The Second Circuit Upholds Regulation Best Interest

On June 26, 2020 the U.S. Court of Appeals for the 2nd District ruled that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) authorizes the Securities and Exchange Commission’s (“SEC”) Regulation Best Interest rule and that the rule is not arbitrary and capricious. Specifically, the Court held that Section 913(f) of the Dodd-Frank Act grants the Securities and Exchange Commission (SEC) confers broad rulemaking authority which includes the Best Interest rule adopted by the SEC.

Background on the Regulation Best Interest Rule

Under federal law, both investment advisers and broker-dealers offer financial services to retail customers. However, only the former owe a fiduciary duty to their clients; broker-dealers do not. To reduce retail investor confusion in the marketplace regarding the investment advisory services and brokerage services, the SEC promulgated the Regulation Best Interest rule. Thus, the point of the Regulation Best Interest rule was to establish a “best interest” standard of conduct applicable to broker-dealers when making a recommendation of a securities transaction to a retail customer. A retail customer is a “natural person, or the legal representative of such a natural person, who: (A) receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an assigned person of a broker or dealer; and (B) uses the recommendation primarily for personal, family or household purposes.” However, the rule does not define “best interest.” Rather, it delineates four component obligations a broker-dealer must follow, in addition to prioritizing the interests of the retail customer above any interests of the broker-dealer or associated persons thereof. Those four obligations include:

• The Disclosure Obligation,
• The Care Obligation
• The Conflict of Interest Obligation, and
• The Compliance Obligation.

Issues in XY Planning Network, LLC., v. U.S. Securities and Exchange Commission

Petitioners in this case, including an organization of investment advisers, seven states, and the District of Columbia brought forth an action challenging the lawfulness of Regulation Best Interest. They argued that the Dodd-Frank Act requires the SEC to adopt a rule holding broker-dealers to the same fiduciary standard as investment advisers.

However, the Second Circuit held that the key language in Section 913(f) of the Dodd-Frank Act, which is permissive, reflects Congress’s intent to confer discretionary rulemaking authority to the SEC. The pertinent language states:

“the SEC may commence a rulemaking, as necessary or appropriate in the public            interest and for the protection of retail customers . . . to address the legal or regulatory standards of care for” broker-dealers.”

Petitioners argued that Section 913(g) narrows this discretionary authority under Section 913(f). Unlike the broad authority under 913(f), Section 913(g) is specific in that it authorizes the SEC to establish a fiduciary duty for broker dealers. Thus, Petitioners reasoned that 913(f) was a procedural authorization to commence rulemaking only and that 913(g) provided the substantive content for any such rulemaking. The Second Circuit disagreed and found this interpretation at odds with the plain meaning of the regulation in which 913(f) and 913(g) are two separate and freestanding grants or rulemaking authority that are not interdependent provisions that limit one another.

The Second Circuit also rejected Petitioners’ argument that Regulation Best Interest is arbitrary and capricious. Rather, the court highlighted the fact that the SEC considered thousands of comments and input before rejecting the extension of the fiduciary duty to broker-dealers. The Petitioners further alleged that Regulation Best Interest is arbitrary and capricious because the SEC failed to adequately address the significant evidence that consumers are not meaningfully able to differentiate between the standards of conduct owed by broker-dealers and investment advisers. But once again, the Court showed deference to the SEC’s determination that while a uniform standard of care may reduce retail investor confusion, this benefit could not overcome the burden that would result with respect to significant compliance costs for broker-dealers that would ultimately cause retail customers to experience an increase in the cost of obtaining investment advice and lead to a potential exit of broker-dealers from the market.

