A recent decision from the U.S. District Court for the Southern District of New York dramatizes the ongoing legal liability to which banking and other financial institutions are exposed when an economic fraud and resulting scandal occur. In this longstanding matter, Defendants Credit Suisse, Deutsche Bank, and Merrill Lynch remain very much in harm’s way due to allegations relating to their conduct in connection with certain debt securities issued by the now infamous Enron Corporation—nearly 17 years ago.

This case was originally filed in the Southern District of New York in 2002: Silvercreek Management, Inc. v. Citigroup, Inc. The case was transferred to the Southern District of Texas as part of the Enron multidistrict litigation. Discovery was completed in 2006. Later that year, the court certified a plaintiff class, of which Silvercreek opted out. Upon opting out, the court stayed Silvercreek’s claim pending the outcome of the class action. The class action concluded in 2010, the stay was lifted that year, and Silvercreek filed its complaint in 2011. Silvercreek moved to remand to the Southern District of New York in 2016. The motion was granted, and after a settlement with JP Morgan Chase and Barclays, the remaining defendants filed a motion to dismiss in 2017. The court denied this motion, leading to the current motion for summary judgment.

Victims of financial deceit routinely and directly seek recompense from banks sitting close to or in the chain of an economic fraud, and especially when the perpetrator is in bankruptcy. Such was the case here.

Background

In late 2001, investment group Silvercreek Management Inc. purchased nearly $120M of debt securities from Enron mere months prior to Enron’s high-profile December 2001 bankruptcy filing. Silvercreek alleged that the defendants each knew of, and substantially assisted, Enron’s deceit by designing, marketing, funding, implementing, and distributing numerous transactions utilized and deployed by Enron to essentially “cook its books.” Silvercreek sued the defendants for aiding and abetting Enron’s fraud and negligent misrepresentations, conspiring with Enron to commit fraud, their own negligent misrepresentations, and claims under state and federal securities laws. The defendants moved for summary judgment on all claims.

The Opinion

Judge Oetken denied the defendants’ summary judgment motions on Silvercreek’s claims for aiding and abetting Enron’s fraud. The court held that fact questions existed for a jury as to whether defendants had actual knowledge and substantially assisted with Enron’s fraud. The court stressed that although “red flags” or “warning signs” were not an acceptable substitute for actual knowledge, circumstantial evidence could be sufficient to allow plaintiffs’ claims to get to a jury and, as to each of the defendants, held that such evidence in fact existed in this case. The record included statements by Deutsche Bank employees that they should “torch” Enron files because of “something funky . . . in those [Enron] books.” Similarly, a Credit Suisse employee allegedly referred to Enron as a “house of cards.” In contrast, the record against Merrill Lynch was “devoid of blunt statements.” Still, the court ruled that a jury could find, given the totality of the circumstances, that Merrill Lynch substantially and knowingly assisted in Enron’s fraud.

Likewise, the court denied summary judgment against all defendants as to plaintiff’s civil conspiracy claims: “[t]o establish a claim of civil conspiracy, plaintiff must demonstrate the underlying tort [here, fraud], plus the following four elements: (1) an agreement between two or more parties; (2) an overt act in furtherance of the agreement; (3) the parties’ intentional participation in the furtherance of a common purpose or plan; and (4) resulting damage or injury.” The court ruled that a “reasonable jury [could] find that Defendants knowingly agreed to further Enron’s underlying fraud in conducting certain transactions.”

The court also went through an instructive defendant-by-defendant analysis of the record and Silvercreek’s claims that both Merrill Lynch and Credit Suisse made negligent misrepresentations when marketing certain of the notes at issue. The court reaffirmed New York’s requirement that the liability for negligent misrepresentation can exist only when a “special relationship” of trust and confidence exists between the parties, and where the injured party plaintiffs relied on that relationship. As a general principle, a broker-customer relationship typically does not qualify as a “special relationship” trigger for a viable claim of negligent misrepresentation; however, the court noted that the existence of such a relationship is always fact intensive, with each case being different. Therefore, if defendants recommended Silvercreek make the Enron purchases knowing Silvercreek would rely on the information provided, and that the defendants’ conduct linked them to Silvercreek’s reliance, such a relationship could be established.

Ultimately, the court found that Credit Suisse (but not Merrill Lynch) would have to answer the claims of negligent misrepresentation at trial. Specifically, the court held that there was evidence that could allow a reasonable jury to conclude that Credit Suisse directly solicited plaintiff’s investments, acted as broker for those purchases, and misrepresented existing facts as to Enron’s creditworthiness to establish the relationship required to sustain negligent misrepresentation claims. Although the relationship with Merrill Lynch was long standing, Silvercreek could not point to any specific facts distinguishing this relationship from the half-dozen other brokers and banks with which Silvercreek dealt. Notwithstanding dealing with other brokers and banks, the court would still have entertained the claim if Silvercreek had been able to show, with specificity, its reliance on Merrill Lynch’s statements.

What Does It Mean?

The decision and analysis in the Silvercreek case reinforces that banks will almost always be in the direct line of fire from plaintiffs whenever and wherever economic fraud strikes. The passage of time in the Enron scandal, or any “fatigue” that might have existed as a result of it, was of no moment to the court. These banks, absent a settlement or legal reversal, are now looking down the barrel of a jury trial on whether they knew of, aided, substantially assisted, conspired, and/or (in the case of Credit Suisse) made their own misrepresentations in connection with Enron’s fraud. This case should serve as a loud reminder to all financial institutions that their internal policies, procedures, supervision, and compliance protocols when making representations or soliciting investments must be robust. Personnel must also react to suspicions or concerns they see in e-mails, and must be equally mindful that such e-mails could form the basis of “evidence” against the bank—even 17 years later.

