Category: Administrative & Regulatory

Financial Services Legislative and Regulatory Update – July 15, 2013

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Leading the Past Week

Although there were several hearings and major implementations of Dodd-Frank rules, the leading story from the past week had to be Majority Leader Harry Reid (D-NV) filing cloture on seven Administration nominees, including Richard Cordray to continue as head of the Consumer Financial Protection Bureau (CFPB).  This is the start of a process that could end up with Leader Reid going for the “nuclear option” of changing the Senate rules dealing with the filibuster of certain nominations.  Based on some reports, it appears that Reid has the votes and that Cordray may be the sticking point in the negotiations.  Interestingly,  late last week Chairman Tim Johnson (D-SD) and the eleven other Democratic Members of the Banking Committee, wrote Minority Leader Mitch McConnell (R-KY) to end the Republican filibuster of Cordray’s nomination, requesting “an up-or-down vote on the nominee’s merits.”

While it remains to be seen how the filibuster cold war will resolve itself, last week the Congressional Budget Office (CBO) announced that the government achieved a surplus of $116.5 billion in June, the largest in five years.  This surplus, due in part to $66.3 billion in dividend payments from the GSEs, only solidified that this fall will see yet another convergence of a debt ceiling / government funding fight as both the debt limit and end of the federal fiscal year appear to be aligned to come due at the same time.  

We also saw several important steps forward in the implementation of the Dodd-Frank Act, including a proposed leverage ratio rule, approval of a final rule implementing capital requirements in excess of those required by Basel III, the designation of two nonbanks as SIFIs, and the long awaited announcement of the Commodity and Futures Trade Commission’s (CFTC) cross-border derivatives rulemaking.

Legislative Branch

Senate

Senate Banking Hearing Discusses Dodd-Frank Progress, Risk Mitigation

On July 11th, the Senate Banking Committee met to discuss Dodd-Frank implementation progress and whether financial reforms have succeeded in mitigating systematic risk from large financial institutions.  Witnesses included Treasury Under Secretary for Domestic Finance Mary Miller, Fed Governor Daniel Tarullo, Federal Deposit Insurance Commission (FDIC) Chairman Martin Gruenberg, and Office of the Comptroller of the Currency (OCC) head Thomas Curry.  In their testimony, regulators said that they expect almost all remaining Dodd-Frank rules, including capital surcharges for systematically important banks, the Volcker Rule, and liquidity rules to be finalized by the end of the year.  Regulators also expressed confidence that the recently finalized Basel III rules, when combined with proposed stricter leverage requirements, will be an effective means of ensuring that banks carry enough capital.  Notwithstanding the assertion of the regulators that the implementation of Dodd-Frank was nearing a close, Ranking Member Crapo remarked in his opening statement that there is a growing bipartisan consensus that some parts of Dodd-Frank need to be reformed.  In particular, he mentioned the burden of regulations on community banks, short-term wholesale funding, debt to equity ratios for large banks, and the perceived continuation of “too big to fail” as areas that require address.   

Democratic Senators Request CFPB, DOL Look Into Prepaid Payroll Cards

Following a front page story in the New York Times, on July 11th, sixteen Senate Democrats wrote to the CFPB and Department of Labor (DOL) requesting that the agencies investigate fees and practices associated with pre-paid payroll cards.  The letter was particularly strong, including the assertion “that mandating the use of a particular payroll card, with no available alternative, seems clearly to violate federal law,” the lawmakers requested that CFPB Director Cordray clarify whether employers provide sufficient alternatives for payment. The letter was signed by Senators Richard Blumenthal (D-CT), Chuck Schumer (D-NY), Joe Manchin (D-WV), Tom Harkin (D-IA), Barbara Boxer (D-CA), Dick Durbin (D-IL),  Debbie Stabenow (D-MI), Bob Menendez (D-NJ), Ben Cardin (D-MD), Robert Casey (D-PA), Jeffrey Merkley (D-OR), Brian Schatz (D-HI), Martin Heinrich (D-NM), Elizabeth Warren (D-MA), Mark Warner (D-VA), and Al Franken (D-MN).  It is unclear whether this letter will spur the CFPB to re-engage on its broader general purpose reloadable card ANPRM that is still pending with the agency.

Bipartisan Group of Senators Introduce the 21st Century Glass-Steagall Act

On July 11th, Senators Elizabeth Warren (D-MA), John McCain (R-AZ), Maria Cantwell (D-WA), and Angus King (I-ME) introduced legislation that would reinstate the Glass-Steagall Act by separating FDIC insured depository divisions from riskier banking activities such as investment banking, insurance, swaps dealing, and hedge fund and private equity activities.  By curbing those activities at federally insured institutions, the bill aims to eliminate the concept of “too big to fail” by making institutions smaller and thus decreasing the need, either real or perceived for a government bailout if the institution were to fail.

Senate Banking Leaders to Introduce FHA Reform Bill

Last week, Senate Banking Committee Chairman and Ranking Member Tim Johnson (D-SD) and Mike Crapo (R-ID) announced they will introduce legislation this week to provide the Federal Housing Administration (FHA) with additional authority, including the ability to charge higher premiums, to “get back on stable footing.” The FHA currently has a $943 million short fall in its insurance fund and a Treasury bailout is expected without additional Congressional action. The House has already passed a measure this year which would allow the agency to make changes to the Home Equity Conversion Mortgage program.

House of Representatives

House Approves FSOC, PCAOB Bills

On July 8th, the House passed two bills, the first to require the Financial Stability Oversight Council (FSOC) to study the effects of derivatives-related capital exemptions, and the second to bar the Public Accounting Oversight Board (PCAOB) from requiring public companies to regularly change auditors. The Financial Competitive Act of 2013 (H.R. 1341) passed the House by a 353 to 24 vote and directs the FSOC to study and report to Congress on an exemption for EU banks from the credit valuation adjustment (CVA) capital charge which was part of the Basel III agreements. The Audit Integrity and Job Protection Act (H.R. 1564) passed the House by a 321 to 62 vote and would do away with mandatory audit-form rotations currently required by the agency. Ranking Member of the House Financial Services Committee Maxine Waters (D-CA) expressed concern that the bill would result in “diminished information” and increased costs. The legislation also directs the Government Accountability Office to update a 2003 study on the Potential Effects of Mandatory Audit Firm Rotation.

House Republicans Unveil Housing Finance Reform Legislation

On July 11th, Chairman of the Financial Services Committee Jeb Hensarling (R-TX), unveiled the Protecting American Taxpayers and Homeowners (PATH) Act which would reform the US housing finance system by phasing out Fannie Mae and Freddie Mac and moving to a largely private system. The legislation would continue to wind down the GSEs’ portfolios while establishing new rules for private covered bonds and mortgage bonds. The legislation would also reign in the FHA and its ability to insure loans for only low income borrowers, reducing how much of a loan the FHA can insure. Notably, the proposal would also repeal the Dodd-Frank Act’s risk-retention rule and place a two year hold on Basel III capital rules. Also worth noting is that despite earlier hopes that Hensarling and Ranking Member Maxine Waters (D-CA) might be able to find some common ground housing reform, Ms. Waters said she was “strongly disappointed” by Hensarling’s proposal.  The Committee would hold a hearing on July 18th to examine the legislation.

House Financial Services Subcommittee Grills CFPB Over Data Collection

On July 9th, the House Financial Services Subcommittee on Financial Institutions and Consumer Credit held a hearing to examine how the CFPB collects and uses consumer data and personal information. CFPB Acting Deputy Director Steven Antonakes received heavy criticism from Committee Republicans for being unable to provide exact numbers on how many Americans the Bureau has collected information.  Republican lawmakers also criticized many of the data collection practices of the agency, citing concerns that the collection infringes on citizens’ right to privacy and attempting to draw analogies to the current NSA and IRS scandals.  Still, Antonakes and to some extent, Committee Democrats insisted that the CFPB is a data-driven agency, that the data being collected is, except when the result of a consumer contact, anonymized and that the CFPB takes very seriously its obligation to protect its data as it is vital to the Bureau’s work.                                                   

 

House Financial Services Subcommittee Explores Constitutionality of Dodd-Frank

On July 9th, the House Financial Services Subcommittee on Oversight and Investigations held a hearing to consider potential legal uncertainties in the Dodd-Frank Act.  The hearing featured testimony from three constitutional scholars, each of whom expressed concern that certain provisions of the law may be unconstitutional.  Professor Thomas Merrill, of Columbia Law School, argued that there are large constitutional concerns surrounding the orderly liquidation provision and the government’s power to seize control of an institution.  While the provision is likely legal, he said, it would undoubtedly be litigated the first time it is invoked. In addition, Boyden Gray, testified that Dodd-Frank violates separation of power by giving too much power to regulators, while Timothy McTaggart, a partner at Pepper Hamilton LLP, argued that Dodd-Frank ultimately does not violate separation of powers or the due process clause. 

