The Securities and Exchange Commission (“SEC”) continues to actively enforce Rule 21F-17 under the Securities Exchange Act of 1934, which provides that “no person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications.”^[1] In its most recent actions, the SEC charged companies with violating Rule 21F-17 by including language in severance agreements that specifically prohibited former employees from communicating disparaging information about the company to the SEC and that prohibited former employees from voluntarily communicating with or contacting any governmental agency in connection with a complaint or investigation.

On Dec. 19, 2016, the SEC announced an enforcement action against NeuStar, Inc., a Virginia-based technology company.^[2] NeuStar entered into severance agreements with former employees containing a non-disparagement provision which prohibited former employees from engaging “in any communication that disparages, denigrates, maligns or impugns” the company. The language at issue specifically stated that such communications could not be made to “regulators” including the SEC. When the SEC began its investigation, NeuStar, on its own accord, removed the reference to “regulators” including the SEC, and added language specifying that nothing in the agreement prohibited the former employee from “communicating, without notice to or approval by NeuStar, with any federal government agency” about a potential violation of a federal law or regulation. These amendments were apparently sufficient to satisfy the SEC. NeuStar agreed to make reasonable efforts to inform former employees who signed the severance agreements between Aug. 12, 2011 (the date Rule 21F-17 became effective) and the date of the amendments. NeuStar also agreed to pay a civil monetary penalty of $180,000.

On Dec. 20, 2016, the SEC announced a settlement in an enforcement action against SandRidge Energy, Inc., an oil and natural gas exploration and production company headquartered in Oklahoma City.^[3] As with NeuStar, SandRidge entered into severance agreements with former employees that contained non-disparagement provisions that prohibited former employees from making any disparaging remarks or statements to any “governmental or regulatory agency.” In addition, SandRidge’s form severance agreement prohibited employees from disclosing confidential or proprietary information to governmental agencies without SandRidge’s consent and from assisting or contacting any governmental agency in connection with a complaint or investigation. The SEC determined that these provisions violated Rule 21F-17. In response to the SEC’s investigation, SandRidge revised its form agreement and advised former employees that the problematic provisions were no longer in effect. SandRidge also added a provision to its form agreement stating that nothing in the agreement was intended to prohibit employees from reporting violations of law to governmental agencies.

In light of the SEC’s actions, employers should review employment and separation agreements, as well as employment and compliance policies and codes of conduct and ensure that they do not contain any contractual or policy provisions that may be interpreted to run afoul of Rule 21F-17, without express carve-outs. Any prohibition or restriction on communications with individuals outside a firm, whether concerning confidential information, disparaging information or general communications with third parties, which does not include a specific carve-out for communications with the SEC without prior notice to the employer, may violate Rule 21F-17.

Authored by Mark E. Brossman, Ronald E. Richman, Holly H. Weiss, Aaron S. Farovitch, and Adam B. Gartner.

If you have any questions concerning this Alert, please contact your attorney or one of the authors.

This On the Subject notes recent expansions regarding buprenorphine prescribing. The Comprehensive Addiction and Recovery Act of 2016 (CARA), signed into law today, extends prescribing authority to physician assistants and nurse practitioners who meet CARA and US Department of Health and Human Services (HHS) requirements. Earlier this month, HHS announced that it would increase the number of patients that a practitioner may treat pursuant to a buprenorphine waiver from 100 to 275.

On Friday, July 22, President Obama signed the Comprehensive Addiction and Recovery Act of 2016 (CARA). Following on federal, state and local trends, CARA seeks to expand access for persons needing opioid treatment.

One of CARA’s more significant provisions expands buprenorphine prescribing privileges to nurse practitioners and physician assistants who meet certain specified education and training requirements to prescribe to treat opiate addiction. Currently, buprenorphine may be prescribed, administered or dispensed for addiction treatment only by a practitioner who meets the definition of a “qualifying physician” as set forth in the Controlled Substances Act and who has applied for and obtained from the Drug Enforcement Administration (DEA) a waiver with an assigned unique identification number (X-waiver).

CARA requires that the US Department of Health and Human Services (HHS) update regulations regarding buprenorphine prescribers within 18 months from the date of its enactment to include nurse practitioners and physician assistants.

