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Government Investigations and White Collar Litigation Group
Fraud, Deception and False Claims

Supreme Court Hands Down Opinion in Universal Health Services v. Escobar

Recently, the 87790287_jpgSupreme Court handed down its much-anticipated opinion in Universal Health Services, Inc. v. United States ex rel. Escobar et al.—a case addressing the viability of the implied certification theory in FCA litigation.  Justice Thomas, writing on behalf of a unanimous Court, found that the implied certification theory can in fact serve as a basis for FCA liability where a defendant has misleadingly failed to disclose its noncompliance with material statutory, regulatory, or contractual obligations.

The Court first addressed whether Universal Health Services, Inc. (“Universal Health”) impliedly certified that it had complied with Massachusetts Medicaid regulations by submitting claims for payment. Although the Court concluded that it did, the holding is narrowly drafted.  The Court held that the act of submitting a claim for payment is an actionable misrepresentation where two conditions are satisfied: (i) in addition to requesting payment, the claim also makes specific representations about the goods or services provided; and (ii) the failure to disclose noncompliance with material statutory, regulatory, or contractual requirements renders the representations “misleading half-truths.”  The Court expressly declined to address “whether all claims for payment implicitly represent that the billing party is legally entitled to payment.”As discussed in a previous article, Escobar is a qui tam case in which two relators allege that Universal Health submitted claims for reimbursement that failed to disclose violations of Massachusetts Medicaid regulations governing the qualifications and supervision requirements for staff at a mental health facility.  The Court determined that when Universal Health submitted reimbursement claims for mental health services using certain payment codes, “anyone would [wrongly] conclude that Universal Health complied with core state Medicaid requirements regarding the qualifications and licensing requirements of its staff members.”  By submitting claims for payment without disclosing the alleged violations, the Court found that Universal Health’s claims constituted actionable misrepresentations.Although many will be disappointed that the Court did not reject the implied certification theory, the Court’s limited ruling gives defendants room to argue that not all claims for payment implicitly represent compliance with statutory, regulatory, and contractual requirements. The Court looked to the common law to determine when nondisclosure constitutes an actionable misrepresentation, which is typically a fact-dependent, case-by-case inquiry.  The Court’s limited ruling leaves a lot of work left to be done in the lower courts and is sure to generate significant litigation.  Given that most jurisdictions had already adopted the implied certification theory, however, the Court’s limited ruling can be seen as a silver lining.The second question the Court addressed was whether the implied certification theory is limited to instances where compliance with a statute, regulation, or contractual provision was a condition of payment. Most lower courts had adopted this bright-line rule to prevent nearly unchecked liability under the FCA for minor regulatory violations and contractual breaches.  The Court addressed this issue solely as a question of materiality, and concluded that “[w]hether a provision is labeled a condition of payment is relevant to but not dispositive of the materiality inquiry.”In a bid to give some teeth to the materiality standard, the Court called the FCA’s materiality standard “rigorous” and “demanding” and reiterated that the FCA is not to be used as “an all-purpose antifraud statute.” The Court again turned to the common law, suggesting that materiality should be measured by whether noncompliance with a regulatory violation would influence the government’s decision to pay a claim.  The Court’s holding on this point was less precise, but it did reject the government’s argument that noncompliance with a regulatory violation is material simply because the government would be entitled to refuse payment.  Additionally, the Court appeared to suggest that defendants must have knowledge that noncompliance would be material.

From a litigation perspective, Escobar has swept away years of precedent on the bright-line rule.  Despite the Court’s effort to bolster materiality as a defense in implied certification cases, the loss of the bright-line rule will make it more difficult for defendants to win motions to dismiss.  The Court addressed this problem in a footnote, arguing that the pleading standards require the government and relators to plead facts to support their allegations of materiality.  No doubt the pleading standards will be an avenue to attack materiality on a motion to dismiss, but the Court may be overly optimistic.  Materiality is generally a mixed question of law and fact, meaning trial courts will be reluctant to dismiss a case before discovery.  As a result many cases that would have previously been dismissed will now go through expensive discovery.

