Category: Corporate Compliance

Department of Labor (DOL) Issues Model Notices to Employees Describing Health Insurance Exchanges

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Deadline to Provide Notices is October 1, 2013

The Patient Protection and Affordable Care Act (PPACA), the new health care reform law passed in 2010, requires many employers to notify their employees of the availability of health coverage under the new health insurance exchanges that are required to be operational effective January 1, 2014. All employers subject to the federal Fair Labor Standards Act must provide this notice, regardless of whether the employer currently offers health coverage to its employees. Employers must provide the notice to all full and part-time employees (but not to dependents).

On May 8, 2013, the Department of Labor (DOL) issued model notices for employers to use in satisfying these requirements. A copy of the notice for employers that offer health coverage is available here and a copy of the notice for employers that do not offer health coverage is available here.

Employers are free to modify the model notices provided that the notices, as modified, continue to satisfy the content requirements set forth in the PPACA. Employers must provide the notices to their existing employees no later than October 1, 2013. Employees hired on or after October 1, 2013 must receive the notice no later than 14 days after their hire date.

The notices may be provided by first class mail or electronically if the DOL’s electronic disclosure rules are met.

Model COBRA Notice

Additionally, the DOL updated its model COBRA notice for use by employers in notifying employees of their rights to continue (after certain losses of coverage) coverage under the employer’s health plan. The updated model notice contains information about the new health insurance exchanges. A copy of the updated model notice is available here.

California Requires Many Foreign Corporations To Send Annual Financial Statements To Shareholders

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California is a net exporter of corporate charters, but it remains home to many corporations. As a result, the California Corporations Code has a preternatural concern with foreign corporations.

One example is Section 1501(a) which requires the board to cause an annual report to be sent to shareholders.  This report must include a balance sheet as of year end and an income statement and statement of cash flows for the year.  The statute doesn’t require that the statements be audited, but if an independent accountant has issued a report, then that report must be sent along as well.  If there is no report, then the report must include a certificate of an authorized officer that the statements were prepared without audit from the books and records of the corporation.  If the corporation has fewer than 100 holders of record (determined in accordance with Section 605), the financial statements need not be prepared in conformity with generally accepted accounting principles if the statements reasonably set forth the assets and liabilities and income and expense of the corporation and disclose the accounting basis used in their preparation.

The report must be sent not later than 120 days after the close of the fiscal year and must be sent at least 15 days (or, if sent by third class mail, 35 days) prior to the annual meeting of shareholders held during the following fiscal year.  Cal. Corp. § 1501(a)(1) & (2).

This requirement applies to domestic corporations, a term that embraces any corporation formed under the laws of California.  Cal. Corp. § 1501(g).  Thus, it includes corporations not formed under the General Corporation Law. See Cal. Corp. Code § 167.  However, a corporation with less than 100 holders of record (determined in accordance with Section 605) may include a bylaw provision that waives the annual report requirement.

The statute also applies to any foreign corporation if the corporation has its principal executive offices in California or it customarily holds meetings of its board in California.  Cal. Corp. § 1501(g).

Publicly traded companies are not exempted per se from this requirement.  However, corporations with an outstanding class of securities registered under Section 12 of the Securities and Exchange Act of 1934 will satisfy the annual report requirement if they comply with Rule 14a-16 (17 C.F.R. § 240.14a-16).  Cal. Corp. § 1501(a)(4).  [Note that this statute purports to include future amendments and this may give rise to a constitutional problem, see Why Incorporation May Be Unconstitutional.]

Here is a flow-chart describing the application of the statute.  This is probably a good time to remind readers that this blog does not provide legal advice.  There are other requirements in Section 1501 (including possible quarterly reporting requirements) that are not covered in today’s post.  Moreover, there are other nuances that I’ve not mentioned.

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Top Five Traps for the Unwary in Spin-Offs

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A wave of corporate breakups has swept through the United States over the last few years as investors have taken notice of the fact that smaller companies focused on a single business tend to outperform their more diversified peers.  A primary vehicle for these breakups has been the spin-off transaction, in which a publicly traded parent company distributes the shares of the spin-off company (spinco) to its own shareholders, creating a new, independent publicly traded entity.  The New York Times, citing Dealogic, reported that there were 93 spin-off transactions worth $128 billion in 2011, and that 2012 kept pace with 85 spin-off transactions worth $109 billion.  The rationale for a spin-off often is to unlock the value in a business or division that is trapped in a larger corporate bureaucracy.  Conglomerates tend to spread capital across all of their divisions rather than focusing on the individual opportunities within each business that are the most promising.  Holding company structures also can make decision-making more cumbersome and equity incentives less incentivizing for division management who feel as though their hard work is being diluted by the underperformance of other divisions or businesses.

Spin-offs, however, are complicated transactions that require a great deal of advance planning.  In many cases, an announcement that a parent company is considering the spin-off of one of its businesses is actually the start of a “dual-track” process wherein the parent company considers and plans for a spin-off while also remaining open to potential bids from third parties to acquire the business.  In even more complicated cases, a parent company agrees to sell a business to an acquirer in connection with a spin-off transaction.

The vast majority of spin-off transactions are designed to qualify under the rules of the Internal Revenue Code as “tax free” to the parent company and the shareholders who receive the spinco stock.

With this in mind, any company considering spinning off a division or business should keep in mind the following five potential traps.

1.  Tax-Free Qualification – Legitimate Business Purpose 

The spin-off must satisfy a legitimate business purpose in order to qualify under both the tax-free rules of the Internal Revenue Code and the Securities Act of 1933.  The tax authorities require that the spin-off be motivated in whole or in substantial part by one or more legitimate corporate business purposes in order to ensure that the purpose of the transaction is not simply “tax avoidance.”  The business purpose requirement is one of many requirements under the tax laws to qualify for a tax-free spin-off.  Because the costs of triggering tax in a spin-off transaction often are very high, most parent companies obtain a legal opinion from outside counsel and obtain a ruling from the Internal Revenue Service as a condition to completing a spin-off transaction.  As discussed in relation to trap number five below, a legitimate business purpose for the spin-off also is required under the securities laws in order for the distribution of the spinco stock to not be treated as a “sale” of securities by the parent company or the spinco requiring Securities Act of 1933 registration and the strict liability standard of care that comes with such a registration.  See the article entitled, “Five Key Tax Considerations for Spin-Off Transactions” for a more in depth discussion of tax issues raised in spin-offs.

