In their newly published ABA Business Law Section book titled The Value-Able Law Firm(June 2018), Steve Lauer and Ken Vermilion offer law firms a new, more comprehensive look at the dynamics of value from the corporate client’s point of view.
Several independent forces operating simultaneously have thrust law firms into an unfamiliar environment—a much more competitive one—for which many seem unprepared. Law departments increasingly express the need for more “value” from the legal service their companies require. They focus on the value, rather than simply the “cost,” of that service.
Firms often struggle to understand, however, what clients mean by the term “value.” Value has a completely different look to a law firm’s managing partners than it does to a corporate law department. A firm that hopes to succeed in tomorrow’s environment must rethink its performance metrics and what “client centric” really means.
The focus on value means that a law firm can no longer simply reduce its hourly rates or propose a simplistic alternative fee arrangement when responding to value-seeking law departments. Success now requires a much more nuanced approach.
In addition, new players now compete for a corporate legal departments’ spend. Law firms now must contend with Alternative Legal Service Providers. ALSPs have value propositions and client-focus principles different from those that have motivated law firms for so long.
Finally, law departments must demonstrate in an objective fashion how well they manage the matters entrusted to them by their companies. Satisfying that mandate requires that they develop and implement more meaningful metrics and protocols that demonstrate the overall efficient operations and other management strategies of the law departments. They pass this pressure to external service providers for those matters. Consequently, firms must develop supportive metrics and collect relevant data to meet this ever-increasing expectation.
The changing market for legal service for corporate clients
Until recently, corporate law departments happily assigned outside counsel specific matters and let them run with those assignments with little interference or close oversight. Corporate legal departments were often small and staffed with lawyers who had access to limited internal resources. Those law departments weren’t scrutinized closely by their companies’ CFOs and CEOs. “Value” was inextricably—and simplistically—connected to cost; end of analysis. Law firms’ accountability didn’t extend beyond informing clients of major developments and, perhaps, complying with billing guidelines.
In connection with their selection and management of external service providers, many law departments can now draw on the assistance of corporate procurement personnel, whose expertise in sourcing and metrics constitutes a valuable asset. Particularly, to satisfy the reporting expectations of the C suite, in-house lawyers utilize those capabilities more and more frequently.
The early 2000s brought dramatic changes to a corporation’s search for improved profitability. Process needed to be made more efficient, new technology was deployed to improve productivity and eliminate quality variances in production, and headcount reduction was often a goal. No corporate department was untouched by the “do more with less” mantra.
Suddenly, the legal department was required to provide budgets for its matters that it was expected to achieve. Law departments began to review the companies’ law firms with an eye toward reducing their numbers and costs and providing the C suite more information about significant legal matters, the expected drain on internal resources, and the external resources needed to achieve acceptable results. Suddenly the typical relationship between a corporate legal department and law firms was under stress. Big change loomed.
As they faced their own changing requirements, corporate law departments’ operations personnel began applying disciplined, data-driven process evaluations, developing project management skills, and analyzing cost down to individual employees’ activities. Corporate legal departments began shifting their focus from the “practice” of law to the “process” of law in their search for greater efficiency. Corporate clients have become more engaged with the overall management of outside counsel in a very different and ever-more-demanding manner.
If corporate clients’ greater focus on process weren’t enough to stress traditional relationships between clients and law firms, the emergence of the above-referenced ALSPs added distinct pressures. ALSPs carved out specific legal processes and developed organizations, technology, and artificial intelligence to deliver results more efficiently than law firms. Some clients even directed law firms to utilize ALSPs for their matters.
Finally, corporate legal departments formed professional legal operations and technology organizations and forums for the exchange of ideas. This enabled them to identify improved practices more quickly and to implement the best ones. How can a law firm respond to these new demands?
Recent surveys illustrate general counsel’s disappointment with law firm response to their need to reduce costs. Pressure to reduce costs too often resulted in quality control slippage. Outside lawyers demonstrated little creativity when asked to reduce the costs of services. Firms rarely met expectations regarding understanding the client’s business and culture. Corporate clients began evaluating firms using untraditional criteria: use of technology, project management skills, responsiveness, diversity, etc.
A new, practical construct for delivering “value”
The book explains an approach to the concept of value that is more actionable for outside lawyers by putting meat on the bones of the concept of Value Related Qualities (VRQs).
Here are a few VRQs of legal service or of the lawyers or law firm delivering the service:
expertise
cost control
predictability
speed of resolution or completion
responsiveness
certainty of acceptable resolution
The authors demonstrate how law firms should review their core competencies. What services is a firm really good at delivering to its core clients? Every firm (and each attorney and other professional in the firm) has its own VRQs. A firm might be known for a particular representation, whether transactional or litigation-oriented, environmental, or related to mergers and acquisitions. Perhaps a firm has offices in multiple international jurisdictions and routinely handles multijurisdictional corporate transactions or has well-regarded expertise in international arbitration.
Some firms have strength in handling “bet the company” matters, whereas others excel at handling high volumes of low-risk matters. It’s unlikely that any one firm can effectively be all things to all clients.
The VRQ framework helps identify the strengths of a firm’s performance and match those strengths with its clients’ VRQs. Firms and clients then can have a broader conversation about the creation of value—an innovative conversation that is more meaningful and actionable than the outdated and ineffective cost-per-hour conversation.
Having a particular reputation does not limit the types of matters that a firm can handle competently and legally. That reputation can, however, constitute an “anchor” for the firm’s market presence and its outreach efforts. If a firm understands its existing practice and reputation, it can examine how that current business serves its existing and potential clients’ value-related needs. Reviewing its VRQs and those of the market targets, how much overlap exists? If not a precise matchup, how easily could the firm develop the VRQs needed to more completely service those companies’ needs?
One of the first, and key, steps in understanding VRQs for a client—Fortune 100 or not—is to understand the client’s business and its role in the market. Then it is critical understand its history as well as important company culture characteristics. We believe synergies exist between a client’s overarching business model and the operational framework for the in-house legal department.
Once a firm has aligned its internal resources with the areas of law in which it wants to provide distinguished services to clients, the task of providing evidence of these skills becomes paramount. Enter the world of metrics. How best can a firm demonstrate to clients its core expertise? Developing easy-to-understand metrics that communicate the firm’s ability to deliver value beyond simple cost reduction is essential to winning clients’ work and loyalty. VRQs support the development of value-oriented metrics.
Next, a law firm should focus on the client’s matter-specific objective or goal and strive to understand that objective using the company’s capacity for risk and its business model lens. For example, an insurance company may have decidedly different objectives for the management of its portfolio of tort matters than a modest-sized regional retailer. The former’s lifeblood may be the minimization of cost when managing claims, so its value drivers revolve around cycle times, reusable work product, and analytics that support innovative cost agreements with firms. A regional retailer may seek to eliminate repeat occurrences of similar offences. Yes, there will be a sensitivity to cost, but perhaps a focus on lessons learned and preventative steps to take limiting future exposure may be key. Client-centric firms clearly understand their clients’ objectives before forcing the spade into the soil, and these firms don’t identify objectives in a vacuum. They openly discuss and formally document objectives in advance of developing key components of strategy and execution plans for that strategy. VRQs can fill a critical role in that planning.
There is much more to understanding the VRQ framework and implementing its concepts to benefit both firms and clients. Hopefully this abbreviated look into a better way to create and measure value for your clients will cause you to dig further into the concept of VRQs to enhance how your firm creates value for your clients and is compensated for doing so.
American lawyers lost a good friend and valued adviser when Professor Ronald D. Rotunda died on March 14 at the age of 73. Coming just two months after the death of Geoffrey Hazard, Ron’s passing has deeply affected many in the legal ethics community.
Like many of today’s senior figures in professional responsibility, Ron Rotunda did not expect legal ethics to be his field of expertise. Ron graduated from Harvard Law School in 1970, clerked for Judge Walter Mansfield of the Second Circuit, and spent two years practicing law at Wilmer, Cutler & Pickering before becoming Assistant Majority Counsel to the Senate Watergate Committee amid a Constitutional crisis. From that experience, he evolved into one of the country’s leading experts in Constitutional Law, a demanding field that makes the scope of his body of work in legal ethics all the more remarkable.
In 1974, Ron Rotunda started his academic career at the University of Illinois, where I was also a young professor. That was a watershed year in the study of legal ethics, because the ABA responded to the Watergate scandal by formally requiring all law schools to offer instruction in legal ethics as a condition of maintaining their accreditation. None of the faculty at Illinois—or at most law schools around the country—had the necessary expertise to offer the required courses. The ABA had adopted the Model Code of Professional Responsibility in 1970, and that Code had been quickly adopted in most states. There were few casebooks, however, and those that did exist mostly covered what were then the three “big” issues—the constitutional right to counsel, the lawyer’s duty not to advertise, and the tension between a lawyer’s duty to clients and to the courts.
Thus, Ron Rotunda and others entered the academy at a moment when effective teaching and serious research about legal ethics were in short supply. Ron recognized the need for new materials and brought his seemingly endless energy to the job of producing them. He shared the belief that legal ethics was less a branch of philosophy than a reflection of the realities of a public service career that is central to our constitutional form of government. We decided that legal ethics could be taught most effectively using problems that required students to picture themselves in the roles they were studying to assume. The wisdom of those assumptions, and Ron’s commitment to teaching legal ethics as “real law”—based on rules and court decisions, not platitudes—have been validated by experience. The casebook we co-authored is now in its 13th edition. By now, other casebooks treat those ideas—which were counterintuitive to many at the time—as their own governing principles as well.
Ron Rotunda worked in a variety of professional settings beyond the classroom. He was a member of the ABA Standing Committee on Professional Discipline. He served as a liaison to the ABA Standing Committee on Ethics and Professional Responsibility, and he was a member of the drafting committee for the Multistate Professional Responsibility Exam. He served as an expert witness on legal ethics and malpractice issues, and he worked on the proposed changes to lawyer advertising regulation soon likely to be presented to the ABA House of Delegates. His Legal Ethics: The Lawyer’s Deskbook on Professional Responsibility is perhaps especially important, as it sits on the desks of thousands of lawyers—both ethics specialists and “real” lawyers—around the country.
