule on retirement investors and the market before its effective date. In late March 2017, following demands by industry participants, such as Vanguard and Blackrock, for a delay in the implementation of the Rule, and after a 15-day public comment period, the DOL decided to delay implementation of the Rule. The DOL sent its decision to the Office of Management and Budget (“OMB”) for review and approval. After the review by the OMB, the DOL delayed implementation of the Rule by 60-days. In the announcement, the DOL explained that “it would be inappropriate to broadly delay application of the fiduciary definition and Impartial Conduct Standards for an extended period in disregard of its previous findings of ongoing injury to retirement investors.” In late May 2017, Alexander Acosta, the newly-appointed Secretary of Labor, wrote in an opinion piece for the Wall Street Journal , that the Fiduciary Rule would not be delayed beyond June 9, 2017, though the DOL was still seeking “additional public input” about the Rule. On June 30, 2017, the DOL reopened the public comment period for another 30 days. In early August 2017, the DOL decided to delay implementation of the Rule to 2019. In a court filing, the DOL proposed an 18-month delay in the implementation of the Rule, changing the final deadline for compliance from January 1, 2018, to July 1, 2019. The proposed delay was approved by the OMB in August 2017. Court Rulings Prior to and during the first year of the Trump presidency, trade groups, among others, challenged the legality of the Rule in court. For the most part, the DOL scored many victories. Some of those cases made it to the appellate courts. In one case, the Rule survived; in another, the Rule was struck down. The Tenth Circuit Affirms The Rule On March 13, 2018, the Court of Appeals for the Tenth Circuit ruled that the DOL did not “arbitrarily treat fixed indexed annuities differently from fixed annuities” under the Fiduciary Rule. The plaintiff, Kansas-based Market Synergy Group (“MSG”), argued that the DOL arbitrarily threw fixed indexed annuities (“FIA”) under the BICE without notice, and therefore without any opportunity for public comment. The Tenth Circuit was “unpersuaded” by the argument, noting that “ he clearly asks for comment on whether removing variable annuities from PTE 84- 24 but leaving FIAs and fixed rate annuities struck the appropriate balance.” Thus, the DOL’s decision to include FIAs under PTE 84-24 was “not arbitrary or capricious.” Market="Market" Synergy="Synergy" Group,="Group," Inc.="Inc." v.="v." United="United" States="States" Department="Department" Labor, ="Labor," et="et" al. ,="al.," No.="No." 17-3038="17-3038" (10th="(10th" Cir.="Cir." Mar.="Mar." 13,="13," 2018),="2018)," can="can" be="be" found="found" here .=">here."> Micah Hauptman, financial services counsel for the Consumer Federation of America, said the decision “is yet another concluding that the DOL acted properly in promulgating the rule. The DOL’s careful analysis in promulgating the rule stands in stark contrast to the agency’s more recent arbitrary and capricious actions in delaying the rule’s full implementation.” The Fifth Circuit Strikes Down The Rule On March 15, 2018, the Court of Appeals for the Fifth Circuit vacated the Rule in a 2-1 decision, overturning a Dallas district court opinion that rejected the attacks on the Rule and the DOL’s authority to promulgate it. The case was brought by several industry groups, including the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Institute. Chief Judge Barbara M.G. Lynn of the United States District Court for the Northern District of Texas, granted summary judgment to the DOL in 2017. Chamber of Commerce of the United States of America, et al. v. Hugler, et al. , 231 F. Supp. 3d 152 (N.D. Tex. Feb. 8, 2017). ( Here .) In doing so, the court rejected each of the arguments advanced by the plaintiffs; namely, that the DOL did not exceed its authority, did not create a private right of action for clients and did not violate rulemaking authority. In fact, Chief Judge Lynn endorsed the DOL’s analysis of how the Rule would affect investors and financial firms, finding that “the DOL adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers.” “In doing so,” said the court, “the DOL conducted a reasonable cost-benefit analysis.” That finding struck at the heart of President Trump’s directive to the DOL to perform an analysis to determine whether the Fiduciary Rule harms investors and/or the market. The plaintiffs appealed. The Fifth Circuit ruled that the DOL exceeded its authority in extending the reach of the Fiduciary Rule to IRAs. In so holding, the Court found that the DOL improperly attempted “to rewrite the law that is the sole source of its authority.” “This it cannot do,” said the Court. The Court observed that the “DOL’s principal policy concern about the lack of fiduciary safeguards in Title II” was one that should be addressed by Congress, not by “de facto statutory amendments” or rule: That times have changed, the financial market has become more complex, and IRA accounts have assumed enormous importance are arguments for Congress to make adjustments in the law, or for other appropriate federal or state regulators to act within their authority. A perceived “need” does not empower DOL to craft de facto statutory amendments or to act beyond its expressly defined authority. On the merits, the Court found that the Rule’s definition of an “investment advice fiduciary” did not comport with ERISA Titles I and II, was not “reasonable” under Chevron U.S.A., Inc. v. NRDC, Inc. , 467 U.S. 837 (1984), and was violative of the Administrative Procedures Act (“APA”), 5 U.S.C. § 706(2)(A) (2016). In holding that the Rule is unreasonable and violative of the APA, the Court found that the DOL ignored the distinction between its authority over employer-sponsored plans and IRAs: By statute, ERISA plan fiduciaries must adhere to the traditional common law duties of loyalty and prudence in fulfilling their functions, and it is up to DOL to craft regulations enforcing that provision. 29 U.S.C. §§ 1001(b), 1104. IRA plan “fiduciaries,” though defined statutorily in the same way as ERISA plan fiduciaries, are not saddled with these duties, and DOL is given no direct statutory authority to regulate them. As to IRA plans, DOL is limited to defining technical and accounting terms, 11 U.S.C. § 1135, and it may grant exemptions from the prohibited transactions provisions. 26 U.S.C. § 4975(c)(2), 29 U.S.C. § 1108(a). Hornbook canons of statutory construction require that every word in a statute be interpreted to have meaning, and Congress’s use and withholding of terms within a statute is taken to be intentional. It follows that these ERISA provisions must have different ranges; they cannot mean that DOL may comparably regulate fiduciaries to ERISA plans and IRAs. Loughrin v. United States , 134 S. Ct. 2384, 2390 (2014). Despite the differences between ERISA Title I and II, DOL is treating IRA financial services providers in tandem with ERISA employer-sponsored plan fiduciaries. The Fiduciary Rule impermissibly conflates the basic division drawn by ERISA. The Court also found that the Fiduciary Rule’s definition of “investment advice fiduciary” was overbroad, illogical and otherwise internally inconsistent, characteristics of “arbitrary and unreasonable agency action.” Moreover, the Court found that the BIC Exemption is overbroad and “inconsistent” with an exemption specifically provided by ERISA: Another such marker is the overbreadth of the BIC Exemption when compared with an exception that Congress enacted to the prohibited transactions provisions. 26 U.S.C. § 4975(d)(17) exempts from “prohibition” transactions involving certain “eligible investment advice arrangements” for individually directed accounts. 26 U.S.C. § 4975(e)(3)(B); 26 U.S.C. § 4975(f)(8)(A), (B). Moreover, in describing the transactions not prohibited by Section 4975(d)(17), Congress distinguished two activities: “the provision of investment advice” and “the . . . sale of a security . . . .” 26 U.S.C. § 4975(d)(17)(A)(i), (ii). Congress further distinguished the “direct or indirect receipt of fees” “in connection with the . . . advice” from fees “in connection with the . . . sale of a security . . . .” 20 U.S.C. § 4975(d)(17)(A)(iii). That Congress distinguished sales from the provision of investment advice is consistent with this opinion’s interpretation of the statutory term, “render investment advice for a fee,” 29 U.S.C. § 1002(21)(A)(ii), and inconsistent with DOL’s conflating sales pitches and investment advice. Perhaps “ ven more remarkable,” said the Court, the “DOL had to exclude Congress’s nuanced § 4975(d)(17) exemption from the BICE exemption’s onerous provisions.” This was critical because “ ut for this exclusion, the BIC Exemption would have brazenly overruled Congress’s careful striking of a balance in the regulation of ‘prohibited transactions’ concerning certain self-directed IRA plans.” The Court concluded: “When Congress has acted with a scalpel, it is not for the agency to wield a cudgel.” Most significantly, the Court found that the BIC Exemption exploited the “DOL’s narrow exemptive power in order to ‘cure’ the Rule’s overbroad interpretation of the ‘investment advice fiduciary’ provision.” The Court noted that the “DOL admitted that without the BIC Exemptions, the Rule’s overbreadth could have “serious adverse unintended consequences.” “That a cure was needed,” said the Court, “should have alerted that it had taken a wrong interpretive turn.” (Citation omitted.) The Court concluded that “ ecause is independently indefensible, this alone dooms the entire Rule.” In dissent, Chief Judge Carl Stewart concluded that “the DOL acted well within the confines set by Congress in implementing the challenged regulatory package, and said package should be maintained so long as the agency’s interpretation is reasonable.” “DOL has acted within its delegated authority to regulate financial service providers in the retirement investment industry — which it has done since ERISA was enacted — and has utilized its broad exemption authority to create conditional exemptions on new investment-advice fiduciaries,” Stewart wrote. “That the DOL has extended its regulatory reach to cover more investment-advice fiduciaries and to impose additional conditions on conflicted transactions neither requires nor lends to the panel majority’s conclusion that it has acted contrary to Congress’ directive.” Micah Hauptman said that the “case was wrongly decided. The industry opponents went forum shopping and finally found a court that was willing to buy into their bogus arguments. This is a sad day for retirement savers.” The opinion, Hauptman added, “is extreme by any measure. It strikes at the essence of the DOL’s authority to protect retirement savers under ERISA. It’s not only an attack on the rule, it’s an attack on the agency.” A spokesman for the DOL said, “Pending further review , the department will not be enforcing the fiduciary rule.” Chamber="Chamber" Commerce="Commerce" the="the" United="United" States="States" America,="America," et="et" al.="al." v.="v." Department="Department" Labor, ="Labor," al. ,="al.," No.="No." 17-10238="17-10238" (5th="(5th" Cir.="Cir." Mar.="Mar." 15,="15," 2018),="2018)," can="can" be="be" found="found" here .=">here."> What’s Next? The Fiduciary Rule may not be dead . . . at least as of now. The DOL can seek an en banc review or it can seek certiorari from the United States Supreme Court. As noted, the Tenth Circuit upheld the Rule, although on a much narrower question than the broader one resolved by the Fifth Circuit.  Also, the Court of Appeals for the D.C. Circuit is slated to hear an appeal involving the Rule. That court is not bound by either circuit court ruling. With a split among the circuits, the Supreme Court may grant a petition for certiorari. Supreme Court review may also occur because the Fifth Circuit decision materially curtails the ability of the DOL to regulate through its rulemaking authority. Letting the Fifth Circuit’s decision stand could impact the DOL’s ability to promulgate rules going forward. Review by the high court will clarify the scope of the DOL’s ERISA rule-making authority. Additionally, the Securities and Exchange Commission (“SEC”) has been considering and working on its own fiduciary rule, which the SEC may release over the next 12 months. Many experts believe that the SEC rule would likely supersede the Fiduciary Rule in some areas and achieve many of the same outcomes that were envisioned by the DOL when it created the Rule. Further, Congress may wait to legislate the end of the Rule now that the Fifth Circuit has acted. In the proposed Choice Act 2.0, House Republicans have sought to end the Fiduciary Rule.  (For a discussion of congressional action, see here .) Finally, there is activity on the state level that is likely to continue. Over the past few years, the states have been proposing their own fiduciary rules for financial advisors. This trend could continue and even be accelerated now that the federal rule has been vacated in toto . Stay tuned for more updates on the Rule as they develop.