House Financial Services Subcommittee Explores Small Business Capital Formation

On July 10th, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held the second in a series of hearings exploring existing barriers to capital formation.  In his opening statement, Chairman Scott Garrett (R-NJ) made it clear that the sponsors of last year’s JOBS Act are not satisfied with the bill’s implementation and are looking for new ideas to help small businesses build capital.  Additional proposals could include increasing tick sizes, creating special exchanges for the stock of small companies, and changing filing rules for small business financial statements. Witnesses expressed additional concerns; Kenneth Moch, CEO of Chimerix, noting the cost of compliance with internal controls associated with Sarbanes-Oxley, and Christopher Nagy, President of Kor Trading, calling for patent litigation reform.

House Appropriations Subcommittee Marks Up FY 2014 Financial Services Spending Bill

On July 10th, the House Appropriations Subcommittee on Financial Services and General Government met to consider the $17 billion FY2014 Financial Services and General Government spending bill, approving the legislation by voice vote. The bill funds a variety of agencies, including the Securities and Exchange Commission (SEC), Treasury, Internal Revenue Service (IRS), and others. The legislation boosts the SEC’s budget by $50 million to $1.4 billion, a figure that is still over $300 million dollars short of the President’s budget request.  In addition, the bill would bring the CFPB into the normal appropriations process beginning in 2015, something which Republicans have sought to do since the standing up of the Bureau. Despite serving as one of the main sticking points against Director Cordray’s confirmation, the bid to move the Bureau’s funding out from the control of the Federal Reserve is unlikely to be successful.

Executive Branch

CFTC

CFTC Finalizes Cross-Border Derivatives Rule, Including Effective Date Delay

Following several weeks of rampant speculation over the fate of the CFTC’s proposal to regulate cross-border swaps trades, the CFTC voted 3 to 1 on July 12th phase in guidance governing how U.S. derivatives laws apply to foreign banks. The CFTC also approved an “exemptive order” extending the effective date for the new requirements to 75 days after the guidance is published in the Federal Register. In addition, by December 21st, the Commission hopes to approve additional “substituted compliance” requests that will enable market participants to meet the requirements put out by other countries, including the EU, Japan, Hong Kong, Australia, Canada, and Switzerland.

The CFTC’s vote follows the news that the Commission reached an agreement with EU regulators on how the two regulatory zones would oversee cross-border derivatives deals. The agreement will allow uncleared transactions that are deemed to fall under certain “essentially identical” US and EU rules to be governed by just the EU. In addition, the agreement allows US market participants to directly trade on a foreign board of trade and addresses US fears over loopholes for firms engaged in high-risk overseas operations, among other things. The CFTC also released four “no-action letters” on July 11thwhich implement the agreement with the EU.

Federal Reserve

Federal Reserve Releases Minutes of June FOMC Meeting

On July 10th, the Fed released the minutes of the June 18th and 19th meeting of the Federal Open Markets Committee. Following market disruptions after Chairman Bernanke’s statements after the June meeting, the FOMC minutes shed light on how the Fed plans to proceed in winding down its quantitative easing program by stressing that continuation of the monthly billion dollar asset purchases will largely depend on continued economic growth. Regardless of the exact timing, it appears a tapering of the highly accommodative monetary policy will occur in the near- to mid-term, as the minutes state: “several members judged that a reduction in asset purchases would likely soon be warranted, in light of the cumulative decline in unemployment since the September meeting and ongoing increases in private payrolls, which had increased their confidence in the outlook for sustained improvement in labor market conditions.”

Regulators Propose Exempting Certain Mortgages from Appraisal Requirements

On June 10th, six regulatory agencies issued a proposed rule exempting certain subsets of high-priced mortgages from Dodd-Frank appraisal requirements.  The exempted mortgages include loans of $25,000 or less, certain “streamlined” refinancings, and some loans for manufactured homes. The new rule is meant to lower cost hurdles for borrowers and improve mortgage lending practices.  The proposal was released jointly by the Fed, CFPB, FDIC, OCC, Federal Housing Finance Administration (FHFA), and the National Credit Union Administration (NCUA).

FDIC

Regulators Propose Leverage Ration Rule; Finalize Rule Implementing Basel III Agreement

On July 9th, the Fed, FDIC, and OCC released a new proposal which would require federally insured banks with more than $700 billion in assets to meet a 6 percent leverage ratio, double the 3 percent ratio agreed to under the Basel III. The proposed rule would currently capture eight US banks, including: JPMorgan Chase, Bank of America, Bank of New York Mellon, State Street, Citigroup, Goldman Sachs, Wells Fargo, and Morgan Stanley. The holding companies of these institutions would be required to meet a 5 percent leverage threshold, the Basel III 3 percent minimum plus a 2 percent buffer. The same day the FDIC and OCC finalized an interim final rule to implement the Basel III international bank capital agreement, which the Federal Reserve adopted unanimously the previous week.

Treasury

FSOC Releases Final AIG, GE SIFI Designations

On July 9th, the Financial Stability Oversight Council (FSOC) voted to designate American International Group (AIG) and GE Capital as the first two nonbank financial companies required to meet additional regulatory and supervisory requirements associated with being systemically important financial institutions (SIFIs). As such, these companies will be subject to supervision by the Fed’s Board of Governors and to enhanced prudential standards. In deciding to designate these two nonbanks, the FSOC noted AIG’s “size and interconnectedness” and GE’s role as a “significant participant in the global economy and financial markets.” Remarking on the designations, Treasury Secretary Jack Lew said that they will help “protect the financial system and broader economy” and that the Council will “continue to review additional companies in the designations process.”

CFPB

Bureau Updates 2013 Rulemaking Schedule

On July 8th, the OIRA released an updated list of rulemakings and their status at the CFPB.  The list included a variety of items, at different stages of the rulemaking process. 

CFPB Warns it Will Closely Scrutinize Debt Collection

On July 0th, the CFPB announced that it will be heavily examining the practices used to collect debt from borrowers.  The CFBP also said that it will be looking into the activities of both third-party collection agencies, which are subject to regulations under the Fair Debt Collection Practices Act (FDCPA), in addition to lenders trying to collect directly from borrowers who are not covered by FDCPA. As part of this effort, the Bureau has published two bulletins outlining illegal and deceptive debt collection practices. The first bulletin outlines that any creditor subject to CFPB supervision can be held accountable for any unfair, deceptive, or abusive practices in collecting a consumer’s debts. The first bulletin also warns against threatening actions, falsely representing the debt, and failing to post payments. The second bulletin cautions companies about statements they make about how paying a debt will affect a consumer’s credit score, credit report, or creditworthiness. As part of this crackdown, the CFPB will also begin accepting debt collection complaints from consumers.

SEC

Commission Finalizes JOBS Act General Solicitation Rule

On July 10th, the SEC adopted in a 4 to 1 vote a final rule to lift the ban on general solicitation and general advertising for certain private securities offerings. Commissioner Luis Aguilar was the sole no vote, saying that the rule puts investors at risk. In remarks delivered the same day, Aguilar said that the rule does not contain sufficient investor protections as is, and it is not enough to rely on “speculative future actions to implement common sense improvements” to ensure investor safety. In conjunction with this vote, the agency proposed for comment a separate rule which will increase the amount of disclosures which issuers must provide on public offerings, such as providing the SEC with 15 days advance notice of the sale of unregistered securities, and provide for other new safeguards.  Commissioners Dan Gallagher and Troy Paredes both opposed the new disclosure requirements, citing concerns that they would “undermine the JOBS Act goal of spurring our economy and job creation.” The SEC also approved in a 5 to zero vote a rule which would prohibit felons and other “bad actors” from participating in offerings.