Ron Rotunda’s interest in public service continued all through his career. He was the only lawyer with a leading role in investigating impeachment of U.S. Presidents Richard Nixon and Bill Clinton, one from each major political party. He also spent a year serving as Special Counsel to the Department of Defense on ethical and constitutional issues relating to Guantanamo Bay detainees.
After retiring from the University of Illinois faculty in 2002, Ron taught at the George Mason University School of Law until 2008. For the last decade, he taught at the Chapman University Fowler School of Law. As the academic world became more specialized in recent years, Ron Rotunda maintained the breadth of his interests and his commitment to making lawyers more effective ambassadors to the institutions and the public whom they serve. All Americans have been affected by his work, and all American lawyers are diminished by his passing.
A New York federal judge held that virtual currencies are commodities that can be regulated by the Commodity Futures Trading Commission (“CFTC”), enjoining the defendants, an individual and affiliated entity, from trading cryptocurrencies on their own or others’ behalf or soliciting funds from others, and ordering an expedited accounting. CFTC v. McDonnell, No. 18-cv-0361, Dkt. 29 (E.D.N.Y. Filed Jan 18, 2018). While the CFTC announced its position that cryptocurrencies are commodities in 2015, this case marks the first time a court has weighed in on whether cryptocurrencies are commodities. Having answered that question in the affirmative, the court went on to hold that the CFTC has jurisdictional authority over defendants’ alleged cryptocurrency fraud under 7 U.S.C. § 9(1), which permits the CFTC to regulate fraud and manipulation in underlying commodity spot markets.
Regulatory Landscape
In recent months, regulators have increasingly turned their attention to cryptocurrency. Although Congress has not yet enacted a regulatory regime for virtual currency, the CFTC and the Securities and Exchange Commission (“SEC”) have exercised concurrent authority over virtual currency primarily by bringing enforcement proceedings.
In September 2015, the CFTC first announced its view that bitcoin and other virtual currencies are commodities within the meaning of the Commodity Exchange Act (“CEA”). See In the Matter of: Coinflip, Inc., CFTC No. 15-29. Initially, the CFTC targeted its enforcement efforts towards unregistered futures and swap marketplaces in virtual currencies. See, e.g., In Re TeraExchange LLC, CFTC No.15-33, 2015 WL 5658082 (Sept. 24, 2015); In re BXFNA Inc. d/b/a Bitfinex, CFTC No. 16-19 (June 2, 2016). More recently, however, the CFTC has begun targeting alleged Ponzi schemes and other frauds involving virtual currencies, regardless of whether those alleged frauds involve trading in futures or swaps. See, e.g., CFTC v. The Entrepreneurs Headquarters Limited, No. 2:18-cv-00345 (E.D.N.Y. Filed Jan. 18, 2018); CFTC v. My Big Coin Pay, Inc., Case No. 1:18-cv-10077 (D. Mass. Filed Jan. 16, 2018); CFTC v. Gelfman Blueprint, Inc., Case No. 17-7181 (S.D.N.Y. Filed Sept. 21, 2017). These more recent enforcement actions have been pursued under the spot market anti-manipulation authority granted to the CFTC as part of The Dodd–Frank Wall Street Reform and Consumer Protection Act, and codified by 7 U.S.C. § 9(1) and 17 C.F.R. § 180.1(a). While the CFTC has acknowledged that its authority in cash or spot markets is limited, it has asserted authority over alleged fraud or manipulation in those markets. SeeCFTC v. McDonnell, No. 18-cv-0361, Dkt. 29 at 22 (citing 7 U.S.C. § 2(c)(2)(C)(i)(II)(bb)(AA)); CFTC Launches Virtual Currency Resource Web Page, Press Release, Dec. 15, 2017, available at http://www.cftc.gov/PressRoom/PressReleases/pr7665-17.
Separately, SEC Chairman Jay Clayton issued a statement in December asserting that many products marketed as cryptocurrencies in fact function as securities, requiring registration with the SEC unless exempted. See SEC Chairman Jay Clayton, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017). Similarly, the SEC has stated that many online platforms for trading cryptocurrencies function in fact as securities exchanges, and must therefore be registered to operate lawfully. See Divisions of Enforcement and Trading and Markets, Statement on Potentially Unlawful Online Platforms for Trading Digital Assets (March 7, 2018). To address these concerns, the SEC has formed a new Cyber Unit within its Division of Enforcement and has brought a number of enforcement actions in the past year concerning alleged frauds in the cryptocurrency market. Chairman’s Testimony on Virtual Currencies: The Roles of the SEC and CFTC before the Committee on Banking, Housing, and Urban Affairs (Feb. 6, 2018) (statement of Jay Clayton, Chairman of the SEC).
For its part, the Internal Revenue Service (“IRS”) asserted in 2014 that virtual currency is “property” and that virtual currency transactions are subject to general tax principles like other kinds of property. Notice 2014-21 (March 25, 2014). To date the IRS has sought trading records from virtual currency exchanges, successfully obtaining a court order compelling the records of roughly 14,000 Coinbase users. SeeUnited States v. Coinbase, Inc., No. 17-CV-01431-JSC, 2017 WL 5890052 (N.D. Cal. Nov. 28, 2017).
Other federal and state authorities such as the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCen), the U.S. Department of Justice, and the N.Y. Department of Financial Services have also undertaken regulatory and/or enforcement efforts concerning cryptocurrency. SeeCFTC v. McDonnell, No. 18-cv-0361, Dkt. 29 at 10-12 (E.D.N.Y. Jan 18, 2018).
Case Background
In January 2018, the CFTC filed a complaint against defendants Patrick McDonnell and his company CabbageTech, Corp., doing business as Coin Drop Markets, alleging that the defendants defrauded virtual currency investors by offering trading and investment services in exchange for U.S. Dollar and cryptocurrency payments, only to close up shop and disappear. Dkt. 1 at 1. Specifically, the CFTC alleged that the defendants inflated their own trading credentials and promised outsized investment returns to induce customers to subscribe to daily investor alerts and hire defendants to trade directly on their behalf. Id. at 1, 4-7. The CFTC alleged that shortly after obtaining payments from numerous customers, defendants shut down the company’s website and chatroom, deleted its social media accounts, and cut off communications with customers, misappropriating the funds without providing the promised advice. Id. at 1, 5, 7.
The court ordered briefing on the CFTC’s request for a preliminary injunction as well as on the authority of the CFTC to bring the instant action. See Dkt. 9, 10. Subsequently, McDonnell filed a pro se motion to dismiss the CFTC’s complaint, arguing in relevant part that the CFTC was politically motivated, and lacked jurisdiction over defendants’ virtual currency activities, which McDonnell argued were not advisory in nature. Dkt. 18, 20. McDonnell’s motion to dismiss did not argue that cryptocurrencies were not commodities, but rather asserted that because his business provided impersonal investment advice to the general public, and did not manage assets, its conduct was outside the scope of CFTC jurisdiction. Dkt. 18 at 1.
The District Court’s Opinion
Senior United States District Judge Jack B. Weinstein denied defendants’ motion to dismiss and granted the CFTC’s motion for a preliminary injunction, holding in relevant part that the CFTC had jurisdictional authority to bring a fraud action against defendants’ allegedly deceptive cryptocurrency scheme despite the absence of futures contracts. Dkt. 29 at 28. In so holding, the court concluded that “[v]irtual currencies are ‘goods’ exchanged in a market for a uniform quality and value,” and therefore fall “well-within” the common definition as well as the CEA’s definition of commodities. Id. at 24.
The court further explained that although the CFTC has traditionally limited its jurisdictional authority to futures and derivatives markets, under Dodd Frank the CFTC may also exercise authority over fraudulent or manipulative conduct in underlying spot markets. Id. at 25. The court held that because virtual currencies are commodities, the CFTC has authority under 7 U.S.C. § 9(1) and 17 C.F.R. § 180.1 to bring a fraud action against defendants even if futures contracts are not involved. The court did not expressly address defendants’ argument that the CFTC lacked jurisdiction over its conduct due to the nature of the advice given, but it necessarily rejected that argument in granting the CFTC’s motion.
In reaching its jurisdictional decision, the court noted that the CFTC’s authority to regulate cryptocurrencies as commodities does not preclude other agencies from regulating cryptocurrencies when they function differently than derivative commodities, at least until Congress sees fit to enact a more tailored regulatory scheme.
The global fight against child labor and forced labor has been led for decades by the International Labor Organization (ILO). The ILO’s most recent estimate is that 25 million people around the world, including millions of children, are currently subjected to forced labor.[1] Under U.S. law, section 307 of the Tariff Act of 1930[2] prohibits the importation of merchandise mined, produced, or manufactured, wholly or in part, in any foreign country by convict, forced, or indentured labor. This law gave the U.S. Customs Service (now the U.S. Customs and Border Protection (CBP)) authority to seize commodities imported into the United States where forced labor was suspected to have been used anywhere in the supply chain.
The Tariff Act defines “forced labor” as “all work or service which is exacted from any person under the menace of any penalty for its nonperformance and for which the worker does not offer himself voluntarily.” Products of forced labor include goods that were produced by convicts and indentured laborers. The ILO defines forced or compulsory labor as service that involves coercion—either direct threats of violence or more subtle forms of compulsion under the menace of any penalty.[3] Goods made by child labor, defined as work that deprives children of their childhood, their potential, and their dignity and that is harmful to their physical and mental development,[4] are included in the forced-labor prohibition especially when combined with any form of indenture. Such tainted merchandise is subject to exclusion and/or seizure by the CBP, may lead to corporate criminal liability, and could even support prosecution of culpable employees individually.
