The National Law Forum

Dispute Resolution Provisions that Dissuade Intransigent Debtors and Empower Creditors

The Wall Street Journal published a riveting story last fall with tales of 007-like investigators chasing a debtor down in a London restaurant in order to collect a judgment that the derelict award-debtor was evading.^[1] “Success” equated to the eventual “voluntary” payment of approximately $30 million on a judgment valued, with interest, at roughly $38 million. “Success” also came at the cost of approximately $10 million in surveillance and other collection-related expenses, and the further payment to the financing firm that funded the efforts of an estimated $12 million. In other words, lost among the sensational details was that the cost of enforcing a money judgment or arbitration award can be quite high, and “success” may mean the creditor recovers only a small percentage of the judgment or award (in the reported case, about 25%).

For most dispute resolution specialists, it is satisfying that the Wall Street Journal focused on the enforcement stage of the dispute resolution process. Too little attention is paid to enforcement risk, both at the time of contracting and at the time a dispute arises. “Enforcement risk” is distinct from “credit risk”— that is, the risk that a contractual counterparty may prove financially incapable of paying obligations. Enforcement risk contemplates that a financially-capable counterparty will refuse to meet its obligations and, through structuring of assets or other means, attempt to evade recovery or make it so difficult that the creditor is willing to accept less than the full amount owed. Enforcement risk is often an issue in international transactions with counterparties based in countries with unfamiliar or opaque legal systems. But enforcement risk can also arise in other circumstances; for example, in transactions involving counterparties that have complex, multi-jurisdictional operating structures capable of concealing assets. The Panama Papers and the Paradise Papers scandals arising out of the hacking of Panamanian and Bermudan law firms revealed just how common this is.

This article reviews contractual strategies that can help mitigate enforcement risk, either by arming creditors with tools to aid in enforcement of judgments or arbitral awards, or by increasing the costs to a debtor of resisting enforcement. Each international negotiation is different, and not all of the provisions discussed will be appropriate in every international commercial agreement. But provisions like those reviewed provide opportunities to limit the risk that either party refuses to honor the result produced by an agreed process for resolving disputes.^[2]

1. Choose Arbitration Over Litigation

A first relevant decision is whether to choose arbitration or a national court system for resolving disputes. In international contracts between sophisticated actors, arbitration can provide a clear advantage because arbitration awards generally can be enforced across national borders more easily than national court judgments. A multilateral treaty — the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards — establishes a streamlined process for recognizing and enforcing arbitration awards. As of August 1, 2017, the New York Convention is in force in 155 countries around the world. No similar multilateral convention establishes a procedure for one nation to enforce judgments of the courts of so many other nations.

Notwithstanding the New York Convention, collection of arbitration awards can still be challenging and expensive, particularly when awards are made against entities (or sovereigns) whose assets are concentrated in jurisdiction(s) that either are not a signatory to the New York Convention or have a tendency to apply the New York Convention’s procedures restrictively.^[3] Nonetheless, from an enforcement perspective, it is almost always easier to enforce an international arbitration award across international borders than it is to enforce a national court judgment.^[4]

2. Require Award Debtors to Fund the Costs of Enforcement

Any time a debtor refuses to pay a debt voluntarily, the creditor incurs costs to collect the debt. Even enforcement of an arbitration award in a New York Convention country requires a legal proceeding, which means legal fees and related costs. In many countries, those fees and costs are not recoverable unless the contract specifically empowers a court to award them. For example, U.S. courts have consistently held themselves powerless to award attorneys’ fees and costs in connection with successful applications to confirm and enforce an arbitration award unless a statute or contract authorizes the court to award fees to the prevailing party.^[5] The U.S. Federal Arbitration Act does not provide for award of attorneys’ fees, leaving most U.S. courts to search the parties’ contracts for any authority to award fees.

In light of this common standard, parties should consider contractual provisions making recalcitrant debtors responsible for the costs and fees associated with enforcement activities. Authority to award fees in a confirmation action can be made expressly in a contract through a provision directed specifically at the issue, for example:

Should either party need to pursue or defend judicial proceedings in relation to an arbitration award made pursuant to this Agreement, the party prevailing in such judicial proceedings shall recover all of its reasonable attorneys’ fees and costs, and a court shall order such payment pursuant to this provision.

Although more risky, a party may prefer to address the issue more subtly. For example, a U.S. court held last year that it had authority to award attorneys’ fees in a confirmation action where the parties had agreed that “[i]n the event of any legal dispute … relating to the Agreement, including arbitration, … the most prevailing party … shall be entitled to all costs and legal expenses including … attorney fees [and] court costs.” CPR Telecom Corp. v. Bullseye Telecom, Inc., No. 16-CV-10214, 2017 WL 106429, at *4 (E.D. Mich. Jan. 11, 2017). Key to the Court’s analysis was that the fee shifting clause was not limited to arbitration, and instead applied broadly to “any legal dispute . . . including arbitration.”

While there may be other strategies for pursuing attorneys’ fees based on statute^[6] or on a breach of the underlying agreement,^[7] addressing attorneys’ fees needed for enforcement in the contract is a safe way to disincentivize resistance to an award, or at least to mitigate the consequences of that resistance. Indeed, absent a fee-shifting provision, the only cost for a debtor to pursue judicial challenges to an arbitration award or judicial judgment may be the legal fees of the debtor. Requiring the debtor to fund not only its own expenses, but also the costs and fees of the creditor, fundamentally changes the value of frivolous judicial challenges.

3. Provide for Waiver of Appeal/Challenge Rights

One aspect of arbitration cherished by many of its adherents is the limited nature of judicial review of arbitration awards once they are issued. As noted above, the New York Convention provides only narrow categories of judicial review of arbitration awards. The Convention does not permit a national court to sit as a traditional appeals court with power to revisit the underlying dispute. It is worth noting, however, that some national arbitration laws, such as the English Arbitration Act, provide for the possibility of more substantive review of certain legal issues.

Even though judicial review under the New York Convention is narrow, the presence of any judicial review of an arbitration award creates opportunity for creative lawyering and increased costs of enforcement (particularly in the absence of a fee-shifting provision like the one described in the previous section).^[8] One way to limit the power of parties seeking to obstruct the enforcement of an arbitral award is thus to limit their ability to seek judicial review even more than the New York Convention and national arbitration laws might otherwise permit. For example, parties might include a provision stating:

Any award made pursuant to this Agreement shall be binding and may be entered as a final judgment in any court having jurisdiction. The parties agree that the award shall not be reviewable or appealable in any court of law, and expressly waive any right to seek judicial review or appeal from the award.

The legal effect of such a clause may vary from jurisdiction to jurisdiction. In the United States, for example, some courts have held that since arbitration is a creature of contract, a clear agreement to eliminate all judicial review of an arbitration award will be enforced.^[9] Other courts, however, have been reluctant to eliminate all form of judicial review, and have held that parties cannot waive the right to raise the narrow grounds for review set forth in the U.S. Federal Arbitration Act.^[10] Similarly, courts have interpreted agreements that an arbitration award would be “binding, final and non-appealable” as having no effect on parties’ ability to seek review based, for example, on an arbitrator’s bias.^[11]

In some jurisdictions that permit limited judicial review of the substance of arbitration awards, a specific waiver may be needed to limit judicial review that would otherwise be available as a matter of national law. For example, Sections 45 and 69 of the English Arbitration Act permit limited judicial review of questions of English law in arbitrations seated in England unless the parties have agreed to waive their rights to seek such review.^[12] Waiver can be accomplished either by express language such as, “The Parties hereby exclude the applicability of Sections 45 and 69 of the English Arbitration Act, 1996,” or by agreeing to arbitrate pursuant to arbitral institution rules that exclude judicial review, such as the rules of the London Court of International Arbitration or of the International Chamber of Commerce.^[13] Thus, depending on the seat of arbitration, parties may need to waive statutory substantive review in order to restrict challenges to the narrow grounds of review available under the New York Convention.