Lawmakers on both sides of the aisle had strong opinions about the final general solicitation rule. Democratic lawmakers, though somewhat assuaged by the additional disclosure safeguards, echoed Commissioner Aguilar’s sentiments regarding investor safety. In particular, Senator Carl Levin (D-MI) said in a statement that he was disappointed in Chairman Mary Jo White for advancing a rule with too few investor protections.  On the other hand, Representative Patrick McHenry (R-NC) accused the SEC of flaunting Congressional intent by moving forward with the additional filing and disclosure requirements, saying the requirements will “unjustifiably burden American entrepreneurs” and “neutralize congressional intent.”

SEC Delays Rules on Retail Forex Transactions

On June 11th, the SEC agreed to delay rulemaking on restrictions to retail foreign exchange (forex) trading by up to three years.  The SEC said that it would use the additional time to assess the market for off-exchange foreign currency contracts and determine if more targeted regulations are necessary.  While the vote for the extension was private, Commissioner Aguilar publically criticized the delay, saying that the transactions, while profitable, pose unnecessary risks to small investors in the economy.   

OCC

Martin Pfinsgraff to be OCC Senior Deputy Comptroller for Large-Bank Supervision

On July 11th, US Comptroller of the Currency Thomas Curry named Martin Pfinsgraff Senior Deputy Comptroller for Large-Bank Supervision.  Pfinsgraff has filled the role on an acting basis since January 30th, and has worked in the OCC since 2011.  Previously, he served as Chief Operating Officer for iJet International, a risk management company, and Treasurer for Prudential Insurance.  In this position, he will continue to supervise 19 of the nation’s biggest banks with over $8 trillion in combined assets.  

International

Basel Committee Considering Simplified Capital Regime

On July 8th, the Basel Committee on Banking Supervision released a paper positing alternative proposals to reform the international capital regime in ways which would simpler and easier to compare global capital levels. Specifically, the Committee proposed reforms such as enhanced disclosures, additional metrics, strategies to ensure effective leverage ratios, and reigning in national discretion as potential options for simplifying the framework. The paper reiterated that risk-based procedures will remain at the heart of the Basel capital framework but these will be complemented by liquidity and leverage ratio metrics.

Upcoming Hearings

  • On Tuesday, July 16th at 10am, in 538 Dirksen, the Senate Banking, Housing and Urban Affairs Committee will meet in executive session to vote on pending nominations. Immediately following votes on nominees, the Committee will hold a hearing titled “Oversight of the Defense Production Act: Issues and Opportunities for Reauthorization.”
  • On Wednesday, July 17th at 10am, in 538 Dirksen, the Financial Institutions and Consumer Protection Subcommittee of Senate Banking, Housing and Urban Affairs Committee will hold a hearing on the consumer debt industry.
  • On Wednesday, July 17th at 10am, in 2128 Rayburn, the House Financial Services Committee will hold a hearing to receive the Semi-Annual Monetary Policy Report to Congress.
  • On Wednesday, July 17th at 2:30pm, in 216 Hart, the Senate Agriculture, Nutrition and Forestry Committee will hold a hearing on the Commodity Futures Trading Commission Reauthorization.
  • On Thursday, July 18th at 10:30am, the Senate Banking, Housing and Urban Affairs Committee will hold a hearing on the Federal Reserve’s Semiannual Monetary Policy Report to the Congress.
  • On Thursday, July 18th at 1pm, in 2154 Rayburn, the Economic Growth, Job Creation and Regulatory Affairs Subcommittee of House Oversight and Government Reform Committee will hold a hearing titled “Regulatory Burdens: The Impact of Dodd-Frank on Community Banking.”
  • On Thursday, July 18th at 1pm in 2128 Rayburn, the House Financial Services Committee will holding a hearing titled “A Legislative Proposal to Protect Americas Taxpayers and Homeowners by Creating a Sustainable Housing Finance System.”
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Supreme Court Decides Indian Child Welfare Act Case

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In Adoptive Couple v. Baby Girl, — S.Ct. —-, 2013 WL 3184627 (U.S. 2013), the baby girl in question (Baby Girl) was born in Oklahoma to unwed parents, including a Cherokee father (Father) and non-Indian mother (Mother). After the couple broke up during the pregnancy, Father, in response to an inquiry from Mother, text-messaged Mother that he would rather give up parental rights than pay child support. Mother decided to terminate her parental rights and give the baby up for adoption.

The adoptive parents (Adoptive Parents), residents of South Carolina, were present when Baby Girl was born September 15, 2009, and took her home with them shortly after receiving permission from Oklahoma pursuant to the Interstate Compact on Placement of Children. Adoptive Parents began adoption proceedings in South Carolina three days after Baby Girl was born but Father did not receive notice until nearly four months later, in January 2010. when a process server presented him with an “Acceptance of Service and Answer,” which purported to waive the 30-day waiting period, waive notice of hearing and waive any objection to the adoption. Father, a soldier about to depart for Iraq, signed but then immediately changed his mind and sought a stay of adoption under the Servicemember’s Civil Relief Act.

The Cherokee Nation, which had previously indicated that Father was not a citizen, later determined that he was. The South Carolina adoption petition was amended accordingly in March 2010. After establishing paternity through DNA testing, Father challenged the adoption. Adoptive parents argued that, under South Carolina law, there was no need for Father’s consent to the adoption because Father had neither lived with Mother or Baby Girl for the six months preceding the adoption nor paid child support. The South Carolina family court judge ruled that the Indian Child Welfare Act (ICWA) applied and mandated that Baby Girl be turned over to father. After various stay motions were denied, Father returned to Oklahoma with Baby Girl December 31, 2011. The South Carolina Supreme Court affirmed.

On June 25, the Supreme Court in a 5-4 decision reversed. The state court had relied in part on Section 1912(f) of the codified ICWA, which bars termination of parental rights to an Indian child unless the court finds that “the continued custody of the child by the parent or Indian custodian is likely to result in serious emotional or physical damage to the child.” Emphasizing the word “continued,” the Court held that “§ 1912(f) does not apply where the Indian parent never had custody of the Indian child” (Emphasis in original).

The Court also disagreed with the South Carolina court’s conclusion that termination of Father’s rights was barred by Section 1912(d), which requires a showing that efforts have been made “to prevent the breakup of the Indian family,” holding Section 1912(d) inapplicable in Father’s case: “But when an Indian parent abandons an Indian child prior to birth and that child has never been in the Indian parent’s legal or physical custody, there is no relationship that would be discontinued – and no effective entity that would be ended – by the termination of the Indian parent’s rights.” (Internal quotes and ellipses omitted).

Finally, the Court held that Section 1915(a), which mandates preference “in any adoptive placement” for a member of the child’s extended family, other members of the child’s tribe or other Indian families, in that order, did not apply in the case of Baby Girl: “This is because there simply is no ‘preference’ to apply if no alternative party that is eligible to be preferred under § 1915(a) has come forward.”

In an important concurrence, Justice Breyer explicitly left open whether ICWA sections 1915(a), (b) and (f) might apply under different circumstances, e.g., where the Indian father (1) has visitation rights, (2) has paid child support, (3) was deceived about the existence of a child, or (4) was prevented from supporting his child.

In a dissent joined by three other members of the Court, Justice Sotomayor accused the majority of distorting the meaning of the term “continued” to defeat the very purposes for which Congress had enacted the ICWA:

The majority’s hollow literalism distorts the statute and ignores Congress’ purpose in order to rectify a perceived wrong that, while heartbreaking at the time, was a correct application of federal law and that in any case cannot be undone. Baby Girl has now resided with her father for 18 months. However difficult it must have been for her to leave Adoptive Couple’s home when she was just over 2 years old, it will be equally devastating now if, at the age of 3 1/2, she is again removed from her home and sent to live halfway across the country. Such a fate is not foreordained, of course. But it can be said with certainty that the anguish this case has caused will only be compounded by today’s decision.

According to the dissent, “continued” custody, consistent with congressional intent, means prospective custody and does not preclude the application of ICWA’s protections to a non-custodial Indian parent, including (1) the requirement that a proceeding be transferred to tribal court upon the Indian parent’s request, in the absence of good cause to the contrary, as required by Section 1911(b), (2) the requirement that any consent to adoption be in writing and executed before a judge, per Section 1913(a), (3) the requirement of Section 1912(a) that an Indian parent and the child’s tribe receive notice, and (4) the requirement of Section 1912(b) that the Indian parent be provided with legal counsel.

