Food Labeling and Marketing after POM LLC v. Coca-Cola Co.: Why Compliance with FDA Regulations May Not Be Enough

On June 12, 2014, the United States Supreme Court issued a unanimous decision in POM Wonderful LLC v. Coca-Cola Co., holding that competitors may bring Lanham Act claims challenging food and beverage labels regulated by the federal Food, Drug, and Cosmetics Act (“FDCA”). (For the full text of the Supreme Court’s decision, please click here.) In this landmark decision, the Supreme Court overturned the Court of Appeals for the Ninth Circuit’s decision as “incorrect,” holding that “[n]either the Lanham Act nor the FDCA, in express terms, forbids or limits Lanham Act claims challenging labels that are regulated by the FDCA.” As we discuss in greater detail below, this decision could play a significant role in changing the landscape of food labeling and marketing because it puts industry on notice that complying with FDA regulations and policies will not be enough to shield against lawsuits from competitors, and potentially even consumers.

Background

POM Wonderful LLC (“POM”) filed a Lanham Act claim against its competitor, Coca-Cola Co. (“Coca-Cola”), for the labeling of its “pomegranate blueberry” juice blend. POM alleged that the name, label, marketing, and advertising of Coca-Cola’s juice blend misled consumers into believing that it consisted predominantly of pomegranate and blueberry juice, when in reality it only contains 0.3% and 0.2% of each juice, respectively. In response, Coca-Cola argued that its label was perfectly compliant with FDA regulations governing juice labels and therefore POM’s Lanham Act claim was precluded.

The Lanham Act was passed by Congress to regulate commerce and, among other things, to create a cause of action for unfair competition through misleading advertising or labeling. Under this provision of the Lanham Act, competitors, and not consumers, are the intended beneficiaries of enforcement. See 15 U.S.C. §1125. The FDCA, on the other hand, is intended to protect the health and safety of the public and contains specific provisions prohibiting any food or beverages in commerce from being misbranded. Under the FDCA, a food or beverage may be deemed “misbranded” if, inter alia, “its labeling is false or misleading,” information required to appear on its label “is not prominently placed thereon,” or a label does not bear the “common or usual name of the food, if any there be.” See 21 U.S.C. §§343.

After POM sued Coca-Cola in the United States District Court for the Central District of California, the court ruled that the FDCA and its regulations preclude challenges to the name and label of Coca-Cola’s juice blend. (To read the full text of this opinion, please click here.) The District Court explained that “the FDA has directly spoken on the issue” through its regulations, where the regulations “ha[ve] not prohibited any, and indeed expressly ha[ve] permitted some” aspects of Coca-Cola’s labeling. On appeal, the Ninth Circuit affirmed the District Court’s decision, reasoning that Congress decided “to entrust matters of juice beverage labeling to the FDA.” (To read the full text of the Ninth Circuit’s decision, please click here.) In its decision, the Ninth Circuit barred POM’s Lanham Act claim “[o]ut of respect for the statutory and regulatory scheme,” and to avoid the “risk [of] undercutting the FDA’s expert judgments and authority.” The Supreme Court granted certiorari to consider whether a private party may bring a Lanham Act claim challenging a food label that is regulated by the FDCA. (For additional coverage of the Supreme Court’s decision, please click here, here, here, and here.)

United States Supreme Court Decision

At the outset of its opinion, the Supreme Court framed this case as “concern[ing] the intersection and complementarity” of the Lanham Act and the FDCA. In its decision, the Supreme Court relied on traditional rules of statutory interpretation and dedicated much of its opinion to a thorough analysis of Congressional intent. The Supreme Court held that nothing in the express terms of the text, history, or structure of the Lanham Act or the FDCA forbids or limits competitors from bringing Lanham Act claims to challenge labeling regulated by the FDCA. To emphasize that Congress did not intend for Lanham Act claims to be precluded, the Supreme Court gave significant weight to the fact that Congress amended the FDCA to include an express preemption provision with respect to state laws addressing food and beverage misbranding, but did not create a similar preclusion of other federal laws. In light of the 70-year co-coexistence of the FDCA and the Lanham Act, the Supreme Court viewed Congress’s inaction as “powerful evidence that Congress did not intend FDA oversight to be the exclusive means” of ensuring proper food and beverage labeling.

Furthermore, the Court recognized the limits on FDA’s regulatory oversight and competence on competitive practices in the marketplace. In reversing the Ninth Circuit, the Supreme Court reasoned that competitors “have detailed knowledge regarding how consumers rely upon certain sales and marketing strategies” and an “awareness of unfair completion practices [that] may be far more immediate and accurate than that of agency rulemakers and regulators.” The decision implied that competition in the marketplace and consumer safety are better preserved by allowing both Lanham Act claims and administrative regulation and enforcement under the FDCA.

The Court emphasized that “[i]t is unlikely that Congress intended the FDCA’s protection of health and safety to result in less policing of misleading food and beverage labels than in competitive markets for other products.” Therefore, to find that Lanham Act claims are precluded by the FDCA would, according to the Supreme Court, “not only ignore the distinct functional aspects of the FDCA and the Lanham Act but also would lead to a result that Congress likely did not intend.”

In addition, the Supreme Court rejected Coca-Cola’s argument that preclusion is proper because Congress intended national uniformity in food and beverage labeling. The Supreme Court explained that the centralization of FDCA enforcement authority in the Federal Government “does not indicate that Congress intended to foreclose private enforcement of other federal statutes.” Because the Lanham Act and FDCA can be implemented together, the Court concluded that the FDCA’s greater specificity with respect to food labeling does not create any more or different variability in food labeling than that of any other industry. Based on the Court’s interpretation of the two statutes, “neither the statutory structure nor the empirical evidence” presented any difficulty in fully enforcing each statute according to its terms.

What Does This Mean? What are the Implications of this Decision?

At first glance, the POM decision may appear narrow in its application to food labeling and advertising. However, the rationale used in the Supreme Court’s opinion could have a much more expansive impact on the way the courts construe the interplay of federal statutes that have overlapping applications. Furthermore, it seems possible that this opinion could be expanded to apply to other federal regulatory bodies, like the U.S. Department of Agriculture (“USDA”) and the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), which require similar labeling requirements under their respective regulatory frameworks.

For example, in a blog entry we posted prior to the Supreme Court’s POM decision, we discussed how the FTC’s regulation of advertising and promotion of FDA-regulated products can create a complex and confusing regulatory framework for industry. Because both agencies have enforcement authority over product promotion but different standards and regulations, the blurred jurisdictional lines fail to provide industry with a clear directive as to which agency’s set of standards it should comply. Under this framework, for example, a product’s labeling claim may comply with the FDCA’s regulations and still run afoul of the FTC’s policies as misleading or lacking adequate substantiation. Therefore, in the absence of clear guidance, industry is forced to guess how its products will be regulated and which standards it must meet to be compliant with both sets of federal laws and regulations. (For more information on this topic, please also read the article “Need for Regulatory Harmonization: How FDA and FTC’s Shared Jurisdiction Poses Problems for Labeling& Advertising Compliance” here.)

The Supreme Court’s POM decision seems to lead industry down a similar rabbit hole. On the one hand, the Supreme Court’s decision emphasizes the importance of compliant labeling under the FDCA. However, the same opinion informs industry that the very same FDCA-compliant labeling can be brought before a court for misleading consumers in violation of the Lanham Act. In the absence of clear guidance, however, it is unclear what, if any, compliance measures may fully immunize manufacturers under all of the applicable laws.

For these reasons, this decision will likely have a significant impact on how manufacturers will choose to label and advertise their food products in the future. In order to minimize the risk of a possible enforcement or legal action, industry should not only ensure that their product labeling complies with the FDCA’s misbranding provisions, but should also be prepared to defend against any possible challenges to the truthfulness and accuracy of any labeling or advertising claims they make. In particular, industry should be prudent in analyzing their labeling and advertising to ensure that the overall context of their claims do not rise to the level of false or misleading claims under the Lanham Act, FTC Act, and state laws governing deceptive advertising.

While it remains to be seen how courts will rule on the merits of future Lanham Act claims like POM’s, it seems evident that industry will have to take more expansive precautions to insulate themselves from advertising and labeling lawsuits in the post-POM era. Fuerst Ittleman David & Joseph, PL will continue to monitor any developments in the regulation of food labeling and advertising. The attorneys in our Food, Drug, and Life Sciences practice group are experienced in assisting regulated industry to ensure that products are marketed and advertised in compliance with all applicable federal laws and regulations. For more information, please call us at (305) 350-5690 or email us at contact@fidjlaw.com.

U.S. District Court rules that FTC can regulate payday lenders regardless of American Indian Tribal affiliation, finds lender violated FTCA.

Generally speaking, those who wish to engage in payday lending will find that the industry is heavily regulated. In addition to regulation at the state level, payday lenders must comply with a wide variety of federal laws such as the Truth in Lending Act (“TILA”), and its implementing regulations known as Regulation Z, which requires that lenders disclose loan terms and APR to potential consumers, and the Electronic Funds Transfer Act (“EFTA”), which prohibits lenders from requiring, as a condition of loan approval, a customer’s authorization for loan repayment through a recurring electronic fund transfer. In addition, violations of the TILA and the EFTA can subject payday lenders to liability under the Federal Trade Commission Act (“FTCA”) for unfair or deceptive business practices.

