• Fall 2020 California Privacy Law Update

    This year has been, and continues to be, a rollercoaster for privacy laws and legislation in California. From CCPA to CPRA, and other new privacy legislation signed into law or vetoed by Governor Newsom, 2020 has shown a flurry of activity in the area of privacy rights, with more developments on the way. Here we provide a brief update of the status of privacy laws, existing and upcoming, and provide guidance to prepare businesses to comply with these varying regimes.

    California Consumer Privacy Act (“CCPA”) Enforcement Begins Amid Pandemic

    The CCPA went into effect on January 1, 2020 and enforcement began July 1, 2020.  Promptly thereafter, California’s Supervising Deputy AG Stacey Schesser confirmed that initial compliance notice letters were sent to allegedly non-compliant businesses based on consumer complaints and publicly available information. Although the details of these compliance letters are not fully known, the AG has stated that its enforcement priorities include protecting minors and sensitive information such as health data, as well as use of the “Do Not Sell My Personal Information” link. Businesses, especially those “selling” information and handling sensitive data and data of minors, should evaluate their practices and take steps to comply with CCPA if they have not done so already.

    Additionally, despite the CCPA’s own language that it should not be used as a basis to bring private claims (except with respect to a data breach), several class action lawsuits have been filed in the first few months of 2020 alleging violations of CCPA provisions. Allegations regarding the CCPA in these lawsuits range from failure to implement reasonable secure measures and safeguards, which resulted in unauthorized disclosures of unencrypted and unredacted personal information, to insufficient notice regarding the collection, use, and sharing of personal information. Violations of Unfair Competition law based on noncompliance with CCPA have also been consistently pleaded. How courts decide these cases remains to be seen, but in the meantime, we can expect to continue to see individuals and plaintiffs’ lawyers test the scope and boundaries of the new law.

    Extension of the CCPA’s Exemptions for Employee and B2B Data

    Under the CCPA, certain HR data collected about employees and job applicants (“Employee data”), and certain data collected about individuals acting as points of contact in business-to-business relationships (“B2B” data) are exempted from most of the requirements of the statute. However, those exemptions were set to expire at the end of 2020, pending further legislation on these issues, unless some action was taken.

    On August 30, 2020, the California legislature passed AB 1281, which extended the Employee and B2B data exemptions for another year, with the caveat being that if the California Privacy Rights Act (“CPRA”) ballot initiative (see below) passes, the CPRA’s provisions extend these exemptions automatically for another two years, until January 1, 2023.

    Either way, the Employee and B2B exemptions are extended, which is good news for most businesses.

    CCPA Amendment Regarding De-identified Information under HIPAA

    One of the many challenges to the CCPA’s broad reach is its intersection with other privacy laws such as the Health Insurance Portability and Accountability Act (“HIPAA”), particularly where the two statutes contain inconsistent provisions regarding standards for de-identification of personal information. To more closely align CCPA with HIPAA, Governor Newsom signed AB 713 into law on September 25, 2020. AB 713 exempts from the CCPA information that is de-identified under HIPAA, so long as it is derived from patient information that was originally collected, created, transmitted, or maintained by an entity regulated by HIPAA, the Confidentiality Of Medical Information Act, or the Federal Policy for the Protection of Human Subjects (Common Rule), and so long as the information is not re-identified. The new law only permits re-identification of such exempted information for specific, limited purposes. It also imposes disclosure obligations on businesses selling or disclosing de-identified health information, and, beginning January 1, 2021, requires contracts for sale or license of de-identified information (where one of the parties resides or does business in California) to include specific provisions stating that the information includes de-identified patient information, prohibiting re-identification of such information, and prohibiting further disclosure of the information to a third party unless the third party is bound by the same or stricter conditions.

    AB 713 went into effect immediately and businesses that deal with de-identified information under HIPAA should take a close look at their practices to ensure their contracts, disclosures, and policies are compliant with the new amendment.

    The Attorney General’s Third Set of Proposed Modifications to CCPA Regulations

    On October 12, 2020, the Attorney General proposed modifications to the finalized CCPA regulations. Consistent with the AG’s priorities to focus on the “sale” of personal information and protect minors’ data, the modifications provide guidance on: notice to opt-out of sale of personal information through offline methods; mechanics of requests to opt-out of sale of personal information; and proof a business may require from an authorized agent and a consumer to verify a request. The regulations also clarify the special rules that apply to businesses handling minors’ data. The comment period for the proposed modification is October 13, 2020 – October 28, 2020.

    The proposed modifications are available at https://www.oag.ca.gov/privacy/ccpa/current

    California Privacy Rights Act (“CPRA”)

    As if businesses did not have enough to deal with in terms of CCPA compliance, there may be a new set of data privacy requirements coming. CPRA, dubbed as “CCPA 2.0,” is on the ballots for the November election. The CPRA would amend and expand the CCPA, keeping certain provisions in place while revising or adding new provisions. Current polling shows strong support for this initiative and it appears likely to pass.

    Select key provisions of CPRA include the following:

    • California Privacy Protection Agency (“CPPA”) – CPRA creates an independent agency – the first of its kind – with authority and jurisdiction to implement and enforce the CCPA. With an agency like this focused solely on enforcing privacy violations, businesses can expect much more rigorous enforcement of privacy laws in California. The CPPA would take over authority for issuing regulations from the Attorney General’s office, and it will be interesting to see how this new agency functions and what its priorities of enforcement will be.
    • Sensitive Personal Information – CPRA introduces a new category of personal information called “sensitive personal information” encompassing health data, sexual orientation, race, origin, geolocation, financial data, genetic data, biometric data, social security number, driver’s license, etc. It also allows consumers the right to limit the use and disclosure of such sensitive personal information by businesses. Accordingly, businesses may need to add yet another link to their website homepage to allow consumers to exercise their rights to limit the use of their sensitive information.
    • Behavioral Advertising – Importantly, the CPRA attempts to address the gray area in the CCPA regarding whether opt-out rights applicable to data “sales” apply to the sharing of personal information for behavioral advertising. The CPRA explicitly extends consumer opt-out rights to the sharing of personal information by a business to a third party for “cross-context behavioral advertising.” Many companies may already have been treating such data sharing as a potential “sale” under the CCPA, in which case, the CPRA may not require further significant modifications to current practices. But companies that were taking the position that the opt-out right did not apply to behavioral advertising will have to alter their practices.
    • Definition of Covered Businesses – CPRA modifies the definition of a “business” to only include those businesses that collect information of 100,000 California consumers or households. This threshold is double the current 50,000 California consumers or households trigger. However, even if passed, CPRA will not be effective until 2023, requiring businesses falling in that 50K threshold to comply with the CCPA in the interim. Additionally, the CPRA expands its application to businesses that derive 50% of their revenue from selling – or “sharing” – personal information.
    • Expanded Consumer Rights – CPRA will give consumers additional rights such as the right to correct their data, right to not be retaliated against for exercising their rights, right to prevent companies from storing the data longer than necessary, right to opt-out of companies tracking precise geolocation within less than 1/3 of a mile, etc. Consumers’ Right to Know will also be expanded under the CPRA to include all information collected about them as opposed to only information collected by the business in the past 12 months.
    • Increased Liabilities – The CPRA leaves in place the CCPA’s private cause of action for data breaches, but adds consumer login credentials, such as email and password or security questions and answers, to the types of data that trigger the private right of action. The CPRA also triples fines related to the collection and sale of personal information of minors.

    If the CPRA passes, all businesses, especially those collecting sensitive personal information or information of minors, will need to again re-evaluate their data mapping, collection, sharing, and use practices in light of the new law and make necessary changes.

    Governor Newsom Vetoes Two Privacy Bills

    While Governor Newsom signed AB 1281, extending the Employee and B2B data exemptions under the CCPA, he vetoed two other laws that would have imposed fairly onerous requirements on businesses collecting data of minors and certain genetic information.

