This update provides an overview of key class action-related developments during the third quarter of 2023 (July to September).

• Part I summarizes an Eighth Circuit decision addressing waiver of arbitration in putative class actions;
• Part II covers a Fourth Circuit opinion analyzing the impact of class action waivers on class certification proceedings;
• Part III discusses a recent opinion from the D.C. Circuit that weighs in on certification of “issue” classes under Rule 23(c)(4);
• And Part IV discusses two decisions reversing attorneys’ fee awards following class settlements.

I.    The Eighth Circuit Holds Defendant Does Not Waive Right to Arbitrate by Waiting Until After Class Certification to Move to Compel Arbitration as to Absent Class Members

In H&T Fair Hills, Ltd. v. Alliance Pipeline L.P., 76 F.4th 1093 (8th Cir. 2023), landowners brought a putative class action against a natural gas pipeline construction company, alleging the company breached its easement contracts with the landowners.  Although most of these contracts contained an arbitration clause, some did not—including the contracts with the named plaintiffs.  Id. at 1097.  After the district court certified the class, the company moved to compel arbitration of the claims of class members whose contracts contained arbitration provisions.  Plaintiffs objected, arguing the company waived its right to compel arbitration because it “wait[ed] more than two years after the complaint was filed” before moving to compel as to the absent class members.  Id. at 1098.  The district court nevertheless granted the motion to compel, highlighting that the company “had no reason to raise arbitration as an affirmative defense” given that none of the named plaintiffs had easement contracts “subject to arbitration agreements.”  Id. at 1098–99.

The Eighth Circuit agreed, holding that the company did not waive its right to arbitrate.  “[N]one of the named plaintiffs … have arbitration provisions in their easements,” id. at 1100, and at least until a class was certified, it made little sense to force a defendant to compel arbitration as to absent class members—“parties who were not yet part of the case.”  Id.  The Eighth Circuit concluded that the company “acted consistently with its right to arbitrate” when it moved to compel arbitration “quickly after the class was certified” as to those class members whose contracts contained an arbitration provision.  Id.

This holding contrasts with the Ninth Circuit’s recent decision in Hill v. Xerox Business Services, LLC, 59 F.4th 457 (9th Cir. 2023), which ruled that a defendant waived its right to compel arbitration against unnamed class members due to the defendant’s pre-certification conduct.  The court noted the defendant engaged in over six years of pre-certification litigation, having never mentioned a particular arbitration provision in its affirmative defenses or opposition to class certification.  Id. at 466.  It was only after the district court certified the class that the defendant invoked that specific arbitration provision—which, in the Ninth Circuit’s view, was too late.  In so holding, the Ninth Circuit rejected the argument pre-certification conduct can never vitiate a yet-to-exist right to arbitrate, reasoning that parties can implicitly relinquish such prospective rights at common law.  See Id. at 469–470 & n.15.  The Ninth Circuit also found it troublesome that the defendant had repeatedly asserted a right to arbitrate under a newer version of its employment contract “without also asserting the same” for the older version upon which it later tried to compel arbitration.  Id. at 473–74.

II.    The Fourth Circuit Vacates Certification Where District Court Failed to Consider Impact of Class Action Waiver Before Certifying Classes

In In re Marriott International, Inc., 78 F.4th 677 (4th Cir. 2023), the Fourth Circuit addressed the impact of a contractual class waiver on certification under Rule 23.  The case involved claims against a hotel chain and its IT service provider after hackers allegedly breached a guest reservations database and gained access to millions of guest records.  Id. at 680.

After holding that the named plaintiffs had adequately alleged an injury-in-fact for purposes of Article III standing, the district court certified classes for monetary damages under Rule 23(b)(3).  Id. at 681.  Defendants argued that the named plaintiffs did not satisfy the typicality requirement because they were all members of the hotel’s guest rewards program, the terms of which included a class action waiver.  Id. at 682.  By contrast, the class included absent class members who were not rewards members, and thus “had not signed such waivers.”  Id.  To address these “serious typicality concerns,” the district court redefined the classes to include only members of the guest rewards program.  Id.  The defendants sought interlocutory review under Rule 23(f).  Id. at 684–85.

On appeal, the Fourth Circuit held that the district court erred by certifying classes “consisting entirely of plaintiffs who had signed a putative class waiver without first addressing the import of that waiver.”  Id. at 687.  The court reasoned that the “time to address a contractual class waiver is before, not after, a class is certified.”  Id. at 686.  In so holding, the court explained that a “class-waiver” defense is not a merits issue, as it speaks only to the “process available” to a plaintiff in pursuit of their claim, and not the “underlying merits of that claim.”  Id. at 687.  As a result, the district court should have ruled on the effect of the “[class] waiver defense before certifying a class.”  Id.

III.    D.C. Circuit Holds Rule 23(c)(4) “Issue” Classes Must Still Satisfy Rule 23(a) and Be Maintainable Under One Category of Rule 23(b)

Rule 23(c)(4) states that “[w]hen appropriate, an action may be brought or maintained as a class action with respect to particular issues.”  Over the years, circuit courts have taken different approaches as to when certification under Rule 23(c)(4) is appropriate—and in particular, whether Rule 23(c)(4) can be used to skirt the predominance analysis under Rule 23(b)(3), since an “issue” class will have, by definition, a common issue.  This past quarter, the D.C. Circuit addressed this issue and followed the Fifth Circuit’s approach of rigorously applying all of Rule 23’s requirements, even for classes sought to be certified under Rule 23(c)(4).

In Harris v. Medical Transportation Management, Inc., 77 F.4th 746 (D.C. Cir. 2023), medical transportation drivers brought a putative class action under the Fair Labor Standards Act (“FLSA”), D.C.’s wage-and-hour laws, and for common-law breach of contract against their employer, alleging it failed to pay them their full wages.  Id. at 753–54.  The plaintiffs also sought certification of a class of drivers under Rule 23 for the wage claims.  Id. at 754.  The district court found that although the plaintiffs met the requirements of Rule 23(a), they failed to meet the predominance requirement of Rule 23(b)(3).  Id.  The district court nonetheless certified a Rule 23(c)(4) “issue” class on the issue of whether the employer was a joint employer or a general contractor.  Id. at 754–55.

After accepting the employer’s interlocutory appeal, the D.C. Circuit acknowledged that it had not yet addressed the question whether an “issue” class “can be certified when no lawsuit or cause of action has been certified as a class” and acknowledged the circuit split on the issue, noting “[o]ther circuits have applied Rule 23(c)(4) in a variety of ways.”  Id. at 756–57 (collecting cases).

