Publication

Gordon Rees Scully Mansukhani's Business Transactions Group Newsletter provides important information about some of the latest legal developments in the business world.

1. Fifth Circuit Vacates DOL Fiduciary Rule
2. SEC Proposes New Fiduciary Interpretations, Rules and Forms for BDs and Advisors
3. VC Fund & Private Fund Adviser Registration Exemptions Now Exclude Small Business Investment Company Assets
4. Can Regulation Be Good for the Client?
5. FinCEN Issues Updated Guidance
6. Successes
7. About Gordon & Rees's Business Transactions Practice; Highlighted this Issue - International Group

On March 15, 2018, in a 2-1 vote, the US Court of Appeals for the Fifth Circuit struck down the US Department of Labor’s (DOL) fiduciary rule. See Chamber of Commerce of the USA, et al. v. US Dep’t of Labor, et al., No. 17-10238, slip op. 46 (5th Cir. Mar. 15, 2018). The DOL rule, since its inception in 2016, has reportedly caused investment and insurance companies to exit the brokerage and retirement investor market and limited the retirement investment products sold by such companies.

The opinion found that the DOL exceeded its statutory authority -- the rule was overly broad and inconsistent with the Employee Retirement Income Security Act’s (ERISA’s) statutory text, by issuing exemptions as a means of imposing expansive duties on service providers to individual retirement accounts (IRAs) and other non-ERISA plans.

Because the Fifth Circuit vacated the fiduciary rule “in toto,” absent an appeal the entire rule package will be invalidated, including the broadened definition of fiduciary investment advice, the Best Interest Contract Exemption, the Principal Transaction Exemption, and the amendments to PTE 84-24 (for annuities) and PTE 86-128 (for affiliated brokerage transactions), among other exemptions.

Motions for rehearing had to be filed by April 30 (absent an extension), and petitions for writ of certiorari must be filed by June 13 (or 90 days after the 5th Circuit denies a petition for rehearing). On May 22, the Fifth Circuit Court of Appeals denied another effort by attorneys general from California, New York and Oregon to defend the Labor Department's fiduciary rule. Assuming there are no challenges to the decision, the court’s order to vacate the rule will likely be effective on May 7, 2018 (the order to vacate the rule is effective on the date the court issues its “mandate,” typically within seven days after the time to file a request for post-judgment relief elapses. The Fifth Circuit has not yet issued the mandate that would put its March 15 decision into effect. Accordingly, May 7 is likely the date the fiduciary rule will be vacated. Although the DOJ has until June 13 to appeal to the Supreme Court, it appears that the fiduciary rule will die in court. Further, on May 7, the DOL announced a new temporary enforcement policy in anticipation of the Fifth Circuit’s mandate to vacate the DOL’s fiduciary rule. Field Assistance Bulletin (“FAB”) 2018-02 is intended to address the “uncertainty about fiduciary obligations and the scope of exemptive relief” following the Fifth Circuit’s actions, by providing that financial institutions may continue to rely on the temporary enforcement relief policy that the DOL adopted under FAB 2017-02. As a result, the DOL will not pursue claims against fiduciaries who are working in good faith to comply with the impartial conduct standards for transactions that would have been exempted under the BIC Exemption or Principal Transactions Exemption, or treat such fiduciaries as violating the applicable prohibited transaction rules, even following the Fifth Circuit’s mandate to vacate those exemptions.

Investment advisers should consider whether they may or may not be a “fiduciary” under the old “five-part” test. When the fiduciary rule is finally and officially vacated, the prior definition that determined whether investment advice was “fiduciary” will be revived, and look at whether the advice is “individualized,” provided on a “regular basis,” pursuant to a “mutual understanding,” and was intended to serve as a “primary basis” for an investment decision.

If the rule is repealed in full, the BIC and Principal Transaction Exemptions will go away. Offerings should be reviewed to determine whether an adviser is currently relying on the BIC Exemption or Principal Transaction Exemption, whether it may be acting as a fiduciary after the repeal date, and whether reliance on a different exemption or approach may be required. Also, once the decision is effective: PTE 86-128 will generally again be available for both discretionary and non-discretionary advice to IRAs, without the new requirements to provide initial, annual, and other disclosures to IRA clients PTE 84-24 will again be available to cover a broad range of annuity sales and transactions. The impartial conduct standards will be stricken from other exemptions like PTE 77-4 for affiliated mutual fund transactions.

