Pastore Wins Payout for Large Investment Bank After Cross-Country Federal Court Litigation Saga

Pastore LLC has won multiple complex securities and M&A actions arising from a derivative rights holder agreement and related investment banking engagement agreements that secured its client’s indemnification rights. This brings an end to the saga between the Defendant, a large investment banking firm, and the Plaintiff, a representative of the shareholders to a company seeking to invalidate investment banking fees owed following a series of complex insurance corporate mergers.

After first securing its investment banking client’s indemnification rights, Pastore LLC successfully defended its client against a multimillion-dollar suit in the United States District Court for the District of Nebraska, obtaining a dismissal of the Plaintiff’s action. After Plaintiff appealed the District of Nebraska’s decision to dismiss the case, Pastore LLC successfully defended its client before the Eighth Circuit. The Eighth Circuit affirmed the District Court ruling in Pastore LLC’s clients’ favor that Plaintiff-Appellants lacked standing.

Plaintiff then brought his same claims against Pastore LLC’s client in the District Court of Delaware only to have the investment bank, yet again, successfully obtain a dismissal of Plaintiff’s action. Pastore LLC’s first Motion to Dismiss in the Delaware District Court action caused Plaintiff to file an Amended Complaint. Its second Motion to Dismiss was granted by the District Court. In its Memorandum Opinion, the District Court agreed that Plaintiff’s claims were batted by the doctrine of res judicata and that the Plaintiff lacked standing to assert its claims.

As a result of the litigation between the Plaintiff and Pastor LLC’s client, from the District of Nebraska to the Eight Circuit and then again in the District of Delaware, Pastore LLC secured its client’s indemnification rights, which included Pastore LLC’s legal fees, and obtained a large payout for its client.

Pastore LLC attorneys have vast experience arguing and defending matters in various federal courts across the country and are well-situated to handle similar claims involving complex contractual and investment banking issues.

Pastore Obtained an Injunction Requiring Return of PPP Funds in National Matter

Pastore successfully represented its client, a Registered Investment Adviser, in a preliminary injunction hearing against a national bank on an issue regarding a Paycheck Protection Program (“PPP”) loan. The hearing was held virtually in the Supreme Court of New York. The bank had taken out PPP loan money from Pastore’s client’s account and provided default notices to the client. Pastore filed for injunction on behalf of its client and the Court agreed with Pastore that the bank had interfered with its client’s ability to apply for forgiveness. The Court directed the bank to put the money in an escrow account and allow the client’s application for forgiveness to proceed through the proper channels. If the loan is forgiven, the money will be released to its client.

Pastore Retained to Advise Multibillion-dollar Registered Investment Advisor in Restructuring

Pastore was retained to advise a multi-billion-dollar registered investment advisor and related private equity funds on the restructuring of the advisor. Pastore advised the advisor and private equity funds in connection with modifications to ownership structure, distribution rights, employment rights, indemnification, and banking issues. Pastore also assisted in substantial revisions to the advisor’s Form ADV, other SEC filings, Compliance Manual, Corporate Governance documents, and Policies and Procedures.

Pastore Obtains an Injunction Requiring Return of PPP Funds in National Matter

Pastore & Dailey successfully represented its client, a Registered Investment Adviser, in a preliminary injunction hearing against a national bank on an issue regarding a Paycheck Protection Program (“PPP”) loan. The hearing was held virtually in the Supreme Court of New York. The bank had taken out PPP loan money from Pastore & Dailey’s client’s account and provided default notices to the client. Pastore & Dailey filed for injunction on behalf of its client and the Court agreed with Pastore & Dailey that the bank had interfered with its client’s ability to apply for forgiveness. The Court directed the bank to put the money in an escrow account and allow the client’s application for forgiveness to proceed through the proper channels. If the loan is forgiven, the money will be released to its client.

Pastore & Dailey Retained by Leading Cryptocurrency Firm

Pastore & Dailey has been retained by a leading cryptocurrency firm specializing in decentralized finance in connection with regulatory and compliance matters in the Cayman Islands and internationally.  Pastore & Dailey has substantial experience and the burgeoning business of cryptocurrency having represented in 2020 a cryptocurrency mining company, and defended a Department of Justice (DOJ) investigation into an initial coin offering.

Pastore & Dailey attorneys have served as Chief Compliance Officer’s at multi-billion-dollar investment advisers and two of the largest institutional banks in the world. Thus, the firm is uniquely positioned to handle this and similar matters.

