Category: finance

The Corporate Transparency Act Requires Reporting of Beneficial Owners

The Corporate Transparency Act (the “CTA”) became effective on January 1, 2024, requiring many corporations, limited liability companies, limited partnerships, and other entities to register with and report certain information to the Financial Crimes Enforcement Network (“FinCEN”) of the U.S. Department of Treasury (“Treasury”). The CTA marks a substantial increase in the reporting obligations for many U.S. companies, as well as for non-U.S. companies doing business in the United States.

IN SHORT:
Most corporate entities are now required to file a beneficial ownership information report (“BOI Report”) with FinCEN disclosing certain information about the entity and those persons who are “beneficial owners” or who have “substantial control.” BOI Reports for companies owned by trusts and estates may require significant analysis to determine beneficial ownership and substantial control.

The CTA imposes potential penalties on entities that fail to file BOI Reports with FinCEN by the prescribed deadline. For entities formed prior to January 1, 2024, a BOI Report must be filed by January 1, 2025. For entities formed on or after January 1, 2024, but prior to January 1, 2025, a BOI Report must be filed within 90 days of the entity’s formation. For entities formed on or after January 1, 2025, a BOI Report must be filed within 30 days of the entity’s formation.

Entities formed after January 1, 2024, must also report information regarding “company applicants” to FinCEN. If certain information within a BOI Report changes, entities are required to file a supplemental BOI Report within 30 days of such change.

While Winstead’s Wealth Preservation Practice Group will not be directly filing BOI Reports with FinCEN, our attorneys and staff will be available this year, by appointment, to answer questions regarding reporting requirements if scheduled by Friday, November 22, 2024. We strongly recommend that company owners begin analyzing what reporting obligations they may have under the CTA and schedule appointments with their professional advisors now to ensure availability.

BACKGROUND:
Congress passed the CTA in an effort to combat money laundering, fraud, and other illicit activities accomplished through anonymous shell companies. To achieve this objective, most entities operating in the United States will now be required to file BOI Reports with FinCEN.

The CTA applies to U.S. companies and non-U.S. companies registered to operate in the United States that fall within the definition of a “reporting company.” There are certain exceptions specifically enumerated in the CTA, which generally cover entities that are already subject to anti-money laundering requirements, entities registered with the Securities and Exchange Commission or other federal regulatory bodies, and entities that pose a low risk of the illicit activities targeted by the CTA.

REPORTING OBLIGATIONS:
Entity Information. Each reporting company is required to provide FinCEN with the following information:

  1. the legal name of the reporting company;
  2. the mailing address of the reporting company;
  3. the state of formation (or foreign country in which the entity was formed, if applicable) of the reporting company; and
  4. the employer identification number of the reporting company.

Beneficial Owner and Applicant Information. Absent an exemption, each reporting company is also required to provide FinCEN with the following information regarding each beneficial owner and each company applicant:

  1. full legal name;
  2. date of birth;
  3. current residential or business address; and
  4. unique identifying number from a U.S. passport or U.S. state identification (e.g., state-issued driver’s license), a foreign passport, or a FinCEN identifier (i.e., the unique number issued by FinCEN to an individual).

DEFINITIONS:
Reporting Company. A “reporting company” is defined as any corporation, limited liability company, or any other entity created by the filing of a document with a secretary of state or any similar office under the law of a State. Certain entities are exempt from these filing requirements, including, but not limited to:

  1. financial institutions and regulated investment entities;
  2. utility companies;
  3. entities that are described in Section 501(c) of the Internal Revenue Code;
  4. inactive, non-foreign owned entities with no assets; and
  5. sizeable operating companies that employ more than 20 full-time employees in the United States that have filed a United States federal income tax return in the previous year demonstrating more than $5,000,000 in gross receipts or sales.

A reporting company that is not exempt must register with and report all required information to FinCEN by the applicable deadline.

Beneficial Owner. A “beneficial owner” is defined as any individual who, directly or indirectly, (i) exercises substantial control over such reporting company or (ii) owns or controls at least 25% of the ownership interests of such reporting company.

Substantial Control. An individual exercises “substantial control” over a reporting company if the individual (i) serves as a senior officer of the reporting company, (ii) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or the similar body governing such reporting company), or (iii) directs, determines, or has substantial influence over important decisions made by the reporting company, including by reason of such individual’s representation on the board (or other governing body of the reporting company) or control of a majority of the reporting company’s voting power.

Company Applicant. A “company applicant” is any individual who (i) files an application to form the reporting company under U.S. law or (ii) registers or files an application to register the reporting company under the laws of a foreign country to do business in the United States by filing a document with the secretary of state or similar office under U.S. law.

DEADLINES:
Entities Formed Before January 1, 2024. A reporting company that was formed prior to the effective date of the CTA (January 1, 2024) is required to register with FinCEN and file its initial BOI Report by January 1, 2025.

Entities Formed After January 1, 2024, but Before January 1, 2025. A reporting company that was formed after the effective date of the CTA (January 1, 2024), but before January 1, 2025, must register with FinCEN and file its initial BOI Report within 90 calendar days of formation.
Entities Formed After January 1, 2025. A reporting company formed after January 1, 2025, will be required to register with FinCEN and file its initial BOI Report within 30 calendar days of formation.

Supplemental BOI Reports. If any information included in a BOI Report changes, a reporting company must file a supplemental report with FinCEN within 30 days of such change. This includes minor changes, such as an address change or an updated driver’s license for a beneficial owner or someone who has substantial control over the reporting company.

PENALTIES FOR NON-COMPLIANCE:
The CTA and Treasury regulations impose potential civil and criminal liability on reporting companies and company applicants that fail to comply with the CTA’s reporting requirements. Civil penalties for reporting violations include a monetary fine of up to $500 per day that the violation continues unresolved, adjusted for inflation. Criminal penalties include a fine of up to $10,000 and/or two years in prison.

REPORTING REQUIREMENTS RELATED TO TRUSTS AND ESTATES:
When a trust or estate owns at least 25% of a reporting company or exercises substantial control over the reporting company, the BOI Report must generally include (i) the fiduciaries of the trust or estate (i.e., the trustee or executor), (ii) certain individual beneficiaries, and (iii) the settlor or creator of the trust. If the trust agreement gives other individuals certain rights and powers, however, such as a distribution advisor, trust protector, or trust committee member, the reporting company may also be required to disclose such individuals’ information in the BOI Report. Similarly, if a corporate trustee or executor is serving, the BOI Report must contain the names and information of the employees who actually administer the trust or estate on behalf of the corporation. Due to these nuances, it is often necessary to engage in additional analysis when a trust or estate is a beneficial owner of or has substantial control over a reporting company.