According to a new report by Cornerstone Research (“Cornerstone”), titled Securities Class Action Settlements—2017 Review and Analysis (the “Report”) ( here ), total settlement dollars from securities class action lawsuits declined “dramatically” in 2017, even as the number of settlements remained relatively steady. Cornerstone’s March 14, 2018 press release about the Report can be found here . In 2017, the total value of court-approved securities class action settlements was $1.5 billion, a substantial decline from the $6.1 billion tallied in 2016. According to the Report, the $1.5 billion in total value is the second-lowest since 2008. There were 81 court-approved securities fraud class action settlements in 2017, down slightly from 85 settlements in 2016. The average settlement value, however, decreased 75 percent from $72.0 million in 2016 to $18.2 million in 2017. This decrease represents a 70% decline from the 1996-2016 average of $57.7 million. According to the Report, for the first time in more than five years, no settlement exceeded $250 million. The Report found that the median settlement amount in 2017 was $5.0 million, over 40 percent lower than both the 2016 median ($8.7 million) and the median for all prior post-Reform Act settlements ($8.5 million). “More than half of 2017 settlements were for $5 million or less. We also saw a significant decline in mid-range to large settlements,” said Dr. Laura E. Simmons, a co-author of the Report and a Cornerstone Research senior advisor. “A combination of lower estimates of the proxy for plaintiff-style damages and smaller issuer defendant firms contributed to this decrease.” The authors of the Report “largely” attributed the decline in settlement value to the size of the cases – they are smaller than in previous years (as measured by Cornerstone’s own estimate of the plaintiff-style damages in the filed cases) – a combination of market volatility and shorter class periods, and “considerably smaller issuer defendants.” Also affecting settlement value was the decline in institutional representation. According to the Report, institutional investors served less frequently as lead plaintiffs, even in large cases.  The authors found that public pension funds served as lead plaintiffs in 32 percent of settled cases in 2017, compared to 41 percent in 2016 and 46 percent in 2012. Recent literature, they said, provided a possible explanation for the decline in institutional representation: there were fewer economic incentives for them, “other than the potential benefit … from political contributions by plaintiff attorneys.” In 2017, there were only four settlements valued at $100 million or more, amounting to 43 percent of total settlement dollars during the year. By contrast, during the period 2008–2016, 70 percent of total settlement dollars were attributable to settlements of over $100 million. Compared to the four settlements over $100 million in 2017, there were ten settlements over $100 million in 2016. “These data suggest that plaintiff counsel have recently been going after smaller fry claims where the issuers are not as large and there is less at stake. The mega-cases involving large firms appear to be in the rearview mirror for the moment,” observed Professor Joseph A. Grundfest of Stanford Law School, and a former Commissioner of the Securities and Exchange Commission. The Report found that the proportion of shareholder derivative actions accompanying settled securities class actions “was among the highest … in more than 15 years.” The Report noted that nearly one-half of all settled cases, and more than one-half of all settlements valued at $5 million or less, were accompanied by a shareholder derivative lawsuit. The authors explained that these results were “unexpected” since shareholder derivative actions are most often associated with “larger class actions and larger settlement amounts.” Not only were the settlement amounts smaller in 2017, but the cases also tended to settle more quickly than in the past. The Report found that 23 percent of the cases that settled in 2017 were resolved within the first two years of filing, compared to less than 16 percent during the period 2008-2016. The Report found that the average time to settlement from filing during 2017 was at its lowest level in ten years. The authors noted that the median settlement involving cases taking more than two years was more than double the median for cases that settled within two years. Moreover, the proportion of settled cases alleging violations of Generally Accepted Accounting Principles was 53 percent in 2017, continuing a three-year decline from a high of 67 percent in 2014. Of the accounting cases settling in the preceding nine years, 23 percent involved named auditor co-defendants. In 2017, this dropped to 13 percent. Finally, approximately 20 percent of the cases that settled in 2017 involved an accompanying enforcement action by the Securities and Exchange Commission (“SEC”), a modest increase over the percentage recorded in 2016 (18 percent). The authors noted that “ ompared to 2011-2014, the relatively high level of class actions settled over the last three years with corresponding SEC actions is consistent with the SEC’s stated focus on financial reporting and disclosure matters during this period.” Cases with corresponding SEC actions tended to involve larger issuer defendants. For approved settlements during the period 2008-2017, the average assets for issuer defendant firms were $135 billion for cases with corresponding SEC actions, compared to only $31 billion for cases without a corresponding SEC enforcement action. The Report also noted that corresponding SEC actions are “frequently associated with delisted firms.” Out of the total 159 settlements during 2008-2017 involving cases with corresponding SEC actions, 63 cases (40 percent) involved issuer defendants that had been delisted. Looking forward, the authors opined that the number of cases filed in the prior two years suggested that “the high volume of settlements continue.” However, the data also suggested that with the higher number of filings there may be a higher number of dismissals, which could offset the increase in settlement activity. The authors also noted that the continued reduction of institutional investor involvement in securities class actions could translate into lower overall settlement values in the foreseeable future.

“Timing is everything”, it is often said.  A fine illustration of this often-uttered phrase can be found in Reverend C.T. Walker Housing Dev. Fund Corp. v. City of New York (E.D.N.Y. March 5, 2018), an appeal from the United States Bankruptcy Court for the Eastern District of New York. The Reverend C.T. Walker Housing Dev. Fund Corp. (“Walker”) owned property on 135 th Street in New York City (the “Property”).  The New York City Department of Housing Preservation and Development (“HPD”) agreed to fund the development of the Property, but the funding was conditioned on certain restrictive covenants that required Walker to use the Property for low-income, rent-stabilized housing for twenty years.  The financial success of the development would have been greatly enhanced by certain property tax exemptions offered by the City.  Unfortunately, the exemption expired before Walker filed its petition to receive same.  Accordingly, Walker fell behind in its property tax payments and the resulting tax lien certificates were sold to Bank of New York Mellon (“BONY”).  BONY assigned its rights to two trusts. The trusts initiated state court foreclosure proceedings in which a judgment of foreclosure and sale was issued and a foreclosure sale was held.  The Property was knocked down to the highest bidder at the sale and a $1.15 million deposit was delivered to the foreclosure sale referee.  The winning bid was assigned to 181 West 135 th LLC (“West”).  The closing of the sale was adjourned twice at West’s request because it was having difficulty obtaining title insurance, but a third request for an adjournment was denied. West filed for bankruptcy protection one day prior to the scheduled closing and the closing was postponed due to the automatic stay.  The trusts, Walker and the City moved to lift the automatic stay imposed by West’s bankruptcy filing. Thereafter, Walker filed its own bankruptcy petition in which it moved the bankruptcy court for an order permitting a sale of the Property to West for $9 million. The bankruptcy court denied Walker’s motion to sell the Property, holding that, under New York law, the Property was not part of the estate because the foreclosure sale extinguished Walker’s equity of redemption prior to the filing of Walker’s bankruptcy petition.  The bankruptcy court did, however grant relief from the automatic stay in the West bankruptcy because, inter alia , West had no equity in the $1.15 million bid deposit because it failed to close on the Property.  Walker appealed to the United States District Court for the Eastern District of New York. The District Court affirmed the bankruptcy court’s order.  In addressing that portion of the appeal relating to the sale of the Property, the Court found that the Property was not property of the estate under 11 U.S.C. §541 and, therefore, a sale could not be ordered under §363 in Walker’s bankruptcy proceeding.  The Court relying on In re Rodgers , 333 F.3d 64 (2003), in which the Second Circuit, applying New York law, found that the subject “property did not become part of the debtor’s bankruptcy estate when it was subject to a tax lien foreclosure auction before the bankruptcy petition was filed.” For a variety of reasons, the Walker court found that, at the time it filed its petition, Walker “had no cognizable legal or equitable interests in the Property” and, therefore, the Property was not part of Walker’s bankruptcy estate.  (Internal quotation marks omitted.)  First, the judgment of foreclosure and sale (the “JF&S”) extinguished any interest Walker had in the Property.  Second, assuming that the JF&S left Walker with an equity of redemption, same was cut-off by the foreclosure sale.  Section 1194 of the Real Property Tax Law permits the owner of a tax lien to “foreclose the lien as in an action to foreclose a mortgage”.  “In such an action, the equity of redemption allows property owners to redeem their property by tendering the full sum at any point before the property is actually sold at a foreclosure sale.”   (Citation and internal quotation marks omitted; emphasis supplied by the Walker court.)  The court further recognized that, under New York law, it is the foreclosure sale, and not the delivery of the deed to the sale purchaser, that operates to extinguish the equity of redemption. The Court also found that the stay was properly lifted in the West bankruptcy.  Pursuant to 11 U.S.C. §362(d)(2) , after notice and a hearing, the stay can be lifted if the debtor has no equity in the property and the property is not necessary for an effective reorganization.  The Court found that West “abandoned all equity in the roperty by failing to close the sale. And because…West is left with only the bid deposit as an asset, there is no reorganization necessary.” TAKEAWAY Frequently bankruptcy actions are filed immediately before a foreclosure sale so that the sale will be stayed.  Once the referee at the sale says “going, going, gone” and knocks down the property to the highest bidder, the foreclosed prior owner no longer has rights to the property itself and cannot generally unwind the foreclosure sale by filing a bankruptcy petition.

