Friday, January 29, 2010


The U.S. Supreme Court is slated to decide this year whether 18 U.S.C.A. § 1346, the honest-services fraud law, is being applied too broadly, rendering it unconstitutional. On December 8, 2009, the Court heard arguments in the cases of former Alaska state legislature, Bruce Weyhrauch, and former Hollinger International CEO, Conrad Black. On March 1, 2010, the Court will hear arguments on former Enron CEO, Jeff Skilling. Decisions on these cases, where each defendant was charged with honest-services fraud, are expected this summer.

The use of honest-services fraud can be traced back to 1949. However, it was not until the 1970s that this legal theory became an outright success. Essentially, this concept extends the traditional theory of fraud beyond the classic Madoff-type cases to cases where deceit was used to deprive the public of honest services. Under this theory, deprivation of honest services is considered to be a theft of intangible rights that falls under the “scheme to defraud” prong of the federal mail and wire fraud laws.

The honest-services fraud theory became extraordinarily useful for federal prosecutors put in the position of prosecuting corrupt state officials because often, federal bribery laws did not apply or it was challenging to prove bribery beyond a reasonable doubt. Honest-services fraud, on the other hand, could be proven more easily because secret payments to a state official cheated the public of the official’s honest services, which is sufficient to prove honest-services fraud. The use of honest-services fraud became so popular in the mid-1980s that the Chief of the business crimes unit at the U.S. Attorney’s office, now U.S. District Judge, Jed Rakoff, wrote that the theory was “our Colt .45, our Louisville Slugger.”

Part of the success of honest-services fraud is due to the fact that it proves most useful in cases where criminality is most unclear. Primarily, honest-services fraud is most suitable in self-dealing cases, wherein a corporate officer directs corporate business to a company in which the officer has an undisclosed private interest, or where an official leans on regulators for the same type of favorable private result. Most recently, it has been used in the high-profile cases of former Illinois Governor, Rod Blagojevich; former U.S. congressman of Louisiana, William Jefferson; and lobbyist Jack Abramoff.

This year will not be the first grapple the Supreme Court has faced with honest-services fraud. In 1987, the Court heard McNally v. U.S. Despite every appellate court endorsing the concept of honest-services fraud, the Supreme Court, by a 7-2 vote, rejected the concept, stating: “we read § 1341 [the mail and wire fraud statute] as limited in scope to the protection of property rights.” The Court was primarily concerned with the vagueness, federalism, and separation-of-powers issues inherent in the unstructured principle. In response, in October 1988, Congress passed the law now at issue (§ 1346), but resolved none of the Court’s constitutional concerns.

Once the law was passed, appellate courts resurrected their pre-McNally precedents and continued to determine limitations on an ad hoc basis. Some federal courts require a defendant to have “contemplated economic harm” to victims; others require that the defendant have violated a state law; and yet there are some federal courts that don’t require state violations. But there must always be some set of factors present. This non-uniform application of § 1346 is precisely what the Supreme Court has set out to analyze and review.

Critics of § 1346 are on both ends of the spectrum, objecting to its constitutionality because of violations of due process or federalism. The due process argument is based on the statute not providing fair notice to businessmen and state officials about what is and is not a crime before inadvertently committing one. Meanwhile, the federalism argument relies on the issue that the Constitution does not give the federal government direct power to punish fraud, and the honest-services fraud beefs-up the federal mail fraud law to such an extent that it violates the language of the Constitution and directly infringes on states’ rights to regulate fraud.

Preliminary discussions in the Supreme Court have not yielded a definitive consensus either way. However, no matter which way the Court rules, the significance of this decision cannot be understated, especially for counsel in the pending cases of Weyhrauch, Black, and Skilling.

Thursday, January 28, 2010


Americans are increasingly using social media websites such as blogs, Linkedin, Facebook, and Twitter. As a result, FINRA has published guidance to member firms seeking to know how the FINRA rules governing communications with the public apply to these social media sites. Back in September 2009, FINRA organized a Social Networking Task Force composed of FINRA staff and industry representatives to discuss how firms and their registered representatives could use social media sites for legitimate business purposes in a manner that ensures investor protection. Regulatory Notice 10-06 was issued as a product of the input from this Task Force in order to guide firms on applying the communications rules to social media sites.

FINRA's stated goal in issuing the Notice is to ensure that investors are protected from false or misleading claims and representations. This way, firms are able to effective and appropriately supervise their associated persons' participation in these sites, while at the same time allowing firms to take advantage of new technology. The Notice does not address the use of social media by individuals solely for personal reasons.

Some of the issues addressed in the Notice are discussed below.

Suitability Responsibilities: If a firm or its personnel recommends a security through a social media site, the broker-dealer must determine that the recommendation is suitable for every investor to whom it is made through that social media site. Whether a particular communication constitutes a "recommendation" for purposes of Rule 2310 will depend on the facts and circumstances of the communication. Moreover, these communications must often include additional disclosure in order to provide the customer with a sound basis for evaluating the facts with respect to the product.

Blogs: Rule 2210 defines "public appearance" to include unscripted participation in an interactive electronic forum such as a chat room or online seminar, and does not require firms to have a registered principal approve in advance the extemporaneous remarks of personnel who participate in public appearances. If a blog is used to engage in real-time interactive communications, FINRA would consider the blog to be an interactive electronic forum that does not require prior principal approval. FINRA considers static postings on blogs to constitute "advertisements" under Rule 2210 such that if a firm or its registered representative sponsors such a blog, it must obtain prior approval of any such posting.

