Terra Extraneus

Regulation D exempts certain securities investment vehicles from registration with the government and generally permits the existence of some types of non-public securities owned by a handful of strangers. Typically, to invest in an unregistered security, the investor must be qualified. One of the ways they must be qualified is by being an “accredited investor.” An “accredited investor” is an investor that has assets that can be invested and that are valued at $1 million or more net of home ownership or earns more than $200,000 per year.

The SEC is reportedly considering revising the definition of “accredited investor” to make it applicable to hedge funds and to define qualification for hedge funds to include a minimum net worth of $2.5 million.

While this makes some sense, it does not go far enough. The reason the SEC is considering this is because the “suitability” requirements, which impose limits on the risk to which an investor can be exposed by a registered representative, do not apply to hedge funds which accept investors directly rather through a broker dealer. In order to make the “accredited investor” definition look like a suitability requirement, it should make the net worth threshold exclude not only the family home, but it should also exclude IRAs, 401(k)s, and other retirement vehicles like SEPs and life insurance cash value. It should also be limited to persons with at least ten years of investing experience with equities, or commodities, or options.

Eventually, some hedge funds will evolve into main stream investment vehicles that will have some sort of short form registration and will be offered by broker dealers. The suitability rules and the drive toward true diversification that motivates the best registered representatives will provide adequate protection. Until that day comes, the customer that would otherwise be served by a retail registered representative or broker dealer should not be in hedge funds. An updated definition for accredited investors will fill part of the gap for the rest.

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It happened again. An 85 year old man came to see me. He had been sold a variable annuity when he was 79 that carried substantial surrender charges and only a death benefit for security. The person that sold it to him was not a registered representative, but some sort of insurance agent with only a series 6 licensure, and little understanding of risk. His life savings was placed into aggressive funds. A third of his savings was lost in the crash of 2001 and in the intervening years, because of a failure to monitor his investments or provide the ongoing review that he thought he was buying from the major national insurer that sold the variable annuity, his investments have recovered less than 20% of the loss suffered in 2001. Money doubles every seven years except in variable annuities that are steeped in too much risk and too little common sense. If after the crash someone had just suggested moving his investments to a balanced fund within the same family of funds already in the variable annuity, he would by now be nearly back to where he started.

Investment News reported that the state regulator for Massachusetts, William F. Galvin, has proposed a set of criteria for variable annuity sales to elderly. Other states, the article reports, like Nebraska, are considering rules.

If suitability rules already on the books are not enforced, new sales practices rules will not add much. Moreover, sales practice rules are not enough to protect the elderly, or anyone, if the issuers of variable annuities are not also held to the same standard as wirehouse registered representatives and supervisors. They are required to review account positions at least annually and make recommendations. State regulators should also have on their websites a list of things for customers to demand and one of those things should be an annual review of positions in every account. If variable annuity issuers are not going to provide this, regardless of the reason, then these products must be clearly labeled as “self-directed” accounts after they are sold and advising the purchaser to obtain a financial advisor to review positions annually. Also, companies that do not offer annual position reviews should be precluded from imposing surrender charges beyond the first year on any variable product. Multi-year surrender charge platforms should be precluded for anyone over the age of 70.

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I was rather stunned today by the data reported by Gruntled Employees, a blog site that seems to be focused on the successful representation of employers. The data suggested that litigation brought by employers to enforce non-compete clauses was becoming so common that the incidence of such cases was exceeding the incidence of Sarbanes – Oxley cases, the cases complained about most vociferously by lobbyists to Congress. Indeed, the data indicated the incidence of these types of cases reported in the legal literature has literally doubled in the last decade.

Employers, according to the Gruntled Employees article, claim this type of litigation is necessary to protect trade secrets. That may be the party line employers use. But, as an apologetic it is simply bogus.

Most of the cases do not involve the types of employees that know trade secrets. They are typically not engineers or processing personnel. They are typically not corporate decisionmakers. Indeed, almost always, they are sales personnel of one type or another that have significant client contacts, sometimes have a title, but are not usually actual corporate officers. The client contacts range from client contacts given to the employee by the employer to client contacts developed solely by the employee for the employer. Some of the client contacts were developed when the employer was salaried but just as many client contact cases involve commission only sales personnel. The result of this collage of fact patterns is the inescapable conclusion that these types of cases are brought for one reason only in most cases, especially those involving sales personnel, to forestall or prevent competition.

