The National Law Forum

Are Diversity Riders Legal?

Some venture capital firms have recently begun including so-called “diversity riders” in their term sheets. In general, these require that the issuer and the lead investor make commercially reasonable efforts to include a member of an underrepresented community as an investor in the financing. However well-intentioned the proponents of these clauses may be, the question arises whether they run afoul of state laws forbidding discrimination in private sector.

California’s Unruh Civil Rights Act, for example, provides:

” All persons within the jurisdiction of this state are free and equal, and no matter what their sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, sexual orientation, citizenship, primary language, or immigration status are entitled to the full and equal accommodations, advantages, facilities, privileges, or services in all business establishments of every kind whatsoever.”

Cal. Civ. Code § 51(b). The question, of course, is whether an obligation to include particular persons based on sex, race, color etc. runs afoul of “full and equal” advantages. Notably, the protection of the Act extends to “all persons” and is not confined to a limited class of protected persons. The use of the word “all” and the phrase “every kind whatsoever” makes it clear that the phrase “business establishments” is to be interpreted in the broadest sense reasonably possible.

It is quite obvious that if an issuer or lead investor discriminates in favor of one class of persons, it is not treating all persons in a “full and equal” manner. Further, discrimination in favor of one class of persons (however defined) necessarily involves discrimination against all persons who do not belong to that class.

ARTICLE BY Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP

For more articles on California Corporate Law, visit the National Law Review Corporate & Business Organizations section.

CFTC Whistleblower Program Helping to Drive Record-Level Enforcement Activity

The FY20 reports of the CFTC Whistleblower Program and CFTC Division of Enforcement reveal that the CFTC Whistleblower Program continues to grow and is helping to drive record-level enforcement activity. The Division of Enforcement reported a total of $1,327,869,760 in monetary relief ordered—the fourth-highest total in CFTC history, the third straight year-over-year increase, and the second straight year in excess of $1 billion. Approximately 30 to 40% of the CFTC’s ongoing investigations now involve some whistleblower component. Since the inception of the CFTC Whistleblower Program, CFTC enforcement actions associated with whistleblower awards have resulted in sanctions orders totaling nearly $1 billion.

Highlights of the annual report on CFTC Enforcement include:

The largest monetary relief ordered in CFTC history ($920 million), which included the highest restitution ($311,737,008), disgorgement ($172,034,790) and civil monetary penalty ($436,431,811) amounts in a spoofing case.
The most enforcement actions filed in CFTC history (113)—an increase over the previous high (102) and significantly higher than the 30-year average (58).
The most retail fraud actions (56) in a single fiscal year in CFTC history, including a record number of actions involving digital assets (7) and a total of 28 actions since the COVID-19 national emergency was declared on March 13, 2020.

During FY 2020, the CFTC paid whistleblowers $20 million and received 1,030 whistleblower tips and complaints, a jump of 126% over the 455 whistleblower tips received in FY 2019. Since the inception of the CFTC Whistleblower Program, the CFTC has issued 25 orders granting a total of more than $120 million in awards. The CFTC’s Whistleblower Office received tips and complaints regarding a wide range of violations, including:

failures to supervise;
record-keeping or registration violations;
swap dealer business conduct;
wash trading;
solicitation, misappropriation, and other types of fraud;
use of deceptive or manipulative devices in trading; and
spoofing and other forms of disruptive trading or market manipulation.

Under the CFTC Whistleblower Reward Program, the CFTC will issue rewards to whistleblowers who provide original information that leads to CFTC enforcement actions with total civil penalties in excess of $1 million. A whistleblower may receive an award of between 10% and 30% of the total monetary sanctions collected.

Original information “leads to” a successful enforcement action if either:

The original information caused the staff to open an investigation, reopen an investigation, or inquire into different conduct as part of a current investigation, and the Commission brought a successful action based in whole or in part on conduct that was the subject of the original information; or
The conduct was already under examination or investigation, and the original information significantly contributed to the success of the action.

