Category: Uncategorized

End of the Year Bonuses – Do They Have to Be Shared with My Ex?

The end of the year is coming, and for many employees that means end of the year bonuses will be included in their paychecks this month. Many question whether their bonus should be included as “income” for the purpose of support obligations, as well as equitable distribution in the context of a divorce.

A baseball manager from Arizona, Anthony DeFrancesco, recently faced issues surrounding his year-end bonus and how it related to his support obligations. Mr. DeFrancesco, the manager of the Houston Astros AAA minor league team, was given a $28,000 bonus in 2017 when the Astros won the World Series. The Arizona Appeals Court recently found that the bonus was considered a gift, as opposed to earnings, and he did not have to provide a portion of the bonus to his now ex-wife.

This result is not typically what happens in New Jersey when courts consider whether bonuses are a part of income. In the vast majority of cases, bonuses are awarded to employees for their exemplary work during the preceding year, often resulting from meeting specific targets, going above and beyond the work of a typical employee, and sharing in the success of the company without which the company would have not have otherwise reached. While employees are not legally entitled to bonuses in most cases, bonuses are most often the result of the employee’s hard work. Thus, in the eyes of most courts, the bonus was earned. Any earned income is considered by courts when setting support obligations.

In connection with equitable distribution, money that is earned during the marriage is considered an asset of the marital estate. Therefore, even if the complaint for divorce has already been filed, an end-of-year bonus may be considered a part of the marital estate. For example, if a complaint for divorce is filed on July 1, and an employee receives a bonus of $50,000 at the end of the year for work performed during the previous calendar year, half of that bonus would be attributable to time spent during the marriage.

New Jersey is a court of equity. Arguments can be made that bonuses, or portions of bonuses, should or should not be considered for support and equitable distribution purposes.

Several years ago there was a case in New Jersey in which a private company had been working for many years to go public. One of the company officers had been a long-time employee and, in fact, his dedication to the company to the exclusion of all else contributed to the failure of his marriage. Two years after the divorce complaint was filed, the company went public. The SEC filings noted that the employee received a bonus in excess of $1 million for his dedication to the company and work over the last five years. His wife was successful in her application to reopen the divorce and obtain a portion of that payout due to the evidence that it was for work conducted during the course of their marriage. While this case may be unique, it speaks to why each case has to be evaluated on its own merits, and why each case may have a different result.

COPYRIGHT © 2019, STARK & STARK

For more on spousal support obligations, see the National Law Review Family Law, Divorce and Custody law page.

New Jersey Appellate Division Affirms Municipal Court Jurisdiction to Enforce Spill Act Penalties

On November 13, 2019, the Appellate Division held that the New Jersey Department of Environmental Protection (“DEP”) can bring a penalty enforcement action under the Spill Compensation and Control Act (the “Spill Act”), N.J.S.A. 58:10-23.11 et seq., in either the Superior Court or the municipal court with territorial jurisdiction. State of New Jersey Department of Environmental Protection v. Alsol Corporation, No. A-3546-17T1, — A.3d – (N.J. Super. App. Div. Div. Nov. 13, 2019).

In this case, DEP filed a summons in municipal court against Alsol Corporation (“Alsol”) alleging that Alsol failed to remediate certain property in accordance with DEP regulations, and sought to impose penalties against Alsol under the Spill Act. Alsol successfully moved to dismiss DEP’s summons for lack of subject matter jurisdiction. In dismissing the summons, the municipal court concluded that its jurisdiction to enforce civil penalties under the Spill Act was limited to “where a finding of liability ha[d] already been adjudicated.” DEP appealed to the Law Division, which reversed the municipal court’s decision. Alsol then appealed to the Appellate Division.

Following a de novo review, the Appellate Division affirmed and held that municipal courts have jurisdiction to impose civil penalties in a summary proceeding under the Spill Act. The Spill Act provides that any person who violates the Act or a court order issued under the Act, or fails to pay a civil administrative penalty will “be subject to a civil penalty not to exceed $50,000.00 per day for each violation,” and such penalties “may be recovered with costs in a summary proceeding pursuant to the [Penalty Enforcement Law of 1999] in the Superior Court or a municipal court.” N.J.S.A. 58:10-23.11u(d). The Appellate Division found that “a plain reading” of the Spill Act authorizes DEP to bring a penalty enforcement action in municipal court. In its reasoning, the Appellate Division cited to a prior decision in which it addressed an analogous issue under the Solid Waste Management Act, and also noted that the Supreme Court endorsed such an approach in Rule 7:2-1(h) “by making this type of summary action cognizable in the municipal courts using the Special Summons . . . DEP used” in this case.

Potentially responsible parties under the Spill Act should be aware that DEP may seek to impose and enforce penalties under the Spill Act in municipal court or Superior Court, and should treat a municipal court summons with the same urgency as a Superior Court complaint.

© 2019 Giordano, Halleran & Ciesla, P.C. All Rights Reserved

More on NJ environmental regulation on the National Law Review Environmental, Energy & Resources law page.

2020 Vision: Protecting Your Hospital’s Tax-Exempt Status

The manner in which medical services are being provided to patients is rapidly changing. Procedures that used to be performed in hospitals and required overnight stays are now being performed at outpatient clinics. Similarly, technological advances have decentralized hospital administration and the way in which treatment is provided. This should not come as a surprise to anyone that has any level of familiarity with the health care system, which includes just about anyone who goes to a doctor on a regular basis.

It should also come as no surprise that the law often lags behind technological advances and is often in a state of playing “catch up.” This trend is readily apparent when it comes to the property tax exemption for Wisconsin hospitals. The good news is that the courts are now taking the advances in hospital care into account when affirming eligibility for property tax exemption, particularly as to clinics and outpatient facilities. That said, hospitals must be vigilant in obtaining and maintaining their exemption.

This Legal Update offers guidance for Wisconsin nonprofit hospitals that may be filing tax exemption applications for calendar year 2020. Later in this Legal Update, we briefly discuss recent developments at the federal level involving hospital exemptions under § 501(c)(3) of the Internal Revenue Code.

Property Tax Exemption for Nonprofit Hospitals

In Wisconsin, all property is subject to taxation unless it is explicitly deemed exempt by statute. The Wisconsin Statutes provide that the following type of property is exempt:

(4m) NONPROFIT HOSPITALS. (a) Real property owned and used and personal property used exclusively for the purposes of any hospital of 10 beds or more devoted primarily to the diagnosis, treatment or care of the sick, injured, or disabled…. This exemption does not apply to property used … as a doctor’s office.

(Wis. Stat. § 70.11(4m)). The legislative intent behind this exemption is to encourage not-for-profit hospitals to provide care for the sick.

Applications for property tax exemption must be filed by March 1. This includes exemption applications for newly constructed property as well as for existing and previously non-exempt property whose use has changed in a way that now makes it eligible for exemption. The property owner bears the burden of proving that the property is exempt and the Wisconsin courts interpret the statutory exemptions narrowly. Hospitals should start analyzing and preparing their exemption applications well in advance of the filing deadline.

All real property is assessed based on its “fair market value” as of January 1 of each year. The Wisconsin Property Assessment Manual (“WPAM”) makes it clear that in the case of partially completed improvements, the assessor must value the improvements as they exist on the assessment date. Accordingly, hospitals with facilities currently under construction need to document the state of building as of January 1, 2020. Key documentation may include photographs and time-lapse construction progress videos. Assessors typically conduct an on-site inspection when there have been significant construction changes, and may also request additional documentation such as construction contracts and blueprints.

