Search Results

It is well-settled that a plaintiff asserting a derivative claim seeks to recover for injury to the business entity. A plaintiff asserting a direct claim seeks redress for injury to himself/herself individually. Sometimes, the distinction between the two types of actions is not readily apparent. Yudell v. Gilbert , 99 A.D.3d 108, 113 (1st Dept. 2012). In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go. Tooley v. Donaldson, Lufkin & Jenrette, Inc. , 845 A2d 1031, 1039 (Del. 2004). See also Yudell , 99 A.D.3d at 114; Higgins v. New York Stock Exch., Inc. , 10 Misc. 3d 257, 264 (Sup. Ct. N.Y. County 2005) (citation omitted). Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation. Tooley , 845 A2d at 1039. Derivative claims that are improperly alleged as direct claims must be dismissed for lack of standing. Abrams v. Donati , 66 N.Y.2d 951, 953 (1985) (“ complaint the allegations of which confuse a shareholder’s derivative and individual rights will, therefore, be dismissed.”) (internal citations omitted). New York Courts have held that, because derivative actions bind absent interest holders, they take on “the attributes of a class action” and a “plaintiff must therefore demonstrate that will fairly and adequately represent the interests of the shareholders and the corporation, and that is free of adverse personal interest or animus.” Steinberg v. Steinberg , 106 Misc. 2d 720, 721 (Sup. Ct. N.Y. County 1980) (citation omitted); see also Gilbert v. Kalikow , 272 A.D.2d 63, 63 (1st Dept. 2000) (“ erivative causes of action were properly dismissed on the ground that plaintiff has failed to demonstrate that he will fairly and adequately represent the interests of the .”). As noted in a recent article posted by this Blog ( here ), these standing requirements are strictly enforced. Earlier this month, the Appellate Division, First Department, considered the foregoing in a case involving the business breakup of two managing partners of a general partnership. Pokoik v. Norsel Realties , 2018 NY Slip Op. 01534 (1st Dept. Mar. 8, 2018) ( here ). Pokoik v. Norsel Realties Background Leon Pokoik (“Pokoik”), among others, commenced the action in 2014, asserting direct and derivative claims against, among others, Norsel Realties (“Norsel”), Michael Steinberg (“Steinberg”) and Jay Lieberman (“Lieberman”) for breaches of fiduciary duty in connection with their management of a closely held real estate business. Norsel, a New York partnership, owns the land under an office building located on Madison Avenue in midtown Manhattan (the “Property”). Defendants Norsel, 575 Realties, Inc. (“575 Realties”) and 575 Associates, LLC (“575 Associates”), an affiliated operating company of 575 Realties, are owned by the Steinberg and Pokoik families, and their children. 575 Realties leases the Property from Norsel, and net leases the Property to 575 Associates. The dispute centered on the ground rent agreed to between Norsel and 575 Realties for the Property. Plaintiffs claimed that the rent was improperly calculated, notwithstanding the fact that it was based on two independent appraisals. The rental terms for the applicable extension periods of the ground lease were approved by 90% of Norsel’s partners. Pokoik and his family hold approximately 11% of the partnership interests in Norsel and slightly different percentages in their affiliates. In July 2015, Justice Oing dismissed the initial complaint based solely on the application of the business judgment rule. By order dated April 12, 2016, the Appellate Division, First Department affirmed Justice Oing’s order in part and reversed it in part ( Pokoik v. Norsel Realties , 138 A.D.3d 493 (1st Dept 2016) ( here ). The First Department affirmed the dismissal with prejudice as to the defendant business entities on the ground that there was no allegation that any of those entities owed Plaintiffs a fiduciary duty, or that those entities engaged in any misconduct. The First Department, however, reversed and remanded the remaining claims against Norsel and the individual defendants (Steinberg and Lieberman), finding that the complaint was sufficient with respect to these defendants to overcome the presumptive application of the business judgment rule in view of the limited record at that stage of the proceeding. Notably, the First Department did not address the issue of whether Plaintiffs’ alleged conflicts of interest prevented them from fairly and adequately representing Norsel’s interests. Plaintiffs subsequently filed an amended complaint in which they named thirty-nine additional defendants, including all of the approving partners, as well as eleven individuals, who either were never partners, or were no longer partners when the new ground rent was approved. As to all defendants, Plaintiffs alleged that “by arranging and/or agreeing” to the ground rent, each of the defendant mangers/general partners breached their fiduciary duties under New York law. The amended complaint also contained a cause of action against all defendants, relating to the transfer of the Property from Norsel to Norsel LLC, a newly formed single­member limited liability company, the sole member of which is Norsel. Plaintiffs alleged that, after they filed their initial complaint, Steinberg, Lieberman and possibly other defendants arranged for Norsel to transfer its interests in the Property to Norsel LLC, which transfer was conducted without their knowledge or consent. Plaintiffs alleged that this transfer was made so as to defeat the terms of Norsel’s partnership agreement. Plaintiffs further alleged that Norsel’s managers refused their demands to protect Norsel and its partners against the transfer. As a result, Plaintiffs sought to set aside and void the deed transferring Norsel’s