SEC Proposes Increased Regulation of High Frequency Trading

The SEC has proposed a rule that would require high frequency computer-driven trading firms to register with the Financial Industry Regulatory Authority.   Such firms have previously been treated as proprietary traders not required to register with FINRA because they trade from their own accounts rather than customer accounts.

Although several more steps need to be completed for the change to take effect, the move would significantly increase oversight of high frequency firms.   The proposed rule is intended to update the financial industry’s regulatory framework to keep pace with today’s trading methods.  SEC Chairwoman Mary Jo White commented:

[Current rules were] implemented at a time when our equity market structure was dominated by floor-based exchanges that could readily regulate all of their members’ trading activity.  It was designed to accommodate exchange specialists and floor brokers that focused their trading on the floor of an individual exchange who might need to conduct limited hedging or other off-exchange activities ancillary to their floor-based business.

That is not our market today.  Trading is now dominated by computer algorithms and active cross-market proprietary trading firms have emerged as significant market participants.  These firms represent a significant portion of off-exchange trading, accounting for nearly half of all orders sent to alternative trading systems.  The business of these firms is not focused on an exchange floor, and their off-exchange activity is far from ancillary. 

Some have speculated that the SEC is responding to pressure to increase regulation of high-frequency trading in light of incidents like the 2010 “Flash Crash,” which caused the Dow to plummet almost 1,000 points.  Previously, the SEC implemented “circuit breaker” rules that stop trading when stock prices experience wild swings in short periods of time.

A lawsuit pending in federal court in Chicago against the CME Group, the Board of Trade of the City of Chicago, and related parties claims the defendants violate the Commodities Exchange Act by providing high frequency traders with preferential access to futures markets. A motion to dismiss the complaint is pending.

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Mo’ Money, Mo’ Problems for Moazzam “Mark” Malik

Moazzam “Mark” Malik, a 33-year-old New Yorker, allegedly convinced at least 16 investors to invest approximately $840,000 in his so-called hedge fund.  Malik is charged with using most of his investors’ funds to finance his lavish lifestyle.

According to the SEC’s complaint against Malik, investors reported him to the agency after Malik ignored repeated demands for the returns of their funds (and tried to fake his own death). The SEC alleges that he claimed to be a “professional money manager” for the past eleven years who had degrees in marketing and finance and was educated at Harvard.  According to the SEC, however, Malik had only attended high school and worked as a stock broker trainee for less than two years. The allegations against Malik parallel a contemporaneous report that a “dashing” young financier employed a contrived CV to rapidly build up and then bust out Southport Lane Management before checking himself into Bellevue Hospital.  Apparently, the economy is sufficiently restored to allow such schemes to prosper again.

The SEC alleges that Malik generated publicity for his fraudulent fund by providing reputable news and information service outlets with false information that grossly overstated assets and performance.  For example, Malik sent Barclay Hedge a statement indicating that his fund held over $100 million of assets under management when the SEC believes Malik’s brokerage account held only $269.52.  Malik has pleaded not guilty.

Malik allegedly attracted investors to his fund due to the accolades reported on Bloomberg and Barclay Hedge.  Bloomberg had identified Malik as a rising fund manager, reporting that his fund had a whopping 92.73% return on investments.  Barclay Hedge had also awarded Malik a “gold star” as a high performing fund manager. Neither service independently verified Malik’s information.

Services such as Barclay Hedge and Bloomberg, which provide information to investors regarding hedge funds’ rankings and data, are not regulated or required to verify information submitted by fund managers.  Bloomberg does not guarantee the accuracy or completeness of its services and disclaims liability under any circumstances arising from use of its services. In the wake of Malik’s arrest, Bloomberg asserted that its practices are consistent with industry standards.  Similarly, Barclay Hedge has stated the main takeaway should be: “let the buyer beware.”  Its Terms of Use include numerous disclaimers warning users that information on its site may include inaccuracies, is provided “as is,” and that it makes no representations about the completeness, reliability, legality, or accuracy of the information.

Jeff Kopiwoda, a member of FVLD who regularly advises clients in the financial services industry, tells us:  “Prudent investors should perform their own due diligence prior to selecting an investment manager.  Even a basic due diligence should include an independent background investigation, as well a review of reports prepared by third-party service providers to confirm that assets under management and performance figures are accurate.”