Assessors frequently utilize the cost approach when valuing new construction. One way to assess value for an under-construction project is to look at construction draws. This method has the appeal of simplicity but does not always produce accurate results. For example, if there have been construction draws of $12 million as of January 1 on a $30 million dollar project, an assessor might be inclined to give the property a fair market value of $12 million as of that date. It is entirely possible, however, that $1 million of that work was done on grading, soil stabilization, or other site development work that adds no value to the building from a “fair market value” perspective. Accordingly, the owner should be armed with knowledge of the actual condition of the building, including statements from the project manager, showing the value of what is “in the ground” as of the assessment date.

While it is important that new exemption applications document value as of January 1, the most important piece of the application involves documentation of exempt use. Recent litigation has focused on whether outpatient clinics or satellite hospital facilities are being used as a “doctor’s office,” which may disqualify the facility from exemption. The Wisconsin courts have identified the following list of factors that must be considered and evaluated when determining whether real property is used as an exempt hospital or as a doctor’s office:

  1. Do physicians own or lease the facility or equipment or are they hospital owned?
  2. Do physicians at the facility receive “variable compensation,” that is, compensation based on their productivity?
  3. Do physicians at the facility employ or supervise non-physician staff, or receive extra compensation for such duties?
  4. Does the facility and hospital generate separate billing statements or use separate billing software?
  5. Do the physicians in the facility have office space in the facility?
  6. Does the facility provide care on an outpatient, as opposed to inpatient, basis?
  7. Is the facility only open during regular business hours during which time the physicians generally see patients by appointment or is there 24/7 urgent care?

It should also be noted that the exemption for a nonprofit hospital is not an all-or-nothing proposition—partial exemptions are permitted. For example, in a seminal case interpreting the breadth of the nonprofit hospital exemption, Covenant Healthcare System, Inc. v. City of Wauwatosa, the Wisconsin Supreme Court upheld Covenant Healthcare System’s application for an exemption for 3 out of 5 floors in an outpatient clinic. The other floors did not fall within the criteria for the hospital exemption because they were doctors’ offices, among other reasons.

Another use-related issue involves the exempt status of vacant space in newly constructed hospital facilities. The WPAM acknowledges that “hospitals often construct oversize additions to anticipate technological and industrial changes and to reduce the unit cost of construction.” Assessors will generally treat this space as exempt so long as it meets the following conditions:

  • The hospital is exempt.
  • The space is attached to an existing hospital.
  • The projected use of the space is declared in the board minutes, in the general building plans, and in the blueprints and is consistent with exempt hospital use.
  • The building specifications and actual construction-to-date include features appropriate for hospital space.
  • The owner annually declares by affidavit that the space will be used as hospital space that would normally be exempt.

Hospitals intending to seek exemption for vacant space in new construction should ensure that they have appropriate documentation for these elements as of January 1.

Wisconsin law states that property tax exemption claims are strictly construed in favor of taxability. Given today’s climate of tight budgets, assessors are understandably conservative in their exemption determinations as they try to protect their tax base. Vigilance and thorough preparation are the keys to obtaining exemption under § 70.11(4m). Hospitals that are planning to file an exemption application by March 1 of this coming year, particularly for property that might have been taxable in the past as a physician clinic, should begin preparing their exemption applications no later than January 1 with an eye on these requirements.

Finally, note that owners of property exempt under sec. 70.11, Wis. Stats., are required to file a Tax Exemption Report form with the municipal clerk in each even-numbered year. Reports are due March 31, 2020.

Federal Tax Exemption under IRC § 501(c)(3)

Hospitals claiming exemption under IRC § 501(c)(3) have been under the microscope for the past several years; judging from events in 2019, that pattern will continue in 2020.

Senator Charles Grassley (R-Iowa) is back at the helm of the Senate Finance Committee and is once again pushing for increased transparency and oversight, including hospital adherence to community benefit requirements. In February 2019, Senator Grassley asked that IRS Commissioner Charles Rettig provide a briefing on the scope of IRS audits of tax-exempt hospitals on matters including charity care, financial assistance, and billing and collection policies. Senator Grassley called into question hospital compliance with the standards set by Congress and made it clear that he expects IRS enforcement to include all of the tools in its toolbox, including denial of exempt status. He specifically asked for details on how many hospitals have been found to be out of compliance with § 501(c)(3) requirements and how the IRS is dealing with noncompliant hospitals. In October of this year, Senator Grassley wrote to the University of Virginia Health System regarding a news report that the System’s financial assistance and debt-collection practices did not comply with its obligations as a tax-exempt entity, as well as regarding possible issues on overcharging.

Nonprofit hospitals and health systems can expect increasing scrutiny on Schedule H of Form 990. Past analyses of Schedule H reporting have found inaccuracies and inconsistencies in reporting of community benefits and financial assistance policies, including how financial assistance policies are publicized – these areas should receive particular attention when preparing 990 forms in the coming year. Form 990 is due on the 15th day of the 5th month following the end of the organization’s taxable year. Hospitals and health systems with September 30 fiscal years will need to file their 990 forms by February 15, while organizations on a calendar year have a due date of May 15.

Conclusion

Nonprofit hospitals remain under attack regarding their tax-exempt status. It is extremely important—now more than ever—for administrators to have a familiarity with the law and the criteria necessary to maintain their exemptions into the future. Proper planning heading into 2020 is an important key to that success.

©2019 von Briesen & Roper, s.c

For more on hospital administration, please see the National Law Review Health Law & Managed Care page.

The 28th National EPLI Conference January 2020 in New York

Back by popular demand, ACI’s EPLI conference returns to New York City. Whether you are a claims manager, underwriter, risk manager, in-house or outside counsel, this is your most worthwhile opportunity to network and benchmark strategies with your peers.

Strategic Guidance so you are prepared for whatever EPLI claim may cross your desk. Strategies to defend, manage and prevent EPLI claims, and the chance to learn from a top-notch faculty.

DON’T MISS CRITICAL UPDATES AND BEST PRACTICES FOR:

BIOMETRIC SCREENING: The biggest misunderstandings about how to manage data breaches and collection of employee information

RETALIATION CLAIMS: The latest defense strategies to facilitate settlements as early as possible

WHISTLEBLOWER CASES: Techniques for navigating complicated fact patterns involving additional allegations of discrimination

ARBITRATION AGREEMENTS AND RESTRICTIVE COVENANTS: Critical updates on what is now considered unenforceable

REVISITING MEDICAL MARIJUANA CLAIMS: Further complications with ADA, testing challenges, and discrimination claims

WEBSITE ACCESSIBILITY AND FMLA REQUIREMENTS: Managing the practical impact on disability claims

See the agenda and learn more about the 29th National Conference on EPLI.

EPLI Conference

 

SEC Proposes Significant Amendments to Investment Adviser Advertising Rule

The Securities and Exchange Commission (the “Commission” or the “SEC”), on November 4, approved the publication of a substantial release (the “Release” 1 proposing significant amendments to the rules under the Investment Advisers Act of 1940 (the “Advisers Act”) that govern advertising by investment advisers and the solicitation of advisory and fund investments, as well as related recordkeeping and SEC Form ADV disclosure requirements. This memorandum provides a summary of the proposed amendments to the advertising rule and related recordkeeping requirements; a separate memorandum addresses the proposed amendments to the solicitation rule.2

The Advisers Act advertising rule, Rule 206(4)-1, has not been amended significantly since it was first adopted in 1961. 3 The changes now proposed by the SEC are largely motivated by the SEC’s desire to modernize the rule and create a more “principles-based” approach to advertising regulation.

