Subject to Inquiry

Subject to Inquiry


Government Investigations and White Collar Litigation Group
Securities and Commodities

D.C. Circuit Vacates SEC Sanctions, Says Negligent Omissions Are Not ‘Willful’ Under Advisers Act

On April 30, the U.S. Circuit Court of Appeals for the District of Columbia Circuit vacated a Securities and Exchange Commission order imposing sanctions. The court held that an investment advisory firm and its owners did not violate Section 207 of the Investment Advisers Act of 1930, 15 U.S.C. § 80b-7, by negligently omitting material facts from the firm’s Form ADV. (See Robare Group, Ltd., et al. v. SEC, No. 16-1453.)

In September 2014, SEC Enforcement charged the petitioners, The Robare Group and its two principals, with violations of Sections 206(1), 206(2) and 207 of the Advisers Act, alleging that they willfully failed to disclose a revenue-sharing arrangement through which the firm received compensation when its clients invested in certain mutual funds. After an administrative law judge dismissed all charges, the SEC reviewed the case de novo and determined that, while the record did not support a finding of scienter, the petitioners violated: (i) Section 206(2) of the Advisers Act by negligently failing to disclose the revenue-sharing arrangement adequately to customers and (ii) Section 207 of the Advisers Act by failing to disclose the revenue-sharing arrangement to the SEC on the firm’s Form ADVs. As a result, the SEC imposed a $50,000 civil monetary penalty on each of the petitioners.

The petitioners appealed the decision to the D.C. Circuit, arguing, inter alia, that “the Commission erred in ruling that [the petitioners] violated Section 207 of the Advisers Act by willfully omitting material information about the [revenue-sharing arrangement]” despite the lack of substantial evidence to establish that they willfully omitted material facts.

Section 207 of the Advisers Act provides the following: “It shall be unlawful for any person willfully to make any untrue statement of a material fact in any registration application or report filed with the Commission under Section 203 or 204 of the Advisers Act, or willfully to omit to state in any such application or report any material fact which is required to be stated therein” (emphasis added).

While the parties agreed that the term “willfully” in Section 207 required the petitioners to have “intentionally commit[ed] the act which constitutes the violation,” they disagreed over what constituted “the act.” Specifically, the petitioners took the position that a violation of Section 207 requires an intentional misrepresentation or omission of a material fact, whereas the SEC asserted that an adviser violates Section 207 by intentionally completing or filing a Form ADV that turns out to contain a material misrepresentation or omission.

The D.C. Circuit held that, while substantial evidence supported the SEC’s negligence-based findings with respect to the Section 206(2) violation, “the Commission’s findings of willful violations under Section 207 based on the same negligent conduct are erroneous as a matter of law.”

In agreeing with the petitioners’ reading of Section 207’s willfulness requirement, the Court stated, “Intent and negligence are regarded as mutually exclusive grounds for liability. Any given act may be intentional or it may be negligent, but it cannot be both” (with internal quotations and citations omitted). Accordingly, the Court held that, in order to violate Section 207, at least one individual must have subjectively intended to omit the material information from the Form ADV.

Thus, the D.C. Circuit found that, because the SEC found there to be no scienter, the SEC could not support a Section 207 violation by the petitioners based on the finding that they negligently omitted the revenue-sharing arrangement from the Form ADV, which did not amount to willful conduct. As a result, the Court remanded the case to the SEC to determine a suitable fine for just The Robare Group’s negligent violation of Section 206(2).

Lessons Learned

The SEC staff is likely evaluating what this opinion means for its enforcement program. Specifically, there is now a significant question about whether this decision upends the long-standing SEC position that administrative proceedings can brought under Exchange Act Sections 15(b)(4) and (b)(6) and Advisers Act Sections 203(e) and (f), which also require a “willfulness” finding, based on just the barest minimum of understanding, as many have said, “not sleepwalking.” In the ubiquitous footnote included in every proceeding instituted under those sections, the SEC states:

A willful violation of the securities laws means merely “’that the person charged with the duty knows what he is doing.’” Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000) (quoting Hughes v. SEC, 174 F.2d 969, 977 (D.C. Cir. 1949)). There is no requirement that the actor “‘also be aware that he is violating one of the Rules or Acts.’” Id. (quoting Gearhart & Otis, Inc. v. SEC, 348 F.2d 798, 803 (D.C. Cir. 1965)).

How the SEC comes out on the question of whether this is still a valid position for them to take in future settlements and litigated administrative proceedings may have a profound impact going forward.

As for the SEC’s immediate consideration for this case and other pending matters, while this finding will make it harder for the SEC to bring Section 207 in the absence of a scienter finding, negligently drafted disclosures may still subject advisers to liability under Section 206(2). Furthermore, while, as noted above, the necessary “willful” finding is a jurisdictional requirement to initiate a proceeding pursuant to Advisers Act Section 203(e), the SEC may still initiate cease-and-desist proceedings pursuant to Section 203(k) of the Advisers Act and obtain monetary penalties. Negligence is enough to bring a cease-and-desist proceeding and obtain a penalty.

