Court Holds That Contingent Remainder Beneficiary Has Standing To Sue Trustee For Breach Of Fiduciary Duty
In In re Est., the court of appeals dealt with whether a contingent beneficiary can file claims against a trustee. No. 02-23-00104-CV, 2024 Tex. App. LEXIS 1878 (Tex. App.—Fort Worth March 14, 2024, no pet.). The court held that contingent beneficiaries do have standing:
We conclude that James is within the class of persons authorized to sue the Trustees. First, we reject the assertion that a trustee can never be sued by a contingent beneficiary… Texas also allows a contingent or vested beneficiary to sue a trustee for breach of fiduciary duty. See Tex. Prop. Code Ann. §§ 111.004 (defining “beneficiary” and “interested person”), 115.011(a) (authorizing any “interested person” to bring suit relating to trust administration); Berry, 646 S.W.3d at 527-28 (applying Texas Property Code Sections 111.004, 115.001, and 115.011 in analysis of whether contingent trust beneficiary was authorized by statute to bring her breach-of-fiduciary-duty claims and concluding that she was). Even at the time that Mary Sue transferred the money, James had a contingent interest in the Trust subject only to Claude’s power of appointment. See Berry, 646 S.W.3d at 529. Second, and more importantly, in this case regardless of whether the applicable laws or the terms of the Trust would have restricted James’s ability to sue the Trustees while Claude was alive, by the time that he did sue, his interest was no longer contingent. James now unquestionably has a right to at least a share of the Trust’s assets, and he contends that Mary Sue’s improper action reduced those assets. Accordingly, James was within the class of persons authorized to bring his claims. See Ala. Code §§ 19-3B-101, 19-3B-1001-02; Tex. Prop. Code Ann. §§ 111.004, 115.011(a); Berry, 646 S.W.3d at 527.
…
In their reply brief, the Trustees argue that Section 115.011 does not authorize James to bring his suit because although that provision allows an “interested person” such as a beneficiary to bring claims under Section 115.001, a claim under Section 115.001 does not include tort claims, and thus Section 115.011 does not authorize James to sue for breach of fiduciary duty. The Trustees do not, however, discuss Berry, in which the Texas Supreme Court applied Sections 115.001 and 115.011 in its analysis of whether a contingent trust beneficiary was within the class of persons authorized to sue the trustee for breach of fiduciary duty. Berry, 646 S.W.3d at 527-30. We therefore disagree that those Property Code sections have no relevance to an analysis of who may sue a trustee for breach of fiduciary duty. Thus, even applying Texas law, we conclude that James was authorized to bring his breach-of-fiduciary-duty claims. We reject the Trustees’ challenge to James’s standing and capacity.
Id.
Skilled Artisan’s View Is Decisive in Assessing Asserted Claim Drafting Error
The Court of Appeal (CoA) of the Unified Patent Court (UPC) clarified the legal standard for correcting obvious type inaccuracies in patent claims, explaining that the view of a skilled person at the filing date is decisive when assessing whether a patent claim contains an obvious error. Alexion Pharmaceuticals, Inc. v. Samsung Bioepis NL B.V., Case No. UPC_CoA_402/2024; APL_40470/2024 (CoA Luxembourg Dec. 20, 2024) (Grabinski, Blok, Gougé, JJ.; Enderlin, Hedberg, TJJ.)
Alexion owns a European patent directed to a drug comprising an antibody that includes the “SEQ ID NO:4” amino acid sequence and that binds “complement component 5” (C5). The description refers to SEQ ID NO:4 as a sequence of 236 amino acids, and the claims also refer to SEQ ID NO:4. It is known in the state of the art that the entire amino acid sequence is unlikely to bind C5, including amino acids, forming “signal peptides.” Alexion sought provisional measures, arguing that Samsung infringed Alexion’s patent even though Samsung’s drug did not include the first 22 amino acids (i.e., the signal peptide in this case) of SEQ ID NO:4.
Originally, Alexion applied for the patent as granted but later requested to amend the claims to exclude the first 22 amino acids because of an obvious error during prosecution. The Technical Board of Appeal (TBA) of the European Patent Office (EPO) rejected the request and found that the requested amendment was not a correction of an obvious error.
The Court of First Instance similarly rejected Alexion’s request, although it found that Samsung made literal use of the patent. The Court of First Instance argued, contrary to the TBA, that the first 22 amino acids were meant to be excluded from SEQ ID NO:4 in the patent claim, and that this sequence was obviously not correctly reproduced in the view of a skilled person because otherwise the claimed drug would be unsuitable to bind to C5 (as was undisputed by the parties). However, the Court of First Instance rejected Alexion’s request for provisional measures against Samsung. The Court of First Instance clarified that it must consider not only its own claim interpretation but also the TBA’s different interpretation. Its rationale was that because it is the infringement-focused court, the Court of First Instance should, before ordering provisional measures, consider whether the TBA, based on its interpretation, would revoke the patent in parallel proceedings because of insufficient disclosure under Article 83 of the European Patent Convention. Ultimately, considering the TBA’s claim interpretation, the Court of First Instance found that the patent’s validity was not certain to the extent required to provide provisional measures. Alexion appealed.
The CoA rejected Alexion’s appeal, finding that the Court of First Instance’s claim interpretation (i.e., excluding the first 22 amino acids from the claim) was legally flawed. The CoA instead adopted the TBA’s claim interpretation and argued (on this point, not much different from the Court of First Instance) that the EPO was likely to revoke the patent. The CoA clarified that the view of a skilled person at the filing date is decisive for assessing whether a patent claim contains an obvious type error. This view was supported by Alexion’s assertions during prosecution (even if it later abandoned those assertions) and by decisions of the EPO. Such prosecution history can outweigh undisputed pleading before the Court of First Instance that the antibody including the first 22 amino acids of SEQ ID NO:4 (or including the signal peptide) would be unable to bind to C5, as long as this inability was not obvious to the skilled person. Alexion and the TBA argued during prosecution that it is generally possible for an antibody, including signal peptides, to bind to C5. The CoA thus concluded that the patent description and claims did not disclose an exclusion of the first 22 amino acids of SEQ ID NO:4, and that it would not have been obvious to a skilled person at the time of the application to correct the sequence by excluding the first 22 amino acids.
Practice Note: Potentially differing EPO decisions on claim construction should be considered when making a prognosis of patent validity in proceedings for provisional measures. The UPC sets a high bar for correcting any errors in patent claims, and a patentee should be prepared to deal with its own assertions made during prosecution.
You Posted What?! Considerations for Employers’ Social Media Policies in 2025
Whether or not the oral arguments in front of the Supreme Court, employers should be aware of some social media trends stemming from the app that are here to stay. As social media becomes inextricably intertwined with employees’ lives, content from their daily routines is increasingly made public for millions of people to view and interact with. Because the workplace encompasses a large portion of daily life, discussions about working conditions, coworkers, and job duties are publicly featured in a manner that simply didn’t exist a decade ago. For example, the following social media video trends may feature discussions about employment or the workplace itself:
“A Day in the Life” – In “day in the life” videos, social media users edit together short clips of certain portions of their day. These curated clips are accompanied by music or by a voice-over explaining the highlights and lowlights of the day. Some “day in the life” videos are occupation specific, such as “a day in the life of a teacher,” and feature various video snippets of the workplace.
Dancing Trends – Popular, short dances spread across social media platforms for users to replicate and post. Sometimes entire workplace offices will participate in a dance trend as an advertising tool or a way to boost employee morale. Coworkers may also create these dance videos together in their free time.