interest in the Property to Norsel LLC, the assumption of the ground lease, and all other instruments in connection therewith. Defendants moved to dismiss the amended complaint, primarily arguing that Plaintiffs lacked standing to assert their direct and derivative claims. In that regard, they argued that Plaintiffs’ claims were all derivative in nature, and that as such, they lacked standing to assert the claims because of Plaintiffs’ “conflicts of interest,” which prevented them from “fairly and adequately” representing the partnership. Justice Oing held ( here ) that Plaintiffs lacked standing to bring the claims asserted in the amended complaint directly, finding that the alleged injuries were suffered by Norsel: Here, a review of all of plaintiffs’ claims in a light most favorable to them unequivocally demonstrates that they are based on alleged injuries to Norsel purportedly caused by the decisions to adopt an apparently below­market ground lease rent, and to transfer its interest in the Property to Norsel LLC, as well as the transfer of the ground lease from Norsel Realties to Norsel LLC. In fact, plaintiffs allege that the acts underlying the amended complaint were directed at Norsel as an entity, repeatedly asserting that such acts were “not in the best interests of Norsel,” and that “Norsel Realties as a whole is damaged $131,000,000.” Plaintiffs also rely on the purported injury to Norsel as the basis for their individual claims in which they assert that they have been injured in an amount equal to their ownership percentage multiplied by the $131,000,000 allegedly loss to Norsel. Under these circumstances, plaintiffs’ direct claims, which are based on allegations that their interests in Norsel have been diminished through the adoption of the ground rent at issue, are inherently derivative claims. Plaintiffs’ remaining allegations that defendants mismanaged Norsel for their own benefit, i.e., by transferring ownership to Norsel LLC, are similarly derivative in nature. Accordingly, to the extent that plaintiffs attempt to bring direct claims against Norsel or its partners, they do not have standing to do so because the claims asserted in the amended complaint are strictly derivative in nature — the claims and damages alleged result from purported injuries to Norsel. Having determined that the claims were derivative in nature, Justice Oing turned to the question of whether Plaintiffs had standing to represent the partnership’s interests. Justice Oing found that, for a number of reasons, Plaintiffs did not “fairly and adequately represent the interests” of the partnership because they were not “free of adverse personal interest or animus.” Citations omitted. As an initial matter, the court found that because Plaintiffs sued all of Norsel’s partners, there were no beneficiaries of the action. “This presents a prototypical conflict of interest,” said Justice Oing. The court also found that Plaintiffs had an “inherent conflict of interest” because of their 12.788% ownership interest in 575 Associates. Since 575 Associates net leases the Property from 575 Realties, the court found that the “plaintiffs are attempting to double dip — they are simultaneously receiving funds from 575 Associates in the form rental income while suing Norsel over the same ground rent.” The court further found that Plaintiffs were harming Norsel rather than benefitting the partnership, finding that they did not “have any genuine concern for Norsel or its related entities.” In addition, plaintiffs do not appear to have any genuine concern for Norsel or its related entities. While plaintiffs seek to extract monetary damages from their partners based upon their extremely high property appraisals, they do not request any relief, such as the revision of the subject ground lease rent or court oversight of the appraisal process, that would benefit Norsel. Indeed, plaintiffs ignore the fact that their $20 million proposed annual rent, an almost 90% increase, would make business operations more difficult for 575 Associates which, in turn, would jeopardize Norsel itself. Last, but not least, Justice Oing found that Leon Pokoik, the lead plaintiff in the action, was not “free from personal animus” when it came to his business partners. According to the court, Pokoik’s “litigious nature” demonstrated that he was using the litigation as “a weapon” “to gain leverage in the other disputes” with his business partners and family. “Having named all of the Norsel partners with whom plaintiffs disagree as defendants in this action, and given Leon Pokoik’s demonstrated animus,” concluded the court, “plaintiffs’ self-interest is palpably obvious to the point that they are unable to show that they will adequately represent the interest of these defendants.” The Court granted Defendants’ motion and dismissed the amended complaint in its entirety. Plaintiffs appealed. First Department Ruling The Court unanimously modified the decision, vacating the dismissal of the individual defendants, reversing the dismissal of Plaintiffs’ first three of the causes of action and affirming the remainder of the motion court’s decision. Relevant to the motion court’s finding that Pokoik was not “free from personal animus,” the Court disagreed, finding that the record was devoid of “any indication of an especially acrimonious relationship between the parties.” We perceive no conflict of interest that would prevent plaintiffs from fairly representing Norsel’s interests. In a separate derivative action by plaintiff Leon Pokoik against other Pokoik family members, who are also defendants in this action, we found that Pokoik’s relationship with defendants had not been shown to be “so acrimonious or emotional as to demonstrate that plaintiff cannot act as