Blog
U.K. Pension Industry’s Reliance on LDIs
BY: Chelsea Wong, RBFL Editor
On September 23rd, 2022, Former Prime Minister Liz Truss shook the entirety of the United Kingdom with an announcement of a budget plan. That budget plan was set to abolish the 45% income tax rate of U.K.’s highest earners and deregulate other industries. Before people had time to argue or even ask, “Why?,” the pound dropped in value against the dollar (to near parity). When the prices dropped, the yields on bonds spiked and a slumbering corner of U.K.’s financial world shook awake. Pensions are often an afterthought, especially for younger generations, just starting out their careers. They may contribute to a retirement plan their employer sponsors or put some money aside in a separate account for retirement. This attitude towards retirement is likely due to a worldwide shift from defined benefit plans to defined contribution plans. At its core, the main difference between the two types of schemes is that defined benefit plans require the employer to manage the funds and ensure that their pensioners get their money when they retire. In comparison, the employees themselves decide how to invest their money in defined contribution plans.
The pension industry quickly became the center of attention in late September 2022, though, and its vulnerabilities came to light. What was once thought of as a secure source of income post-retirement was no longer reliable. When the price dropped on bonds, causing a spike in yields, an avalanche tumbled through the pension market. Asset managers who oversaw the holdings of pension funds required more collateral to maintain the complicated and messy web of financial transactions known as liability-driven investments (“LDIs”). By the end of the week, the Bank of England caved and bailed out the funds by buying bonds for the next thirteen days. The market soon returned to its normal state. This entire debacle resolved itself in a little less than a month, culminating in Liz Truss’s resignation on October 20th, 2022. Though the market was back to normal, U.K.’s regulators and lawmakers were demanding answers from pension fund managers about how they got to this vulnerable state.
In essence, the U.K. pension industry found itself in a precarious position because of its increasing reliance on LDIs. If the funds were directly investing in bonds, then the returns would simply move up and down with yield. However, because of the complexity of the LDI strategy, the funds were left scrambling to complete the transactions they have started when the yield spiked. Direct investments, though, did not produce enough yields for the number of pensioners there were. Some critics argue for the abolishment of the LDI in pension funds, while others argue that LDI itself is not the problem, but its use of leverage is. One leading recommendation is increasing transparency regarding the amount of leverage a particular fund is using to prevent a problem on this scale from happening again.
Key Sources:
Eshe Nelson, Stephen Castle & Mark Landler, U.K. Government Goes Full Tilt on Tax Cuts and Free-Market Economics, N.Y. Times, Sept. 23, 2022, at A1.
Joe Rennison, British Borrowers Face Up to a Broken Mortgage Market, N.Y. Times, Sept. 30, 2022 at B1.
John Ralfe, Making the Switch to Bonds, Treasurer 20, 20 (2001).
Hymans Robertson & Nomura, The Age of Peak LDI, 7 (2018).
Harriet Agnew et al., How bond market mayhem set off a pension ‘time bomb’, Fin. Times, Oct. 8, 2022.
Theranos is a Symptom of a Larger Problem within VC Backed Startups
BY: Caroline Estey, RBFL Editor
Early last year, Elizabeth Holmes was charged with wire fraud for lying to investors about the capabilities of her company, Theranos. After news broke of the massive fraud, many wondered how and why it was able to happen. The answer to these questions appears to be connected to the regulation (or lack thereof) of “Unicorns.” Unicorns are private companies with a valuation of over $1 billion. They were once a rather rare occurrence, as indicated by their name, but in recent years they have become increasingly common. This is due to a noticeable shift in the lifecycle of startup companies. Initial Public Offerings (IPOs), which among other things bring companies into the public eye and help hold them accountable for their actions, were previously quite common. Most private companies knew they would eventually go public because of a need for more capital and/or because they would grow past a certain threshold which would trigger mandatory reporting. Because they had an impending IPO looming over them, these companies usually acted by the book while they were still private to prevent issues from popping up when they had to disclose company information during the IPO. In more recent years, regulations have changed and subsequently made it much easier for companies to stay private. These regulations have made it easier for companies to increase their capital while remaining private and have upped the thresholds that trigger mandatory reporting. Thus, the pressures of an impending IPO have disappeared for many private companies, which has in turn removed the pressure to keep everything by the book for the inevitable future disclosures. With no one watching them and no threat of future scrutiny, it has become increasingly easy, and probably tempting, for these private companies to make morally, ethically, and sometimes legally, questionable business decisions to increase the company’s success.