The statutory expansion of buprenorphine prescribing limits follows on a significant regulatory expansion announced earlier this month. On July 8, 2016, the Obama administration announced new rules that substantially increased the number of patients that a given practitioner may treat with buprenorphine at any one time. The rules take effect on August 8, 2016, and expand the number of patients that a practitioner may treat from 100 to 275.

HHS, which issued the rules, noted that the policy rationale is a desire to expand access to Medication Assisted Treatment (MAT) for opiate addiction, thereby addressing a pressing public health problem:

Evidence suggests that utilization of buprenorphine is limited directly by the existence of treatment limits. Practitioners currently providing MAT with buprenorphine [] report that being limited to treating not more than 100 patients at a time is a barrier to expanding treatment. (81 FR 44729)

HHS’s revised rules reflect a continued dedication to the concept of limiting buprenorphine prescribing to practitioners who have met specific training requirements, who prescribe for the purpose of MAT, and who meet other “good standing” requirements with regard to the DEA and the Centers for Medicare and Medicaid Services. As with previous waiver expansions, the move from a limit of 100 to 275 is a “graduated” process. A practitioner may apply for the 275 waiver one year after receiving approval to treat 100 patients.

The application to move to 275 patients will require practitioners to certify that they meet a number of requirements, including that they will (1) adhere to nationally recognized evidence-based guidelines for the treatment of patients with opioid use disorders; (2) provide patients with necessary behavioral health services; (3) use patient data to inform the improvement of outcomes; (4) adhere to a diversion control plan; (5) consider how to ensure continuous access to care in the event of practitioner incapacity or an emergency situation that would affect a patient’s access to care; and (6) in the event that the request for the higher patient limit is not renewed or the renewal request is denied, notify all patients above the 100 patient level that the practitioner will no longer be able to provide MAT services using buprenorphine to them and make every effort to transfer patients to other addiction treatment.

HHS acknowledged that it received many comments urging that nurse practitioners and/or physician assistants have a role in prescribing buprenorphine, but noted that prior to CARA it did not have statutory authority to extend buprenorphine prescribing privileges to allied health professionals.

With the statutory authority provided by CARA, HHS will extend the prescribing authority to allied health professionals within 18 months. CARA calls for HHS to determine additional parameters of training, experience and other qualifications that allied health professionals must meet in order to obtain such authority.

The release provisions in a corporate debtor’s Chapter 11 plan were “not sufficiently specific to release” a plaintiff’s Fair Labor Standards Act (“FLSA”) claim against the debtor’s president (“P”), held the U.S. Court of Appeals for the Fifth Circuit on Jan. 6, 2016. Hernandez v. Larry Miller Roofing, Inc., 2016 WL 67217, at *4 (5th Cir. Jan. 6, 2016). Relying on established precedent to reverse the district court’s dismissal of the plaintiff’s suit against P, the Fifth Circuit stressed that P “is not identified by name in any of the release language.” Id. at *6.

Statutory Context

Bankruptcy Code (“Code”) Section 524(a) provides in relevant part that “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Thus, the discharge obtained by the corporate debtor in Hernandez would not ordinarily “affect the liability of any entity other than the debtor.” 4 Collier, Bankruptcy ¶ 524.01, at 524-17 (16th rev. ed. 2009). But the plaintiff (“H”) never objected to the plan’s release provision or appealed from the bankruptcy court’s plan confirmation order.

Relevance

Courts have split over whether the provisions of a Chapter 11 reorganization plan may override Code Section 524(e). According to some courts, the Code’s express limitation on a debtor’s discharge cannot be undermined by the provisions of a reorganization plan. Underhill v. Royal, 769 F.2d 1426, 1432 (9th Cir. 1985) (“court has no power to discharge the liabilities of a nondebtor [with] the consent of creditors as part of a reorganization plan”); In re Lowenschuss, 67 F.3d 1394, 1401 (9th Cir. 1995) (same); In re Western Real Estate Fund, Inc., 922 F.2d 592, 602 (10th Cir. 1990). Other courts will permit third-party release provisions when individual creditors sign releases. In re Specialty Equip. Cos., 3 F.3d 1043, 1047 (7th Cir. 1993). And the U.S. Court of Appeals for the Third Circuit takes a case-by-case approach. In re Continental Airlines, 203 F.3d 203, 213-14 (3d Cir. 2000) (“Establishing … a blanket rule prohibiting all non-consensual releases and permanent injunctions of non-debtor obligations … would be ill-advised when we can rule on Plaintiffs’ appeal without doing so”; on facts of case, third-party release “does not pass muster under even the most flexible tests. … The hallmarks of permissible non-consensual releases — fairness, necessity to the reorganization, and specific factual findings … — are all absent here.”). Of course, individual creditors who simply acquiesce in third-party release provisions and fail to challenge the plan or to appeal from a bankruptcy court’s order confirming the plan may not later attack release provisions. Travelers Indem. Co. v. Bailey, 129 S. Ct. 2195 (2009).