This is an important decision in that the Second Circuit has explicitly ruled that that Regulation Best Interest is the standard of conduct expected from broker-dealers. And, moreover, the court rejected the argument that Congress required the SEC to harmonize the investment adviser and broker-dealer regulatory models. Going forward, Regulation Best Interest will open the door to disclosures required for various broker-dealers when they are making explicit recommendations to clients in scenarios where the broker does not already have discretion to make trades. Given this important circuit decision, firms should heed the three-page Appendix the SEC issued on April 7, 2020 to implement plans with respect to Regulation Best Interest. The compliance date for Regulation Best Interest began in June 30, 2020.

VW Contributor: Skylar Young
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Separating Claim Recovery and Lawsuit Fees: 2nd Circuit Paves Way for Better Negotiations in FLSA Claims

In Fair Labor and Standards Act (FLSA) lawsuits, recovering damages for claims is typically only one part of the discussion when negotiating settlements. Employers engaged in FLSA lawsuits and settlement negotiations with employees and their representative counsel, can quickly become aware that lawsuit costs and plaintiff’s attorney fees are a factor in the overall bargaining process. On February 4, 2020, the Second Circuit, in Fisher v. SD Protection Inc., 2020 WL 550470 (2d Cir. 2020) held that attorneys’ fee awards in FLSA claim settlements are not limited by the principle of “proportionality” in that such fees are not limited or subject to a 1/3 cap based on the amount of the overall settlement.

In the Second Circuit, settlements in FLSA lawsuits were typically subject to strict court scrutiny court review to ensure that the agreed upon terms, including the amount of attorneys’ fees, were fair and reasonable. Thus, many of the district courts within the Second Circuit applied the rule of “proportionality” and refused to approve fee amounts greater than an amount 1/3 of the total settlement.

In Fisher, however, the Second Circuit held that such a rule is at odds with the purpose of the FLSA and has the potential to discourage competent lawyers from taking on cases for low-wage workers due to such limitations on collecting attorneys’ fees. The issue in Fisher arose from a wage dispute brought by an hourly employee, which is a normal cause of action under FLSA lawsuits. The employee sued under the FLSA based on the employer’s alleged failure to pay overtime and provide mandatory accurate wage statements.

The parties reached a settlement before a class was certified, with the total settlement amount at $25,000, including fees and costs. In submitting approval for the settlement from the district court, the parties disclosed that the plaintiff would be paid only $2,000 of that amount, with the remaining $23,000 going to the employee’s attorney. The district court judge disagreed with the terms and reduced the attorneys’ fee to only $8,250, or 1/3 of the total settlement amount as a matter of general policy.

The plaintiff appealed the district judge’s actions to the Second Circuit, and in a detailed decision, the Court reversed and remanded, disapproving of the district court’s requirement of “proportionality” between the amount of the settlement and the size of the fee award. The Second Circuit held that such a rule is not mandated by either the text or the purpose of the FLSA statute. While acknowledging that the proposed split of $23,000 to the plaintiff’s attorney and $2,000 to the plaintiff “understandably gave the district court pause,” the Court rejected an “explicit percentage cap” on fee awards. The Second Circuit justified this decision as in most FLSA wage dispute cases, the plaintiffs are generally hourly workers, and favorable settlement outcomes result in limited recovery. Limiting attorney fees can dissuade competent attorneys from taking on FLSA cases when fee recovery would be proportional to only 1/3 of total recovery. The Second Circuit also criticized the district court judge for rewriting the settlement agreement instead of just simply rejecting the agreement and having the parties revise it. The Second Circuit concluded that in rewriting the agreement, the district court judge exceeded his authority.

The ruling in Fisher is good news for employers in the negotiation process of FLSA lawsuits. In practice it should allow for more free negotiating of settlements, without limitations imposed on fee awards. This ruling will hopefully foster settlements and drive down costs for all parties involved.