CONCLUDING REMARKS:
The CTA and its BOI Report filing requirement are still relatively new, and although FinCEN continues to publish additional guidance, many open questions remain. All companies formed or operating in the United States should carefully review whether they are required to file an initial BOI Report in accordance with the CTA, and take further steps to identify all individuals who must be included in such BOI Report.

© 2024 Winstead PC.
For more news on Corporate Transparency Act Reporting Requirements, visit the NLR Financial Institutions Banking section.

SEC Revises Tick Size, Access Fees and Round-Lot Definition and Takes Steps to Disseminate Odd-Lot and Other Better Priced Orders

On September 18, the Securities and Exchange Commission (SEC or the Commission) adopted amendments to Rule 612 (Tick Sizes) and Rule 610 (Access Fees) under Regulation NMS under the Securities Exchange Act of 1934, as amended (Regulation NMS).1 The SEC also added and amended definitions and other rules under Regulation NMS to address round-lot and odd-lot sizing and dissemination. We address each category of revisions below and highlight at the outset that the SEC did not adopt the controversial provision that would have prevented market centers from executing orders at prices less than the current or revised tick sizes. That is, the minimum tick size continues to address only the minimum price increment at which a market center can publish a quotation for a security. This is significant, as adopting such a prohibition would have prevented broker-dealers and other market centers from providing price improvement at prices finer than the quotation tick sizes.

The SEC also took a measured approach to other aspects of the rule. As explained more fully below, the Commission adopted only one additional minimum quotation size (rather than the three proposed), narrowed the scope of securities that might be subject to the smaller minimum quotation size, reduced the frequency with which primary listing exchanges must calculate tick sizes and round-lot sizes, and expanded the amount of data to be evaluated for these calculations from one month’s worth to three months’ worth.

Tick Sizes/Minimum Pricing Increments

Rule 612 of Regulation NMS regulates the price increments (that is, the “tick size”) at which a market center can display a quotation and at which a broker-dealer can accept, rank, or display orders or indications of interest in NMS stocks. Currently, for NMS stocks priced at or above $1.00 per share, broker-dealers and market centers can accept orders or quote in one-penny ($0.01) price increments and at a much smaller increment ($0.0001) for NMS stocks priced less than $1.00 per share.

The SEC and other market participants had observed that many stocks were “tick constrained” — that is, bids, offers, and other orders in those stocks might regularly allow for quotation spreads narrower than $0.01, but the penny spread requirement of Rule 612 constrained such narrower quoting. Determining the “right” quote size for a security can be complicated: on the one hand, a narrower spread reduces transaction costs for investors. On the other hand, too narrow a quotation spread allows other market participants to “step ahead” of a quotation — that is, obtain better priority — by entering an order that is priced only slightly better. Obtaining priority by quoting for an economically insignificantly better price disincentivizes those offering liquidity or price improvement to the market. Stated simply, a market participant has little incentive to expose its order to the market if another participant can easily get better priority over that order at an insignificant cost. Accordingly, the Commission sought to balance the two competing concerns of spread size and fear of stepping ahead.

Tick sizes are also relevant in the competition between exchange and non-exchange trading venues. Due to their market structure, exchanges generally execute orders at the prices they quote, but cannot execute at prices within the quoted spread. Narrower spreads provide better opportunities for exchanges to execute at the higher bids or lower offers represented by those narrower spreads. In short, narrower spreads allow exchange venues to be more competitive with off-exchange venues.

In December 2022, the SEC proposed to add three minimum tick sizes for NMS stocks priced $1.00 or more: one-tenth of a cent ($0.001), two-tenths of a cent ($0.002), and five-tenths (or one-half) of a cent ($0.005). Public comment suggested that this proposal was too complicated and the smaller price increment of $0.001 might also have been too small, thereby facilitating stepping ahead.

The adopted rule provides for only one new tick size for certain NMS stocks priced at or above $1.00 per share: $0.005. This half-penny minimum quotation size will apply for those NMS stocks priced at or above $1 that have a “time-weighted average quoted spread” (a metric defined in the rule) of $0.015 during a three-month Evaluation Period (as described in the table below) occurring twice a year.[1] “Time-weighted average quoted spread” seeks to estimate tick constraint and identify those securities that are quoted on average at close to a one-cent spread. Specifically, under the revised rule, primary listing exchanges must calculate the time-weighted average spread over the months of January, February, and March and July, August, and September. The results of the first (Q1) calculation determines which securities are subject to the half-penny tick size for the business days between May 1 and October 31 of that year. The results of the second (Q3) calculation determines which securities are subject to the half-penny tick size for the business days between November 1 of that year and April 30 of the following year.

The following chart shows the applicable tick sizes and calculations:

The SEC’s policy rationale for adopting these amendments is that they relax existing restrictions on tick sizes, which should reduce transaction costs and provide for better price discovery for certain NMS stocks. Additionally, smaller tick sizes for NMS stocks that merit them should improve liquidity, competition, and price efficiency.

Access Fees

Securities exchanges generally charge access fees to those who take liquidity and rebate a portion of that access fee to those who provide liquidity. As the SEC explains, “the predominant exchange fee structure is maker-taker, in which an exchange charges a fee to liquidity takers and pays a rebate to liquidity providers, and the rebate is typically funded through the access fee.”3 Rule 610(c) of Regulation NMS limits the fee that an exchange can charge for accessing protected quotations4 pursuant to Rule 611 of Regulation NMS. Currently, the access fee is capped at 30 cents per 100 shares (or “30 mils” per share) for NMS securities priced at or above $1. The access fee is capped at 0.3% of the quotation price for NMS stocks priced below $1.

With a smaller minimum quotation size, the SEC took the opportunity to revise the access fee cap, which some market participants believed had been set too high. Like the tick size changes, the access fee amendment ultimately adopted was modified from what was originally proposed. Originally, the SEC proposed to reduce access fee caps (a) from 30 mils to 10 mils per share for NMS stocks priced at or over $1 that would have been assigned a tick size larger than $0.001 and (b) to 5 mils per share for NMS stocks priced at or over $1 that would have been assigned a $0.001 tick size. For protected quotations in NMS stocks priced under $1.00 per share, the Commission originally proposed to reduce the 0.3% fee cap to 0.05% of the quotation price.