In determining a reward percentage, the CFTC considers the particular facts and circumstances of each case. For example, positive factors may include the significance of the information, the level of assistance provided by the whistleblower and the whistleblower’s attorney, and the law enforcement interests at stake.

ARTICLE BY Jason Zuckerman and Matthew Stock of Zuckerman Law

For more articles on whistleblowers, visit the National Law Review Criminal Law / Business Crimes section.

President Trump issues Executive Order adopting Most Favored Nation Approach

In what appears to be one of President Trump’s last official acts, he has issued an Executive Order adopting, for certain purposes, the Most Favored Nation clause approach to the pricing of drugs in the United States. During the campaign, it was the position of President-Elect Biden that we should be negotiating the price with the drug companies for the sale of drugs in the United States.

Obviously, an Executive Order by one President can be quickly replaced with an Executive Order by the next President.

The only approach in regard to institutionalizing the Most Favored Nation clause approach to drug pricing, would be Congressional legislation, which has not been forthcoming during the four years of the Trump Administration.

A recent development is the decision of the Canadian government to enact significant restrictions on the bulk purchase of drugs in Canada for shipment into the United States. This is most likely the result of pressure by the drug companies, who have made it clear to the Canadians that the drug companies will only provide Canada with a certain quantity of drug products at particular pricing levels and at quantities which are sufficient for the Canadian population alone. The drug companies will not permit the Canadians to sell drugs that had been purchased at the much cheaper Canadian price than the price for which those drugs are sold in the United States to institutions in the United States.

This action of the Canadians highlights that the approach of the Most Favored Nation clause would not be greeted in a friendly manner, by many of our allies. These allies benefit from being able to negotiate cheaper prices for drugs, since the drug companies can then make up the shortfall needed for their R&D or their profit, by charging much higher prices for drugs in the United States. Enacting a Most Favored Nation clause would shut down that option, on behalf of the drug companies, and they would be forced to negotiate with our allies at much higher prices for drugs sold to the allies. Of course, this would stop the cost shifting to the American consumers and spread the cost of the development of drugs among all users, including those of our allies.

It will be interesting to see what approach the Biden Administration takes in regard to the pricing of drugs and whether or not it will continue the Trump approach of Most Favored Nation or will attempt to develop a different negotiating strategy for the pricing of drugs.

ARTICLE BY Frank R. Ciesla, Beth Christian, Anjali N. Baxi, Ari G. Burd of Giordano, Halleran & Ciesla, P.C.

For more articles on executive orders, visit the National Law Review Election Law / Legislative News section.

Off Payroll Working—April 2021 Changes for the Private Sector

What’s the new law all about?

On 6 April 2021, the delayed off-payroll working/IR35 rules take effect in the private sector, being brought in to address non-compliance with IR35 in the private sector. The new law:

applies when an individual provides services personally to a client/end user via a qualifying intermediary (personal service company, partnership or individual);
moves responsibility for determining employment status and deducting payroll taxes to the client/end user.

Do the new rules affect me?

The law affects all UK businesses that use intermediaries other than those in the small business exemption, and requires cooperation along the contingent labour supply chain.

Is “doing nothing” an option?

Not without risking a tax bill, HMRC investigation and bad press.

What must end users do to comply?

Use reasonable care to make employment status determination statement (SDS)/IR35 assessments for theircontractors, asking if, absent the intermediary, the nature and conditions of the work would cause the worker to be classed, for tax purposes, as an employee;
before first payment, provide a copy of the SDS, and rationale, to the contractor and down the supply chain;
implement a process for resolving employment status disputes (and appeals); respond to challenges within the 45 day time limit.

As end users, what steps should we be taking now?

The team: Who will take ownership of off payroll working compliance? Multi-disciplinary: HR, tax, procurement, legal.

Audit of contingent workforce and review of labour supply chains: Who are your contractors and how are they engaged (e.g., directly, through personal service company or umbrella)?