    • Parent’s Accountability and Child Protection Act – In the wake of several large tech companies paying hefty fines for misuse of data obtained from minors, and in an effort to protect minor’s privacy on social media platforms, the California legislature passed AB 1138, titled “Parent’s Accountability and Child Protection Act.”If this Act had been signed by Governor Newsom, it would have required operators of social media websites or applications, who actually know the person attempting to create an account on their platform is under 13 years of age, to explicitly obtain consent from a parent or guardian before creating the account. “Social media” was defined broadly. Methods to obtain consent would have required reasonable measures to ensure that the person giving consent is the parent or legal guardian of the minor trying to create an account, such as through a signed consent form, provision of a credit or debit card, calling a toll-free number or connecting via videoconference with trained personnel, or other methods providing valid proof of parental identity and consent.Social media platforms should be relieved that they do not have to revisit their consent procedures just yet. However, businesses should continue to be aware of the Children’s Online Privacy Protection Act (“COPPA”), which is still in force to protect the rights of minors.
    • Genetic Information Privacy Act (“GIPA”) – DNA testing has gained popularity in recent years as companies like 23andme and Ancestry DNA have provided consumers with an easy way to trace their familial roots.  Recognizing the sensitivity of genomic data and the huge potential for misuse, the California legislature passed GIPA in an effort to protect genetic privacy.If Governor Newsom had signed GIPA into law, it would have applied to direct-to-consumer genetic testing companies and any company that collected, used, maintained, or disclosed genetic data collected or derived from a direct-to-consumer genetic testing product or service or provided directly by a consumer. The law would have required transparency about such companies’ data practices and procedures — collection, use, maintenance, and disclosure of genetic data — through clear privacy notices.Significantly, GIPA would have required companies to obtain express and separate consent for the collection, use, or disclosure of the consumer’s genetic data. GIPA would also have mandated implementation and maintenance of reasonable security procedures and practices to protect a consumer’s genetic data against unauthorized access, destruction, use, modification, or disclosure. It also gave consumers the rights to access the genetic data, delete an account and genetic data (subject to exceptions), and destroy the biological sample.While Governor Newsom’s veto takes this law off the table, we can expect privacy concerns regarding genetic data to continue to be an area of focus for privacy rights advocates.

    National Privacy Law Update

    No discussion of privacy laws would be complete without a check on the status of federal privacy law. A federal privacy regime has been in the works for quite some time, and the current state of affairs – including the COVID pandemic’s acceleration of remote work and online schooling and other activities, greater use and concern over the use of health data, invalidation of the EU–US Privacy Shield based on cybersecurity concerns, and the ban on TikTok – have brought privacy concerns front and center and prompted lawmakers to revisit this important topic. However, the path to national privacy legislation remains murky.

    Implementing a federal law presents complex problems such as enforcement (whether federal, combined federal and state, or private), harmonizing the current patchwork of federal, state, and industry laws, and potential preemption of state laws, particularly where those laws provide higher standards of privacy protections such as in California.

    Thus, while national privacy legislation appears inevitable, the timing of when it will arrive remains uncertain.

    Conclusion

    In sum, 2020 has given businesses a lot to deal with, including in terms of privacy laws and compliance, and there is much more to come. Stay tuned for further developments. If your company needs assistance with any privacy issues, Coblentz Cybersecurity and Data Privacy attorneys can help. Please contact Scott Hall at shall@coblentzlaw.com for further information or assistance.

    Posted on: October 14, 2020 Tags: Categories: Publications

  • Another Daunting San Francisco Ballot

    San Francisco voters will again confront a formidable ballot on November 3, 2020, with 13 San Francisco propositions to consider in addition to state and federal offices and measures. The local propositions address an array of topics, including governance, affordable housing, taxes, and permits. Some of the key measures impacting San Francisco businesses are summarized below. Except where indicated, the measures require a simple majority vote to pass.

    Proposition A (Health, Parks and Streets Bond): Proposition A would authorize issuance of general obligation bonds of up to $487.5 million for capital projects across three primary categories: mental health, substance abuse, and homelessness; parks, open space, and recreation facilities; and street maintenance and repair. The projects funded by Proposition A are recommended in the City’s 10-year capital plan and are generally viewed as supporting employment and economic recovery in the wake of the COVID-19 public health crisis. The Citizens’ General Obligation Bond Oversight Committee would review how bond funds are spent. According to the San Francisco Controller’s Office report, Proposition A is not anticipated to raise taxes and is consistent with the City’s current non-binding debt management policy to keep the property tax rate for City general obligation bonds below the 2006 rate by issuing new bonds as older ones are retired and the tax base grows. The measure was proposed by Mayor Breed and placed on the ballot by a unanimous vote of the Board of Supervisors. Proposition A is supported by various community groups, the San Francisco Democratic Party, and local and state officials. Opponents include the Libertarian Party of San Francisco and the San Francisco Taxpayers Association. As a bond measure, Proposition A requires a two-thirds majority to pass.

    Proposition B (Department of Public Works): This Charter Amendment would make substantial changes to the Department of Public Works (DPW) at a time when complaints about the condition of San Francisco streets are widespread. It would create a new Public Works Commission to oversee the Department and a new Department of Sanitation and Streets to perform a number of functions currently within the jurisdiction of DPW. Functions to be transferred to the Department of Sanitation and Streets include street cleaning and maintenance and street tree maintenance. The new Department of Sanitation and Streets would also be overseen by a new Commission. According to the San Francisco Controller’s Office report, Proposition B would cost between $2.5 million and $6 million annually beginning in 2022 and would shift approximately half of DPW’s employees to the new Department of Sanitation and Streets. The Charter Amendment was submitted to the voters by the Board of Supervisors by a vote of 7-4. Proposition B’s supporters include the San Francisco Labor Council, the San Francisco Democratic Party, and various local public officials. Opponents include the San Francisco Taxpayers Association and the San Francisco Republican Party.

    Proposition F (Business Tax Overhaul): Proposition F would amend the San Francisco Charter and City Ordinances in significant ways. These include eliminating the payroll expense tax, ultimately increasing the Gross Receipts Tax rates, and increasing the number of small businesses that are exempt from the Gross Receipts Tax. Overall rates for some businesses would increase, with the new rates phased in over a 3-year period effective in 2021. There would also be temporary tax decreases for certain industries that have been heavily impacted by economic impacts from COVID-19. The measure allows one-time spending of a projected $1.5 billion from two dedicated taxes (homelessness, child care) that are currently being assessed and impounded pending the resolution of litigation. It also authorizes two contingent taxes that would be imposed if the two dedicated taxes are invalidated by the courts. The San Francisco Controller’s Office projects that Proposition F would result in approximately $97 million in annual net new revenue to the General Fund and $1.5 billion in one-time revenues from the impounded dedicated taxes. Proposition F was placed on the ballot by a unanimous Board of Supervisors vote. It is supported by the San Francisco Democratic Party and various groups representing small businesses, child care and other non-profit organizations, and unions representing nurses, firefighters, health care and other workers. Its opponents include the San Francisco Chamber of Commerce, various pro-business groups, and the Libertarian Party of San Francisco.

    Proposition H (Save Our Small Businesses Initiative): This Initiative Ordinance, submitted to the voters by Mayor Breed, would make numerous changes to the San Francisco codes governing storefront commercial uses and small businesses. It would, among other things, streamline and expedite the City permitting process for principally permitted storefront uses in the City’s Neighborhood Commercial zoning districts, allow eating and drinking uses in those districts to offer workspaces, and remove certain neighborhood notice requirements for new principally permitted businesses. It would also make changes to facilitate the use of outdoor spaces by eating and drinking establishments and other businesses. In addition, the conditional use requirement for certain commercial uses would be eliminated. According to the San Francisco Controller’s Office report, Proposition H would minimally to moderately increase City costs. Proposition H is supported by various small business associations, the San Francisco Democratic Party, the San Francisco Republican Party, and the Libertarian Party of San Francisco. Although limited formal opposition was submitted to the Department of Elections, groups including the San Francisco Tenants Union, the San Francisco Green Party, and other progressive voters’ organizations oppose Proposition H.

    Proposition I (Real Estate Transfer Tax): Proposition I, an Initiative Ordinance submitted to the voters by five members of the Board of Supervisors, would increase the real property transfer tax on transfers of property valued between $10 million and less than $25 million from 2.75 percent to 5.5 percent, and the rate on transfers valued at $25 million or more from 3 percent to 6 percent. The San Francisco Controller’s Office estimates that Proposition I could result in an increase in annual net revenue of approximately $196 million, but also notes that the nature of real estate transactions and associated tax revenue is highly volatile and could result in tax avoidance strategies. Proposition I is supported by the San Francisco Democratic Party and various tenants’ rights and pro-housing organizations. It is opposed by the San Francisco Chamber of Commerce and various building owner and real estate organizations.