In addition, the decision makes it clear that relying on industry standards does notnecessarily serve as a defense to negligence where, as the D.C. Circuit found here, The Robare Group’s principals recognized that the payment arrangement “created potential conflicts of interest and that they knew of their obligation to disclose this information to clients.” (See Robare at 12-13.) The Court determined that the numerous violations of the defendants’ fiduciary duty were unreasonable and thus negligent.

One benefit of the D.C. Circuit ruling is that it may be easier to settle a matter without a finding of willfulness, as statutory disqualification will be avoided. (A finding by the SEC that a person or firm acted willfully is a disqualifying event according to Section 3(a)(39) of the Exchange Act.)

Should you wish to discuss the D.C. Circuit’s decision, please contact one of the authors or any of McGuireWoods’ securities enforcement and regulatory attorneys.

Anti-Money Laundering, Enforcement and Prosecution Policy and Trends, Financial Institution Regulation

Suspicious Activity Monitoring and Reporting – FINRA Issues Notice Consolidating Governmental and Regulatory “Red Flag” Guidance

Enforcement actions sanctioning firms and, in a few cases, individuals for failing to investigate and report suspicious activity have been significantly on the rise. SEC, FinCEN, FINRA, and others have been active in this area, particularly with regard to trading at, by, or through the financial institution.  One critical component of a financial institution’s ability to maintain a robust anti-money laundering (“AML”) program and comply with its suspicious activity reporting (“SAR”) obligations is to ensure that the firm actively identifies and timely reviews “red flags” of potentially suspicious activity. What constitutes a “red flag” varies depending on many factors, including the firm’s business, location of the firm and customers, customer activity, and many other factors. Regulators over the years have issued guidance detailing “red flags” for potentially bad activity in an effort to assist firms in developing and enhancing their SAR reporting programs.

Consolidation of “Red Flag” Guidance or One Stop Shopping 

On May 6, FINRA published a Regulatory Notice 19-18 (the “Notice”), which aggregates federal government and other regulatory “red flag” guidance issued over the past 17 years.  Included in the Notice are the “red flags” that FINRA included in its own original notice issued in 2002, Notice to Member 02-21. FINRA issued the Notice to provide “one stop shopping” for firms searching for insights from the government and regulators on what they should monitor.  The Notice lists no fewer than 104 “red flags” compiled in five categories: customer due diligence and interactions with customers, deposits of securities, securities trading, money movements, insurance products, and a catch all (other potential red flags).


  • Never static – not one-and-done. Firms need to review periodically their AML/SAR programs to assess “red flags” employed to ensure they evolve to reflect new concerns in the industry, new methods by the “bad guys” to use the financial system to engage in illegal activity, and changes at the particular firm that implicate new “red flags.”
  • Not one size fits all. Variations of firms in terms of size, business, model, products, etc. means different “red flags” will be at play.
  • Not an exhaustive list. The 104 “red flags” are examples and not a complete list.  As noted, additional “red flags” will arise based on unique facts and circumstances of the activity at issue. If something appears questionable, follow up.
  • As the slogan says: “if you see something, say something.” SAR reports are extremely valuable resources and information to law enforcement to put the investigative pieces together. The reports have led to many successful law enforcement cases, and firms remain obligated to investigate a red flag and where appropriate file a SAR report.
  • Ignore a red flag at your peril. Of course, the bottom line for financial institutions with SAR reporting obligations: failure to investigate and, if appropriate, file SAR reports exposes the firm to significant sanctions and reputational damage when a regulator identifies the “red flags” and no appropriate follow up.
Securities and Commodities

SEC OCIE Highlights Potential Deficiencies in Firm Privacy Policies

On April 16, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert highlighting Regulation S-P compliance deficiencies and issues it found in recent examinations of broker-dealers and investment advisers. Regulation S-P is the primary SEC rule detailing the safeguards these firms must take to protect customer privacy. The Risk Alert provides an important reminder for firms to assess their supervisory and compliance programs related to Regulation S-P and make any necessary changes to strengthen those systems. Indeed, in light of the substantial fines that can accompany a finding that Regulation S-P has been violated, firms must pay careful attention to the OCIE’s guidance regarding potential pitfalls.

Regulation S-P requires broker-dealers and advisors to adopt written policies and procedures addressing the protection of customer information and records. These policies and procedures must be reasonably designed to ensure the security and confidentiality of customer records and information as well as protect against unauthorized access or threats. Additionally, Regulation S-P requires firms to send customers notices regarding the firm’s privacy policies and practices (at the establishment of the customer relationship and then annually thereafter) as well as an “opt out notice” that explains to customers their right to opt out of some disclosures of their non-public information to third parties. Firms that fail to comply with Regulation S-P can be hit with substantial fines; last year the SEC fined a broker-dealer $1 million for failing to maintain adequate safeguards against identity theft.