Mark A. Kornfeld is the co-chair of Quarles & Brady LLP Securities and Shareholder Litigation Practice Group, and is a partner resident in their Tampa office. Mark was one of the core attorneys contributing to the Madoff Recovery Initiative, where he served the Trustee and his lead counsel as the first chair of the Settlement and Expert Committees, and was one of the handful of attorneys to have interviewed Bernard L. Madoff in prison. Nicholas D’Amico is an associate in the Tampa office of Quarles & Brady LLP and is a member of the Business Law Group.

Although the legal industry understands the importance of sales and marketing efforts, there appears to be a disconnect between key decision makers and sales and marketing teams. According to the Legal Sales and Service Organization’s annual report, which tracks the emerging field of sales in law firms, 80 percent of legal sales professionals have an impact on revenue through sales; however, only 14 percent of survey respondents reported having a marketing/sales/business development seat on the firm’s management committee. How can a law firm effectively reach prospects and clients when it lacks resources or organizational structure to support sales and marketing efforts? Technology.

Technology has completely transformed the client intake process for law firms. Twenty years ago, the process looked very different than it does now—an individual in need of legal services would likely call a law firm, speak to a secretary or legal assistant, and then be connected with a lawyer or member of the legal team who could provide further assistance. There was no concrete process for determining who received the lead, and there was rarely any insight into how the individual connected with the law firm in the first place.

Law firms can now utilize customer relationship management (CRM) software, such as Salesforce, to assist with the client intake process. The ultimate goal of a CRM platform for the legal industry is simple: to help improve the relationship between law firms and clients. An American Bar Association (ABA) study found that 42 percent of the time, law firms take three or more days to reply to a voicemail or web-generated form from a prospective client. This delayed response time can be harmful when trying to build a relationship.

CRM platforms provide the ability to capture a lead, whether originating through a phone call or interaction with a law firm’s website, and help law firms keep track of where the lead is in the sales cycle. Understanding the status of each lead will help firms recognize trends that can improve the overall customer experience. For example, if the implementation of a CRM system helped a law firm identify that the longest step in the process was between initial contact and a follow-up from a member of the legal team, the firm could take necessary measures to shorten that timeframe.

Call-tracking and analytics systems are another technology platform helping law firms optimize the client intake process. Forty-nine percent of consumers expect a response from an attorney within a 24-hour window, according to FindLaw research; therefore, it is vital that firms use technology to shorten response time to a potential client’s phone call. Many call-tracking tools, such as Invoca, can integrate with CRM systems, allowing the data collected on those calls to be stored in an easily accessed platform.

If a law firm is trying to implement many different platforms, it can become overwhelming for the marketing or sales team to manage all the collected data. By partnering with technology companies that specialize in automating the sales and marketing process, law firms can streamline the lead generation and analysis process. These companies can build customized solutions that integrate the multiple platforms used by the firm.

In addition to customized solutions, technology companies can help law firms understand lead origination and, in turn, attribute the value of marketing efforts. A law firm will likely use a variety of different advertising or marketing efforts at once, so the ability to attribute how a lead came to the firm is extremely valuable in determining further marketing budgets. When firms can allocate the marketing budget in the communication channels that are most effective for clients, the overall relationship improves once again.

When law firms embrace technology, the overall client experience improves. With the help of a few tools—namely, a CRM platform and call-tracking systems—and a trusted partner to integrate various solutions, law firms will begin to understand clients and the intake process on a deeper level.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) was enacted in the wake of the 2008 financial crisis. Although reforms under Dodd-Frank primarily targeted large banks, they have affected banks of all sizes. During the years of implementation of Dodd-Frank, it became clear that the regulatory tightening in response to the crisis was becoming onerous especially for smaller community banks. In response, Congress, led by Senate Banking Committee Chairman Mike Crapo, passed the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, Pub. L. 115-174 (the Crapo Act). As a result of the relief provided by the Crapo Act, in addition to the current market environment for smaller banks, the industry expects to see increased merger and acquisition activity for both regional and community banks.

This new law provides meaningful relief for many financial institutions while keeping the basic framework of Dodd-Frank intact. However, many commentators have focused on the regulatory relief it grants to larger regional banking organizations. Specifically, it raises the asset threshold from $50 billion up to $250 billion for the systemically important financial institution designation at which enhanced prudential standards apply. These standards include, among other things, comprehensive, company-run stress tests. Prior to the Crapo Act, banking organizations had been reluctant to undertake mergers that would create a combined company exceeding $50 billion in assets because of the additional costs and regulatory scrutiny associated with enhanced prudential standards.

Although the Crapo Act reduces the regulatory burden for about two-dozen regional banks, it has a much more widespread effect on the nation’s community banks. (Federal Reserve Statistical Release, Large Commercial Banks as of March 31, 2018; see also Federal Reserve, National Information Center (there were 4,657 commercial banks, 481 savings banks, and 167 savings and loans chartered in the United States with assets less than $10 billion as of June 30, 2018)). Regulatory relief is granted to community banks through a few different avenues. (See Gregory J. Hudson & Joseph E. Silvia, Crapo Helps Community Banks, 135 Banking L.J. 456 (Sept. 2018 (discussion on how the Crapo Act reduces the regulatory burden for community banks)). This includes capital simplification, extended examination cycles, reduced reporting requirements, and increased simplicity for small bank holding companies to finance the acquisition of banks. More specifically, the Crapo Act lays out a capital simplification scheme through the establishment of the “community bank leverage ratio,” it raised banks’ eligibility for an 18-month exam cycle from $1 billion to $3 billion in assets, and made short-form call reports available for banks under $5 billion. Banking organizations with assets less than $10 billion are also provided relief from the prohibitions on proprietary trading and relationships with hedge funds and private equity funds under section 13 of the Bank Holding Company Act—the so-called Volcker Rule.

