FDA Releases CPG for Labeling and Marketing of Therapeutic Animal Foods

On September 10, 2012, the U.S. Food and Drug Administration (FDA) released a draft compliance policy guide (“CPG”) entitled “Labeling and Marketing of Nutritional Products Intended for Use to Diagnose, Cure, Mitigate, Treat or Prevent Disease in Dogs and Cats.”  Therapeutic animal food products are products that, based on the product’s labeling and indications for use, meet the statutory definition of an animal drug under the Federal Food, Drug, and Cosmetic Act (“FDCA”). Pursuant to 21 U.S.C. 321(g)(1)(B), a product that is labeled as intended to diagnose, cure, mitigate, treat, or prevent diseases is a drug. Further, a product that is labeled as intended to provide nutrients in support of an animal’s daily nutrient needs also satisfies the definition of a drug under 21 U.S.C. 321(f). This proposed CPG outlines how the FDA intends to enforce its regulatory authority over the labeling and marketing practices of manufacturers of animal food products that meet these definitions.

Animal food products that purport to diagnose, cure, mitigate, treat, or prevent disease have been available on the U.S. market for over fifty years, but were generally only sold through, and used under the direction of,  licensed veterinarians. The FDA, however, has noticed a recent rise in the sale of therapeutic animal food products directly from manufacturers to consumers. This uptick in marketing and sales toward consumers sparked FDA concern about whether product labeling adequately informs consumers about the effectiveness and safety of products for pet consumption. As a result, the FDA has released this CPG to address continued concerns over the sale and use of unapproved therapeutic animal foods that are not used under the direction of veterinarians.

In this CPG, the FDA takes a stricter stance on how foods that bear health claims should be regulated. Specifically, the FDA takes the position that in order to market these therapeutic animal food products in compliance with federal regulations, manufacturers must obtain animal drug approval from the FDA. This process would require FDA approval indicating that the product is safe for use, only includes food additives that are generally recognized as safe (“GRAS”), and in compliance with requirements for facility registration, listing, and current good manufacturing practices.

According to this CPG, the FDA does not generally intend to recommend or initiate regulatory actions against dog and cat food products that are labeled as drugs when all the following factors are present:

  1. The product is made available to the public only through licensed veterinarians or through retail or internet sales to individuals purchasing the product under the directions of a veterinarian.
  2. The product is not marketed as an alternative to approved new animal drugs.
  3. The manufacturer is registered under section 415 of the FDCA.
  4. The product’s labeling complies with all food labeling requirements for such products.
  5. The product does not include indications for a disease claim (e.g., obesity, renal failure) on the label.
  6. Distribution of labeling and promotional materials with any disease claims for the product is limited to that it is provided only to veterinary professionals.
  7. Electronic resources for the dissemination of labeling information and promotional materials are secured so that they are available only to veterinary professionals.
  8. The product contains only ingredients that are GRAS ingredients, approved food additives, or feed ingredients defined in the 2012 Official Publication of the Association of American Feed Control Officials.
  9. The label and labeling of the product is not false and misleading in other respects.

The release of this CPG puts manufacturers of animal food products on notice that the FDA will closely scrutinize product labeling, particularly any claims that give the impression that a product purports to diagnose, cure, treat, or prevent diseases in animals. The FDA, however, will continue to take into consideration other factors in determining whether to take regulatory enforcement action. Specifically, the FDA has narrowed its enforcement attention to prioritize products that:

  1. Are marketed as alternatives to approved new animal drugs
  2. Contain unapproved food additives, unless the use of that unapproved food additive conforms to uses as listed in the 2012 Official Publication of the Association of American Feed Control Officials
  3. Include words or vignettes on the label of the product(s) that explicitly or implicitly indicate diseases for which the product is to be used.
  4. Are made directly available to the public circumventing the role of a licensed veterinarian for provision of directions for use, supervision of treatment and evaluation of the treatment outcome.

The FDA’s decision to develop and release a CPG on the regulation of therapeutic animal food products is an interesting one. Historically, the FDA has regulated pet foods similarly to human foods. In this CPG, the FDA’s description of therapeutic animal foods sounds rather similar to the language the FDA uses to describe human medical foods under section 21 U.S.C. 360ee(b)(3). The FDA defines a medical food as “a food which is formulated to be consumed under the supervision of a physician and which is intended for the specific dietary management of a disease or condition for which distinctive nutritional requirements, based on recognized scientific principles, are established by medical evaluation.” In the regulations for medical foods, the FDA species further criteria for meeting the statutory definition of a medical food. The FDA has not outlined similar criteria for animal foods. Even though there are distinct similarities in the FDA’s descriptions of therapeutic pet foods and human medical foods, the FDA has yet to specifically clarify what constitutes a therapeutic pet food product, how it interprets the meaning of use “under the direction of licensed veterinarians,” or whether the sale of these products is restricted to licensed veterinarians.

Despite the lack of clarity regarding the definition of a therapeutic drug product, manufacturers should not take this CPG lightly. The information proposed in this CPG suggests that the FDA intends to strictly enforce animal drug approval requirements for these animal food products and also plans to considerably tighten its oversight on pet food labeling claims. Because the use of health claims on product labeling would require manufacturers to undergo the drug approval process, manufacturers should take extra caution when developing claims about a product’s safety and efficacy in affecting the body or treating health conditions.

Overall, this proposal could have a significant impact on the cost of bringing therapeutic animal food products to market. The heightened threat of enforcement action could result in significant costs associated with filing applications for new drug approval, testing, re-formulation, and/or re-labeling. Moreover, the animal drug approval pathway would likely extend the timeline required for a product to become compliant with applicable regulations and eligible for distribution and sale.

