April 19, 2010 (Skip to list, you will have to click on "Read More" first)

"The Week That Was" looks back at the ten legal topics that got the most law firm coverage last week. Below you will find brief, readable summaries of the ten topics and some of the key "takeaways" offered up by the covering law firms.

1.    Health Care Reform Becomes Law

In a week that had no new developments amongst our top ten topics (Congress, courts, schools and large parts of law firms being in recess), health care reform continued to dominate, with law firms getting increasingly granular in their coverage and the flow of Alerts on HCR comprising @ half of everything we posted on the site. We now have more than 20 categories of Alerts on health care reform from the esoteric (eg the economic substance doctrine) to the mundane (breaks for nursing mothers). Are there many better (free or otherwise) resources on the Internet than that provided by the dozens of law firms that have covered the subject? We don't think so.

2.     The UK Bribery Act

Just how deep would problems be for the UK if the financial services sector shipped off to Mumbai or Dubai (or any other inviting bay with a more attractive regulatory and meteorological climate)? What would happen if a competitor in the UK's other critical sector, defence, was barred from bidding on contracts as the result of a bribery conviction (BAE having barely avoided this fate)?  The Bribery Act is going to be an enormously tricky piece of legislation to implement; if the UK Government is perceived as being overly zealous it may further alienate the already jittery financial services sector or fatally wound a player in the defence sector; if it isn't and takes a more traditional laissez-faire approach, it may end up a laughing stock.

And while it is hard not to feel sorry for any group of politicians/regulators who attempt to find the balance/finesse necessary to pull off this re-invention of British corporate culture without causing too much damage, it is corporate Britain that will bear the brunt of the change and anxiety that accompany the Act; and it needs to expect and prepare for the worst. When the Act goes "live" it is likely to come hard and fast as the UK Government tries to establish it as a meaningful/credible deterrent and in a maddeningly unpredicatble fashion as regulators try to cope with a neurosis-inducing change in their roles.

This is only partly psycho-babble. There is one reason, and one alone, that the UK did not have something equivalent to the Bribery Act (or at least the FCPA) years ago: There was no legislative or commercial appetite for it. The UK may have nominally leap-frogged into first place in the anti-corruption stakes, but it will be a while before the business mindset catches up with the ideal. It was only three years ago that Tony Blair unabashedly called off the SFO's investigation into secret payments by BAE to Saudi Arabia's Prince Bandar. Asked by the then leader of the Liberal Democrats, "Whatever happened to Robin Cook's ethical foreign policy?", Blair replied ""It's cloud-cuckoo-land ... the natural habitat of the Liberal Democrats." Fast forward three years to February of this year and BAE gets given a slap on the wrist (and absolution) by the UK Government for the very same transgressions jauntily dismissed by the former Prime Minister. Just two months later, the Bribery Act was rushed into existence (Clifford Chance superbly summing up its passage with, "[L]ike a long, circumspect courtship ending in one night of fumbled passion, the Bribery Bill was in the end rushed through Parliament in just under 5 months, after 30 years of dithering, deferring and delaying by governments of different persuasions").

This is not a criticism of business mores in the UK,  just the recognition that things have been done differently in London, Washington D.C. and Riyadh. In truth, there is very little that is black and white about the ethics of currying favor or winning business with payments of cash; and BAE is a great example of how divergent perceptions as to propriety can be. Is the payment of 1 or 2% of the value of a transaction (even if that payment is over a $1 billion) to an official representative of an absolute monarchy which otherwise provides critical oil supplies to the payor's country, provides critical support to that country's defence sector (not to mention strategic interests) and creates thousands of jobs for that country's citizens a crime? Tony Blair didn't think so, the Saudi monarchy didn't think so and in all likelihood parts of the Bush Administration didn't think so. The culture of business payments varies the world over, is often relative and almost always occurs in shades of gray.

The fact remains that the Act has been rushed into existence in an incomplete form to be administered by regulators whose role is now as different as it is expanded. It is to be applied to corporate entities which do not know what to expect and which have long-standing international commercial relationships nurtured under an old set of rules. To make things even more difficult, the Act is being introduced during a fragile recovery and just prior to a general election. Transition is not going to be easy.

So what is in the Act?

There are three basic groupings of offences, the "general bribery offences," the "offence of bribing foreign public officials" and the offence of failure of a commercial organization to prevent bribery (aka "the corporate offence").

The "general bribery offences" make it a criminal offence to give, promise, offer or receive a bribe; with bribery defined by reference to a new test of intending to induce, or inducing, the “improper performance” of a function or any private business activity.

The "offence of bribing foreign public officials" is drafted to comply with the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (the “OECD Convention”) and occurs where there is an intention to influence an official in order to obtain or retain business or a business advantage. The "intention to influence" threshold is actually lower than that in the OECD Convention which has an "intention to seek improper advantage" threshold. Bribery can occur directly or through a 3rd party and a “foreign public official” (broadly defined) is considered to have been “influenced” if he/she fails to exercise his/her functions or seeks to use an official position to a particular end. In a significant distinction from the FCPA, it does not contain an exception for "facilitation" (ie grease) payments.

The "corporate offence" introduces a new strict liability offence of failure to prevent bribery (a bribe is something given with the intention to obtain or retain business for the corporate itself) by persons “associated” with a corporate organization, including its employees, agents and subsidiaries. It may be called the "corporate offence" but it covers individuals too. Senior corporate officials are individually subject to liability if they consent to, or connive in, the commission of an offence.

One of the most daunting aspects of the Act is a corporate's liability for failure to prevent bribery offences by an “associated person.” The definition of an associated person is unsatisfactorily broad/vague, ie someone who performs services on behalf of a principal, with the "performance of services" to be determined by reference to all of the relevant circumstances.

Critically there is a defence (it is the only defence!) for companies that have in place “adequate procedures” to prevent bribery. 

What is the reach of the Act?