Our readers should note that the SEC continues to review the role of fiduciaries and state regulations and proposed new restrictions and disclosure requirements, pointed out in the following section.

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On April 18, 2018, the Securities and Exchange Commission voted 4-1 to propose new standards of conduct for broker-dealers to act in the best interest of the retail customer at the time a recommendation is made (“Regulation Best Interest;” Exchange Act Release 34-83062).

The SEC also proposed an interpretation on investment advisers’ standards of conduct and enhanced rules under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 (Release IA-4889) to require registered investment advisers and broker-dealers to deliver to retail investors a “relationship summary” that provides information about the relationships and services the firm offers, the standard of conduct and the fees and costs associated with those services, specified conflicts of interest, and whether the firm and its financial professionals currently have reportable legal or disciplinary events. Firms must create brochures to clarify their fees and legal duties. The proposed interpretation does not seek a uniform standard of conduct for broker-dealers and investment advisers. Recognizing that the proposed Regulation Best Interest has similar but not the same obligations for broker-dealers, the SEC is seeking to improve investor protections through potential enhancement of the legal obligations of advisers and offers potential improvements to their fiduciary duties by considering areas where the current broker-dealer framework provides investor protections that may not be found in the investment adviser context.

A third rule proposal (Releases 34-86036 and IA-4888) would impose new rules to require both investment advisers and broker-dealers to deliver to retail investors a customer/client relationship summary (“Form CRS”) to explain the nature and scope of services, fees, material conflicts of interest, and disciplinary histories, and address confusion based on titles (i.e., restricting standalone BDs and their financial professionals from using the terms “adviser” and “advisor” as part of their names or title, which may mislead the BD’s prospective customers). Amendments to the uniform Investment Adviser Registration Form ADV were also proposed.

Comments on these proposals must be received within three months of their publication.

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Effective March 12, 2018, the rules under the Investment Advisers Act of 1940 (the “Advisers Act”) that define a venture capital fund (Rule 203(l)-1) and that implement the private fund adviser exemption (Rule 203(m)-1) exclude the counting of “small business investment company” (“SBIC”) assets.

An SBIC is (A) a small business investment company licensed under the Small Business Investment Act of 1958 (“SBIA”), (B) an entity that has received from the Small Business Administration notice to proceed to qualify for a license as a small business investment company under the SBIA, which notice or license has not been revoked, or (C) an applicant that is affiliated with one or more licensed small business investment companies described in subparagraph (A) and that has applied for another license under the SBIA, which application remains pending. See Advisers Act Section 203(b)(7). SBICs do not include “business development companies” (entities under Section 54 of the Investment Company Act of 1940).

The Fixing America’s Surface Transportation Act of 2015 (the “FAST Act”), under Title LXXIV, Sections 74001 and 74002, amended Sections 203(l) and 203(m) of the Advisers Act. 

Section 74001 amended the exemption from investment adviser registration for any adviser solely to one or more “venture capital funds” in Advisers Act Section 203(l) by deeming “small business investment companies” to be “venture capital funds” for purposes of the exemption. Section 74002 amended the exemption from investment adviser registration for any adviser solely to “private funds” with less than $150 million in assets under management in Advisers Act Section 203(m) by excluding the assets of SBICs when calculating “private fund assets” towards the registration threshold of $150 million.

Accordingly, the Securities and Exchange Commission (“SEC”) amended the definition of “assets under management” (“AUM”) in the rules that apply these exemptions to exclude the assets of SBICs.

Prior to the FAST Act, most investment advisers to SBICs primarily relied upon an exemption from registration for advisers solely to SBICs.  The FAST Act expanded the applicability to SBIC investment advisers of two additional exemptions from registration: (1) the exemption for any adviser solely to one or more “venture capital funds” in Advisers Act Section 203(l) (the “venture capital fund adviser exemption”), and (2) the exemption for any adviser solely to “private funds” with less than $150 million in AUM in Advisers Act section 203(m) (the “private fund adviser exemption”). 

The amendment to Advisers Act Rule 203(l)-1 includes SBICs in the definition of venture capital funds for purposes of the registration exemption.  Rule 203(m)-1 was also amended to make it consistent with Advisers Act Section 203(m)(3) by excluding an adviser’s regulatory AUM attributable to SBICs from the definition of AUM under the private fund adviser exemption, so private fund advisers will now exclude the assets of their SBICs for purposes of calculating private fund assets towards the $150 million registration threshold.

