Florida Appeals Court Clarifies Law On Derivative And Direct Shareholder Lawsuits

July 22nd, 2014

On July 9, 2014, Florida’s Third District Court of Appeal issued a landmark opinion in the case of Dinuro Investments, LLC vs. Felisberto Figueira Camacho, et al., 3D13-1242 & 3D13-1246, (July 9, 2014).  In Dinuro, the Court analyzed whether a member of a limited liability company (“LLC”) had standing to commence a lawsuit directly against fellow LLC members.  In reaching its conclusion, the Court synthesized nearly fifty years of inconsistent Florida case law bringing clarity to which actions must be maintained directly and which actions must be brought derivatively.

Direct Claim vs. Derivative Claim

But first, it’s important to understand the basic distinctions between direct and derivative claims.  Generally, a derivative action is “an action in which a stockholder seeks to sustain in his own name a right of action existing in the corporation. The corporation is the real party in interest, the stockholder being only a nominal plaintiff.” James Talcott, Inc., v. McDowell, 148 So. 2d 36, 37 (Fla. 3d DCA 1962). A derivative action “must allege two distinct wrongs: the act whereby the corporation was caused to suffer damage, and a wrongful refusal by the corporation to seek redress for such act.” Id. at 38.  See also Kaplus v. First Cont’l Corp., 711 So. 2d 108, 110 (Fla. 3d DCA 1998) (“In a derivative action, a stockholder seeks to sustain in his or her name, a right of action belonging to the corporation.”).  Both the Florida Business Corporation Act and Florida Revised Limited Liability Company Act contain provisions for derivative actions.  See Fla. Stat. §607.07401 (shareholder derivative actions) and Fla. Stat. §605.0801-605.0806 (member derivative actions).See also Florida Limited Liability Company Act, specifically, Fla. Stat. §608.60, for derivative actions in LLCs formed before January 1, 2014.  However, effective January 1, 2015 all LLCs will be governed by the Revised Limited Liability Company Act. Comparatively, a direct action (a/k/a an “individual action”) is a suit by a shareholder/member to enforce a right of action existing in him, separate and distinct from that sustained by other shareholders/members. Citizens National Bank of St. Petersburg v. Peters, 175 So. 2d 54, 56 (Fla. 2d DCA 1965).

A significant distinction between a derivative and a direct lawsuit is one that ultimately impacts the bottom line.  In a derivative action, all recoveries belong to the corporate entity. In a direct action, all recoveries belong to the individual shareholder/member plaintiff(s). That said, aggrieved shareholders/members typically prefer to initiate direct actions and pocket the recovery. However, as clarified by Dinuro, the bar to initiate a direct lawsuit has now been raised.

The Dinuro Facts

In Dinuro, three equal members of San Remo Homes, LLC (“San Remo”) obtained financing to purchase pieces of real estate through subsidiary entities. Due to a decline in the housing market San Remo was forced to negotiate a loan modification with its lender. A term of the revised loan agreement required the three members to make additional contributions to San Remo. Two members made the contributions, while one member, Dinuro, did not. Further, the two compliant members refused to front Dinuro’s member contribution. Consequently, the loan went into default.

The two compliant members formed a new corporation, SR Acquisitions, LLC, and successfully negotiated a purchase of San Remo’s defaulted loan from the lender. Thereafter, SR Acquisitions, LLC initiated foreclosure proceedings against San Remo, acquired the San Remo properties, and left San Remo with no viable assets. Dinuro initiated a direct member lawsuit against the two other members and the lender alleging a breach of operating agreements, tortious interference, and conspiracy to cause the damage outlined in previous counts.

The Defendants moved to dismiss on several grounds, including Dinuro’s lack of standing.  The trial court granted the motion to dismiss “finding that Dinuro lacked individual standing to bring a direct claim against the other members for this type of harm, and that its claims should have been brought derivatively on behalf of San Remo.”

The Third District Court of Appeal agreed with the trial court and provided a detailed opinion to “provide clarity on a complicated point of law.”

Florida’s New Two-Prong Approach

Pulling from “scholarly literature and case law from around the country,” including Florida, the Dinuro Court stated as follows:

[t]he only way to reconcile nearly fifty years of apparently divergent case law on this point is by holding that an action may be brought directly only if (1) there is a direct harm to the shareholder or member such that the alleged injury does not flow subsequently from an initial harm to the company and(2) there is a special injury to the shareholder or member that is separate and distinct from those sustained by the other shareholders or members.

(Emphasis added).

The Court also identified an exception to the rule stating that a “shareholder or member need not satisfy this two-prong test when there is a separate duty owed by the defendant(s) to the individual plaintiff under contractual or statutory mandates.”

Succinctly, if a plaintiff cannot satisfy the two-prong test (direct harm and special injury) or demonstrate a contractual or statutory exception, the plaintiff will have to bring his or her claims derivatively on behalf of the corporation or company.  Relying on this new approach, the Dinuro Court reached the same conclusion as the trial court, that is, Dinuro’s claims could only be maintained derivatively because it was the entity that was initially injured, not the individual.

The attorneys at Fuerst Ittleman David & Joseph, PL will monitor subsequent application of Dinuro.  Our attorneys have extensive experience in the areas of complex corporate litigation, business litigation, tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  If you have any questions, an attorney can be reached by emailing us at contact@fuerstlaw.com or by calling 305.350.5690.


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Tax Litigation Update: Supreme Court Limits Taxpayers’ Ability to Fight IRS Summons

July 15th, 2014


As we previously reported, on April 23, 2014, the United States Supreme Court heard oral argument in United States v. Clarke, a case which involved the extent to which a taxpayer may investigate the underlying reasons or motivations for the IRS’s issuance of a summons.  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.

On June 19, 2014, in a unanimous opinion delivered by Justice Kagan, the Supreme Court held that “a bare allegation of improper purpose does not entitle a taxpayer to examine IRS officials. Rather, the taxpayer has a right to conduct that examination when he points to specific facts or circumstances plausibly raising an inference of bad faith.”


As we previously reported, Clarke arose out of an IRS examination 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. When the IRS requested a third extension of the statute of limitations, 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 during 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.  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.

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 presented some evidence supporting the contention that the summons was designed to circumvent the Tax Court’s discovery limitations, 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. According to Clarke, this fact was significant because in United States v. Powell, 379 U. S. 48 (1964), the Supreme Court ruled that only examining agents, and not lawyers representing the IRS in Tax Court proceedings, were allowed to interview summoned individuals.

Clarke also 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 Clarke’s first argument as a “naked assertion” unsupported by evidence. The Court then dismissed Clarke’s 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 district court also denied Clarke’s request for an evidentiary hearing.

On appeal, the Eleventh Circuit Court of Appeals reversed and held that the district court 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.”


