Author: National Law Forum

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E-Verify Tentative Nonconfirmations: Don’t Panic Just Yet

Recent Business of Law Guest Blogger at the National Law Review, John Fay of LawLogix Group, Inc. provides a nice walk-through of what employers can expect when they receive a mismatch or tentative nonconfirmation (TNC) through the e-verify system. 

As an employer, there’s a certain amount of trepidation that comes with using the E-Verify system. While roughly 97% of all employees are instantly (or shortly thereafter) confirmed as work authorized, it’s the potential 3% which receive a mismatch or tentantive nonconfirmation (TNC)  that keep us up at night. Was there a mistake in the information that we submitted or perhaps a mistake with the SSA or DHS database? Or what if the employee is unauthorized to work? When do I have to terminate him? Processing a TNC requires employer guidance, employee action, and often, lots of patience. The most important thing to remember is that a TNC does not mean that your employee is unauthorized to work. It’s just the first step in an E-Verify dance with government systems. Sounds like fun, right?

Process Overview

First, there are many perfectly legitimate reasons for a TNC, and your role as the employer is to communicate that fact with your employee. For example, your employee could receive a Social Security mismatch because of the following:

  • Name, SSN or date of birth is incorrect in SSA database
  • Employee failed to report a name change to SSA (married name, perhaps?)
  • USCIS immigration status was not updated with SSA

You might also receive a DHS TNC because of the following:

  • Photo ID of green card, EAD , or US passport (starting September 26th) does not match DHS records (this is a comparison you would perform manually when prompted)
  • Information was not updated in DHS records
  • Citizenship or immigration status has recently changed
  • Name, alien number, and/or I-94 admission number were incorrect in DHS database

Regardless of the reason, you must first notify the employee in private of the TNC case result by printing the TNC Notice (to be signed) which is automatically generated by the E-Verify system. This letter explains all of the possible reasons why the TNC may have occurred and instructs the employee to review their information to make sure it was correct. Assuming it was, the employee then has 2 choices: CONTEST or NOT CONTEST. If the employee chooses to contest, then you must initiate a referral (in the E-Verify system) and provide them with a TNC Referral Letter (to be signed) that is automatically generated. This letter instructs the employee to contact the appropriate government agency (SSA or DHS) within 8 federal government work days to resolve the case. If there was a photo mismatch, you will also be instructed to send a copy to E-Verify. Alternatively, if the employee chooses not to contest, you may terminate employment and close the case.

The Waiting Game

Assuming that your employee has contested and you have properly referred them, the waiting game begins. E-Verify instructs employers that they will provide a case update (in the system) within 10 federal government working days. Employers using the web interface will need to check the system periodically, whereas employers using electronic I-9 systems can see updates automatically on their dashboard. Regardless of how you check, remember that you may not ask the employee for additional evidence of confirmation that SSA or DHS resolved the case. Doing so might be viewed as discriminatory. On the other hand, you should be diligent in checking on the case to see if there are updates. I did say this was a dance didn’t I?

Occasionally, the SSA or DHS may need more time to resolve a TNC – this could happen for a variety of reasons. Local SSA offices may be over-burdened with their core tasks (application for SSA benefits) or the employee may not have the documentation needed by SSA to support a change in their records. These record requests can add weeks to the process, and needless gray hairs to the worried HR representative. Regardless, the rules make it clear that you may not terminate, suspend, delay training, withhold or lower pay, or take any other adverse action against an employee based on the employee’s decision to contest a TNC or while the case is still pending with SSA.

The End Game

If all goes well, SSA or DHS will update its records and the employee’s case in E-Verify to indicate “Employment Authorized.” Occasionally, SSA may require the employer, employee or the U.S. Department of Homeland Security (DHS) to take additional action before a final case result can be issued. In these cases, SSA will update the employee’s case with a different message. Once the employee has received a final case status, such as “Employment Authorized” or “SSA FNC,” the employer must close the case in E-Verify. If the employee received an “SSA FNC,” the employer must also indicate whether the employee was terminated.

Paper Trail

If you review the last 4 paragraphs, you’ll notice I mentioned a variety of letters and notices. As with most areas of I-9 compliance, documentation is key. Therefore, as an employer, you’ll want to make sure to keep these signed letters on file with the I-9 (as instructed in your E-Verify User Manual). In the event of a government audit (relating to I-9s or E-Verify), you may be required to present these.  If you are usinga good electronic I-9 and E-Verify compliance system, the employee and employer should be able to electronically sign these letters, and the system should automatically attach them to the employee’s record along with a detailed audit trail.  Documentation is good, but paperless documentation with detailed audit trails is even better yet in building your “Good Faith” defense in case of an EEOC/OFCCP investigation and/or ICE audit!

More Information

Resolving TNCs can be a complicated process, and I’ve just given you a very brief overview. For more information, check out the USCIS web site here and review the latest E-Verify user manual. And if you’re stuck with a tricky E-Verify situation, make sure you consult experienced immigration counsel to avoid any missteps in this government dance

LawLogix Group, Inc. © 2001-2010 All Rights Reserved

Rise in Foreclosures + An Increase in Mortgage Fraud = More Homeowner Fires

A recent posting at the National Law Review by Rick Hammond of Johnson & Bell Ltd. highlights some of many problems related to mortgage fraud.  

According to recent reports, many insurers have experienced an increase in the number of fire claims since the onset of the subprime mortgage crisis.  Allegedly, many of these fires were intentionally set by homeowners facing foreclosure.  Not surprisingly, when homeowners’ monthly mortgage payments increase after their low introductory rates expire or when falling home values and stricter lending practices reduce the possibility of restructuring or refinancing loans, the natural result is an increase in the number of foreclosures and an increase in homeowner fires.

That’s not the only problem facing the insurance industry.  Insurers are also experiencing an increase in fires associated with the rise in mortgage fraud, which is also running rampant across the United States.  Mortgage fraud is generally defined as the intentional misstatement, misrepresentation, or omission by an applicant or other interested party relied on by a lender or underwriter to provide funding for a mortgage loan.

Victims of mortgage fraud include borrowers, mortgage industry entities, and those living in the neighborhoods affected by mortgage fraud. As properties affected by mortgage fraud are sold at artificially inflated prices, properties in surrounding neighborhoods also become artificially inflated. When property values are inflated, property taxes increase as well. Legitimate homeowners also find it difficult to sell their homes. When properties foreclose as a result of mortgage fraud, neighborhoods deteriorate and surrounding properties depreciate.

Legal Issues and Developing Law

  • Insurable Interest by the Insured

The threshold question in many cases involving mortgage fraud and its effect on insurance coverage is whether the insured has an insurable interest in the property at the time of a loss.  An insurable interest at the time of loss is essential to the validity of an insurance policy.  Hawkeye Security Ins. Co. v. Reeg, 128 Ill. App. 3d 352, 470 N.E.2d 1103 (Ill. App. Ct. 1984).  Generally speaking, a person has an insurable interest in property whenever he or she would profit or gain some advantage by a property’s continued existence, and suffer loss or disadvantage by its destruction. Lieberman v. Hartford Fire Ins. Co., 6 Ill.App.3d 948, 287 N.E.2d 38 (Ill. App. Ct. 1972).

To determine whether an individual has an insurable interest in property, a court will usually examine whether an economic benefit or detriment inures to the named insured under any set of circumstances.  In cases involving a straw person, a close examination of the facts might reveal that in every conceivable manner an insured did not contribute a single cent towards the purchase of the insured property or its maintenance.  That is, an investigation might reveal that every payment towards the purchase or maintenance of the insured premises was made by a straw person, that is, the property’s unidentified buyer-in-fact.

Therefore, a proper investigation would seek to determine whether a buyer-in-fact paid for the insurance, paid the initial down payment, the mortgage payments, and for all upkeep and necessary expenses, and whether he or she paid for every attendant cost for the property.  In these cases, the actual insured will likely not incur economic loss due to the damage suffered by the insured premises, nor gain economically from any recoverable insurance proceeds.  Simply put, the primary question is whether there was an actual relationship between the insured and the insured premises, or whether the insured’s relationship to the insured premises is illusory.

  • Mortgagee’s Duty to Notify Insurer of Foreclosure Proceedings

An insurer is often unaware of a pending foreclosure on property that it insures until after a fire has occurred.  Must a mortgagee, as a condition to receiving coverage, give notice to the insurer when that mortgagee initiates foreclosure?  A recent case in Tennessee is instructive in analyzing this question (See: U.S. Bank, N.A. v. Tennessee Farmers Mut. Ins. Co., 2007 WL 4463959).

In this case, a homeowner and insured fell behind on her monthly mortgage payments and the mortgagee, U. S. Bank, N.A., initiated foreclosure.  The bank sent a letter to the homeowner stating that it started foreclosure, but the bank neglected to give notice of the foreclosure to the property insurer, Tennessee Farmers Mutual Insurance Company.  Before the foreclosure process was completed, the homeowner and her husband filed for bankruptcy, which stayed the foreclosure proceedings.  Shortly thereafter, the house was destroyed by fire.

U.S. Bank filed a claim with the insurers, Tennessee Farmers, for the fire loss, but the insurer denied the claim because the bank had failed to notify Tennessee Farmers that a foreclosure had been initiated.  Tennessee Farmers stated that the foreclosure filing constituted an increase in hazard and, as such, the bank was required to notify the insurance company, and the bank’s failure to provide this notice was a breach of the policy’s mortgage clause, which stated:

We will:

(a)        protect the mortgagee’s interest in the insured building.  This protection will not be invalidated by any act or neglect of any insured person, breach of warranty, increase in hazard, change of ownership, or foreclosure if the mortgagee has no knowledge of these conditions

The trial court denied Tennessee Farmers’ motion for summary judgment and granted summary judgment to the bank.  The insurance company then filed an appeal.  On appeal, Tennessee Farmers argued that the foreclosure proceedings was an “increase in hazard” under the terms of the policy of insurance, and contended that the bank’s bad faith claim was unfounded.  On the other hand, U.S. Bank argued that commencing foreclosure proceedings did not constitute an increase in hazard, and asked the court to adopt the Kentucky’s court’s opinion in Anderson v. Kentucky Growers Ins. Co., Inc., 105 S.W.3d 462 (Ky. Ct. App. 2003).

In Anderson, the policy’s mortgage clause stated that the insurance company’s denial of the insured’s claim would not apply to a mortgagee’s claim if the mortgagee had notified the insurer of a “substantial change in risk of which the mortgagee becomes aware.”  In that case, the house was destroyed by fire, and the insurance company argued that the filing of foreclosure proceedings constituted a “substantial change in risk of which the mortgagee became aware.”

The court in Anderson ruled against the insurer, noting that insurance contracts are liberally construed in favor of the insured: “While we agree that the filing of foreclosure proceedings constitutes a ‘change of risk,’ we do not agree that such a change is necessarily ‘substantial.”  The court then concluded that the policy did not “clearly and unambiguously” require the mortgagee to give the insurer notice when foreclosure was initiated.  The court in Anderson further held that commencing foreclosure proceedings, while certainly a “change of risk,” did not constitute a “substantial change of risk” within the meaning of the mortgage clause.