The Trade Facilitation and Trade Enforcement Act of 2015 (TFTEA) removed the “consumptive demand” exception to the United States Tariff Act of 1930,[5] which was a commonly exploited loophole to the prohibition against importing products of forced labor. Prior to the new provision, CBP used the law only 39 times since 1930 to apprehend goods tainted at some point from creation to delivery by forced labor. Since the passage of TFTEA, CBP has issued four new Withhold Release Orders (each a WRO) on specific goods from China.[6] Although 2017 saw more antidumping and countervailing duty orders and intellectual property rights protection activity under TFTEA,[7] there have been no published detentions to date, although CBP has pledged to the U.S. Congress that more import bans under section 307 are forthcoming.
Government agencies other than CBP are also authorized to investigate allegations that forced labor is used to produce goods imported into the United States. U.S. Immigration and Customs Enforcement (ICE), for example, investigates allegations of forced labor related to overseas manufacturing or mining of items that are exported to the United States. The Department of Labor (in consultation with the Department of State and Homeland Security) maintains and annually publishes a list of products that it believes are produced by forced labor, and this list is used to inform the U.S. State Department’s annual Trafficking in Persons Report.
CBP promises to hold goods and issue the dreaded WRO pending further investigation whenever the “information available reasonably but not conclusively indicates that merchandise” to be imported is subject to the anti-forced or indentured labor provision.[8] CBP has made it clear that the “some reasonable indication” standard for issuing a WRO allows it to base a decision on a risk assessment and does not require clear and convincing evidence. Enforcement actions can be triggered by anyone who reports suspicious activity to a CBP officer who then issues a report to the CBP commissioner. Goods can be detained with the commissioner’s issuance of a WRO even when information reasonably but inconclusively indicates that merchandise was made with forced labor. Once a shipment is seized by the CBP and subject to a WRO, the purchaser or importer must provide a detailed demonstration that the commodities were not produced with forced labor as proof of admissibility into U.S. markets. CBP will then decide whether to release shipments on a case-by-case basis. CBP actively seeks the help of NGOs with feet on the ground, and if CBP ultimately deems the gathered information sufficient to make a determination, the commissioner will publish a formal finding in the Customs Bulletin and in the Federal Register.[9]
Enhanced Internal Reviews and Disclosure
In response, responsible importers are taking steps to enhance their compliance measures. They are undertaking review of all products where they commonly act as the importer of record because that role automatically makes them responsible parties for dealings with CBP. Conducting supply-chain audits and performing supplier due diligence to be sure there is no forced labor at any level is clearly now part of good governance as well as corporate social responsibility. In fact, supply-chain audits and due diligence is a legal requirement for certain American companies and large international companies supplying goods and services (including goods and services online) to consumers in California and a growing number of countries outside of the United States.[10]
What is the proper course of action, however, if a company discovers goods tainted by forced labor as part of its compliance monitoring? Do the company’s legal obligations change before and after accepting those goods and incorporating the tainted ingredient into products placed in the U.S. markets? Certainly, a company that discovers goods tainted by forced labor should immediately consider terminating its supply-chain agreement with the offending importer or at least employ greater diligence before accepting delivery of future, possibly tainted goods at the port of entry. However, does the company have a legal obligation to report its findings to the port director or the commissioner of CBP?
Government contractors are bound by the False Claims Act’s mandatory disclosure rule, which provides that contractors must “timely disclose” whenever the contractor has “credible evidence” of certain criminal law violations or violations of the civil False Claims Act.[11] If the importer is member of the Customs-Trade Partnership against Terrorism and part of the Importer Self-Assessment Program, it is expected to take action to mitigate risk and report noncompliance to CBP.
Self-disclosure under TFTEA still appears to be discretionary, however, at least for now. Revised CBP regulations invite “[a]ny person outside the CBP who has reason to believe that merchandise produced in the circumstances mentioned in paragraph (a) of this section [use of convict, forced, or indentured labor] is being, or is likely to be, imported into the United States may communicate his belief to any port director or the Commissioner to CBP.”[12] Nevertheless, if you ask a representative of the CBP’s Office of Trade whether a company’s discovery of forced labor violations must be reported to CBP, you will hear a resounding “Yes.” I know because I asked. Given the use of the “may” above, rather than “shall” in the new regulation, what is the basis of the CBP position?
CBP Expectations
Historically, CBP has operated under the twin principles of “informed compliance” and “shared responsibility,” placing the burden on the importer of record to make entries on the required forms correctly. Failure to make accurate statements with respect to imported goods can result in seized entries, lost import privileges, and civil and criminal penalties. The Department of Justice (DOJ) initiates action seeking criminal penalties by using statutory provisions related to customs matters (goods entering into the United States via fraud, gross negligence, or negligence,[13] goods that were falsely classified upon entry,[14] and entry of goods by means of false statements[15]) or, at its election, through noncustoms provisions (the use of federal provisions regarding the obstruction of justice,[16] the federal conspiracy statute,[17] money laundering,[18] smuggling,[19] and aiding and abetting[20]), with the noncustoms provisions supporting higher criminal penalties.
On October 2, 2016, the DOJ issued Guidance Regarding Voluntary Self-Disclosures, Cooperation, and Remediation in Export Control and Sanctions Investigations Involving Business Organizations. This Guidance memorialized the policy of the National Security Division (NSD) of the DOJ to encourage business organizations to voluntarily self-disclose criminal violations of the statutes implementing the U.S. government’s primary export control and sanctions regimes.[21] It sets forth the criteria that NSD, through the Counterintelligence and Export Control Section and in partnership with the U.S. Attorneys’ Offices, uses in exercising its prosecutorial discretion in determining the possible inducements it can offer an organization to make a voluntary self-disclosure (VSD). For export control and sanctions cases, the Guidance also implements the September 9, 2015 Deputy Attorney General Sally Yates memorandum (Yates Memo) promoting greater accountability for individual corporate defendants and the November 2015 revisions to the Principles of Federal Prosecution of Business Organizations set forth in the U.S. Attorneys’ Manual (USMA Principles).[22]
The Guidance only applies to export control and sanctions violations, however, and rests on the assumption that all criminal violations of U.S. export controls and sanctions harm the national security or have the potential to cause such harm. This threat to national security informs how the NSD and U.S. Attorneys’ Offices arrive at an appropriate resolution with a business organization and distinguishes those cases from other types of corporate wrongdoing, including violations of import controls. Unlike the exporter that finds itself in breach of export controls and sanctions, if an importer truly had no knowledge of the forced labor violations upon original acceptance of the goods, is the failure to report a subsequent discovery as a result of a comprehensive compliance program or audit a violation of law unto itself, or is the violation the failure to amend the original import paperwork?
Penalties for Misstatements to CBP
Federal law prohibits material false statements, acts, or omissions in connection with imports resulting from the importer’s negligence, gross negligence, or fraud.[23] Some typical examples of false statements, acts, or omissions made by importers with respect to goods include misclassifications, undervaluation, antidumping/countervailing duty order evasion, or improper country of origin declarations, but the prohibited activity could also include misstatements with respect to the absence of forced labor. Upon an importer’s discovery of any false statement made in its paperwork, disclosure before a CBP inquiry or issuance of a pre-penalty or penalty notice might be the suggested course of action, yet prior disclosure to CBP does not appear to be required under current law.
The U.S. Attorneys’ Manual section 9-28.900, “Voluntary Disclosures,” now states: “[T]he Department encourages corporations, as part of their compliance programs, to conduct internal investigations and to disclose the relevant facts to the appropriate authorities.” Although “a prosecution may be appropriate notwithstanding a corporation’s voluntary disclosure,” there are concrete, tangible benefits available to entities that do elect to self-disclose corporate misconduct. Where there is a finding of full cooperation and remediation, the corporation and its principals are eligible for a full range of consideration with respect to both charging and penalty determinations.[24]
Importers may look for guidance from the application of corporate compliance programs addressing audits for possible violations of the Federal Corrupt Practices Act of 1977, as amended (FCPA).[25] The Securities and Exchange Commission clearly has taken the position that a company must self-report misconduct in order to be eligible for a deferred prosecution agreement or a nonprosecution agreement. Although there is no blanket affirmative duty to disclose an internal investigation, disclosure may be required if a publically traded company uncovers facts during the investigation that make prior disclosures false or misleading or material.
The DOJ has similarly clarified what is expected and how self-disclosure will vastly affect the ultimate resolution of any FCPA matter. On November 29, 2017, the DOJ announced a new FCPA Corporate Enforcement Policy that formalizes the prior internal guidance, with a few slight revisions, and makes permanent the pilot program[26] established in 2016 to incentivize companies to self-report FCPA violations. The new policy went a step further than the pilot program by creating a rebuttable presumption that the DOJ will decline to prosecute, or impose any penalties on, companies that voluntarily self-disclose potential violations of the FCPA, fully cooperate with the DOJ investigation, and “timely and appropriately” remediate[27] with each of these elements defined in the new policy. Under the revised FCPA enforcement policy, the self-disclosure must be genuinely voluntary (i.e., prior to the “imminent threat” of disclosure or government investigation) and must be made within a “reasonably prompt time” after discovery of the violation. This creates some potential issues for the directors and officers of a company that learn of potential violations and seek to conduct an internal investigation to gather more information. Companies now have to be concerned that protected (and protracted) investigations may jeopardize their ability to make an effective voluntary disclosure. “Full cooperation” in DOJ terms may include deconfliction, which is a request by the government that a company’s legal team step back during an investigation in order to allow the government to interview witnesses first.
Even before the new FCPA policy, the DOJ’s Criminal Division’s Fraud Section released guidance on how it evaluates the effectiveness of a company’s corporate compliance program entitled Evaluation of Corporate Compliance Programs[28] (the Compliance Guideline). The Compliance Guideline sets forth 11 topics and questions investigators may ask when evaluating the adequacy of a compliance program to determine whether to bring charges and the scope of a negotiated plea or other agreements. One of the 11 factors to be taken into consideration is whether the company has implemented an effective and confidential reporting mechanism that can evaluate the risk level or seriousness of reports. Once a report of a compliance breach arrives, the company must timely respond to the complaint and, if appropriate, involve all levels of senior leadership up to the board of directors. In response to investigation findings which should be documented, when warranted, remediation capable of correcting the source of the violations must occur, and all individuals involved in the misconduct must be disciplined.