Anti-Bribery and Corruption, Enforcement and Prosecution Policy and Trends

SEC Highlights Model Response to Evidence of FCPA Violations, Announces Non-Prosecution Agreements

On June 7, the Securities and Exchange Commission (SEC) announced two non-prosecution agreements (NPAs) following a pair of investigations into alleged violations of the Foreign Corrupt Practices Act (FCPA).  Both companies were ensnared by the FCPA through the conduct of their foreign subsidiaries.  The way the companies responded to the apparent violations provides a potential roadmap for a company that uncovers wrongdoing within the firm.

The Alleged Misconduct

Akamai Technologies, a global internet services company based in Massachusetts, owned a subsidiary that operated in China.  A sales manager at the subsidiary bribed employees at state-owned Chinese companies to purchase up to 100-times more network capacity than the companies actually needed.  Additionally, employees at the subsidiary routinely provided improper gifts to Chinese government officials in order to obtain or retain their business.

The second company, Nortek, Inc., also owned a subsidiary in China.  The subsidiary manufactured products for Nortek’s business, which consisted of selling products for residential and commercial construction.  Officers and employees at Nortek’s subsidiary made or approved improper payments and gifts to Chinese officials to obtain business and preferential treatment, including more favorable regulatory oversight and reduced taxes and fees.  Subsidiary employees made at least one improper payment every month in a five-year period.

The Investigation and Reporting to the SEC

Neither Akamai nor Nortek had adequate accounting controls to detect the bribery schemes as they unfolded.  Akamai uncovered the scheme only when a lower level sales representative filed a complaint against the manager.  Although Nortek discovered the bribery at its subsidiary during the course of an audit, the scheme had by that time been going on for five years.

Once the schemes were uncovered, both companies launched internal investigations.  A key component of that process was notifying the SEC of potential violations.  The companies notified the SEC early on and kept the SEC informed as the investigation developed.  Additionally, the companies disclosed summaries of witness interviews and made witnesses available to the SEC staff, including witnesses located in China.

Both companies also undertook extensive remedial measures.  Akamai named a Chief Compliance Officer and established a global team of compliance professionals.  It also strengthened its anti-corruption and training policies.  Nortek did the same.  It established a new Compliance Committee to oversee the implementation of its remedial efforts.  The companies terminated those who participated in the schemes and severed their relationships with problematic local partners.

The Non-Prosecution Agreements

As a result of these measures, the SEC determined it was appropriate to enter into NPAs with Akamai and Nortek.  The SEC required Akamai to disgorge over $650,000, plus interest.  Nortek disgorged nearly $300,000.  However, both companies escaped charges under the FCPA because of how they handled the discovery of the potential violations and the ensuing investigation.

The SEC attributed the decision not to pursue an FCPA case against the companies to prompt self-reporting and extensive cooperation with the investigation that followed.  It was critically important to the SEC that the companies laid “all their cards on the table.”  The SEC was also satisfied with the remedial measures the companies put in place.  One SEC official noted: “They handled it the right way and got expeditious resolutions as a result.”

The Akamai and Nortek cases lay out a roadmap to an NPA for companies that uncover clear evidence of a potential FCPA violation.  The companies (1) promptly disclosed the issues they uncovered to the SEC; (2) kept the SEC informed as the internal investigations proceeded; (3) fully cooperated with the SEC, including making witnesses available to be interviewed; and (4) took a hard look at their existing compliance programs and changed them to address the problem.  Experienced counsel can help companies navigate their way through the internal investigation process and craft a compliance regime responsive to the SEC’s concerns.

Compliance

Department of Education Proposes Rules Increasing Student Loan Risk to Schools

Government-Regulatory-and-Criminal-Investigations.jpg

On June 13, the Department of Education (DOE) proposed new rules relating to effective discharges of student loans. The proposed rules should be of note and concern to all schools, nonprofit and for-profit alike, because of significant new provisions and the broadening of defense to repayment rules.

Since 1995, DOE regulations have permitted borrowers to seek a defense to repayment, which currently requires a showing that the student has a state law cause of action against the school. In accompanying commentary to the proposed rules, DOE observes that the existing provisions have been relatively rarely used, and it acknowledges both that the standard is difficult to apply consistently and that there is no existing process for obtaining a defense to repayment. DOE justified the need for the new rules in the fallout from the bankruptcy of Corinthian Colleges, which resulted in thousands of former students seeking student loan relief. In that process, DOE concluded that new borrower defense rules were necessary.