In an effort to skirt federal and state regulation, many payday lenders have established affiliations with American Indian tribes and conduct their lending activities on tribal lands. However, it has been the position of the Federal Trade Commission (“FTC”) that the FTCA and various other laws apply to payday lenders regardless of American Indian tribal affiliations. Recently, the issue of whether the FTC had jurisdiction over payday lenders operating in affiliation with American Indian tribes was the subject of a series of federal court decisions in the case of Federal Trade Commission v. AMG Services, Inc. Not only do the recent decisions clarify the authority of the FTC in its regulation of all payday lenders, but the decisions also highlight the potential multiple liabilities payday lenders face when they fail to adequately disclose terms mandated by the TILA.

In AMG, the FTC sued numerous payday lenders operating in affiliation with American Indian Tribes for violations of the FTCA related to improper disclosures of terms under the TILA and EFTA violations. In response, AMG argued that they were exempt from regulation and FTC enforcement because of their affiliation with the American Indian tribes. In deciding the issue, the District Court of Nevada ruled on two separate issues: 1) whether the FTC had authority to regulate payday lenders operating in affiliation with American Indian Tribes; and 2) if so, whether the lenders’ conduct violated the FTCA.

In finding that the FTC can regulate payday lenders operating in conjunction with American Indian tribes, the Court found that the FTCA is a broad statute of general applicability which grants the FTC the authority to bring suit against “any person, partnership, or corporation for violating any provision of law enforced by the FTC.” Thus, the District Court found that “the FTC does have authority under the FTC Act to regulate Indian Tribes, Arms of Indian Tribes, employees of Arms of Indian Tribes and contractors of Arms of Indian Tribes.” A copy of the District Court’s order can be read here and the FTC’s press release on the decision can be read here.

Based upon this finding, on June 4, 2014, the court issued its second ruling in the AMG matter finding that the payday lenders violated the FTCA by imposing undisclosed charges and inflated fees which AMG failed to disclose to its customers. The Court found that while AMG disclosed its initial fee and APR rate in the loan documents, it was AMG’s practice to conceal and scatter the terms of its automatic rollover program through the loan agreement such that the program’s existence was hidden. (“Rollover” is a term used to describe the extension of a payday loan. In circumstances where a borrower cannot repay a payday loan, certain states allow for the borrower to extend the term of the loan by paying a fee to the lender. As a result, borrowers will often “rollover” their loan several times resulting in excessive fees paid for the original amount borrowed.) Further, the District Court found the defendants’ own documents showed that defendants’ instructed their employees to conceal how the loan repayment plans worked.

As explained by the District Court:

[T]he net impression of the Loan Note Disclosure is likely to mislead borrowers acting reasonably under the circumstances because the large prominent print in the TILA Box implies that borrowers will incur one finance charge while the fine print creates a process under which multiple finance charges will be automatically incurred unless borrowers take affirmative action.

Thus, because of the misleading net impression created by how the defendants disclosed the terms of their rollover programs, the District Court found the lenders’ practices to be deceptive, misleading, and in violation of the FTCA.

In addition, because the misleading disclosures at issue involved the disclosure of the appropriate finance charge, APR, total number of payments, and the payment schedule, the District Court went on to find that the defendants failed to make appropriate and adequate disclosures as required by the TILA. A copy of the FTC’s press release regarding the District Court’s decision can be read here and the order of the District Court can be read here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, regulatory compliance, and litigation against the U.S. Department of Justice. Our anti-money laundering practice has extensive experience in working with MSBs and other non-bank financial institutions, including payday lenders, in all aspects of their business. In addition, our attorneys have experience working with regulated industry to ensure that marketing, advertisements, and disclosures are in compliance with applicable FTC law and regulation. If you are a financial institution seeking information regarding the steps your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Corporate Compliance Officers Face Threat of Civil Monetary Penalties and Criminal Prosecution for Institutional AML Deficiencies

While financial institutions have long faced the possibility of civil monetary penalties and criminal prosecution for violations of the Bank Secrecy Act (“BSA”) and its implementing regulations, found at 31 C.F.R. Chapter X, a recent FinCEN enforcement action against former MoneyGram chief compliance officer Thomas Haider highlights the most recent trend in BSA enforcement: holding compliance officers personally liable for corporate AML deficiencies.

In November 2012, MoneyGram entered into a deferred prosecution agreement with the United States Department of Justice stemming from allegations that MoneyGram failed to maintain an effective anti-money laundering compliance program and, as a result, aided in multiple instances of wire fraud. In the agreement, MoneyGram admitted that its AML program was ineffective due to the company’s failure to report the perpetrators of the fraud. As part of the deferred prosecution agreement, MoneyGram agreed to forfeit $100 million. A copy of the deferred prosecution agreement can be read here.

Pursuant to 31 U.S.C. § 5324, FinCEN is authorized to assess civil monetary penalties against a financial institution and its partners, directors, officers, or employees for violations of the Bank Secrecy Act. At the time of the signing of the deferred prosecution agreement, FinCEN did not assess any additional civil monetary penalties. However, as reported in a recent Reuters article, earlier this year, FinCEN sent former MoneyGram chief compliance officer Thomas Haider a letter notifying him of that he may be liable for a potential civil monetary penalty of $5 million stemming from the admissions made by MoneyGram in its deferred prosecution agreement. A copy of the article can be read here.

The Haider penalty comes as FinCEN has faced increased pressure from Congress to hold individual officers and personally accountable for institutional BSA violations in the wake of the HSBC Consent Decree and Deferred Prosecution Agreement wherein HSCB agreed to a record $1.9 billion in penalties but no individuals were held civilly or criminally liable. After the HSBC case concluded and in the face of mounting pressure from Congress, Treasury undersecretary David Cohen assured the Senate Banking Committee that FinCEN would look for more opportunities to issue civil penalties to partners, officers, directors, and employees of financial institutions who actively participated in the misconduct. A transcript of Mr. Cohen’s testimony before the Senate Banking Committee can be read here.

FinCEN’s new focus on individual corporate compliance officer liability has drawn harsh criticism from the regulatory compliance community for the potential chilling effect it will have on financial institutions’ willingness to cooperate with law enforcement and on quality personnel avoiding entering the field. As explained by Rob Rowe of the American Bankers Association in a recent interview, the potential for corporate officer civil liability, regardless of the amount, “will cause all compliance officers to think” and could “lead to a shortage of compliance officers.”

Although cases like Mr. Haider’s are relatively new in the BSA/AML environment, they are not unique, and we can point to various cases in other environments where individuals have been held personally liable for institutional misdeeds. For example, as we previously reported, although criminal sanctions against corporate officers for violations for the Food, Drug & Cosmetic Act (FDCA) have been on the books since 1938, federal prosecutors have recently taken aim at individual executives through the use of the “responsible corporate officer doctrine,” better known as the Park doctrine. (More information regarding the Park doctrine can be read in our other reports here, here, here, and here.)

We will continue to watch for the latest developments. Fuerst Ittleman David & Joseph’s Anti-Money Laundering practice covers a wide range of businesses and legal issues. Our AML attorneys advise a wide variety of financial institutions regarding their licensing and anti-money laundering requirements as set forth by the Bank Secrecy Act and individual state laws. The anti-money laundering law firm of Fuerst Ittleman David & Joseph, PL has represented a wide array of financial services providers in IRS-BSA audits, OFAC licensing issues, grand jury investigations, state investigations, criminal and civil litigation, and commercial transactions. For more information regarding the Bank Secrecy Act or if you seek further information regarding the steps which your business must take to become or remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

International Tax Compliance Update: IRS Hints at Coming Changes for Certain OVDP Filers

Remarks on Monday by John Koskinen, the Commissioner of Internal Revenue, indicate that the IRS is close to conceding to outside pressure to more clearly distinguish between Offshore Voluntary Disclosure Program (OVDP) filers whose past reporting failures were willful and those whose reporting failures do not rise to the traditional level of willfulness.

Specifically, speaking at the U.S. Council for International Business-OECD International Tax Conference in Washington, Koskinen noted with regard to the currently effective 2012 OVDP that “we [the IRS] are currently considering making further program modifications to accomplish even more. We are focusing on whether our voluntary programs have been too focused on those willfully evading their tax obligations and are not accommodating enough to others who don’t necessarily need protection because their compliance failures have been of the non-willful variety.”

As an example, Koskinen stated

We are well aware that there are many U.S. citizens who have resided abroad for many years, perhaps even the majority of their lives. We have been considering whether these individuals should have an opportunity to come into compliance that doesn’t involve the type of penalties that are appropriate for U.S.-resident taxpayers who were willfully hiding their investments overseas. We are also aware that there may be U.S.-resident taxpayers with unreported offshore accounts whose prior non-compliance clearly did not constitute willful tax evasion but who, to date, have not had a clear way of coming into compliance that doesn’t involve the threat of substantial penalties.

The Willfulness Standard

The most common federal tax crimes require the government to prove that the taxpayer acted “willfully” in violating the specific statute. For example, IRC § 7201 makes it a felony to “willfully attempt in any manner to evade or defeat any tax imposed by this title or the payment thereof…” Similarly, IRC § 7203 prohibits “willfully” failing to pay estimated tax, pay tax, make a return, keep required records, or supply required information.