The dissent also sends a message to the state court, which will now consider the case on remand, laying out a scenario that could result in Father having no parental rights but having a relationship with his own daughter through relatives:

[T]he majority does not and cannot foreclose the possibility that on remand, Baby Girl’s paternal grandparents or other members of the Cherokee Nation may formally petition for adoption of Baby Girl. If these parties do so, and if on remand Birth Father’s parental rights are terminated so that an adoption becomes possible, they will then be entitled to consideration under the order of preference established in § 1915. The majority cannot rule prospectively that § 1915 would not apply to an adoption petition that has not yet been filed. Indeed, the statute applies “[i]n any adoptive placement of an Indian child under State law,” 25 U.S.C. § 1915(a) (emphasis added), and contains no temporal qualifications. It would indeed be an odd result for this Court, in the name of the child’s best interests, cf. ante, at —-, to purport to exclude from the proceedings possible custodians for Baby Girl, such as her paternal grand-parents, who may have well-established relationships with her.

In an odd concurring opinion, Justice Thomas blesses the majority for not reaching more fundamental constitutional questions but then embarks on an originalist reimagining of federal Indian law pursuant to which (1) Congress had no authority to enact the ICWA, (2) the doctrine of congressional plenary power is error, (3) congressional power is strictly limited to commercial trade with Indian tribes located beyond state borders, and (4) congressional power does not extend to citizens of tribes. The idea behind concurrences of this nature is to plant seeds that the author hopes will germinate into a majority of the court at some future date.

Treasury and IRS Postpone the Effective Dates of Several Key Foreign Account Tax Compliance Act (FATCA) Provisions

GT Law

On July 12th, the IRS issued Notice 2013-43, which postpones the effective dates of several key FATCA provisions.   This Notice provides: (i) revised timelines for implementation of FATCA; and (ii) additional guidance concerning the treatment of financial institutions located in jurisdictions that have signed intergovernmental agreements (IGAs) for the implementation of FATCA but have not yet brought those IGAs into force.

Overview

FATCA, which will be phased in between 2013 and 2017, subjects many categories of payments made by U.S. persons to “Foreign Financial Institutions” (including most banks, funds, investment entities, depositories and insurance companies, collectively referred to as  “FFIs”) and certain non-financial foreign entities (including multinationals, partnerships and trusts, collectively referred to as “NFFEs”) to a 30% U.S. withholding tax unless the foreign recipient, and each member of its affiliated group, have agreed in advance to provide information to the IRS on their (direct and indirect) U.S. owners, creditors and investors (“U.S. Account Holders”).

FATCA generally (i) requires FFIs to provide information to the IRS regarding their U.S. Account Holders; (ii) requires certain NFFEs to provide information on their “Substantial U.S. Owners” to withholding agents; (iii) requires certain certifications that the FFI or NFFE is compliant with FATCA rules; (iv) enhances certain withholding tax rules and imposes a withholding tax on certain payments (“Withholdable Payments”) to FFIs and NFFEs that fail to comply with their obligations; and (v) imposes increased disclosure obligations on certain NFFEs that present a high risk of U.S. tax avoidance.

The burden of complying with FATCA falls on both the foreign recipients of Withholdable Payments, which have to identify and disclose their U.S. Account Holders in order to be exempt from the FATCA withholding, and on the payors of such payments (as withholding agents), which are required to obtain certification of such exemption from the foreign payees in order not to withhold.  A failure to obtain such certification can subject the payors to personal liability for any taxes not withheld.

Treasury Regulations under FATCA were issued on January 17, 2013.  In addition, the United States has begun the process of signing IGAs with other countries to implement FATCA on a government to government basis. The IGAs currently fall into two categories, Model 1 and Model 2, which contain different terms and requirements.

Notice 2013-43

Notice 2013-43 provides a six-month extension (from January 1 to July 1, 2014) for when FATCA withholding will begin and for implementing new account opening procedures as well as related requirements to comply with FATCA.  Importantly, the definition of “Grandfathered Obligation” (i.e., an obligation not subject to withholding) will be revised to include obligations outstanding on July 1, 2014 (whereas under the current rules, “grandfathered obligations” were obligations issued before January 1, 2014).  Withholding on gross proceeds is still scheduled to begin on January 1, 2017.

The timeline for foreign financial institutions (FFIs) to register as participating foreign financial institutions (PFFIs) is also extended, with the registration portal expected to open on August 19, 2013.  When the FATCA registration website opens, a financial institution will be able to begin the process of registering by creating an account and inputting the required information.  Prior to January 1, 2014, however, any information entered into the system, even if submitted as “final,” will not be regarded as a final submission, but will merely be stored until the information is submitted as final on or after January 1, 2014. Thus, financial institutions can use the remainder of 2013 to get familiar with the registration process, to input preliminary information, and to refine that information. On or after January 1, 2014, each financial institution must finalize its registration information and submit the information as final.  The IRS will electronically post the first IRS FFI List by June 2, 2014, and will update the list on a monthly basis thereafter. Thus, to ensure inclusion in the June 2014 IRS FFI List, FFIs would need to finalize their registration by April 25, 2014.

Finally, a jurisdiction will be treated as having in effect an IGA with the United States if the jurisdiction is listed on the Treasury website as a jurisdiction that is treated as having an IGA in effect. In general, Treasury and the IRS intend to include on this list jurisdictions that have signed but have not yet brought into force an IGA. The list of jurisdictions that are treated as having an IGA in effect is available at the following address: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx.

Conclusions

Six months ago, when the IRS issued the final FATCA Regulations, it intended to provide some clarity and certainty for FFIs and other affected taxpayers intending to comply with FATCA this year.  However, as of today, FFIs still face significant uncertainties pertaining to the implementation of FATCA in accordance with the timeline provided in the Regulations.  In addition, the progress of the IGA program has been much slower than expected.  At the beginning of the year, the Treasury and IRS indicated that active negotiations on IGAs were taking place with dozens of countries.  Nevertheless, as of today, only 10 IGAs have been signed.  FATCA compliance may differ depending on whether the FFI is in an IGA or non-IGA jurisdiction (and if the FFI is from an IGA jurisdiction, there will be a different term; depending on whether the IGA is a Model 1 or Model 2 IGA and whether the IGA is reciprocal or not).  Thus, there is growing concern among FFIs from jurisdictions that have yet to sign an IGA with the IRS with respect to the course of action to comply with FATCA.

Furthermore, last year, the IRS issued a draft version of the IRS Form W-8BEN-E, which foreign persons would use to certify as to their FATCA status.  The proposed W-8BEN-E form is an eight page long complex form containing a list of over 20 types of FATCA categories.  It was expected that the IRS would finalize the W-8BEN-E, and, importantly, would issue guidance on how to prepare it early enough so that all affected taxpayers would be able to comply with it.  Nevertheless, the IRS instead issued another draft in May 2013, and still expects comments from the tax community on the new draft.  As a result, it is not expected that the final W-8BEN-E Form, with the instructions, will be issued before the fall of 2013.

The six-month extension provided in Notice 2013-43, will hopefully allow Treasury and the IRS, on the one hand, to provide more guidance with respect to implementation of FATCA; and affected taxpayers, on the other hand, to get more clarity as to how to comply with FATCA.

What the SEC’s Elimination of the Prohibition on General Solicitation for Rule 506 Offerings Means to the EB-5 Community

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As we previously reported, on July 10, 2013, the SEC adopted the amendments required under the JOBS Act to Rule 506 that would permit issuers to use broad-based marketing methods such as the Internet, social media, email campaigns, television advertising and seminars open to the general public.  These types of methods are referred to in U.S. securities laws as “general solicitation,” and they have until now been prohibited in most offerings of securities that are not registered with the SEC. This is an important development to the EB-5 community because EB-5 offerings very often rely on Rule 506 as an exemption from offering registration requirements.

In addition, the SEC amended Rule 506 to disqualify felons and other “bad actors” from being able to rely on Rule 506.  This is also an important development for the EB-5 community, which has developed a heightened sensitivity to the potential for fraud in the wake of the Chicago Convention Center project.

Please note that these new rules are not yet effective.  See “When do the new rules become effective?” below.

Overview

Companies intending to raise capital through the sale of securities in or from the United States must either register the securities offering with the SEC or rely on an exemption from registration.   Failure to assure an available exemption for unregistered securities can result in civil and criminal penalties for the participants in the offering and rescission rights in favor of the investors.