    Proposition J (Parcel Tax for San Francisco Unified School District): This Initiative Ordinance, submitted to the voters by Mayor Breed, would impose an annual tax of $288 on each parcel in the City to generate $50 million in annual revenue to support the San Francisco Unified School District for salaries and educational improvements. The School District has faced the threat of budget cuts and layoffs in recent years, and Proposition J aims to address these budget shortfalls. If adopted, Proposition J would replace a very similar parcel tax approved by 61 percent of the voters in 2018. This existing parcel tax—which, at $320 per parcel annually, is higher than the $288 tax proposed under Proposition J—is currently on hold pending litigation asserting that the 2018 ballot measure required a two-thirds majority vote to pass. Proposition J would provide a workaround to these legal challenges by repealing the 2018 parcel tax and imposing a new parcel tax that is subject to two-thirds majority voter approval. Proposition J offers an exemption to the tax for property owners over the age of 65 in owner-occupied units. Proposition J is supported by various teacher and parent organizations, the San Francisco Labor Council, and the San Francisco Democratic Party. It is opposed by the San Francisco Taxpayers Association.

    Proposition K (Affordable Rental Units): This Initiative Ordinance, submitted to the voters by a unanimous Board of Supervisors vote, would authorize the City of San Francisco to own, develop, construct, acquire, or rehabilitate up to 10,000 affordable rental units, fulfilling the requirement of the California Constitution that the City seek voter approval for public low-income rental housing. Article 34 of the California Constitution—which arose from public sentiment against public housing when it passed by voter referendum in 1950, now widely recognized as motivated by racism—requires majority voter approval before any city or other political subdivision of the state may construct, develop, or acquire “low-rent housing projects” using public funds. (Article 34 places no restrictions upon the development of affordable housing by non-governmental entities.) Proposition K would not designate funding or implement a plan for City-led affordable housing development, but voter approval would be the first step toward such development if a plan is created and funded in the future. Proposition K is supported by the San Francisco Democratic Party, various state and local officials, and various tenants’ rights and housing organizations. It is opposed by the Libertarian Party of San Francisco.

    Proposition L (Business Tax Based on Executive to Employee Pay Comparison): Proposition L, submitted to the voters by a unanimous Board of Supervisors vote, would create an additional tax on San Francisco businesses whose highest-paid managerial employee has a salary exceeding the business’s median employee compensation by a ratio of 100 or more to 1. The increased tax would vary between those larger businesses subject to the Administrative Office Tax, and smaller businesses subject to the Gross Receipts Tax, with larger businesses paying an additional tax between 0.4 percent to 2.4 percent of their San Francisco payroll expense, and smaller businesses paying an additional tax between 0.1 percent to 0.6 percent of their San Francisco gross receipts. The San Francisco Controller’s Office estimates that the tax would result in between $60 million and $140 million in additional annual revenue, but notes that these estimates could vary based on changing economic conditions, fluctuations in executive compensation, and relocation risk associated with the tax increases. Proposition L’s supporters include the San Francisco Democratic Party, the San Francisco Labor Council, and various state and local officials. Its opponents include the San Francisco Taxpayers Association.

    Measure RR (Caltrain Tax): This measure would authorize a 0.125 percent sales tax increase in San Francisco, San Mateo, and Santa Clara counties to provide $100 million of annual funding for the Caltrain rail system. Caltrain has historically received 70 percent of its funding from rider fares; however, with ridership down as much as 95 percent due to the COVID-19 pandemic, there is some uncertainty around Caltrain’s future financial stability. This funding would cover operational costs to allow Caltrain service to continue through the pandemic while fare revenue remains low, while also providing longer-term financial support for Caltrain to electrify its trains, offer affordable fare options for low-income riders, and expand train service in accordance with its 2040 Strategic Plan. Before a compromise was reached between the various agencies over the summer, the sales tax measure was nearly scuttled by political disputes over Caltrain’s governance; now, possible changes to the governance structure will be considered separately from the tax increase, and not through an electoral vote. Measure RR is supported by various pro-transit organizations and various government officials. It is opposed by the Silicon Valley Taxpayers Association. As a local tax measure, Measure RR requires a two-thirds majority to pass, calculated collectively across the three counties.

  • California State Ballot Includes Major Property Tax, Rent Control Measures

    While the focus in November is on the top of the ticket, Californians also face a long list of ballot measures. Here we focus on three major measures that impact California real estate: Propositions 15, 19 and 21.

    Proposition 15: Split Roll Tax for Commercial/Industrial Properties. Proposition 15 would remove certain limitations established under Proposition 13 (passed in 1978) that place a 2 percent cap on increases to assessed property values. The proposed “split roll” would assess property taxes on certain commercial and industrial properties based on fair market value rather than purchase price. Commercial and industrial properties with a fair market value of $3 million or less would be exempt from Proposition 15 reassessment, but if an owner of such a property owns other commercial or industrial properties in California, those properties would also count against the $3 million limit for the exemption. The proposed split roll would not change the overall property tax rate, nor would it apply to residential or agricultural property.

    Proposition 15 was placed on the ballot through signature collection. Supporters (including the California Teachers Association, the SEIU and the Chan Zuckerberg Initiative) say that Proposition 13 provided a significant tax break over a long period of time to businesses and that there are other priorities now for cities, counties and school districts. Opponents (including business and taxpayer associations) cite the significant new tax burden on businesses from this and other proposed local measures, particularly in light of the challenging economic climate and businesses leaving the state.

    Proposition 19: Change Assessed Value Calculations for Residential Property. California law currently allows certain homeowners—such as those who are over age 55, severely disabled, or victims of wildfires or other natural disasters—to transfer their assessed property values to replacement residences intra-county, and to certain other counties that have adopted local ordinances allowing for reciprocity. Proposition 19 would expand the exemption to all replacement residences state-wide for these specified groups of homeowners. California law currently also allows exemptions from reassessment for two types of transfers between parents and children: (i) transfers of principal residences and (ii) transfers of up to $1 million worth of assessed value of other real property. Proposition 19 would limit the exemption available for (i) and eliminate it for (ii). It would allow a limited exemption from reassessment only for a transfer of a principal residence between parent and child where the property continues as the recipient’s principal residence. If the property value at the time of transfer exceeds the transferor’s assessed value by less than $1 million, the transfer would be exempt from reassessment. However, if the property value exceeds the transferor’s assessed value by $1 million or more, then the recipient’s assessed value would be the current value of the property less $1 million.

    This measure was placed on the ballot by the State Legislature. Supporters (including realtors and firefighters associations) say that Proposition 19 will incentivize seniors to downsize and free up new housing inventory and flatten wealth inequality, and that limiting property tax exemptions will provide important funds to local governments, state firefighting and other uses. Opponents (including taxpayer associations) claim that Proposition 19 is driven by realtors who are focused on increased commissions, and cite the new property tax laws as unduly burdensome.

    Proposition 21: Expansion of Local Residential Rent Control. Proposition 21 is one of several measures proposed in recent years by the voters and in the Legislature to expand local rights to enact residential rent control. State law currently limits local rent control laws by exempting single-family housing units with separate, alienable title (such as condos, townhouses and single-family homes) and newly constructed housing completed on or after February 1, 1995. It also allows landlords to reset rent after a tenant vacates. For tenants in place, the Tenant Protection Act of 2019 limits annual rent increases statewide for most rental housing that is more than 15 years old, to the lesser of (i) 5 percent plus inflation, or (ii) 10 percent, excluding single-family housing units (unless the owner is a real estate investment trust, corporation, or LLC with a corporate member).

    Proposition 21 would expand local rights to enact rent control by allowing local governments to: (1) enact rent control on all housing units except (a) housing first occupied within the last 15 years, and (b) homes owned by natural persons who own no more than two single-family housing units; and (2) prohibit landlords from raising rental prices by more than 15 percent cumulatively during the first three years following a vacancy.

    Proposition 21 was placed on the ballot by signature collection. Supporters (including various tenant advocacy and social justice groups and the AIDS Healthcare Foundation) say that Proposition 21 would allow local control and allow cities to put measures in place to address the state’s homelessness and housing affordability crisis. Opponents (including the California Apartment Association and other real estate advocacy and investment groups) claim that it will constrain housing supply by creating a chilling effect on investment and will decrease tax revenues for city and state government.