Ultimately, the Commission adopted a more simplified reduction in access fee caps. Because it added only one tick size to Rule 612, the SEC adopted only one reduction in access fee caps, from 30 mils to 10 mils per share for protected quotations in NMS stocks priced $1.00 or more. For such quotations priced less than $1.00, the Commission reduced the access fee cap from 0.3% to 0.1% of the quotation price per share. In addition, the SEC adopted (as proposed) new Rule 612(d), requiring all exchange fees charged and all rebates paid for order execution to be determinable at the time of execution. Currently, such exchange fees are subject to complex fee schedules that apply tiered and other discounts at month-end. As a result, market participants would not necessarily know intra-month whether their broker might access a higher tier later in the month, which would adjust the fee charged for the subject order. The new rule ends this uncertainty.

Setting the revised access fee cap at 10 mils per share was somewhat controversial, with Commissioners Peirce and Uyeda questioning the manner in which 10 mils was determined, whether another rate should have been used (15 mils? 5 mils? 12 mils?) and whether the Commission should be in the rate-setting business at all. The Commissioners ultimately voted in favor of the proposal based upon a pledge (discussed below) that the SEC staff will, by May 2029, “conduct a review and study the effects of the amendments in the national market system.”5

Required Staff Review and Study

The Adopting Release requires that the Commission staff conduct a “review and study” by May 2029 of the effects of the amendments on the national market system. The details of such study are not clearly defined, but the Adopting Release provides that:

[s]uch a review and study might include, but would not be limited to, an investigation of: (i) general market quality and trading activity in reaction to the implementation of the variable tick size, (ii) the reaction of quoted spreads to the implementation of the amended access fee cap, and (iii) changes to where market participants direct order flow, e.g., to exchange versus off-exchange venues, following the implementation of the amendments.6

Compliance Dates and Timelines

The amendments described above become effective 60 days after the publication of the SEC’s Adopting Release in the Federal Register. The date by which exchanges, broker-dealers, and other market participants must comply with the rule amendments is generally in November 2025 but, in some instances, in May 2026, as described more fully below. Specifically, the Compliance Date:

  • for the tick size amendments (half-penny quoting for “tick-constrained” stocks) of Rule 612 is “the first business day of November 2025,” or November 3, 2025.
  • for the 10 mils per share access fee cap amendment of Rule 610 and the new requirement under Rule 612(d) that exchange fees be known at time of execution in each case, is also November 3, 2025.
  • for the new round-lot definition (100 shares, 40 shares, 10 shares, or 1 share) is November 3, 2025.
  • for the dissemination of “odd-lot information,” including the new BOLO data element, is six months later, to allow broker-dealers and others to program systems accordingly. These changes will take effect on “the first business day of May 2026,” or May 1, 2026.

Closing Thoughts

The tick size and access fee amendments, and the other provisions adopted, appear to reflect negotiated concessions and a reasonable approach to addressing tick-constrained securities while avoiding the complex framework originally proposed. The decision not to prevent executions at prices within the minimum quotation size is appropriate and preserves the ability of market participants to provide price improvement to investors. While there can be some lingering debate about the appropriate level to which to reduce the access fee cap and whether 10 mils is an appropriate level, the net cumulative effect of these amendments appears reasonable. The planned “review and study” of the effect of the amendments may come too late if conducted towards the outer limit of “by May 2029,” but the overall effect of the amendments should serve to narrow spreads and increase quotation transparency through sub-penny quoting, reduced round-lot sizes, and the inclusion of odd-lot information.

1 Release No. 34-101070, Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders, U.S. Sec. Exch. Comm’n (Sept. 18, 2024), https://www.sec.gov/files/rules/final/2024/34-101070.pdf (the “Adopting Release”).
2 The SEC modified of these requirements in the final rule. For example, the SEC had originally proposed smaller tick sizes for stocks with a time-weighted average quoted spread of $0.04 (rather than $0.015). The proposal also sought to evaluate tick-sizes 4 times per year rather than twice a year and based on monthly data rather than quarterly data.
3 Adopting Release at 15.
4 A protected quotation is defined in Rule 600(b)(82) of Regulation NMS as “a protected bid or protected offer.” 17 C.F.R. § 242.600(b)(82). A protected bid or protected offer is defined as “a quotation in an NMS stock that: (i) is displayed by an automated trading center; (ii) is disseminated pursuant to an effective national market system plan; and (iii) is an automated quotation that is the best bid or best offer of a national securities exchange, or the best bid or best offer of a national securities association.” 17 C.F.R. § 242.600(b)(81)
5 Adopting Release at 288.
6 Id. (emphasis added).
©2024 Katten Muchin Rosenman LLP
For more news on Rule 612 and Rule 610 of Securities Exchange Act of 1934, visit the NLR Securities SEC section.

End of Summer Pool Party: CFTC Approves Final Rule Amending 4.7 Regulatory Relief for CPOs and CTAs

On 12 September 2024, the Commodity Futures Trading Commission (CFTC) published a Final Rule impacting registered commodity pool operators (CPOs) and commodity trading advisors (CTAs) relying on the regulatory relief provided under CFTC Regulation 4.7. “Registration light,” as Regulation 4.7 is sometimes known, provides reduced disclosure, reporting and recordkeeping obligations for CPOs and CTAs that limit sales activities to “qualified eligible persons” (QEPs).

The Final Rule amends Regulation 4.7 by:

  • Updating the QEP definition by increasing the financial thresholds in the “Portfolio Requirement” to account for inflation; and
  • Codifying certain CFTC no-action letters allowing CPOs of Funds of Funds to opt to deliver monthly account statements within 45 days of month-end.

For most asset managers, however, the most significant update is that the CFTC declined to adopt the proposed minimum disclosure requirements. Under existing Regulation 4.7, CPOs and CTAs are exempt from certain disclosure requirements when offering pools solely to QEPs. Without those exemptions, dually-registered managers would be burdened with duplicate or conflicting disclosure requirements under the Securities and Exchange Commission’s (SEC) rules. The Proposed Rule would have rescinded or narrowed certain of these exemptions. Commenters almost unanimously opposed the disclosure-related amendments, and the CFTC ultimately decided to take additional time to consider the concerns and potential alternatives.

The Final Rule doubled the Portfolio Requirement for the Securities Portfolio Test and the Initial Margin and Premium test to US$4,000,000 and US$400,000, respectively. Despite the increased suitability standards for QEPs, the Final Rule will not impact most private funds relying on Rule 506 of Regulation D, as those amounts are still less than the “Qualified Purchaser” threshold under the SEC’s rules.