The Risk Alert highlights examples of common deficiencies or weaknesses that OCIE staff identified related to Regulation S-P in their examinations, which serve as considerations for firms evaluating their own policies and procedures:

  • Failure to Provide Adequate Notices. Some examined firms failed to provide the notices required by Regulation S-P, whereas others provided notices that did not contain required information, such as information regarding a customer’s opt-out right.
  • Lack of Adequate Policies and Procedures. Some firms did not have adequate written policies and procedures addressing customary privacy. The OCIE noted that policies and procedures that simply restate the rules contained within Regulation S-P are insufficient; rather, these documents must actually address the administrative, technical, and physical safeguards the firm has put in place. Similarly, “off the shelf” policies and procedures—which firms sometimes buy from third party vendors—are insufficient if firms do not include detail as to how they are actually being implemented.
  • Poorly Designed or Unimplemented Policies. The OCIE observed that even where firms had written policies and procedures, in some cases they were either not actually implemented or not reasonably designed to meet the requirements of Regulation S-P. The OCIE identified specific areas where firms’ policies and procedures were either poorly designed or not implemented:
    • Personal devices. The OCIE highlighted firms whose employees regularly stored and maintained customer personally identifying information (“PII”) on their personal laptops, but whose policies and procedures did not address how to safeguard that information.
    • Email. Some firms did not have policies and procedures reasonably designed to prevent employees from regularly sending unencrypted emails containing customer PII. Other firms did have such policies but did not provide adequate training to employees or failed to monitor if their policies were actually being followed.
    • Outside Vendors. Some firms failed to follow their own policies and procedures when dealing with outside vendors. The OCIE noted firms that failed to require outside vendors to contractually agree to keep customer PII confidential, even where their own policies and procedures required such agreements.
    • Failure to Identify Systems with Customer Information. Some firms did not inventory all systems on which they maintained customer PII, which the OCIE stated could limit their ability to safeguard that information.
    • Inadequate Incident Response Plans. Some firms’ incident response plans did not address important areas such as actions required to address a cybersecurity incident and assessments of system vulnerabilities.
    • Unsecure Physical Locations and Unauthorized Access. The OCIE noted firms that stored customer PII in unsecure physical locations (such as unlocked file cabinets) as well as cases where customer login credentials had been sent to employees who were not authorized to receive that information.
    • Departed Employees. Finally, the OCIE noted instances where former employees of firms retained access rights to customer PII after their departure.

The Risk Alert serves as a timely reminder to all broker-dealers and investment advisers to review their written policies and procedures, as well as the implementation of those policies and procedures, to ensure they are compliant with Regulation S-P. The Alert also serves as a complement to FINRA’s 2018 Report on Selected Cybersecurity Practices, which set forth FINRA’s observations regarding effective practices that firms have implemented to address cybersecurity risks, including risks related to identity theft.

McGuireWoods’ experienced broker-dealer/investment adviser team will continue to monitor and report on important issues affecting the broker-dealer industry. For more information, contact the authors of this article or any member of the team.

Financial Institution Regulation, Securities and Commodities

Recent New Jersey Rule Proposal Progresses State Efforts to Impose Fiduciary Duties on Brokers

On April 15, the New Jersey Bureau of Securities (the “Bureau”) issued a rule proposal to establish a uniform fiduciary duty standard applicable to investment advisers, brokers-dealers and their registered representatives and agents.  Specifically, the proposed rule (N.J.A.C. 13:47A-6.4), which could take effect as early as the end of the year, will require all investment professionals registered with the Bureau to provide investment advice, recommend investment strategies, open or transfer assets to any type of account, or make the purchase, sale, or exchange of any security without regard to their company’s (or their own) interest.

While the proposed rule merely codifies the fiduciary duty already owed to customers by investment advisers, it would impose a heightened standard of care on broker-dealers.  Currently, broker-dealers and their representatives are subject to the suitability standard, which requires them to hold a reasonable belief that recommended transactions or investment strategies are suitable for their customers.  If the proposed rule is implemented, brokers will also owe their customers a statutory duty of care and a duty of loyalty, requiring them to make recommendations about securities and provide investment advice “without regard to the financial or any other interest of the broker-dealer, agent, adviser,” or any other third-party.

The Bureau believes the proposed uniform standard will “protect[] investors against abuses that can result when financial professionals place their own interests above those of their customers, will help to reduce confusion, and will work to foster public confidence in the financial profession,” noting that “retail investors do not understand the differences between investment advisers and broker-dealers or the standards of care applicable,” specifically in the context of dual registrants.

Additionally, in an effort to address the Bureau’s concern about incentives (i.e., sales contests), the proposed rule also creates a presumption that the duty of loyalty is breached where an investment professional offers or receives any compensation when recommending or trading in customer accounts securities that are “not the best of the reasonably available options.”

The Bureau’s rule proposal comes as other states, including Connecticut, New York, and Nevada, similarly have proposed new rules and regulations governing the conduct standards of broker-dealers and investment advisers.  The varying state-level approaches have led some financial industry groups to express concerns about “patchwork” state-level regulation and inconsistent conduct standards across state lines.  At the same time, the SEC is expected to finalize its proposed Regulation Best Interest—which would set forth a nationwide standard of conduct—this year.  The interplay between Regulation Best Interest and state-level rules—including New Jersey’s, if codified—could lead to litigation over the preemptive effect of SEC rulemaking in this arena.  Indeed, some industry groups have already argued that state-level laws imposing heightened standards of conduct create implicit or explicit recordkeeping requirements and are thus preempted by the National Securities Markets Improvement Act of 1996, which sets forth recordkeeping requirements for advisers and brokers.  As states codify laws governing brokers and advisers within their jurisdiction, these preemption arguments are likely to come to the forefront.