The Tennessee Farmers’ court rejected the Anderson court’s analysis, noting that the mortgage clause in the Tennessee Farmer’s policy required notification of “any” increases in hazard, not just a “substantial” increase in hazard.  However, this issue remains a moving target.  Thus, after the Tennessee Court of Appeals agreed with the insurance company and reversed the trial court’s decision, U.S. Bank then appealed to the Tennessee Supreme Court.  The state’s high court held that the bank’s commencement of foreclosure proceedings was not an increase of hazard requiring notification to insurance company under the standard mortgage clause in a fire insurance policy, and the bank’s commencement of foreclosure proceedings was not an increase of hazard requiring statutory notification to insurance company.

  • Mortgage Fraud and the Insurer’s Right of Rescission

By its very nature, mortgage fraud involves the intentional misstatement and misrepresentation of material information to a mortgagee.  Often, the same misrepresentations made to the mortgagee are also made to an insurer on an insurance application and give rise to a rescission action.  For an insurer to rescind a policy due to misrepresentation, the insured’s statement must be false, and the false statement must have been made with the intent to deceive ormaterially affect the acceptance of the risk or hazard by the insurer.  Illinois State Bar Assn. Mut. Ins. Co. v. Coregis Ins. Co., 335 Ill. App. 156, 821 N.E.2d 706 (Ill. App. Ct. 2004).  In such circumstances, an insurance policy becomes voidable, not void ab initio, and an insurer can waive its right to void if it does not invoke it promptly.

However, in some states an insurer has no general duty to investigate the truthfulness of answers to questions asked on an insurance application.  Those states have recognized that “an insurance company has the right to rely on the truthfulness of the answers given by an insurance applicant, and the insured has the corresponding duty to supply complete and accurate information to the insurer.”  Commercial Life Insurance v. Lone Star Life Insurance, 727 F. Supp. 467, 471 (N.D. Ill. 1989).

However, an insurer is generally estopped from voiding a policy for untrue representations in the application if the insured discloses facts to the agent and the agent, in filling out the application, does not state the facts as disclosed to him, but instead inserts conclusions of his own or answers inconsistent with the facts. See Boyles v. Freeman, 21 Ill. App. 3d 535, 539, 315 N.E.2d 899 (Ill. App. Ct. 1974). Typically, an insurer cannot rely on incorrectly recorded answers, even when the insured knows that the agent has entered answers different from the ones he or she provided, if the incorrect answers are entered under the agent’s advice, suggestion, or interpretation.  Loganv. Allstate Life Insurance Co., 19 Ill. App. 3d 656, 660, 312 N.E.2d 416 (Ill. App. Ct. 1974).

Thus, the agent’s knowledge of the truthfulness of the statements is imputed to the insurer.  Generally, only when an applicant has acted in bad faith, either on his or her own or in collusion with the insurer’s agent, will a court refuse to impute the agent’s knowledge to the insurance company.

Most laws that are enacted to regulate rescission actions are designed to prevent insurance companies from rescinding policies based on cursory or unintended misstatements by an insured.  However, in cases involving straw persons, an argument can be made that the buyers-in-fact act as puppet masters and typically arrange to have the insureds’ names placed on the mortgage and the insurance policies to shield him or herself from exposure, while still enjoying potential profits from sales or insurance proceeds.  In these cases, a court will likely recognize this deceptive arrangement, and that the buyer-in-fact elicited an insurance policy using the purported insured as a front.  Arguably, a court should order rescission of the insurance policy in these types of cases.

  • Rescission of the Mortgagee’s Right of Recovery

Most policies’ mortgage clause does not address rescission of the contract, nor does it describe the mortgagee’s rights in the context of rescission, because these rights are, in fact, extinguished by rescission.  Therefore, a novel approach in cases involving fraud in the application for insurance is to file a declaratory judgment action seeking rescission and voiding of the policy, which will possibly render the mortgage clause inapplicable, and asking a court to bar the mortgagee from receiving any benefits of that clause.  Thus, rescission could potentially wipe the entire policy away, and the insurer would owe no contractual duties to either the insured or the mortgagee.  Assuming rescission is granted, in effect, the policy will have never legally existed, and all parties that had any putative rights under that policy would have none.

Importantly, some courts have held that an insurer’s right to rescind or deny coverage on the basis of fraud only applies to the claims of the insured, not to claims of innocent third-parties that are injured by the insured’s tortuous acts.  However, this argument is inapplicable here, since a mortgagee is not a third party but is tantamount to a first-party insured.  Moreover, contract law governs the alleged wrongful acts of the insured rather than tort law.

  • Increasing the Effectiveness of an Insurance Claims Investigation

To conduct a more effective investigation when faced with mortgage fraud and foreclosure issues, the author encourages insurers, as part of their investigations, to check the sales history of the insured premises because several sales within a short period of time could indicate false, inflated values.  Also, it is advisable to conduct a title search, checking with the local tax assessment office or recorder of deeds, to analyze the property’s ownership history and to ensure that the insured owns the property.  Interviewing and completing background checks on the appraisers and real-estate brokers that were involved in a transaction are also advisable.

Finally, review information regarding recent comparable sales in the area, and other documents, such as tax assessments, to verify the property’s value.  Reviewing a title history can help determine if a property has been sold multiple times within a short period, which could indicate that the property has been “flipped” and that the value is falsely inflated.

©2010 Johnson & Bell, Ltd. All Rights Reserved.

Adult Dancers at Penthouse, Claiming they are Employees not Independent Contractors, Granted Right to Proceed with Wage Claims as a Class Action

Who says Labor & Employment Law isn’t sexy? Richard J. Reibstein of Pepper Hamilton doesn”t think so.  In a recent post at the National Law Review, Richard provides some good insight on how businesses can effectively navigate the possible pitfalls of using Independent Contractors.

Within the past month, a federal court in Manhattan granted a motion for class action certification to a group of  adult dancers who have worked at the Penthouse Executive Club in New York City.  They alleged, among other things, that the Club violated the federal Fair Labor Standards Act (FLSA) by failing to pay them overtime for hours worked in excess of 40 per week, requiring them to pay a “house fee” that sometimes exceeded $100 per night, deducting service charges for tips paid in scrip issued by the Club, and requiring that the dancers share their tips with other Club personnel. Penthouse asserted as a defense that the adult dancers were independent contractors.

Judge Naomi Reice Buchwald found unpersuasive all five of Penthouse’s arguments, including that class certification would be improper because the issue of whether the dancers were independent contractors was unsuitable for class action treatment.  Penthouse argued that this type of inquiry regarding their status as employees or independent contractors required an individualized, fact intensive inquiry into the nature of the dancer’s relationships with the Club.

In a 16-page opinion, the New York federal district court judge rejected that argument.  As Judge Buchwald stated, a plaintiff’s burden in seeking a preliminary class action certification is “simply to make a ‘modest factual showing sufficient to demonstrate that [plaintiffs] and potential plaintiffs together were victims of a common policy or plan that violated the law.’ ”  In dismissing this argument, the judge noted that members of the proposed class “all hold the same job title, have the same job responsibilities, work at the same location, and, by extension, are subject to the same ownership and management.”  She concluded that “[i]f such a group does not merit at least preliminary class treatment, one would expect that class treatment would rarely be granted in FLSA actions, a proposition that is plainly incorrect as an empirical matter.”

This is by no means the first adult club class action misclassification case.  Other class action cases involving claims by adult dancers that they were improperly classified as independent contractors include an exotic dancer case in Massachusetts, an adult entertainment dancer case in Georgia, and another New York City adult dancer case.

A Couple of Takeaways:

1. Where a business uses a relatively large number of independent contractors or is built on an independent contractor model, it faces misclassification liability not only for unpaid overtime but also for unpaid:

  • unemployment taxes,
  • workers compensation premiums,
  • payroll taxes, and
  • employee benefits,

just to name some of the many types of claims made by workers who claim they were misclassified as independent contractors.

2. Businesses that use many independent contractors or pay workers on a 1099 basis are well advised to address the issue of their independent contractor compliance before receiving a notice from a state unemployment or workers compensation office, before receiving notice from the IRS or state revenue department that it will be conducting a tax audit, or before being served with a summons and complaint (which can lead to class action certification if the case involves a substantial number of similarly situated workers).

Regardless of any business’s current state of compliance with such laws, there are a number of ways by which organizations can enhance their future compliance and minimize their exposure to future misclassification liabilities, including the costs of defending class actions by workers who receive 1099s instead of W-2s.  See “Independent Contractor Misclassification: How Companies Can Minimize the Risks,” Pepper Hamilton LLP, Apr. 26, 2010.  Indeed, some of these class actions seek damages for unpaid employee benefits – an area of exposurethat can often be avoided simply by properly amending the language of a company’s benefit plans, as explained in the above article.

While efforts today to enhance independent contractor compliance cannot eliminate past exposure to misclassification liability, any changes that enhance compliance with the independent contractor laws will not only minimize or avoidfuture liability but also lessen the likelihood that the business will become a target for class action lawyers and government agencies.

Copyright © 2010 Pepper Hamilton LLP

Create Your Own Arbitration Provision: Two Recent Supreme Court Decisions Emphasize That Parties Have the Freedom to Define the Nature and Scope of Their Agreement to Arbitrate

Posted recently on the National Law Review by Damian V. Santomauro and Jennifer Marino Thibodaux of Gibbon PC – great analysis of the US Supreme Court’s recent interpretation of arbitration agreements: 

Arbitration provisions are a common component of a wide array of contracts, including many commercial and consumer agreements.  Recently, the Supreme Court of the United States issued two opinions addressing the enforceability of arbitration clauses that require businesses incorporating such clauses into their consumer agreements to re-evaluate how they are drafted and for those businesses that do not utilize such clauses in their agreements to reconsider whether to do so.  First, in Stolt-Nielsen S.A. v. AnimalFeeds International Corp.(“Stolt-Nielsen”), 130 S. Ct. 1758 (2010), the Court held that consent to class arbitration cannot be assumed based upon the parties’ general agreement to arbitrate and that a court cannot compel class arbitration where the arbitration clause is silent as to class arbitration.  Second, in Rent-A-Center, West, Inc. v. Jackson (“Rent-A-Center”), 130 S.Ct. 1758 (2010), the Court held that a party’s challenge to the validity of an arbitration agreement must be resolved by an arbitrator, not the District Court, where the agreement contains a provision delegating such issues to an arbitrator.  Taken together, these opinions (in both of which Justices Alito, Kennedy, Roberts, Scalia, and Thomas were in the majority) demonstrate that the direction of the current Court is to respect the language the parties used in their arbitration clauses, with a corollary emphasis on the underlying principle of parties’ freedom to contract.

The Stolt-Nielsen Decision

In Stolt-Nielsen, the Court considered a relatively straight-forward dispute among commercial parties regarding the propriety of ordering class arbitration where the parties’ arbitration provision was silent on the issue.  Specifically, the plaintiff, a supplier of raw ingredients utilized in animal fees, filed a demand for class arbitration seeking to represent a class of customers that had purchased transportation services from the defendant shipping companies.  130 S.Ct. at 1764-65.  The parties agreed that their dispute was subject to arbitration, but disagreed as to whether it could be arbitrated on a class-wide basis.  Ultimately, the parties agreed that an arbitration panel would decide whether class arbitration was appropriate in light of their arbitration agreement, which the parties stipulated was “silent” regarding class arbitration.  Id. at 1765.  When the arbitration panel determined that class arbitration could proceed under the arbitration clause because the parties’ evidence did not show an intent to preclude class arbitration, the shipping companies filed an application to vacate the arbitrators’ award.  Id. at 1766.  The District Court for the Southern District of New York vacated the award on the grounds that federal maritime law (and its emphasis on custom and usage) should have governed the issue, but the Court of Appeals for the Second Circuit reversed.  Id. at 1766-67.