In its opinion, the Supreme Court stated that a person receiving an IRS summons is entitled to contest it, but only in an enforcement proceeding. Further, the Court reasoned that because Congress recognized that the power vested in tax collectors may be abused, as all power may be abused, enforcement of an IRS summons must be contingent on a court’s approval. In addition, the Court held that that requisite judicial proceeding is adversarial, the summoned party must receive notice and may present argument and evidence on all matters bearing on a summons’s validity.

While the Court recognized a taxpayer’s right to challenge a summons, it emphasized that summons enforcement proceedings must be “summary in nature.” Further, the Court reasoned that as part of the adversarial process concerning a summons’s validity, the taxpayer is entitled to examine an IRS agent regarding facts or circumstances plausibly raising an inference of bath faith; that is, the taxpayer must offer some credible evidence supporting his charge. The Court recognized that although a bare assertion or conjecture is not enough, neither is a fleshed out case demanded – the taxpayer need only make a showing of facts that give rise to a plausible inference of improper motive.

In light of competing interests between the parties involved, the Supreme Court struck a balance between preventing abuse from IRS officials when issuing a summons, and preventing taxpayers from making naked allegations of improper purpose. Therefore, the Supreme Court held that “a bare allegation of improper purpose does not entitle a taxpayer to examine IRS officials. Rather, the taxpayer has a right to conduct that examination when he points to specific facts or circumstances plausibly raising an inference of bad faith.”

The Supreme Court also ruled that the standard it announced will allow for inquiry where the facts and circumstances make inquiry appropriate, without turning every summons dispute intro a fishing expedition for official wrongdoing. Nevertheless, the Court did not decide whether the evidence provided by those summoned in connection with Dynamo Holdings was insufficient to meet that standard. Rather, it sent the issue back to the district court to apply the “correct legal standard” to the facts.


This case presented two issues which the Supreme Court left unresolved: (1) whether the IRS can punish taxpayers for not extending the statute of limitations, and (2) whether the IRS was attempting to use its summons enforcement power in bad faith.

As we previously reported, 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 ruled 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, 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 have 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.

The Internal Revenue Manual (“IRM”) and IRS standard operating procedures require IRS employees to review taxpayer documents with enough time to make a tax assessment before the statute of limitations period ends. See IRM Further, the IRM requires that statute of limitations extensions be requested with enough time and based on a genuine need for more time to investigate a matter before making a tax assessment. Id. A taxpayer has a right to refuse to extend the normal statute of limitations period and the IRS should not retaliate for a taxpayer’s refusal to do so. See IRM

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.

While there seemed to be enough evidence to support the contention that the IRS was in fact punishing the taxpayers for not agreeing to extend the statute of limitations and that the summons were issued for an improper motive, the Supreme Court did not rule on those issues. Instead, the Supreme Court sent the issues back to the district court to decide.


As a matter of law, the Supreme Court’s reasoning in this case is understandable. If any naked allegation of impropriety triggered a full blown evidentiary hearing, the resulting litigation would create a log jam in courts which would bring the justice system to a standstill. Nevertheless, the Supreme Court’s reasoning does not reflect the practical realities of most people who receive IRS summons. While Justice Kagan’s opinion rightly sets forth that a summons represents an inquiry rather than an accusation, the person receiving the summons has no choice but to act as though it is an accusation.

Because the Supreme Court left certain issues unanswered – sending them back to the court below to apply what it called the “correct legal standard” to the facts – it is difficult to predict what the lower courts will consider “credible evidence supporting [the taxpayer’s] charge” or what facts will the taxpayer need to show which “give rise to a plausible inference of improper motive.” In light of this new legal standard, it is hard to predict whether the court below will find that the IRS was punishing taxpayers for not extending the statute of limitations, and whether the taxpayers pointed to specific facts or circumstances plausibly raising an inference of improper motive in enforcing the summons.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax litigation.  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@fuerstlaw.com or by calling 305.350.5690.

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When “Minor” Export Violations Can Become Federal Crimes

July 10th, 2014

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute,and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

Your foreign customer has been complaining to you about the high duties on your products when they are imported into his country. He asks if you could manifest an item as a “Return of Goods under Warranty.” That way, his company will avoid having to pay customs duties when the merchandise is imported.

 You know that the merchandise will be properly valued and described (other than the “warranty return” label) when your freight forwarder inputs the Electronic Export Information into the Automated Export System (AES). This will really help the customer, so this isn’t a big deal, right?

There is an old proverb that states, “What you don’t know can’t hurt you.” However, when it comes to export regulation and enforcement matters, the “First Law of Blissful Ignorance” is probably more accurate:

What you don’t know will always hurt you.

Improperly declaring export information in AES is a violation of the Foreign Trade Regulations (FTRs), which are codified at title 15 of the Code of Federal Regulations (C.F.R.) part 30. Specifically, 15 C.F.R. § 30.3(a) requires that electronic export information (EEI) be “complete, correct, and based on personal knowledge of the facts stated or on information furnished by the parties to the export transaction.” This requirement of accuracy applies (in this case) to the merchandise information that is submitted pursuant to 15 C.F.R. § 30.6(a)(13), which calls for a description of the commodity.

Therefore, even if you disregard the guidance contained in the FTRs regarding the “reporting of repairs and replacements” (15 C.F.R. §30.29) and accurately report the price and the commodity classification number, misrepresenting that merchandise as a warranty return, when it is not, is still a violation of the FTRs.

Subpart H of the FTRs (15 C.F.R. §§ 30.71-74) outlines the penalty provisions for export violations; these penalty provisions are enforced by U.S. Customs and Border Protection (CBP). Penalties for this type of infraction can be as high as $10,000 per violation, but CBP mitigation guidelines could reduce the penalties to as low as $500, if this is your company’s first offense. Moreover, according to CBP:

For first violations of the FTR, CBP may take alternative action to the assessment of penalties, including, but not limited to, educating and informing the parties involved in the export transaction of the applicable U.S. export laws and regulations, or issuing a warning letter to the party.

(U.S. Customs and Border Protection, “Guidelines for the Imposition and Mitigation of Civil Penalties for Failure to Comply with the Foreign Trade Regulations in 15 CFR Part 30,” CBP Dec. 08-50 (Feb. 2009)).

But that may not be the end of your potential enforcement liabilities.

In 2005, the U.S. Supreme Court considered the case of Carl and David Pasquantino and Arthur Hilts who were arrested and convicted of smuggling large quantities of liquor from the United States into Canada to evade Canada’s high alcohol import taxes. In this case, the men were convicted of criminal wire fraud, in violation of 18 U.S.C. § 1343.