Practical Considerations

The Bureau is accepting written comments regarding the proposed uniform fiduciary rule through June 14, 2019.  In the meantime, firms conducting securities business in New Jersey should consider reviewing their policies and procedures to assess the need for potential enhancements in anticipation of the heightened standard of care.

Should you wish to discuss (1) the requirements and/or implications of the Bureau’s rule proposal, or (2) submitting comments on the proposal to the Bureau, please contact any of the authors or any of McGuireWoods’ securities enforcement and regulatory attorneys.

Financial Institution Regulation

FINRA Issues New Guidance Regarding Customer Communications Relating to Departing Registered Representatives

As recognized by new guidance from the Financial Industry Regulatory Authority (FINRA), the departure of a registered representative often prompts customer questions about the departing representative and the continued servicing of a customer’s account. In light of the continued frequency of movement of registered representatives from, or among, member firms, FINRA issued guidance on April 5, 2019, regarding what information it expects member firms to communicate to customers upon the departure of a registered representative.

Pursuant to FINRA Regulatory Notice 19-10, FINRA expects member firms to: (1) promptly and clearly communicate to affected customers how their accounts will continue to be serviced; and (2) subject to privacy and other legal requirements, provide customers with timely and complete answers, if known, to questions about a departing representative.

Under this new guidance, FINRA expects member firms to implement policies and procedures that “assure that the customers serviced by that registered representative are aware of how their account will be serviced at the member firm, including how and to whom the customer may direct questions and trade instructions following the representative’s departure and, if and when assigned, the representative to whom the customer is now assigned at the member firm.” As with all customer communications, FINRA expects that the information provided by member firms about a departing registered representative to be fair, balanced and not misleading.

Practical Considerations

As with any new guidance, firms should review their existing policies and procedures in order to assess the need for potential enhancements. With respect to FINRA’s expectation that firms will have policies and procedures designed to promptly provide information to customers related to the continued servicing of their accounts, a firm’s existing communications program should be reviewed to ensure that all of the necessary information listed above is in fact promptly communicated to customers. Furthermore, firms should also review their policies and procedures (as well as their training programs) regarding how to respond to customer inquiries relating to a departed registered representative. In light of this new guidance, as well as a matter of risk management, firms should consider practices and procedures that ensure consistent and timely responses to customer inquiries concerning a departed registered representative and that take into account applicable privacy and other legal requirements.

While FINRA’s recent guidance will likely become a new point of contention in arbitration and litigation involving departing registered representatives, a firm’s implementation of appropriate policies and procedures will help to mitigate litigation risk, as well as related regulatory inquiries and exposure.

Should you wish to discuss the requirements and/or implications of FINRA Regulatory Notice 19-10, please contact any of the authors or any of McGuireWoods’ securities enforcement and regulatory attorneys.

Enforcement and Prosecution Policy and Trends, Fraud, Deception and False Claims

Key Lessons for Colleges and Universities from Operation Varsity Blues

On March 12, 2019, the United States Attorney’s Office for the District of Massachusetts announced federal criminal charges in “Operation Varsity Blues,” the largest college admissions case ever prosecuted by the Department of Justice. Fifty people have been charged for their involvement in what prosecutors describe as a nationwide conspiracy to get the children of wealthy parents into elite colleges around the country. As alleged, wealthy parents paid tens of thousands of dollars to facilitate cheating on college entrance exams to increase their children’s test scores. Additionally, many of the parents are accused of paying hundreds of thousands of dollars in bribes to college officials to secure their children’s acceptance into colleges as athletic recruits using fabricated athletic credentials.

The defendants accused of facilitating these schemes, including the university officials, and college entrance exam proctors and examiners, have been charged with racketeering conspiracy under the federal RICO statute. The parents accused of paying the bribes have been charged with conspiracy to commit mail fraud and wire fraud. Other charges levied against various defendants include money laundering and tax fraud.

Potential Vulnerabilities for Colleges and Universities

Beyond the individuals implicated in the criminal investigation, certain allegations made by prosecutors create risk for colleges and universities. For example, prosecutors have alleged that certain bribe payments were used for the benefit of college athletics programs or were wired directly into college accounts.

Within days of the operation being made public, lawsuits were filed against many of the figures involved, including the colleges. A class-action lawsuit filed in the U.S. District Court for the Northern District of California against some of the colleges referenced in the charging documents should be of particular concern to schools around the country. That lawsuit alleges that the colleges at issue fraudulently represented that their admissions processes were neutral and merit-based, when they knew or should have known that some students were admitted through corruption.