In the criminal context willfulness is usually defined as the intentional violation of a known legal duty. Implied in this definition is a level of bad faith on the taxpayer’s part—the taxpayer knew the law but intentionally chose to violate it. The willfulness requirement is designed to prevent individuals who sincerely believe they are not violating the law from being convicted for actions that meet every other element of the subject criminal statute. Willfulness is based on the subjective state of mind of the defendant. One’s honest belief that he or she was acting lawfully, or one’s honest failure to be aware that he or she was acting unlawfully, is a defense to willfulness tax crimes. Cheek v. United States, 498 U.S. 192 (1991).

Willfulness in the civil context is defined by a lower standard. Generally actions that rise to the level of reckless disregard of, or willful blindness to, legal obligations are sufficient to establish civil willfulness. See United States v. Williams, 489 Fed. Appx. 655, 658-59 (4th Cir. 2012). The distinction between criminal and civil willfulness lies in the fact that a civil defendant does not have to be specifically aware of his legal obligation to willfully violate it. However, in both the civil and criminal context, willfulness requires a heightened level of misconduct by the defendant. Honest mistakes, or honest failures to become apprised of a legal obligation, should not give rise to a willful violation of the law, and the attendant penalties, in either the criminal or civil contexts.

The Problem: “Willfulness” Disregarded in the OVDP

To date, the willfulness requirement for most tax crimes and civil penalties has proven to be too nuanced for the OVDP. As a result, taxpayers who willfully violated tax laws, particularly the requirement to disclose the existence of foreign financial accounts when their aggregate balance exceeds $10,000 (generally known as the FBAR requirement), are given the same protections, and penalized in the same manner, as those who did not willfully violate the tax laws. In order to understand the practical effect of generally treating all OVDP filers the same way, it is helpful to understand how the OVDP works.

Generally speaking, the OVDP offers the chance for amnesty from criminal prosecution in exchange for making a full disclosure about past, offshore tax non-compliance. We have written about the OVDP here, here, and here. The OVDP is designed for taxpayers holding assets offshore who have failed to report the existence of those assets and the income generated by them. In return for the reduced risk of criminal prosecution, OVDP filers are generally required to pay all back taxes, interest, accuracy related penalties under IRC § 6662(a), and a single penalty of 27.5 percent of the highest average annual balance in their offshore accounts over an eight year look-back period (unreported offshore assets, such as real property or artwork, that are related to tax non-compliance must also be included in the base amount from which the 27.5 percent penalty is calculated).

In many circumstances, while the 27.5 percent penalty is significant, it is less than the total penalties the taxpayer would otherwise have to pay, which can include penalties for failure to file FBARs, fraud penalties, and penalties for failure to disclose ownership in foreign corporations or trusts. For instance, if a taxpayer’s failure to file an FBAR is determined to be willful, the penalty for each year can be up to 50 percent of the maximum account balance. If a taxpayer has an offshore account with a million dollars in it, the penalties imposed for willful FBAR violations over several years would dwarf the penalty imposed by the OVDP.

However, for many taxpayers, the failure to file FBARs or meet other disclosure or reporting requirements was not willful. Many U.S. citizens living abroad are honestly and justifiably unaware of their obligation to report their foreign accounts, or even pay U.S. tax. Many U.S. citizens are titled on, or have a beneficial interest in, foreign, interest bearing accounts without being aware of their status as to the account. For these taxpayers, their FBAR violations do not rise to the level of an “intentional violation of a known legal duty” or “reckless disregard” of a legal obligation and should therefore not be considered willful, either criminally or civilly. However, many taxpayers, when faced with any risk of criminal prosecution or a finding that their FBAR violations could be considered civilly willful and therefore give rise to massive penalties, choose to take the safe route and enter the OVDP.

Once admitted to the OVDP, taxpayers are subject to a penalty regime that offers very little flexibility. That is, regardless of the level of willfulness involved in their tax non-compliance, the same 27.5 penalty is generally imposed and taxpayers are granted the same general reduction in the likelihood of criminal prosecution. For that reason, the OVDP in its current form unfairly favors individuals who willfully engaged in tax-noncompliance, i.e. those that knowingly violated or recklessly disregarded the tax and asset reporting laws. In other words, a taxpayer who willfully fails to file FBARs is subject to the same penalty rate as an individual who did not realize he had signatory authority over offshore bank accounts and thus had an FBAR filing obligation. Further, although the willfully acting taxpayer is much more likely to be subject to criminal prosecution absent the OVDP, both taxpayers will likely receive identical protection against criminal prosecution.

Right to Opt-Out Insufficient

The OVDP in its current form provides taxpayers with the option of “opting out” of the OVDP, and thereby remaining in the OVDP structure but choosing to bear the traditional penalties associated with their non-compliance, as opposed to the 27.5 percent penalty imposed by the OVDP. However, this is often little comfort to taxpayers. Once the opt-out election is made, it is irrevocable and the taxpayer faces the substantial risk that the IRS will undertake a full examination of the years included in the OVDP (as part of the OVDP submission, the taxpayer must agree to extend the statute of limitations to assess tax and FBAR penalties for all years covered by the taxpayer’s disclosure). If anything is uncovered in the examination that was not disclosed in the OVDP submission, the possibility of criminal prosecution reemerges.

Furthermore, the taxpayer again runs the risk of a determination that their FBAR violations were civilly willful, thus risking exposure to significantly higher penalties. This is a particularly strong concern because “willful blindness,” an extremely malleable and difficult to predict standard, is generally sufficient to give rise to a willful, civil FBAR violation which, as described above, can lead to a penalty of 50 percent of the highest balance in the subject account(s) each year for which there was a reporting failure. By opting out, taxpayers expose themselves to the risks they joined the OVDP to avoid in the first place.

Calls for Reform

These disparities have led to calls for the IRS to take a more exact approach in the application of penalties under the OVDP. Currently, there are only three possible penalty rates, 27.5 percent, 12.5 percent, and 5 percent. The 27.5 percent rate applies to the large majority of cases. The 12.5 percent applies only if the taxpayer’s undisclosed accounts and assets did not exceed $75,000 in any of the OVDP years, and the 5 percent rate applies only in narrow circumstances, such as for foreign residents who were unaware they were U.S. citizens, or where the taxpayer did not open the offshore account, had infrequent contact with the account, withdrew less than $1,000 per year from the account, and can prove that all income taxable by the U.S. in relation to the account has been paid. In short, the reduced penalties apply in very narrow circumstances and one misstep can cause a filer to lose the limited opportunity to take advantage of the reduced penalty.

This past January, the National Taxpayer Advocate issued scathing criticism of the current OVDP structure. In part, the Taxpayer Advocate stated:

The FBAR penalties are generally designed to apply to taxpayers who are intentionally evading U.S. tax by hiding significant untaxed assets in offshore accounts. But they are also affecting taxpayers with modest account balances and/or who did not intentionally evade tax, including those with assets in higher tax jurisdictions where no tax evader would reasonably plan to ide assets. In administering this law, the IRS needs to do a better job of recognizing this distinction, and a key part of what is needed is to remove the fear of opting out of the OVD programs.

The fundamental problem, as identified by the National Taxpayer Advocate and others, is that the willfulness requirement has been removed from the analysis of how to penalize non-compliant taxpayers. Whereas generally proving willfulness, either under the criminal or civil standard, is a burden the government must carry in order to convict taxpayers of serious tax crimes or impose significant penalties, once a taxpayer joins the OVDP willfulness is removed from the equation and all non-compliant taxpayers are treated equally.

To remedy this, the National Taxpayer Advocate proposed classifying OVDP filers in three categories:

  • The first category, applicable to taxpayers whose underpayment of tax is below a reasonable threshold, would be permitted to come forward and pay their back tax, interest, and penalty without the imposition of any information-reporting related penalties, such as the FBAR penalty.
  • The second category would cover OVDP filers that cannot meet the threshold of category one, but can provide an explanation as to why their actions were non-willful. They would be required to pay back tax, interest, penalties, and Title 26 information reporting penalties (i.e. failure to file Form 5471 disclosing an interest in a foreign corporation) but not FBAR penalties.
  • The third category would cover all others, and they would be subjected to the currently applicable OVDP penalties (i.e. payment of back tax, penalties, interest, and a single 27.5 percent penalty).

While the structure proposed by the National Taxpayer Advocate is not perfect, it does at least attempt to address the disparity between willful and non-willful non-compliance.

As Commissioner Koskinen’s comments seem to make clear, the IRS finally appears to be headed in that direction. As we have written before, past criticism of the OVDP by the National Taxpayer Advocate has been ignored by the IRS, so the Commissioner’s comments represent a significant step forward. While the Commissioner’s comments were vague, he stated that the IRS’s “goal is to ensure we have struck the right balance between emphasis on aggressive enforcement and focus on the law-abiding instincts of most U.S. citizens who, given the proper chance, will voluntarily come into compliance and remedy past mistakes.” This seems to be an indication that some modification of the current, one-size-fits-all treatment of OVDP filers will be forthcoming.