As a cautionary note, a clause waiving all judicial review of an arbitration award may in fact eliminate all judicial review, so be careful what you ask for. But depending on objectives, a properly drafted clause can reinforce the parties’ intent that judicial review not interfere unnecessarily with enforcement of an award, and will likely foreclose judicial review of the substance of an award.

4. Provide for High Post-Award Interest in the Arbitration Agreement

Arbitral tribunals traditionally have discretion — subject to a choice of law analysis — to award interest for the period between the point in time when a claim arises and award, as well as for the period from issuance of an award to payment of that award.[14] In the absence of contractual or statutory guidance, arbitrators can base rate and terms of interest on various factors. Many national legal systems have statutory interest rates applicable to judgments; these rates can, however, be quite low. As a general rule, those statutory rates are not mandatory or directly applicable to arbitral awards. Arbitral institution rules, meanwhile, do not address the interest rate applicable to awards.^[15]

Setting a high contractual rate of interest for unpaid arbitral awards is thus another way to encourage quick payment of awards, or at least to make delayed payment more palatable. Arbitrators will generally respect such expressions of intent, as do most national court systems.^[16] A simple clause along the following lines may be effective:

Any award issued under this Section XX shall be payable in full within thirty (30) business days of being made. The arbitral tribunal shall provide for interest at a rate of 12% per annum, compounded quarterly, for any portion of an award not paid within thirty (30) business days of being made until such award is paid in full. These interest terms shall survive conversion of the award into a national court judgment.

It is important to make clear in such a clause (i) whether interest is to be calculated on a simple or compound basis and (ii) that entry of a judgment on the award shall not displace the contractual interest terms. The second point is important to avoid the risk that in jurisdictions where confirmation of an arbitration award merges the award into a local court judgement, local statutory interest rates applicable to judgments do not apply.^[17]

Securing a high interest rate may fundamentally change a creditor’s approach to enforcement of awards against creditworthy debtors. Indeed, most counterparties involved in international commerce of the sort that leads to international disputes will have, or will eventually have, assets located in jurisdictions that permit attachment. A high rate of interest allows the creditor to be patient in pursuing such claims.

5. Require Award Debtors Seeking to Resist Enforcement to Bond the Award

Another way to protect against enforcement risk is to require a party who wishes to challenge an award to post a bond guaranteeing payment of the award if the challenge is not successful. In the United States and some other jurisdictions, appellants may be required to post a bond in order to prevent enforcement of a judgment pending appeal.^[18]This approach has the effect of protecting a creditor from dissipation by the debtor of assets pending appeal, or unwillingness of the debtor to abide by an appellate decision with which it disagrees. The clause contemplated here advances those same goals, but even more stringently, effectively requiring a bond to pursue a judicial challenge to an arbitral award:

If a party asserts that an award made under this Section XX is not enforceable against it for any reason (in any jurisdiction), that party shall only be permitted to present such argument after posting security in the form of a bond, letter of credit or bank guarantee for the full amount of the award plus one year of interest on the award. The parties hereby waive any right or ability they may have to challenge or otherwise resist enforcement of an award without posting security as provided by this Section, it being the intent of the parties that no court will entertain any challenge to the validity or enforceability of an award made under this Section XX in the absence of such security.

In circumstances where a debtor lacks resources to post a bond prior to challenging an award, this type of clause would deprive the debtor of the ability to challenge an award. But in the context on which this article focuses – international agreements among sophisticated parties – it would be difficult to assert that such a clause should not be enforced because it is unfair. In any event, if the effect of the clause is to prevent a party from pursuing an otherwise valid challenge, then courts may have ways to limit enforcement of the clause.^[19] In most cases, however, the clause would raise the stakes for a party seeking to challenge an award, and force that party to abide by the result.

Conclusion

No combination of provisions can ensure that an intransigent award debtor will voluntarily meet its obligations. But there are tools available that can reduce the power of intransigent debtors to make mischief. Provisions like those described above that impose costs on those who seek to avoid their debts without legal basis are some of these tools. Incorporating these types of provisions at the contracting stage can make life as an award creditor much more cost-effective − and make 007-like tactics less likely − should enforcement become an issue.

_{[1] Jet-Set Debt Collectors Join a Lucrative Game: Hunting the Superrich, Margot Patrick, Wall Street Journal, November 7, 2017.}

_{[2] This article does not focus on credit risk and tools for protecting against it, such as letters of credit or parent guarantees. Such tools can be effective in protecting against both credit risk and enforcement risk. But they may not always be available, or may come at too high a commercial cost.}

_{[3] Various signatories to the New York Convention have developed reputations for being difficult environments in which to enforce arbitration awards against their own nationals. For example, national courts might have a tendency to apply broadly the public policy exception to enforcement of an award to bar enforcement of awards that are not consistent with national law. In this regard, it is important to look at the actual enforcement practices of a state, rather than accept its reputation (whether it is positive or negative).}

_{[4] In drafting an arbitration agreement, enforcement issues can bear on the choice of a seat for the arbitration, with some jurisdictions offering more robust tools for enforcement of arbitration awards than others. This article does not focus on drafting of the arbitration agreement, but drafters should consider enforcement related issues when selecting an arbitral seat.}

_{[5] See, e.g., Crossville Medical Oncology P.C. v. Glenwood Systems L.L.C., 610 Fed. Appx. 464, 468 (6th Cir. 2015); Menke v.}_Manchecourt_{, 17 F.3d 1007, 1009 (7th Cir. 1994); Schlobohm v. Pepperidge Farm, Inc., 806 F.2d 578, 581-82 (5th Cir. 1988).}

_{[6] Some commentators have suggested that it may be possible to base a claim for attorneys’ fees in a confirmation action on applicable state law in the United States.}

_{[7] Many arbitration agreements specifically provide that an award shall be paid within a certain period of time. Failure to make such payment would thus constitute an independent breach of the underlying agreement with the damages measured, perhaps in part, by the attorneys’ fees and other costs required to secure payment on the award. Of course, this type of proceeding would require a new arbitration and thus additional time and cost to pursue.}

_{[8] Although this discussion focuses on waiver of challenge rights to an arbitral award, it may also be possible to restrict appeal from trial verdicts in commercial contract matters. Analyzing the enforceability of such waivers in the trial context is beyond the scope of this article.}

_{[9] See Aerojet-General Corp. v. Am. Arbitration Ass’n, 478 F.2d 248, 251 (9th Cir. 1973); Kim-C1, LLC v. Valent Biosciences Corp., 756 F. Supp. 2d 1258 (E.D. Cal. 2010).}

_{[10] See Hoeft v. MVL Group, Inc., 343 F.3d 57, 63 (2d Cir. 2003).}

_{[11] See Rollins Inc. v. Black, 167 Fed. App’x 798, 799 (11th Cir. 2006).}

_{[12] Section 45 concerns applications made during the arbitration proceedings, while section 69 concerns applications made after an award has been rendered.}

_{[13] English courts have consistently held that incorporation of such arbitral rules waives rights sections 45 and 69. See Lesotho Highlands Development Authority v. Impregilo SpA [2006] 1 AC 221; Arab African Energy Corporation Ltd v. Olieprodukten Nederland BV. [1983] 2 Lloyd’s Rep. 419; Marine Contractors, Inc. v. Shell Petroleum Development Co. of Nigeria Ltd., [1984] 2 Lloyd’s Rep. 77.}

_{[14] See Gary B. Born, International Commercial Arbitration, § 23.09 (2d ed. 2014).}

_{[15] While the LCIA rules do not provide a rate of interest, they expressly empower arbitrators to award compound interest unless the parties have agreed otherwise. See LCIA Rule 26(4).}

_{[16] In some cases, a national legal system may not permit award of interest at all, such as some Middle Eastern states that have commercial codes based on Shari’a law.}

_{[17] E. Sav. Bank, FSB v. McLaughlin, No. 13-CV-1108 NGG LB, 2014 WL 2440582, at *2 (E.D.N.Y. May 30, 2014) (applying New York law to hold that “where there is a clear, unambiguous, and unequivocal expression to pay an interest rate higher than the statutory interest rate until the judgment is satisfied, the contractual interest rate is the proper rate to be applied.”); see also NML Capital v. Republic of Argentina, 17 N.Y.3d 250, 928 N.Y.S.2d 666, 952 N.E.2d 482, 489 (N.Y.2011) (“[I]nclusion of a clause directing that interest accrues at a particular rate ‘until the principal is paid’ (or words to that effect) alters the general rule that interest on principal is calculated pursuant to New York’s statutory interest rate after the loan matures or the debtor defaults.”)}

_{[18] See, e.g., Fed R. Civ. Proc. 62.}

_{[19] See also, infra, at n. 10. Authorities that hold the limited grounds for judicial review set forth in the New York Convention are mandatory could also suggest that a bond requirement like the one contemplated should not restrict assertion of potentially valid New York Convention defenses.}

This article was written by Ryan E. Bull of Baker Botts LLP

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Sessions, Oprah, Obama but not the Russians in Trump’s On-Going Twitter War

On February 20, 2018, DNC deputy communications director Adrienne Watson responded to a recent series of tweets by President Trump. Last week’s Russian election meddling indictments renewed the debate about whether Obama did enough to counter Russian interference when he was in office.