VW Contributor: Ryan J. Coufal
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Seventh Circuit Follows Fifth Circuit in Holding FLSA Collective Action Opt-In Notices Should Not be Sent to Employees with Valid Arbitration Agreements

On January 24, 2020 in the case of Bigger v. Facebook, Inc., the Seventh Circuit held that a federal district trial court should not authorize notice of a Fair Labor and Standards Act (FLSA) collective action suit to employees of the defendant company who are ineligible to join the suit because they entered into agreements to resolve disputes exclusively via arbitration. The Seventh Circuit warned that without such limitations, FLSA collective actions run the risk of abuse for being too broad to opt-in and cause unfair harm to employers.

The appellate decision stems from FLSA collective action claims. Typically, early on in these types of litigation cases, plaintiffs will request that courts authorize written notice to potential plaintiffs of the opportunity to join in the collective action suit, in order to certify the collective class. These notices are generally sent to current or previous employees of a defendant employer, allowing them the opportunity to “opt-in” as another plaintiff in the suit.

In Bigger v. Facebook, Inc., a former Client Solutions Manager claimed that Facebook misclassified her as an overtime-exempt employee in violation of the FLSA. Plaintiff Bigger asked the United States District Court for the Northern District of Illinois to conditionally certify a collective action class and to authorize opt-in notice to a national collective of fellow Facebook Client Solutions Managers. In opposition to the request for notice, Facebook argued that most of the employees Bigger proposed to notify had previously entered into arbitration agreements. Facebook asserted these employees should not be classified as potential opt-in plaintiffs due to being limited to resolving disputes with Facebook through arbitration. Thus, Facebook asserted these employees should not receive any notice. The District Court held it was too early to make merits determinations at the conditional certification stage of an FLSA collective action and therefore authorized notice to the entire group plaintiff proposed, regardless of whether they had signed arbitration agreements or not.

Upon appeal, the Seventh Circuit held that the District Court should have allowed Facebook to prove that a large number of its employees had entered into arbitration agreements. The Seventh Circuit noted that the ruling is to protect employers from unfair or “dangerous” harm by stating, “notice giving, in certain circumstances, may become indistinguishable from the solicitation of claims . . . .” The Seventh Circuit thus concluded that district courts must give employers a chance to show that potential notice recipients have valid arbitration agreements.

The Seventh Circuit’s decision in Bigger followed the similar Fifth Circuit ruling last year of In re JPMorgan Chase and Company, 916 F.3d 494 (5th Cir. 2019). The rulings in these cases present a number of considerations for employers. On one hand, these rulings can make it harder for plaintiff’s counsel to use opt-in notices to identify potential plaintiffs for FLSA claims. While on the other hand, employers could run the risk of bearing the cost of arbitration for hundreds of potential FLSA claims upfront if such an issue were to arise, but be limited to arbitration.

VW Contributor: Ryan Coufal
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Supreme Court to Determine Whether Fossil Must Turn Over Profits for Trademark Infringement

Fossil, Inc., the luxury goods retailer, could owe a manufacturer, Romag Fasteners, Inc., its profits for infringing on Romag’s trademark. The issue of whether Fossil owes Romag approximately $6.7 million dollars in profits gained by using the infringing trademark depends on whether the remedy of disgorgement of profits by a party infringing on a trademark requires willfulness by the infringing party.

The issue arises from Fossil using a magnetic snap fastener on some of its bags, purchasing some of the fasteners directly from Romag. However, Fossil also purchased some fasteners that looked nearly identical to those of Romag from another source, likely knowing that the fasteners were counterfeit and infringed on the trademark of Romag. Despite this knowledge, Fossil proceeded to use them anyways in “callous disregard” to the rights of Romag. In a moment of luck for Romag, an employee discovered the counterfeit products when visiting a Macy’s, finding the Fossil bags with the counterfeit fastener. Romag successfully argued that Fossil infringed on their trademark rights, but an open question regarding the remedy remains. The United States Supreme Court will determine whether the remedy includes the profits of Fossil, and such decision will be based on whether Fossil must willfully infringe on Romag’s trademark rights or if “callous disregard” is sufficient to entitle Romag to the profits of Fossil.