Moreover, the modification will likely be coming soon as the Commissioner noted “We believe that re-striking this balance between enforcement and voluntary compliance is particularly important at this point in time, given that we are nearing July 1, the effective date of FATCA.” FATCA is a law that generally requires foreign banks and financial institution to disclose their U.S. account holders or face a withholding tax on payments coming from U.S. sources. Its implementation, along with other efforts by the United States to acquire information about offshore accounts held by U.S. taxpayers has placed pressure on foreign banks to disclose their account holders’ identities which, in turn, has placed pressure on non-compliant account holders to address their past non-compliance. The IRS’s proposed modification of the OVDP could not come at a better time, and those contemplating making an offshore voluntary disclosure should give serious consideration to the current circumstances in deciding whether to proceed with a disclosure.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who are seeking to avail themselves of the OVDP. We will continue to monitor the development of these issues, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fidjlaw.com.

FDA Regulatory Update: International Crack Down on Online Pharmacies Identifies Over 1,900 Websites Selling Unapproved or Potentially Counterfeit Drugs to U.S. Consumers

By participating in the organized, global action known as Operation Pangea VII, the U.S. Food and Drug Administration (“FDA”) made good on its promise to continue working with the international community to investigate online pharmacies that sell potentially unapproved, counterfeit, or adulterated drugs and medical devices. (To read the full text of FDA’s press release, please click here.) Between May 13 and May 20, 2014, the FDA partnered with the U.S. Customs and Border Protection (“CBP”), the U.S. Department of Homeland Security, INTERPOL and over 111 law enforcement, customs, and regulatory authorities around the world in targeting websites that sell potentially dangerous, unapproved prescription drugs to consumers. (For additional media coverage of Operation Pangea VII, please click here, here, and here.) This world-wide collaborative effort brought together even more countries than in previous years and required participating countries to carry out “extensive examinations at U.S.-based international mail facilities.” (To read INTERPOL’s summary of Operation Pangea VII, please click here and here.)

Operation Pangea VII resulted in the detention or seizure of 19,618 packages containing over 9.4 million unapproved or suspected counterfeit drugs, including insulin, estrogen, bimatroprost, tramadol, and sildenafil citrate. A large number of these packages claimed to contain medicines from Australia, the United Kingdom, New Zealand, and Canada. Upon further investigation, however, many of those packages were found to contain unapproved or suspected counterfeit drugs from other countries, such as India, China, Singapore, Taiwan, Mexico, Laos, and Malaysia. The total value of these seized and detained products amounted to approximately $36 million.

Based on these findings, regulators and customs authorities across the globe ordered more than 10,000 websites to shut down their operations and remove over 19,000 advertisements for these medicines on social media. Through these efforts, the FDA identified over 1,975 websites as selling products in violation of U.S. law and notified related internet service providers and domain name registrars of the websites’ allegedly violative practices.

Together, the participating countries launched roughly 1,235 investigations and made 239 arrests in connection with online operations for the sale of potentially dangerous or unapproved prescription drugs. Furthermore, INTERPOL’s report explained that Operation Pangea VII “identifi[ed] and dismantle[d] three illicit laboratories in Colombia” and “targeted the main areas exploited by organized crime in the illegal online medicine trade: rogue doman name registrars, electronic payment system and delivery services.” (To read the full text of INTERPOL’s announcement, please click here.)

As we previously reported here, after 2012’s Operation Pangea V, which targeted over 4,100 internet pharmacies and required 18,000 pharmacy websites to shut down their operations, the FDA launched a new website, BeSafeRx: Know Your Online Pharmacy, to provide consumers with information about the dangers of purchasing medicine from online pharmacies. Last year, the FDA participated in Operation Pangea VI, which resulted in the shutdown of over 9,600 websites and seizure of more than $41 million worth of illegal medicines worldwide. (To read the FDA’s announcement regarding Operation Pangea VI, please click here.)  The FDA’s continued participation in Operation Pangea sends a strong signal to industry that the FDA does not plan to back down anytime soon. Rather, it seems clear that the FDA intends to closely monitor online pharmacies and will continue to actively enforce drug and medical device regulations.

Fuerst Ittleman David & Joseph, PL will continue to monitor the regulation of online pharmaceutical drug companies. The attorneys in the Food, Drug, and Life Sciences practice group are well-versed in the complex regulatory framework for prescription drugs and medical devices. If you have any questions or would like more information, please email us at contact@fidjlaw.com or call us at (305) 350-5690.

FDA Publishes New Draft Guidance on Biosimilars As Congress Raises Questions About FDA’s Use of Draft Guidance Documents

As we previously reported here, here, and here, the U.S. Food and Drug Administration (“FDA”) has been drafting guidance regarding the regulation of biosimilars since as early as 2011. A biological product is biosimilar if it is “highly similar to the reference product notwithstanding minor differences in clinically inactive components” and if there are “no clinically meaningful differences between the biological product and the reference product in terms of the safety, purity, and potency of the product.” See section 351(i)(2) of the PHS Act here. The biosimilar approval process is an abbreviated pathway for FDA licensure of biological products that are demonstrated to be biosimilar to or interchangeable with an FDA-licensed reference product under the Biologics Price Competition and Innovation Act (“BPCIA”).

In 2012, the FDA released three guidance documents, which outlined its expectations for submitting applications for biosimilar products to FDA pursuant to the Biologics Price Competition and Innovation Act of 2009 (“BPCIA”). Together, these three draft guidances provided industry with general questions and answers regarding the implementation of BPCIA, as well as scientific and quality considerations for demonstrating biosimilarity to a reference product. The following year, the FDA released a fourth draft guidance document outlining the procedures for formal meetings that occur between the FDA and sponsors or applicants during the development phase of a biosimilars. Since then, manufacturers of biological products have eagerly anticipated the FDA’s release of final guidance.

On May 14, 2014, instead of issuing final guidance on biosimilars, the FDA issued yet another draft guidance document, Clinical Pharmacology Data to Support a Demonstration of Biosimilarity to a Reference Product. According to the FDA, this draft guidance is “intended to assist biological product sponsors with the design and use of clinical pharmacology studies to support a showing that a proposed therapeutic biological product is ‘biosimilar’ to its reference product under [BPCIA].” This draft guidance specifically applies to products for which pharmacokinetic (“PK”) and pharmacodynamic (“PD”) data are required to help demonstrate biosimilarity.

Summary of FDA’s Draft Guidance on Clinical Pharmacology Data to Support a Demonstration of Biosimilarity

Although the information set forth in the FDA’s newest draft guidance is extensive, much of the information covered here was previously addressed in the draft guidances issued in 2012 and 2013.  Unfortunately for industry, the FDA’s newest draft guidance does not offer much insight into the FDA’s regulation of biosimilars, the specific requirements for submitting a biosimilar application (“§351(k) application”), nor the likelihood of success of obtaining approval through this pathway. (For coverage of the FDA’s recent draft guidance, please click here, here, and here.)

Similar to the draft guidances issued by the FDA in 2012, FDA’s 2014 guidance explains the step-wise process for demonstrating biosimilarity. This draft guidance emphasizes the “critical” role of pharmacological studies in the demonstration of biosimilarity because they “support[] a demonstration that there are no clinically meaningful differences between the proposed biosimilar and the reference product.” Moreover, clinical pharmacology studies are important because they “add to the totality of the evidence, reduce residual uncertainty, and thus guide the need for and design of subsequent clinical testing” in the overall demonstration of biosimilarity. Id. When developing proposed biosimilar products, the FDA identified three key concepts that must be addressed in any §351(k) application: (1) exposure and response assessment, (2) evaluation of residual uncertainty, and (3) assumptions about analytical quality and similarity.

–          Exposure and Response Assessment: The FDA explains that exposure-response information is important for determining the “safety, purity, and potency of any biological product.” For the purposes of this guidance document, exposure refers to PK variables, including input of all active components of a biological product as measured by dose and drug concentrations in plasma and other biological fluids. Response, on the other hand, refers to PD variables, or the direct measures of the pharmacological or toxicological effects of a drug on the body.

–          Evaluation of Residual Uncertainty: The FDA intends to use a risk-based approach in evaluating the data provided in a sponsor’s § 351(k) application. Specifically, the FDA announced that it will consider the “totality of the data and information submitted,” including data from structural and functional characterization, nonclinical evaluations, human PK and PD studies, clinical immunogenicity testing, and investigation of clinical safety and clinical effectiveness.

–          Assumptions About Analytical Quality and Similarity: The FDA directs sponsors to conduct “extensive and robust comparative structural and functional studies (e.g. bioassays, binding assays, and studies of enzyme kinetics)” to evaluate whether the proposed biosimilar and the reference product are highly similar. The capabilities and limitations of these “state-of-the-art analytical assays” should be fully described in the § 351(k) application’s analytical assessment. Interestingly, the FDA encourages applicants to compare the quality attributes of the proposed biosimilar product with those of the reference product using a “meaningful fingerprint-like analysis algorithm” that “covers a large number of product attributes and their combinations with high sensitivity using orthogonal methods.” In using this “fingerprint-like analysis algorithm,” the FDA expects sponsors to reach one of four assessments about their product: not similar, similar, highly similar, and highly similar with fingerprint-like similarity. “Not similar” products are not recommended for the biosimilar pathway unless, for example, modifications are made to the manufacturing process that are likely to lead to a highly similar biological product. “Similar” products require additional data or studies to determine if the differences are acceptable to consider the proposed product as highly similar to the reference product. Proposed biosimilars that are “highly similar” and “highly similar with fingerprint-like similarity” permit high or very high confidence that the proposed product meets the statutory standard for biosimilarity and allow sponsors to “conduct targeted and selective animal and/or clinical studies to resolve residual uncertainty and support a demonstration of biosimilarity.”