2.  Separation of Assets and Liabilities

Before a business or a division can be spun off, both its assets and its liabilities must be separated.  Large companies with long operating histories often find that the process of separating out the spinco business is not straightforward, because the legal entities that house the business might also house other businesses and divisions that share assets, services, products, employees, vendors and customers with the spinco business.  The pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial agreements, financing agreements, intellectual property licensing agreements, collective bargaining agreements, employment contracts, benefit plans, etc.  Often the spinco and the parent company or another legacy business must enter into complex sharing or licensing agreements or joint ventures relating to valuable intellectual property, such as trade names, trademarks or patents, as well as employee matters.  See the article entitled “Trademark, Domain Name and Other IP Considerations for Spin-Offs” for a more in depth discussion of IP issues raised in spin-offs and see the article entitled, “Employee Benefit Issues in a Spin-Off” for a more in depth discussion of employee benefit issues raised in spin-offs.

The sharing of liabilities is often the most complicated endeavour because of the slew of legal obligations that are triggered.  In allocating liabilities to the spinco, the parent company must evaluate the impact such allocation will have on the solvency of the parent and the spinco.  Parent company directors can face personal liability under state corporate law for making an unlawful dividend because the company lacked sufficient capital to make such a dividend or for rendering the parent company insolvent by distributing out the spinco business, and the parent company itself can face claims of constructive fraudulent conveyance—i.e., the parent company received less than equivalent value, and either the parent or spinco was rendered insolvent (assets do not exceed liabilities), the parent and/or spinco was left with unreasonably small capital to run its respective business, or the parent or spinco was left with debts that exceed its respective ability to pay those debts as they become due.  Parent company directors can rely on legal experts and financial advisors to assist them in satisfying their duty of care.  A solvency opinion from a nationally recognized provider of such opinions is often a condition to the consummation of a spin-off transaction.  Such an opinion may be helpful to the directors of the parent company and spinco for a variety of reasons: (i) it can help to show that the directors properly exercised their duty of care in determining to enter into the spin-off transaction; (ii) it can assist in rebutting a fraudulent conveyance claim; and (iii) it can assist in rebutting a claim that the company had insufficient capital to make such a dividend.

3.  Transition Services

While one of the key rationales for spinning off a business or division is to allow the enterprise to operate independently, the reality in most cases is that, at least during the first year or so post-spin, a spinco must rely on its former parent company to provide many key administrative and operational services during the spinco’s transition period to a self-sufficient, independent public company.  During the pre-spin planning period, companies should consider, among other things, which transition services will be required, how they will be provided, for how long and under what pricing terms.  Typical transition services include legal, internal auditing, logistics, procurement, quality assurance, distribution and marketing.  These arrangements often have durations that last between six and 24 months.  Many parent companies agree to provide such transition services purely on a cost basis, while others will use a “cost plus” or “market” rate.

4.  Spinco Management and Board of Directors

Again, while independence from the former parent company is a key benefit for most spincos, having corporate managers with institutional knowledge and history with the enterprise is an important factor in assisting the spinco to successfully transition to independence.  Many spinco management teams include members who have served as executives at the former parent company.  In many cases, these are managers who served as division leaders who reported to the parent company CEO or CFO and are now ready to step into executive roles on their own.  It is also common for between one and three members of the parent company board to agree to take seats on the spinco board to provide the new public company board with a source of the company’s history and culture to ensure a smooth transition.  However, because of the competing fiduciary duties that these directors will face if they hold seats on both the parent and spinco boards, it is important for the spinco board to also have a majority of truly independent directors.  Spinco directors who are former executive officers of the parent also must be aware that the stock exchanges and influential shareholder services firms such as Institutional Shareholder Services will not view them as being truly independent from a corporate governance standpoint for some time after the completion of the spin-off.  This will inhibit their ability to serve on key board committees of the spinco.

5.  Preparation of the Disclosure 

Under the U.S. Securities and Exchange Commission’s rules, a spin-off of the shares of a subsidiary to a parent company’s shareholders does not involve the sale of securities by either the parent company or the subsidiary as long as the following conditions are met: (i) the parent company does not provide consideration for the spun-off shares; (ii) the spin-off is pro rata to the parent company shareholders; (iii) the parent company provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; and (iv) the parent has a valid business purpose for the spin-off.

To meet the adequate public information requirement, parent companies are required to prepare and disseminate detailed “information statements” that effectively look like initial public offering registration statements for the spinco.  These information statements are filed with the spinco’s Form 10 registration statement, which is required in order to register the spinco’s shares under the Securities Exchange Act of 1934 and to permit listing of such shares on a national securities exchange.  The preparation of the spinco information statement can take up to three or four months and requires a great deal of effort and cooperation among the lawyers, the business leaders, the finance department, the human resources/employee benefits department and the auditors.  In addition, under New York law, a spin-off of all or substantially all of a company’s assets may require a vote of such company’s shareholders, while under Delaware law, such a requirement is much less likely.

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SEC Announces First Non-Prosecution Agreement Involving Foreign Corrupt Practices Act (FCPA) Violations

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On April 22, 2013, the Securities and Exchange Commission (SEC) announced it had entered into a Non-Prosecution Agreement (NPA) with Ralph Lauren Corporation under which the company agreed to disgorge approximately $700,000 in connection with certain unlawful payments made by a foreign subsidiary to government officials in Argentina from 2005 to 2009.  This is the first time the SEC has used a NPA for violations of the Foreign Corrupt Practices Act (FCPA).

According to the NPA, Ralph Lauren Corporation’s Argentine subsidiary paid “bribes,” i.e., payments in violation of the FCPA, to government and customs officials to improperly secure the importation of Ralph Lauren Corporation’s products in Argentina.  The purpose of the unlawful payments, made through a “customs broker,” was to obtain entry of Ralph Lauren Corporation’s products into the country without certain paperwork and to avoid certain inspections by customs officials.  The unlawful payments to Argentine officials totaled $593,000 during a four-year period.

The NPA further notes that the unlawful payments occurred during a period when Ralph Lauren Corporation lacked meaningful anti-corruption compliance and control mechanisms over its Argentine subsidiary.  The company discovered the misconduct in 2010 as a result of measures it adopted to improve its worldwide internal controls and compliance efforts, including implementation of a FCPA compliance training program in Argentina.  The NPA notes that the SEC determined not to charge Ralph Lauren Corporation with violations of the (FCPA) in light of several factors including:  (1) the company’s prompt reporting of the violations on its own initiative, (2) the completeness of the information it provided, and (3) the company’s extensive, thorough, and real-time cooperation with the SEC’s investigation.  According to the SEC, Ralph Lauren Corporation’s cooperation saved the Commission “substantial time and resources.”