In addition to these regulatory changes, there has been an influx of new kinds of investors looking to invest in private startup companies. These investors have come onto the scene with a lot of money and a lot less interest in controlling the companies they are investing in. This is in great contrast to the traditional source of funding for such companies, Venture Capital funds (VCs), who would essentially trade money for control of the company. With this new competition, VCs had to change their structure to entice founders to still work with them. They did so by implementing a more “founder friendly” model, which often gives founders special shares of the company that hold extra voting power, allowing the founders to retain at least some control of the company. Thus, the founders of these companies are now simultaneously being given excessive amounts of money to use within the company as they please, and being released from any oversight, by regulations and investors, on how they are running the company. It is no wonder things have begun to spiral out of control.
Further compounding this issue is the “fake it till you make” mindset that runs rampant through Silicon Valley. Entrepreneurs and innovators in this space are encouraged to talk up their ideas and stretch the truth of their innovations in order to get them off the ground. It is such a well-accepted practice that some VCs have said they expect founders to lie to them about the capabilities of their products. This practice would not be too concerning if the companies had to later prove themselves and the abilities of their products, but because of the lack of oversight and accountability discussed above, this practice is proving to be rather dangerous.
Between Theranos and the multitude of other private companies, including Zenefits, Nikola, Uber, and WeWork, that have recently been caught engaging in questionable corporate governance practices, it seems clear that the current structure of regulation and oversight for these companies is not working. One potential solution is to require companies to start reporting at least some information about their company after they finish their first or second round of funding. This would allow the company a chance to establish itself through wooing investors with big promises, but it would also hold them accountable much earlier, which would likely push them to produce a legitimate product instead of pretending they have one hidden away. Some may feel this timeline would not give the companies enough time to create a working product, and that certainly could be true, but I believe at that point the investors have the right to know the true status of the invention and whether or not the product is likely to ever come to fruition. It would still be up to the investors to decide whether they want to believe in the future success of the idea and continue funding the company, but they would be able to make an informed decision about it, something they are often not able to do right now.
Sources
Renee M. Jones, The Unicorn Governance Trap, 166 U. Pa. L. Rev. Online 165 (2017), http://pennlawreview.com/online/166-U-Pa-L-Rev-Online-16.
See Michael Ewens & Joan Farre-Mensa, The Deregulation of the Private Equity Markets and the Decline in IPOS, 33 Rev. Fin. Stud. 5463, 9-11 (2020).
Amy Deen Westbrook, We(’re) Working on Corporate Governance: Stakeholder Vulnerability in Unicorn Companies, 23 J. Bus. L. 505, 505-74, 507 (2020).
Therese Poletti, The government tried to encourage IPOs, but it helped create the Age of the Unicorn, MarketWatch (Dec. 31, 2022 at 2:44 pm), https://www.marketwatch.com/story/the-government-tried-to-encourage-ipos-but-it-helped-create-the-age-of-the-unicorn-2017-12-26.
Erin Griffith, Theranos and Silicon Valley’s ‘Fake It Till You Make It’ Culture, Wired, (Mar. 14, 2018), https://www.wired.com/story/theranos-and-silicon-valleys-fake-it-till-you-make-it-culture/
Appraisal Discrimination in Residential Mortgage Lending: Past and Present
BY: Nicole Chatt González, RBFL Editor
One way to fool appraisers and increase the value of your home -- make the appraiser think the current occupants are white. In 2021, a black family’s picture hanging in the living room made a nearly $300,000 difference when Nathan Connolly and Shani Mott had their home initially appraised. On a second appraisal, with the photos replaced with pictures of a white family friend, the home’s value jumped from $472,000 on the initial appraisal to $750,000 after the changes were made. This is just one example of a long-standing practice in the appraisal industry, where appraisals conducted for the same home, just with differing evidence of the homeowners’ racial identity, have resulted in discrepancies of thousands of dollars.
These practices are nothing new in the residential appraising sphere. The earliest examples of, not only racist tendencies, but racist directives from appraisal authorities, stem from the 1946 McMichael’s Appraising Manual, used in both public and private appraisal sectors. The Manual went as far as ranking races and nationalities in order of desirability in American neighborhoods. This led to racial redlining, a form of racial segregation where, generally, a neighborhood’s racial composition is largely determined by discriminatory lending and appraisal practices.
The logical next question is to ask who oversees the appraisal industry and why this discriminatory conduct is allowed to continue. Essentially, appraisal supervisory bodies grant a significant amount of discretion to appraisers, enabling usage of race-related conclusions and generalizations in the appraisal process, under the guise of it being appraiser discretion. Further, the appraisal profession still operates on an apprenticeship model, where individuals looking to become real property appraisers must find an established appraiser to supervise them. This creates an “appraiser pipeline” that discourages involvement from those without connections to the profession. Because the appraisal industry is estimated to be between 78-99% white, minority applicants may feel particularly intimidated and discouraged, perpetuating its lack of diversity.