The FDA is currently seeking public comment on this proposed draft compliance policy guide (Docket No. FDA-2012-D-0755). To ensure that comments are considered before the FDA begins work on the final draft, all comments should be submitted prior to November 9, 2012. Fuerst Ittleman David & Joseph will continue to monitor the FDA’s enforcement of this Compliance Policy Guide for therapeutic pet foods. For more information, please contact us at contact@fidjlaw.com

Update: Online Poker Executives Guilty Plea Highlights the Additional Penalties Payment Processors When Processing Illicit Gambling Proceeds

On September 19, 2012, Nelson Burtnick, former director of the payment processing department of Full Tilt Poker and PokerStars, pled guilty to charges of conspiracy to commit violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), Bank Fraud, and Money Laundering, stemming from the April 15, 2011 indictment of eleven people in connection with their involvement in PokerStars, Full Tilt Poker, and Absolute Poker.

The Department of Justice had charged Burtnick with multiple charges including violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), conspiracy to commit bank fraud and wire fraud, operating an illegal gambling business, and money laundering. In his plea deal, Burtnick pled guilty to one count of conspiracy to accept funds in connection with unlawful internet gambling, bank fraud, and money laundering, and two counts of accepting funds in connection with unlawful internet gambling. As a result of his guilty plea, Burtnick faces a maximum of 15 years in prison. A copy of the U.S. Department of Justices press release announcing the guilty plea can be read here.

As we have previously reported here, here and here, ongoing federal prosecutions have targeted internet poker operators and their payment processors for violations of federal law under UIGEA 31 U.S.C. §§ 5361-5366 and the Illegal Gambling Business Act (“IGBA”) found at 18 U.S.C. § 1955. However, as exemplified by Mr. Burtnicks indictment and guilty plea, payment processors face various other violations of federal law when accused of processing illicit gambling proceeds. These violations include bank fraud, found at 18 U.S.C. § 1344, which makes it a crime for “whoever knowingly executes, or attempts to execute, a scheme” to either: 1) defraud a financial institution; or 2) obtain any of the moneys under the custody or control of a financial institution by means of a false or fraudulent representation. Here, prosecutors alleged that Burtnick violated 18 U.S.C. § 1344 by deceiving U.S. financial institutions into processing payments for Poker companies from U.S. gamblers through disguising such payments as payments to non-existent online merchants and non-gambling businesses.

Another federal law of which payment processors must be aware is the prohibition against money laundering found at 18 U.S.C. § 1956. Generally speaking, “money laundering” is the act of concealing or disguising the nature, location, source, or ownership of money begotten through illicit means in order to make such funds appear as if earned through legitimate and lawful activity. More specifically, 18 U.S.C. § 1956(a)(2)(A) prohibits the transportation, transmission, or transfer of a monetary instrument or funds from a place in the U.S. to or through a place outside of the U.S. (or vice versa) “with the intent to promote the carrying on of a specified unlawful activity.” In its Indictment, the Government alleged that Burtnick violated 18 U.S.C. § 1956(a)(2)(A) by disguising payments by U.S. gamblers to Full Tilt and Poker Stars, both offshore entities, as payments to phony internet merchants. Bank accounts in the fake merchants names were opened in U.S. banks through which the poker companies could receive payments from the U.S. based gamblers.

More importantly, each of these crimes is separate and distinct from the illegal gambling activities themselves. Thus, regardless of whether a payment processor is charged under IGBA or UIGEA, acts of payment processors in disguising or misrepresenting the source of funds they process can subject the processor to criminal liability.

If you have questions pertaining to UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about FIDJs experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com

CBP Expands its Simplified Entry Program

If you have ever attempted to import merchandise into the United States you are probably aware that there are numerous rules, regulations, forms, and guidelines which must be compiled with and submitted prior to the entry of your goods. For even the most seasoned importer, the task of properly assembling this information for US Customs & Border Protection (“CBP” or “Customs”) can seem confusing and overwhelming. Recognizing these difficulties, Customs has formulated the Trade Transformation Initiative. This initiative focuses on driving down trade costs and promoting trade efficiency. The intended result is a more streamlined and efficient means for importers and brokers to expedite the clearance and review process of their trade goods.

On November 9, 2011, CBP announced the commencement of the initial phase of its Simplified Entry Pilot Program (“SEP Program” or “Program”). Serving as one of CBPs integral trade transformation initiatives, the Program was created to streamline the entry process, enhance cargo security, and reduce transaction costs for trade. This Program offers a direct response to the industrys call for more predictability in the importation process. Under the Programs framework, importers produce an entry data set with 12 required elements and 3 optional elements as opposed to the 27 currently required on the CBP 3461 entry form. Carriers will be required to submit manifest/ ACAS security filings, and importers will submit the SEP Program data set. All of this data will be included in the newly developed commercial trade processing system called the Automated Commercial Environment (“ACE”).

Filing well in advance allows CBP to run all targeting earlier and ensure that transport is not delayed for issues that can be resolved pre-shipment. While in route, CBP can indicate whether the goods are cleared for release or if additional data is required. Because of this, filers can resolve many issues before departure or in transit which results in a more efficient trade transaction. On June 4, 2012 CBP announced that it had received its first Simplified Entry filings at the three pilot ports located in Indianapolis, Chicago, and Atlanta. 9 brokers selected by CBP are currently participating in the Program which is available for Air Mode of Transportation exclusively.