Note that an adviser to SBICs who relies on the venture capital or private fund adviser exemption will still be required to submit reports to the SEC as an “exempt reporting adviser” and include the SBICs that it advises on its Form ADV report.

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As a lawyer, I am often engaged to spend a lot of time figuring out how to get around regulations and regulatory compliance: keeping my clients from having to ‘register’ or certify for something.

It is well understood that the current business and political climate is “anti-regulation,” driven largely by the position that heavy regulation creates a drag on economic growth and employment. Sometimes, however, it’s important to bear in mind that being registered or regulated can actually work to a client’s advantage. Two examples come to mind. The first is in the work that I often do for investment funds. After they are established and start to grow in terms of money under management and number of investors, funds and their asset managers often reach criteria that require them to register, respectively, as investment companies or investment advisers. These lines, arbitrarily imposed by legislatures and bureaucrats, often create fear and panic in the minds of entrepreneurs, who are certain that they will never have enough experience, background, money or margin with which to fully and accurately comply.

In my practice, I have frequently seen that prospective investors ask, early in their diligence process, whether the prospective fund was registered as an Investment Company or whether the Manager was licensed as an Investment Adviser. The number of prospective investors that do so is more common than one would generally expect. I also noticed that, frequently, investors were visibly comforted when the Manager said “yes, we are registered [in this state or federally] as an investment adviser”, or that “the Fund is registered as an IC” or “we looked at this closely and the fund is exempt under a particular exemption from the ICA.”

The conclusion is that investors generally like to know that SOMEBODY is overseeing what the fund and its adviser are doing, and that if they are registered, they meet the recordkeeping and other requirements and qualifications for registration.

A second example of the benefits of regulation for businesses is with products related to the military or DOD (Department of Defense) and Congressional Appropriations. Oftentimes, the Pentagon will REQUIRE certain products to meet the International Trafficking in Arms Regulations (ITARs) and be on the “Munitions List.”  For example, imagine a sophisticated Drone system that spies on Russia looking for abandoned munitions dumps and missile silos for spent rods, uranium, plutonium and warheads.  And imagine a drone goes down (and they do, and WHEN they do, we almost NEVER report it because NOBODY dies), near a silo.  And then imagine that we have sophisticated, proprietary, and EXCLUSIVE technology on that drone. The Pentagon will REQUIRE that the drone have self-erasing equipment and self-destruction equipment so that our secrets remain ours.  And that means that the Pentagon will ride herd on the design, development, manufacture, testing and placement of the product and require it to comply with the ITARs

What this means for clients then, is that they may WANT/NEED to have a product (or a version thereof) on the ML and may WANT/NEED to be subject to the ITARs in order to be able to compete in a Pentagon RFP.

As a result, instead of reacting as though regulations and certifications are ALWAYS a negative, the first couple of questions that I try to ask with respect to regulations and compliance are: “why would we fear regulations and/or why would we want to comply with regulations?’; and “what true disadvantages do the regulations create?”, or put another way “what do we really lose by taking the time and spending the money to get registered/regulated?”, and “how can we benefit from being regulated?”  Approaching the question of regulation and compliance in this way can create new and expanded opportunities for clients and can also expand our expertise and relationships with clients.

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On April 3, 2018 the Financial Crimes Enforcement Network (FinCEN) issued updated “Frequently Asked Questions” to assist covered financial institutions to understand the scope of the Customer Due Diligence Requirements for Financial Institutions (“CDD Rule” or “Rule”).  The new CDD Rule became applicable to new accounts beginning on May 11, 2018. See FIN-2018-G001 at https://www.fincen.gov/sites/default/files/2018-04/FinCEN_Guidance_CDD_FAQ_FINAL_508_2.pdf.