The DOE rulemaking process began last year, with the publication of a notice that it intended to establish a negotiated rulemaking committee. After public hearings and an opportunity for the public to nominate committee members, a committee of approximately 30 members and alternates was established. The members of the committee represented a number of interests including state regulators, lenders, students, consumer advocates, two-year colleges, public schools, four-year public and private schools, and for-profit schools. The committee met in February and March of this year, but did not reach a unanimous consensus on any language for proposed rules. DOE’s press release states that it took into account the recommendations of the committee.

Although the rule changes were motivated by the Corinthian bankruptcy, the majority of the proposals apply equally to for-profit and not-for-profit schools. Among the provisions that apply to all schools are the following:

  • A requirement that private schools identified as financial risks, including those with high levels of borrower defense claims or an ongoing suit by state or federal regulators, must in some circumstances provide DOE a letter of credit equal to, in the case of ongoing suits, at least 10 percent of all federal loan funds received by the school in the most recent year. If the requirement for a letter of credit is triggered, it is mandatory. If the letter of credit is not provided within 30 days of a request by DOE, DOE may offset loan funds due to the school and hold them in an escrow account for the same purpose. Schools that are required by DOE to provide this financial protection must notify both enrolled and prospective students.
  • A provision prohibiting the use of all arbitration clauses and class action waivers between students and schools going forward, and rendering unenforceable any existing ones.
  • A provision forbidding schools from requiring students to first use an internal complaint process before making complaints to accreditors and government agencies.
  • Language clarifying that DOE can recover its losses from discharged loans from schools, including loans discharged because of borrower defenses.

One of the most significant aspects of the proposed rules is the new set of standards established for borrower defense, which would become effective for all loans first disbursed after July 1, 2017. Under the new rules, a borrower would have a defense to repayment and a claim for previously repaid amounts when (a) the school breached the terms of a contract with the student; (b) the student, a class of which the student was a member, or a government entity on behalf of the student won a favorable contested judgment against the school in court or before an administrative tribunal; or (c) the school or its agents made a substantial misrepresentation that the borrower reasonably relied on in deciding to attend the school.

Under the proposed rules, a student may submit an application to DOE seeking a defense to repayment on any of these bases. The student’s loans are automatically placed into forbearance while DOE considers the application. A DOE official decides whether the student is entitled to a defense to repayment, under a preponderance-of-evidence standard. The school must be notified and may submit a response. The rules do not provide for an appeal process for either students or schools. There are also procedures for DOE to initiate a consideration of potential defenses to repayment for an entire class of students.

The criteria allowing for a defense to repayment may potentially be implicated in many situations, for both for-profit and not-for-profit schools. In particular, the “substantial misrepresentation” prong could potentially be used against schools that are accused of misrepresenting the opportunities available to students, graduation rates, job placement rates, or graduate salary data. DOE has provided some factors that may be evidence of the reasonableness of the borrower’s reliance, but little guidance on what is a substantial misrepresentation. The proposed rules do alter the existing definition of misrepresentation to clarify that it encompasses any communication that has the likelihood or tendency to mislead under the circumstances.

Given recent news regarding allegations that nonprofit schools, including law schools, have misrepresented information that caused students to attend, many schools have reason to examine the proposed rules closely. Any allegation or suit against a school, particularly a putative class suit, poses additional risks that students may seek to use the suit as a defense to repayment.

In addition, the potential implications of settled cases are unclear. Even under the current standard, the Massachusetts Attorney General has said it will use admissions in a recent consent judgment to urge DOE to cancel loans that were taken out to attend certain programs at American Career Institute. Under the new regulations, a settlement does not qualify as a favorable judgment automatically entitling the student to a defense to repayment, but it is not clear whether a consent judgment would qualify as a favorable judgment. Further, the DOE discussion of the proposed rules expressly states that a settlement can be used as evidence establishing one of the other defenses to repayment criteria, such as a substantial misrepresentation. It is also not clear whether language in the settlement disclaiming liability or denying the allegations would have its intended effect or whether the DOE official could look beyond such language and find a substantial misrepresentation on the basis of a settlement. At a minimum, schools should be aware that if the proposed rule goes into effect as written, the language of any related settlements are likely to be scrutinized for potential support for a defense to repayment claim.