From a governmental standpoint, there have been indications of attempts towards improvement. While Congress has held power to regulate the appraisal profession through the Appraisal Subcommittee, this power is limited as it only applies to federally related transactions. A private organization, The Appraisal Foundation, sets the standards and rules that are adopted in all 50 states. However, it is worth noting the congressional subcommittee oversees the Foundation and, subsequently, has the authority to respond to the widespread issues regarding appraisers’ “discretionary” choices.
One recent development has been President Biden’s implementation of the Property Appraisal and Valuation Equity (PAVE) Task Force in June 2021 whose stated goal is “strengthening guardrails against discrimination” through various executive agencies, such as the Federal Housing Finance Agency and the Department of Housing and Urban Development. Despite no indication of direct congressional involvement in the Task Force, perhaps executive branch actions will lead to improvements in the industry.
Sources:
Debra Kamin, Home Appraised With a Black Owner: $472,000. With a White Owner: $750,000., N. Y. Times, https://www.nytimes.com/2022/08/18/realestate/housing-discrimination-maryland.html.
Stanley L. McMichael, McMichael’s Appraising Manual: A Real Estate Appraising Handbook for Use in Field Work and Advanced Study Courses, 3rd ed. 1944.
Safia Samee Ali, Black appraisers call out industry’s racial bias and need for systemic change, NBC NEWS (June 7, 2021, 11:57 PM), https://www.nbcnews.com/news/us-news/black-appraisers-call-out-industry-s-racial-bias-need-systemic-n1269452.
About the Appraisal Subcommittee, Appraisal Subcommittee, https://www.asc.gov/about.
Action Plan to Advance Property Appraisal and Valuation Equity, PAVE: Interagency Task Force on Property Appraisal and Valuation Equity, https://pave.hud.gov/actionplan.
Insider Trading by Members of Congress
BY: Tyler Bial, RBFL Student Editor
With the ever-increasing polarization of American politics, both sides of the aisle have amplified their calls to restrict congressional insider trading in recent years. While Congress passed the STOCK Act in 2012 as an attempt to combat congressional insider trading, the STOCK Act is widely regarded as a failed solution that is in desperate need of an overhaul. Nevertheless, despite these renewed calls for reform, Congress has resisted imposing restrictions on itself.
Both Democrat and Republican officials, among others, claim the failure to reform this area of law is likely due to the fact that any passed reform would be to each elected Congressman’s personal detriment. Despite holding a majority in both the House of Representatives and the Senate from 2020-2022, Democrats elected not to push through legislation that would overhaul the STOCK Act and address congressional insider trading. Democrat leaders claimed this was a tactical move, intended to ensure that any reform is done the right way so as to not be a repeat of the STOCK Act’s failing. Several Republican officials (as well as many officials inside the Democratic party) claim instead that Democrats chose not to pass legislation of this sort, despite bipartisan support, based on their personal interests to the contrary. While the Democrats did not see the “Red Wave” that was forecasted in the 2022 elections, their success in the midterms does not necessarily solve the wonder of why the party would pass up a chance to accomplish meaningful reform that they could champion in future elections. Despite the lack of indictment on Democrat leadership for their failure to reform congressional insider trading laws, reform remains highly popular among both party’s constituents. Thus, many believe the Democrats missed a free opportunity to gain points with voters on a heavily scrutinized issue based on their own conflicts.
Although a majority of Americans wish to see reform that addresses congressional insider trading, and despite the vocal bipartisan support for such reform, both the Republican and Democrat parties have elected officials who are likely to oppose reform. Thus, resistance to congressional insider trading laws is likely to persist in the future, regardless of which party is in control. This leaves open the question of whether meaningful reform will eventually be passed, or whether Congress will refuse to put forth self-regulating legislation that serves to their personal detriment. While the calls for congressional insider reform are likely to grow louder the longer that Congress fails to address the issue, the fact remains that there is a likelihood that Congress simply fails to regulate itself, despite the bipartisan support for such regulation.
Sources:
Sana Mesiya, Failures of the STOCK Act and the Future of Congressional Insider Trader Reform, 58 Am. Crim. L. Rev. Online 92, 98 (2021).
Alicia Parlapiano, Adam Playford & Kate Kelly, These 97 Members of Congress
Reported Trades in Companies Influenced by Their Committees, N.Y. Times (Sept. 13, 2022), https://www.nytimes.com/interactive/2022/09/13/us/politics/congress-members-stock-trading-list.html/.
Rebecca Ballhaus et al., As Covid Hit, Washington Officials Traded Stocks with Exquisite Timing, Wall St. J. (Oct. 19, 2022), https://www.wsj.com/articles/covid-washington-officials-stocks-trading-markets-stimulus-11666192404.