Finally, the Crapo Act reforms expanded the number of institutions eligible to use debt to facilitate bank merger and acquisition transactions. This was accomplished by amending the Federal Reserve’s Small Bank Holding Company Policy Statement (the Policy Statement), which we review below.

Small Bank Holding Company Policy Statement

On August 30, 2018, the Federal Reserve published an interim final rule in the Federal Register, which was effective the same day and implements relevant provisions of the Crapo Act by expanding the applicability of the Policy Statement through an increase in the Policy Statement’s asset threshold from $1 billion to $3 billion in total consolidated assets. The Policy Statement also applies to savings and loan holding companies with less than $3 billion in total consolidated assets.

Almost 40 years ago, the Federal Reserve acknowledged that small bank holding companies have less access to equity financing than larger bank holding companies; therefore, the transfer of small-bank ownership often requires acquisition debt, which was previously unavailable to them. Accordingly, the Federal Reserve originally adopted the Policy Statement in 1980 to allow small bank holding companies to assume debt at levels higher than typically permitted for larger bank holding companies. (Regulation Y, 12 C.F.R. § 225, Appendix C to Part 225 (Small Bank Holding Company and Savings and Loan Holding Company Policy Statement)). Under the Policy Statement, holding companies meeting the qualitative requirements described in Regulation Y may use debt to finance up to 75 percent of an acquisition, subject to the following ongoing requirements:

1. Small bank holding companies must reduce their parent company debt consistent with the requirement that all debt be retired within 25 years of being incurred. The Federal Reserve also expects that these bank holding companies reach a debt-to-equity ratio of .30:1 or less within 12 years of the incurrence of the debt. The bank holding company must also comply with debt servicing and other requirements imposed by its creditors.
2. Each insured depository subsidiary of a small bank holding company is expected to be well capitalized. Any institution that is not well capitalized is expected to become well capitalized within a brief period of time.
3. A small bank holding company whose debt-to-equity ratio is greater than 1:1 is not expected to pay corporate dividends until such time as it reduces its debt-to-equity ratio to 1:1 or less and otherwise meets the criteria set forth in Regulation Y. (See 12 C.F.R. § 225.14(c)(1)(ii), 225.14(c)(2), 225.14(c)(7)).

This marks the third time the Policy Statement has been amended. It was previously revised in 2006 to raise the asset threshold from $150 million to $500 million. In 2015, the asset threshold was raised further from $500 million to $1 billion, and the scope of the Policy Statement was expanded to include savings and loan holding companies.

Legislation Encourages Bank M&A Activity

When the Policy Statement was first adopted in 1980, there were more than 14,000 commercial banks, according to the FDIC’s Historical Statistics on Banking. Today, there are less than 4,900 commercial banks. Bank failures play a role in the decline in the number of banks, but so do mergers and acquisitions. Over the last 10 years, there were approximately 2,300 bank mergers in the United States.

There are a number of factors beyond just regulatory relief that could drive further consolidation across the banking industry. Yet, the reforms implemented under the Crapo Act will encourage merger and acquisition activity. Regional banks have been reluctant to complete acquisitions that would push their asset size above the $50 billion threshold due to the enhanced prudential standards that would then apply. However, the Crapo Act’s increase in that threshold allows many regional banks to complete substantial acquisitions while remaining well below the new $250 billion threshold.

In addition, the revised Policy Statement allows an additional 280 small bank holding companies to use debt to facilitate acquisitions of other smaller banks. As a result, there are now 3,670 holding companies that can take advantage of the Policy Statement. The increased asset thresholds for the applicability of the enhanced prudential standards, along with the increased asset threshold for small bank holding companies to take advantage of the Policy Statement, is expected to result in further consolidation of the industry through increased merger and acquisition activity.

Gregory J. Hudson is director of examinations at the Federal Reserve Bank of Dallas where he oversees the regulatory supervision of banks and holding companies. Joseph E. Silvia is senior counsel in the Banking and Financial Services Department and a member of the Bank Corporate Group in the Chicago office of Chapman and Cutler, LLP. Messrs. Silvia and Hudson currently serve as chair and vice chair of the ABA Banking Law Subcommittee on Community Banks and Mutual Savings Associations. The authors thank Mimi Connors for her assistance. The views expressed do not necessarily reflect the official positions of the Federal Reserve System.

Interpretation of the Federal Arbitration Act (FAA) has been a frequent issue considered by the U.S. Supreme Court this year. On October 29, 2018, the Supreme Court heard oral argument in Lamps Plus, Inc. v. Varela, No. 17-988. In Lamps Plus, the Court considered whether the FAA precludes a state-law interpretation of an arbitration agreement that would authorize class arbitration based solely on general language commonly used in arbitration agreements. The Court’s analysis in answering this question will necessarily implicate its prior ruling in a 2010 decision, Stolt-Nielsen, S.A. v. AnimalFeeds International Corp., wherein the Court held that in light of the fundamental differences between class and bilateral (one-on-one) arbitration, class arbitration cannot be required unless there is a specific contractual provision in the agreement that would support the conclusion that the parties agreed to arbitrate as a class. As a result of the decision in Stol-Nielsent, courts will not presume that an agreement to arbitrate exists based upon the fact that the agreement in question is silent on the issue of class arbitration or based upon the mere fact that the parties agreed to arbitrate at all.

Despite this precedent, a divided panel of the U.S. Court of Appeals for the Ninth Circuit, utilizing state contract construction canons, determined that the parties in the Lamps Plus dispute had agreed to class arbitration based upon the standard language in their agreement, which stated that “arbitration shall be in lieu of any and all lawsuits or other civil proceedings,” and which provided a description of the substantive claims subject to arbitration. The Ninth Circuit’s decision contradicts decisions by a multitude of other appellate courts, i.e., the Third, Fifth, Sixth, Seventh, and Eighth Circuits, all of which have concluded that the FAA preempts state contract law in determining this issue because the FAA requires affirmative evidence of consent as a matter of federal law.

