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Archive for the ‘Financial Services and Banking Litigation’ Category

Next Up Libra: Regulating Cryptocurrency

Posted on: July 23rd, 2019

By: David Molinari

Reluctance to accept cryptocurrency as a medium of exchange continues to focus, in substantial part, on the inability to regulate a virtual form of currency.

Cryptocurrencies were originally meant to be stateless entities, not beholden to legal frameworks of any state or country.  Such intent was/is short-sighted if the goal is to function as an alternative currency.  Regulation is the doorway through which cryptocurrency must pass to be considered a viable system of currency for everyday transactions.  The word “regulation” has taken on a negative meaning.  “Regulation is bad for (fill in the blank)” is a familiar refrain.  However, regulation, at least concerning currency markets and exchanges, establishes rules and order.  When the currency alternatives are defined by the term “virtual,” proponents of cryptocurrency will face skepticism.  In the absence of federal directives on the cryptocurrencies, some states have tried to take matters into their own hands.  The result is a patchwork approach trying to meld old currency regulations to control the new frontier of cryptocurrencies.  Perhaps as a nod to the inevitable choice of government regulation or irrevocable stamp of “outlaw,” Facebook’s executive, David Marcus, in recent statements before the Senate Banking Committee noted that Libra will get “appropriate approvals” from regulatory agencies and be subject to regulatory oversight and review.

But what does regulatory oversight look like in a virtual currency world? How can any state or the Federal Government regulate a system where any major corporation with international reach can create their own form of cryptocurrency.  Cryptocurrencies raise concerns of national security because virtual currencies have the potential for illicit activities such as money laundering or facilitating other unlawful behavior.  The virtual currency market was created so digital asset service providers can operate in the shadows of no regulation.  Also, cryptocurrencies are highly volatile because exactly what backs the currency?  What is the value of any cryptocurrency at any time?  How can the system be protected from fraud?

There are three aspects that should be covered when attempting to establish a system of regulation for virtual currency: The use of cryptocurrencies as legal tender in business transactions, imposing authority on operation of cryptocurrency exchanges as money transmitters; and the status of smart contracts and Ethereum Tokens.

The first two factors seem amendable to the type of regulatory framework of establishing a commissioner or government arm that is responsible to evaluate whether the crypto/digital currency has capital enough to ensure safety and soundness of the currency for consumer protection.  A minimum amount of capital should be maintained by the cryptocurrency provider measured by total assets, total liabilities, the expected value of the virtual business activity, the amount of leverage employed and liquidity.

A difficult factor is determining a definition of “digital unit” to be used as a form of stored value.  Further, should there be carve-outs for online gaming platforms, digital units used exclusively as part of a consumer affinity or rewards program; or, digital units redeemable for goods, services or purchases exclusively with the issuer or designated merchant.

Libra is the latest threat to an old guard established financial system.  Where Facebook’s Libra allegedly differs is it is not intended to compete with the US or other countries’ sovereign currency; and therefore, won’t interfere with central banks on monetary policy. Yet by the very nature of being an alternative currency, Libra like other cryptocurrencies are competitors and disruptors of established currency markets.  A competitor is seen as a threat in most environments; when the environment is a financial system, competitors are a threat that raise serious concerns.  Libra, like other cryptocurrencies were designed to be independent of legal frameworks.  Regulation is the opposite to cryptocurrency’s design.  While such opposites in another environment or market would cripple any new product or service, cryptocurrency as a technology, is an idea whose development isn’t tied to or halted by government oversight.  While it is quaint to conclude cryptocurrency will be forced to adjust to government’s brand of regulation, that may not be accurate in this situation.  Cryptocurrencies are operating and will go on and continue to be unregulated. It is the regulating bodies that are playing catch-up.

If you have questions or would like more information, please contact David Molinari at [email protected].

Duties of Care and Loyalty Coming to Investments Near You

Posted on: June 28th, 2019

By: Matthew Jones

The approval of Regulation Best Interest by the Securities and Exchange Commission last month continues to spark debate and controversy, and the future of the Rule remains uncertain.  The Rule’s implementation was set for June 30, 2020. However, on June 27, 2019, the United States House of Representatives passed a bill that would strip the SEC of its ability to implement the Regulation Best Interest package. The bill would prohibit the SEC from spending funds for Regulation Best Interest and the other items included in the Regulation. It is unclear whether the bill will pass both the Senate and White House, but the initial reaction is that the President will likely be advised to veto the bill.