On appeal, the Supreme Court, in a five to three decision (with Justice Sotomayor abstaining), reversed and held that the decision of the arbitration panel must be vacated pursuant to Section 10(a)(4) of the Federal Arbitration Act (“FAA”), 9 U.S.C. § 1, et seq., because the panel exceeded its powers by imposing its own views with respect to the policy of class arbitration in lieu of what the parties actually agreed to.  Id. at 1767-68.  Specifically, the Court concluded that the panel had failed to identify any rule of decision from the FAA, maritime law, or New York law that addressed the question of class arbitration where the parties’ contract was silent on the issue and, instead, simply based its decision on its own policy choice.  Id. at 1770.

In ascertaining the appropriate law to apply to the dispute, the Court held that “a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”  Id. at 1775 (emphasis in original).  The Court emphasized that, although interpretation of arbitration provisions is generally an issue of state law, the FAA imposes certain rules that must be considered, including that arbitration is principally an issue of consent.  Id. at 1773.  Noting that parties have the freedom to draft their arbitration provisions in accordance with their own preferences, including (1) the issues they want to arbitrate; (2) the rules under which an arbitration will occur; and (3) who will arbitrate the dispute, the Court said that in analyzing the nature and scope of an arbitration provision, courts and arbitrators must “give effect to the intent of the parties.”  Id. at 1774-75.

Although the Court could have remanded to the Court of Appeals for a rehearing in accordance with these principles, it elected to resolve the issue of class arbitration itself because, in light of the parties’ stipulation that the arbitration provision was silent, the Court determined that there was only one permissible outcome.  Id. Specifically, because the parties had stipulated that they had not reached an agreement on class arbitration, there was no basis to conclude that the parties had consented to arbitration on a class wide basis.  Id. at 1775.  Moreover, because of the significant differences between bilateral arbitration and class arbitration, the Court ruled that “[a]n implicit agreement to authorize class-action arbitration . . . is not a term that the arbitrator may infer solely from the fact of the parties’ agreement to arbitrate.”  Thus, the parties’ silence on the issue could not be presumed to confer consent to class arbitration.  Id. As a result, the Court held that because the parties had not expressly agreed on class arbitration, the parties could not be compelled to submit their dispute to class arbitration.

The Rent-A-Center Decision

The Rent-A-Centerdecision involved a dispute as to whether the court or the arbitrator decides the issue of whether the arbitration agreement is unconscionable.  In this case, the plaintiff employee sued his employer, Rent-A-Center, in the United States District Court for the District of Nevada, alleging employment discrimination.  130 S.Ct. at 2775.  The plaintiff had signed an arbitration agreement that expressly provided for arbitration of claims of discrimination and contained a provision that expressly delegated to the “[a]rbitrator, and not any federal, state, or local court or agency, [] the exclusive authority to resolve any dispute relating to the interpretation, applicability enforceability, or formation of the” arbitration agreement.  Based on the arbitration agreement, Rent-A-Center moved to dismiss or stay the proceedings under the FAA and to compel arbitration.  In opposition, the plaintiff employee argued that the arbitration agreement was unenforceable on the grounds of unconscionability.  Id.

The District Court granted Rent-A-Center’s motion to dismiss and to compel arbitration, finding that the “delegation clause” in the arbitration agreement, which provided that the arbitrator had the exclusive authority to resolve all disputes regarding the agreement, governed because the plaintiff was challenging the arbitration as a whole.  Id. at 2775-76.  On appeal, the Court of Appeals for the Ninth Circuit reversed on the question of whether the court or the arbitrator had the authority to determine whether the agreement was enforceable, concluding that where a party asserts that an arbitration agreement is unconscionable that threshold inquiry is for the court to decide regardless of what the agreement provides.  Id. at 2776.

On appeal, the Supreme Court, in a five to three decision (with the same five Justices in the majority as were in the majority in Stolt-Nielsen) reversed, holding that the question of the validity of the subject arbitration agreement was reserved for the arbitrator by the delegation clause.  Id. at 2779.  The Court’s opinion focused on the FAA’s recognition of “the fundamental principle that arbitration is a matter of contract” and noted that “the FAA [] places arbitration agreements on an equal footing with other contracts.”  Id. at 2776.  As a result, the Court stated that the delegation provision governed the dispute unless it was otherwise unenforceable pursuant to Section 2 of the FAA, which provides that arbitration provisions “shall be valid irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”  9 U.S.C. § 2.

In analyzing the enforceability of the delegation provision, the Court noted that there are two ways to challenge the validity of an arbitration provision under Section 2 of the FAA: (1) to challenge the validity of the specific arbitration provision at issue, or (2) to challenge the entire contract as a whole.  130 S.Ct. at 2778.  As the Court explained, only the former challenge implicates a court’s involvement because Section 2 of the FAA provides that a “written provision” to arbitrate is valid — without regard to the validity of the entire contract in which the provision is contained.  Thus, a party’s challenge to the entire contract does not preclude a court from enforcing a specific agreement to arbitrate, which is severable from the contract.  Id. In other words, only if a party challenges the validity of the specific arbitration provision, rather than the validity of the entire contract, is the inquiry one for the court.  Id.

Although the subject contract in this case was an arbitration agreement, the Court concluded, in the face of a strongly worded dissent, that was not a distinction with any significance, stating “[a]pplication of the severability rule does not depend on the substance of the remainder of the contract.”  Id. In this case, the plaintiffs unconscionability challenges (i.e. that the arbitration agreement was one-sided in that it only applied to claims of an employee and that the arbitration procedures called for by the arbitration agreement, including fee-splitting and limitations on discovery, were unconscionable) were all directed at the arbitration agreement as a whole.  Thus, because the plaintiff only challenged the validity of the contract as a whole (i.e. the arbitration agreement) and the not the specific arbitration provision at issue (i.e. the delegation provision in the arbitration agreement), the majority held that the delegation provision was enforceable under the FAA and the issue of the enforceability of the arbitration agreement was one that was within the exclusive authority of the arbitrator.  Id.

Analysis

Arbitration can, under certain circumstances, be a less expensive and more efficient forum in which to resolve disputes than traditional litigation.  The Stolt-Nielsen and Rent-A-Center decisions provide parties with the ability to craft arbitration provisions with clearly defined parameters, and potentially allow parties to more readily ensure that their disputes are addressed in arbitration.

As an initial matter, the Rent-A-Center decision enables parties to exert greater control over the forum in which issues relating to their arbitration agreement are resolved.  Specifically, parties can draft arbitration agreements limiting a court’s involvement in any subsequent dispute regarding the arbitration agreement by including a delegation clause in the agreement that expressly requires that all disputes regarding the arbitration agreement, including those that challenge the enforceability of the arbitration agreement, will be decided by the arbitrator rather than a court (conversely, parties may draft a delegation provision that requires the court to resolve such disputes, although the use of such provisions is unlikely given that the parties have agreed to arbitrate the underlying dispute).  In such an agreement, only challenges specifically directed to the validity of the delegation clause could be heard by a court, while challenges to the arbitration agreement as a whole would be addressed by the arbitrator.  Thus, the practical effect of theRent-A-Center decision is that disputes between parties with arbitration agreements containing such delegation clauses are more likely to be arbitrated than in the past.  That is, because a delegation clause referring disputes regarding the arbitration agreement to arbitration is generally more difficult to invalidate in court than an arbitration agreement as a whole, 130 S.Ct. at 2778 andRent-A-Center provides that the court can only consider the former, arbitration should now be easier to successfully invoke in that (1) opposing parties will be less likely to resist referral to arbitration and/or (2) courts will be more likely to refer the dispute to arbitration because of the limitations imposed by Rent-A-Center on their authority to invalidate arbitration agreements.

While the Rent-A-Center decision related to a delegation provision in a stand-alone arbitration agreement, the Court’s holding should be equally applicable where the delegation clause is contained in an arbitration provision that is part of a larger contract.  Indeed, as the dissent noted in Rent-A-Center, “the written arbitration agreement [was] but one part of a broader employment agreement between the parties.”  Id. at 2782.  Until further clarification is provided by District Courts or Circuit Courts of Appeal, however, it may be prudent for businesses to utilize arbitration agreements (containing the appropriate delegation clause) that are separate from, but still applicable to, the underlying contract.

The Stolt-Nielsen decision enables parties to more readily control the forum in which class claims will be resolved.  That is, unless the parties specifically agree to arbitrate class claims, an agreement to arbitrate does not compel arbitration of class claims.  This decision, thus, provides significant protection for parties that want to arbitrate individual claims, but ensure that any class claims are litigated in the courts.  Although the decision in Stolt-Nielsen provides that silence on the issue of class arbitration does not equal consent, the preferred practice is for business to expressly include provisions in their arbitration agreements that the parties do not consent to class arbitration.

In addition, Stolt-Nielsen calls into question those decisions in which courts have held that class arbitration waivers are unconscionable and unenforceable, severed such waivers from the arbitration provision, and compelled arbitration of all claims, including class claims.  If silence cannot be construed as consent to class arbitration, then arbitration provision containing a class arbitration waiver, even if that waiver is determined to be unenforceable, should not be construed as consent to class arbitration.  Nevertheless, business can avoid any ambiguity on the issue by expressly stating that (1) the class arbitration waiver is not severable from the arbitration agreement and (2) if a court or other authority determines that the class action waiver is unenforceable, then the parties do not consent to arbitration of any class claims.

Finally, it is important to note that the Supreme Court’s grant of certiori in AT&T Mobility LLC v. Concepcion, 130 S.Ct. 3322 (May 24, 2010) has the potential to drastically alter the nature and scope of enforceable arbitration provisions and significantly increase the use of such provisions, particularly in consumer contracts.  In this case, the Court of Appeals for the Ninth Circuit held that the FAA did not expressly or impliedly preempt California state law regarding the unconscionability of class arbitration waivers in the arbitration agreements.  Laster v. AT&T Mobility LLC, 584 F.3d 849 (9th Cir. 2009).  That the Supreme Court granted certiori suggests, particularly in light of the Stolt-Nielsen and Rent-A-Center cases, the potential that the Court may conclude that the FAA — and not state law — governs the issue of the enforceability of class action waivers and that such waivers are enforceable.  If that were to occur, then such a decision could, depending upon the nature and scope of the Court’s decision, enable businesses to potentially insulate themselves from class actions in either the courts or arbitration proceedings through the utilization of arbitration agreements contain class arbitration waivers (i.e. an enforceable agreement that refers the parties to arbitration to resolve any dispute relating to the agreement, but expressly provides that such disputes may not be arbitrated on a class-wide basis).

Conclusion

The Supreme Court’s decisions in Stolt-Nielsen and Rent-A-Center evidence the significance of the FAA and signal that the Court, as currently constituted, is likely to enforce the terms of arbitration provisions in parties’ agreements as written.  Thus, even in circumstances that may be susceptible to concern as to whether the parties really had a “freedom to contract,” parties will more likely be bound by the terms of their written arbitration agreements, and there is a significant likelihood that these decisions will result in the federal courts referring more litigation to arbitration where the parties’ agreements so provide.  The Court’s pending decision in Concepcion promises to provide further direction from the Court regarding the scope of the FAA and, when the Court issues this decision, businesses and parties to contracts should further assess their use of arbitration provisions and the validity and enforceability of the language they include in such provisions.

