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Archive for March, 2016

Disclose! Disclose! Disclose! Says the S.E.C. to a Municipal Advisor

Posted on: March 28th, 2016

By: John Goselin and Ze’eva Kushner Banks

Earlier this month, the Securities and Exchange Commission announced its first ever enforcement proceeding for breach of fiduciary duty for municipal advisors created by the Dodd-Frank Act of 2010. On March 15, 2016, the Securities and Exchange Commission publicized a settlement with Central States Capital Markets, LLC, its CEO and two employees arising from a failure to disclose a conflict of interest created by the role of Central States’ employees in providing both municipal advisor services and underwriting services for the municipal entity client.

The problematic arrangement started when Central States was hired by a city as its municipal advisor. Central States then arranged for the City’s offerings to be underwritten by a broker-dealer.  However, rather than engage in a negotiation or bidding process to secure the services of a non-conflicted broker-dealer, Central States unilaterally selected the broker-dealer at which Central States’ CEO and two employees were still working as registered representatives.  This arrangement resulted in Central States receiving from the City not only $130,117 in municipal advisory fees but also 90% of the $121,530 paid by the City in underwriting fees, pursuant to an agreement between Central States and the Broker-Dealer.

The S.E.C. found Central States, its CEO and two employees failed to make three specific disclosures to the City: (i) the fact that certain Central State employees worked for the Broker-Dealer; (ii) the fact that certain Central State employees were engaged in dual roles by performing both municipal advisor services and underwriting services for the City’s offerings; and (iii) these Central States employees had a conflict of interest due to their direct financial benefit from the underwriting services. The failure to make these disclosures constituted a breach of fiduciary duty.

Not only did they fail to disclose the conflict of interest as required under the Dodd-Frank Act, Central States and the individuals also violated Municipal Securities Rulemaking Board Rule G-17, which prohibits municipal advisors from engaging in any “deceptive, dishonest or unfair practice.” Meanwhile the individuals violated Rule G-23 as well, which prohibits brokers from acting as advisors on municipal securities they are underwriting. According to the settlement, Central States is paying a total of $374,827.8, and the three individuals are separately paying civil penalties ranging from $25,000 to $17,500.

Under the Dodd-Frank Act, municipal advisors, such as Central States, have a duty to put their clients’ interests ahead of their own. As stated by the S.E.C. in its press release, “[a]s fiduciaries, municipal advisors must identify and address all material conflicts of interest by eliminating or disclosing such conflicts.  Municipal entities rely on the advice of their municipal advisors and must feel confident that those advisors are working in the municipal entity’s best interests.”

The moral of the story is that municipal advisors are not immune from enforcement of the fiduciary duty provisions of the Dodd-Frank Act. As stated in an earlier post in the context of a conflict of interest stemming from outside business activities, the best practice is to err on the side of disclosure when there is any potential for a conflict of interest.




S.E.C. Smacks CFO and CAO for Inadequate Internal Controls

Posted on: March 23rd, 2016

By: John Goselin and Ze’eva Kushner Banks

On March 10, 2016, the Securities and Exchange Commission announced a settlement with Texas-based oil company Magnum Hunter Resources Corporation, its former chief financial officer and its former chief accounting officer arising from a failure to properly evaluate and maintain internal control over financial reporting for more than a year and a half. Pursuant to the settlement, Magnum is paying a penalty of $250,000 subject to bankruptcy court approval, and the chief financial officer and former chief accounting officer are individually paying $25,000 and $15,000, respectively.

At the heart of the matter is a failure to identify staffing problems in the oil company’s accounting department, following four major acquisitions, as a material weakness that should be disclosed to the public.  Although the company’s consultant and audit engagement partner had raised red flags about the staffing problems, the former CFO and CAO applied the wrong standard when determining the severity of this control deficiency.  The executives based their decision on the lack of an actual error in the company’s financial reporting resulting from the staffing issue while they should have been considering whether there was a reasonable possibility that a material misstatement in the company’s financial reports would not have been detected in a timely manner.