The federal criminal wire fraud statute prohibits the use of the “instrumentalities of interstate or international telecommunications in furtherance of any scheme or artifice to defraud.” The Court in Pasquantino held that a scheme to deprive a foreign government of lawful duties and taxes comes within the scope of a “scheme or artifice to defraud” in the U.S. federal wire fraud statute. (Pasquantino v. United States, 544 U.S. 349, 354-55 (2005)).

The bottom line is that whenever a U.S. exporter knowingly falsifies any export information or export documents with the result that a foreign country is deprived of its lawful import duties, that action may constitute a Pasquantino violation.

Therefore, if you electronically transmit your EEI to AES with the erroneous “warranty return” information, under Pasquantino, you could be guilty of criminal wire fraud, because you are using your U.S. computer to deprive your customer’s foreign government of its duties. Also, if you mail copies of the export documents with that same false information, that may be a violation of the federal criminal mail fraud statute (18 U.S.C. § 1341).

While the penalties for the AES violations may be as negligible as informed compliance from CBP, a warning letter, or a mitigated penalty of $500, a criminal conviction of federal wire fraud and/or mail fraud can carry prison sentences up to 20 years per violation and a fine of up to $250,000 for each violation. Such serious potential consequences of even “minor” export violations is why your company – and every U.S. exporter – should religiously adhere to all export laws and regulations, and make export compliance a top corporate priority.

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Operation Choke Point Update: Despite Congressional and Industry Criticism, DOJ Will Continue Crackdown On Payday Lending Industry

July 3rd, 2014

Since early 2013, the United States Department of Justice (“DOJ”) has been formally targeting banks and payment processors servicing a wide range of lawfully operating businesses that various federal agencies, including DOJ and the Federal Deposit Insurance Corporation (“FDIC”), consider “high risk,” including nontraditional financial services providers such as payday lenders. The probe, known as “Operation Choke Point,” seeks to eliminate these “high risk” industries by cutting off their access to banking services. More information regarding Operation Choke Point can be read in our previous report here.

Not surprisingly, Operation Choke Point has drawn harsh criticism from both Congress and the financial services community because it has forced banks to terminate relationships with a wide variety of perfectly legitimate merchants. In January of this year, the U.S. House of Representatives Committee on Oversight and Government Reform requested that DOJ produce numerous documents regarding its general policies and procedures involving Operation Choke Point. Based on DOJ’s disclosures, on May 29, 2014, the Committee issued its staff report entitled: “The Department of Justice’s ‘Operation Choke Point’: Illegally Choking Off Legitimate Businesses?.” In its report, the Committee found that the DOJ has taken the position that providing normal banking services to certain merchants, including payday lenders, creates a “reputational risk” sufficient to trigger a federal investigation. The report concluded that as a result of increased pressure by DOJ and federal bank regulators, banks are terminating their relationships with “high risk” merchants in order to avoid heightened scrutiny by the federal government.

The report further questioned DOJ’s authority to implement Operation Choke Point. As explained in the report:

Operation Choke Point is being executed through subpoenas issued under Section 951 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The intent of Section 951 was to give the Department the tools to pursue civil penalties against entities that commit fraud against banks, not private companies doing legal business. Documents produced to the Committee demonstrate the Department has radically and unjustifiably expanded its Section 951 Authority.

(emphasis in original).

Operation Choke Point has also drawn the ire of the financial services industry. On June 5, 2014, the Community Financial Services Association of America (“CFSA”) filed a lawsuit seeking to end Operation Choke Point alleging that regulatory agencies and the DOJ are “engaged in a concerted campaign to drive [payday lenders] out of business by exerting back-room pressure on banks and other regulated financial institutions to terminate their relationships with payday lenders.” A copy of CFSA’s press release can be read here and the complaint can be read here.  (Our previous report regarding the financial services industry’s criticism of Operation Choke Point can be read here.)

However despite this criticism, the DOJ has no plans to discontinue the program. Instead, the DOJ argues that Operation Choke Point is necessary to crack down on online payday lenders (and other “high risk” businesses) who attempt to operate in states where payday lending is illegal. According to DOJ, many online payday lenders operate in states where payday lending is prohibited by utilizing third party payment processors that have bank accounts to make direct deductions from borrower’s accounts. (Non-bank or “third party” payment processors provide payment processing services to merchants and other business entities. Typically, payment processors use their own deposit accounts at financial institutions to process such transactions and sometimes establish deposit accounts at the financial institution in the names of their merchant clients.) By using payment processors to process payday loans and debit borrowers’ accounts, online lenders can operate in states where such activity is prohibited. (Our most recent report regarding how effective anti-money laundering compliance programs can help reduce the risk that third party payment processors may be facilitating fraudulent and illegal activity can be read here.)

DOJ also argues that Operation Choke Point has been successful. On April 29, 2014, DOJ announced a settlement with Four Oaks Fincorp. Inc., which was sued as part of Operation Choke Point. According to the Complaint filed by DOJ, Four Oaks permitted a third party payment processor facilitate $2.4 billion in fraudulent and illegal online payday loans through its banking system. As a result, Four Oaks agreed to pay $1.2 million in civil penalties. A copy of the DOJ press release announcing the settlement can be read here.


While DOJ’s stated position is that Operation Choke Point is designed to eliminate online payday lenders operating in states where online lending is illegal, in reality Operation Choke Point has resulted in banks severing ties with payday lenders operating in states where online lending is perfectly legal. In fact, the House Committee’s Report concluded that DOJ is using Operation Choke Point as a tool to target all forms of online lending. As explained in the Report, “Internal memoranda and communications demonstrate that Operation Choke Point was focused on short-term lending, and online lending in particular. Senior officials expressed their belief that its elimination would be a ‘significant accomplishment’ for consumers.”

Fuerst Ittleman David & Joseph, PL will continue to monitor the development of Operation Choke Point. 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. 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@fuerstlaw.com or by calling us at 305.350.5690.

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United States Supreme Court: Warrants are required to search digital data on seized cell phones

July 2nd, 2014

On June 25, 2014, in Riley v. California, a unanimous United States Supreme Court held that the Fourth Amendment requires that police obtain a warrant prior to searching the digital data found on an arrested suspect’s cell phone. The opinion can be read here.

Generally speaking, a warrantless search is unreasonable and a violation of the Fourth Amendment unless it falls within a specific exception to the warrant requirement. At issue in Riley v. California was whether the warrantless search of the digital data of a cell phone is permissible under the long recognized “search incident to arrest” exception to the warrant requirement which generally provides that law enforcement may search an arrestee at the time of his or her arrest.

In a series of decisions, the Supreme Court has explained the bounds of the search incident to arrest exception. In Chimel v. California, 395 U.S. 752 (1969), the Supreme Court held that for a warrantless search incident to arrest to comport with the Fourth Amendment, the search must be limited to the area within the arrestee’s immediate control. The Chimel court made clear that the purposes behind the search incident to arrest exception are twofold: 1) the need to protect officer safety; and 2) the need to prevent the destruction of evidence.

