By David Maser
In March of 2020 the COVID-19 coronavirus was declared a pandemic, and two COVID-related securities class action lawsuits were quickly filed. The filing of these cases led to a heated debate of whether plaintiffs’ attorneys would leverage the effects of the pandemic to file an increased amount of securities class actions.
A year ago, in April 2020, Kent Schmidt, a California attorney who specializes in defending businesses in litigation, said a “tsunami” of class-action lawsuits in three areas—consumer, employment, and shareholder cases—was already sweeping ashore. “These early filings can be indicative of the liabilities that companies should take into consideration and inform their practices now to avoid getting hit with one of these costly lawsuits,” he told Newsweek. “I think we’re going to see these cases play out for years.”
Mr. Schmidt’s view was not unique. Many in the defense bar quickly assumed that there would be an increase in the filing of securities fraud class actions, along with insurance, consumer, and other types of cases.
Perhaps not surprisingly, most lawyers who represent plaintiffs in shareholder lawsuits had a different opinion of whether the pandemic would lead to a wave of frivolous securities filings. “Trying to take advantage of a worldwide tragic epidemic disaster? I just hope those suits aren’t brought,” Steven J. Toll, Cohen Milstein’s Managing Partner and the Co-Chair of its Securities Litigation & Investor Protection practice, said to Reuters in March 2020.
To this point, the plaintiffs’ bar appears to have done a better job of forecasting—at least with respect to shareholder lawsuits. As of March 2021, a total of 28 coronavirus outbreak-related securities class action lawsuits have been filed. While 28 securities lawsuits over 12 months is not a small number, it hardly constitutes a flood of litigation, given the 300 to 400 securities class action filed each year.
Cohen Milstein Partner Laura Posner was recently quoted by Law360 as saying that the huge numbers of COVID-19 filings predicted by the defense bar had “largely not come to fruition.” In fact, Ms. Posner told Law360, she expected to soon see a return to normal filing levels of lawsuits, even against the pharmaceutical industry, “given where the country is in drug development relating to COVID-19.”
“There may be a few more cases involving allegations that a company’s projections or revenue and income representations were false and misleading, but assuming that the economy picks up as expected and we begin to return to a more ‘normal’ lifestyle, I think those cases will grow even less common as well,” she said.
Mr. Toll said the “tsunami” never came to pass in part because the unpredictable nature of the pandemic made it hard for plaintiffs to meet the heightened pleading standards required for securities fraud lawsuits to succeed.
“It would have been extremely difficult to show a direct link of any subsequent stock price decline to an earlier fraudulent statement about the pandemic—in other words, to connect the dots to satisfy the element of loss causation,” he told the Shareholder Advocate.
“When the pandemic hit and started to change the nature of how society functioned, it really wasn’t known what the impact would be,” Mr. Toll said. “Thus, it would be very hard to allege a company had the requisite intent under the securities laws to commit fraud—that it was intentionally or recklessly misleading the investing public about the impact of the pandemic on its future earnings or profitability.”
Finally, Mr. Toll said, U.S. stock markets’ broad and sharp decline in early 2020 followed by an equally broad upswing helped keep the number of shareholder lawsuits in check. “When most or all stocks in a particular segment decline, it makes it almost impossible to claim an alleged fraud caused this loss when similar stocks all declined in the same manner,” he said. When stocks across the board rise, he added, it erases any shareholder losses.
Meanwhile, it is also true that litigation in general increased during the pandemic. Law360 reports that restaurants, bars and businesses filed more than 6,900 lawsuits related to the pandemic in 2020 with nearly 1,400 filed over insurance coverage alone and are making their way both state and federal courts. For the most part, these lawsuits reflect the enormous economic and physical damages wrought by the COVID-19 pandemic on individuals and businesses across the country, who have turned to the courts for help when other remedies fail them.
By now even casual followers of financial news have heard of Special Purpose Acquisition Companies, or SPACs, blank-check companies that purportedly provide a smoother path for privately held companies to go public with less exposure to liability.