Should we anticipate a requirement of full cooperation in enforcement of national and international anti-forced labor initiatives? By analogy with FCPA initiatives, there is growing tension between (i) an importer’s need to comply with expanding international legal initiatives requiring supply-chain audits, due diligence, and periodic public reporting with remediation plans to combat the use of forced labor [29] and (ii) a decision not to report violations to CBP upon discovery. If for no other reason, the newly required public reports of efforts to combat forced labor, if complete and accurate, give CBP ample ground to initiate investigations not only with respect to the publically reported discovered violation, but all those that might have occurred at any time within the prior five-year statute of limitations.[30]
The official policy of CBP is clearly to encourage the submission of disclosures before enforcement authorities find violations. It certainly appears to be the case that parties who advise CBP of noncompliance before CBP or ICE discovers the possible noncompliance can expect reduced penalties (to as low as zero) where no fraud is involved. Valid prior disclosures can save the importer time and money, so assuming there is a decision to self-disclose after finding and publishing a report of a supply-chain violation, what should be disclosed and how?
Since businesses are increasingly global, so too are enforcement actions in response to alleged corporate wrongdoing. A company that reports its internal finding of corporate wrongdoing may find itself the focus of not just one law enforcement body, but of many across the world. In addition to the possibility of multiple enforcement actions, a criminal investigation and/or civil proceedings initiated by the victims of forced labor can be devastating to a company’s operations and reputation. Accordingly, companies struggling to both satisfy the legal requirements of global anti-forced labor initiatives and to meet the timeliness and full cooperation criterion of protected self-disclosure must determine the appropriate scope of their disclosures even if an internal investigation is not complete. It is imperative for a company that has discovered forced labor in its supply chain to assess the potential consequences of strategies and tactics in multiple jurisdictions, preserving, to the greatest extent possible, the attorney-client privilege.
Attorney-Client Privilege
General counsel and general business practitioners throughout the United States let out a collective sigh of relief when the U.S. Court of Appeals for the D.C. Circuit granted a writ of mandamus and overturned the district court decision in United States ex rel. Barko v. Haliburton Co.[31] The district court in Barko had held that documents relating to an internal investigation were not protected from disclosure by the attorney-client privilege.[32] In vacating the district court’s order to produce documents, the court of appeals insisted the lower court’s analysis failed to grasp the scope of the attorney-client privilege that protects confidential employee communications gathered by company lawyers in an internal investigation under the seminal Supreme Court case Upjohn Company v. United States.[33]
Three years and counting after the court of appeals decision in Barko, companies have continued to build and invest in robust compliance programs that include self-investigation of potential regulatory violations under the protection of the attorney-client privilege.
The increasing volume of electronic communications has not made an assessment of the scope of the attorney-client privilege in the world of internal audits any easier, however. Should the privilege apply when employees communicate with fellow employees and copy the company’s general counsel? Does such an e-mail implicitly seek legal advice and thus deserve privilege protection without an explicit request for legal guidance but with the mere inclusion of the lawyer as one of the recipients? In Greater New York Taxi Ass’n v. City of New York,[34] the magistrate found that some but not all of the e-mails at issue fit into the framework of privileged communications when the sender indicated that he was soliciting legal advice or that the communication implicated specific legal issues.[35] A similar case in the United Kingdom came to the opposite conclusion, however, holding that communications by corporate lawyers with third parties (including employees) who are not authorized to seek or receive legal advice, and therefore are not the “client” for privilege purposes, are not covered by legal advice privilege (LAP) or litigation privilege (LP), concepts akin to the U.S. attorney-client privilege.[36]
Keeping New York Taxi and other case law in mind, the best practice would be to adopt an aggressive policy in the hope of securing privilege status for as much of the audit results as possible. Officers of the investigating company should state in writing in advance of any e-mail or other communication that the person giving the initial formal instructions to an internal or external lawyer is authorized by the company to obtain legal advice on its behalf. Any employee and executive participating in an internal supply-chain audit or a specific review of a particular shipment should be directed to title all notes as “Attorney Work Product” and to always copy general counsel or outside counsel, as the case may be, as early as possible, explicitly stating that they seek legal advice in all such communications. In addition, companies and their legal advisers should consider the following practical steps in any forced labor inquiry and any decision making with respect to prior disclosure to minimize the risk of inadvertently waiving or losing the attorney-client privilege.
If in-house or outside counsel must obtain data from within the company, whether e-mails or documents, counsel should make clear and document that the collection and use of such information as part of the internal investigation is for the purpose of providing legal advice and counsel to the client company.
Counsel should advise in writing and orally those who collect information during the investigation of the confidentiality of the information and the fact that such information is being collected under the company’s privilege.
The record of the discovered facts should be labeled “Attorney Work Product” and include a statement that, on the information currently available, the drafter entertains a concern that the material gives rise to a real likelihood of a prosecution or other sufficiently adversarial proceeding against the company, and the purpose of the instructions to the lawyer is to give advice to the board (or executive, depending on the stage of the investigation) regarding such concern.
Counsel should indicate in writing also labeled “Attorney Work Product” whether, on the basis of the information initially provided, there would appear to be a reasonable anticipation of a proceeding by the CBP or some other governmental unit.
If a decision is made to proceed with interviews of personnel, in advance of any such interview counsel should inform the person(s) to be interviewed that the dominant purpose of the interview is to enable the lawyer to provide the company with advice regarding the likelihood of prosecution/litigation, and this statement by counsel should be included in the written record of the interview.
At every step, counsel and investigators must state unequivocally before any interview that the investigation is being conducted under the privilege, and that it is the company’s privilege so that waiver or any claim belongs to the company and not to any individual.
Counsel should record in writing within the attorney work product some form of qualitative assessment of what has been said by any person interviewed and his or her thoughts as to its importance or relevance to the legal advice sought.
Attorney-Client Privilege and FAR
An examination of the preservation of the attorney-client privilege under the Federal Acquisition Regulations (FAR) might be helpful in this context. Part 22 of the FAR regulates the application of labor laws to government acquisitions. Subpart 22.1700- 1705, Combating Trafficking in Persons,[37] applies to all federal contracts and represents a policy prohibiting contractors, subcontractors, and their respective agents from conduct including, but not limited to, the following:
engaging in severe forms of trafficking in persons during the period of performance of the contract;
procuring commercial sex acts during the period of performance of the contract; and
using forced labor in the performance of the contract.
Pursuant to FAR Subpart 22.1705, “all solicitations and contracts” are required to include a clause requiring contractors to fully cooperate with the U.S. government by providing access to its facilities and staff to contracting/other responsible federal agencies. The agreed-upon access is to facilitate the federal agencies audits and other investigations to ascertain compliance with the Trafficking Victims Protection Act of 2000 and any other law or regulation restricting the trafficking of persons, the procurement of commercial sex acts, and the use of forced labor.[38] The clause specifies that the requirement for full cooperation does not:
require the Contractor to waive its attorney-client privilege or the protections afforded by the attorney work-product doctrine;
require any officer, director, owner, employee, or agent of the Contractor, including a sole proprietor, to waive his or her attorney client privilege or Fifth Amendment rights; or
restrict the Contractor from—
(A) conducting an internal investigation; or
(B) defending a proceeding or dispute arising under the contract or related to a potential or disclosed violation.[39]
Content of Disclosure to CBP
Turning back to importers, once an internal audit uncovers products tainted by forced labor and a decision is made to proceed with a prior disclosure, the importer should be sure to follow up any verbal report to a CBP officer at every port of entry where the disclosed violation(s) occurred in writing within 10 days. The writing should indicate the importer’s name, address, and contact information and should be addressed to the commissioner of CBP with copies to each applicable port. The written disclosure should list all of the concerned ports, identify the class or kind of merchandise, identify the entry number(s), dates of entry, or drawback claims, and specify the previously believed absence of the use of forced labor as a material false statement. The disclosure should go on to include an explanation as to the true and accurate information or data with respect to labor that should and would have been provided if previously known. Every effort must be made to be sure the disclosure is as complete as possible. If necessary, to maximize the intended benefit of the disclosure, the disclosing importer must first determine whether its internal inquiry and resulting disclosure should look back five years to cover those violations, if any, not barred by the statute of limitations.
Notwithstanding the desire to be thorough in the disclosure, efforts can and should be made to preserve the attorney-client privilege to the extent possible. The U.S. International Trade Commission gives only approved parties to an investigation access to business proprietary information (BPI),[40] and even that access is subject to an administrative protective order (APO) designed to protect the confidentiality of the BPI.[41] Information that is privileged, classified, or “of a type for which there is a clear and compelling need to withhold from disclosure” is nevertheless exempt from disclosure and service under the APO.[42] There is a special procedure for a submitter of BPI to follow if he or she considers that any of the information falls within the exempt categories, requesting an exemption from general availability to the secretary.[43] The submitter must file multiple copies of the same documents claimed to be privileged, with their covers and pages clearly marked as to whether they are the “confidential” or “nonconfidential” versions, and the confidential business information must be clearly identified by means of brackets. All written submissions, except for confidential business information, will be made available for inspection by interested parties.
Contract Rights upon Discovery of Tainted Goods
The discussion above does not distinguish between a company’s pre- or post-acceptance discovery of the impermissible use of forced labor in the production or manufacture of goods. Should the company’s decision to report the infraction to the CBP depend upon the timing of the discovery?
If the supplier’s acts constitute the use of forced or child labor, and such acts are discovered by the would-be buyer before acceptance of the goods, disclosure to the CBP would, under such circumstances, not appear to be legally required under current U.S. law because there was no false or misleading information submitted to CBP by the importer. Referring back to the discussion above with respect to the CBP regulations use of the words “may communicate,” rather than the mandatory “shall communicate,” the regulations seem to pose no risk to a buyer that rejected such goods as nonconforming because there is no entry into U.S. markets attributable to that buyer. What if the buyer accepted identical goods from the same supplier historically (anytime in the five-year period of the statute of limitations)? If that is the case, and it probably will be more often than not, disclosure might be problematic, but nondisclosure may be worse. What if the prohibited acts of the supplier are discovered and disclosed by another, and CBP initiates an investigation of all buyers from that supplier in the prior five-year period? After all, once the tainted goods are revealed by another, such an investigation is likely low-bearing fruit for the CBP’s enforcement arm. In fact, a competitor that can secure the protections afforded by full cooperation would have every incentive to damage the brand and operations of less transparent companies in the same space.