The proposed new rules are open to public comment until August 1, and DOE intends to publish the final rule by November 1.

Compliance, Financial Institution Regulation

CFPB Proposes Rule on Small Dollar Lending

On JunMoneye 2, 2016, the Consumer Financial Protection Bureau (“CFPB”) released its proposed rule on small dollar lending during its scheduled field hearing in Kansas City, Missouri. The controversial proposed rule will affect payday loans, single-payment vehicle title loans, deposit advance products, and certain-high cost loans.

Under the proposed rule, lenders would be responsible for making sure that borrowers take on only debt that they can afford to repay. The proposed rule would require lenders to make a “full-payment test” before making most small dollar loans. This test would verify that the borrower can afford to make each payment and still meet all major financial obligations including basic living expenses. The proposed rule further limits the number of times and under what conditions loans can be rolled over each month. For example, payday and single-payment vehicle title loans would be capped at three successive loans followed by a mandatory 30-day cooling off period before the borrower could take out a new loan.

The proposed rule includes some limited exceptions to the full payment test requirement if certain criteria are met. Under the “principal payoff option,” lenders could make short term loans up to $500 in low-risk situations if the debt is repaid in a single payment or with up to two extensions without fully verifying the borrower’s ability to repay. For longer term loans, the proposed rule gives lenders two options to avoid the full payment test. Lenders would be allowed to offer loans that meet the National Credit Union Administration’s “payday alternative loan” criteria of capping interest rates at 28 percent with an application fee of not more than $20. Additionally, lenders could also offer loans payable in equal installments with a term not to exceed 24 months as long as the lender’s projected rate of default on the loans was 5 percent or less. But, if the lender’s default rate exceeded 5 percent in a given year, the lender would be required to refund its origination fees.

The proposed rule, however, is not just focused on the types of loans lenders offer. Rather, the rule will also regulate how lenders attempt to collect payment from consumers’ accounts. Specifically, under the new rule, lenders would be required to give borrowers written notice three days before debiting a borrower’s account for any loan covered by the rule. After two straight unsuccessful attempts, the lender would be prohibited from attempting to debit the account unless the borrower specifically consented to a further attempt. According to remarks by CFPB Director Richard Cordray, this gives “consumers a chance to question or dispute any unauthorized or erroneous payment attempts and to make arrangements for covering payments that are due.”

But despite CFPB claims that this new rule “would put an end to the risky practices in these markets that trap consumers in debt they cannot afford,” the new regulation is not without controversy. As previously reported, an earlier outline of the proposed rule was harshly criticized. Consumers and members of the finance industry voiced concern that the proposed rule could harm small businesses, take away options from consumers, and possibly infringe on authority of states and tribal nations. Members of Congress also introduced legislation last November directed at curtailing the CFPB’s rulemaking. If enacted, the proposed Consumer Protection and Choice Act would drastically limit the strength of the regulation by delaying the rule for two years and excluding states that already have certain payday lending laws from the CFPB’s regulation.

The CFPB is currently accepting comments on its proposed rule, and a final rule is expected to follow.

Financial Institution Regulation

CFPB Sues Payment Processor for Facilitating Fraudulent Transactions

The CFPB sued payment processor Intercept Corporation, its owner, and its CEO on June 6, 2016, for allegedly enabling unauthorized withdrawals and other illegal activities of Intercept’s clients.  The complaint, filed in district court in North Dakota, accuses Intercept of processing transactions for its clients that it knew or “consciously avoided knowing” initiated fraudulent or illegal transactions.  Based on Intercept’s conduct, the CFPB alleges Intercept violated the Consumer Financial Protection Act (“CFPA”).

Intercept is a third-party payment processor that processes electronic fund transfers through the ACH network.  Intercept counts among its clients payday lenders, debt collectors, and auto title lenders.  The complaint described Intercept’s typical transaction:  Intercept’s client instructs Intercept to withdraw loan repayments from a borrower’s bank account; Intercept instructs its bank to contact the borrower’s bank to withdraw the money; the borrower’s bank debits the account, remits the money to Intercept’s bank, and Intercept remits the money to its client.

