On July 23rd, 2019, Pastore and Dailey prevailed in a jurisdictional motion against a Texas defendant accused of participating in the theft of intellectual property, obtaining a ruling that denied the defendant’s motion to dismiss for want of jurisdiction. An evidentiary hearing has been scheduled to assess the jurisdictional claims of two other defendants connected to the alleged intellectual property theft, which involves the transfer of proprietary information between competing health food companies.
Author: Liam Mennitt
New DFS Cybersecurity Division
Perhaps as a signal of its commitment to fight cybercrime and stringently enforce its cybersecurity regulations, New York State recently established a “cybersecurity division”1 within the state’s Department of Financial Services (DFS). The creation of the division marks yet another step taken by New York State to guard against the dangers posed by cyberattacks, perhaps motivated by its status as the home of many prominent financial services firms. In addition, the presence of the division strongly suggests that the cybersecurity regulation2 issued by DFS in Spring 2017 [WB1] cannot be taken lightly by the state’s largest and most important financial services firms. Aside from the comprehensive nature of the regulation and the sizable power afforded to the new cybersecurity division, the novelty of New York’s recent innovations in cybersecurity regulation suggests their importance and staying power. In fact, as JDSupra notes, the creation of the new division more or less completed a years long process that has made “New York[…]the only state in the country that has a banking and insurance regulator exclusively designated to protect consumers and companies from the ever-increasing risk of cyber threats.”1
Some financial services firms, conscious of their vulnerability to cyberattacks, will doubtless welcome these additional steps. As a report from the Identity Theft Resource Center notes, financial services firms “are reportedly hit by security incidents a staggering 300 times more frequently than businesses in other industries.”3 Far from being mere annoyances, these cyberattacks are often extremely costly. In fact, according to a study from IBM and the Ponemon Institute, the cost to a financial services firm per record lost in a cyberattack was more than $100 greater than the cost to the average company.4 Moreover, cyberattacks can also cripple consumer confidence in financial services firms, causing them to lose business and endure even greater costs.5 In general, then, cyberattacks can damage both a financial services firm’s sensitive records and its public image, making them a grave threat to any such company’s bottom line.
It would be a mistake, however, to think about DFS regulation purely in terms of cost reduction. Regulation also entails costs – not least because compliance with the 2017 regulation can be investigated and punished by DFS’ new cybersecurity division. In fact, these new developments indicate that cybersecurity will not come cheaply, especially because the regulation imposes a bevy of new security requirements on top firms, costing them a not insignificant amount of time and money. From multi-factor authentication to training programs to the appointment of a “Chief Information Security Officer,” the now fully enforceable regulation will force financial services firms to foot the bill for a host of cybersecurity measures.6
- https://www.jdsupra.com/legalnews/new-york-creates-cybersecurity-division-20881/
- https://www.dfs.ny.gov/docs/legal/regulations/adoptions/dfsrf500txt.pdf
- https://www.idtheftcenter.org/wp-content/uploads/2019/02/ITRC_Generali_The-Impact-of-Cybersecurity-Incidents-on-Financial-Institutions-2018.pdf, pg. 3
- IBM and the Ponemon Institute, The Cost of a Data Breach (2017), summarized in https://www.idtheftcenter.org/wp-content/uploads/2019/02/ITRC_Generali_The-Impact-of-Cybersecurity-Incidents-on-Financial-Institutions-2018.pdf, pg. 6
- https://www.idtheftcenter.org/wp-content/uploads/2019/02/ITRC_Generali_The-Impact-of-Cybersecurity-Incidents-on-Financial-Institutions-2018.pdf, pg. 8
- https://www.dfs.ny.gov/docs/legal/regulations/adoptions/dfsrf500txt.pdf, pg. 5
Cryptocurrency Mining and the Danger of Halving
As cryptocurrencies continue to grow more sophisticated and widespread, the economic possibilities offered by cryptocurrency mining have drawn greater attention from prospective investors. Cryptocurrency mining, which helps to ensure that “transactions for various forms of cryptocurrency are verified and added to the blockchain digital ledger,”1 is a potentially profitable activity because a small amount of cryptocurrency is awarded to the “miner” able to verify the transaction fastest. On a large scale, cryptocurrency mining could potentially provide a solid revenue stream to a company able to overcome hurdles related to capital and operating costs. In the first place, the capital costs (in terms of computers, software, and other tools) that deter many would-be cryptocurrency miners would not constitute major impediments to any well-funded company intent on entering the field. But operating costs, rather than capital costs, constitute a larger problem for large-scale cryptocurrency mining companies. Because a certain amount of power is consumed whenever cryptocurrency is successfully mined, ensuring that the cost of electricity does not exceed the value of the cryptocurrency awarded is necessary before any such mining can be profitable. The power required to validate one cryptocurrency transaction, while not large on its own, adds up quickly in the context of large-scale mining operations. According to a report compiled by Coinshares, which provides cryptocurrency-related research and investment tools, companies and individuals mining Bitcoin (a popular cryptocurrency) consume roughly 41 terawatts a year in power.2 And according to that same report, investing in higher-quality equipment will not reduce the power requirement because “only the value of the [cryptocurrency] reward[…]can impact the network’s total electricity draw.”2 The solution, then, is to locate sources of cheap electricity – a solution which many cryptocurrency mining companies have already hit upon. In fact, the report notes that bitcoin miners tend to cluster in “regions dominated by cheap hydro-power,” especially the Pacific Northwest and Northeast regions of the United States.3 Although the influx of cryptocurrency mining operations into these areas has produced a measure of political backlash,4 it is not unreasonable to assume that the economic benefits conferred by such activities will soon outweigh such resistance.