I.  Overview of the Amendments

  • Broadened Definition of “Advertisement”: The proposed amendments to Rule 206(4)-1 would broaden the definition of “advertisement” to cover all communications that promote an investment adviser’s services, even if sent to a single person, subject to specific exemptions.
  • Advertising Standards: The amendments would replace the current list of prohibited forms of advertisement with general prohibitions on misleading advertising practices. The proposed amendments would also adopt new requirements for advertisements that include gross, past, extracted, related or hypothetical performance.
  • Administrative Provisions: Advisers would have to designate specific employees to review and approve advertisements before distribution. Advisers would also be required to report certain of their advertising practices on Form ADV, and would be subject to new recordkeeping obligations under Rule 204-2 intended to require advisers to demonstrate their compliance with the new obligations under Rule 206(4)-1.
  • Comment Period: The comment period will end 60 days after the Release is published in the Federal Register.
  • Compliance Date: Compliance with the amended rules would be required one year after the effective date.

II.  Broadened Definition of “Advertisement”

A.  Overview

Rule 206(4)-1 currently defines “advertisement” to mean “any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television [emphasis added].”

Under Proposed Rule 206(4)-1(e), “advertisement” would be defined to mean “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser [emphasis added].” The proposed rule would expand the definition of “advertisement” to apply to any communication that promotes an investment adviser’s services, regardless of the form of the communication or the manner in which it is distributed (e.g., in writing, electronically, in audio or video files, blogs or social media), and even if sent to a single person.

Certain communications would nonetheless be excluded from the proposed expanded definition of “advertisement”: (i) live oral communications not broadcast on electronic media; 4 (ii) responses to unsolicited requests for information about an adviser’s services, except for (a) communications about performance results to Retail Persons and (b) all communications about Hypothetical Performance; 5 (iii) communications about registered investment companies (“RICs”) or business development companies (“BDCs”);6 and (iv) disclosures required by statute or regulation (e.g., information required by Part 2 of Form ADV or Form CRS).

B.  Key Terms

Certain of the terms used in the proposed definition of “advertisement” are further explained or defined in the Release or in the proposed amendments. The key terms are as follows:

  • Disseminated by any means. This phrase would replace the current limitation to written communications or announcements made over radio or television. The Release emphasized that the focus of the amended rule is “on the goal of the communication, and not its method of delivery.”
  • By or on behalf of an investment adviser. The proposed rule would apply to material disseminated by an adviser’s agents, such as consultants and solicitors, 7 or by an investment adviser’s affiliates, and may apply, depending on the facts and circumstances, to material disseminated by unaffiliated third parties. 8 The determination of whether material distributed by a third party is considered an “advertisement” of the adviser will depend on the adviser’s involvement in the content or production of the material (g., whether the investment adviser assists in preparing the content, influences or controls the substance of the content or pays for the distribution). Advisers should thus implement appropriate procedures to monitor materials distributed on their behalf to assure compliance with the requirement of any newly adopted rules.
  • Offers or promotes the investment adviser’s investment advisory services. Material providing a client with general account information in the regular course of business or disseminating general educational materials about investing and markets would not be considered advertisements. However, the Commission may consider an adviser’s market commentary to be an advertisement if the commentary offers or promotes the adviser’s services. 9
  • Investors in any pooled investment vehicle. This provision treats investors in a pooled investment vehicle, other than investors in a RIC or a BDC,10 as clients of the adviser. This provision would provide additional protections for investors in pooled investment vehicles beyond those already provided under Rule 206(4)-8 (prohibiting fraudulent practices with respect to pooled investment vehicles).

III.  Advertising Standards

A.  General Prohibitions

The current rule contains a general prohibition on false or misleading statements, and additionally prohibits four specific types of communications in advertisements: (i) testimonials; (ii) past specific recommendations; (iii) representations that a chart or graph alone can be relied upon to make investment decisions; and (iv) misrepresentations about the cost of services. The proposed amendments replace these specific prohibitions by instead creating General Prohibitions that largely incorporate principles developed through the Commission’s prior no-action letters and are consistent with other anti-fraud provisions in the Federal securities laws.11

Under Proposed Rule 206(4)-1, advisers would be prohibited from making untrue or misleading statements or omissions, making material claims that are unsubstantiated,12 failing to “clearly and prominently” disclose potential risks, or referencing performance results and specific investment advice in a way that is not fair and balanced.13 A finding of negligence would be sufficient to establish a violation of the General Prohibitions.14

B.  Specific Investment Advice

The SEC proposes to replace the prescriptive requirements currently applicable to advertisements that include discussions of “past specific recommendations” with a principles-based approach that would permit material that discusses “specific investment advice” as long as it is “fair and balanced.”15 The Release notes that the following current guidance may be helpful to advisers in satisfying the “fair and balanced” requirement:

  1. referring to the information that must currently be included when presenting a list of all past specific recommendations made by the adviser within the past year;16
  2. using objective, non-performance based criteria to select the securities discussed in advertisements;17 and
  3. considering “the facts and circumstances of the advertisement, including the nature and sophistication of the audience.”

While reference to current guidance may be useful, the proposed rule would provide advisers with greater flexibility to include discussions of specific investment advice in advertising material, provided that the discussion is fair and reasonable, and includes sufficient information and context to enable recipients to evaluate the discussion.18 Advisers would, however, be subject to the specific requirements applicable to performance information discussed in Section D below.

C.  Testimonials, Endorsements, and Third-Party Ratings

The proposed amendments establish conditions that, if followed, allow for the use of testimonials, endorsements and third-party ratings in advertisements.19

  • Advisers using Testimonials20 or Endorsements21 in advertisements must “clearly and prominently disclose”: (i) that the testimonial was given by a client or investor, and the endorsement was given by a person who is not a client or investor; and (ii) whether the adviser, or anyone acting on its behalf, provided (cash or non-cash) compensation for the testimonial or endorsement.22
  • Third-Party Ratings23 may be used if: (i) the adviser “reasonably believes”24 that the questionnaires used to produce the ratings were designed to produce unbiased results; and (ii) the adviser or third party clearly and prominently discloses information including the rating date, time period on which the rating was based, the identity of the third party that produced the rating and whether the adviser, or anyone acting on its behalf, provided compensation, in the form of cash or otherwise.

D.  Performance Advertising

The current rule does not address the appropriate presentation of an adviser’s performance results. Guidance on performance advertising has been developed through SEC no-action letters.25 The proposed rule would establish explicit requirements as to the use of performance results, setting different standards depending on whether the advertisement is a Retail or Non-Retail Advertisement, as defined below.

  • Non-Retail Advertisements would mean advertisements directed at Non-Retail Persons, defined for this purpose as “qualified purchasers” or “knowledgeable employees,”26 as defined in the Investment Company Act.27 For such advertisements, an adviser would be required to implement “policies and procedures reasonably designed to ensure that the advertisement is disseminated solely to qualified purchasers and knowledgeable employees.”
  • Retail Advertisements would mean advertisements directed at Retail Persons, meaning anyone other than a Non-Retail Person.