  • SEC Expands Accredited Investor Definition to Increase Participation in Private Offerings

    By Christopher Westman.

    On August 26, 2020, the Securities and Exchange Commission (SEC) adopted new final rules intended to modernize the existing rules, and provide additional flexibility for certain entities and individuals the SEC deems financially sophisticated enough to understand the risks of participating in private offerings.

    These additions to the definition of accredited investor, particularly those changes regarding professional certifications, designations, or credentials and to qualifying family offices, are positive changes that will expand investment opportunities for certain entities and sophisticated individuals who previously did not qualify as accredited investors, and increase the private fundraising capabilities of corporations.

    The accredited investor definition in Rule 215 and Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended, has been amended to make the following additions:

    • Individuals Holding Professional Certifications: Individuals holding certain professional certifications, designations or other credentials issued by an accredited educational institution, as designated by the SEC from time to time, may qualify as accredited investors.  When the new final rules take effect, holders in good standing of FINRA Series 7, Series 65, and Series 82 licenses will now qualify, and the SEC retained discretion to add additional professional certifications, designations, and credentials at a later date.
    • Knowledgeable Employees: Individuals who are “knowledgeable employees” of a private fund may now qualify as accredited investors for the purposes only of investing in that fund. This list of “knowledgeable employees” includes, among others: (i) executive officers, directors, trustees, general partners, advisory board members, and others who oversee the fund’s investments, and (ii) employees or affiliated persons of the fund that have regularly participated in the fund’s investment activities over the past year.
    • Certain Investment Advisers & Rural Business Investment Companies: SEC- and state-registered investment advisers, exempt reporting investment advisers, and rural business investment companies (RBICs) that are so licensed by the United States Department of Agriculture may qualify as accredited investors.
    • Entities With $5 Million or More in Investments: Any entity, including Indian tribes, governmental bodies, funds, and those organized under the laws of foreign countries, that owns investments in excess of $5 million may qualify as an accredited investor.
    • Family Offices and Family Clients: Family offices (i.e., entities established by families to manage the family’s wealth and provide other services to family members, such as tax and estate planning services) with at least $5 million in assets under management and their family clients may qualify as accredited investors if they are not specifically formed for the purpose of acquiring the securities offered, and are directed by a person capable of evaluating the merits and risks of the prospective investment.
    • Limited Liability Companies: The new definition clarifies that limited liability companies with $5 million in assets may qualify as accredited investors.
    • Spousal Equivalents: The term “spousal equivalent” has been added to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors just as spouses may do under the old rules.

    Notably, the SEC did not revisit the accredited investor financial criteria for natural persons, which remain largely unchanged since 1982 despite not having been indexed for inflation.

    These amendments were announced on August 26, 2020, and will become effective 60 days after publication in the Federal Register.

    For more information or to discuss how this may impact the structure of your future investments, please contact Coblentz’s Corporate attorneys Sara Finigan at sfinigan@coblentzlaw.com or Christopher Westman at cwestman@coblentzlaw.com.

    Posted on: September 16, 2020 Tags: Categories: Publications

  • 2020 Housing Legislation Overview: Started with a Bang, Ended with a Whimper

    Like so much of this unprecedented year, the 2019-2020 California Legislative Session ended with unexpected twists and pointed disappointments as the Assembly and Senate wrestled with the coronavirus pandemic, social distancing protocol, and friction between Assembly and Senate leadership in the final hours of the session, ultimately resulting in a number of highly anticipated housing bills failing to pass.  High profile bills that died include SB 995 (extending the former AB 900 expedited CEQA review process for environmental leadership development projects through 2024); SB 1120 (providing ministerial approval and subdivision processes for residential duplexes on single-family zoned lots); and SB 1085 (expanding the Density Bonus Law to include qualifying moderate-income rental projects and student housing projects, among other changes).

    Despite the failure to pass key bills, there were some notable developments regarding housing-related bills, several of which are heading to the Governor’s desk for signature.  The Governor has 30 calendar days, ending on September 30, 2020, to sign these proposals into law.  Key bills include:

    AB 2345 (Gonzalez, Chiu): AB 2345 makes a number of important changes to the state Density Bonus Law, which was originally adopted in 1979 and has recently gained traction as a critical tool for increasing housing production across the state. The existing Density Bonus Law requires local governments to grant additional residential density and to provide relief from certain development standards that would result in project cost savings (referred to as “concessions” or “incentives”) for projects that incorporate qualifying amounts of income-restricted units.

    Among other changes, AB 2345: increases the maximum density bonus from 35% to 50%; reduces the qualifying thresholds of total affordable units to qualify for both two and three incentives or concessions; and reduces the amount of parking a local government can require of a developer requesting a density bonus.  AB 2345 also requires that local governments include information regarding the total number of density bonus applications received and approved that year in their state-mandated annual progress reports to the Department of Housing and Community Development.

    AB 725 (Wicks): AB 725 is intended to make a dent in California’s “Missing-Middle” housing crisis, by requiring that many jurisdictions across the state plan for moderate-density housing (e.g., duplexes, fourplexes, garden apartments, townhomes, etc.) through their state-mandated general plan housing elements.  AB 725 requires that qualifying jurisdictions allocate at least 25% of their state-mandated Regional Housing Needs Allocation for moderate and above-moderate units to housing sites zoned for at least four units, with moderate income sites being capped at a density of 100 units per acre.  These sites must be identified in the housing element inventory of land suitable for residential development.  Accessory dwelling units or junior accessory dwelling units do not count towards the 25% requirement.  AB 725 will apply only to housing elements due after January 1, 2022.

    AB 831 (Grayson): AB 831 provides several important clarifications to SB 35 (Wiener), the housing streamlining bill adopted in 2017 that established a ministerial approval process for qualifying housing projects in jurisdictions that are not meeting their state-mandated goals for above-moderate and lower-income housing production.  Consistent with SB 35, AB 831 clarifies the limits of local government discretion in implementing projects already approved under SB 35.  AB 831 limits local agency discretion regarding its review and approval of public improvements necessary to complete an SB 35 project, such as installation of utilities, pedestrian and bicycle connections, and landscaping.  It also clarifies that SB 35 projects may be modified following SB 35 approval and limits local agency discretion in reviewing such modification requests.

    AB 831 also clarifies the applicability of the SB 35 requirement that two-thirds of a qualifying mixed-use project must be dedicated to residential uses.  In response to a superior court determination, AB 831 clarifies that the two-thirds residential requirement is intended to apply to the proposed project itself, not to the underlying zoning.  AB 831 is urgency legislation that will take effect immediately upon the Governor’s signature.

    AB 168 (Aguiar-Curry): AB 168 establishes a mandatory consultation process with Native American Tribes for projects intending to utilize SB 35 streamlining to determine if the proposed project would impact a tribal cultural resource.  Prior to submitting an SB 35 application, AB 168 requires that developers submit a pre-application that triggers a “scoping consultation” process between the local agency and any California Native American Tribe traditionally and culturally affiliated with the proposed project site.  An SB 35 application may then be submitted under the following circumstances: if no California Native American Tribe seeks to engage in consultation; if no potential tribal cultural resource impact is identified during the scoping consultation period; or if a potential tribal cultural resource impact is identified and the parties can agree to methods, measures, and conditions to treat the resource. However, an SB 35 application may not be submitted if a potential tribal cultural resource impact is identified and the parties cannot agree to such measures, or if a tribal cultural resource is identified that is listed on a designated register.

    Please contact a member of the Coblentz Real Estate team for additional information and any questions related to the impact of these new bills on land use and real estate development.

     

  • 2020 Tax Planning: Consider Transfers of California Legacy Properties in Light of Proposition 19

    By Kit Driscoll.

    Please note: Coblentz is not taking on new clients for Proposition 19 matters at this time.