The Fifth Circuit avoided the overarching statutory issue in Hernandez. Instead, it applied principles of contract interpretation to the terms of the reorganization plan to determine whether it released P. 2016 WL 67217, at *3-4. As a practical matter, therefore, if the plan provided no release of P by its precise terms, H would be free to pursue him.

Facts

The plaintiff sued his former employer, the corporate debtor and P, its president, prior to bankruptcy, alleging a failure to pay overtime wages in violation of the FLSA. While the suit was pending, the corporate debtor filed a Chapter 11 petition, resulting in the stay of the FLSA litigation in the district court. The plaintiff later filed a claim in the corporate bankruptcy case, alleging $47,698 in unpaid wages. The debtor filed a reorganization plan. H accepted the plan, and the court confirmed it.

In relevant part, the plan provided that a creditor’s receipt of a distribution on its claim would deem the claims to have been “paid in full, including the release of rights to enforce or collect such Claims against non-debtor parties … . The Debtor, Reorganized Debtor, the officers and directors of the Debtor and the shareholders shall be discharged and released from any liability for Claims … except for obligations arising under this Plan.” Id. at *1-2. H received a 30-percent distribution on his claim for unpaid wages — $14,309.40.

The District Court

H later continued his FLSA suit in the district court against P individually. P moved for summary judgment, arguing that “the FLSA claim against him was discharged under the Plan and that, in the alternative, the doctrine of res judicata precluded [H] from advancing the claim,” citing the provisions of the plan. The district court agreed, granted summary judgment in favor of P and dismissed the complaint. When H argued on a motion for rehearing “that bankruptcy courts lacked the authority to discharge the debts of non-debtor third parties, such as [P],” the district court rejected his argument, reasoning that it was “an impermissible collateral attack on the judgment of the bankruptcy court [i.e., the order confirming the Chapter 11 Plan].” Id. at *2.

The Court of Appeals

The Fifth Circuit agreed with the district court that “principles of contract interpretation” should “determine the meaning of the Plan.” But it reversed the district court’s holding that the plan had released P. Id. at *4.

First, it explained, the applicable federal law makes “a corporate officer with operational control” liable as “an employer along with the corporation, jointly and severally liable … for unpaid wages.” Id. at *3, citing Donovan v. Grim Hotel Co., 747 F.2d 966, 972 (5th Cir. 1984). Thus, because the corporate debtor and P were “jointly and severally liable for any FLSA violation that may have occurred,” the language of the reorganization plan was key. Id.

The court avoided the application of Code Section 524(e) because H had not challenged the plan or appealed from the bankruptcy court’s confirmation order. 2016 WL 67217, at *4, citing In re Applewood, 203 F.3d 914, 919 (5th Cir. 2000). Moreover, reasoned the court, “once the time for objecting to, or directly appealing, a plan has passed, parties may not challenge particular provisions of the plan as exceeding the bankruptcy court’s authority.” Id. at n.4. As the court noted, H did not have to “address whether confirmation of the Plan was beyond the authority of the bankruptcy court under” Code Section 524(e). Id.

The court then examined “the specificity of the release provisions” to determine whether they were “sufficiently specific to release [H’s] FLSA Claim against [P].” Id. at *4. It explained the “specificity test” it had developed in earlier cases. Id. at *5. In Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987), the court found “clear and unambiguous” language that “expressly released a third party from liability on a guaranty.” 815 F.2d at 1047, 1050. There, the order confirming the reorganization plan expressly stated that it released “any guarantees given to a creditor of the Debtor, which guarantees arose out of the Debtor’s business dealings with any creditor of the Debtor.” The language was included in the plan at the request of the guarantor who had agreed to release funds in exchange for the release. Id. at 1049. Although the creditor had failed to object to the plan or to appeal directly, the Fifth Circuit held the plan’s release to be “specific enough to discharge [the defendant] guarantors of liability.” 2016 WL 67217, at *4.