Under the SEC proposal, performance information would be subject to the following requirements:

  • All Portfolio28 performance results included in Retail Advertisements must be presented in 1-, 5-, and 10-year periods, “each presented with equal prominence and ending on the most practicable date.”29
  • To use Gross Performance30 in a Retail Advertisement, the advertisement must: (i) present Net Performance31 results “with at least equal prominence,” in a format designed to facilitate comparison with the Gross Performance, using the same calculation methods and calculated over the same prescribed time periods;32 and (ii) provide, or offer to provide promptly, a percentage schedule of the fees and expenses deducted to calculate Net Performance.33
  • To use Gross Performance in a Non-Retail Advertisement, an adviser must provide or offer to provide promptly, a percentage schedule of the fees and expenses deducted to calculate Net Performance. The Non-Retail Advertisement would not, however, be required to include Net Performance results.34
  • An advertisement may include Related Performance35 only if it includes the performance of all Related Portfolios,36 unless (a) the performance results advertised are no higher than they would have been if no Related Portfolios were excluded, and (b) for Retail Advertisements, the performance results must be presented for the required time periods noted above, notwithstanding the exclusion of some Related Portfolios.37
  • Extracted Performance38 may be used only “if the advertisement provides, or offers to provide promptly, the performance results of all investments in the Portfolio from which the performance was extracted.”
  • To use Hypothetical Performance,39 an adviser would be required to:
    1. adopt policies and procedures “reasonably designed to ensure that the Hypothetical Performance is relevant to the financial situation and investment objectives” of the recipient. The purpose of this requirement is to ensure that an adviser only provides hypothetical performance “where the recipient has the financial and analytical resources to assess the hypothetical performance and that the hypothetical performance would be relevant to the recipient’s investment objective”;40
    2. provide, in both Retail and Non-Retail Advertisements, “calculation information” that is tailored to the audience receiving it, to enable recipients to understand the criteria and assumptions used in calculating Hypothetical Performance; and
    3. provide in Retail Advertisements, or offer to provide promptly in Non-Retail Advertisements, “risk information” tailored to the audience receiving it, to enable recipients to understand the risks and limitations of using the Hypothetical Performance in making investment decisions.

All performance advertisements must comply with the General Prohibitions. Though the Commission declined to require specific disclosures, the Release noted that examples of disclosures currently used by advisers in performance advertisements include: “(1) the material conditions, objectives, and investment strategies used to obtain the results portrayed; (2) whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings; (3) the effect of material market or economic conditions on the results portrayed; (4) the possibility of loss; and (5) the material facts relevant to any comparison made to the results of an index or other.”41 In line with its principles-based approach, advisers would be required to include appropriate disclosures to reflect the assumptions and factors relevant to the calculation of performance information.42

E.  Portability

The Commission has issued a number of no-action letters on when investment advisers may advertise performance results from the firm’s predecessor entities or from entities at which the firm’s employees were previously employed.43 Neither the current rule nor the proposed amendments set explicit standards for portability; the determination is subject to analysis under whether the porting of the prior results would be misleading. However, the Release does summarize and discuss the Commission’s considerations as to when portability is appropriate:

“(i) the person responsible for such results is still the adviser;

(ii) the prior account and the present account are similar enough that the performance results would provide relevant information;

(iii) all prior accounts that are being managed in a substantially similar fashion to the present account are being factored into the calculation; and

(iv) the advertisement includes all relevant disclosures.”44

The Release stated that the portability of testimonials, endorsements, and third-party ratings would be governed by the same considerations as predecessor performance results.

IV.  Administrative Provisions

A.  Internal Review and Approval of Advertisements

Proposed Rule 206(4)-1(d) creates a new requirement that investment advisers designate an employee to review and approve all advertisements before they are disseminated. The only exceptions to this rule are for (1) communications to only a single person, household, or investor in a pooled investment vehicle and (2) live oral communications broadcast on electronic media. The SEC did not propose an exemption from pre-distribution reviews for Non-Retail Advertisements.45

B.  Amendments to Form ADV

The proposed rule would amend Item 5 of Part 1A of Form ADV to add a subsection “L. Advertising Activities” to help SEC staff prepare for on-site examinations. This five-question subsection would ask advisers to respond yes or no to the following questions:

(1) Whether any of the adviser’s advertisements contain performance results;

(2) If so, whether all of those performance results were verified or reviewed by a person who is not a “related person” (i.e., an entity unaffiliated with the adviser);

(3) Whether any of the adviser’s advertisements include testimonials, endorsements, or third-party ratings, and if so, whether the adviser provides direct or indirect compensation in connection with their use; and

(4) Whether any of the adviser’s advertisements includes a reference to specific investment advice provided.

C.  Amendments to the Books and Records Rule

First, the recordkeeping requirements of Rule 204-2(a)(11) would be expanded to require advisers to keep copies of all advertisements disseminated, whereas the rule currently requires that advisers only keep records of written communications disseminated to 10 or more people. This provision would require that advisers retain records of the risk and calculation information for Hypothetical Performance that they are required to provide under amended Rule 206(4)-1(c)(1)(v) because the Commission views such additional information as part of the advertisement itself.46

Second, the amended recordkeeping rule would require investment advisers make and keep originals of: (1) written communications sent or received relating to the performance or rate of return of any or all Portfolios and (2) supporting records regarding the calculation of the performance or rate of return of any or all Portfolios.

Third, advisers would be required to retain records of any questionnaires and surveys used to obtain third-party ratings for advertisement purposes.

Finally, advisers would be required to maintain records of the written approvals for all advertisements.

V.  Summary and Policy Considerations

The SEC has issued a thoughtful proposal that would adopt a technology-neutral, principles-based approach to investment adviser advertising. The Release includes extensive questions on all aspects of the proposal, and industry participants should carefully consider whether to submit responses.

One issue that is not specifically addressed in the Release is the degree to which the amended rules should be harmonized more closely with equivalent FINRA standards for broker-dealer communications and NFA standards for promotional material distributed by CFTC-registered firms. These considerations are particularly relevant to SEC-registered investment advisers that are also registered with the CFTC as CPOs or CTAs, which are subject to both SEC and NFA requirements, and advisers who market interests in funds they advise through broker-dealers, in which case the sales material would be subject to both the SEC and FINRA requirements. Finally, we note that the Release contains a wealth of material on current requirements for investment adviser advertising, which firms may consult to confirm that their current advertising practices conform to applicable SEC standards.

1   Commission Release No. IA-5407 (Nov. 4, 2019).

2  See Cadwalader Clients and Friends Memo titled SEC Proposes Significant Amendments to Investment Adviser Solicitation Rule, dated December 3, 2019 (the “Cadwalader Investment Adviser Solicitation Proposal Memo”).

3   Any reference to Rules in this memorandum shall mean rules promulgated under the Advisers Act, unless otherwise specified.

4   The Release differentiates between “live” oral communications, which are not “advertisements” if not broadcast widely on electronic media, and pre-recorded communications, which could be considered advertisements. Additionally, any written materials (e.g., slides, storyboards, or scripts) prepared in advance for use during a live oral communication could be considered advertisements. See Release, pp. 41-42.

5   See Section III.D., infra, for definitions.

6  Specifically, the exclusion would apply to sales material about RICs and BDCs complying with the advertising requirements of rules 156 and 482 under the Securities Act of 1933 (the “Securities Act”).

7   Persons who promote an investment adviser’s services through testimonials or endorsements may be considered solicitors and thus subject to the requirements of both Rule 206(4)-1 (the advertising rule) and Rule 206(4)-3 (the solicitation rule). See Cadwalader Investment Adviser Solicitation Proposal Memo, Section III.A at nn.16-17 and accompanying text.

