Swales v. KLLM Transport Services LLC has recently received considerable attention for directing district courts in the Fifth Circuit to abandon the two-step certification process for Fair Labor Standards Act collective actions that has been widely followed in every circuit for over two decades.
While the U.S. Court of Appeals for the Fifth Circuit adopted a one-step process in Swales, it did not alter the interpretation of the “similarly situated” certification standard required by Title 29 of the U.S. Code, Section 216(b), nor add other requirements to the standard. Moreover, courts outside the Fifth Circuit have not been adopting the Swales analysis, nor do they seem likely to do so.
Swales is unlikely to have far-reaching effects outside of the Fifth Circuit. The cases in other circuits that have addressed whether Swales impacts their use of the two-step approach have all decided that it does not.
For example, in February in McCoy v. Elkhart Products Corp., the U.S. District Court for the Western District of Arkansas rejected the defendant’s entreaty to follow Swales, stating: “The court will follow the historical, two-stage approach, which has proven to be an efficient means of resolution of this issue.”[1]
Similarly, in Piazza v. New Albertsons LP the U.S. District Court for the Northern District of Illinois in February declined to follow Swales where — unlike Swales — there was no threshold merits questions intertwined with the determination of whether the opt-in plaintiffs were similarly situated.[2]
In March, in Moreau v. Medicus HealthCare Solutions LLC, the U.S. District Court for the District of New Hampshire followed the two-step approach and rejected the defendant’s request to allow merits discovery before deciding the plaintiffs’ motion for conditional certification.[3]
In Wright v. Waste Pro USA Inc., the U.S. District Court for the Southern District of Florida in April refused to grant reconsideration of its prior conditional certification because of extensive support from the U.S. Court of Appeals for the Eleventh Circuit for the two-step process, and the rejection of Swales by all courts outside the Fifth Circuit.[4] The U.S. District Court for the Eastern District of Kentucky also declined in April to abandon the traditional two-step process in favor of Swales with its decision in Brewer v. Alliance Coal LLC.[5]
Parties should not expect Swales to broadly change the two-step process, which has been widely endorsed among the circuits[6] and implemented at the district court level.[7] However, FLSA plaintiffs should be vigilant in identifying and resisting attempts to apply Swales on the margins, a tactic to which some courts have been receptive.
For example, while in McColley v. Casey’s General Stores Inc. the U.S. District Court for the Northern District of Indiana explained in March that the “FLSA certification two-step remains the dance of this circuit” post-Swales, it questioned whether there should be more than a modest showing that plaintiffs are similarly situated at the conditional certification stage.[8]
Similarly, in Loomis v. Unum Group Corp., the U.S. District Court for the Eastern District of Tennessee in January relied on Swales to grant precertification discovery over the plaintiffs’ objection, but was careful to clarify that its method did “not undermine the two-step approach of FLSA cases in the Sixth Circuit.”[9] Even pre-Swales courts had discretion to permit precertification discovery, so this does not represent significant change.
Parties addressing Swales arguments outside the Fifth Circuit should be prepared to grapple with the timing issue, which was completely ignored by the Fifth Circuit in issuing Swales. In opt-in cases governed by Section 216(b), the statute of limitations continues to run for each potential plaintiff until they opt in to the litigation.
In Hoffmann-La Roche Inc. v. Sperling, the U.S. Supreme Court in 1989 identified the importance of timely notice as one reason the district court should be involved in the notice process.[10] One reason courts have widely adopted the two-step process is so that notice can be issued early in the litigation, before potential plaintiffs’ statute of limitations expires; proceeding with discovery prior to ruling on issuance of notice, as Swales advocates, would interfere with timely notice.[11]
When there are delays in issuing notice — which engaging in discovery before deciding on notice would certainly cause — then plaintiffs should seek tolling of the statute of limitations until the notice issue is resolved. Many courts have tolled the running of the statute of limitations in collective actions where there was delay in ruling on certification, including delay caused by discovery.[12]
One would expect to see plaintiffs in the Fifth Circuit, or in any other jurisdiction imposing discovery prior to ruling on certification, ask for tolling of the statute of limitations. Otherwise, defendants would be incentivized to drag their feet on discovery to run out the clock on claims.
Another point that courts confronting efforts to expand Swales should consider is one that Swales purports to answer: how best to ascertain “whether putative plaintiffs are similarly situated — not abstractly but actually.”[13] Until notice is issued, and opt-in forms received, any analysis of whether the group of plaintiffs seeking to proceed collectively are similarly situated is abstract and theoretical. Whether plaintiffs are similarly situated should be decided based on the specific individuals who opt in, not all those who theoretically might have been able to do so.
Cohen Milstein publishes on consumer safety and product liability issues.