© 2010 Gibbons P.C., All Rights Reserved.

Should Jurors Use the Internet?

The National Law Review would like to congratulate Gareth Lacy of the University of Washington School of Law as one of our Fall 2010 Law Student Legal Writing Contest Winners! 

During trials jurors are increasingly using cell phones and other devices capable of accessing the Internet. Courts are responding by amending court rules to explicitly ban these devices. This Article points out problems with these new court rules. This Article also reviews scientific literature on the effect of pre-trial publicity on jury decision-making to conclude some concerns about outside Internet research may be unwarranted. This Article exposes weaknesses in the arguments against allowing jurors to conduct outside Internet research.

Introduction

“Jurors are rarely brilliant and rarely stupid, but they are treated as both at once.” – Judge Warren K. Urbom[i]

“When lawyers speak about courtroom technology, they are typically debating the merits of making their presentations in Powerpoint.”[ii]

2010 is the year of mobile Internet. One quarter of all Americans get news via their cell phones.[iii] Amazon’s Kindle e-reader allows readers to carry thousands of novels and access the Internet with a single notepad-sized device. As jurors bring these devices into the courtroom, they are causing quite a commotion. Last year several courts ordered mistrials after discovering jurors had accessed Wikipedia or became Facebook friends with their fellow jurors during trial.[iv] Following a case in Florida that ended in mistrial, counsel told the New York Times that courts have been unprepared for this new technology in the courthouse: “It’s the first time modern tech­nology struck us in that fashion, and it hit us right over the head.”[v]Now that 22 million U.S. cell phone users access the mobile Internet on a daily basis, courts must respond quickly and effect-tively.[vi]

This article will first explain why the recent response to increasing use of outside information—“just say no”—will be inadequate. Second, it will ques­tion the underlying assumption that access to outside information is always harmful. Third, it will argue that denying useful tools and information is unwise in the face of increasingly complex trials.

I. Judicial Response: “Just Say No”

Courts and commentators fear that access to the Internet could introduce bias into trial proceedings.[vii] The court rules and jury instructions are apparently designed to ensure jurors only consider evidence admitted at the appropriate time.[viii] But the underlying rationale for these rules is not made clear to jurors. Jurors are therefore likely to feel—rightly so—information is being hidden from them.

Courts have recently responded by drafting new jury instructions and admonitions. New York’s criminal jury instruction, for example, explains that basing opinions on news reports, rather than trial testimony, would be unfair to both parties:

Finally, our law requires that you not read or listen to any news accounts of the case, and that you not attempt to research any fact, issue, or law related to the case. Your decision must be based solely on the testimony and other evidence presented in this courtroom. It would not be fair to the parties for you to base your decision on some reporter’s view or opinion, or upon information you acquire outside the courtroom.[ix]

This is a slightly persuasive effort to explain the reasoning behind the court’s rule. An instruction in Oregon goes a bit further by explaining the rule in the context of everyday experience:

In our daily lives we may be used to looking for information on-line and to “Google” something as a matter of routine. Also, in a trial it can be very tempting for jurors to do their own research to make sure they are making the correct decision. You must resist that temptation for our system of justice to work as it should. I specifically instruct that you must decide the case only on the evidence received here in court.[x]

Again this instruction is better than nothing, but it still fails to explain why the “system of justice” requires restricting access to outside information. Any-thing short of transparent explanations will likely continue to feed jury—and public—mistrust for the legal system.

In February 2010, the U.S. Judicial Conference suggested jury instruc­tions on the use of “electronic communication technologies.[xi] The instruc­tions ban a laundry list of devices and resources—“blogs, websites such as Facebook, MySpace, LinkedIn, YouTube or Twitter, to communicate to anyone any information about this case or to conduct any research”—but fail to explain why jurors should not, for example, look up the definition of “lividity.”[xii] Again, if courts want to convince jurors not to “google” on their cell phones, they must give concrete explanations for the court rules.

Failure to explain the reason for a ban can create mistrust for the judicial system. A recent New York Times article on jurors’ use of the Internet gathered 300 comments in one hour,[xiii] some of which expressed belief in a “systemic effort to keep jurors from learning the truth . . . [in which] jurors, therefore, needed to dig deeper to uncover the truth.”[xiv] What can ease this mistrust? Clear and convincing explanations of judicial policies will help. Furthermore, giving jurors the tools and information in court that they need to make informed decisions in court will make them less likely to look out of court for answers.

II. Does Outside Research Really Bias Jurors?

After commentators raise concerns about jurors turning to extrinsic information, their most common recommendation is for courts to issue stronger admonitions to juries.[xv] Other suggestions include more vigorous voir dire or banning cell phones in the courthouse.[xvi] The problem with these recommen-dations is that courts are already doing most of these things. Juries are already told not to conduct outside research. Voir dire is about as vigorous as it can get.[xvii] Cell phone bans might help for one-day trials, but they will have no effect—and maybe even adverse effects—on multiday litiga­tion. In short, commentators have offered few new suggestions for how to respond to juries using the Internet.

The reason these suggestions have been minimal is because they contain an underlying assumption that external information biases jurors. This assumption therefore restricts the judiciary’s options; if external information is always harmful, cell phone and Internet policies should not be liberalized. One California legislator who adopts this view introduced a bill imposing criminal penalties on jurors who access the Internet.[xviii] This assumption behind the restrictive policies—that external information is always harmful—should be questioned.

Courts and commentators have generally not given balanced appraisals of the scientific research on the effect of outside information on jury decision-making.[xix]For example, a recent article on jury Internet usage states confi­dently: “[j]urors may feel their searching is harmless and will not bias them, something that research has demonstrated is untrue.”[xx] But has scientific research really demonstrated outside research is always harmful? Indeed some research suggests jurors are influenced by pretrial publicity or negative information.[xxi] But the majority of these studies were laboratory simulations, not field studies of actual jury behavior.[xxii]Moreover, a close examination of the scientific evidence reveals more nuanced data than most courts and commentators have acknowledged.[xxiii]

Researchers have found, for example, that in federal criminal cases “it does not appear that highly publicized defendants are treated much differently in terms of ultimate conviction rates than defendants who receive no publicity at all.”[xxiv]Moreover, it was low levels of publicity that resulted in greater probability of conviction.[xxv] Other research found evidence that pretrial publicity did not influence trials outcomes.[xxvi] These results suggest that courts ought to focus on the content and quantity of the information jurors receive, rather than on outright bans.

Researchers have also found that when juries learn substantial and contrary information from evidence and judicial instructions during trial, they are capable of displacing information received before trial.[xxvii] In other words, prior beliefs are diluted by new, relevant information.[xxviii] When trial evidence is strong, this can reduce the effect of bias and external information: “the effect of irrelevant, inadmissible, or biasing information is reduced in its effect to the degree that relevant, probative evidence is available for the jurors’ considera-tion.”[xxix] Again, this suggests that courts should manage the flow of information rather than make unrealistic efforts to weed out all juror expo­sure to the Internet.

III. Giving The Internet A Second Chance

“A major question is whether the protective cocoon we want to preserve of the courtroom trial, where jurors calmly and dispassionately receive only relevant and reliable information based on evidentiary rules . . . can viably be maintained in the face of the informational tsunami pressing against it.”[xxx]

For decades, various groups of judges and scholars have called for better tools in the courtroom. They have argued for engaging jurors in the legal process by providing trial notebooks summarizing key information, allowing jurors to take notes, granting access to dictionaries, and allowing jurors to ask questions.[xxxi]These calls for juror engagement have met with vocal approval but have led to few concrete changes.[xxxii]

Jurors are not going to stop looking at outside information. The best way to keep jurors away from Wikipedia would be to sequester them. But seques­tration is rarely practical on a large scale because it is prohibitively expensive and tends to promote mistrust for the jury system.[xxxiii] A more realistic response would be for attorneys and courts to conduct advance Internet research to identify what information about their case is available online, analyze that information, and then deal with it during trial. Another realistic response would be to give jurors the tools they need to make informed decisions in court so they do not need to conduct outside research.

Jurors want to know everything they can about a case so they can make informed decisions. But rather than promote the jury’s interest in Truth and Justice, courts tend to discourage curiosity and obscure information. For example, some courts still debate the “fairly recent innovation” of “allowing jurors to take notes during trial.”[xxxiv] Note-taking! And while some evidence shows judicial resistance to note-taking may be waning, individual judges still have the final say.

Juries were not always this sheltered. For four-hundred years after William the Conqueror’s reign, jurors were expected to investigate facts and “declare the truth” on the basis of personal knowledge.[xxxv] Even after sworn testimony became common in the sixteenth century, jurors were still permitted to ask questions. It was only when lawyers began to assert the func­tion of law-making and law-finding that “[t]struggle for control over the jury came to a head.”[xxxvi] Rules of evidence then emerged to limit the information available to juries and to control how the information was received.[xxxvii] Jury power was ultimately curbed by strong demands from bankers, merchants, and industrialists for a more predictable—and sympathetic—legal system.[xxxviii] As for the prohibition against note-taking? That arose at a time when most jurors were illiterate.[xxxix]

Today the legal profession may be justified in exercising caution in some circumstances, but it is absurd to continue many of these traditional prac­tices. Trials can involve hundreds of witnesses and thousands of exhibits. No juror can store all that information in his or her head. Even in shorter trials, jurors would be well-served by note-taking. Psychologists (and law students) have known for some time that the dual process of hearing and writing enhances retention.[xl] And lest there be any concern about the law: Trial judges are well within their authority to allow note-taking during trials.[xli]

In the early 1990s, one-hundred law professors, attorneys, judges, researchers, and representatives of business, insurance, and various interest groups met in North Carolina to consider the workings of the jury system and to recommend improvements. The participants did not agree about everything, but the overwhelming proportion strongly supported making jurors more active during trials:

Jurors need not and should not be merely passive listeners in trials, but instead should be given the tools to become more active participants in the search for just results. To that end, trial procedures and evidentiary rules should take greater advantage of modern methods of communica­tion and recognize modern understanding of how people learn and make decisions.[xlii]

Jurors want answers to their questions. Some judges have begun to allow jurors to submit questions to the court and to allow attorneys to provide answers. This is a good start. But courts are competing with pocket-sized encyclopedias inside every cell phone, so they will need to explain to juries exactly why the court rules exist. And of course lawyers must be permitted to deliver useful information to reduce the desire to turn to outside sources.

Conclusion

“Once a new technology rolls over you, if you’re not a part of the steam­roller, you’re part of the road.” – Stewart Brand

It is still quite fashionable to attack the jury system as moribund. Indeed jury participation is at an all-time low. Jurors report feeling unengaged. But it is not correct to blame the jury for the judicial system’s failures. Alexis de Tocqueville found a key purpose of the American jury was to be a “gratuitous public school” that empowers citizens with information about how to take charge of social affairs.[xliii] It is simply time to add some technology to this civics classroom. It is time to give jurors the tools they need to do their job.

 

[i]Warren K. Urbom, Toward Better Treatment of Jurors by Judges, 61 Neb. L. Rev. 409, 425 (1982).

[ii]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257, 1273. (2001).

[iii] Kristen Purcell, et al., Understanding the Participatory News Consumer, Pew Research  Center 5 (Mar. 1, 2010), available at http://www.pewinternet.org/~/media//Files/Reports/ 2010/PIP_Understanding_the_Participatory_News_Consumer.pdf.