The SEC is seeking a disgorgement of Malik’s ill-gotten gains but investors may recover only a fraction of their losses.  For example, Irving Picard, the trustee handling the bankruptcy of Bernie Madoff’s firm, has returned to investors just $5.3 billion of the $17.3 billion stolen in Madoff’s Ponzi scheme.  The problems with recovery include delays which allow a fraudster to dissipate funds or transfer them to family members and offshore accounts.  Only time will tell whether investors will be able to recover their money from Mark Malik.

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Court: First Amendment Unleashes “Raging Bitch” Beer

Following a recent decision from the Sixth Circuit Court of Appeals, the craft brewery Flying Dog will be able to pursue First Amendment claims against the state liquor commissioners who barred it from selling its “Raging Bitch” Belgian Style IPA without considering the First Amendment implications of the ban.

While some craft beer labels may seem deliberately provocative, FVLD member Glenn Rice, who represents many such brewers as well as the Illinois Craft Brewers Guild, pointed out that “craft breweries take great pride in distinguishing their unique products with creative and expressive trademarks and logos, and it is important that courts continue to protect their First Amendment rights.”

The Michigan Liquor Control Commission nevertheless curbed the “Raging Bitch” label, refusing to register it in the state because it was detrimental to public welfare.  Flying Dog sued, claiming the commissioners violated its free speech rights by refusing to let the dogs out.   Although the Commission eventually rescinded its ruling due to intervening Supreme Court precedent emphasizing constitutional protections for commercial speech, Flying Dog continued to seek damages from the commissioners for lost sales suffered during the ban.

The commissioners claimed they were entitled to immunity from damages, in part because Flying Dog’s First Amendment right to market the Raging Bitch label on Michigan’s supermarket shelves was not clearly established.  The Sixth Circuit disagreed, finding that, even in 2009, “any reasonable state liquor commissioner” was on notice that a content based ban on the label must conform to the First Amendment, and cited a 1995 Supreme Court case, Rubin v. Coors, which invalidated a ban on including alcohol contents on beer labels.  The Court held that the commissioners should have applied the “Central Hudson test,” from the 1980 Supreme Court case, which bars restrictions on truthful commercial speech regarding lawful activities unless (1) the government has a substantial interest in regulating the speech, (2) the proposed restriction directly advances the government’s substantial interest, and (3) the proposed restriction is no more extensive than necessary to further the government’s interest.

Flying Dog’s range may extend beyond craft beer.  For example, the case may lend support to the Washington Redskins’ position in the team’s dispute with the US Patent and Trademark Office over its decision to strip the team of several trademarks (although, unlike the liquor commission ruling in Flying Dog, the USPTO’s decision does not bar the Redskins from selling products bearing the team’s name and logos).

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Plug or Perish

FVLD attorney Seth Stern recently made a presentation to the Chicago Bar Association comparing the European Union’s “Right to be Forgotten” to United States privacy law.  Seth explained that any Right to be Forgotten legislation in the USA faces significant obstacles including the First Amendment, Section 230 of the Communications Decency Act, and the limited scope of American privacy law.  CBA members can view the presentation here.

Seth cited a recent survey indicating that, even though the Right to be Forgotten conflicts with the First Amendment, over 60% of Americans favor a right to have content about oneself removed from the Internet.  The Social Science Research Network posted another recent paper indicating that Americans are concerned about their current lack of options for seeking removal of damaging information that is available online.

The notion that First Amendment speech rights trump personal privacy was a relatively easy sell back when only celebrities and politicians had to worry about their dirty laundry being aired by the press.  These studies, however, may indicate a shift in public opinion now that everyone is a celebrity in their own social media universe, where the people publishing posts may lack the restraints often exercised by professional journalists.  Courts will need to resist chipping away at First Amendment freedoms when sympathetic plaintiffs ask them to assume a censorship role.

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Court: Biting Criticism of Dentist was Fair Use

A federal court in New York rejected a dentist’s attempt to take the teeth out of her patients’ Yelp reviews by requiring them to sign contracts prospectively assigning her the copyrights to any future social media postings about her services.

The court held that patient Robert Allen Lee’s Yelp review of dentist Stacey Makhnevich was a “fair use” of any copyright that Makhnevich held in the posting. The fair use doctrine permits the limited use of otherwise protectable copyrighted material for purposes including criticism and commentary.