If the discovery of the use of forced labor by the importer precedes acceptance of the goods delivered to a port, the importer must also be sure to evaluate its contract rights with its supplier to reject the goods as nonconforming. There will probably be a contractual obligation to notify the supplier of the importer’s discovery and rejection of goods. Although the contract might have a general reference to a supplier’s obligation to adhere to all applicable law, breach of applicable anti-forced labor laws may not be identified as a breach justifying rejection of the goods or termination of the contract. The importer may find itself in the impossible position of having to choose between violating TEFRA and breaching a contract with a supplier, with both alternatives posing operational and reputational risks.
The Uniform Commercial Code Subcommittee of the ABA Business Section is currently working on model contract clauses designed to protect the human rights of workers in international supply chains. By way of reference and incorporation into the supply contract, a breach of the anti-slavery, human trafficking, and human rights policies of the buyer/importer made known to the seller/supplier and required in the supplier’s performance can be deemed a clear material breach of the contract and support rejection of the tainted goods as nonconforming. Putting these provisions in supply contracts will provide support for a company’s desire to prove that it is complying with prevailing international legal developments to assure fundamental freedoms for all workers. Audit rights, if also included in the contract and utilized regularly, would assist the buyer/importer in its efforts to be vigilant in fighting forced labor throughout the supply chain.
The incorporation of such policies into the supply-chain contract will provide a framework for agreed-upon disclosure by an importer/buyer of the supplier/seller’s use of forced labor to CBP, SEC, California, the United Kingdom, France, and the general public. Without such explicit contractual provisions, an importer that discloses its supplier’s use of forced labor to third parties could arguably otherwise be subject to the supplier’s claim that the importer breached standard nondisclosure covenants by revealing confidential supplier information.
Such contractual incorporation of anti-forced labor and general human rights policies has yet another benefit. Contract provisions that refer to anti-forced labor and human rights policies and incorporate such policies throughout the supply chain will allow businesses to self-regulate. Self-regulation might just be more effective at preventing forced labor and other abuses of human rights than laws governmental agencies find difficult to enforce given their limited resources. Corporate policies, audits, and remediation plans that reflect a broad concern for all supply-chain workers could play an important role in prevention not only of forced labor, but also factory collapses and fires, unacceptable living quarters, sub-par medical care for accidents, shift break restrictions, and similar work-related hardships that do not rise to the level of forced labor as that term is defined in the beginning of this article.
Pitiable working conditions suffered by employees of suppliers are not addressed in the scope of current legal requirements, whether national or international, so disclosure upon discovery is rarely, if ever, required. If such working conditions are violations of supplier contract requirements, however, mistreatment of workers could justify rejection (or threatened rejection) of the goods and/or termination of the contract, unless the contract breach is remedied by the offending supplier within the time period provided. The efforts of internal governmental units and NGO investigators would be supplemented across the world by thousands of internal auditors’ feet on the ground, and what has been pervasive for too long might finally change.
[5]See Trade Facilitation and Trade Enforcement Act of 2015, Pub. L. 14-125, 130 Stat. 122 § 910(a); see also U.S. Customs and Border Protection, Repeal of the Consumptive Demand Clause.
[6] Soda ash, calcium chloride, and caustic soda from Tangshan Sanyou Group and its subsidiaries on March 29, 2016; potassium, potassium hydroxide, and potassium nitrate from Tangshan Sunfar Silicon Industries also on March 29, 2016; Stevia and its derivatives from Inner Mongolia Hengzheng Group Baoanzhao Agricultural and Trade LLC on May 20, 2016; and peeled garlic from Hangchange Fruits & Vegetable Products Co., Ltd. on September 16, 2016.
[7] A March 31, 2017 Executive Order on Establishing Enhanced Collection and Enforcement of Antidumping and Countervailing Duties and Violations of Trade and Customs Laws authorizes the Secretary of Homeland Security, through the commissioner of CBP, to develop implementation plans and a strategy for interdiction and disposal of inadmissible goods and to develop persecution practices to treat significant trade law violations as a high priority. https://www.cbp.gov/trade/trade-community/programs-outreach/convict-importations.
[10]See California’s Transparency in Supply Chain Act of 2012 (TSCA), Federal Acquisition Regulations §§ 52.222-256 (FAR), the UK Modern Slavery Act, the Netherlands Child Labour Due Diligence Law, France’s Corporate Duty of Vigilance Law, proposals for a corporate modern slavery reporting requirement in Australia and Pillar II of the UN Guiding Principles on Business and Human Rights (UN Guiding Principles), and the Sustainable Development Goals (also referred to as Agenda 2030) launched on September 25, 2015.
[16]Id. at § 1519 (“Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, . . . any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States . . . or contemplation of any such matter or case, shall be fined under this title, imprisoned no more than 20 years, or both.”).
[21]See Arms Export Control Act, 22 U.S.C. § 2778; International Emergency Economic Powers Act, 50 U.S.C. § 1705.
[22]See U.S. Dep’t of Justice, United States Attorneys’ Manual 9-28.000, 9-28.900 (2015) (“[P]rosecutors may consider a corporation’s timely and voluntary disclosure, both as an independent factor and in evaluating the company’s overall cooperation and the adequacy of the corporation’s compliance program and its management’s commitment to the compliance program.”).
[26] In an April 5, 2016 memorandum titled The Fraud Section’s Foreign Corrupt Practices Act Enforcement Plan and Guidance, the DOJ rolled out a program under which companies could receive a reduction in criminal penalties of up to 50 percent, avoidance of a compliance monitor, and even a declination to prosecute. Since its inception through the end of November 2017, the leniency program yielded 30 voluntary disclosures, and the DOJ issued seven declinations. See DOJ’s Pilot Program Declinations.
[27] U.S. Dep’t of Justice, United States Attorneys’ Manual 9-47.120, FCPA Corporate Enforcement Policy (2017).
You’ve worked out the thousands of details necessary to close an acquisition, you’re getting close to the signing date, and then . . . your antitrust colleague asks whether the deal team considered the relevant antitrust issues that may stem from the acquisition.
Don’t wait until this question stops you in your tracks. To help you think through these important issues early, below is a practical guide—and best practices—to dealing with antitrust issues during the lifecycle of an acquisition. Of course, each transaction is different and must be evaluated on a case-by-case basis, thus we recommend you contact antitrust counsel early in the process so that he or she can provide proper guidance.
Counsel, we’re ramping-up the due diligence process; are there any antitrust issues that I need to keep in mind?
As soon as possible, you should discern the competitive relationship between the parties. This is a key point that directly influences the level of antitrust scrutiny in the contemplated deal under Section 7A of the Clayton Act, 15 U.S.C. § 18, which prohibits transactions in the United States that may “substantially” lessen competition. Other jurisdictions around the world have similar tests. In general, transactions among competitors will be viewed more critically by antitrust authorities than other transactions. To determine whether your client competes with its merger partner, you should ask questions such as whether the parties have competing products or services and whether they compete for the same types of customers.
In addition, important antitrust issues can arise in the due diligence process, particularly with respect to sharing competitively sensitive information (CSI) with your merger partner.[1] If you determine that the parties are competitors even in broad terms, your client must take precautions to protect the flow of CSI. Section 1 of the Sherman Act, 15 U.S.C. § 1, prohibits a “contract, combination . . . or conspiracy” that unreasonably restrains trade. Information exchanges among competitors can therefore be risky under Section 1 because they may increase competitors’ (and to be clear, merging parties are considered competitors until they close the transaction) ability to collude or coordinate behavior that lessens competition between or among them. For instance, competitors exchanging price information could facilitate illegal coordination among them, and there are notable examples of competition enforcers finding instances of such facilitation when reviewing merger parties’ documents during the pendency of a review.[2]
Enforcement bodies around the world—including the Antitrust Division of the U.S. Department of Justice (DOJ), U.S. Federal Trade Commission (FTC), and European Commission (EC)—will investigate the improper sharing of CSI between competitors. They have made clear that the due diligence process does not provide a shield.[3] The most competitively sensitive information includes nonaggregated data relating to: (i) pricing, including information related to margins, discounts, and rebates; (ii) other confidential, customer-specific data for current or potential customers (i.e., relating to product plans or terms that will be offered); (iii) detailed research and development efforts or product forecasts; and (iv) other forward-looking, market-facing activities.[4] Although there are many categories of information that can be shared with fewer restrictions—such as balance sheets, aggregated and/or anonymized customer information, and operational systems—note that these are just examples of common categories of CSI and not an exhaustive list of information that should be monitored.
Given the importance of due diligence in evaluating the transaction, however, there are standard ways of sharing CSI that can limit antitrust risk involved in this process. For instance, CSI can be shared with outside counsel and other third parties assisting in the evaluation of the transaction to prevent a direct exchange between competitors. Further, certain CSI (e.g., relating to costs and prices) many times can be shared on an aggregated and historic level. Additionally, you can establish a clean team consisting of a small number of individuals within the organization to evaluate the CSI. Keep in mind that clean team members may need to be screened off from certain of their day-to-day responsibilities for a period, given the sensitive information they will learn. Regardless of how CSI is shared, it should be used only for the purpose of analyzing the potential transaction and only within a small group of individuals that must see it in order to properly diligence the potential acquisition. The most important thing with any protocol that is implemented is that it establishes a clear structure that limits who can see this information and how it can be used.
If an antitrust enforcement body believes there may have been an improper information exchange, it will likely open a separate investigation.[5] This will not only expose the parties to additional antitrust risk, which could include fines, but it could also lengthen any investigation related to the deal itself.