The CFPB alleges that Intercept violated the CFPA by engaging in unfair acts and practices by failing to heed warnings from banks and consumers; failing to adequately monitor and respond to high return rates; and failing to investigate red flags when vetting its clients.  The CFPB further contends that Intercept’s owner and CEO violated the CFPA by providing substantial assistance to Intercept.  According to the CFPB, Intercept falls under the CFPA for two reasons: (1) it provides payments or other financial data processing products or services to consumers by technological means; and (2) it provides services to cover persons.

Intercept’s banks notified it on multiple occasions that it was concerned with Intercept’s clients’ high return rates of disputed transactions, which the CFPB contends can be indicative of illegal or fraudulent activity.  But Intercept allegedly ignored its own banks’ warnings.  When one of Intercept’s banks would end its relationship with Intercept, Intercept would move on to another bank, never stopping to investigate the banks’ concerns or take a look at its relationships with its trouble clients.  Intercept’s clients’ rates of return for unauthorized transactions exceed industry standards.

The CFPB cited to industry rules and guidelines requiring participants in ACH transactions to monitor return rates and other suspicious activity.  The implication in the complaint is that Intercept should have investigated or terminated its relationships with clients with high return rates.

Intercept also allegedly failed to act in the face of significant numbers of consumer complaints to its banks about unauthorized withdrawals by Intercept’s clients and legal action taken against its clients.  Consumer complaints and legal action should have also triggered an investigation by Intercept of its clients, according to the CFPB.

Notwithstanding Intercept’s alleged failure to investigate high return rates or consumer complaints and legal action against its clients, the CFPB alleges that Intercept should have been more thorough in its due diligence of potential clients.  Intercept disregarded government investigations and negative Better Business Bureau rankings during the client intake process.

While CFPB v. Intercept Corp., et al. involves extreme facts, its implications for payment processors may be more broadly applicable.  It is evident that the CFPB expects payment processors to be proactive in monitoring their clients’ transactions.  It is not evident where the CFPB will draw that line.

Enforcement and Prosecution Policy and Trends, Financial Institution Regulation, Securities and Commodities

A Circuit Split is Born. Eleventh Circuit Rules Declaratory Relief and Disgorgement Sought by the SEC Are Subject to 5-Year Statute of Limitations. Injunctive Relief is Not.

SEC Enforcement DefenseOn May 26th, the Eleventh Circuit held that declaratory relief and disgorgement sought by the SEC are subject to the 5-year statute of limitations under 28 U.S.C. § 2462, but injunctive relief is not.  The court’s holding that § 2462 applies to disgorgement creates two circuit splits:  one with the D.C. Circuit, which has held that the 5-year statute of limitations codified in § 2462 does not apply to claims for disgorgement; and one with the Fifth Circuit, which has held that § 2642 does apply to injunctive relief.

Background

Section 2462 bars the government from bringing suit to enforce “any civil fine, penalty, or forfeiture” more than five years after the claim first accrued.  The SEC has long taken the position that § 2462 only applies to claims for statutory civil penalties.  Defendants in enforcement actions have challenged that position and are beginning to make some headway.

As a brief refresher, as previously discussed here, in May 2014, the Southern District of Florida addressed an issue that the Supreme Court specifically declined to address in Gabelli v. SEC – whether the 5-year statute of limitations in § 2462 applied to the SEC’s claims for disgorgement.  The SEC filed the action in Graham in 2013, following a protracted investigation spanning more than seven years.  The SEC sought declaratory relief, injunctive relief, civil money penalties, a sworn accounting, and the repatriation and disgorgement of all ill-gotten gains.  The defendants moved for summary judgment on grounds that the 5-year statute of limitations codified in § 2462 barred the SEC’s claims.  The district court granted summary judgment for the defendants, finding that § 2462 applied to injunctive relief, declaratory relief, and disgorgement. Many commentators considered the district court’s decision to be an outlier.

Eleventh Circuit’s Ruling

The Eleventh Circuit affirmed the district court’s application of § 2462 to declaratory relief and disgorgement, but not injunctive relief.  The court reasoned that declaratory relief and disgorgement are both backward-looking remedies, and, therefore, fall within the purview of § 2462.  Considering the SEC’s claim for declaratory relief, the court quoted language from Gabelli, recognizing that civil penalties “go beyond compensation, are intended to punish, and label defendants wrongdoers.”  A public declaration that the defendants violated the law, the court explained, “does little other than label the defendants as wrongdoers.”