After continued criticism about how he is handling Russia’s meddling in the 2016 Election, President Trump took to Twitter. Watson details Trump’s tweets from his attacks on Oprah, down to the Pennsylvania redistricting map. Trump’s tweets from last week and even today, included no mention of prevention of future Russian attacks on US elections, he did not condemn the Kremlin’s attack of the 2016-Presidential and he adamantly denies that the Mueller investigation will or has uncovered any unsavory connections between him and the Russians.

Why Doesn’t Sessions Go After Obama for the Russian Meddling?

On February 21^st Trump lashed out at Attorney General Jeff Sessions, asking why he isn’t investigating the Obama-administration for being weak in the face of Russian aggression.

Pressuring Sessions to investigate Obama’s knowledge of Russian involvement is somewhat awkward because Session’s involvement with Russian government officials was investigated by the Department of Justice in March 2017. Sessions stated during his confirmation hearing in January 2017, that he “did not have communications with the Russians.” It was later determined by the Justice Department that he met with Russian ambassador, Sergey I. Kislyak twice in the preceding 12 months.

Sessions clarified the apparent disharmony between his sworn confirmation testimony and the two meetings with the Russian ambassador by stating that he “never met with any Russian officials to discuss issues of the campaign.”

The President seemed to forget that Sessions recused himself from the Russian investigation in June 2017. “I recused myself not because of any asserted wrongdoing on my part during the campaign,” Sessions stated. “But because a Department of Justice regulation, 28 CFR 45.2, required it.”

What did the Obama Administration Know and When?

From the Mueller indictment, we now know that in 2015 the Russians purchased advertisements on social-media sites designed to influence public opinion, but it remains unclear whether the F.B.I. or any other intelligence agencies were aware of the purchases and other election interferences in real time.

By the summer of 2016, U.S. intelligence agencies had collected a “critical mass” of data about Russian efforts to intervene in the election. This prompted John Brennan, the then director of the C.I.A., to brief Obama and other top advisers in August about the threat. But President Obama and his advisors didn’t learn of the extent of the Russian inference, including the use of fake personas online, or that the Russians were exploiting Facebook and other social-media sites until after the 2016 elections former administration officials said. “We knew some things, but didn’t have all the pieces,” a senior official said, referring to Obama’s final weeks in office.

Who is Tougher on Russia? It Depends on Who You Ask.

From the beginning, President Trump has vehemently denied that his campaign and administration had any knowledge of Russian meddling in the election. As detailed in his tweets, he also continues to state that the current administration has been “tougher on Russia than Obama.”

Although the President claims the Obama administration didn’t take proper actions against Russia, Obama did make strides towards imposing sanctions against Russia, with a major retaliatory measures coming after the 2016 Election, when the Obama Administration expelled 35 Russian diplomats accused of interfering with the Presidential Election, sanctioning three companies and also closing two Russian diplomatic offices in the United States.

Trump has yet to impose sanctions against the Russians, after the overwhelming passage of the Countering America’s Adversaries Through Sanctions Act by Congress last year. The sanctions were to take effect on January 29th. The law gives the administration the power to target powerful Russian elites and companies and countries that do business with blacklisted Russian military and intelligence entities. The administration also failed to meet a deadline to identify Russian entities and individuals which would be added to a sanctions list. Instead, the Administration published a list of 96 known prominent Russian Oligarchs, as noted on Twitter by Tom ParfittMoscow Correspondent at The London Times.

Treasury Secretary Steven Mnuchin said February 14 that the Trump administration is “actively working” on imposing sanctions on Russia over its interference in the 2016 US election. And on February 20^th, White House Press Secretary Sarah Sanders stated that Donald Trump “has done a number of things to put pressure on Russia and be tough on Russia.” We’ll have to see what’s coming and maybe we’ll find out exactly what Trump has done to put pressure on Russia, monitor Twitter.

This post was written by Alessandra de Faria and Jennifer Schaller of the National Law Forum.

Read more coverage of Trump’s tweets and other political news at the Election page of the National Law Review.

Army Corps of Engineers Issues Draft Guidance on Section 408 Permission Requests, Solicits Comments

On January 23, 2018, the United States Army Corps of Engineers (Corps) issued Draft Engineering Circular (EC) 1165-2-220, Policy and Procedural Guidance for Processing Requests to Alter U.S. Army Corps of Engineers Civil Works Projects Pursuant to 33 U.S.C. § 408 (Draft EC). Comments on the draft circular are due March 7^th, but there are reports that the comment deadline may be extended to April 6^th.

The Draft EC, once finalized, will replace existing guidance on the permission process required by Section 14 of the Rivers and Harbors Act of 1899, as amended and codified in 33 U.S.C. § 408 (Section 408). The Draft EC consolidates existing guidance on Section 408 permissions and makes numerous changes to the existing guidance, including revising the test for when a Section 408 permission will be required, announcing general terms and standards that will be applied to all Section 408 permissions, and prescribing new timeframes for the Section 408 review process. The comment period provides an opportunity for entities that need Section 408 permissions to address specific concerns with the Section 408 process and to advise the Corps on how to better streamline the Section 408 process.

Background

Section 408 requires that any proposed occupation or use of an existing Corps civil works project be authorized by the Secretary of the Army. Examples of civil works projects include levees, dams, sea walls, bulkheads, jetties, dikes, wharfs, piers, and wetland restoration projects funded by or built by the Corps. The Corps may grant such permission if it determines the alteration proposed will not be “injurious to the public interest” and “will not impair the usefulness” of the civil works project. Under Corps policy, a Section 408 permission will not be issued before decisions on Clean Water Act Section 404 permits and Rivers and Harbors Act Section 10 permits are made.

Section 408 review may be required in a wide variety of situations. For example, a Section 408 permission was required for the Dakota Access Pipeline, a crude oil pipeline, to cross 2.83 miles of federal flowage easements and approximately 0.21 miles of federally-owned property. In addition, Section 408 review may be required where the Corps’ only connection to the project is funding, such as a wetland restoration project.

Section 408 permissions have become a significant issue in recent years because they have the potential to significantly delay projects. The Corps has limited capacity to review Section 408 permission requests because such requests are not handled by the Corps’ regulatory program. In the event that a Section 408 permission is required, the Corps may not have the staff resources to review the request unless the applicant pays for such a review. Under the authority of Section 214 of the Water Resources and Development Act (WRDA) of 2000, the Corps may accept funds from non-Federal public entities to expedite the review and evaluation of a Section 408 request. Under the 2016 WRDA, funding privileges were extended to certain private entities. It should be noted that the recent Presidential “infrastructure legislative outline” that was released on January 12, 2018 along with the President’s budget would allow any non-federal entity to pay for expedited review and evaluation of a Section 408 request.

The Corps previously issued EC 1165-2-216 in 2014 on Section 408 permissions and since that time has issued a number of interim memoranda to improve the Section 408 permission process. The Draft EC, once finalized, will replace EC 1165-2-216 as well as all interim memoranda, and will be effective for two years.