The general bribery offences and the bribery of a foreign public official offence cover the domestic and overseas conduct of UK citizens, residents, and incorporated entities and any conduct which occurs in the UK.

The corporate offence applies to UK entities (corporations and partnerships) and non-UK entities which carry on business in the UK, although private sector bribery offences will not apply to non-UK entities if no part of the offence is committed in the UK.

What are the penalties?

The penalties for violations of the Act can be severe for both businesses and individuals with businesses subject to unlimited fines and individuals subject to unlimited fines and/or a jail sentence of up to 10 years.

When does the Act come into force?

The bribery offences will come into force at a date to be determined by whomever is Secretary of  State after the May election. The best guess is that the general bribery offences and the bribery of a foreign public official offence will go live in June or July 2010 and that the corporate offence will follow sometime in the Autumn. The UK Government has promised that it will give companies adequate time to prepare for the corporate offence, ie to consider forthcoming guidance as to what constitute "adequate procedures."

What needs to be done?

The corporate offence has just one defence so do your best to be in position to use it. The Ministry of Justice has warned that companies using an "adequate procedures" defence better be able to "adduce evidence which shows that … given the size of the organisation, the particular sector or country in which it operated and the foreseeable risks, its procedures employed to prevent bribery being committed on its behalf were adequate despite the fact of the bribe.” Until formal guidance is published, corporates are advised to look like they have taken things very seriously and at the highest level. Bryan Cave suggests looking at "the US Federal Sentencing Guidelines, OECD Guidelines for Multinational Enterprises, OECD Approaches for Combating Corrupt Practices, the recent Woolf Committee Report and certain industry codes." Fulbright & Jaworski recommends draft guidance from the GC100, a group of General Counsel from leading UK companies, and Clifford Chance has a good list of what the Government's guidance will focus on based on discussions preceding passage of the Act.

Takeaways:

From Norton Rose: "In part, the historic failure to investigate and prosecute corruption offences has been attributed to a lack of impetus by the Serious Fraud Office. However, to some extent, the lack of action has been a result of the antiquated and piecemeal nature of the UK law on bribery and corruption."

From Herbert Smith: "Lord Bach in the House of Lords yesterday explained that it was the present Government's intention to publish guidance well in advance of the corporate offence coming into force which he said should go 'a little way to satisfy those in the business community who are understandably wary of the how the Bill will work.'"

From Gibson Dunn: "The only defence to this new offence is that the company has in place "adequate procedures" for tackling bribery. What qualifies as "adequate procedures" is still unclear. What is clear, however, is that companies will need to take a hard look at their compliance programs to ensure they are up to scratch."
 
From Clifford Chance: What remains unknown are how the prosecutors will exercise their unusually wide discretion, what, if any, further resources will be devoted to investigation and prosecution, and how the courts will interpret the new offences.

From Fulbright & Jaworski: "While guidance from the Secretary of State on what amounts to “adequate procedures” is awaited, the government has a clear expectation that businesses will be proactive in the meantime in establishing, maintaining and monitoring procedures to prevent and detect bribery and corruption."

From Norton Rose: "In the Act, an 'associated person' is one which performs services on behalf of the principal. The definition of performing services is vague; the Act states that it will be determined by reference to all the relevant circumstances. It is far from clear what level of supervision by the principal would be necessary to help satisfy the adequate procedures defence in a case based on the acts of a distributor, sub-contractor or joint venture. There is, and will continue to be, much debate on this subject."

3.     SEC's Proposed Rules Re: Asset-Backed Securities (ABS)

On April 7, 2010, the SEC proposed rules that "would revise the disclosure, reporting and offering process for asset-backed securities (ABS) to better protect investors in the securitization market." The changes are substantial and are intended to revive a market that has remained wounded since the height of the financial crisis by ramping up regulation. As Chairman Schapiro put it, the proposed rules release “represents a fundamental revision to the way in which the ABS market would be regulated ... [with the proposed changes] ... both necessary and critical components of restoring investor confidence.” Like much of the securities regulation spawned by the financial crisis, the proposed rules try to protect investors from themselves (ie from making poor investments) by placing further responsibilities on issuers. The premise that purchasers of ABS are sophisticated investors that should understand and price risk is largely discarded in favor of a view that even nominal professionials quickly get out of their depth and need a lifeguard around at all times. Commenting on lessons from the financial crisis, Chairman Schapiro noted "that investors and other participants in the securitization market did not have the necessary tools to be able to fully understand the risk underlying those securities and did not value those securities properly or accurately." Those "other participants" including rating agencies, the lawyers who signed off on 10,000's of ABS transactions and the pre-Obama era SEC. Is this the SEC being overly patronizing or were the "big boys" of the ABS market not very grown up?

What are ABS?

Asset-backed securities are securities issued by an entity (usually especially created for the purpose and called a "special purpose vehicle or "SPV") that has bought and then bundled a group of outstanding loans (eg mortgages or credit card receivables, you often hear this referred to as a "pool" of assets) and has then offered investors an opportunity to buy a piece of the action (in the form of a note or some other type of debt instrument). The investor usually gets an interest payment in respect of its investment and this is generally financed by the interest paid on the underlying loan (eg the interest a homeowner pays to the new holder of his mortgage, the SPV, or the credit card interest paid by a credit card holder). Simply put the SPV collects interest from the original borrower and uses it to make payments to investors. It is "asset-backed" because the investor has a right to the underlying asset (the loan) should things go wrong. Usually the SPV creates different tiers of debt that are of interest to different types of investors depending on how risk averse they are. An SPV might create four types of notes with an effective return ranging from 5% to 15%, with those notes which have a lower rate of return (either because they have a lower interest rate or because they were more expensive to buy in the first place) appealing to conservative investors who are willing to settle for a lower rate of return in return for a greater degree of security (remember they are first in line to get get paid). At the other end of the spectrum are investors who are willing to trade security for a higher return. When things go well, ie when the SPV collects enough interest on the mortgages/credit cards, these investors rake it in. When things go badly, these investors can end up empty-handed.