Copyright 2024 K & L Gates
For more news on CFTC Final Rule, visit the NLR Antitrust Trade Regulation section.

FTC Staff Issue Report on Multi-Level Marketing Income Disclosure Statements

Staff reviewed income disclosure statements in February 2023 that were publicly available on the websites of a wide array of MLMs, from large household names to smaller, less well-known companies, according to FTC attorneys. “These statements are sometimes provided to consumers who are considering joining MLMs, and often purport to show information about income that recruits could expect to receive.”

According to the report, FTC staff found a number of issues with the statements they reviewed, including that most omit key information when calculating the earnings amounts they present. Specifically, the report notes that most of the reviewed statements do not include participants with low or no earnings in their display of earnings amounts and also don’t account for the expenses faced by participants, which can outstrip the income they make. The report notes that these omissions are often not plainly disclosed in the income statements.

The report also notes that most statements emphasize the high earnings of a small group of participants, and many entirely omit or only inconspicuously disclose key information about the limited earnings made by most participants. In addition, the staff report notes that most of the disclosure statements staff reviewed present earnings information in a potentially confusing way, “like giving average earnings amounts for groups that could have very different actual incomes, or using annual income figures that aren’t based on what an actual group of participants made for the year.”

The report also notes based on staff’s analysis of data in the income disclosure statements, including information included in fine print, that many participants in those MLMs received no payments from the MLMs, and the vast majority received $1,000 or less per year—that is, less than $84 per month, on average.

“The FTC staff report documents an analysis of 70 publicly available income disclosure statements from a wide range of MLMs — big and well-known to smaller companies. The report found that these income disclosure statements showed most participants made $1,000 or less per year — that’s less than $84 dollars per month. And that may not account for expenses. In at least 17 MLMs, most participants didn’t make any money at all.”

As referenced above, the staff report documents (and provides numerous examples of) how most of the publicly available MLM income disclosure statements used all the following tactics:
  • Emphasizing the high dollar amounts made by a relatively small number of MLM participants.
  • Leaving out or downplaying important facts, like the percentage of participants who made no money.
  • Presenting income data in potentially confusing ways.
  • Ignoring expenses incurred by participants — even though expenses can, and in some MLMs often do, outstrip income.
© 2024 Hinch Newman LLP

Selection of Gov. Walz as VP Candidate Implicates SEC Pay-To-Play Rule

Kamala Harris’ selection of Tim Walz as running mate for her presidential campaign has implications under the Securities and Exchange Commission’s (SEC) Rule 206(4)-5 under the Investment Advisers Act (SEC Pay-to-Play Rule). In particular, certain political contributions to vice presidential candidate Tim Walz, who serves as Chair of the Minnesota State Board of Investment (SBI), and other actions by investment advisers and certain of their personnel could trigger a two-year “time-out” that would prevent an investment adviser from collecting fees from any of the statewide retirement systems or other investment programs or state cash accounts managed by the SBI. As a result, all investment advisers should consider reviewing their existing policies and procedures relating to pay-to-play and political contributions, and they should remind employees of these policies in connection with the 2024 election cycle.

A few key takeaways in this regard

  • The SEC Pay-to-Play Rule prohibits investment advisers, including exempt advisers and exempt reporting advisers,1 from receiving compensation for providing advisory services to a government entity client for two years after the investment adviser or certain personnel, including executive officers and employees soliciting government entities,2 has made a contribution to an “official”3 of the government entity.
    • Governor Walz is an “official” of the SBI under the SEC Pay-to-Play Rule because he serves on the board of the SBI.
    • An investment adviser was recently fined by the SEC for violations of the SEC Pay-to-Play Rule following a contribution by a covered associate to a candidate who served as a member of the SBI.4
  • As a result of Governor Walz’s role with regard to the SBI, any contributions by a covered adviser (or any PAC controlled by the adviser) or any contributions by its covered associates above the de minimis amount of US$3505 to the Harris/Walz campaign will trigger a two-year “time-out.” This may have implications for investment advisers that are not currently seeking to do business with the SBI but may in the future, as the “time out” period applies for the entirety of the two-year period, even if Governor Walz ceases to be an “official” of the SBI after the election.
  • Contributions by family members of covered associates and contributions to super PACs or multicandidate PACs (so long as contributions are not earmarked for the benefit of the Harris/Walz campaign) generally are not restricted under the SEC Pay-to-Play Rule, if not done in a manner designed to circumvent the rule.
  • In addition to the SEC Pay-to-Play Rule, financial services firms should be mindful of other restrictions under Municipal Securities Rule Making Board Rule G-37, Commodity Futures Trading Commission Regulation 23.451, Financial Industry Regulatory Authority Rule 2030, and SEC Rule 15Fh-6.
  • Similar concerns were implicated when then-Governor Mike Pence of Indiana was the Republican vice presidential nominee in 20166; however, former President Donald Trump and current U.S. Senator J.D. Vance (R-OH) are not “officials” for purposes of the SEC Pay-to-Play Rule or other applicable pay-to-play rules, and contributions to the Trump/Vance campaign will not be restricted under these rules.

In addition to the SEC Pay-to-Play Rule and other federal pay-to-play rules noted above, many states and localities have also adopted pay-to-play rules that are applicable to persons who contract with their governmental agencies. Campaign contributions to other candidates may trigger disclosure obligations or certain restrictions under such rules. As political contributions can lead to unintended violations of the SEC Pay-to-Play Rule or other applicable pay-to-play rules, advisers should assess whether any of these rules present a business risk in the 2024 election cycle and take appropriate steps to protect themselves.

From a compliance standpoint, some investment advisers have implemented pre-clearance procedures for all employees, which can permit an investment adviser’s compliance team to confirm that political contributions by employees will not lead to unintended consequences. Compliance teams may also consider periodic checks of publicly available campaign contribution data to confirm contributions by employees are being disclosed pursuant to applicable internal policies.

Should you have any questions regarding the content of this alert, please do not hesitate to contact one of the authors or our other lawyers.

Footnotes

1 The rule applies to “covered advisers,” a term that includes investment advisers registered or required to be registered with the SEC, “foreign private advisers” not registered in reliance on Section 203(b)(3) of the Investment Advisers Act, and “exempt reporting advisers.”

2 The rule applies to “covered associates,” which are defined for this purpose as: (i) any general partner, managing member, executive officer, or other individual with a similar status or function; (ii) any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and (iii) any political action committee (PAC) controlled by the investment adviser or by any person described in parts (i) or (ii).