In addition, the Eleventh Circuit agreed with the district court that disgorgement “can truly be regarded as nothing other than a forfeiture . . . , which remedy is expressly covered by § 2462.”  The court looked to the definition of forfeiture, finding that the available definitions “illustrate that forfeiture occurs when a person is forced to turn over money or property because of a crime or wrongdoing.”  According to the court, there is “no meaningful difference in the definitions of disgorgement and forfeiture”; moreover, disgorgement is backward-looking because it is “imposed as redress for wrongdoing.”

The Eleventh Circuit did not, however, find that § 2462 applies to all claims for equitable relief and vacated the district court’s ruling that the injunctive relief was time-barred.  The court rejected the district court’s finding that the SEC injunction was “nothing short of a penalty.”  Unlike penalties, which “address a wrong done in the past,” and, therefore, are, by definition, backward-looking in nature, injunctions are typically forward-looking.  Accordingly, they do not constitute a penalty and are not subject to § 2462.  In a footnote, the Eleventh Circuit once again decried the SEC’s use of its “obey the law” injunctions, reiterating its view that such injunctions, which merely track the language of the statutes and regulations instead of specifically describing impermissible conduct, are unenforceable.

Legal Impact

The Eleventh Circuit’s ruling splits with other circuits on these issues.  Its ruling on injunctions is at odds with the Fifth Circuit’s holding in SEC v. Bartek, 484 Fed. Appx. 949, 956 (5th Cir. Aug. 7, 2012) that injunctions are penalties subject to § 2462’s bar.

The Eleventh Circuit is also the first federal appellate court to hold that § 2462’s bar applies to disgorgement.  In Riordan v. SEC, 627 F.3d 1230 (D.C. Cir. 2010), the D.C. Circuit continued a line of cases from that circuit holding that disgorgement orders are not penalties, “at least so long as the disgorged amount is causally related to the wrongdoing.”  In a pre-Gabelli case, the Ninth Circuit held that no statute of limitations applied to SEC enforcement actions, including when the action seeks disgorgement, which is equitable in nature.  See SEC v. Rind, 991 F.2d 1486 (9th Cir. 1993).  It remains to be seen how the Ninth Circuit will rule in the post-Gabelli era and how other circuits will rule when faced with similar issues.  But, in circuits where the court of appeals has not definitively ruled on the issue, it’s not uncommon for the district courts within those circuits to take different approaches.

In another interesting development, the Internal Revenue Service recently opined in an Office of Chief Counsel Memorandum that disgorgement payments to the SEC are not deductible pursuant to § 162(f) of the Internal Revenue Code, which disallows deductions “for any fine or similar penalty paid to a government for the violation of any law.”  The IRS reasoned that disgorgement can serve as a direct substitute for a civil penalty and equated disgorgement to forfeiture, for which Section 162(f) never allows a deduction.

Despite the Eleventh Circuit’s holding in Graham, or perhaps because of it, until we hear further from the Supreme Court, we can expect the SEC to continue to argue that § 2462’s 5-year statute of limitations does not apply to relief other than civil penalties, including declaratory relief and disgorgement.  We can also expect defendants and industry groups like SIFMA to  argue with new vigor that it does.  Before long we will likely have some additional movement on these issues, with Timbervest v. SEC, No. 15-1416, which presents similar issues that are currently pending before the D.C. Circuit.

Financial Institution Regulation

CFPB’s Vehicle Title Loan Report Signals Future Proposed Rule

The CGovernment-Regulatory-and-Criminal-Investigations.jpgonsumer Financial Protection Bureau (CFPB) recently released a 23-page report claiming that single-payment vehicle title loans result in vehicle repossessions for nearly one in five borrowers. While this report has been questioned, it also claims that the average annual percentage rate for such loans is approximately 300 percent. These findings are based on a CFPB study analyzing almost 3.5 million loans made to more than 400,000 borrowers in 10 states during 2010-2013. It is widely believed that the CFPB’s report is a portent of proposed regulations aimed at auto title lending, payday lending, and other small-dollar, short-term loan products.