Siding with the approach first set out by the Fifth Circuit in Castano v. American Tobacco Co., 84 F.3d 734 (5th Cir. 1996), the D.C. Circuit held that, under Rule 23, all certified classes—including a Rule 23(c)(4) “issue” class—must meet both the threshold requirements of Rule 23(a) and be maintainable under one of Rule 23(b)’s categories.  Harris, 77 F.4th at 757.  Noting “Rule 23’s carefully calibrated limits on class certification,” the D.C. Circuit emphasized the importance of the predominance inquiry as “an important safeguard against unreasonably fractured litigation, [which] simultaneously protects the rights of named parties and absent class members alike.”  Id. at 762.  The D.C. Circuit concluded that “district courts must ensure that Rule 23(c)(4)’s authorization of issue classes does not end up at war with Rule 23(b)(3)’s predominance requirement,” lest courts let plaintiffs “effectively skirt the functional demands of the predominance requirement by seeking certification of an overly narrow issue class and then arguing that the issue (inevitably) predominates as to itself.”  Id. (citing Castano, 84 F.3d at 745 n.21).  The court therefore vacated certification and remanded, instructing the district court to explain “how the use of issue classes is ‘superior to other available methods for fairly and efficiently adjudicating the controversy’” (such as the alternative of “deciding a partial summary judgment motion focused on the issues proposed to be certified”).  Id. (quoting Fed. R. Civ. P. 23(b)(3)).

IV.   Continuing Trend of Applying Greater Scrutiny to Class Action Settlements, Seventh and Ninth Circuits Eschew Mechanical Approaches to Calculating Attorneys’ Fees and Reverse Class Counsel Fees Awards

In Lowery v. Rhapsody International, Inc., 75 F.4th 985 (9th Cir. 2023), plaintiffs’ counsel sought $1.7 million in attorneys’ fees based on a capped $20 million settlement fund with a claims rate of less than 0.3%—effectively, only a $50,000 recovery for the class.  Id. at 988, 990.  The district court granted class counsel’s full fee award based on the “lodestar” method, and the defendant appealed.  Rejecting class counsel’s arguments, the Ninth Circuit held that attorneys’ fees should be based on the actual—and not theoretical—amount recovered by the class.  Id. at 992.  The court elaborated that district courts awarding fees “must consider the actual or realistically anticipated benefit to the class—not the maximum or hypothetical amount—in assessing the value of a class settlement” for purposes of evaluating the reasonableness of a fee award.  Id.

The Ninth Circuit ordered the district court on remand to “disregard the theoretical $20 million settlement cap,” and instead focus on the amount actually claimed by the class because “[a]ny other approach would allow parties to concoct a high phantom settlement cap to justify excessive fees, even though class members receive nothing close to that amount.”  Id.  The court also “encourage[d]” the district court “to cross-check the fees against the benefit to the class and ensure that the fees are reasonably proportional to that benefit.”  Id. at 993–94.  In its view, the fact that class counsel’s fees “greatly exceed[ed] 25% of the value of the settlement” was a “major red flag” signifying “that lawyers [were] being overcompensated and that they achieved only meager success for the class.”  Id. at 994.  Lowery is a timely reminder to parties litigating in the Ninth Circuit to prepare for the possibility of heightened scrutiny of the class’s recovery when seeking approval of class settlements, particularly those with a claims-made structure.

In In re Broiler Chicken Antitrust Litigation, 80 F.4th 797, 800 (7th Cir. 2023), the Seventh Circuit vacated class counsel’s $57.4 million fee award in an antitrust case based on a settlement fund of $181 million.  The district court considered whether the fees represented the “market rate,” and approved the award by relying on evidence that fee awards in antitrust cases in the Seventh Circuit “are almost always one-third” of the settlement value, which it viewed as a “strong indication” that this represented the “market rate.”  Id. at 801.  The Seventh Circuit vacated the award, holding that the district court’s market rate “evaluation fell short in two areas: the consideration of bids made by class counsel in auctions, and the weight assigned to out-of-circuit decisions.”  Id. at 802.

As to the first area, the Seventh Circuit faulted the district court for discounting recent bids submitted by class counsel in other cases with declining fee award structures, believing such declining fee award structures “do not reflect market realities” and “create perverse incentives” by reducing attorneys’ incentives to seek a larger recovery.  Id. at 803.  The Seventh Circuit disagreed, clarifying that it “never categorically rejected consideration of bids with declining fee scale award structures” and that these prior auction bids by class counsel in other cases were probative of the hypothetical bargain that could have been struck ex ante.  Id. at 802–03.

As to the second area, the Seventh Circuit disapproved of the district court’s decision to give less weight to fee awards received by the same class counsel in Ninth Circuit cases because the relevant law governing fee awards differed in some meaningful ways from Seventh Circuit law.  Id. at 804.  The Seventh Circuit held that even if Ninth Circuit law differed, class counsel’s economic choice to continue litigating in those Ninth Circuit cases was informative of the price of their legal services and the bargain they may have struck in this case.  Id.

On remand, the court instructed the district court to reevaluate the bargain the parties would have struck ex ante while giving appropriate consideration and weight to the two additional factors.  Id. at 805.  The court “express[ed] no preference as to the amount or structure of the award,” but said that an attorney fee award of one-third of the net settlement “warrants greater explanation.”  Id.

---

The following Gibson Dunn lawyers contributed to this client update: Lauren Fischer, Timothy Kolesk, Psi Simon,* Wesley Sze, Lauren Blas, Bradley Hamburger, Kahn Scolnick, and Christopher Chorba..

Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions, Litigation, or Appellate and Constitutional Law practice groups, or any of the following lawyers:

Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Lauren R. Goldman – New York (+1 212-351-2375, lgoldman@gibsondunn.com)
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
Lauren M. Blas – Los Angeles (+1 213-229-7503, lblas@gibsondunn.com)

*Psi Simon is an associate practicing in the firm’s San Francisco office who is not yet admitted to practice law.

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

In the past month, Governor Gavin Newsom signed into law a variety of employment law changes for California employers.  Below, we discuss eleven areas that may require attention from California employers.

1. Expanded Restrictions on Non-Compete Agreements

As detailed in our previous client alert, beginning on January 1, 2024, employers may not enter into or enforce employment agreements, “no matter how narrowly tailored,” that restrict an employee from “engaging in a lawful profession, trade, or business of any kind.”[1]  This restriction applies “regardless of where and when” such agreements are presented or were originally executed.[2]  Current, former, and prospective employees presented or threatened with such agreements may seek immediate injunctive relief or damages in California courts, as well as “reasonable attorney’s fees and costs.”[3]  In addition, by February 14, 2024, California employers and non-California employers with California employees must notify current and former employees (defined as those employed after January 1, 2022) in writing that previously executed agreements covered by the new law are now void.[4]

Failure to comply with these new laws, including the notification requirement, may result in civil penalties for “unfair competition” under Business and Professions Code section 17206, which are capped at $2,500 per violation.[5]  While neither statute addresses how civil penalties will be calculated—i.e. whether per employee, per non-compliant agreement, or per overall failure to notify an employee population, California courts are “afforded broad discretion” when determining the amount of civil penalties to impose under section 17206.[6]