The Supreme Court further explained the search incident to arrest exception in United States v. Robinson, 414 U.S. 218 (1973). In Robinson, the Court held that physical evidence found on a person during a lawful search incident to arrest could itself be searched pursuant to the doctrine announced in Chimel. Finally, in Arizona v. Gant, 556 U.S. 332 (2009), the Court again relied upon Chimel in holding that a search incident to arrest permits searches of a car where the arrestee is unsecured and within reaching distance of the passenger compartment, or where it is reasonable to believe that evidence of the crime of arrest might be found in the vehicle.

In declining to extend Robinson and Gant to warrantless searches of digital data of an arrestee’s cell phone, the Court found that neither of the unique and narrow purposes (officer safety and preventing the destruction of evidence) is served by allowing the search of digital data on cell phones. As to officer safety, the Court found that digital data stored on a cell phone cannot itself be used as a weapon to harm an officer. Thus, while warrantless physical inspections of a seized phone are permissible to ensure officer safety, such as a search to ensure that a cell phone is not concealing a weapon which may harm an arresting officer, searches of digital content require a search warrant.

With regard to the destruction of evidence, the Court rejected the Government’s argument that, because remote wiping of information may be possible, officers should be allowed to conduct warrantless searches of digital data. The Court found that the Government’s briefing did not indicate that wiping and encryption were pervasive problems and that other techniques and technologies, such as simply turning the phone off or placing in a radio wave proof bag, could combat those problems.

Although finding that the purposes of Chimel were not satisfied, the Court did recognize that in certain rare circumstances the need for officer safety or the prevention of the destruction of evidence would necessitate the searching of a cell phone. However, the Court found that those rare instances would be governed by the “exigent circumstances” exception, not the search incident to a lawful arrest exception.

The Supreme Court also made clear that due to the vast storage capabilities of modern cell phones, greater privacy interests are implicated when addressing the Fourth Amendment’s warrants requirement as applied to the search of digital data. As explained by the Court, “[t]he search incident to arrest exception rests not only on the heightened government interests at stake in a volatile arrest situation, but also on an arrestee’s reduced privacy interests upon being taken into police custody.” Riley, 573 U.S. ___ (2014) slip op. at 15. However, the Court noted:

The fact that an arrestee has diminished privacy interests does not mean that the Fourth Amendment falls out of the picture entirely. Not every search is acceptable solely because a person is in custody. To the contrary, when privacy-related concerns are weighty enough a search may require a warrant, notwithstanding the diminished expectations of privacy of the arrestee.

Id. at 16 (internal citations and quotations omitted).

The Supreme Court also found that the privacy concerns regarding digital data on cell phones was different than those concerning the contents of physical objects. First, the Court found that modern “smart” cell phones allow users to store various distinct types of information that, when searched in combination, would reveal much more information than any one particular record in isolation. Second, the storage capacity of cell phones allows far broader access to information than previously possible. As explained by the Court, “the sum of an individual’s private life can be reconstructed through a thousand photographs labeled with dates, locations, and descriptions; the same cannot be said of a photograph or two of loved ones tucked into a wallet.” Id. at 18. Finally, the data on cell phones can date back years. Whereas “before cell phones, a search of a person was limited by physical realities and tended as a general matter to constitute only a narrow intrusion on privacy,” today the search of digital data of seized cell phones would be far more exhaustive, revealing, and intrusive. As a result, greater privacy concerns exist.

Of course, the Court’s decision does not mean that law enforcement is somehow foreclosed from searching cell phones. As explained by the Court:

Modern cell phones are not just another technological convenience. With all they contain and all they may reveal, they hold for many Americans the privacies of life. The fact that technology now allows an individual to carry such information in his hand does not make the information any less worthy of the protection for which the Founders fought. Our answer to the question of what police must do before searching a cell phone seized incident to an arrest is accordingly simple – get a warrant.

Id. at 28 (internal citations and quotations omitted)(emphasis added).

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, constitutional law, white collar criminal defense and litigating against the U.S. Department of Justice. You can reach an attorney by emailing us at contact@fuerstlaw.com or by calling us at 305.350.5690.

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Tax Litigation Update: Eleventh Circuit Holds Clear and Convincing Evidence Standard Applies to Penalties Imposed under IRC § 6701

June 25th, 2014

The Eleventh Circuit Court of Appeals, which hears appeals from the federal district courts in Florida, Georgia, and Alabama, ruled earlier this month that in order to impose penalties under IRC § 6701, the government bears the burden of proving each element of the statute by clear and convincing evidence.  In so doing, the Eleventh Circuit reversed the holding of the Middle District of Florida that a lower standard, preponderance of the evidence, applies to § 6701.  Moreover, the Eleventh Circuit’s decision was contrary to the Second and Eighth Circuits, which have held that proof by a preponderance of the evidence is the proper standard.  The Eleventh Circuit’s decision also created precedential case law that tax practitioners can potentially use to defend their clients from civil penalties beyond just § 6701.


The case before the Eleventh Circuit, Carlson v. United States, involved a tax return preparer, Frances Carlson, working for two companies doing business as Jackson Hewitt.  Prior to starting this job, Carlson did not have any professional tax return experience.  In this position, Carlson prepared both individual and corporate returns.  In total, Carlson worked for Jackson Hewitt for five years and prepared between 1200 and 1500 tax returns.

In 2006, the owner of the two Jackson Hewitt franchises that employed Carlson was arrested for, among other crimes, money laundering.  The arrest prompted an investigation of the businesses by the IRS.  In its investigation, the IRS determined that approximately 40 of the returns prepared by Carlson during the course of her employment contained unsubstantiated deductions.  The IRS thereafter assessed penalties against Carlson under IRC § 6701(a), which imposes a penalty against any person who:

(1) aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,


(2) knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and


(3) knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Carlson paid 15 percent of the assessed penalty, filed a claim for refund, which was rejected, and then sued in the district court for a refund.  Prior to trial, the IRS conceded 13 of the 40 penalties (one for each return bearing unsubstantiated deductions), leaving 27 penalties to determine.  At trial, Carlson moved for judgment as a matter of law as to 5 of those penalties because the Government had failed to introduce any evidence that Carlson knew the returns she prepared were incorrect.  The district court denied the motion and all 27 penalties went to the jury.  Carlson then objected to the district court’s jury instruction that the Government’s burden of proof under IRC § 6701 was proof by a preponderance of the evidence rather than by clear and convincing evidence.  The Court overruled the objection and the jury returned a verdict in favor of the government on all of the 27 penalties at issue, resulting in a judgment of $119,173.12 against Carlson.