Furthermore, the FDA explains that using “accurate, precise, specific, sensitive, and reproducible” bioanalytical methods of evaluating PK and PD properties of a proposed biosimilar and its reference product is “critical” to evaluating clinical pharmacology similarity. The draft guidance document goes on to detail the requirements for these data types, including specific information regarding ligand binding assays, concentration and activity assays, and pharmacodynamics assays that should be included in an application. In addition to these bioanalytical evaluations, the FDA recommends that applicants collect safety and immunogenicity data to supplement the overall assessment of biosimilarity.

Lastly, the guidance document encourages applicants to discuss crucial aspects of their clinical pharmacology development plan with the FDA. Specifically, the draft guidance outlines nine different study design areas that industry should consider in those discussions: crossover design, parallel design, the reference product, study population, dose selection, route of administration, pharmacokinetic measures, pharmacodynamic time profile, and the statistical comparison of PK and PD results.

The FDA is accepting comments on this draft guidance until the August 12, 2014. Comments can be submitted electronically to https://www.regulations.gov [Docket No. FDA-2014-D-0234].

FDA Under Scrutiny for Draft Guidances

In its 2014 biosimilars draft guidance, the FDA reiterates that, once finalized, this guidance will be a part of a series of guidance documents intended to implement the BPCIA. It will be interesting to observe how swiftly the FDA issues final guidance on biosimilars, especially in light of the recent scrutiny the FDA has faced regarding its policies on and use of draft guidances. One week before the most recent draft guidance was issued, the FDA received a letter from the U.S. Senate Committee on Health, Education, Labor and Pensions (the “Senate HELP Committee”), expressing “significant concern about the [FDA’s] use of draft guidances to make substantive policy changes.” (The full text of the Senate HELP Committee’s letter to FDA can be accessed here, courtesy of Hyman, Phelps, & McNamara, P.C.) In its letter to FDA, the Senate HELP Committee voiced its concern that “that these draft guidances are not being revised, finalized, or withdrawn in a timely manner.” As a result of the FDA’s failure to finalize guidances in a timely manner, FDA review staff, patients, clinicians, and FDA-regulated companies “feel compelled to follow draft guidances as if they were final” because these drafts are the only information available on the agency’s most current thinking on important issues.

Furthermore, the Senate HELP Committee expressed concern that the FDA “issues guidance that seemingly does not take into account, or may even conflict with, the scientific community.” In order to better understand the FDA’s use of guidance to effectively communicate with FDA-regulated entities seeking advice on how to bring life-saving medical products to patients, the Senate HELP Committee has requested FDA to provide additional information about all Level 1 Draft Guidances, including the date issued, and the timeline with which the FDA plans to withdraw, revise, or finalize each guidance. The Senate HELP Committee also requested the FDA to provide an update on FDA-wide activities to implement the “best practices” to make the finalization of guidance more efficient and expeditious. In addition, the letter asked the FDA to produce information on the average amount of time that FDA has taken to finalize draft guidances in the last five years, and to explain how it ensures that FDA staff does not follow the guidance in the absence of any other policy or final guidance.

Conclusion

Given that the FDA is operating under the Senate’s microscope, it is difficult to speculate exactly when industry should expect the FDA to publish final guidance on biosimilars. It remains to be seen whether issuing the recent draft guidance shortens FDA’s timeframe for releasing final guidance or tolls FDA action in asking for public comment. The attorneys at Fuerst Ittleman David & Joseph, PL will continue to monitor any developments in the FDA’s regulation of biosimilars. For more information, please feel free to contact us by email at contact@fidjlaw.com or by phone at (305) 350-5690.

“Prescription” v. “Recommendation”: How State Medical Marijuana Laws May Insulate Treating Physicians From Liability Under The Controlled Substances Act

As of today, twenty states and the District of Columbia have legalized marijuana for medicinal purposes. (A complete list of the states which have legalized  marijuana use, including summaries of each state’s use laws can be found here.) While the nationwide debate has focused on how the patchwork of laws in the United States treats patient use and commercial dispensaries, physicians must also assess their potential liabilities when recommending or prescribing marijuana for their patients.

As we have previously reported, despite changing state legislation, federal law still lists marijuana as a Schedule I controlled substance under the Controlled Substances Act (“CSA”); 21 U.S.C § 801 et seq. Schedule I controlled substances are subject to the most strict regulation under the CSA because the federal government has determined that these substances have a “high potential for abuse,” “no currently accepted medical use in treatment in the United States, “ and a “lack of accepted safety” for “use under medical supervision.” See  21 U.S.C. § 812(b)(1). The CSA prohibits physicians from prescribing Schedule I drugs. Under the CSA, Schedule I drugs may only be dispensed in the United States through strictly-controlled, federally-approved research programs.

In order to prescribe a controlled substance, a physician must first register with the Attorney General of the United States. However, the CSA also confers authority on the Attorney General to revoke a physician’s registration for a variety of reasons, including if the physician “has committed such acts as would render his registration under section 823 of this title inconsistent with the public interest. . . .” See 21 U.S.C. § 824(a)(4). In determining whether a physician has acted “inconsistent with the public interest,” the Attorney General may consider a physician’s “compliance with applicable State, Federal, or local laws relating to controlled substances.” See 21 U.S.C. § 823(f). Thus, because marijuana is a Schedule I substance that the CSA makes unlawful to possess, use, or distribute, a physician prescribing medicinal marijuana pursuant to State law could subject himself to federal criminal penalties and revocation of his registration to dispense controlled substances. However, as explained below, physician liability under federal law may turn on whether doctors can be properly classified as “prescribing” marijuana for patient use.

Pursuant to the CSA and its implementing regulations, a “prescription” is defined as “an order for medication which is dispensed to or for an ultimate user but does not include an order for medication which is dispensed for immediate administration to the ultimate user.” See 21 C.F.R. § 1300.01. However, many states with medicinal marijuana laws, including California, Massachusetts, Michigan, Maine, Colorado, and Illinois do not authorize their physicians to “prescribe” marijuana as that term is defined under state law or the CSA. Instead, these states provide that a patient’s treating physician “recommend” or “certify” that the patient qualifies for participation in the state’s medicinal marijuana program. In addition, these recommendations or certifications are not designed to allow patients to directly obtain marijuana. Instead, patients gain access to medicinal marijuana solely through registration with the state and purchase the product through state licensed dispensaries. Put simply, the physician’s role is limited to evaluating whether, in the physician’s medical opinion, a patient qualifies for participating in the state sanctioned marijuana program.

In Conant v. Walters, 309 F.3d 629 (9th Cir. 2002), a case analyzing California’s Compassionate Use Act, the Ninth Circuit found that the recommendation of marijuana use by a treating physician to a patient cannot serve as the sole basis for revoking or suspending the physician’s registration to dispense controlled substances under the CSA. In Conant, the Ninth Circuit made clear that a doctor’s recommendation that a patient use a controlled substance is not the same as a prescription for a controlled substance, and without more, would fall outside of the scope of aiding and abetting or conspiracy to commit a violation of the CSA.

As explained in greater detail in the decision, a doctor’s recommendation of marijuana could lead to several lawful and legitimate responses, including lawful use of medicinal marijuana through a federally-approved experimental therapy program or travel to a country where marijuana is legally dispensed. Moreover, the Ninth Circuit found that the mere possibility that illegal conduct could occur was too attenuated to justify a restriction on the free speech rights of doctors and patients. Thus, the Ninth Circuit found that the First Amendment prohibited the government policy which threatened to punish physicians for recommending to a patient the medical use of marijuana on the ground that the recommendation might encourage illegal conduct by the patient. Therefore, at least as it stands in the Ninth Circuit, recommendation alone cannot serve as a basis for liability under the CSA. As medicinal marijuana statutes proliferate in states outside of the Ninth Circuit, it remains to be seen whether other Circuits will adopt the Ninth Circuit’s interpretation.

Fuerst Ittleman David & Joseph, PL will continue to watch for the latest developments in the regulation of the marijuana industry. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a physician or marijuana-related business, or if you seek further information regarding the steps which your business must take to become or remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

FATCA Update: As Additional Countries Agree to Share International Tax Information, Hiding Assets Abroad becomes Increasingly Difficult

In recent years the United States has increasingly amplified the pressure on United States persons to disclose assets they hold and income they earn abroad, especially relating to offshore financial accounts.  Two prominent examples of these efforts are the United States’ increased focus on imposing penalties and prosecuting entities and individuals for failing to file Foreign Bank Account Reports (FBARs), and the passage and forthcoming implementation of the Foreign Account Tax Compliance Act (FATCA), Internal Revenue Code §§ 1471-1474.  Many of our previous blog entries have focused on FBAR and FATCA enforcement and compliance, such as those entries found here, here, and here.

Now, the United States’ focus on reining in offshore tax evasion has spurred other countries to cooperate and agree to share financial information on a global scale, greatly reducing the effectiveness of well-established bank secrecy laws in the process.