    Proposition 19, which will be on California’s November 2020 ballot, dramatically changes the property tax rules exempting certain intra-family transfers and primary residence transactions for certain individuals such as those over age 55 or severely disabled.[1] This memo illustrates the impact of the proposed change for properties transferred between parents and children, which could significantly increase the cost to future generations of keeping legacy properties within the family.[2]

    California property tax is assessed based on the property’s purchase price and the cost of any improvements to the property. Unless a “change of ownership” occurs, the assessed value of real property increases by no more than 2% annually. Because average appreciation of California real property has far exceeded the 2% annual adjustment since the enactment of Proposition 13 in 1978, long time owners of California real estate generally enjoy a very low property tax burden relative to owners of newly acquired property. California currently provides two valuable exemptions from reassessment, which allow the continuation of this benefit after transfers of qualifying property interests between parents and children.[3] First, a transfer of parent’s principal residence to a child is completely exempted from reassessment. The child succeeds to the parent’s assessed value regardless of the value of the property or its assessed value at the time of transfer. Second, transfers of real property interests which are not the parent’s primary residence (residential or commercial) are exempted from reassessment to the extent of $1 million of assessed value, regardless of the fair market value of the property.

    Proposition 19 revises the Parent-to-Child Exemptions to limit (1) the types of transfers between parents and children that can be exempted from reassessment, and (2) the property tax benefit available. First, only a transfer of the parent’s principal residence to the child where the property continues as the child’s principal residence qualifies. Second, provided the transfer meets the principal residence requirements, the child’s assessed value is then determined based on whether the property’s value at the time of transfer is greater than the parent’s assessed value by more than $1 million. If the value of the property at the time of the transfer exceeds the parent’s assessed value by less than $1 million, then the child takes the parent’s assessed value. If the value of the property at the time of the transfer exceeds the parent’s assessed value by more than $1 million, then the child’s assessed value is the current value of the property less $1 million. The following hypotheticals illustrate the consequences under current law versus Proposition 19

    Hypothetical No. 1 – Prop 19 Increases Taxes 10x

    Facts:

    • Property #1 is Mom’s principal residence: $10M FMV, $500,000 assessed value
    • Property #2 is Mom’s secondary residence: $5M FMV, $1M assessed value
    • Mom’s total assessed values that she pays property tax on is $1.5M
    • Property tax rate is 1.25% (estimated)
    • Mom’s estimated total property taxes are $18,750
    • Mom gives Property #1 and Property #2 to Child and claims exemption
    • Child does not use either property as principal residence

    Child’s Assessed Values and Property Tax Consequences:

    Current Law Proposition 19
    Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

    Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

    		 Properties #1 and #2 are both reassessed to their fair market value because of the requirement the property be both Mom and Child’s principal residence before and after transfer, respectively
    Assessed value is $1.5M, total, same as Mom’s Assessed value is $15M, total
    Property tax is $18,750, total, same as Mom’s Property tax is $187,500, total

     

    Hypothetical No. 2 – Prop 19 Increases Taxes 9.3x

    Facts:

    • Same facts as Hypothetical No. 1, except that Child maintains Property #1 as Child’s principal residence after the transfer.

    Child’s Assessed Values and Property Tax Consequences:

    Current Law  Proposition 19
    Same result as Hypothetical No. 1

    Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

    Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

    		 Property #1 receives a limited exemption from reassessment of the fair market value, less $1M ($10M – $1M = $9M)

    If Property #1 FMV were instead $1M then the assessed value would remain $500,000 and Child would have same property tax as Mom for Property #1

    Property #2 is reassessed to its fair market value because of the requirement the property be both Mom and Child’s principal residence
    Assessed value is $1.5M, total, same as Mom’s Assessed value is $14M, total
    Property tax is $18,750, total, same as Mom’s Property tax is $175,000, total

     

     

    [1]           Note that Prop 19, if passed, would expand the ability of certain homeowners, such as those over age 55 or severely disabled, to transfer the assessed value of their principal residence to a replacement residence and likely provide property tax savings to such homeowners.  In particular, Prop 19 would allow such a transfer of assessed value to a replacement residence in any California county.

    [2]              R & T Code Section 63.1 provides the “Parent-to-Child” exemptions. The Parent-to-Child exemptions are for transfers “between” parents and children. The Parent-to-Child exemptions are also available for transfers between grandparents and grandchildren in certain circumstances. For purposes of this illustration, “parent” is the transferor and “child” is the transferee.

    [3]              Note that certain procedural requirements must be satisfied to benefit from these exemptions and that other types of exemptions exist other than the Parent-to-Child transfers.

    Posted on: September 3, 2020 Tags: Categories: Publications

  • 2020 Tax Planning: Benefits of GRATs

    By Kit Driscoll

    Now may be an opportune time to gift assets out of your estate, particularly through an estate planning technique known as the Grantor Retained Annuity Trust (“GRAT“)—a small silver lining of the alarming pandemic and down economy. As you undoubtedly noticed, the stock market and other economic indicators declined significantly in reaction to the COVID-19 pandemic, and the federal interest rates declined in tandem. The federal interest rates remain exceptionally low and many asset values are still generally depressed despite some gains and volatility in the stock market since its initial downturn. A GRAT is a highly efficient wealth transfer vehicle in low interest rate environments when funded with assets that are expected to appreciate considerably after the gifting date. It uses virtually none of your lifetime gift and estate tax exemption amount (currently $11.58 million per person) and has practically no downside risk, which is key in this volatile environment.

    GRAT Structure

    A GRAT is an irrevocable trust that is generally structured with a short term to which you gift property that is expected to appreciate over that term—you may consider contributing a concentrated position or securities in one asset class. The GRAT pays an annuity to you during the trust term equal to 100% of the value of the assets at the time you transfer them into the GRAT plus a small amount of interest. The amount of interest included in the annuity (also known as the “hurdle rate”) is based on the Internal Revenue Code Section 7520 rate, which is tied to the applicable federal rate (“AFR”). The GRAT then transfers all remaining appreciation to your beneficiaries, either outright or often to a continuing irrevocable grantor trust (“IDGT”) at the end of the term. Click here to view a flowchart for a simple example of a GRAT structure.

    The current Internal Revenue Code Section 7520 rate is exceptionally low in September (0.4%). Gifting certain stocks or interests in assets currently depressed but expected to rebound will shift that relatively significant appreciation out of your estate while using almost none of your lifetime gift and estate tax exemption. If the gifted assets do not appreciate, then the downside is only lost transaction costs because all assets transferred to the GRAT are ultimately distributed back to you. The beneficiaries or IDGT that receives the GRAT appreciation can mirror the provisions of your existing estate plan or you can provide for additional beneficiaries or changed terms, which we can discuss in more detail.

    You can also “roll” these GRATs, meaning that when the annuity is paid to you on the applicable anniversaries of the GRATs, you can fund those annuities into new GRATs and continue the process. Click here to view the flowchart for an example of a rolling GRAT structure.

    Further, if the GRATs fail from the start because of an immediate downturn, the GRATs are structured so that you can swap the assets back to yourself in exchange for assets of an equal fair market value and then you can fund new GRATs right away to take advantage of the immediate downturn.

    Income Tax Consequences of GRATs

    The GRAT and IDGT are “grantor trusts” for income tax purposes. You, as an individual, are taxed on the income and realized gains of the GRAT and IDGT. Instead of the trusts bearing their own tax liabilities at the compressed trust tax rates, your payment of the taxes will be a tax-efficient wealth transfer as it will not utilize any of your lifetime gift and estate tax exemption. Grantor trust status may be switched off for the IDGT at any time, in which case the IDGT will bear its own tax liabilities at all times in the future.

    A tradeoff between making the gifts discussed herein and retaining them until your death is that assets held at death receive a full step-up in basis for income tax purposes. The income tax basis of assets transferred to the IDGT generally has a “carryover basis” as your basis attaches to the property when gifted to the GRAT. (Note that in certain circumstances this planning could foreclose recognition of losses on gifted assets.) Once the IDGT receives the assets, you may reacquire the assets by substituting other assets with an equal fair market value at the time of the reacquisition. In particular, you may swap assets of the IDGT for other assets that have a relatively high basis to minimize capital gains consequences upon a sale by the IDGT.

    Gift Tax Consequences of GRATs

    A small “adjusted taxable gift” (e.g., typically less than $100) is made upon the transfer of property to the GRAT. There is no gift tax due in connection with the transfer, assuming you have remaining lifetime exemption from gift and estate tax.

    Gift Tax Return Due

    Although there is no gift tax due, you need to file a gift tax return (Form 709) reporting the transfer of property to the GRAT at the same time you file your 2020 income tax return. Either we or your accountant will prepare the gift tax return.