an adequate representative for the companies” ( Pokoik v Pokoik , 146 AD3d 474, 475 <1st dept 2017> ). Nor is there in the present record any indication of an especially acrimonious relationship between the parties. Takeaway Breaking up a business relationship is hard to do. It can be acrimonious and/or emotional. The First Department’s decision in Pokoik shows that the degree of acrimony alleged is important, especially on a motion to dismiss. Although the facts in Pokoik – namely, Pokoik’s “litigious nature” and his improper use of the lawsuit as leverage in other cases against the defendants – showed some acrimony, it was not enough on the pleadings to demonstrate a conflict of interest sufficient to defeat derivative standing. The lesson of Pokoik , therefore, is that acrimony and/or personal animus alone is not be enough to defeat derivative standing, no matter how intensely expressed they may be. More facts are needed. Without such facts, defendants will be unable to demonstrate that a plaintiff cannot, and will not, “fairly and adequately represent the interests of the shareholders and the corporation.…”

On March 20, 2018, the United States Supreme Court decided Cyan, Inc. v. Beaver County Employees Retirement Fund , No. 15-1439, in which it unanimously held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) does not strip state courts of subject-matter jurisdiction over class actions involving claims exclusively brought under the Securities Act of 1933 (the “1933 Act”), and does not allow for the removal of those cases to federal court. ( Here .) The Court resolved a split among state and federal courts that has spanned nearly two decades concerning state court jurisdiction over securities class actions that exclusively allege claims under the 1933 Act. Some courts have held that, after SLUSA, federal courts have exclusive jurisdiction over class actions alleging only 1933 Act claims. Other courts, by contrast, have concluded that SLUSA did not remove state courts’ concurrent jurisdiction over such actions. Legal Background In the 1930s, Congress passed sweeping legislation to regulate the offer and sale of securities – the 1933 Act and the Securities Exchange Act of 1934 (the “Exchange Act”). Prior to the legislation, the states primarily regulated the purchase and sale of securities. The 1933 Act requires companies that offer securities to the public (known as issuers) to make accurate disclosures of material information. Under the statute, violations of the 1933 Act are actionable in state and federal court. Notably, and relevant to the Court’s decision in Cyan , Congress barred removal of actions filed in state court to federal court. By contrast, the Exchange Act, which regulates the trading of securities (on the national exchanges), deprives the states of jurisdiction over claims arising under that statute. In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”) over President Clinton’s veto. The PSLRA included a number of procedural and substantive provisions affecting the prosecution and defense of securities class action litigation. To avoid the application of these provisions, plaintiffs filed their class action lawsuits in state court, asserting claims under state law only. Congress passed SLUSA to pre-empt state court jurisdiction, requiring “covered” class action lawsuits ( i.e. , a lawsuit on behalf of 50 or more people) to proceed in federal court only. In passing SLUSA, Congress amended Section 16(b) of the 1933 Act, which prohibits securities class actions based on state law in both state and federal courts that allege false or misleading practices in the purchase or sale of a covered security – i.e. , a security traded on the national exchanges. That provision is known as the “state-law class-action bar.” Congress added a new provision, Section 77p(c), which permits the removal of state-law class actions to federal court: “Any covered class action brought in any State court, as set forth in subsection (b) of this section, shall be removable to the Federal district court … and shall be subject to subsection (b) of this section.” The purpose of this provision, as the Supreme Court concluded in another case, is to ensure that the district court promptly dismisses the action. Finally, Congress made conforming amendments to Section 22(a) of the 1933 Act, making clear that the grant of concurrent jurisdiction over 1933 Act claims is limited: “except as provided in with respect to covered class actions.” The district courts of the United States … shall have jurisdiction …, concurrent with State and Territorial courts, except as provided in section 77p of this title with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter. This provision is known as the “except clause.” Cyan addressed the question what does SLUSA mean when it refers to “covered class actions” in the “except” clause. Cyan argued – relying on the definition of “covered” in Section 77p(f) – that SLUSA bars state courts from hearing large securities class actions ( e.g. , class actions having more than 50 class members), based on state or federal law. The plaintiffs, on the other hand, argued that SLUSA prohibits state courts from hearing securities class actions barred by Section 77p(b) only. Cyan also addressed the question whether a covered securities class action alleging only 1933 Act claims can be removed to federal court. Factual Background The case arose from the initial public offering (“IPO”) of Cyan, Inc. (“Cyan”) shares in May 2013. The plaintiffs/respondents, three pension funds and an individual (together, the “Investors”), purchased shares of Cyan stock in the IPO. After the stock declined in value, the Investors brought a damages class action against Cyan in California Superior Court. The