Perhaps anticipating this potential obstacle, last week, Massachusetts released its own proposed fiduciary rule and is accepting comments until July 26, 2019. Its proposed rule requires that advice must be provided in the best interest of the customers without regard to the interests of the broker-dealer, advisory firm, or its personnel. The proposed standard permits the payment of transaction-based fees if the fee is reasonable, is the best of the reasonably available fee options, and the “care” obligation is complied with. This proposal applies to recommendations, advice, and the selection of account types. The stated goal of this standard is to protect the public interest and investors alike. This idea is nothing new, as the SEC’s Regulation Best Interest was designed to address and prevent similar issues. However, Massachusetts points out that the SEC Regulation fails to establish a strong and uniform fiduciary standard and fails to define the term “best interest.”

If you have questions or would like more information, please contact Matthew Jones at [email protected].

The SEC Seeks to Enhance the Quality and Transparency of Investors’ Relationships; Approves the Regulation Best Interest Rule

Posted on: June 17th, 2019

By: Joseph Suarez

On June 5, 2019, the U.S. Securities and Exchange Commission (“SEC”) approved its Best Interest Rule (the “Rule”) package requiring broker-dealers, and investment advisors, to act in their retail clients’ “best interests.” The SEC states the Rule, “will impose a materially heightened standard of conduct for broker-dealers when serving retail clients.” Broker-dealers must begin complying with the new rule, and broker-dealers and investment advisers must prepare, deliver to retail investors, and file a “relationship summary” by June 30, 2020.

The Rule is designed to enhance investor protections while preserving retail investor access and choice in: (1) the type of professional with whom they work, (2) the services they receive, and (3) how they pay for these services. In order to satisfy the new best interest standard of care, a broker-dealer who makes recommendations to a retail customer must fulfill four obligations: 1) a “disclosure obligation”; 2) a “duty of care” obligation; 3) a “conflicts of interest” obligation; and, 4) a “compliance obligation.” The duty of care obligation requires a broker-dealer to exercise reasonable “diligence, care and skill” when making investment recommendations. This obligation is similar to FINRA’s suitability rules. In order to satisfy the best interest obligation, a broker-dealer must understand and communicate the “risk, rewards and costs of any recommendation;” have a reasonable basis to believe that the recommendation is in the best interest of the customer; and refrain from making “excessive” recommendations, given the customer’s investment profile.

Regardless of whether a retail investor chooses a broker-dealer or an investment adviser, the retail investor will be entitled to a recommendation (if (s)he chooses a broker-dealer) or advice (if (s)he uses an investment adviser) that is in the retail investor’s best interest and that does not place the interests of the firm or the financial professional ahead of the retail investor’s interests. Nonetheless, the Rule’s perceived uncertainty is cause for division. The SEC claims the Rule is designed to enhance the quality and transparency of retail investors’ relationships with broker-dealers and advisors. Proponents say the Rule will elevate the standard for what is considered an investor’s best interest, specifically, that broker-dealers will need to make substantial changes to enhance investor protection. Opponents argue the Rule is too vague and retains a muddled standard that will not change any practices in the brokerage industry.

Given the current uncertainty, the question becomes: will the Rule cause more litigation? Given the near immediate scrutiny, the answer may be in the affirmative. The Plaintiff’s Bar will likely argue that the Rule now provides customers with a higher standard of care than the suitability standard in furtherance of asserting claims against broker-dealers. In any event, the Rule’s lack of clarity will surely stir debate over the next year before its implementation.

For more information, please contact Joseph Suarez at [email protected].