Counsel, the deal is moving forward; what else should the deal team be doing?
Given that a merger filing may be necessary, as explained below, it is never too early to remind members of the business team that their correspondence (including e-mails, voicemails, instant messages, text messages, handwritten notes, standalone documents, and presentations) regarding the deal may be evaluated by antitrust regulators. It is imperative that the business team members be factual and accurate in their communications because overstatements or hyperbole could be misinterpreted. Recent cases and statements from antitrust enforcers show that the U.S. government has relied heavily on the merging parties’ ordinary course documents when evaluating a transaction’s potential harm or filing a complaint to block a transaction. For instance, then-Acting Associate Attorney General and former Assistant Attorney General for Antitrust Bill Baer noted that the DOJ’s “assessments of competitive effects do not simply rely on quantitative evidence provided by expert testimony; we look at likely effects as shown by qualitative evidence, including party documents and industry and customer witness testimony.”[6] This is a trend that we have also noticed in cases with the EC in which the regulator will increasingly issue questions that focus solely on the merging parties’ internal documents.
Counsel, we’re negotiating the merger agreement; what about antitrust-related provisions in the agreement?
There are several antitrust-related deal points that can be addressed in the merger agreement itself, particularly where the deal carries antitrust risk. If the parties expect a lengthy regulatory review resulting in a divestiture or lawsuit to block the merger by an antitrust regulator, they can negotiate certain terms to alleviate some of that risk. For example, a “hell or high water” provision can be included that requires the parties to see the regulatory review process through litigation with the antitrust authorities and to use all or best efforts to get a deal cleared; a divestiture provision can be included that requires the buyer to divest certain assets in order to alleviate regulators’ concerns; or a termination fee provision can be included in the event that one or both of the parties decide against completing the acquisition because of regulatory concerns. Finally, and particularly for deals that may not close for an extended period of time due to antitrust scrutiny, your client should consider timing provisions, which specify a date by which the deal must be closed.
Counsel, it’s now time to consider the merger control process; what do we need to think about?
It is important to evaluate whether any antitrust-related filings are necessary as the deal progresses. In the United States, a deal can trigger a Hart-Scott-Rodino (HSR) filing obligation that requires the acquirer to pay a filing fee and provide certain documents to antitrust enforcers. The HSR filing requirements depend primarily on the value of the transaction and the size of the merging parties. Filings may also be required in many other jurisdictions around the world, with different filing tests or thresholds—including those relating to the parties’ turnover, asset values, and market shares. Antitrust counsel should be consulted early to manage the jurisdictional filing analysis.
Failure to comply with antitrust regulatory requirements can result in substantial fines. For instance, the EC has the authority to impose fines up to 10 percent of the aggregate worldwide turnover of the parties for failing to make a merger notification. In the United States, if a party is found in violation of the HSR Act,[7] 15 U.S.C. § 18a, it can be fined up to $40,000 per day.[8] Other jurisdictions (including Brazil, China, Canada, India, Japan, and Germany, among others) also have penalties for violation of applicable merger notification laws.
Finally, as noted above, some jurisdictions require the production of documents and the submission of accurate information as part of the filing. For instance, the U.S. antitrust bodies and the EC require the production of certain deal-related documents prepared by or for any officer or director. Failure to adhere to this requirement can result in penalties for the company. The DOJ, for example, imposed a $550,000 fine against a party for failure to provide required documents, even though the DOJ ultimately found that the deal did not pose any substantive antitrust issues.[9] In the EU, the EC fined Facebook EUR110 million for allegedly submitting misleading information in its acquisition of WhatsApp.[10] These cases provide an important reminder that filing requirements must be taken very seriously.
Counsel, we’ve now signed; are there pre-closing issues that we should be aware of?
Many of the questions we get from our clients relate to the scope of proper conduct after the deal has been signed, but before regulatory approval and closing. At a high level, the rule is that the two merging parties are still separate companies and must act accordingly. That means that they cannot go to customers jointly and sell products of the future, combined company. They also cannot exchange CSI without proper safeguards in place, integrate research and development efforts, or make any public statements (in press releases or to investors) that would imply that the two companies are one.
The merging parties have every incentive to start selling the benefits of the deal to clients and investors as soon as it is signed, but antitrust regulators will focus on improper conduct in combining the two merging parties, known as “gun jumping,” before they have received a chance to review the acquisition. For example, in November 2016, the French Competition Authority fined telecommunications company SFR and its parent Altice EUR80 million for allegedly implementing two transactions before receiving regulatory clearance.[11] Two months later in the United States, the DOJ settled gun-jumping allegations stemming from Duke Energy’s acquisition of Osprey Energy Center. There, Duke allegedly took control over Osprey’s output as well as received the right to Osprey’s day-to-day profits and losses.[12]
There is, however, some pre-closing conduct that is permissible. For instance, it is permissible for your clients to tout to customers or investors the benefits of merging the two companies and to begin to plan for day one of the merged company, including discussions on how to combine corporate functions, but it is not permissible to actually combine them. Another way to address pre-closing issues, in addition to the continued assistance by outside counsel and other third parties, is to have an isolated integration clean team that has no market-facing responsibilities in either company. These clean teams have the ability to plan for integration but are not exposed to CSI from either of the merging parties. This best practice allows the parties to structure the interim period between signing and closing in a way that prevents CSI from ever traveling from one party to the other.
Finally, your clients will often be eager to announce the acquisition for a whole host of strategic reasons. In those instances, it is important to make clear in any public statement that regulatory approvals are pending and that closing will occur only after those approvals are obtained. This rule applies to shareholder calls and any other public forum where executives may be talking about the acquisition.
Counsel, we’ve got approval from the regulators; what’s next?
Once you receive approval from all necessary regulatory agencies, no further antitrust obstacles prohibit you from closing, so close! Regulatory approval often is the last hurdle before an acquisition can close, so it is not difficult to convince clients to do everything they must do in order to complete this step. Although limited, there is some antitrust risk while the companies are still separate even after any antitrust review of the deal has closed.[13] Once they have merged operations, however, the two companies are now one and cannot be liable under the antitrust laws aimed at illegal agreements between competitors.
[1] Of course, nonantitrust issues can arise during the due diligence process as well. For instance, the sharing of personally sensitive information can result in privacy concerns.
[3] The FTC in a recent blog post highlighted this point, noting that that agency “looks carefully at pre-merger information sharing to make sure that there has been no inappropriate dissemination of or misuse of [CSI] for anticompetitive purposes.” Holly Vedova et al., Fed. Trade Comm’n, Avoiding antitrust pitfalls during pre-merger negotiations and due diligence (Mar. 20, 2018).
[4]See, e.g., id.; see also Michael Bloom, Fed. Trade Comm’n, Information exchange: be reasonable, (Dec. 11, 2014); Omnicare, Inc. v. UnitedHealth Group, 629 F.3d 697, 709–11 (7th Cir. 2011).
[5] The FTC highlighted this point in its recent blog post, noting that “if FTC staff uncover documents in their merger review indicating that a problematic exchange occurred, or that the parties may not have fully lived up to the protocols they established to protect confidential information, this may well result in FTC staff pursuing a separate investigation, potentially costing additional time and resources.” Vedova, supra note 4.
[11]See Press Release, Autorité de la concurrence (Republique Francaise), Gun jumping/Rachat de SFR et de Virgin Mobile par Numéricable – L’Autorité de la concurrence sanctionne le groupe Altice à hauteur de 80 millions d’euros pour avoir réalisé de manière anticipée deux opérations notifiées en 2014 (Nov. 8, 2016).
[13] For instance, as the FTC recently noted: “[companies] must also be conscious of the risks of sharing information with a competitor before and during merger negotiations—a concern that remains until the merger closes.” Vedova, supra note 4.
Digital accessibility is about the ability of people with disabilities to find, read, navigate, interact with, and create digital content. It is about people who use computers without being able to see a screen or hold a mouse, and it is about students who watch videos for school and pleasure who can’t hear or understand the audio.
Digital accessibility is achieved by meeting well-established and internationally accepted design standards and maintaining a culture of accessibility in business policies and processes.
Accessibility can be a team motivator, a source of creativity, and a business differentiator. It benefits not just people with disabilities, but aging boomers and anyone who prefers technology that is easy to navigate and use. In addition, digital accessibility is a civil right. Why? Because without it, people with disabilities are excluded from government services, employment, education, private sector offerings, and a host of other activities that happen online.
The Americans with Disabilities Act (ADA) has required digital accessibility for decades. There has recently been an increase in lawsuits and administrative complaints about digital accessibility in virtually every sector of the economy. For these reasons, digital accessibility is something every business lawyer should understand.
This article cannot cover everything a lawyer must know to advise businesses about accessible technology, but a good starting point is vendor contracts. Even companies with a commitment to digital inclusion can run into trouble if they purchase inaccessible content or technology.
In a recent accessibility lawsuit in Florida, a plaintiff sued both the website owner and the vendor who “designed and hosted” the website. Gil v. Sabre Technologies, Inc. et al., 1:18-cv-20156 (S.D. Fla. 2018). In addition, a federal judge ruled in 2017 that a grocery chain’s inaccessible website violated the ADA. The decision, now on appeal, ordered Winn-Dixie to “require any third party vendors who participate on its website to be fully accessible to the disabled.” Gil v. Winn-Dixie Stores, Inc., 242 F. Supp. 3d 1315 (S.D. Fla. 2017).
The risk of inaccessible products and ADA lawsuits can be minimized by implementing basic smart practices in vendor contracts. We welcome feedback about other practices that have helped your clients stay ahead of the legal curve and offer technology that is available to everyone.
Smart Practices for Addressing Accessibility in Vendor Contracts
Adopt an Accessibility Policy
Before asking vendors to deliver accessible digital products, an organization needs its own accessibility policy. At a minimum, the policy should state the organization’s commitment to digital accessibility and the standard for accessibility. The most commonly used standard is the Web Content Accessibility Guidelines 2.0 Level AA.