Investors alleged that Cyan’s offering documents contained material misstatements in violation of the 1933 Act. The Investors did not assert any state law claims. Cyan moved to dismiss the Investors’ suit for lack of subject matter jurisdiction. It argued that the “except clause”— i.e. , the amendment made to §77v(a)’s concurrent-jurisdiction grant —stripped state courts of the power to adjudicate 1933 Act claims in “covered class actions.” The Investors did not dispute that their lawsuit qualified as such an action under SLUSA’s definition. But they maintained that SLUSA left intact state courts’ jurisdiction over all suits — including “covered class actions”— alleging only 1933 Act claims. The California Superior Court agreed with the Investors and denied Cyan’s motion to dismiss. The state appellate courts denied review of that ruling. The Supreme Court granted Cyan’s petition for certiorari to resolve the split among state and federal courts about whether SLUSA deprived state courts of jurisdiction over “covered class actions” asserting only 1933 Act claims. The Supreme Court’s Opinion In a unanimous decision, the Court held that state courts have concurrent jurisdiction over federal securities class actions asserting claims exclusively brought under the 1933 Act. Although SLUSA bars certain securities class actions based on state law, and expressly authorizes removal of such actions so that they may be dismissed by federal courts applying SLUSA, the Court concluded that “SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations.” In reaching that conclusion, Justice Kagan noted that the language used by Congress was clear: “SLUSA’s text, read most straightforwardly, leaves in place state courts’ jurisdiction over 1933 Act claims, including when brought in class actions.” Put another way, said Justice Kagan, “ he statute says what it says—or perhaps better put here, does not say what it does not say. State-court jurisdiction over 1933 Act claims thus continues undisturbed.” The Court made it clear that the “except clause” “does not” limit “state-court jurisdiction over class actions brought under the 1933 Act.” Section 16(b) “bars certain securities class actions based on state law … nd as a corollary of that prohibition, it authorizes removal of those suits so that a federal court can dismiss them.” “But,” said Justice Kagan, “the section says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule of §77v(a)—under which a state court may hear the Investors’ 1933 Act suit—continues to govern.” Citations omitted. Justice Kagan rejected Cyan’s attempt to “cherry pick” a sub-paragraph in a larger section of the statute to reach a result that is incompatible with that larger provision: … Cyan thus concludes that the except clause exempts all sizable class actions—including the Investors’ suit—from §77v(a)’s conferral of jurisdiction on state courts. But that view cannot be squared with the except clause’s wording for two independent reasons. To start with, the except clause points to “section 77p” as a whole—not to paragraph 77p(f)(2). Cyan wants to cherry pick from the material covered by the statutory cross-reference. But if Congress had intended to refer to the definition in §77p(f)(2) alone, it presumably would have done so—just by adding a letter, a number, and a few parentheticals.… And “ hen Congress want to refer only to a particular subsection or paragraph, it sa so.…” It said no such thing in the except clause. Justice Kagan explained that Cyan’s reliance on the definitional paragraphs of the statute to give meaning to Section 77p(f)(2) could not withstand scrutiny because the former does not do latter: In any event, the definitional paragraph on which Cyan relies cannot be read to “provide[ ]” an “except ” to the rule of concurrent jurisdiction, in the way SLUSA’s except clause requires. A definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.… If Congress had wanted to deprive state courts of jurisdiction over 1933 Act class actions, it had an easy way to do so: just insert into §77p an exclusive federal jurisdiction provision (like the 1934 Act’s) for such suits. That rule, when combined with the except clause, would have done the trick because it would have “provided” an “except ” to §77v(a)’s grant of concurrent jurisdiction; by contrast, a mere definition of “covered class action” (as a damages suit on behalf of 50-plus people) does not so provide. Finally, Justice Kagan rejected Cyan’s argument that the except clause was merely a “minor tweak” or a “conforming amendment”: And finally, Cyan’s take on the except clause reads too much into a mere “conforming amendment.” The change Cyan claims that clause made to state court jurisdiction is the very opposite of a minor tweak. When Congress passed SLUSA, state courts had for 65 years adjudicated all manner of 1933 Act cases, including class actions. Indeed, defendants could not even remove those cases to federal court, as schemes of concurrent jurisdiction almost always allow. State courts thus had as much or more power over the 1933 Act’s enforcement as over any federal statute’s. To think Cyan right, we would have to believe that Congress upended that entrenched practice not by any direct means, but instead by way of a conforming amendment to §77v(a) (linked, in its view, with only a definition). But Congress does not make “radical—but entirely implicit—change ” through “technical and conforming amendments.” In short, quoting a metaphor from an opinion written by Justice Antonin Scalia, Justice Kagan concluded that “Congress does not ‘hide elephants in mouseholes.’” As to defendants’ ability to remove class actions alleging 1933 Act claims to federal court, the Court held that the removal provision applies to only “covered class actions,” which are “state-law class actions.” Section 77p(b) does not preclude federal-law class actions. So under our decision, §77p(c) does not authorize their removal. Takeaway Class action plaintiffs asserting claims only under the 1933 Act will most likely file their complaints exclusively in state court. After Cyan , such exclusivity could subject defendants to litigating 1933 Act cases in state court while at the same time litigating in federal court Exchange Act claims arising under substantially the same facts and circumstances as the 1933 Act claims. Cornerstone Research recently noted that this phenomenon is already being played out, albeit on a small scale. See here (noting that there were seven 1933 Act actions pending in state court since 2014, all of which have parallel actions in federal court.) here.