The Eleventh Circuit’s Reasoning

On appeal, the Eleventh Circuit determined that the district court was incorrect in its jury instruction and in denying Carlson’s motion for judgment as a matter of law.  In reversing the district court on the jury instruction issue, the Eleventh Circuit began by stating that under its longstanding precedent, the Government’s burden for proving fraud in a civil tax case was “clear and convincing evidence.”  Based on this principle, the Eleventh Circuit stated that the pertinent question before it was whether § 6701 requires the Government to prove fraud.  If so, then the proper burden of proof is “clear and convincing evidence.”

In holding that § 6701 does require the Government to prove fraud, the Eleventh Circuit analyzed the text of § 6701(a), particularly subsection (a)(3) which requires the defendant to “know[s] that such portion [of a return or other document] (if so used) would result in an understatement of the liability for tax of another person…”

Section 6701(a)(3) contains the statute’s scienter requirement–the state of mind the defendant must have had to be liable under the statute.  The Eleventh Circuit read § 6701(a)(3) to require actual knowledge by the return preparer that the return the prepare had assisted in the preparation of would deprive the government of tax that is owed to it.  To the Eleventh Circuit, § 6701’s requirement of actual knowledge of the understated tax is akin to “the preparer deceitfully prepar[ing] a return knowing it misrepresented or concealed something that understates the correct tax,” which amounts to “a classic case of fraudulent conduct.”

The Government attempted to argue that the statute could not require a finding of fraud, and therefore could not necessarily require clear proof of a violation by clear and convincing evidence, because the statute does not contain the word “fraud.”  The Court summarily rejected that argument as elevating form over substance—“the lack of the word ‘fraud’ is immaterial if the conduct the government must prove meets the definition of fraud.”

Moreover, the Government itself had previously argued that because § 6701 is an anti-fraud provision, no statute of limitation applied to deficiencies resulting from actions prohibited under § 6701.  Thus, the government was seeking to cabin the characteristics of fraud contained in § 6701 to situations in which only it benefitted.

Creation of a Circuit Split

In holding that § 6701 requires proof by “clear and convincing evidence,” the Eleventh Circuit contradicted the Second Circuit and the Eighth Circuit Courts of Appeal.  In Mattingly v. United States, 924 F.3d 785 (8th Cir. 1991), the Eighth Circuit determined that § 6701 requires proof by a preponderance of the evidence for two reasons (which the Second Circuit followed without much elaboration in Barr v. United States, 67 F.3d 469 (2d Cir. 1995)): first, the Eighth Circuit reasoned that § 6701 does not require proof of fraud (and thus does not require a heightened standard of proof) because it does not refer to the “evasion of tax.” The Eleventh Circuit in Carlson rejected this notion because it could not discern a reason why a reference to evasion of tax in § 6701 was relevant to its analysis of the burden of proof imposed by § 6701.  Moreover, the Eleventh Circuit reasoned, even if it were necessary for the statute to reference tax evasion to implicate a higher standard of proof, § 6701 does reference tax evasion (without explicitly using that phrase) due to its requirement that the return preparer’s knowing violation “result in an understatement of the liability for tax of another person.”

Second, in Mattingly, the Eighth Circuit reasoned that the structure of sections 6700, 6701, 6702, and 6703 suggests the application of a uniform standard of proof.  The Eleventh Circuit dismissed this reasoning on the basis that applying standards of proof based on a statute’s relationship to other statutes could lead to perverse results.  Additionally, even if sections 6700-6703 suggest the need to apply a uniform standard of proof, there is no specified standard of proof for those sections.  Thus, there is nothing specifically requiring a court to impose a preponderance of the evidence standard over a clear and convincing evidence standard in any of those statutes.

Finally, the Eighth Circuit, in justifying the application of a lower standard of proof to § 6701, reasoned that § 6701 was enacted as “another piece in the expansive non-fraud penalty scheme” applicable to taxpayers and tax preparers.  In refusing to follow this rationale, the Eleventh Circuit, drawing on the case of Sansom v. United States, 703 F.Supp. 1505 (N.D. Fla. 1988), identified three penalties applicable to tax preparers, IRC §§ 6694(a), 6694(b), and 6701.  Of those, only § 6701 requires the return preparer to actually know that that the return understates the proper amount of tax, thus suggesting that § 6701 was unique among those three statutes and worthy of a higher standard of proof.

The Fallout

After rejecting the approach taken by the Second and Eighth Circuits and holding that the imposition of penalties under § 6701 required proof by clear and convincing evidence, the Eleventh Circuit further determined that the district court’s application of the incorrect standard of proof was not harmless and required a new trial.

Additionally, the Eleventh Circuit reversed the district court’s decision to deny Carlson’s motion for judgment as a matter of law as to the penalties imposed on five specific returns.  With regard to each of these five penalties, the Government only presented evidence that the taxpayer assisted by Carlson did not substantiate the claimed deductions.  The Government did not present evidence that Carlson actually knew the returns understated the correct tax.

A verdict based on evidence that merely demonstrates that the taxpayers could not substantiate their deductions would have the effect of improperly transferring the burden to Carlson to prove that she did not actually know of the error, as opposed to the Government proving she did know of the error.  Additionally, it would be an impermissible inference by a jury to conclude that Carlson actually knew of the error based solely on the fact that the taxpayer could not substantiate his deduction—the presence of an incorrect deduction does not prove that the return prepare knew the return was inaccurate.

Because the government failed to present any evidence as to Carlson’s knowledge of the inaccurate returns on these five penalties, the Eleventh Circuit held that Carlson’s motion for judgment as a matter of law should have been granted.  The Eleventh Circuit went out of its way to state that it was not deciding what standard of proof should be used to review a district court’s denial of a motion for judgment as a matter of law on § 6701 penalties (as opposed to the context of jury instructions, which it did decide).  Under either the preponderance of the evidence or clear and convincing evidence standards, the government’s failure to introduce any evidence of Carlson’s knowledge required judgment as a matter of law in Carlson’s favor.

The Carlson decision is an important victory for tax return preparers operating in the Eleventh Circuit.  Under a fair reading of the decision, tax return preparers are entitled to rely upon the information supplied to them by the taxpayer, without the fear of being accused they were “willfully blind” to the errors contained in the taxpayer’s claimed deductions.  Additionally, by deciding the question in contravention of the Eighth and Second Circuits, the Eleventh Circuit has created a circuit split, heightening the chances the Supreme Court may ultimately decide the question.

Potential Relevance in Other Contexts

        i.            Willful FBAR Violations

It remains to be seen if the Eleventh Circuit’s articulation of the burden of proof under IRC § 6701 will translate to or be adopted in other areas where the correct burden of proof is less than clear.  A very active area where the burden of proof is less than clear is the imposition of willfulness penalties for failing to file a Report of Foreign Bank Account (“FBAR”).  A non-willful failure to file an FBAR may lead to a penalty of $10,000 per violation, but a willful failure to file an FBAR can lead to a penalty of the greater of $100,000 or 50 percent of the highest balance in the undisclosed account during the given year, so the determination of willfulness or non-willfulness is an important one.