Recent Efforts to Compel Account Information: FATCA

Generally, FATCA imposes a regime under which Foreign Financial Institutions (FFIs), such as foreign banks, foreign mutual funds, and foreign private equity funds, as well other foreign, non-financial entities are subject to a 30 percent withholding tax on income that would not otherwise be taxable by the United States, unless they enter into agreements with the IRS to identify and provide information regarding their US account holders or, in the case of a foreign entity, their US owners.  For instance, if a Foreign Financial Institution is due to be paid an interest payment from a US obligor that would otherwise qualify as tax-exempt portfolio interest, and that FFI has not entered into an agreement under FATCA with the IRS, the US business making the interest payment is obligated to withhold 30 percent of the otherwise non-taxable interest payment.

After passing FATCA, the United States found that in some cases conflicts existed between the mandates of FATCA and the domestic law of the FFIs that were subjected to FATCA.  In particular, certain nations’ domestic bank secrecy laws prevented the disclosure of much of the information required by FATCA.  In order to overcome these conflicts, the United States has entered Inter Governmental Agreements (IGAs) specifically intended to facilitate the implementation of FATCA.  There are two models of IGAs, Model 1 and Model 2.  Model 1 requires foreign financial institutions to report information regarding US account holder to their domestic government, with the domestic government to then provide the information to the United States.  Under Model 2, the foreign financial institution provides the US account holder information directly to the United States.  Most nations have entered into a Model 1 agreement.  A complete list of countries that have entered into IGAs with the United States is here.

The United States has entered into IGAs with a number of prominent banking nations, including Switzerland and the Cayman Islands.  Additionally, the United States has just agreed to an IGA with Israel and Singapore in substance (i.e. it has been agreed to but not yet signed) at the end of April and the beginning of May respectively.  On account of the IGAs, banks in the corresponding countries will generally not be able to rely on domestic bank secrecy laws to avoid meeting their obligations under FATCA.

As described above, a key part of FATCA is the withholding obligation imposed on payors with obligations to FFIs.  If the FFI does not comply with FATCA and reach an agreement with the IRS to disclose information regarding its account holders, income that is otherwise not taxable will be taxed at a flat 30 percent and is collected by requiring payors to withhold the tax.  This regime creates an extremely strong incentive for foreign banks to comply with FATCA.  In the end, most banks will protect their own bottom line rather than the keeping secret the identity of their account holders.  As a result, US persons holding offshore accounts should expect disclosure of their identity and account information as FATCA begins to be implemented.

Withholding under FATCA was initially set to begin January 1, 2014.  That date was moved back to July 1, 2014.  While the July 1, 2014 date is still effective, the IRS recently announced that 2014 and 2015 would be viewed as transitional years, and that foreign banks and withholding agents subject to FATCA that make good faith efforts to comply with FATCA may be relieved from its withholding regime.  Absent good faith compliance efforts, however, the IRS will not provide relief.

Exchange of Information among OECD Nations: Applying the Principles of FATCA on a Global Scale

FATCA requires FFIs and other foreign entities to disclose information regarding their account holders or owners only to the United States.  However, international cooperation in the sharing of tax information on a much wider scale took a big step forward earlier this month when two of the world’s most prominent hosts of offshore bank accounts, Switzerland and Singapore (along with a number of other countries) agreed to participate in the Organization of Economic Cooperation and Development’s (OCED) Automatic Exchange of Information in Tax Matters.  Some have speculated that the pending implementation of FATCA accelerated the sharing of tax information across a wider international scale.

Under the OECD Agreement, taxpayers’ financial information, including bank balances, dividend income, interest income, and information regarding asset sales, will be automatically shared among the member countries on an annual basis.  In addition, financial companies will be required to identify and disclose the ultimate beneficiaries of shell corporations, foreign trusts, and other foreign entities that can potentially be used to disguise beneficial recipients of taxable income.  With this information, signatories to the OECD Agreement will be able to largely determine their citizens’ offshore income without reliance on the citizens fulfilling their reporting obligations.

Particularly relevant is the inclusion of Switzerland and Singapore in the agreement.  Switzerland has long been a destination for those seeking to hide assets abroad, primarily due to the country’s strict bank secrecy laws.  Singapore has recently grown in prominence as a host of offshore bank accounts.  Switzerland’s and Singapore’s decision to agree to the automatic sharing of financial information is a clear indication that the United States’ efforts to combat offshore tax evasion are working.

The United States has made tremendous efforts to compel Swiss banks in particular to identify their US account holders notwithstanding Swiss bank secrecy laws.  For example, in the second half of 2013 the United States Department of Justice partnered with the Swiss Federal Department of Finance and established a program allowing Swiss banks not currently under criminal investigation by the Department of Justice to come forward and disclose potential past violations, pay penalties, close accounts of recalcitrant account holders, and establish programs to comply with FATCA going forward in exchange for an agreement by the Department of Justice to not prosecute the bank. We have previously written about these cooperative efforts between the United States and Switzerland here.

In addition, the United States has been investigating 14 prominent Swiss banks, including UBS and Credit Suisse, for potential criminal violations.  Through these criminal investigations, the United States has prosecuted banks, taxpayers, and individual bankers that evaded tax or aided or abetted US taxpayers in the evasion of income tax through undisclosed Swiss accounts.  Switzerland’s decision to sign onto the OECD Agreement represents a major shift in Switzerland’s historical approach to bank secrecy and appears to be, at least in part, a consequence of the United States’ efforts to compel information from Swiss banks.

The Fallout for US Taxpayers

The signatories to the OECD Agreement did not set a specific deadline to begin automatic sharing of information, but reports indicate that sharing will begin in 2017 and will involve tax information collected through 2015.  While the United States has entered into IGAs with a number of the countries that are parties to the OECD Agreement, there are a number of countries included in the OECD Agreement that do not yet have executed IGAs with the United States.  Therefore, to the extent local law still prohibits compliance with aspects of FATCA, the OECD Agreement should have the effect of breaking down those impediments and permitting the US to acquire information it would not otherwise be able to acquire relying on FATCA and IGAs alone.

More fundamentally, the wide range of countries that signed on to the OECD Agreement marks a significant indication that hiding assets in foreign jurisdictions for the purpose of avoiding tax on the income produced by those assets is becoming increasingly difficult.  Moreover, there is no indication that the United States’ interest in rooting out offshore tax evasion will wane anytime soon.  Taxpayers with offshore assets related to tax non-compliance need to seriously contemplate disclosing their assets and past non-compliance under the 2012 Offshore Voluntary Disclosure Program (OVDP).  As described in previous blog entries, the OVDP permits taxpayers with offshore assets and a history of non-compliance to come clean with the IRS for generally reduced penalties and a commitment from the IRS to not recommend criminal prosecution.  It is important to keep in mind that entry into the OVDP is generally unavailable to taxpayers whose identity and history of non-compliance has already been made known to the IRS or other federal authorities.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who have availed themselves of the IRSs voluntary disclosure program. We will continue to monitor the development of these issues, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at  contact@fidjlaw.com.

Florida Litigation Update: Arbitration Clauses are Not Always Enforceable

In Basulto, et. al. v. Hialeah Automotive, etc., et. al., SC09-2358 (March 20, 2014), the Florida Supreme Court addressed the enforceability of an arbitration clause between a car dealership and purchasers. In the Basulto case, purchasers signed blank contracts for the purchase of a new vehicle and trade-in of their existing vehicle following representations by the dealership that the agreed upon dollar amounts would be inserted into the contracts prospectively. Ultimately, the dealership inserted a value for the purchasers’ vehicle trade-in without the consent or agreement of the purchasers. After several days of negotiations (and the purchasers leaving the dealership with the vehicle), the dealer refused to revise the contracts.  Seeking to rescind the deal, the purchasers requested the return of their trade-in (which they only drove a total of seven miles), only to be advised that the vehicle had been sold.
The purchasers filed a lawsuit in Miami-Dade County against the dealership alleging Fraud in the Inducement, a violation of the Florida Unfair Deceptive Trade Practices Act, rescission of the arbitration agreements, and rescission of the loan agreement. The dealership moved to compel arbitration (per the terms of the agreements).  During an evidentiary hearing, the following additional facts were unveiled:  (a) despite the fact that the purchasers could only communicate in Spanish, all contracts were in English; (b) dealership employees attempted to explain the arbitration clauses to the purchasers; however, the dealership employees had virtually no understanding as to the meaning of such clauses; (c) the purchasers were never informed that they were actually waiving their rights vis-à-vis the arbitration clauses; (d) the finance manager advised the purchasers that if they refused to sign the form contracts there would be no deal; and (e) the purchasers were compelled to sign all documents in rapid succession without the ability to understand exactly what they were signing.
At this point, you might be thinking, among other things, that the purchasers appear at fault for signing contracts the terms of which were written in a language they did not speak and which included blanks to be filled in at a later time. Thus, because the agreements contained arbitration clauses, the purchasers should be required to arbitrate, right? Wrong. That was not how the courts in Florida ruled. First, in Florida, “there are three elements for courts to consider in ruling on a motion to compel arbitration of a given dispute: (1) whether a valid written agreement to arbitrate exists; (2) whether an arbitrable issue exists; and (3) whether the right to arbitration was waived.” Seifert v. U.S. Home Corp., 750 So. 2d 633 (Fla. 1999). The trial court, relying on Seifert, held that there was no valid agreement to arbitrate because the contracts, when read in unison, contained multiple conflicting dispute resolution provisions which could not be reconciled.  The trial court further reasoned that despite a finding that there was never a “meeting of the minds,” the agreements would have been deemed unenforceable being both procedurally and substantively unconscionable. The dealership then appealed to Florida’s Third District Court of Appeal, which held that one of the arbitration clauses was enforceable. However, the Court of Appeals failed to perform a Seifert analysis in reaching its conclusion.  The purchasers appealed to the Florida Supreme Court.
Before the Florida Supreme Court, the dealership argued that under Florida contract law, it should not matter whether a party to an agreement is “blind, illiterate, or has limited understanding of the language.”  Rejecting this, and several other arguments presented by the dealership, the Florida Supreme Court reversed the appellate court’s decision and affirmed the trial court’s application of Seifert. Succinctly, as established by Basulto, arbitration clauses in Florida will be enforced unless (a) an agreement to arbitrate fails to satisfy a Seifert analysis, (b) there is a finding that that the parties never reached a “meeting of the minds,” or (c) the agreements at issue are found to be both procedurally and substantively unconscionable. The Florida Supreme Court’s ruling in this case was critical, and will govern how arbitration clauses in Florida will be enforced for the foreseeable future.
FIDJ, P.L. has extensive experience dealing with commercial contract disputes, including those involving arbitration clauses.  If we can be of assistance to you, email us at contact@fidjlaw.com or call 305.350.5690.