Stephanie Lai & Kate Kelly, House Puts Off Vote to Limit Lawmakers’ Stock Trades, Casting Doubt on Prospects, N.Y. Times (last updated Oct. 3, 2022), https://www.nytimes.com/2022/09/30/us/politics/stock-trading-vote-congress.html.
James Downie, Opinion, If Dems Can't Even Use Their Majority for This No-Brainer, What's the Point of Having It, MSNBC (last updated Oct. 3, 2022), https://www.msnbc.com/opinion/msnbc-opinion/democrats-botched-stock-trading-ban-huge-missed-chance-n1299215.
What is Rule 17 and Rule 17a-4?
BY: Imara Joroff, RBFL Student Editor
In 2022, the Securities and Exchange Commission (SEC) reached a record number of ordered money totaling $6.4 billion. This same year, the SEC reached a $1.8 billion settlement with sixteen firms for repeated violations on Rule 17a-4 – Texting Scandals. Rule 17a-4 details the “manner and length of time [business communication] records. . . must be maintained and produced promptly to [SEC] representatives.” The SEC uses these “preserved records . . . [as] the primary means of monitoring compliance with applicable securities laws.”
Off-Channel Communication
Business communication refers to any employee communication made in furtherance of a fundamental business goal. Off-channel communication is business communication that happens on an unofficial and unmonitored platform. This includes communication through secure electronic messaging apps, personal email accounts, and personal social media accounts. Firms face unique compliance challenges created by the use of apps with end-to-end encryption, such as WhatsApp, Signal, WeChat, and Telegram, on personal devices. How are members supposed to record and store business communication that they themselves cannot access?
More Guidance
Rule 17 was created in 1948, twenty-three years before email was created and forty-four years before the first text message was sent. One major complaint from firms is that the SEC does not provide sufficient guidance for how to comply with Rule 17 in the face of rapidly changing technology. Given that Rule 17a-4 is all encompassing, how much guidance is necessary? Firms either save all written electronic business communications in compliance with Rule 17a-4 or they don’t. Thus, if a messaging system does not allow firms to save their broker-dealers’ business communication then firms must prohibit the use of that messaging system.
JP Morgan, a firm involved in the texting scandals, had an explicit policy banning encrypted platforms like WhatsApp but also fostered an environment where senior managers encouraged junior broker-dealers to use the app and actively delete their business communications. In the face of such flagrant disregard for Rule 17a-4, would more guidance from the SEC have saved JP Morgan? No.
Rule 17a-4 Purpose and Threat of Increased Enforcement
The SEC’s mission is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.” Rule 17a-4 not only holds members accountable, it is also the bedrock of the SEC’s functionality. Unfettered access to off-channel business communication allows the SEC to determine illegal activity, gather evidence, and enforce corrective action before the activity delivers a bomb to the United States economy.
A seldom enforced rule is a suggestion. At the Securities Enforcement Forum, Chair Gensler stated, “Without examination against and enforcement of our rules and laws, [the SEC] can’t instill the trust necessary for our markets to thrive.” The general understanding surrounding violations of Rule 17 is that most firms know about the issues but do not correct them. Thus, the SEC is strictly enforcing Rule 17a-4 against end-to-end encrypted messaging apps with the hope that members will be deterred from using such services.
Potential Future Impact
Mark Zuckerberg is a zealous proponent of Metaverse - his virtual reality platform. The Metaverse will impact the employee experience by allowing people to join a virtual meeting room while working remotely. Would business conversations in the Metaverse, that would have been in-person and thus exempt from Rule 17a-4, now count as business communication being “received” by one avatar and “sent” by another? Alternatively, if all business transpired through virtual reality, would this eliminate the need for written communication like emails and text and thus render Rule 17 obsolete? As stated, in-person verbal communication is not subject to Rule 17a-4. Is this because such communication does not automatically generate a record for firms to store? If so, if the verbal communication in the Metaverse is recorded, would firms be required to transcribe, store, and furnish the transcripts of all meetings? Are firms required to do this now if they record a meeting via Zoom?