3 An “official” means any individual (including any election committee of the individual) who was, at the time of a contribution, a candidate (whether or not successful) for elective office or holds the office of a government entity, if the office (i) is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity; or (ii) has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity.

4 Wayzata Investment Partners LLC, Investment Advisers Act Release No. 6590 (Apr. 15, 2024).

5 Under the SEC Pay-to-Play Rule, covered associates (but not covered advisers) are permitted to make a de minimis contribution up to a US$350 amount in an election in which they are able to vote without triggering the two-year “time-out.”

6 Clifford J. Alexander, Ruth E. Delaney & Sonia R. Gioseffi, Impact of Pay-to-Play Rules in the 2016 Election Cycle, K&L GATES (Aug. 18, 2016), https://www.klgates.com/Impact-of-Pay-to-Play-Rules-in-the-2016-Election-Cycle-08-18-2016.

Copyright 2024 K & L Gates
by: Ruth E. Delaney, Richard F. Kerr of K&L Gates
For more news on the SEC Pay-to-Play Rule, visit the NLR Securities SEC section.

Filing Requirements Under the Corporate Transparency Act: Stealth Beneficial Owners

The Corporate Transparency Act (“CTA”) requires most entities to file with the Financial Crimes Enforcement Network (“FinCEN,” a Bureau of the U.S. Department of the Treasury) Beneficial Ownership Information (“BOI”) about the individual persons who own and/or control the entities, unless an entity is exempt under the CTA from the filing requirement. There are civil and criminal penalties for failing to comply with this requirement.

A key issue: WHO are the Beneficial Owners?

FinCEN has issued a series of Frequently Asked Questions along with responses providing guidance on the issue of who the beneficial owners are.

Question A-1, issued on March 24, 2023, states that “[BOI] refers to identifying information about the individuals who directly or indirectly own or control a company.”

Question A-2, issued on Sept. 18, 2023: Why do companies have to report beneficial ownership information to the U.S Department of the Treasury? defines the CTA as “…part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other opaque ownership structures.”

Question D-1, updated April 18, 2024: Who is a beneficial owner of a reporting company? states that “A beneficial owner is an individual who either directly or indirectly (i) exercises substantial control over a reporting company” and, in referring to Question D-2 (What is substantial control?), “owns or controls at least 25 percent of a reporting company’s ownership interests.”

Question D-1 goes on to note that beneficial owners must be individuals, i.e., natural persons. This guidance is extended by Question D-2 on Substantial Control, where control includes the power of an individual who is an “important decision-maker.” Question D-3 (What are important decisions?) identifies “important decisions” with a pictorial chart of subject matters that FinCEN considers important, such as the type of business, the design of necessary financings, and the structure of the entity. Question D-4 explores ownership interests (again with a pictorial) including equity interests, profit interests, convertible securities, options, or “any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.”

Who, in FinCEN’s view, has “substantial control”?

Question D-2 lists four categories of those who have substantial control:

  1. A senior officer, including both executive officers and anyone “who performs a similar function;”
  2. An individual with “authority to appoint or remove certain officers or directors;”
  3. An individual who is an important decision-maker; or
  4. An individual with “any other form of substantial control.”

“Silent partners” and/or other undisclosed principals, including some who may be using the reporting company for nefarious purposes, might be discussed here, but that is not the intended subject of this writing. Rather, this piece is intended to warn businesspersons and their advisers of potential “stealth beneficial owners” – those whose status as beneficial owners is not immediately obvious.

First, consider the typical limited liability company Operating Agreement for an LLC with enough members and distribution of ownership interests so that no member owns over 25% of the LLC’s equity. If the LLC is manager-managed, then the manager(s) is/are Beneficial Owners, but the other members are not. But what if the Operating Agreement requires a majority or super-majority vote to approve certain transactions? Assuming that those transactions are “important” (as discussed in Question D-3), then possessing a potential veto power makes EACH member a beneficial owner. Such contractual limitations on executive power necessarily raise the issue of “beneficial ownership” in corporations, in limited liability companies, and even in limited partnerships where the Limited Partners have power to constrain the general partner (who clearly is a beneficial owner).

Second, consider the very recent amendments to the Delaware General Corporation Law (“DGCL”) in response to the Delaware Chancery Court’s holding in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co (“Moelis”) Feb. 23, 2024. In Moelis, the CEO had a contract with the Company that materially limited the power of the Board of Directors to act in a significant number of matters. Vice Chancellor Travis Laster issued a 133-page opinion finding the agreement was invalid, as it violated the Delaware Law that placed management and governance responsibilities in the Board. Because such arrangements are frequently used in venture capital arrangements as part of raising capital for new enterprises, the Delaware Legislature and the State’s Governor enacted amendments to the DGCL that expressly authorize such contracts. In the Moelis situation itself, Ken Moelis was a major owner and CEO so he would have had to be disclosed as a Beneficial Owner if Moelis & Co. had not been exempt from the filing requirements of the CTA because it is a registered investment bank.

But what of a start-up venture entity where a wealthy venture investor owns a 10% interest in the entity, but has a stockholder agreement that gives him substantial governance rights including the ability to veto or even overrule board decisions? Is that venture investor not a “beneficial owner”? Somewhat even more Baroque, what about the private equity fund controlled by a dominant investor, say William Ackman or Nelson Peltz? If that fund invests in the same start-up entity and holds a 10% interest, but also has a stockholder agreement giving the fund substantial governance rights, isn’t the controlling owner of the fund a “beneficial owner” of the start-up?

Finally, consider financing with a “bankruptcy remote entity” where the Board of that entity includes a contingent director chosen by the finance source. The contingent director does not participate in any part of the governance of the entity unless the entity finds itself in financial distress. The organizational documents of the entity provide that at that point, the contingent director can veto any decision to file for bankruptcy protection. At that point, the contingent director apparently becomes a “beneficial owner” of the entity, with the CTA filing requirements applicable. A more interesting question is whether the contingency arrangement in the organizational documents makes the contingent director a “beneficial owner” from the inception of the financing. Further, with respect to bankruptcy, key questions remain unanswered, such as whether the trustee in a Chapter 7 bankruptcy proceeding or a liquidating trustee in a Chapter 11 bankruptcy proceeding has a reporting obligation under the CTA.

This piece is not intended to identify all the situations that may give rise to “Stealth Beneficial Owners.” Rather, its intent is to raise awareness of the complexities involved in answering the initial question – WHO is a “beneficial owner”?