Get Ready With Me – In these videos, users get ready for work, a social event, or any other aspect of their day. While the user walks through their skincare, makeup, or hair routine, they may share an experience from work or rant about a boss or coworker.
These trends represent a limited sample illustrating the way that social media is now not only used to capture “perfect” and manufactured snapshots of life, but also contemporaneous videos and photos of mundane, everyday activities, which can include the workplace. As social media use continues to shift and become further integrated into daily routines, employers should consider both the benefits and risks that social media may pose to the workplace. In addition, employers should likely update their social media policies in accordance with the changing landscape. In doing so, employers should keep the following in mind:
Protect client, patient, and other confidential information
As social media trends towards contemporaneous videos that film any and all aspects of a user’s day, confidential information may be inadvertently captured in the background of a video. For example, an attorney may create a “day in the life” video, film the view from his or her office, and accidentally capture a client file on the desk or a laptop screen in the clip. Similarly, a nurse at a hospital may participate in a dance trend during a break and inadvertently capture the OR scheduling board containing the surgeries for the day and patient names. Depending on the needs of your workplace, consider limiting the times and areas in which employees are permitted to film. For example, your social media policy may validly permit employees to only use social media during designated break times or limit employees’ social media use to a break room that lacks exposed confidential information.
Consider current guidance from the National Labor Relations Board (NLRB)
Employees have the legal right to discuss their wages, hours, and terms and conditions of employment with other employees. Specifically, the National Labor Relations Act (NLRA), which applies to all non-supervisory employees, both unionized and non-unionized, guarantees employees “the right to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” The NLRB – the federal agency that enforces the NLRA – most recently held that employer rules are considered presumptively unlawful if they “could reasonably be” interpreted to prevent an employee from exercising his or her rights under Section 7. (Stericycle, Inc., 372 NLRB No. 113 (2023)) Employers may rebut this presumption by providing that the rule(s) advance a legitimate and substantial business interest, and that the employer cannot advance that interest with a more narrowly tailored rule. In addition, the board interprets whether the challenged rule has a tendency to chill employees from exercising their Section 7 rights from the perspective of an economically dependent employee (a layperson, not a lawyer).
Instead of broadly banning social media use at work or the discussion of the workplace on social media, which would likely be construed as limiting Section 7 activity in light of Stericycle, consider focusing the social media policy on protecting confidential information and/or respecting coworker privacy. Similarly, abstract requirements that employees “must communicate with each other in a respectful manner at all times” will likely fail. After all, complaining in a group on social media about a supervisor’s conduct, which is a form of protected activity, could reasonably be viewed as disrespectful. Such a policy would currently be interpreted as tending to chill employees’ exercise of their rights under the NLRA.
In order to “narrowly tailor” the social media policy, make sure to explicitly include the business reasons that support why keeping certain information confidential and out of the camera lens is important. Finally, ensure that the policy has a NLRA “savings clause” specifying that the social media guidelines are established to protect the company’s business interests and are not intended to impede employees’ rights under the NLRA.
Reflect on the benefits of social media
Although it can be difficult to walk the fine line between adequately protecting your workplace and tailoring a social media policy to be sufficiently narrow, the cons of social media in the workplace are often outweighed by the pros. After all, a company dancing video may increase employee morale and engagement; a “day in the life” video featuring your company may encourage hundreds of applications or new customers to filter in. Companies can reach wider audiences, keep a pulse on client trends or preferences, and significantly increase the visibility of their brand. Carefully drafting social media policies allows you to harness the immense benefits of new social media trends and platforms, while minimizing the risks your company may face.
Court Holds That Mental Competence Claims Regarding the Execution of Documents Containing Arbitration Clauses Should Be Determined in Arbitration
In In re Est. of Moncrief, certain parties alleged that the decedent was mentally incompetent, was unduly influenced, and was defrauded into executing certain documents that contained arbitration clauses. 699 S.W.3d 315 (Tex. App—Fort Worth 2024, pet. filed). The trial court held that the capacity issues should be resolved by the trial court, and the arbitrations were stayed and the opposing parties were enjoined from pursuing the arbitrations. The court of appeals reversed, holding that those claims should be decided in arbitration.
The court discussed the law regarding challenging arbitration clauses:
If the challenge is to the validity of a broader contract (container contract) but not to the arbitration provision contained within the container contract, then courts must enforce the arbitration agreement and require the arbitrator to decide the validity or scope of the arbitration agreement. However, if a party challenges the scope or validity of an arbitration provision within a container contract, courts generally resolve the issue of whether the parties agreed to arbitrate the controversies. An exception to this rule exists when parties to an agreement agree to arbitrate disputes in accordance with third-party arbitration rules that provide that the arbitrator has the power to determine the arbitrability of any claim. In such a case, the parties are considered to have “clearly and unmistakably” intended to delegate arbitrability issues to the arbitrator.
Id. The court held that the incapacity issues in the case were defensive issues to the entire contact, not just the arbitration clause, and that the arbitrators should determine those issues, not the trial court:
Based on clear precedent from both Texas and Delaware, we hold that the arbitration agreement in the MPA clearly and unmistakably delegated arbitrability to the arbitrator, not the court. Despsite Moncrief Partners’ and CBM’s dismissals from the case when their interventions were struck, Appellants, as facially designated Trustees of Management Trust, were still parties to the MPA arbitration with Moncrief Partners and CBM that was based on an arbitration provision in the MPA.8 Tex’s capacity issues, as defenses to Appellants’ status as rightful Trustees with authority to bring the arbitration claims on behalf of Management Trust, were defenses to MPA (the container contract)—not the arbitration provision—and were for the arbitrator to decide.
Id. The court addressed three different documents and held that the incorporation of AAA rules meant that the arbitrators should determine competence claims.
There was a dissenting justice, who would have held that the mental competence and undue influence claims should be determined by the trial court and not referred to arbitration:
I would affirm the rulings of the statutory probate court in all respects because the mental incapacity of a contracting party is a contract formation defense, not a merits defense, and a question for adjudication by a court, not an issue of arbitrability for an arbitrator. Sousa v. Goldstein Faucett & Prebeg, LLP, No. 14-20-00484-CV, 2022 Tex. App. LEXIS 5277, 2022 WL 2976820, at *5 (Tex. App.—Houston [14th Dist.] July 28, 2022, no pet.) (mem. op.) (“The supreme court has concluded that the issue of mental incapacity is for the court to decide rather than the arbitrator, because it is a formation defense calling into question the very existence of a contract.” (citing In re Morgan Stanley & Co., 293 S.W.3d 182, 189-90 (Tex. 2009) (orig. proceeding)); Sanders v. Sanders, No. 02-08-00201-CV, 2010 Tex. App. LEXIS 8308, 2010 WL 4056196, at *1 (Tex. App.—Fort Worth Oct. 14, 2010, no pet.) (mem. op.) (“Mental incapacity is a common law contract formation defense.”). Moreover, as I observed in Moncrief, the testamentary capacity of the decedent, William Alvin “Tex” Moncrief, Jr., was the subject of litigation in the probate courts and no party has yet argued that “his testamentary capacity is meaningfully different from his capacity to contract during the same time frame.” Moncrief, 672 S.W.3d at 174 n.6. Because the majority’s arbitrability holding deprives the statutory probate court of its exclusive jurisdiction to probate the last will and testament of the decedent—and thereby to adjudicate whether he lacked testamentary capacity or, alternatively, was subject to undue influence at the time of its execution—I would additionally hold that, as a matter of law, the questions of testamentary capacity and undue influence cannot be the subject of arbitration but must always be determined by a court with probate jurisdiction.
Id.