Fair use aside, the court also held that by requiring patients to execute assignment of copyrights as well as a covenant not to publish criticism of her services, Makhnevich breached her fiduciary duties to her patients, and that efforts to enforce the restrictions would be barred by her “unclean hands.” The court also awarded a default judgment to Lee on his unrelated contract claims.

It is questionable whether a prospective copyright assignment of unspecified hypothetical postings could be enforced outside of, for example, a “work for hire” context. Following backlash including the Lee litigation, Medical Justice Corp. – the organization that supplied form copyright assignment contracts to doctors and dentists including Makhnevich – announced in 2011 that it has discontinued its form and no longer recommends using it.

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Another Day, Another Dollar? Exotic Dancers Bringing and Winning Wage Disputes Against Strip Clubs

Misclassification of independent contractors has come under scrutiny across multiple industries of late to include even strip clubs, which have long categorized performers as independent contractors outside the reach of federal and state minimum wage and overtime protections. Even a muse of Terpsichore may qualify as an employee, however, and now they are bringing wage-and-hour lawsuits (see here and here), under the Fair Labor Standards Act (FLSA), with retroactive paydays amounting to millions of dollars. These cases (examples below) are challenging the long-held business model of treating exotic dancers as independent contractors.

  • New York:  In November 2014, a federal district court awarded $10.8 million to exotic dancers in Hart v. Rick’s Cabaret Int’l, Inc. The court concluded that the dancers were employees of Rick’s and therefore entitled to a minimum wage under the FLSA and New York state law. The court explained that the “performance fees” dancers received from customers for personal dances or time in private rooms did not offset Rick’s duty to pay a minimum wage, and furthermore would not be applied to reduce the minimum wage obligations.
  • Texas:  In December 2014, a federal district court in Texas approved a $2.3 million settlement of FLSA claims brought by exotic dancers who worked at Jaguar Gold Clubs. The dancers in Jones v. JGC Dallas, LLC alleged not only that they were misclassified as independent contractors but also that the Clubs did not keep adequate records and retaliated against them for filing the lawsuit. Adding to the indignity, dancers testified they had to share tips with DJs, house moms, and managers (although the dancers’ lawyer asked 40% of the settlement ($920,000) and will receive 33.33%).
  • Arkansas:  In September 2014, a federal district court in Whitworth v. French Quarter Partners, LLC awarded more than $28,000 to three dancers who were misclassified as independent contractors by the club, French Quarter, in Hot Springs, Arkansas.
  • Nevada:  In October 2014, the Nevada Supreme Court ruled in Terry v. Sapphire/Sapphire Gentlemen’s Club that performers at the semi-nude Sapphire Gentlemen’s Club were employees. The court rejected the Club’s argument that they had agreed to be independent contractors after finding the Club for gentlemen voyeurs heavily monitored its performers, including dictating their appearance, interactions with customers, work schedules, and minute-to-minute movements when working.

Misclassification can be a latent and expensive problem for any employer under the FLSA, which sets federal standards for minimum wage and overtime pay, but it also can trigger tax liability by the IRS, healthcare compliance consequences, and workers’ compensation issues (although the factors distinguishing employees from independent contractors may vary by agency). In light of the IRS’s scrutiny of employee classifications this year, employers should carefully review their worker classifications, even if they lack terpsichorean aspects.

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Circuit Court Affirms That Charter School Operator Must Comply with FOIA

A scandal ridden Chicago charter school operator must produce documents under the Illinois Freedom of Information Act (the “FOIA”).  The Circuit Court of Cook County ruled against UNO Charter School Network, Inc. (“UCSN”) and United Neighborhood Organization of Chicago (“UNO”), the private company that UCSN hired to manage its charter schools, and in favor of Chicago Sun-Times news reporter Dan Mihalopoulos, represented by FVLD.

The Chicago Sun-Times had published a series of investigative reports revealing politically connected UNO’s misuse of state funds to construct and manage local charter schools under a grant of $98 million awarded by the Illinois Department of Commerce and Economic Opportunity (“DCEO”) for charter school development.  The Chicago Sun-Times reporting led the President of UCSN and UNO to resign from both Boards and triggered an investigation by the United States Securities and Exchange Commission, which ultimately charged both organizations with misleading investors by concealing conflicts of interest.