Although DOJ has stated that the schools involved in Operation Varsity Blues are not the targets of their current investigation “right now,” plaintiffs’ lawyers throughout the country as well as state Attorneys General, and other state and federal prosecutors, could seek to pursue similar theories against schools throughout the country.

Recommendations In the Wake of Operation Varsity Blues

As the FBI put it when it announced these charges, these allegations “strike at the core of the college admissions process at universities across the country.” Based on the potential risks, colleges should consider a proactive approach. This should begin with having an outside assessment of all aspects of admissions policies and procedures to identify any processes in need of revision, as well as implementation of robust compliance procedures. Admission preferences, particularly related to athletics, should be a focus. Identifying and eliminating weaknesses and vulnerabilities in the admissions process may be critical in protecting colleges from regulatory and private civil action. Having this done strategically by outside legal counsel and within the confidentiality protections of attorney-client privilege is imperative.

In addition to thoroughly vetting their admissions processes, colleges and universities should also examine the controls and level of due diligence that they impose over the application process and consider requiring verification by parents and students of the accuracy of the information in the application and attestation by parents and students that no payments, contributions to third parties, gifts or favors have been made to anyone in connection with the admission process.

Conducting an internal review is particularly important in light of the potential for federal enforcement action. As we have previously commented, recent changes to DOJ’s enforcement policy favor those who self-investigate, make prompt voluntary self-disclosure of violations, fully cooperate with DOJ investigations, remediate swiftly and meaningfully, and implement effective compliance programs.

In view of the unprecedented focus on the integrity of the admission process by federal prosecutors, it should be expected that future related action will follow. Regulators, accrediting agencies, other state or federal prosecutors, alumni and aggrieved private parties may be contemplating whether to address the perceived inequities. Executive management of all educational institutions should take immediate steps to assess their vulnerabilities and implement prudent policies to regulate the admissions processes. Governing boards and the public will likely demand no less.

Finally, educational institutions should assess whether their insurance policies may provide coverage for “Varsity Blues” related investigations or litigation. Many institutions are ensured under the higher education equivalent of directors & officers’ liability policies. These policies go by different names, such as a “higher education non-profit liability policy,” and typically provide coverage for loss incurred on account of a “claim” arising out of a “wrongful act.” Policy definitions of “claim” vary, but may include civil litigation and governmental investigations. Many policies define “wrongful act” broadly to include any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty, by an insured. Educational institutions may also have other types of insurance policies that may also provide coverage for these types of claims. Institutions should understand what coverage is available and be prepared to give notice promptly if a claim is asserted.

Immigration and Worksite Enforcement

Employer Update: DHS Extends Temporary Protected Status and Work Authorization for El Salvador, Haiti, Sudan, and Nicaragua

The Department of Homeland Security (DHS) announced on March 1, 2019, an extension of the Temporary Protected Status (TPS) for qualifying individuals from El Salvador, Haiti, Sudan, and Nicaragua. DHS also announced a nine-month automatic extension of these TPS beneficiaries’ Employment Authorization Documents (EADs), allowing beneficiaries to work in the United States until January 2, 2020. The Department took this action to ensure its continued compliance with the preliminary injunction order of the U.S. District Court for the Northern District of California in Ramos v. Nielsen, No. 18–cv–01554 (N.D. Cal. Oct. 3, 2018).

The announcement provided welcome news to employers awaiting word on whether they could continue to employ individuals with work authorization expiring on March 4, 2019. However, the January 2, 2020, extension could change in the future depending on the outcome of the lawsuit.

For now, employers should be prepared when reviewing employment documentation of new or current employees from these four countries. Taking an adverse employment action against a TPS beneficiary under the mistaken belief that they cannot work because their EAD card is expired can subject a company to investigation by the Department of Justice’s Immigrant and Employee Rights Section and can result in significant fines. Current employees from these four countries who are TPS beneficiaries need not provide any further documentation to continue working. However, employers must take steps to update these employees’ Form I-9s to remain complaint with federal law.

The Federal Register notice provides guidance to employers on updating Form I-9s for existing employees. Specifically, the notice instructs:

For Section 1, the employee should:

  • Draw a line through the work authorization expiration date in Section 1;
  • Write 1/2/20 above the previous date; and
  • Initial and date the correction in the margin of Section 1.

For Section 2, employers should:

  • Determine if the Employment Authorization Document (EAD) is auto-extended by confirming the EAD’s code category is A12 or C19 and has one of the following expiration dates:

If the EAD is auto-extended:

  1. Draw a line through the expiration date in Section 2;
  2. Write 1/2/20 above the previous date; and
  3. Initial and date the correction in the Additional Information field in Section 2.

The notice also provides specific instructions for completing Form I-9s for new hires falling under TPS protected status.

This notice received little attention upon its release, but it has a far-reaching impact on employers throughout the United States. For employers and HR professionals, understanding and complying with this Federal Register notice will help mitigate risk and avoid potentially costly mistakes.