Tax Litigation Update: United States v. Clarke Tests Limits of IRS Summons Enforcement Power

On April 23, 2014, the United States Supreme Court heard oral argument in United States v. Clarke, a case which may affect every taxpayer subject to a future IRS examination.

At issue in the case is the extent to which a taxpayer may investigate the underlying reasons or motivations for the IRS’s issuance of a summons, a subpoena-like document that allows the IRS to demand documents, interview witnesses, and seek other information during the course of an examination.  Under IRC § 7602, the IRS may issue a summons to:

a person liable for the tax or required to perform the act, or any officer or employee of such person, or any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for tax or required to perform the act, or any other person the Secretary may deem proper, to appear before the Secretary at a time and place named in the summons and to produce such books, papers, records, or other data, and to give such testimony, under oath, as may be relevant or material to such inquiry.

IRS SUMMONS POWER

The IRS’s summons power is immense, and the limitations placed on it, either by statute or by the courts, are limited.  The basic limitations placed on the IRS summons power were set forth in a seminal case, United States v. Powell, 379 U.S. 48 (1964), in which the Supreme Court held that in order to enforce a summons against an uncooperative recipient, the IRS must establish that (1) the examination is being conducted for a legitimate purpose; (2) the information sought may be relevant to that purpose; (3) the IRS does not already possess the information sought; and (4) the IRS has followed all necessary administrative steps, particularly regarding notice and service of the summons.

The Service’s burden to prove these matters is “slight.” An affidavit from the examiner attesting to these facts is sufficient. United States v. Samuels, Kramer and Co., 712 F.2d 1342, 1345 (9th Cir. 1983).

Once the IRS makes it prima facie showing, the burden shifts to the party opposing the summons to either disprove one of the four Powell elements or convince the court that enforcement of the summons would constitute an abuse of the court’s discretion.

Appropriate defenses to summons enforcement include asserting that (1) the summons was issued after the IRS had recommended criminal prosecution to the Department of Justice; (2) the summons was issued in bad faith; (3) the materials sought are already in the possession of the IRS; and, (4) the materials sought by the IRS are protected by either the attorney-client privilege, the work-product doctrine, or other traditional privileges and limitations. United States v. Riewe 676 F.2d 418, 420 n.1 (10th Cir. 1982).

IMPROPER PURPOSE AND BAD FAITH

The IRS is authorized to use a summons for the purposes described in IRC §7602, which are generally related to tax determination and collection. When the IRS uses its summons power for an unauthorized purpose or for any purpose reflecting on the good faith use of its power, the Supreme Court has said that the summons will not be enforced. Reisman v. Caplin, 375 US 440 (1964). Further, in Powell the Supreme Court stated that an “improper purpose” includes harassing the taxpayer, pressuring the taxpayer to settle a collateral dispute, or any other purpose reflecting negatively on the good faith of the particular investigation. (See also IRM 5.17.6.2.2, which discusses summonses legal authority). In addition, case law and IRC §7602(c) make it clear that the IRS is not authorized to use this power to assist another agency by, for example, using a summons to investigate a matter already being investigated by a grand jury, or by gathering evidence for the Department of Justice in its prosecution of a criminal case. United States v. LaSalle Nat’l Bank, 437 US 298 (1978)..

In general, since it is the court’s process that the IRS invokes in an enforcement proceeding to obtain compliance with a summons, a court will not order compliance unless it is satisfied that the IRS has served the summons in a good faith pursuit of its summons authority.

Before 1982, the IRS’s authority to issue summons did not expressly include power to use a summons to investigate a criminal violation of the tax laws. As a result, there was much litigation over the question whether the IRS was using a summons for an improper criminal purpose. In 1982, IRC §7602 was amended to provide that the statutorily authorized purposes for which a summons may be issued include “the purpose of inquiring into any offense connected with the administration or enforcement of the internal revenue laws.” Accordingly, the IRS is permitted to use a summons to gather evidence of a criminal violation of the tax laws. IRC §7602 was further amended to prohibit the use of a summons when a Department of Justice referral for criminal prosecution or grand jury investigation is in effect.

Significantly, persons affected by a summons have made objections that the summons has been issued for improper purposes other than for gathering evidence for use in a criminal prosecution. In United States v. LaSalle Nat’l Bank, 437 US 298 (1978), the Supreme Court recognized that a summons might be unenforceable for reasons other than an improper criminal purpose. Further, in Pickel v. United States, 746 F2d 176 (3d Cir. 1984), the third circuit stated that it did not doubt that portions of the Powell and LaSalle discussions of bad faith retain vitality even after the 1982 amendment to IRC §7602  and that where the taxpayer can prove that the summons is issued solely to harass him, or to force him to settle a collateral dispute, or that the IRS is acting solely as an information-gathering agency for other departments, such as the Department of Justice, the summons will be unenforceable because of the IRS’s bad faith. Further, where a substantial preliminary showing of abuse of the court’s process has been made, a summoned party is entitled to substantiate his allegations by way of an evidentiary hearing. United States v. Millman, 765 F2d 27 (2d Cir. 1985) (at the hearing, the agents responsible for the investigation and other witnesses may be called). See also United States v. Church of Scientology, 520 F2d 818, 824 (9th Cir. 1975)(limited evidentiary hearing approved).

When the challenge to a summons is based on an improper purpose, discovery and an evidentiary hearing are critical to prove the challenge, and it is by no means certain that the moving party will obtain either one or both opportunities. The district court’s decision to deny discovery and an evidentiary hearing is reviewed by a court of appeals under an abuse of discretion standard—that is, only if the taxpayer demonstrates in the summons enforcement hearing that the district court abused its substantial discretion in denying discovery and an evidentiary hearing. Discovery on motivation of an audit is permitted by some circuit courts only when the movant has shown “extraordinary circumstances” that take the movant out of “the class of the ordinary taxpayer, whose efforts at seeking discovery, would if allowed universally, obviously be too burdensome” to the IRS. United States v. Fensterwald, 553 F2d 231, 231–232 (DC Cir. 1977), cited in United States v. Judicial Watch, Inc., 371 F3d 824 (DC Cir. 2004). Another statement of the showing that is required to be entitled to discovery and an evidentiary hearing is that the movant need only establish the possibility of an improper motive before obtaining further discovery. This standard is more rigid than the standard that must be met by a party opposing a motion for summary judgment. Under this standard, the moving party must have evidence sufficient to raise a genuine issue of fact material to whether the audit is an act of political retaliation, or some other improper purpose. Further, requiring a taxpayer to produce records already in the IRS’s possession is arguably an abuse of the court’s process (or a bad faith use of the summons power). However, courts generally have enforced a summons in this situation.

In Clarke, the taxpayer alleged that the IRS had an improper purpose in issuing the summons, and thus was not entitled to enforce its subpoena. Specifically, Clarke asserted that the IRS was retaliating against the Dynamo’s refusal to extend the statute of limitations for a third time and that the IRS was seeking to circumvent the limited discovery rules available to litigants in Tax Court proceedings (The scope of documents and information that can be requested in a summons is generally wider than that which is permitted in a Tax Court Request for Production.)  This allegation was supported by the fact that when the IRS conducted its investigation with regard to a summons that was not challenged, attorneys representing the IRS in the Tax Court proceeding, rather than the agent in charge of the examination of Dynamo, performed the investigation. In essence, Clarke argued that the IRS was attempting to use its summons power in bad faith – as if it was a grand jury proceeding – to be able to obtain information which it would not otherwise obtain under normal Tax Court discovery rules, and thus have the upper hand in the case.

UNITED STATES V. CLARKE

Clarke arises out of an examination conducted by the IRS of a partnership called Dynamo Holdings for tax years 2005-2007.  During the course of the examination, Dynamo agreed to extend the statute of limitations for assessment two times.  Generally, the IRS has three years from the later of the due date for a return or the date the return is actually filed to assess a tax.  A tax is not collectible unless it is first assessed.