[iv]John Schwartz, As Jurors Turn to Web, Mistrials Are Popping Up, N.Y. Times, Mar. 18, 2009, available at http://www.floridasupremecourt.org/decisions/probin/sc10-51_AppendixD.pdf.

[v] Id.

[vi]Enid Burns, Mobile Internet Usage Becomes the Norm for Many in U.S., Search Engine Watch, Mar 17, 2009, http://searchenginewatch.com/3633213.

[vii]Hillary Hylton, Tweeting in the Jury Box: A Danger to Fair Trials?, Time, Dec. 29, 2009, http://www.time.com/time/nation/article/0,8599,1948971,00.html.

[viii]Evan Brown, Some thoughts on jurors doing internet research – keep the process clamped down,  Internet Cases, Jan. 2, 2010, http://blog.internetcases.com/2010/01/02/some-thoughts-on-jurors-doing-internet-research-keep-the-process-clamped-down/.

[ix] Jury Admonitions In Preliminary Instructions, May 5, 2009, www.nycourts.gov/cji/1-General/CJI2d.Jury_Admonitions.pdf.

[x]Gregory S. Hurley, Cell Phone Policies/Instructions for Jurors, Jur-E Bulletin, May 1, 2009, http://view.exacttarget.com/?j=fe4f1579726d04747313&m=ff3417737561&ls=fe03 13707667047d74147970&l=feee117976630d&s=fdf015757d6006757d127377&jb=ffcf14& ju=fe2116727c6d0778771377.

[xi]Proposed Model Jury Instructions The Use of Electronic Technology to Conduct Research on or Communicate about a Case (Jan. 28, 2010), http://www.wired.com/images_ blogs/threatlevel/2010/02/juryinstructions.pdf.

[xii]A Maryland appeals court threw out a first degree murder conviction after a juror, confused by the word “lividity” during a murder trial, looked up the term on Wikipedia. Del Quentin Wilber, Social networking among jurors is trying judges’ patience, Wash. Post, Jan. 9, 2010 at C01.

[xiii]John Schwartz, As Jurors Turn to Web, Mistrials Are Popping Up, N.Y. Times, Mar. 18, 2009, available at www.nytimes.com/2009/03/18/us/18juries.html.

[xiv]Douglas L. Keene & Rita R. Handrich, Online and Wired for Justice: Why Jurors Turn to the Internet, The Jury Expert 14 (Nov. 2009) http://www.astcweb.org/public/publication /article.cfm/1/21/6/Why-Jurors-Turn-to-the-Internet.

[xv]See,e.g., Ellen Brickman, et al., How Juror Internet Use Has Changed the American Jury Trial, 1 J. Ct. Innovation 297 (2008).

[xvi] See e.g., Anita Ramasastry, Why Courts Need to Ban Jurors’ Electronic Communications  Devices, Findlaw, Aug. 11, 2009, http://writ.news.findlaw.com/ramasastry/20090811.html.

[xvii]Ironically some commentators have recommended doing background checks on jurors by using the very resources, for example Facebook, they seek to ban.

[xviii]Paul Elias, Courts finally catching up to texting jurors, Associated Press, Mar. 6, 2010, http://abcnews.go.com/US/wireStory?id=10028507.

[xix]Ellen Brickman, et al., How Juror Internet Use Has Changed the American Jury Trial, 1 J. Ct. Innovation 287 (2008).

[xx]Id. (emphasis added).

[xxi]See Brickman, et al., supra, note 19, at 290 nn. 2-8 (citing Amy L. Otto et al., The Biasing Impact of Pretrial Publicity on Juror Judgments, 18 Law & Hum. Behav. 453 (1994)); Christina A. Studebaker & Steven D. Penrod, Pretrial Publicity: The Media, the Law, and Common Sense,
3 Pscyhol. Pub. Pol’y & L. 428 (1997); Studebaker, et al., Assessing pretrial publicity effects: Integrating content analytic results, 24 Law & Hum. Behav. 317 (2000); Neil Vidmar, Case Studies of Pre- and Midtrial Prejudice in Criminal and Civil Litigation,26 Law & Hum. Behav. 73 (2002). None of these studies offer full support for Brickman et al.’s assertion that research on pretrial publicity is definitive. Otto et al., found negative information about a defendant’s character can influence initial judgments about the defendant’s guilt, but this bias is weakened by trial evidence. Otto et al., supra, at 453. Studebaker and Penrod assessed pretrial publicity effects reported in previous studies, but did not offer new evidence; they merely “propose[] a multimethod research approach by which meditational mechanisms can be assessed.” Studebaker & Penrod, supra, at 428. Studebaker et al., did not study juries per se, but instead conducted a content analysis of media coverage of the Oklahoma City bombing. Studebaker et al.,supra, at 317. Vidmar points out deficiencies in research on prejudicial publicity and explains how courts have rejected research based on laboratory simulations rather than actual case studies. Vidmar, supra, at 73.

[xxii]See Studebaker, et al., supra note 21, at 317.

[xxiii]SeeJon Bruschke & William E. Loges, Free Press vs. Fair Trials: Examining Publicity’s Roles in Trial Outcomes(2004).

[xxiv] Jon Bruschke & William E. Loges, Relationship Between Pretrial Publicity and Trial Outcomes, 49 J. of Comm. 104, 115 (1999).

[xxv]Id. at 114.

[xxvi]See e.g., J. L. Freedman & T. M. Burke, The Effect of Pretrial Publicity: The Bernardo Case, 38 Can. J. Criminology 253 (1996); John S. Carroll, et al., Free Press and Fair Trial: The Role of Behavioral Research, 10 Law & Hum. Behav. 187 (1986); D. R. Pember, Does Pretrial Publicity Really Hurt? 23(3) Colum. Journalism Rev. 16 (1984); H. E. Rollings & J. Blascovich, The Case of Patricia Hearst: Pretrial Publicity and Opinion, 27 J. of Comm. 58 (1977).

[xxvii]Rita J. Simon, Does the Court’s decision in Nebraska Press Association fit the research evidence on the impact on jurors of news coverage?, 29 Stan. L. Rev. 515 (1977); accord Martin F. Kaplan, Cognitive Processes in the Individual Juror, in The Psychology of the Courtroom 197 (1982); but see Geoffrey P. Kramer et al., Pretrial Publicity, Judicial Remedies, and Jury Bias, 14 Law & Hum. Behav. 409 (1990) (finding judicial admonition had no effect and deliberations exacerbated negative effects of factual or emotional information).

[xxviii]Martin F. Kaplan & Lynn E. Miller, Reducing the Effects of Juror Bias, 36 J. Personality & Soc. Pscyhol. 1443 (1978).

[xxix]Michael J. Saks, What Do Jury Experiments Tell Us About How Juries (Should) Make Decisions?, 6 S. Cal. Interdisc. L.J. 1, 28 (1997).

[xxx]Michael Hoenig, Juror misconduct on the Internet, N.Y. L.J., Oct. 8, 2009.

[xxxi]Interview by Donald C. Dilworth with Judge B. Michael Dann, Arizona Superior Court, Waking up Jurors, Shaking Up Courts, Trial, July 1, 1997, at 20, available athttp://www. thefreelibrary.com/_/print/PrintArticle.aspx?id=19634468; The Honorable B. Michael Dann, “Learning Lessons” and “Speaking Rights”: Creating Educated and Democratic Juries, 68 Ind. L.J. 1229, 1241 (1993); William W. Schwarzer, Reforming Jury Trials, 1990 U. Chi. Legal F. 199, 137 (1990); Warren K. Urbom, Toward Better Treatment of Jurors by Judges, 61 Neb. L. Rev. 409, 425 (1982).

[xxxii]ABA/Brookings Symposium, Charting a Future for the Civil Jury System 16 (1992).

[xxxiii]James P. Levine, The impact of sequestration on juries, 79 Judicature 266 (1995).

[xxxiv]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257, 1276. (2001). Believe it or not, the merits of note-taking is still subject to some scholarly debate. See e.g., Victor E. Flango,Would Jurors Do a Better Job if They Could Take Notes?, 63 Judicature 436 (1979-1980); Steven D. Penrod & Larry Heuer, Tweaking Commonsense: Assessing Aids to Jury Decision Making, 3 Psychol., Pub. Pol’y & L. 259, 271 (1997); Irwin A. Horowitz & Lynee ForsterLee, The Effects of Note-Taking and Trial Transcript Access on Mock Jury Decisions in Complex Civil Trial, 25 Law & Hum. Behav. 373 (Aug. 2001).

[xxxv]Blackstone’s Commentaries on the Law 673-77 (Bernard C. Gavit ed., 1941).

[xxxvi]Morris S. Arnold, Law and Fact in the Medieval Jury Trial: Out of Sight, Out of Mind, 18 Am. J. Legal Hist. 267, 279 (1974).

[xxxvii]Lawrence M. Friedman, A History of American Law 101 (3rd ed. 2005).

[xxxviii]Morton J. Horwitz, The Transformation of American Law 1780-1860 140-41 (1977).

[xxxix]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257 (2001).

[xl]Elizabeth F. Loftus, Memory 19-20 (1980).

[xli]See e.g., Johnson v. State 887 S.W. 2d 957 (Tex Crim. 1994); Sonja Larsen,Taking and use of trial notes by jury, 36 A.L.R. 5th 255 (1996).

[xlii]ABA/Brookings Symposium, supra note32, at16.

[xliii]Alexis De Tocqueville, 1 Democracy in America 266 (Henry Reeve trans., George Adlard 2d ed. 1838) (1830).

Copyright © 2010 Gareth Lacy

 

Final Genetic Information Non Discrimination Act "GINA" Regulations Impact All Employers

From National Law Review’s featured blogger Patricia Anderson Pryor of Taft Stettinius & Hollister LLP, important information for both employers and employees about the Genetic Information Non Discrimination Act (“GINA”).

On November 9, 2010, the EEOC published its final regulations concerning the employment aspects of the Genetic Information Non Discrimination Act (“GINA”).

Although very few employers consciously utilize genetic information or discriminate against individuals because of genetic information, the prohibitions in GINA impact all employers.  Prohibited genetic information includes medical information about an employee’s family members.  The new regulations provide that an employer may violate GINA even if the employer does not specifically intend to acquire genetic (or family medical) information.

Many employers inadvertently come into contact with what the law defines as “genetic information” when they send employees for medical exams, when they request medical information in connection with requests for accommodation or requests for leave, when they provide employee wellness programs, when their supervisors engage in, or overhear, general, water cooler type conversations or even when supervisors look through Facebook posts.

In order to protect themselves, employers may need to update postings, policies and leave of absence or other medical request forms.

Employers should take precautions to avoid receiving genetic information in connection with requests for medical information and medical exams.

An employer who requests medical information from an employee or provider to support a request for an accommodation, FMLA leave or other leave, may inadvertently receive genetic information, including family medical information, that is already contained in the provider’s file.  The regulations provide that such receipt will not run afoul of GINA if either the employer informed the provider not to provide genetic information, with language similar to that suggested by the EEOC, or the request was so narrowly tailored that the request for medical information was not likely to result in the production of genetic information.

However, according to the final regulations, if an employer is requiring an employee to submit to a medical exam in connection with employment (either a pre-employment/post-offer exam or a fitness for duty exam), the employer “must” tell the health care provider not to collect genetic information, including family medical history, as part of the exam.  If the provider nonetheless requests genetic information, the regulations provide that the employer may need to take additional reasonable measures, including potentially no longer using that health care professional’s services.