Recently, Credit Suisse (the "Bank"), the multinational financial services holding company based in Switzerland, was hit with two  class action lawsuits , one from investors over the Bank's writedown of more than $1 billion and the other from U.S.-based brokers who refused or were unable to move to Wells Fargo & Co. ("Wells Fargo") after their private banking unit was closed in 2015 .   Both lawsuits come at a time when the Bank has been in the news for legal challenges and inquiries linked to it or former employees. Credit Suisse Writedowns The investor class action lawsuit was brought by the City of Birmingham Firemen’s and Policemen’s Supplemental Pension System (“Birmingham”) on behalf of all persons or entities that purchased or otherwise acquired Credit Suisse's American Depositary Receipts (“ADRs”) on the New York Stock Exchange (“NYSE”) between March 20, 2015, and February 3, 2016 (the “Class Period”). Birmingham seeks relief under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et. seq. The Complaint alleges that, throughout the Class Period, Credit Suisse and certain of its officers ("Defendants") made false and/or misleading statements, as well as failed to disclose material adverse facts about the Company's business, operations, and risk controls.  In particular, Birmingham maintains that Defendants made false and/or misleading statements and/or failed to disclose that: (1) Credit Suisse's risk protocols and control systems were routinely disregarded; (2) the Company was accumulating billions of dollars of risky, highly illiquid securities in violation of those risk protocols; and (3) as a result of the foregoing, Defendants' statements about Credit Suisse's business, operations, and risk controls were false and misleading and/or lacked a reasonable basis. According to Birmingham, throughout the Class Period, Defendants represented in SEC filings that Credit Suisse maintained “comprehensive risk management processes and sophisticated control systems” – a notable component of such systems was the Bank’s high-level Capital Allocation and Risk Management Committee (“CARMC”) – which established and allocated appropriate trading and risk limits for the Bank’s various businesses.  Birmingham alleges that Credit Suisse’s trading and risk limits routinely increased to allow the Bank to accumulate billions of dollars in extremely risky, highly illiquid investments. According to the complaint, the Bank “surreptitiously accumulate nearly $3 billion in distressed debt and U.S. collateralized loan obligations (“CLOs”), which were … difficult to liquidate and required significant capital investments.”  This investment position, says Birmingham, was undisclosed, "violated Credit Suisse’s represented risk protocols and rendered the Bank highly susceptible to losses when credit markets contracted.” On February 4, 2016, Credit Suisse announced its fourth quarter and year-end financial results, which included a $633 million writedown from the sale of the Bank’s illiquid distressed debt and CLO positions. That amount, says Birmingham, “swell to nearly $1 billion in the ensuing weeks.” The complaint notes that Defendant Tidjane Thiam, Credit Suisse’s recently-appointed CEO, “admitted that these risky and outsized investments were only allowed because trading limits were continuously raised, which enabled traders to take larger positions in violation of the Bank’s risk policies. The complaint notes that market analysts and former Credit Suisse insiders were “incredulous that the position went unreported,” and doubted that the bank’s senior executives did not know about the illiquid positions sooner. Some said it was “inconceivable” that the CARMC was unaware of the holdings. Birmingham alleges that as a result of the announcement, the price of the Bank’s ADRs declined from a close of $16.69 on February 3, 2016, to a close of $14.89 on February 4, 2016—an 11% drop that "wiped out" approximately $230 million in market capitalization. Credit Suisse said in a recent statement that “the claim is unfounded and without merit.” “In the last three years, Credit Suisse has analyzed these allegations and responded to information requests from supervisory bodies.  All regulatory reviews were closed without any action against Credit Suisse,” the Bank said. The shareholder class action is not the only legal challenge facing the Bank. As noted, former U.S.-based brokers have accused the Bank of withholding up to $300 million of deferred compensation after their private banking unit was shuttered in 2015. The Broker Class Action In a class action complaint filed last month in the United States District Court for the Northern District of California, Christopher Laver (“Laver”), a former Credit Suisse Securities broker of 13 years who joined UBS Financial Services in 2015, alleges that the Bank intentionally entered into a recruiting transaction with Wells Fargo rather than a sale to avoid triggering a change-of-control provision in brokers’ employment agreements that would have accelerated deferred compensation payments. Brokers who joined Wells Fargo collected their deferred shares. Wells Fargo is not a named defendant and was not accused of wrongdoing. Laver also alleges that many brokers turned down offers from Wells Fargo out of concern over its ability to serve their customers.  In that regard, Laver maintains that Credit Suisse knew many brokers would not join Wells Fargo because its business and client base was different but entered the recruiting deal because a sale of the unit would have constituted a “change of control” requiring the payments. “Wells Fargo was incapable of and/or ill-suited to handle certain significant portions of Credit Suisse advisers’ business, and Wells Fargo maintained a different type of client base than Credit Suisse advisers,” the complaint says. “At the time it entered into the ‘recruiting agreement’ with Wells Fargo, Credit Suisse knew and expected that many of the Credit Suisse financial advisers would not and/or could not work for Wells Fargo.” The class-action lawsuit supplements dozens of arbitration proceedings that former Credit Suisse brokers commenced to collect back pay and to avoid repaying balances on promissory notes that the Bank is demanding. Credit Suisse has maintained that it can keep the deferred compensation, which the complaint says may be as much as $300 million because the brokers “resigned” rather than joined Wells Fargo. “Credit Suisse should not be able to avoid its obligation to compensate the advisers fully and fairly by claiming they ‘resigned’ when, in fact, Credit Suisse simply ceased operating this business,” the complaint says. Karina Byrne, a Credit Suisse spokeswoman, said that if the brokers had accepted Wells Fargo’s offers they would have received all their deferred compensation. She also disputed the allegation that a change of control would have triggered accelerated awards of the deferred shares. “Those who chose not to accept those offers had negotiated equally or more lucrative compensation packages from competing institutions that also covered the same contingent deferred compensation at issue here, consistent with standard industry practice,” she wrote in an e-mail. “Simply put, the plaintiff here is looking to be paid the same money twice.” The class-action lawsuit was filed on behalf of brokers with unvested compensation awards who were effectively “terminated” between October 20, 2015, and March 31, 2016, because their “private bank” went out of business. Laver seeks unspecified damages for roughly 200 brokers.

Ameriprise Settles with The SEC for Overcharging Retirement Account Customers for Mutual Fund Shares On February 28, 2018, just a few weeks after launching its Share Class Selection Disclosure Initiative (discussed below), the Securities and Exchange Commission (“SEC”) announced ( here ) that Ameriprise Financial Services Inc. (“Ameriprise”), the Minnesota-based broker-dealer and investment adviser, agreed to settle charges for recommending and selling higher-fee mutual fund shares to retirement account customers and for failing to provide sales charge waivers. According to the SEC, Ameriprise disadvantaged certain retirement customers by failing to ascertain their eligibility for less expensive mutual fund share classes. As set forth in the SEC’s order ( here ), Ameriprise recommended and sold retirement customers more expensive mutual fund share classes when less expensive share classes were available. Ameriprise also failed to disclose that it would receive greater compensation from the purchases and that the purchases would negatively impact the overall return on the customers’ investments. The SEC said that approximately 1,791 customer accounts paid a total of $1,778,592.31 in unnecessary up-front sales charges, contingent deferred sales charges, and higher ongoing fees and expenses (also known as 12b-1 fees) as a result of Ameriprise’s practices. “Ameriprise generated greater revenue for itself but lower returns for its retirement account customers by recommending higher-fee share classes,” said Anthony S. Kelly, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “As evidenced by our recently announced Share Class Selection Disclosure Initiative, pursuing these types of actions remains a priority for the Division as we seek to get money back in the hands of harmed investors.” As noted in the announcement, Ameriprise cooperated with the SEC and voluntarily identified the affected accounts, issued payments including interest to the affected customers, and converted eligible customers to the mutual fund share class with the lowest expenses for which they are eligible, at no cost. The SEC’s order instituting a settled administrative and cease-and-desist proceeding finds that Ameriprise violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933. Without admitting or denying the findings, Ameriprise consented to the cease-and-desist order, a censure, and a $230,000 civil penalty. The Share Class Selection Disclosure Initiative Conflicts of interest can arise in the sale of mutual funds that offer different share classes and fee structures. Because each share of a mutual fund represents an interest in the same portfolio of securities regardless of the share class, to the extent that multiple share classes are available to an investor, it is in the investor’s best interest to purchase the share class with the lowest fees. By contrast, an adviser, its affiliates, and/or its associated persons has a financial incentive to recommend the share class that results in the client paying higher fees. To the extent a conflict exists, it must be fully disclosed by the adviser so that its clients have the information necessary to make an informed investment decision. The SEC created the Share Class Selection Disclosure Initiative (“SCSD Initiative”) to address the foregoing (e.g., undisclosed conflicts of interest). ( Here. ) The SEC Asset Management Unit is leading the SCSD. Under the SCSD Initiative, the SEC will not recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to mutual fund share class selection issues and promptly return money to harmed clients. The SEC has been focused on the conflicts of interest associated with mutual fund share class selection for a long period of time. In the past several years, the SEC has charged nine firms with failing to disclose such conflicts of interest. These actions have resulted in the imposition of significant penalties against the advisers and the return of millions of dollars to the affected clients. In addition, the SEC’s Office of Compliance Inspections and Examinations has repeatedly cautioned investment advisers and other market participants to examine their share class selection policies and procedures and disclosure practices. “This focused initiative reflects our effort to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors,” said Stephanie Avakian, Co-Director of the Division of Enforcement. “The legal and regulatory requirements in this area are clear, and the Commission will continue to pursue securities violations associated with mutual fund share class selection disclosure failures. We strongly encourage advisers to take advantage of the favorable terms we are offering; these terms will not be available to advisers who do not self-report under this initiative, and we will continue to proactively seek to identify and pursue investment advisers that fail to make the necessary disclosures,” said Steven Peikin, Co-Director of the Division of Enforcement. In addition to requiring the adviser to disgorge its ill-gotten gains and pay those amounts to affected clients, under the SCSD Initiative, the SEC will recommend favorable settlement terms to advisers that self-report their failure to disclose conflicts of interest associated with the recommendation to purchase a higher-cost mutual fund share class when a lower-cost share class of the same mutual fund is available for advisory clients. The SEC has warned, however, that it will impose stronger sanctions against advisers that fail to take advantage of the SCSD Initiative. “Proper disclosure of conflicts of interest is of utmost importance, and a necessity for any investment adviser to ensure that it is satisfying its obligations as a fiduciary to its clients,” said C. Dabney O’Riordan, Co-Chief of the Asset Management Unit in the Division of Enforcement. “This initiative is designed to promote compliance with these obligations with respect to mutual fund share class selection, while at the same time quickly returning money to harmed clients.” The SCSD Initiative was explained in a detailed announcement issued by the SEC’s Enforcement Division on February 12, 2018 ( here ). The deadline for investment advisers to avail themselves of the SCSD Initiative is June 12, 2018.