In parallel criminal proceedings, the Justice Department also entered into a Non-Prosecution Agreement with Ralph Lauren Corporation under which the company will pay an $882,000 penalty.[1]

NPAs are part of the Enforcement Division’s Cooperation Initiative announced in 2010.  Prior to 2010, the SEC did not have the ability to enter into NPAs or Deferred Prosecution Agreements (DPAs).  The purpose of the Cooperation Initiative was to give the Commission the flexibility to incentivize and reward cooperation while at the same time ensuring that cooperators are held accountable for their misconduct.  Since 2010 and prior to this instance, the Commission has entered into three NPAs[2] and two DPAs[3]  It is likely that the SEC will continue to use DPAs and NPAs particularly in connection with FCPA matters given the factual complexity of the cases and the difficulty in discovering violations, which almost always occur outside the U.S.

The Ralph Lauren NPA provides useful guidance as to what the SEC will consider in assessing corporate cooperation by detailing the significant actions that Ralph Lauren Cooperation took in connection with the parallel investigations.  According to the NPA, Ralph Lauren Corporation:

  • reported preliminary findings of its internal investigation to the staff within two weeks of discovering the illegal payments and gifts:
  • voluntarily and expeditiously produced documents;
  • provided English language translations of documents to the staff;
  • summarized witness interviews that the company’s investigators conducted overseas; and
  • made overseas witnesses available for staff interviews in the U.S.

The NPA also notes that Ralph Lauren Corporation entered into tolling agreements during the staff’s investigation.  The statute of limitations with respect to the 2005 conduct, the earliest conduct charged, would have likely run in 2010, just as the company reported the violations to the SEC.

The Ralph Lauren NPA provides several other takeaways.  First, the Ralph Lauren Corporation agreed to enter into the NPA “without admitting or denying liability.”  While the NPA also contains the standard provision prohibiting the Ralph Lauren Corporation from “denying, directly or indirectly, the factual basis of any aspect of the” NPA, the inclusion of the “without admitting or denying language” seems to run counter to the policy announced by the Enforcement Division in January 2012 to eliminate the use of “neither admit nor deny” language from settlement documents involving parallel (i) criminal convictions or (ii) NPAs or DPAs[4]  This may suggest that the “without admitting or denying liability” language remains negotiable.

Second, under the agreement, the Company must seek the staff’s prior approval of the contents of any press release concerning the NPA.  Third, while the SEC emphasizes the Ralph Lauren Corporation’s enhanced compliance program and successful implementation of the enhancements, it also highlights that the Ralph Lauren Corporation has ceased retail operations in Argentina and is in the process of winding down all operations there.  It is possible Ralph Lauren Corporation’s decision to close operations in Argentina was a significant factor in the SEC’s decision to use a NPA in this circumstance.  Fourth, notably, the NPA does not require the Ralph Lauren Corporation to retain an independent consultant to review its policies and procedures and to prepare a report to the staff regarding any findings.  The financial burden of independent consultant “reviews” is often significant.  The staff’s willingness to forego such an undertaking demonstrates the value of taking quick and full remedial action during an investigation.

Fifth, the NPA also refers to “gifts” such as perfume, dresses and handbags valued at between $400 and $14,000, which were provided to three different government officials during the relevant time.  This underscores the importance of having policies and procedures that extend beyond prohibiting monetary payments to government officials.  Finally, the NPA requires that the Ralph Lauren Corporation “to pay disgorgement obtained or retained as a result of the violations discovered during the investigation.”  In its press release, the SEC notes that Ralph Lauren Corporation will “disgorge” $700,000 in illicit profits and interest.  The disgorgement, however, appears to be the total amount of unlawful payments plus interest made rather than any profit earned as a result of the unlawful payments.  Disgorgement is frequently difficult to calculate, especially in FCPA cases.  It appears that rather than tracing the unlawful payments to profits, the SEC was satisfied to use the amount of unlawful payments as a proxy for disgorgement.  Moreover, the low monetary value of the unlawful payments may have also contributed to the SEC’s decision to enter into a NPA in this instance.

[1]  The agreement with the Justice Department stands as yet another example of DOJ’s position that senior management be intricately involved in anti-corruption compliance efforts.  More specifically, the agreement requires that Ralph Lauren’s “directors and senior management provide strong, explicit, and visible support and commitment to its corporate policy against violations of the anti-corruption laws and its compliance code.”  Further, the agreement requires that the company “assign responsibility to one or more senior corporate executives of the Company for the implementation and oversight of the Company’s anti-corruption compliance code, policies and procedures.” 

[2]  In December 2010, the SEC entered into a NPA with Carters Inc. in connection with a financial fraud perpetrated by a former Executive Vice President of Carters.  The NPA focused on the isolated nature of the misconduct, Carters’ prompt self-reporting, extensive cooperation and remedial actions.  In December 2011, the SEC entered into DPAs with Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) in connection with certain misleading statements claiming that the companies had minimal holdings of higher-risk mortgage loans including subprime loans.  The NPA focused on Freddie Mac’s and Fannie’s Mae’s cooperation in connection with the SEC’s litigation against former senior executives.

[3]  In May 2011, the SEC entered into a DPA with Tenaris S.A. in connection with FCPA violations.  The DPA required Tenaris to disgorge approximately $5.4 million.  The DPA focused on Tenaris’ early self-reporting, extensive cooperation and remedial actions.  InJuly 2012, the SEC entered into a DPA with Amish Helping Fund in connection with certain misrepresentations and omissions in offering documents.  Again, the DPA focused on Amish Helping Fund’s immediate and complete cooperation, its willingness to offer investors a right of rescission and its remedial efforts. 

[4]  The Amish Helping Fund DPA entered into on July 18, 2012, does not contain the “without admitting or denying” or “neither admitting nor denying” language.

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Investment Regulation Update – April 2013

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The Investment Regulation Update is a periodic publication providing key regulatory and compliance information relevant to broker-dealers, investment advisers, private funds, registered investment companies and their independent boards, commodity trading advisers, commodity pool operators, futures commission merchants, major swap participants, structured product sponsors and financial institutions.