The three limited statutory exceptions allowing restrictive covenants in the sale or dissolution of corporations, partnerships, and limited liability corporations remain in effect.[7]

2. Workplace Violence Prevention

A. Written Prevention Plans

By July 1, 2024, most California employers must create, adopt, and implement a written Workplace Violence Prevention Plan.[8]  Generally, the plan must include “effective” procedures to: (1) investigate and respond to reports of workplace violence; (2) prohibit retaliation against reporters; (3) communicate with employees regarding workplace violence; (4) identify and evaluate workplace violence hazards; and (5) revise and review the plan as needed.[9]  “Workplace violence” is broadly defined as “any act of violence or threat of violence that occurs in a place of employment.”[10]

The new law also requires annual employee training on various topics related to workplace violence and the employer’s plan, such as how to report workplace violence, potential corrective measures, and how to avoid physical harm.[11]  Additional training will be required whenever an employer changes its plan or identifies a previously unrecognized workplace violence hazard.[12]  The law does not specify how long each training must be.  Employers must maintain training records and records of each workplace violence hazard or incident (including how they were identified, investigated, and corrected, as applicable) for five years.[13]  “Violent incident” logs must include specific information, such as a description of the violence, involvement of law enforcement or security, and any protective action taken on the employee’s behalf.[14]  Employees are entitled to view and copy the violent incident log, with certain medical information omitted, within 15 calendar days of a request.[15]

The new law does not apply to: (1) employers already covered Cal/OSHA’s Violence Prevention in Health Care requirements; (2) employees who telework from a location of their own choice outside of the employer’s control; (3) locations not accessible to the public with fewer than 10 employees at one time; (4) the Department of Corrections and Rehabilitation; and (5) law enforcement agencies.[16]

B. Temporary Restraining Orders

While not on the immediate horizon, as of January 1, 2025, employers may seek restraining orders on behalf of employees who have suffered harassment, and not just those with a “credible threat of violence.”[17]  Under the new law, “harassment” is defined as “a knowing and willful course of conduct directed at a specific person that seriously alarms, annoys, or harasses the person,” “that serves no legitimate purpose,” that “would cause a reasonable person to suffer substantial emotional distress,” and actually does “cause substantial emotional distress” to the employee at issue.[18]  The employee need not be named in the temporary restraining order.[19]

3. Expanded Leave Protections

A. Reproductive Loss Leave

As of January 1, 2024, employees are entitled to five days of protected time off for a “reproductive loss event.”[20]  The new law applies to private employers with five or more employees, and any California employee employed for at least 30 days prior to the commencement of leave, even if a portion of that time was spent working outside of California.[21]  The term “reproductive loss event” is broadly defined to include a failed adoption, failed surrogacy, miscarriage, stillbirth, or unsuccessful assisted reproduction.[22]  Unlike California’s bereavement leave law, this new law does not contain a provision allowing employers to request documentation to confirm the reproductive loss event.  In addition, employers must keep confidential an employee’s request, as well as any other information provided, from “internal personnel or counsel” unless necessary or otherwise required by law.[23]

Employers’ existing leave policies will determine whether the reproductive loss leave is paid or unpaid; however, employees must be allowed to use paid time off, paid vacation, paid personal leave, accrued paid sick leave, or other compensatory time off in lieu of taking the five days unpaid.[24]  The five days must be taken within three months’ of the reproductive loss event, but need not be taken consecutively.[25]  Employees who experience more than one reproductive loss event in a 12 month period need only be provided with a maximum of 20 days of leave.[26]

B. Increased Sick Leave

As of January 1, 2024, California employees must be provided with at least five days or 40 hours of paid sick leave under the Healthy Workplaces, Healthy Families Act, increased from the three days or 24 hours previously required.[27]  Local ordinances may require higher amounts of paid sick leave.

Employers using the accrual method may still provide paid sick leave at an accrual rate of one hour for every 30 hours worked.[28]  However, employees must now accrue at least three days of paid sick leave by their 90th calendar day of employment, and five days of paid sick leave by their 200th calendar day of employment.[29]  Further, employees must be allowed to carry-over at least 10 days (or 80 hours) of paid sick leave to the following calendar year.[30]

Alternatively, employers may provide the full five days or 40 hours of paid sick leave upfront in a lump-sum each calendar year or 12-month period.[31]  Employers using the upfront, lump-sum method do not have to accrue any sick leave or allow carryover to the following year; however, all sick leave provided must be available for use during the same calendar year in which the employer provides it.[32]

Employers may still require employees to work for 90 calendar days before using sick leave.[33]  Accrued but unused sick time provided separate and apart from a vacation or omnibus paid time off policy still does not need to be paid out upon termination.[34]

4. Discretionary Stays Pending Appeals of Arbitrability

As of January 1, 2024, the California Code of Civil Procedure will no longer provide for automatic stays of trial court proceedings pending appeal of “order[s] dismissing or denying a petition to compel arbitration[.]”[35]  Instead, trial courts will have discretion to deny a stay pending appeals of arbitrability.[36]  Because S.B. 365 creates a procedural change, it is possible that courts will apply the discretionary standard to pending and future litigation.  Given its marked departure from the U.S. Supreme Court’s recent decision in Coinbase, Inc. v. Bielski, 599 U.S. 736, 737 (2023), which held that the FAA requires “a district court [to] stay its proceedings while the interlocutory appeal on arbitrability is ongoing,” S.B. 365 will likely face preemption challenges on the ground that it disfavors arbitration.  See Kindred Nursing Centers Ltd. P’ship v. Clark, 581 U.S. 246 (2017) (a state law that “discriminate[s] on its face against arbitration” or “singles out arbitration agreements for disfavored treatment … violates the FAA”).

5. Expanded Public Prosecution Rights

Beginning January 1, 2024, district attorneys, city attorneys, and county counsel (collectively, “public prosecutors”) will be able to prosecute or independently enforce violations of the Labor Code (except those related to agricultural labor relations, apprenticeships, or a Private Attorneys General Act action).[37]  Essentially, public prosecutors will be able to step into the shoes of the Labor Commissioner for their geographic jurisdictions.  Public prosecutors will be able to seek injunctive relief and seek the same attorney’s fees and costs the Labor Commissioner would be entitled to under Section 98.3 of the Labor Code.[38]

Importantly, the amended law also provides that any agreement between a worker and a putative employer limiting representative actions or mandating arbitration “shall have no effect on the authority of [a] public prosecutor or the Labor Commissioner to enforce the [Labor] [C]ode.”[39]  Further, the law states that an “appeal of the denial of any motion … to impose such restrictions on a public prosecutor or the Labor Commissioner shall not stay the trial court proceedings.”[40]  Because A.B. 594 entirely prohibits stays pending appeals of arbitrability in cases brought by public prosecutors or the Labor Commissioner, the anti-stay provision will likely be challenged on preemption grounds.