By way of factual background, this case arose out of a class-action lawsuit initiated by Frank Varela against his employer, Lamps Plus, which had inadvertently released Varela’s personally identifiable information (PII) and that of other employees in connection with a third-party phishing scam. In response to Varela’s lawsuit filed in the U.S. District Court for the Central District of California, Lamps Plus sought to compel arbitration based upon the provisions of Varela’s employment agreement, which contained no provisions providing for class-action arbitration. The district court compelled class arbitration, finding that the mere absence of a reference to “class action” in the agreement was not alone determinative, but rather federal law required an absence of agreement on the issue.

Lamps Plus appealed, arguing that the FAA requires a specific contractual basis showing the parties’ intent to arbitrate class actions and contending that the district court could not read into the contract an agreement to class arbitration based on language relating to personal disputes. Further, Lamps Plus argued that even if the contract was ambiguous as to intent, U.S. Supreme Court precedent supported a resolution of such ambiguity in favor of arbitration. The Ninth Circuit subsequently upheld in part the district court’s ruling. Lamps Plus then filed a petition for certiorari.

Varela has opposed the appeal, contending that in the first instance, the Supreme Court lacks jurisdiction to hear the appeal. With respect to the merits, Varela argues that California contract law interpretive principles used by the district court were properly applied and, thus, should not be overturned. Although Varela agrees that interpreting private contracts is normally a question of state law and that the FAA requires enforcing agreements to arbitrate through that state law, Varela focuses on certain standards of contract interpretation. The Ninth Circuit recognized a reasonable layperson standard for interpreting the contracts. Varela thus points to specific language in the underlying contract that expressly waives Varela’s right “to file a lawsuit or other civil action or proceeding,” and argues that “proceeding” could reasonably be interpreted to include class actions according to California’s standard.

Lamps Plus contends that there are no jurisdictional issues because the dispute arises out of an appealable order dismissing Varela’s claims. Lamps Plus asserts that the district court’s decision to compel class arbitration was an adverse decision that is subject to appeal, and on matters of appellate jurisdiction, the Court must focus on the underlying substance of the dispute rather than the form. In response, Varela argued that not only did the circuit court lack jurisdiction over the appeal, but Lamps Plus lacked standing to even seek an appeal. According to Varela, section 16(b)(2) of the FAA explicitly prohibits appeals directly from interlocutory orders directing arbitration to proceed. Further, Varela contends that the determination by the Court granted Lamps Plus its desired relief—a dismissal of the individual claims brought by Varela. That the Court determined to direct class arbitration is not a decision adverse to Lamps Plus, even though it may not like the result.

Oral argument on this appeal seemed to indicate a potential split among the justices. Justice Kagan focused in particular on the language of the arbitration agreement, and her questions suggested that she believes the language of the agreement is broad enough to encompass class arbitration. Similarly, Justice Sotomayor seemed to recognize that state law controls the interpretation of arbitration agreements and did not seem inclined to embrace the “clear and unmistakable” standard put forth by Lamps Plus. However, certain of the other justices questioned Varela as to whether arbitration was the appropriate forum for resolving class claims, including a specific concern that allowing class actions to be handled in this manner could open the door for potential class members to be bound by an arbitration award even though they never agreed to arbitration in the underlying agreement.

This is the third issue involving the FAA before the Supreme Court in the past year. Looking at the one decision that has already issued may provide some guidance to where the Court could be headed when a decision on Lamps Plus issues next term. Earlier this year, the Court decided Epic Systems Inc. v. Lewis, in which the Court emphasized that Congress, through the FAA, was instructing courts to enforce arbitration agreements as written. In light of Lewis, and keeping in mind prior precedent under Stolt-Nielsen, it is possible that the Supreme Court may reaffirm the principles of Stolt-Nielsen and hold that class arbitration cannot be forced upon a party in the absence of specific and unambiguous contractual language authorizing class arbitration. Whatever the result, business lawyers must keep these recent decisions in mind when they draft arbitration agreements and contemplate the waiver of class arbitration.

The U.S. Supreme Court recently ended a nearly six-year legal battle regarding the constitutionality of the Professional and Amateur Sports Protection Act (PASPA). In Murphy v. National Collegiate Athletic Association, 138 S. Ct. 1461 (2018), the Supreme Court, with Justice Alito authoring the majority opinion, joined by Chief Justice Roberts and Justices Kennedy, Thomas, Kagan, and Gorsuch, held that PASPA violated the 10th Amendment’s “anti-commandeering” principle, which provides that if the Constitution does not give power to the federal government or take power away from the states, that power is reserved for the states or the people themselves.

In essence, the Supreme Court held that “PASPA’s anti-authorization provision unequivocally dictates what a state legislature may or may not do,” and further, there is no distinction between “compelling a State to enact legislation or prohibiting a State from enacting new laws.” Rather, the basic principle of anti-commandeering applies in each case, and Congress cannot issue a “direct order to state legislatures.”

Additionally, the Supreme Court held that no part of PASPA could be salvaged because it was unconstitutional in its entirety. The Supreme Court reasoned that no provision could be severed from the provisions directly at issue—the anti-authorization provision and the prohibition on state licensing of sports gambling schemes. The remaining provisions in PASPA—(1) prohibiting states from licensing or operating sports gambling schemes, (2) prohibiting private actors from operating sports gambling schemes “pursuant to” state law, and (3) prohibiting advertising of sports gambling—were too closely intertwined with the main provisions at issue and could not survive independently.

This decision has ushered in the next gold rush for the U.S. gaming industry. Delaware, Mississippi, New Jersey, Pennsylvania, Rhode Island, and West Virginia have legalized sports betting and are taking bets. Arkansas and New York[1] have legalized sports betting but have not started taking bets. In addition, one tribe in New Mexico launched sports betting in its casino in October. With this period of unprecedented sports wagering expansion, however, comes a rapidly evolving legal landscape and important hurdles of which both gaming and nongaming attorneys must be mindful as they counsel clients.