What went wrong?

At the height of the financial crisis, a lot of investors ended up empty-handed. When homeowners could not make payments on their mortgages, because the interest on their mortgages ballooned or because they lost their jobs, SPVs could not collect enough interest to pay off investors. When those investors said "enough is enough, you have breached the terms of our investment agreement and we want access to the underlying asset," it turned out that the mortgage wasn't worth what people had expected. House values had dropped dramatically, there was an illiquid market for real estate and the "pool" turned out to be much shallower than expected (catching out even some of the most risk-averse investors). It is also the view of many that the quality of pool assets was to often poor to begin with; bundling can mask a few real duds, but only so many.

What do the rules propose?

The SEC wants investors to have much more information about the pool, specifically how deep it is (both when ABS are sold and on an ongoing basis) and how (and to whom) its waters flow, and to make sure that this information is reliable. In the SEC's view, disclosure, reporting and a more regulated offering process are the keys to re-invigorating investor interest.

Disclosure

The proposed rules will require much more granular details as to the pool; with comprehensive data as to each of its constituent loans (terms, location, performance, etc. depending on requirements for each of eleven different asset classes) and a computer program showing the effect of the “waterfall” as to the distribution of borrowers’ loan payments (and who gets stuck in the event of a shortfall). This information would have to be available at least 5 days before a sale of ABS.

Historically, ABS issuers have been able to use a "shelf offering" which permitted them to use a base prospectus including the general terms of an ABS offering (this sits "on the shelf" ready to use) that could be updated with a prospectus supplement that includes specific terms as to a particular offering. Not anymore; the new rules will require a complete prospectus for each ABS transaction.

Reporting

ABS issuers will be responsible for ongoing Exchange Act reporting which means quarterly and annual reports (10-Qs and 10-Ks, respectively) to be filed on EDGAR as well as interim reports for material changes. The later, on Form 8-K, will have to be filed if there is a 1% change in the material pool characteristics.

Offering Process

The SEC wants ABS sponsors to have "skin in the game" as a means to keep them honest about the quality of a pool's assets and information that they provide investors. As such, the proposed rules would require the sponsor of an ABS transaction to retain 5% of each class of securities offered and not hedge such positions.

The SEC also wants someone to sign off on the fundamentals of a transaction with the issuer's CEO required to certify that he/she has a reasonable basis to believe that the pool will produce cash flows at times and in amounts necessary to service payments on the ABS. In addition, a third party opinion will be required to the effect that the assets meet the relevant representations and warranties. This requirement would need to be satisfied quarterly.

Lots of ABS are sold in private transactions to large institutional investors known as qualified purchasers (QIBs). QIBs, as big boys, were supposed to know what they were doing and therefore were less in need of the SEC's supervision. Obviously, in the SEC's view they were not so qualified/grown up as once thought. Going forward, issuers will only be able to rely on the safe harbors (allowing for an offer of unregistered securities) provided by Rule 144A and Regulation D if issuers agree to provide to investors (nominally upon request, but expect to see the request built-in to documentation) the same information that would otherwise have been to be filed with the SEC in a public offering (including as to ongoing reporting).

Takeaways:

Bingham: "In a historic shift away from the decades-old doctrine that large, sophisticated institutional investors are able to fend for themselves, the SEC voted today to propose new rules that would require that in any private offering made in reliance on Rule 144A or Regulation D, an ABS issuer provide to any investor that so requests, at the time of the initial offering and on an ongoing basis, all information that would be required in an SEC-registered offering."

Sullivan & Cromwell: "Significantly, in an apparent effort to encourage continued use of shelf registration and to provide more information to investors in the private markets, the proposals would condition availability of the Rule 144A and Regulation D safe harbors, for a private offering of asset-backed securities and other 'structured finance products', on investors’ being given, upon request, the same information that would be required if the offering were registered."

Alston + Bird: "The proposals would make dramatic changes to the current offering, disclosure and reporting requirements for registered offerings of ABS and also would impose significant disclosure requirements on private offerings of structured finance products."

Patton Boggs: "In noting that the proposal would essentially collapse the distinction between private and public offerings, Commissioner Aguilar stated the proposal risks 'compromising the essential function of the private market as an efficient capital formation.' He also noted the proposal is at odds with giving the market a true alternative, and cautioned that it is premature to believe these regulations would then restore a more vibrant marketplace."

Orrick:  "Although the SEC unanimously approved the release of the proposed rules for public comment, two of the Commissioners expressed significant reservations about the efficacy of the proposed rules in advancing the SEC’s dual objectives to enhance investor protection and promote more efficient ABS markets."

Cleary Gottlieb:  "The proposed regulation would not only establish extensive new requirements for SEC-registered publicly-offered asset-backed securities but would impose many of the new requirements on private placements of ABS under Rule 144A and Regulation D."

4.     A Break for Nursing Mothers

The recently enacted Patient Protection and Affordable Care Act of 2010 (the "PPACA") includes amendments to the federal Fair Labor Standards Act (the "FLSA") which will require (with immediate effect) that employers provide nursing mothers with breaks for expressing milk.

Specifically Section 4207 of the PPACA requires that employers provide:

• "A reasonable break time for an employee to express breast milk for her nursing child for 1 year after the child’s birth each time such employee has need to express the milk; and
• "a place, other than a bathroom, that is shielded from view and free from intrusion from coworkers and the public, which may be used by an employee to express breast milk.”

It should also be noted that (i) employers with fewer than 50 employees may qualify for an "undue hardship" exemption under the new rules, (ii) the PPACA does not preempt any State laws that currently provide greater protections for nursing mothers and (iii) an "employer shall not be required to compensate an employee receiving reasonable break time .... for any work time spent for such purpose."