For EB-5 programs, a widely used exemption from registration is Rule 506 of Regulation D, under which an issuer may raise an unlimited amount of capital from an unlimited number of “accredited investors” and up to 35 non-accredited investors.  Historically, this exemption has prohibited general solicitation or advertising in connection with the offering, including publicly available web sites, social media, email campaigns, television advertising and seminars open to the general public.

The other commonly used exemption, Regulation S, has been less restrictive on general solicitation, but is not available for investors already present in the United States and does not preempt state securities law registration/exemption obligations, which often prohibit general solicitation.  Rule 506 does preempt such state laws (except as to notice filings and filing fees).  For many EB-5 programs and investors, there is no available exemption other than Rule 506 that does not also prohibit general solicitation.

In connection with the passage by Congress of the Jumpstart Our Business Startups (JOBS) Act in April 2012, Congress directed the SEC to remove the prohibition on general solicitation or general advertising for securities offerings relying on Rule 506, provided that sales are limited to accredited investors only and that the issuer takes reasonable steps to verify that all purchasers of the securities meet the requirements for accredited investors. The SEC initially proposed a rule to implement these changes in August 2012, but did not pass final rules on the changes to Rule 506 until now.

What changes were made to Rule 506?

The final rule adds a new Rule 506(c), which permits issuers (that is, the partnerships or other organizations actually issuing partnership interests and the like in exchange for EB-5 capital) to use general solicitation and general advertising  for the offer their securities, provided that:

  • All purchasers of the securities are accredited investors as defined under Rule 501; and
  • The issuer takes “reasonable steps” to verify that the purchasers are all accredited investors.

Who is an accredited investor?

Under Rule 501 of Regulation D, a natural person qualifies as an “accredited investor” if he or she is either:

  • An individual net worth (or joint net worth with a spouse) that exceeds $1 million at the time of the purchase, excluding the value of a primary residence; or
  • An individual annual income of at least $200,000 for each of the two most recent years (or a joint annual income with a spouse of at least $300,000 for those years), and a reasonable expectation of the same level of income in the current year.

What are reasonable steps to verify that an investor is accredited?

What steps are reasonable will be an objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction.  The SEC indicates that among the factors that issuers should consider under this facts and circumstances analysis are:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

The final rule provides a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons, including:

  • For the income test, reviewing copies of any IRS form that reports the income of the purchaser for the two most recent years and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
  • For the net worth test, reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed:
    • With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
    • With respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies;
  • As an alternative to either of the above, an issuer may receive a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that it has taken reasonable steps within the prior three months to verify the purchaser’s accredited status.

Simply relying on a representation from the purchaser, or merely checking a box on an accredited investor questionnaire, will not meet the requirement for objective verification. EB-5 Regional Centers should consider this carefully if they intend to make “accredited investor” determinations.

What actions must an issuer take to rely on the new exemption?

Issuers selling securities under Regulation D using general solicitation must file a Form D. The final rule amends the Form D to add a separate box for issuers to check if they are claiming the new Rule 506 exemption and engaging in general solicitation or general advertising. An issuer is currently required to file Form D within 15 days of the first sale of securities in an offering, but the SEC promulgated proposed rules to require an earlier filing.  See “Are there any other changes contemplated for Rule 506?” below.

Will the new rule affect other Rule 506 offerings that do not use general solicitation?

Not directly. The existing provisions of Rule 506 remain available as an exemption. This means that an issuer conducting a Rule 506 offering without using general solicitation or advertising is not required to perform the additional verification steps.

Who is excluded from using the Rule 506 exemption?

Under the new rule regarding “bad actors” required by the Dodd-Frank Act, an issuer cannot rely on a Rule 506 exemption (including the existing Rule 506 exemption) if the issuer or any other person covered by the rule has had a “disqualifying event.”  The persons covered by the rule are the issuer, including its predecessors and affiliated issuers, as well as:

  • Directors and certain officers, general partners, and managing members of the issuer;
  • 20% beneficial owners of the issuer;
  • Promoters;
  • Investment managers and principals of pooled investment funds; and
  • People compensated for soliciting investors as well as the general partners, directors, officers, and managing members of any compensated solicitor.

What is a “disqualifying event?”

A “disqualifying event” includes:

  • Felony and misdemeanor criminal convictions in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The criminal conviction must have occurred within 10 years of the proposed sale of securities (or five years in the case of the issuer and its predecessors and affiliated issuers).
  • Court injunctions or restraining orders in connection with the purchase or sale of a security, making of a false filing with the SEC, or arising out of the conduct of certain types of financial intermediaries. The injunction or restraining order must have occurred within five years of the proposed sale of securities.
  • Final orders from certain regulatory authorities that:
    • bar the issuer from associating with a regulated entity, engaging in the business of securities, insurance or banking, or engaging in savings association or credit union activities, or
    • are based on fraudulent, manipulative, or deceptive conduct and were issued within 10 years of the proposed sale of securities.
  • Certain SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies, and investment advisers and their associated persons.
  • SEC cease-and-desist orders related to violations of certain anti-fraud provisions and registration requirements of the federal securities laws.
  • Suspension or expulsion from membership in or association with a self-regulatory organization (such as FINRA, the membership organization for broker-dealers).
  • U.S. Postal Service false representation orders issued within five years before the proposed sale of securities.

What disqualifying events apply?

Only disqualifying events that occur after the effective date of the new rule will disqualify an issuer from relying on Rule 506. However, matters that existed before the effective date of the rule and would otherwise be disqualifying must be disclosed to investors.

Are there exceptions to the disqualification?

Yes. An exception from disqualification exists when the issuer can that show it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.  The SEC can also grant a waiver of the disqualification upon a showing of good cause.

When do the new rules become effective?

Both rule amendments will become effective 60 days after publication in the Federal Register.  Publication normally occurs within two weeks after final rules are adopted.

Are there any other changes contemplated for Rule 506?

In connection with the foregoing final rules, the SEC separately published for comment a proposed rule change intended to enhance the SEC’s ability to assess developments in the private placement market based on the new rules regarding general solicitation. This proposal would require issuers to provide additional information to the SEC, including:

  • identification of the issuer’s website;
  • expanded information about the issuer;
  • information about the offered securities;
  • the types of investors in the offering;
  • the use of proceeds from the offering;
  • information on the types of general solicitation used; and
  • the methods used to verify the accredited investor status of investors.

Though this proposed rules is not specifically directed to EB-5 offerings, the SEC could use such information to enhance the monitoring it is already doing of EB-5 programs.

The proposed rule would also require issuers that intend to engage in general solicitation as part of a Rule 506 offering to file the Form D at least 15 calendar days before engaging in general solicitation for the offering. Then, within 30 days of completing the offering, the issuer would be required to update the information contained in the Form D and indicate that the offering had ended.

The proposed rule has a 60-day comment period.

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A Bad Smoke Break: Stringent Documentation of Work Rules Defends Against Unemployment Claims

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A recent Missouri case demonstrates the importance of documentation when defending against unwarranted unemployment claims. The case also underlines the need for the reforms passed by the Missouri General Assembly and pending signature by Gov. Jay Nixon.

cigarettes

Facts

James Sullivan worked as a part-time cook for nearly a year and a half at Landry’s Seafood House. One day, he disappeared during dinner service and was found 20 minutes later smoking and talking on his cell phone in the parking lot. He was fired and filed a claim for unemployment benefits. In Missouri, when employees are terminated for work-related misconduct, they can be disqualified from receiving unemployment benefits. However, a deputy at the Missouri Division of Employment Security initially determined that Sullivan was eligible for benefits. The restaurant appealed that determination to the Division Appeals Tribunal.

Appeals Tribunal Finds Willful Misconduct

During the hearing, which Sullivan failed to attend, Landry’s Seafood House offered the testimony of a senior kitchen manager. The manager said the restaurant had policies prohibiting employees from smoking at work or leaving their work area without a supervisor’s permission. Landry’s posted signs on its doors to remind employees of the rule and had discussed the policy with employees at shift meetings. Further, Landry’s provided employees with a copy of its policies. Sullivan had signed an acknowledgment of receipt when hired. Sullivan had been counseled for violating the rules in the past and had complied with the policies on several occasions by asking for permission to leave his workstation and clocking out before going outside to smoke a cigarette.

After the hearing, the Appeals Tribunal reversed the determination and found in favor of Landry’s. Sullivan was to be disqualified from receiving unemployment benefits because he was discharged for work-related misconduct. Sullivan appealed.