©2024 Norris McLaughlin P.A., All Rights Reserved

Investing in SAFE and Convertible Note Rounds ꟷKnow Your Bedmates!

Early-stage companies often rely on Simple Agreements for Future Equity (SAFEs) and convertible promissory notes to raise capital either prior to a company’s first priced preferred equity round, or to raise bridge capital between priced equity raises. In addition to the economic terms, investors considering participation in these financings should seek visibility as to the other investors in the round, and the potential misalignment of incentives among those investors.

Raising funds via SAFEs and convertible notes has a number of advantages for the issuer, not least of which is the speed with which such financings can be achieved. SAFE and convertible note financings involve significantly less documentation, legal lift, and expense than a standard preferred stock financing. Further, depending on how a SAFE or convertible note is structured, it can allow an early-stage company experiencing rapid growth (and, accordingly, valuation) to raise capital without selling equity at a valuation materially lower than the valuation it can justify in the next 12-24 months.

Similarly, SAFEs and convertible note rounds can appeal to early-stage investors. Again, the documentation is relatively straightforward and, to a large extent, consistent from transaction to transaction. Further, more recent iterations of Y-Combinator’s form SAFE include investor-favorite provisions that protect investors from dilution associated with the issuance of other convertible instruments.

That said, most SAFEs and convertible promissory notes include amendment provisions providing that their terms can be amended or waived with the approval of holders representing a majority of the total invested amount. Such amendments can fundamentally change the terms on which investors originally based their decision to participate in the SAFE or note round. For example, common amendments include reductions in the conversion discount, valuation cap, and/or required equity financing threshold at which the SAFE or note is required to convert. Perhaps more drastic, we increasingly see companies raising significant funds in multiple SAFE or note rounds without ever needing to do an equity financing prior to a liquidity event. In those instances, it is not uncommon for the company to get a majority-in-interest of the SAFE or noteholders to convert into equity on terms that bear little or no relation to what was contemplated in the original investment instrument.

Of course, you may ask, why would a majority-in-interest of the SAFE or noteholders agree to an amendment or adjustment that is not in their best interests? The answer is that savvy founders will often ensure that a majority-in-interest of the investors are “company-friendly,” with incentives that may be very different than those of a passive investor. For example, founders and their friends and family may control a majority of the round. Similarly, SAFE and noteholders may already have equity interests in the company, such that they see a net benefit to agreeing to changes in their note or SAFE terms that, viewed in isolation, are subpar.

Accordingly, before making a material investment in a SAFE or convertible note financing, investors should have a clear understanding of the maximum amount that can be raised, and the likelihood that a significant number of those investors may sign off on amendments that undermine the original deal terms.

© 2024 Winstead PC.

Understanding the Enhanced Regulation S-P Requirements

On May 16, 2024, the Securities and Exchange Commission adopted amendments to Regulation S-P, the regulation that governs the treatment of nonpublic personal information about consumers by certain financial institutions. The amendments apply to broker-dealers, investment companies, and registered investment advisers (collectively, “covered institutions”) and are designed to modernize and enhance the protection of consumer financial information. Regulation S-P continues to require covered institutions to implement written polices and procedures to safeguard customer records and information (the “safeguards rule”), properly dispose of consumer information to protect against unauthorized use (the “disposal rule”), and implementation of a privacy policy notice containing an opt out option. Registered investment advisers with over $1.5 billion in assets under management will have until November 16, 2025 (18 months) to comply, those entities with less will have until May 16, 2026 (24 months) to comply.

Incident Response Program

Covered institutions will have to implement an Incident Response Program (the “Program”) to their written policies and procedures if they have not already done so. The Program must be designed to detect, respond to, and recover customer information from unauthorized third parties. The nature and scope of the incident must be documented with further steps taken to prevent additional unauthorized use. Covered institutions will also be responsible for adopting procedures regarding the oversight of third-party service providers that are receiving, maintaining, processing, or accessing their client’s data. The safeguard rule and disposal rule require that nonpublic personal information received from a third-party about their customers should be treated the same as if it were your own client.

Customer Notification Requirement

The amendments require covered institutions to notify affected individuals whose sensitive customer information was, or is reasonably likely to have been, accessed or used without authorization. The amendments require a covered institution to provide the notice as soon as practicable, but not later than 30 days, after becoming aware that unauthorized access to or use of customer information has occurred or is reasonably likely to have occurred. The notices must include details about the incident, the breached data, and how affected individuals can respond to the breach to protect themselves. A covered institution is not required to provide the notification if it determines that the sensitive customer information has not been, and is not reasonably likely to be, used in a manner that would result in substantial harm or inconvenience. To the extent a covered institution will have a notification obligation under both the final amendments and a similar state law, a covered institution may be able to provide one notice to satisfy notification obligations under both the final amendments and the state law, provided that the notice includes all information required under both the final amendments and the state law, which may reduce the number of notices an individual receives.

Recordkeeping

Covered institutions will have to make and maintain the following in their books and records:

  • Written policies and procedures required to be adopted and implemented pursuant to the Safeguards Rule, including the incident response program;
  • Written documentation of any detected unauthorized access to or use of customer information, as well as any response to and recovery from such unauthorized access to or use of customer information required by the incident response program;
  • Written documentation of any investigation and determination made regarding whether notification to customers is required, including the basis for any determination made and any written documentation from the United States Attorney General related to a delay in notice, as well as a copy of any notice transmitted following such determination;
  • Written policies and procedures required as part of service provider oversight;
  • Written documentation of any contract entered into pursuant to the service provider oversight requirements; and
  • Written policies and procedures required to be adopted and implemented for the Disposal Rule.

Registered investment advisers will be required to preserve these records for five years, the first two in an easily accessible place.

COPYRIGHT © 2024, STARK & STARK
For more news on SEC Amended Regulations, visit the NLR Securities & SEC section.

Deep-Sea Mining–Article 1: What Is Happening With Deep-Sea Mining?

Debate continues on whether the UAE Consensus achieved at COP28 represents a promising step forward or a missed opportunity in the drive towards climate neutral energy systems. However, the agreement that countries should “transition away from fossil fuels” and triple green power capacity by 2030 spotlights the need for countries to further embrace renewable power.

This series will examine the issues stakeholders need to consider in connection with deep-sea mining. We first provide an introduction to deep-sea mining and its current status. Future articles will consider in greater detail the regulatory and contractual landscape, important practical considerations, and future developments, including decisions of the ISA Council.