Proposed Changes to Section 408 Permission Process

Key changes proposed under the Draft EC include the following:

Program Governance Changes. The Draft EC updates the Section 408 program governance. It commits the Corps to conduct an internal audit of its decisions to examine whether Section 408 is being implemented consistently. It provides for the creation of a database, which will be partially available to the public, as a tool for requestors to be informed about the status of their requests.

Section 408 Applicability Changes. The Draft EC clarifies the geographical limitations on the applicability of the Section 408 permission process. The Section 408 process applies to the lands and real property interests identified and acquired for a Corps project. The Draft EC clarifies that, within navigable waters, the Section 408 process applies to alterations proposed to submerged lands and waters occupied or used by a Corps project. The Draft EC process may be applied to alterations proposed in the vicinity of a Corps project that occur on or in submerged lands and waters that are subject to the navigation servitude.

The Draft EC clarifies how emergency situations should be addressed under Section 408. Emergency alterations performed on a Corps project pursuant to Public Law (PL) 84-99 do not require a Section 408 permission, but urgent alterations that do not fit within the definition of emergency under PL 84-99 may require a Section 408 permission. PL 84-99 authorizes the Corps to undertake activities, including disaster preparedness, “advance measures” to prevent or reduce flood damage from imminent threat of unusual flooding, emergency operations, rehabilitation of flood control works threatened or destroyed by flood, protection or repair of federally authorized shore protective works threatened or damaged by coastal storm, and provisions of emergency water due to drought or contaminated source. The Draft EC indicates that when an alteration cannot be performed pursuant to PL 84-99, Corps districts can reprioritize and expedite reviews as appropriate given the urgency required for each specific situation.

The Draft EC identifies certain activities that will not require a Section 408 permission. As under the existing guidance, non-federal sponsor activities that are included in an operation and maintenance (O&M) manual for the project do not require Section 408 permission. The Draft EC also provides that a Section 408 permission is not required if a non-federal sponsor is performing activities on a Corps project that restores such project to the physical dimensions and design of the constructed project. Although a Section 408 permission will not be required, the project sponsor may still need to coordinate with the Corps. In addition, under the Draft EC, a Section 408 permission is not required for geotechnical explorations that comply with the Corps’ drilling requirements.

The Draft EC recognizes that the requirements of Section 408 may be fulfilled by another process. For example, where a project requires a real estate outgrant—an authorization of the use of real property managed by the Corps—or a Rivers and Harbors Act of 1899 Section 10 permit that covers the same scope and jurisdiction as a Section 408 permission, a separate Section 408 permission is not required. What is not addressed in the Draft EC is whether a Section 408 permission will be required to conduct O&M on a non-Corps project for which a Section 10 was previously issued.

Procedural Changes. The Draft EC identifies new procedures for seeking a Section 408 permission. Under the existing guidance, there are two options for review under Section 408—a single-phase review and a categorical review. In a single-phase review, all information for a Section 408 permission is submitted at the same time. In a categorical review, the Corps performs an analysis of impacts and environmental compliance in advance for a common category of activities. When a Section 408 permission request meets the criteria of the categorical permission, the Section 408 permission may be granted under a simplified validation process. To add flexibility, particularly for projects that involve multiple stages of engineering or construction, the new guidance allows for a multi-phased review. The Draft EC also removes the requirement that plans and specifications be, at a minimum, 60% complete to initiate the Section 408 review process.

The Draft EC incorporates new timelines for a Section 408 review that are provided in the 2016 WRDA. When a Corps district receives a Section 408 request, the district must respond within 30 days, informing the requestor that the submission was complete or specifying what additional information is required. The Draft EC does not speak to the Corps’ failure to respond within 30 days. If a completeness determination is made, the Corps district has 90 days to render a decision. If the district cannot meet the 90 day timeline, it can provide an estimated date of a final decision. If that estimate extends beyond 120 days, the Corps must provide congressional reporting.

Click here for a side-by-side chart comparing the Draft EC to the legislative provision on Section 408 developed by our firm’s Corps Reform Working Group and the legislative provisions on Section 408 that are contained in the President’s “infrastructure legislative outline”.

This post was written by Jenna R. Mandell-Rice and Brent Carson of Van Ness Feldman LLP.

SEC Issues Updated Disclosure Guidance on Cybersecurity

On February 21, 2018, the U.S. Securities and Exchange Commission (“SEC”) issued updated interpretative guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. The updated guidance reinforces and expands upon the prior guidance on cybersecurity disclosures issued by the SEC’s Division of Corporation Finance in October 2011. In addition to highlighting the disclosure requirements under the federal securities laws that public companies must pay particular attention to when considering their disclosure obligations with respect to cybersecurity risks and incidents, the updated guidance (1) emphasizes the importance of maintaining comprehensive policies and procedures related to cybersecurity risks and incidents, and (2) discusses the application of insider trading prohibitions and Regulation FD and selective disclosure prohibitions in the cybersecurity context. The guidance specifically notes that the SEC continues to monitor cybersecurity disclosures carefully through its filing review process.

Cybersecurity-Related Disclosures

Timely Disclosure of Material Nonpublic Information

In determining disclosure obligations regarding cybersecurity risks and incidents, companies should analyze the potential materiality of any identified risk and, in the case of incidents, the importance of any compromised information and the impact of the incident on the company’s operations. When assessing the materiality of cybersecurity risks or incidents, the SEC notes that the following factors, among others, should be considered:

Nature, extent, and potential magnitude (particularly as it relates to any compromised information or the business and scope of company operations), and
Range of possible harm, including harm to the company’s reputation, financial performance, customer and vendor relationships, and possible litigation or regulatory investigations (both foreign and domestic).

When companies become aware of a cybersecurity incident or risk that would be material to investors, the SEC expects companies to disclose such information in a timely manner and sufficiently prior to the offer and sale of securities. In addition, steps should be taken to prevent directors and officers (and other corporate insiders aware of such information) from trading in the company’s securities until investors have been appropriately informed about the incident or risk. Importantly, the SEC states that an ongoing internal or external investigation regarding a cybersecurity incident “would not on its own provide a basis for avoiding disclosure of a material cybersecurity incident.”

Risk Factors

In evaluating cybersecurity risk factor disclosure, the guidance encourages companies to consider the following:

the occurrence of prior cybersecurity incidents, including severity and frequency;
the probability of the occurrence and potential magnitude of cybersecurity incidents;
the adequacy of preventative actions taken to reduce cybersecurity risks and the associated costs, including, if appropriate, discussing the limits of the company’s ability to prevent or mitigate certain cybersecurity risks;
the aspects of the company’s business and operations that give rise to material cybersecurity risks and the potential costs and consequences of such risks, including industry-specific risks and third party supplier and service provider risks;
the costs associated with maintaining cybersecurity protections, including, if applicable, insurance coverage relating to cybersecurity incidents or payments to service providers;
the potential for reputational harm;
existing or pending laws and regulations that may affect the requirements to which companies are subject relating to cybersecurity and the associated costs to companies; and
litigation, regulatory investigation, and remediation costs associated with cybersecurity incidents.

The guidance also notes that effective communication of cybersecurity risks may require disclosure of previous or ongoing cybersecurity incidents, including incidents involving suppliers, customers, competitors and others.

MD&A of Financial Condition and Results of Operations

The guidance reminds companies that MD&A disclosure of cybersecurity matters may be necessary if the costs or other consequences associated with such matters represent a material event, trend or uncertainty that is reasonably likely to have a material effect on the company’s operations, liquidity or financial condition or would cause reported financial information not to be necessarily indicative of future results. Among other matters, the cost of ongoing cybersecurity efforts (including enhancements to existing efforts), the costs and other consequences of cybersecurity incidents, and the risks of potential cybersecurity incidents could inform a company’s MD&A analysis. In addition to the immediate costs incurred in connection with a cybersecurity incident, companies should also consider costs associated with:

loss of intellectual property;

implementing preventative measures;

maintaining insurance;

responding to litigation and regulatory investigations;

preparing for and complying with proposed or current legislation;

remediation efforts; and

addressing harm to reputation and the loss of competitive advantage.