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Building Safe Online Spaces
April is Sexual Assault Awareness Month and this year’s theme is “We Can Build Safe Online Spaces.” Never before has the need for safe online spaces for children and teens been so critical than this past year due to COVID-19. Children and teens are using the Internet every day for school, online games, video chat and more with greater frequency, making them potentially more vulnerable to online abuse and predatory behavior.
As sexual assault awareness advocates, Cohen Milstein believes that education is the most effective way to help prevent unthinkable tragedies from happening. We encourage you to share these tips from the National Sexual Violence Resources Center (NSVRC) to help keep kids safe online.
- Spend time online together to teach your kids appropriate online behavior.
- Keep the computer in a common area where you can watch and monitor its use, not in individual bedrooms.
- Monitor any time spent on smartphones or tablets.
- Bookmark kids’ favorite sites for easy access.
- Check your credit card and phone bills for unfamiliar account charges.
- Take your child seriously if he or she reports an uncomfortable online exchange.
- Contact local law enforcement if you hear of or see any offensive material that was directed at a child or if any predatory behavior towards a child takes place.
A victim in an abuse situation may not be able to directly communicate what is happening to them, especially a child. Here are some possible red flags that may indicate abuse:
- Yelling in the background of video or phone calls,
- Behavioral changes such as social withdrawal, difficulty concentrating, or loss of interest in usual activities,
- Unexplained absences, or
- Complaints about soreness, pain, or trouble sleeping.
Cohen Milstein’s Sexual Abuse, Sex Trafficking & Domestic Violence Litigation attorneys have recovered significant jury awards and confidential settlements on behalf of clients who are survivors of childhood and adult sexual abuse and assault. Our attorneys are nationally recognized as leaders in their areas of practice. If you’re interested in learning more about our Complex Tort Litigation practice or the Sexual Abuse, Sex Trafficking & Domestic Violence team, please email us, or call us at 561.515.1400.
We co-counsel nationwide.
Read Building Safe Online Spaces.
Agnieszka Fryszman will speak at Harvard Law School on March 26, 2021 at 12:00 p.m.
Ms. Fryszman’s program, “Civil Litigation as a Tool to Combat Forced Labor in Global Supply Chains,” will address the potential of bringing civil lawsuits under the Trafficking Victim Protection Reauthorization Act (“TVPRA”) to combat labor trafficking and exploitation in global supply chains and advance corporate accountability.
She will be joined by other internationally renowned human rights legal experts.
If you have any questions about the issues raised below or would like to learn more about the False Claims Act, please contact one of our Whistleblower Attorneys at whistleblower@cohenmilstein.com or via our Contact Us page to arrange a complimentary confidential consultation.
By David Engel, JD, Gary Azorsky, JD, Jeanne Markey, JD, and Ray Sarola, JD
Can a patient have and not have diabetes at the same time? According to private insurers participating in the Medicare Advantage program, the answer is yes. The data architecture of Medicare Advantage is vulnerable to fraud perpetrated by the Medicare Advantage Organizations (MAOs) who administer Medicare Advantage plans. These MAOs stand to collect inflated profits if they determine that their beneficiaries have complicating diagnoses for certain purposes but not for others.
Why does it matter?
The stakes for the new administration – and the country as a whole – are enormous. Over 23 million Medicare beneficiaries are enrolled in Medicare Advantage plans, for whom the federal government paid out $264 billion in 2019 alone. It is increasingly clear that these public funds are vulnerable to fraud. The HHS Office of Inspector General recently reported that in just one year $2.6 billion was paid to MAOs based on their reports of patient diagnoses that lacked supporting data from providers. It is widely anticipated that investigations and prosecutions of corporate fraud will increase under the Biden administration, and given the dollars at issue and the critical importance of our national healthcare system, fraud in the Medicare Advantage program should be a particular focus of this renewed enforcement effort.
Why is the program so vulnerable to fraud?
To illustrate Medicare Advantage’s vulnerability to fraud, consider how it relies upon two independent data systems to pay for a beneficiary’s inpatient hospital care.
The first system determines the amounts MAOs pay hospitals. This system uses the same MS-DRG prospective payment methodology as traditional Medicare, under which payment for each episode of care is a fixed fee. This fee is based on the procedures performed and the patient’s current diagnoses as reported by the hospital to the MAO.
The second system determines the capitated amount the government pays the MAO for insuring all of a beneficiary’s covered care during the relevant period. The government estimates the cost of this care by calculating a Risk Adjustment Factor (RAF) for each beneficiary. The RAF is based on information regarding each beneficiary’s demographic information and current diagnoses as reported to the government by the patient’s MAO. The higher the RAF, the greater the payment the MAO will receive for that beneficiary.
In the first system, the data flow is between the hospital and the MAO. In the second, it is between the MAO and the government. The problem arises because the government does not have real-time access to hospital claims data in the first system, and hospitals do not have access to the MAO’s reports to the government in the second system.
