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Last month, the United States, along with other G7 members, stepped up efforts to curtail Russia’s evasion of western sanctions adopted to impede Russia’s invasion of Ukraine. It has been reported in the press that U.S. components are showing up in weapons systems used against Ukraine and from firms that produce high-technology equipment ultimately sold to Russian defense entities.  Likewise, restricted U.S. commercial products are ending up in Russian hands. Now more than ever, U.S. companies must strictly follow the “Know Your Customer” compliance principles.

The U.S. government has long touted the “Know Your Customer” principle as a basic element of a robust export compliance program. To guard against efforts by purchasers to evade sanctions, U.S. companies should perform enhanced due diligence to ensure that a purchaser (1) is trustworthy, (2) will comply with applicable U.S. laws, and (3) will not divert (or allow to be diverted) restricted U.S. products for ultimate use by Russia, a military end-use or by Russian consumers. Additional measures for ensuring compliance include (i) end-use and end-user certificates, (ii) incorporating warranties on trade and sanctions compliance in contractual documents, and (iii) above all, continued monitoring of customers.  If at any time a U.S. company identifies any “red flags” such as reluctance to provide end-use and end-user information, or a request to ship goods to a freight forwarder, it should halt all shipments until those “red flags” are resolved.

As indicated in guidance from the U.S. Department of Commerce’s Bureau of Industry and Security (BIS), U.S. exporters “have a duty to exercise due diligence to inquire regarding the suspicious circumstances and ensure appropriate end-use, end-user, or ultimate country of destination in the transactions [an exporter] propose[s] to engage in.” If any concerns remain, the exporter must refrain from going through with the transaction. Otherwise, BIS may conclude that the exporter chose to “self-blind.” If a violation occurs, BIS could find the circumstances to be egregious, constituting grounds for higher penalties or fines than would be assessed had the exporter taken steps to resolve the “red flags.” In certain circumstances, violations can lead to criminal or civil inquiries by the U.S. Department of Justice.

Taking steps to “Know Your Customer” is a must for all U.S. businesses. Though BIS’s guidance is geared towards U.S. exporters, all U.S. companies should take care to avoid, minimize and mitigate supply chain risks. Simply put, the duty to exercise due diligence relates not only to exports, but also to reexports and in-country transfers. That is, the risk extends beyond a company’s own actions; what happens downstream in the supply chain matters.  Financial and reputational damages can be quite severe.  Now more than ever, it is important to ask the right questions and seek advice as to whether your company is doing enough to protect itself. 

A recent U.S. District Court ruling dealt a major setback to the U.S. Department of Labor’s (DOL) guidance regarding rollover recommendations as fiduciary investment advice under ERISA. In American Securities Association (ASA) v. U.S. Department of Labor, Case No. 8:22-cv-330 (M.D. Fla. Feb. 13, 2023) (the “ASA Case”), the court vacated a critical part of the DOL’s latest fiduciary rule, bringing uncertainty to financial institutions and advisors who implemented new rollover policies and procedures in order to comply with the DOL fiduciary rule.

1975 Fiduciary Rule and PTE 2020-02

In 1975, the DOL released regulations clarifying that a “fiduciary” is one who: (1) renders investment advice; (2) on a regular basis; (3) pursuant to an agreement; (4) on a primary basis for investment decisions; and (5) which advice is individualized for the needs of the plan (the “1975 Fiduciary Rule”). In 2020, the DOL released Prohibited Transaction Exemption (PTE) 2020-02. PTE 2020-02 permits financial institutions and advisors to provide rollover advice and receive compensation in connection with the rollover. Receipt of such compensation would otherwise be impermissible without a prohibited transaction exemption.

A critical piece of the PTE 2020-02 guidance centered around what constitutes investment advice and whether advice provided as part of the rollover process satisfies the “regular basis” portion of the 1975 five-part fiduciary test. Through frequently asked questions (FAQ), the DOL clarified that advice relating to a rollover (e.g., 401(k) plan account to an IRA) meets the regular basis requirement if such advice is part of or the beginning of an intended ongoing relationship. This topic was addressed in FAQ-7 of the DOL guidance and departed from past interpretations of the 1975 Fiduciary Rule.