Initial public offerings of SPACs have exploded over the last several years, driven by market volatility, low interest rates, their own growing popularity, and the lucrative profits they can make for sponsors. But while the SPAC frenzy continues unabated, increased scrutiny from regulators may mean its days are numbered.
SPACs are shell companies that go public, usually priced at $10 a share, with the sole purpose of combining with an as-yet-undetermined private operating company within 18-24 months. Sometimes their barebones prospectuses specify a targeted industry or business, but that’s not required. If a deal materializes for the SPAC by the deadline, it merges with the private company to create a new publicly traded corporation in a business combination known as “de-SPACing.”
A total of 248 SPACs went public last year, accounting for 55% of U.S. IPOs and raising $83.34 billion—more capital than all previous SPACs combined, according to SPAC Analytics. And this year it took only three months to eclipse last year’s astounding total; as of this writing, 303 SPACs have raised nearly $98 billion this year, making up eight of ten U.S. IPOs and a staggering 70% of their proceeds.
SPACs have a mixed track record for investors. Those who buy in the original IPO get their money back with interest if there’s no merger or if they don’t approve of the acquisition. Still, they may end up receiving shares worth less than what they paid for their warrants. As for those who buy shares of the de-SPACed company on the secondary market, several studies show performance of de-SPACed companies lagged that of corporations that go through traditional IPOs.
In addition, some lawyers who advise on offerings say that SPACs actually may be a more expensive way to go public than traditional IPOs at the end of the day. Bloomberg columnist Matt Levine estimated they typically gobble up 25% of the money raised, “three or four times as much as you’d pay in an IPO, albeit better disguised.”
In contrast, SPACs all but guarantee big profits for sponsors—if they meet the de-SPAC deadline. In exchange for their expertise and a nominal investment, sponsors receive warrants worth 20% of the merged company, an outsized payoff that could tempt them to overpay for a target company, bring it public before it is ready, or ignore red flags.
Lured by the potential rewards, every financier, dealmaker, and industry expert seem to have sponsored a SPAC in the last couple of years. Lately they have been joined by celebrities like Fox Business commentator Larry Kudlow, former House Speaker Paul Ryan, musician Jay-Z, baseball great Alex Rodriguez, and basketball’s Shaquille O’Neal, whose venture was quickly dubbed the “Shaq SPAC.”
The misaligned incentives, celebrity sponsorship, and sheer number of SPACs have drawn the attention of the Securities and Exchange Commission, which is considering tighter regulations and increased disclosures regarding these blank-check IPOs.
On April 12, 2021, the SEC issued new guidance on the convertible warrants SPACs issue to their early investors, saying that some should be classified as liabilities for accounting purposes instead of equity instruments, as they currently are. The statement is the strongest in a series of what observers see as warnings to both SPAC issuers and target companies and may force some companies to restate their financial results, if the accounting change is deemed material.
The new guidance came just four days after John Coates, acting director of the SEC’s Division of Corporate Finance, issued a public statement saying the “unprecedented surge” in the popularity of SPACs was prompting “unprecedented scrutiny” and that it “may be time to revisit” the regulations governing them.
Mr. Coates cited a litany of troubling “concerns,” including “risks from fees, conflicts, and sponsor compensation, from celebrity sponsorship and the potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs, each of which is designed to hunt for a private target to take public.”
In particular, the statement took issue with claims that SPACs provide “less securities law liability exposure for targets and the public company itself” than traditional IPOs. Mr. Coates questioned the idea, for example, that business projections contained in disclosures filed with de-SPAC transactions are shielded from liability under the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995.
Material misstatements made in the registration statements that must be filed with the SEC as part of the de-SPAC are subject to Section 11 of the Securities Act, he said; material misstatements in connection with proxy statements trigger liability under Section 14(a) of the Exchange Act. Both sections offer plaintiffs an easier path to establish liability than Section 10(b) of the Exchange Act.
“Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst,” Mr. Coates said. “Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.”