On August 14, 2012, CBP announced its plans to further expand the SEP Program for Air Mode of Transportation.  Utilizing a regional expansion approach, the Program has already expanded to include the port of Seattle with San Francisco, Oakland, and Los Angeles to follow soon after. In Mid-September expansion will continue into the south and southeast with the inclusion of Dallas/Ft. Worth, Houston, and Miami followed by northeastern expansion into Newark, New York, and Boston.

CBP plans to further develop the Simplified Entry Pilot program to eventually include functionalities such as the Participating Government Agency Message Set, the Simplified Entry transaction set, Single Transaction Bonds, automatic cancellations and deletions, the Document Image System, and Remote Location Filing. CBP will run the Air Mode Transportation SEP Program until approximately December 31, 2013 and will continue to further develop the Programs functionality until Cargo Release is fully available in the ACE.

The attorneys in the Customs, Import and Trade Law practice group at Fuerst Ittleman David & Joseph, PL will continue to keep abreast of the developments in the Simplified Entry Program. If you are a broker and have any trade concerns or legal issues stemming from the use or implementation of the new Simplified Entry Program, feel free to contact us at 305-350-5690 or contact@fidjlaw.com.

Time is Money: CBP Proposes New Mitigation Guidelines for Liquidated Damages Response Petitions

For importers and brokers, there may be several aspects of US Customs & Border Protections (“CBP” or “Customs”) policies that are obscure. One of those areas is liquidated damages provisions and their proposed consequences. Under CBPs most recent proposal, importers who fail to respond to liquidated damages claims in a timely manner will face possible fines and consequences far beyond what is currently in place. As any shrewd business person will note, it is important to keep operating costs low and to avoid any extra bills whenever possible. This holds the same for importers and brokers whose job is to quickly and efficiently get merchandise from point A to point B. Brokers and importers must be attentive to deadlines and time requirements just as much as any other business, but even more so because of the nature of their profession.

If the newly proposed changes to the Liquidated Damages Mitigation Guidelines (as will be discussed below) are put into place, filing timely may be the difference between a few hundred and a few thousand dollars in extra bills. But lets not get too far ahead of ourselves, lets first get a clear understanding of what exactly a Liquidated Damage is, where it comes from, and why it is so crucial for importers to “timely” respond to Liquidated Damages claims made by Customs.

Background & Current Mitigation Guidelines for Untimely Liquidated Damage Response Petitions

Before we address the consequences of untimely responding to a liquidated damages claim, we need to first understand how they occur. Liquidated damages arise out of customs bonds. A customs bond is typically filed by the importer of record, warehouseman, or other custodian of merchandise. It is effectively an agreement between an importer and surety that ensures compliance with all of Customs obligations with respect to entry, storage, and transport of goods.   In the event that an importer breaches one of these obligations, this bond functions as security for liquidated damages claims issued by the CBPs Office of Fines, Penalties, and Forfeitures.

In the event that a liquidated damages claim is issued, CBP affords importers the opportunity to challenge the claim by submitting a petition pursuant to 19 C.F.R. § 172.3(b). Under this regulation, a petition must be filed within 60 days from the date of mailing to the bond principal the notice of claim for liquidated damages or penalty secured by a bond. Historically, CBP has been lenient with respect to accepting late petitions.

CBPs most current Mitigation Guidelines: Fines, Penalties, Forfeitures, and Liquidated Damages provide instruction on how CBP determines settlement amounts for late petitions. CBP begins by calculating the mitigation amount as if a timely petition was submitted. This is called the “base amount.” CBP then takes 1% of the base amount and multiplies that by the amount of days the petition was late. This amount is then be added to the original base amount with a minimum additional value to be no less than $400.

Now that we have established what Liquidated Damages are, how they arise, and the current calculation for untimely filing, let us now turn our attention to the newly proposed changes to Customs Mitigation Guidelines.

CBPs Proposed Changes to Mitigation Guidelines for Late Petitions

In an informal document made available to members of the trade industry, CBP has claimed that the current mitigation guidelines have not effectively reduced or deterred the number of late petition filings by importers. Furthermore, in recent discussions between CBP the International Trade Surety Association (“ITSA”) and Customs Surety Executive Committee (“CSEC”), CBP explained its intent to significantly alter the calculation scheme for mitigation on untimely liquidated damage responses by importers.

Under the proposed calculation, CBP will take 1% of the full original assessment amount and multiply that by the amount of days the petition was late. This amount will then be added to the base amount. It is also reported that petitions later than 180 days late will not be accepted at all and the full original assessment amounts will be paid.

This proposed change in CBPs Mitigation Guidelines is significant and can result in final mitigation amounts being tens of thousands of dollars more than they would otherwise be under the current scheme. Importers are advised to be aware of the proposed changes and to make sure to submit liquidated damages response petitions timely.

If you need assistance filing a response petition to Customs or want more information on the developments in CBPs Mitigation Guidelines contact the Customs, Import and Trade Law practice group at Fuerst Ittleman David & Joseph, PL at 305-350-5690 or contact@fidjlaw.com.

CBP Changes Regulations for Suspected Counterfeit Merchandise

In an effort to combat the importation of counterfeit goods into the United States, US Customs & Border Protection (“CBP” or “Customs”) has significantly increased the number of seizures of suspected counterfeit merchandise. Between 2010 and 2011, Customs seized nearly 25,000 shipments with a domestic value of approximately 200$ Million and retail values exceeding 1.1$ Trillion. These seizures accounted for just under a 25% increase for the fiscal year 2011. Customs is making a statement, and is taking significant steps to ensure that counterfeits are not getting into the United States market place. The downside of these efforts is that with the increased volume of seizures, it is becoming more difficult for Customs to differentiate between good faith importers and those who knowingly import counterfeits.