On February 23, 2018, the U.S. Supreme Court set oral argument in Lucia v. SEC , 17-130, a case involving the use of administrative law judges (“ALJ”) by the Securities and Exchange Commission (“SEC” or the “Commission”) as hearing officers in administrative proceedings. The issue presented to the Court concerns whether the use of ALJs violates the constitutional limitations of the Appointments Clause on “Officers of the United States” ( here ).  U.S. Const., art. II, § 2, cl. 2.  Resolution of the issue is important because there is a conflict among the circuits over the meaning of the Appointments Clause and the interpretation of the Court’s precedents addressing that provision ( e.g. ,  Freytag v. Comm’r , 501 U.S. 868, 881-82 (1991) (holding that non-Article III adjudicators, such as ALJs, who exercise discretionary powers are Officers of the United States who must be appointed pursuant to the Appointments Clause). Lucia v. SEC Background The case arose from an administrative proceeding brought by the SEC against Raymond J. Lucia and his investment company (collectively, “Lucia”).  Lucia marketed a wealth-management strategy, which they called “Buckets of Money,” under which retirement savings were divided among assets of different risk levels ( e.g. , bonds, fixed annuities, and stocks) and periodically reallocated as those assets changed in value.  The Commission instituted administrative proceedings against Lucia based on allegations that they had used misleading slideshow presentations to deceive prospective clients about how the Buckets of Money strategy would have performed under historical market conditions. The Commission charged Lucia with violating the Securities Exchange Act of 1934, the Investment Advisers Act of 1940 (“IAA”), and the Investment Company Act of 1940. An ALJ conducted the initial stages of the proceeding. During a nine-day hearing, the ALJ presided over witness testimony and cross-examinations, admitted documentary evidence, and ruled on objections.  After the hearing, the ALJ issued an initial decision finding that Lucia had made fraudulent misrepresentations related to one of their investment strategies.  After the Commission directed the ALJ to make additional factual findings with respect to other alleged misrepresentations, the ALJ issued a revised initial decision finding that Lucia had willfully and materially misled investors, in violation of the IAA. The ALJ ordered a variety of sanctions to be imposed on Lucia, including revocation of his registration as an investment adviser; a permanent bar on associating with investment advisers, brokers, or dealers; a cease-and-desist injunction against future violations; and $300,000 in civil penalties. Lucia appealed. On appeal, the Commission conducted “an independent review of the record, except with respect to those findings not challenged on appeal.”  Exchange Act Release No. 73,857, at 3, 2015 WL 5172953 (SEC Sept. 3, 2015) ( here ). The Commission determined that the ALJ had correctly found that Lucia had willfully made fraudulent statements and omissions in violation of the IAA. The Commission also largely “affirm ,” with limited exceptions, “the sanctions imposed” by the ALJ. Two Commissioners dissented with respect to one aspect of the Commission’s liability determination. Lucia argued before the Commission that the proceeding against him was unlawful because the ALJ who had conducted the hearing and issued the initial decision was an “Officer[ ] of the United States” within the meaning of the Appointments Clause. Id . at 28. As such, the ALJ had not been appointed, in accordance with that provision, “by the President, the head of a department, or a court of law.” Id . at 29. The Commission rejected Lucia’s argument. In the Commission’s view, its ALJs were mere employees rather than constitutional officers because they do not exercise “significant authority independent of the supervision.” Id. Among other things, the Commission explained, its ALJs “issue ‘initial decisions’ that are … not final”; a person aggrieved by an initial decision may seek review before the Commission, which “grant virtually all petitions for review”; the Commission may review any ALJ decision sua sponte ; review of an ALJ’s decision is de novo ; and under the Commission’s rules, “no initial decision becomes final simply on the lapse of time by operation of law,” but instead becomes final only upon “the Commission’s issuance of a finality order.” Id . at 30 (citation and internal quotation marks omitted). The Commission also distinguished the  Freytag decision, finding that “ Freytag inapposite here.” Id . at 32. On appeal of the Commission’s order, a panel of the Court of Appeals for the D.C. Circuit denied the petition for review. Lucia v. SEC , 832 F.3d 277 (D.C. Cir. 2016). The court rejected Lucia’s Appointments Clause challenge, holding that the Commission’s ALJs are mere employees rather than officers under the Constitution because they do not exercise “significant authority pursuant to the laws of the United States.” Id . at 284. For that conclusion, the court relied on its prior decision in Landry v. FDIC , 204 F.3d 1125, 1133-1134 (D.C. Cir.), cert. denied , 531 U.S. 924 (2000).  In Landry , the court held that the ALJs used by the Federal Deposit Insurance Corporation (“FDIC”) were not officers of the United States because they could not issue final decisions on behalf of the agency – i.e. , they could not exercise significant authority to bind third parties, or the government itself, for the public benefit. Id . at 1333; see also Lucia , 832 F.3d at 285. The Lucia court determined that an SEC ALJ’s initial decision is similarly non-final, and it rejected Lucia’s attempts to distinguish Landry . Lucia , 832 F.3d at 285. The court also rejected Lucia’s argument that the SEC’s ALJs “exercise greater authority than FDIC ALJs in view of differences in the scope of review of the ALJ’s decisions.” Id . at 288. The court acknowledged that “the Commission may sometimes defer to the credibility determinations of its ALJs,” but it concluded that “the Commission’s scope of review is no more deferential than that of the FDIC Board.” Id . The court further rejected Lucia’s attempt to equate the SEC’s ALJs with the special trial judges of the Tax Court who were held to be officers in Freytag . In the court’s view, the special trial judges were distinguishable because, as “members of an Article I court,” they “could exercise the judicial power of the United States” and “issue final decisions in at least some cases.” Id . at 284-85.  The court also found special trial judges to be different than SEC ALJs because “the Tax Court in Freytag was required to defer to the special trial judge’s factual and credibility findings unless they were clearly erroneous.” Id . at 288 (citation and internal quotation marks omitted). The Commission, by contrast, “is not required to adopt the credibility determinations of an ALJ.” Id . On the merits, the court determined that substantial evidence supported the Commission’s finding that Lucia, acting with the requisite scienter, had made material misstatements and omissions in violation of the IAA. The court also concluded that the Commission had not abused its discretion in ordering sanctions against Lucia. Lucia sought rehearing en banc , which the court of appeals granted on February 16, 2017. The order granting rehearing en banc vacated the panel’s judgment but not its opinion. The court directed the parties to limit their briefs to two issues: (1) whether “the SEC administrative law judge who handled this case an inferior officer rather than an employee for the purposes of the Appointments Clause”; and (2) whether the court should “overrule Landry.” On June 26, 2017, an equally divided  en banc court issued a per curiam judgment denying the petition for review. Appeals Courts are Split on Administrative Proceedings Since the original opinion of the three-member panel of the D.C. Circuit remains controlling, it is at odds with the ruling of the Tenth Circuit, which expressly disagreed with that decision. In Bandimere v. SEC , 844 F.3d 1168, 1170 (10th Cir. 2016), the court ruled that SEC ALJs are Officers of the United States within the meaning of the Appointments Clause. In Bandimere , an ALJ issued an initial decision finding that the respondent had violated antifraud and registration provisions of the federal securities laws by operating as an unregistered broker and by failing to disclose potentially negative facts to investors. In re David F. Bandimere , Securities Act Release No. 9972, 2015 WL 6575665, at *1 (Oct. 29, 2015). On review of the ALJ’s initial decision, the Commission upheld the liability finding and imposed disgorgement and civil-penalty sanctions. Id . at *2. The Commission also rejected the respondent’s argument that its ALJs are officers under the Appointments Clause. Id . at *19-*21. The Tenth Circuit granted the respondent’s petition for review, holding that the Commission’s ALJs are invested with powers that require their appointment as inferior officers under the Appointments Clause. Bandimere , 844 F.3d at 1179-1182. In reaching that conclusion, the court relied on Freytag , which it interpreted as turning on the significance of the special trial judges’ duties, not on their authority to render final decisions of the Tax Court. Id . at 1182-1185; see also id . at 1179.  The Tenth Circuit expressly “disagree ” with the D.C. Circuit’s decisions in Landry and Lucia , which, the court determined, had “place undue weight on final decision-making authority.” Id . at 1182. Judge Monroe G. McKay dissented, arguing that Freytag does not “mandate[ ] the result proposed here.”  Bandimere , 844 F.3d at 1194. Like the panel in Lucia , Judge McKay distinguished the special trial judges at issue in Freytag because of their authority to enter final decisions in a number of cases and because “the Tax Court was required to defer to its special trial judges’ findings.” Id . at 1197. Judge McKay emphasized that the Commission’s ALJs, by contrast, “possess only a ‘purely recommendatory power.’” Id . (quoting Landry , 204 F.3d at 1132). In May 2017, the Tenth Circuit denied the Commission’s petition for rehearing en banc , with two judges dissenting. See Bandimere v. SEC , 855 F.3d 1128, 1128-1133 (10th Cir. 2017).  On September 29, 2017, the government filed a petition for a writ of certiorari urging the Court to resolve the question whether the Commission’s ALJs are inferior officers rather than employees. SEC v. Bandimere , No. 17-475.  But the government explained that Lucia , rather than Bandimere , presented the Court with the preferable vehicle for addressing the question. The government accordingly “request that the Court hold th petition” in Bandimere “pending its consideration of the petition” in Lucia . On July 21, 2017, Lucia filed his petition for a writ of certiorari. The Court granted the petition on January 12, 2018. As the docket shows, numerous amici filed briefs in connection with the petition. ( Here .) The Takeaway Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Commission has increased both the number and proportion of enforcement actions brought in administrative hearings before its ALJs. There are more than 100 cases currently under review by SEC ALJs, as well as a dozen on appeal in the federal courts. Given the foregoing, it is clear that the fact-finding and credibility determinations of the SEC’s ALJs are important to its ability to enforce the federal securities law. Congress created the ALJ position pursuant to the Administrative Procedure Act ("APA") (Pub. L. No. 79-404, 60 Stat. 237 (1946), codified at 5 U.S.C. §§ 551-559).  In doing so, Congress sought a mechanism by which federal agencies could provide for due process in administrative adjudications. Since the enactment of the APA, numerous federal agencies use ALJs in adjudicating administrative proceedings ( e.g. , the Commodities Futures Trading Commission, Federal Energy Regulatory Commission, the FDIC, the Consumer Finance Protection Bureau, National Labor Relations Board, the Environmental Protection Agency, and the Social Security Administration). Therefore, the decision by the Court will impact administrative proceedings beyond those conducted by SEC ALJs. This Blog will be following the case as developments occur. Stay tuned for additional posts.