Assess the impact of the new regime: Carry out SDSs and analyse what impact the new regime will have. Do engagements need ending, or renegotiating? Do working practices and arrangements need to change?

Implementing compliance process going forward: How will new contractors be identified? How will working practices be monitored and how will SDSs be kept up to date?

ARTICLE BY Jonathan Maude and Esther Langdon of Vedder Price

For more articles on L&E, visit the National Law Review Labor & Employment section.

The Legality of Loot Boxes: A Primer

What is a Loot Box?

Loot boxes are virtual items that may be redeemed to receive a randomized selection of additional virtual items. In some instances, they are free. In others, loot boxes can be a lucrative monetization mechanic. These random sets of virtual items can range from aesthetic items, which make something in the game look good (e.g., a visual customization for a player’s avatar or weapons), to functional items that improve in-game performance (e.g., weapons, power-ups, powers, etc.). Loot boxes can be “accessed” in a variety of ways, such as by earning access via game play or purchasing a “key” using virtual currency or real money to unlock the loot box.

Legal Considerations with Loot Boxes

With the proliferation of loot boxes over the past 15 years, the use of them in games has received increased attention from legislators, regulators and the plaintiffs’ bar. The primary legal issue is whether a loot box mechanic constitutes gambling. Other issues include whether the age rating of games with loot box mechanics should be impacted based on the inclusion of the game mechanic, and whether consumer protection laws require disclosure of the odds of obtaining certain virtual items through loot boxes. Some of these key issues are discussed below.

Gambling. There is a great debate about whether loot boxes constitute gambling. The gambling laws vary by country, and in the United States, by state as well. In the US, few if any laws specifically address gambling based on virtual items. At a high-level, an overly simplified definition of gambling involves: staking something of value (consideration) for a chance to win something of value (a prize). If all three elements are present in an activity (prize, chance, and consideration), it may be gambling.

Impact on Children. Content ratings typically indicate the appropriate age group for and type of content included in a video game. Some advocate that even if loot box mechanics are not gambling, they have an addictive effect and therefore this should be reflected in the games rating. Some commenters have suggested modifying the ESRB rating for games with loot boxes, for example by rating all such games as Mature or Adult Only, or by creating a new rating.

Disclosure Considerations

• Disclosure of Loot Box Odds. Currently, Apple and Google require all mobile apps that have loot boxes to disclose odds. By the end of 2020, Nintendo and similar companies manufacturing consoles are supposed to require disclosure of loot box odds for new games and existing games that add new loot box features. Many major game publishers have also committed to disclosing loot box odds by the end of 2020. Disclosure of loot box odds must be accurate and non-misleading to avoid a FTC Act Section 5 violation.

• In-Game Purchase Disclosures. In April 2020, the ESRB announced a new “Interactive Element”—used to describe disclosures for video games that highlight a game’s interactive or online features that may be of interest but do not influence a game’s rating. The “In-Game Purchases (Includes Random Items)” disclosure sits just below a game’s content rating assigned to any game that contains in-game offers to purchase digital goods or premiums with real world currency (or with virtual coins or other forms of in-game currency that can be purchased with real world currency) for which the player doesn’t know prior to purchase the specific digital goods or premiums they will be receiving (e.g., loot boxes, item packs, mystery awards).

• Content Creator Disclosures. With the rise of avid video game players livestreaming gameplay to followers, these players are reminded of the need to follow FTC Endorsement Guidelines. These guidelines require, among other things, disclosure of any material connections between the players and the products they are touting, such as compensation agreements.

Increasing Litigation from Consumers

The legality of loot boxes may be challenged through a variety of paths. For example, state attorneys general may bring criminal or civil actions, or aggrieved consumers may bring challenges directly under most states’ anti-gambling laws. Even if loot boxes are presumptively legal and do not constitute gambling under applicable law, consumers may bring lawsuits based on consumer protection or false advertising laws if they believe that the loot boxes are promoted in an arguably misleading way.