The original guidance was published on May 11, 2016 and amended on September 29, 2017. Covered institutions should carefully review the new FAQs as there are a number of changes and clarifications. For example, the 2016 FAQs said simply that “The rule does not cover existing accounts that were opened before the [rule’s applicability date.]  The new guidance introduces the concept of a triggering event. The FAQs state that financial institutions are not required to conduct retroactive reviews to obtain beneficial ownership information from customers with accounts opened prior to May 11, 2018. The obligation to obtain or update beneficial ownership information on legal entity customers with accounts established before May 11, 2018, is triggered when a financial institution becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change of beneficial ownership. They state that “On or after May 11, 2018, when a legal entity customer initially opens a new account or an existing account is updated to incorporate beneficial ownership information for the first time in response to a triggering event, covered financial institutions must identify and verify the identity of beneficial owners.”

The updated FAQs also focus on “pooled investment vehicles.”  Question 18 indicates that while “the rule requires covered financial institutions to collect and verify the identity of beneficial owners who own 25 percent or more of the equity interests of a legal entity customer, in general, institutions are not required to look through a pooled investment vehicle to identify and verify the identity of any individuals who own 25 percent or more of its equity interests.” Because it would be “impractical for covered financial institutions to collect and verify ownership identity for this type of entity” there is no requirement that the financial institution should request the customer to look through the pooled investment vehicle to determine and report any individual’s equity interest. Notwithstanding that, institutions must collect beneficial ownership information for the pooled investment vehicle under the “control prong” (i.e., individuals with significant responsibility to control, manage, or direct the vehicle).

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Multi-office Team Closes Client’s Asset Sale
In late 2017, San Francisco Partner Mark Davis and Orange County Partner Lisa Klein, led a team of Gordon & Rees lawyers in assisting the firm's client, a leading provider of ergonomic office equipment and furnishings, with the sale of its assets to a global furniture and business products company. The combination of the two businesses was complicated by the need to determine and ensure compliance with state and federal government agency procurement and supply procedures, which included the novation of government contracts in accordance with state and federal acquisition regulations. The Gordon & Rees team included Phoenix Of Counsel Lawrence Cohen regarding certain corporate and due diligence matters, Pittsburgh Partner Gavin Eastgate, regarding Hart-Scott-Rodino issues, Phoenix Partner Kami Hoskins, regarding labor and employment issues, San Diego Partner Richard Sybert, regarding intellectual property matters and due diligence support, Orange County Senior Counsel Peter Ente, regarding tax matters, San Diego Senior Counsel Susan Meter, regarding ERISA matters; Orange County Partner Ronit Stone, regarding certain due diligence matters; and Atlanta Senior Corporate Paralegal Rebecca Barnes, on due diligence and closing matters.

Carol Schaner Wins Challenge of CA Franchise Tax Board Adjustment for Irrevocable Trust
Carol P. Schaner, Chair of Gordon & Rees’s tax practice and a Partner in our Orange County, CA office, recently obtained a complete victory in defending her client, an irrevocable trust, against a California Franchise Tax Board (FTB) audit. The trust was established upon the death of an entrepreneur who is considered to be the creator of the “warehouse store” retail model and the FTB asserted a $1 million tax adjustment. Schaner filed a protest challenging the proposed adjustments and the FTB withdrew the proposed adjustments in the entirety upon a review of the protest.

Kent Carter, Scott Theobald Advise Client on Customer’s Conversion to ESOP-Ownership
In early January 2018, Chicago Partner Kent Carter, and Phoenix Partner Scott Theobald, advised a heavy equipment finance company on the conversion of one its largest customers into an Employee Stock Ownership Plan-owned equipment dealer. The transaction was valued at nearly $20 million. The Gordon & Rees team advised the client on protecting the lender’s collateral and the priority of its security interests in the ESOP transaction.

Craig Heryford Represents Venture Capital Investor in Series B Financing
Craig Heryford, a Partner in our Pittsburgh office and National Co-Chair of the Business Transactions Section assisted our client, a national venture capital investment firm with more than $1 billion under management, in closing a Series B financing for a rapidly growing data analytics company.  The financing involved numerous investors, including Gordon & Rees’s client, the lead investor.

Multi-Office Team Closes Asset-Based Financing
In April 2018, a multi-office team of Business Transactions section lawyers, lead by Pittsburgh partner Craig Heryford and Chicago partner Jonathan Boulahanis, advised our client, a National commercial and residential building products company, in the refinancing of its asset-based line of credit.  The financing included assets in a number of states, including Pennsylvania, Ohio, Illinois, California, Texas and Florida.