Protecting Seniors From Investment Exploitation – One Year Later

Posted on: June 3rd, 2019

By: Ryan Baggs

One year after the passage of the Senior Safe Act (the “Act”) the SEC, FINRA, and NASAA continue to emphasize the importance of “covered financial institutions” (“CFIs” or “CFI”) providing adequate training to all relevant employees for the protection of investors over the age of 65. If an employee undergoes proper training and reports a violation of the act in “good faith” and “with reasonable care” she/he will be immune from suit or issues related to the reporting. What’s even more of an incentive to CFIs, such as a large broker-dealer, is that if the broker-dealer properly trains and educates all of its representatives and a representative later reports a violation of the Act, the broker-dealer itself, not just the representative, will be immune from that suit. Each organization involved, as can be seen by the numerous articles and reminders regarding the Act’s one year anniversary, is eagerly dedicated to encouraging training and education related to the immunity benefits behind the Act.  As noted by FINRA President and CEO Robert Cook: “The Senior Safe Act seeks to empower financial professionals to detect and report cases of suspected abuse of senior investors and we believe it is important to broaden awareness and understanding of the Act throughout the securities industry.” (finra.org May 23, 2019 news release).

The goals of the SEC, FINRA, and NASAA are extremely important and beneficial to the industry in general; however, with all well-meaning intentions, there always exists the possibility of abuse. What is uncertain because of the brief history of the Act is exactly what “good faith” and “with reasonable care” mean or will mean in the future. Are there ways a CFI or representative will be able to manipulate the Act to avoid liability or litigation? Almost undoubtedly, but how is remained to be seen. But overall, despite the possibility of some abuse at some point, the purpose of the Act and dedication to protecting seniors from investment and elder abuse is an admirable step in the industry.

For more information, please contact Ryan Baggs at [email protected].

ERISA Plaintiffs Continue Their Assault on Major Universities, but Every ERISA Fiduciary is Vulnerable

Posted on: May 15th, 2019

By: John H. Goselin II

Beginning in August 2016, the ERISA Plaintiffs’ Bar launched a concerted attack on more than 20 major universities across the country filing class action lawsuits for alleged violations of ERISA fiduciary duties under ERISA Section 404 and alleged participation in ERISA prohibited transactions under Section 406.

Each side has won significant victories. Duke University, the University of Chicago and Vanderbilt University have capitulated and are paying six and seven-figure class action settlements. The University of Rochester and Long Island University fought until the plaintiffs simply walked away earlier this year. Northwestern University, New York University, Washington University and the University of Pennsylvania won impressive victories at the motion to dismiss stage.

But the battle is never over at the district court level. The United States Court of Appeals for the Third Circuit has provided new life to the plaintiffs bringing suit against the University of Pennsylvania, albeit only for 2 of the 7 counts that were originally alleged. Sweda v University of Pennsylvania, 2019 U.S. App. LEXIS 13284 (No. 17-3244, May 2, 2019). Not only does this reversal present new risks for the University of Pennsylvania, but it may put a damper on lower courts willing to dismiss these class action lawsuits.

The Third Circuit rejected a per se rule that would protect plan fiduciaries who provide a “mix and range of investment options” to plan participants. Instead, the Third Circuit held that Plaintiff Sweda had plausibly alleged that the defendants had “failed to conform to the high standard required of plan fiduciaries [under ERISA Section 404(a)(1)]” by alleging that (i) the recordkeeping fees were 6-7 times greater than the fees paid by similar plans, (ii) defendants failed to solicit competitive bids for recordkeeping and other plan services or (iii) defendants failed to hire an independent consultant to assess the plan’s administrative costs. Furthermore, the University of Pennsylvania Plan maintained high-cost investment options with historically poor performance compared to available alternatives, particularly the ongoing use of retail mutual fund shares when lower-cost institutional shares were available, but never adopted by the plan.

It is important to note that the claims being asserted against the universities apply to every business that maintains a 401(k) plan, or other ERISA investment plan, for their employees. The employer as a plan sponsor and the named and functional fiduciaries administering the plan will be held to the “prudent man” standard of care which requires all plan fiduciaries to exercise “the skill, care, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

In short, the structure and administration of an ERISA plan must be continually reviewed, evaluated and modified to reflect the prevailing better/best practices. Plan sponsors and individual fiduciaries should develop a process of continuing and ongoing education regarding (i) what is expected of ERISA fiduciaries and (ii) the available options in the market place. Furthermore, plan fiduciaries must have a documented process pursuant to which they periodically evaluate the ERISA plan(s) for which they are responsible and make changes when necessary and appropriate.

Once the ERISA Plaintiffs’ Bar is done with the universities, they will be looking for their next targets.

If you have any questions or would like more information, please contact John Goselin at [email protected].