Sanctions, Trade Embargo, and Export Controls

What the Venezuela Sanctions May Mean for Future Sanctions Programs

When the Trump Administration designated Venezuelan state-owned oil producer Petreoleos de Venezuela (“PdVSA”) on January 28, 2019, pursuant to preexisting sanctions relating to the political situation created by the Maduro regime, it sent a significant but not unanticipated ripple through the global petroleum markets.  The impact of the sanctions for commodities traders and petroleum refiners—particularly in the U.S. Gulf Coast, where PdVSA’s steady supply of heavy crude has long been a sizable staple feedstock—was fairly immediate, and appears to have had the intended effect of isolating PdVSA, impairing its production capabilities and reducing its cash revenues.  According to industry reports, many of the larger commodity traders around the world have largely if not entirely backed away from trading in PdVSA crude, and PdVSA has been cut off from its primary sources of naphtha and other diluents it needs to move its heavy crude through pipelines.  Whether the sanctions will have the intended political effect of forcing regime change in Venezuela remains to be seen.

Although at a high level the PdVSA sanctions are not functionally different from other OFAC sanctions designations, their political contours, the immediacy of the underlying humanitarian crisis in Venezuela, and the proximity and entanglement of PdVSA in U.S. markets—including the fact that one of PdVSA’s most valuable assets is the U.S.-based Citgo—makes them appear like a different creature.  So, what can the Venezuela sanctions, as imposed against PdVSA, tell us about the future of U.S. sanctions?

Possibly, Nothing

All sanctions regimes, export controls, import controls and other forms of trade restriction are reflections of foreign policy.  In the case of sanctions, their form and function tends to be highly particularized to the political situation at issue.  The Venezuela sanctions appear unique in part because of the specific circumstances in which they are imposed: Maduro’s government is in crisis, Venezuela is a significant crude producer and exporter for the international oil market, and PdVSA is a critical element of the Venezuelan economy and of great  symbolic importance to the Venezuelan people.  Combine that with Venezuela’s physical proximity to the United States and the fact that the imposition of sanctions against PdVSA is cutting that company off from its biggest export market and cutting U.S. refiners off from one of their largest sources of feedstock, and you have a uniquely impactful sanctions action that is unlikely to be repeated.

It’s Complicated

Sanctions can be a blunt instrument, but they can also be a precise tool, as they appear to be here.  The Venezuela sanctions continue a trend of applying incremental pressure to targeted sectors of an economy or particular operators in that sector, without going so far as to impose a comprehensive embargo against an entire country.  Unlike the Russia/Ukraine sectoral sanctions, the Venezuela sanctions, through the PdVSA designation, went from incremental to exponential in the pressure being applied.  But like the sectoral sanctions, the Venezuela sanctions are more complex in design and application.  It is reasonable to expect that future sanctions programs will probably look more like the Venezuela sanctions and Russia/Ukraine sectoral sanctions than the Cuba embargo.

Sanctions to the Front

As of this writing, the Maduro regime remains in place and it is unclear whether the regime change being sought by the Trump Administration will occur—at least in a reasonably orderly fashion.  Regardless of that outcome, the PdVSA designation has certainly impacted the political conversation, and moved Venezuela’s political and humanitarian crisis more to the forefront in terms of U.S. and international awareness and attention.  As a result, it is possible that the current and future administrations will feel emboldened to consider the use of sanctions more liberally, particularly if Maduro does step aside without internal armed conflict or outside military intervention.  On that point, we can’t ignore that the Trump administration has not shied away from applying sanctions and appears ready and willing to do so to further its foreign policy agenda.

For now, we remain relatively early in the life cycle of the PdVSA designation, with the first wind-down deadlines set to pass and the global commodities markets remaining in a wait-and-see posture.  More time needs to pass before we will have a clear understanding of the likely political and economic trajectory of the situation in Venezuela, and that clarity may remain elusive.  For now, we have to view the posture of the Venezuela sanctions as dynamic and subject to significant change with limited notice.


Positive FCA Enforcement Trend for Defense Contractors: DOJ Reaffirms Commitment to Exercise Statutory Authority to Dismiss

Following recent changes to Department of Justice policy regarding individual accountability in government investigations of corporate wrongdoing, DOJ has recently further demonstrated its willingness to consider a flexible approach in applying the False Claims Act.

In a January 28, 2019 speech by Deputy Associate Attorney General Stephen Cox to the 2019 Advanced Forum on False Claims and Qui Tam Enforcement, DOJ reaffirmed its commitment to applying the so-called Granston Memo, which sets forth the factors under which DOJ may dismiss qui tam actions under the False Claims Act. False Claims Act enforcement remains a key DOJ enforcement priority, but DOJ is now expressly allowing government investigators to exercise discretion in identifying qui tam actions that should be dismissed.