Despite the evident promise of large-scale cryptocurrency mining, some have suggested that the upcoming “halving” of the cryptocurrency awarded for mining Bitcoin might seriously eat into profits and upset the delicate balance of power costs.5 However, this is not likely to constitute a serious headache for the industry for several reasons. First, as a Forbes article on the “halving” notes, Bitcoin operates according to the basic principles of supply and demand. That is to say, as fewer and fewer Bitcoins are disbursed during the mining process, fewer are available to be traded, causing their price to increase. This would conceivably offset the “halving” somewhat. Moreover, the recent increase in miner fees6 (fees paid by blockchain users to miners which supplement the cryptocurrency awarded) could also counterbalance the “halving.” All in all, despite the obstacles posed by power costs, capital investment and the gradual reduction of cryptocurrency awarded, large-scale cryptocurrency mining promises both steady revenue and growth potential in the years to come.
- https://www.webopedia.com/TERM/C/cryptocurrency-mining.html
- https://coinshares.co.uk/assets/resources/Research/bitcoin-mining-network-june-2019-fidelity-foreword.pdf , pg. 6
- https://coinshares.co.uk/assets/resources/Research/bitcoin-mining-network-june-2019-fidelity-foreword.pdf, pg. 10
- https://www.politico.com/magazine/story/2018/03/09/bitcoin-mining-energy-prices-smalltown-feature-217230
- https://www.forbes.com/sites/forbesfinancecouncil/2019/05/10/what-will-the-next-halving-mean-for-the-price-of-bitcoin/#d8a2fc15f340
- https://www.coindesk.com/bitcoin-fees-jump-to-nearly-1-year-highs-but-why
Upon Information and Belief Requires More than Information and Belief
Under the Federal Rules of Civil Procedure, a party must allege fraud with particularity. FRCP 9(b). When a party alleges fraud upon information and belief, that is generally insufficient to meet the standards under FCRP 9(b) absent additional allegations that demonstrate the origin of the information and belief. This is a nuanced difference from the particularity requirement for claims that are not alleged upon information and belief. This subtle difference is discussed in the cases Exergen Corp. v. Wal-Mart Stores, Inc. 575 F.3d 1312 (Fed Cir. 2009) and Munro v. Lucy Activewear, Inc., 899 F.3d 585 (8th Cir. 2018).
In Exergen, the Court found that where deceptive intent was plead on information and belief and the Plaintiff did not plead either information on which it relied on or any plausible reasons for its belief, the pleading was insufficient. The Court further stated that the circumstances Plaintiff did allege do not plausibly lay out the elements required for a claim of deceptive intent. Similarly in Munro, where the Plaintiff’s allegations are based on information and belief and the Plaintiff’s complaint did not set forth any supporting facts showing that Defendant intended to defraud him, the Court found the Plaintiff did not adequately allege fraud under Minnesota law.
This rule is applied in multiple jurisdictions and one to consider carefully when pleading allegations on “information and belief.” (Mikityanskiy v. Podee, Inc., 2011 U.S. Dist. LEXIS 55746 (S.D.N.Y 2011) (a complaint that was made up entirely of allegations made on “information and belief” was not sufficient especially when some allegations were made of readily available facts) Easton Tech. Prods. v. FeraDyne Outdoors, LLC 2019 U.S. Dist. LEXIS 60313 (D. Del 2019) (pleading was not sufficient under Rule 9(b) standard because there were no allegations of underlying facts to support the allegations made on “information and belief”); Gamevice, Inc. v. Nintendo Co., Ltd 2018 U.S. Dist. LEXIS 221777 (N.D. Cal. 2018) (allegation of prosecution laches is insufficient when the complaint does not plead the specifics of which of the five patents at issue unreasonably delayed prosecution).