This case highlights the broader importance of protecting the brand and intellectual property of a company. Traditionally, this means taking active steps to ensure that the trademarks, copyrights, trade secrets, and patents are protected under applicable law, but it should also mean proactively verifying that the initiatives of the company don’t infringe on the rights of another. Failure to take consider trademark rights, as Fossil is learning the hard way, could result in disgorgement of profits.

VW Contributor: Alex Rainville
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Nebraska Supreme Court Addresses Evidentiary Standards for Approving Average Weekly Wages in Workers’ Compensation Court

One of the issues evaluated by the Nebraska Supreme Court in the recent case of Bortolotti v. Universal Terrazzo and Tile Company, 304 Neb. 219, 933 N.W.2d 851 (Neb. 2019), was what evidence is necessary for a Plaintiff to prove applicable average weekly wages for an owner/operator of a business. In Bortolotti, the Plaintiff was the sole stockholder and president of Universal Terrazzo and Tile Company (Universal), a subchapter S corporation. The Plaintiff had been an installer of terrazzo tile and fabricator and installer of granite for over 30 years before becoming the sole stockholder and president in 2011. The injury at issue occurred in June 2013 and the Plaintiff’s operative petition for workers’ compensation benefits alleged weekly earnings of $3,625 at the time of the injury, but Universal and their compensation insurance provider denied the allegation. At trial the Plaintiff offered one page from his 2013 tax return noting that the employer was an S corporation, and his earnings for the year were $3,950. The compensation court did not believe the Plaintiff’s earnings were so low as president of the company. The evidence at trial also discussed the total gross income of the corporation, but offered no evidence regarding what business expense deductions were taken by the Plaintiff from business earnings. Thus, the compensation court was unable to verify if business expenses had been properly deducted from the company’s gross earnings or the Plaintiff’s testimony that his weekly draw from the corporation was $3,625. Ultimately, compensation court determined that the Plaintiff sustained a compensable injury, but had difficulty in determining the Plaintiff’s average weekly wage due to a lack of exhibits, and instead held the Plaintiff’s average weekly wage was $1,399.95, entitling him only to a statutory maximum compensation rate of $728 per week.

The Supreme Court affirmed the Court of Appeals’ determination that there was not sufficient evidence to support the high average weekly wage and that the only competent evidence in the record supported the Court of Appeals’ determination of an average weekly wage of $49, the minimum weekly income benefit provided by statute based on the 2013 earnings of $3,950. The Supreme Court held that net profits or net income of an S corporation do not necessarily qualify as “wages” under the Nebraska Workers’ Compensation Act, as the statute requires focus on the “money rate at which the service rendered is recompensed,” not payments received solely because of a recipient’s status as a shareholder.

As the Supreme Court notes, the burden was on the Plaintiff, the president and sole shareholder of the S corporation to provide evidence differentiating his wages as a corporate employee from his profits as a corporate shareholder. The co-mingling of ownership and employment burdens the party seeking workers compensation to provide sufficient evidence of what their total income is. Bortolotti demonstrates that simply indicating the total revenue of a company will not be sufficient evidence for computing an average weekly wage.

VW Contributor: Ryan Coufal
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A Criminal Conviction for Theft of a Trade Secret Does Not Require a Trade Secret

In an unusual case involving trade secrets, a court determined that the mere belief that stolen information is a trade secret, even when no trade secret was stolen, is criminally convictable. As an important tool for protecting intellectual property, businesses will often keep valuable information  secret, and only provide access to individuals necessary to complete some business objective. Most businesses grant access to the trade secret on the belief that misappropriation is actionable under the Defend Trade Secrets Act of 2016, as well as state laws that are substantially similar to the federal law. It is less known, however, that the theft of a trade secret is a federal crime, pursuant to the Economic Espionage Act of 1996 (“EEA”), as codified at 18 U.S.C. § 1832.