This Update includes the following topics:

  • SEC Adopts Rules to Help Protect Investors from Identity Theft
  • Increased Attention to Broker-Dealer Registration in the Private Fund World
  • SEC Issues Guidance Update on Social Media Filings By Investment Companies
  • AIFMD — Effect on U.S. Fund Managers
  • SEC Announces 2013 Examination Priorities
  • Reminder — Upcoming Form PF Filing Deadline
  • Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline
  • Are you a Lobbyist?
  • Recent Events

SEC Adopts Rules to Help Protect Investors from Identity Theft

On April 10, 2013, SEC Chairman Mary Jo White’s official first day on the job, the SEC, jointly with the CFTC, adopted rules and guidelines requiring broker-dealers, mutual funds, investment advisers and certain other regulated entities that meet the definition of “financial institution” or “creditor” under the Fair Credit Reporting Act (FCRA) to adopt and implement written identity theft prevention programs designed to detect, prevent and mitigate identify theft in connection with certain accounts. Rather than prescribing specific policies and procedures, the rules require entities to determine which red flags are relevant to their business and the covered accounts that they manage to allow the entities to respond and adapt to new forms of identity theft and the attendant risks as they arise. The rules also include guidelines to assist entities subject to the rules in the formulation and maintenance of the required programs, including guidelines on identifying and detecting red flags and methods for administering the program. The rules also establish special requirements for any credit and debit card issuers subject to the SEC or CFTC’s enforcement authority to assess the validity of notifications of changes of address under certain circumstances. Chairman White stated, “These rules are a common-sense response to the growing threat of identity theft to all Americans who invest, save or borrow money.” The final rules will become effective 30 days after date of publication in the Federal Register and the compliance date will be six months thereafter.

Increased Attention to Broker-Dealer Registration in the Private Fund World

The role of unregistered persons in the sale of interests in privately placed investment funds is an area of great interest for the SEC and the subject of recent enforcement actions. On March 8, 2013, the SEC filed and settled charges against a private fund manager, Ranieri Partners, LLC, one of the manager’s senior executives and an external marketing consultant regarding the consultant’s failure to register as a broker-dealer. The Ranieri Partners enforcement actions are especially interesting for two reasons: (i) there were no allegations of fraud and (ii) the private fund manager and former senior executive, in addition to the consultant, were charged.

On April 5, 2013, David Blass, the Chief Counsel to the SEC’s Division of Trading and Markets, addressed a subcommittee of the American Bar Association. His remarks have been posted on the SEC website. Mr. Blass referenced a speech by the former Director of the Division of Investment Management, who expressed concern that some participants in the private fund industry may be inappropriately claiming to rely on exemptions or interpretive guidance to avoid broker-dealer registration.

In addition, Mr. Blass noted Securities Exchange Act Rule 3a4-1’s safe harbor for certain associated persons of an issuer generally is not or cannot be used by private fund advisers. He suggested that private fund managers should consider how they raise capital and whether they are soliciting securities transactions, but he did acknowledge that a key factor in determining whether someone must register as a broker-dealer is the presence of transaction-based compensation. The Chief Counsel also raised the question of whether receiving transaction-based fees in connection with the sale of portfolio companies’ required broker-dealer registration. He suggested that private fund managers may receive fees additional to advisory fees that could require broker-dealer registration, e.g., fees for investment banking activity.

On a related note, in two recent “no-action” letters, the SEC has established fairly clear rules regarding how Internet funding network sponsors may operate without being required to register as broker-dealers. On March 26 and 28, 2013, the SEC’s Division of Trading and Markets addressed this narrow, fact-specific issue in response to requests from FundersClub Inc. and AngelList LLC seeking assurances that their online investment matchmaking activities would not result in enforcement action by the SEC. The April 10, 2013 GT Alert—SEC Clarifies Position on Unregistered Broker-Dealer Sponsors of Internet Funding Networks is availablehere.

SEC Issues Guidance Update on Social Media Filings by Investment Companies

On March 15, 2013, the SEC published guidance from the Division of Investment Management (IM Guidance) to clarify the obligations of mutual funds and other investment companies to seek review of materials posted on their social media sites. This report stems from the SEC’s awareness of many mutual funds and other investment companies unnecessarily including real-time electronic materials posted on their social media sites (interactive content) with their Financial Industry Regulatory Authority filings (FINRA). In determining whether a communication needs to be filed, the content, context, and presentation of the communication and the underlying substantive information transmitted to the social media user and consideration of any other facts and circumstances are all taken into account, such as whether the communication is merely a response to a request or inquiry from the social media user or is forwarding previously-filed content. The IM Guidance offers examples of interactive content that should or should not be filed with FINRA. The IM Guidance is the first in a series of updates to offer the SEC’s views on emerging legal issues and to provide transparency and enhance compliance with federal securities laws and regulations. You may find a link to the SEC Press Release and IM Guidance here.

On a related note, on April 2, 2013, the SEC released a report of an investigation regarding whether the use of social media to disclose nonpublic material information violates Regulation FD. The SEC has indicated that, in light of evolving communication technologies and habits, the use of social media to announce corporate developments may be acceptable; however, public companies must exercise caution and undertake careful preparation if they wish to disseminate information through non-traditional means. The April 5, 2013 GT Alert—Social Media May Satisfy Regulation FD But Not Without Risk and Preparation by Ira Rosner is available here.

AIFMD – Effect on U.S. Fund Managers

New European Union legislation that regulates alternative asset managers who manage or market funds within the EU comes into force on July 22, 2013. The Alternative Investment Fund Managers Directive (AIFMD) will have a significant impact on U.S. fund managers if they actively fundraise in Europe after July 21, 2013 (or if they manage EU-domiciled fund vehicles). Historically, U.S. private equity firms raising capital in Europe have relied on private placement regimes that essentially allowed marketing to institutions and high net worth investors. Beginning July 22, 2013, U.S. fund managers may continue to rely on private placement regimes in those EU jurisdictions that continue to operate them; however, they will now be under an obligation to meet certain reporting requirements and rules set out in the AIFMD relating to:

  • transparency and disclosure, and
  • rules in relation to the acquisition of EU portfolio companies.