Back in 2007, the Securities and Exchange Commission put out guidance on internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002. The underlying objective of internal controls over financial reporting is to provide the public with reasonable assurance that the financial reporting of the company is reliable.  Every year, a company’s management must evaluate and report on the effectiveness of the internal controls over financial reporting.   The S.E.C’s Order demonstrates that the S.E.C continues to monitor and value the importance of effective internal controls over financial reporting.  Moreover, the Order against Magnum’s chief financial officer and chief accounting officer cautions such high level accounting executives to rigorously assess internal controls to avoid sanctions.

“How Much is that Steak Bowl Really?” A Costly Reminder About Social Media Policies

Posted on: March 21st, 2016

By: Robert Krandel

On March 14, 2016, an Administrative Law Judge for the National Labor Relations Board ruled that Chipotle violated the National Labor Relations Act when it unlawfully forced an employee to delete negative tweets about the restaurant. The Chipotle employee, James Kennedy, worked at the Havertown, Pennsylvania Chipotle.  Kennedy posted derogatory tweets about Chipotle’s “cheap labor”. He further tweeted, “crew members only make $8.50hr how much is that steak bowl really?”

In a ruling which is not a surprise to labor law practitioners, the Judge held that Kennedy’s tweets “were protected concerted activity and were for the purpose of mutual aid or protection (of employees).” Importantly, Kennedy’s posts were not part of an employee discussion and he did not consult other employees before tweeting.  Nevertheless, the Judge still found that the tweets “were truly group complaints” protected under Section 7 of the National Labor Relations Act.

Section 7, which has existed in some form or another for almost 70 years (way before tweeting), 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,” as well as the right “to refrain from any or all such activities.”

Employers need to understand how their social media policies might get them in trouble with the Labor Board. For the past 5 years, the Labor Board has used Section 7 to prevent many employers from disciplining employees who make disparaging remarks about the company on Facebook or Twitter.  Even text messages among employees are considered protected under Section 7.  In cases very similar to Chipotle’s case, the Labor Board found the following examples to be protected activity under Section 7:

  • An employee who posts complaints about fellow coworkers on Facebook;
  • Starting a Facebook discussion to complain about a supervisor;
  • An employee criticizing corporate events on his private Facebook account;
  • An employee posting her withholding deductions on Facebook and complaining that the owner was an, “asshole.”

Just like in the Chipotle case, these employers tried to enforce social media policies which violated Section 7. The Labor Board extended Section 7 protection to all of this social media activity in these examples.

Most employers think that Section 7 only applies when the employees are part of a union. Also, most employers think that a strong social media policy can only be a good thing because it helps protect the company’s image.  They are wrong in both cases.  Section 7 applies regardless of whether a union is present in the workplace (Kennedy, for example, was not part of a union while working for Chipotle).  Additionally, a social media policy which is so strong that it prevents routine employee complaints will always violate Section 7.  Consider that in Chipotle’s case, its social media policy contained very narrow provisions designed to protect the company’s image:

  • “If you aren’t careful and don’t use your head, your online activity can also damage Chipotle or spread incomplete, confidential, or inaccurate information.”
  • “You may not make disparaging, false, misleading, harassing or discriminatory statements about or relating to Chipotle, our employees, suppliers, customers, competition, or investors.”

Despite this somewhat benign language, the Administrative Law Judge found that these provisions from the social media policy could be reasonably construed by employees to prohibit their Section 7 rights and that the social media policy was promulgated in response to union activity. The Judge ordered Chipotle to cease enforcement of this policy.

Employers need to understand that social media policies must be carefully crafted.  They cannot be used to stop all employee tweets or Facebook posts.  Employees must be allowed to post discussions about their wages and employment conditions – even when they are not posting as part of a group discussion like Kennedy.  The Labor Board has never condoned outright insubordination and will not consider tweets or posts a violation of Section 7 when the employee is ranting or raving against a supervisor.  But the line is very narrow and as Chipotle found out, it can be an expensive mistake.  Be careful that your social media policy does not cost you more money than you anticipated.

Liability Insurance Specific for Dog Bites?

Posted on: March 15th, 2016

By: Wayne S. Melnick

 While many dog owners merely assume liability for their pets are covered under their home owner’s insurance, new data would suggest dog owners should think twice.  According to the Insurance Information Institute and State Farm, the average liability claim for a dog-related injury in 2014 was $32,072.  According to a recent article in USA Today, dog-related injury claims accounted for more than one-third of the money that homeowners insurance companies paid out on liability claims that year. That same article notes that while many homeowners and renters insurance policies include liability protection that still cover dogs, some insurers charge more to insure certain breeds, such as pit bulls, or ask customers to sign liability waivers for dog bites. However, some insurers lower the liability limits for dog-related injuries or exclude dog-related injuries altogether.