The public statement came two weeks after a March 25 Reuters report that the Commission had begun an inquiry into SPACs, sending letters to Wall Street banks “seeking information on how underwriters are managing the risks involved.” Though the letters asked for the information to be provided voluntarily, Reuters reported, they were sent by the SEC’s Enforcement Division.
Mr. Coates was the second SEC official to issue a public statement on SPACs. On March 31, Acting Chief Accountant Paul Munter encouraged private companies to “consider the risks, complexities, and challenges related to SPAC mergers, including careful consideration of whether the target company has a clear, comprehensive plan to be prepared to be a public company.”
Mr. Munter’s statement flagged five areas of concern for target companies: the demands of going public on an accelerated timeline; their ability to comply with increased and heightened financial reporting requirements; the importance of maintaining internal control over financial reporting; the need for corporate board oversight, especially by the audit committee; and the shift to financial statements audited in accordance Public Company Accounting Oversight Board standards.
As SPACs have proliferated, so inevitably have shareholder lawsuits involving their offspring. Since 2019, 22 blank-check companies have been subject to securities class actions, according to the Stanford Law School Securities Class Action Clearinghouse.
These lawsuits, typically brought on behalf of investors who own shares in the merged company, asserting claims under the Exchange Act, focused on false statements after the merger, and the Securities Act, relating to the Registration Statement filed at the time of the merger. Few, if any, securities lawsuits are filed in connection with the original IPO, given the vague nature of most SPACs’ initial registration statements and investors’ ability to cash out.
A SPAC-related lawsuit filed April 2 against electric vehicle company Canoo, Inc. offers a cautionary tale of what can happen when a privately held company is not prepared to go public.
Canoo was formed in December 2020 through the merger of Hennessy Capital Acquisition Corp. and Canoo Holdings Ltd., a transaction that raised $600 in cash and valued the company at $2.5 billion. Electric vehicle and battery companies have been popular targets for blank-check companies over the last year, with at least 22 announcing deals to go public via SPACs, The Wall Street Journal reported. They have also drawn a number of securities lawsuits, whether or not they were formed via SPACs.
The August 18, 2020 news release announcing the planned merger said Canoo would rely on a “unique business model” based on three revenue streams: providing engineering services under contract to other vehicle makers; offering vehicles to consumers via a subscription service; and selling “last-mile” delivery vehicles to businesses.
The news release and accompanying presentation, which was filed with the SEC, said the consumer subscription service would be especially important, since it would be “more profitable and resilient” than selling new vehicles. In later public statements, the Canoo team continued to stress the three revenue streams. The company also touted a February 2020 agreement to provide contract engineering services to Hyundai Motor Group as an example of its experience and potential in that area.
But in its first post-merger earnings call on March 29, 2021, Canoo abruptly changed course, announcing the departure of its CFO, saying it would “deemphasize” the contract engineering services, and casting doubt on the future of the subscription service.
Adding to the confusion, the merged company’s CEO, who had co-founded and run Canoo as a privately held company, did not appear on the conference call, which was run by Executive Chairman Anthony Aquila, who had joined the company two months before the merger. As one analyst said, these were “significant surprises.” Soon after the call, The Verge reported the deal with Hyundai “appeared to be dead.”
Asked to explain the shift, Aquila pointed to the inexperience of the prior leadership team, which had been “a little more aggressive” and “presumptuous” than advisable in its public statements about business prospects and didn’t meet “our standard of representation to the public markets.”
“This comes back to having an experienced public company team,” Aquila said, referring to statements about potential engineering contracts with other manufacturers. “You’ve got to be careful of the statements you make.”
Well, yes. Canoo’s stock price fell 21% the next day.
With more than 400 SPACs on deadline to find targets, the pressure is only increasing on private companies to join the blank-check party—ready or not. Tighter regulations that gently let the air out of the SPAC bubble offer the best hope for a soft landing.
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.
Please contact us at bmaguire@cohenmilstein.com if you’d like to be added to our Complex Tort email list.
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.