The transparency and disclosure rules require, for the most part, the disclosure of information typically found in a PPM; however, additional items are likely to be required such as the disclosure of preferential terms to particular investors and level of professional indemnity cover. The rules also require reports to be made to the regulator in each jurisdiction in which the fund has been marketed. The reports will need to include audited financials, a description of the fund’s activities, details of remuneration and carried interest paid, and details of changes to material disclosures. Acquisitions of EU portfolio companies also lead to reporting obligations on purchase – an annual report – and a rule against “asset stripping” for 24 months after the acquisition of control. Firms with less than €500 million in assets under management are exempt from the reporting requirements and reverse solicitation is potentially an option, as the directive does not prevent an EU institution from contacting the U.S. fund manager, but in practice it may be difficult to apply systematically.  Fund managers may choose to register in the EU on a voluntary basis from late 2015. This will allow marketing across all EU member states on the basis of a single registration. However, registration will come with a significant compliance burden. If you plan to market in the EU after July 23, 2013, ensure that you review your marketing materials, evaluate your likely reporting obligations and consider how the portfolio company acquisition rules are likely to impact your transactions.

SEC Announces 2013 Examination Priorities

On February 21, 2013 the SEC’s National Examination Program (NEP) published its examination priorities for 2013. The examination priorities address issues market-wide, as well as issues relating to particular business models and organizations. Market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and technology controls.  Priorities in specific program areas include: (i) for investment advisers and investment companies, presence exams for newly registered private fund advisers, and payments by advisers and funds to entities that distribute mutual funds; (ii) for broker-dealers, sales practices and fraud, and compliance with the new market access rule; (iii)for market oversight, risk-based examinations of securities exchanges and FINRA, and order-type assessment; and (iv) for clearing and settlement, transfer agent exams, timely turnaround of items and transfers, accurate recordkeeping, and safeguarding of assets, and; (iv) for clearing agencies, designated as systemically important, conduct annual examinations as required by the Dodd-Frank Act. The priority list is not exhaustive. Importantly, priorities may be adjusted throughout the year and the NEP will conduct additional examinations focused on risks, issues, and policy matters that are not addressed by the release.

Reminder—Upcoming Form PF Filing Deadline

SEC registered investment advisers who manage at least $150 million in private fund assets with a December 31st fiscal year end should be well underway in preparing their submissions for the approaching April 30, 2013 deadline. Filings must be made through the Private Fund Reporting Depository (PFRD) filing system managed by the Financial Industry Regulatory Authority (FINRA). As a reminder, advisers to three types of funds must file on Form PF: hedge funds, liquidity funds and private equity funds. Hedge funds are generally defined as a private fund that has the ability to pay a performance fee to its adviser, borrow in excess of a certain amount or sell assets short. Liquidity funds are defined as a private fund seeking to generate income by investing in short-term securities while maintaining a stable net asset value for investors. Private equity funds are defined in the negative as not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not generally provide investors with redemption rights. When classifying its funds, advisers should carefully read the fund’s offering documents and definitions on Form PF and should seek assistance of counsel. Particularly, we have seen the broad definition of hedge fund cause a fund considered a private equity fund by industry-standards to be a hedge fund for purposes of Form PF, thus subjecting the fund to more expansive reporting requirements. As is the case with filing Form ADV through IARD, the $150 Form PF filing fee is paid through the same IARD Daily Account and must be funded in advance of the filing. FINRA recently updated their PFRD System FAQs. The SEC has also posted new Form PF FAQs, which should be referred to for upcoming filings.

Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline

All entities, including private funds, engaged in swap transactions must adhere to the ISDA Dodd-Frank Protocol no later than May 1, 2013 in order to engage in new swap transactions on or after May 1. Adherence to the Dodd-Frank Protocol will result in an entity’s ISDA swap documentation being amended to incorporate the business conduct rules that are applicable to swap dealers under Dodd-Frank.  Adherence to the Protocol involves filling out a questionnaire to ascertain an entity’s status under Dodd-Frank (e.g., pension plan, hedge fund and corporate end-user).  Further information on adherence to the Protocol can be obtained at ISDA’s website by clicking here.

Are you a lobbyist?

Over the last decade, many state and municipal governments have enacted new laws regarding how businesses may interact with government officials. These laws often establish new rules expanding the activities that are deemed to be “lobbying,” who is required to be registered as a lobbyist and what information must be publicly disclosed. Approximately half of the states, and countless municipalities, now define lobbying to include attempts to influence government decisions regarding procurement contracts – including contracts for investment advisors and placement agents – and impose steep penalties for companies that fail to register and disclose their “lobbying” activities and expenditures. Although some lobbying laws include exceptions for communications that occur as part of a competitive bidding process, the rules are inconsistent and not always clear. For example, although New York City’s lobbying law long included procurement lobbying, in 2010 the City’s Corporation Counsel and the City Clerk issued letters warning businesses that “activities by placement agents and other persons who attempt to influence determinations of the boards of trustees by the City’s . . . pension funds” are likely to be considered lobbying activity that requires registration and disclosure. Similarly, California’s lobbying law was expanded in 2011 to expressly include persons acting as “placement agents” in connection with investments made by California retirement systems, or otherwise seek to influence investment by local public retirement plans. Greenberg Traurig’s Investment Regulation Group, in conjunction with our Political Law Compliance team, is available to assist clients with questions regarding how to navigate increasingly complex lobby compliance laws and rules across the country and beyond. GT has a broad range of experience in advising to some of the world’s leading corporations, lobbying firms, public officials and others who seek to navigate lobbying and campaign finance laws.

Recent Events

On April 18, 2013, GT hosted the seminar, “The Far Reaching Impact of FATCA Across Borders and Across Industries” as both a webinar and live program in NY and Miami. The seminar explored the latest FATCA regulations and key intergovernmental agreements as well as their applications to a variety of industries. Click here to view the presentation.

On April 10, 2013, GT sponsored Artisan Business Group’s EB-5 Finance seminar at our NYC office. The program exposed participants to a unique alternative financing opportunity for projects that lend themselves to the EB-5 immigrant investor program and featured several GT speakers, including Steve Anapoell and Genna Garver, Co-Chair of the Investment Regulation Group, who provided a securities law update and considerations in the EB-5 area. Guest speakers included Jeff Carr from EPR, Phil Cohen from the EB-5 Resource Center, and Reid Thomas from NES Financial.

On April 2, 2013, GT co-hosted a Global Compliance seminar with Dun & Bradstreet on Foreign Corrupt Practices Act (FCPA) issues. The program included an overview of the FCPA, with a specific emphasis on the Department of Justice’s recently released Resource Guide to the FCPAand recent enforcement activities. A link to the Resource Guide can be found here.

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Second Circuit Bars Criminal Defendant from Accessing Assets Frozen by Regulators

Katten Muchin

The US Court of Appeals for the Second Circuit recently upheld a district court’s refusal to release nearly $4 million in assets frozen by the Securities and Exchange Commission and the Commodity Futures Trading Commission to help a defendant fund his criminal defense.