There is a dearth of judicial precedent regarding the proper burden of proof in determining willfulness in the FBAR context.  In a recent high profile case, United States v. Zwerner, the Southern District of Florida submitted the willfulness question to the jury with the instruction to apply the preponderance of the evidence standard, and the jury found that the taxpayer had willfully failed to meet his FBAR obligations.

While the amount of the penalty to be imposed in the Zwerner case settled before the jury’s verdict could be appealed, some have speculated that had the Eleventh Circuit’s decision in Carlson been released earlier, the taxpayer in Zwerner would have had leverage to seek a more favorable settlement.  This is because under Carlson, the imposition of civil penalties based on fraudulent conduct requires the Government to prove its case by clear and convincing evidence, even where the subject statute does not explicitly reference fraud.  Rather, under Carlson, the key determination was whether the return preparer knew that her actions would result in the understatement of liability for the taxpayer, which the Eleventh Circuit held to be synonymous with fraud.

Willfulness is generally defined as an intentional violation of a known legal duty.  It can be effectively argued that knowingly taking action that would result in an understatement of liability (which the Eleventh Circuit held in Carlson to require proof by clear and convincing evidence) is analogous to an intentional (i.e. knowing) violation of the FBAR requirement.  Hence, establishing willfulness for purposes of applying the higher civil FBAR penalty should require proof by clear and convincing evidence just as proving the elements of a § 6701 violation now (in the Eleventh Circuit at least) requires proof by clear and convincing evidence.

While there are certainly counterarguments as to why the Carlson should not extend to the context of FBARs, the Carlson decision certainly provides a weapon for clever and resourceful tax attorneys to use in defense against civil penalties imposed beyond the scope of IRC § 6701.

     ii.            The Offshore Voluntary Disclosure Program

In a related issue, the IRS recently modified the rules applicable to its Offshore Voluntary Disclosure Program (OVDP).  As we wrote about more extensively here, a key determination regarding what type of voluntary disclosure a taxpayer may make is whether that taxpayer’s past non-compliance (such as failure to file FBARs) was willful or non-willful.  In general, far more lenient treatment is provided to those OVDP filers who successfully establish that their past non-compliance was not willful.

The problem, as more thoroughly explained in our previous blog entry, is that defining “non-willfulness” in the context of the OVDP is extremely difficult.  Under the new OVDP rules, the ultimate arbiter of whether an OVDP filer’s past non-compliance was or was not willful is the IRS—its determinations are final and the methodology it will employ in evaluating willfulness is unknown to both taxpayers and to IRS personnel.

To compound the uncertainty, as the Carlson case demonstrates, not even the Circuit Courts of Appeal are in agreement as to what proof is required to establish certain penalties, such as those imposed under § 6701, that are based on the violator’s knowledge and willfulness, and there appears to be no circuit-level authority regarding the standard of proof for imposing civil, willful FBAR penalties.  The disagreement and lack of guidance from the courts on these points simply exacerbates the uncertainty surrounding how the IRS will evaluate willfulness in the OVDP and leaves potential OVDP filers searching for answers.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience litigating tax cases in the Tax Court, Federal District Courts, and the Court of Claims. We will continue to monitor the development of the Carlson case and other issues relating to IRC § 6701, FBAR penalties, and the non-willfulness in the OVDP 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@fuerstlaw.com.

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FTC Settlement with Payment Processor Highlights Importance of Anti-Money Laundering Programs for Non-Bank Financial Institutions

June 23rd, 2014

On June 11, 2014, the Federal Trade Commission (“FTC”) announced that it had entered into a stipulated permanent injunction with Independent Resources Network Corp., a payment processor, to settle charges that it knowingly assisted and facilitated a telemarking scam that swindled nearly $10 million from unsuspecting consumers. A copy of the FTC’s press release can be read here.

In its most simple terms, payment processors are entities that process credit or debit card transactions between merchants and consumers. As described by FinCEN:

Non-bank, or third party, Payment Processors … provide payment processing services to merchants and other business entities, typically initiating transactions on behalf of merchant clients that do not have a direct relationship with the Payment Processor’s financial institution. Payment Processors use their own deposit accounts at a financial institution to process such transactions and sometimes establish deposit accounts at the financial institution in the names of their merchant clients.

See FinCEN Advisory FIN-2012-A010.

In its Complaint, FTC alleged that Independent Resources either knew or consciously avoided knowing facts about the illegal conduct of a telemarketing scam operated by one of its merchants, Innovative Wealth Builder, Inc. (“IWB”). According to the complaint, IWB operated a phony debt relief scam wherein IWB would cold call its victims explaining how, for a fee, IWB could reduce the interest rates the customers were correctly paying on their outstanding credit card debt. In reality, no such program existed.

As alleged in the complaint, Independent Resources ignored several indicators of potential fraud including: 1) that IWB had an “F” rating with the Better Business Bureau; 2) that IWB was the subject of an investigation by the Florida Attorney General’s Office for unfair and deceptive trade practices; 3) that MasterCard identified IWB as “tier 3” or “high fraud alert” because of the number of fraudulent transactions which were associated with the debt relief company; 4) that IWB was the subject of an FTC investigation for unfair and deceptive trade practices; and 5) from August 2009 until January 2013 (the filing date of the complaint) IWB’s chargeback rate exceeded 40% multiple times despite the average chargeback rate for all other merchants of the payment processor was below 1%. In addition, the complaint alleged that the payment processor assisted IWB in responding to and defeating thousands of chargeback requests and helped structure sales transactions in order to divide fees over multiple transactions.

In an effort to settle the FTC’s allegations of violations of the Telemarketing Sales Rule, Independent Resources entered into a Stipulated Order. As part of the Stipulated Order for Permanent Injunction and Monetary Judgment, the payment processor agreed to pay $1.1 million. In addition, the order prohibits the payment processor from processing payments for any client that sells debt relief products or services. Further, the payment processor cannot process payments from collection agencies, credit card protection services, lead source provides, mortgage loan modifications, or outbound telemarketing without conducting upfront screening and ongoing monitoring.