Conclusion
- P. Morgan Securities LLC., No. 3-20681 (SEC Dec. 17, 2021) https://www-law360-; com.ezproxy.bu.edu/articles/1449792/attachments/1; Barclays Capital Inc., No. 3-21164 (SEC Sept. 27, 2022); Citigroup Global Markets Inc. No. 3-21165 (SEC Sept. 27, 2022); BofA Securities, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, No. 3-21166 (SEC Sept. 28, 2022); Goldman Sachs & Co. LLC, No. 3-21167 (SEC Sept. 28, 2022); Jefferies LLC, No. 3-21168 (SEC Sept. 28, 2022); Morgan Stanley & Co. LLC and Morgan Stanley Smith Barney LLC, No. 3-21169 (SEC Sept. 27, 2022); Nomura Securities International, Inc., No. 3-21170 (SEC Sept. 27, 2022); Credit Suisse Securities (USA) LLC, No. 3-21171 (SEC Sept. 27, 2022); Cantor Fitzgerald & Co., No. 3-21172 (SEC Sept. 27, 2022); Deutsche Bank Securities Inc., DWS Investment Management Americas, Inc., and DWS Distributors, Inc., No. 3-21173 (SEC Sept. 27, 2022); UBS Financial Services, Inc. and UBS Securities LLC, No. 3-21174 (SEC Sept. 27, 2022)
- Commission Guidance to Broker-Dealers on the Use of Electronic Storage Media under the Electronic Signatures in Global and National Commerce Act of 2000 with Respect to Rule 17a-4(f), 17 C.F.R. Part 241, Exchange Act Rel. No. 44238 (May 1, 2001); see also 17 C.F.R. § 240.17a-4 (2021)
- Press Release, CFTC No. 8599-22, CFTC Orders 11 Financial Institutions to Pay Over $710 Million for Recordkeeping and Supervision Failures for Widespread Use of Unapproved Communication Methods (Sept. 27, 2022) https://www.cftc.gov/PressRoom/PressReleases/8599-22
- Gary Gensler, Chair, Securities and Exchange Commission, Remarks at the Securities Enforcement Forum (Nov. 4, 2021) https://www.sec.gov/news/speech/gensler-securities-enforcement-forum-20211104
- Ryan Mac, Sheera Frenkel and Kevin Roose, Skepticism, Confusion, Frustration: Inside Mark Zuckerberg’s Metaverse Struggles, New York Times (Oct. 9, 2020)
SEC Rule 14a-8: Should the SEC Narrow the Grounds on Which Registered Issuers May Exclude Shareholder Proposals?
BY: Joseph Brav, RBFL Student Editor
SEC Rule 14a-8[i] requires corporations to include eligible shareholders’ proposals in their proxy materials to be voted on at the next shareholder meeting. However, 14a-8 has various exceptions that corporations can rely on to exclude shareholder proposals. 14a-8’s most controversial exception is known as the “ordinary business exception,” which allows corporations to exclude proposals that relate to the company’s ordinary business operations. This exception is meant to allow firms’ executives to run the company operations without interference from shareholders. In 1976, the SEC qualified this exception by announcing[ii] that firms must include shareholder proposals that implicates a significant social issue, but in 1998[iii], the SEC announced that even a proposal that implicates a significant social issue is excludible if it seeks to “micro-manage” the company.
Unfortunately, the ordinary business exception is not applied consistently by the SEC or courts because there is no way to determine whether a proposal pertains to daily business operations or raises a significant social issue. Furthermore, the SEC and courts have held that if the “form” of a proposal does not relate to ordinary business activities, the proposal can still be excludible if its “substance” seeks to influence ordinary business activities. Additionally, it is unclear how to separate activities that are “ordinary business” from those that are not, and while interpreters have pointed to media coverage and congressional attention as measures of an issue’s significance, no standard has been set forth that establishes when a social issue is significant enough to prevent a firm from excluding a shareholder proposal under the ordinary business exception.
Trinity Wall Street v. Wal-Mart Stores, Inc.[iv] is a recent Third Circuit case that highlights the issues with the ordinary business exception. The majority held that a shareholder proposal that implicates a significant social policy is nonetheless excludible if the social issue does not “transcend” the firm’s ordinary business operations—but the SEC’s interpretation of the ordinary business exception does not include this transcendence element. Furthermore, the concurrence held that the plaintiff’s proposal was excludible because it did not focus specifically on gun sales to raise a significant social issue, while the majority found that the proposal was excludible because it pertained to the sale of specific products. The SEC announced its preference for the concurring opinion, showing that the SEC and Third Circuit interpret the ordinary business exception differently, which is significant because the Third Circuit includes Delaware.
To address these problems, the SEC should eliminate the significant social issue caveat because it defies definition. To counteract the effect this would have on expanding firms’ ability to exclude shareholder proposals, the SEC or Congress should also eliminate the distinction between form and substance—companies should be required to include shareholder proposals that, by their form, seek to influence management’s treatment of ordinary business operations so long as they do not subvert managerial control and directly dictate the performance of certain daily business activities.
[i] 17 C.F.R. § 240.14a-8 (2023).
[ii] Reilly S. Steel, The Underground Rulification of the Ordinary Business Operations Exclusion, 116 Colum. L. Rev. 1547, 1559 (2016).