8  The Release discusses the circumstances in which online material may be deemed to be an investment adviser’s advertising as a result of linkages between the investment adviser’s website or social media site and third-party sites. See Release, pp. 25-28.

9   See Release, p. 33 (citing Investment Counsel Association of America, Inc., SEC Staff No-Action Letter (Mar. 1, 2004)).

10 The Release reasons that investors in RICs and BDCs are adequately protected by provisions of the Securities Act and Investment Company Act of 1940 (the “Investment Company Act”). See Release, pp. 36-40.

11 See, e.g., Release, pp. 67-68 (delineating criteria that would help advisers comply with the proposed rule (citing Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998))).

12 Put differently, an adviser would have to be able to substantiate every material claim contained in its advertisements.

13 This would prohibit, for example, cherry-picking favorable results or time periods. The “fair and balanced” standard mirrors FINRA Rule 2210(d)(1)(A), which requires broker-dealer communications to be “fair and balanced.”

14 See Release, p. 54 at n.109 and accompanying text.

15 The SEC proposes to replace the current Rule’s reference to “past specific recommendations” with “specific investment advice” to clarify that the Rule applies to current advice, and investments in a discretionary account. See Release, pp. 68-69.

16 Rule 206(4)-1(a)(2) currently requires that advisers advertising their past specific recommendations disclose a list of all recommendations they made in the last year, including: the name of each security, the date and nature of the recommendation (e.g., buy, sell, hold), the market price of the security at the time of the recommendation and as of the most recent date, the price at which the recommendation was to be acted upon and a warning that “it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.”

17 See the TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008) (declining to recommend enforcement action when a chart contained in an advertisement was clear, consistent, and included both the account’s best and worst performance during the period).

18 See Release, pp. 64-65.

19 FINRA permits broker-dealers to include testimonials in sales material, but requires additional disclosures when they are used in retail communications. See FINRA Rule 2210(d)(6).

20 “Testimonial” would be defined in Proposed Rule 206(4)-1(e) as “any statement of a client’s or investor’s experience with the investment adviser or its advisory affiliates.” The proposed rule defines “advisory affiliate” by reference to the definition in Form ADV, which includes, among others, entities “directly or indirectly controlling or controlled by” the investment adviser. This would thus include entities in the ownership chain of the adviser, but not entities under common control (i.e., sister companies). See Release, pp. 78-79 at n.152 and accompanying text.

21 “Endorsement” would mean “any statement by a person other than a client or investor indicating approval, support, or recommendation of the investment adviser or its advisory affiliates.”

22 Examples of non-cash compensation could include reduced-fee or no-fee advisory services, or the adviser referring its clients or investors to the third-party’s business. See Release, p. 90.

23 “Third-party rating” would mean “a rating or ranking of an investment adviser provided by a person who is not a related person and such person provides such ratings or rankings in the ordinary course of its business.” The proposed rule uses the Form ADV definition of “related person”: “[a]ny advisory affiliate and any person that is under common control with your firm.” A third-party rating is thus a rating produced by an entity that is not a parent, subsidiary, or entity in a common control relationship with the adviser. The Release notes that “The requirement that the provider not be an adviser’s related person would avoid the risk that certain affiliations could result in a biased rating.” See Release, p. 81.

24 The Release provides no definition for “reasonable belief,” and instead suggests that advisers be responsible for creating internal policies and procedures to implement the “reasonable belief” provisions.

25 See, e.g., Clover Capital Mgmt., Inc., SEC Staff No-Action Letter (Oct. 28, 1986) (discussing when an advertisement using Hypothetical Performance might be false or misleading); Anametrics Investment Management, SEC Staff No-Action Letter (Apr. 5, 1977) (stating that advertising account performance without disclosing that the market significantly outperformed the account over the same time period was misleading); Bradford Hall, SEC Staff No-Action Letter (Jul. 19, 1991) (stating that the presentation of gross performance not reflecting a deduction for advisory fees would be misleading).

26 A “knowledgeable employee” would be a Non-Retail Person solely with respect to a fund falling within the exclusion from the definition of an “investment company” in Section 3(c)(7) of the Investment Company Act, advised by the investment adviser. See Release, pp. 114-15.

27 The Commission decided against treating other categories of investors as Non-Retail Persons, such as Regulation D accredited investors, and Rule 205-3(d)(1) qualified clients. See Release, p. 114. We note the following regarding the treatment of retail vs. non-retail advertisements by the National Futures Association (“NFA”) and the Financial Industry Regulatory Authority (“FINRA”):

– The NFA governs communications by firms registered with the Commodity Futures Trading Commission (“CFTC”), including commodity pool operators and commodity trading advisors (“CPOs” and “CTAs”). The NFA imposes somewhat more lenient requirements on promotional material directed at “qualified eligible persons” (“QEPs”) as defined in CFTC Rule 4.7. See, e.g., NFA Compliance Rule 2-29(c). QEPs include, but are not limited to, “qualified purchasers” and “knowledgeable employees.” An SEC-registered investment adviser that is also registered with the CFTC as CPO or CTA would thus have to determine whether it is sending sales material to (i) a Retail or Non-Retail Person under the SEC’s proposed rule, and (ii) a QEP or non-QEP under CFTC Rule 4.7.

– FINRA Rule 2210, governing broker-dealer communications, distinguishes between “retail communications” and “institutional communications.” For this purpose, an “institutional communication” is a communication sent exclusively to “institutional investors,” which are defined as certain categories of regulated entity, and other entities or individuals that have total assets of at least $50 million. See FINRA Rule 2210(a)(4) incorporating the definition of “institutional account” in FINRA Rule 4512(c). This is a higher asset test than that used in the “qualified purchaser” definition, which requires individuals to own at least $5 million in investments, and institutions to own and invest at least $25 million in investments. This means that where an investment adviser directly markets interests in a fund operated under Section 3(c)(7) of the Investment Company Act to “qualified purchasers” and “knowledgeable employees,” it may treat those investors as “Non-Retail Persons,” whereas if interests in the fund are sold through a broker-dealer, the broker-dealer would be required to treat those investors as “retail investors” for purposes of complying with the communications requirements of FINRA Rule 2210.

28 “Portfolio” would mean a group of investments managed by the investment adviser, including an account or a “pooled investment vehicle” as defined in Rule 206(4)-8(b) (i.e., an “investment company” as defined in Section 3(a) of the Investment Company Act, or a fund falling within the exclusion from the definition of an “investment company” in Section 3(c)(1) or 3(c)(7) of the Investment Company Act). Proposed Rule 206(4)-1(e)(10).

29 If the relevant Portfolio did not exist for a particular prescribed period, then the life of the Portfolio must be submitted for that period.

30 “Gross Performance” would mean “the performance results of a Portfolio before the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant Portfolio.” Proposed Rule 206(4)-1(e)(4).

31 “Net Performance” would mean “the performance results of a Portfolio after the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant Portfolio, including, if applicable, advisory fees, advisory fees paid to underlying investment vehicles, and payments by the investment adviser for which the client or investor reimburses the investment adviser.” Proposed Rule 206(4)-1(e)(6).

32 The Release does not prescribe a specific calculation of Gross and Net Performance; the Commission seeks comment on what additional guidance it should provide for such calculations.

33 See Release, p. 128 (noting that “Where an adviser presents net performance, whether because net performance is required under the proposed rule or because the adviser otherwise chooses to present it, the schedule should show the fees and expenses actually applied in calculating the net performance that is presented.”).