    Estate Tax Consequences of GRATs

    Once the property is transferred from the GRAT to the remainder beneficiaries of the IDGT at the end of the GRAT term, the property is not considered part of your taxable estate and will not be taxed at your death. Your lifetime exemption from gift and estate tax will be reduced by the amount of the “adjusted taxable gift” discussed in Paragraph III above. If you do not survive the GRAT term, however, any remaining GRAT property is includable in your taxable estate and may be subject to estate tax depending on your remaining gift and estate tax exemption just as if you never implemented the GRAT planning.

    Please reach out to Coblentz Family Wealth attorneys if you would like to further discuss the GRAT technique and why this may be an opportune time to implement a GRAT gifting strategy.

  • 2020 Tax Planning: Techniques that May Not Exist in 2021

    By Kit Driscoll

    Major tax reform discussions are ongoing in Washington and Sacramento while everyone at home is busy navigating the pandemic. Many commentators are predicting that budgetary pressures resulting from the COVID-19 stimulus measures will necessitate a near-term reversal of some of the 2017 federal tax cuts and provide further rationale for the passage of significant California property tax propositions. We encourage you to revisit your estate plan and consider gifting strategies in light of the potential legislative changes and unprecedented economic environment as highlighted below.

    Estate, Gift, and GST Tax Increases Under Biden’s Proposal

    In 2020, the lifetime exemption allows individuals to transfer up to $11.58 million free of estate and gift tax and generation-skipping transfer (“GST”) tax either by gift during life or upon death. Transfers in excess of those exemption amounts, other than to charity or to or for the benefit of a spouse, are taxed at a 40% rate. Biden and Sanders published 110 pages of policy reforms that would restore the estate tax regime to the “historical norm.” Many commentators are speculating this proposal means reducing the estate and gift tax and GST tax exemptions from $11.58 million per person to $3.5 million per person. However, “historical norm” could also mean even lower exemption amounts and a higher tax rate.[1] If not sooner amended, the estate and gift tax and GST tax exemptions are slated to revert to pre-2017 levels effective January 1, 2026, absent Congressional action.

    The IRS issued guidance confirming that transfers taking advantage of the current exemption amounts will not be “clawed back” by a change to the law, making 2020 the time to utilize the balance of your exemptions by making gifts before any legislation becomes effective.

    Property Tax Increases Under California Propositions 15 and 19

    Propositions 15 and 19 will be on California’s November 2020 ballot and, if passed, could significantly change the property tax landscape.

    • Proposition 15: Split Roll Tax for Commercial/Industrial Properties. The “split roll” would assess taxes for certain commercial and industrial properties based on their fair market value. Accordingly, Prop 15 removes limitations established under Proposition 13 (1978) that place a 2% cap on increases to the assessed value of these types of properties. Commercial or industrial properties whose fair market value does not exceed $3 million are exempted from Prop 15 reassessment. There is a significant exception to this $3 million threshold: the value of a subject property must be aggregated with the values of any other commercial or industrial properties in California for which a direct or indirect beneficial owner of the subject property shares a direct or indirect ownership interest. Note that the split roll system established under the Prop 15 proposal does not change the overall property tax rate, nor does it apply to residential property or agricultural property.
    • Proposition 19: Change Assessed Value Calculations for Residential Property. Proposition 19 would expand exemptions allowing certain homeowners such as those over age 55 to transfer their assessed values to replacement residences in different counties within California, but would significantly narrow or eliminate existing exemptions from reassessment for other intra-family transactions. If you have any California real property with a low assessed value that you hope to pass to future generations, there are several strategies you might consider to take advantage of the current expansive exclusions from reassessment. See a more detailed explanation of Prop 19 here.

    Low Interest Rates Favor GRATs, CLATs, and Sales to IDGTs

    The current low interest rate environment makes certain wealth transfer vehicles especially attractive. Three of these techniques are briefly described below.

    1. GRAT. A grantor retained annuity trust (“GRAT”) is a short-term irrevocable trust to which you transfer property that you expect to appreciate or generate income at a rate greater than that assumed by the IRS. The GRAT pays an annuity back to you during the trust term roughly equal to 100% of the value of the assets at the time you transferred them into the GRAT plus interest at a rate which the IRS publishes on a monthly basis. To the extent that the contributed assets generate income or appreciate at a higher rate than that IRS assumed rate, the excess appreciation passes to your beneficiaries free of tax. See a more detailed explanation of GRATs here.
    2. CLAT. A charitable lead annuity trust (“CLAT”) is similar to a GRAT, except that the annuity is paid to a charitable beneficiary. The annuity distributable to the charitable beneficiary can be set at a value of the assets contributed to the trust. The non-charitable beneficiaries receive all appreciation above the contributed amount adjusted for the hurdle rate. A CLAT can be structured either to provide you a charitable income tax deduction in the year of creation or provide the CLAT deductions for the annuities paid to the charitable beneficiary. Please contact us to discuss the many variations on and ways to structure CLATs if you are interested in gifting a portion of your estate to charity.
    3. Sales to IDGT. A sale of assets to an irrevocable grantor trust (“IDGT”) is a tax-efficient way to further leverage the use of lifetime estate, gift, and GST tax exemptions. Assets are sold to the IDGT in exchange for a note which bears interest at a rate tied to the IRS assumed “applicable federal rate,” which presently is very low. The IDGT pays you the low interest and principal for the duration of the note. You pay the income taxes on assets owned by the IDGT (for as long as you wish) which is a further tax-free wealth transfer. There are many ways to tailor sales to IDGTs that we are happy to discuss with you in more detail.

    Low Income Tax Rates Favor ROTH Conversions

    It is unknown what future income tax rates will be, but income tax rates for high-earners may be increased through Biden’s proposal to reverse the 2017 tax cuts or other California and federal proposals to increase tax revenue after the COVID-19 stimulus. Federal and state taxes are owed on the conversion; however, future distributions from the Roth account are then income tax-free. Contact your financial advisor to discuss whether a Roth conversion or partial conversion is advantageous.

    Tax Haven States Benefit Trust Planning for Legacy Assets

    California’s high state income tax rates are encouraging residents to move out of state, but another option may be to transfer legacy assets to a trust in a favorable tax state. Legacy assets that are expected to be held for future generations and not used for current expenses or distributions might be held in a trust outside of California and accumulate and grow free of state income taxes. We are happy to discuss the optimal structure for legacy assets and advantages of different states with you in more detail.

    For more information or to discuss your estate planning and gifting strategies, please contact Coblentz Family Wealth attorneys.

     

    [1]           Earlier in his campaign, Biden proposed eliminating the step-up in basis at death so that beneficiaries would have income tax due on the sale of estate assets.

  • DOJ and SEC Release Updated Guidance On The FCPA

    By Emlyn Mandel.

    The Foreign Corrupt Practices Act doesn’t ensnare just those involved in foreign corruption. It also can cover conduct in the United States that has nothing to do with either foreign officials or bribery schemes. So the recent release of the government’s new edition of the FCPA Resource Guide is worth noting even for those staying close to home.

    The FCPA has two main components: an anti-bribery provision, which prohibits bribery of foreign officials, and accounting provisions, which require certain reporting companies to keep accurate books and records and maintain a system of internal accounting controls. The FCPA can be prosecuted both criminally by the U.S. Department of Justice and civilly by the Securities and Exchange Commission. In July 2020, the DOJ and SEC released the Second Edition to the FCPA Resource Guide, a manual relied upon heavily by practitioners and businesses in navigating the FCPA.[1] The release marks the first substantive update to the Resource Guide since the First Edition was published in 2012. The Resource Guide is particularly valuable given the dearth of case law interpreting the FCPA.

    The Second Edition reflects updates in the law over the past eight years in a number of different areas, including the definition of the term “foreign official;” the jurisdictional reach of the FCPA; the FCPA’s “foreign written laws” affirmative defense; the mens rea requirement and statute of limitations for criminal violations of the accounting provisions; updated data, statistics, and case examples; and new policies applicable to the FCPA that have been announced over the past several years by the DOJ and SEC.

    A number of these changes are particularly noteworthy.