=">here."> Class action defendants litigating in state court will likely find that the procedural safeguards of the PSLRA will not be available to them, unless the state court decides to apply them anyway. These safeguards include, among others, the lead plaintiff provisions, which are intended to ensure that investors with the largest financial interest in the litigation will direct the lawsuit. On the other hand, as the Cyan Court emphasized, the substantive provisions of the PSLRA, including the safe harbor protection for forward-looking statements, will apply in both federal and state courts. The Court did not, however, address whether other protections, such as the automatic stay of discovery during the pendency of a motion to dismiss, will apply in state court actions. The applicability of those protections will likely be litigated in the state courts. After Cyan , companies may try to dictate the forum in which shareholders litigate their 1933 Act claims. This approach adds to the law in some states, notably Delaware, in which corporations are permitted to include in their by-laws a choice of forum provision establishing the state’s courts as the exclusive forum for litigation involving the internal affairs of the company. Stanford Law Professor Joseph Grundfest, for example, has advocated for forum-selection by-laws involving 1933 Act claims. The limitation imposed by that approach, however, might be prohibited by Section 14 of the 1933 Act. Section 14 provides that: “Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title … shall be void.” Whether the courts will consider a by-law designation of forum exclusivity to be the same as a waiver of compliance remains to be seen. Regardless, after Cyan , companies may be more inclined to include such forum selection designations in their by-laws. In addition, companies may be inclined to adopt corporate by-laws requiring shareholder disputes, including those arising under the 1933 Act, to be arbitrated. For the past few years, companies have been adopting arbitration by-laws.  In the few cases in which these by-laws have been addressed by the courts, they have been upheld. E.g. , Delaware Cty. Employees Ret. Fund v. Portnoy , Civil Action No. 13-10405-DJC (D. Mass. Mar. 26, 2014). Just as the approach advocated by Professor Grundfest may be prohibited by Section 14 of the 1933 Act, so too may the foregoing solution. This Blog will continue to watch for material developments after Cyan and report on the impact the decision has on class action litigation alleging claims arising under the 1933 Act.

A mechanic’s lien is an encumbrance on the title to the real property. Contractors and subcontractors, among others (collectively, “Contractors”), whose work improves real property, are entitled to place a mechanic’s lien on the real property so improved to secure the payment of the amounts due to them.  Oftentimes, mechanic’s liens are problematic for real property owners.  For example, the filing of such a lien could be an event of default under a mortgage or a lease. Under New York’s Lien Law, there are numerous ways to discharge a mechanic’s lien for a private improvement.  For example, an action must be commenced to foreclose a lien, or the lienor must obtain an order to continuing the lien, within one year of its filing or the lien will be discharged.  (See Lien Law §§17 and 19(2) .)  Before or after a lien foreclosure action is commenced, but after a lien is filed, a lien can also be discharged by procuring and filing with the clerk of the county in which the lien is filed, a bond or undertaking in an amount equal to 110% of the amount of the lien.  (See Lien Law §19(4).) A mechanic’s lien for a private improvement can also be discharged by paying money into court.  ( See Lien Law §20 .)  If the payment is made before an action to foreclose the lien is commenced, the deposit must equal the amount of the lien plus interest to the time of the deposit.  (See Lien Law §20.)  If the payment is made after the commencement of a foreclosure action, the lien will be discharged upon payment into court “of such sum of money, as, in the judgment of the court or a judge or justice thereof, after at least five days' notice to all the parties to the action, will be sufficient to pay any judgment which may be recovered in such action.”  (See Lien Law §20.) Section 37 of the Lien Law permits an owner or contractor to obtain a bond either before or after the commencement of the improvement in an amount as directed by the court “which shall not be less than the amount then unpaid under such contract, conditioned for the payment of any judgment or judgments which may be recovered in any action brought for the enforcement of any and all claims, notices of which may be filed as in this section provided, arising by virtue of labor performed or materials furnished in or about the performance of any such contract.”  (See Lien Law §37.)  