34 We note that the NFA recently amended NFA Compliance Rule 2-29(b)(5) to include a specific requirement that past performance be presented on a net basis, regardless of whether the recipient is a QEP (and thus a Non-Retail Person). See NFA Notice to Members I-19-26 (Nov. 13, 2019). This reflects existing requirements under the CFTC and NFA rules that require CPOs and CTAs to calculate rate of return information on a net basis regardless of whether the investor is a QEP. See NFA Compliance Rule 2-29(b)(5)(ii).

35 “Related Performance” would mean “the performance results of one or more related Portfolios, either on a Portfolio-by-Portfolio basis or as one or more composite aggregations of all Portfolios falling within stated criteria.” Proposed Rule 206(4)-1(e)(11).

36 “Related Portfolio” would mean a “Portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered or promoted in the advertisement,” including, but not limited to, Portfolios for the account of the investment adviser or its advisory affiliate. Proposed Rule 206(4)-1(e)(12).

37 Under FINRA guidance, a broker-dealer may only include related performance information in sales materials distributed to (i) “institutional investors,” as defined in FINRA Rule 2210(a)(4), or (ii) qualified purchasers with respect to their investment in funds falling within Section 3(c)(7) of the Investment Company Act. See, e.g., FINRA Interpretive Letter to Stradley Ronon Stevens & Young, dated April 16, 2018; see also FINRA Interpretive Letter to Davis Polk & Wardwell, dated Dec. 30, 2003. The Release notes FINRA’s more restrictive approach, and comments that: “We believe that the utility of related performance in demonstrating the adviser’s experience in managing portfolios having specified criteria, together with the provisions designed to prevent cherry-picking and the provisions of paragraph (a) [imposing prohibitions on false or misleading advertisements], support not prohibiting related performance in advisers’ Retail Advertisements.” See Release, p. 151.

38 “Extracted Performance” would mean “the performance results of a subset of investments extracted from a Portfolio.”

39 “Hypothetical Performance” would mean “performance results that were not actually achieved by any Portfolio of any client of the investment adviser.” Under this definition, results achieved by proprietary accounts of the adviser would be “hypothetical” as they would not be achieved by a client of the adviser. Examples of Hypothetical Performance that an adviser may use include Backtested Performance, Representative Performance (including performance of “model” portfolios), and Targets and Projections. See Proposed Rule 206(4)-1(e)(5) and Release, pp. 162-67, for definitions and discussions of these subsets of Hypothetical Performance.

40 See Release, p. 171. The Release further notes that in determining whether hypothetical performance is relevant to a Retail Person, a firm’s policies should include “parameters that address whether the Retail Person has the resources to analyze the underlying assumptions and qualifications of the hypothetical performance to assess the adviser’s investment strategy or processes, as well as the investment objectives for which such performance would be applicable.” In light of this requirement, the Release concludes that investment advisers would not be permitted to include hypothetical performance in advertisements that are distributed generally to Retail Persons regardless of their financial situation or investment objectives. See Release, p. 174.

FINRA and the NFA take differing approaches to hypothetical performance information:

– FINRA only permits broker-dealers to include hypothetical (backtested) performance information in certain communications with “institutional investors” as defined in FINRA Rule 2210(a)(4). See, e.g., FINRA Interpretive Letter to Foreside, dated Jan. 31, 2019.

– The NFA prohibits CFTC-registered firms from including hypothetical performance in promotional material sent to non-QEPs (i.e., Retail Persons) with respect to any trading program for which the firm has three months of actual trading results. Further, to the extent hypothetical performance information is permitted in retail promotional material, NFA requires a CFTC-registered firm to include comparable information regarding actual past performance of all customer accounts directed by the firm for the last five years (or the entire performance history, if less than five years). These restrictions do not, however, apply to hypothetical performance included in promotional material sent exclusively to QEPs (i.e., Non-Retail Persons). See NFA Compliance Rule 2-29(c)(3), (4) and (6).

41 See Release, pp. 103-05.

42 See Release, p. 105

43 The Commission also recently extended these guidelines to a case in which an investment adviser desired to use performance results of its predecessor entity after an internal restructuring. See South State Bank SEC Staff No-Action Letter (May 8, 2018) (not recommending enforcement action when the successor entity would operate in the same manner and under the same brand name as the predecessor).

44 See Horizon Asset Management, LLC, SEC Staff No-Action Letter (Sept. 13, 1996).

45 By contrast, FINRA Rule 2210(b)(3) permits post-distribution reviews of broker-dealer communications to “institutional investors” as defined in FINRA Rule 2210(a)(4) provided the firm trains personnel in the firm’s procedures governing institutional communications, and implements follow-up procedures to confirm that the procedures have been followed.

46 This information includes the criteria, assumptions, and methodology used in calculations, and the risks and limitations of the calculations. See Release, pp. 176-77, 287-88.

© Copyright 2019 Cadwalader, Wickersham & Taft LLP

For more Securities and Exchange Commission regulations, see the National Law Review Securities Law section.

“Presents” of Mind for the Holidays: Six Q&As on Sensible Workplace Gift Giving

‘Tis the season of generosity, random acts of kindness, and selfless gifts. But not all gifts are well received—or positively perceived. In the employment law context, where compliance and best practice remain the watchwords, presents exchanged by colleagues, however well-intentioned, must still pass muster under law and corporate policy. Below are answers to several questions addressing the appropriateness of workplace gifts given during this time of year.

Q: Are there any employment law concerns about gifts given around the holidays—such as gifts with potentially romantic overtones, such as flowers, perfume, or perhaps an invitation to a one-on-one carriage ride—that may give rise to subsequent claims of sexual harassment? Or are such presents innocuous in the holiday season?

A: The nature of the holiday doesn’t change the nature of the gift exchanged between workers (regardless of managerial or non-managerial level). If an item is one that could lead to questions regarding the sender’s motivation (e.g., a veiled romantic overture), it should be avoided. Failing to do so could create misimpressions as to a sender’s true motive or could lead to the perception of favoritism or inappropriate sexual advances.

Q: Managers sometimes are told not to accept gifts from subordinates. Why might accepting presents from subordinates be imprudent? And how might managers tactfully turn down presents from subordinates?

A: Allowing gifts from subordinates may create the false impression that gift-givers are treated differently than non-gift-givers. It also may allow tacit competition concerning who can give the best, most expensive, or most thoughtful gift, and lead to morale problems or discomfort among employees. A considerate way to turn down a gift from a subordinate is to make it known, graciously but unequivocally, prior to the holidays, that gifts will not be accepted. If such a statement seems Scrooge-like, suggesting that an anonymous donation to a charity would be acceptable (rather than a tangible gift to the supervisor) could be an appropriate alternative.

Q: Are there are any issues with employees giving each other religious presents at this time of year? (It is, after all, a religious time of year for many.) In the workplace, might that be problematic? What limits on presents between coworkers might be warranted?

A: Religious gifts should generally be avoided, both at holidays and at other work times. Such gifts could create the impression that one particular religion is more acceptable than others to the gift-giver, and could lead to discomfort in the workplace on that issue.

Other limits on gift giving in the workplace (besides the “romantic” gifts and the religious gifts mentioned previously) could be related to gag gifts concerning protected characteristics—for instance, “over-the-hill” or other age-related gifts or cards, or items that derogate a physical or mental disability. Such gifts could lead inadvertently to claims of discrimination or inappropriate workplace actions.

Q: What about bosses giving presents or holiday cards to employees? Are there any risks with this?