The Department of Labor has yet to provide detailed guidance as to the implementation of the new law and there are a number of open issues that have been flagged in the Alerts on the site.  They include:

• What qualifies as an "undue hardship" exemption;
• How the seemingly explicit language as to compensation dovetails with existing law requiring that breaks under 20 minutes be compensated (law firms differ as to their interpretation of this point); and
• How companies with a physical space challenge (imagine the layout of a typical fast food restaurant) will be required to respond.

From Mintz Levin:   "All employers with 50 or more employees should immediately adopt changes to their employee policies that explicitly allow breaks during the work day for nursing mothers to express milk. In addition, such employers should identify one or more areas which may be used by the employee for that purpose."

From Morgan Lewis: "The U.S. Department of Labor has been given the authority to draft regulations offering guidance in this area, but until it does so, employers may wish to interpret this provision generously in order to avoid litigation risk under the FLSA."

From Seyfarth Shaw: "The PPACA may run contrary to existing Department of Labor regulations, which require employers to compensate for rest breaks of short duration (5-20 minutes) or even certain state laws related to breaks."

From Barnes & Thornburg: "It is important to note that the Amendment does not preempt State-specific laws that provide greater protection to employees who are nursing mothers. For example, the District of Columbia, Illinois, Indiana and Minnesota are among those that have passed laws requiring employers to provide certain accommodations to nursing mothers....employers must ensure that their practices are compliant with any State-specific law that provides protection beyond what the Amendment requires."

From Winston & Strawn: "The FMLA generally considers breaks lasting between five and 20 minutes to be 'common in industry' and counts that time as hours worked. The PPACA does not make clear if employees who choose to overlap their 'common in industry' break time with their breaks used to express milk must be compensated."

From Akerman Senterfitt: "[Undue hardship] is a high burden that is placed on the employer to prove, and such exceptions will undoubtedly be rare. With the Department of Labor’s Wage and Hour Division, which has responsibility for enforcing the provisions of the Fair Labor Standards Act, increasing its enforcement and employee education efforts, employers believing they can utilize this exception should tread cautiously."

From Morgan Lewis "The [undue hardship] language closely tracks the undue hardship exception to the reasonable accommodation requirement under the Americans with Disabilities Act, so case law and regulations specific to that exception may provide some guidance until the Department of Labor issues regulations in this area."

From Davis Wright Tremaine: "According to Sen. Jeff Merkley, D-Ore., who sponsored the federal amendment and helped pass Oregon’s statute, no company in Oregon has prevailed in arguing that they could not accommodate employees under Oregon’s statute."

From Alston + Bird: "The provision was introduced into the health care reform bill by Oregon Senator Jeff Merkley, and it is modeled after Oregon’s current state law. Oregon’s law became effective in 2007 and defines “reasonable time” as 30 minutes for every four hours worked."

From Davis Wright Tremaine: "Aside from potential conflicts with state legislation directly dealing with break time for expressing milk, there will be numerous questions regarding the interplay between the new requirement and other state and federal laws regarding rest and meal breaks generally, as well as the patchwork of laws regarding breastfeeding (a related, but separate, issue) that exist in nearly all states."

5.   The HIRE Act

On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment Act (the "HIRE Act"), a $17.6 billion jobs bill intended to stimulate the economy and encourage employment with, inter alia, a limited payroll tax "holiday" for employers hiring new workers, an income tax credit of up to $1,000 for each qualifying new employee hired and retained for at least 52 weeks, funding for highway and mass transit programs, and an expansion of the Build America Bonds program. $17.6 billion is a lot of money that has to come from somewhere and the HIRE Act provides that costs are to be offset in part by provisions substantially similar to ones contained in the tax “extenders” bill passed by the House in December 2009 (including a version of the “Foreign Account Tax Compliance Act” expected to raise $8.7 billion over ten years, a provision repealing the “TEFRA” rules for U.S. issuers of bearer debt, and a provision imposing U.S. withholding tax on “dividend equivalents” paid or credited under notional principal contracts and certain other transactions). Although the job creation goals of the Act and its nominal sources of funding seem to have next to nothing to do with one another, what could be better from an optics perspective than funding a jobs bill with revenue from FATCA(t)s looking to use offshore accounts (legally or otherwise) to reduce their tax liabilities?

Although we have bunched all of the HIRE Act Alerts together under one Hot Topic, we have also separated out the 35+ Alerts covering the FATCA aspects of the HIRE Act. 

6.    Jones v Harris Associates & Excessive Investment Adviser Fees

On March 30, 2010, the Supreme Court unanimously voted (in Jones et al. v. Harris Associates L.P.) to reaffirm the standard set out in Gartenberg v. Merrill Lynch Asset Management, Inc. as to what constitute excessive mutual fund management fees under Section 36(b) of the Investment Company Act of 1940 ("the Act").  Summing things up, Justice Alito found that Gartenberg "was correct in its basic formulation of what Section 36(b) requires: to face liability under Section 36(b), an investment adviser must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's length bargaining." The Supreme court also provided guidance as to factors that a court (and therefore an investment company board) should consider in determining whether a board has satisfied its duties under the Act's Section 15(c) in evaluating the legality of an adviser’s compensation.

Jones has taken on a particular interest in part because its novel replacement for the Gartenberg standard has been accompanied by a spat between two prominent Seventh Circuit Judges (and lions of the law and economics school) Frank Easterbrook and Richard Posner. Easterbrook, writing for the Seventh Circuit majority, had rejected Gartenberg because it “relies too little on markets” and Posner had retorted in a vehement dissent that this markets-based view was premised “mainly on an economic analysis that is ripe for reexamination.” In what may be perceived as a rebuke to Easterbrook and Posner for highjacking a judicial process to debate economic theory, the Supreme Court noted that the Seventh Circuit debate as to the economic underpinnings of Section 36(b) was “a matter for Congress, not the courts.”

Section 36(b) provides that investment advisers to a mutual fund have a fiduciary duty with respect to their receipt of advisory fees and authorizes civil actions by the SEC and mutual fund shareholders for breach of that duty and for the recovery of excessive advisory fees.