Our diabetes example demonstrates the consequences of this lack of integration and transparency, particularly in the context of secondary diagnoses. For instance, suppose that a Medicare Advantage member with type 2 diabetes is admitted for surgery, and the hospital later codes this secondary diagnosis on its bill to the MAO. This diagnosis may move the episode of care into a more heavily weighted DRG, which can increase by thousands of dollars the amount the MAO must pay the hospital. These increased payments incentivize MAOs to challenge the propriety of such secondary diagnoses by contending that they are inactive conditions or otherwise irrelevant to the episode of care. Some MAOs have initiated programs to routinely delete certain diagnoses in order to downgrade DRGs and reduce payments to hospitals.
Whether a patient has type 2 diabetes is also an important datum in the Medicare Advantage risk adjustment system. A beneficiary with a current diabetes diagnosis will receive a higher RAF score, and the government will pay the MAO more to insure that beneficiary. While the MAO has an incentive to delete this secondary diagnosis to reduce its payment to the hospital, it can increase its own payments from the government by including this diagnosis in the risk adjustment reports it transmits to the government. If the MAO does not synchronize its provider payment determinations with its risk adjustment reports, our patient will both have and not have diabetes at once. The MAO will improperly profit by being paid to insure a diabetic patient while not paying a hospital to care for one.
How can we prevent this fraud?
It is unfortunate that the current Medicare Advantage data reporting systems are vulnerable to this type of fraud and do not have real-time policing mechanisms. MAOs are likely to continue to take advantage of a system that lets them act as though a patient is less sick when paying for their care, and more sick when seeking money from the government to cover that same patient. The most effective tool to deter and remedy this type of fraud is the federal False Claims Act, which imposes treble damages and significant monetary penalties on companies that defraud the government. Prosecuting those who engage in this fraud under the False Claims Act, including through cases brought by whistleblowers, is the most effective remedy and deterrent.
The complete article can be accessed here.
What is an ESOP?
An Employee Stock Ownership Plan (“ESOP”) is an ownership program where a company provides its employees with company stock, usually at no cost to the employees. Shareholders often create an ESOP by selling their shares of stock to the newly created ESOP as a form of an “exit strategy.” The ESOP may pay the shareholders for these shares of stock by taking out a loan (“leveraged ESOP”). As the company creates revenue, it repays the ESOP’s loan, and the ESOP releases shares of company stock to its employees.
When shareholders sell the company to its employees by selling all the stock to the ESOP, the company may tout this move as giving its employees the ability to grow the company and reap the benefits of their work. But often undisclosed are the risks to the employees, particularly in ESOPs that involve privately traded employee stock.
Is My ESOP Account at Risk?
ESOPs in general carry inherent risks not present in other retirement plans—ESOPs don’t diversify investments, an employee’s retirement account value is tied to the performance of the company, and large amounts of employee layoffs can cause the ESOP to spiral. The risks become even more amplified in privately traded ESOPs.
An ESOP is privately traded when its stock is not available for public purchase and not valued by the stock market. The stock in the privately traded ESOP is valued by a third party who performs a yearly valuation. If the third party is biased, or trying to produce a valuation that pleases the shareholders, it may overvalue the stock, which allows the shareholders, when exiting the company, to receive more money for the privately traded stock than it may actually be worth.
Many ESOPs take on loans to purchase the privately traded stock from the shareholders (called a “leveraged ESOP”). The risk to employees’ ESOP accounts comes when the ESOP takes on too much debt. An ESOP that takes on significant debt has little room to survive financial downturn of the sponsoring company, which is now owned by the employees.
What Should I Do if I Believe My ESOP is at Risk:
If you are a participant in an ESOP of a privately traded company and you believe that the ESOP may be subject to any of the risks described above, please use the Contact Us box below.
Many traditional 401(K) plans are being replaced with employee stock ownership plans (“ESOPs”). While in many cases an ESOP is a valuable benefit to employees, they are also vulnerable to abuse.
What is an ESOP?
An ESOP is a qualified defined-contribution employee benefit plan designed to invest primarily in the stock of the sponsoring employer. That means, instead of investing the retirement contributions into traditional investment vehicles like stocks, bonds or money market funds, the retirement contributions are invested back into company stock. ESOPs are “qualified” in the sense that the ESOP’s sponsoring company, the selling shareholder and participants receive various tax benefits. For these reasons, ESOPs are often used to give the employees a vested interest in the company’s success and aligning their interests with the company’s shareholders. In some instances, shortly after the sale to employees, the Company stock purchased by the ESOP is reported by the Company to be worth a small fraction of what the ESOP paid for it.
How Does a Private ESOP Work?