Several class action lawsuits have been brought recently in California against game developers, game publishers, and distributors of games. While some of the lawsuits have alleged violations of unfair competition laws by engaging in an “unlawful” business under the states’ gambling law, other cases claimed that the defendant misrepresented its marketing and selling of the loot box. We discussed one of those lawsuits in this post.

Regulatory Attention

Various federal, state, and foreign officials, have proposed regulating loot boxes. In 2018, state legislatures in at least four states (California, Hawaii, Minnesota, and Washington) introduced bills aimed at regulating loot box sales. All failed to pass. At the federal level, the most notable effort to restrict loot boxes was “The Protecting Children from Abusive Games Act,” a 2019 bill introduced by Sen. Josh Hawley aimed at prohibiting loot boxes in any game played by minors (which we covered here). In August 2020, the FTC released a staff perspective paper in response to the workshop held a year prior in 2019 about loot boxes and microtransactions. The FTC paper summarizes key concerns from panelists and commenters about how loot boxes function, as well as recommendations to address the concerns.

There is no consistent approach internationally either, although many EU member states have released position papers within the last few years.

Considerations to Help Mitigate Risk

Take steps to avoid creating a wager, chance or win/loss structure required for a finding of gambling
Accurately and transparently disclose probably for winning
Consider substantial parental controls on loot box purchases made by minors
Ensure that there are minimal “fine print” terms or fees that consumers plausibly could contend are hidden or obscured
Develop and implement strategies for enforcement against unauthorized secondary markets that improperly sell your virtual items

ARTICLE BY Julia K. Kadish and James G. Gatto of Sheppard, Mullin, Richter & Hampton LLP

Supreme Court Hears Oral Argument in Its First CFAA Case

On November 30, 2020, the Supreme Court held an oral argument in its first case interpreting the “unauthorized access” provision of the Computer Fraud and Abuse Act (CFAA). The CFAA in part prohibits knowingly accessing a computer “without authorization” or “exceeding authorized access” to a computer and thereby obtaining information and causing a “loss” under the statute. The case concerns an appeal of an Eleventh Circuit decision affirming the conviction of a police officer for violating the CFAA for accessing a police license plate database he was authorized to use but used instead for non-law enforcement purposes. (See U.S. v. Van Buren, 940 F. 3d 1192 (11^th Cir. 2019), pet. for cert. granted Van Buren v. U.S., No. 19-783 (Apr. 20, 2020)). The issue presented is: “Whether a person who is authorized to access information on a computer for certain purposes violates Section 1030(a)(2) of the Computer Fraud and Abuse Act if he accesses the same information for an improper purpose.”

The defendant Van Buren argued that he is innocent because he accessed only databases that he was authorized to use, even though he did so for an inappropriate reason. He contended that the CFAA was being interpreted too broadly and that such a precedent could subject individuals to criminal liability merely for violating corporate computer use policies. During oral argument, Van Buren’s counsel suggested that such a wide interpretation of the CFAA was turning the statute into a “sweeping Internet police mandate” and that the Court shouldn’t construe a statute “simply on the assumption the government will use it responsibly.” In rebuttal, the Government countered that Van Buren’s misuse of access for personal gain was the type of “serious breaches of trust by insiders” that statutory language is designed to cover.

The CFAA does not define “authorization” (but courts have generally interpreted it to mean to access a computer with sanction or permission), but the Act defines “exceeds authorized access” as “to access a computer with authorization and to use such access to obtain or alter information in the computer that the accesser is not entitled so to obtain or alter.” 18 U.S.C. § 1030(e)(6). As we explained in our last post on the emerging CFAA issue, in the criminal context circuit courts are split on how to interpret the “unauthorized access” or “exceeding unauthorized access” provisions with respect to accessing a database with an improper purpose or against posted policies.