Pastore Advises Clients on Accredited Investors

Recently, Pastore & Dailey advised clients on a unique issue related to accredited investors.  The client, an SEC registered investment advisor, asked Pastore & Dailey whether the death of an accredited investor had any legal implications for the funds it manages when the accredited investor bequeathed his investment to a non-accredited investor.  The simple answer is no.

Under the securities laws, the term “sale” is defined as to include every contract of sale or disposition of a security or interest in a security, for value. Additionally, the term “offer to sell”, “offer for sale”, or “offer” is defined to include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.  15 U.S.C. § 77b(a)(3).

Thus, an involuntary transfer by operation of law, such as a divestment of an investment upon death to beneficiaries will not be considered a “sale” or an “offer to sell.”  Therefore, the recipient is not required to be an accredited investor.

Special Rule for Family Offices

Pastore & Dailey also advised the client on the legal implications of this unique circumstance when the accredited investor is a family office.

An accredited investor now includes any family office as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (“Advisers Act”): (i) with assets under management in excess of $5,000,000, (ii) that is not formed for the specific purpose of acquiring the securities offered, and (iii) whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.  17 C.F.R. § 230.51(a)(12).

The accredited investor definition was also expanded to include a family client, as defined in Rule 202(a)(11)(G)-1 under the Advisers Act.  A family client as defined in Rule 202(a)(11)(G)-1 is: (i) Any family member; (ii) Any former family member; or (vi) Any estate of a family member, former family member or key employee.  17 C.F.R. § 275.202(a)(11)(G)-1(d)(4).

In the Adoption Release, the SEC explained that it is not excluding from the accredited investor definition a beneficiary that temporarily qualifies as a family client under the family office rule.  Thus, a beneficiary who receives the stocks from the decedent will be considered a family client for purposes of the accredited investor definition for exactly one year.  SEC Release No. 33-10824, August 26, 2020.

There are limitations to this rule.  Although a beneficiary would not be required to unwind any of the securities received in an involuntary transfer, the beneficiary would not be considered an accredited investor in connection with the purchase of additional securities, unless the beneficiary qualified as an accredited investor on another basis.[1]

In conclusion, the requirement that an offering or sale of restricted securities be made to an accredited investor applies at the “time of sale of the securities to that person.” Thus, an involuntary transfer such as a divestment of shares to a beneficiary upon death of the accredited investor should not pose a problem for a testator and their funds.

Summary

As the requirement that an offering or sale of restricted securities be made to an accredited investor applies at the “time of sale of the securities to that person,” a involuntary transfer, such as a divestment of shares to a beneficiary upon death of the accredited investor should not pose a problem for an RIA and its funds.

__________________________________________________________________________________________

[1] SEC Expands the “Accredited Investor” and “QIB” Definitions and the Permitted Scope of “Testing the Waters.” Proskauer. September 9, 2020. https://www.proskauer.com/alert/sec-expands-the-accredited-investor-and-qib-definitions-and-the-permitted-scope-of-testing-the-waters#_ftnref3

Pastore & Dailey has been retained in DOJ Crypto Currency Proceeding

Pastore & Dailey has been engaged as co-counsel to an Am Law 50 Firm in a Department of Justice (DOJ) investigation into an initial coin offering. The matter is pending in the District of New Jersey and involves the creation of a Bloomberg terminal for the cryptocurrency industry. The software created by the start-up was designed to provide all data related to thousands of cryptocurrencies and the crypto trading functionality was to be provided through third parties accessible through the terminal.

PPP Flexibility Act of 2020 Update

As of June 17, 2020, the Small Business Association (SBA), along with the Department of Treasury, has passed revisions to the loan forgiveness application under the Paycheck Protection Program (PPP) Flexibility Act of 2020 that was signed into law by President Trump on June 5, 2020. 

The newly issued application forms and instructions are available in both a full and an EZ version. The EZ application is less intensive and requires fewer calculations and documentation for borrowers. If an applicant wants to use the EZ form, it must be able to answer at least one of the three questions on the face of the EZ Instructions in the affirmative. Both applications offer borrowers the choice to use the 8-week covered period if their loan was made before June 5, 2020, or an extended covered period of 24 weeks. 

It is particularly important that eligible applicants for PPP loan forgiveness have available all the necessary documentation at the time of application. Late submission of documentation will disqualify an applicant for forgiveness.

These changes were made with the intention of increasing the efficiency and availability of full loan forgiveness for businesses. 