In Jones, the plaintiffs alleged that advisory fees charged by advisers in respect of a mutual fund were excessive as compared to fees charged to its institutional clients and that fund directors charged with approving the fee arrangement were not truly "independent." The district court, applying Gartenberg, granted the defendant investment adviser's motion for summary judgment. On appeal to the Seventh Circuit, the summary judgment was affirmed but with Gartenberg's "reasonable relationship" standard jettisoned in favor of one that relied on a properly functioning market to produce acceptable results. As Easterbrook put it, as long as a fiduciary (eg a fund adviser) "make[s] full disclosure and play[s] no tricks," that fiduciary should be able to negotiate its compensation in its own interest, like any other market participant.

The Supreme Court's analysis of Section 36(b) largely ignores the Seventh Circuit's alternative framework in favor of reassessing the utility of the old, comfortable and almost universally applied Gartenberg standard. Applying an "if its not broken, don't fix it" logic, the Court opined that the "Gartenberg standard, which the [Seventh Circuit] panel rejected, may lack sharp analytical clarity...[but]...we believe that it accurately reflects the compromise that is embodied in Section 36(b), and it has provided a workable standard for nearly three decades."

In particular, in assessing the fiduciary duties of an investment adviser under Section 36(b), the Supreme Court disapproved of the Seventh Circuit's single-minded focus on the element of disclosure, preferring instead Gartenberg's more holistic "arm's-length" standard: “The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm’s-length bargain.” So, given that the plaintiffs' gripe was that they were being charged more for advisory services than other institutional clients, where does fee comparison come into an approach that insists that all relevant factors be taken into account when assessing the presence of an arm's length deal? The court warned against comparing apples and oranges, commenting that "[s]ince the Act requires consideration of all relevant factors . . . we do not think that there can be any categorical rule regarding the comparisons of the fees charged different types of clients. Instead, courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require."

So how does a board protect itself, Given Gartenberg's broadstroke guidelines? The Supreme Court advises that courts should consider both substantive and procedural aspects of a board's decision. The substantive aspect will be governed by Gartenberg's “disproportionately large” fee standard set forth above as to the fiduciary duty of investment advisers. The process standard should involve a consideration of both a board’s process and the information it used in arriving at a fee arrangement. Section 36(b) provides in part that approval of the fee arrangements by a fund board of directors “shall be given such consideration by the court as is deemed appropriate under all the circumstances.” For its part, Gartenberg places much of the onus on a board's independent directors noting that “the expertise of the independent trustees . . . whether they are fully informed about all the facts bearing on the service and fee, and the extent of care and conscientiousness with which they perform their duties are important factors to be considered in deciding whether they and the [adviser] are guilty of a breach of fiduciary duty in violation of §36(b).”

The Supreme Court concluded that two inferences could be drawn from the statute and Gartenberg: “First, a measure of deference to a board’s judgment may be appropriate in some instances. Second, the appropriate measure of deference varies depending on the circumstances.” As one might expect, this deference is predicated on how thoroughly independent (ie disinterested) directors approach the fee arrangement process. If their efforts are "robust," a court should "afford commensurate deference to the outcome of the bargaining process." In addition, a decision to approve a particular fee agreement that considers relevant factors is entitled to "considerable weight” since “the standard for fiduciary breach under §36(b) does not call for judicial second-guessing of informed board decisions.” If a board's efforts are "deficient," however, they merit “a more rigorous look at the outcome.”

The Takeaways:

O'Melveny & Myers: In sum, Jones confirmed that where the independent directors of a mutual fund act with appropriate information and consider the relevant factors governing advisory fees, that judgment is entitled to significant deference from the court... absent a showing of a deficient process or a result so far from the norm that it could not have been the result of arms-length bargaining, a court should not reweigh the fees approved by a fund’s board."

Debevoise & Plimpton: "The Supreme Court’s Harris decision may do little to change the current state of affairs. Its general language about the need to consider all factors may, however, leave the door open for the discovery by plaintiffs of new lines of inquiry that the board of directors should have, but did not, pursue."

Paul Hastings: "While Jones essentially adopted the Gartenberg standard as a substantive matter, Jones moved further procedurally by expressly stating that unless there is some reason to believe the higher fees did not correspond to higher, more costly service levels, and the fees were beyond the range of arm’s length bargaining, or were otherwise 'disproportionately large,' the plaintiff will be unable to reach trial."

Morgan Lewis: "...boards should continue to request any information they deem relevant to their consideration. Boards should continue to obtain such information far enough in advance to allow for a thoughtful review and the opportunity to ask any questions or request supplemental information. Boards should also continue to be diligent in conducting a thoughtful discussion of the factors they considered and the weight allotted to such factors in coming to their decision, as appropriate. Lastly, boards should be diligent in documenting their reviews."

Simpson Thacher: "Justice Thomas authored a concurring opinion clarifying that the Court’s decision does not allow 'the free-ranging judicial ‘fairness’ review of fees that Gartenberg could be read to authorize . . . .'”

Skadden: "For mutual fund companies, this is a mixed blessing....[the] standard sets a high merits bar for plaintiffs, counsels deference to well-informed boards, and presents obstacles to the kind of institutional-fee comparison that plaintiffs have advocated in the recent cases [but] application of that standard generally entails broad factual review, meaning that, when 36(b) cases are pursued, they will likely continue to threaten significant discovery burdens on mutual fund advisers, whose counsel will need to press for discovery proceedings that are carefully designed to elicit the necessary facts concerning the relevant factors in a rational and appropriately modulated manner."