    Insight on Who Can Be Prosecuted Under the FCPA

    The jurisdictional reach of the FCPA has long been subject to debate. The anti-bribery provision of the FCPA lays out several categories of persons over whom the government may exercise jurisdiction, including “domestic concerns” (any individual who is a citizen, national, or resident of the United States or a business organized under United States law or with its principal place of business in the United States), no matter where in the world they act; companies issuing securities regulated by federal law (“issuers”), no matter where in the world they act; any officer, director, employee, or agent of a domestic concern or issuer, no matter where in the world they act; and foreign persons (including foreign nationals and companies) acting in the territory of the United States.[2] The Resource Guide now mentions a recent Second Circuit case that had the effect of limiting jurisdiction, United States v. Hoskins.[3] Hoskins held that a nonresident foreign national who was not an agent of a United States company and who acted outside American territory to allegedly participate in a foreign bribery scheme could not be liable for conspiracy to violate the FCPA, since such an individual was not in the class of individuals capable of committing a substantive FCPA violation. However, the government’s willingness to be guided by Hoskins in bringing future conspiracy prosecutions or enforcement actions is unclear, as the Resource Guide acknowledges conflicting authority from another jurisdiction.

    Nevertheless, the Resource Guide does make some edits that align with the Hoskins holding. While the Resource Guide still asserts that a foreign national who engages in activity in American territory, such as by attending a meeting in the United States that furthers a foreign bribery scheme, may be subject to prosecution, it conspicuously removes language from the prior version that previously indicated “any co-conspirators, even if they did not themselves attend the meeting” may be subject to prosecution. It also removes the statement that a foreign national or company may be liable if she or it assists an issuer, regardless of whether the foreign national or company itself takes any action in the United States. In doing so it acknowledges that there is a limit to those whom the FCPA can reach.

    Contrary to the specific delineations in the anti-bribery provision, the accounting provisions apply to “any person.”[4] In that vein, the Resource Guide points out that the Hoskins holding does not extend to violations of the FCPA’s accounting provisions – an indication that the DOJ and SEC are likely to continue prosecuting violations of the accounting provisions even without an accompanying bribery charge. This is not new – a number of the options backdating cases of the 2000s were based in part on the FCPA.  The DOJ’s willingness to continue to bring charges based on the FCPA’s accounting provision is evident in, for example, the deferred prosecution agreement (“DPA”) between the DOJ and Novartis AG announced at the end of June 2020.  While one Novartis subsidiary was charged with violations of both the anti-bribery and the accounting provisions, former Novartis AG subsidiary Alcon Pte. Ltd. was charged only with conspiracy to violate the accounting provision.[5]

    Definition of “Instrumentality” Within The Definition of “Foreign Official”

    The FCPA’s anti-bribery provision prohibits corrupt payments to “any foreign official.” The FCPA defines “foreign official” as “any officer or employee of a foreign government or any department, agency, or instrumentality thereof,”[6] a standard that can be difficult to evaluate given the sometimes murky intersection of government and business in countries such as China. The Resource Guide now incorporates important case law from the Eleventh Circuit that defines “instrumentality” as “an entity controlled by the government of a foreign country that performs a function the controlling government treats as its own.”[7] Esquenazi provided a list of five non-exhaustive factors that courts should consider in a fact-based analysis of whether the government “controls” an entity: the foreign government’s formal designation of that entity; whether the government has a majority interest in the entity; the government’s ability to hire and fire the entity’s principals; the extent to which the entity’s profits, if any, go directly into the governmental fiscal accounts, and, by the same token, the extent to which the government funds the entity if it fails to break even; and the length of time these indicia have existed. Esquenazi also provided a list of four non-exhaustive factors regarding whether the entity performs a function the government “treats as its own”: whether the entity has a monopoly over the function it exists to carry out; whether the government subsidizes the costs associated with the entity providing services; whether the entity provides services to the public at large in the foreign country; and whether the public and the government of that foreign country generally perceive the entity to be performing a governmental function.

    The Resource Guide notes that companies should consider these factors when evaluating the risk of FCPA violations and designing compliance programs.

    Clarification of the Statute of Limitations and Mental State Requirement for Criminal Violations of Accounting Provisions

    While criminal violations of the anti-bribery provisions carry a five-year statute of limitations,[8] the Resource Guide clarifies that criminal violations of the accounting provisions carry a six-year statute of limitations.[9] In contrast, the statute of limitations is five years in civil cases brought by the SEC.[10]

    In addition, the Resource Guide explains that, for criminal violations of the accounting provisions, prosecutors must show the violation was done “knowingly and willfully” rather than only “knowingly” as provided in the First Edition. This difference matters, as it provides a higher mens rea bar for prosecutors to meet. The Resource Guide acknowledges that “willfully” is not defined in the FCPA but remarks that it has generally been construed by courts to connote an act committed voluntarily and purposefully and with a bad purpose, i.e., with “knowledge that [a defendant] was doing a ‘bad’ act under the general rules of law.” However, the government need not prove that the defendant was specifically aware of the FCPA or knew that his conduct violated the FCPA.

    More Detail On What Makes An Effective Compliance Program

    Even if it doesn’t prevent an FCPA violation, a company’s compliance program can have a major impact on the government’s charging and sentencing decisions.[11] The Resource Guide now clarifies that “a company’s internal accounting controls are not synonymous with a company’s compliance program,” although the components may overlap. It states that, “[t]he truest measure of an effective compliance program is how it responds to misconduct.” According to the Resource Guide, an effective compliance program should have a well-functioning and appropriately funded mechanism to investigate wrongdoing, including analyzing root causes of the misconduct and integrating lessons learned.

    In addressing successor liability, the Resource Guide explicitly acknowledges the potential benefits of corporate mergers and acquisitions in stemming corporate corruption, particularly when the acquiring entity has a robust compliance program in place and implements that program as quickly as possible. It goes on to state that in certain instances robust pre-acquisition due diligence may not be possible and, in those cases, timely discovery and remediation by an acquiring entity can help avoid successor liability. On the other hand, the potential pitfalls of successor liability are evident in a recent SEC settlement with Novartis AG, where the company’s failure to stop improper post-merger payments contributed to the SEC’s decision to prosecute the company.[12] 

    Incorporation of Recent DOJ and SEC Policies

    Over the past several years the DOJ and SEC have rolled out several new policies, which the Resource Guide now expressly incorporates.

    FCPA Corporate Enforcement Policy. This policy provides that, where a company voluntarily self-discloses misconduct, fully cooperates, and timely and appropriately remediates, there will be a presumption that DOJ will decline prosecution of the company absent aggravating circumstances. The Resource Guide adds three examples of declinations from the past few years, including instances where high-level corporate officers were involved, reinforcing how important self-disclosure, cooperation, and remediation can be.

    Selection of Monitors in Criminal Division Matters. The Resource Guide now incorporates the DOJ’s guidance in determining whether to impose an independent corporate monitor as part of a company’s resolution. It notes that appointment of a monitor is not appropriate in all circumstances and should never be imposed for punitive purposes. A monitor may be appropriate, for example, where a company does not already have an effective internal compliance program or needs to establish necessary internal controls. DOJ’s guidance provides that, in determining whether to impose a monitor as part of a corporate resolution, prosecutors should assess (1) the potential benefits that employing a monitor may have for the corporation and the public, and (2) the cost of a monitor and its impact on the operations of a corporation.

    Anti-Piling On Policy. The DOJ and SEC can coordinate responses with other authorities to avoid “piling on” with those who are prosecuting the same company for misconduct, which policy includes giving credit for penalties paid to other authorities both foreign and domestic.

    Criminal Division’s Evaluation of Corporate Compliance Programs. This policy guides prosecutors in deciding whether the corporation’s compliance program was effective at the time of the offense and is effective at the time of a charging decision or resolution. These determinations can have a significant impact on  the appropriate form of any resolution or prosecution, monetary penalty, and compliance obligations contained in any corporate criminal resolution. The three overarching questions that prosecutors ask to evaluate a company’s compliance program are: (1) Is the program well designed? (2) Is the program adequately resourced and empowered to function effectively? and (3) Does the program work in practice?[13]

    Conclusion

    The Resource Guide remains non-binding, but DOJ prosecutors and SEC enforcement attorneys will give significant weight to this guidance in determining whether to bring charges (and against whom) and how to resolve them. So this update provides valuable information for practitioners and enterprises in both proactively creating effective compliance policies and defending prosecutions or enforcement actions brought under the FCPA. It’s always a good idea to conduct periodic assessments of your company’s compliance program to ensure that it is appropriate to the company’s risk and that it is functioning effectively. With this enhanced guidance from the DOJ and SEC, now is an opportune time to check in.