Although it is a criminal case, the Supreme Court has the opportunity to clarify the meaning of “exceeds authorized access” under the CFAA and perhaps bring more legal certainty to “unauthorized access” claims advanced against entities engaged in unwanted data scraping. Interestingly, during oral argument, there was an exchange between the the Deputy Solicitor General arguing on behalf of the Government and Chief Justice Roberts that touched on what “authorization” means with respect to public websites:

CHIEF JUSTICE ROBERTS: Mr. Feigin, is your friend correct that everyone who violates a website’s terms of service or a workplace computer use policy is violating the CFAA?

FEIGIN: Absolutely not, Your Honor. […] First of all, on the public website, that is not a system that requires authorization. It’s not one that uses required credentials that reflect some specific individualized consideration.

CHIEF JUSTICE ROBERTS: Okay. Then limit my — my question to any computer system where you have to, you know, log on.

FEIGIN: So, Your Honor, I don’t think all log –all systems that require you to log in would be authorization-based systems because what Congress was driving at here are inside –

CHIEF JUSTICE ROBERTS: All right. Well, then every — every system that has a password.

FEIGIN: No, Your Honor, and let me explain why. What Congress was aiming at here were people who were specifically trusted, people akin to employees, the kind of person you — that had actually been specifically considered and individually authorized.

While prognosticating on how the Court will rule based on the tone and substance of the oral argument is an inexact science, it appeared that that the Justices encountered some difficulty parsing the ambiguity in the statute surrounding “authorization.” Indeed, as Justice Alito commented: “Well, I find this a very difficult case to decide based on the briefs that we’ve received,” even adding that “I don’t really understand the potential scope of this statute, without having an idea about exactly what all of those terms mean.” Thus, we will simply have to wait until next year to see how the Supreme Court interprets “exceeding authorized access.”

Final Thoughts

When first enacted in 1984 the CFAA was originally directed at serious “hacking” activities into government networks, inspired by the pre-digital era movie War Games, where a teenager hacks into the U.S. military missile system NORAD and nearly starts a global thermonuclear war while playing a simulated game with the computer (“Shall we play a game?). But, we live in a different world now and the CFAA has also changed. Over the past three decades, Congress has expanded the statute and added a civil right of action, and technology and the way we store and access data have become more advanced. As a result, the language of the CFAA is susceptible to broader application and has been brought to bear in many contexts beyond traditional outside hacking scenarios. With the Van Buren case, the Supreme Court has the opportunity to rule on the contours of “unauthorized access” and thus bring some clarity beyond the criminal context. However, criminal convictions present different equities than civil cases, and it remains to be seen if the Court’s opinion will resolve questions surrounding civil liability that we’ve been seeing in many scraping disputes, including the ongoing hiQ dispute (which itself is before the Supreme Court on a petition for cert.).

ARTICLE BY Jeffrey D. Neuburger of Proskauer Rose LLP

For more articles on SCOTUS, visit the National Law Review litigation section.

Consumer Public Interest Lawsuit Seeks 21 Million RMB for Counterfeit Trademark Sales of Starbucks in China

On November 22, 2020, the Jiangsu Provincial Consumer Protection Committee announced they filed a public interest lawsuit on October 26, 2020 against Shuangshan Food (Xiamen) Co., Ltd. for selling counterfeited Starbucks coffee. Shuangshan was previously subject to criminal prosecution for the sale of the counterfeit coffee amounting to 7 million RMB (~$1 million USD). This is the first consumer civil punitive damages public interest litigation in Jiangsu Province and the demand for compensation of 21 million RMB is the highest demand ever made in China in a consumer civil public interest litigation.