US Treasury Releases Second Round of Tax Law Updates
The following is a summary of the second round of tax developments implemented by the US Treasury. Please click the link to view the full article.
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SEC Final Rules Regarding Conduct of Broker-Dealers and Investment Advisors
On June 5, 2019, the Securities and Exchange Commission (“SEC”) approved new Rules and interpretations regarding the standards of conduct of broker-dealers (“BD”) and investment advisers (“IA”). The rules and interpretations were adopted pursuant to a grant of rulemaking authority in Section 913(f) of the Dodd-Frank Act and reflect a heightened standard for quality and transparency, enhancing the investors’ relationship with BDs and IAs.
The rules and interpretations are:
- Regulation Best Interest: The Broker-Dealer Standard of Conduct (“Reg BI”).
- Form CRS Relationship Summary; Amendments to Form ADV (“Form CRS”).
- Commission Interpretation Regarding Standard of Conduct for Investment Advisers (“IA Conduct Interpretation”).
- Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser (“BD Exclusion Interpretation”.
Regulation Best Interest
Reg BI provides a new standard of conduct for BDs when making recommendations of securities transactions or providing investment strategy involving securities to a retail customer. The rule requires BDs to act in the “best interest” of their customers and place the interests of their customers ahead of their own or other interests. Broker-dealers must comply with four obligations when making recommendations to satisfy Reg BI. These four obligations are: (1) a disclosure obligation; (2) a care obligation; (3) a conflict of interest obligation; and (4) a compliance obligation.
The disclosure obligation requires the BD to provide in writing full and fair disclosure of (1) all material facts relating to the scope and terms of the relationship as well as (2) all material facts relating to conflicts of interest associated with the recommendation.
The care obligation requires BDs to exercise reasonable diligence, care and skill to (1) understand the risks, rewards, and costs associated with the recommendation and have a reasonable basis to believe that the recommendation is in the best interest of the customer; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on the customer’s investment profile; and (3) have a reasonable basis to believe that a series of recommended transactions is not excessive and is in the best interest of the retail customer.
The conflict of interest obligation requires (1) identification and at a minimum disclosure or elimination of all conflicts of interests associated with such recommendations; (2) identify and mitigate any conflicts of interests that create an incentive for associated persons (“AP”) to place the other interests ahead of the interests of the customer; (3)(i) identify and disclosure any material limitations on the securities, and (ii) prevent such limitations and conflicts from causing the BD or AP to put other interests ahead of the interests of the customer; and (4) identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales specific securities or specific types of securities within a limited period of time.
Finally, the compliance obligation requires the BD to establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Reg BI.
Form CRS
Form CRS requires both BDs and IAs to provide retail investors with a short relationship summary document that provides certain information about the firm and the brokerage and/or investment advisor services it offers, including fees and costs, conflicts of interest, and whether or not the firm and its professionals have been disciplined. The Form CRS also includes specific instructions as to content, formatting, and length.
IA Conduct Interpretation
The IA Conduct Interpretation was issued to reaffirm and clarify its views on the fiduciary duties that investment advisers owe to their clients, including the Duty of Care and the Duty of Loyalty. This will apply to all investment advisers whether they are registered and/or have retail customers.
Under the duty of care, IAs have additional duties such as, the duty to provide advice that is in the Best Interests of the Client, the Duty to Seek Best Execution, and the Duty to Provide Advice and Monitoring over the Course of the Relationship. Each of these three duties place an emphasis on the IA putting the interests of their customers before their own or other interests.
BD Exclusion Interpretation
The BD Exclusion Interpretation clarifies the scope of the BD exclusion from the definition of “investment adviser” in the Investment Advisers Act of 1940. The SEC realized that this exclusion allowed BDs to provide substantial amounts of investment advice and therefore it set out clear definitive limits to this exclusion.
These limits include limitations on when a BD may exercise investment discretion and provide investment advice, which is only when it is in connection with their business to buy and sell securities. The investment advice cannot be the main goal of the transaction.
The SEC also clarified that a BD may voluntarily and without any agreement with the customer review the holdings in a customer’s account for purposes of deciding whether to make an investment recommendation.
Pastore & Dailey Defeats Motion to Dismiss Filed by Billionaire in Greenwich Hedge Fund Dispute.