First, although PASPA has been overturned, the decision did not result in an unbridled legalization of sports betting. In the states that have authorized sports betting, it is still unlawful for individuals to conduct their own sports betting offerings without undergoing licensure and adhering to a strict regulatory framework. Moreover, as discussed below, the parties that can even obtain operational licenses are restricted. Thus, interested parties exploring this space must understand licensing requirements and operational restrictions.

Second, although interstate sports betting would be a windfall for licensed, sports book operators, interstate sports wagering remains unlawful under the federal Wire Act, 18 U.S.C. § 1084. The Wire Act currently prohibits the knowing use of a wire communication facility to transmit in interstate or foreign commerce bets or wagers, information assisting in placing certain bets or wagers, or any information that entitles the recipient to money or credit resulting from such a wager on any sporting event or contest. Until the Wire Act is repealed or amended, sports betting will be conducted on only an intrastate basis in those states that authorize sports wagering. As a result, each operator must comply with each jurisdictions’ requirements, whether regulatory or otherwise, which itself presents a host of issues. Most notably, depending on how uniform these requirements are from state to state, a multijurisdictional operator may have to develop an independent infrastructure and product in each jurisdiction to conduct its sports wagering operations.

Federal lawmakers are currently studying the various issues related to sports betting regulation. In September, the first hearing on sports betting was held by the House Subcommittee on Crime, Terrorism, Homeland Security, and Investigations (the Committee). Chris Krepich, press secretary for Committee Chairman Jim Sensenbrenner (R-Wis.), told Bloomberg Tax in an e-mail that the Committee is considering what role Congress should have as states begin to develop policies toward sports wagering, including a potential amendment to the Wire Act.

On November 15, 2018, Sensenbrenner sent a letter to Deputy Attorney General Rod Rosenstein urging the Department of Justice (DOJ) to work with the Committee to protect the public from nefarious organizations that may use online gambling sites to launder money and engage in identify theft. The letter posed three questions to the DOJ: (1) whether the 2011 Office of Legal Counsel opinion that reinterpreted the Wire Act to permit online gambling is currently supported; (2) whether any DOJ guidance is currently provided to states interested in authorizing sports betting; and (3) whether the DOJ foresees any legal and illegal issues that may arise regarding sports betting if Congress takes no action in response to the Supreme Court’s decision. Sensenbrenner noted at the September hearing that he was presented with three viable options for Congress: (1) re-enact a federal prohibition against sports betting; (2) give complete deference to states to regulate sports betting; or (3) adopt uniform federal standards. Congress taking no action, he stated, would be the worst option.

Whether federal lawmakers will seriously consider repealing/modifying the Wire Act is uncertain. However, even if they decide to act, a complete regulatory scheme will take significant time given the current political environment and outstanding issues. For example, if the Wire Act were amended to allow interstate sports wagering, a host of questions must be addressed, such as how taxation would work if the operator is located in a state different than the bettor, and which state would be entitled to the tax revenue. In the interim, states are pushing forward with their own legalization efforts.

Not surprisingly, similar to the federal legislative process, interested stakeholders have varying degrees of power and influence on a state-by-state basis. This includes the commercial/tribal gaming operators, state lotteries, local/state governments, and trade associations, just to name a few. Similar to New Jersey’s implementation of internet gaming, which requires any internet operator to partner with a land-based operator, the land-based operators who previously spent considerable capital to develop land-based infrastructure will likely demand similar partnerships for sports wagering if a third-party operator enters their marketplace. In contrast, the District of Columbia, which does not have casinos, has a bill pending that will authorize the D.C. Lottery to act as regulator and operator of mobile sports betting. Executive Director of the D.C. Lottery, Beth Bresnahan, told GamblingCompliance that of the 408 retail lottery locations, only about 20 percent are expected to participate. This may include kiosks that allow for straight bets or parlays. The current version of the bill grants the D.C. Lottery authority to offer online and mobile sports betting throughout the district, whereas private operators could offer retail betting, and any mobile betting is restricted to the confines of the establishment.

In addition to the aforementioned stakeholders, you have the professional leagues. The leagues initially pushed for their much maligned “integrity fees,” which effectively serve as a royalty fee. In short, the leagues feel entitled to receive some form of compensation from the sports book operators because authorized sports betting is based on professional league games. Although such a fee is not unprecedented, given that professional sports leagues in France and Australia receive a percentage of wagers made in those jurisdictions, the likelihood of such fees built into U.S. regulation is dwindling due to the extensive opposition received from the industry. As a result, none of the states that have enacted legislation authorizing and regulating sports betting have incorporated integrity fees.

In lieu of integrity fees, leagues have begun to partner with sports book operators for branding purposes. For instance, in August the NBA became the first major U.S. sports league to partner with a sports book operator, namely MGM, in a deal that is estimated to be worth $25 million. Pursuant to this exclusive partnership, MGM was named the exclusive official gaming partner of the NBA and receives the rights to use league highlights, logos, and a direct data feed. Additionally, to further promote sports betting integrity, stakeholders in the betting industry, including Caesars and MGM, formed the Sports Wagering Integrity Monitoring Association in November for the purpose of partnering “with state and tribal gaming regulators; federal, state and tribal law enforcement; and other various stakeholders to detect and discourage fraud and other illegal or unethical activity related to betting on sporting events.” See https://www.bna.com/nevada-sports-books-n57982093300/.