But the Fifth Circuit refused to enforce a release against a third-party guarantor in the Applewood case when the reorganization plan contained no “specific discharge of the indebtedness of the third party.” 203 F.3d at 920. In that case, the release provision “did not specifically release the guarantor, who was also an officer, from his personal guaranties.” 2016 WL 67217, at *5. But seeFOM P.R. S.E. v. Dr. Barnes Eyecenter Inc., 255 F. App’x 909, 912 (5th Cir. 2007) (plan release provisions held to bar creditor’s claims; “release of claims was an integral part of the bankruptcy order”; “release of claims was not simply boilerplate language that was inserted into the [reorganization plan], but rather a necessary part of the [reorganization plan] itself”; language “explicitly mention[ed] [guarantor] as an entity that benefit[ed] from the release”).

Applying its “specificity test” in Hernandez, the Fifth Circuit held that the release provisions were not “specific enough to release [H’s] FLSA claim against [P].” 2016 WL 67217, at *6. First, the release language did not identify P “by name.” Also, while P was “an officer of” the debtor, “a party’s status as an officer combined with boilerplate release language is not sufficiently specific.” Further, “nowhere does the Plan mention anything related to a FLSA claim or employment law violations more generally.” “The language in the Plan is, if anything, generic,” concluded the court. Id.

H was therefore not barred from suing P “simply because he has already received compensation from” the debtor under the plan for “the underlying FLSA violation.” Id. at *7. Under Code Section 524(e), the debtor’s discharge in the plan did not affect the liability of P for the remaining balance of H’s claim. Of course, the court was not deciding whether any FLSA violation had occurred, but only whether H could pursue his claim in the district court.

Comments

The lesson for creditors from Hernandez: object to any third-party release in a proposed reorganization plan, and appeal if unsuccessful. See In re Gentry, 2015 WL 8117969, at *4 (10th Cir. Dec. 8, 2015) (reversed lower courts; individual Chapter 11 debtors’ guaranty liability not affected by their corporation’s discharge under Chapter 11 plan; corporate debtor’s discharge “does not affect a guarantor’s liability” under Code Section 524(e); in any event, language of guarantees contained unconditional promise to pay, waiver of defenses and agreement not to assert deductions by way of setoff or counterclaim).

Authored by Michael L. Cook.

If you have any questions concerning this Client Alert, please contact your attorney or the author.

On April 1, 2015, the Securities and Exchange Commission (“SEC”) announced its first enforcement action against a company for using language in a confidentiality agreement that could prevent or deter whistleblowing activity.^[1] Rule 21F-17 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) provides that “no person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications.”^[2] To date, the SEC has not issued formal guidance as to how to avoid violating Rule 21F-17.

In the fall of 2014, the SEC announced its intention to bring enforcement actions against companies that use restrictive language in agreements and policies that could discourage whistleblowing. Sean McKessy, chief of the SEC’s Office of the Whistleblower, said that the SEC was “on the lookout for contracts [and] codes of conduct” that include language that could prevent or dissuade an employee from reporting securities law violations to the SEC.^[3] Thereafter, according to a Wall Street Journal article, the SEC sent letters to a number of companies asking for every “nondisclosure agreement, confidentiality agreement, severance agreement and settlement agreement they entered into with employees since Dodd-Frank went into effect, as well as documents related to corporate training on confidentiality.”^[4]

As reflected in the April 1 cease-and-desist order, which was accompanied by a press release,^[5] the SEC charged KBR Inc., a global technology and engineering company, with violating Rule 21F-17 by requiring employees to sign a confidentiality agreement before the start of an investigatory interview. The agreement prohibited employees from discussing any particulars of their interviews or the subject matter of the interviews with anyone without the prior authorization of KBR’s legal department. It also threatened that any unauthorized disclosure “may be grounds for disciplinary action up to and including termination of employment.”^[6] In its press release, the SEC said that by requiring its employees to sign confidentiality agreements that require pre-notification before contacting the SEC, KBR “potentially discouraged employees from reporting securities violations.” While the SEC acknowledged that it was unaware of any instances in which KBR enforced the agreement or a signatory was prevented from communicating with the SEC, the agreement undermined the purpose of Rule 21F-17 — to “encourage individuals to report to the Commission.” In the press release, Andrew J. Ceresney, director of the SEC’s Division of Enforcement, warned: “We will vigorously enforce this provision.”