6. Increased Penalties for Independent Contractor Misclassification

Section 226.8 of the Labor Code will require courts and the Labor and Workforce Development Agency to impose $5,000 to $15,000 in civil penalties per violation starting on January 1, 2024 for: (1) willful misclassification, and/or (2) charging a willfully misclassified person a fee or “making any deductions from compensation” for any purpose “arising from [their] employment” that would otherwise be illegal if they were not misclassified (i.e. charges for necessary uniforms, tools, etc.).[41]  The penalties can be increased to $10,000-$25,000 per violation where there is, or has been, a pattern or practice of violations.[42]  These penalties are in addition to any other available penalties or fines.[43]  A violator will be required to prominently display a notice on their website, for one year, stating that they have engaged in willful misclassification and have made business changes to avoid further violations, along with other information.[44]

The Labor Commissioner will have the power to enforce these rules, in accordance with existing Labor Code Sections 98, 98.1, 98.2, 98.3, 98.7, 98.74, or 1197.1, and can do the following: (1) determine that a person or employer has committed violations, (2) investigate alleged violations, (3) order appropriate temporary relief pending the completion of an investigation or hearing, (4) issue citations, and (5) file civil actions.[45]  As for employees suing to enforce these rights, they can either recover damages or enforce a civil penalty under PAGA, but not both.[46]

7. Re-Hiring Rights for Laid-Off Hospitality Employees

Employers in the hospitality industry should be aware that as of January 1, 2024, California Labor Code Section 2810.8 will be expanded to cover more employees and extend the sunset period to December 31, 2025.[47]  California Labor Code Section 2810.8 will require covered employers to provide  “laid-off employee[s]” with information about available job positions for which they are qualified, and to offer positions to said employees based on a preference system and in accordance with a specified timeline.[48]  Under the new law, “laid-off employee” means anyone employed “6 months or more and whose most recent separation from active employment by the employer occurred on or after March 4, 2020, and was due to a reason related to the COVID-19 pandemic, including a public health directive, government shutdown order, lack of business, reduction in force, or other economic non-disciplinary reason due to the COVID-19 pandemic.”[49]  The law previously defined “laid off employee” as anyone “employed by the employer for 6 months or more in the 12 months preceding January 1, 2020, and whose most recent separation from active service was due to a reason related to the COVID-19 pandemic[.]”[50]  Critically, the revised law presumes “that a separation due to a lack of business, reduction in force, or other economic, non-disciplinary reason is due to a reason related to the COVID-19 pandemic, unless the employer establishes otherwise by a preponderance of the evidence.”[51]

As with the original version of the law, covered employers include hotels with fifty or more guest rooms, airport hospitality operations and service providers, certain event centers, and employers that provide “janitorial, building maintenance, or security services” to office, retail, or other commercial buildings.[52]

8. Prior Marijuana Usage

Starting January 1, 2024, employers may not request information about an applicant or employee’s prior use of marijuana.[53]  Employers also cannot discriminate against current or prospective employees on the basis of criminal history specifically related to prior marijuana use unless otherwise allowable by law.[54]

9. Labor Code’s New Rebuttable Presumption of Retaliation

A new rebuttable presumption of retaliation will be codified starting January 1, 2024.  The California Labor Code will include a rebuttable presumption of retaliation if an employer takes adverse action against or disciplines an employee within 90 days of that employee engaging in protected conduct.[55]  Protected conduct may include, but is not limited to, discussing, inquiring, or complaining about wages, or encouraging other employees to exercise their own protected conduct rights.[56]  Neither the preamble nor the statute itself mentions whether the presumption will have retroactive effect.

10. Increased Minimum Wage for Fast Food Workers

As of April 1, 2024, fast-food workers at “national fast food chains” in California must receive at least $20 per hour in minimum wage.[57]  “National fast food chains” is defined as “limited-service restaurants consisting of more than 60 establishments nationally that share a common brand, or that are characterized by standardized options for decor, marketing, packaging, products, and services, and which are primarily engaged in providing food and beverages for immediate consumption on or off premises where patrons generally order or select items and pay before consuming, with limited or no table service.”[58]

California Labor Code Section 1475 also creates the “Fast Food Council” within the Department of Industrial Relations.  The Council must have its first meeting by March 15, 2024, and will ultimately be responsible for establishing minimum standards for wages, hours, and other working conditions “to ensure and maintain the health, safety, and welfare” of fast-food workers.[59]

Beginning on January 1, 2025, the Council will have the authority to increase minimum wages for fast-food workers on an annual basis through 2029, provided the increases meet certain criteria.[60]

11. Diversity Reporting for Venture Capital Firms

Venture capital firms should be aware that starting March 1, 2025, they will likely be required to annually report various demographic data about the companies in which they invest to the California Civil Rights Department (“CRD”).[61]  Covered venture capital  firms include any with portfolio companies based in or with significant operations in California, as well as any that solicit or receive funds from California residents.[62]  The annual report must contain information about the gender identity, race, ethnicity, disability status and veteran status of the founders who receive their investments.[63]  Founders may opt out of reporting without penalty, but venture capital  firms who fail to provide any data they do receive will be subject to undisclosed fines.[64]  Any data submitted will then appear in an online searchable database available to the public, and CRD may also use it “in furtherance of its statutory duties, including, but not limited to, using the information in a civil action” under the new law or other law.[65]

It should be noted though that Governor Newsom issued a contemporaneous statement with his signing of the law.  He identified several concerns with the law, including “unrealistic timelines” and various questions regarding its funding.  The specific requirements of the law are likely to change prior to its effective date.

__________________________

[1] 2023 Cal. S.B. No. 699 (2023-2024 Regular Session).

[2] Id. § 2 (Cal. Bus. & Prof. Code § 16600.5(b)).

[3] Id. § 2 (Cal. Bus. & Prof. Code §§ 16600.5(d), (e)).

[4] 2023 Cal. A.B. No. 1076 (2023-2024 Regular Session).

[5] Id. § 2 (Cal. Bus. & Prof. Code §§ 16600, 16600.1(c)).

[6] See Nationwide Biweekly Administration, Inc. v. Superior Court (2020) 9 Cal.5th 279, 326.

[7] Cal. Bus. & Prof. Code §§ 16601, 16602, 16602.5.

[8] 2023 Cal. S.B. No. 553 (2023-2024 Regular Session).

[9] Id. § 3 (Cal. Lab. Code § 6401.9(c)).

[10] Id. § 3 (Cal. Lab. Code § 6401.9(a)(6)(A)).

[11] Id. § 3 (Cal. Lab. Code § 6401.9(e)).

[12] Ibid.

[13] Id. § 3 (Cal. Lab. Code § 6401.9(f)).

[14] Id. § 3 (Cal. Lab. Code § 6401.9(d)).

[15] Id. § 3 (Cal. Lab. Code § 6401.9(f)(6)).

[16] Id. § 3 (Cal. Lab. Code § 6401.9(b)(2)).

[17] 2023 Cal. S.B. No. 428 (2023-2024 Regular Session).