The other opportunities created by the recent decision that are often overlooked are those that have availed themselves in tribal gaming jurisdictions. In addition to the massive opportunities for commercial gaming jurisdictions, the same potential for success exists among tribal gaming jurisdictions. Some tribes have a monopoly on gaming in certain states pursuant to tribal-state compacts entered into between each sovereign nation and the state. Compacts often offer tribes within the state the exclusive right to offer gambling, with the exception of state-operated lotteries or limited amounts of racetracks. As such, many tribes have successfully operated casinos for many years and are capable of offering sports betting. Given the large amount of market share tribes hold, along with their established gaming facilities, there is great potential for sports betting success in tribal gaming jurisdictions.

These are just a few examples that highlight the significant lobbying and advocating in every jurisdiction by the stakeholders to maximize the potential benefits that each would enjoy.

Although the stakeholders and regulatory environment may vary from state to state, certain regulatory components, e.g., standards to ensure integrity, are fundamental to the make-up of an effective sports betting regulatory regime. So, although the regulations may vary based on the particular policy goals in each jurisdiction, the universal policy goal should be ensuring the operations are conducted in a fair and honest manner, and that the integrity of the industry is vital to its success. Without an effective regulatory framework, any short-term success will be followed by increasing issues that will weaken public confidence and support for the industry.

In summation, the Supreme Court’s decision is a big step forward for the sports wagering industry in the United States. That said, several impediments still exist, the largest of which is the Wire Act. Until the Wire Act is amended or repealed, sports book operators will be required to undergo licensing and establish sports wagering infrastructures in each jurisdiction where they operate. Additionally, interested operators will have to account for any interested stakeholders and their varying degrees of power and influence. For instance, in certain states such as New Jersey, sports book operators must partner with existing land-based casinos. In other states they must partner with the lottery or racetracks.

Lewis Roca Rothgerber Christie LLP’s gaming practice has been at the center of these issues in Nevada, the United States, and internationally. If you need assistance, whether it is providing advice, analysis, and/or evaluation of the numerous opportunities, regulatory frameworks, and issues that will arise in the coming years as legalized sports wagering expands, please do not hesitate to contact the authors: Karl Rutledge at [email protected], Glenn Light at [email protected], or Mary Tran at [email protected].

[1] Legislation to permit full-scale sports betting in New York failed in June 2018, but New York passed a law in 2013 to allow sports betting at four on-site locations. This law could be revived, and the New York State Gaming Commission is aiming to complete regulations “in the short term” for the four locations specified in the 2013 law. http://www.espn.com/chalk/story/_/id/19740480/gambling-sports-betting-bill-tracker-all-50-states.

Commercial real estate markets have experienced significant challenges over the last decade in all regions and sectors of the country, from retail to office to medical to senior living to golf courses. Some facilities and developments have thrived and continue to thrive, while others are subject to relentless external changes and influences in our economy. Every real estate sector in the country has experienced changes in their markets due to increases in internet and online sales, shifts in spending habits and interests, changes in demographics, declines in revenues, increases in over-built areas, increases in virtual offices, and declines in population centers, among other factors. Given these market challenges, the repurposing of commercial properties will likely focus on who the ultimate owner is to solve them, what the obstacles are in reshaping the property, and what some of the solutions to the challenges include. No doubt, innovation, creative thinking, and capital investment will be needed for the repurposing of spaces in these sectors.

As for retail, news articles are full of stories reporting that over 8,000 stores were closed in 2017, and 2018 is on track to see the same or a higher number of store closures. Some retailers have gone out of business completely; others have downsized significantly, decreasing the number of stores and concentrating on their more profitable areas. On the other hand, Amazon and other similar types of businesses with increasing online sales have expanded their distribution centers and are experimenting with ventures with other businesses in brick-and-mortar areas to fill in their business models. Consumers have changed their spending trends, which has caused retailers to chase them via online sales, thus choosing a different kind of shopping cart.

Landlords have been significantly impacted by store closings and have had to change their tenant mix and repurpose their shopping centers. The owner, the landlord, the lender, and the ultimate buyer of the property have all had to adjust and evolve to repurpose and redevelop their projects. Capital investment of course is needed. In some limited situations, shopping malls have been razed or “de-malled.” In others, significant renovations and redevelopment have taken place. There are multiple examples of landlords and owners changing the mix of shops and restaurants and activity centers to include theaters, gyms, walk-in medical centers, entertainment spaces, museums, aquariums, bowling alleys, arcades, and other experimental and service-oriented tenants in what has traditionally been retail sales space. Other changes include nonretail uses, such as charter schools, community colleges, call centers, libraries, multifamily housing, medical space, and a mix of uses to increase traffic and neighborhood involvement. Some proposals require zoning and other entitlement changes. It is plain to see that creativity, flexibility, and capital are needed to repurpose the changing landscape in retail space.

As for healthcare and senior living space, the aging population will continue to drive this sector for years to come. Trends toward more outpatient care have grown in order to provide lower costs and have impacted the traditional healthcare space. Medical office space has continued to increase, and hospitals have seen growth in metropolitan areas, although declining revenues have impacted community and rural hospitals. Driving the pressure were problems such as payment delays, bad mergers, overexpansion, reimbursement changes, rapid changes in the healthcare environment, and tort litigation, among others. Some of the senior living facilities also experienced challenges with deferred maintenance, capex constraints, slow revenue increases, and competition in increased outpatient care. In addition, the industry is complex due to nonprofit ownership, state regulatory structures, single tenant usage, and public financing. Solutions exist, including consolidation of uses and administrative costs, expansion into independent living, and repurposing of facilities to include other, additional medical usages, and where appropriate closing facilities or buildings and repurposing the property for nonmedical uses. Struggles continue, but like the other real estate areas, creativity, capital, and community involvement can give this sector a much-needed shot in the arm.

As for golf courses and recreational properties, the challenges to the industry appear to be caused by factors such as overbuilt facilities, extensive costs for maintenance of facilities, declining demographics, and flat markets, among others. However, membership alternatives and a variety of users seem to be the keys to driving improvements in golf and recreational properties. Expansion of categories of membership, expansion of family facilities, reconfiguration of the course, or even consolidation of other clubs and courses into a new program all seem to be in the mix to repurpose this sector.