As the Independent Resources settlement makes clear, in addition to the numerous agencies which regulate the financial services industry, including FinCEN, FDIC, OCC, and the IRS, non-bank financial institutions must also ensure that the business practices of their customers are not false, misleading, or unlawfully deceptive so as to violate the FTCA. The stipulated order and settlement highlights the need for payment processors, and the financial institutions that serve them, to develop, implement, and maintain robust anti-money laundering compliance programs. See generally, 31 U.S.C. § 5318. A properly constructed AML program — even for companies which are not technically required to have one – will be helpful in accomplishing two critical tasks: 1) detecting potential fraud and abuse by merchants, and 2) ensuring that the company is not unwittingly participating in the legal violations of third parties. As we have previously reported with regards to internet gambling, in addition to civil liabilities, third party payment processors face potential criminal prosecution for facilitating violations of federal law. (Our previous reports regarding payment processor liability can be read 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 practice group has represented a wide array of financial services providers 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. 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@fuerstlaw.com or by calling us at 305.350.5690.

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International Tax Compliance Update: Offshore Voluntary Disclosure Program Modifications: A Trap for the Unwary

June 23rd, 2014

Several weeks ago, we reported that changes to the IRS’s Offshore Voluntary Disclosure Program (“OVDP”) were imminent and would focus on distinguishing between taxpayers who willfully violated their reporting requirements, and those whose past reporting failures were non-willful.

On Wednesday, the IRS officially announced the anticipated changes to the OVDP.  The IRS’s announcement of the modifications and additional guidance regarding the modifications can be found here.  As predicted, the changes create a clear distinction in treatment between OVDP filers who can successfully certify their reporting failures were non-willful and those who cannot.

Fundamentally, OVDP filers whose past reporting failures were non-willful are, from July 1, 2014 forward, eligible for admission into the OVDP under “streamlined” procedures that previously only applied to a narrow category of filers (generally non-US residents with less than $1,500 of unpaid tax in tax years covered by the OVDP).  Moreover, taxpayers whose past non-compliance was non-willful will be subject to dramatically lowered penalties (5 percent of the penalty base as opposed to 27.5 percent for US residents or no penalties for non-US residents). A more detailed description of the new, streamlined procedure is set forth below.  However, before an OVDP filer can take advantage of the streamlined procedure and reduced or eliminated penalties, he must establish that his violations were non-willful.

Non-willfulness: A Crucial, Yet Uncertain, Determination

The streamlined procedures and reduced or eliminated penalties only apply under the modified OVDP if the filer can successfully certify that his or her past non-compliance was non-willful.  For this purpose, the IRS has defined non-willful conduct as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”  By adopting this definition, the IRS has more closely aligned the concept of willfulness within the OVDP with the standard definition of willfulness applied by the federal courts in civil cases, i.e. an intentional violation of a known legal duty.

It is essential to recognize that filing a streamlined disclosure and certifying that past reporting failures were non-willful does not immunize the OVDP filer from examination and does not guarantee that the non-willfulness certification will be accepted.  The information and supporting documents submitted by the filer may still be examined and the IRS is permitted to overrule the filer’s non-willfulness certification.  Thus, the IRS’s ability to reject a non-willfulness certification upon its independent examination may justifiably create a great deal of uncertainty for an OVDP filer whose non-willfulness is difficult to prove.

Although the IRS has articulated a standard of non-willfulness that appears to be in line with the standard generally applied by courts across the country, the true test lies in whether the IRS will be faithful to that standard.  Willfulness is a potentially malleable concept, and though court decisions regarding willfulness under civil and criminal tax statutes abound, because the OVDP is subject to the IRS’s plenary authority, it is doubtful whether judicial precedent regarding willfulness can be meaningfully relied upon.  Also, there are no appeal rights in the OVDP; once the IRS makes a determination regarding the willfulness or non-willfulness of an OVDP filer’s past non-compliance, that determination is fixed.

Moreover, due to privacy laws applicable to the IRS and the generally secretive nature with which the IRS treats its resolution of cases under the OVDP, it will be extremely difficult for potential OVDP filers to discern any sort of uniform applicability of the non-willfulness requirement with the IRS.  The standard applied could vary from case to case and examining agent to examining agent without OVDP filers ever being aware of the disparate standards being applied.

The uncertainty surrounding the standard by which the IRS will analyze non-willfulness in the context of the streamlined OVDP was exemplified by reports of comments made by IRS officials at a recent conference held by New York University Law School.  Specifically, division counsel for the Small Business and Self-Employed Division, John McDougal, was reported as saying that an OVDP filer is non-willful if he “isn’t really worried about being prosecuted.”  Additionally, McDougal was quoted as saying “the concept of willfulness is well-documented in the case law,” and “we’re depending on practitioners to help clients work their way through what the risk is of criminal prosecution and significant penalties.”  In other words, it appears not even IRS officials are exactly sure what “non-willfulness” means for the streamlined OVDP, which begs the question: if the IRS can only vaguely define what non-willfulness means, what hope does an uncertain OVDP filer have?

The Effect of Rejection

The fact that the IRS’s initial determination regarding whether an OVDP filer’s past reporting failures were willful or non-willful are binding and final leads to perhaps the most pressing underlying issue created by the OVDP modifications.  If a taxpayer certifies that his past non-compliance was not willful and thereby attempts to take advantage of the streamlined disclosure program, and the IRS examines the disclosure and rejects the non-willfulness assertion, that taxpayer is precluded from entering the traditional OVDP, as confirmed by this statement in the IRS announcement of the streamlined program: “Once a taxpayer makes a submission under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures, the taxpayer may not participate in OVDP.”

As a result, if an OVDP filer attempts to certify non-willfulness and the certification is overruled, the filer will have disclosed his offshore assets and past non-compliance, and exposed himself to the maximum potential penalties, without any benefit.  In essence, taxpayers that are not completely confident about their ability to prove that their past non-compliance was not willful–as that term is defined by the IRS–are taking a significant risk in attempting to avail themselves of the streamlined procedure.

Unfortunately for potential OVDP filers, how strict the IRS will be in evaluating a filer’s past non-compliance can only remain to be seen.  Further, unless the IRS alters its generally secretive approach to the OVDP, OVDP filers will be forced to rely on anecdotal evidence gleaned from others who have attempted to participate in the streamlined disclosure.  Sadly, while the OVDP program is meant to provide certainty for taxpayers seeking to resolve past non-compliance, the IRS, in attempting to draw the line between willful and non-willful filers, appears to have created a brand-new source of uncertainty.

The Specifics of Disparate Treatment for Willful and Non-Willful Past Noncompliance

Under the modified OVDP, taxpayers successfully certifying that their non-compliance was non-willful are treated much more leniently than they previously were, when almost all OVDP filers were subject to a 27.5 percent penalty regardless of the circumstances surrounding their past non-compliance.  Moreover, the disclosure obligations of non-willful OVDP filers are less onerous than those of willful filers.