    For further information on the topic covered in this alert or for general FCPA or compliance guidance, contact Coblentz White Collar Defense & Investigations attorneys Timothy P. Crudo at tcrudo@coblentzlaw.com or Emlyn Mandel at emandel@coblentzlaw.com.

    [1] https://www.justice.gov/criminal-fraud/fcpa-resource-guide

    [2] 15 U.S.C. §§ 78dd-1(a); 78dd-2(a); 78dd-2(h)(1)(A); 78dd-2(h)(1)(B).

    [3] 902 F.3d 69, 76-97 (2d Cir. 2018).

    [4] 15 U.S.C. § 78ff(a).

    [5] https://www.justice.gov/opa/pr/novartis-hellas-saci-and-alcon-pte-ltd-agree-pay-over-233-million-combined-resolve-criminal

    [6] 15 U.S.C. § 78dd-1(f)(1)(A).

    [7] United States v. Esquenazi, 752 F.3d 912, 920-32 (11th Cir. 2014).

    [8] 18 U.S.C. § 3282(a).

    [9] 18 U.S.C. § 3301(b).

    [10] 28 U.S.C. § 2462.

    [11] See U.S. Sentencing Commission Guidelines Manual (2018), §8B2.1 (discussing effective compliance and ethics program) available at https://www.ussc.gov/guidelines/2018-guidelines-manual-annotated; U.S. DOJ Justice Manual, 9-47.120 FCPA Corporate Enforcement Policy available at https://www.justice.gov/jm/justice-manual.

    [12] https://www.sec.gov/litigation/admin/2020/34-89149.pdf at para. 24.

    [13] https://www.justice.gov/criminal-fraud/page/file/937501/download

  • California Housing Approval Law Is A Strong Tool For Developers

    By Miles Imwalle, Katharine Van Dusen, and Charmaine Yu. Originally published in Law360, July 24, 2020.

    Click here to download a PDF of this article.

    When the California Legislature enacted S.B. 35 in 2017, the goal of the law was clear: to increase the state’s housing production by requiring swift approval of housing in communities often opposed to new development.

    The law was designed to bypass community opposition from vocal neighbors or anti-development groups, as well as from local elected officials, who often feel beholden to the interests of local neighbors rather than the needs of the greater regional community.

    Recent research highlights the problem with the existing entitlement process for housing. In a series of papers[1] coming out of the University of California, Berkeley, and Columbia University, researchers studied the entitlement process and timelines for housing in several Bay Area and Southern California cities.

    For those in the industry, the results were not surprising: Housing entitlements are generally discretionary, and the type of approval, the timing, the number of hearings, the approval body and compliance with California Environmental Quality Act all vary considerably between jurisdictions.

    In some jurisdictions, getting through the process is relatively straightforward. In others, it is a slog. The number of units approved also varies significantly, but jurisdictions with efficient, shorter timeframes produce more units.

    S.B. 35 only applies to communities that have failed to meet their regional housing needs; as a practical matter, almost all communities in California are subject to S.B. 35. It offers a creative cure for the traditional, lengthy and discretionary approval process that delays, or blocks, so many housing and mixed use developments. It allows for streamlined approval of projects that meet specific objective standards — a mix of statewide and local laws.

    Projects are eligible if they dedicate at least two-thirds of their space to residences or residential uses, if they include an appropriate mix of affordable and market rate units, and if they are built in urban areas, among other objective standards.

    A city has either 90 or 180 days (depending on project size) to complete its determination whether the proposed S.B. 35 project complies with these objective standards. In order to reject an S.B. 35 application, the city must timely issue a written determination identifying the objective standard(s) with which the project conflicts.

    If the city does not issue this written determination, then the project is deemed to satisfy S.B. 35’s standards. Neither elected officials nor project opponents can otherwise “inhibit, chill, or preclude” a project application. A city cannot withhold approval of a project that complies with the objective standards.

    But, in California, approval of a project is often just the beginning of protracted litigation with project opponents. And local governments may not always apply S.B. 35 as strictly as they should. Because S.B. 35 had not been tested in court until recently, lingering questions remained. Could local opposition groups use S.B. 35 to seek judicial review of a city’s approval of an S.B. 35 project? Could a local government deny S.B. 35 approval even if it could not identify an objective standard with which the project application conflicted?

    Two recent cases from the Superior Court of California, County of Santa Clara, have confirmed S.B. 35 as the powerful a tool that many housing advocates and developers had hoped it would be: Local opposition groups cannot use S.B. 35 to require a city to withdraw an approval, and a local government is deemed to have approved a project if it fails to follow S.B. 35’s strict structure and timelines.

    In Friends of Better Cupertino v. City of Cupertino, a case involving redevelopment of the Vallco Fashion Mall in Cupertino, a proposed S.B. 35 mixed-use project would add 2,402 units of housing to Cupertino, including 1,201 affordable units. Cupertino city staff reviewed the project application and determined that it met S.B. 35’s objective standards. But a local opposition group, which had opposed redevelopment at the Vallco mall for years, filed a writ petition, arguing that the city should not have approved it.

    On May 6, the superior court rejected each of petitioner’s arguments in a detailed, carefully reasoned decision. As a factual matter, the court determined that the Vallco project actually complied with S.B. 35’s objective standards. But the court’s most significant holding involved the question whether a city could ever be required to reverse an approval. The court determined that a city is never required to reject an S.B. 35 project.

    Indeed, by deeming a project compliant with S.B. 35’s standards in the event a city fails to process an application, S.B. 35 specifically contemplates that some projects will receive S.B. 35 streamlined approval even if they do not meet the objective standards as a matter of fact. For that same reason, a court cannot issue an order compelling a city to reverse its decision to approve an S.B. 35 project. The law never requires an application to be rejected, and the court cannot compel what the law does not require.

    The Vallco decision will substantially restrict, if not eliminate, challenges to S.B. 35 projects by project opponents. The holding means that project opponents have no right to ask a court to reconsider whether a project actually meets S.B. 35’s objective standards. If a project is approved under S.B. 35, a developer can be reasonably certain the approval will withstand legal challenges.

    The other recent S.B. 35 case involved a 15-unit development in Los Altos. The city of Los Altos attempted to deny a 15-unit project submitted under S.B. 35. But the city’s denial letter did not follow S.B. 35’s strict requirement to identify specific objective standards with which the project conflicted.

    Instead, the denial letter referenced vague, unmeasurable standards like whether parking access was adequate. In the decision, issued on April 27, the same court ruled that Los Altos’ denial letter was inconsistent with S.B. 35 and therefore ineffective. Because the city failed to issue a valid inconsistency determination within the statutory deadline, the project was deemed to comply with objective standards as a matter of law. The court directed the city to approve the project.

    The Los Altos decision, if upheld on appeal, will ensure that cities cannot shirk their responsibilities under S.B. 35. Only if a project conflicts with objective standards can it be denied. And if a city fails to timely and properly determine whether the project is consistent with objective standards, then the project will be permitted to proceed.

    In tandem, these two decisions illustrate that S.B. 35 is a powerful tool — not just to obtain swift approval of a development, but also to avoid lengthy litigation challenges. Cities have limited authority to deny project applications, and local opposition groups cannot ask courts to second-guess whether a project should have received approval under S.B. 35.

    The law is beginning to work as intended — the path is now clear to develop much-needed housing in two South Bay communities. Moreover, the decisions should help shape S.B. 35 as a force to ensure needed housing development both in the Bay Area and throughout California.

    Miles Imwalle, Katharine Van Dusen and Charmaine Yu are partners at Coblentz Patch Duffy & Bass LLP.

    Disclosure: Coblentz Patch Duffy & Bass LLP attorneys assisted Vallco Property Owner LLC and its affiliate, Sand Hill Property Company, during all stages of entitlements and in the litigation relating to the Vallco project, Friends of Better Cupertino, et al. vs. City of Cupertino, et al.

    The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

    [1] https://www.law.berkeley.edu/research/clee/research/land-use/getting-it-right