In sum, innovation, creative thinking, and capital investment are necessary to surviving and repurposing the changing landscape in all of these sectors of commercial real estate. Owners must challenge their traditional thinking on uses and users and try different concepts. In today’s market, there are a growing number of creative ideas, innovation, and applications of capital that appear to be part of the solutions that must be made to make the properties and industries profitable and productive again.

Blockchains reduce the need for “trust” in legal transactions. From a legal perspective, trust has some specific meanings with respect to custody, control, and transactional risk. It can be accurately defined as “reliance on assurance of others to reduce transactional risk.” Blockchains radically shift the economics of providing transactional assurances.

For example, blockchains reduce the cost and complexity of obtaining assurances of asset ownership and control. Blockchain offers a cheaper and more reliable mechanism of creating, storing, and proving evidence.

Commercial and financial legal processes currently rely on numerous systems to reduce overall transactional risk and give people enough confidence to transact. A critical legal inquiry regarding any kind of property is, who owned title, when, and what is the transactional history? In asset transactions, property registries provide custodial and financial histories. To risk buying an item or making a loan secured by property, a buyer or creditor must be able to verify that the person purporting to own the property really does have title, and that there are no other enforceable inconsistent claims.

For high-value, complex transactions, this means obtaining assurances of (1) proof of authoritative title to an asset (title is clean and untampered), and (2) proof that the proof of title is reliable (the source of assurance (1) is clean and untampered). Underpinning it all is property law. Rules of property law apply whether the object in question is a house, a retail installment contract, or a digital token. Critical to property law is the concept of title, or ownership of property.

Legal systems have developed multiple property registries and custodial systems to manage information and give buyers, lenders, and invested parties the ability to verify whether a specific deal represents an enforceable obligation. Financial market infrastructure spends tremendous sums to maintain structures that provide assurances of things like chain of custody and title.

Registries. Creditors and other interested parties file notices with deeds registries, secretaries of state, departments of motor vehicles, and places a creditor checks for notice of an adverse interest. Common examples are land registries and, in the United States, the U.C.C.-1 filing registry within a state. The registry record is deemed authoritative for legal enforcement of contracts, and insurers, lenders, buyers, and sellers rely on it equally to track rights and obligations. The records produced by central property registries supply chain of title and custody details.

Registries like these developed out of need: without a reliable system for registering, or “perfecting,” one’s interest in property, market confidence in buying, selling, and lending is disincentivized. Functional registries make functional markets.

Custody and Control of Intangibles. Second-and-third order monetization of a value stream often involves intangible property. For example, financial products leverage contract rights and obligations to create additional assets and revenue streams like securities and derivatives. In pre-internet commerce, custody and control of intangible assets were proved by “possession”; a lender holding a note as a security pledge against a loan might actually take possession of the note. It is impractical to run valuable paper instruments from holder to holder in real time, so the notes were placed with a trusted third party who acted as intermediary, for example, holding the notes in custodial trust, matching and settling promises to pay. The market assigned possessory rights to custodial agents who held assets “in trust” and maintained their chain of title so deals were free to flow without paper slowing them down.

Electronic Contracts. With the advent of electronic contracts, the law evolved a new method of perfecting a security interest in digital originals of notes and chattel paper. The key, when vaulting an electronic contract, is to prevent multiple copies that might result in adverse claims, or “double spends” of the same obligation. Sounds familiar!

Electronic contracting laws like Uniform Electronic Transactions Act (UETA) established standards for vaulting and proving custody and control of digital assets. The UETA drafters, however, noted that their recommendations were based on late-20th-century technological capabilities to establish “control.” UETA’s custodial “control” requirements substitute for possession to perfect electronic contracts in the absence of a unique digital “token” to represent a contract. The drafters looked to the market to develop better systems of digital asset control.

Where Blockchain Comes In

A better property registry. Blockchain gives us a decentralized, tamper-evident record of what happened and when with respect to data stored in specific tokens. This tamper-evident ledger means less reliance on central authorities to prove the integrity of assets. A blockchain-based property registry proves its own transactional history.

Assets that prove their own chain of custody. Blockchain-based data objects can represent any number of property types extrinsic to the blockchain, as well as assets that are native to digital technology, e.g., tokens. A blockchain-native asset represented by a token is inherently and immutably tied to its transaction history. This means assets stored in a blockchain can prove their own titles, chains of custody, and transactional records.

Blockchains can get chain of custody right. Without structures that prove chain of custody, the lack of reliable proof structures has a chilling effect on legitimate commerce. Blockchain offers a low-cost way to scale legal infrastructure and build commercial rails on the bedrock of rule of law.

Poorly controlled legal proof structures are also a problem with existing custodial systems. For example, after the 2008 recession, we learned of multiple frauds in the system of keeping chain of custody of loan records. Many assets were so poorly tracked that when it came time to enforce legal rights, creditors were left holding assets with chains of custody any lawyer could challenge to defeat the creditor’s claim. Blockchain storage of contract assets solves this problem, ab initio.

Blockchain proof of title, custody, and transaction history reduces the need to rely on external assurances. This opens economic potential wherever there was previously a lack of reliable legal infrastructure. Along the way, blockchain will shed light upon, and drive the transition to, more efficient methods of proof in digital infrastructure.