[iii] Id. at 1561.
[iv] Trinity Wall Street v. Wal-Mart Stores, Inc., 792 F.3d 323, 323 (3rd Cir. 2015).
RBFL Presents: An Interview with Professor Madison Condon
Personal Income Tax Implications of COVID-19 & Remote Employment
BY: Harrison Fregeau, RBFL Editor
When the pandemic caused by the novel coronavirus (“COVID-19”) struck the United States in March of 2020, many workers, particularly white-collar office workers, began to work from home. This movement to a work-from-home environment produced interesting state tax consequences for those whose homes were in different states than their workplace offices. These issues are of particular importance for states where there is a lot of daily commuting from nearby states into a key metropolis (think of Wisconsin and Indiana residents commuting to Chicago, Maryland and Virginia residents commuting to Washington D.C. or Connecticut and New Jersey residents commuting to New York City). Should the trend towards long-term work-from-home flexibility continue following the eventual end of the COVID-19 pandemic, states’ decisions on whether to tax out-of-state workers teleworking into their state could have critical impacts on state and local finances.
This issue is particularly acute for closely adjacent states which have notably differing levels of state and local taxation. An example of this boiled over in 2021 when New Hampshire sued Massachusetts alleging that Massachusetts wrongfully taxed New Hampshire residents telecommuting to Massachusetts. The number of people affected by this is not insubstantial, as prior to COVID-19, the State of New Hampshire estimated that over 12% of its workers commuted to Massachusetts. For these workers, and for the two states involved, the question of how teleworking was to be taxed provoked critical questions of tax arbitrage, double taxation, state sovereignty, and public policy. For example, in its Brief to the Supreme Court, New Hampshire claimed Massachusetts intruded upon its sovereignty by assessing taxes on individuals who had not left New Hampshire during the year, and thus had made no use of services supported by Massachusetts income tax. From Massachusetts’s perspective however, taxing these suddenly out-of-state workers was critical, as it was the dynamic Massachusetts economy that caused employers to found or relocate businesses to the Commonwealth in the first place.
Though the Supreme Court ultimately declined to hear the case in June 2021, and the issue seems to have subsided as Massachusetts temporarily changed its nexus rules to accommodate COVID-related telecommuters, this issue is likely to not go away. For one thing, even following the Omicron variant, many large firms continue to offer a much higher share of their positions remotely. Additionally, while the Supreme Court declined to hear the case in its original jurisdiction capacity, the case might well make its way through the state courts to the Supreme Court on its merits. Above all, the issue likely will not go away due to powerful incentives to practice tax arbitrage. For example, a resident of Vancouver, Washington working in Portland, Oregon (ten miles apart from one another) has tremendous incentive to be classified as working from home in Washington (which has a state sales tax but no state income tax) rather than in Oregon (which has a state income tax, but no state sales tax). Regardless of how it resolves, this question will be one to watch.
Key Sources:
New Hampshire v. Massachusetts, SCOTUSblog: Indep. News & Analysis on the U.S. Sup. Ct., (June 28, 2021), https://www.scotusblog.com/case-files/cases/new-hampshire-v-massachusetts/
See Edward A. Zelinsky, Taxing Interstate Remote Workers After New Hampshire v. Massachusetts: The Current Status of the Debate, 656 Cardozo Legal Stud. Rsch. Paper 1, 11 (Oct. 4, 2021).https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3934566
State of New Hampshire, Motion for Leave to File Bill of Complaint, New Hampshire v. Massachusetts, (Oct. 19, 2020) 1,. https://www.governor.nh.gov/sites/g/files/ehbemt336/files/documents/nh-v-ma-action.pdf.TIR 20-5: Massachusetts Department of Revenue, Massachusetts Tax Implications of an Employee Working Remotely due to the COVID-19 Pandemic, (Apr. 21, 2020). TIR 20-5: Massachusetts Tax Implications of an Employee Working Remotely due to the COVID-19 Pandemic | Mass.gov
Commonwealth of Massachusetts, Brief in Opposition to Motion for Leave to File Complaint, New Hampshire v. Massachusetts, 1. https://www.supremecourt.gov/DocketPDF/22/22O154/163519/20201211121204330_New%20Hampshire%20v.%20Massachusetts%20brief%20in%20opposition.pdf
Paycheck Protection Program and Loan Fraud: DOJ’s Response
BY: Zachary Trombly, RBFL Student Editor
It’s been just over two years since the first outbreak of COVID-19 in the United States. Since early 2020, many small businesses who were crippled by mandated lockdowns and other COVID-related restrictions are still fighting to stay afloat while some have been forced to close their doors due to diminished revenues. In an effort to provide emergency relief to these businesses, Congress enacted The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which therein established one of the cornerstones of the act, the Paycheck Protection Program (“PPP”).