Other policies that build a strong accessibility foundation include putting accessibility in performance evaluations to hold employees accountable, ensuring all technologies (not just web) are covered, developing an effective training program, and having an efficient way for customers, employees, etc. to report barriers (and to fix them).
Include Accessibility Requirements in Requests for Proposals
Issuing an RFP for technology? Accessibility requirements must be included. Attach the organization’s accessibility policy, and be specific. Don’t just say the technology will “meet federal requirements.” List federal accessibility laws, such as the ADA and section 508 (federal procurement). For web content, specifically identify the applicable accessibility standard, e.g., WCAG 2.0 AA. In addition, list some disabilities as examples to ensure vendors know what is expected. A good resource is WebAIM’s People with Disabilities on the Web.
State the Requirements for Evaluating Accessibility
It is not enough to require accessibility. RFPs should specify how accessibility will be evaluated. Resources include the Web Accessibility Initiative’s Web Accessibility Evaluations Tools List and guidance for selecting tools. If a business is not sure what testing tool is best, ask what tool the vendor uses. The answer (or lack of one) will speak volumes.
Remember that 100-percent automatic (computerized) testing is not sufficient. RFPs should include requirements for user testing and require vendors to include disabled people in product testing. If possible, specify at what points in the development process disabled people should evaluate the product. Having users review a product early in the development cycle avoids costly fixes later. A review before delivery catches last-minute errors.
Evaluate Proposals for Accessibility
Insist that vendors provide accessibility information and be sure to read it and ask questions. Understand exactly what the vendor will do to ensure accessibility. In 2018, any vendor that says they’ve never worked with accessibility principles should be passed over. Vendors who provide seemingly strong accessibility answers should be questioned the same way vendors are evaluated for security and privacy issues. In other words, take it seriously and be specific. How do they know their product is accessible? What tests and standards did they use? Will they share test results?
Review VPATs with Care
Some vendors offer Voluntary Product Accessibility Templates (VPATs). If one is offered, it is important to read it and understand what it means. A vendor often will not answer the actual question for an accessibility standard or will give an unacceptable answer. For example, Section 508 requires that “At least one mode of operation . . . that does not require user vision shall be provided. . . .” The answer, “Support Line is available,” means the product is not accessible, and customers who can’t use the product online are expected to call someone who may or may not be able to help. Remember that a VPAT that says a product is “partially compliant” means it is “not compliant” in some respect. It’s up to your client to find out what that means and how to address it for their customers.
Put Accessibility in the Contract
Once a vendor is identified that can meet other criteria and deliver an accessible product, accessibility details must be spelled out. To avoid lawsuits and ensure all customers can use the business’s technology, make accessibility a contract term. Some specifics include the following:
state the accessibility standard (e.g., WCAG 2.0 Level AA);
state how and when the technology will be tested;
hold the vendor responsible if the product turns out not to be accessible by requiring the vendor to remediate barriers immediately, deliver a new product, return money paid, pay any damages and attorney’s fees incurred by the business, and/or pay any damages and fees the business must pay because of a complaint;
allow the business to do its own testing upon delivery, and require the vendor to remediate any identified accessibility barriers; and
given that accessibility defects may not be immediately apparent, specify vendor responsibility whenever a barrier needs remediation.
After the Ink Is Dried
Accessibility is not a “one and done” issue. It must be maintained and periodically evaluated. When problems arise, an efficient remediation system must be in place. Once a vendor has delivered an accessible product, here are some steps to prevent problems down the road:
when a customer or employee raises an accessibility problem, get the problem into the right hands and fix it as soon as possible;
train all customer-facing staff about the company’s accessibility policy and how to escalate to the appropriate person;
build a monitoring program that suits the size of the company to ensure accessibility is maintained, and train content creators (anyone who can post to the company’s website) to recognize, and use content management systems that flag, accessibility errors.
Finally, don’t keep a business’s accessibility commitment in the closet. Accessibility is a brand differentiator and a way to bring in more customers both with and without disabilities. Be explicit and transparent about accessibility efforts. It will make technology more usable for everyone.
The U.S. Department of Justice (DOJ) kicked off 2018 with two new resolutions to help clarify some enforcement and litigations policies, both of which are directly relevant to claims brought under the False Claims Act. The DOJ issued two internal memoranda in January 2018 that offer valuable insight into how the DOJ intends to prosecute, or opt to dismiss, pending and future civil enforcement actions.
On January 25th, the DOJ issued a brief memorandum limiting the use of agency guidance documents in civil enforcement cases where the government seeks to impose penalties or to recover money lost to fraud or misconduct, including False Claims Act cases, which often arise from government contracts in health care, construction, and defense services. The memorandum builds on a position statement issued by the DOJ in November 2017 in which the Attorney General announced that the DOJ was prohibited from enforcing as law any agency guidance documents that have the effect of changing the law or creating additional standards. The earlier statement makes clear that agency guidance—which is intended to provide advice illustrating the agency’s application or interpretation of the law—does not create binding legal obligations or requirements and cannot be treated as law by the DOJ.
The January 25th memorandum expands the restriction on the DOJ’s use of its own guidance to also restrict its use of other agencies’ guidance, clearly stating that the DOJ “may not use its enforcement authority to effectively convert agency guidance documents into binding rules.” Consistent with this policy, it instructs that the DOJ may no longer rely on a defendant’s failure to comply with guidance documents as a way to prove that the defendant violated the statutes or regulations discussed in those guidance documents. However, it draws a practical distinction: the DOJ remains free to use a defendant’s acknowledgment of guidance documents to show that the defendant had knowledge of the applicable law.
Although this policy will shape the DOJ’s prosecution in all civil enforcement cases, it is specifically noted that it applies in False Claims Act cases in which the DOJ alleges that a defendant knowingly committed fraud where it certified, falsely or incorrectly, its compliance with material statutory or regulatory requirements. This likely references the U.S. Supreme Court’s June 2016 decision in Universal Health Services, Inc. v. United States ex rel. Escobar et al., which recognized an implied false certification theory as a basis for False Claims Act liability and has since been the subject of significant attention in courts across the country.
The January 25th memorandum comes on the heels of another internal communication from the DOJ Civil Division’s Fraud Section on January 10th, which sheds new light on the DOJ’s decision-making process in asking courts to dismiss qui tam False Claims Act cases that, for any number of reasons, should be dismissed without further investigation or litigation.
Prompted by the record number of qui tam actions filed in recent years that have strained the limited government resources, the January 10th memorandum emphasizes the DOJ’s “important gatekeeper role” in preserving resources, protecting government interests, and avoiding unfavorable precedent caused by weak cases. Although the False Claims Act contains a dismissal provision that explicitly gives the DOJ the power to seek to dismiss a case over the objection of a relator (who stands to gain financially if their lawsuit leads the government to recover money), the DOJ historically has been hesitant to do so. This memorandum, however, encourages DOJ attorneys to consider not only their power to seek dismissal, but also their responsibility to do so.
With that directive in mind, the memorandum offers practical guidance on how the DOJ anticipates analyzing cases. Although the dismissal provision does not set forth a standard of review, most courts have adopted one of two standards, both offering considerable deference to the DOJ’s decision; one grants it an “unfettered right” to seek dismissal, whereas the other requires a “valid government purpose” for dismissal. Given that the dismissal provision is also silent as to any specific grounds for dismissal, the memorandum next presents a list of seven reasons that the DOJ has cited in seeking dismissals over the last three decades:
Curbing Meritless Qui Tams Although rarely cited (often because the DOJ’s investigation is not exhaustive enough to declare the case completely frivolous), a case’s lack of legal or factual merit is appropriate grounds for dismissal even if the DOJ extends the relator a grace period to come up with a stronger case.
Preventing Parasitic or Opportunistic Qui Tams The dismissal power may weed out qui tam cases that provide no new information or duplicate an existing investigation. This will prevent the relator from receiving a windfall recovery that would otherwise come out of the government’s (the public’s) share.
Preventing Interference with Agency Policies and Programs Seeking dismissal is appropriate where a qui tam delays or interferes with a program or policy that the government wishes to promote or pursue, particularly where the alleged FCA violation was based on a program the government intends to modify or reform.
Controlling Litigation Brought on Behalf of the United States Dismissal may prevent a weak qui tam case from prejudicing the DOJ’s efforts in other cases as a result of adverse precedents, contradictory rulings, or complicated settlements.
Safeguarding Classified Information and National Security Interests Themere potential for or riskofinadvertent disclosure of classified information is considered sound reason to seek dismissal from the court.
Preserving Government Resources Dismissal may be based on the fact that the government’s expected recovery is less than its expected costs, including the opportunity costs of not pursuing a better case.
Addressing Egregious Procedural Errors Where the relator has fumbled fundamental procedural requirements in a way that prejudices the government’s enforcement efforts, the DOJ should consider seeking dismissal.
The memorandum offers other advice regarding how to responsibly exercise the dismissal provision, including reiterating that the seven reasons listed are not exhaustive or exclusive grounds; in fact, the DOJ urges its attorneys to assert multiple and alternative legal grounds for dismissal. Its final recommendation is to proactively warn relators with defective or problematic cases about the probability of declination or dismissal because voluntarily dismissal by the relator is the common resolution after declination.
The European Union’s General Data Protection Regulation (GDPR) will come into effect on May 25th of this year. Although the GDPR has been a hot topic for some time in Europe, it has only recently received attention from companies outside the European Union (EU).
As the implementation date nears, many organizations outside the EU are wondering whether they are required to comply with the GDPR if they do not have a physical presence within the EU. Although the answer will largely depend on the specific activities of each organization, there are good reasons to believe that compliance with the GDPR may be required for many.