Products such as electronics, pharmaceuticals, and footwear are at the top of CBPs watch list and good faith importers of these goods are getting caught in the crossfire. Counterfeit or not, the chances of import cargo being detained or seized is much higher, and importers are forced to wait out what could be months of administrative proceedings to have their cargo released. Worst of all, until recently, there has been virtually no recourse for importers who want to dispute these claims expeditiously. Fortunately, Customs has recognized this problem and implemented new seizure and detention policies in response.

On April 24, 2012, Customs issued an interim rule entitled Disclosure of Information for Certain Intellectual Property rights Enforced at the Border. This regulation amends 19 C.F.R. § 133.21 which outlines CBPs regulations regarding the seizure and detention of suspected counterfeit imports.

In its interim rule, Customs established an entirely new notification and response procedure between itself and importers suspected of importing counterfeits. This new procedure is designed to benefit importers because the previous version of the regulation was silent as to how importers could respond to allegations of suspected forfeiture and provided little immediate recourse for upstanding importers who have been wrongfully accused of counterfeit importation.

Under the new regulations, CBP is given a maximum of thirty days to detain suspected counterfeit goods after which the goods will be excluded from entry or delivery pursuant to 19 U.S.C. § 1514(a)(4). This period can be extended up to an additional thirty days if the importer can display good cause. Under the old regulatory framework, CBP effectively had the power to detain importers items indefinitely and offered no remedy for importers to dispute the seizure of their goods.

Pursuant to the amended regulation in 19 C.F.R. § 133.21(b), CBP is also now required to notify an importer, in writing, that his goods are being detained within 5 days of the detention. The importer will then be afforded seven days to respond to CBP and offer evidence of the merchandises authenticity. Prior to the amendment, Customs had no formal requirement to notify importers of its intentions to seize their merchandise. In fact, CBP was only required to notify the trademark owner.

Section (b) creates a twofold benefit. First, it affords honest importers an opportunity to quickly dispute claims and have merchandise released without waiting (for what could have previously taken up to 60 days) to have the authenticity of there merchandise verified. Under the new regulation good faith importers could potentially have their shipments released in a fraction of the time if they can sufficiently and quickly gather evidence of the seized goods authenticity.

Secondly, this section requires CBP to become more efficient in its verification and disposition of alleged counterfeit goods. Under the auspices of the previous regulation, CBP had full discretion to take as much time as it felt necessary to complete the forfeiture proceeding. This is no longer the case. Customs must now be much more efficient with its procedure and have matters resolved within 30 days, barring any good cause extensions.

Aside from the previously mentioned changes, 19 C.F.R. § 133.21 is effectively the same with respect to Customs dealings with the actual trademark owner. CBP is still required to notify the trademark owner about information regarding the seized shipment (i.e. port of entry, quantity, description of merchandise, product samples, etc) within thirty days. The regulation also continues to afford trademark owners the discretion to provide written consent to have the goods disposed or entered into the US (after obliteration of counterfeit trademarks).

The effect of this updated regulation seems to be positive on all fronts: It puts all involved parties on notice, affords importers the opportunity to dispute and resolve claims quickly, and continues to enforce and protect the trademarks of companies who may be damaged from counterfeit goods in the domestic marketplace.

If you are an importer and have been notified that your cargo has been detained, do not hesitate to contact an attorney in our Customs practice to assist you in responding to CBP.

Florida’s Concurrent Cause Doctrine May Be a Valuable Tool to Overcome Insurance Policy “Intentional Acts” Exclusions

Plaintiff “V” is yet another victim of unscrupulous business practices perpetrated by the evil Defendant B. V retains counsel to investigate and prosecute its claims to the fullest extent permitted by law. V’s counsel reviews the facts and serves a carefully crafted, professionally envious demand letter, filled with details of every facet of wrongdoing, backed with volumes of evidence sure to drive any wrongdoer into imminent capitulation. B’s counsel responds not with a denial, not with excuses, but rather with a curt response indicating that B is no longer in business, and its key principal has fled the country. In other words, “Go ahead and shoot ‘cause there’s nothing here to hit!”

In the not-so-distant past, victims such as V could look to B’s errors and omissions insurance coverage and recover most of the losses, depending only on the amount of coverage available.  Errors and omissions policies are, after all, designed to protect, defend and indemnify the insured from acts of negligence and accidental misconduct, thus ensuring that the insured’s business can continue without serious interruption and further that victims will be compensated for their losses. However, in this world of Ponzi-perpetrated losses, insurance companies have fought back, and are now more than ever exploiting their Policy’s “Intentional Acts” exclusions to avoid paying for either coverage or indemnification for the losses. The insurer’s aggressive tactics have left victims holding the bag in the long line of trustee-driven check-out registers.

“Intentional Acts” exclusions typically allow the insurer to avoid defending against or paying for claims based on an insured wrongdoer’s conduct which was intentionally designed to cause injury. The “Intentional Act” exclusion most heavily litigated typically includes claims centered on allegations of the insured’s intentional fraud. Thus, where Plaintiff V is the victim of Defendant B’s fraud, Defendant B’s insurer will escape paying against any of the policy’s protections.

All may not be lost. What if Plaintiff V had not only suffered from B’s fraud, but also suffered from Defendant B’s separate, independent claims of negligence? In other words, what happens when an insured is sued for a covered claim and an excluded claim? Florida courts traditionally construe insurance policies to afford the greatest degree of coverage.