Issued in January 2018, the Granston Memo described the DOJ’s exercise of its authority to dismiss qui tam cases brought under the False Claims Act pursuant to 31 U.S.C. § 3730(c)(2)(A). Authored by the Director of the DOJ’s Commercial Litigation Branch, Fraud Section, Michael Granston, the Memo was generally interpreted as a signal of DOJ’s greater willingness to consider dismissing certain qui tam matters pursuant to its statutory authority. Specifically, the Granston Memo set forth a list of seven factors under which the DOJ historically exercised its statutory right to dismiss qui tam actions:

  1. Curbing meritless qui tam matters
  2. Preventing parasitic or opportunistic qui tam actions
  3. Preventing interference with agency policies and programs
  4. Controlling litigation brought on behalf of the United States
  5. Safeguarding classified information and national security interests
  6. Preserving government resources
  7. Addressing egregious procedural errors

The Granston Memo stated that these factors were neither exhaustive nor mutually exclusive, noting that “there may be other reasons for concluding that the government’s interests are best served by the dismissal of a qui tam action.” It further suggested that, although the DOJ may exercise its authority in connection with a decision not to intervene in a qui tam matter, it may also move to dismiss the matter at a later stage of litigation.

During his January 28 speech, Cox reiterated that DOJ views the Granston Memo as part of its “gatekeeping role,” advising that “when qui tam cases are non-meritorious, abusive, or contrary to the interests of justice, they impose unnecessary costs on the Department, on the judiciary, and on the defendants.” These “bad cases” result in bad case law and consume scarce DOJ time and resources. In this regard, Cox advised that DOJ views its ability to dismiss cases as “an important tool to protect the integrity of the False Claims Act and the interests of the United States.” Although he advised that DOJ has used this authority only sparingly, Cox specifically stated that DOJ has instructed its lawyers to consider dismissing qui tam cases when they are not in the DOJ’s best interests, as it has done on roughly two dozen matters since 2017.

Indeed, two recent matters demonstrate the DOJ’s willingness to use the Granston Memo factors to dismiss matters where a relator’s case is weak and dismissal is otherwise in the government’s interest.

First, in an amicus brief filed in opposition to a petition for certiorari in Gilead Sciences, Inc. v. United States ex rel. Campie, et al., the DOJ stated that it would dismiss the relators’ qui tam on remand pursuant to Section 3730(c)(2)(A). In the underlying case, the 9th U.S. Circuit Court of Appeals had decided that the relators had adequately pled the materiality element of the False Claims Act under the standard set forth in Health Services, Inc. v. United States ex rel. Escobar, even though the agency at issue had continued to accept and pay for products that failed to comply with certain regulatory requirements. Although the brief did not reference the Granston Memo by name, DOJ stated that its decision to dismiss the matter was based upon its own investigation of relators’ allegations, as well as the potential for “burdensome discovery and Touhy requests for [agency] documents and [agency] employee discovery (and potentially trial testimony), in order to establish ‘exactly what the government knew and when,’ which would distract from the agency’s public-health responsibilities.” Accordingly, the DOJ’s decision can reasonably be read as based on the Granston Memo’s priorities of preventing interference with agency policies and programs and preserving government resources (with the added bonus of preserving a materiality standard under the 9th Circuit decision that strongly benefits DOJ).

Second, in motions filed in December 2018, DOJ moved to dismiss 10 qui tam matters filed by a business that the DOJ contends was created primarily for the purpose of filing qui tamactions. These matters included: United States ex rel. SAPF, LLC, v. Amgen, Inc. and United States ex rel. SMSPF, LLC v. EMD Serono, Inc., both in the Eastern District of Pennsylvania; United States ex rel. SMSF, LLC v. Biogen, Inc., in Massachusetts; United States ex rel. NHCA-TEV, LLC v. Teva Pharma., in the Eastern District of Pennsylvania; United States ex rel. SCEF, LLC v. Astra Zeneca PLC, in the Western District of Washington; United States ex rel. Miller v. AbbVie, Inc., in the Northern District of Texas; United States ex rel. Carle, v. Otsuka Holdings Co., in the Northern District of Illinois; United States ex rel. CIMZNHCA v. UCB, Inc., in the Southern District of Illinois; United States ex rel. Health Choice Group, LLC v. Bayer Corp., in the Eastern District of Texas; and United States ex rel. Health Choice Alliance, LLC, also in the Eastern District of Texas. The relator had dismissed an 11th related action, United States ex rel. Health Choice Advocates, LLC v. Gilead, also in the Eastern District of Texas. DOJ justified the dismissal of the matters under Section 3730(c)(2)(A) based on the government’s interests in “preserving scarce government resources and protecting important policy prerogatives of the federal government’s healthcare programs,” similarly aligning with the Granston Memo factors.

Cox’s comments and these cases serve as strong indicators that DOJ is starting to exercise the discretion granted to government investigators in the Granston Memo to dismiss unmeritorious matters. While it remains to be seen how frequently and under what circumstances DOJ will exercise this discretion, defendants should analyze the application of the Granston Memo factors in any new matter to determine whether there is a possibility of terminating litigation at a stage that would avoid costly discovery and litigation.

For more information on McGuireWoods’ Government Contract Investigations and Enforcement team, please click here.

McGuireWoods’ Government Investigations & White Collar Litigation Department is a nationally recognized team of nearly 60 attorneys representing Fortune 100 and other companies and individuals in the full range of civil and criminal investigations and enforcement matters at both the federal and state levels. Our team is comprised of a deep bench of former senior federal officials, including a former Deputy Attorney General of the United States, former U.S. Attorneys, more than a dozen federal prosecutors, and an Associate Counsel to the President of the United States. Strategically centered in Washington, DC, our Government Investigations & White Collar Litigation Department has been honored as a Law360 Practice Group of the Year and earned the trust of international companies and individuals through our representation in some of the most notable enforcement matters over the past decade.