In a private ESOP, the sponsoring company sets up a retirement plan solely to purchase the company from the existing shareholders. Sometimes, the ESOP needs to borrow most or all the money necessary to purchase the company stock. Then the future retirement contributions to the plan are used to repay the ESOP debt from purchasing the company. Some ESOPs invest up to 100% of their assets in employer stock. The decision to set up an ESOP to buy the employer stock is often made by corporate insiders who stand to benefit directly from the transaction. Often, the CEO and principal owner of a company picks the ESOP’s trustee who will approve of the sale of company from the CEO to the ESOP (i.e., the employees). The trustee negotiates with the selling shareholder(s) to determine the price the ESOP will pay for the Company shares. To be legal, the price the ESOP pays for the company cannot be more than fair market value. But lawsuits our firm has filed on behalf of employees show that corporate executives abuse ESOP transactions to unload their interests in the company at an inflated price, and saddle employees/participants with tens of millions of dollars of debt which goes to pay the corporate executives who stay at the helm of the company. Shortly after the sale to employees, the value of the company plummets to a fraction of what the employees paid.
How Do Leveraged ESOP transactions Harm Employees/Participants?
Even though ESOPs are technically considered to be retirement plans existing for the benefit of employees, the assets of these plans can be – and often are – used to enrich the management of the company, to create liquidity for existing shareholders, and to serve as a lucrative “exit strategy” for company founders. This can result in significant conflicts of interest, between the management of the company and its employees, and between existing shareholders and the employees who are “buying” the shares via an ESOP. Generally, the employees who are forced into buying the company through their retirement plan are not able to negotiate the price they paid, and they are not able vote on whether to move forward with the purchase. Often, the trustee who is appointed to represent the employees in the ESOP is picked by the selling shareholders and thus may not be acting solely in the best interest of the employees to negotiate a fair price. Also, it can be very difficult for employees to obtain enough information to determine whether the ESOP has paid too much for the company shares.
Contact Us
If you think you may have suffered losses to your retirement savings because of an ESOP transaction, we would be interested in investigating your case. Cohen Milstein’s attorney Michelle Yau is here to answer your questions and to learn about your experience with your ESOP. To schedule a complimentary phone appointment, please call our office at (202) 408–4600.
Cohen Milstein Sellers & Toll PLLC
1100 New York Avenue, N.W., Suite 500
Washington, D.C. 20005
Telephone: 888-240-0775 or 202-408-4600
Whether a Section 216(b) collective action under the Fair Labor Standards Act, or a Rule 23 class action under state wage and hour law, notice to the potential class members will be required at some point for any class case.This may arise with the initial notice of the opportunity to opt in to an FLSA action or a notice of proposed settlement at the conclusion of a Rule 23 case.
However, class members are not always reliably found by first-class mail, for a number of reasons, and there are numerous alternatives to consider in appropriate circumstances.
For Rule 23(b)(3) classes seeking damages, Rule 23(c)(2)(B) requires:
The best notice that is practicable under the circumstances, including individual notice to all members who can be identified through reasonable effort. The notice may be by one or more of the following: United States mail, electronic means, or other appropriate means.
The language of the rule points specifically to the circumstances of the case, indicating that the best notice practicable will be different depending on the facts of the case and the makeup of the parties.
And while compliance with the rule may seem like a procedural formality, it is in fact a critical part of a class action, as judgments and settlements bind the entire class, and therefore class members’ constitutional rights can be violated if class notice is ineffective or inappropriate under the circumstances.[1]
Rule 23(c)(2)(B) was amended in 2018 to include notice via electronic means, or other appropriate means, cementing the flexibility already afforded by the courts to authorize notice other than first-class mail under the appropriate circumstances.
As the 2018 advisory committee note points out:
[W]hen selecting a method or methods of giving notice … [the court should] … consider the capacity and limits of current technology, including class members’ likely access to such technology.
When attempting to disseminate notice to class members who are difficult to find, such as transient or seasonal employees, notice by electronic means such as text, social media and digital advertising may be effective, in particular when used alongside regular mail notice.
Reasons for Alternative Notice
There are several common scenarios where mailed notice will not reach a large percentage of the class:
- When there is substantial turnover among employees, so that most class members are former employees, who may not be at the same address as when they worked for the employer. This is particularly common with lower-wage workers who rent rather than own a home.
- When the workforce is inherently transient, such as migrant farmworkers, or where the workers spend months living and working away from the home address where they get mail (such as workers on oil rigs in the Gulf, or working on fracking and living in temporary housing).
- When the employer has not kept records of its employees’ addresses — or in some cases, names.
Types of Alternative Notice
Email and Text Notice
If the employer has cellphone numbers or email addresses for employees, those numbers are more likely to be stable, when physical addresses are not.
For example, if class members are likely to be off in the oil fields, they may not get mail forwarded from home very often, but they’ll have their cellphones with them.
And even some employers who don’t do much to record employee addresses may still record cellphone numbers, because they are useful to the employer.
Thus, when the class is characterized as having a high turnover rate or frequent changes in location, email or text notice may be highly effective.[2]
In addition, notice by email is comparatively cost-efficient, as email is generally free, and most claims administrators and firms have systems in place to send mass emails.