Florida has adopted the concurrent cause doctrine to dispose of this very scenario. See Wallach v. Rosenberg, 527 So.2d 1386 (Fla. 3d DCA 1988); see further Paulucci v. Liberty Mut. Fire Ins. Co., 190 F.Supp.2d 1312, 1318-19 (M.D. Fla. 2002). The concurrent cause doctrine mandates that coverage shall be provided when a loss would not have occurred but for the joinder of independent covered and excluded causes. Wallach, 527 So.2d 1387. The Court must find coverage “where an insured risk constitutes a concurrent cause of the loss even where ‘the insured risk [is] not … the prime or efficient cause of the accident.’” Id. (quoting 11 G. Couch, Couch on Insurance 2d § 44:268 (rev. ed.1982)).

The Wallach Court reviewed a homeowner’s policy which insured against “physical loss to the property.” The property included a sea wall. The policy excluded coverage for “for loss resulting directly or indirectly … water damage.” After a flood, the sea wall collapsed, causing damage to the Property. The coverage issue was whether the loss was caused by the negligent construction of the sea wall, which would be a covered loss, or by the flood, which was excluded. Ultimately, the court found it unnecessary to find causation by one over the other causes, because under the doctrine of concurrent causes, coverage existed because a covered event contributed to the loss. The insurer then argued that it would inequitable to provide coverage if an excluded event was “one of the causes” of the occurrence. The Third District disagreed and held:

We reject that theory and adopt what we think is a better view”that the jury may find coverage where an insured risk constitutes a concurrent cause of the loss even where “the insured risk [is] not … the prime or efficient cause of the accident.”

Wallach, 527 So.2d at 1387. The court, relying on authority from other jurisdictions, explained:

Where a policy expressly insures against loss caused by one risk but excludes loss covered by another risk, coverage is extended to a loss caused by the insured risk even though the excluded risk is a contributory cause.

Id. at 1388.

Like everything in the law, the clarity of this doctrine is the color of mud. What, for example, would happen if a victim has a claim against a securities lawyer for professional negligence and statutory securities fraud? Is the covered claim for malpractice sufficiently separate and independent from the excluded claim for securities fraud to allow coverage?

While there are no Florida cases directly on point, the plaintiff would need to show that the defendant’s underlying negligence “resulted in and was the proximate cause of actual loss to the plaintiff. If the client cannot show that it would have suffered harm ‘but for’ the [professional] negligence, the client will not prevail.” KJB Vill. Prop., LLC v. Craig M. Dorne, P.A., 36 Fla. L. Weekly D2557 (Fla. 3d DCA 2011). Thus, the plaintiff must prove that its asserted claim of negligence was the contributing cause of actual loss in order to prevail.

Guideone Elite Ins. Co. v. Old Cutler Presbyterian Church, Inc., 420 F.3d 1317, 1330 (11th Cir. 2005), is particularly illustrative. In Guideone, the defendant sought insurance coverage when the loss was the result of a crime involving both robbery and rape.  The court reviewed an insurance policy where sexual assault was expressly excluded from the insurance policy, but other criminal acts, including robbery, were deemed to be covered losses. Applying Florida law, the court held, “Florida’s concurrent cause doctrine permits coverage under an insurance policy when the loss can be attributed to multiple causes, ‘as long as one of the causes is an insured risk.’” In noting the independence of the two criminal acts which took place at the same time by the same actor, the Court explained:

Causes are dependent when one peril instigates or sets in motion the other. In this case, the perils were independent. Robbery and rape have separate objectives that can work in tandem to cause one loss Where two crimes combine to cause a loss, it seems ‘logical and reasonable to find the loss covered … even if one of the causes is excluded from coverage.’

Id. Explaining its rationale, the Court reasoned:

Robbery is not part and parcel to the crime of rape, and the same is true of kidnapping, assault, imprisonment, and battery. Perhaps the confusing element here is that the same actor committed all of the crimes. If the actions perpetrated that day, however, were only parts of one larger crime, that would obviate the rationale behind multiple criminal statutes under which an offender could be charged.

Id.

Thus, if the plaintiff can prove that the claims for professional negligence are not dependent upon or arise from any claim for securities fraud, the insurer will not likely be able to escape from meeting its duties and obligations owed under the insurance policy. In other words, at every stage of representing the plaintiff-victim, plaintiff’s counsel must plot the litigation strategy by focusing not only on the defendant, but on the underlying insurance policy which may be the only source of recovery.

Eleventh Circuit Affirms Tax Court in Recharacterizing Loan as a Sale for Tax Purposes

On August 23, 2012, the U.S. Court of Appeals for the Eleventh Circuit affirmed the decision of the Tax Court and ruled in favor of the IRS in Calloway v. Commissioner of the IRS, case no. 11-10395, available here.

The facts of the case are as follows:
Albert Calloway worked for IBM for a number of years and acquired IBM stock by exercising his employee stock options. During 2001, Bert Falls, Mr. Calloway’s financial adviser, introduced Mr. Calloway to a program operated by Derivium Capital, LLC (“Derivium”). Under that program, Derivium would “lend” a client ninety percent of the value of securities that the client pledged to Derivium as collateral. During the term of the non-recourse loan, Derivium had no restrictions on its use of the collateral. At the end of the loan’s term, the client had three options: (1) He could reclaim the collateral by paying the principal and accrued interest; (2) He could surrender the collateral to Derivium; or (3) He could refinance. Mr. Calloway testified that the loan program was attractive to him because, had he sold his stock, he would have had to pay twenty percent in capital gains tax; under the Derivium program, however, he received ninety percent of the stock’s fair market value.