Pastore & Dailey defeated a motion to dismiss, and a motion to stay filed by heirs to a large national retail fortune in connection with their alleged efforts to take over a Greenwich based alternative investment hedge fund. Pastore & Dailey also defeated a motion to stay the proceedings and a motion to dismiss certain particular claims. The case involves the purposeful deflection of a planned $1 Billion investment by a large UK fund into the Greenwich fund and related defamation.
Pastore & Dailey Settles Complex CERCLA Suit with the Department of Justice on behalf of Client
Recently, Pastore & Dailey entered into a consent decree with the Department of Justice on behalf of an asset management firm, settling a complex Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) suit in the United States District Court for the Southern District of Florida. Pursuant to the consent decree, the United States agreed to not to sue or take administrative action against Pastore & Dailey’s client. The Department of Justice printed the resolution of the matter in Volume 84 of the Federal Register dated May 24, 2019.
Tax Law Updated, First Quarter 2019
The following is a summary of important tax developments that occurred in January, February, and March of 2019 that may affect you, your family, your investments, and your business. Please contact me for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Estimated tax penalty relief. The IRS announced that it is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. This waiver covers taxpayers whose total withholding and estimated tax payments are equal to or greater than 80% of their taxes owed, rather than the usual statutory percentage threshold of 90%. The provided relief expanded that initially offered by IRS; the earlier relief pertained to taxpayers who had paid 85% of their taxes owed. The relief was prompted by changes in the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), some of the which might impact withholding (e.g., the repeal of the personal exemptions and many itemized deductions and the capping the state and local income tax deduction at $10,000). A Government Accountability Office (GAO) report estimated that nearly 30 million taxpayers could be underwithheld in 2018. IRS also provided procedures for requesting the waiver and procedures under which taxpayers who have already paid underpayment penalties but who now qualify for relief may request a refund.
For more information, see this IRS News Release.
Employer identification number (EIN). As part of its ongoing security review, the IRS announced that, starting May 13, only individuals with tax identification numbers may request an Employer Identification Number (EIN) as the “responsible party” on the application. Individuals named as responsible party must have either a Social Security number (SSN) or an individual taxpayer identification number (ITIN). Under Code Sec. 6109(a)(1), persons are required to include taxpayer identifying numbers on returns, statements, or other documents filed with the IRS. One of the principal types of taxpayer identifying numbers is an EIN. IRS generally assigns an EIN for use by employers, sole proprietors, corporations, partnerships, nonprofit associations, trusts, estates, government agencies, certain individuals, and other business entities for tax filing and reporting purposes. A person required to furnish an EIN must apply for one with the IRS on a Form SS-4 (Application for Employer Identification Number). The new change will prohibit entities from using their own EINs to obtain additional EINs. The requirement will apply to both the paper Form SS-4 and online EIN application.
As of May 13, 2019, only individuals with tax identification numbers may request an EIN. You can read the IRS press release here.
Electric car credit declines. IRS announced that, during the fourth quarter of 2018, General Motors (GM) reached a total of more than 200,000 sales of vehicles eligible for the plug-in electric drive motor vehicle credit under Code Sec. 30D(a). Accordingly, the credit for all new qualified plug-in electric drive motor vehicles sold by GM began to phase out April 1, 2019. Qualifying vehicles from GM purchased for use or lease are eligible for a $7,500 credit if acquired before April 1, 2019. Beginning Apr. 1, 2019, the credit will be $3,750 for GM’s eligible vehicles. Beginning Oct. 1, 2019, the credit will be reduced to $1,875. After Mar. 31, 2019, no credit will be available.
You can read the IRS press release on this issue here.
Deduction for back alimony. The Tax Court held that an ex-husband’s payment of alimony arrearages resulted from a contempt order by a Family Court was not a “money judgment”, and so qualified as deductible alimony. With respect to divorce instruments executed before Jan. 1, 2019, amounts received as alimony or separate maintenance payments are taxable to the recipient and deductible by the payor in the year paid. An alimony payment is one that meets the certain specific requirements, such as it must be made under a divorce or separation instrument and the payor’s obligation to make the payment must end at the death of the payee spouse. On the other hand, a money judgment is a document issued by a court stating that the creditor (or other plaintiff) has won a lawsuit and is entitled to a certain amount of money. A New York court found a taxpayer to be in contempt due to his failure to make his alimony payments and sentenced him to 150 days in jail unless he paid $225,000 to his former spouse. The taxpayer paid the $225,000 at issue and claimed an alimony deduction. The Tax Court found that the court’s order was not a money judgment, but rather a contempt order to achieve the payment of alimony arrearages which retained their character as alimony.
You can download the court’s opinion in the Siegel case, TC Memo 2019-11, here.