Under the modified program, non-willful filers (again, those who successfully establish that their reporting failures were due to negligence, inadvertence, or a good faith misunderstanding of the law) are broken into two groups: those who are U.S. residents and those that are not.  For each group, the procedure for taking advantage of the new, streamlined OVDP is largely the same, with a key difference noted below.  OVDP filers in either non-willful group are required to:

  1. File three years of amended or delinquent returns.  Note that US residents cannot file delinquent returns, so for US residents to be eligible for the streamlined procedures, they must have filed a return for the previous three tax years.  If a US resident has not filed returns for the previous three tax years, that person should not attempt to enter the OVDP under the streamlined procedures, as it is likely their submission will be rejected and they may end up being precluded from using the traditional OVDP;
  2. Pay all previously unpaid tax and interest reflected on the newly filed returns;
  3. File any FBARs that were required to be filed, but were not, for any of the six most recent tax years for which the filing due date has passed;
  4. Sign and file a certification regarding the taxpayer’s residency status (either a U.S. resident or non-resident), and further certifying that all required FBARs have been filed and that all past reporting failures were due to non-willful conduct.

The primary difference in the IRS’s treatment of U.S. residents and non-residents is that non-residents are not subject to any penalties (and therefore are required only to pay back taxes and interest to resolve their past non-compliance), whereas U.S. residents will be required to pay a miscellaneous 5 percent penalty.  The determination of whether a taxpayer is a US resident depends on that taxpayer’s legal status.  If the taxpayer is a US citizen or green card holder, he will be considered a non-resident if, in any one or more of the three most recent years for which the tax return due date has passed, the individual did not have a US abode (which generally means the location of the taxpayer’s primary residence) and was physically outside the US for at least 330 full days.

For taxpayers who are not US citizens or green card holders, they will be considered non-residents for OVDP purposes if they do not meet the substantial presence test of IRC § 7701(b)(3), which generally requires a taxpayer to be present in the US for at least 31 days in the current year and at least 183 days over the previous three years (with days in the years 2 being counted as 1/3 of a day and days in year 3 being counted as 1/6 of a day).

Additional Modifications to the OVDP

While generally beneficial to OVDP filers whose past non-compliance was not willful, the IRS’s modifications increase the burden on filers who cannot certify that their non-compliance was not willful.  Before the IRS’s modifications, a 27.5 percent penalty was applied to OVDP filers almost uniformly.  Now, beginning August 4, 2014, if an OVDP filer fails to disclose an offshore account and it has become public that the host financial institution is under investigation by or is cooperating with the IRS or Department of Justice or the host financial institution has been identified by in a “John Doe summons,” then a 50 percent penalty will apply to all of the taxpayer’s undisclosed assets (not just those hosted by the subject financial institution).  The IRS has published a list of those financial institutions that currently meet these criteria:


2. Credit Suisse AG, Credit Suisse Fides, and Clariden Leu Ltd.

3. Wegelin & Co.

4. Liechtensteinische Landesbank AG

5. Zurcher Kantonalbank

6. swisspartners Investment Network AG, swisspartners Wealth Management AG, swisspartners Insurance Company SPC Ltd., and swisspartners Versicherung AG

7. CIBC FirstCaribbean International Bank Limited, its predecessors, subsidiaries, and affiliates

8. Stanford International Bank, Ltd., Stanford Group Company, and Stanford Trust Company, Ltd.

9. The Hong Kong and Shanghai Banking Corporation Limited in India (HSBC India)

10. The Bank of N.T. Butterfield & Son Limited (also known as Butterfield Bank and Bank of Butterfield), its predecessors, subsidiaries, and affiliates

Taxpayers who have or had accounts in those institutions and failed to report the accounts or pay tax on the interest or dividends generated by the account should act promptly if they plan to enter the OVDP.  Additionally, this list will likely expand in the future.

Furthermore, under the modified program all OVDP filers must provide the account statements generated during the OVDP period (previously that requirement applied only to account holders that had a balance in excess of $500,000 at any point during the OVDP period), and, more importantly, the OVDP filer must pay the OVDP penalty at the time the voluntary disclosure is made.  Under the old rules, the taxpayer waited until negotiations with the examining agent assigned to the disclosure were complete before paying the OVDP penalty.

Has the IRS Truly Eased the Burden on OVDP Filers?

In his statement previewing the OVDP modifications earlier this month, IRS Commissioner John Koskinen repeatedly emphasized the need to treat OVDP filers who did not willfully violate their reporting obligations consistently with the non-willful manner of their violations.  In some ways, the IRS’s modifications to the OVDP have met that goal.  The modifications more appropriately take into account the willfulness of the OVDP filer’s non-compliance in setting the applicable punishment and are especially helpful in the case of obvious non-willfulness, such as US citizens who have lived abroad for nearly their entire lives and were never aware they had any US tax obligations.

Yet at the same time, IRS’s modifications create a significant conundrum for potential filers whose non-willfulness is not clear cut.  In many factual circumstances, the IRS can plausibly assert that a taxpayer’s reporting failures were the result of willful blindness.  This is especially so given the questions regarding foreign accounts taxpayers are required to answer on Schedule B of the 1040.

Specifically, in order to determine whether the taxpayer has an FBAR filing obligation, schedule B asks taxpayers whether they have a financial interest in or signatory authority over a financial account located in a different country, and then directs the taxpayer to read the applicable instructions.  Any taxpayer who files schedule B with their tax return has arguably been placed on notice that they have an FBAR or other reporting obligation regarding their foreign account, which the IRS can use to overrule an OVDP filer’s non-willfulness certification.

One can imagine a multitude of other scenarios in which an OVDP filer’s honest misunderstanding of the facts or law can be painted as willful blindness.  Until the IRS more clearly articulates how it will judge non-willfulness in the context of the OVDP, based on real, practical circumstances rather than an abstract legal standard, the looming threat of the IRS making a willful blindness determination and rejecting a filer’s entry into the streamlined procedure will undoubtedly affect the decisions of many OVDP filers.

Additionally, while it is clear the IRS has reduced the burden on filers who successfully establish non-willfulness, a strong argument can be made that taxpayers whose non-willfulness was readily apparent should have never faced the possibility of significant penalties or criminal prosecution for their non-compliance in the first place, and that by including those taxpayers at all within the scope of the previous iterations of the OVDP the IRS was overreaching.

Now, by either eliminating or lowering the applicable penalty for non-willful filers, the IRS can be seen as justified in nearly doubling the penalty applicable to certain willful filers (i.e. taxpayers with undisclosed accounts in banks that are cooperating with the US government, such as those listed above).  Overall, while the fallout remains to be seen, the IRS’s OVDP modifications should not be viewed as being as forgiving to taxpayers disclosing their offshore assets and past non-compliance as the IRS might argue or publicize.

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@fuerstlaw.com.

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

June 18th, 2014

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.


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 Compliancehere.)

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@fuerstlaw.com.

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

June 16th, 2014

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@fuerstlaw.com or by calling us at 305.350.5690.

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