These savings may prove important in class actions involving low monetary payouts, given that expensive notice programs may diminish the available recovery for class members.
However, as the 2018 advisory committee note points out, email notice would not be appropriate if class members don’t have access to modern technologies or an understanding to navigate notice sent through email, such as a class of older workers or migrant farmworkers.
Texting is also cost-effective and used by a wider range of individuals than email.
Email as the sole means of notice should be used with caution.
Emails can be blocked by the recipient as spam or returned as undeliverable, or bounced back, for various reasons.
Because of this, it is important to use and monitor read receipts, which send a response message to the sender when an email is opened.
A more appropriate method of disseminating notice than email alone may be to supplement with email when direct mail is returned as undeliverable, or by supplementing with regular mail if an email is bounced back or has no read receipt.[3]
In addition, class counsel should make sure to fashion the subject line of the email so that it stands the best chance of being read and not discarded as potential spam, such as including the name of the employer or type of work involved in the settlement.
Both email and text messages are electronic means of communication under Rule 23(c)(2)(B), but there are important differences with respect to their appropriateness for disseminating class notice.
While both email and cellphone numbers are relatively stable and don’t frequently change over time, allow for bounce back messages if they are undeliverable, and are extremely cost-efficient, “many Americans use text messages as their primary contact and access text messages much more than they would email.”[4]
In addition, people typically have only one cellphone to receive texts, while they may have multiple email accounts, some of which are provided as a junk accounts to receive unimportant emails.[5]
Indeed, one court addressing a request to send notice to potential class members by text message in addition to email and mail observed that:
Providing notice via text message in addition to other traditional notice methods will almost always be more appropriate in modern society.[6]
And many workers who come to America for temporary work not only use cellphones but use them as a primary means of communication with their U.S.-based employers.
Text messages, however, will not allow the sender to send all the information that might need to be communicated about the case, settlement and claims process.
It therefore would be useful to include in a text notice plan a dedicated website for the case.
The site would be designed to relay the extensive information about the case or settlement to class members and to answer frequently asked questions class members may have.
This can provide the additional information that a text cannot, and the text can provide a link to the website.[7]
Finally, providing a telephone number for potential class members to ask questions and get assistance submitting a claim form is beneficial.
If such a hotline is made available, text notice should include this number, in particular when class members may have limited access to or familiarity with electronic means of communication.
It is also worth noting that courts have held that sending mass text messages does not violate the Telephone Consumer Protection Act or any Federal Communications Commission regulations if part of a court-approved notice plan, as the court is fulfilling its duty of ensuring class members are provided their due process rights in the most effective manner possible.[8]
Telephone Notice
Telephone numbers, whether cellphone or landline, can be used to provide notice by voice message instead of, or in addition to, texting.
However, notice by telephone call is less favored.
Courts are most likely to direct production of telephone numbers for the limited purpose of facilitating tracing potential class members whose mailing is returned undeliverable.[9]
Telephone notice has been permitted when no email address is available, or when email and regular mail addresses have proven to be incorrect, provided an approved script is used.[10]
Publication Notice
If the employer did not keep records of employees’ addresses and neither plaintiffs nor defendants have the ability to identify individual members of the class through other means, notice through publication may be the only way to let them know about a potential case.[11]
Publication may take various forms, such as print, internet banner or pop-up advertisements, social media, or radio. This is most feasible if the former employees are all in a relatively narrow geographic area, or are likely to read a particular publication or participate in a website that serves a particular industry.
As their names suggest, banner advertisements display notice in a banner at the top of a webpage, while pop-up advertisements appear dynamically on the webpage. Most courts permit these advertisements to be posted on the defendant’s own website, which may be useful if current or former employees frequent that website.[12]
Social media platforms offer robust targeting mechanisms allowing plaintiffs to narrowly tailor the reach of class notice. For example, on Facebook, class members can be targeted by age, gender, education, job title, location, or people who have visited a particular website or downloaded a corporate defendant’s mobile app.[13]
Courts have also approved parties’ use of keyword search results to place advertisements containing notice for anyone who has searched a term or phrase related to the class.[14]
With this type of notice, a search engine like Google will display the advertisement when a person searches for certain keywords or phrases connected to the class, such as the name of a defendant employer or the job or industry involved in the case.
This could prove more effective than trying to determine which newspapers and websites class members may frequent.
Posting in the Workplace
Courts have often approved notice plans that include requiring the employer to post a notice at the worksite, often where employees would clock in.[15]
Workplace posting can be particularly helpful when many class members are current employees, but they are working someplace other than their permanent address that is on file with the employer.
Some courts permit posting of notice in the workplace only after other forms of notice prove inadequate or if the defendant employer does not provide individual contact information for the class member employees.[16] However, many courts permit such posting as a matter of course.[17]
In-Person Delivery
While uncommon, and rarely addressed, courts have permitted notice to be delivered in person.[18] This may be the most effective form of notice for employees like migrant laborers who do not have consistent physical addresses, do not use permanent cellphones, and move around the country to various farms or other temporary workplaces.