Managing Documentation of Your PPP Loan

To date, nearly 18.5 thousand Connecticut businesses have received forgivable loans under the Paycheck Protection Program. This note will briefly review some of the recordkeeping requirements of the program you should keep in mind if you anticipate being able to qualify for loan forgiveness.

The program requires that borrowers meet two tests for loan forgiveness:

  • The loan proceeds are used to cover payroll costs, and most mortgage interest, rent, and utility costs over the 8 week period after the loan is made; and
  • Employee and compensation levels are maintained

The loan proceeds may only be used for four categories of business expenses:

  • Payroll costs, including benefits. Payroll costs include –
    • Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
    • Employee benefits including costs for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payments required for the provisions of group health care benefits including insurance premiums; and payment of any retirement benefit;
    • State and local taxes assessed on compensation; and
    • For a sole proprietor or independent contractor: wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis for each employee
  • Interest on mortgage obligations, incurred before February 15, 2020;
  • Rent, under lease agreements in force before February 15, 2020; and
  • Utilities, for which service began before February 15, 2020

Payroll costs also include employee benefits such as parental leave, family leave, medical leave, and sick leave.  Note, however, that the CARES Act, P.L. 116-136, excludes qualified sick and family leave wages for which a credit is allowed under section 7001 and 7003 of the FFCRA, P.L. 116-127. You can read an IRS summary of this credit here.

The CARES Act also excludes from payroll costs the following:

  • Any compensation of an employee whose principal place of residence is outside of the United States; and
  • Federal employment taxes imposed or withheld between February 15, 2020 and June 30, 2020, including the employer’s share of FICA and Railroad Retirement Act taxes

Mortgage prepayments and principal payments are not permitted uses of PPP loan proceeds. Borrowers will need to request loan forgiveness from their lenders. The request must include:

  • Verification of the number of employees and pay rates
  • Payments made on eligible mortgage, lease and utilities
  • Documentation that you used the forgiven amount to keep employees and make the eligible mortgage, lease, and utility payments

This documentation will generally take the form of:

  • Payroll reports from your payroll provider
  • Payroll tax filings, including Form 941
  • State income, payroll, and unemployment insurance filings
  • Documentation of retirement and health insurance contributions
  • Documentation of payment of eligible expenses. This documentation should meet the same standards as your documentation of business expenses on your tax return. Invoices matched with cancelled checks, payment receipts, and account information
  • Documentation that you used at least 75% of your loan for payroll costs

Lenders are expected to require forgiveness documentation to be provided in digital form, so borrowers should get scanning done in advance.

Lenders must rule on forgiveness within 60 days of the borrower’s request. In some cases, borrowers may be asked to provide additional documentation.

If you are not approved for loan forgiveness, your loan balance will continue to accrue interest at the rate of 1% annually for the remainder of the two-year loan period.

These notes review general principles only and are not intended as tax or legal advice.  Readers are cautioned to discuss their specific circumstances with a qualified practitioner before taking any action.

Are RIAs Eligible for PPP?

Is a Registered Investment Advisor (“RIA”) eligible to participate in the Payment Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”)? The short answer is “yes.”

The PPP was promulgated as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) which in part set aside hundreds of billions of dollars to help small businesses retain their employees during the COVID-19 crisis and the resultant work from home orders set forth by governors across the country.

Background

We understand that many RIAs applied for and were granted a loan under the CARES act, and that some of these RIAs may be unsure of whether they were granted the loan in error, how they may spend the loan funds or if they can spend the loan funds. The guidance below will hopefully answer some of these questions because applying for and receiving a PPP loan in a knowingly false fashion is a criminal offense, and we strongly encourage any RIA unsure of its PPP eligibility to seek particular legal advice.

The guidance below hinges on whether an RIA engages in speculative operations, holds any securities or other speculative assets, or is simply engaged in financial advisory services.

SBA Guidance

The SBA published an Interim Final Rule on April 2, 2020 (the “Interim Final Rule”). Specifically, the Interim Final Rule provides that “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2….” (the “SOP”).

Some of the ineligible financial markets and funds businesses listed in the SOP include, without limitation:

  • Banks;
  • Life insurance companies (but not independent agents);
  • Finance companies;
  • Investment companies;
  • Certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
  • Speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

On April 24, 2020, the SBA issued its Fourth Interim Final Rule on the PPP (the “Fourth Interim Final Rule”). The Fourth Interim Final Rule explicitly states that hedge funds and private equity firms are not eligible for a PPP loan.

Discussion

Ineligible Companies.