Pittsburgh Team Assists Client in the Sale of Multiple Commercial Locations
A Gordon & Rees team, lead by Craig Heryford, the National Co-Chair of the Business Transactions Section and assisted by Chris Haselhoff, real estate Partner in our Pittsburgh office and Anthony Judice and Sarah Hancher of our Pittsburgh office, represented a Western Pennsylvania based client in the sale of multiple commercial restaurant and office locations having a value in excess of $6 million.

Ron Neiwirth Represented FL Land Trust in $60 Million Sale of Island and $55 Million Refinancing
Miami Partner Ron Neiwirth, represented a Florida Land Trust with respect to business, trust and fiduciary issues involved in the renegotiation and closing of a $60 million sale of an island in Florida to a developer, partly owned by the land trustee. The developer was constructing a condominium project on the island under a preexisting development agreement, but its construction lender refused to allow its loan proceeds to pay in full for the land. Neiwirth advised the Trust, as seller, along with the developer, on a renegotiation of the deal in order to get the client a part-cash; part-second mortgage financing; with the remaining balance contributed as capital to the developer in exchange for a preferred, nonvoting membership interest with a designated priority rate of return. For tax purposes, the sale remained an installment sale, since the contractual terms of the nonvoting preferred membership mimic a promissory note. Following that sale, Neiwirth represented the Trust on fiduciary duties in connection with the developer’s $55 million refinancing of unsold units and the resulting satisfaction of the second mortgage; along with the redemption in full and cancellation of the preferred membership interest in the developer entity.

Wallace Glausi Represents “Fin-Tech” Software Firm in Marketing & Distribution Deal
Wallace Glausi, a Partner in our Portland, Oregon office, represented a financial-technology software client in a large marketing and distribution deal with a multi-billion dollar financial media company. The arrangement is expected to produce $3-5 million in annual revenue for our client. Our client’s unique product compares the distinctions between public company Exchange Act reports on Forms 10-Q and 10-K, on a quarter by quarter basis. Its software can research, analyze, and redact the periodic reports, determining the delta in value and other differences, and prepare a short summary on each SEC filing.

Craig Heryford named M&A Lawyer of the Year
Craig Heryford, a Partner in our Pittsburgh office and National Co-Chair of the Business Transactions section was named “Merger & Acquisitions Lawyer of the Year in Pennsylvania” in a peer review by Best Lawyers, as reported in the Wall Street Journal.  The designation received by Craig is given to one lawyer per year per region, as voted on by senior lawyers within the region practicing in the area of designation.

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The Business Transaction Practice Group includes lawyers with special experience working with clients abroad. We advise American and foreign businesses that have interests and operations in Latin America and the Pacific Rim in particular, as well as in Europe and the rest of the world. The services provided range from contract negotiations and project finance, to advising on free-trade agreements, customs, FCPA and international IP issues, to overseeing and managing litigation and due diligence.

Our business and tax attorneys provide legal services to a broad array of public and private business clients including Fortune 500 companies, private equity funds, and subsidiaries of foreign multinationals. Today’s global environment requires that cross-border matters be handled by experienced international lawyers in close collaboration with an established network of firms located in jurisdictions around the world. Effective tax planning and corporate structuring includes dynamic international, federal, state, and local tax planning that proactively manages income, excise and property taxation enhancing business profitability and competitive advantage. Our tax attorneys closely collaborate with other subject matter experts throughout the firm providing comprehensive legal solutions that include tax planning.

Gordon & Rees lawyers are admitted and practice law in Mexico, Canada, and Hong Kong. We have employees who are fluent in Farsi, French, German, Italian, Japanese, Portuguese, Russian and Spanish, among other languages.The language capabilities of our staff and attorneys, and their knowledge of foreign cultures, together with extensive litigation and transaction experience, deliver convenience and efficiency in international matters.

Gordon & Rees’s Business Transactions Practice Group includes more than 65 attorneys nationwide and provides full service counsel to public and privately held U.S. and foreign clients, ranging from start-up entrepreneurs to Fortune 100 corporations. Our services cover the wide range of challenges and opportunities clients encounter throughout the business life cycle, from formation to exit strategies, including mergers and acquisitions, strategic planning and advice on daily operations to protecting intellectual property, raising capital to securities law compliance, and corporate governance to international ventures and tax management.  We strive to provide exceptional client service in an efficient manner to our clients. Our goal is to provide our clients with customized care and pro-active advice on a consistent basis.

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