For example, a class of farmworkers known to have worked for a specific farm labor contractor may work for that same farm labor contractor at other locations in the United States where they can be found at specific times of year during a growing or harvesting season.
This type of notice, while sometimes appropriate, should be approached with caution, as employers may attempt to obstruct these in-person visits, especially if the labor contractor is a defendant in the case.
Thus, third-party claims administrators or class counsel should be present — along with interpreters, if needed — and the laws against retaliation should be clearly explained.
Conclusion
Courts expect the parties to fashion notice plans that will effectively reach the class, and are tailored to the particular circumstances of each case.
And while using just one form of notice may be sufficient, it is more likely that class members will be found by using various forms of notice that complement each other.
This is particularly true with hard-to-find class members, and attorneys in such cases should become knowledgeable about their class and the methods by which the class members most often communicate.
This information may come from various sources, including class representatives, experts or reviews of relevant case authority regarding a particular industry.
With U.S. stock indexes at historic peaks, it may seem counterintuitive to add investor protection to the Biden administration’s list of priorities as it plans an economic recovery strategy from the COVID-19 recession.
But as with virtually all areas of our economy, the pandemic has laid bare inequities in our financial markets and provided cover for continued — and sorely misguided — deregulation that will hamstring our economic recovery and continue to put capital markets at risk.
While those wealthy enough to let their stocks ride largely profited during the pandemic, many others were forced to raid their retirement savings to replace lost income. With pre-pandemic 401(k) balances already severely underfunded and barely half of U.S. households invested in the stock market at all, many Americans will be dependent on Social Security and other government programs once their working years end.
It is thus vital to our national economic interests that we ensure that our markets are safe, fair, welcoming and easier to understand for the many people who can benefit from long-term capital growth. That is why President Joe Biden must prioritize rewriting the harmful legacy the Trump administration’s SEC has had on ordinary Americans.
Instead of strengthening protections for Main Street investors, however, the U.S. Securities and Exchange Commission under Chairman Jay Clayton pursued policies that exempted numerous offering types and individuals from regulatory oversight and broke wide open risky and opaque private markets to retail customers. In 2018, the SEC estimated that approximately $2.9 trillion was raised through exempt offerings, surpassing the capital raised in the public markets.
Further, consumers, particularly the elderly and other retail investors who can ill afford to lose their retirement savings, were steered by the Clayton SEC’s policies toward opaque, complex and risky investment products by financial professionals whose duty to their customers remains unclear or confusing.
Meanwhile, investors who are cheated are often unable to seek justice in the courts, instead increasingly forced into lopsided arbitration proceedings where they have little chance at success.
Fortunately, the Biden administration can do much to put things back on track, including, but not limited to, creating rules that define accredited investors; overhauling or giving real teeth to Regulation Best Interest; and re-empowering investors. Biden’s pick for SEC chair, former Obama administration Commodity Futures Trading Commission Chairman Gary Gensler, portends a welcomed and renewed focus on investor protection.
In 2020, the SEC expanded its definition of “accredited investors” — people presumably wealthy and savvy enough to invest in unregistered securities traded in often risky, opaque private markets — to include investment professionals and other people with purported financial sophistication, regardless of their assets.
Compounding its mistake, in its revision the commission failed to update minimum wealth and income requirements, which have not changed in nearly 40 years. When these minimums were put in place in 1982, 1.6% of U.S. households earned or had enough or had enough to qualify — that number has soared to at least 13%, or 16 million households.
A new SEC should, at a minimum, update these wealth and income requirements to keep up with inflation to best protect investors.
Falling far short of aligning brokers and clients’ interests, Regulation Best Interest — which ostensibly was supposed to ensure that brokers put their clients’ interests first — instead left a confusing patchwork of loyalty standards for investment professionals, many of whom wear dual hats as both investment advisers and brokers.
Because “best interest” itself is not defined in the regulation, the new SEC should at a minimum issue regulatory guidance defining “best interest” to mean something largely akin to a fiduciary duty and use its examination and enforcement powers to ensure financial professionals put investors’ interests ahead of their own.
Finally, there are several opportunities for the Biden administration and the incoming SEC to re-empower investors. Under Clayton, the SEC made a number of changes that significantly constrained investors’ ability to influence the corporations they own.
It constrained proxy information access and increased the time and monetary thresholds necessary for bylaw proposals. At the same time, it did nothing to either require mandatory and uniform environmental, social and governance disclosures or constrain the corporate royalty often self-bestowed on company founders which allows them to control the companies they started even after they are long gone.
Investors can be re-empowered through the means of shareholder proposals and voting, which have played a major role in bringing about valuable changes in corporate governance practices, corporate reporting, and on environmental and social matters. Numerous studies have also demonstrated that shareholder proposals often generate positive long-term returns for companies and serve to protect both the markets and corporations from unnecessary risk.