New Rules for Small Business Government Contractors

On Dec. 17, 2018, President Trump signed the Small Business Runway Extension Act of 2018 into law. It amends § 3(a)(2)(C)(i)(II) of the Small Business Act “by striking ‘3 years’ and inserting ‘5 years,’” so a contractor’s size will be measured by the annual average of its previous five years’ revenue, instead of the annual average of its previous three years’ revenue.

Notably, the amendment does not alter employee-based size standards, or the definition of a small business concern using a headcount rather than average revenue.

Implementation Timeline

In a recently issued SBA information notice, the Small Business Administration (SBA) indicated its position that the new five-year average is not effective until SBA issues a formal rule implementing the statute. While this legal theory may be open to challenge, it is important to note that SBA’s position would require that current contracts and solicitations continue to use the old three-year average until completion of the formal rulemaking process.


According to a House Committee on Small Business report on the bill before its Dec. 17 signing, the purpose of the amendment is to “help advanced-small contractors successfully navigate the middle market as they reach the upper limits of their small size standard.” Since many small businesses have initially lean operating years, this change may allow overgrown businesses (i.e., other than small business concerns) to potentially qualify as small businesses when their earlier revenue is considered.

At the same time, if a qualified small business concern had higher revenues in, e.g., 2013 and 2014, it may no longer qualify as a small business concern when the two additional years’ revenue is added and measured against the applicable size standard(s) for the applicable revenue-based NAICS code(s). Pursuant to the Federal Acquisition Regulation (FAR), a change in size status “does not change the terms and conditions of the contract,” but the contracting officer “may require a subcontracting plan for a contract containing 52.219-9, Small Business Subcontracting Plan, if a prime contractor’s size status changes from small to other than small as a result of a size representation.”

The statutory amendment is intriguing, given SBA’s opposition to the change. On April 27, 2018, the SBA responded to a comment proposing a change in calculating average annual receipts using a five-year period rather than a three-year period. The commenter claimed that the change “would allow small businesses to plan and increase capacity before entering full and open competition and provide longer transition time from small business status to other than small business status.” SBA rejected that comment in the following response:

SBA does not adopt this comment. SBA believes that calculating average annual receipts over three years ameliorates fluctuations in receipts due to variations in economic conditions. SBA maintains that three years should reasonably balance the problems of fluctuating receipts with the overall capabilities of firms that are about to exceed the size standard.

Notwithstanding SBA’s stated opposition to the change, the bill passed in the House on Sept. 25 and in the Senate on Dec. 6. The bill went to President Trump’s desk on Dec. 11 and went into immediate effect on Dec. 17 when he signed it.

Ultimately, the Small Business Administration will need to update its size regulations — particularly, 13 C.F.R. § 124.104 — to resolve the inconsistency and clarify that the measurement period is five years, not three. There is no forecast as to when SBA will implement this change to its regulations, nor any indication of whether a similar revision will be made to FAR provisions, including FAR Part 19, on the subject of small businesses. (FAR 19.101(1)-(2) defines “Annual receipts” in terms of the concern’s “annual average gross revenue of the concern taken for the last 3 fiscal years.”)

For now, small businesses and overgrown, other than small business concerns operating in the federal contracting arena should consider recalculating their revenue over the past five years, and determine whether they meet the requirements to properly self-certify as small under any revenue-based NAICS Code they work under, and any SBA-administered program (e.g., 8(a), HUBZone and Economically-Disadvantaged Women-Owned Small Business). However, contractors should not be surprised to see contracting officers and SBA representatives continue to apply the old three-year average until a new SBA rule is implemented.

Given the harsh penalties for contractors who knowingly misrepresent their size for purposes of a procurement, it is crucial for all potentially affected businesses to understand the risks involved with aggressively applying the new five-year rule. (See FAR 19.301-1(d), which states: “The SBA’s regulations on penalties for misrepresentations and false statements are contained in 13 CFR 121.108 for small business, 13 CFR 124.501 for 8(a) small business, 13 CFR 124.1004 for small disadvantaged business, 13 CFR 125.29 for veteran or service-disabled veteran-owned small business, 13 CFR 126.900 for HUBZone small business, and 13 CFR 127.700 for economically disadvantaged women-owned small business concerns and women-owned small business (WOSB) concerns eligible under the WOSB Program.”)

As always, if a business determines that it no longer qualifies as small for certain NAICS code(s), or now qualifies as small under applicable NAICS code(s), the business must promptly update its certifications and representations on the System for Award Management and other federal procurement databases that rely upon self-reporting of small business status.

McGuireWoods has extensive experience advising clients on small business compliance matters, and has brought size protests on behalf of clients and defended protested concerns before SBA and its appellate authority, the Office of Hearings and Appeals. Please contact the firm’s government contracts team with any questions or to discuss further.

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