A: This is simply the inverse of the question regarding managers accepting or refusing gifts, and it raises similar issues. Unless a boss is giving a neutral gift (e.g., a one-pound bag of coffee, local history book, or non-religious seasonal card) to every employee, selective gift giving may occasion claims of preferential treatment, discrimination, and/or workplace harassment.

Q: Are limits on gift giving likely to be perceived as not in the holiday spirit? How can an employer enforce these limits without seeming unfestive?

A: While limits on gift giving could be perceived as “not in the holiday spirit,” the risk avoidance element is more critical to employers. There’s often a fine line between limiting the fun associated with the holidays and creating an atmosphere that could encourage inappropriate behavior. The solution is clear, thoughtful communication. It’s OK to tell employees that there’s a limit on gift giving, and that part of the reason is so that no one feels left out or unable to keep up with the level of gifts exchanged. Setting a reasonable limit—either in value or in substance—could allow employees to understand that the employer is doing this thoughtfully, with the best interests of the employees in mind.

Q: What might be some elements of a company gift policy, both during the holidays and at other times of year?

A: A company-wide gift policy, assuming that the employer is not already limited by regulations or laws, would depend upon the nature of the company or work group, the size of the business, and the holiday being celebrated (i.e., is it a religious holiday or, say, an employee’s birthday?). Policies may also address gifts from outside sources, including contractors, customers, lobbyists, and others. Clear rules supported by language explaining the general rationale for the policy can help employees fully understand the restrictions being imposed.

 

© 2019, Ogletree, Deakins, Nash, Smoak & Stewart, P.C., All Rights Reserved.
The author of this article was previously quoted on this topic on SHRM Online.
For more on company policies around the holidays, see the National Law Review Labor & Employment law page.

A Slam-Dunk? Sweeping and Dramatic Changes may be Coming to the NBA

Adrian Wojnarowski and Zach Lowe dropped, what is known as a Woj Bomb, last week as they announced that the NBA is in high level discussions with the NBPA (the National Basketball Players Association) and broadcasting partners concerning “sweeping and dramatic changes to the league calendar that include a reseeding of the four conference finalists, a 30 team in-season tournament, and a postseason play-in”.

Reasons for change

There are a number of reasons why the NBA may consider changing the league format.

A culture of ‘load management’ has emerged in the league, which involves players opting to rest for certain matches, especially where teams play back-to-back games. Players are resting in the regular season so that they are fresh and healthy for the playoffs. The intense regular season takes its toll on players with a commitment of 82 games between October and April coupled with the demands of travel across North America.

TV viewing figures have dropped this season – broadcast audiences have declined by 18% compared to this point last season.

The Western Conference is also “stacked” when compared to the Eastern Conference. Teams in the West are perceived to have a large number of title contenders whereas the East is considered to have very few title contenders. The current format splits the 30 NBA teams into two conferences of 15 teams: East and West. At the end of the regular season, the top eight teams in each Conference qualify for the playoffs, where they compete against other teams within their Conference. The winners of the respective Conference playoffs meet in the NBA Finals. There is growing pressure on the NBA to change this format so the 16 best teams across the NBA compete in the playoffs, potentially skewing the playoffs so that more Western Conference teams qualify.

Proposed changes

 The proposed changes include:

  • shortening the regular season from 82 games to 78 games;

  • an in-season tournament;

  • play-in games for the playoffs; and

  • re-seeding the final four.

basketball hoopIn-season tournament: the NBA is separated into a number of divisions based on location. Teams will play a round-robin schedule against teams within their division and the top three teams from each division will advance to the quarterfinals. Reports indicate this may take place in December, possibly in Las Vegas. The NBA could incentivise teams to compete in this additional tournament by giving better draft odds to the winner or by counting victories in the tournament towards a team’s regular season record. Whilst this may encourage teams to compete seriously in the tournament, it may not encourage the players. James Harden and PJ Tucker, of the Houston Rockets, criticised the tournament with Tucker stating, “you fight for an NBA championship. I don’t want to play for anything else.” Additional financial incentives for players may be required.

Play-in games for the playoffs: this proposal involves two four-team tournaments featuring the seventh, eighth, ninth and 10th seeds in each Conference who would compete for the last two playoff spots available in each Conference.

Re-seeding the final four: this would involve re-seeding the top four teams left in the playoffs at the point they reach the Conference finals. The top seeded team would play against the lowest seeded team of the final four, regardless of Conference, whilst the teams with the second and third best records in the regular season would compete against one another. So the NBA Finals could include two teams from one Conference. This would appear to be an avenue to ensure the two best teams compete in the NBA Finals.

Implementing the changes

The NBA intends to implement these changes for the 2021-22 season, which will mark the NBA’s 75th anniversary. These changes will require approval from the Board of Governors and amendments to the current Collective Bargaining Agreement (CBA) between the league and the players. The CBA is due to run until the 2023-24 season, with an opt-out provision in its final year. Amending the CBA will pose a difficult challenge for the NBA, requiring significant negotiation with the NBPA (which represents the players’ interests). The CBA sets out numerous rules that govern the format and mechanics of the regular season and the revenue split between the league and its players, amongst other things. Its renegotiation is crucial in order to process and validate the proposed changes.

However, amending the existing CBA will present a number of challenges. The CBA is a mutual agreement, which requires compromise from both sides of the table. The NBPA will ensure that any changes to the league format confer certain rights and benefits on its players and that such changes are not detrimental to the interests of NBA athletes.

The NBA will also need to negotiate existing arrangements it has with sponsors and broadcasting partners. The changes present sponsorship and revenue-generating opportunities for the league. Although regular season games are likely to decrease in number (which will need to be reflected in existing agreements with broadcasters and partners), the introduction of an in-season tournament will likely generate interest from current and new fans. Similarly, the play-in games to secure the seventh and eighth playoff spots in each Conference should create an extra buzz at the end of the regular season.

Comment

Under Adam Silver’s stewardship, the NBA has progressed year on year financially and in terms of popularity across the world. Silver is certainly not resting on his laurels and the proposed innovations should be welcomed but there are significant logistical hurdles to overcome before they are implemented.

© Copyright 2019 Squire Patton Boggs (US) LLP

For more in NBA and other sports league news, check out the National Law Review Entertainment, Art & Sports Law page.

FERC Requires Public Utilities to Address Excess ADIT in Transmission Rates

On November 21, 2019, the Federal Energy Regulatory Commission (“FERC”) issued Order No. 864, a final rule on Public Utility Transmission Rate Changes to Address Accumulated Deferred Income Taxes. The new rule requires  public utilities with formula transmission rates to revise their formula rates to include a transparent methodology to address the impacts of the Tax Cuts and Jobs Act of 2017 (2017 Tax Act) and future tax law changes on customer rates by accounting for “excess” or “deficient” Accumulated Deferred Income Taxes (ADIT).  FERC also required transmission providers with stated rates to account for the ADIT impacts of the 2017 Tax Act in their next rate case.

Background

The 2017 Tax Act reduced the corporate income tax rate from 35 percent to 21 percent. The tax rate change will result in a reduction in a public utility’s future tax liabilities so that a portion of its ADIT balances (rate receipts collected in anticipation of future tax liability) will no longer be due to the IRS, and is thus considered excess ADIT.  This transmission-related excess ADIT must be returned to customers through a public utility’s transmission rates.