Stephen Walsh, a defendant in a criminal fraud case, had requested the release of $3.7 million in assets stemming from the sale of a house that had been seized by regulators in a parallel civil enforcement action. In denying Walsh’s motion to access the frozen funds, the US District Court for the Southern District of New York found that the government had shown probable cause that the proceeds had been tainted by defendant’s fraud, and were therefore subject to forfeiture. Though Walsh and his wife had purchased the home in question using funds unrelated to the fraud, Walsh ultimately acquired title to the home pursuant to a divorce settlement in exchange for a $12.5 million distributive award paid to his wife, at least $6 million of which, according to the court, was traceable to the fraud.

Agreeing with the District Court, the Second Circuit found that although the house itself was not a fungible asset, it was “an asset purchased with” the tainted funds from the marital estate by operation of the divorce agreement and affirmed the denial of defendant’s request. Further, since Walsh’s assets did not exceed $6 million at the time of his arrest, under the Second Circuit’s “drugs-in, first-out” approach, all of his assets became traceable to the fraud.

U.S. v. Stephen Walsh, No. 12-2383-cr (2d Cir. Apr. 2, 2013).

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Securities and Exchange Commission’s (SEC) Rule 10b5-1 Trading Plans Under Scrutiny

The National Law Review recently published an article, Securities and Exchange Commission’s (SEC) Rule 10b5-1 Trading Plans Under Scrutiny, written by the Financial, Corporate Governance and M&A Litigation Group of Barnes & Thornburg LLP:

Barnes & Thornburg

 

For more than a decade, corporate officers and directors of publicly traded companies have relied on trading plans, known as Rule 10b5-1 trading plans, in order to trade stock in their companies without running afoul of laws prohibiting corporate “insiders” from trading on material information not known to the general public. Historically, effective 10b5-1 plans have provided corporate insiders with an affirmative defense to allegations of unlawful insider trading.

Such plans typically involve a prior agreement between a corporate executive or board member and his or her broker. Under such agreements, the insider would provide standing trading instructions to the broker, requiring the broker to trade at a set stock price or a set time, for example. The broker would then effect the trade at the required price or time, regardless of the information held by the insider.

Recently, notwithstanding the Securities and Exchange Commission’s (SEC) longtime knowledge of potential abuses, such 10b5-1 plans have been under fire. In a Nov. 27, 2012, article in the Wall Street Journal titled “Executives’ Good Luck in Trading Own Stock,” the authors aired several complaints about such plans, including that “[c]ompanies and executives don’t have to file these trading plans with any federal agency. That means the plans aren’t readily available for regulators, investors or anyone else to examine. Moreover, once executives file such trading plans, they remain free to cancel or change them—and don’t have to disclose that they have done so. Finally, even when executives have such a preset plan, they are free to trade their companies’ stock at other times, outside of it.” The article went on to chronicle several purported abuses by officers and directors of such plans.

The current regulatory environment has simultaneously raised suspicions about plans and trades that are innocent, and potentially provided shelter for others that may be less so. In fact, in a Feb. 5, 2013, article in the Wall Street Journal entitled “SEC Expands Probe on Executive Trades,” the author noted that “[t]he Securities and Exchange Commission, expanding a high-profile investigation, is gathering data on a broad number of trades by corporate executives in shares of their own companies, according to people familiar with the probe.”

It would appear, from news like this, that the SEC is concerned that corporate insiders are adopting or amending 10b5-1 plans when in possession of non-public information that might affect market participants’ decision to trade in the company’s stock. Such changes could nullify the use of a 10b5-1 plan as a defense.

Seemingly in reaction to the perceived manipulation of 10b5-1 plans, the Council of Institutional Investors (CII) submitted a letter to the SEC on Dec. 28, 2012, requesting that the SEC implement rulemaking to impose new requirements with respect to Rule 10b5-1 trading plans. The CII letter calls for company boards of directors to become explicitly responsible for monitoring 10b5-1 plans, which undoubtedly will subject boards to increased scrutiny by the SEC. In addition, the CII letter proposes stricter regulatory rules including:

  • Adoption of 10b5-1 plans may occur only during a company open trading window
  • Prohibition of an insider having multiple, overlapping 10b5-1 plans
  • Mandatory delay of at least three months between 10b5-1 plan adoption and the first trade under the plan
  • Prohibition on frequent modifications/cancellations of 10b5-1 plan

The CII also advocates pre-announced disclosure of 10b5-1 plans and immediate disclosure of plan amendments and plan transactions. Under the CII’s suggested new rules, a corporate board also would be required to adopt policies covering 10b5-1 plan practices, monitor plan transactions, and ensure that such corporate policies discuss plan use in a variety of contexts. A similar set of suggestions can be found in Wayne State University professor Peter J. Henning’s Dec. 10, 2012, article, “The Fine Line Between Legal, and Illegal, Insider Trading,” found online at:  http://dealbook.nytimes.com/2012/12/10/the-fine-line-between-legal-and-illegal-insider-trading/.

Given the uncertainty in the market concerning the current use of Rule 10b5-1 plans and the future of such plans, companies or individuals who may be subject to Rule 10b5-1 plans and/or future regulations in this area should consult with counsel before adopting or amending such plans.

© 2013 BARNES & THORNBURG LLP

Court Grants Summary Judgment Against Coca-Cola in Breach of Collective Bargaining Agreement Claim by United Steel Workers

The National Law Review recently published an article by Bryan R. Walters of Varnum LLP regarding Coca-Cola’s Breach of Collective Bargaining Agreement:

Varnum LLP

 

In Local Union 2-2000 United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial, Chemical and Service Workers International Union v. Coca-Cola Refreshments U.S.A. Inc. (W.D. Mich. Nov. 21, 2012), the Honorable Janet T. Neff granted summary judgment in favor of the United Steel Workers against Coca-Cola on a breach of contract claim concerning wage increases under the parties’ collective bargaining agreement. The opinion addressed two interesting legal issues.

First, the court rejected Coca-Cola’s statute of limitations argument under 29 U.S.C. § 160(b), which provides that “no complaint shall issue based upon any unfair labor practice occurring more than six months prior to the filing of the charge with the Board and the service of a copy thereof upon a person against whom such charge is made.”  Coca-Cola argued that, because the United Steel Workers had filed an unfair labor practice charge concerning their unpaid wages claim approximately nine months after becoming aware of the issue, Section 160(b) barred the union’s claim.  The court rejected this argument, concluding that it would be “inappropriate” to apply the six-month limitations period to what was a pure breach of contract claim.  Instead, the court held that the applicable statute of limitations was the six-year statute of limitations under Michigan law for breach of contract actions.  Op. at 13–15.