POLYMETALLIC NODULES

Current technology for the generation of wind and solar power (as well as the batteries needed to store such power) requires scarce raw materials, including nickel, manganese, cobalt, and copper. The fact that these minerals are found in the millions of polymetallic nodules scattered on areas of the ocean floor gives rise to another debate on whether the deep-sea mining of these nodules should be pursued.
This issue attracted considerable attention over the summer of 2023, when the International Seabed Authority (ISA) Assembly and Council held its 28th Session and, in January 2024, when Norway’s parliament (the Storting) made Norway the first country to formally authorise seabed mining activities in its waters.

INTERNATIONAL REGULATION OF DEEP-SEA MINERALS: UNCLOS AND ISA

The United Nations Convention on the Law of the Sea (UNCLOS) provides a comprehensive regime for the management of the world’s oceans. It also established ISA.

ISA is the body that authorises international seabed exploration and mining. It also collects and distributes the seabed mining royalties in relation to those areas outside each nation’s exclusive economic zone (EEZ).

Since 1994, ISA has approved over 30 ocean-floor mining exploration contracts in the Atlantic, Pacific, and Indian oceans, with most covering the so-called ‘Clarion-Clipperton Zone’ (an environmental management area of the Pacific Ocean, between Hawaii and Mexico). These currently-approved contracts run for 15 years and permit contract holders to seek out (but not commercially exploit) polymetallic nodules, polymetallic sulphides, and cobalt-rich ferromanganese crusts from the deep seabed.

UNCLOS TWO-YEAR RULE AND ISA’S 28TH SESSION

Section 1(15) of the annex to the 1994 Implementation Agreement includes a provision known as the “two-year rule.” This provision allows any member state of ISA that intends to apply for the approval of a plan of work for exploitation of the seabed to request that the ISA Council draw up and adopt regulations governing such exploitation within two years.

In July 2021, the Republic of Nauru triggered the two-year rule, seeking authority to undertake commercial exploitation of polymetallic nodules under license. That set an operative deadline of 9 July 2023.

At meetings of the ISA Assembly and ISA Council in July 2023, the ISA Council determined that more time was needed to establish processes for prospecting, exploring, and exploiting mineral resources, and a new target was set for finalising the rules: July 2025.

The expiration of the two-year rule in July 2023 does allow mining companies to submit a mining license application at any time. However, the above extension gives the ISA Council direct input into the approval process, which will make approval of any application difficult.

NORWAY’S DEEP-SEA MINING PLAN

State legislation regulates deep-sea mining in different EEZs. Norway is one of the only countries that has its own legislation (the Norway Seabed Minerals Act of 2019) regulating the exploration and extraction of deep-sea minerals.

In December 2023, Norway agreed to allow seabed mineral exploration off the coast of Norway, ahead of a formal parliamentary decision. The proposal was voted 80-20 in favour by the Storting on 9 January 2024.

The proposal will permit exploratory mining across a large section of the Norwegian seabed, after which the Storting can decide whether to issue commercial permits.

The decision initially applies to Norwegian waters and exposes an area larger than Great Britain to potential sea-bed mining, although the Norwegian government has noted that it will only issue licenses after more environmental research has been done.

The Norwegian government has defended the plan as a way to seize an economic opportunity and shore up the security of critical supply chains. However, there is concern that this will pave the way towards deep-sea mining around the world. Green activists, scientists, fishermen, and investors have called upon Oslo to reconsider its position. They cite the lack of scientific data about the effects of deep-sea mining on the marine environment, as well as the potential impact on Arctic ecosystems. In November 2023, 120 European Union lawmakers wrote an open letter to Norwegian members of the Storting, urging them unsuccessfully to reject the project, and in February 2024, the European Parliament voted in favour of a resolution that raised concerns about Norway’s deep-sea mining regulations. This resolution carries no legal power, but it does send a strong signal to Norway that the European Union does not support its plans.

In May 2024, WWF-Norway announced it will sue the Norwegian government for opening its seabed to deep-sea mining. WWF-Norway claim that the government has failed to properly investigate the consequences of its decision, has acted against the counsel of its own advisors, and has breached Norwegian law.

METHODS OF POLYMETALLIC NODULE EXTRACTION

Should Norway, or any other nation, initiate commercial deep-seabed mining, one of the following methods of mineral extraction may be employed:

Continuous Line Bucket System

This system utilises a surface vessel, a loop of cable to which dredge buckets are attached at 20–25 meter intervals, and a traction machine on the surface vessel, which circulates the cable. Operating much like a conveyor belt, ascending and descending lines complete runs to the ocean floor, gathering and then carrying the nodules to a ship or station for processing.

Hydraulic Suction System

A riser pipe attached to a surface vessel “vacuums” the seabed, for example, by lifting the nodules on compressed air or by using a centrifugal pump. A separate pipe returns tailings to the area of the mining site.

Remotely Operated Vehicles (ROVs)

Large ROVs traverse the ocean floor collecting nodules in a variety of ways. This might involve blasting the seafloor with water jets or collection by vacuuming.

Recent progress has been made in the development of these vehicles; a pre-prototype polymetallic nodule collector was successfully trialed in 2021 at a water depth of 4,500 metres, and in December 2022, the first successful recovery of polymetallic nodules from the abyssal plain was completed, using an integrated collector, riser, and lift system on an ROV. A glimpse of the future of deep-sea ROVs perhaps comes in the form of the development of robotic nodule-collection devices, equipped with artificial intelligence that allows them to distinguish between nodules and aquatic life.

Key to all three methods of mineral extraction is the production support vessel, the main facility for collecting, gathering, filtering, and storing polymetallic nodules. Dynamically positioned drillships, formerly utilised in the oil and gas sector, have been identified/converted for this purpose, and market-leading companies active in deep-water operations, including drilling and subsea construction, are investing in this area. It will be interesting to see how the approach to the inherent engineering and technological challenges will continue to develop.

THE RISKS OF DEEP-SEA MINING

As a nascent industry, deep-sea mining presents risks to both the environment and the stakeholders involved:

Environmental Risks

ISA’s delayed operative deadline for finalising regulations has been welcomed by parties who are concerned about the environmental impact that deep-sea mining may have.

Scientists warn that mining the deep could cause an irreversible loss of biodiversity to deep-sea ecosystems; sediment plumes, wastewater, and noise and light pollution all have the potential to seriously impact the species that exist within and beyond the mining sites. The deep-ocean floor supports thousands of unique species, despite being dark and nutrient-poor, including microbes, worms, sponges, and other invertebrates. There are also concerns that mining will impact the ocean’s ability to function as a carbon sink, resulting in a potentially wider environmental impact.