[18] Id. § 1 (Cal. Lab. Code § 527.8(b)(4)).

[19] Id. § 1 (Cal. Lab. Code § 527.8(e)).

[20] 2023 Cal. S.B. No. 848 (2023-2024 Regular Session).

[21] Id. § 1 (Cal. Gov. Code §§ 12945.6(a)(3), (a)(2)).

[22] Id. § 1 (Cal. Gov. Code § 12945.6(a)(7)).

[23] Id. § 1 (Cal. Gov. Code § 12945.6(e)).

[24] Id. § 1 (Cal. Gov. Code § 12945.6(b)(4)).

[25] Id. § 1 (Cal. Gov. Code § 12945.6(b)(3)).

[26] Id. § 1 (Cal. Gov. Code § 12945.6(b)(1)).

[27] 2023 Cal. S.B. No. 616 (2023-2024 Regular Session).

[28] Id. § 2 (Cal. Lab. Code § 246(b)).

[29] Ibid.

[30] Id. § 1 (Cal. Lab. Code § 246(j)).

[31] Id. § 1 (Cal. Lab. Code § 246(d)).

[32] Ibid.

[33] Id. § 1 (Cal. Lab. Code § 246(c)).

[34] Id. § 1 (Cal. Lab. Code § 246(g)).

[35] 2023 Cal. S.B. No. 365 (2023-2024 Regular Session).

[36] Id. § 1 (Cal. Code. Civ. Proc. § 1294(a)).

[37] 2023 Cal. A.B. No. 594 (2023-2024 Regular Session).

[38] Id. § 4 (Cal. Lab. Code § 226.8(g)).

[39] Id. § 2 (Cal. Lab. Code § 182).

[40] Ibid.

[41] Id. § 4 (Cal. Lab. Code § 226.8).

[42] Id. § 4 (Cal. Lab. Code §§ 226.8(b), (c)).

[43] Ibid.

[44] Id. § 4 (Cal. Lab. Code § 226.8(e)).

[45] Id. § 4 (Cal. Lab. Code § 226.8(g)).

[46] Ibid.

[47] 2023 Cal. S.B. No. 723 (2023-2024 Regular Session).

[48] Id. § 1 (Cal. Lab. Code §§ 2810.8(a), (i)).

[49] Id. § 1 (Cal. Lab. Code § 2810.8(a)(10)).

[50] Ibid.

[51] Ibid.

[52] Id. § 1 (Cal. Lab. Code §§ 2810.8(a)(1)–(13)).

[53] 2023 Cal. S.B. No. 700 (2023-2024 Regular Session).

[54] Id. § 1 (Cal. Gov. Code § 12954(c)).

[55] 2023 Cal. S.B. No. 497 (2023-2024 Regular Session).

[56] Id. §§ 1, 3 (Cal. Lab. Code §§ 98.6(b); 1197.5(k)).

[57] 2023 Cal. A.B. No. 1228 (2023-2024 Regular Session).

[58] Id. § 3 (Cal. Lab. Code § 1474(a)).

[59] Id. § 3 (Cal. Lab. Code § 1474(b)).

[60] Id. § 3 (Cal. Lab. Code § 1474(d)(2)).

[61] 2023 Cal. S.B. No. 54 (2023-2024 Regular Session).

[62] Id. § 1 (Cal. Bus. & Prof. Code § 22949.85(a)).

[63] Id. § 1 (Cal. Bus. & Prof. Code § 22949.85(b)).

[64] Id. § 1 (Cal. Bus. & Prof. Code §§ 22949.85(b)(2), (g)).

[65] Id. §1 (Cal. Bus. & Prof. Code §§ 22949.85(d)(1)–(3)).

---

The following Gibson Dunn attorneys assisted in preparing this client update: Jason C. Schwartz, Katherine V.A. Smith, Tiffany Phan, Brandon Stoker, and Lauren Fischer.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors and practice leaders:

Tiffany Phan – Partner, Los Angeles (+1 213-229-7522, tphan@gibsondunn.com)

Brandon J. Stoker – Of Counsel, Los Angeles (+1 213-229-7574, bstoker@gibsondunn.com)

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Join leaders of our renowned ESG practice for a lively, informative and interactive discussion about recent European Union ESG and AI developments and the impact on U.S. businesses.

The discussion highlights:

• human rights implications
• how companies can best comply
• the current temperature in Europe
• anti-ESG sentiment in the US

---

The leading German legal publication JUVE recommended Gibson Dunn in Germany in the 2023/2024 edition of its annual directory. Gibson Dunn was named among the National Top law firms in Germany and was recognized in the Antitrust, Compliance and Internal Investigations, Corporate Law, Dispute Resolution, M&A and Private Equity – Mid-cap and Large Cap Transactions categories. German partners Lutz Englisch, Ferdinand Fromholzer, Markus Nauheim, Dirk Oberbracht, Wilhelm Reinhardt, Markus Rieder, Benno Schwarz, Georg Weidenbach and Finn Zeidler were “frequently recommended” in one or more practice areas.

I.   Introduction

On October 17, 2023, the Department of Commerce’s Bureau of Industry and Security (“BIS”) released three rules to update its export controls on advanced computing and semiconductor manufacturing items. Two are new interim final rules (“IFRs”) and the third is a final rule amending the Entity List.[1] For ease of reference we refer to two IFRs together as the 2023 Amendments and separately as the SME IFR and AC/S IFR.

Broadly, the two IFRs impose controls on additional types of semiconductor manufacturing equipment; refine the restrictions on U.S. persons to ensure U.S. companies cannot provide support to advanced semiconductor manufacturing in the People’s Republic of China (“China”); expand license requirements for the export[2] of semiconductor manufacturing equipment to apply to additional countries; adjust the licensing requirement criteria for advanced computing integrated circuits (hereinafter “Advanced ICs”); and impose new measures to address risks of circumvention of the controls by expanding them to additional countries. In the final rule, BIS seeks to further direct the flow of Advanced ICs and semiconductor manufacturing equipment (“SME”) away from two new China-headquartered entities and their subsidiaries by adding them to its BIS Entity List. With the exception of a Temporary General License that was issued with the SME IFR and the Entity List additions, which are now in effect, the IFR amendments will become effective on November 17, 2023.