The new SEC needs to ensure that investors can get needed information in a timely fashion so they can continue to make their voices heard.
While many additional steps will and should be taken by the incoming SEC chair, the primary focus of the new SEC chair should be to rededicate the agency to prioritizing investor protection so that investors — both new and old — feel confident in our financial markets. The steps outlined in this article are, first, big steps in the right direction.
Laura H. Posner is a partner at Cohen Milstein Sellers & Toll PLLC and a member of the firm’s Securities Litigation & Investor Protection and Ethics & Fiduciary Counseling practice groups. She previously served as chief of the New Jersey Bureau of Securities.
The U.S. Supreme Court has agreed to address the circumstances under which defendants in a securities class action can rebut the “fraud on the market” presumption of class-wide reliance necessary for plaintiffs to form a certified class. On December 11, 2020, the Supreme Court granted defendants’ petition to consider whether the Second U.S. Circuit Court of Appeals erred when it certified a plaintiff class in Goldman Sachs Group, Inc., et al., Petitioners v. Arkansas Teacher Retirement System, et al. A decision in the case, the first shareholder class action before the Supreme Court since the appointment of Associate Justice Amy Coney Barrett, could offer insight into how far the current court is willing to deviate from longstanding precedent in this area.
The case itself stems from allegations Goldman Sachs misled investors when marketing a subprime mortgage product in 2007 just as the U.S. housing market was starting to collapse. The investment bank created a collateralized debt obligation (CDO) known as ABACUS 2007- AC1 at the request of hedge fund manager John Paulson so he could bet against the risky underlying subprime mortgages it held. Goldman received $15 million in fees and Paulson pocketed $1 billion by shorting the CDO.
In 2010, Goldman agreed to pay $550 million to settle Securities and Exchange Commission charges for failing to disclose Paulson’s involvement in selecting the CDO’s underlying securities. Goldman Sachs stock fell on news of the enforcement action, the largest-ever SEC penalty against a Wall Street firm. Goldman Sachs shareholders sued the company and three former executives, claiming their false and misleading statements kept its stock price artificially high until the SEC announced its complaint.
In 2012, the district court judge denied defendants’ motion to dismiss and the case proceeded to the class certification stage. Since then, the Second Circuit weighed in twice, the second time in April 2020 when it upheld certification of the plaintiff class, ruling that defendants had failed to rebut the presumption of classwide reliance first established in the Supreme Court’s 1988 Basic Inc. v. Levinson decision. Basic held that “in an open and developed securities market,” a company’s stock price is determined by all material information available to the public. Therefore, under Basic, investors need not show that they individually relied on defendants’ misrepresentations to pursue a claim under Rule 10b-5 of the Securities Exchange Act of 1934. Their reliance is “presumed.”
Basic, however, also held that defendants could rebut this “fraud on the market” presumption by, among other things, showing that the misstatements had no impact on the company’s stock price, a right that was clarified by the Supreme Court in a 2014 decision, Halliburton v. Erica P. John Fund, Inc., known as Halliburton II.
In Goldman, the Second Circuit refused to let defendants rebut the presumption of class-wide reliance by arguing that the bank’s statements about identifying conflicts of interest and acting in clients’ best interests were so “generic” and “aspirational” that they had no impact on the stock price. Accepting that argument, the Second Circuit said in a split decision, would allow defendants to “smuggle materiality” into the class-certification stage. Arguments over materiality— whether a reasonable shareholder would consider the information important to investment decisions—are “merits” issues reserved for trial, which follows class certification.
In its petition, Goldman Sachs asked the Supreme Court to decide whether “a defendant in a securities class action may rebut the presumption of classwide reliance … by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality.” It also sought to clarify whether a defendant rebutting the Basic presumption must persuade a court or simply present evidence on the issue of price impact.
Calling Goldman “the most important securities case to come before the [Supreme] Court” since Halliburton II, the petitioners argued that, left undisturbed, the Second Circuit’s decision would have “devastating practical consequences for public companies” by making it impossible to rebut the Basic presumption. In opposing the petition, lawyers for Arkansas Teacher Retirement System called such “breathless” claims exaggerated, mentioned the lack of a conflict between appeals courts in different circuits, and said neither question posed by the petitioners “presents an issue of recurring importance.” Observers have also pointed out that issues like materiality and price impact, explicitly or not, are usually factors in whether judges grant defendants’ motion to dismiss—something that occurs prior to both the class certification and merits stages.