As part of its settlement with the SEC, KBR agreed to pay a $130,000 fine and, as a remedial measure, agreed to amend the confidentiality agreement to add the following carve-out:

Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.^[7]

In the press release, McKessy advised that “[o]ther employers should similarly review and amend existing and historical agreements that in word or effect stop their employees from reporting potential violations to the SEC.”

In light of the SEC’s actions, companies should review employment, separation and settlement agreements, as well employment and compliance polices and codes of conduct. Common provisions in these agreements and policies — such as provisions designed to prevent unauthorized use and disclosure of confidential, proprietary or trade secret information and separation or settlement terms, non-disparagement provisions, releases, covenants not to sue, cooperation provisions, and internal notification and reporting requirements — may be interpreted to run afoul of Rule 21F-17, unless they are overridden by provisions permitting whistleblowing activity without notice to or authorization by the company.

Authored by Holly H. Weiss, Brian T. Daly, and Marc E. Elovitz.

If you have any questions concerning this Alert, please contact your attorney or one of the authors.

Registered investment advisers in the process of planning an annual compliance review will generally include a review of their best execution processes and their use of so-called “soft dollars.” Managers that trade in fixed-income securities may find it useful to review a no-action letter issued earlier this year by the Division of Trading and Markets of the U.S. Securities and Exchange Commission. This letter, granted to Carolina Capital Markets Inc.,^[1] confirmed that institutional asset managers, in reliance on the safe harbor of Section 28(e) of the Securities Exchange Act of 1934, may purchase eligible third-party brokerage and research services with commissions generated by qualifying transactions in fixed-income securities.

Background on the Section 28(e) Safe Harbor

Section 28(e) of the Securities Exchange Act of 1934 creates a safe harbor that allows private fund managers (and other investment advisers), under certain circumstances, to use client commission payments to purchase eligible brokerage and research services. The Section 28(e) safe harbor protects a manager from a claim that it breached its “best execution” fiduciary duty by not selecting, in conjunction with a purchase of eligible brokerage and research services, the lowest commission rate available.

The portion of a client commission that is used to purchase eligible research or brokerage services by a manager is referred to as “soft dollars.” To qualify for the Section 28(e) safe harbor, a “soft dollared” product or service must satisfy a three-step test:

1. The manager must determine that the product or service is eligible “research”^[2] or “brokerage.”^[3]

2. The manager must determine that the eligible research or brokerage product or service provides “lawful and appropriate assistance”^[4] to the manager in making investment decisions.

3. Finally, the manager must determine that the applicable commissions are reasonable in relation to the value of the products or services received.

The Eligibility of Fixed-Income Commissions Under the Section 28(e) Safe Harbor

The 1998 OCIE Soft Dollars Study. The use of fixed-income trades to generate soft dollars has been scrutinized for some time. In a 1998 study,^[5] the SEC’s Office of Compliance Inspections and Examinations focused on fixed-income trades in two contexts:

First, OCIE noted in its review of problematic principal transactions that a small, but notable, percentage of the trades utilized to generate soft dollars in their sample came from fixed-income principal transactions. The study stated that the SEC staff “has long taken the position that advisers cannot claim the protection of Section 28(e) when generating soft dollar credits through principal trades[,]” and then went on to report that 3.6 percent of the advisers in its sample had earned soft dollar credits on principal trades of fixed-income securities. The study further noted that these fixed-income principal transactions were worrisome, among other reasons, because the confirmations of some of these trades

“disclosed only the net amount of the trades and did not disclose commission amounts paid by clients . . . [and in] other arrangements, the price quoted may include an express or imputed mark-up or mark-down, a portion of which is used to generate soft dollar benefits.”

Second, the study also scrutinized fixed-income soft dollar commissions in the context of a review of over-the-counter transactions. It found that 21 percent of the advisers in its sample earned research credits based on OTC agency trades for fixed-income securities, but

“[b]ecause the OTC market is a dealer market (i.e., securities are normally traded on a principal, and not an agency, basis), the practice of receiving soft dollar credits based on OTC agency transactions raises disclosure and best execution issues . . . because an agent is being interposed between an adviser’s client and an OTC market maker, [and therefore] the adviser is possibly causing the client to pay more than the lowest available cost to execute the trade. These concerns are heightened in the fixed-income market due to limited quote, trade and mark-up information available to advisers and their clients.”