In this particular case out of Chicago, an employee resigned and, before leaving, downloaded 1900 files from his employer. He believed that this information constituted trade secrets of his employer, and had the intention to take these trade secrets to his new foreign based employer. However, prior to boarding his plane to China, he was stopped by the United States Customs and Border Patrol, where the hard drive was discovered.

In February 2019, he was convicted by a jury of actual and attempted theft of trade secrets, pursuant to the EEA. The jury also determined that, to a large extent, the stolen documents did not constitute a trade secret. The defendant filed for a post-conviction motion for a new trial, with an argument that you can’t be convicted of theft of trade secrets if the information did not include any trade secrets.

On October 9, 2019, the judge ruled that theft of trade secrets under the EEA exists even if the underlying materials don’t constitute a trade secret. This suggests that stealing what is believed to be a trade secret constitutes a crime. This outcome certainly poses a unique perspective on a lesser known consequence regarding theft of a trade secret. Whether this concept will transfer to non-criminal litigation over the theft of trade secrets has yet to be determined.

For a detailed history, please see United States of America v. Robert O’Rourke, No. 17-cr-00495, (N.D. Ill. 2019).

VW Contributor: Alex B. Rainville
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Continue to Scrape Away! Microsoft’s LinkedIn Ordered to Lift Ban on Third Party Access to Public Profile Data

In the closely followed hiQ Labs, Inc. v. LinkedIn case, the Ninth Circuit affirmed the district court’s decision holding that hiQ, a data analytics company, is entitled to a preliminary injunction forbidding LinkedIn from denying hiQ access to publicly available LinkedIn member profiles. hiQ had been scraping data and building products from LinkedIn public profiles. LinkedIn argued that hiQ was in violation of LinkedIn’s user agreement as well as California law and federal law, including the Computer Fraud and Abuse Act (CFAA) and sent hiQ a cease-and-desist letter.

Similarly, back in 2018, a district court in Washington D.C. ruled that using automated tools to access publicly available information on the open web is not a crime, even when a website bans automated access in its terms of service. The case, Sandvig v. Sessions, narrowly interpreted the CFAA. This federal law makes it illegal to access a computer connected to the Internet “without authorization,” but neglects to specify what “authorization” means. In pertinent part, the court reasoned that:

“Scraping is merely a technological advance that makes information collection easier; it is not meaningfully different from using a tape recorded instead of taking written notes, or using the panorama function on a smartphone instead of taking a series of photos from different positions. And, as already discussed, the information plaintiffs seek is located in a public forum.”

The Ninth Circuit decision and reasoning is in line with Sandvig. However, the court was clear not to outlaw a website owner from pursuing any recourse against wholesale appropriation of its public content. Rather, the court articulated a public policy concern if companies like LinkedIn can use sole discretion to determine who can collect and use data when that company does not own the data which they make publicly available to viewers. Read in this way, the court is mitigating the opportunity for LinkedIn to gain a monopoly on public information of the site’s 500 million member profiles.

Many view hiQ Labs, Inc. v. LinkedIn as a victory for the open source web. The internet is a critical space for researchers, journalists, businesses, and individuals who require meaningful access to collect and analyze public information. Specifically, businesses use web scraping bots to relentlessly pursue data which might help grow their business by monitoring competitor pricing. Web scraping is also integral for predictive analysis, where businesses can study and understand products and associated consumer behavior to assess their costs and benefits. Thus, web scraping provides significant business value to a multitude of companies across various sectors.

LinkedIn could appeal the 9th Circuit’s decision to the U.S. Supreme Court. Until then, data miners, researchers, and other third parties can continue to use any public online data not owned or password protected by a website owner.

VW Contributor: Skylar Young
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Oral Argument to Be Heard By Supreme Court Over Specifics of Title VII

Supreme Court Update

The 2019-20 term of the United States Supreme Court opens today.