The guidance further notes that the impact of cybersecurity incidents on each reportable segment should also be considered.

Business and Legal Proceedings

Companies are reminded that disclosure may be called for in the (1) Business section of a company’s SEC filings if cybersecurity incidents or risks materially affect a company’s products, services, relationships with customers or suppliers, or competitive conditions, and (2) Legal Proceedings section if a cybersecurity incident results in material litigation against the company.

Financial Statement Disclosures

The SEC expects that a company’s financial reporting and control systems would be designed to provide reasonable assurance that information about the range and magnitude of the financial impacts of a cybersecurity incident would be incorporated into its financial statements on a timely basis as the information becomes available. The guidance provides the following examples of ways that cybersecurity incidents and risks may impact a company’s financial statements:

expenses related to investigation, breach notification, remediation and litigation, including the costs of legal and other professional services;

loss of revenue, providing customers with incentives or a loss of customer relationship assets value;

claims related to warranties, breach of contract, product recall/replacement, indemnification of counterparties, and insurance premium increases; and

diminished future cash flows, impairment of intellectual, intangible or other assets; recognition of liabilities; or increased financing costs.

Board Risk Oversight

The securities laws require a company to disclose the extent of its board of directors’ role in the risk oversight of the company, including how the board administers its oversight function and the effect this has on the board’s leadership structure. To the extent cybersecurity risks are material to a company’s business, the disclosure should include the nature of the board’s role in overseeing management of that risk.

Cybersecurity-Related Policies and Procedures

Disclosure Controls and Procedures

The guidance encourages companies to adopt comprehensive policies and procedures related to cybersecurity and to regularly assess their compliance. Companies should evaluate whether they have sufficient disclosure controls and procedures in place to ensure that relevant information about cybersecurity risks and incidents is processed and reported to the appropriate personnel to enable senior management to make disclosure decisions and certifications and to facilitate policies and procedures designed to prohibit directors, officers, and other corporate insiders from trading on the basis of material nonpublic information about cybersecurity risks and incidents. Controls and procedures should enable companies to identify cybersecurity risks and incidents, assess and analyze their impact on a company’s business, evaluate the significance associated with such risks and incidents, provide for open communications between technical experts and disclosure advisors, and make timely disclosures regarding such risks and incidents.

The certifications and disclosures regarding the design and effectiveness of a company’s disclosure controls and procedures should take into account the adequacy of controls and procedures for identifying cybersecurity risks and incidents and for assessing and analyzing their impact. In addition, to the extent cybersecurity risks or incidents pose a risk to a company’s ability to record, process, summarize, and report information that is required to be disclosed in filings, management should consider whether there are deficiencies in disclosure controls and procedures that would render them ineffective.

Insider Trading

Companies and their directors, officers, and other corporate insiders should be mindful of compliance with insider trading laws in connection with information about cybersecurity risks and incidents, including vulnerabilities and breaches. The guidance urges companies to consider how their code of ethics and insider trading policies take into account and prevent trading on the basis of material nonpublic information related to cybersecurity risks and incidents. Specifically, the guidance suggests that as part of the overall investigation and assessment during significant cybersecurity incidents, companies should consider whether and when it may be appropriate to implement restrictions on insiders trading in their securities to avoid the appearance of improper trading during the period following a cybersecurity incident and prior to the dissemination of disclosure.

Regulation FD and Selective Disclosure

Companies are expected to have policies and procedures in place to ensure that any disclosures of material nonpublic information related to cybersecurity risks and incidents are not made selectively, and that any Regulation FD required public disclosure is made simultaneously (in the case of an intentional disclosure) or promptly (in the case of a non-intentional disclosure) and is otherwise compliant with the requirements of Regulation FD.

This post was written by Monique A. Cenac and Brett Beter of Jones Walker LLP.

Supreme Court Limits Scope of Dodd-Frank Whistleblower Protections

On February 21, the US Supreme Court decided Digital Realty Trust, Inc. v. Somers (583 U.S. ____ (2018)), which resolved a circuit split related to whether the anti-retaliation provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 124 Stat. 1376 (Dodd-Frank) extend to individuals who have not reported a securities law violation to the Securities and Exchange Commission and, therefore, falls outside of Dodd-Frank’s definition of a “whistleblower.”

Paul Somers alleged that Digital Realty Trust, Inc. (Digital Realty) terminated his employment shortly after reporting suspected securities-law violations to the company’s senior management. Somers filed a case in the US District Court for the Northern District of California (District Court) alleging that his termination amounted to whistleblower retaliation under Dodd-Frank. Digital Realty moved to dismiss the claim on the grounds that Somers did not qualify as a “whistleblower” for purposes of Dodd-Frank because (1) the statute defines a “whistleblower” as someone “who provides . . . information relating to a violation of the securities laws to the [SEC];” and (2) Somers failed to report the allegations to the SEC prior to his termination. The District Court denied Digital Realty’s motion and the Ninth Circuit affirmed on the grounds that Dodd-Frank’s whistleblower protections should be read to protect employees regardless of whether they provide information to the SEC.

Reversing the District Court and the Ninth Circuit, Justice Ruth Bader Ginsburg, writing for the Court, explained that Dodd-Frank’s whistleblower retaliation provisions do not extend to an individual who has not reported alleged securities law violations to the SEC. Citing Dodd-Frank’s definition of a “whistleblower,” the Court determined that the statute explicitly required an individual to report such violations to the SEC in order to receive whistleblower protections. The Court found this interpretation of the whistleblower definition to be corroborated by Dodd-Frank’s intended purpose of motivating individuals to report securities law violations directly to the SEC.

The text of the decision is available here.

This post was written by Richard D. Marshall and Stanley V. Polit of Katten Muchin Rosenman LLP.

Read more Litigation news on the National Law Review Litigation page.

Myths About Self-Consumption in MLMs

Recently, legislation has been introduced in Congress (the Blackburn-Veasey bill, H.R. 3409) that seeks to bring clarity and consistency to activities that distinguish illegal pyramids from legitimate multi-level marketing companies (“MLMs”). A select few interest groups and certain regulators, who project a bias against MLMs, have spoken out against this legislation by relying on a false legal premise.

The false legal premise: The opponents of the legislation, often non-lawyers, invariably make the bold assertion that for decades the courts have held that the critical difference between a legitimate MLM business and a pyramid scheme is that an MLM’s revenues must come primarily from the sale of products and services to retail customers unaffiliated with the business opportunity. This assertion misrepresents the law.

The recently issued FTC Business Guidance Concerning Multi-Level Marketing^[i] confirms the long-standing Koscot^[ii]legal standard that a company is an illegal pyramid where “the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users.”^[iii]

Critics of MLMs have argued that the italicized language means that the majority of an MLM’s revenue must come from product sales to persons who are not participants in the MLM. They call these “retail sales,” implying that a “retail sale” does not include a participant buying her vitamins from her MLM company instead of CVS. That is not what the Koscot opinion says.

Nor does the argument follow from the facts in Koscot. There, the FTC found that the company was an illegal pyramid because high recruitment fees provided the primary basis for participant compensation.^[iv] The case did not turn on participants’ self-consumption of a large portion of the company’s product sales. In fact, for over its first year of operation, the company had no products for its distributors to sell or consume.^[v]

Shortly after Koscot, the case law clearly debunked the notion that self-consumption is the litmus test for determining if an MLM is an illegal pyramid. After an exhaustive four-year investigation and extensive trial, the FTC ruled that Amway, the quintessential MLM, was not an illegal pyramid under the Koscot standard.^[vi] In doing so, the FTC acknowledged that a large portion of Amway’s products were “consumed by the distributors themselves rather than resold.”^[vii]

Did the FTC say that self-consumption by distributors were not sales to “ultimate users” as the term is used in Koscot? No. To the contrary, the FTC held that Amway was not an illegal pyramid even though its distributors self-consumed (that is, they were “ultimate users” of) a large portion of Amway’s product sales.

In re Amway is the seminal case for establishing that MLMs are not illegal pyramids where distributor compensation flows from product sales, including purchases by the distributors, that are not required as part of the cost to participate in the MLM. Critics of MLMs often ignore In re Amway, or try to brush it aside with irrelevant distinctions, because it refutes their narrative that a large portion of product sales must come from purchases by non-distributors.