Once a Section 37 bond is approved by the court and filed with the county clerk an order shall be made by such court, judge or justice discharging such property from the lien of each and every Contractor, who, thereafter, “shall have a claim, which shall attach against and be secured by such bond, for the principal and interest of the value, or the agreed price, of such labor and materials”.  (See Lien Law §37(4) and (5).) The Lien Law sets forth the necessary parties defendant to a mechanic’s lien foreclosure action.  ( See Lien Law §44. )  Among others, lien law §44(3) requires that “ ll persons appearing by the records in the office of the county clerk or register to be owners of such real property or any part thereof” be named as a defendant. In the event that a bond or cash deposit is made to discharge a lien, does the owner of the real property remain a necessary party to a mechanic’s lien foreclosure action?  There is presently a split among the Departments on this issue.  The law in the Second Department is that the owner need not be named as a party defendant.  In Bryant Equipment Corp. v. A-1 Moore Contr. Corp. , 51 A.D.2d 792 (1973), the Bryant   Court held that the subject bond “replace the real property as the security to be attached and attacked” and, therefore, Lien Law Section 37(7) controls and “sets forth the classes of persons who shall be joined as parties defendant, namely the principals and surety on the bond, the contractor, and all claimants who have filed notices of claim prior to the date of the filing of such summons and complaint.”  (Internal quotation marks omitted.) The Third Department shares this view and held that “ here the lien no longer attaches to real property due to the filing of a bond under the Lien Law…the owners of the real property are no longer necessary parties to the action.”  ( M. Gold & Son, Inc. v. A.J. Eckert, Inc. , 246 A.D.2d 746 (1998).) The First Department, however, does not share the view of the Second and Third Departments.  In Harlem Plumbing Supply Co., Inc. v. Handelsman , 44 A.D.2d 768 (1972), a tenant was building out space leased from the landlord owner of the property.  A materials supplier filed a lien, which, before the commencement of a foreclosure action, was discharged by deposit into court made by the tenant pursuant to Lien Law §20.  The property owner, who was named as a defendant in the action, moved to dismiss.  The Court recognized that the “effect of the deposit was to discharge the lien upon the real estate and shift it to the fund.”  Nonetheless, relying on Lien Law §44(3), the Harlem Court in holding that the owner was a necessary party to a mechanic’s lien foreclosure action stated: The fact that this lien was discharged by a deposit (Lien Law s 20) rather than by an undertaking (id. s 19(4)) is of no consequence. Where, as here, the lienor has elected to proceed in equity to enforce its lien, both sections envision the establishment of the validity of such lien before further rights accrue. Under such circumstances, the owner of the property is a necessary party defendant, although the prior owners are not. The Supreme Court, New York County, in Doma Inc. v. 885 Park Avenue Corp. (March 13, 2018), was faced with the very issue decided by the Harlem Court, but adopted the reasoning of the Second and Third Departments after recognizing that “ he law on this question is not settled.”  The plaintiff in Doma was a contractor that performed renovation work for defendant Gilman, a tenant/shareholder in a cooperative apartment in a building owned by defendant 885 Park Avenue Corp.  Owner defaulted in answering the complaint.  In response to plaintiff’s motion for a default judgment, Owner cross-moved to dismiss the complaint “on the ground that a bond discharging the lien has been filed ensuring full payment of the lien amount.” The Doma court, accepted the cross-motion as timely made in lieu of an answer and addressed the merits of Owner’s position.  The Doma court characterized the reasoning of the Harlem Court as being “very technical” and recognized that some motion courts in New York County have followed Harlem .  Relying on the authority set forth above, the Doma court stated that the First Department “appears to stand alone in the view that the owner is a necessary party following the posting of a bond discharging the lien.”  Accordingly, the Doma court, in refusing to follow the First Department in Harlem , stated: Since the owner of the building ceases to have a stake in an action by a contractor against a tenant following the posting of a bond, wherein any subsequent action deals with the surety and not the real property, from a public policy perspective, there is no purpose in keeping the owner in the caption.  Indeed, to keep the owner of the building in the action would only serve to needlessly increase the costs associated with the ownership and management of real property in this State….Given, however, that two other departments of the Appellate Division have disagreed with technical reasoning, relying on Lien Law §37(7); that other motion courts in New York County have followed the Second and Third Departments and avoided the technical problem; inasmuch as this Court can discern no public policy reason to keep the owner in the action under these circumstances; and noting that the First Department has not had occasion to revisit this proposition in many years; this Court follows the rule that, upon the filing of a bond discharging a mechanic’s lien, Lien Law §37(7) supplants Lien Law §44(3) in prescribing the necessary parties to the action, and causes the owner to no longer be a necessary party. Notice of entry of the Doma order was filed on March 16, 2018, and no notice of appeal has been filed as of yet.