The parties in Stravroulakis v. Pelakanos , 58 Misc.3d 1221(A) (Sup. Ct. N.Y. Co. Feb. 13, 2018), are the owners of Bareburger.  The majority owners attempted to oust a shareholder by improper means and the court thought otherwise. The oversimplified facts of Stravroulakis are as follows.  Plaintiff and some of his buddies (the “Owners”) owned a dive bar in Brooklyn called Sputnik, in which they started to sell organic hamburgers.  The hamburgers became so popular that the Owners, with the help of some investors (collectively, the “Founders”), decided to form a corporation to own the first “Bareburger” restaurant.  A few of the “buddies” worked at the restaurant and drew salaries while the remainder of the shareholders, who had full time jobs, did not. The first restaurant was so successful that the Founders decided to franchise Bareburger and formed Bareburger, Inc. (the “Company”) for that purpose.  Each of the six Founders invested $6,000 and received 16.666% of the Company.  The Company received its Bareburger trademark from the PTO in 2010. The Founders and some additional investors formed another corporation and entered into a franchise agreement with the Company to own a second Bareburger restaurant.  Prior thereto, however, all of the Founders (with the exception of plaintiff) (the “Shareholder Defendants”) began discussing terminating plaintiff’s interest in the Company (but not the two restaurants in which he had an ownership interest) because he was not working for the Company (as he was a passive investor that had no obligation to work – as the court pointed out many times throughout the Stravroulakis decision).  In this regard, in a letter from one Founder to the remaining Shareholder Defendants, it was written, among other things: …After repeated attempts to work and motivate we have not seen the results expected by this company.  As per our conversation with him, he was granted a probationary period that has now lapsed.  At this time, I propose we terminate our good friend but inattentive partner …. (Emphasis added by court.) Similarly, meeting minutes reflect that the Shareholder Defendants discussed the hours they worked while plaintiff was absent and the fact that the “money invested is minimal compared to the amount of labor and time involved….”  According to the minutes: ptions discussed include (1) removing (2) giving back the $6,000 invested plus interest (3) start over with those willing to do the work required.   Members/shareholders agree that they will either remove or take other measures to the same effect.  should receive fair value for the amount he contributed.  Any interests has in the actual physical restaurant will not be affected.  (Emphasis supplied by court; footnote omitted.) Thereafter, and after some internal disputes as to how to deal with plaintiff, the five Shareholder Defendants formed Bareburger Group (“Group”) and each received a 20% interest in same.  Eventually, all the Company’s assets (the right to royalties under the franchise agreements, cash and the Bareburger trademarks) were transferred, without plaintiff’s knowledge, to Group without consideration.  Almost a year later, and after repeated requests for his K-1 from the Company, plaintiff was advised that the Company had no income, the Company’s assets were transferred to Group and he had no interest in Group. An assignment of the Bareburger trademark from the Company to Group was filed with the PTO indicating “that it was for good and valuable consideration no actual cash or other assets of value were paid by Bareburger Group to the Company.”) (Emphasis supplied by the court; some internal quotation marks and brackets omitted.)  On the same day, Group filed a trademark application for the word “Bareburger” based on its ownership of the “Bareburger Organic” trademark, which application contained numerous misrepresentations. In its franchise agreements, Group permitted franchisees to use the Bareburger trademarks although it was not the true owner of the trademarks and “did not have the power or authority to license their use.” Plaintiff asserted twenty causes of action in his complaint and moved for summary judgment on the following seven: breach of fiduciary duty (corporate waste and self-dealing); breach of fiduciary duty (shareholder oppression);  breach of fiduciary duty (corporate waste, self-dealing and usurpation of a corporate opportunity); trademark infringement under the Lanham Act; fraud on the trademark office; fraudulent conveyance (constructive and intentional); and, aiding and abetting breach of fiduciary duty. The court granted summary judgment to plaintiff on the breach of fiduciary duty claims. In so deciding, the court reasoned that the “business judgment rule” does not apply where the challenged “acts not further the interest of the corporation, especially when the directors have a personal stake in the corporation” and where “the board acted in bad faith, e.g., deliberately singled out an individual for harmful treatment. ”  (Emphasis added by court; some internal quotation marks and citations omitted.)  Because of the inapplicability of the “business judgment rule” to “create a presumption of legality”, the burden shifted to the interested directors or shareholders to prove their good faith and the “entire fairness” of the transaction.  Because the subject transactions were not fair to a minority shareholder in terms of “price” and “process” and because the transactions could not be ratified by the Shareholder Defendants because they were not “disinterested,” the Shareholder Defendants do not pass the “entire fairness” test. The court also found that there was corporate waste because assets were transferred without consideration.  The court also found that corporate opportunities were diverted.  This occurs when directors divert opportunities “to other companies in which neither the corporation nor its minority shareholder has an interest.”  (Citation omitted.)   The court noted that “ his doctrine is violated where, as here, a director secretly forms a new entity and transfers the corporation’s entire business to that entity.” (Citation omitted.)   The court explained: imply put, where the defendants are either conflicted or have engaged in corporate waste, they have the burden of establishing entire fairness.  Here, the Shareholder Defendants (or their wholly owned LLCs) are members of Bareburger Group, which owns Be My Burger.  Hence, the subject transfers of the Company’s assets are interested transactions.  That, in addition to the discussed evidence of waste and theft of corporate opportunities, makes entire fairness the applicable the standard of review.  (Footnote omitted.) The court found that the Shareholder Defendants did not meet their burden and, to the extent that they invoked the fairness concept by urging that plaintiff refused to work for the Company, the argument was rebuffed by the court.  In rebuking the Shareholder Defendants for justifying their subjective belief that their actions were warranted because of plaintiff’s “lack of contributions” coupled with the fact that they were not lawyers, the court stated in footnote 26: Defendants note that they are not corporate lawyers.  However, the subject transactions were done with the aid of a lawyer and accountant.  Leaving aside the court’s dismay that a lawyer could agree to help structure an illegal transaction, defendants cannot hide behind ignorance of corporate law to claim a lack of bad faith.  Their contemporaneous emails demonstrate a clear intent to steal plaintiff’s interest in the business, which recognized was problematic. The court, in recognizing that many businesses have passive investors, whose interest may be worth far more than the amount invested, stated: his is a good thing, and is an aspirational outcome in the minds of many who decide to chance their money on a fledgling business.  If investors intend to condition an equity grant on the requirement of further contribution (either labor or capital), they must expressly agree to that condition.  The majority investors may not, as here, later decide that pari passu treatment of active and passive investors is not fair.  Likewise, to the extent a majority believes a business would be better off without a problem shareholder, there is legal recourse available to them, such as a buyout or a freeze-out merger.  (Emphasis in original; citations omitted.) Summary judgment was also granted on plaintiff’s claim that one of the defendants aided and abetted the Shareholder Defendants in their respective breaches of fiduciary duty.  The elements of such a claim are: “(1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) that plaintiff suffered damage as a result of the breach.”  (Citation omitted.)  As to the first prong, the court found that the Shareholder Defendants breached their fiduciary duty to plaintiff.  The second prong requires “substantial assistance”, which exists where “(1) a defendant affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed, and (2) the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated.”  (Citations and internal quotation marks omitted.)  The court found that the aider/abettor “knowingly and intentionally” participated in the fiduciary breaches by, inter alia , helping to transfer assets, crafting audited financial statements that hid the illicit formation of Group from plaintiff, and preparing Group tax returns and operating agreements that excluded plaintiff.  Plaintiff clearly suffered damage from defendant’s actions. The court also granted summary judgment on plaintiff’s trademark infringement claim and stated: There is no question of fact that…Bareburger Group used the Trademark without authorization and without providing any consideration to the Company.  This is trademark infringement…. Indeed, the very reason why they executed the Trademark Assignment Agreement was because they recognized that Bareburger Group…needed to obtain the rights to the Trademark to validly use and license it to the franchisees.  (Citations omitted.) The court did not dismiss the infringement claim as duplicative because plaintiff may be entitled to treble damages under the Lanham Act – a quantum of damages unavailable under the other causes of action subject to the plaintiff’s summary judgment motion. The court did, however, did dismiss plaintiff’s fraudulent conveyance and fraud on the PTO causes of action to the extent that the damages in those causes of action are duplicative of the damages to which plaintiff would be entitled for the fiduciary duty breach and/or the trademark infringement claims. TAKEAWAY There are appropriate ways to excise unwanted shareholders/members from a business.  The court in Stravroulakis was not pleased with the way that defendants proceeded to remove plaintiff.

Since the summer of 2015, the Delaware Chancery Court has issued a series of rulings in which disclosure-only settlements in merger objection lawsuits have been rejected. Those rulings culminated with the decision by Chancellor Andre Bouchard in January 2016, in which he confirmed that parties submitting disclosure-only settlements to Chancery Court judges should expect enhanced scrutiny of such settlements.  In In Re Trulia, Inc. Stockholder Litigation , 129 A.3d 884 (Del. Ch. 2016) ( here ), Chancellor Bouchard rejected a proposed disclosure-only settlement of a shareholder lawsuit arising from the February 2015 acquisition of Trulia, Inc. by Zillow, Inc. In doing so, Chancellor Bouchard found that because “none of the supplemental disclosures were material or even helpful to Trulia’s stockholders,” the proposed settlement did “not afford them meaningful consideration to warrant providing a claim release.” In rejecting the settlement, Chancellor Bouchard reviewed “the dynamics that have led to the proliferation of disclosure settlements.”  “ oting the concerns that scholars, practitioners and members of the judiciary have expressed” about these settlements – they “rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with rigor” –  Chancellor Bouchard warned practitioners to expect the Court to “be increasingly vigilant in scrutinizing the ‘give’ and the ‘get’ of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.” 129 A.3d at 887. In the wake of the Chancery Courts’ hostility to disclosure-only settlements, shareholders have sought redress in other jurisdictions, namely in federal court and/or the courts in other states. But, most of those courts have not been as receptive as shareholders expected. For instance, in In Re: Walgreen Co. Stockholder Litigation , 832 F.3d 718 (7th Cir. 2016), the Seventh Circuit overturned the approval of a disclosure-only settlement, while referencing with approval Chancellor Bouchard’s opinion in Trulia . Writing for the court, Judge Richard Posner expressed skepticism about merger objection litigation and of disclosure-only settlements. Other jurisdictions have applied a less hostile approach to disclosure-only settlements. In New York, for example, the Appellate Division, First Department, reaffirmed, with some refinement, its more lenient standard for reviewing disclosure-only settlements in Gordon v. Verizon , 148 A.D.3d 146 (1st Dep’t 2017) (citing Matter of Colt Indus. Shareholder Litig ., 155 A.D.2d 154, 160 (1st Dep’t 1990), mod on other grounds , 77 N.Y.2d 185 (1991)). In Gordon , the First Department held that “a court conducting a settlement review in a putative shareholders’ class action has a responsibility to preserve the viability of those nonmonetary settlements that prove to be beneficial to both shareholders and corporations, while protecting against the problems with such settlements recognized trulia court and other courts in new york> trulia court and other courts in new york> …, in order to promote fairness to all parties.” The court identified seven factors for the trial courts to consider in reaching a determination as to whether it is appropriate to approve a disclosure-only settlement. These factors are: the likelihood of success, the extent of support from the parties, the judgment of counsel, the presence of bargaining in good faith, the nature of the issues of law and fact, whether the proposed settlement is in the best interests of the class ( i.e. , whether the supplemental disclosures provide “some benefit to the shareholders”), and whether the proposed settlement is in the best interest of the corporation. 