This development has spawned a cottage industry of coverage for dog-related liability. There is even a specific website,, which provides insurance quotes for just these types of liability claims.

In light of the increasing amount of restrictions and exclusions, when a dog-bite liability claim is received, it is incumbent upon insurers to review their forms to ensure such a claim is covered; or otherwise not specifically excluded from coverage.  Even if there is coverage, it is worthwhile inquiring with the insured as to whether they have purchased separate dog-bite liability insurance that might even be primary.


One Small Step for Machine, a (Potentially) Giant Leap for Insurance

Posted on: March 15th, 2016

By: Seth Kirby

In 1969 the United States successfully landed a manned spacecraft on the moon.  Upon stepping on the lunar surface, Neil Armstrong commented on the momentous occasion by proclaiming that it represented a “giant leap for mankind.”  It was an amazing accomplishment for the United States in the space race, and in many respects, the lunar missions have fueled the technological advances that we enjoy today.  Consider for a moment that the computers that were on board the spacecraft used in the Apollo missions had far less processing power than the cell phone in your pocket.  Indeed, the Apollo Guidance Computer that was used to control the flight of the spacecraft was more basic than most modern toasters.  The entire network of mainframe computers used to monitor and control the lunar missions operated on less memory than the capacity of today’s usb flash drives.  Technology has advanced at an exponential rate.

Last week, the world may have witnessed another technological breakthrough.  A computer system known as AlphaGo won a Go match against 18 time world champion Go player Lee Se-dol.  AlphaGo won the match by winning the first 3 games of the 5 game series, only to suffer its first loss to its human opponent over the weekend. The final game of the series is scheduled to be played today.

Alpha Go is an artificial intelligence (“AI”) program developed by Google’s DeepMind division.  While other AI programs have previously beaten world class competitors in games like checkers and chess, this is the first time that AI has successfully played Go at a world class level.  The significance of this accomplishment can only be understood with reference to the game itself.  Go is a 2,500 year old game that is played with colored stones on a game board with a 19 by 19 grid.  Unlike chess, that has a possible 35 moves in any particular turn, Go has a possible 250 moves per turn.  It is claimed that there are more possible positions on a Go board than atoms in the universe.  As a result, the game cannot be played at a high level simply by analyzing all possible moves, instead it is a game of strategy combined with human intuition.  Thus, AlphaGo has been able to demonstrate that AI is capable of “acting” like a human including predicting its opponents behavior.

AlphaGo was created for the purpose of exploring and further developing AI.  Like most modern AI systems, it is a neural network that is able to collect and analyze large volumes of data and make predictions about what will happen next based upon previous outcomes in similar situations.   It has improved its play by first studying millions of human moves and then using those game models to play other versions of itself, constantly looking for which moves will generate better outcomes in the context of the game board.  AlphaGo is not just playing a move that has the highest chance of success, it is also deciding upon that move based upon its opposition’s predicted response.  It is not hard to imagine how this improved strategic thinking and learning could have a significant impact in the insurance industry.

The insurance industry is based upon the concept of spreading the risk of loss among a group of policyholders.  The careful collection and analysis of data by an insurance company allows the company to anticipate how often a group of similar individuals will experience a loss and the likely monetary value of any loss that occurs.  This underwriting process enables the carrier to create and price policies so that the anticipated losses are covered and the carrier is able to generate a profit from the endeavor.

AI could improve this analytical process so that risk analysis and underwriting is based upon far more than basic demographic information.  Instead, AI could be used to examine an applicant pool’s insurance profile and other available information (Facebook posts, cell phone usage, hobbies, educational background, etc.) to more accurately determine their risk of loss based upon the likely future conduct of the group.  Not just developing a risk assessment, but actually predicting their losses.

Before you dismiss this thought as sci-fi fantasy (a la Minority Report), you should know that Amazon already engages in this type of predictive analysis for its Amazon Prime customers by shipping products to local distribution centers for delivery before they are ordered by their customers.  With further development, AI has the potential to become a game changer for the insurance industry.  Only time will tell.