The MLM critics also tend to ignore another critical point in In re Amway: “‘Pyramid’ sales plans involve compensation for recruiting regardless of consumer sales.In such schemes, participants receive rewards for recruiting in the form of ‘headhunting fees’ or commissions on mandatory inventory purchases by the recruits known as ‘inventory loading.’”^[viii]These are the outcome-determinative factors in subsequent cases where companies were adjudged to be illegal pyramids.Yet anti-MLM advocates conflate and confuse these factors with dicta that was not outcome determinative.

Omnitrition^[ix]is often misrepresented by those who would like to implicitly overrule In re Amway. In Omnitrition, to become a “Supervisor,” a distributor was required to purchase thousands of dollars of product each month with only limited ability to return the product for a refund. In other words, a large recruitment fee was disguised in the form of inventory loading.

The company defended itself by arguing it had written rules similar to those cited with approval in In re Amway. The 9th Circuit noted a critical distinction: Amway’s rules “served to encourage retail sales and prevent “inventory loading” by distributors.”^[x] Whereas, Omnitrition’s rules were weaker, and evidence was lacking that they actually worked. While Omnitrition contains dicta that suggests purchases by distributors for their own use should not be considered “retail sales” to “ultimate users,” the Court’s decision turned on the company’s failure to prevent inventory loading.

MLM critics often seize upon and distort the dicta in Omnitrition to assert that the case established a legal requirement that a majority of an MLM’s sales must come from non-participants. In fact, the 9th Circuit said no such thing. Nor did the Court overrule or criticize In re Amway, where distributor self-consumption constituted a large portion of the company’s sales. The Court repeatedly noted that in In re Amway the company actually “encouraged” retail sales.^[xi] The Court did not say that any particular amount of retail sales is required.

In the years following Omnitrition, repeated misrepresentations about the relevance of internal consumption by MLM participants led the FTC to issue an Advisory Opinion to clarify its position on the subject:

Much has been made of the personal, or internal, consumption issue in recent years. In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme.^[xii]

The FTC further explained that “a multi-level compensation system funded primarily by payments made for the right to participate in the venture is an illegal pyramid scheme.”^[xiii] This Advisory Opinion was consistent with decades of case law where the sine qua non of an illegal pyramid scheme is that a participant’s compensation comes primarily from consideration paid by new participants for the right to participate in the enterprise, whether that consideration comes directly from registration fees or disguised as inventory loading.

Unable to refute the FTC Advisory Opinion, some MLM critics try to summarily dismiss it as “poorly worded”, and maintain their legal fiction regarding self-consumption by mischaracterizing subsequent FTC actions, such as BurnLounge, Vemma, and Herbalife.^[xiv] In fact, none of those actions support the MLM critics’ errant notions about internal consumption and sales to non-participants.

Nowhere in BurnLounge did the 9^th Circuit say that a particular percentage of an MLM’s sales must be made to non-participants. In fact, the Court explicitly rejected the FTC’s argument that “internal sales to other [participants known as Moguls] cannot be sales to ultimate users consistent with Koscot.”^[xv] The Court also expressly noted that “when participants bought packages in part for internal consumption . . . , the participants were the ‘ultimate users’ of the merchandise.”^[xvi]

What made BurnLounge’s Mogul program illegal is that a participant’s compensation actually came from mandatory music package purchases that were tied to an enrollment fee and were non-refundable in practice. In other words, a participant’s compensation was dependent on the aggregate payments of new recruits to join the Mogul program. Again, the 9th Circuit distinguished Amway’s MLM business model as legal because it conditioned rewards on voluntary product sales (including internal consumption) and not for “the mere act of recruiting,” and Amway’s rules discouraged inventory loading.^[xvii]

Vemma also does not support the narrative of MLM critics. There, distributors were required to make large product purchases (a $600 initial purchase plus $150 per month); they were “very likely engaging in inventory loading”; and their bonuses were tied to purchases of products required to stay eligible for those bonuses.^[xviii] Those key findings convinced the court to issue a preliminary injunction. But, citing BurnLounge, the court also noted that self-consumption by distributors are sales to ultimate users and do not prove that an MLM is a pyramid scheme. As the 9th Circuit did in Omnitrition and BurnLounge, this court also distinguished Vemma from In re Amway because Amway enforced anti-inventory loading rules.^[xix]

Herbalife involves a recent settlement between Herbalife and the FTC. Any first year lawyer knows that a settlement agreement is not binding precedent on any other party. The FTC also made this point clear in its 2004 Advisory Letter, where it explained that its consent orders “often contain provisions that place extra constraints upon a wrongdoer that do not apply to the general public. These ‘fencing-in’ provisions only apply to the defendant signing the order and anyone with whom the defendant is acting in concert. They do not represent the general state of the law.”^[xx] The FTC reiterated the same point again in its recently issued Guidance.^[xxi]

Finally, the FTC’s new Guidance explicitly confirms that it is still correct “as stated in the 2004 ‘FTC Staff Advisory Opinion – Pyramid Scheme Analysis’ that ‘the amount of internal consumption does not determine whether the FTC will consider the MLM’s compensation structure unlawful.’”^[xxii]

The foregoing discussion demonstrates that MLM critics rely on and advocate a false legal premise. Decades of case law make it clear that internal consumption by MLM distributors constitutes sales to “ultimate users,” and is not a litmus test for an illegal pyramid. Other court decisions^[xxiii] and statute statutes^[xxiv], which the MLM critics typically ignore, reach the same conclusion.

The Blackburn-Veasey bill (H.R. 3409) is consistent with decades of precedent that distributors’ purchases for their own consumption is a legitimate sale to an ultimate user. The legislation also would provide new enforcement tools for the FTC to go after the type of inventory loading that was the crux of the pyramid findings in Omnitrition and Vemma. Nor does the legislation restrict the FTC from stopping the BurnLounge type of registration-payment-based compensation scheme. If the proposed legislation had been adopted prior to those cases, the ultimate decision in each case would not have changed.

What the proposed legislation would change is that, going forward, the federal courts would have a uniform legal standard for an illegal pyramid, and legitimate MLMs would not have to expend significant resources defending against lawsuits based on a false legal premise.

_{[i] Press Release, Fed. Trade Comm’n, FTC Staff Offers Business Guidance Concerning Multi-Level Marketing (Jan. 4, 2018),https://www.ftc.gov/news-events/press-releases/2018/01/ftc-staff-offers-….}

_{[ii] In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1975 FTC LEXIS 24 (1975).}

_{[iii] Id. at *166–67.}

_{[iv] Id. at *162–64.}

_{[v] Id. at *67–69.}

_{[vi] In re Amway Corp., 93 F.T.C. 618, 1979 FTC LEXIS 390 (1979).}

_{[vii] Id. at *95.}

_{[viii] Id. at *97–98 (emphasis added).}

_{[ix] See generally Webster v. Omnitrition Intern., Inc., 79 F.3d 776 (9th Cir. 1996).}

_{[x] Id. at 783 (emphasis added).}

_{[xi] Id. at 783–84 (emphasis added).}

_{[xii] See Letter of James A. Kohm, Acting Dir. of Mktg. Practices at the U.S. Fed. Trade Comm’n, to Neil H. Offen, President of the Direct Selling Ass’n 1 (Jan. 14, 2004), https://www.ftc.gov/system/files/documents/advisory_opinions/staff-advis….}

_[xiii] Id.