SEC’s Latest Complaint Against Elon Musk Spawns Questions About The Politics Of SEC Enforcement
Earlier this week, the Securities and Exchange Commission filed a civil complaint in the U.S. District Court for the District of Columbia. The complaint alleges that Mr. Musk in acquiring shares of Twitter failed to file a required beneficial ownership report within the time then prescribed in Exchange Act Section 13(d) and Rule 13d-1. The SEC is seeking, among other things, disgorgement and a civil penalty. According to the SEC, Mr. Musk underpaid by at least $150 million for his purchases of Twitter stock.
The most obvious question raised by the SEC’s filing is one of timing. The events in question occurred nearly three years ago – in the Spring of 2022. The facts alleged in the complaint are fairly straightforward according the complaint – Mr. Musk should have filed no later than March 24, 2022 but failed to do so until April 4 (a Schedule 13G) and April 5 (a Schedule 13D), 2022. Two plus years seems like an inordinately long time for the SEC to conclude that April 4 falls after March 24 on the calendar. The SEC initiated its investigation, Donald Trump was elected President and will assume office on January 20, 2025. Chairman Gensler has announced that he will resign on noon on the day of Mr. Trump’s inauguration. Thus, the timing of the filing of the SEC’s complaint ineluctably creates the implication that the SEC wanted the complaint filed before there was shift in the party alignment of the Commissioners.
There is also a question about how the SEC investigated Mr. Musk and whether it is targeting him for his criticism of the agency and his association with Donald Trump. The SEC has conducted various investigations of Mr. Musk since at least 2018 when it settled charges against Tesla and Musk relating to Mr. Musk’s tweets. In the present case, the SEC’s Division of Corporation Finance asked about Mr. Musk’s Schedule 13G filing on the same day that it was filed. Shortly thereafter, the SEC’s Enforcement Division intervened “so that the same individuals investigating Mr. Musk’s compliance with the consent decree could also manage the present investigation.” Sec. & Exch. Comm’n v. Musk, 2024 WL 1511903, at *2 (N.D. Cal. Feb. 10, 2024) (footnote omitted). The SEC opened the current investigation the day after it closed a prior investigation. Id. Mr. Musk has been a high profile critic of the SEC, famously dubbing it the “Shortseller Enrichment Commission”. He is co-leading Mr. Trump’s advisory commission on government efficiency (the Department of Government Efficiency or DOGE).
US Supreme Court Clarifies Employer’s Burden of Proof for Showing Exempt Status Under the FLSA (US)
In an increasingly-rare unanimous decision, on January 15 the United States Supreme Court held in E.M.D. Sales, Inc., et al. v. Carrera that employers must prove that an employee is exempt from the minimum wage and overtime pay provisions of the Fair Labor Standard Act by only a preponderance of the evidence, and not by “clear and convincing” evidence.
The FLSA generally requires employers to pay a minimum wage and overtime compensation (at a rate equal to one-and-a-half times the regular rate of pay) to employees, but it also exempts many categories of employees from these requirements. These categories include employees who are paid on a salary basis that exceeds the FLSA’s minimum salary requirements and who perform executive, professional, administrative, outside sales, and certain computer-related duties. When an employee alleges that their employer failed to pay them minimum wage or failed to pay them overtime compensation for hours worked in excess of 40 hours in a workweek in violation of the FLSA, if the employer’s defense is that the employee was exempt from those provisions of the FLSA, the law places the burden on the employer to show that an exemption applies. Prior to the Court’s ruling in E.M.D. Sales, there was a conflict in the federal appellate courts as to what level of proof the employer had to show to prove the exemption: “preponderance of the evidence” – meaning more likely than not – or the more stringent “clear and convincing evidence” standard.
In resolving the circuit split, the Court found the preponderance of the evidence standard applies because it is the “default standard of proof” in civil litigation and none of three bases for requiring a heightened standard of proof applied. The Court explained that the FLSA does not designate a different standard of proof; FLSA claims are not disputes as to which the United States Constitution requires a heightened standard (such as when constitutional claims involving the First Amendment or the Due Process Clause are at issue); and that FLSA cases are not an “uncommon” case in which the government seeks to impose unusual remedies more dramatic than money damages or other conventional relief, such as taking away a person’s citizenship.
In reaching its decision, the Court relied heavily on the fact that the preponderance of evidence standard also applies in Title VII employment discrimination cases. And the Court rejected what it referred to as the employees’ “policy-laden arguments” that employers should have to establish exempt status by clear and convincing evidence due to the public’s interest in guaranteeing fair wages, the fact that FLSA rights are not waivable, and the fact that much of the evidence is under the employer’s control.
Justice Gorsuch and Justice Thomas issued a concurring opinion to note that on occasion, the default standard is a “heightened standard of proof,” depending on the legal backdrop against which Congress passed the law. They concluded, however, that the Court’s decision in E.M.D. Sales was appropriate and consistent with that understanding.
It is important to note that the Court’s decision does not change the applicable exemptions under the FLSA. Instead, it only clarifies the evidentiary burden imposed on an employer to prove a FLSA exemption applies. Employers who classify employees as FLSA-exempt should take appropriate steps to ensure they would be able to demonstrate – by a preponderance of evidence – that they properly classified each employee who is not paid minimum wage or overtime compensation by ensuring that they have appropriate and sufficient records of their payment on a salary basis and of the nature of the duties the employee performs.
Trump Tariffs Survival Guide: 10 Strategies for U.S. Importers
Tariffs remain the focus of the incoming Trump Administration. Over the past several months, the announcements from president-elect Trump and his transition team have been dynamic. We expect the Trump trade policy team to use creative methods to deliver aggressive new tariff policies this year.
There are several strategies U.S. importers may consider to cope with the anticipated tariff increases. Some of the strategies are lessons learned during the first Trump Administration (e.g., to mitigate the impact of the Section 301 tariffs on Chinese-origin imports). The key to success remains to plan ahead, understand the laws, and weigh all options.
Potential New U.S. Import Tariffs
Before turning to strategies, we outline the potential types of tariffs that have been shared by Trump insiders. For each type, we cover the potential tariff action, timing for such imposition, and our assessment of the potential likelihood of imposition. Exporters, please note that we may expect to see other countries impose retaliatory tariffs against imports from the United States following the increase of U.S. import tariffs. China, Canada, Mexico and the EU have all threatened such tariffs.
Chinese-Origin Goods.
Potential Tariff Action: Currently, the Section 301 tariffs on most imports of Chinese-origin goods are largely in the 25-50 percent range. During the Trump presidential campaign, we heard about a 60 percent tariff on all Chinese-origin goods. At the end of November 2024, president-elect Trump announced immediately upon taking office, tariffs on imports from China would increase by 10 percent. When coupled with the existing Section 301 tariffs, that action would result in a 35 to 60 percent tariff on such imports.
Timing: Such a tariff could be imposed using the same Section 301 of the Trade Act of 1974, but that method would take several months to implement. The wild card option under consideration (leaked on January 8, 2025) would be to use the president’s emergency authority under the International Emergency Economic Powers Act of 1977 (IEEPA), which would enable the incoming Administration to impose tariffs almost immediately. IEEPA has not been used previously to implement tariffs, so any such tariff action could be a bit of the Wild West.
Likelihood: Very likely.
Chinese-Owned or Operated Ports.
Potential Tariff Action: During the Trump presidential campaign, we heard brief threats about the imposition of tariffs on any goods, regardless of country of origin, that entered the United States through any Chinese-owned or operated ports.
Timing: Such a tariff could be implemented quickly after inauguration. Congress has delegated broad authority to the Executive Branch to impose tariffs for reasons of national security. Thus, the same IEEPA-type action could authorize such tariffs immediately upon inauguration, or potentially even Section 232 of the Trade Expansion Act. Any Section 232 action would require several months.