Qualified business income deduction: final regulations. The IRS issued final Code Sec. 199A regulations for determining the amount of the deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate (the qualified business income deduction). The regulations cover a wide range of topics and discuss the operational rules, including definitions, computational rules, special rules, and reporting requirements; the determination of W-2 wages and unadjusted basis immediately after acquisition of qualified property; the computation of qualified business income, qualified real estate investment trust (REIT) dividends, and qualified publicly traded partnership income; the optional aggregation of trades or businesses; the treatment of specified services trades or businesses and the trade or business of being an employee; and the rules for relevant passthrough entities, publicly traded partnerships, beneficiaries, trusts, and estates.
IRS released in January of 2019 various guidance associated with the Qualified Business Income (QBI) deduction:
- A set of regulations, finalizing proposed regulations issued last summer, as well as a new set of proposed regulations providing guidance on several aspects of the QBI deduction, including qualified REIT dividends received by regulated investment companies
- A revenue procedure providing guidance on determining W-2 wages for QBI deduction purposes,
- A notice on a proposed revenue procedure providing a safe harbor for certain real estate enterprises that may be treated as a trade or business for purposes of the QBI deduction
Qualified business income deduction: calculating W-2 wages. IRS provided three methods for calculating W-2 wages under Code Sec. 199A, the qualified business income deduction, for purposes of the deduction limitation based on W-2 wages and for purposes of the deduction reduction for certain specified agricultural and horticultural cooperative patrons. Under Code Sec. 199A, W-2 wages include:
- The total amount of wages as defined in Code Sec. 3401(a) (dealing with income tax withholding);
- The total amount of elective deferrals (within the meaning of Code Sec. 402(g)(3));
- Compensation deferred under Code Sec. 457; and
- The amount of designated Roth contributions.
For any taxable year, a taxpayer must calculate W-2 wages for purposes of Code Sec. 199A using one of the three methods provided by IRS. The first method (the unmodified Box method) allows for a simplified calculation, while the second and third methods (the modified Box 1 method and the tracking wages method) provide greater accuracy. The Box numbers referenced under each method refers to those on the Forms W-2 (Wage and Tax Statement).
The IRS published Notice 2018-64, which explains the calculation of W-2 wages for purposes of Code Section 199A. You can download the Notice here.
Qualified business income deduction: rental real estate safe harbor. The IRS provided a safe harbor under which a rental real estate enterprise will be treated as a trade or business for purposes of the qualified business income deduction under Code Sec. 199A. That Code provision provides a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship, as well as a deduction of up to 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. Solely for this purpose, a rental real estate enterprise will be treated as a trade or business if:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
- For tax years beginning prior to Jan. 1, 2023, 250 or more hours of rental services were performed per year with respect to the rental enterprise; and
- The taxpayer maintains contemporaneous records on the hours of all services performed; a description of all services performed; the dates on which such services were performed; and who performed the services. (This contemporaneous records requirement doesn’t apply to tax years beginning before Jan. 1, 2019).
You can download IRS Notice 2019-07 here. It explains the IRS views on the safe harbor. Observe that the question of whether triple-net leases qualify as a trade or business for purposes of Section 199A remains unanswered, although it appears they will not qualify under the safe harbor.
Options for those unable to pay taxes due. The April 15th deadline for filing 2018 income tax returns (for most taxpayers, at least; April 17 for Maine, Massachusetts, and the District of Columbia) has recently passed. The IRS advised taxpayers who don’t have cash to pay the balance due on their returns, that taxpayers can avoid penalties but not interest if they can get an extension of time to pay from the IRS. However, such extensions merely postpone the day of reckoning for the period of the extension (generally, six months). The IRS has described other ways in which financially distressed persons may be able to defer paying their income taxes, including installment agreements (a short-term 120-day payment plan and a long-term payment plan) and an offer in compromise with the IRS.
The IRS offers brief explanations of some of the payment alternatives available to taxpayers:
https://www.irs.gov/payments/alternative-payment-plans-hardship-information
These notes are intended only for clients and friends of my law practice. These notes illustrate general principles only and are not intended as legal or tax advice. The reader is cautioned to discuss his or her specific circumstances with a qualified professional before taking any action. In some jurisdictions, this newsletter may be considered attorney advertising.
Pastore & Dailey Advises Clients on the Complexities of Family Offices
Recently Pastore & Dailey advised clients on complex questions regarding family offices and the compensation of non-family member “key employees” of such offices. Pastore & Dailey referenced the Investment Advisers Act of 1940, Dodd-Frank, and other securities act provisions to help the clients maneuver the complex structure of a family office and how to properly compensate non-family member employees pursuant to these provisions so as to not lose the family office exemption.