Wellness programs cannot include a financial incentive for the disclosure of genetic information.

Many wellness programs include a health risk assessment that often requests family medical history.  Requesting genetic information in connection with a wellness program is permissible only if the employee’s participation is knowing and voluntary (among other things).  The final regulations clarify that “voluntary” means that an employer cannot offer a financial incentive to induce individuals to provide genetic information.  If a health risk assessment includes questions concerning genetic information, the employer must inform the employees that any incentive will be provided regardless of whether the employee answers the particular questions identified as requesting genetic or family medical information.

Information obtained through casual conversations or social network sites may still be inadvertent, as long as there is no intentional probing.

The final regulations keep intact the exceptions for certain inadvertent acquisitions of genetic information, including a supervisor overhearing a conversation about an employee’s genetic information or a family member’s medical condition or a supervisor viewing similar information on a social media site that he or she had permission to access.

However, the new regulations clarify that although an employer may obtain genetic information inadvertently or through information that is publicly or commercially available, these exceptions do not apply if the employer has deliberately sought the information by asking probing questions or searching for genetic information on line.

GINA’s requirements go far beyond simply prohibiting genetic testing.

Copyright © 2010 Taft Stettinius & Hollister LLP. All rights reserved.

Law Firm Business Development Must Mature in an Increasingly Competitive Market

Featured Business of Law Blogger this week at the National Law Review is Angela Spall of Williams Mullen.  Angela provides some great specific points about business development for law firms during these trying economic times. 

The legal profession continues to find itself in increasingly competitive markets.  The focus on business development has by necessity sharpened.  The key to a successful business development program in a law firm is to provide lawyers with the best possible competitive advantage in a highly competitive marketplace.

Vital components in building a successful business development program encompass the following:

Business development professionals, in a fully supported marketing department, must be as focused as the lawyers they serve and experts on the practice areas and industries they are assigned.  Credibility will be a key factor in working successfully with lawyers. The following are the recommended requirements for an effective business development professional:

  • Assigned to practice areas and industries where they must become experts.
  • Conduct comprehensive research to identify challenges and opportunities within a client entity, an industry or a target prospect.
  • Support and coach their lawyers in business development techniques.
  • Understand the sales process and most likely have had a background in sales or sales support.
  • Regularly engage in client feedback or end-of-matter interviews.
  • Regularly present proactive ideas to practice and industry groups.
  • They must be in an integral strategic role in all business development activities working alongside the lawyers they support.

Teamwork is vital in successful business development in law firms.  Business development professionals and lawyers must work together in client and industry teams for successful results. Teamwork must be rewarded and compensation systems must take into account the whole team that brought the business in or expanded a client relationship.  Encouraging teamwork ensures all levels of expertise and skills are used effectively and rewarded accordingly.

Keep your targets organized. Targets, whether they are prospects or clients, must be worked across the board. Use technology to access and store information on targets and clients and their industries so that it is readily available 24/7.  Opportunities can happen at any time.  In business development, making your own luck by being prepared and ready to act quickly without too many prior meetings or discussions, is imperative.  A window of opportunity can be jumped through by a competitor and can close quickly.

Clients will always be THE top priority.  Clients want all the things that clients or customers in any industry want: value for their dollar.  Providing value is more about results than it is about cost; it is more about knowledge, expertise, and trusting relationships.  Clients are the number one business development source and law firms must be competitive in how services are offered and delivered to their clients.  Expanding client relationships is still an under-utilized business development action.  Client feedback and end-of-matter interviews are a necessity.

It has been said that many law firms succeed despite themselves.  But, after a deep recession and the economy experiencing a slow recovery, it is time for law firms to invest in key areas to be competitive.  You will need technology to help streamline the business development process.  You will need to invest in qualified and experienced individuals, attorneys and non-attorneys alike to be successful. These areas of investment include:

  • Installing technologies such as Contact Relationship Management (CRM) and Email Relationship Management (ERM) and the newer add on tools that assist lawyers and business development professionals in providing ways to organize and utilize client and target contact information.
  • Research software that can quickly access business information of all kinds to pull together business and industry information.
  • Motivate lawyers and practice and industry teams by investing in appropriate reward systems through innovative approaches to compensation programs.
  • Ongoing training for lawyers and staff in business development, client service, technologies, the business of law, etc. Effective business development techniques can be learned.  While innate skills are highly valued, training lawyers in business development at an early point in their careers will benefit the firm in the long term.
  • Invest in people by hiring the best qualified and providing them the tools to be effective in their responsibilities.

And finally, and this has been said and written time after time by so many other marketing professionals, business development professionals must encourage their lawyers to accept and embrace business development as an essential part of their professional lives. No other time in the last 20 years has it been so critical to take care of your clients, participate in activities that get you in front of clients and prospects, take care of reputation management, and becoming known in your communities through building practice expertise and volunteering time in community organizations.  These activities will pay off.

Originally published in the Fall 2010 issue of LMA Practice Marketing Newsletter Copyright 2010 Legal Marketing Association –The Virginias Chapter

©2010 LMA Virginias. All rights reserved.

Employment-Based Preference EB-5 Program Assistance

For the National Law Review’s featured guest bloggers from Taft Stettinius & Hollister LLP.  Hugh E. Wall III discusses an immigrant visa program which gives preference to qualified foreign investors. 

The fifth employment-based preference (“EB-5”) immigrant visa program encourages qualified foreign investors to invest within the United States in exchange for permanent residency. The program is currently underutilized; of the 10,000 EB-5 visas available last year, the United States Customs and Immigration Service (“USCIS”) only issued 4,218 visas. The following list is a summary of the program features.

  • Pursuant to the basic program, an alien investor must make a capital investment of either $500,000 or $1,000,000, depending on whether the investor invests in a “Targeted Employment Area” (“TEA”), in a new commercial enterprise located within the United States. The enterprise must directly create or preserve at least ten full-time jobs for qualified U.S. workers.
  • Under the Regional Center Pilot Program, foreign investors must complete the basic program requirements by investing either $500,000 or $1,000,000 in a new commercial enterprise. However, unlike the basic program, under the Regional Center Pilot Program, the new commercial venture need not directly create the ten jobs required by the basic program. Instead, the commercial venture need only show that the investment indirectly created or preserved ten jobs.
  • To create a Regional Center, an individual or entity must file a Regional Center Proposal with USCIS to request approval of the investment proposal and the designation of the applying entity as a Regional Center. The entity applying for Regional Center status must maintain at least $100,000 in capital before the USCIS will award Regional Center status. There are currently 90 Regional Centers operating in 34 states. USCIS awards the vast majority of utilized EB-5 visas to alien investors who have invested in a Regional Center.
  • A TEA is an area with an unemployment rate that is at least 150% of the national average. If the foreign investor invests in a non-TEA, the investor must contribute the standard threshold minimum of $1,000,000. If the investor invests in a TEA, the investor need only invest $500,000 to be eligible for the EB-5 visa.

Copyright © 2010 Taft Stettinius & Hollister LLP. All rights reserved.

Time to Retire the ESOP from the 401k: Assessing the Liabilities of KSOP Structures in Light of ERISA Fiduciary Duties and Modern Alternatives

The National Law Review would like to congratulate Adam Dominic Kielich of  Texas Wesleyan University School of Law as one of our 2010 Fall Student Legal Writing Contest Winners !!! 

I. Introduction

401k plans represent the most common employer-sponsored retirement plans for employees of private employers. They have replaced defined benefit pension plans, as well as less flexible vehicles (such as ESOPs) as the primary retirement plan.1 However; some of these plan models have continued their legacy through 401ks through structures that tie the two together or place one inside the other. A very common and notable example is the Employee Stock Ownership Plan (ESOP). ESOPs are frequently offered by companies as an investment vehicle within 401ks that allow participants to invest in the employer’s stock as an alternative to the standard fund offerings that are pooled investments (e.g. mutual funds or institutional funds). Participants may be unaware that the company stock option in their 401k is a plan within a plan. These combination plans are sometimes referred to as KSOPs.2

Although this investment vehicle seems innocuous, KSOPs generate considerable risk to both participants and sponsors that warrants serious consideration in favor of abandoning the ESOP option. Participants face additional exposure in their retirement savings when they invest in a single company, rather than diversified investment vehicles that spread risk across many underlying investments. They may lack the necessary resources to determine the quality of this investment and invest beyond an appropriate risk level. Moreover, sponsors face substantial financial (and legal) risk by converting their plan participants into stockholders within the strict protections of ERISA.3 The risk is magnified by participant litigation driven by the two market downturns of the last decade. Given the growing risk, sponsors may best find themselves avoiding the risks of KSOPs by adopting a brokerage window feature (sometimes labeled self-directed brokerage accounts) following the decision in Hecker.4

II.  Overview and History of ESOPs

A.  ESOP Overview

ESOPs are employer-sponsored retirement plans that allow the employee to invest in company stock, often unitized, on a tax-deferred basis. They are qualified defined contribution plans under ERISA. As a standalone plan, ESOPs take tax deferred payroll contributions from employees to purchase shares in the ESOP, which in turn owns shares of the employer’s stock. That indirect ownership through the ESOP coverts participants into shareholders, which gives them shareholder rights and creates liabilities to the participants both as shareholders and as participants in an ERISA-protected plan. They may receive dividends, may have the option to reinvest dividends into the plan, and may be able to receive distributions of vested assets in cash or in-kind, dependent upon plan rules.5

ESOPs offer employers financial benefits: they create a way to add to employee benefit packages in a manner that is tax-advantaged while providing a vehicle to keep company stock in friendly hands – employees – and away from the hands of parties that may seek to take over the company or influence it through voting. Additionally, ESOPs create a consistent flow of stock periodically drawn out of the market, reducing supply and cushioning prices. Moreover, with those shares in the hands of employees, who tend to support their employer, there are fewer shares likely to vote against the company’s decision-makers or engage in shareholder activism.6

B.  Brief Relevant History of ESOPs

ESOPs are generally less flexible and less advantageous to employees than 401ks. ESOPs lack loan options, offer a single investment option, typically lack a hardship or in-service distribution scheme and most importantly, lack diversification opportunities. Individual plans may adopt more restrictive rules to maintain funds within the plan as long as possible, as long as it is ERISA-compliant. Perhaps the most important consequence of that lack of diversity is that it necessarily ties retirement savings to the value of the company. If the company becomes insolvent or the share price declines without recovery, employees lose their retirement savings in the plan, and likely at least some of the pension benefits funded by the employer. The uneven distribution of benefits to employees helped pave the way for ERISA in 1974.7

C.  Current State of Law on ESOPs

1.  ESOPs Within 401k Plans

After the ERISA regulatory regime paved the way for 401k plans, employers began folding their ESOPs and other company stock offerings into the 401ks. For decades employers could mandate at least some plan assets had to be held in company stock. When corporate scandals and the dot com bubble burst in 2001, it evaporated significant retirement savings of participants heavily invested in their employer’s stock, often without their choice. Congress responded by including in the Pension Protection Act of 2006 (PPA) by eliminating or severely restricting several permissible plan rules that require 401k assets in any company stock investment within 401k plans.8

2. ERISA Litigation of the 2000s

Participants who saw their 401k assets in company stock vehicles disappear with the stock price had difficulty recovering under ERISA until recent litigation changed how ERISA is construed for 401k plans. ERISA was largely written with defined benefit plans in mind. Defined benefit plans hold assets collectively in trust for the entire plan. Participants may have hypothetical individual accounts in some plan models, but they do not have actual individual accounts. ERISA required that suits brought by participants against the plan (or the sponsor, trust, or other agent of the plan) for negligence or malfeasance would represent claims for losses to the plan collectively for all participants, so any monetary damages would be awarded to the plan to benefit the participants collectively, similar to the shareholder derivative suit model. Damages were not paid to participants or used to increase the benefits payable under the plan.