7.     Assoc. for Molecular Pathology v USPTO: In "Myriad," District Court Rules DNA Not Patentable Subject Matter

On March 29, 2010, Judge Robert W. Sweet of the U.S. District Court for the Southern District of New York held (in Association for Molecular Pathology, et al., v. United States Patent and Trademark Office, et al ("Myriad")) that patent claims directed to “isolated DNA” containing the Breast Cancer Susceptibility Gene 1 (BRCA1) and the Breast Cancer Susceptibility Gene 2 (BRCA2), as well as methods of analyzing, comparing, and using that DNA were invalid because they failed to recite patentable subject matter under 35 U.S.C.§101. In granting a motion for summary judgment to invalidate the patents, the court held that (i) the isolated DNA was a product of nature and (ii) the methods constituted nothing more than a mental process, neither of which are eligible for patent protection. In short, the court answered the question “are isolated human genes and the comparison of their sequences (without anything more) patentable?” with a resounding "no."

Although this is a district court decision with no binding authority outside of the Southern District of New York, it cannot be ignored by the biotech/life sciences sector as it frames a debate that is going to unfold on a larger stage. The erstwhile patent holders have announced their intention to appeal to the Federal Circuit and it is likely that this litigation will one way or another end up in the Supreme Court. The litigation is also part of a larger public policy debate on genetic issues that includes powerful voices that will resist the ownership and commercialization of genetic material. The Myriad plaintiffs reflected the mobilization of these interest groups and included the ACLU, major medical organizations, cancer and women’s health groups, universities, individual patients, etc. For its part, the USPTO has already indicated that if the decision is upheld on appeal, it would conform its patent examination policies to avoid issuing patents directed to isolated DNA. We would also note that none of the Alerts we reviewed were critical of the court's reasoning or methodology notwithstanding the novelty of the decision and law firms' general pro-business outlook. Normally on an issue like this we would expect to find some degree of open criticism towards a court's holdings.

Composition of Matter Claims

Section 101 states that “Whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefor, subject to the conditions and requirements of this title.”  The USPTO takes the position that genes are chemical compounds (albeit complex ones) and can be patentable as compositions of matter; and although a naturally occurring product as it exists in nature cannot be patented, the USPTO has allowed patents on naturally occurring products that have been purified, isolated, or otherwise altered. The National Institute of Health estimated that around 20% of human genes have been patented using claims that purport to shift matter from its natural state through some form of alteration. In Judge Sweet's view, however, the USPTO has been overly liberal in granting such patents, and has been issuing DNA patents on the unsound premise that “purification from the body, using well-known techniques, renders [DNA] patentable by transforming it into something distinctly different in character.” In the matter before the Court, Judge Sweet held the BRCA1 and BRCA2 genes were not “markedly different,” and hence were not patentable, from their native DNA just because they were isolated. Purification/isolation might make a natural product different in degree, but this is not enough; it must transform matter into something different in kind if it is to pass the threshold test of being "markedly different" (i.e. having a new or distinctive form, quality, or property) from the underlying natural product.

Judge Sweet summed things up with: “DNA represents the physical embodiment of biological information, distinct in its essential characteristics from any other chemical found in nature . . . [its] existence in an ‘isolated’ form alters neither this fundamental quality of DNA as it exists in the body nor the information it encodes....the patents at issue directed to ‘isolated DNA’ containing sequences found in nature are deemed unpatentable subject matter.”

Method Claims

The court then assessed Myriad's method claims, both of which use the BRCA1/2 genes in processes related to cancer research/treatment. Using Bilski's "machine or transformation" test, which allows for patent protection where a claim is tied to a particular machine or apparatus or transforms a particular article into a different state or thing, the Myriad court found that the method claims were limited to the abstract mental processes of "comparing" or "analyzing" gene sequences and were not "transformative" in nature.

The Takeaways:

Bryan Cave: "The decision, if upheld, could disturb over 30 years of jurisprudence and cast doubt upon the validity of many so-called “gene patents” directed to other isolated DNA sequences and similarly claimed subject matter [&] may extend to patents claiming other isolated naturally occurring compositions used as pharmaceuticals, in diagnostics, or even as reagents in chemical processes."

Baker Donelson: "Applicants would still be able to get patents directed to genetic material, but would have to show that their claimed invention had "markedly different characteristics" from native DNA. In anticipation of this, applicants with currently pending applications should examine their current claims and consider adding claims to inventions with 'markedly different characteristics', if possible. If the decision is upheld, then the chances of having at least some of the claims survive are greatly improved."

WilmerHale: "The case, which is likely to be considered en banc – and quite possibly on certiorari to the Supreme Court thereafter – could have substantial and far-reaching consequences in the biotechnology and pharmaceutical industries. The immediate implications, and the results of following appellate decisions, will be closely monitored in these industries."

Kilpatrick Stockton: "Finally, as also noted by the District Court, there are broader public policy issues implicated by the issue of the patentability of genes.  For example, there are compelling arguments on both sides of the issue whether research is stifled, or promoted, by gene related patents.  The policy choice would likely require Congressional action into this sensitive, controversial, but extremely important issue." 

Foley & Lardner: "It also is interesting to note that all seven patents at issue in this case will expire in 2014 or 2015; thus, it is clear that this case is not really about the Myriad patents in particular, but rather about the patentability of isolated genes and genetic screening methods in general."

Foley & Lardner: "Until the case is resolved, companies isolating genes and developing tests for genetic mutations may consider reevaluating their strategies for protecting their intellectual property. For example, when considering options including those running counter to the ideals behind patent law, companies may consider maintaining the sequences and mutations associated with particular diseases as trade secrets, rather than making them available through publication and patenting."

Sidley Austin: "As the case may be reversed upon appellate review, it does not change the long-standing U.S. Patent and Trademark Office policy that isolated DNA and methods of using that DNA are indeed patentable subject matter under 35 U.S.C. § 101, and as a result we do not expect patent applicants to change their patenting strategies relating to genetic material prior to a ruling from the Federal Circuit."

Baker Donelson: "Based on comments by several justices during oral argument, it appears likely that the Supreme Court will uphold the rejection of the Bilski method claims, although perhaps using a different rationale or test. Thus, while the rejection of the BRCA method claims in this case may be based on a test that soon may be moot, it is unlikely that the claims would survive whatever test or analysis replaces it."  