Court of Appeals Sides with the Employer

The Missouri Court of Appeals upheld the decision in Landry’s favor, finding there was substantial evidence to support it. The court noted that Sullivan was aware of the rules, had signed a written statement acknowledging receipt of the policies, and had been counseled on the rules. The supervisor’s testimony at the hearing established these facts and constituted substantial evidence that Landry’s terminated Sullivan for work-related misconduct. The court explained that Landry’s rule on breaks was also reasonable because a restaurant’s business depends on employees preparing food for its customers in a timely manner. Landry’s rule against smoking on the clock was reasonable because an employer has a right to expect employees to be engaged in meaningful work while being paid.

Bottom Line

At the time of this case, Missouri law defined misconduct as a “wanton and willful” act in order to disqualify a terminated employee from receiving unemployment benefits in Missouri. But as the first decision made by the deputy at the Missouri Division of Employment Security shows, that definition can lead to inconsistent rulings. Although the Missouri Court of Appeals ruled in favor of the employer, it was a time-consuming and expensive undertaking to work through the appeals process to secure a decision that would seem obvious to most people.

During the 2013 Legislative Session, the Missouri Chamber championed legislation to change the definition of misconduct to provide more consistency in unemployment compensation cases. Sponsored by Rep. Will Kraus, a Republican from Lee’s Summit, SB 28 is currently pending signature by Gov. Jay Nixon. House Bill 611 contains similar language and also awaits signature. Proof that you properly communicated your work rules to employees and required them to acknowledge receipt of the rules is key when seeking to establish that an employee’s violation of the rules was intentional. Landry’s actions in this case protected the restaurant from having to pay unemployment benefits to a former employee who violated its well-publicized policies.

Published in the July 2013 issue of Missouri Business, the Magazine of the Missouri Chamber of Commerce and Industry

Federal Judge Finds that Apple Conspired to Raise E-book Prices

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On July 10, 2013, Judge Denise Cote of the Southern District of New York issued a 160-page opinion holding that Apple conspired with five book publishers to raise e-book prices and eliminate retail price competition in violation of Section 1 of the Sherman Act and several relevant state statutes.  United States v. Apple Inc., case number 12-civ-2826 (DLC).  The five publishers – Hatchett, HarperCollins, Macmillan, Penguin and Simon & Schuester – had all previously settled with the U.S. Department of Justice (DOJ).

The opinion stated that as Apple prepared to launch its iPad to the public and sought to concurrently enter the e-book market with its iBookstore, it met with the publishers and agreed to provide them with an “agency model” for e-book pricing that allowed the publishers to set the prices of the e-books themselves, subject to certain price caps.  Apple’s agreements with the publishers also included Most Favored Nation provisions which ensured that Apple could match its competitors’ prices and also provided an incentive for the publishers to lobby Amazon and other retailers to change their wholesale business models to agency models.  According to the court’s opinion, these agency model agreements caused e-book prices to increase, sometimes 50% or more for a specific title.

A separate trial for potential damages will be scheduled later.  Apple said it will appeal the ruling.

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Insurer Enters Into $1.7 Million Health Insurance Portability and Accountability Act (HIPAA) Settlement

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The U.S. Department of Health and Human Services (HHS) announced yesterday that it has entered into a resolution agreement with a national managed care organization and health insurance company (hereinafter “Company”) to settle potential violations of the Health Insurance Portability and Accountability Act of 1996 (HIPAA).

Investigation and Resolution Agreement

The HHS Office for Civil Rights (OCR) conducted an investigation after receiving the Company’s breach report, a requirement for breaches of unsecured protected health information (PHI) pursuant to the Health Information Technology for Economic Clinical Health Act (HITECH) Breach Notification Rule.

The investigation indicated that the Company had not implemented appropriate administrative and technical safeguards required by the Security Rule; and as a result, security weaknesses in an online application database left electronic PHI (ePHI) of 612,042 individuals unsecured and accessible to unauthorized individuals over the internet. PHI at issue included names, dates of birth, addresses, social security numbers, telephone numbers, and health information. Specifically, with regard to ePHI maintained in its web-based application database, the Company did not:

  1. Adequately implement policies and procedures for authorizing access to ePHI;
  2. Perform an adequate technical evaluation in response to a software upgrade affecting the security of ePHI; or
  3. Adequately implement technology to verify the identity of the person/entity seeking access to ePHI.

HHS and the Company entered into a resolution agreement, and the Company agreed to pay a $1.7 million settlement.  Notably, the resolution agreement did not include a corrective action plan for the Company.

Stepped up Enforcement

Beginning with the September 23, 2013 Omnibus Rule compliance date, HHS will have direct enforcement authority over business associates and subcontractors.  The settlement is an indication that HHS will not hesitate to extend enforcement actions to business associates and subcontractors.

The settlement is also a reminder of HHS expectations regarding compliance with HIPAA and HITECH standards.  HHS noted “whether systems upgrades are conducted by covered entities or their business associates, HHS expects organizations to have in place reasonable and appropriate technical, administrative and physical safeguards to protect the confidentiality, integrity and availability of electronic protected health information – especially information that is accessible over the Internet.”

More information regarding the Omnibus Rule and its expanded liability is available here.

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What Have We Learned from Audits under the Medicare Electronic Health Record (EHR) Incentive Program?

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Through the first half of this year, the Centers for Medicare & Medicaid Services auditor has conducted numerous pre- and post-payment audits of meaningful use attestations submitted by eligible providers to the Medicare Electronic Health Record Incentive Program.  This newsletter provides an overview of pre- and post-payment audit activity as well as recommendations for how Eligible Providers should prepare themselves for audits.

Through the first half of this year, Figliozzi & Company (Figliozzi), the audit contractor for the Medicare Electronic Health Record (EHR) Incentive Program (EHR Incentive Program), has conducted numerous pre-payment and post-payment audits of meaningful use attestations submitted by eligible professionals, eligible hospitals and critical access hospitals (collectively, Eligible Providers).  This experience navigating pre-payment and post-payment audits has generated several recommendations that Eligible Providers should consider, whether or not they are under audit.

The following sections of this On the Subject provide an overview of Medicare EHR Incentive Program pre- and post-payment audit activity, an overview of the more recently implemented pre-payment audit program and recommendations for how Eligible Providers should prepare themselves for audits.

Overview of Incentive Program Audit Activity

The Centers for Medicare & Medicaid Services’ (CMS) EHR Incentive Program regulations authorize CMS to review an Eligible Provider’s meaningful use attestation to determine whether the Eligible Provider has met the requirements for an incentive payment.  Since its inception, CMS has incorporated automatic pre-payment edit checks into the EHR Incentive Program attestation and payment systems.  According to a February 2013 publication from CMS titled “EHR Incentive Programs Supporting Documentation for Audits” (CMS Audit Publication), CMS uses such pre-payment edit checks “to detect inaccuracies in eligibility, reporting and payment.”  Beginning with attestations submitted in January 2013, CMS also conducts pre-payment audits, which are “random and may target suspicious or anomalous data.”

In addition to pre-payment edit checks and audits, CMS also conducts post-payment audits, amounting to approximately 5 percent to 10 percent of Eligible Providers receiving incentive payments.  Eligible Providers selected for post-payment audits must present supporting documentation to validate their submitted attestation data, and CMS will withhold payment of the incentive payment for the Eligible Provider’s subsequent EHR incentive payment year until the audit is resolved.

Pre-Payment Audit Program

Implementation of pre-payment audits was widely anticipated in response to criticism from the Department of Health and Human Services Office of Inspector General (OIG).  In November 2012, the OIG released a report titled “Early Assessment Finds That CMS Faces Obstacles in Overseeing the Medicare EHR Incentive Program” (OIG Report).    The OIG Report noted that “CMS does not verify the accuracy of professionals’ or hospitals’ self-reported meaningful use information prior to payment.”

In recommending pre-payment audits, the OIG Report states that “[a]lthough CMS is not required to verify the accuracy of this information prior to payment, doing so would strengthen its oversight of the anticipated $6.6 billion in incentive payments.  Verifying self-reported information prior to payment could also reduce the need to identify and recover erroneous payments after they are made.”

CMS initially resisted the implementation of pre-payment audits in an October 2012 letter from CMS Acting Administrator Marilyn Tavenner to the OIG, speculating that implementation of pre-payment audits could significantly delay payments to Eligible Providers and, further, that requesting additional documentation from Eligible Providers would also impose an increased upfront burden.