In February 2018, the Wuxi City Market Supervision Department received a report stating that there were counterfeit “Starbucks” brand coffee being sold. An investigation determined the “Starbucks” coffee sold by Shuangshan was a counterfeit product. After verification, the market supervision department notified the Wuxi public security department. Later, it was found that the coffee sold by Shuangshan Company was not authorized by the owner of the “Starbucks” brand. Under the premise of knowing that the purchased products were counterfeit, Shuangshan still forged customs declaration documents and false authorization documents, and sold the products. The counterfeit Starbucks coffee went to more than 50 merchants in 18 provinces across China, and finally sold to end consumers. In 2019, the Xinwu District Procuratorate prosecuted Shuangshan Company and related personnel with a verdict reached in December. At the same time, the Xinwu District Procuratorate recommended that the Jiangsu Provincial Consumer Protection Committee file a consumer civil public interest lawsuit.

The Jiangsu Provincial Consumer Protection Committee concluded that the case was an intellectual property case involving counterfeit trademarks. The facts were clear and fixed, the amount involved was huge, and the infringement was serious. The fake coffee sales constituted fraud and the Committee therefore claimed punitive compensation of three times the amount involved. On October 26, 2020, the Wuxi Intermediate People’s Court formally accepted the case.

How to distribute any funds collected by the Committee as a result of the lawsuit has yet to be determined.

Starbucks Thanks You Letter

ARTICLE BY Aaron Wininger of Schwegman, Lundberg & Woessner, P.A.

For more articles on IP law, visit the National Law Review Intellectual Property section.

SEC Adopts Final Rules to Modernize Financial Disclosure Requirements

On November 19, 2020, the Securities and Exchange Commission (SEC) adopted final rules to update the core financial disclosure requirements of Regulation S-K – relating to Selected Financial Data, Supplementary Financial Information and Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) – to efficiently provide investors with material financial information and ease the compliance burden for registrants.¹ As noted in our client alert on the proposed rules earlier this year, these final rules are part of the broader initiative by the SEC to modernize and simplify disclosure requirements.

Highlights of the rules include the following:

Eliminate Item 301 (Selected Financial Data)

Registrants will no longer be required to provide five years of selected financial data.

Simplify Item 302(a) (Supplementary Financial Information)

Replace the current requirement in Item 302(a) to provide two years of tabular selected quarterly financial data with a principles-based requirement for material retrospective changes.
Specifically, disclosure will only be required under Item 302(a) when there are one or more retrospective changes to the statements of comprehensive income for any of the quarters within the two most recent fiscal years or any subsequent interim periods for which financial statements are included or required to be included that are, individually or in the aggregate, material.

Restructure and Streamline Item 303 (MD&A)

Add a new Item 303(a) to clarify the objective of MD&A and streamline the instructions.
- The objective clarifies that the disclosure is to provide material information relevant to an assessment of the financial condition and results of operations of the registrant, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources. The disclosure is expected to better allow investors to view the registrant from management’s perspective.
Amend current Item 303(a)(1) and (2) (amended Item 303(b)(1)) to enhance disclosure requirements for liquidity and capital resources.
- The amended rules elicit enhanced analysis, by encouraging registrants to provide a more meaningful discussion of the reasons underlying material changes in line items (and discouraging registrants from simply reciting amounts of changes).
- Registrants will need to provide material cash requirements, including commitments for capital expenditures, as of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements, and the general purpose of such requirements.
Amend current Item 303(a)(3) (amended Item 303(b)(2)) to simplify disclosure requirements for results of operations.
- Registrants will need to disclose known events that are reasonably likely to cause a material change in the relationship between costs and revenues, such as known or reasonably likely future increases in costs of labor or materials or price increases or inventory adjustments.
- Registrants will also need to discuss material changes in net sales or revenue (as opposed to just material increases).
- Although the specific disclosure requirement with respect to the impact of inflation and price changes (Item 303(a)(3)(iv)) will be eliminated, registrants will still be required to discuss these topics if they are part of a known trend or uncertainty that had, or is reasonably likely to have, a material impact on net sales, revenue, or income from continuing operations.
Add a new Item 303(b)(3) to clarify and codify SEC guidance on critical accounting estimates.
- Registrants will also be required to disclose, to the extent that the information is material and reasonably available, how much an estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.
Replace current Item 303(a)(4) regarding off-balance sheet arrangements with an instruction to discuss such obligations in the broader context of MD&A.
- Registrants will be required to discuss commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons that have, or are reasonably likely to have, a material current or future effect on the registrant’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements, or capital resources even when the arrangement results in no obligation being reported in the registrant’s consolidated balance sheets.
Eliminate current Item 303(a)(5) regarding tabular disclosure of contractual obligations.
- Registrants must still disclose material contractual obligations as part of an enhanced principles-based liquidity and capital resources requirement focused on material short- and long-term cash requirements from known contractual and other obligations.
Amend Instruction 4 to Item 303(a) (amended Item 303(b)) to clarify disclosure of material changes in line items.
- Where there are material changes in a line item, including where material changes within a line item offset one another, registrants must disclose the underlying reasons for these material changes in quantitative and qualitative terms.
Amend current Item 303(b) (amended Item 303(c)) to allow for flexibility in the comparison of interim periods.
- Registrants will be permitted to compare their most recently completed quarter to either the corresponding quarter of the prior year or to the immediately preceding quarter to provide a more tailored and meaningful analysis that is relevant to their specific business cycles.