The details of Mr. Calloway’s arrangement with Derivium are set forth in three documents: “Master Agreement to Provide Financing and Custodial Services” (“Master Agreement”), “Schedule D Disclosure Acknowledgment and Broker/Bank Indemnification” (“Schedule D”) and “Schedule A-1 Proper Description and Loan Terms” (“Schedule A-1”). Schedule A-1 details the terms of the loan. Specifically, the loan amount was ninety percent of the fair market value at the time of closing; the estimated value of the collateral at that time was $105,444.90. The interest rate to be charged was ten-and-one-half percent, compounded annually; the interest accrued until, and was due at, maturity. Any dividends on the pledged collateral were to “be received as cash payments against interest due.” The loan could not be prepaid, and the lender could not seek recourse against the borrower, only the collateral. The closing date was “[u]pon receipt of securities and establishment of [Derivium’s] hedging transactions.” Mr. Calloway executed the Master Agreement and attached schedules on August 8, 2001, and authorized the transfer of 990 shares of his IBM stock to Derivium’s account with Morgan Keegan & Company, Inc., on the following day. Cathcart, as president of Derivium, signed the Master Agreement and schedules on August 10, 2001.

On August 17, 2001, Derivium’s operations office sent Mr. Calloway two documents. The first was a valuation confirmation indicating that Derivium had received the stock, valued at $104,692.50, into its account. The second document, titled “Activity Confirmation,” indicated that, as of August 17, 2001, Derivium had hedged the IBM stock for slightly less, $103,984.70, yielding an “Actual Loan Amount” of $93,586.23. On August 21, 2001, Derivium sent Mr. Calloway a letter informing him that the proceeds of the loan were sent to him according to the wire transfer instructions he had provided a few days earlier. On the same date, $93,586.23 was credited to Mr. Calloway’s credit union account. Previously, on August 17, Derivium had exercised its right to sell the stock without giving notice to Mr. Calloway.

During the period of time covered by the loan, Mr. Calloway received quarterly and year-end account statements. Each quarterly statement set forth the loan balance at the beginning of the quarter, indicated the interest accrued during the quarter and credited the account for the dividends paid during the quarter to yield the end-of-quarter loan balance. The statement also provided the end-of-quarter collateral value. Mr. Calloway did not receive any tax statements reflecting dividend income (Form 1099-DIV), nor did he report on his tax returns any dividend income earned from the 990 shares of IBM stock. In a letter dated July 8, 2004, Derivium informed Mr. Calloway that the loan would mature on August 21, 2004. Consistent with the Master Agreement and accompanying schedules, the letter stated that Mr. Calloway could either (1) pay the maturity amount of $124,429.09 and recover his collateral, (2) renew or refinance the transaction for an additional term, or (3) surrender the collateral. On July 27, 2004, Mr. Calloway returned the response form to Derivium indicating that he was “surrender[ing his] collateral in satisfaction of [his] entire debt obligation.”

The IRS issued a notice of deficiency to the Calloways for failing to include the income from the sale of the IBM stock on their 2001 income tax return. It also assessed two penalties for failure to timely file a return and for significant understatement of income.

The case before the Tax Court produced a majority opinion authored by Judge RUWE, and joined by Judges COLVIN, COHEN, WELLS, GALE, THORNTON, MARVEL, GOEKE, KROUPA, GUSTAFSON, and PARIS. Judge HALPERN, issued an opinion concurring in the result only, which was joined by Judge WHERRY. Judge HOLMES, also issued an opinion concurring in the result only.

The Eleventth Circuit adopted the reasoning of both Anschutz Co. v. Comm’r, 664 F.3d 313, 324 (10th Cir. 2011), available here, and the Ninth Circuit’s opinion Sollberger v. Comm’r, case no. 11-71883 (Aug. 16, 2012), available here, and distilled the analysis regarding whether the transaction was a sale down to the following factors:

(1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquired any equity in the property; (4) whether the purchaser has any control over the property and, if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser will receive any benefit from the operation or disposition of the property. The Eleventh Circuit noted, however, that no one factor is controlling, nor is the list exhaustive.

The 11th Circuit then held as follows: “[W]e believe that the most relevant of those factors point firmly to the conclusion that the 2001 transaction was a sale of stock for the purposes of Federal income tax.” Slip op. at 28. But the 11th Circuit then rejected the alternative analytical framework advanced by either Judge HALPERN or Judge HOLMES (“Moreover, we do not believe that the tests applied by the concurring judges provide viable alternatives to the benefits and burdens test.”). Slip op. at 35-36.

The Calloway case demonstrates that federal courts of appeal tend to take a more holistic and flexible approach to viewing transactions for income tax purposes. However, given the obvious disagreement as to the appropriate analytic framework among the Tax Court judges, it appears that tax court litigants need to be cognizant of the fact that methods of proof may vary not only among judges, but among circuits as well.

The attorneys at Fuerst Ittleman David & Joseph, have extensive experience litigating before the U.S. Tax Court and the various U.S. Circuit Courts of Appeal. You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

Seventh Circuit: FBAR Forms Governed by Required Records Doctrine, Not Protected by Fifth Amendment

On August 27, 2012, the United States Court of Appeals for the Seventh Circuit decided In Re: Special February 2011-1 Grand Jury Subpoena Dated September 12, 2011, available here, holding that the “Required Records Doctrine” requires a taxpayer asserting a Fifth Amendment privilege over documents which the taxpayer is required to maintain pursuant to the Bank Secrecy Act to produce the documents.