Stakeholder and Investor Risks

While deep-sea mining doesn’t involve the recovery and handling of combustible oil or gas, which is often associated with offshore operations, commercial risks associated with the deployment of sophisticated (and expensive) equipment in water depths of 2,000 metres or greater are significant. In April 2021, a specialist deep-sea mining subsidiary lost a mining robot prototype that had uncoupled from a 5-kilometer-long cable connecting it to the surface. The robot was recovered after initial attempts failed, but this illustrates the potentially expensive problems that deep-sea mining poses. Any companies wishing to become involved in deep-sea mining will also need to be careful to protect their reputation. Involvement in a deep-sea mining project that causes (or is perceived to cause) environmental damage or that experiences serious problems could attract strong negative publicity.

INVESTOR CONSIDERATIONS

Regulations have not kept up with the increased interest in deep-sea mining, and there are no clear guidelines on how to structure potential deep-sea investments. This is especially true in international waters, where a relationship with a sponsoring state is necessary. Exploitative investments have not been covered by ISA, and it is unclear how much control investors will have over the mining process. It is also unclear how investors might be able to apportion responsibility for loss/damage and what level of due diligence needs to be conducted ahead of operations. Any involvement carries with it significant risk, and stakeholders will do well to manage their rights and obligations as matters evolve.

Copyright 2024 K & L Gates
For more news on Deep Sea Mining, visit the NLR Environmental, Energy & Resources section.

Acting U.S. Attorney Levy Forecasts False Claims Act COVID Cases Targeting Private Lenders Of CARES Act Loans That Failed In Their Obligation To Safeguard Government Funds

Acting U.S. Attorney Joshua Levy discussed the enforcement priorities for the Massachusetts U.S. Attorney’s Office (USAO) during a Q&A session on May 29, 2024, and made clear that the historical focus of the office remains the top priority: detecting and combating health care fraud, waste, and abuse. In particular, both Levy and Chief of the USAO’s Civil Division, Abraham George, have recently indicated that the government will pursue large dollar COVID fraud cases both criminally and civilly. As we have discussed previously, we expect False Claims Act (FCA) COVID cases to materialize in the coming years as the government zeroes in on wrongdoers via enhanced data analytics and AI tools as well as via traditional investigative methods and the forthcoming Whistleblower Rewards Program.

Recent COVID FinTech Lender, Kabbage, $120 MM False Claims Act Settlement

The recent Kabbage settlement is illustrative of the types of COVID cases the office is looking to bring pursuant to the FCA. Acting U.S. Attorney Levy discussed the settlement, publicized in May, with now-bankrupt online lender, Kabbage Inc. Kabbage allegedly knowingly processed and submitted thousands of false claims for Paycheck Protection Program (PPP) loan forgiveness, loan guarantees, and processing fees. The PPP – a loan program for small businesses created via the Coronavirus Aid, Relief, and Economic Security (CARES) Act – was administered the federal Small Business Administration (SBA). The CARES Act authorized private lenders to approve PPP loans for eligible borrowers who could later seek forgiveness for the loans if borrowers used the loans for eligible expenses, including employee payroll.

Among other things, participating PPP lenders were obligated to 1) confirm borrowers’ average monthly payroll costs by PPP loan documentation; and 2) follow applicable Bank Secrecy Act/Anti-Money Laundering (BSA/AML) requirements. SBA guaranteed any unforgiven or defaulted PPP loans as long as the private lender adhered to PPP requirements.

Private lenders received a fixed fee calculated as a percentage of the loan amount. Here, U.S. Attorney Levy’s office alleged that Kabbage awarded inflated and fraudulent loans to maximize its profits, then sold its assets and left the remaining company financially depleted, leading to bankruptcy. Kabbage was allegedly aware of the following errors as of April 2020, failed to correct them, and continued to make improper loan disbursements after learning of the issues:

  1. double-counting state and local taxes paid by employees when calculating gross wages;
  2. failing to exclude annual compensation above $100,000 per employee; and
  3. improperly calculating employee leave and severance payments.

Kabbage also allegedly failed to implement appropriate fraud controls to comply with the PPP, BSA, and AML by knowingly:

  1. removing underwriting steps to facilitate processing a high volume of loan applications and maximizing loan processing fees;
  2. setting substandard fraud check thresholds;
  3. relying on automated tools that were inadequate in identifying fraud;
  4. devoting insufficient personnel to conduct fraud reviews;
  5. discouraging its fraud reviewers from requesting information from borrowers to substantiate their loan requests; and
  6. submitting to the SBA thousands of dubious PPP loan applications that were fraudulent or highly suspicious.

The settlement, which will result in the U.S. securing up to $120 million pursuant to bankruptcy proceedings, resolves qui tam complaints brought by two separate whistleblowers: an accountant who submitted PPP loan applications to multiple lenders and a former analyst in Kabbage’s collection department.

Predictions for Future COVID Fraud Enforcement

Acting U.S. Attorney Levy’s comments make clear that we can expect to see FCA COVID cases targeting private lenders of CARES Act loans that failed in their obligation to safeguard government funds. To date, COVID fraud prosecution has largely targeted “low-hanging fruit” criminal cases, such as those involving submission of false information to obtain COVID relief funding that the recipient spends on luxury items. We discussed in April that the COVID Fraud Enforcement Task Force (CFETF) and a bipartisan group of Senators had, via a report and draft legislation, pleaded with Congress to increase funding to prosecute COVID fraud. Investigations such as those involving Kabbage require a large investment of resources and, as U.S. Attorney Levy commented, his office must prioritize large-dollar COVID fraud cases most likely to result in specific and general fraud deterrence.

As we have written previously, the government is playing a long game tracking COVID fraud. The Justice Department’s CFETF reported in April that to date, the DOJ had seized or forfeited $1.4 billion in stolen relief funds as well as bringing criminal charges against 3,500 defendants and 400 civil settlements. With a ten-year statute of limitations and increasingly more accurate data analytics tools, we expect the DOJ will continue to identify and recover misappropriated funds from large and lower dollar fraudsters. So long as COVID fraud enforcement remains a well-funded priority of the government, we anticipate a steady stream of FCA COVID settlements involving lenders and borrowers. The government is casting a wide net to recoup the nearly $300 billion in COVID fraud estimates. We will continue to monitor and report on developments.

©1994-2024 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
For more on COVID, visit the NLR Coronavirus News section.