Likelihood: Not likely.
Mexico and Canada.
Potential Tariff Action: Trump has all but promised a 25 percent tariff on all imports from United States-Mexico-Canada Agreement (USMCA) partners Canada and Mexico. The USMCA was negotiated by the first Trump Administration. The agreement has a national security carveout (a theme here) that enables a party to the agreement to apply measures it considers necessary for protection of its own essential security interests. Thus, the USMCA gives the incoming Administration the pretext it needs to impose such tariffs.
Timing: Such a tariff could again be implemented quickly using IEEPA or much longer should negotiations drag on related to any such tariff. The immediate imposition of such a tariff would be aggressive, though not impossible. There is a decent chance the threat is being used as a negotiating tool (or stick) ahead of the 2026 joint review of the USMCA by the member parties.
Likelihood: Possible, but more likely used as negotiating leverage.
Universal Tariff.
Potential Tariff Action: The incoming Administration has also announced the potential for a 10 or even 20 percent universal tariff. Such a tariff would apply to all imports from all countries. However, in recent weeks, we have seen leaks that such a universal tariff would be targeted to imports relating to national security as follows: defense industrial supply chain (through tariffs on steel, iron, aluminum and copper); critical medical supplies (syringes, needles, vials and pharmaceutical materials); and energy production (batteries, rare earth minerals and even solar panels).
Timing: Such a tariff could again be implemented quickly using again using national security arguments. There are also recent reports that it would be phased in gradually to minimize disruption to supply chains and financial markets.
Likelihood: A broad universal tariff is not likely, but also not impossible. A universal tariff targeting imports relating to national security considerations is fairly likely.
Antidumping and Countervailing Duties.
Potential Tariff Action: President-elect Trump’s team is committed to the fair trade end of the free trade/fair trade spectrum. The main tool in that arsenal is an old one: antidumping duties and countervailing duties (AD/CVD). We expect the use of the AD/CVD laws to increase steadily during the incoming Trump administration. One major focus will be anti-circumvention proceedings that are designed to punish imports from countries where foreign manufacturers under AD/CVD orders may try to shift their production.
Timing: AD/CVD cases are slow by nature. No real changes will be noticeable until 2026 or 2027.
Likelihood: Very likely.
Top 10 Tariff Coping Strategies
The potential for new tariffs is substantial. We provide the following for consideration in preparing for such actions. Any plan requires tailoring to specific supply chains, products, and compliance realities. Sometimes a combination of the below strategies may be necessary.
Contract Negotiation: Review supplier and customer contracts to assess the assignment of liability for tariff increases; and negotiate favorable tariff burden-sharing.
Supply Chain Management: Consider suppliers in countries subject to lower tariffs, but be aware of the potential for AD/CVD and circumvention issues. Also consider sourcing a different product or raw material subject to a lower tariff rate. Don’t forget to examine whether manufacture in a third country using raw materials from a high tariff country creates a “substantial transformation,” such that the end product would be considered to originate in the third country. And of course, to the extent possible, review the possibility of sourcing from domestic suppliers.
Trade Agreements: Consider sourcing from countries subject to free trade agreements with the United States, which would enable duty-free imports. But do not assume that Canadian and Mexican goods will be duty-free; be aware of the potential of a national security-based tariff or renegotiated USMCA.
Trade Preference Programs: Keep an eye on potential programs that provide duty-free imports. For example, past programs included the Generalized System of Preferences (GSP) and the Miscellaneous Tariff Bill (MTB). But be aware that the GSP and MTB programs have been languishing without reauthorization by Congress for years.
In-Bond Shipments and Foreign Trade Zones (FTZ): If a company’s supply chain involves goods transiting through the United States, for sale elsewhere, consider use of in-bond shipments or an FTZ, where tariffs do not normally apply. But be aware that in-bond and FTZ schemes can involve high storage fees, rigorous accounting procedures, and other costs.
Duty Drawback: If manufacturing products in the United States for export, consider making use of a drawback program. Drawback enables importers to obtain refunds of certain U.S. duties paid on the imported component goods or materials. Section 301 duties are eligible for drawback, but AD/CVD are not.
Exclusions: If new tariffs are issued under Sections 301 or 232, consider seeking a tariff exclusion if such an administrative process is provided.
Comments: If Sections 301 or 232 are used, we expect to see a notice and comment period as part of the rulemaking, which should provide interested parties an opportunity to comment on the economic impact of the proposed tariffs.
Congressional Relations: Consider whether outreach to congressional delegations could help in any tariff mitigation strategy.
Litigation: We expect multiple lawsuits challenging the authority to impose certain tariffs. But U.S. courts have generally been receptive to the national security justifications offered for such tariffs, and the timeline to resolve such actions requires years.
In sum, while the imposition of additional tariffs will be challenging for U.S. importers, there are several possible strategies that may reduce certain negative impacts of these tariffs. All importers must carefully analyze any supply chain changes under the applicable laws, and each decision should be well documented and supported by the company’s written import policies and procedures.
Employers Need Only Use ‘Preponderance of Evidence’ Test to Show Workers Are Exempt From FLSA, Supreme Court Rules
On January 15, 2025, the Supreme Court of the United States held that employers need only demonstrate that an employee is exempt from the minimum wage and overtime requirements of the Fair Labor Standards Act (FLSA) by a preponderance of the evidence, rejecting a higher evidentiary standard used by some courts.
Quick Hits
The Supreme Court held that the preponderance-of-the-evidence standard governs when an employer seeks to prove employees are covered by an FLSA exemption.
The ruling resolves a circuit court split whereby the U.S. Court of Appeals for the Fourth Circuit held that employers must prove an exemption by a more demanding “clear and convincing evidence” standard, but six other circuit courts held that only the preponderance-of-the-evidence standard governs.
In an eleven-page unanimous opinion in E.M.D. Sales, Inc. v. Carrera, the Supreme Court resolved the conflict between the U.S. Circuit Courts of Appeal over what standard of proof applies when employers seek to prove that employees are covered by one of the thirty-four exemptions to the FLSA. Six circuits—the Fifth, Sixth, Seventh, Ninth, Tenth, and Eleventh—apply the preponderance-of-the-evidence standard, but the Fourth Circuit, as it did in the underlying case, applied a more demanding “clear and convincing evidence” standard.
“We hold that the preponderance-of-the-evidence standard applies when an employer seeks to show that an employee is exempt from the minimum-wage and overtime-pay provisions of the [FLSA],” Justice Brett Kavanaugh wrote in the Court’s opinion.
E.M.D. Sales, Inc., an international foods distributor, was sued by several sales representatives, who alleged the company violated the FLSA by failing to pay them overtime. E.M.D. Sales argued that the employees were covered by the FLSA’s “outside-salesman exemption.”
A district court concluded that E.M.D. Sales had not proven that the employees were exempt “by clear and convincing evidence” and ordered E.M.D. Sales to pay overtime wages and liquidated damages. On appeal, the Fourth Circuit affirmed the district court based on circuit precedent that employers prove an FLSA exemption by the heightened clear-and-convincing-evidence standard.
However, the Supreme Court reversed, holding that the preponderance-of-the-evidence standard governs in FLSA exemption cases, and remanded the question of whether the employer had proved the outside-salesman exemption.
The high court observed that when the FLSA was enacted, the preponderance-of-the-evidence standard was “the default standard of proof in American civil litigation.” Indeed, the FLSA does not specify a standard for proving that an exemption applies, and none of the situations calling for a heightened standard of proof were found to apply to FLSA’s exemptions.