The Financial Industry Regulatory Authority (“FINRA”) is the largest independent, non-governmental regulator of broker-dealer firms doing business in the United States. See UBS Fin. Servs., Inc. v. W. Va. Univ. Hosps., Inc. , 660 F.3d 643, 648 (2d Cir. 2011).  FINRA was formed in 2007, pursuant to Section 15A of the Securities Exchange Act of 1934 (“Exchange Act”), through the merger of the National Association of Securities Dealers (“NASD”) and the New York Stock Exchange Regulation, Inc., the regulatory arm of the New York Stock Exchange ( see 15 U.S.C.A. § 78o-3). The Securities and Exchange Commission regulates FINRA. FINRA is involved in almost every aspect of the securities industry. Among other things, FINRA registers and educates industry participants, examines securities firms, promulgates rules and enforces them, enforces the federal securities laws, and educates the investing public. FINRA also provides regulatory services for the equities and options markets, as well as trade reporting and other utilities for the industry. Significantly, FINRA administers nearly all securities-related arbitrations in the country. FINRA has a uniform set of rules for arbitrating disputes between Member firms and their customers and between Member firms and Associated Persons. Among these rules are FINRA Rule 12200, which requires Member firms, at a customer’s request, to arbitrate disputes that arise in connection with their business activities, and FINRA Rule 13200, which requires Member firms and Associated Persons to arbitrate their employment disputes. Despite the requirement to arbitrate under Rules 12200 and 13200, customers and Associated Persons may avoid arbitration by including non-exclusive judicial forum selection clauses in their agreements with Member Firms. FINRA Rules 12200 and 13200 FINRA Rule 12200 Rule 12200 requires FINRA members to submit to arbitration if the following factors are met: Arbitration is either required by a written agreement or requested by the customer; The dispute is between a customer and a member or an associated person of a member; and The dispute arises in connection with the business activities of the member or associated person, with certain exceptions for insurance company members. Under Rule 12200, customers are given the unilateral right to demand arbitration even in the absence of a pre-dispute arbitration agreement. FINRA Rule 13200 Under Rule 13200, disputes between Member firms and Associated Persons arising out of the business activities of a Member or an Associated Person must be arbitrated through FINRA. Rule 13200 does not permit waiver by the Member firm. A dispute must be arbitrated under the rule and administered in the FINRA forum. There is no provision for contractual waiver or modification of this requirement. The purpose of Rule 13200 is to encourage market participants, both Members and their Associated Persons, take advantage of arbitration in the FINRA forum. In promulgating the rule, FINRA wanted to make it clear that it has the authority, expertise, and Congressional mandate to resolve intra-industry disputes in a manner that fairly and efficiently protects the markets, market participants, and the public. Although the rule is mandatory, as with Rule 12200, Associated Persons may waive their right to a FINRA arbitration in a pre-dispute agreement. Judicial Forum Selection Clauses Judicial forum selection clauses – contractual provisions in which the parties agree to resolve their disputes in court – are intended to supersede or waive the right to arbitration under Rules 12200 and 13200. In 2014, the Court of Appeals for the Second Circuit held that forum selection clauses in contracts between Members and customers supersede Rule 12200, permitting the parties to submit their disputes in state and federal court rather than in a FINRA arbitration. Goldman, Sachs & Co. v. Golden Empire Sch. Fin. Auth. , 764 F.3d 210, 217 (2d Cir. 2014). The Ninth Circuit took the same view in Goldman, Sachs & Co. v. City of Reno , 747 F.3d 733, 747 (9th Cir. 2014).  Like the Second Circuit, the Ninth Circuit did not apply the presumption in favor of arbitration because the forum selection clause cast doubt on whether the agreement to arbitrate remained in effect at all. Applying state-law contract interpretation principles, the court held that the mandatory nature of the forum selection clause superseded the default obligation under FINRA’s rules to arbitrate, and that by agreeing to that clause, the customer waived any right to a FINRA arbitration. Id . at 741-46. The Fourth Circuit, likewise, has held that Members can contract with their customers to resolve their disputes in court. UBS Fin. Servs., Inc. v. Carilion Clinic , 706 F.3d 319, 328 (4th Cir. 2013). Hyuncheol Hwang v. Mirae Asset Sec. (USA) Inc. On February 28, 2018, Justice Saliann Scarpulla of the Supreme Court, New York County Commercial Division, issued a decision in Hyuncheol Hwang v. Mirae Asset Sec. (USA) Inc. , 2018 N.Y. Slip Op. 30368(U) ( here ), in which she held that a forum selection clause in a broker’s employment contract trumped an arbitration clause in the broker’s later-signed Form U-4. Background Hwang involved an employment dispute in which Hyuncheol Hwang (“Hwang”) sought to stay the arbitration of his claims on the grounds that his employment agreement with Mirae Asset Securities (USA) Inc. (“Mirae”), a broker-dealer firm registered with FINRA, contained a forum selection clause directing the parties to litigate their disputes under the agreement in a New York court, notwithstanding his later signed Form U-4, which contained a mandatory arbitration provision. Hwang was hired to serve as Mirae’s Head of Prime Brokerage Services and Capital Markets Business, unless Mirae terminated his employment with or without cause, or if Hwang resigned with or without cause. The employment agreement included an exclusive judicial forum selection clause that required the parties to litigate any disputes relating to the terms of the agreement, including any counterclaims, in either a state or federal court sitting in New York County. The employment agreement also contained a standard provision requiring any amendments or modifications of the agreement to be signed in writing by both parties. Immediately after entering into the employment agreement, Hwang applied to become a registered representative by filling out a