According to BIS, these new rules, as with the October 7, 2022 IFR (hereinafter, “2022 Regulations”), are intended to address specific national security and foreign policy threats presented by China’s “military-civil fusion” program and its efforts to modernize its military through the use of Artificial Intelligence (“AI”) and supercomputing applications.[3] BIS has designed the 2023 Amendments to strengthen, expand, and reinforce the 2022 Regulations, which curtailed China’s ability to purchase and manufacture Advanced ICs for use in advanced weapon systems and other military applications of AI,[4] products that enable mass surveillance, and other technologies used in the abuse of human rights.[5]

BIS’s amendments are the latest in a whole of government effort spanning U.S. presidential administrations to employ various international trade regulation tools at the government’s disposal (including export controls, import controls, CFIUS, and economic sanctions) to ensure that the U.S. maintains military and strategic economic superiority over China. The 2023 Amendments also reflect an unprecedented effort by the Biden Administration to coordinate new international trade controls with key allies and to minimize the impact on U.S. allies. Such efforts include minimizing some of the known collateral impacts that current unilateral controls could have on international trade flows, especially on the Advanced IC and SME supply chains of U.S. and allied country companies, and encouraging a collective “friend-shoring” of U.S. and allied country supply chains for critical technologies. We further discuss the broader set of policies these export controls help in part to advance in our recent client alerts detailing President Biden’s August 2023 executive order imposing restrictions on outbound investments in China’s semiconductor, AI, and quantum computing industries and outlining the Biden Administration’s priorities as described in the recent National Security Strategy.

This update provides an overview of key changes and insights presented by the 2023 Amendments. In Section II, we summarize significant amendments contained in the SME IFR concerning expanded license requirements for SME exports, clarified and elaborated SME classifications, clarified and expanded prohibitions on U.S. person support of Advanced IC development and production, and a new temporary general license for SME-related exports. We then summarize significant amendments contained in the AC/S IFR concerning a new performance density parameter in the Export Control Classification Number (“ECCN”) description for Advanced ICS, measures to address circumvention risk, expand end-use restrictions, and guidance on due diligence and red flag identification.

In Section III, we analyze the implications of the new regulations. Importantly, the new regulations create increased diligence responsibilities and compliance costs for transaction parties due to enhanced transaction and counterparty diligence requirements and the need for greater upstream and downstream supply chain visibility. We also discuss how a divergence in the ways that BIS and the Department of Treasury Office of Foreign Assets Control (“OFAC”) construe key concepts such as support and facilitation, and in how they view the mechanics of recusal policies, may place certain U.S. person employees of non-U.S. employers and multinational firms at a higher risk of noncompliance.  Additionally, we discuss BIS’s new guidance on the application of its foreign-direct product rules, and how two temporary general licenses and other features of the 2023 Amendments advance the U.S. policy of “friend-shoring” Advanced IC manufacturing.

In Section IV, we describe a BIS-acknowledged gap in its current ability to regulate AI foundational model training and other areas that BIS is now seeking further public comments to address.

II.   Summary of the 2023 SME and Advanced AC/S IFR Amendments

In our client update on the 2022 Regulations, we detailed the initial steps taken by BIS to establish comprehensive controls restricting the export of technology, software, manufacturing equipment, and commodities crucial for the development of Advanced ICs, semiconductors, and supercomputers. BIS took a two-pronged approach to implement these watershed restrictions, creating (i) new Commerce Control List (“CCL”)-based Regional Stability (“RS”) controls and (ii) end-use/end-user-based controls for semiconductor manufacturing items destined for China and Macau. The RS restrictions required licenses for exports of Advanced ICs, computer commodities containing these ICs, and certain SME, along with associated software and technology, to China and Macau.[6] BIS’s end-use/end-user-based controls imposed licensing requirements for the export of specific items related to supercomputers and Advanced IC development and production based on the exporter’s knowledge of potential end uses in China or Macau.[7]

The 2023 Amendments fortify and broaden these controls in several ways.

A.   SME IFR

1.   Expansion of Destinations Now Requiring Licenses for SME

Perhaps the most significant change BIS has made through its SME IFR amendments is the expansion of the list of destinations for which manufacturers and distributors of SME will require export licensing. Whereas before, the licensing requirement applied only to China and Macau, it now applies to 21 other destinations for which the U.S. maintains an arms embargo (excluding Cyprus).[8] These countries are listed in Country Group D:5[9] and include Afghanistan, Belarus, Burma, Cambodia, Central African Republic, Democratic Republic of Congo, Cuba, Cyprus, Eritrea, Haiti, Iran, Iraq, North Korea, Lebanon, Libya, Russian Federation, Somalia, the Republic of South Sudan, Sudan, Syria, Venezuela, and Zimbabwe.[10] While it may seem unlikely that many of the countries now subject to these controls would be involved in Advanced IC development and production, this expansion is intended to account for the possibility that counterparties located in these jurisdictions might try to obtain SME for other end-users in other destinations, and also to apply the prohibitions to the longer list of countries that the United Nations[11] and the United States have identified as posing heightened risks for weapons of mass destruction (WMD) proliferation.

2.   Elaborated SME Item Controls

The rule removes a kind of see-through ECCN 3B090 that BIS had introduced in its 2022 Regulations to control Advanced IC manufacturing equipment, the use of which had created issues for companies’ compliance systems because of the difficulty recording two ECCNs and their associated licensing requirements for the same product in their automated systems.[12] BIS now includes a specific positive list of SME items it sought to control with ECCN 3B090 in ECCNs 3B001 and 3B002.[13] In addition to refining past ECCN descriptions, the ECCN 3B001 subparagraphs impose licensing requirements on several additional types of SME that BIS has identified since its 2022 Regulations, including:

• Equipment designed for silicon, carbon doped silicon, silicon germanium (“SiGe”), or carbon doped SiGe epitaxial growth with specified parameters;
• Semiconductor wafer fabrication for equipment designed for ion implantation;
• Equipment designed for dry etching, including isotropic dry etching;
• Equipment designed for wet chemical processing and having the largest “silicon germanium-to-silicon etch selectivity” ratio of greater than or equal to 100:1;
• Equipment designed for plasma enhanced chemical vapor deposition of carbon hard masks meeting specified parameters;
• Spatial Atomic Layer Deposition (“SALD”) equipment having a wafer support platform that rotates around an axis having any of the following: a spatial plasma enhanced Atomic Layer Deposition (“ALD”) mode of operation, a plasma source, or a plasma shield or means to confine the plasma to the plasma exposure process region;
• Equipment designed for ALD or chemical vapor deposition (“CVD”) of plasma enhanced low fluorine tungsten films;
• Equipment designed to deposit a metal layer and maintain a specified vacuum or inert gas environment;
• Equipment designed for depositing a metal layer and maintaining a specified vacuum or inert gas environment, including equipment designed for selective tungsten growth without a barrier and equipment designed for selective molybdenum growth without a barrier;
• Equipment designed for depositing a ruthenium layer using an organometallic compound while maintaining the wafer substrate at a specified temperature;
• Equipment assisted by remotely generated radicals enabling the fabrication of a silicon and carbon containing film having specified properties;
• Equipment designed for void free plasma enhanced deposition of a low-k dielectric layer in gaps between metal lines with specified parameters;
• Equipment designed for ion beam deposition or physical vapor deposition of multi-layer reflector for extreme ultraviolet (“EUV”) masks, EUV pellicles, and equipment for manufacturing EUV pellicles;
• Equipment designed for coating, depositing, baking, or developing photoresist formulated for EUV lithography;
• Semiconductor wafer fabrication annealing equipment with specified parameters;
• Equipment designed for removing polymeric residue and copper oxide film and enabling deposition of copper metal in a vacuum (equal to or less than 0.01 Pa) environment;
• Single wafer wet cleaning equipment with surface modification drying; and
• Equipment designed for dry surface oxide removal preclean or dry surface decontamination.