UCSN had denied having responsive documents in its possession while UNO contended that it was a “private entity” beyond the FOIA’s reach.  The Attorney General’s Public Access Counselor disagreed, however, and issued a binding opinion that both entities are subject to the FOIA. Among other factors, the Attorney General found that UCSN’s delegations of responsibility to UNO under their management services agreement encompassed “virtually all of the governance of the charter school” and that records concerning “the use of public funds to design and build charter schools are public records” subject to the FOIA.

UCSN sued for administrative review but the court found that financial experts and even the DCEO had treated UCSN and UNO as a single entity, further noting that both entities had common Boards, offices, and record-keeping systems.  The decision, which favors transparency and accountability where local government delegate functions to private entities, should facilitate the public’s oversight of charter school operators.

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Litigation Regarding the Late Robin Williams’ Estate Highlights the Importance of Specificity in Estate Planning

Actor Robin Williams’ sudden death on August 11, 2014 shocked the world and left his family heartbroken.  Yet even heartbroken families may dispute a latent ambiguity in an estate plan when the stakes are high enough.  Williams left an estate of approximately $45 million to be divided among his heirs, who include his third wife, Susan Schneider Williams, and Williams’ three adult children from his two previous marriages.

Currently, Susan and the Williams children are embroiled in a legal battle over the interpretation of the several provisions of the Robin Williams Trust that have become equivocal in context.  In his Trust, Williams provided that his children are to receive all of his “clothing, jewelry, personal photos taken prior to his marriage to Susan” and his “memorabilia and awards in the entertainment industry.”  The Trust provides that Susan will be allowed to reside in the marital home in Tiburon, California for the rest of her life, and should receive the furniture, furnishings, some of the contents of the home, and a trust to pay for all expenses of the residence.  Seemingly clear directives, however, were muddied in this particular context by Williams’ penchant for storing his collections of Japanese anime figurines, watches, bicycles, books, coins, and other effects in the Tiburon home.

Although ordinarily interpretation of a trust would be handled by the trustee, Susan allegedly felt compelled to seek court intervention when the trustee requested access to the Tiburon house.  Susan believes that “memorabilia” should include only items related to Williams’ acting career, and that “memorabilia,” “clothing,” and “jewelry” should automatically exclude all items in the Tiburon house.  Her attorneys claim that “any other interpretation would lead to Mrs. Williams’ home being stripped while Mrs. Williams still lives there.” Viewing “memorabilia” as distinct from “awards in the entertainment industry” the Williams children claim that Williams’ collections in the Tiburon home qualify as “memorabilia” given to them under the terms of the Robin Williams Trust.  In their mind, Susan is trying to ignore the “plain language of his will and trust” after being married to the actor for “less than three years.”  Unfortunately, despite Williams’ efforts to create a clear estate plan, this decision will now be left to the courts.

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The New Miami Vice

Slate reports on a recent appellate case from Florida holding that the state’s anti-teen sexting statute is unworkable on its face.   Apparently, the law makes a teen’s first sexting offense a civil offense, but juveniles cannot be prosecuted for civil offenses under Florida law.  That means there can be no second-time offenders who, theoretically, would be prosecutable for criminal offenses and subject to harsher penalties.  Florida teens, of course, should still be careful to avoid sexting in the state’s already lawless movie theaters.

Illinois’ own anti-sexting law took effect in 2011 and, among other provisions, permits adjudication of teens who sext as minors in need of supervision.  Sexters may be subject to prosecution for other crimes in addition to violations of state anti-sexting statutes.

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The Tao of the Internet: FCC and FTC Getting Aggressive

Two federal government agencies issued consumer protection warnings last week in connection with trending Internet practices.  While the Federal Communications Commission (FCC) sought to facilitate personal connectivity, the Federal Trade Commission (FTC) expressed concerns over the risks of consumers meshing too deeply with the Internet.

First, the FCC issued an Enforcement Advisory stating that businesses cannot block consumers from using their own personal Wi-Fi hot spots on the businesses’ premises in order to force consumers to pay for Wi-Fi services.  The FCC noted that this was a “disturbing trend” and warned that it will be “protecting consumers by aggressively investigating and acting against such unlawful intentional interference.”