The second significant issue related to interpretation of the collective bargaining agreement.  The collective bargaining agreement included schedules for wage increases in “Year 1, Year 2, and Year 3” without further defining those terms within the primary contract document.  The court held that this contract language was ambiguous, requiring introduction of parol evidence of the parties’ negotiation history. The court found clear and convincing evidence in the negotiating history that the union’s interpretation of the “Years” was correct, in that “Year 1” referred to the first 365 days after the effective date of the contract, etc.  Id. at 19.

The court also concluded that there was clear and convincing evidence of a mutual mistake in the drafting of the final collective bargaining agreement. Coca-Cola listed specific dates for the wage adjustments in an appendix to the collective bargaining agreement. The court found that the dates listed in the appendix were not bargained for and never agreed to by the parties, rejecting as self-serving subsequent statements from Coca-Cola’s negotiators that Coca-Cola did not consider the dates unilaterally added to the appendix by Coca-Cola a “mistake.”  Id. at 20–21.

© 2012 Varnum LLP

Big Brother Gets Better Glasses: FERC Enhances Its Market Surveillance Tools

In a concerted effort to enhance its ability to monitor energy markets for possible anti-competitive or manipulative conduct, FERC has undertaken a number of separate initiatives to strengthen its market surveillance capabilities over electric power and natural gas markets.  Among the areas of focus, FERC has been especially keen on obtaining data and market information on a real-time, or near real-time, basis, which is in contrast to FERC’s traditional collection of data through quarterly or annual reports submitted well after-the-fact.  FERC has also been intent on gathering data outside of organized wholesale electric markets.

These initiatives include:

  • On February 16, 2012, FERC Chairman Jon Wellinghoff announced the creation of a new Division of Analytics and Surveillance to the Office of Enforcement.  Described by the Chairman as staffed with “geeks and wonks”, the Division is intended to provide continuous, real-time market surveillance and data analysis of physical gas and electric power markets and of related financial products.  The Division also is intended to develop and implement surveillance tools to detect potential market manipulation, anticompetitive behavior, and other anomalous activity.
  • Beginning in August 2012, FERC enacted a rule to require Regional Transmission Organizations (RTO) and Independent System Operators (ISO) to electronically deliver to FERC non-public data on a rolling basis, seven days after creation.  Specifically, FERC requires RTOs and ISOs to provide: market participant names and pricing points; virtual offers and bids; capacity market offers, awards, and prices; marginal cost estimates; financial transmission rights, or FTR, data; pricing data for interchange transactions; supply offers and demand bids; energy and ancillary services awards; resource output; day-ahead generation and load shift factors associated with constraints; internal bilateral contracts; and uplift charges and credits.  FERC allowed a phased implementation, with only certain data required August 2012, leading up to full implementation by February 2013.  This data collection is intended to supplement ongoing market monitoring efforts by the RTOs’ and ISOs’ market monitors.
  • FERC has also taken efforts to enhance its more traditional forms of reporting, including extending FERC’s Electric Quarterly Report (EQR) requirements to non-public utility entities that make sales above a 4,000,000 MWh threshold under Section 220 of the Federal Power Act (FPA).  These non-public utility entities—which generally consist of governmentally-owned entities, such as federal power marketing administrations, municipal utilities, public utility districts, and coops—have traditionally been exempt from FERC’s EQR filing requirements.  In the Energy Policy Act of 2005, Congress granted FERC increased authority over these entities in order to improve market transparency, as non-public utility entities represent large portions of the market, particularly in areas of the country outside of organized markets.  In the same order, FERC also increased the amount of data required of all EQR filers to include individual trade dates, whether a transaction was reported to an index publisher, the broker or exchange used for a transaction, and e-Tag IDs associated with individual transactions.  In a separate order issued in February 2012, FERC also indicated it will consider requiring EQR filers to report electric “buy-sell” transactions, termed by FERC as “simultaneous exchanges”.
  • FERC is also in the process of considering a rule that proposes to require theNorth American Electric Reliability Corporation (NERC) to provide FERC staff with access to the complete set of non-public e-Tag data.  (Notably, NERCresponded to the Commission’s proposal by noting that other entities, and not NERC, maintained the desired e-Tag information.)  When viewed in conjunction with the new requirement to report e-Tag IDs in the EQRs, it is clear that FERC intends to associate the broader set of e-Tag data with parties’ transaction reports in an effort to understand how power is transacted and scheduled.
  • Finally, on October 15, 2012, FERC Staff issued a set of proposed metrics that would compare the performance of market performance in areas outside of organized wholesale electric markets with performance in organized markets.  As part of this effort, FERC Staff issued a new report, FERC-922, that would collect information from utilities outside of organized markets.  Requested information includes price data and information relating to reliability, transmission planning, requests for service, and system capacity.  Staff stated it will use this information to help develop a common set of metrics for both RTO/ISO markets and non-RTO/ISO markets, and for evaluating market performance thereafter.  FERC Staff noted that it could not require many non-public utility entities to provide such information but requested such entities to comply as part of “a voluntary and collaborative process”.

Taken as a whole, these efforts show an agency intent on gaining a deeper and more granular perspective on energy markets and a better understanding of how those markets function day-to-day.

© 2012 Bracewell & Giuliani LLP

Michigan Zaps Zappers – Cash Business Owners Beware!

The National Law Review recently featured an article by Paul L.B. McKenney of Varnum LLP regarding Cash Business Owners in Michigan:

Varnum LLP

The proverbial “second set of books” cat and mouse game with taxing authorities now reflects the fact that most point-of-sale, or POS, bookkeeping is done electronically.  Michigan recently joined numerous other jurisdictions by enacting tax enforcement spawned legislation making the sale, purchase, installation, transfer or mere possession of any “zapper” software subject to a felony.   Zappers are also known as automated sales suppression devices.  Michigan’s statute contains a mandatory minimum of one year incarceration and severe monetary sanctions. See MCLA § 750.411w.  The statute defines a zapper as a software program, however accessed or possessed, that “falsifies the electronics records of electronic cash registers and other point-of-sale systems, including, but not limited to transaction data and transaction reports.”  MCLA § 750.411w(4)(a). In essence it creates a second set of books, albeit electronic. While the sole purpose of zappers is tax evasion, the prosecution does not have to prove intent, merely use, sale or possession. The zapper software is typically run off a USB thumb drive rather than residing on the computer’s hard drive to avoid leaving evidence of its use.  However, as noted below, there is a readily identifiable electronic trail.  Zappers have been quietly marketed by freelancing IT types and certain cash register sales people.