If the RIA is also a hedge fund or a private equity firm, then it may not be eligible to receive a PPP loan. If, however, the RIA is legally distanced from those entities through appropriate corporate structures, and the loan is only used for the RIA business, then the RIA should be eligible to receive the PPP funds.

Because most RIAs are not also banks or life insurance companies, the exclusions should not apply. However, as some RIAs also sell life insurance products, such individual situations may require more research.

Finance companies are also ineligible under the SBA guidelines to receive PPP funds. The SBA guidelines define a finance company as one “primarily engaged in the business of lending, such as banks, finance companies, and factors.” (Sec. 120.110(b) of the SBA’s Business Loans regulations). Thus, this exclusion should not apply. Similarly, an RIA may not be deemed an investment company, which is a company organized under the Investment Company Act of 1940, unless the RIA was in fact incorporated under that Act.

An RIA also may not meet the definition of a “speculative business” as defined above in the Interim Final Rule. If an RIA does not purchase or hold assets until the market price increases or engage in a risky business for the chance of an unusually large profit, then it will not meet this definition. Speculative businesses may also include: (i) wildcatting in oil, (ii) dealing in stocks, bonds, commodity futures, and other financial instruments, (iii) mining gold or silver in other than established fields, and (iv) building homes for future sale, (v) a shopping center developer, and (vi) research and development. (Sec 120.110(s) of the SBA’s Business Loans regulations, SBA Eligibility Questionnaire for Standard 7(a) Guaranty and SOP Subpart B D (Ineligible Businesses).  It is our understanding that an RIA that merely provides portfolio management services would not be deemed to be involved in a “speculative” business based on the examples of such businesses provided by the SBA. If the SBA had taken the position that financial advisory services are speculative, it could easily have so indicated by including such services in its lists of speculative services.

Financial Advisory Services.

Consistent with this view, the SBA has provided clear guidance that financial advisory services are eligible for SBA loans, including loans under the PPP. In the SBA’s SOP, the SBA provides the following: “A business engaged in providing the services of a financial advisor on a fee basis is eligible provided they do not use loan proceeds to invest in their own portfolio of investments.” (SOP Sec III(A)(2)(b)(v) pp.104-105) (emphasis added).

This guidance is clear that the focus of ineligibility is at the portfolio company level, not the advisory level, and this is consistent with the guidance noted above making hedge funds and private equity firms ineligible. Hedge funds and private equity firms make money based upon speculative investments and/or appreciation of the markets. An investment advisor operates at the consulting or services level. In other words, the SBA has distinguished between true speculative operations such as wildcatting, speculative real estate development and investing in securities, and service-based operations such as the investment advisory business. Assuming that an eligible RIA did not use any proceeds of the PPP loan at any investment level, such RIA should not be deemed a speculative business and is eligible for a PPP loan.

SEC Guidance

SEC guidance affirms that RIAs are eligible for PPP loans. While the SEC imparts certain burdens on RIAs that accept PPP loans, the fact that the SEC even acknowledges such burdens should give most RIAs confidence that a PPP loan is available to them.

For RIAs who are eligible to receive PPP funds under the SBA guidance set forth above, the SEC instructs that they must comply with their fiduciary duty under federal law and make a full and fair disclosure to their clients of all material facts relating to the advisory relationship. The SEC further posits that “If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance.” An example of a situation the SEC would require such disclosures would be an RIA requiring PPP funds to pay the salaries of RIA employees who are primarily responsible for performing advisory functions for clients of the RIA. In this case the SEC would require disclosure as this may materially affect the financial well-being of an RIA’s clients.

The SEC additionally provides that “if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients, you may be required to disclose this financial condition in response to Item 18 (Financial Information) of Part 2A of Form ADV (brochure), or as part of Part 2A, Appendix 1 of Form ADV (wrap fee program brochure). (SEC Division of Investment Management Coronavirus (COVID-19) Response FAQs).

Summary

While the Cares Act and PPP are recently enacted, and there is some confusion surrounding the eligibility requirements for the PPP, the SBA had a clear opportunity to deem financial advisors ineligible in the Interim Final Rule and Fourth Interim Final Rule, but specifically chose not to do so. Instead, the SBA followed the direction of its historical eligibility requirements, holding to ineligibility at the fund and portfolio company level, but continuing to permit loans to firms operating at the advisory level.

While it is possible that the SBA could interpret its own rules and regulations inconsistently with the specific guidance provided in the Interim Final Rule and Fourth Interim Final Rule, the weight of the evidence strongly suggests that an investment advisor is eligible for a PPP loan as long as it does not use the proceeds for fund or portfolio company purposes.