Nina Kilbride

Introduction

On October 17, 2018, the Cannabis Act came into force in Canada, establishing a comprehensive legislative scheme governing the licensing, production, distribution, and sale of cannabis and related products for recreational use. Canada’s nascent recreational cannabis industry has faced its share of growing pains, but there is reason for optimism moving forward. Statistics Canada estimates that the illicit market for cannabis was worth approximately CDN$5 – $6 billion (US$3.79 – $4.55 billion) in 2015, while a 2018 Deloitte report suggests that the total Canadian cannabis market could generate up to CDN$7.17 billion (US$5.44 billion) in sales in 2019. If the sales figures forecast by the Deloitte report are achieved, that would put the cannabis market on the same footing as both the Canadian wine industry and the Canadian spirits industry.

Excitement surrounding legalization has led to a flurry of capital markets activity in Canada, resulting in billion dollar market capitalizations for several Canadian cannabis companies traded on the Toronto Stock Exchange (“TSX”), as well as the one Canadian cannabis company that currently trades solely on the NASDAQ.

Investor optimism is not fueled exclusively by the market potential that exists within Canada’s borders; rather, international opportunities represent a significant growth target. A 2018 report published by CIBC suggests that the global cannabis market could reach approximately CDN$25 – $30 billion (US$18.96 – $22.75 billion) in 2020. The U.S. could play a significant role in the global cannabis economy, as a study conducted by the Brightfield Group estimates that Canada and the U.S. will account for more than 86% of global cannabis sales in 2021.

Although cannabis is currently legal for recreational use in ten U.S. states and for medical use in 33 states and the District of Columbia, cannabis remains a Schedule 1 narcotic under the U.S. federal Controlled Substances Act. This classification has prevented Canadian cannabis companies from entering the U.S. market. Although cannabis may be exported from Canada for medical or scientific purposes under the Cannabis Act, an export permit may be refused if such exportation would contravene the laws of the country of import, or if such exportation would not comply with the permit for importation issued by a competent authority of the country of import.

Notwithstanding these obstacles, enthusiasm regarding the U.S. market was on full display when Tilray Inc.’s shares jumped 28.95% on the same day it was reported that the Canadian cannabis producer had received approval from the U.S. Drug Enforcement Agency to export cannabis to California for a clinical trial.

What does this mean for U.S. cannabis companies?

U.S. stock exchanges are regulated by federal legislation and, as a result, you will not find any pure play U.S. cannabis companies listed on the major American stock exchanges. Similarly, the TSX and its affiliated TSX Venture have taken the position that companies with operations or investments in the U.S. cannabis industry will be in violation of the listing requirements of their exchanges and thus subject to de-listing.

However, Canada’s more junior exchange, the Canadian Securities Exchange (the “CSE”), has welcomed Canadian and U.S. cannabis companies alike, listing 116 companies that operate in the cannabis industry, as of the date of this writing. Rather than prohibiting issuers with ties to the U.S. cannabis industry, the CSE has taken a disclosure-based approach, requiring its issuers to disclose the extent of its activities in the U.S. and the risk that its activities present from a U.S. legal standpoint.

Investor response to CSE listed cannabis companies has been extremely positive, with investors showing a particular appetite for companies offering exposure to the U.S. cannabis market. While historically being considered a “third-tier” Canadian stock exchange, the CSE is gaining notoriety, attracting industry-leading U.S. cannabis companies that have been denied access to more traditional exchanges.

For example, in May 2018, MedMen Enterprises Inc., a leading cannabis retailer in the U.S., began trading on the CSE at an implied value in excess of US$1.6 billion and on November 16, 2018, filed to raise CDN$75 million (US$56.88 million) via bought deal.  In October 2018, Curaleaf Holdings Inc., a vertically integrated cannabis cultivator and retailer, closed a private placement on the CSE which raised approximately US$400 million, implying a valuation close to US$4 billion. The most recent debut on the CSE was that of Acreage Holdings, a multi-state cannabis producer that boasts former House Speaker John Boehner and former Canadian Prime Minister Brian Mulroney as board members. Acreage Holdings began trading on the CSE on November 15, 2018, shortly after raising US$314 million in a private placement, implying an enterprise value of approximately US$2.1 billion.

How are U.S. cannabis companies becoming listed?

The most popular approach to listing on the CSE  by far is the reverse takeover, or “RTO”. RTOs involve the entity acquiring a publicly-listed shell or dormant company to pursue listing. RTOs are typically completed by way of a statutory amalgamation or arrangement and may require approval of each company’s shareholders, depending on the structure of the transaction and constating documents of the companies.

Compared to an IPO, RTOs are generally less time consuming and expensive and do not necessarily need to be accompanied by a concurrent equity financing—although MedMen, CuraLeaf and Acreage Holdings each completed private placements connected to their respective RTOs.

Another primary driver of expediency in RTOs is that they do not require regulatory review by securities regulators, and rather only require approval of the stock exchange. While a document with prospectus-level disclosure is still a requirement, eliminating the review of the securities regulators is one less obstacle to face in an RTO process.

Looking forward

There has been growing support to amend federal cannabis laws in the U.S. On June 7, 2018, Senators Cory Gardner and Elizabeth Warren introduced the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act in Congress, which would amend the Controlled Substances Act to make it impossible to prosecute individuals and corporations who are in compliance with U.S. state laws on cannabis. A companion bill was introduced on the same day in the House of Representatives by Representatitives Earl Blumenauer and David Joyce.

The STATES Act would not remove cannabis as a Schedule 1 narcotic, meaning that cannabis would remain federally illegal. However, the STATES Act provides that compliant transactions would not be considered trafficking and would therefore not result in the proceedings accompanying an unlawful transaction. With this distinction in mind, it remains unclear what impact the STATES Act, if passed, may have on the willingness of U.S. stock exchanges and federally regulated banks to participate in the U.S. cannabis industry.

While much uncertainty remains with respect to the long-term outlook of the U.S. cannabis market, there appears to be a significant appetite among investors to participate in this burgeoning industry. As of right now, the most attractive way for U.S. cannabis companies to capitalize on this enthusiasm and to access capital markets is to look north of the border, where the CSE awaits with open arms.