A not uncommon example illustrates what a zapper does.  Assume a restaurant or other cash receipts business grosses $250,000 per month and is highly profitable.  A zapper software “entrepreneur” visits the restaurant early in the month and is told precisely what recorded cash bank deposits are as well as credit card charges totals by day.  Alternately, the peddler may sell a USB drive and also provide needed technical support. Assume reported sales total $200,000 and there is $50,000 of unreported cash, or “skim.”  The zapper software will quickly and accurately modify the sales records a) by transaction b) by day c) to the penny resulting in the credit card charges and cash deposits equaling what is reported on the books.  Thus a traditional audit will find that everything appears to be in order, at least until someone finds evidence of the zapper.

Zappers represent significant lost sales tax and other tax dollars to states.  For example, three years ago California estimated zappers at restaurants cost that state $2,800,000,000 in receipts and the corresponding New York estimate was $1,700,000,000.  See “State governments target tax-cheating software,” Bloomberg Businessweek, April 3, 2012.  In an era of record state fiscal problems, this is real money.

The recent Michigan legislation is effective as of August 29, 2012.  It is patterned after  another enforcement problem the Michigan Department of Treasury encountered and overcame, false cigarette tax stamps.  The Michigan Treasury was hemorrhaging cash because of cigarettes that were brought in from out of state and counterfeit Michigan stamps were purchased on a flourishing underground market.  The Department of Treasury urged the legislature to adopt legislation that the mere possession of cigarettes with counterfeit stamps required a minimum prison term.  Legislation followed, the minimum mandatory jail time virtually ended the fake stamp problem overnight and Treasury receipts from  cigarette taxes swelled.

Economic Sanctions Too

The zapper legislation has teeth.  In addition to the one-year minimum mandatory term, there is a fine of up to $100,000.  However, from a monetary perspective, there is another more costly provision with which requires disgorgement of “all profits associated with the sale or use of …” a zapper.  In the above example, if the skim is $50,000 a month, then $600,000 a year is subject to forfeiture.  The offending party is also responsible for all Michigan sales, withholding and other taxes, penalties and interest.  These other levies include the corporate income tax and  individual income tax.  Typically cash businesses that use zappers, such as restaurants and retailers selling small dollar amount items, also pay employees all or some of their wages in cash “under the table” and/or purchase food or inventory.

Zapper programs originated in Europe and migrated first to Quebec in North America.  They came from jurisdictions where there were value added taxes.  The Internal Revenue Service has taken certain steps to target businesses that might employ zappers, and the State of Michigan has taken notice.  It should be pointed out that Michigan’s vigorous criminal and civil penalty regime is separate and distinct from the Internal Revenue Service, which is also free to pursue the same individual and business.  There is an exchange of information agreement between the Internal Revenue Service and the Michigan Department of Treasury.

Zapper’s Electronic Fingerprints and Enforcement

Those selling zappers to business owners tout that it leaves no electronic fingerprints, and thus is invisible to the IRS and other law enforcement agencies. That dog don’t hunt.  The reality is that zappers leave telltale electronic fingerprints, and the IRS and other agencies have sophisticated criminal techies who can readily check a computer system and flag evidence of a zapper.

How have the IRS and Michigan uncovered businesses running zappers?  A secret ceases to be secret when two or more people know about it.  When the owner, the manager of a restaurant or store, the zapper software peddler and others, such as the controller or bookkeeper, key employees at the restaurant, at least one or more people at each location, etc. know about the zapper, only one needs to talk.  Somebody may have reason to talk, such as a problem with the DEA, IRS, FBI or other law enforcement agency and will readily give up the business owner in exchange for no prosecution or a reduction in charges or sentencing.  For example, a metro Detroit freelance IT salesman peddling zappers to bars and restaurants was discovered when a party with law enforcement issues named him.  That salesman, in exchange for an extremely lenient sentence,  in turn identified and cooperated with Federal law enforcement in prosecuting numerous customers for tax evasion.  Some of his customers went to jail. The IRS and other federal and state agencies are seasoned veterans of how to play that game most effectively.

Reality

Those who raid businesses with search warrants typically take away computers, hard drives, USB thumb drives, and other hardware for inspection by highly sophisticated technicians.  What does a cash business owner face if his or her business is raided by the State Police or other tax or  law enforcement personnel and evidence that a zapper has been applied to the electronic books is uncovered?  A plethora of problems.  A short, non-inclusive list includes:

  1. The new Michigan legislation and its mandatory jail time and economic sanctions;
  2. Michigan criminal sanctions for various false returns as well as associated civil tax liabilities, fraud penalties and other penalties and interest;
  3. IRS criminal issues including, a five year evasion felony per year and a three year max for false statements on a tax return,
  4. Myriad IRS civil liabilities for income tax and payroll taxes and associated penalties as well as interest, compounded daily, and
  5. If there is fraud, then there is no civil statute of limitations in tax.  The IRS and Michigan can and do go back many, many years.

In a well-publicized local zapper case,  the owner of the LaShish chain of thirteen suburban Detroit restaurants  and his wife were found by the IRS with zapper software that underreported over $16,000,000 in skimmed revenues.  The owner was indicted on tax and other charges, is currently a fugitive living in Lebanon, his wife went to jail, and the government seized and sold the formerly prosperous restaurants.

Passive Business Owners & Entities With Multiple Locations

Owners are not the only ones who might want to skim, and use a zapper to hide it. A absentee owner as well as owners of multiple locations have two problems if managers or key employees use zappers to hide embezzlement.  In addition to being the victim of the skim, the larcenous employee will tell the IRS and Michigan Treasury that the owner must have done it, and the owner has criminal and civil exposure.  Such owners can protect themselves by unannounced electronic audits to determine if any zappers have been used.  A telltale sign is that servers, per managers, need to be replaced with unusual frequency.  That can well be  an attempt to hide evidence of electronic tampering..

What To Tell Clients

Smaller business clients that have zappers are not going to boast about it to their counsel. You might pass along a proverbial word to the wise to cash business owners.  This new zapper law is out there, it has teeth, and those who ignore it do so at their peril to both personal liberty and treasure.  Also, as noted just above, beware of skimming employees.

© 2012 Varnum LLP