_{[xiv] FTC v. BurnLounge, Inc., 753 F.3d 878 (9th Cir. 2014); FTC v. Herbalife Int’l of Am., Inc., No. 2:16-cv-05217 (C.D. Cal. July 25, 2016); FTC v. Vemma Nutrition Co., 2015 U.S. Dist. LEXIS 179855 (D. Ariz. Sept. 18, 2015).}

_{[xv] BurnLounge, Inc., 753 F.3d at 887.}

_{[xvi] Id. at 887.}

_{[xvii] Id. at 886.}

_{[xviii] Vemma Nutrition Co., 2015 U.S. Dist. LEXIS 179855, at *11–13.}

_{[xix] Id. at *4–8, *26–28.}

_{[xx] Letter, supra note 13, at 3.}

_{[xxi] Press Release, supra note 2.}

_{[xxii] Id. The Guidance discusses other factors that it will consider in evaluating MLMs, such as consumer demand, which raise new issues beyond the scope of this article.}

_{[xxiii] See, e.g., Whole Living, Inc. v. Tolman, 344 F. Supp. 2d 739, 745–46 (D. Utah 2004) (“Defendants misread the relevant case law. A structure that allows commissions on downline purchases by other distributors does not, by itself, render a multi-level marketing scheme an illegal pyramid”); State ex rel. Miller v. Am. Prof’l Mktg., Inc., 382 N.W.2d 117, 120 (Iowa 1986) (“Although a supervisor or director obtains a commission by wholesaling to personal representatives and earns bonuses based on their output, these remunerations are directly related to products that are either consumed by the personal representatives or retailed to their customers.”).}

_{[xxiv] See, e.g., Ga. Code Ann. § 16-12-38(b)(2); Idaho Code Ann. § 183101(6); Ky. Rev. Stat. Ann. § 367.830(5); La. Rev. Stat. Ann. § 51:361(1)(a); Mont. Code Ann. § 30-10-324(1)(b)(ii); Neb. Rev. Stat. § 87-302(12); Okla. Stat. tit. 21, § 1072(1)(a); S.D. Codified Laws § 37-33-8; Bus. & Com. § 17.461(1); Utah Code Ann. § 76-6a-2(1)(b); Va. Code Ann. § 18.2-239(1); Wash. Rev. Code Ann. § 19.275.020(1).}

This article was written by James R. Sobieraj of Brinks, Gilson & Lione

The Trump Administration Proposes A Budget Increase To Fight Healthcare Fraud

The Trump administration proposed a budget increase of 19 million to aid in the fight against health care fraud. This showcases the continued (and heightened) importance of anti-fraud programs, especially compared to the suggested $18 billion in cuts to other health-care related programs. If approved by Congress, the budget increase will result in an increase in fraud and employee investigations, which in recent years, has shown a good return on investment for the Federal government.

The remaining funds will go to the Health Care Fraud and Abuse Control Program (HCFAC). This program manages all federal, state, and local law enforcement activities linked to health-care fraud and abuse. This additional funding will be split between the Centers for Medicare & Medicaid Services, the Department of Justice and the Health and Human Services Office of Inspector General.

The budget proposal included several recommendations to Congress to help reduce the threat of fraud:

Cutting Medicare and Medicaid costs.
Punishing doctors or physicians filing claims with inadequate documentation.
Expanding Medicare’s previous program to include more services that have high risk for health fraud.
Permitting Medicaid Fraud to receive equal funds to investigate fraud in home-health care settings.
Halting the coverage and reimbursement of drugs prescribed to high risk patients or given by doctors with a history of overprescribing.

At a minimum, the proposal shows the Federal government’s continued emphasis on the importance (both financially and otherwise) of fighting non-compliant conduct. Providers should increase their compliance program efforts and ensure their programs are effective to minimize their risk of running afoul of applicable rules and regulations.

This article was written by Rose Willis of Dickinson Wright PLLC

For more Health Care news, check out our Health Law Twitter @NatLawHealthLaw

Democratic lawmakers seek information about reorganization of CFPB Office of Fair Lending

A group of Democratic Senators and House members have sent a letter to Mick Mulvaney and Leandra English expressing concern about Mr. Mulvaney’s announcement that he plans to reorganize the CFPB’s Office of Fair Lending (OFLEO).

Earlier this month, Mr. Mulvaney announced that he plans to transfer the OFLEOfrom the Supervision, Enforcement, and Fair Lending Division (SEFL) to the Director’s Office, where it will become part of the Office of Equal Opportunity and Fairness (OEOF). At that time, Mr. Mulvaney stated that OFLEO “will continue to focus on advocacy, coordination, and education, while its current supervision and enforcement functions will remain in SEFL.” The OEOF oversees equal employment, diversity, and inclusion at the CFPB, and has no enforcement or supervisory role.

In their letter, the Democratic lawmakers expressed concern that the reorganization will frustrate the CFPB’s efforts to protect consumers from unfair, deceptive, or abusive acts and practices and from discrimination. They cited OFLEO’s role in “help[ing] design specialized oversight and support[ing] bank examiners in assuring that CFPB’s regulated institutions were complying with anti-discrimination laws” and in “work[ing] with the CFPB’s enforcement lawyers and the Department of Justice to bring lawsuits” when problems identified in examinations could not be resolved. They noted that OFLEO has “also counseled banks in their efforts to build good compliance systems” and comment that of the OFLEO’s functions to date, “only the counseling will be supplied after the reorganization, though in the absence of dedicated anti-discrimination enforcement, it’s not clear whether there will be continuing demand.”

The Democratic lawmakers seek written responses to the questions asked in their letter by March 1, 2018 as well as “a copy of all documents and communications relating to the decision to [reorganize the OFLEO].” Among the questions asked by the lawmakers are:

Whether the CFPB performed “a legal analysis to determine whether stripping the OFLEO of its enforcement authority would hinder the CFPB’s ability to carry out its statutory mandate to provide oversight and enforcement of federal fair lending laws
How transferring the OFLEO to the Director’s Office will “modify the Bureau’s decision-making process with regard to enforcement and other actions to protect consumers from unfair discrimination”
Whether Mr. Mulvaney or any other CFPB employee discussed the reorganization before it was announced “with any outside entities—including lobbyists or representatives of the banking or financial services industry”
Whether the CFPB is considering any substantive changes to its approach to the enforcement of fair lending laws, including changes to the CFPB’s interpretation of such laws

This article was written by Barbara S. Mishkin of Ballard Spahr LLP

For more information on the CFPB, check out our finance twitter @NatLawFinance

SEC Announces Share Class Selection Disclosure Initiative

On February 12, 2018, the SEC Division of Enforcement announced the Share Class Selection Disclosure Initiative self-reporting initiative (the SCSD Initiative). The SCSD Initiative is in response to numerous enforcement actions filed against investment advisers for disclosure failures relating to advisers’ selection of mutual fund share classes that paid the adviser, or its related entities or individuals, a 12b-1 fee when a lower-cost share class of the same fund was available to clients.

Pursuant to Section 206(2) of the Investment Advisers Act of 1940 (the Advisers Act), advisers are prohibited from engaging in any acts or practices that operate as a fraud upon any client or prospective client. In addition, Section 206(2) imposes a fiduciary duty on investment advisers to act for their clients’ benefit and to make full disclosure of all material facts, including conflicts of interest. Furthermore, Section 207 of the Advisers Act makes it unlawful to willfully make any untrue statement of any material fact in a registration application or report filed with the SEC, or to willfully omit from such a registration application or report any material fact which should be included therein. Relying upon Sections 206 and 207 of the Advisers Act, the SEC recently pursued the numerous actions against investment advisers referenced above.

Who Should Consider Self-Reporting to the Division of Enforcement

The Enforcement Division describes a “Self-Reporting Adviser” as an adviser who received 12b-1 fees in connection with recommending, purchasing or holding 12b-1 paying share classes for its advisory clients when a lower-cost share class of the same fund was available to those clients, and failed to disclose “explicitly” in its brochure/brochure supplement(s) the conflict of interest associated with the receipt of such fees. The investment adviser received 12b-1 fees if:

It directly received the fees;
Its supervised persons received the fees; or
Its affiliated broker-dealer (or its registered representatives) received the fees.