The American Securities Association challenged this guidance, stating that the DOL acted in an arbitrary and capricious manner by releasing guidance that went against the plain reading of ERISA and the 1975 Fiduciary Rule. The court agreed and vacated FAQ-7. The court stated that the DOL’s policy in FAQ-7 discarded the plan-specific focus of the 1975 Fiduciary Rule by sweeping in conduct that is not related to plan assets. 

What Is Next?

As yet, the DOL had not taken any action in response to the ASA Case decision. The DOL may appeal the ASA Case or let the decision stand. Because the decision was handed down by a district court, the DOL has multiple levels of appeal available to it. Given this uncertainty, financial institutions and advisors should tread carefully and continue to comply with DOL guidance under PTE 2020-02 until there is more clarity on the ASA Case status.

OnFebruary 9, 2023, the SEC Charged Payward Ventures, Inc. and Payward Trading Ltd. (d/b/a Kraken) (collectively, “Kraken”) with violating Sections 5(a) and 5(c) of the Securities Act for operating a crypto asset “staking-as-a-service program” without properly completing the registration process.  According to the SEC, a staking program allows investors to lock up “their crypto tokens with a blockchain validator with the goal of being rewarded with new tokens when their staked crypto tokens become part of the process for validating data for the blockchain.”  The SEC alleged that Kraken offered and sold its crypto asset staking services, which allowed investors to transfer crypto assets to Kraken in exchange for promised annual investment returns, but failed to make any public disclosures relating to its financial history, the associated fees for its services, or how it would obtain investment returns.  In settlement, Kraken agreed to pay over $30 million and to immediately stop offering or selling securities through its staking programs.

The enforcement action against Kraken establishes, as SEC policy, that staking-as-a-service providers must register with the SEC and publicly disclose all material information to inform and protect potential investors.  This is a significant development because the SEC had not previously issued guidance on staking programs.  Further, Commissioner Hester Peirce dissented on this ground and noted that the SEC’s “solution to a registration violation is to shut down entirely a program that has served people well.”  Notwithstanding these concerns, the SEC permanently enjoined Kraken from offering or selling securities through its crypto asset staking programs.  Based upon this enforcement action, the SEC may in the future look to further increase transparency around similar staking programs.

On March 10, the Federal Trade Commission (the “FTC”) issued a Request for Information (“RFI”) to learn more about “the means by which franchisors exert control over franchisees and their workers.”  The RFI focuses on two aspects of the franchisor-franchisee relationship:  the means by which the franchisors disclose restrictions and requirements on their franchisees (e.g., in franchise agreements, manuals); and the scope and effects of the requirements and restrictions themselves.  Specific questions cover six broad categories: bargaining power between franchisors and franchisees; provisions of franchise agreements that may be detrimental to franchisees; franchisor business practices regarding organizing activity, wages, and working conditions; payments to franchisors from third parties for franchisee purchases; indirect effects of franchisee labor costs; and the effect of language barriers on the effectiveness of disclosures and other communications.

The RFI marks the third effort by the FTC to examine any inequities in franchisor business practices or the agreements themselves.  In 2019 the FTC launched a regulatory review of the Franchise Rule, which governs the disclosures that franchisors must make to prospective franchisees before the franchise purchase occurs.  The review is still underway.  And on January 5, 2023, the FTC proposed a rule that would ban nearly all employment noncompetition agreements and would require the rescission of existing noncompetes.  We have discussed the FTC’s proposal in two prior alerts and in a Vedder OnDemand webinar.  Although the proposed rule would not ban restrictions imposed by franchisors on franchisees, Chair Lina Khan requested comments specifically on whether to address franchises in the rule, stating that “in some cases [franchise agreements] may raise concerns that are analogous to those raised by noncompetes between employers and workers.”

With its RFI, the FTC has begun to move its simmering uneasiness with franchisor-franchisee relations away from the back burner.  Whether this will become a priority for the agency may depend on the nature of the comments and information received, but not necessarily.  This FTC has not hesitated to move very quickly to address what individual Commissioners believe to be unfair competitive practices, as demonstrated by its issuance of proposed rules banning noncompetes even in the absence of much prior experience with or public comment about them at the FTC.  Franchisors and franchisees alike may wish to review their agreements—particularly their restrictions on competition and means of allocating revenue between the parties—in order to comment meaningfully on any forthcoming FTC proposed rules, and to plan for alternative means of reaching their business goals.