148 A.D.3d at 156, 158-59, 161. City Trading Fund v. Nye Applying the seven Gordon factors, Justice Shirley Werner Kornreich of the Supreme Court, New York County, Commercial Division, recently rejected a proposed disclosure-only settlement of a shareholder lawsuit challenging Martin Marietta’s 2014 acquisition of Texas Industries. In a scathing opinion ( here ), Justice Kornreich rejected the proposed settlement as “utterly useless to shareholders.” City Trading Fund v. Nye , 2018 N.Y. Slip Op. 28030 (Sup. Ct. N.Y. County Feb. 8, 2018). Background The case arose from the acquisition of Texas Industries, Inc. by Martin Marietta Materials, Inc. (the “Company”). The plaintiffs, shareholders of the Company, sought to enjoin the merger on the grounds that the disclosures regarding the transaction were inadequate.  The plaintiffs alleged that the Company breached its fiduciary duties to its shareholders by making material misstatements and omissions in the definitive proxy, which was provided to shareholders for the purpose of evaluating and voting on the proposed merger. The plaintiffs moved for a preliminary injunction, and on the eve of the hearing, the parties settled the action for a “peppercorn and a fee.” “In other words, they entered into a ‘disclosure-only’ settlement that provides no monetary relief to the stockholders, but which calls for a significant payment of attorneys’ fees to plaintiffs’ counsel (here, $500,000).” The “supplemental disclosures” purportedly remedied the alleged deficiencies in the proxy statement by providing shareholders with additional information sufficient to allow them to make a more informed decision about the merger. In January 2015, Justice Kornreich rejected the plaintiff’s motion for preliminary approval of the settlement, based on, among other things, her analysis of the “immateriality” of the additional disclosures. She also noted “the public policy concerns that arise from worthless disclosure-only settlements of strike suits that seek to enjoin mergers of publicly traded corporations,” and the decisions from other courts that “have addressed worthless disclosure-only settlements.” (Citing Trulia ). The plaintiffs appealed. The First Department “reversed court’s denial of preliminary approval, remanded the case, and directed court to hold a fairness hearing to determine whether final approval of the settlement should be granted.” In reversing the court’s ruling, the First Department found that “the shareholders obtained a number of additional disclosures reflected in the supplemental proxy statement, including disclosures of additional information regarding the investment banks’ conflicts of interest and the projections upon which they relied in rendering their fairness opinions, that were arguably beneficial .” (Emphasis added.) The February 8, 2018 Opinion After discussing the choice of law, Judge Kornreich turned to the change in judicial attitudes toward disclosure-only settlements since her January 2015 ruling rejecting preliminary approval of the proposed settlement.  Describing the Trulia decision as “a thorough and compelling decision,” and “the culmination of the Chancery Court’s negative experience with such strike-suits,” Justice Kornreich noted that Delaware courts would approve disclosure-only settlements only when the supplemental disclosures were “plainly material” and the releases “narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.” Citing Trulia , 129 A.3d at 888. By “plainly material,” Justice Kornreich noted that Delaware courts leave no room for disclosures that are “‘arguably beneficial’” or “provide ‘some benefit.’” “In using the term ‘plainly material,’” the Chancellor explained that he meant “that it should not be a close call that the supplemental information is material as that term is defined under Delaware law .” Id . (emphasis added). In other words, approval requires a clear showing that the supplemental disclosures were more than “arguably beneficial” or that they may provide “some benefit.” Rather, it must be clear that the new disclosures would clearly aid shareholders in deciding whether to vote on the merger by significantly altering the “total mix” of available information. Citing Trulia , 129 A.3d at 899. In contrast to the Delaware courts, and the Fifth and Seventh Circuits, which followed the lead of Chancellor Bouchard in Trulia , the First Department adopted what Justice Kornreich described as a “more lenient approval standard” in Gordon . Though less exacting than the Delaware materiality standard, Justice Kornreich explained that Gordon’s “some benefit test” required the court “to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger.” Thus, “ f the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders.” That being said, regardless of whether Gordon’s some benefit test was intended to mirror the Delaware mootness fee standard, the only reasonable way to interpret “some benefit” is that while the plaintiff need not (as under Trulia ) rule out all doubts as to the materiality of the supplemental disclosures, the court must be able to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger. If the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders. After all, the whole point of a lawsuit challenging the sufficiency of pre-merger disclosures is to ensure that shareholders have all the information they need to make an informed vote on the merger’s wisdom. For the relief in such a suit to be beneficial, the procured new disclosures must actually be useful to the shareholders — that is, the disclosures must aid them in the decision-making process. If the disclosures reveal information that has no bearing on the wisdom of the merger — such as a disclosure of the CEO’s favorite baseball team — no one would contend such revelation makes a shred of difference to … voting shareholders. There is no benefit to such disclosure. Analyzing the supplemental disclosures against the Gordon factors, Justice Kornreich found that the disclosures were “utterly worthless — because they would not matter to any reasonable shareholder and provide no benefit to the class….” The Court noted that it was “not a close call” reaching that conclusion. After finding the settlement to be of no benefit, Justice Kornreich concluded with a policy discussion about “utterly worthless” disclosure-only settlements, such as the one before her. In that regard, she explained that such settlements were detrimental to shareholders and benefited only the lawyers who propose them. The supplemental disclosures, at best, are of the “tell me more” sort that countless courts have recognized are of little to no value, and which certainly do not substantially alter the total mix of available information. In other words, after having received the supplemental disclosures, the universe of information upon which shareholders decided whether to vote in favor of the merger did not meaningfully change …To be sure, under controlling ( i.e. , Gordon) and persuasive ( i.e. , Delaware) authority, a stockholder’s counsel deserves at least some reward if he can procure information that, while not landscape changing ( i.e. , material), is of some benefit to the stockholders. Plaintiffs’ counsel has not done so in this case. The shareholders are not better off. In fact, the shareholders are net losers here, for at least two reasons. The first, obvious reason, is the payment of counsel fees in exchange for worthless supplemental disclosures. The second, less obvious reason is that there is a cost to the shareholders if, in fact, management concealed material facts about the merger. Even though the settlement only calls for a release of disclosure violations ( i.e. , it is not a galactic release), there is no reason the shareholders should lose the right to eventually file a post-closing action alleging inadequate disclosures if, in fact, some subsequent revelation makes clear that, unlike those at issue in this case, there were material facts withheld from them. To be clear, the court has no reason to believe that is the case here. However, shareholders do not benefit from giving up the right to pursue future meritorious claims in exchange for relief from patently baseless ones. In other words, settling a baseless claim should not create immunity for a related, but currently unknown meritorious claim. Takeaway In Trulia , Chancellor Bouchard expressed “hope” that courts outside of Delaware will apply a materiality standard to the consideration of disclosure-only settlements. While the First Department in Gordon chose not to follow suit, it remains to be seen whether the other appellate courts in New York, including the Court of Appeals, will adopt the Gordon standard. Whatever happens going forward on the appellate level in New York, City Trading makes it clear that disclosure-only settlements providing no value for shareholders will face heightened judicial scrutiny, even under the “more lenient settlement approval standard” set forth in Gordon . In light of such scrutiny, “utterly worthless” disclosure-only settlements will not be tolerated. Therefore, practitioners presenting a disclosure-only settlement for approval in New York should ask: “Are the company and its shareholders better off if the court permits plaintiffs’ disclosure claims to be settled in consideration for the supplemental disclosures and a substantial attorneys’ fees award?” If “ he answer is no,” they should expect enhanced scrutiny from the reviewing judge.

On February 21, 2018, the United States Supreme Court ruled that the anti-retaliation protections passed by Congress after the 2008 financial crisis extend only to individuals who report suspected violations of the securities laws to the Securities and Exchange Commission (“SEC” or “Commission”). In Digital Realty Trust, Inc. v. Somers , 583 U.S. _____ (2018) ( here ), the Court held that individuals who blow the whistle through internal means only are precluded from the anti-retaliation protections enjoyed under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank” or the “Act”). This Blog has written about Digital Realty here , here , here and here . The Court, in an opinion authored by Justice Ruth Bader Ginsburg, resolved a circuit court split over whether individuals are required to report alleged violations of the securities laws to the SEC to qualify as a whistleblower under Dodd-Frank. The Ninth and Second Circuits held that Dodd-Frank did not limit the anti-retaliation protections of the Act to those who disclose information to the SEC only.  Digital Realty Trust, Inc. v. Somers , 850 F.3d 1045 (9th Cir. 2017); Berman v. NEO@OGILVY LLC , 801 F.3d 145 (2d Cir. 2015). Rather, the anti-retaliation provisions also protect those who were fired after making internal disclosures of alleged unlawful activity under the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley” or “SOX”) and other laws, rules, and regulations. By contrast, the Fifth Circuit, which was the first to address the issue, held that the Act’s definition of “whistleblower” applied only to those who disclose suspected wrongdoing to the SEC. Asadi v. G.E. Energy (USA), L.L.C. , 720 F.3d 620, 621 (5th Cir. 2013). The court rejected the SEC’s regulation (17 C.F.R. § 240.21F-2), which extends the anti-retaliation protections to those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC. Id . at 630. In reversing the Ninth Circuit decision, the Court held that a “plain-text reading” of Dodd-Frank controlled because the statute unequivocally limited the definition of “whistleblower” to only those individuals who provide “information relating to a violation of the securities law to the commission.” 15 U.S.C. §78u-6(a)(6). The Court held as such notwithstanding the anti-retaliation provision of Sarbanes-Oxley, which applies to all “employees” who report misconduct to the SEC, any other federal agency, or their internal supervisors. In giving Section 21F(a)(6) its plain meaning, Justice Ginsburg refused to give deference, under Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc. , 467 U. S. 837 (1984), to the SEC’s interpretation of Dodd-Frank – that is, the Court refused to ascribe different meanings to “whistleblower” in the reward and anti-retaliation provisions of the Act. Because “Congress has directly spoken” to the matter, she wrote, the SEC is precluded from a more expansive interpretation. Background Paul Somers (“Somers”), a former Vice President of Digital Realty Trust (“Digital Realty”), a real estate investment trust specializing in properties for data centers, alleged that he was fired after reporting possible securities law violations to senior management. Somers was an executive in the company’s Singapore office when he reported that his boss had hidden millions of dollars in cost overruns, granted no-bid contracts and made payments to friends, among other things. Although nothing impeded Somers from reporting the suspected wrongdoing to the SEC prior to his termination, he failed do so. Additionally, Somers failed to file an administrative complaint within 180 days of his termination, rendering him ineligible for relief under Sarbanes-Oxley. Thereafter, Somers sued Digital Realty, alleging violations of state and federal securities laws, including violations of the anti-retaliation provisions of the Act ( e.g. , Section 21F(h)(1)(A) of the Act).  Digital Realty moved to dismiss on the ground that Somers was not a “whistleblower” under Dodd-Frank because he only reported the wrongdoing internally and not to the SEC. In May 2015, the district court denied the company’s motion to dismiss. In denying the motion, the district court deferred to the SEC’s interpretation of “whistleblower” to include internal whistleblowers. The court analyzed the statutory text, the Act’s legislative history, and the procedural and practical implications of harmonizing the narrow definition of “whistleblower” with the broad protections of the anti-retaliation provision.  Somers v. Digital Realty Trust, Inc. , 119 F. Supp. 3d 1088, 1100–05 (N.D. Cal. 2015). The court observed that “ t bottom, it is difficult to find a clear and simple way to read the statutory provisions of Section 21F in perfect harmony with one another.” Id . at 1104.  