So as to be sufficient, an adviser’s disclosure must clearly describe the conflicts of interest associated with making investment decisions in light of the receipt of 12b-1 fees, and selecting the more expensive 12b-1 fee paying share class when a lower-cost share class was available for the same fund. Additional information regarding adequacy of disclosures is provided in the various enforcement actions referenced in the announcement. In our third quarter 2017 Newsletter, DCS provides information regarding the administrative proceeding In the Matter of SunTrust Investment Services, Inc.,Investment Advisers Act Rel. No 4769 (September 14, 2017). Regarding the inadequacy of disclosures relating to 12b-1 fees retained by an adviser, the SunTrust Order provides the following:

STIS [SunTrust Investment Services] did not adequately inform its advisory clients of the conflicts of interest presented by its IARs’ share class selections and the receipt by STIS and the IARs of 12b-1 fees. STIS disclosed in its Form ADV Part 2A brochures for its investment advisory programs that STIS “may” receive 12b-1 fees as a result of investments in certain mutual funds and – for several STIS programs – that such fees presented a “conflict of interest.” However, STIS did not disclose in its Form ADV Part 2A brochures or otherwise that many mutual funds offered a variety of share classes, including some that did not charge 12b-1 fees and were, accordingly, less expensive for eligible investors. Moreover, STIS failed to disclose to affected clients that an IAR could purchase, hold, or recommend—and in certain instances did purchase, hold or recommend—mutual fund investments in share classes that paid 12b-1 fees to STIS, which STIS ultimately shared with its IARs as compensation, even though such clients also were eligible to invest in share classes of the same mutual funds that did not charge such fees and were less expensive.

When Must Investment Advisers Self-Report

To be eligible for the SCSD Initiative, an investment adviser must self report by notifying the Division of Enforcement by midnight EST on June 12, 2018. Notification can be made by email to SCSDInitiative@sec.gov or by mail to SCSD Initiative, U.S. Securities and Exchange Commission, Denver Regional Office, 1961 Stout Street, Suite 1700, Denver, Colorado 80294.

What Must Investment Advisers Self-Report

Within 10 business days from the date of its notification, an adviser must confirm its eligibility for the SCSD Initiative by submitting a completed questionnaire. Following is a summary of the information included in the questionnaire:

Identification and contact information;
To the extent applicable, identification and contact information for the affiliate broker-dealer;
Identification of the periods during which brochure(s) and brochure supplement(s) failed to include the necessary disclosures and copies of such forms;
The following information regarding each mutual fund that paid 12b-1 fees for investing or holding client assets (submitted in a provided Excel format):
- Fund name;
- Ticker symbol;
- CUSIP;
- Amount of year-end assets held by the adviser’s clients;
- Total amount of 12b-1 fees incurred by the adviser’s clients (by each share class);
- Amount of 12b-1 fees (if any) if the adviser’s clients assets had been invested in the lowest cost share class available;
- Amount of 12b-1 fees in excess of the lowest cost share class;
- Total 12b-1 fees received by the adviser, its supervised persons, an affiliated broker-dealer and/or the affiliated broker-dealer’s registered representatives; and
- 12b-1 fees that the adviser plans to disgorge.
Any other facts that the adviser determines would be relevant to the Division of Enforcement’s understanding of the circumstances.

The Standardized Terms of Settlement

If an adviser meets the terms of eligibility for the SCSD Initiative and the Division of Enforcement decides to recommend enforcement action against the adviser, the following are the settlement terms to be recommended by the Division of Enforcement.

Types of Proceedings and Nature of Charges

The proceeding will be an administrative cease-and-desist proceeding under Sections 203(e) and 203(k) of the Advisers Act for violations of Sections 206(2) and 207 of the Advisers Act based on the adviser’s failure to disclose the conflict of interest. In an approved settlement, the adviser will neither admit nor deny the findings of the SEC.

Cease-and-Desist Order and Censure

The settlement will include an order to cease-and-desist from committing violations of Sections 206(2) and 207 of the Advisers Act, and a censure.

Disgorgement and Prejudgment Interest

The settlement will include disgorgement of the inappropriately received 12b-1 fees and prejudgment interest on such amounts. For eligible advisers, the Division of Enforcement will not recommend the imposition of a penalty.

Undertakings

Approved advisers will be required to acknowledge taking the following steps within 30 days of an approved settlement order:

Review and as necessary correct the disclosure documents;
Evaluate whether existing clients should be moved to a lower cost share class and move clients as necessary;
Evaluate, update if necessary and review for effectiveness the implementation of policies and procedures designed to prevent violations of the Advisers Act related to disclosures regarding mutual fund class share selection;
Notify all affected clients of the settlement terms; and
Provide to the SEC, no later than 10 days after completion, a compliance certification regarding the undertakings.

Individual Liability

The SCSD Initiative covers only advisers. The Division of Enforcement is providing no assurances as part of the program that individuals will be offered similar terms if they engaged in violations of federal securities laws. The Division of Enforcement may seek enforcement actions against such individuals and remedies beyond those provided for in the SCSD Initiative.

Entities That Do Not Take Advantage of the SCSD Initiative

For advisers that would have been eligible for the SCSD Initiative but did not participate, the Division of Enforcement expects in any proposed enforcement action to recommend additional charges and the imposition of penalties. The Division of Enforcement and the Office of Compliance Inspections and Examinations plan to continue to make mutual fund share class selection practices a priority.

This article was written by Kevin S. Woodard of Dinsmore & Shohl LLP

For more news on the SEC and other topics, check out our Finance Law Twitter @NatLawFinance

Documenting Backcharges on Construction Projects

It would be unusual for a large to medium scale construction project to be completed without the general contractor experiencing issues with at least some of its subcontractors or suppliers.

Under such circumstances, it is typical for back charges to be assessed by the general contractor against the subcontractor or supplier who failed to perform properly pursuant to the terms of their contract. If the possibility of litigation looms in the future concerning such issues, or even if it may not, it is suggested that the general contractor carefully document any potential back charges against the subcontractor or vendor.

The process discussed below will ensure that the back charges are appropriately documented and will give the general contractor the best chance of success in any potential future litigation or negotiations.

The most important issue that a contractor must be aware of when documenting back charges, is to provide appropriate notice to the subcontractor or vendor, as may be required by the terms of the subcontract. If the subcontractor is entitled to a time to cure any deficiencies, this opportunity must be given by the general contractor to the subcontractor or vendor. If the subcontractor properly cures the issue, than in that event, the matter is concluded. On the other hand, if the subcontractor or vendor fails to take remedial measures than the general contractor should take the following additional steps before assessing a back charge. It is important that these steps be carefully followed in order to provide the best chance of success in potential future litigation or negotiations.

The first thing that the general contractor should do is to notify the subcontractor or vendor in writing specifically what the issues are with the materials or services which were provided. This letter should spell out in great detail any and all issues with regard to the materials or services.

The next step is for the contractor to provide notice to the subcontractor or vendor and give them the ability to come to the project to inspect the purported issues prior to any remedial measures taking place. Once again, providing the opportunity to inspect is a very important step in this process.

The next step is to advise the subcontractor or vendor as to when the remedial measures will occur to remedy the deficient condition. This notification should be in writing and should also provide the subcontractor or vendor with the opportunity to be present to observe the remedial measures.

This may very well be the most important piece of documentation to be provided to the vendor or subcontractor and should be sent via certified, regular mail, or any other way in which the contractor can provide to the subcontractor or supplier.

While the remediation is proceeding, the general contractor should carefully videotape any and all remedial efforts, and take very detailed photographs with regard to the remediation process. It is also suggested that any and all invoices, timesheets, or other documents with regard to the back charge be stored in a separate folder and that all of these documents be provided to the defaulting subcontractor or vendor once the back charge work is completed.

The final step in the process would be to provide a complete back charge form to the vendor or supplier with all the relevant invoices which detail the total amount of the back charges. Thereafter, the contractor can deduct this amount from any amount which may be due the subcontractor or vendor.

This article was written by Paul W. Norris of Stark & Stark

1. Choose Arbitration Over Litigation

2. Require Award Debtors to Fund the Costs of Enforcement

3. Provide for Waiver of Appeal/Challenge Rights

4. Provide for High Post-Award Interest in the Arbitration Agreement

5. Require Award Debtors Seeking to Resist Enforcement to Bond the Award

Conclusion

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Background

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Cybersecurity-Related Policies and Procedures

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Regulation FD and Selective Disclosure

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The Standardized Terms of Settlement

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