For the most part, the PPP was successful in increasing the overall health of the small businesses, as these loans allowed small businesses to stay operating during the height of COVID. At the same time, the enactment of the PPP also opened the door for many individuals attempting to game the loan system and engage in fraudulent activity. As a result of this fraudulent activity, the Department of Justice (“DOJ”) and federal government have ramped up their efforts in combating this type of fraudulent activity through various measures.
The primary way the DOJ has pursued cases of PPP loan fraud is by reverting back to their playbook for dealing with mortgage fraud cases, most notably the ones around the 2016 financial crisis. The primary statutory schemes in these cases were the use of the False Claims Act (“FCA”) and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”). While each of these statutes have their own pros and cons, they are typically used concurrently by the DOJ to pursue civil resolutions and damages for PPP fraud. For example, on January 12, 2021, the DOJ obtained its first civil resolution in the In re Slidebelts Inc. case out of the Eastern District of California. In this case, Slidebelts, an internet fashion retailer, and its CEO paid $100,000 in damages after fabricating information on their application in order to receive a larger loan through the PPP program. In prosecuting Slidebelts, the DOJ relied on both the FCA and FIRREA statutes, determining they had enough evidence to meet the elemental test of the FCA and the additional requirements of FIRREA. Since Slidebelts, the DOJ has continued to rely on these two statutes in prosecuting PPP fraud and have prosecuted over 500 individuals with over $569 million dollars being implicated in these fraudulent schemes.
Outside of statutory schemes used by the DOJ, the federal government has also instituted various efforts to resolve current fraud cases and safeguard from future ones. Attorney General Merrick Garland announced the DOJ would be taking a “historic enforcement initiative to detect and disrupt COVID-19 related fraud schemes,” and has subsequently prosecuted individuals at a historic rate through the Criminal Fraud Division of the DOJ. Assistant Attorney Brian C. Rabbitt also announced that data analytics would play an important role in safeguarding and detecting future fraud cases. The details around this approach have not been released to the public but Rabbitt mentioned they have leveraged their analytical tools with other state and federal agencies to detect cases of fraud.
SOURCES:
Kathy Gurchiek, Small Businesses Get Creative to Survive During the Pandemic, Soc’y For Hum. Res. Mgmt. (Sept. 19, 2020), https://www.shrm.org/hr-today/news/all-things-work/pages/small-businesses-get-creative-to-survive-during-the-pandemic.aspx [https://perma.cc/4YGJ-565H].
Coronavirus Aid, Relief, and Economic Security (CARES) Act, Pub. L. 116-36. 134 Stat. 286 (codified as 15 U.S.C. § 116).
Derek Adams, United States: Trio of DOJ Civil Resolutions Under the Paycheck Protection Program are the Tip of the Iceberg, Potomac L. Grp. (June 25, 2021), https://www.mondaq.com/unitedstates/white-collar-crime-anti-corruption-fraud/1083648/trio-of-doj-civil-resolutions-under-the-paycheck-protection-program-are-tip-of-the-iceberg [https://perma.cc/54AX-PU6N].
Press Release, Department of Justice, Combating Mortgage Fraud (Nov. 9, 2009), https://www.justice.gov/archives/opa/blog/combating-mortgage-fraud [https://perma.cc/SP5J-JRPW].
Press Release, Department of Justice, Justice Department Takes Action Against COVID-19 Fraud (Mar. 26, 2021), https://www.justice.gov/opa/pr/justice-department-takes-action-against-covid-19-fraud [https://perma.cc/A7XL-WTE5].
Press Release, Department of Justice, Eastern District of California Obtains Nation’s First Civil Settlement for Fraud on Cares Act Paycheck Protection Program (Jan. 12, 2021), https://www.justice.gov/usao-edca/pr/eastern-district-california-obtains-nation-s-first-civil-settlement-fraud-cares-act.
Cybersecurity & the SEC Enforcement
BY: Joshua Stein, RBFL Student Editor
Since the internet boom in the early 2000’s, cybersecurity risks have developed into significant threats to investors, markets, and the economy in general. This article explores the possible changes to regulations regarding cybersecurity and their effects on the public sector. The article largely focuses on SEC guidance surrounding cybersecurity and anticipates the upcoming SEC guidance by analyzing recent government actions dealing with the topic.
In the past decade, the SEC has continuously monitored these “new age” threats of security related to technology, proposing rules for corporations to follow to avoid potential attacks and limit the consequences of these attacks. The goal of the SEC in implementing these new rules is to create transparency for investors and other interested parties by eliminating elective disclosures and deterring corporations from refraining from disclosing material information.