More demanding or heightened standards of proof have typically been reserved for situations where it is required by statute, the U.S. Constitution, or in “uncommon” situations involving “coercive” government action against an individual more “dramatic” than an award of money damages or conventional relief, such as taking away a person’s citizenship.
Further, the Court rejected the policy argument that certain FLSA employment rights are not waivable and should therefore be subject to a higher standard of proof, noting that the preponderance-of-the-evidence standard is applied with respect to certain nonwaivable National Labor Relations Act (NLRA) rights. Furthermore, the Court rejected a second policy-based argument that since the employer controls “most of the cards” in FLSA cases, a heightened proof standard should apply, noting that the same circumstances exist in employment discrimination cases under Title VII of the Civil Rights Act of 1964, which are also subject to the default preponderance standard.
Justice Neil Gorsuch issued a brief concurring opinion, in which he noted that “courts apply the default standard unless Congress alters it or the Constitution forbids it” and that “[t]o do otherwise would be to ‘choose sides in a policy debate,’ rather than to declare the law as our judicial duty requires.”
This decision is not altogether unexpected. In the Supreme Court’s 2018 decision in Encino Motorcars, LLC v. Navarro, it rejected the Ninth Circuit’s holding that “exemptions to the FLSA should be construed narrowly.” There, too, analyzing the language of the FLSA, the Supreme Court ruled that “the FLSA gives no ‘textual indication’ that its exemptions should be construed narrowly, ‘there is no reason to give [them] anything other than a fair (rather than ‘narrow’) interpretation.” While Encino Motorcars was a split decision, the unanimous E.M.D. Sales decision reminds employment lawyers and employers of the importance of the text of the FLSA to our highest Court and the efficacy of invoking that text in defending misclassification claims.
Practical Impact
The E.M.D. Sales decision provides a clear answer that employers can prove the applicability of an exemption to the FLSA by a preponderance of the evidence, which the Court noted “allows both parties in the mine-run civil case to ‘share the risk of error in roughly equal fashion.’” Business groups had argued that the “clear and convincing” standard is inappropriate and, if applied broadly, would have made it more difficult for employers to demonstrate an exemption and lead to additional unnecessary litigation.
Although employers bear the burden of proof in proving an FLSA exemption, with the “fair reading” holding from Encino Motorcars and the “preponderance of evidence” proof path confirmed by the Supreme Court in E.M.D. Sales, employers may be coming into a season of greater success in defending misclassification claims, at least in litigation. That said, employers may still want to audit exemptions and job descriptions, ensuring job duties and compensation meet the requirements of the applicable exemption, and consider making adjustments as necessary.
Second Circuit Revives New York Reproductive Health Bias Law’s Notice Requirement for Employee Handbooks
On January 2, 2024, the U.S. Court of Appeals for the Second Circuit reinstated the New York Reproductive Health Bias Law’s requirement that New York State employers include a notice in their employee handbooks regarding the law’s prohibition on discrimination and retaliation based on employees’ reproductive health care choices.
Quick Hits
The Second Circuit has revived a requirement that New York employers include in employee handbooks a notice informing employees of their right to be free from discrimination or retaliation based on their [the employees’] or their dependents’ reproductive health decisions.
The ruling also revived a First Amendment challenge by religious organizations to New York’s Reproductive Health Bias Law (New York Labor Law Section 203-e), impacting how employers may address expressive association claims in the employment context.
In CompassCare v. Hochul, three religious groups—CompassCare, the National Institute of Family and Life Advocates (NIFLA), and First Bible Baptist Church—challenged the constitutionality of New York Labor Law Section 203-e, which went into effect in November 2019.
The law prohibits employers from accessing personal information regarding employees’ or their dependents’ reproductive health decision making without the employees’ “prior informed affirmative written consent.” The law also prohibits employers from discriminating or retaliating against employees based on their reproductive health decisions, “including, but not limited to, a decision to use or access a particular drug, device, or medical service.” Importantly, the law included a notice provision requiring employers to inform employees of their rights and remedies under the law in employee handbooks.
On March 29, 2022, the U.S. District Court for the Northern District of New York entered a permanent injunction blocking the State of New York from enforcing the requirement that employers that issue employee handbooks “include in the handbook notice of employee rights and remedies under [Section 203-e].” The district court found that the notice provision of Section 203-e violated the First Amendment because it compelled speech that was contrary to the religious organizations’ religious beliefs as they related to reproductive choices.
The Second Circuit reversed that permanent injunction, finding the notice requirement “a content-based regulation of speech” that “is subject to … rational basis review.” Under that review, the Second Circuit found that the notice requirement did “not interfere with [the] [p]laintiffs’ greater message and mission” and that “the required disclosure of the existence and basic nature of an otherwise-valid statute” was a simple expression of employee rights, similar to many other required employment rights notices and postings.
Additionally, the Second Circuit remanded the case to the district court for reconsideration in light of the Second Circuit’s 2023 decision in Slattery v. Hochul, which held that an employer may have an associational rights claim if the law “forces [the employer] to employ individuals who act or have acted against the very mission of its organization.” (Emphasis in the original.)
The Second Circuit stated that to sustain such a claim, an employer must show that it does not simply hold particular views or interests but that an association threatens the “very mission” of the employer “in the context of a specific employment decision.” This showing would be based on an assessment of whether (1) a position at issue is client-facing or involves expressing the particular views of the employer, and (2) the conduct or specific attribute of an employee “renders the employment of that person, in that position, a threat to the employer’s mission,” the court stated.
Next Steps
As a result of this ruling, New York employers must immediately comply with the notice provision of Section 203-e. Thus, employers with New York employees that issue employee handbooks must include a notification to employees of their rights and remedies under Section 203-e in their employee handbooks or in an addendum containing New York–specific employment policies.
This requirement includes informing employees of their rights to make reproductive health decisions and not be discriminated against or retaliated against for such decisions.
With respect to the expressive association claim, employers, particularly those with specific missions or religious affiliations, may have grounds to challenge laws that they believe force them to employ individuals whose actions conflict with their organizational missions. However, such claims must be specific and demonstrate how the law threatens the organization’s mission in the context of particular employment decisions.
This Week in 340B: January 7 – 13, 2025
Find this week’s updates on 340B litigation to help you stay in the know on how 340B cases are developing across the country. Each week we comb through the dockets of more than 50 340B cases to provide you with a quick summary of relevant updates from the prior week in this industry-shaping body of litigation.
Issues at Stake: Contract Pharmacy; Other
In two appealed cases challenging a proposed Louisiana law governing contract pharmacy arrangements, the appellants filed their opening brief.
In a breach of contract case related to the Medicare 340B cuts, the court terminated the action without prejudice.
Matt David, associate in McDermott’s Los Angeles office, also contributed to this blog post.
SCOTUS Hands Big Win to Employers Defending FLSA Claims
Today, in the matter of E.M.D. Sales, Inc. v. Carrera, the United States Supreme Court held that employers must not meet a heightened standard of proof when defending claims under the Fair Labor Standards Act (“FLSA”). The decision is a victory for employers defending FLSA actions across the country.
In the Carrera matter, the Supreme Court was asked to address the standard of proof employers must meet to demonstrate a plaintiff/employee is exempt from the FLSA. The plaintiff/employees in Carrera alleged they were denied overtime wages under the FLSA. The defendant/employer, E.M.D., argued the employees fell within the FLSA’s “outside sales” exemption and were therefore not entitled to overtime wages. In a bench trial, the district court applied a heightened “clear and convincing” evidence standard to E.M.D.’s outside sales defense and ultimately found in the employees’ favor.