What’s Next?

The final rules will become effective 30 days after they are published in the Federal Register, and registrants will be required to comply with the rules beginning with the first fiscal year ending on or after the date that is 210 days after such publication date. Following the effective date, however, registrants may provide disclosure consistent with the final amendments, as long as registrants provide disclosure responsive to an amended item in its entirety. For example, following the effective date, a registrant with a calendar year-end may omit disclosure to comply with Item 301 in its Annual Report on Form 10-K to be filed in early 2021, and may provide disclosure to comply with amended Item 303 in such report, if the registrant provides disclosure pursuant to each provision of amended Item 303 in its entirety in such report.

¹ See “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” SEC Release No. 33-10890 (Nov. 19, 2020), available here.

ARTICLE BY Sudhir N. Shenoy and Thomas S. Walker of Womble Bond Dickinson (US) LLP

OCIE Director Instructs Advisers to Empower Chief Compliance Officers

On November 19, 2020, Peter Driscoll, director of the Office of Compliance Inspection and Examination (“OCIE”) of the Securities and Exchange Commission (“SEC”), gave a speech urging advisory firms to empower their Chief Compliance Officers (“CCOs”). The speech, made at the SEC’s annual compliance outreach conference, accompanied OCIE’s Risk Alert, issued the same day, identifying notable deficiencies and weaknesses regarding Registered Investment Advisors (“RIAs”) CCOs and compliance departments. Driscoll’s speech complemented the Risk Alert by outlining the fundamental requirements for CCOs: “empowered, senior and with authority.”

Under Rule 206(4)-7 promulgated under the Investment Advisers Act of 1940, 17 C.F.R. § 270.38a-1 (the “Compliance Rule”), an RIA must adopt and implement written policies and procedures reasonably designed to prevent violation of the Advisers Act and the rules thereunder. According to Driscoll, this cannot be done unless the RIA’s CCO is empowered to fully administer the firm’s policies and procedures and holds a position of sufficient seniority and authority to compel others to comply with those policies and procedures. In its Risk Alert, OCIE identified common compliance deficiencies among RIAs directly stemming from an unempowered CCO, including a lack of sufficient human resources to implement policies and procedures, failure of executive management to support the CCO, and even firing the CCO for reporting suspicious behavior. In order to address and prevent these deficiencies, Driscoll described a set baseline expectations regulators should look for, and which firms can adopt, in assessing the power and authority of the CCO and compliance function.