In its decision, the Seventh Circuit’s wrote as follows: “In this appeal, we are asked to decide whether compulsory production of foreign bank account records required to be maintained under the Bank Secrecy Act would violate appellee T.W.’s Fifth Amendment privilege against self-incrimination. Because we find the Required Records Doctrine applicable to this case, we hold that T.W. must produce the subpoenaed records.” The Seventh Circuit’s holding is consistent with the Ninth Circuit’s holding in M.H. v. United States (In re Grand Jury Investigation M.H.), 648 F.3d 1067 (9th Cir. 2011), available here.

As discussed by the Seventh Circuit, the Required Records Doctrine can be traced to Shapiro v. United States, 335 U.S. 1 (1948), available here. In Shapiro, a fruit wholesaler invoked his Fifth Amendment privilege in response to an administrative subpoena that sought business records which were required to be maintained under the Emergency Price Control Act (EPCA), which was passed immediately following the outbreak of World War II to prevent inflation and price gouging.  The Court revisited its decision in Shapiro twenty years later in Marchetti and Grosso v. United States, 390 U.S. 62 (1968), available here.

In holding that the Required Records Doctrine was inapplicable to the circumstances before it in both Shapiro and Grosso, the Court articulated the following three requirements for determining the applicability of the Required Records Doctrine: (1) the purposes of the government inquiry must be essentially regulatory; (2) information is to be obtained by requiring the preservation of records of a kind which the regulated party has customarily kept; and (3) the records themselves must have assumed public aspects which render them at least analogous to a public document. Grosso, 390 U.S. at 67-68. When the requirements of the Required Records Doctrine are met, a witness cannot resist a subpoena by invoking the Fifth Amendment privilege against compelled, testimonial self-incrimination.

That the act of producing documents may be testimonial and incriminating is not a phenomenon unique to this case. The act of production privilege recognizes that, while the contents of the documents may not be privileged, the act of producing them may be. See, e.g., Fisher v. United States, 425 U.S. 391 (1976); United States v. Doe (Doe I), 465 U.S. 605 (1984); Braswell v. United States, 487 U.S. 99 (1988); Doe v. United States (Doe II), 487 U.S. 201 (1988). In other words, producing incriminating documents under government compulsion may have testimonial aspects”aside from the contents of the documents”that are protected under the Fifth Amendment.

One of the rationales, if not the main rationale, behind the Required Records Doctrine is that the government or a regulatory agency should have the means, over an assertion of the Fifth Amendment Privilege, to inspect the records it requires an individual to keep as a condition of voluntarily participating in that regulated activity.  That goal would be easily frustrated if the Required Records Doctrine were inapplicable whenever the act of production privilege was invoked.

The Seventh Circuit remarked that:
Recently, in a case nearly identical to this one, the Ninth Circuit held that records required under the Bank Secrecy Act fell within the Required Record Doctrine. In re M.H., 648 F.3d 1067 (9th Cir. 2011) cert. denied, No. 11- 1026, (U.S. June 25, 2012). In the Ninth Circuit’s case, the court held that the witness could not resist a subpoena”identical to the one in this case”on Fifth Amendment grounds because the records demanded met the three requirements of the Required Records Doctrine. Id. We need not repeat the Ninth Circuit’s thorough analysis, determining that records under the Bank Secrecy Act fall within the exception. It is enough that we find”and we do” that all three requirements of the Required Records Doctrine are met in this case.

The takeaway from this case is that the IRS and the Department of Justice will continue to assert that there are no viable 5th Amendment protections to taxpayers producing evidence of their foreign bank accounts.  However, as only the Ninth and the Seventh Circuits have ruled on this issue it remains to be seen whether the other Circuits will follow.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in both the civil tax and the criminal tax litigation before the U.S. District Courts and the U.S. Circuit Courts of Appeal.  You may contact us by calling 305.3560.5690 or by emailing us at contact@fidjlaw.com

Update: Eastern District of New York Judge Finds Poker to be Game of Skill Not Chance Under Illegal Gambling Business Act

On August 21, 2012, Judge Jack Weinstein of the United States District Court for the Eastern District of New York dismissed the indictment against Lawrence Dicristina under 18 U.S.C. § 1955, the Illegal Gambling Business Act (“IGBA”) for Mr. Dicristina’s operation of a poker room. Judge Weinstein found that poker does not fall under the definition of gambling, as that term is defined under IGBA because poker is a game of skill as opposed to chance. In so holding, the Court’s opinion may mark a sea change in the ability of federal prosecutors to prosecute online pay-for-play poker operators and the payment processors who transmit funds between those sites and their customers. A copy of the Court’s opinion can be read here. 

As we have previously reported here, here and here, ongoing federal prosecutions have targeted internet pay-for-play poker operators and their payment processors for violations of federal law under IGBA, the Unlawful Internet Gambling Enforcement Act of 2006 “UIGEA” 31 U.S.C. §§ 5361-5366 and various other violations of federal law including wire fraud and money laundering. Under IGBA, it is a felony for anyone to conduct, finance, manage, supervise, direct, or own a gambling business which is prohibited by the State in which the business is operating. IGBA defines “gambling” as: “includ[ing] but is not limited to pool-selling, bookmaking, maintaining slot machines, roulette wheels or dice tables, and conducting lotteries, policy, bolita or numbers games, or selling chances therein.”

The heart of Dicristina’s argument turned on the basic premise that merely because something is defined as “gambling” at the state level does not automatically make it “gambling” for purposes of federal prosecution under IGBA. In his Motion to Dismiss, Dicristina argued that IGBA was not designed to regulated poker because: 1) a business must involve games sufficiently similar to the games enumerated in the federal definition in order to be prosecuted as a “gambling business” under the IGBA; and 2) a game run by a “gambling business” must be both: a) house-banked, and b) predominated by chance. In its opposition, the Government argued that the statute’s plain language does not restrict what kinds of games constitute gambling under IGBA. The Government further argued that when the statute’s broad language is read in the context of its purposes of bolstering state efforts at reducing organized criminal gambling activity, any gambling activity that is illegal under state law should be considered gambling under IGBA.