On appeal, the specific question presented was whether an employer must prove this defense by a “preponderance of the evidence”—a far lower bar used by most federal circuits—or by “clear and convincing evidence”—a much higher standard previously adopted by the Fourth Circuit. Our prior discussion of the Carrera case and its implications can be found here.
In a huge win for employers, the Supreme Court held that the lower, preponderance of the evidence standard should apply. Writing for a unanimous Court, Justice Kavanaugh noted that the Fourth Circuit “stands alone in requiring employers to prove” FLSA defenses by clear and convincing evidence. The Court noted that, as a general matter, civil cases only require a higher burden of proof in three circumstances:
If a statute demands one;
If the Constitution requires one; or
In certain “uncommon” cases.
Ultimately, the Court found none of these circumstances applied to FLSA actions. With respect to the latter category of “uncommon” actions, Justice Kavanaugh noted these primarily arise “when the government seeks to take unusual coercive action—more dramatic than entering an award of money damages” against an individual. Civil actions brought under the FLSA do not fit this category.
The Court also found the standard of proof in other, employment-related civil actions to be relevant. The Carrera plaintiffs argued that FLSA exemption defenses should require a heightened evidentiary standard because of the “public’s interest in a well-functioning economy where workers are guaranteed a fair wage.” But Justice Kavanaugh countered that Title VII cases—which only require a preponderance of the evidence standard—also seek to vindicate important public interests. Accordingly, the employees’ policy arguments for implementing a heightened standard of proof left the Court unconvinced.
The Court ultimately concluded that “the default preponderance standard governs when an employer seeks to prove that an employee is exempt” under the FLSA. The Court reversed and remanded the case for further proceedings consistent with its opinion.
As noted at the outset, the decision is a huge win for employers seeking to defend against FLSA claims. Carrera ensures that—regardless of where it is sued—the ordinary, preponderance of the evidence standard, applies when an employer seeks to show a plaintiff/employee is exempt from the FLSA.
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Regulatory Update and Recent SEC Actions January 2025
Recent SEC Administration Changes
SEC Chair Gensler to Depart Agency on January 20
The Securities and Exchange Commission (the “SEC”) announced, on November 21, 2024, that its Chair, Gary Gensler, will step down. Chair Gensler’s resignation from the SEC will be effective at 12:00 pm EST on January 20, 2025. On December 4, 2024, President-elect Trump stated his intention to nominate Paul Atkins as the Chair of the SEC. Mr. Atkins served as a Commissioner from 2002 to 2008 and on the SEC staff in the 1990s.
SEC Announced Departure of Trading and Markets Division Director
The SEC, on December 9, 2024, announced that Haoxiang Zhu, Director of the Division of Trading and Markets, would depart the agency effective December 10, 2024. David Saltiel, a Deputy Director who also heads the Division of Trading and Markets Office of Analytics and Research, will serve as Acting Director. Mr. Saltiel served as the Division of Trading and Markets Acting Director for several months in 2021.
SEC Announces Departure of Corporation Finance Division Director
The SEC, on December 13, 2024, announced that Erik Gerding, Director of the Division of Corporate Finance, would depart the agency effective December 31, 2024. Cicely LaMothe is now the Acting Director. Ms. LaMothe previously served as the Deputy Director, Disclosure Operations for the Division of Corporation Finance. Before joining the SEC, Ms. LaMothe worked in the private sector for six years, including as the financial reporting manager for a public company and as a senior associate with a national accounting firm.
SEC Rulemaking
SEC Adopts Rule Amendments and New Rule Addressing Wind-Down Planning of Covered Clearing Agencies
The SEC, on October 25, 2024, announced the adoption of rule amendments and a new rule to improve the resilience and recovery and wind-down planning of covered clearing agencies. The rule amendments establish new requirements regarding a covered clearing agency’s collection of intraday margin, as well as its reliance on substantive inputs to its risk-based margin model. The new rule requires a covered clearing agency to specify nine elements for its recovery and wind-down plan that address: (1) the identification and use of scenarios, triggers, tools, staffing, and service providers; (2) timing and implementation of the plans; and (3) testing and board approval of the plans.
SEC Modernizes Submission of Certain Forms, Filings, and Materials Under the Securities Exchange Act of 1934
The SEC, on December 16, 2024, adopted amendments to require the electronic filing, submission, or posting of certain forms, filings, and other submissions that national securities exchanges, national securities associations, clearing agencies, broker-dealers, security-based swap dealers, and major security-based swap participants make with the SEC. Prior to the adoption of these amendments, registrants filed with, or otherwise submitted to, the SEC many of the forms, filings, or other materials in paper form. Under the amendments, registrants will make these filings and submissions electronically using the SEC’s EDGAR system, in structured data format where appropriate, or by posting them online.
SEC Adopts Rule Amendment to Broker-Dealer Customer Protection Rule
The SEC, on December 20, 2024, adopted amendments to Rule 15c3-3 (the “Customer Protection Rule”) to require certain broker-dealers to increase the frequency with which they perform computations of the net cash they owe customers and other broker-dealers from weekly to daily. The amendments will become effective 60 days after the date of publication of the adopting release in the Federal Register. Broker-dealers that exceed the $500 million threshold using each of the 12 filed month-end FOCUS Reports from July 31, 2024, through June 30, 2025, must comply with the daily computations no later than December 31, 2025.
SEC Enforcement Actions and Other Cases
SEC Charges Market Makers and Nine Individuals in Crackdown on Manipulation of Crypto Assets Offered and Sold as Securities
The SEC, on October 9, 2024, announced fraud charges against three companies purporting to be market makers and nine individuals for engaging in schemes to manipulate the markets for various crypto assets. The SEC alleges that the companies provided “market-manipulation-as-a-service” which included generating artificial trading volume through trading practices that served no economic purpose and that they used algorithms (or bots) that, at times, generated “quadrillions” of transactions and billions of dollars of artificial trading volume each day.
SEC Charges Investment Adviser and Owner for Making False and Misleading Statements About Use of Artificial Intelligence
The SEC, on October 10, 2024, announced charges against an investment adviser (the “Adviser”) and two individuals, an owner and a director of the Adviser, with making false and misleading claims about the Adviser’s purported use of artificial intelligence (“AI”) to perform automated trading for client accounts and numerous other material misrepresentations. The SEC’s order states that the two individuals raised nearly $4 million from 45 investors for the growth of the Adviser that was falsely described as having an AI-driven platform. The Adviser and individuals were charged with fraudulent conduct in the offer or sale of securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, and the Adviser was charged with fraudulent conduct by an investment adviser under the Investment Advisers Act of 1940, as amended.
SEC Charges Advisory Firm with Failing to Adhere to Own Investment Criteria for ESG-Marketed Funds
The SEC, on October 21, 2024, charged a New York-based investment adviser (the “Adviser”) with making misstatements and for compliance failures relating to the execution of the investment strategy of three exchange-traded funds (“ETFs”) that were marketed as incorporating environmental, social, and governance (“ESG”) factors. According to the SEC’s order, the Adviser represented in the prospectuses for the ETFs and to the board of trustees overseeing the ETFs, that the ETFs would not invest in companies involving certain products or activities, such as fossil fuels and tobacco. Further, the SEC order states that the Adviser used data from third-party vendors that did not screen out all companies involved in fossil fuel and tobacco-related activities. The SEC’s order further finds that the Adviser did not have any policies and procedures over the screening process to exclude such companies. The Adviser consented to the entry of the SEC’s order finding that the firm violated the antifraud provisions of the Investment Advisers Act of 1940 and the Investment Company Act of 1940 and the Compliance Rule of the Investment Advisers Act.