Social Networking Sites: Websites such as Facebook, Twitter, and Linkedin contain both static and interactive content. Static content, such as profile or wall information, must be approved by a registered principal of the firm prior to its posting. The portion of a social networking site that provides for interactive communications constitutes an interactive electronic forum, and firms are not required to have a registered principal approve these communications prior to use.

FINRA noted that every firm should consider the guidance provided by the Notice in the context of its own business and its compliance and supervisory programs. A complete copy of Notice 10-06 can be found here.

Friday, January 22, 2010


Recently, the Federal Trade Commission for the first time in nearly thirty years issued updated guidelines governing the use of testimonials and endorsements in advertisements. The FTC’s new Guideline “incorporates several changes to the FTC’s Guides Concerning the Use of Endorsements and Testimonials in Advertising, which address endorsements by consumers, experts, organizations, and celebrities, as well as the disclosure of important connections between advertisers and endorsers.” See, FTC Press Release, October 5, 2009. These Guidelines, last updated in 1980, now include specific guidance on posting by bloggers and other online social networking platforms.

Gone from these new Guidelines is the “safe harbor” provision of a “results not typical” disclaimer or “disclaimers of typicality” in advertisements. Now, advertisers in claims of typicality must be more explicit and make clear what results would generally be expected.

For the first time, the Guidelines recognize the new world of online media and its new ways of reaching people through advertising. The Guidelines add new examples of their application to advertisers and endorsers in blogs. “Bloggers who make an endorsement must disclose the material connections they share with the seller of the product or service. Likewise, if a company refers in an advertisement to findings of a research organization that conducted research sponsored by the company the advertisement must disclose the connection between the advertiser and the research organization.” FTC Press Release, October 10, 2009.

There is no exception to these Guidelines for professional services. So, if your firm takes advantage of online blogs or network resources to advertise, you should consider reviewing your policies on advertising and social media networking in light of these new FTC Guidelines.

Friday, January 15, 2010


On January 14, 2010, the U.S. Department of Labor (“DOL”) adopted a final regulation to clarify the safe harbor period during which amounts that an employer has received from employees or withheld from wages for contribution to certain employee benefit plans will not constitute ``plan assets'' for purposes of Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”). The new regulation aims to resolve an ongoing uncertainty by sponsors and fiduciaries of small welfare and pension plans as to when participant contributions will be treated as contributed in a timely manner to such plans.

As set forth in the new final regulation, the DOL, in 1996, published amendments to 53 FR 17628, which modified the outside limit beyond which participant contributions to an employee pension plan become plan assets. Since that time, the outer limit for participant contributions to a pension plan has been the 15th business day of the month following the month in which participant contributions are received by the employer (in the case of amounts that a participant or beneficiary pays to an employer), or the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash (in the case of amounts withheld by an employer from a participant’s wages). In addition, the general rule has been that amounts paid to or withheld by an employer become plan assets on the earliest date on which they can reasonably be segregated from the employer’s general assets.

The 1996 amendments created uncertainty among employers and plan advisers as to exactly when they must forward participant contributions to the plan in order to avoid the requirements associated with holding plan assets. Accordingly, on February 29, 2008, the DOL proposed a safe harbor with the goal of providing more clarity over the foregoing participant contributions concerns. The DOL ultimately received 28 comments to its proposal, which can be found here.

In response to the public comments, the DOL issued its recent final regulation, which is nearly identical to the 2008 proposal. The final safe harbor rule, and specifically Section 2510.3-102(a)(2), provides that participant contributions to an employee benefit plan with fewer than 100 participants at the beginning of the plan year will be treated as having been made to the plan in accordance with the general rule (the earliest date on which such contributions can reasonably be segregated from the employer's general assets) when contributions are deposited with the plan no later than the 7th business day following the day on which such amount is received by the employer (in the case of amounts that a participant or beneficiary pays to an employer) or the 7th business day following the day on which such amount would otherwise have been payable to the participant in cash (in the case of amounts withheld by an employer from a participant's wages).

Click here for a complete copy of the DOL’s final safe harbor rule.

Thursday, January 14, 2010


On January 13, 2010, the SEC announced initiatives it is putting in place to encourage individuals and companies to assist in the agency's investigations and enforcement actions. The developments announced are the latest in the most significant reorganization of the Enforcement Division in more than 30 years.

The SEC approved the following measures:

First, the Division of Enforcement will have tools to encourage individuals and companies to report violations. These tools include:

  • Cooperation Agreements — the Enforcement Division will agree to recommend to the Commission that a cooperator receive credit for cooperating in investigations or related enforcement actions if the cooperator provides substantial assistance such as full and truthful information and testimony.

  • Deferred Prosecution Agreements — the Commission will agree to forego an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and to comply with express prohibitions and undertakings during a period of deferred prosecution.

  • Non-prosecution Agreements — only in limited circumstances the Commission will agree not to pursue an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and comply with express undertakings.

Second, witness immunity requests to the Justice Department have been made more efficient for witnesses who have the capacity to assist in its investigations and related enforcement actions.

Third, the Commission has formalized the way in which it will evaluate whether, how much, and in what manner to credit cooperation by individuals to ensure that potential cooperation arrangements maximize the Commission's law enforcement interests.

This announcement, along with the information the SEC will make available regarding these topics in the coming months, is intended to provide guidance and encouragement to those third parties who have knowledge which will lead to and assist with actions taken by the Enforcement Division. A copy of the SEC's press release disclosing this information can be found here.