Single-payment vehicle title loans, available in 20 states, are usually payable within 30 days, and are secured by title to the borrower’s vehicle. If the borrower fails to repay the loan, the lender can repossess and sell the vehicle. The CFPB’s study found that, in about 90 percent of cases, borrowers repay the loan, then re-borrow from the lender within 60 days of repayment. According to the CFPB, most borrowers have to take out other loans to repay the initial one, which increases fees and interest, creating what the CFPB called “an unaffordable, long-term debt load.”

Vehicle title lenders usually require that the borrower own the vehicle “free and clear,” as the vehicle’s value generally determines the amount of available funds to a borrower. Lenders generally do not check a borrower’s credit or ability to repay the loan.

On June 2, the CFPB will host a hearing on small-dollar, short-term loan products that will include testimony from consumer groups, industry representatives, and the public. The CFPB has provided some hints as to what those regulations may entail:

  • Requirement that the lender check a borrower’s ability to repay by confirming credit score, income, borrowing history, and major financial obligations
  • Restriction of loans to borrowers who cannot establish an ability to repay
  • Presumption that a borrower cannot repay any short-term loan taken out within 60 days of a prior, outstanding short-term loan
Compliance, Enforcement and Prosecution Policy and Trends, Securities and Commodities

The SDNY Provides Guidance on a Company’s Duty to Disclose Government Investigations

Due to thedocument-review-thumb-200x133-156.jpg absence of instructive case law and interpretative guidance from the U.S. Securities and Exchange Commission (SEC), companies are often left in the dark with regard to whether and/or when they should publicly disclose that they are under investigation.  The Southern District of New York recently provided much-needed guidance on the issue.

On January 22, 2016, the Southern District of New York dismissed the complaint filed in In re Lions Gate Entertainment Corp. Securities Litigation, which was a consolidated securities action brought on behalf of a proposed class of shareholders of common stock of Lions Gate Entertainment Corporation.  The complaint alleged that Lions Gate was aware of an active SEC investigation into certain corporate transactions allegedly structured to prevent a minority investor from gaining control of the company.  Eventually, the company settled with the SEC and agreed to pay a civil penalty of $7.5 million in March 2014.  The plaintiffs alleged, among other things, that the failure to disclose the SEC investigation and possible settlement was a violation of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder.  While dismissing the complaint, the court held that “a government investigation, without more, does not trigger a generalized duty to disclose” and the defendants “did not have a duty to disclose … because the securities laws do not impose an obligation on a company to predict the outcome of investigations.  There is no duty to disclose litigation that is not ‘substantially certain to occur.’”

Although In re Lions Gate provides some guidance, a company’s duty to disclose requires careful examination of the relevant factual circumstances.  Such considerations should include, among other things, whether the company is subject to an existing duty of disclosure under the securities law, whether the company has made express prior disclosures related to the investigation which are rendered materially misleading by omitting further information about the investigation, and whether the investigation itself is material.  Companies evaluating whether there is a duty to disclose should seek the assistance of experienced counsel in order to avoid the potential pitfalls of failing to disclose investigations to the public or prematurely disclosing such investigations to the public.

Enforcement and Prosecution Policy and Trends

HIGH COURT ADOPTS OUT-OF-DISTRICT ELECTRONIC SEARCHES

binarydataBy letter to House Speaker Paul Ryan on April 28, 2016, the Supreme Court adopted two significant amendments to Rule 41 of the Federal Rules of Criminal Procedure–the rule governing search and seizure.  The amendments, if enacted, expand a federal magistrate’s jurisdiction to issue warrants for remote search and seizure of electronic records located outside of the judge’s district.  Unless Congress acts before December 1, the amendments will take effect.

Let’s start with the current rule.  Rule 41(b) defines a judge’s authority to issue a warrant, and generally limits that authority to search and seize persons or property located within the magistrate’s district.  Out-of-district searches are limited to certain enumerated events.  For example, when the property is located in the magistrate’s district but moves before the warrant is executed.   Likewise, a tracking device installed in the district may track movement outside of the district.  Another exception exists in terrorism investigations and where activities related to terrorism occurred within the magistrate’s district but evidence resides outside.