In October 2011, the SEC’s Division of Corporation Finance issued its first guidance on the topic, stating that “[a]lthough no existing disclosure requirement explicitly refers to cybersecurity risks and cyber incidents,” companies nonetheless may be obligated to disclose such risks and incidents. In 2018, the SEC offered two additional recommendations to address developments in the cyber space following 2011. The guidance stressed the “importance of maintaining comprehensive policies and procedures related to cybersecurity risks and incidents” and reminded companies and their “directors, officers, and other corporate insiders of the applicable insider trading prohibitions under the general antifraud provisions of the federal securities laws.” In particular, the SEC pointed to the “obligation to refrain from making selective disclosures of material nonpublic information about cybersecurity risks or incidents.”
The updated SEC guidance is expected to be released in 2022 after being pushed back from Fall 2021, and although there is not much available information about the new rules yet, we can speculate on certain policy points based on recent actions by the government. Recently, Congress enacted The Cybersecurity Information Sharing Act of 2015 and the Internet of Things Cybersecurity Improvement Act of 2020. While the 2020 Act is focused on government agencies and employees, it is based on the 2015 Act which established certain protections to “encourage companies voluntarily to share information—specifically, information about ‘cyber threat indicators’ and ‘defensive measures’—with the federal government, state and local governments, and other companies and private entities.” President’s Biden’s Executive Order on Improving the Nation’s Cybersecurity (Cyber EO) from May of 2021 also offered insight into the upcoming SEC rules, though it did not focus on security of consumer products.
Beyond direct guidance offered by the SEC, early enforcement trends from SEC Chairman Gary Gensler provide a picture of how his administration will act towards cybersecurity concerns. Gensler has already shifted the SEC’s focus further towards disclosure violations since he was sworn into the Chairman position in April 2021. In June 2021, the SEC settled charges with First American Financial Corporation in “one of the first instances in which the SEC had brought charges in the absence of an actual data breach or intrusion by a third party.” Gensler has made it clear that cybersecurity will be a priority for the SEC, and strict enforcement of disclosure rules will become routine as technology continues to develop.
As blockchains, cryptocurrencies, and other advances in business and technology move the operations of corporations to digital mediums, cyberattacks become a greater threat to investors and the corporations they invest in. While the atmosphere of cybersecurity within the financial sector is continuously changing, the upcoming SEC proposal should provide increased insight into the path that the government is taking to educate corporations and investors to prevent the threat.
Citations
Commission Statement and Guidance on Public Company Cybersecurity Disclosures, 17 C.F.R. §§ 229, 249 (Sec. Exch. Comm’n, Feb. 26, 2018).
Vivek Mohan, David Simon & Richard Rosenfeld, SEC Increasingly Turns Focus Toward Strength of Cyber Risk Disclosures, Harv. L.F. on Corp. Governance (July 25, 2021). https://corpgov.law.harvard.edu/2021/07/25/sec-increasingly-turns-focus-toward-strength-of-cyber-risk-disclosures/ [https://perma.cc/4YBA-JGNF].
Our goals, U.S. Sec. Exch. Comm’n, https://www.sec.gov/our-goals (Oct. 16, 2018)) [https://perma.cc/ZH9C-MTGL]
CF Disclosure Guidance: Topic No. 2 – Cybersecurity, U.S. Sec. Exch. Comm’n (Oct. 13, 2011), https://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic2.htm [https://perma.cc/KWX5-5BQH].
Rajesh De Et Al., President Biden Issues Executive Order to Improve Nation’s Cybersecurity, Mayer Brown, (May 17, 2021), https://www.mayerbrown.com/en/perspectives-events/publications/2021/05/president-biden-issues-executive-order-to-improve-nations-cybersecurity [https://perma.cc/ZJ27-9MMT]
Brad S. Karp, Paul, Weiss, & Rifkind, Federal Guidance on the Cybersecurity Information Sharing Act of 2015, Harv. L.F. on Corp. Governance (March 3, 2016), https://corpgov.law.harvard.edu/2016/03/03/federal-guidance-on-the-cybersecurity-information-sharing-act-of-2015/ [https://perma.cc/C9KQ-M2JS]
Julianne Landsvik, Randall Lee & Michael Welsh, Early SEC Enforcement Trends from chairman Gensler's first 100 Days, The Harv. L. Sch. F. on Corp. Governance (Aug. 11, 2021), https://corpgov.law.harvard.edu/2021/08/11/early-sec-enforcement-trends-from-chairman-genslers-first-100-days/ [https://perma.cc/TG2L-YYV7]
Press Release, SEC, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors, (Sep. 25, 2017) (on file with author)
Final rule: Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, 17 C.F.R. § 210-74 (2003)