Form U-4. The Form U-4 included a mandatory arbitration clause. Less than a year after signing the employment agreement, Mirae terminated Hwang’s employment for cause. Thereafter, Hwang sent Mirae a draft complaint that outlined the claims he intended to assert against the broker-dealer. The complaint was to be filed in federal court. In response, Mirae filed a statement of claim with FINRA, asserting the following claims: 1) declaratory award that Hwang was terminated for cause; 2) breach of employment agreement; 3) fraudulent inducement and misrepresentation, seeking rescission of the agreement and recoupment of the compensation paid to Hwang under the agreement; and 4) breach of the duties of good faith and loyalty, seeking disgorgement of the compensation paid to Hwang under the agreement. The same day that Mirae filed its complaint, Hwang filed his complaint in state court. Hwang alleged that he was terminated without cause and was therefore entitled to his base salary for the remainder of his employment term, the remainder of his sign-on bonus, his retention bonus, his annual bonuses, his additional annual bonuses, and his benefits for the remainder of his employment term. He asserted causes of action for: (1) breach of contract; (2) violation of NYLL Section 193; (3) a declaratory judgment that he did not breach the agreement; (4) a declaratory judgment that the employment agreement should not be rescinded; and (5) a declaratory judgment that he did not breach any duty of good faith and loyalty. Hwang moved to stay the arbitration and Mirae cross moved to compel arbitration and stay the action pending the resolution of the arbitration. Hwang argued that the dispute should not be arbitrated because his employment agreement contained a forum selection clause directing the parties to litigate any disputes relating to the terms of the agreement in a New York court. He also contended that the Form U-4 did not amend or supersede the forum selection clause in his employment agreement, because any amendment would have required both parties to enter into a signed written agreement to modify its terms. Mirae argued that Hwang agreed to arbitrate any employment related claims with Mirae when he signed his Form U-4, which replaced his earlier employment agreement to resolve his claims in a different forum. Further, Mirae argued that under Rule 12200, Mirae and Hwang were required to submit any disputes arising under the employment agreement to FINRA for arbitration. The Court’s Decision The court granted the motion to stay arbitration. The court found that the evidence presented “demonstrate that the parties intended to be bound by the forum selection clause in the employment agreement.” “Mirae present no evidence,” said the court, “to show that the parties intended the arbitration clause in the U4 to supplant the forum selection clause in the employment agreement.” The court found dispositive the fact that “the forum selection clause, was negotiated and executed” a few weeks before Hwang signed the Form U-4: Hwang avers in his affidavit in support that, when he signed the employment agreement, both he and Mirae understood that Hwang’s position at Mirae would require him to sign the FINRA U4. As such, his signing of the U4 — which was done a few weeks after the employment contract was executed — was contemplated when the employment agreement, and specifically the forum selection clause, was negotiated and executed. Mirae submits no evidence to the contrary. In a footnote, the court noted that the law in the Appellate Division, First Department (to which the motion court is bound), confirmed that “specific contract terms can supersede FINRA’s arbitration rules.” Bortman v. Lucander , 150 A.D.3d 417 (1st Dept. 2017) (citing Golden Empire Schs. Fin. Auth. , 764 F.3d at 215). Finally, the court rejected Mirae’s argument that the Form U-4 amended the employment agreement, finding that Mirae failed to proffer any evidence that the parties “knowingly agreed, in a written employment contract modification, to eliminate the forum selection clause in Hwang’s employment agreement.” Further, Hwang’s employment contract contains a clause requiring any changes to the agreement be set forth in a signed written agreement. Mirae submits no evidence to show that both parties knowingly agreed, in a written employment contract modification, to eliminate the forum selection clause in Hwang’s employment agreement. If the parties intended to change the forum for disputes concerning Hwang’s employment, they would have had to indicate such in a signed written agreement, but they did not do so. Takeaway In the briefing of the motions, the parties addressed whether FINRA Regulatory Notice 16-25 (the “Notice”) mandated arbitration of their dispute. The Notice clarified FINRA’s position that its mandatory arbitration rules cannot be waived by Member firms in customer and industry disputes, notwithstanding the existence of a pre-dispute agreement to a different forum. See FINRA Regulatory Notice 16-25 ( here ). The Notice expressed the view that FINRA’s rules prohibit Member firms from precluding customers and Associated Persons, as the case may be, from pursuing arbitration at a FINRA arbitration, but do not prohibit customers and Associated Persons from agreeing to forego FINRA arbitration. The Notice specifically recommends that if Member firms wish to use a forum-selection provision in pre-dispute agreement, they are permitted to use a “non-exclusive forum selection provision” leaving the choice as to whether to proceed before FINRA to the customer or the Associated Person. The Hwang court did not address the Notice directly. However, the result comports with the purpose of the Notice. Although the forum selection clause in Hwang was an exclusive one, and therefore subjected Mirae to FINRA scrutiny, it was Hwang, the Associated Person, not Mirae, the Member firm, that sought to enforce the clause. Hwang also highlights the point that courts use state-law principles of contract interpretation to decide whether a contractual obligation to arbitrate exists. Thus, as in Hwang , where the parties’ agreement is clear on its face, courts will enforce it as written. Greenfield v. Philles Records, Inc. , 98 N.Y.2d 562 (2002) (“ written agreement that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms.”).

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.