Courts prejudicially devoted to supporting employers do not even take this into account. In many states, statutes preclude non-compete agreements that stifle competition or act as a restraint on trade. Even in those states, courts prejudicially devoted to supporting employers may ignore the restraint on trade, the over reaching and unequal bargaining power inherent in the non-compete clauses, and the disproportionate impact on the employee rather than the employer. Even a court inclined to enforce a non-compete clause that is a restraint of trade should consider the disproportionate impact and award fair compensation to the employee precluded from competing. Courts that do not do so risk becoming used in unseemly scrambles over customers that have nothing to do with trade secrets and only to do with protecting short term profits and economic inefficiency.

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Indiana appears to enforce the at will employment doctrine even when the employer allegedly fails to actually pay withheld taxes to federal and state taxing authorities. Then, when the employee made a claim, the employer fired the employee.

The Indiana Supreme Court opinion, Myers v J. Myers Construction, Inc., No. 29504-0609-CV-326 (February 2007), does not provide any rationale for the decision other than a review of the stare decisis of Indiana. The stare decisis of Indiana was not so clear as to require such a conclusion. Indeed, the law of Indiana, like most states, makes actionable for wrongful termination a termination in retaliation for whistleblowing based on the illegal conduct of the employer. The failure of an employer to pay taxing authorities the wages withheld to pay those taxes seems to be about as violative of public policy as could be imagined and in most states would have justified a wrongful termination claim for termination in retaliation for reporting unpaid employment taxes.

Beyond the tax law implications, the other and more disturbing implication is that if an employer breaks the trust conferred on the employer by law to collect taxes and then fires the employee that reports it or makes a claim about it, the employer does so with impunity under the cloak of the at will doctrine in Indiana. Clearly, the at will doctrine was supposed to be an articulation and explanation of the employment contract. But, in Indiana, it is being distorted into some sort of shield law for employers.

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Karen Barrows, a public school teacher, sent her children to a private Christian school. When she applied for the job of Assistant Principal, at the suggestion of the Superintendent, her boss, the Superintendent subverted her application because her children were in still in a private school. The Superintendent denied the reason was religious, but there seemed to be little doubt that the Superintendent made it clear that Ms. Barrows had no future in the school district as long as her children were enrolled in a private school.

The United States Court of Appeals for the 5th Circuit held, in an opinion you can find here, that Barrows could not state a §1983 claim for violation of her property rights in her governmental employment because an essential element of the claim, that the Superintendent was a policymaker and that his policy violated her rights, was not legally possible. The court held that the Superintendent was not a policymaker because under the laws of Texas, the policy making function was vested solely in the school board and the Superintendent was merely an agent of the Board.

There is absolutely no doubt the Circuit Court was right, the Superintendent was not the policymaker under Texas law. However, the Circuit Court was absolutely wrong. Clearly, under the facts both the trial court and the Circuit Court should have considered questions of fact for a trial, the Superintendent had usurped some policymaking authority, implemented it ultra vires, and in violation of the property rights of Ms. Barrows, added a job requirement that precluded her application. Also, the teacher, Ms. Barrows wanted her children to have a religious education. She told the Superintendent that was her motive. Nevertheless, the Superintendent imposed his policy anyway and the school board turned a blind eye.

Also, the Circuit Court was being intentionally obtuse. It is the rare school board that controls the Superintendent. That the school board can legally rein in the Superintendent is technically true but usually irrelevant. Ignoring reality, such as who was actually setting policy and implementing policy, harms the credibility of the Courts and in this case, denied the right of a school teacher to make a lawful parental choice about schooling her children without sabotaging her own career.

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The State of Oregon has a statute that requires that 60% of any punitive damages awarded to a plaintiff be paid into a victim’s compensation state fund. For a couple of reasons, it sounded like a “taking” of “property.” In the particular case in which it was enforced by the State of Oregon, the State of Oregon was also the defendant and wrongdoer.

This statute was reviewed by the United States Court of Appeals for the 9th Circuit arising in a federal trial court employment case, Enquist v Oregon Department of Agriculture, in which the wrongfully discharged employee was awarded compensatory damages, punitive damages and attorney fees. The award of the jury became a judgment of the court.

The plaintiff then became a judgment creditor. Wouldn’t a judgment creditor be a property owner? In order to find the statute constitutional, the 9th Circuit had to and did determine that the plaintiff was not a “property owner” of the punitive damage award so that the 9th Circuit could conclude there was no unconstitutional “taking without just compensation” by the state. Clearly, the 9th Circuit had to turn nearly all of the law regarding judgments into Gumbies that could be twisted and turned into any desirable shape. This type of legal reasoning, getting to the desired end by torturing fundamental legal principles until they surrender, brings our courts into disrepute and makes all of our rights subject to political and social expediency. That this happens in employment cases with regularity is of no small concern, either.

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