In other words, the study effectively concluded that the lack of transparency in commission rates and compensation amounts being paid to broker-dealers in fixed-income transactions, whether principal transactions or interposed OTC agency transactions, effectively put a client at risk of paying excessive commissions and therefore placed the transactions outside of the Section 28(e) safe harbor.

2001 SEC Soft Dollars Guidance. Three years later, however, the SEC reconsidered its general policy of restricting the Section 28(e) safe harbor to agency transactions.^[6] In the 2001 release, in recognition of advances in OTC transaction reporting, the SEC modified the interpretation of the term “commission” in Section 28(e) to include “a markup, markdown, commission equivalent or other fee paid by a managed account to a dealer for executing a transaction where the fee and transaction price are fully and separately disclosed on the confirmation and the transaction is reported under conditions that provide independent and objective verification of the transaction.”

The effect of the 2001 release was to bring a subset of OTC transactions, i.e., those subject to an effective commission disclosure and reporting regime, within the Section 28(e) soft dollars safe harbor. This relief, however, did not expressly extend to fixed-income OTC transactions that were not part of the transaction reporting systems that the relief was predicated upon.

2006 SEC Soft Dollars Guidance. In 2006, the SEC issued a release that provided a new set of comprehensive guidance on soft dollar practices.^[7] The 2006 release reiterated the requirement that “money managers must make a good faith determination that commissions paid are reasonable in relation to the value of the products and services provided by broker-dealers[.]” It also clarified that “research services” are restricted to Section 28(e) “advice,” “analyses” and “reports” and that “brokerage services” within the safe harbor are those products and services that relate to the execution of the trade from the point at which the money manager communicates with the broker-dealer for the purpose of transmitting an order for execution, through the point at which funds or securities are delivered or credited to the advised account.

The 2006 Release did not, however, specifically address fixed-income commissions other than to state that “[m]anagers may not use client funds to obtain brokerage and research services under the safe harbor in connection with fixed-income trades that are not executed on an agency basis, principal trades (except for certain riskless principal trades), or other instruments traded net with no explicit commissions” (italics added).

2013 Carolina Capital No-Action Letter

In 2013, Carolina Capital Markets Inc., which describes itself as a “leading provider of third party fixed income research with superior execution” requested a no-action letter, presumably to provide comfort to its clients, that would confirm that commissions from fixed-income trades can constitute eligible “soft dollars” under the Section 28(e) safe harbor.

This request addresses a lack of clarity in the marketplace regarding fixed-income commissions. In Carolina Capital’s no-action request, its counsel stated:

“Notwithstanding our view [that SEC guidance suggests that commissions from agency transactions in fixed-income securities can satisfy the Section 28(e) safe harbor] . . . CCM has indicated to us that there is a fairly widespread misconception among fixed-income asset managers that the Section 28(e) safe harbor is unavailable or its availability is in doubt for acquiring third-party research through fixed-income transactions executed on an agency basis.”

By issuing its July 2013 no-action letter, the SEC staff confirmed that commissions from fixed-income trades conducted on an agency basis can qualify for the Section 28(e) safe harbor, and that commissions from these fixed-income trades may be used to purchase third-party research, assuming compliance with the other requirements of Section 28(e) and overall best execution.^[8]

This guidance will not extend to all fixed-income transactions, as many of these kinds of trades are conducted on a principal basis (or otherwise do not qualify), but for qualifying trades, private fund managers now have certainty on their ability to utilize the Section 28(e) safe harbor.

Authored by Brian T. Daly and Marc E. Elovitz.

If you have any questions concerning this Alert, please contact your attorney at Schulte Roth & Zabel or one of the authors.