The new ECCN 3B002 subparagraphs also impose new destination-based licensing requirements on the export of inspection equipment designed for EUV mask blanks or EUV patterned masks and restrict the use of certain license exceptions.

3.   U.S. Person Support to the Development or Production of Advanced ICs

BIS also uses its 2023 Amendments to clarify and expand prohibitions on U.S. person support of Advanced IC development and production in certain jurisdictions—which BIS introduced in its 2022 Regulations—and to codify some of the guidance it has provided in the form of Frequently Asked Questions on the kinds of U.S. person support that now require licensing. BIS created the U.S. person support prohibition to ensure that U.S. companies and U.S. natural persons do not provide support to China or Macau-based companies, including their non-China and Macau-located subsidiaries, in their development or manufacturing of Advanced ICs, or support their acquisition of certain SME. Since the 2022 Regulations, any U.S. person involved in the shipping, transmission, transferring (i.e., from one end-user to another in the same country), or servicing the end-items or services identified to Advanced IC development or production facilities in China and Macau has required a BIS license to engage in those activities.

BIS has now broadened this control to extend to U.S. person support for development or production of Advanced ICs at any facility of an entity headquartered in (or whose ultimate parent company is headquartered in) either Macau or a country subject to a U.S. arms embargo where the production of Advanced ICs occurs.[14] BIS also similarly broadened the control on U.S. person support involving SME that can be used to produce Advanced ICs.[15] At the same time, BIS clarifies that its facility-focused support prohibition is intended to include facilities engaged in all phases of production, important late-stage product engineering or early-stage manufacturing steps (among others) may occur. However, BIS narrowed its facility-based prohibition in one important way, by limiting its scope to exclude “back-end” production steps, such as assembly, testing, or packaging steps that do not alter the technology level of an IC.[16]

Additionally, BIS added an exclusion for U.S. persons employed or working on behalf of a company headquartered in the United States or a destination specified in Country Group A:5 or A:6 and not majority-owned by an entity that is headquartered in Macau or a destination specified in Country Group D:5.[17] Country Groups A:5 or A:6 include U.S. allies and other countries that have adopted export controls similar to those of the United States, such as the United Kingdom (U.K.), Japan, South Korea, and Taiwan, and members of European Union (E.U.) and NATO, among others.[18]

4.   Temporary General License for Continuing SME-Related Exports to Embargoed Countries and Macau

Amidst BIS’s expanded destination and item-based licensing requirements, BIS has also issued a new Temporary General License (“TGL”), which is valid through the end of 2025, to authorize companies headquartered in the United States, allied countries, and countries that maintain similar export controls to continue shipping less sensitive items to manufacturing facilities located in an arms embargoed country or Macau for limited purposes.[19] BIS intends this TGL to allow additional time for Advanced IC and SME producers located in the United States and the Group A:5 and A:6 countries, to identify alternative supply chains outside of arms embargoed countries.[20]

B.   Advanced IC and Supercomputing IFR

The AC/S IFR maintains the licensing requirements from the 2022 Regulations and makes two types of updates to the 2022 Regulations to address efforts by China and others to circumvent the new Advanced IC licensing requirements in different ways. The first is an addition to its item-based control parameters for Advanced ICs. The second are a set of additional measures BIS has designed to address other types of circumvention risks.

1.   BIS Has Added a New Parameter to Its Advanced IC Description to Reflect the Potential for Aggregate Computing Power

The AC/S IFR adds a new control parameter in the ECCN description for Advanced ICs, found in ECCN 3A090. Advanced ICs now include any ICs that meet or exceed the preexisting performance thresholds set in the 2022 Regulations or a new “performance density”[21] parameter. The “performance density” parameter recognizes that those seeking to use Advanced ICs for AI foundational model training to support specific military and intelligence applications can acquire many smaller, less or non-controlled ICs and then combine them to achieve the processing power and related capabilities that Advanced ICs provide.

While this new parameter may better reflect reality, the introduction of this new threshold will be a challenge for some companies to apply. Not only do many companies lack the types of engineering talent required to determine whether this control threshold has been met, but depending on their business model, some exporters might be required to perform this calculation for thousands of products. Compounding the difficulty, companies whose ICs, electronic assemblies, components, or computers incorporate parts from multiple suppliers may lack sufficient technical information regarding the parts to make the calculation, necessitating the need for outreach and technical exchange with manufacturers who may be reluctant to share the requested information for a variety of reasons. Given these factors, it may be difficult for many companies to perform the required calculations to determine whether their products pass the threshold and therefore require export control licensing.

2.   2023 Amendments Seek to Prevent the Circumvention of Its New Controls in Several Ways

The AC/S IFR also addresses circumvention risk in other ways.

a.   Foreign Direct Product Rule 

In its 2022 Regulations, BIS introduced two new foreign direct product (“FDP”) rules to reach non-U.S.-origin products used in advanced computing and supercomputers.[22] The 2023 Amendments expand the scope of the Advanced Computing FDP rule by expanding the destinations covered by the rule to cover Macau, all countries subject to an arms embargo (except Cyprus). Further, the new restrictions expand the scope of the restrictions worldwide whenever an exporter has “knowledge” that the items controlled by the rule are destined for any entity headquartered in, or whose ultimate parent company is headquartered in this expanded set of destinations. These changes are aimed at preventing companies from countries of concern from securing Advanced ICs directly or indirectly through their foreign subsidiaries and branches.

b.   Advanced IC Licensing Requirements

To limit diversion risk of Advanced ICs, the AC/S IFR expands an ECCN-based license requirement for their export to any destination specified in Country Groups D:1, D:4, and D:5 (excluding Cyprus and Israel).[23] These items include the Advanced ICs and electronic assemblies, components, and computers described in the ECCN 3A090 and 4A090 subparagraphs, respectively, and to items BIS now specifies in new “.z” paragraphs that BIS has added to nine ECCNs to more easily identify items that meet or surpass the ECCN 3A090 and 4A090 control parameters.[24] BIS will review license applications for exports of these items to Macau or D:5 countries with a presumption of denial and license applications for exports to other countries with a presumption of approval, unless the recipient is headquartered in, or their ultimate parent company is headquartered in, either Macau or in any one of the embargoed countries to which the licensing requirement applies.[25]