When the IRS requested a third extension of time within which to complete the assessment, the partnership refused.  Soon thereafter, the IRS issued five summonses, including one to Michael Clarke, the CFO of two partners of Dynamo.  The focus of the IRS’s summonses was interest deductions of $34 million taken by Dynamo over the course of two of the years subject to the IRS’s examination.

The IRS issued a Final Partnership Administrative Adjustment (FPAA) in December 2010, three days before the expiration of the statute of limitations.  By issuing the FPAA, the IRS tolled the statute of limitations period, formally set forth the amount it claimed the partnership owed, and began the process of assessing the tax deficiency and collecting the tax from the partnership’s partners.  Notably, the FPAA issued by the IRS in December 2010 was dated and signed in August 2010, before the IRS had issued the at-issue summons to Clarke.

In February 2011, Dynamo challenged the FPAA in the Tax Court.  Meanwhile, Clarke had refused to obey the summons, and the IRS began summons enforcement proceedings.  In April 2011, well after commencement of the Tax Court case.

In the typical enforcement proceeding, the IRS submits an affidavit of an agent familiar with the case establishing the Powell factors.  From there, the burden shifts to the taxpayer to allege and prove that one or more of the factors has not been established.  The district court, the forum for summons enforcement litigation, has discretion to determine whether to hold an evidentiary hearing or permit discovery regarding the summons recipient’s allegation that one or more of the Powell factors has not been established.

Before the district court, Clarke argued that the IRS did not have a legitimate purpose in issuing the summonses because, among other reasons, they were (1) issued in retaliation for the partnership’s refusal to extend the statute of limitations period a third time and (2) designed to circumvent the U.S. Tax Court’s limitations on the scope of discovery.  United States v. Clarke, 111 AFTR 2d 2013-1697 (S.D. Fla. Apr. 16, 2012).

Clarke brought forth some evidence supporting the contention that the summon was designed to circumvent the U.S. Tax Court’s limitations on the scope of discovery, including (1) the fact that the IRS sought to continue the Tax Court proceeding on the ground that the summonses were still outstanding and (2) a declaration from the lawyer of the sixth summoned individual (who ultimately complied with the summons request) that her IRS interview was conducted exclusively by the two lawyers representing the IRS in the Tax Court proceeding and that the examining agent was not even in attendance.  Notably, when Powell was decided, lawyers representing the IRS in Tax Court proceedings were not allowed to interview summoned individuals, only examining agents could do that.

To further prove their contentions, the Respondents requested an evidentiary hearing to inquire into the government’s purposes for issuing and enforcing the summonses (and also requested pre-hearing discovery).  The district court, however, ordered enforcement of the summonses.  It rejected the first argument as a “naked assertion” unsupported by evidence.  It then dismissed the second contention because it determined that, even if the IRS had used the summons process to sidestep discovery limitations, such a finding was not a valid reason to quash a summons.  Cf. Mary Kay Ash v. Commissioner, 96 T.C. 459, 462, 472-73 (1991) (denying taxpayer’s motion for protective order barring IRS from using evidence obtained through a summons but emphasizing that it was not deciding the enforceability of the summons since that issue was in the district court’s jurisdiction).

The United States District Court for the Southern District of Florida denied Clarke’s request for an evidentiary hearing.  On appeal, the Eleventh Circuit Court of Appeals reversed and held that the district court had abused its discretion in refusing to hold an evidentiary hearing.  The Eleventh Circuit held that an allegation of improper purpose is sufficient to trigger a limited adversary hearing before enforcement is ordered, and that, at the hearing, the taxpayer may challenge the summons on any appropriate ground.  The Eleventh Circuit’s reasoning was based in part on a prior summons enforcement case, Nero Trading.  In that case, the Eleventh Circuit reasoned that requiring the taxpayer to provide support for an allegation of improper purpose without giving the taxpayer the opportunity to obtain such facts “saddles the taxpayer with an unreasonable circular burden.”

Given the clear structure applicable to deciding summons enforcement proceedings, the parties’ arguments before the Supreme Court focused on narrow issues dictated by the facts specific to the case and the standard of review applicable to a district court’s decision to allow, or deny, an evidentiary hearing. The goals of the parties, specifically to persuade the Supreme Court to either affirm or reverse the Eleventh Circuit’s judgment based on the narrow facts of the case, were somewhat at odds with the Supreme Court’s goal of providing instruction to the district courts across the country that regularly face summons enforcement proceedings.

The government argued, and Clarke seemed to concede, that merely alleging bad faith in response to a summons does not necessarily entitle a summons objector to an evidentiary hearing during which IRS personnel can be examined by the objector. The differences arose with regard to what type of showing, beyond a mere allegation, an objector must make before being entitled to an evidentiary hearing.  Clarke argued that the affidavits  he submitted highlighting the questionable actions of the IRS—the close proximity between Dynamo’s refusal to extend the statute of limitations and issuance of the summonses, the issuance of the summonses well after the date the FPAA was signed, and the IRS’s use of its Tax Court attorneys to conduct the summons investigation—were sufficient to require the district court to hold an evidentiary hearing during which he would be permitted to question IRS personnel.  The government countered that the district court’s decision, which took into account all of the reasons for improper purpose raised by Clarke before the Eleventh Circuit and Supreme Court, should be respected because the district court did not abuse its discretion.

The Court’s focus during argument seemed to be on fashioning a rule of more general applicability from the specific and somewhat unique facts of the Clarke case.  What is clear from the Court’s questioning during oral argument is that any type of “automatic hearing” rule, in which a mere allegation of bad faith or impropriety will allow a summons objector the opportunity to participate in an evidentiary hearing, will not be permitted.  What is not as clear is whether the Court will adopt a generally applicable standard, rather than deciding the case before it on narrow grounds, and, if a general standard is adopted, what it will be.

There were hints from some of the Justices that they need to provide guidance to the district courts, and that limiting their decision to the narrow facts presented in Clarke would not be helpful.  Furthermore, there were indications that some of the Justices could seek to adopt more familiar litigation standards for application in the summons enforcement process.  Specifically, Justice Sotomayor raised the question of whether the heightened pleading standards set forth in two fairly recent Supreme Court cases called Twombly and Iqbal is the proper guide or whether the more rigorous standard applicable to summary judgment motions—in which the litigants must set forth specific, admissible evidence to support or oppose a motion for summary judgment—is more appropriate.  Not surprisingly, the government argued that the more rigorous summary judgment standard is more analogous, while Clarke argued that the Court’s rule should more closely follow the scrutiny applied to pleadings facing a motion to dismiss.

CONCLUSION

As with all SCOTUS cases, it is virtually impossible to determine precisely how the Court will rule. If the questions posed by the Justices during oral arguments were any indication of how the Court will rule, it is likely the Justices will side with the IRS.  Further, it is probably safe to assume that the Court will err on the side of requiring some clear, probative evidence before permitting a summons objector to question IRS personnel in Court.  This is because a rule that is too lenient, i.e. one that requires an evidentiary hearing upon the objector’s proffer of any evidence tending to show an improper purpose, would be seen as too damaging to the IRS’s examination process.

Moreover, the IRS is in the process of implementing more efficient processes relating to information gathering in the process of auditing large businesses.  A rule that takes a permissive approach toward entitling summons objectors to an evidentiary hearing, particularly one in which the agent conducting the exam can be questioned, would contravene the IRS’s stated focus on efficiency in gathering information during exams.

The impact of the Clarke decision will be especially relevant to taxpayers in South Florida.  As we have blogged about previously, South Florida has been a focus of recent IRS summons issuance.  Under the language of Nero Trading, taxpayers residing in the Eleventh Circuit (Alabama, Georgia, and Florida) had seemingly the most accommodating appellate court in the country to hear their appeal when a district court had denied a request for an evidentiary hearing.  If the Supreme Court issues a broad decision, the Eleventh Circuit’s prior decision to taxpayers seeking an evidentiary hearing to support their claims of an improper motive in summons issuance may no longer be precedential.

Notably, on April 28, 2014 – only five days after the Supreme Court heard oral arguments on Clarke – the Tenth Circuit Court of Appeals, in Jewell v. United States, Nos. 13–7038, 13–6069(2014), quashed IRS summonses that were issued after the 23-day period required under IRC §7609(a)(1). IRC §7609(a)(1) requires the IRS to notify summons recipients that it will examine records at least 23 days before the date fixed in the summons as the date upon which such records are to be examined. In deciding whether to quash the summonses, the appeals court examined whether the IRS had complied with the Powell requirements and determined that the 23-day period is an administrative step required by statute. In doing so, the Court acknowledged that it was creating a split between circuits. However, the Tenth Circuit emphasized that the Supreme ruled clearly in Powell when it said that “if the IRS does not comply with the administrative requirements of the Internal Revenue Code, its summonses are unenforceable.” In this battle between taxpayers and the government regarding IRS summons power, the ruling in Jewell and the split that now exists only serve to add fuel to the fire, and make the upcoming Supreme Court’s decision in Clarke all the more significant.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  They will continue to monitor developments in this and similar cases. If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling 305.350.5690.