“At a fundamental level, the federal securities laws enforce a straightforward proposition: investment advisers must do what they say and say what they do,” said Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement. “When investment advisers represent that they will follow particular investment criteria, whether that is investing in, or refraining from investing in, companies involved in certain activities, they have to adhere to that criteria and appropriately disclose any limitations or exceptions to such criteria. By contrast, the funds at issue in today’s enforcement action made precisely the types of investments that investors would not have expected them to based on the Adviser’s disclosures.”
Directors of Money Market Fund Sued Over Share Class Conversion
Two shareholders (the “Shareholders”) filed a lawsuit alleging that the directors of a money market fund (the “Directors”) breached their fiduciary duty by failing to automatically move fund investors’ assets from higher cost share classes of the fund to lower-cost share classes. The Shareholders allege that the board of the money market fund allowed certain fund investors to continue paying higher fees as retail class shareholders rather than auto-converting their holdings to the cheaper, but otherwise identical premium class, even though their holdings were eligible for the “auto-conversion”. The complaint states that “[the Directors’] inaction demonstrates gross neglect or reckless disregard for the best interest of the class shareholders… Either the [Directors] have been recklessly uninformed of these massive overcharges that cause significant losses to the shareholders, or have known about the issue and inexcusably failed to take action to remedy it.” The Shareholders seek damages, restitution, disgorgement, and an injunction preventing the Directors from continuing to engage in the alleged conduct.
Two Entities Affiliated with Major Institutional Organization to Pay $151 Million to Resolve SEC Enforcement Actions
The SEC, on October 31, 2024, charged two affiliated and commonly-owned investment advisers (each an “Adviser” and together, the “Advisers”) in five separate enforcement actions for compliance failures including misleading disclosures to investors, breach of fiduciary duty, prohibited joint transactions and principal trades, and failures to make recommendations in the best interest of customers. The enforcement actions related to:
Conduit Private Funds – An Adviser made misleading statements regarding its ability to exercise discretion over when to sell and the number of shares to be sold, despite disclosures representing that it had no discretion.
Portfolio Management Program – An Adviser failed to fully and fairly disclose the financial incentive that the firm and some of its financial advisors had when they recommended the Adviser’s own Portfolio Management Program over third-party managed advisor programs offered by the Adviser.
Clone Mutual Funds – An Adviser recommended certain mutual fund products, Clone Mutual Funds, to its retail brokerage customers when materially less expensive ETF products that offered the same investment portfolios were available.
Joint Transactions – An Adviser engaged in $3.4 billion worth of prohibited joint transactions, which advantaged an affiliated foreign money market fund for which it served as the delegated portfolio manager over three U.S. money market mutual funds it advised.
Principal Trades – An Adviser engaged in or caused 65 prohibited principal trades with a combined notional value of approximately $8.2 billion. In order to conduct these transactions, according to the SEC’s order, a portfolio manager directed an unaffiliated broker-dealer to buy commercial paper or short-term fixed income securities from the Adviser which the other Adviser then purchased on behalf of one of its clients.
SEC Charges Adviser for Making Misleading Statements About ESG Integration
The SEC, on November 8, 2024, charged an investment adviser (the “Adviser”) with making misleading statements about the percentage of company-wide assets under management that integrated ESG factors. The Adviser stated in marketing materials that between 70 percent and 94 percent of its parent company’s assets under management were “ESG integrated.” However, in reality, these percentages included a substantial amount of assets that were held in passive ETFs that did not consider ESG factors. Furthermore, the SEC’s order found that the Adviser lacked any written policy defining ESG integration.
SEC Charges Three Broker-Dealers with Filing Deficient Suspicious Activity Reports
The SEC, on November 22, 2024, announced that three broker-dealers (the “Broker-Dealers”) agreed to settle charges relating to deficient suspicious activity reports (“SARs”) filed by the Broker Dealers. The SEC alleged that multiple SARs filed by the Broker-Dealers failed to include important, required information. SARs must contain “a clear, complete, and concise description of the activity, including what was unusual or irregular” that caused suspicion of the use of funds derived from illegal activity or activity that has no apparent lawful purposes. The SEC’s orders alleged that each Broker-Dealer filed multiple deficient SARs over a four-year period.
SEC Charges Former Chief Investment Officer with Fraud
The SEC, on November 25, 2024, charged the former co-chief investment officer (the “CIO”) of a registered investment adviser with engaging a multi-year scheme to allocate favorable trades to certain portfolios, while allocating unfavorable trades to other portfolios (also known as “cherry-picking”). The SEC’s complaint alleges that the CIO would place trades with brokers but wait until later in the day to allocate the trades among clients in the portfolios he managed. According to the complaint, the CIO’s delay in allocating the trades allowed him to allocate trades at first-day gains to favored portfolios and trades at first-day losses to disfavored portfolios.
SEC Charges Wealth Management Company for Policy Deficiencies Resulting in Failure to Prevent and Detect Financial Advisors’ Theft of Investor Funds
The SEC, on December 9, 2024, charged a wealth management company (the “Company”) with (1) failing to reasonably supervise four investment advisers and registered representatives (the “Financial Advisers”) who stole millions of dollars of advisory clients’ and brokerage customers’ funds and (2) failing to adopt policies and procedures reasonably designed to prevent and detect the theft. Specifically, the SEC found that the Company failed to adopt and implement policies designed to prevent the Financial Advisers from using two forms of unauthorized third-party disbursements, Automated Clearing House payments and certain patterns of cash wire transfers, to misappropriate funds from client accounts.
SEC Charges Two Broker-Dealers with Recordkeeping and Reporting Violations for Submitting Deficient Trading Data to SEC
The SEC, on December 20, 2024, announced settled charges against two broker-dealers (each a “Broker-Dealer” and together, the “Broker-Dealers”). According to the SEC’s order, the Broker Dealers made numerous blue sheet submissions to the SEC that contained various deficiencies, including inaccurate or missing information about securities transactions and the firms or customers involved in the transactions. The SEC found that, one of the Broker-Dealers made 15 types of errors, that caused nearly 11,200 blue sheet submissions to have missing or inaccurate data for at least 10.6 million total transactions, while the other Broker-Dealer made 10 types of errors that caused 3,700 blue sheet submissions to have misreported or missing data for nearly 400,000 transactions.
International Bank Subsidiary to Pay $4 Million for Untimely Filing of Suspicious Activity Reports
The SEC, on December 20, 2024, charged a registered broker-dealer (the “Broker-Dealer”) for failing to file certain SARs in a timely manner. According to the SEC’s order, the Broker-Dealer received requests in connection with law enforcement or regulatory investigations, or litigation that prompted it to conduct SARs investigations. The SEC’s order found that in certain instances, the Broker-Dealer failed to conduct or complete the investigations within a reasonable period of time.
SEC Files Settled Charges Against Multiple Entities for Failing to Timely File Form D in Connection with Securities Offering
The SEC, on December 20, 2024, announced charges against three companies (for this section only, the “Companies”) for failing to timely file Forms D for several unregistered securities offerings in violations of Rule 503 of Regulation D of the Securities Act of 1933. The SEC found that one of the Companies, a registered investment adviser that controls two private funds, failed to ensure that such private funds timely filed Forms D in connection with offerings involving the sale of membership interest in such private funds. The SEC found that two other Companies, both privately held companies, failed to timely file Forms D in connection with unregistered securities offerings for which the Companies engaged in certain communications that constituted general solicitations.
“Form D filings are crucial sources of information on private capital formation, and compliance with the requirement to make such filings in a timely manner is vital to the Commission’s efforts to promote investor protection while also facilitating capital formation, especially with respect to small businesses,” said Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement. “Today’s orders find that the charged entities deprived the Commission and the marketplace of timely information concerning nearly $300 million of unregistered securities offerings.”