On June 24, 2013, the Supreme Court of the United States issued its long-awaited opinion in Fisher v. University of Texas at Austin, where the Court was asked to consider the constitutionality of a race-conscious admissions policy at the University of Texas at Austin. The case has been followed closely by colleges and universities concerned about what impact it might have on diversity and admissions.^[1] In a 7-1 decision (Justice Kagan recused herself), the Court held that the United States Court of Appeals for the Fifth Circuit misapplied the “strict scrutiny” standard required by the Court’s previous decisions in Grutter v. Bollinger, 539 U.S. 306 (2003), Gratz v. Bollinger, 539 U.S. 244 (2003)and Regents of the University of California v. Bakke, 438 U.S. 265 (1978), and therefore vacated the Circuit Court’s decision and remanded the case so the Circuit Court could apply the correct standard.

According to the Court, “racial ‘classifications are constitutional only if they are narrowly tailored to further compelling governmental interests.’” Fisher, at 18 (quoting Grutter, 539 U.S., at 326). Thus, the inquiry involves two steps: a determination that there are “compelling governmental interests” involved, and a second determination of whether the means chosen are sufficiently “narrowly tailored” to meet that goal.

The Fisher opinion confirmed that “the attainment of a diverse student body . . . is a constitutionally permissible goal for an institution of higher education.” Id. (quoting Bakke, 438 U.S., at 311-312). Further, the Court agreed with the lower court’s decision to defer to the University’s judgment “that a diverse student body would serve its educational goals,” though the Court emphasized that there must still be “a reasoned, principled explanation for the academic decision.” Id., at 19. The Court took issue, however, with the lower court’s analysis of the “narrow tailoring” prong. The Court stated that “the University receives no deference” in this analysis and criticized the lower court for “confin[ing] the strict scrutiny inquiry in too narrow a way by deferring to the University’s good faith in its use of racial classifications,” stating that, instead, a “searching examination” needs to be performed to ensure that race or ethnicity are merely considered in the application process, and not determinative or defining, and that no race-neutral alternatives could achieve similar results. Fisher, at 20-22.

Since the Court did not reach an actual conclusion on the constitutionality of the University of Texas’ policy, much uncertainty remains as to what the Fisher decision means for educational institutions going forward. Both sides have claimed victory: affirmative action defenders pointing out that the Court did not find the current policies at the University of Texas unconstitutional and did not overrule affirmative action; opponents hopeful that it has set the stage for the lower court to reject its original ruling.

While Fisher and most of the affirmative action cases deal with college and graduate programs, their constitutional analysis will also be applied to public elementary and secondary school affirmative action programs. While independent schools need not comply with the constitutional principles addressed by the Court, we recommend continuing to watch the evolution of the Fisher case and affirmative action jurisprudence generally, as all schools should consider their rulings as best practices in drafting policies.

Authored by Mark E. Brossman and Donna Lazarus.

If you have any questions concerning this Alert, please contact your attorney or one of the authors.

The staff of the U.S. Securities and Exchange Commission (the “SEC”) has announced its new National Exam Program (“NEP”) initiative to conduct “Presence Exams” of newly-registered investment advisers. In a letter sent today from various regional offices of the SEC to newly-registered advisers, the staff described the new exams as “focused” and “risk-based” and highlighted the following five “higher-risk” areas that may be covered during an exam:

• Marketing
• Portfolio Management
• Conflicts of Interest
• Safety of Client Assets
• Valuation

The letter makes it clear that the NEP staff will contact advisers separately if and when their firm is selected for an examination. The letter also explains that the Presence Exams are part of a two-year initiative that will include (1) an Engagement Phase — involving outreach to newly registered advisers, (2) an Examination Phase — during which the exams will occur and (3) a Reporting Phase — during which the NEP will report to the SEC and the public its observations from the examinations (including common practices identified in the higher-risk areas, industry trends and significant issues).

The higher-risk areas identified in the letter are consistent with many of the issues we are seeing in recent SEC examinations. Fund managers should be prepared to address these issues in detail with the SEC staff, for example, by explaining their procedures, disclosures and testing with respect to allocation of investment opportunities and allocation of expenses among funds and other accounts. Supporting materials for all factual statements made in marketing materials (including pitch books, DDQs and other communications) should be identified and their accuracy confirmed. Advisers should be prepared to explain their valuation methodologies, particularly for fair valuing illiquid or difficult-to-value instruments. In preparation for examination, fund managers should review the accuracy of their management- and performance-fee calculations, as well as the means by which they satisfy the custody rule taking into consideration all categories of instruments and other investments.

Identifying and addressing the types of issues raised in today’s letter should be a priority for all registered advisers.

Authored by Marc E. Elovitz.