8.     ebay Held Not Liable for Counterfeit Goods

On April 1, 2010, in what may have seemed like a bad joke to plaintiff Tiffany, the Second Circuit held that eBay was not liable for failing to identify and exclude counterfeit Tiffany items being sold on its website notwithstanding ebay's generalized knowledge that many of the supposed Tiffany goods for sale on its auction website were in fact counterfeit. There are several key lessons (see the "Takeaways" below) here for both trademark holders and service providers, but in the Second Circuit anyway it is clear that courts are to help those who help themselves.

In 2004 Tiffany unsuccesfully sued ebay for alleged direct and contributory trademark infringement, dilution, and false advertising stemming from the sale of counterfeit goods by ebay vendors. Following a bench trial, the district court found in favor of eBay on all claims. On appeal, the Second Circuit has now upheld the lower court ruling in respect of the allegations of direct trademark infringement, contributory trademark infringement and dilution; but remanded Tiffany’s false advertising claims to the district court for further consideration.

Directly liability

Recognizing that ebay "may lawfully use a plaintiff’s trademark where doing so is necessary to describe the plaintiff’s product and does not imply a false association or endorsement by the plaintiff by the defendant" (and that ebay had played by the rules), the Second Circuit held that to "impose liability because eBay cannot guarantee the genuineness of all of the purported Tiffany products offered on its website would unduly inhibit the lawful resale of genuine Tiffany goods."

Contributory liability

Extending a test adopted by the Supreme Court (in Inwood Labs., Inc. v. Ives Labs, Inc.) to include service providers, the Second Circuit held that “a service provider must have more than a general knowledge or reason to know that its service is being used to sell counterfeit goods. Some contemporary knowledge of which particular listings are infringing or will infringe in the future is necessary.” In this respect, and throughout its decision, the Second Circuit cited sophisticated and persistent efforts by ebay to remove listings placed by vendors it had reason to know were selling counterfeit goods.

Dilution

The Second Circuit held that eBay's use of the Tiffany mark directly to advertise and identify the availability of authentic Tiffany merchandise and not to refer to its own goods or services (ie only using "Tiffany" to describe Tiffany goods) could not be dilutive. A plaintiff needs to have a second mark or product at issue; you can't dilute yourself.

False Advertising

The Second Circuit also held that the District Court had used the wrong test to determine whether ebay's advertisements constituted false advertising under Section 43(a) of the Lanham Act and remanded the false advertising charge for further consideration. According to the Second Circuit, the correct test is whether extrinsic evidence indicates that the challenged advertisements were misleading or confusing for consumers. In remanding, the Second Circuit noted that “the law prohibits an advertisement that implies that all of the goods offered on a defendant’s website are genuine when in fact, as here, a sizeable proportion of them are not.” The court also noted, however, that a simple disclaimer might be enough for ebay to avoid liability in this respect.

Takeaways:

From Bryan Cave: "On appeal, the Second Circuit initially emphasized eBay’s efforts to combat the sale of counterfeit merchandise. Specifically, eBay spent 'as much as $20 million each year on tools to promote trust and safety,” hired thousands of employees devoted to trust and safety to monitor the site, and 'implemented a ‘fraud engine’...principally dedicated to ferreting out illegal listings, including counterfeit listings.'”

From Kaye Scholer: "The decision also provides great incentive to trademark owners to beef up their policing efforts and to maximize their efforts to provide online marketers with actual notice of specific individuals or entities infringing their marks, as well as to proceed against direct infringers themselves.

From Kilpatrick Stockton:  "Moreover, this decision is obviously linked to the particular evidentiary showings before the court, one of which was that the preventive measures undertaken by eBay were far more extensive than most website operators can match. Tiffany’s loss also contrasts dramatically with recent victories by Hermes and Louis Vuitton in similar cases against eBay in France. Consequently, the long-term significance of the decision remains to be seen."

From Foley & Lardner: "The Second Circuit was clearly impressed by the scope of eBay’s anticounterfeiting efforts, which included more than 200 employees devoted to combating infringement and implementation of “fraud engines” to screen out counterfeit listings at an early stage. These efforts helped convince both the District Court and the Court of Appeals that eBay should have breathing room to continue the 'notice and takedown' approach to counterfeiting on its site, and maintains the burden on trademark owners to police eBay for infringements."

More from Kaye Scholer: "The Second Circuit's decision is a significant ruling regarding the principles of secondary trademark iability. It suggests that if an online service provider (or distributor of goods as well) takes steps, when notified of specific instances of infringing activity, to eliminate the specific activity as to which it has received notice, it will be insulated from a claim of contributory infringement based on generalized knowledge that others are engaged in the same conduct where the identities of such individuals are not known to the service providers."

On April 12, 2019, the EPA published a series of proposed rules (first announced on March 23rd) that would amend its November 2009 GHG Mandatory Reporting Rule (the "GHG reporting rule") to add three new sectors to the list of 31 already covered. Pursuant to the proposed rules, the oil and natural gas sector (Subpart W), carbon dioxide (CO2) injection and geologic sequestration facilities (Subpart RR), and facilities that produce or use fluorinated gases (Subparts I, L, DD, OOa, and SS) would each now be subject to the GHG reporting rule with their first reports due on March 31, 2012 (in respect of the 2011 emission year). The proposed rules are largely a follow-up to the November 2009 rulemaking during which the EPA received a number of comments expressing concern as to the technical feasibility of compliance by these three sectors. Choosing to press on with the rulemaking as a whole, the EPA opted to leave these three sectors aside for further consideration.

In addition to proposed rules bringing these three sectors back within the regulatory fold, the EPA is also proposing to require that all entitities subject to the GHG reporting rule provide certain additional ownership information.