Having analyzed the tension between the definition and anti-retaliation provisions, the district court deferred to the SEC’s interpretation that individuals who report internally only are nonetheless protected from retaliation under Dodd-Frank. Id . at 1106. The district court certified the question for interlocutory appeal pursuant to 28 U.S.C. § 1292(b), and the Ninth Circuit granted Digital Realty’s petition for permission to appeal. The court concluded, like the Second Circuit, that Congress intended Section 21F(h)(1)(A) (iii) to broaden the anti-retaliation protections to include internal reporters.  Digital Realty Trust, Inc. v. Somers , 850 F.3d 1045 (9th Cir. 2017).  The majority found that “ y broadly incorporating, through subdivision (iii), Sarbanes-Oxley’s disclosure requirements and protections, necessarily bars retaliation against an employee of a public company who reports violations to the boss, i.e. , one who ‘provide information’ regarding a securities law violation to ‘a person with supervisory authority over the employee.’” The court noted that “ strict application of ’s definition of whistleblower would, in effect, all but read subdivision (iii) out of the statute.”  The court also noted that there are provisions in SOX and the Securities Exchange Act of 1934 that mandate internal reporting before external reporting in certain instances.  Therefore, “ eaving employees without protection for that required preliminary step would result in early retaliation before the information could reach the regulators.” The Ninth Circuit found that Dodd-Frank’s anti-retaliation provision “unambiguously and expressly protects” whistleblowers of both types: those who report matters to the SEC and those who only make internal reports to their employer. 850 F.3d at 1050. In a brief dissent, Judge John Owens sided with the Fifth Circuit.  Judge Owens maintained that the statutory definition of whistleblower was clear, left no room for interpretation, and plainly governed. Id . at 1051. Sommers appealed to the Supreme Court. The Supreme Court’s Decision In reversing the Ninth Circuit decision, the Court held that the plain text of the statute, in conjunction with the Act’s anti-retaliation provision, as well as the intent of Congress in enacting the statute, negated the Ninth Circuit’s expansive reasoning. The Court found that the definition of “whistleblower” under Section 21F(a)(6) plainly “describes who is eligible for protection” from retaliation, i.e. , someone who “‘provides … information relating to a violation of the securities laws to the Commission.’” (Citation omitted; orig’l emphasis.) This definition, Justice Ginsburg found, applies “throughout” the statute. The definition section of the statute supplies an unequivocal answer: A “whistleblower” is “any individual who provides . . . information relating to a violation of the securities laws to the Commission .” §78u–6(a)(6) (emphasis added). Leaving no doubt as to the definition’s reach, the statute instructs that the “definitio shall apply” “ n this section,” that is, throughout §78u–6. §78u–6(a)(6). Having determined “who” is a whistleblower, the Court turned to the conduct protected under the Act – that is, “what” conduct is protected by Dodd-Frank. The Court explained that such conduct can be found in the three clauses of Section 21F(h)(1)(A). The three clauses of §78u–6(h)(1)(A) then describe what conduct, when engaged in by a whistleblower, is shielded from employment discrimination. See §78u–6(h)(1)(A)(i)–(iii). Reading the “who” and the “what” provisions together, Justice Ginsburg explained how an individual can obtain the anti-retaliation protections of the Act. An individual who meets both measures may invoke Dodd-Frank’s protections. But an individual who falls outside the protected category of “whistleblowers” is ineligible to seek redress under the statute, regardless of the conduct in which that individual engages. Justice Ginsburg noted that “Dodd-Frank’s purpose and design corroborate our comprehension of §78u–6(h)’s reporting requirement,” noting that Congress enacted Dodd-Frank “to motivate people who know of securities law violations to tell the SEC,” and, in connection with this purpose, Congress granted such individuals “immediate access to federal court, a generous statute of limitations … and the opportunity to recover double backpay.” The Court, however, found that the reason for such incentives was to effectuate Dodd-Frank’s narrow objective of motivating individuals to “tell the SEC,” and not (as with SOX) to “disturb the ‘corporate code of silence’” and embolden employees to report fraudulent behavior “not only to the proper authorities … but even internally.” The “core objective” of Dodd-Frank’s robust whistleblower program, as Somers acknowledges is “to motivate people who know of securities law violations to tell the SEC .” By enlisting whistleblowers to “assist the Government identify and prosecut persons who have violated securities laws,” Congress undertook to improve SEC enforcement and facilitate the Commission’s “recover money for victims of financial fraud.”  To that end, §78u–6 provides substantial monetary rewards to whistleblowers who furnish actionable information to the SEC. See §78u–6(b). Financial inducements alone, Congress recognized, may be insufficient to encourage certain employees, fearful of employer retaliation, to come forward with evidence of wrongdoing. Congress therefore complemented the Dodd-Frank monetary incentives for SEC reporting by heightening protection against retaliation. While Sarbanes-Oxley contains an administrative-exhaustion requirement, a 180-day administrative complaint-filing deadline, and a remedial scheme limited to actual damages, Dodd-Frank provides for immediate access to federal court, a generous statute of limitations (at least six years), and the opportunity to recover double backpay. Dodd-Frank’s award program and anti-retaliation provision thus work synchronously to motivate individuals with knowledge of illegal activity to “tell the SEC.” When enacting Sarbanes-Oxley’s whistleblower regime, in comparison, Congress had a more far-reaching objective: It sought to disturb the “corporate code of silence” that “discourage employees from reporting fraudulent behavior not only to the proper authorities, such as the FBI and the SEC, but even internally.” (Citations omitted; orig’l emphasis; internal quotation marks omitted.) The Court concluded that, given the unambiguous definition of whistleblower, because “Somers did not provide information ‘to the Commission’ before his termination,” “he did not qualify as a ‘whistleblower’ at the time of the alleged retaliation.”  Therefore, he was “ineligible to seek relief under §78u–6(h).” In a concurrence, Justice Clarence Thomas, joined by Justices Samuel Alito and Neil Gorsuch, agreed with the Court’s conclusion, but declined to adopt Justice Ginsburg’s argument that the purpose and design of Dodd-Frank and its legislative history supported the Court’s decision. Justice Thomas maintained that even if “a majority of Congress read the Senate Report, agreed with it, and voted for Dodd-Frank with the same intent, ‘we are a government of laws, not of men, and are governed by what Congress enacted rather than by what it intended’” (quoting Justice Antonin Scalia’s concurring opinion in Lawson v. FMR LLC ). Justice Sonia Sotomayor, joined by Justice Stephen Breyer, filed a separate concurrence that supported Justice Ginsburg’s use of legislative history, noting that “ ust as courts are capable of assessing the reliability and utility of evidence generally, they are capable of assessing the reliability and utility of legislative-history materials.” Takeaway As Justice Ginsburg observed, Congress “complemented the Dodd-Frank monetary incentives for SEC reporting by heightening protection against retaliation.” In this regard, the Act “provides for immediate access to federal court, a generous statute of limitations (at least six years), and the opportunity to recover double backpay.” (Citation omitted.) Thus, “Dodd-Frank’s award program and anti-retaliation provision … work synchronously to motivate individuals with knowledge of illegal activity to “‘tell the SEC.’” (Citation omitted.) In light of this synchronicity, giving the term “whistleblower” a consistent meaning makes sense. It not only comports with the plain text of the Act, but also the legislative history and “purpose and design” of the statute. After Digital Realty , whistleblowers will no longer have a reason to blow the whistle internally, even where the company has a strong and robust compliance program. Instead, to avail themselves of the Act’s anti-retaliation protections, employees will likely report their concerns of suspected wrongdoing directly to the SEC – before any adverse action occurs, but also before employers have had the chance to hear, investigate, and address their concerns – notwithstanding the fact that they may receive a higher bounty for participating in internal compliance programs in the first instance. See Rule 21F-6, 17 C.F.R. § 240.21F-6 (listing as a factor that may increase an award whether the individual reported internally before, or at the same time, as any report to the SEC). Whether the incentive to report wrongdoing to the SEC in the first instance trumps the financial incentive to report internally remains to be seen. No doubt, the number of filings with the SEC after Digital Realty will be watched closely by practitioners and the Commission. Finally, although Digital Realty eliminates the ability of individuals who report suspected violations of the securities laws only internally to bring retaliation actions under Dodd-Frank, internal whistleblowers still have protections under Sarbanes-Oxley.

In Dormitory Authority of the State of New York v. Samson Construction Co. (Feb. 15, 2018) , the New York Court of Appeals was called on to address, inter alia, the question of whether the City of New York “is an intended third-party beneficiary of the architectural services contract between…Dormitory Authority of the State of New York (DASNY) and…Perkins Eastman Architects, P.C. (Perkins)….” The facts of Dormitory are relatively simple and typical of many construction projects. The City was interested in building a forensic biology laboratory for the Office of the Chief Medical Examiner (OCME) next to Bellevue Hospital (the “Project”). The City entered into a Project Management Agreement with DASNY, pursuant to which DASNY was to finance and manage the design and construction of the Project. DASNY entered into a contract with Perkins to provide design, architectural and engineering services. The Perkins contract provided that “Perkins would ‘indemnify and hold harmless’ DASNY and the ‘Client’ (that is, OCME…) from any claims arising out of Perkins’ negligent acts or omissions and that extra costs or expenses incurred by DASNY and the Client as a result of Perkins’ ‘design errors or omissions shall be recoverable from and/or its Professional Liability Insurance carrier.’” Samson Construction Co. was also retained by DASNY to perform excavation and foundation work for the Project. The Court of Appeals emphasized that “the contract executed between DASNY and Samson provides that the Client - i.e., the City - ‘is an intended third party beneficiary of the Contract for the purposes of recovering any damages caused by Samson.’” (Brackets omitted.) Conversely, the Court noted that “ though there are passing references to the Client in the Perkins Contract, no analogous language providing that the City is an intended third-party beneficiary appears there.” During the prosecution of the foundation work, the failure to properly install an excavation support system led to significant problems, including severe damage to neighboring Bellevue buildings. As a result, the Project was delayed by more than 18 months and $37 million in additional costs were incurred. In the ensuing litigation, the City asserted, inter alia, a breach of contract claim against Perkins. In granting Perkins’ motion for summary judgment on that claim, Supreme Court held that the City was not an intended third-party beneficiary of the Perkins contract with DASNY. The Appellate Division, holding that there were factual issues as to the City’s status as a third-party beneficiary, modified Supreme Court’s order by denying that portion of Perkins’ motion for summary judgment. The Court of Appeals reversed the Appellate Division and held that the City failed to raise any factual issues concerning its status as a third-party beneficiary and, therefore, Perkins was entitled to summary judgment. In so holding, the Court generally described the relevant law as follows: A third party may sue as a beneficiary on a contract made for its benefit. However, an intent to benefit the third party must be shown, and, absent such intent, the third party is merely an incidental beneficiary with no right to enforce the particular contracts. We have previously sanctioned a third party’s right to enforce a contract in two situations: when the third party is the only one who could recover for the breach of contract or when it is otherwise clear from the language of the contract that there was an intent to permit enforcement by the third party. (Citations, internal quotation marks and brackets omitted.) When construction contracts are at issue, the Court noted that in order to be a considered a third-party beneficiary, “express contractual language stating that the contracting parties intended to benefit a third party by permitting that third party to enforce a promisee’s contract with another.” (Citations, internal quotation marks and brackets omitted.) Absent express language, “such third parties are generally considered mere incidental beneficiaries.” (Citations, internal quotation marks and brackets omitted.) The Court explained that “ his rule reflects the particular nature of construction contracts and the fact that - as is the case here - there are often several contracts between various entities, with performance ultimately benefitting all of the entities involved.” In applying the previously quoted “two-situation” analysis to the facts of Dormitory, the Court found that the City was not a third-party because “the City is not the only entity that can recover under the Perkins Contract” and “the Perkins Contract does not expressly name the City as an intended third-party beneficiary nor authorize the City to enforce any obligations thereunder….”