Territorial Scope of GDPR
Article 3(1) of the GDPR applies to EU-based organizations engaged in the processing of personal data (i.e., any information relating to an identified or identifiable natural person) belonging to EU data subjects. However, Article 3(2) goes a step further by extending the territorial scope of GDPR to organizations that are not physically established in the EU. The GDPR provides that the rules apply to a “controller” or “processor” who is not established in the EU and is engaged in processing of personal data of EU subjects. (A “controller” is an entity that, alone or jointly with others, determines the purposes and means for the processing of personal data. On the other hand, a “processor” is an entity that processes personal data on behalf of the controller. In some countries, such as the United States and Canada, local privacy laws do not make the same distinction between a controllers and processors.) Specifically, the GDPR will apply:
where the processing relates to the “offering of goods or services” to European data subjects regardless of whether payment is required), or
where the behavior of European data subjects within the EU is monitored.
There is no clear guidance as to what constitutes an “offering of goods or services” under Article 3. According to Recital 23, a case-by-case analysis must be conducted in order to determine whether a given activity can be deemed to be an offering of goods or services. Ultimately, the key is to determine whether the data controller or the processor intends to offer goods or services in the EU.
With respect to the second part of the test, behavior monitoring occurs when a natural person is “tracked on the Internet.” This includes the use of personal data to profile a natural person, particularly in order to inform decisions an organization makes about a particular individual by analyzing or predicting her or his personal preferences, behaviors, and attitudes.
European Representative
Where an organization not based in the EU—acting either as a data controller or processor—is subject to the GDPR, it will be required under Article 27 to designate a European representative. This representative is meant to receive communications addressed to the controller by the EU data-protection supervisory authorities and by data subjects.
It is noteworthy that Article 25 exempts controllers from this obligation under certain circumstances: if the processing is occasional, does not include the large-scale processing of “special categories of data,” and is “unlikely to result in a risk for the rights and freedoms of individuals, taking into account the nature, context, scope and purposes of processing.” Within this framework, “special categories of data” include those that reveal racial or ethnic origin, political or religious beliefs, or genetic, biometric, or health data.
Key Takeaways
The GDPR was intentionally drafted to ensure that it applies not only to EU-based organizations, but also to organizations based outside of the EU that handle the personal data of EU data subjects. Given the ubiquity of digital commerce, many organizations outside the EU—acting as a controller or processor—are likely subject to the GDPR as a result of the expanded territorial scope under Article 3.
If they have not already done so, organizations outside the EU should review their digital activities to determine whether they are actually subject to the GDPR and, if so, develop and begin the implementation of a GDPR compliance roadmap.
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In Digital Realty Trust, Inc. v. Somers, the Supreme Court of the United States defined the class of individuals protected by the anti-retaliation provision contained in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The Court held that to constitute a protected “whistleblower” under Dodd-Frank, a person must first “provid[e] … information relating to a violation of the securities laws” to the Securities and Exchange Commission (SEC, or the Commission). Any company that retaliates against such a whistleblower is potentially subject to damages and injunctive relief.
By incentivizing putative whistleblowers to report alleged misconduct directly to the SEC, the Court’s decision may result in more SEC investigations that occur before companies have had an opportunity to investigate internally. Because of the importance that the SEC places on its whistleblower program, companies should expect the SEC to continue to focus on investigations involving claims of retaliation, as well as continuing to focus on possible violations of Exchange Act Rule 21F-17. (The rule prohibits “any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement […] with respect to such communications.)
Statutory Whistleblower Protections
Both the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) and Dodd-Frank protect putative whistleblowers from retaliation. Sarbanes-Oxley protects all “employees” who report misconduct to a federal regulatory or law enforcement agency from retaliation, including the SEC, Congress, or any “person with supervisory authority over the employee.” By contrast, Dodd-Frank defines whistleblower as “any individual who provides … information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission.”
Notwithstanding the statutory definition of whistleblower in Dodd-Frank, SEC regulations implementing Dodd-Frank’s whistleblower anti-retaliation provisions do not require reporting to the SEC. The SEC regulations define whistleblower for purposes of Dodd-Frank’s anti-retaliation protections to include persons who report internally, as long as they report to a supervisor or to a person working for the employer who has authority to investigate, discover, or terminate misconduct.
The differences between the whistleblower protections in Sarbanes-Oxley and Dodd-Frank are significant because the statutes offer different paths to whistleblowers seeking redress for retaliation. Under Sarbanes-Oxley, whistleblowers cannot bring an action in federal district court unless they first exhaust their administrative remedies. Specifically, Sarbanes-Oxley requires an employee to file a complaint with the Department of Labor (DOL) within 180 days of the retaliation or learning of the retaliation. Only if the DOL fails to issue a final decision within 180 days after the whistleblower filed the administrative complaint may the whistleblower then file an action in federal district court alleging retaliation under Sarbanes-Oxley. On the other hand, Dodd-Frank permits whistleblowers to file complaints in federal court without first pursuing an administrative action. Dodd-Frank also extends the statute of limitations from Sarbanes-Oxley’s 180 days to a default limitation period of six years.
Sarbanes-Oxley and Dodd-Frank also authorize different awards to prevailing whistleblowers. Under Sarbanes-Oxley, prevailing whistleblowers are entitled to reinstatement, back pay, and litigation fees and costs, as well as other special damages. Under Dodd-Frank, prevailing whistleblowers can obtain not only reinstatement and litigation fees and costs, but also double back pay. (Dodd-Frank does not provide for special damages beyond litigation costs, expert witness fees, and reasonable attorney fees.)
The Somers Action
Paul Somers, a former vice president for Digital Realty Investment Trust, Inc. (Digital Realty), filed suit in federal district court, asserting a claim of whistleblower retaliation under Dodd-Frank. Somers alleged that Digital Realty terminated his employment shortly after he reported suspected violations of securities laws to senior management. Somers did not report his suspicions about violations to the SEC, nor did he file an administrative complaint within 180 days of his termination.
Digital Realty moved to dismiss Somers’ claim, arguing that Dodd-Frank’s whistleblower protections were not available to Somers because he had only reported internally, and had not provided any information to the SEC. The district court denied Digital Realty’s motion, finding the statutory scheme ambiguous and according deference to the SEC’s broad regulatory definition of whistleblower. A divided panel of the Court of Appeals for the Ninth Circuit affirmed the district court’s decision on interlocutory appeal. In doing so, the Ninth Circuit sided with the Second Circuit (which had likewise upheld the SEC’s regulatory definition) and disagreed with the Fifth Circuit (which had held that Dodd-Frank only protects employees who first report to the SEC).
Digital Realty sought review of the Ninth Circuit’s decision in the Supreme Court, which granted certiorari to decide whether Dodd-Frank’s anti-retaliation provisions extend to individuals who have not reported a violation of the federal securities laws to the SEC.
The Supreme Court’s Decision
In a unanimous opinion with two concurrences, the Supreme Court agreed with Digital Realty and held that to sue under Dodd-Frank’s whistleblower anti-retaliation provisions, a person must first “provide information relating to a violation of the securities laws” to the SEC. The Justices agreed that Dodd- Frank’s statutory definition of whistleblower is unambiguous, and that the SEC’s regulatory definition had impermissibly broadened the statute. The Court explained that Dodd-Frank’s statutory definition describes “who is eligible for protection” and advances Dodd-Frank’s overarching purpose of encouraging employees to report suspected securities violations to the SEC.
Significance
By restricting who can qualify as a whistleblower to persons who first provide information relating to a violation of the securities laws to the SEC, the Supreme Court’s decision in Digital Realty may incentivize employees to report suspected violations of securities laws directly to the SEC instead of internally.
Companies should not interfere with employees’ efforts to report information to the Commission. However, companies frequently design and implement their internal reporting mechanisms, policies, and training to encourage internal reporting of compliance matters, including potential violations of federal securities laws. Such internal reporting mechanisms generally enable companies faced with internal allegations of compliance failures to investigate, respond, and remediate—and to assess whether self- reporting to the SEC is appropriate—without a simultaneous SEC investigation.
When the Commission interpreted Dodd-Frank’s whistleblower anti-retaliation provisions not to require reporting to the SEC, it noted that “reporting through internal compliance procedures can complement or otherwise appreciably enhance [the Commission’s] enforcement efforts … .” The SEC argued that its interpretation of Dodd-Frank’s whistleblower anti-retaliation provisions to cover those who only report internally would help companies, by discouraging employees from bypassing internal mechanisms and taking their reports directly to the Commission in the first instance. Digital Realty may change those employees’ calculus. Now, those same employees may lean toward reporting to the SEC directly—so as to take advantage of Dodd-Frank’s retaliation protections—instead of relying on a patchwork of state laws or the more cumbersome Sarbanes-Oxley procedures for recovery for retaliation.
Such a response would continue the trend of increased reporting to the SEC. The SEC has stated that “[t]he whistleblower program has had a transformative impact on enforcement,” and the program continues to grow, with ever-increasing reports and awards. In 2017, for example, the SEC received 4,400 tips, an increase of nearly 50% since FY 2012, and the SEC ordered awards totaling nearly $50 million dollars to 12 individuals.
Digital Realty may result in the SEC receiving even more reports about possible violations from whistleblowers, and potentially reports of lesser quality. A purported whistleblower needs only a “reasonable belief” that the information he or she is providing to the Commission relates to a “possible” violation of the federal securities laws in order to qualify for Dodd-Frank’s anti-retaliation provisions. Before Digital Realty, whistleblowers who believed they had information about a possible violation of federal securities laws, but were not fully confident in their belief, may have been inclined to report internally. Now those persons may forego reporting internally in favor of reporting to the Commission in the first instance.
Digital Realty may also prompt the Commission to attempt to expand the ways employees can provide information to the SEC and therefore qualify as whistleblowers under Dodd-Frank. Dodd-Frank expressly authorizes the SEC to establish the “manner” in which a whistleblower may provide information to the Commission. In response to concerns voiced by the Solicitor General that employees who, for example, give testimony to the SEC may not qualify as whistleblowers under Dodd-Frank’s statutory definition, the Supreme Court expressly noted that “[n]othing in today’s opinion prevents the agency from enumerating additional means of SEC reporting.” Accordingly, the Commission may articulate expansive means through which an employee can provide information to the SEC for the purposes of Dodd-Frank, which could have the effect of further incentivizing employees to report externally.
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