Notwithstanding the initial resistance, CMS began conducting pre-payment audits for attestations submitted in 2013.  Figliozzi, which was previously appointed as a CMS contractor for purposes of conducting post-payment audits, conducts pre-payment audits on behalf of CMS.

As with the post-payment audits, CMS intends to conduct pre-payment audits of approximately 5 percent to 10 percent of Eligible Providers submitting attestations for meaningful use; according to the CMS Audit Publication, some Eligible Providers will be selected at random, while others will be audited based on submission of “suspicious or anomalous data.”  Given the unrelated process for selecting Eligible Providers for pre- and post-payment audits, it is possible that CMS may audit up to 20 percent of Eligible Providers submitting attestations for meaningful use in a given year.

Eligible Providers selected for pre-payment audits must present supporting documentation to validate data submitted during attestation before CMS will release their incentive payments.  The CMS regulations for the Medicare and Medicaid Program provide that Eligible Providers must keep documentation supporting their demonstration of meaningful use for six years.

Pre-Payment Audit Preparation Best Practices

Based on Eligible Providers’ experience with the pre-payment and post-payment audits, we recommend the following practices to improve the chance of a successful audit:

  • Understand Core and Menu Set Measures.  An Eligible Provider should review and be familiar with the specification sheets and frequently asked questions (FAQs) for the core and menu set meaningful use measures published by CMS on the EHR Incentive Program website.  The specification sheets and FAQs resolve many ambiguities created by the measures themselves and the auditors rely upon them as interpretive guidance to the measures.
  • Use Multi-Disciplinary Teams.  Eligible Providers should utilize a multi-disciplinary team of information technology and clinical personnel for the implementation and management of their EHR systems and meaningful use requirements to ensure the system is properly configured for measures (such as the drug-drug and drug-allergy interaction checks measure) that simply require functionality to be activated during the Eligible Provider’s meaningful use reporting period.
  • Documenting Measure Compliance.  Eligible Providers should retain documentation for each of the measures.  Such documentation may include: dated screen captures that demonstrate the Eligible Provider met the measure during the reporting period or otherwise by the applicable deadline, security risk assessment reports or an e-mail from an immunization registry confirming receipt.
  • Security Assessment. If an Eligible Provider relies upon a vendor hosting its EHR to conduct the security risk analysis required for the protection of electronic health information meaningful use measure, then the Eligible Provider should request a letter from the vendor stating the timing of the vendor’s assessment in order to demonstrate that the security assessment was completed before the end of the Eligible Provider’s meaningful use reporting period.
  • Certification of EHR System.  Eligible Providers should be prepared to provide documentation that they have implemented the version of a vendor’s EHR that has been certified as supporting meaningful use by the Office of the National Coordinator for Health Information Technology rather than an earlier uncertified version.  Eligible Providers using an EHR system that is provided on a “software-as-a-service” (SaaS) basis or otherwise from a cloud environment should be prepared for the auditor to request verification regarding the version number of the EHR system in use during the applicable reporting period.  Eligible Providers must obtain such verification from their EHR vendor and, as such, should maintain a relationship with an appropriate contact person at the vendor.  Eligible Providers should also monitor upgrades and version changes pushed by EHR vendors to ensure any upgrade does not affect the certified status of the EHR technology.  A significant change to an EHR system may require the vendor to seek re-certification of the system.
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Securities and Exchange Commission (SEC) Sanctions Revlon Financial Makeover; Tips for Setting a Strong Foundation for Going Private Transaction Success

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On June 13, 2013, the SEC entered into a cease and desist order and imposed an $850,000 civil money penalty against Revlon, Inc. (Revlon) in connection with a 2009 “going private” transaction (the Revlon SEC Order).  This article identifies some of the significant challenges in executing a going private transaction and highlights particular aspects of the Revlon deal that can serve as a teaching lesson for planning and minimizing potential risks and delays in future going private transactions.

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Background of Revlon Going Private Transaction.

The controlling stockholder of Revlon, MacAndrews & Forbes Holdings Inc. (M&F), made a proposal to the independent directors of Revlon in April of 2009 to acquire, by way of merger (the Merger Proposal), all of the Class A common stock not currently owned by M&F (the Revlon Minority Stockholders).  The Merger Proposal was submitted as a partial solution to address Revlon’s liquidity needs arising under an impending maturity of a $107 million senior subordinated term loan that was payable to M&F by a Revlon subsidiary.  A portion of this debt (equal to the liquidation value of the preferred stock issued in the Merger Proposal) would be contributed by M&F to Revlon, as part of the transaction.  This was submitted as an alternative in lieu of potentially cost-prohibitive and dilutive financing alternatives (or potentially unavailable financing alternatives) during the volatile credit market following the 2008 sub-prime mortgage crisis.

In response to the Merger Proposal, Revlon formed a special committee of the Board (the Special Committee) to evaluate the Merger Proposal.  The Special Committee retained a financial advisor and separate counsel to assist in its evaluation of the Merger Proposal.  Four lawsuits were filed in Delaware between April 24 and May 12 of 2009 challenging various aspects of the Merger Proposal.

On May 28, 2009, the Special Committee was informed by its financial advisor that it would be unable to render a fairness opinion on the Merger Proposal, and thereafter the Special Committee advised M&F that it could not recommend the Merger Proposal.  In early June of 2009, the Special Committee disbanded, but the independent directors subsequently were advised that M&F would make a voluntary exchange offer proposal to the full Revlon Board of Directors (the Exchange Offer). Revlon’s independent directors thereafter chose to continue to utilize counsel that served to advise the Special Committee, but they elected not to retain a financial advisor for assistance with the forthcoming M&F Exchange Offer proposal, because they were advised that the securities to be offered in the Exchange Offer would be substantially similar to those issuable through Merger Proposal.  As a result, they did not believe they could obtain a fairness opinion for the Exchange Offer consideration.  The Board of Directors of Revlon (without the interested directors participating in the vote) ultimately approved the Exchange Offer without receiving any fairness opinion with respect to the Exchange Offer.

On September 24, 2009, the final terms of the Exchange Offer were set and the offer was launched.  The Exchange Offer, having been extended several times, finally closed on October 8, 2009, with less than half of the shares tendered for exchange out of all Class A shares held by the Revlon Minority Stockholders.  On October 29, 2009, Revlon announced third quarter financial results that exceeded market expectations, but these results were allegedly consistent with the financial projections disclosed in the Exchange Offer.  Following these announced results, Revlon’s Class A stock price increased.  These developments led to the filing of additional litigation in Delaware Chancery Court.

The Revlon SEC Order and Associated Rule 13e-3 Considerations.

A subset of the Revlon Minority Stockholders consisted of participants in a Revlon 401(k) retirement plan, which was subject to obligations under the Employee Retirement Income Security Act of 1974, as amended (ERISA) and a trust agreement (the Trust Agreement) between Revlon and the Plan’s trustee (the Trustee).  Provisions of ERISA and the Trust Agreement prohibited a 401(k) Plan participant’s sale of common stock to Revlon for less than “adequate consideration.”

During July of 2009, Revlon became actively involved with the Trustee to control the flow of information concerning any adequate consideration determination, to prevent such information from flowing back to Revlon and to prevent such information from flowing to 401(k) participants (and ultimately Revlon Minority Stockholders); certain amendments to the Trust Agreement were requested by Revlon and agreed to by the Trustee to effect these purposes.  This also had the additional effect of preventing the independent directors of Revlon from being aware that an adequate consideration opinion would be rendered for the benefit of Revlon’s 401(k) Plan participants.

On September 28, 2009, the financial advisor to the 401(k) Plan rendered an adverse opinion that the Exchange Offer did not provide adequate consideration to 401(k) Plan participants.  As a result, the Trustee informed 401(k) Plan participants, as previously directed by Revlon, that the 401(k) Plan Trustee could not honor tender instructions because it would result in a “non-exempt prohibited transaction under ERISA.”  Revlon Minority Stockholders, including 401(k) Plan participants, were generally unaware that an unfavorable adequate consideration opinion had been delivered to the Trustee.