Defined contribution plans with individual participant accounts, such as 401k plans and ESOPs, were grafted onto those rules. Therefore, any suit arising from an issue with the company stock in one of these plans meant participants could not be credited in their individual accounts relative to injuries sustained. It rendered participant suits meaningless in most cases because the likelihood of recovery was suspect at best.9

The Supreme Court affirmed this view in 1985 in Russell, and courts have consistently held that individual participants could not individually benefit from participant suits. Participants owning company stock through the plan could take part separately in suits as shareholders against the company, but these are distinguished from suits under ERISA. In 2008, the Supreme Court revisedRussell in LaRue and held that Russell only applied to defined benefit plans. Defined contribution plan participants could now bring claims individually or as a class and receive individual awards as participants. This shift represented new risks to sponsors that immediately arose with the market crash in 2007.10

III.  Risks to Employees

The primary risk to employees is financial; a significant component of employee financial risk is the investment risk. 401k sponsors are required to select investments that are prudent for participant retirement accounts. This is why 401k plans typically include pooled investments; diversified investment options spread risk. ESOPs are accepted investments within 401k plans, although they are not diversified.11 This increases the risk, and profit potential, participants can expose themselves to within their accounts. While added risk can be exponentially profitable to participants when the employer has rising stock prices or a bull market is present, the downside can also be significantly disastrous when the company fails to meet analyst expectations or the bears take over the markets.

Moreover, employees may be more inclined to invest in the employer’s stock than an independent investor would. Employees tend to be bullish about their employer for two reasons.12 First, employees are inundated with positive comments from management while typically negative information is not disclosed or is given a positive spin. This commentary arises in an area not covered by ERISA, SEC, or FINRA regulations. This commentary is not treated as statements to shareholders; they arise strictly from the employment relationship. This removes much of the accountability and standards that otherwise are related to comments from the company to participants and shareholders. Management can, and should, seek to motivate its employees to perform as well as possible. While the merit of misleading employees about the quality of operations may be debatable, the ability to be positive to such an end is not.

Second, employees tend to believe in the quality of their employer, even if they espouse otherwise. They tend to believe the company is run by experienced professionals who are leading the company to long term success. Going to work each day, seeing the company operating and producing for its customers encourages belief that the company must be doing well. It can even develop into a belief that the employee has the inside edge on knowing how great the company is, although this belief is likely formed with little or no knowledge of the financial health of the company. The product of the internal and external pressures is a strong likelihood employees will invest in an ESOP over other investment options for ephemeral, rather than financial, reasons.13

Additionally, participants may have greater exposure to the volatility of company stock over other shareholders due to 401k plan restrictions. While some plans are liberally constructed to give participants more freedom and choice, some plans conversely allow participants few options. This is particularly relevant to the investment activity within participant accounts. Participants may be limited to a certain number of investment transfers per period (e.g. quarterly or annually), may be subject to excessive trade restrictions, or may even find themselves exposed to company stock through repayment of a loan that originated in whole or in part from assets in the ESOP. Additionally, the ESOP may have periodic windows that restrict when purchases or redemptions can occur. While a regular shareholder can trade in and out of a stock in seconds in an after-tax brokerage account, ESOP shareholders may find themselves hung out to dry by either the ESOP or 401k plan rules. These restrictions are not penal; they represent administrative decisions on behalf of the sponsor to avoid the added expense generally associated with more liberal rules.

Although employees take notable risk to their retirement savings portfolio by investing in ESOPs within their 401k plans, it can add up to a tremendous financial risk when viewed in the bigger picture of an employee’s overall financial picture. Employees absorb the biggest source of financial risk by nature of employment through the company because it is the major, if not sole, income stream during an employee’s working years. This risk increases if the employer is also the primary source of retirement assets or provides health insurance. The employee’s present and future financial well being is inherently tied directly to the employer’s financial well being. This risk is compounded if the employee also has stock grants, stock options, or other stock plans that keep assets solely tied to the value of the company stock. If the employee is fortunate enough to have a defined benefit plan (not withstanding PBGC coverage) or retirement health benefits through the company, then that will further tie the long term success of the company to the financial well being of the employee. Adding diversification in the retirement portfolio may be a worthwhile venture when those other factors are considered in a holistic fashion.

IV.  Risks to the Sponsor

ERISA litigation is a serious risk and concern to sponsors. Although there is exposure in other areas related to participants as stockholders, ERISA establishes higher standards towards participants than companies otherwise have towards shareholders. Sponsors once were able to protect themselves under ERISA but since LaRue participants have an open door to reach the sponsor to recover losses related to the administration of the plan.14 ERISA requires sponsors to make available investment options that are prudent for 401k plans. The dormant side of that rule requires sponsors to remove investment options that have fallen below the prudent standard. Company stock is not excluded from this requirement.15

Any time the market value of the stock declines, the sponsor is at risk for participant losses for failure to remove the ESOP (or other company stock investment option) as an imprudent investment within the plan. Participants are enticed to indemnify losses through the sponsor. Such a suit is unlikely to succeed when the loss is short term and negligible, or the value declined in a market-wide downturn. However, as prior market downturns indicate, investors look to all possible avenues to indemnify their losses by bringing suits against brokers, advisors, fund companies, and issuers of their devalued assets. There is no reason to believe that participants would not be enticed to try this route; LaRuewas born out of the downturn in the early 2000s.16

The exposure for sponsors runs from additional costs to mount a defense to massive monetary awards to indemnify participants for losses. In cases where participants are unlikely to recover, sponsors still must finance the defense against what often turns into expensive, class action litigation or a long serious of suits. However, there is a serious risk of sponsors having to pay damages, or settle, cases where events have led to a unique loss in share value. Participants have filed suit under the theory that the sponsor failed to remove imprudent investment options in a timely fashion. BP 401k participants filed suit following the gulf oil leak under a similar theory that the sponsor failed to remove the company stock investment option from the plan, knowing that it would have to pay clean up costs and settlements. While it remains to be seen if these participants will be successful, they surely will not the last to try.17

Sponsors should take a good, long look at the ESOP to determine whether the sponsor receives more reward than risk – particularly future risk – from its inclusion. The risk to a company does not have as severe as the situation BP faced this year. Even bankruptcy or mismanagement that results in serious stock decline can merit suit when the sponsor fails to immediately withdraw the ESOP, since it has prior knowledge of the bankruptcy or mismanagement prior to any public release.

To hedge these risks, sponsors can adopt several options. First, sponsors may limit the percentage of any account that may be held in company stock. This is easily justified as the sponsor taking a position in favor of diversification and responsible execution of fiduciary duties. While this may not completely absolve the sponsor of the duty to remove imprudent investment options, it does act as a limit on liability. Although it does provide some protection against risk, it is an imperfect solution.

Second, ESOP plans can adopt pricing structures to discourage holding large positions of company stock for the purpose of day trading. Some 401k plans allow participants to trade between company stock and cash equivalents without restraint. When the ESOP determines share pricing based on the closing price of the underlying stock, it creates a window where participants can play the company stock very differently than the constraints of most 401k investment options.

It is a very alluring reason to take advantage of the plan structure by taking an oversized position in company stock. Add the possibility to indemnify losses in court and it becomes even more desirable. The process is simple: participants can check the trading price minutes before the market closes. If the stock price is higher than the basis, they sell and net profit. If it is below, they hold the stock and try against each day until the sale is profitable. They will then buy back into the ESOP on a dip and repeat the process. This is distinguishable from the standard diversified fund options in 401k plans, where ignorance of the underlying investments preempts the ability to game closing prices. Funds generally discourage day trading – and may even carry redemption fees to penalize it – and encourage long term investing strategies more consistent with the objective of retirement accounts.

Available solutions are directly tied to the cause of the problem; changing the ESOP pricing scheme can eliminate gaming closing prices. ESOPs can adopt other pricing schemes such as average weighted pricing and next day order fulfillment. Average weighted pricing gives participants the average weighted prices of all transactions in the stock, executed that day, by a given entity. For example, if the ESOP is held with Broker X as the trustee, it may rely upon Broker X to provide the prices and volumes of all of its executed orders that day in the stock, which is used to determine the average weighted price participants will receive that day. Alternately, participants could be required to place orders on one day and have the order fulfilled on the following day’s closing with that day’s closing price. Both of these pricing schemes introduce some mystery into the price that diminishes gaming the closing price. This is also an imperfect solution, even if combined with the first option, because it maintains the risks of the ESOP.

Sponsors may also take advantage of brokerage windows to expand employee investment options, including company stock, without the risks afforded to ESOPs. Brokerage windows create brokerage accounts within 401k plans. The brokerage window is not an investment in itself; it is a shell that allows employees to reach through the window to access other investments. Sponsors found good reason to be suspicious of brokerage windows, seeing it as liability for all the available investments that could be deemed imprudent for retirement accounts. A minute minority of participants saw it as a way to have their cake and eat it too during the last rise and fall of the markets; they could invest more aggressively within their 401ks and then demand sponsors indemnify their losses when the markets gave up years of gains on the basis of sponsor failure to review the available contents of the window under the prudence standard.

However, in Deere the court handed down a critcal decision: sponsors could not be responsible for the choices made by participants within brokerage windows. InDeere, several Deere & Co. (John Deere) employees sued the company for making available investments that were imprudent for 401k accounts that caused substantial losses in the 2007 market downturn. John Deere had not reviewed the thousands of available options under the ERISA prudence standard. Although the plaintiffs’ theory was a compelling interpretation of ERISA duties, the court rejected the theory on two grounds. First, it would be impossible for any sponsor to review every investment available through the window. Second, participants had taken ownership of the responsibility to review their investment decisions by choosing to invest through the window.18

Following the court’s decision in Deere, brokerage windows gained new life as a means for sponsors to expand investment availability at less risk. Rather than having to review a menu of funds and company stock for prudence under ERISA, sponsors can justifiably limit the fund selection directly offered through the plan and leave the rest of the options to the brokerage window. Importantly, this includes offering company stock in the window. By utilizing the brokerage window, sponsors allow access to the company stock without the liabilities of offering an ESOP through the plan. The sponsor will likely lose out on any benefits received from the ESOP, although for most established employers ESOPs are likely more of a convenience factor and a legacy offering rooted in the history of employer-sponsored plans.

Although Deere foreclosed participant abuse of brokerage windows, this option is not without its own negative aspects. Future litigation may reestablish some liability upon the sponsor for the brokerage link. Sponsors may face alternate liability under ERISA for selecting a brokerage window with excessive commissions or fees, similar to requirements for funds under ERISA.19 Given the flurry of awareness brought to 401k management fees and revenue sharing agreements between sponsors and fund providers following the market crash in 2007, it is likely that brokerage windows will be the hot ticket for participants in the next market crash. Therefore, sponsors should preemptively guard against future litigation by reviewing available brokerage window options to make sure any fees or commissions are reasonable and the categories of investment options are reasonable (even if specific investments in those categories are not).