Shareholders File Derivative Complaint Against Independent Directors and Fund Management Alleging Breach of Fiduciary Duties
In December 2024, a derivative complaint was filed against the independent directors and fund management, alleging that their breach of fiduciary duties was responsible for the “astonishing collapse” of several funds. In December 2021, the board of directors (the “Board”) approved a plan of liquidation involving transferring nearly all the $300 million in assets of four closed-end feeder funds and a master fund, along with several private funds, for unlisted preferred units from the buying company (the “Buyer”). Ultimately, the units converted into common shares worth eight dollars each when the Buyer went public through a merger with a special purpose acquisition company. Since going public, the value of the shares has fallen to 81 cents, or less than a penny after accounting for a one-for-80 reverse stock split. According to the lawsuit, fund management and the Board did not inform the shareholders of the liquidation plan until weeks after it happened, and the liquidation plan was never submitted to shareholders for approval.
Other Industry Highlights
SEC Division of Examinations Announces its Examination Priorities for Fiscal Year 2025
The SEC Division of Examinations (the “Division”), on October 21, 2024, published its Fiscal Year 2025 Examination Priorities which highlights the practices, products, and services that the Division of Examinations believes present heightened risk to investors or the overall integrity of U.S. capital markets. The report indicated that the Division would focus on:
Investment Advisers – (1) adherence to fiduciary standards of conduct, (2) effectiveness of advisers’ compliance programs, and (3) examinations of advisers to private funds.
Investment Companies – (1) fund fees and expenses, and any waiver or reimbursements, (2) oversight of service providers (both affiliated and third-party), (3) portfolio management practices and disclosures, for consistency with claims about investment strategies or approaches and with fund filings and marketing materials, and (4) issues associated with market volatility.
The report also indicated that the Division is going to continue examining advisers and funds that have never been examined or those that have not been examined recently, with a particular focus on newly registered funds. The full report can be found here.
SEC Announced Enforcement Results for Fiscal Year 2024
The SEC announced that it filed a total of 583 enforcement actions in fiscal year 2024 while obtaining orders for $8.2 billion in financial remedies. The 583 enforcement actions represent a 26 percent decline in total enforcement actions compared to fiscal year 2023. Key areas of focus by the SEC included:
Off-channel communications. In fiscal year 2024, the SEC brought recordkeeping cases against more than 70 firms resulting in more than $600 million in civil penalties.
Marketing Rule (Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”)) compliance. More than a dozen investment advisers were charged with non-compliance of the Advisers Act Marketing Rule including charges for advertising hypothetical performance to the general public without implementing policies and procedures reasonably designed to ensure hypothetical performance was relevant.
Misleading claims regarding AI. AI and other emerging technologies presented heightened investor risk from market participants using social media to exploit elevated investor interest in emerging investment products and strategies. These actions included multiple actions against advisers alleging the use AI in their investment processes.
SEC Risk Alert Highlights Examination Deficiencies Found in Core Focus Areas for Registered Investment Companies
The SEC’s Division of Examinations (the “Staff” or the “Division”) issued a risk alert (the “Alert”) regarding its review of certain core focus areas and associated document requests for registered investment companies (each a “Fund”, and collectively, the “Funds”). The Alert highlighted that examinations typically focus on whether Funds: (1) have adopted and implemented effective written policies and procedures to prevent violation of the federal securities laws and regulations, (2) provided clear and accurate disclosures that are consistent with their practices, and (3) promptly addressed compliance issues, when identified.
The Staff reviewed deficiency letters sent to Funds during the most recent four-year period and analyzed deficiencies and weakness related to the core areas of fund compliance programs, disclosures and filings, and governance practices. Below are some of the common deficiencies:
Fund Compliance Programs
Funds did not perform required oversight or reviews as stated in their policies and procedures or perform required assessments of the effectiveness of their compliance programs.
Funds did not adopt, implement, update, and/or enforce policies and procedures.
Policies and procedures were not tailored to the Funds’ business models or were incomplete, inaccurate, or inconsistent with actual practices.
Funds’ Codes of Ethics were not adopted, implemented, followed, enforced, or did not otherwise appear adequate.
Chief Compliance Officers did not provide requisite written annual compliance reports to Fund boards.
Fund Disclosures and Filings
Fund registration statements, fact sheets, annual reports, and semi-annual reports contained incomplete or outdated information or contained potentially misleading statements.
Sales literature, including websites, appeared to contain untrue statements or omissions of material fact.
Fund filings were not made or were not made on a timely basis.
Fund Governance Practices
Fund board approvals of advisory agreements appeared to be inconsistent with the requirements of the Investment Company Act of 1940, as amended, and/or the Funds’ written compliance procedures.
Fund boards did not receive certain information to effectively oversee Fund practices.
Fund boards did not perform required responsibilities.
Fund board minutes did not fully document board actions.
The full alert can be accessed here.
SEC’s Division of Investment Management’s Disclosure Review and Accounting Office Identifies Common Issues Found in Review of Tailored Shareholder Reports
As of July 24, 2024, open-end funds have been required to file more concise annual and semi-annual reports (“Tailored Shareholder Reports” or “TSRs”) that highlight information that the SEC deems “particularly important” to retail shareholders in assessing and monitoring their fund investments. After three months of TSR filings, on November 8, 2024, the Division of Investment Management’s Disclosure Review and Accounting Office (“DRAO”), which is responsible for reviewing TSR filings, published Accounting and Disclosure Information 2024-14 (the “ADI”) which flags common issues it has identified in its review of TSR filings and provides a reminder to funds of certain requirements.
Issues Regarding Expense Information
Annualizing expenses in dollars paid on a $10,000 investment in a semi-annual shareholder report, instead of reflecting the dollar costs over the period on a non-annualized basis.
Calculating expenses in dollars paid on a $10,000 investment by incorrectly multiplying the “Costs paid as a percentage of your investment” by $10,000, instead of multiplying the figure in the “Cost paid as a percentage of your investment” column by the average account value over the period based on an investment of $10,000 at the beginning of the period.
Presenting expenses in dollars paid on $10,000 investments to the nearest cent, when the figure must be rounded to the nearest dollar.
Funds might consider noting in their semi-annual reports that costs paid as a percentage of a $10,000 investment is an annualized figure.
Issues Regarding Management’s Discussion of Fund Performance
Disclosure by many ETFs of average annual total returns for the past one-, five-, and 10-year periods based on market value, instead of the ETF’s net asset value; additional disclosure of market value performance is not permitted to be included in the shareholder reports.
Failure by some funds to compare their performance to an appropriate broad-based securities market index both in their shareholder reports and in its prospectus.
Failure by some funds to include a statement to the effect that past performance is not a good predictor of the fund’s future performance, or to utilize text features to make the statement noticeable and prominent.
Other Issues
Including portfolio-level statistics, such as average maturity or average credit rating, under the heading “Graphical Representations of Holdings,” instead of under the heading “Fund Statistics.”
Disclosing holdings as a percentage without specifying the basis for the presentation of the information (i.e., net asset value, total investments, or total or net exposure).
Disclosing material fund changes while omitting the required cover page disclosure or including the cover page disclosure but failing to include any disclosure about the material fund changes.
Including broken links (to their websites) in their shareholder reports.
Including extraneous and sometimes lengthy disclosures such as disclaimers or risks that are not required or permitted.
For Inline XBRL structured data purposes, tagging all of their indexes as broad-based indexes instead of tagging their additional indexes with the separate tag intended for additional indexes.
For further information, the complete ADI may be accessed, here.