In its decision, the Court noted that, based on the text and legislative history of IGBA, both Dicristina’s argument, that “gambling” under IGBA is restricted to those games predominated by chance, and that of the government’s, that “gambling” under IGBA is co-extensive with how gambling is defined in the state in which the business operates, were plausible. Therefore, the Court found that the rule of lenity placed the burden on the government to prove that its position was the correct interpretation of IGBA. As explained by the United States Supreme Court in United States v. Santos, when interpreting ambiguous criminal statutes, “[t]he rule of lenity requires ambiguous criminal laws to be interpreted in favor of the defendants subjected to them. This venerable rule not only vindicates the fundamental principle that no citizen should be held accountable for a violation of a statute whose commands are uncertain, or subjected to punishment that is not clearly prescribed. It also places the weight of inertia upon the party that can best induce Congress to speak more clearly and keeps courts from making criminal law in Congress’s stead.”

In evaluating skill versus chance, the Court stated that “chance (as compared to skill) has traditionally been thought to be a defining element of gambling and is included in dictionary, common law, and other federal statutory definitions of it.” The Court found that the fundamental question in determining whether poker was a game of chance or skill “is not whether some chance or skill is involved in poker, but what element predominates.” (emphasis in original). In finding that skill, not chance, predominates poker, the Court noted that poker involved more than the luck of the draw. Instead “expert poker players draw on an array of talents, including facility with numbers, knowledge of human psychology, and powers of observation and deception.” Thus, the Court found that the Government failed to show that it is more likely than not that chance predominates over skill in poker and therefore poker is not considered “gambling” under IGBA.

While this decision may have removed an arrow from the quiver of federal prosecutors in their efforts to prohibit pay-for-play poker, the Court expressly noted that prosecution at the federal level for organized criminal poker operations could still be prosecuted under other federal statutes, such as RICO, and states were free to prohibit poker site operations within their own jurisdictions.

Fuerst Ittleman will continue to monitor these developments. If you have questions pertaining to IGBA, UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about Fuerst Ittleman’s experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com.

Class Action Lawsuits Allege Deceptive “Natural” Labeling Claims

As we previously reported here and here, there has been a noticeable increase in the number of lawsuits filed by consumers aiming to challenge “natural” advertising and labeling claims for dietary supplements and food products over the past year. Most recently, on July 26, 2012, a class action lawsuit was filed in the U.S. District Court for the Northern District of California alleging that General Mills, Inc. (“GM”) deceived consumers by marketing its Nature Valley granola bars as natural “when they are not wholly natural.” The complaint alleges GM deceptively uses the term “natural” to describe products containing ingredients that have been fundamentally altered from their natural state.

GM is the maker of Nature Valley food products including granola bars and other snack food items. According to the complaint, GM’s advertising and labeling Nature Valley products as “natural” violates several California consumer protection laws, including the California Legal Remedies Act, the Unfair Competition Law, and the False Advertising Law, because the products contain non-natural, highly processed ingredients such as high fructose corn syrup (“HFCS”), high maltose corn syrup (“HMCS”), maltodextrin, and rice maltodextrin.

Detailed in our previous report, many consumers feel they are being deceived by “natural” marketing claims and have urged the U.S. Food and Drug Administration (“FDA”) to adopt a formal definition for the term “natural.” In 1991, the FDA solicited comments on a potential rule regarding the definition. However, the FDA ultimately declined to adopt a formal definition. Currently, the FDA’s policy states that it considers “natural” to mean “merely that nothing artificial or synthetic (including colors regardless of source) is included, or has been added to, the product that would not normally be there.” 58 F.R. 2302. The informal policy regarding the use of the term “natural” does not carry the force of law. However, the FDA has sent Warning Letters to companies whose products claim to be “natural” yet contain ingredients the Agency regards to be synthetic which caused the product to be deemed to be misbranded pursuant to 21 U.S.C. 343(a)(1).

The uncertainty over the meaning of the term “natural” has brought a wave of recent class action lawsuits. Other products that have also faced consumer class action lawsuits for the use of “natural” claims on advertising and labeling include: ConAgra‘s Wesson Oils, Skinnygirl Margaritas, Kellogg’s Kashi, Tropicana’s not-from-concentrate orange juice, Frito Lay’s Tostitos and SunChips, Snapple beverages, and Ben & Jerry’s ice cream.

The plaintiffs’ attorneys in these cases argue that the “all natural” claim at issue is false and misleading because the product contains unnaturally processed, synthetic substances, or, in the case of Kashi, that the cereal contains genetically modified ingredients. While some products may technically be in compliance with FDA’s policy statement, they are not insulated against private actions because there is a lack of formal FDA or other government definition for “natural” claims. See, e.g., Holk v. Snapple Beverage Corp., 575 F.3d 329 (3rd. Cir. 2009). Without an FDA or other government definition, the plaintiffs’ attorneys can bring these suits and the food manufacturers must prove the claims are not false or misleading. Id. A formal FDA definition of “natural” could set a definitive standard for “natural” and eliminate these lawsuits. Id. For more information regarding what food manufacturers should know about “natural” claims, see please our previous report here.

A formal FDA definition of natural would not only benefit food companies, but it would also provide consumers with a clearer understanding and less confusion. For more information about the regulation of food advertising and labeling claims, please contact us at contact@fidjlaw.com or (305) 350-5690.