In the Revlon SEC Order, the SEC concluded that Revlon engaged in a series of materially misleading disclosures in violation of Rule 13e-3.  Despite disclosure in the Exchange Offer that the Revlon Board had approved the Exchange Offer and related transactions based upon the “totality of information presented to and considered by its members” and that such approval was the product of a “full, fair and complete” process, the SEC found that the process, in fact, was not full, fair and complete.  The SEC particularly found that the Board’s process “was compromised because Revlon concealed from both minority shareholders and from its independent board members that it had engaged in a course of conduct to ‘ring-fence’ the adequate consideration determination.”  The SEC further found that “Revlon’s ‘ring-fencing’ deprived the Board (and in turn Revlon Minority Stockholders) of the opportunity to receive revised, qualified or supplemental disclosures including any that might have informed them of the third party financial advisor’s determination that the transaction consideration to be received by the 401(k) members . . . was inadequate.”

Significance of the Revlon SEC Order.

The Revlon Order underscores the significance of transparency and fairness being extended to all unaffiliated stockholders in a Rule 13e-3 transaction, including the 401(k) Plan participants whose shares represented only 0.6 percent of the Revlon Minority Stockholder holdings.  Importantly, the SEC took exception to the fact that Revlon actively prevented the flow of information regarding fairness and found that the information should have been provided for the benefit of these participants, as well as all Revlon Minority Stockholders.  This result ensued despite the fact that Revlon’s Exchange Offer disclosures noted in detail the Special Committee’s inability to obtain a fairness opinion for the Merger Proposal and the substantially similar financial terms of the preferred stock offered in both the Merger Proposal and the Exchange Offer transactions.

Going Private Transactions are Subject to Heightened Review by the SEC and Involve Significant Risk, Including Personal Risk.

Going private transactions are vulnerable to multiple challenges, including state law fiduciary duty claims and wide ranging securities law claims, including claims for private damages as well as SEC civil money penalties.  In the Revlon transaction, the SEC Staff conducted a full review of the going private transaction filings.  Despite the significant substantive changes in disclosure brought about through the SEC comment process, the SEC subsequently pursued an enforcement action and prevailed against Revlon for civil money penalties.

Although the SEC sanction was limited in scope to Revlon, it is worth noting that the SEC required each of Revlon, M&F and M&F’s controlling stockholder, Ronald Perelman, to acknowledge (i) personal responsibility for the adequacy and accuracy of disclosure in each filing; (ii) that Staff comments do not foreclose the SEC from taking action including enforcement action with regard to the filing; and (iii) that each may not assert staff comments as a defense in any proceeding initiated by the SEC or any other person under securities laws.  Thus, in planning a going private transaction, an issuer and each affiliate engaged in the transaction (each, a Filing Person) must make these acknowledgements, which expose each Filing Person (including certain affiliates who may be natural persons) to potential damages and sanctions.

The SEC also requires Filing Persons to demonstrate in excruciating detail the basis for their beliefs regarding the fairness of the transaction.  These inquiries typically focus on the process followed in pursuing and negotiating the transaction, the procedural fairness associated with such process, and the substantive fairness of the overall transaction, including financial fairness.  As a result of this, each Filing Person (including certain natural persons) in a going private transaction should be prepared to diligently satisfy cumbersome process and fairness requirements as part of the pre-filing period deliberative process, and later stand behind extensive and detailed disclosures that demonstrate and articulate the basis of the procedural and substantive fairness of the transaction, including financial fairness.

Damages and Penalties in Going Private Transactions Can Be Significant.

It is worth noting that civil money penalties and settlements that have been announced to date by Revlon for its Exchange Offer going private transaction is approximately $30 million.  After factoring in professional fees, it would not be surprising that the total post-closing costs, penalties and settlements approach 50 percent of the implied total transaction value of all securities offered in the Exchange Offer transaction.  From this experience, it is obvious that costs, damages and penalties can be a significant component of overall transaction consideration, and these risks must be factored in as part of overall transaction planning at the outset.

Given the risks of post-transaction damages and costs, it is essential that future going private transactions be structured and executed by Filing Persons with the foregoing considerations in mind in order to advance a transaction with full transparency, a demonstrably fair procedural process and deal consideration that is substantively fair and demonstrably supportable as fair from a financial point-of-view.

New York State Court of Appeals Backs Starbucks Policy on Tip-Pooling

Sheppard Mullin 2012

Starbucks shift supervisors can legally participate in tip-sharing with other store employees, but the coffee chain’s assistant managers have enough managerial responsibility to disqualify them from sharing in customer tips, according to the New York State Court of Appeals.

Starbucks’ policy provides for weekly distribution of gratuities to the company’s two lower ranking categories of employees, baristas and shift supervisors, but not to its two higher ranking categories of employees, assistant managers and store managers. In addressing questions certified by the Second Circuit regarding the validity this policy, the Court of Appeals concluded that since shift supervisors, like baristas, directly serve patrons, they remain tip-pool eligible even if their role also involves some supervisory responsibility. But assistant managers, because they are granted “meaningful authority” over subordinates, are not eligible to participate in the tip pool.

The decision provides guidance to the Second Circuit as it hears appeals of two suits, Barenboim et al. v. Starbucks Corporation, No. 10–4912–cv, and Winans et al. v. Starbucks Corporation, No. 11–3199–cv, each brought by a different putative class of Starbucks workers. The plaintiffs in Barenboimare Starbucks baristas who argue that only baristas, and not shift supervisors, are entitled to participate in tip-sharing. The Winans plaintiffs are assistant managers who claim that they should be allowed a share of the tips. In both cases, the Southern District of New York awarded summary judgment to Starbucks, and the plaintiffs appealed. The Second Circuit certified questions to the New York Court of Appeals regarding the interpretation of New York Labor Law §196-d, which governs tip-pooling.

Shift Supervisors Are Not Company “Agents”

New York Labor Law §196-d prohibits an “employer or his agent or an officer or agent of any corporation, or any other person” from accepting or retaining any part of the gratuities received by an employee. It also states, “Nothing in this subdivision shall be construed as affecting the… sharing of tips by a waiter with a busboy or similar employee.”

According to the plaintiff baristas in Barenboim, Starbucks’ policy of including shift supervisors in the stores’ tip pools violates §196-d because the shift supervisors are company “agents” and therefore not permitted to “demand or accept, directly or indirectly, any part of the gratuities, received by an employee.” Starbucks argues that shift supervisors are sufficiently analogous to waiters, busboys and similar employees, and should therefore be permitted to share in the gratuities pursuant to §196-d.

The Court of Appeals, in deciding that shift supervisors are entitled to share in the tip pool, deferred to the New York State Department of Labor’s (“DOL”) long-standing view that “employees who regularly provide direct service to patrons remain tip-pool eligible even if they exercise a limited degree of supervisory responsibility.” The Court compared the shift supervisors to restaurant captains who have some authority over wait staff, but are nonetheless eligible to participate in tip pools pursuant to the DOL’s Hospitality Industry Wage Order and DOL guidelines dating back to 1972.

“Meaningful Authority” Standard

In Winans, the Starbucks assistant store managers argue that they should be deemed similar to waiters and busboys under §196-d (and therefore eligible for tip-sharing) because they do not have full or final authority to terminate subordinates. The Court of Appeals disagreed: “[W]e believe that there comes a point at which the degree of managerial responsibility becomes so substantial that the individual can no longer fairly be characterized as an employee similar to general wait staff within the meaning of Labor Law §196-d.” That line is drawn, according to the decision, at “meaningful or significant authority or control over subordinates.”

Examples of meaningful authority, according to the decision, are the ability to discipline subordinates, the authority to hire and terminate employees, and input into the creation of employee work schedules. Contrary to the plaintiffs’ claim, authority to hire and fire is not the exclusive test for determining whether an employee is similar to wait staff for the purposes of §196-d.

Tip-Sharing Required?

In addition to the question of which employees are eligible for tip-sharing, the Second Circuit asked the Court of Appeals to consider whether an employer may deny tip pool distributions to an employee who is eligible to split tips under §196-d. The Court held that §196-d excludes certain employees from tip pools, but does not require employers to include all employees who are not legally barred from participating.

Conclusion

The Court of Appeals decision provides specific guidance to the Second Circuit Court of Appeals in connection with the two Starbucks cases pending on appeal, but it also provides helpful clarity to any employers with tip-sharing policies. In particular, the decision confirms that employees who regularly provide direct service to patrons may still participate in tip-sharing, but are not required to do so, even if they exercise a limited degree of supervisory responsibility. On the other hand, employees with meaningful authority over subordinates are not eligible to participate in tip-sharing. Employers should carefully review their tip-sharing policies in light of this guidance from the Court of Appeals.

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