In October 2014, the FCC had investigated the Marriott for blocking hotel guests’ personal Wi-Fi hot spots.  Marriott eventually agreed to pay a $600,000 penalty to settle the case.  Although Marriott paid the fine, it subsequently petitioned the FCC to change its policy, arguing that Wi-Fi blocking was necessary to protect the reliability and security of its own networks.

The FCC’s new Enforcement Advisory rejects Marriott’s argument: “No hotel, convention center, or other commercial establishment or the network operator providing services at such establishments may intentionally block or disrupt personal Wi-Fi hot spots on such premises, including as part of an effort to force consumers to purchase access to the property owner’s Wi-Fi network.  Such action is illegal and violations could lead to the assessment of substantial monetary penalties.”

Second, the FTC released a report on the Internet of Things (IoT), which emphasizes protections for consumer privacy and security.  IoT is the ability of everyday objects to connect to the Internet and to send and receive data, e.g., Internet-connected cameras, health or fitness monitor bracelets, home security devices, connected cars, and home automation systems.  The FTC warned that IoT raises numerous risks, such as the unauthorized access and misuse of personal information, attacks on other systems, and risks to personal safety.

The detailed report outlines the FTC’s recommended best practices, including that companies should build security into devices at the outset by conducting a privacy or security risk assessment, minimizing the data they collect and retain, and testing security measures before launching their products.  The FTC also recommended that companies examine their data practices and business needs to develop policies and practices that impose reasonable limits on the collection of consumer data or obtain consumers’ consent for collecting additional categories of data.

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Small BREW Act – Potential Tax Breaks for Craft Breweries

Craft breweries have enjoyed growth in popularity in America over recent years, and Chicago features some of the finest.  Too often the very existence of craft breweries does not depend on quality hops and barley, rather it depends on whether a particular brewery can generate sufficient revenue to pay high federal excise taxes.

On January 8, 2015, Congressmen Erik Paulsen (MN-03) and Richard Neal (MA-01) re-introduced bipartisan legislation to reduce the tax burden on America’s craft breweries.  The “Small Brewer Reinvestment and Expanding Workforce Act” (Small BREW Act) would impose an excise tax rate of $3.50 per barrel on the first 60,000 barrels (half of the current excise tax) and $16 per barrel on the next 1,940,000 barrels (down a few dollars a barrel).

Glenn Rice, a member of our firm who represents the Illinois Craft Brewers Guild as well as several prominent brewers, tells us:  “Small brewers face significantly greater production costs than multi-national brewing conglomerates due to vast differences in economies of scale.  Passage of the Small BREW Act will both level the playing field for small craft brewers and enable them to add jobs and grow their businesses.”

Only time will tell whether the Small BREW Act gains traction in Congress.

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Court Finds Plausible Retaliation Claim For Support of Coworker [Plug or Perish]

As reported by the Chicago Daily Law Bulletin, Judge Edmond Chang of the Northern District of Illinois denied a defense summary judgment motion in a retaliation and wrongful discharge case brought by a former employee. (Truth in labeling: FVLD represented the successful plaintiff.) The court found that the plaintiff’s support for a co-worker who filed a charge of discrimination against the company constituted protected activity under the Civil Rights Act of 1964 even if the plaintiff did not actively participate in the investigation or formally testify. The court also found that, although 20 months passed between the protected activity and discharge, the “chain of negative job actions” was enough for a jury to conclude that the company retaliated because of protected activity.

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Plug or Perish

FVLD’s January Legal Update discusses significant new laws that will affect both individuals and businesses in Illinois this year.  In short, if your New Year’s Resolutions for 2015 included making surreptitious recordings of private conversations and posting revenge porn online, it looks like you may have picked the wrong year.  Click here to read the Update.

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Faculty Bloggers Sue University: Will the Real “Cyberbully” Please Stand Up?

Two professors who contribute to a blog called CSU Faculty Voice sued Chicago State University officials over CSU’s “Cyberbullying Policy,” which prohibits electronic communications that have an “adverse impact on the work environment of a CSU faculty member or employee.”  The bloggers seek an injunction against enforcement of various policies to silence the blog, arguing that enforcement would contravene Supreme Court precedent barring public employers from retaliating against employees for protected speech.  CSU countered that, although it had requested civility, it never stated that it would enforce its policies to stifle protected speech, and that the cease and desist letter it sent the bloggers primarily focused on claims of trademark infringement.