Expansion of GHG reporting rule to cover oil and gas sector

The EPA's proposed rules would subject oil and gas facilities emitting 25,000 metric tons of CO2 equivalent or more to the GHG reporting rule with the amended rules defining “facility” so as to aggregate all equipment associated with production and distribution under common ownership or control and located in a single hydrocarbon basin into a single emission source for reporting purposes. If adopted, the modified GHG reporting rules for Subpart W would require reporting of fugitive and vented emissions from facilities engaging in:

• onshore petroleum and natural gas production,
• offshore petroleum and natural gas production,
• onshore natural gas processing,
• natural gas transmission,
• underground natural gas storage,
• liquefied natural gas (LNG) storage,
• LNG import and export facilities, and
• natural gas distribution facilities;

with the result that approximately 1,800 additional facilities would be covered. The EPA will hold a public hearing on this proposal on April 19, 2010 and is accepting comments on the proposal until until June 11, 2010.

Expansion of GHG reporting rule to cover injection and geologic sequestration facilities

The EPA's proposed rules would require all CO2 injection and geologic sequestration facilities to report on (but not control) the injection and geologic sequestration of CO2.

Expansion of GHG reporting rule to cover facilities with fluorinated greenhouse gas emissions

The EPA's proposed rules would also require reporting of fluorinated GHG emissions by facilities that have emissions equal to or greater than 25,000 metric tons of CO2 equivalents per year.

Expanded reporting requirements as to ownership

In addition to rules expanding the scope of the GHG reporting rule, the EPA is proposing to amend ownership disclosure requirements that would apply to all covered entities. Rules being considered would require reporting entities to provide (i) the name, address, and ownership status of one or more top level U.S. parents and their respective ownership percentages, (ii) North American Industry Classification System code(s), and (iii) an indication of whether any of their reported emissions are from a cogeneration unit.

10.     Shady Grove Orthopedic Associates: In Class Action, Federal Diversity Rules Trump State Rules  

On March 31, 2010, the Supreme Court voted 5-4 to reject state law limitations on class actions heard in federal court. In Shady Grove Orthopedic Assocs., PA v. Allstate Ins. Co, the Court held that Section 901 of the New York Civil Practice Law and Rules, which bars class actions seeking penalties or statutory minimum charges, conflicts (or collides) with Federal Rule of Civil Procedure 23 and therefore cannot be applied by a federal court sitting in diversity.

In Shady Grove, the plaintiff filed a putative class action in a New York federal district court for recovery of unpaid statutory interest on overdue automobile insurance benefits from Allstate. The district court dismissed the case for lack of jurisdiction because plaintiff’s claim (worth roughly $500) on a stand alone basis was insufficient to satisfy the amount in controversy requirement for diversity cases and the suit could not proceed as a class action (ie aggregate claims so as to meet the amount in controversy requirement) due to a New York statute prohibiting classwide imposition of statutory penalties, such as statutory interest.

Under Erie Railroad Co. v. Tompkins, federal courts exercising diversity jurisdiction apply state substantive law and federal procedural law. The district court concluded that Section 901 applied in Shady Grove because it is “substantive” law within the meaning of Erie and further held there was no conflict because Section 901 and Rule 23 because they address different issues, eligibility of the particular type of claim for class treatment and certifiability of a given class, respectively. The Second Circuit affirmed, holding that the two provisions were not in conflict.

Justice Scalia, writing in part for a 5-justice majority, disagreed. He reasoned that because both provisions address whether a class action can be maintained, the two provisions are irreconcilable. Paying homage to the car crash roots of the case, Scalia wrote that the New York statute was “an unavoidable collision” with the “one-size-fits-all formula for deciding the class action question” under Federal Rule 23, because “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rule’s prerequisites are met.”

In a collision, Rule 23 must govern.

The Takeaways:

From Mayer Brown: "Justice Ginsburg [in dissent] noted a 'large irony'.....'Congress surely never anticipated that CAFA would make federal courts a mecca for . . . class actions seeking state-created penalties for claims arising under state law—claims that would be barred from class treatment in the State’s own courts'.”

From Jenner & Block: "The Court observed that if Rule 23 answers the question, Rule 23 governs unless Rule 23 exceeds the statutory authorization or Congress’s rule-making power. Thus, the Supreme Court did not treat the case as an 'Erie question,' stating that '[w]e do not wade into Erie’s murky waters unless the federal rule is inapplicable or invalid'.”

From Morrison Foerster:  "An important practical effect of Shady Grove is predicted by the Court itself: forum shopping. If the federal rules preempt certain state statutes (as in this case), litigants may seek to file in federal court."

From Sutherland:  "Because numerous state statutes provide for civil actions to enforce state law rights but prohibit class actions, the decision has broad implications, particularly in view of the expansive federal jurisdiction over class actions conferred by the Class Action Fairness Act (CAFA)."

From Troutman Sanders:  "Shady Grove might have been of limited importance but for the Class Action Fairness Act of 2005 (CAFA).  CAFA dramatically expanded federal-court jurisdiction over state-law class actions.  Prior to CAFA, maintaining a state-law class action in federal court under diversity jurisdiction was nearly impossible; however, CAFA provided that many high-dollar state law class actions could be removed to or filed in federal court."

NB: The numbers next to each Hot Topic reflect new alerts this week (& totals to date).

1.      Health Care Reform Becomes Law  54 (316)

2.      The UK Bribery Act 16 (54)

3.      SEC's Proposed Rules Re: Asset-Backed Securities (ABS) 6 (14)

4.       A Break for Nursing Mothers   6 (11)

5.      The HIRE Act   3 (58)

6.      Jones v Harris Associates & Excessive Investment Adviser Fees   2 (26) 

7.      Assoc. for Molecular Pathology v USPTO:  "Myriad" Court Rules DNA Not Patentable   2 (18)

8.      ebay Held Not Liable for Counterfeit Goods  2 (7)

9.      EPA Expands its GHG Mandatory Reporting Rule to Cover Oil & Gas Sector   2 (82)   

10.    Shady Grove: In Class Action, Federal Diversity Rules Trump State Rules   2 (14)