In its forays into securities class actions in the three decades since Basic, the Supreme Court has nipped and tucked at the rights and obligations of both plaintiffs and defendants without excising shareholders’ fundamental ability to sue as a class under the Exchange Act. Indeed, judicial restraint and respect for prior decisions has been a hallmark of the court led by Chief Justice John Roberts. The addition of Justice Barrett has expanded the court’s conservative majority but is unlikely to cause wholesale overnight abandonment of precedent in this case. It seems far more likely that a pro-petitioner ruling would force plaintiffs to address the issue of price impact earlier in the case than eliminate securities class actions altogether
Pension plans, like the rest of the country, were no doubt happy to wave goodbye to 2020 in the rearview mirror. To say that it was a challenging year would be an understatement. And yet pension trustees and administrators stepped up to fulfill their retirement systems’ mission to deliver pension checks to more than 10 million retirees—including teachers, fire fighters, police officers, other public servants and their beneficiaries—who depend on the timely receipt of their benefit payments. They transitioned their teams to work remotely while processing payments and managing billions of dollars of pension fund assets in a time of tremendous turmoil in the markets. And now they’re ready to welcome 2021!
While we’re hopeful that the rollout of the vaccine will eventually ease the impacts of the COVID 19 crisis on operational and other related issues, here are some issues that the prudent fiduciary may want to watch for in the new year.
- Ethics: We saw an example of the very real impact of the application of state ethics laws in August of last year when issues stemming from the filing of state financial disclosure forms resulted in the departure of a chief investment officer at one of the country’s largest pension plans. Fast forward to January of this year, when a state treasurer and two other trustees filed a complaint with their state ethics commission alleging that the system’s executive director violated ethics laws by providing misleading or false information to the board. Fiduciaries can expect that issues related to disclosure, recusal, and conflict-of-interest law to remain in the forefront.
- SPACs: Special Purchase Acquisition Companies (SPACs) may continue to be another hot topic in 2021 after a tremendous amount of activity in 2020. As of late December, there had been 243 reported SPAC initial public offerings raising total gross proceeds of over $82 billion. The surge in popularity of the use of these “blank check companies” as a way to go public came as the method’s reputation improved, with supporters citing an ability to go public faster with greater certainty regarding the company’s valuation and equity capital raised. But improved governance practices weren’t enough to stave off lawsuits regarding SPACs that started to accumulate in 2020. And in January the Council of Institutional Investors sent comments to the SEC questioning whether a proposed loosening of SPAC listing standards was consistent with the protection of investors and the public interest. Keep an eye out for more on SPACs in 2021.
- Secure Choice: “Secure Choice Pensions” refer to public-private partnerships to provide retirement security for American workers, particularly those who work for small businesses and don’t already have access to a defined benefit or defined contribution plan. In the typical scenario, as described by the National Conference on Public Employee Retirement Systems (NCPERS), a state would enact legislation to establish a Secure Choice plan in which employee participation is voluntary. Contributions would be made by employees and preferably employers as well. For participating employers, administrative and fiduciary duties would largely be removed and placed in the hands of the board of trustees. While each employee would have an individual participant account, all contributions to the plan would be pooled for investment purposes to achieve economies of scale and the ability to negotiate lower fees. To date, almost a dozen states have passed legislation to create secure choice plans and an additional two dozen have pending legislation to do so.
- ESG: Environmental, Social and Governance (ESG) issues will no doubt remain a hot topic for pension plans in 2021. As the CFA Institutes notes, ESG analysis has become an increasingly important part of the investment process and is “now entering a true mainstreaming phase” as investors incorporate ESG data to gain a fuller understanding of the entities in which they invest and the risks they face. Expect an increased focus on reporting standards and metrics in 2021.
- Regulatory Changes: A new administration in Washington will bring changes to federal agencies such as the DOL and the SEC that will affect pension plans. For example, the DOL’s guidance on ERISA rules on ESG investing, while not directly applicable to public pension plans, is influential in creating standards that are looked to even for non-ERISA plans. The SEC’s new rules on proxy voting and other issues will be closely watched for potential reversal in areas such as the rules governing proxy advisory firms, which underwent sweeping changes under Trump-appointed Chairman Jay Clayton. Also note that with control of both the House and Senate, Democrats may use the Congressional Review Act to reverse federal regulations made in the last 60 days of the administration.
- DE&I: Diversity, Equity and Inclusion, or DE&I as it is commonly called, is one aspect of the “S” in ESG investing. Look for increasing calls for corporate board diversity building on efforts by Nasdaq and others such as the U.S. Chamber of Commerce and the Real Estate Roundtable. Moreover, DE&I is also something that is increasingly being addressed by pension systems in their own internal policies and procedures. Several major pension funds stepped up their DE&I efforts in 2020 and more will likely do so in 2021.
Finally, here’s a jaw-dropping fiduciary story to carry you into the new year. We know that pension plans are long-term (or indeed perpetual) investors, but this really brings it home: in 2020, the last Civil War pensioner died. The 90-year-old woman had cognitive impairments, qualifying her for a lifetime pension as an adult child of a veteran. Her father, who served as a private in the Confederate Army before defecting to the Union, was on his second marriage when she was born just weeks before his 84th birthday.