Denying the CSU defendants’ motion to dismiss, the court in Beverly v. Watson found that the faculty bloggers  claim was “ripe” because the University sent them the aforementioned letter demanding they take down the blog due to violations of “the University’s values and policies requiring civility and professionalism.”  Although federal suits seeking “advisory” opinions on hypothetical controversies generally must be dismissed, the court found that CSU’s letter could be read as a threat to enforce the policies against the bloggers and therefore was sufficient to show that there was a live dispute between the parties.

The Court also rejected CSU’s argument that the faculty bloggers did not specify what expressive speech was chilled:  “Here, the general tenor of the speech at issue is not speculative:  the plaintiffs clearly wish to continue to criticize CSU’s administration as they have done in the past.”  Finally, the CSU defendants contended that, because their cease and desist letter mainly threatened trademark claims — based on the blog’s use of CSU’s name and logo — a ruling on the policies would not impair the bloggers’ right to continue blogging.  The court, however, noted that the plaintiffs did not seek trademark-related relief.  Therefore, the trademark issues did not impact the redressability of the First Amendment complaint.  In any case, CSU’s trademark theory would face challenges because the blog used CSU’s marks in a critical context, not a commercial one likely to confuse readers into thinking that CSU endorsed the blog.

Although the Beverly case deals with First Amendment issues unique to public employers, similar policies adopted by private employers may run afoul of the National Labor Relations Act because they could dissuade employees from discussing working conditions.

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Court: Firing Up Doesn’t Send Unemployment Benefits Up in Smoke

With the Compassionate Use of Medical Cannabis Pilot Program Act, Illinois has joined a growing number of states that have legalized marijuana under various circumstances, although no dispensaries are up and running yet in Illinois. (For a comprehensive summary of the Act, please see our December 2013 Legal Update.) While no Illinois court has yet ruled on the new medical marijuana law in the employment context, the Illinois Appellate Court has recently issued a decision on an employee’s off-duty use of marijuana.

In Eastham v. Housing Authority of Jefferson County, the court ruled for an employee who challenged the denial of unemployment insurance benefits after he was fired for violating his employer’s drug- and alcohol-free workplace policy. While working for the Housing Authority of Jefferson County, William Eastham was required to submit to a random drug test pursuant to the Housing Authority’s drug- and alcohol-free workplace policy. Eastham told his supervisor that he had smoked marijuana twice during a recent vacation and that he believed he would fail the drug test. The Housing Authority discharged Eastham for violating its policy before his test results were available. (His drug test came back negative.)

Eastham then filed a claim for unemployment insurance benefits. The Illinois Department of Employment Security denied Eastham’s claim because he had violated his employer’s drug- and alcohol-free workplace policy and “his choice to use the drug represent[ed] willful misconduct.” Under the Illinois Unemployment Insurance Act, an employee discharged for misconduct is ineligible to receive unemployment benefits. The Housing Authority’s policy stated that the “possession, use, consumption or being under the influence of a controlled substance … while in the course of employment of the Housing Authority” violates the terms of employment. Eastham appealed, arguing that the policy should not apply because the phrase “while in the course of employment” should not include his vacation. In response, the Housing Authority argued that its policy was required in order to receive federal funding and must be interpreted to include even time away from work.

Ultimately, the Eastham court disagreed with the Housing Authority, holding, for purposes of contesting unemployment benefits, it was unreasonable for a policy to deem off-duty marijuana use as “misconduct” absent a positive drug test. The Court further found that eligibility for federal funding did not require the discharge of employees for off-duty marijuana use. The court also rejected the argument that Eastham violated the policy by coming to work when he believed that he was under the influence of marijuana, noting that even if Eastham believed there was marijuana in his system, he did not test positive for drugs.

The court emphasized, however, that its decision only addressed whether Eastham’s conduct would amount to “misconduct” that would disqualify him from receiving unemployment insurance benefits. It did not address whether the Housing Authority was entitled to fire Eastham for his admitted marijuana use. The Housing Authority has since asked the Illinois Supreme Court to review the decision.

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