Under the current rule, federal prosecutors must seek a warrant to search and seize electronic information in the district where the data resides.  In this era of Silk Road, Tor, advanced encryption and ever-changing technology, however, identifying the location of electronic information is a challenge.  In response to these challenges, the Department of Justice (DOJ) has lobbied for two additional exceptions for out-of-district searches and seizures, both concerning electronic records.  The amendments, if enacted, would authorize a judge to issue a search and seizure warrant for electronic data inside or outside of the district where either:

  1. technology is used to conceal the location of the media to be searched; or
  1. in a computer fraud investigation, the media to be searched include protected computers that have been damaged and are located in five or more districts.

Critics say the amendments are tantamount to law enforcement hacking, and greatly expand the government’s substantive, not procedural, authority under Rule 41.  For example, a judge in Virginia could authorize federal agents to search a computer located in California, or even Thailand for that matter, so long as the location of the computer is unknown.  The potential for international application may also conflict with current diplomatic arrangements, including existing Mutual Legal Assistance Treaties between the U.S. and foreign nations.

The amendments, critics also suggest, could impact anyone using routine and legitimate privacy tools to protect their electronic data.  For example, many businesses use Virtual Private Networks (VPNs) to connect remote offices or to allow employees to remotely access the corporate intranet.  The use of VPNs, which also increase privacy and security, has been cautioned as an example of technological “concealment” arguably suggested by the proposed changes.

In response to strong opposition – including from the world’s largest technology companies – the DOJ counters that the amendments don’t create a new right to search or otherwise alter existing statutory or constitutional requirements.  Rather, the amendments address only permissible venue.  This is a critical distinction as the amendment process utilized by the Judicial Conference Advisory Committee on Criminal Rules is reserved for rules of practice and procedure.  Substantive changes, on the other hand, are the purview of congressional lawmaking.

The technologies central to this issue are undoubtedly complex, and the potential implications of the amendments are not fully realized.  It is evident, however, that the amendments may not pass quietly.  At least one member of Congress, Sen. Ron Wyden (D-Oregon), has called for Congress to reject the changes.  Whether Congress heeds the call and requires further debate remains to be seen.

Compliance, Financial Institution Regulation

CFPB Announces Plan to Promulgate Key Mortgage Disclosure Rule

Mortgage Loan Agreement

Consumer Financial Protection Bureau (CFPB) Director Richard Cordray recently informed several banking and other industry groups that the Bureau plans to introduce a proposed rule to address concerns related to CFPB mortgage disclosure requirements.

In an April 21, 2016 letter to several key industry groups, Cordray stated that the CFPB received feedback on the Know Before You Owe rule and began drafting a notice of proposed rulemaking.  The Know Before You Owe rule is designed to help consumers understand their loan options, shop for the mortgage that is best for them, and avoid costly surprises during closing.  The program combines four disclosure forms under the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) into two new forms – the Loan Estimate and the Closing Disclosure – and requires that consumers have three days to review the Closing Disclosure before closing on a mortgage.  Such changes are designed to avoid overlapping and inconsistent information under the requirements of TILA and RESPA, which tend to confuse consumers and burden lenders and settlement agents.  The changes were proposed as part of a wider program by the CFPB to restore “confidence and common sense” to the U.S. mortgage market, according to Bureau officials.

The CFPB hopes to release the proposal in July, and is meeting regularly to determine how best to implement the rule.  Because the rule applies to a significant number of financial institutions and lenders, the CFPB desires a smooth transition for those affected, and has asked for continued feedback from the financial services industry to make that a reality.

The Mortgage Bankers Association praised Cordray’s letter, stating that “the approach laid out should provide a swift path to issuing a final rule that will give lenders, the secondary market and consumers the clarity and consistency of disclosures the market needs.”  The American Bankers Association echoed this sentiment, as Chairman and CEO Rob Nichols stated that “we are particularly pleased that the notice of proposed rule-making is on a fast track, which will accelerate and strengthen strong compliance regimes.”  Nichols further stated that “many of the elements in the industry identified for clarification or amendment were developed in ABA’s compliance working group meeting, and we look forward to the opportunity to continue sharing banker feedback with the CFPB.”