Compliance Resources: RIAs should continually reassess their budgetary needs based on their business model, size, sophistication, adviser representative population and dispersal, and provide for sufficient resources as necessary for compliance with applicable laws. This may mean hiring additional compliance staff and upgrading information technology infrastructure, especially if the firm has grown or taken on a new business. Compliance staff should be trained, at a minimum, to perform annual reviews, accurately complete and file advisor registration forms (Form ADV), and timely respond to OCIE requests for required books and records.
Responsibility of CCOs: While CCOs may have multiple responsibilities, they must be, at a minimum, knowledgeable of the Advisers Act and its mandates in order to fulfill their responsibilities as CCO. CCOs should not only assist firms from avoiding compliance failures, but should also provide guidance on new or amended rules.
Authority of CCOs: Senior management should vest CCOs with ample authority and routinely interact with them. CCOs need to understand their firm’s business and, when necessary, be brought into the business decision-making process. CCOs should also have access to critical operational information such as trading exception reports and investment advisory agreements with key clients. CCOs should be consulted on all matters with potential compliance implications, such as disclosures of conflicts to clients, calculation of fees, and client asset protection.
Position of CCOs: At a minimum, CCOs should report directly to senior management, and preferably be a part of senior management. CCOs should not be mid-level officers or placed under the Chief Financial Officer function.
Security of CCOs: CCOs should have confidence that they can raise compliance issues with the backing and support of senior management without being scapegoated or terminated.

These expectations should not be read as an exhaustive checklist but as a preliminary framework for evaluating the effectiveness of a firm’s compliance function and its CCO – key elements of a firm’s ability to comply with the mandates of the Compliance Rule. This framework can be also be used to ensure the firm’s compliance function is appropriately tailored to its size, business model, and compliance culture.

ARTICLE BY Bochan Kim and Sarah E. Aberg of Sheppard, Mullin, Richter & Hampton LLP

For Title IX and Athletics Professionals in Higher Education, One Less Moving Part

Year after year, the issue of sexual misconduct in violation of Title IX on college campuses continues to confront higher education leaders. The topic is one on which innumerable individuals and special interest groups have strong opinions and agendas. Athletics, commonly called the “front porch” to universities, can often be at the center of the Title IX storm. Among other high-profile issues, there have been reports of college athletes transferring to other schools and returning to competition even after being expelled, convicted or otherwise disciplined for sexual misconduct.

In response, in April 2020, the National College Athletic Association (NCAA) expanded its sexual violence policy to require that all incoming, current and transfer college athletes disclose annually to their school whether they have been subject to an investigation, discipline through a Title IX proceeding, or a criminal conviction for sexual, interpersonal or other acts of violence. Failure to accurately and fully disclose, could result in penalties for the athlete, including a loss of athletics eligibility.

It was recently reported that in October 2020 the NCAA quietly made the controversial decision to delay implementation of this policy until the 2022-2023 academic year.

This means that, until the fall of 2022, athletes might not face penalties if they do not disclose past accusations or discipline, and schools will not be required to create processes to track such misconduct. The NCAA stated that the decision to delay implementation was based on challenges related to the pandemic and the new Title IX federal regulations that went into effect in August 2020. Layered on top of these justifications is the speculation that President-elect Biden may at some point roll back or amend the new regulations. Advocates for victims of campus assault have reacted to the NCAA decision with disappointment.

Though all of this, institutions of higher learning must remain steadfast in their concurrent commitments to both an environment free from sexual misconduct, and equitable, reliable processes for all. While patience can be difficult, there is undoubtedly wisdom in allowing time to build a good process that fulfills these mutually beneficial commitments. Colleges and universities are well advised to use the time to develop robust and equitable processes surrounding the reporting of misconduct.

ARTICLE BY Pamela Wilkins Connelly of Strassburger McKenna Gutnick & Gefsky

The National Law Forum

Are Diversity Riders Legal?

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CFTC Whistleblower Program Helping to Drive Record-Level Enforcement Activity

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President Trump issues Executive Order adopting Most Favored Nation Approach

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