FERC issued a Notice of Proposed Rulemaking (NOPR) on ADIT issues on November 15, 2018.   In the NOPR, FERC proposed to require public utilities with formula rates to adjust their formula rates to include (i) a mechanism to reflect any excess or deficient ADIT resulting from the 2017 Tax Act, or any future tax rate change, in rate base; (ii) a mechanism to adjust income tax allowance to reflect amortization of excess or deficient ADIT; and (iii) a new worksheet in its transmission formula rate to track on an annual basis information related to excess/deficient ADIT.  FERC also proposed to require public utilities with stated rates to make a compliance filing to address excess ADIT resulting from the 2017 Tax Act.

Order No. 864 – Final Rule on ADIT Adjustments to Account for Tax Rate Changes

ADIT Adjustments in Formula Rates

In the final rule, FERC adopted each of its proposals to address ADIT adjustments for transmission providers with formula rates.

  • Rate Base Adjustment Mechanism.  FERC required public utilities with formula rates to include a mechanism by which excess ADIT is deducted from rate base, and deficient ADIT is added to rate base.  This mechanism must be broad enough to cover any future tax changes that might give rise to excess/deficient ADIT.  FERC did not require use of a specific mechanism, and instead will consider proposed changes on a case-by-case basis.  FERC noted that, consistent with its previous accounting guidance, public utilities are required to record a regulatory asset (Account 182.3) associated with deficient ADIT or a regulatory liability (Account 254) associated with excess ADIT.
  • Income Tax Allowance Adjustment Mechanism.  FERC required public utilities with formula rates to incorporate a mechanism to adjust income tax allowances to reflect amortized excess or deficient ADIT.  This mechanism must cover amortization of excess or deficient ADIT resulting from any future tax changes as well as the 2017 Tax Act.  FERC will consider proposed changes on a case-by-case basis.  FERC clarified that, consistent with guidance provided in the 2017 Tax Act, excess ADIT that is “protected” (i.e., plant-related) should be amortized no more rapidly than over the life of the underlying asset using the Average Rate Assumption Method (ARAM), or an alternative method if insufficient data is available to use ARAM.  FERC will evaluate proposed amortization methods for the return of excess ADIT that is “unprotected” (i.e., not plant-related) on a case-by-case basis. FERC clarified that regardless of the effective date of tariff changes submitted by a public utility, the full amount of excess ADIT resulting from the 2017 Tax Act must be returned to its customers.
  • New ADIT Worksheet.  FERC required public utilities to add a new permanent worksheet that will annually track information related to excess or deficient ADIT in their formula rates.  FERC required that the new ADIT worksheet address: (1) how any ADIT accounts were re-measured and the excess or deficient ADIT contained therein; (2) the accounting for any excess or deficient amounts in Accounts 182.3 (Other Regulatory Assets) and 254 (Other Regulatory Liabilities); (3) whether the excess or deficient ADIT is protected or unprotected; (4) the accounts to which the excess or deficient ADIT are amortized; and (5) the amortization period of the excess or deficient ADIT being returned or recovered through the rates. FERC expects public utilities to identify each specific source of excess/deficient ADIT, classify such excess/deficient ADIT as protected or unprotected, and list the proposed amortization period associated with each classification or source.  FERC also expects public utilities to provide supporting documentation in their compliance filings to justify the proposed amortization periods.  FERC did not require that use of a pro forma worksheet to convey such information, but did require that on compliance, public utilities populate the worksheets with excess/deficient ADIT resulting from the 2017 Tax Act to facilitate review by interested parties.

FERC clarified that given the formula rate changes required in the final rule, public utilities with formula rates would not be required to make subsequent FPA Section 205 filings to address rate impacts of excess/deficient ADIT associated with future tax rate changes.  FERC also stated that a public utility may show that existing ADIT-related mechanisms meet the requirements of this final rule.

ADIT in Stated Rates

FERC declined to adopt its proposal to require public utilities with stated rates to determine excess ADIT resulting from the 2017 Tax Act and return such amounts to customers in a single-issue filing responding to the final rule.  Instead, FERC stated it would maintain the status quo under its precedent, which requires public utilities with stated rates to address excess/deficient ADIT, including that caused by the 2017 Tax Act, in their next rate case.  FERC clarified it will address the timing of proposed excess ADIT amortization on a case-by-case basis, and that public utilities may propose to delay such amortization until its next rate case.

Compliance Filings 

FERC required that public utilities with formula rates submit a compliance filing by the later of 30 days after the effective date of the final rule (the effective date will be 60 days after publication of the rule in the Federal Register) or the public utility’s next annual informational filing. FERC stated that proposed tariff changes to address the final rule’s requirements should be made effective on the effective date of the final rule.

Several public utilities have already revised their formula rates to address excess ADIT resulting from the 2017 Tax Act.  These filings sought to implement the requirements proposed by FERC in the NOPR.  Under the final rule, these utilities will need to make a compliance filing, but can argue that the already-made changes satisfy the requirements of the final rule.  These past filings may serve as helpful models for compliance filings by other utilities, but must be considered in light of the requirements of the final rule.

Public utilities with stated rates are not required to make a compliance filing; excess/deficient ADIT issues will be considered in the next rate proceeding.

© 2019 Van Ness Feldman LLP

ARTICLE BY Van F. Smith and  Ani M. Esenyan of  Van Ness Feldman LLP.
Read more about utility tax regulation on the Environmental, Energy & Resource law page of the National Law Review.

US Banking Agencies Issue Statement on Alternative Date in Credit Underwriting

On December 3, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Consumer Financial Protection Bureau (CFPB) and the National Credit Union Administration (the Banking Agencies) released interagency guidance related to the use of alternative data for purposes of underwriting credit (the Guidance).

The Guidance acknowledges that alternative data may “improve the speed and accuracy of credit decisions,” especially in cases where consumer credit applicants have “thin files” because they are generally outside the mainstream credit system. In order to comply with applicable federal laws and regulations when using such alterative data, including those related to unfair, deceptive, or abusive acts or practices, the Banking Agencies advise that lenders should responsibly use such information. Furthermore, the Guidance reminds lenders of the importance of an appropriate compliance management program that comports with the requirements of applicable consumer protection laws and regulations.

As a final recommendation, the Banking Agencies suggest that lenders consult with appropriate regulators when planning to use alternative data to underwrite credit.

The Guidance is available here.

©2019 Katten Muchin Rosenman LLP

Privacy Tip #219 – FBI Considers FaceApp a Counterintelligence Threat

For those of you who have downloaded the face editing app FaceApp, please note that the Federal Bureau of Investigation (FBI) has classified FaceApp as a counterintelligence threat because of its Russian origins.

According to the FBI, “[T]he FBI considers any mobile application or similar product developed in Russia, such as FaceApp, to be a potential counterintelligence threat, based on the data the product collects, its privacy and terms of use policies, and the legal mechanisms available to the Government of Russia that permit access to data within Russia’s borders.”

When the FBI considers an app a security threat to the U.S., we all should. Downloading apps, in general, is risky, but downloading apps based in foreign countries that are trying to obtain information about U.S. citizens – and in fact are obtaining information from unwitting U.S. citizens – is potentially putting us in danger.

Now is the time to perform app hygiene. Check the apps on your phone to determine whether you are using them or not. If you aren’t using them, delete them. There is no reason to continue to allow them to collect your information if you are not using them and getting a benefit from them. If you are using them and can’t live without them, do some due diligence to determine the background of the app, read the Privacy Policy and Terms of Use to know what they are collecting and using about you, and delete the app if your gut tells you something’s not right. If you have downloaded FaceApp, that would be the first one to delete.

Copyright © 2019 Robinson & Cole LLP. All rights reserved.