On October 8th, the Court will heard an oral argument on a set of cases that could determine whether sexual orientation and gender identity are covered by Title VII of the 1964 Civil Rights Act.  Courts and commentators are divided on the issue, which has been the subject of active litigation in multiple cases for several years.  This may be the most significant ruling of the Court in the area of employment law this term, and will be closely watched.

A decision could be issued before the end of the year; timing is to be determined by the Court.

https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/17-1618.html

VW Contributor: Matthew G. Dunning
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CBD Sellers Beware: FTC Issues Warnings on CBD Marketing Practices

By Ryan Coufal

On September 10^th, 2019 the Federal Trade Commission (“FTC”) sent warning letters to three companies that sell oils, tinctures, capsules, “gummies,” and creams which contain cannabidiol (“CBD”), a chemical compound derived from the cannabis plant.  While the FTC did not identify the companies publicly, the letters warn that it is illegal to advertise a product that can prevent, treat, or cure human disease without reliable scientific evidence to support such claims. 

The companies’ websites claim that CBD products “’work like magic’ to relieve ‘even the most agonizing pain,’” are a “miracle pain remedy,” and are highly effective at treating “the root cause of most major degenerative diseases.”  The websites then promote that CBD treats a whole host of diseases including: cancer, Alzheimer’s disease, multiple sclerosis (MS), fibromyalgia, cigarette addiction, colitis, autism, anorexia, bipolar disorder, post-traumatic stress disorder, schizophrenia, anxiety, depression, Lou Gehrig’s Disease (ALS), stroke, Parkinson’s disease, epilepsy, brain injuries, diabetes, Crohn’s disease, psoriasis, AIDS, arthritis, and heart disease, with one of the websites even stating the treatment is “clinically proven.” 

In its letters the FTC instructs the companies to review all claims made about their products, including consumer testimonials, to ensure such claims are supported by competent and reliable scientific evidence.  Making such unsubstantiated claims can be in direct violation of sections of the FTC Act, 15 U.S.C. §§ 45(a) and 52, which regulate advertising.  Additionally, such claims can violate the Federal Food, Drug, and Cosmetic Act (FDCA), 21 U.S.C. § 321(g)(1)(B) which is regulate by the U.S. Food and Drug Administration (FDA).  On March 28, 2019 the FTC and FDA jointly sent similar warnings to three different CBD companies about their marketing practices, with the FDA taking the stance that such marketing practices are evidence that CBD products are intended to be used as drugs, which require extensive testing and FDA approval before marketing the products in such a manner.  Making a claim that CBD is a drug that can cure disease when it has not been approved by the FDA could create the potential for violation of the FDCA.

The FTC gave the latest three companies fifteen (15) days to notify the agency of the specific actions they have taken to correct the agency’s concerns.  Companies that sell CBD products should take note of the marketing practices the FTC and FDA are regulating and review all claims made about their CBD products and ensure they are backed by reliable and competent scientific evidence, and ensure they are not marketing CBD products as drugs under the FDCA.

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New Nebraska Law’s Impact on Filing Requirements for Corporations and Partnerships

LB 512 signed into law on May 30^th, 2019, requires all S Corporations, limited liability companies, and partnerships with Nebraska source income to file a Nebraska return for all tax years beginning on or after January 1^st, 2019.

Previously, S Corps, LLCs, and partnerships had to file a Nebraska income tax return if they had nonresident owners and were apportioning income.

The Nebraska Department of Revenue (DOR) encourages all S corporations, limited liability companies, and partnerships to e-file their pass-through entity returns. A Nebraska state ID is required when e-filing a pass though entity return.

A pass-through entity without an assigned Nebraska identification number will need to apply for a number before e-filing a 2019 Nebraska tax return. If your business does not have a Nebraska Tax ID Number, follow the link below to the Nebraska Department of Revenue to register your business.

http://www.revenue.nebraska.gov/electron/online_f20.html

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