Through the years, numerous class action lawsuits have been brought involving securities fraud, corporate misconduct, unfair business practices and other claims. This article provides a brief overview of class action lawsuits . What is a class action lawsuit? A class action is a procedural device in which one or more persons sue on behalf of a larger group of persons, referred to as the “class.” The class action lawsuit started in the courts of equity in seventeenth-century England as a Bill of Peace. A Bill of Peace allowed the Court of Chancery to hear the dispute of a group of persons – known as the “multitude” – in one lawsuit. The Bill of Peace provided the means by which a court could resolve legal disputes affecting numerous people with similar claims in one lawsuit rather than in separate actions. To bring a Bill of Peace, the number of persons affected had to be so numerous that joining their claims in one lawsuit would be impractical; the members of the group had to possess a common interest in the issues to be adjudicated; and the persons named in the lawsuit had to adequately represent the interests of persons who were absent from the action but whose rights would be affected by the outcome. If a court allowed a Bill of Peace to proceed, the judgment that resulted would bind all members of the group. In the early nineteenth century, the Bill of Peace came to the United States. Justice Joseph Story, then serving on the United States Court of Appeals for the First Circuit, advocated the use of the Bill of Peace in courts of equity. In that regard, Justice Story wrote that “all persons materially interested, either as plaintiffs or defendants in the subject matter of a bill ought to be made parties to the suit, however numerous they may be,” so that the court could “make a complete decree between the parties prevent future litigation by taking away the necessity of a multiplicity of suits.” West v. Randall , 29 F. Cas. 718, 2 181 <1820> . Initially, a class action could be brought only in actions in which the plaintiffs sought equitable, as opposed to monetary, relief.  In 1938, with the adoption of Rule 23 of the Federal Rules of Civil Procedure, plaintiffs were permitted to seek monetary damages using the class action device. In 1966, Rule 23 was amended to provide that absent class members would be bound by a final judgment so long as their interests were adequately represented by the class representative. There are three categories of actions that fall within the scope of Rule 23. The first category involves the commencement of separate actions that may adversely affect members of the class or the defendant in one of two ways: it may impose inconsistent rulings on the defendant, or it may “impair or impede” class members from protecting their interests. The second category involves non-monetary relief, where the party against whom the class seeks relief “has acted or refused to act on grounds generally applicable to the class” so that injunctive or declaratory relief as to class would be appropriate. The third category involves cases seeking monetary relief in which there are questions of law or fact common to the class that predominate over questions specific to each class member, and the class action device is a more efficient means to resolve the controversy – that is, it is “superior to other available methods” for resolving the dispute. Regardless of the category of class action, a plaintiff, known as the class representative, who seeks class certification, must demonstrate that: (1) the number of class members is too numerous making it impracticable to join them in the action; (2) there are common questions of law and fact shared by members of the class; (3) the claims or defenses of the proposed class representative are typical of the class; and (4) the proposed class representative will adequately protect the interests of the class. Defendants can object to class certification. For instance, defendants can argue that the proposed class representative does not satisfy the adequacy and typicality requirements of Rule 23(a)(3) and (4). Defendants can also argue that the proposed class representatives have injuries that are different or more severe than those suffered by the class. If a class is certified, then members of the class must receive notice of the action. The notice includes information about the lawsuit and informs class members that their rights may be affected by the outcome of the litigation. The notice also provides information about how class members may opt out of, or exclude themselves from, the class if they do not want to be bound by the outcome of the litigation. If class members remain in the class, they give up their right to sue the defendants individually on the same claim after the class action concludes. If the named plaintiff and defendants reach a resolution, all members of the class must receive notice of the settlement. The court must approve the settlement to ensure that it is fair, reasonable and in the best interests of the class. Many, but not all, states permit class action lawsuits. The states that permit class actions have rules that mirror the Federal Rules of Civil Procedure. One notable exception is California, which has materially different rules for class actions in its state courts. Virginia does not allow class actions – there are no procedural rules or statutes permitting the commencement of a class action lawsuit in Virginia state courts. Here.=">Here."> The Benefits and Criticisms of Class Actions The Benefits Class action lawsuits advance important public policy goals. Such lawsuits often provide an oversight function for misconduct the government may be unable or unwilling to police, whether because of deregulation or resource conservation. A class action is often the only way average Americans with limited means can remedy wrongs committed by powerful, multi-million-dollar corporations and institutions. As noted by Justice William O. Douglas, “The class action is one of the few legal remedies the small claimant has against those who command the status quo.” Class action lawsuits have a deterrent effect on bad actors.  It forces those within the defendants’ industry or sector to change their behavior, product or procedures. In short, because a class action lawsuit combines and disposes of numerous claims that may not be practical to litigate individually, the process is more efficient. Additionally, aggregating small claims into a collective action can reduce the cost of litigation. A class action lawsuit can also ensure that all the plaintiffs obtain some compensation, even though the award may not cover all of the damages. The Criticisms Many critics consider the plaintiffs’ lawyers, not the class, to be the only “winners” in a class action lawsuit – if successful, the plaintiffs’ lawyers receive a percentage of any recovery achieved for the class. Proponents of the class action device, in particular, those from the plaintiffs’ bar, contend that this perception ignores the risk that class action attorneys take in starting such lawsuits. Indeed, not every class action results in a successful outcome. Without a financial incentive, attorneys will not handle class action lawsuits, thereby depriving average Americans the ability to recover damages for their injuries and losses. Proponents of the device also note that contingent fee attorneys receive large percentages of the awarded damages through their fee agreements. Class action lawyers should not be treated differently. Critics maintain that there is no salutary purpose to class actions, especially in small claims actions, in which individual class members have very small stakes. These critics argue that such actions are lawyer-driven – because the class representatives have so little at stake, they do not exercise any control over the litigation. With the class action lawyer in complete control, the economics of the lawsuit change. The lawyer has the largest financial interest in the outcome of the litigation, leading to settlements that produce high attorneys’ fees and minimal payouts to class members. Some critics argue that class action attorneys are more interested in securing a lucrative fee than advancing social justice. These critics claim that if social justice was the driving force behind the lawsuit, then class action lawyers would let the government perform its regulatory and oversight functions. Instead, by filing a class action lawsuit, private lawyers are substituting their judgment for that of a government agency charged with overseeing the conduct at issue. This usurpation of the government function is significant when the agency concludes that the conduct at issue and the injuries sustained by the plaintiff are immaterial and do not warrant prosecution of the defendant. Finally, as to the deterrence factor, critics maintain that state and federal law enforcement organizations have the ability to investigate and punish cases involving fraud and other wrongdoing regardless of its size and scope and offer an alternative means of addressing wrongful conduct. Private enforcement through a class action, they say, reduces the accountability of the law enforcement effort and delegates to the plaintiffs’ attorney control over enforcement priorities.  Since payouts to class members are often insignificant, class actions wind up being the cost of doing business rather than a deterrent to future conduct.

The New York Court of Appeals rules that a litigant must produce information from her Facebook account notwithstanding her chosen “privacy” settings.  The plaintiff in Forman v. Henkin (February 13, 2018) was injured after falling from a horse owned by defendant and alleges she suffered “spinal and traumatic brain injuries resulting in cognitive deficits, memory loss, difficulties with written and oral communication, and social isolation.”  During the litigation, plaintiff revealed she was a frequent Facebook user, but deactivated her account within six months of her accident.  Plaintiff claims that, after her accident, she had “difficulty using a computer and composing coherent messages” and that her e-mails were riddled with grammatical and spelling errors and took too long to compose. During discovery, defendant “sought an unlimited authorization to obtain plaintiff’s entire ‘private’ Facebook account, contending the photographs and written postings would be material and necessary to his defense of the action under CPLR 3101(a).”  Defendant moved to compel disclosure when plaintiff refused to provide the requested authorization. Plaintiff opposed the motion arguing that defendant failed to establish a basis to access the “private” portion of the Facebook account.  Defendant argued that the information sought would lead to relevant evidence – such as the amount of time it took plaintiff to write posts. Supreme Court granted the motion and directed plaintiff to “produce all photographs of herself privately posted on Facebook prior to the accident that she intends to introduce at trial, all photographs of herself privately posted on Facebook after the accident that do not depict nudity or romantic encounters, and an authorization for Facebook records showing each time plaintiff posted a private message after the accident and the number of characters or words in the message.”  The content of any of plaintiff’s written Facebook posts, whether authored before or after the accident, were not directed to be produced. The Court of Appeals pointed out several times that although defendant was denied some of the discovery it sought, only plaintiff appealed to the Appellate Division.  The Appellate Division modified Supreme Court’s decision by “limiting disclosure to photographs posted on Facebook that plaintiff intended to introduce at trial (whether pre- or post-accident) and eliminating the authorization permitting defendant to obtain data relating to post-accident messages, and otherwise affirmed.” The Court of Appeals reversed the Appellate Division and reinstated Supreme Court’s Order.  In its opinion, the Court generally reiterated the liberal discovery rules that permit the disclosure of “material and necessary” information that “bear on the controversy which will assist preparation for trial by sharpening the issues and reducing delay and prolixity.”  (Citations omitted.)  The Court also recognized that there are limitations to discovery and that when faced with “onerous” demands “competing interests must always be balanced; the need for discovery must always be weighed against any special burden to be borne by the opposing party.” (Citations omitted.) The Court recognized that when faced with discovery disputes, discovery requests must be evaluated on a “case-by-case basis.” The Court of Appeals found that there is no reason to apply any different standard to the disclosure of social media materials and, thus, stated that “ hile Facebook-and sites like it-offer relatively new means of sharing information with others, there is nothing so novel about Facebook materials that precludes application of New York’s long-standing disclosure rules to resolve this dispute.” Thus, the Court rejected the ruling of the First Department in Tapp v. New York State Urban Dev. Corp., 102 A.D.3d 620 (2013) , that “ o warrant discovery, defendants must establish a factual predicate for their request by identifying relevant information in plaintiff’s Facebook account –that is, information that ‘contradicts or conflicts with plaintiff’s alleged restrictions, disabilities, and losses, and other claims.’” (Quoting Tapp , emphasis in original.) The Court also rejected Tapp’s progeny, relied upon by the plaintiff in Forman , which “conditioned discovery of material on the ‘private’ portion of a Facebook account on whether the party seeking disclosure demonstrated there was material in the ‘public’ portion that tended to contradict the injured party’s allegations in some respect.”  (Citations omitted.) The Court agreed with defendant’s argument that the “Appellate Division erred in employing a heightened threshold for production of social media records that depends on what the account holder has chosen to share on the public portion of the account.”  The rule employed by the Appellate Division would permit the account holder “to unilaterally obstruct disclosure merely by manipulating ‘privacy’ settings or curating the materials on the public portion of the account.” In applying the general concepts of disclosure to social media discovery, the Court stated: New York discovery rules do not condition a party’s receipt of disclosure on a showing that the items the party seeks actually exist; rather, the request need only be appropriately tailored and reasonably calculated to yield relevant information.  Indeed, as the name suggests, the purpose of discovery is to determine if material relevant to a claim or defense exists.  In many if not most instances, a party seeking disclosure will not be able to demonstrate that items it has not yet obtained contain material evidence.  Thus, we reject the notion that the account holder’s so-called “privacy” settings govern the scope of disclosure of social media materials. The Court, however, tempered its decision by rejecting the notion that “commencement of a personal injury action renders a party’s entire Facebook account automatically discoverable”, holding that “ ather than applying a one-size-fits-all rule…, courts addressing disputes over the scope of social media discovery should employ our well-established rules – there is no need for a specialized or heightened factual predicate to avoid improper “fishing expeditions.” When judicial intervention is necessary in cases involving social media discovery disputes, the Court instructed lower courts to: 1. consider the nature of the event giving rise to the litigation, the injury claimed and any other case specific information to assess whether relevant information is likely to be found on Facebook; and, 2. “balanc the potential utility of the information sought against any specific ‘privacy’ or other concerns raised by the account holder… tailor to the particular controversy that identifies the types of materials that must be disclosed while avoiding disclosure of nonrelevant materials.”  In issuing such a ruling, the Court recognized that “private” materials, such as medical records, are discoverable in litigation if relevant. Among other things, the Court found that Supreme Court’s order was consistent with the principals espoused in Forman because, for example: 1. the request for photographs was “reasonably calculated to yield evidence” related to plaintiff’s claim that she was unable to engage in previously enjoyed activities; and, the request for the data revealing the timing and number of characters in posted messages would be relevant to plaintiff’s claim cognitive injuries caused difficulty writing and using a computer.   Because defendant did not appeal Supreme Court’s order, the Court of Appeals could not decide whether said order barring access to the content of the messages on plaintiff’s Facebook account (as opposed data revealing the timing and number of characters in posted messages) was appropriate. _____________________________________ <1>   Because defendant did not appeal Supreme Court’s order, the Court of Appeals could not decide whether said order barring access to the content of the messages on plaintiff’s Facebook account (as opposed data revealing the timing and number of characters in posted messages) was appropriate.