Perhaps a lesser concern, sponsors need to consider overall plan operation and any negative impacts that may arise from shifting to a brokerage window-based investment offering. These concerns may be less of a legal risk issue than a risk of participant discontent and dealing with those effects. There are primarily two areas that brokerage windows can create discontent. First, when participants want to move from a fund to the brokerage window, they must wait for the sale to settle from the fund and transfer to the window, which generally makes the money available in the window the day after the fund processes the order. Conversely, selling investments in the window may delay transferring money into plan funds because of settlement periods and the added delay of settlement with the fund once the funds are available to move out of the window. Additionally, the settlement periods within the window may frustrate participants, although the plan has no control over those timeframes. Those natural delays in processing the movement of money may create discontent, especially for those participants trying to invest based upon short term market conditions.

Second, those same processes and delays can negatively affect plan distributions. Many plans offer loans and withdrawal schemes, and while sponsors may have their own reasons for making those options available, participants often use those offerings to finance emergency financial needs. Brokerage windows can complicate and delay releasing money to participants. Settlement periods will create delays; if money has to be transferred out of the window to another investment to make those funds available for a distribution that will add at least one more day before money can be released. If participants find themselves in illiquid investments, the money may not be able to move for a distribution at all. Although these issues may not be of legal significance but they will be significant to the people responsible for absorbing participant complaints and there may be additional expenses created in handling those issues.

An additional concern is that the Department of Labor (DOL) is still fleshing out several requirements surrounding brokerage windows and how they relate to ERISA requirements. For example, the DOL October 2010 modification of 401k disclosure rules affects plans as a whole, but it leaves open several areas of ambiguity around the specific effects on brokerage windows. Sponsors may face continuing financial costs complying and determining how to comply with DOL requirements. Future changes in the regulations may negatively affect plans that rely heavily on brokerage windows to provide access to a greater range of investment options.20

These considerations are not exhaustive to the benefits or risks of either ESOPs or brokerage windows, they merely highlight some of the more salient points as they relate generally to the legal and significant financial benefits and risks to sponsors. There may be additional concerns equally salient to sponsors given their particular situation, such as participant suspicion of the removal of the ESOP or unwillingness at the executive level to retire the ESOP.

V.  Conclusion

Although brokerage windows may open the door to some new liabilities, it closes the door to the risks of ESOPs, for both participants and sponsors. Sponsor diligence in administering retirement plans will always be the most successful method of checking liability; however, as discussed ESOPs risk putting sponsors in an unwinnable position. Removing the company stock option may not be the most beneficial option in all cases but it may be time for sponsors to consider retiring the ESOP from the 401k in light of the current regulatory regime. A brokerage window option is well suited to take advantage of participant ownership of the employer’s stock, as well as other investment opportunities, while limiting the risk that normally accompanies that ownership. Ultimately, sponsors must consider what is best for the plan and its participants over both the short term and the long term.

Endnotes.

1. Chris Farrell, The 401(k) Turns Thirty Years Old, Bloomberg Businessweek Special Report, Mar. 15, 2010,http://www.businessweek.com/investor/content/mar2010/pi20100312_874138.htm.

2. National Center for Employee Ownership401(k) Plans as Employee Ownership Vehicles, Alone and in Combination with ESOPs, (no date provided),http://www.nceo.org/main/article.php/id/15/.

3. Id.; 29 U.S.C. § 1104 (2010); the term “sponsor” can be used interchangeably with “employer” for purposes of this discussion, however there are some situations where the employer is not the sponsor, such as union plans, or the employer is not the sole sponsor in the case of multi-employer plans. This discussion relates to KSOPs where the sponsor is the employer. Different rules and different liability may apply to other plan structures.

4. Hecker v. Deere & Co., 556 F.3d 575, 590 (7th Cir. 2009), cert. denied, 130 S. Ct. 1141 (2010).

5. Todd S. Snyder, Employee Stock Ownership Plans (ESOPs): Legislative History, Congressional Research Service, May 20, 2003.

6. William N. Pugh et al. The Effect of ESOP Adoptions on Corporate Performance: Are There Really Performance Changes?, 21Managerial & Decision Econ., 167, 167-180 (2000).

7. Supra note 5.

8. Pension Protection Act of 2006 § 901, 29 U.S.C. 401 (2010).

9. LaRue v. DeWitt, Boberg & Assocs., Inc., 552 U.S. 248, 254-55 (2008).

10. Id. at 255-56.

11. Shlomo Benartzi et al., The Law and Economic of Company Stock in 401(k) Plans, 50 J.L. & Econ. 45, 45-79 (2007).

12. Id.

13. Id.

14. LaRue, 552 U.S. at 254-55.

15.  § 1104.

16. LaRue, 552 U.S. at 250-51.

17. E.g., In Re: BP P.L.C. Securities Litigation, MDL No. 2185, 2010 WL 3238321 (J.P.M.L. Aug. 10, 2010).

18. Hecker, 556 F.3dat 590.

19. §1104.

20. 29 C.F.R. § 2550 (2010).

© Copyright 2010 Adam Dominic Kielich

 

Alternatives to International Criminal Justice – Restorative Justice and Peace Through Peaceful Means

The National Law Review would like to congratulate Heejung Park of Washington University in St. Louis as one of our Fall 2010 Law Student Legal Writing Contest Winners! 

“Out of timber so crooked as that from which man is made nothing entirely straight can be carved.” -Immanuel Kant-

Individuals live their own lives, and have their own goals.  An entity may be an individual, a group, or a nation.  The purposes of two parties may be in harmony with each other and without conflict, or may not.  Such purposes may be good, or evil.  Essentially, problems occur when the purposes of two or more parties do not coincide.  The basic position of the traditional criminal justice system is to address problems simply by punishing the perpetrators.  However, over the last several decades, there have been new studies in the area of peace and human rights, and in this environment, new institutions may be welcome.  This is inspiring changes from the perspective of human integrity and the right to peace, which pursues harmonious coexistence.

If the criminal justice system, which aims to punish perpetrators, takes an interest in the perpetrators as well as the victims by enabling the perpetrators to truly repent for their offenses and voluntarily make restitution to their victims, while allowing the victims to accept the restitution based on a principle of forgiveness and tolerance, a foundation for peace and respect of others in the community will be formed. As such, it is very significant to prepare for a system wherein the pepetrator and the victim can remediatetheir hurt,and recover.  If we are working from a principle that values life above all, and values human rights to the extent that they carry more weight than the earth itself, such an approach must be inspiring.  It is not that easy to buildasociety that is better and more peaceful, in which everyone can live together harmoniously.  When criminals are punished, this does not mean that everything has been resolved.  Often,the root causesof a crime can be foundin the community, or even in the victim himself or herself.  On this basis, victims and communities also have a responsibility to take an interest in the perpetrators of crimes.  The intent must be to identify the fundamental causes of crimes, and by addressing these causes, to create a better society and a better country, byseeking an alternative to the international criminal justice system based on peaceful means.

To achieve this, one or more of the following three approaches may be effective.  The first is to constitute a truth commission to pursue truth and reconciliation. This approach has been successful in South Africa, as well as in some Latin American and Asian countries.  Truth will be identified, and reconciliation will be made based on investigations into violations of human rights and provisions concerning ethical and legal responsibilities and duties.  The Report of the Truth and Reconciliation Commission that was prepared by the government of South Africa in 2003 also addressed this issue.  Through the Truth and Reconciliation Commission, violations of human rights relating to apartheid have been addressed.[i] The second is to hold public inquiries.  This is closely related to post-conflict management.  “Bloody Sunday[ii]” in the UK is a representative sample.  In this event, 13 people were shot to death and several were injured on January 30, 1972, a Sunday. A high-profile public inquiry, it was led by English Supreme Court Justice Mark Saville together with a judge from New Zealand and a judge from Canada, and was established on April 3, 1998.  The last is “Community-based Restorative Justice”, which is the most important and is addressed intensively herein.  This is a mechanism that focuses on the post-conflict environment, and is deeply related to the peaceful coexistence of a community.  In this area, new justice systems have emerged, called “gacaca” and restorative justice.[iii]  Gacaca is a new court system that was launched by the Rwandese government on June 18, 2002.  This new court system follows the customary system for community hearings, which have been used whenever a conflict occurs in the community.  Begun at a Canadian church in the 1970s, restorative justice is a crime-fighting approach for victim-sensitive victim-offender mediation.

Criminal prosecution is not always the right solution.  It is a good method only when it can benefit society and nation.  If we acknowledge that unexpected pitfalls exist for everyone, then people should be given one more chance, even if they have committed a crime. The proposition of the “restoration of offenders” is not suitable for all conflicts.  Nonetheless, it is a new approach to consensus, and aims at facilitating mutual understanding.  The Bible features an approach similar to this restorative justice.[iv]  It also refers to accountability for healing that goes through discipline to move toward a peaceful environment, which is different from the existing criminal justice system.[v]   The Bible considers every individual a sinner.  It says that an individual can receive forgiveness when he/she sincerely repents, surrenders to God, and produces the fruit of repentance.[vi]  It further says that reconciliation will take place when one makes restitution and reparation for the harm, and this action bears fruit.[vii]  When this is done, the offender is able to commit himself/herself to the community and the nation by producing the fruit of the Spirit[viii], through his/her indebtedness and freedom from being forgiven. Curing offenders, allowing them to repent for their wrongdoings and to voluntarily make restitution and reparation, a win-win situation for perpetrator and victim, is possible in the love of God through the remediation of hurt, restoration, forgiveness, and tolerance.  Through this, the community can seek peace through social justice and tolerance.  Both perpetrators and victims have fundamental rights as human beings.  In this area, the roles of national reconciliation/mediation agencies, protection agencies, and NGOs are important.

These approaches may equally be applied to international criminal justice.  As demonstrated above, post-conflict management should be approached peacefully.   Disputes occur when the purposes of parties do not coincide with each other. This discord emerges in the form of conflict.  A conflict is a polarization of opinions or powers.  Ultimately, such polarization may reach the level of violence, which leaves residual trauma.  This process repeats itself, continuously.  The ring of this vicious circle should be peacefully severed.  Such an approach to peaceful means advocates solving problems through mediation (this is directed toward the future, and it is better than “victory”) at the stage of conflict; through the positive involvement of peace-building at the stage of polarization; and through nonviolence rather than violence, and reconciliation and conciliation (which is against the past, and requires healing) instead of trauma.

[i]Mark Freeman, Truth Commissions and Procedural Fairness, Part 1:‘Introduction’ 3 (Cambridge University Press, 2007).

[ii]Angela Hegarty, “Truth, Law and Official Denial: The Case of Bloody Sunday”15Criminal Law Forum 199 (2004).

[iii]Phil Clark, “Hybridity, Holism and ‘Traditional’ Justice: The Case of the Gacaca Community Courts in Post- Genocide Rwanda”, 39 Geroge Washinton International Law Review 4 20 (2007).

[iv]Tony F. Marshall, Restorative Justice An Overview 6 (Research Development and Statistics, 1998).

[v]Edward Bouverie Pusey, The Confessions Of Saint Augustine 5-6 (Kessinger Publishing, 2004).

[vi]Matthew, New International Version Bible,The New Testament: Matthew 2 (Word Of Life Press, 2009).

[vii]Jeremiah, New International Version Bible, The Old Testament: Jeremiah 706 (Word Of Life Press, 2009).

[viii]Paul, New International Version Bible, The New Testament: Galatians 185 (Word Of Life Press, 2009).

© Copyright 2010 Heejung Park