At the same time, BIS also has created a new license exception – Notified Advanced Computing (“NAC”) – which will authorize exports of certain Advanced ICs and associated items to Group D countries, but will also enable BIS to monitor and track which Group D:1, D:4, and D:5 country end-users are seeking these Advanced ICs and for what purpose. NAC will be available to authorize exports to end users in all of these countries, but like all license exceptions, exporters are required to report their use in their export clearance filings (i.e., Electronic Export Information – “EEI,” filings).[26] Exporters of Advanced ICs to Country Group D:5 countries and Macau also will need to notify BIS of their intent to export the controlled ICs to end users in these destinations and then wait 25 days for BIS to evaluate the proposed export.[27] Moreover, in order to use License Exception NAC, the export must be made pursuant to a written purchase order (unless the export is for commercial samples) and cannot involve any prohibited end users or end uses (including “military end users” or “military end uses” as defined in the U.S. Export Administration Regulations (“EAR”)).[28]

BIS has also issued a second Temporary General License, valid through December 31, 2025, authorizing the export of Advanced ICs and electronic assemblies, components, and computers that contain Advanced ICs, and their associated software and technology to certain facilities in Country Groups D:1, D:4, and D:5 in order to enable companies to continue using facilities in these countries to perform more limited manufacturing tasks such as assembly, inspection, testing, quality assurance, and distribution.[29] Importantly, this TGL can only be used when the items being manufactured are not destined for ultimate end use in these countries, however, and the license cannot be used by a company that is headquartered in or whose ultimate parent is located in Macau or a destination specified in Country Group D:5.[30] We discuss the policy rationale for this TGL further in the next section.

c.   2023 Amendments’ End-Use Controls Revisions

The 2022 Regulations introduced a new end-use prohibition on the export of certain items when the exporter knows at the time of the export that the items will be used for a specified end use.  In response to several public comments received on the 2022 Regulations, BIS substantially revised the format and content of the end-use licensing requirements and introduced a tiered license application review policy.

Consistent with other restrictions discussed above, BIS’s 2023 Amendments expanded the destination and end-use scope of the prohibitions beyond China and Macau to any destination subject to a U.S. arms embargo (Country Group D:5).  BIS also further tailored its end-use licensing requirements depending on the items to be exported.  For example, the export of items subject to U.S. export controls that will be used in almost any activity involving supercomputers, or that will be incorporated into or used in the development or production of components or equipment that will be used in supercomputers require a license.  Another end-use licensing requirement applies to the exports of advanced computing items now described in ECCN “z” entries to any destination outside of the Group D countries if one knows that they are destined for use by a company that is headquartered in, or whose ultimate parent company is headquartered in, either Macau or an arms embargoed country.  Tellingly, the example BIS provides for this end-use prohibition is the knowing export of one of the specified items to a China-headquartered cloud or data server provider located in a destination not otherwise excluded to, for example, train AI models in ways that would be contrary to U.S. national security interests.  An additional, new end-use seeks to prevent entities located in Macau or an embargoed country from exporting ECCN 3E001 technology for use in making Advanced ICs to any production facility worldwide without a license.  BIS also crafted an end-use licensing requirement for exports of certain kinds of SME when the exporter knows that they will be used in the development or production of front-end IC production and associated components, assemblies, and accessories.

No license exceptions are available to overcome the above licensing requirements, but BIS has established a tiered system for reviewing licenses.  Specifically, license applications for Macau and destinations specified in arms embargoed countries will be reviewed with a presumption of denial. Whereas proposed exports involving other destinations and uses will be reviewed either under a on a case-by-case basis policy or a policy presumption of approval.

d.   Due Diligence

Finally, BIS also provides additional guidance on its due diligence expectations and on the types of red flags that exporters should be looking when they are trying to determine whether a proposed export will require licenses. We analyze BIS’s diligence guidance and its expanding diligence expectations further in the next section.

III.   Analysis

A.   The Importance—and Challenge—of Being Diligent

BIS’s 2022 Regulations significantly increased the diligence responsibilities of transaction parties involved in semiconductor and semiconductor equipment development and production. For example, companies anywhere in the supply chain have had to review whether their products may be ultimately provided to semiconductor fabrication facilities engaging in Advanced IC manufacturing, to ultimately support the development or production of certain controlled equipment, or to ultimately be incorporated into a supercomputer—even when they were several steps removed from the final product. Over the past year, we supported many clients whose products are used in semiconductor development and production to map their upstream and downstream supply chains for particular products, develop new tools for gathering the required information, and rewrite their compliance procedures to ensure the relevant information is gathered and licensing analysis completed at the appropriate times.

The 2023 Amendments reflect BIS’s continuing and expanded expectation that companies should exercise heightened due diligence when dealing with the semiconductor and advanced computing industries in China. How important private sector diligence is to BIS’s implementation of these new controls is evident by how often BIS used the words “diligence” (26 times) and some formulation of the words “know/known/knowable/knowledge” (84 times) across the 2023 Amendments. BIS’s efforts to control Advanced IC, supercomputing, and SME development, supply chains, and use away from the countries targeted by the 2023 Amendments depends on private sector companies making new investments in their due diligence systems.

Not surprisingly, BIS received several comments from the public regarding the challenges of the diligence responsibilities imposed under the 2022 Regulations. In the SME IFR, BIS acknowledged public comments that companies further up the supply chain do not have full visibility into the specific operations of the end-user facilities.[31] In the AC/S IFR, BIS summarized (although disagreed with) public comments that its controls “represent[] an unprecedented burden shift” by “effectively mandat[ing] diligence via a licensing requirement.”[32] Ultimately, BIS did not relieve parties from the responsibility to be diligent, stating that China’s activities “warrant[] imposition of a higher level of affirmative duty to ‘know’ in order to not be subject to a license requirement.”[33]

Rather, BIS provided additional guidance on how to meet its expanding diligence expectations.

Know Your Customer Guidance and Red Flags. BIS updated its existing Know Your Customer Guidance and Red Flags to add additional red flag indicators, including a customer’s marketing materials, representations, and anticipated or intended future capabilities.[34] Following the 2022 Regulations, BIS had issued the FAQs for Interim Final Rule that stated that a reasonable level of due diligence for U.S. support activities outlined in 15 C.F.R. 744.6 include the “review of publicly available information, capability of items to be provided or serviced, proprietary market data, and end-use statements.” In response to a public comment BIS confirmed in the AC/S IFR that it expects companies to apply the same kinds of diligence to ensure their compliance with the SME end-use prohibitions.[35] Both guidance documents confirm that transaction parties must be vigilant even to aspirational development or production of their counterparties (and parties down the supply chain), which BIS acknowledged to be a “moving target.”[36]

End-User/End-Use Certification. In the 2022 Regulations, BIS provided a voluntary model end-user/end-use certification to assist people in applying the new FDP rules.[37] In the AC/S IFR, BIS clarified that the model certificate can be used with all FDP rules to ease the compliance burden. That said, BIS still stated that the certification is neither necessary to be obtained from all counterparties in China,[38] nor sufficient or determinative without other due diligence steps.[39] Rather, “[t]he exporter, reexporter, or transferor must evaluate all the information that it obtains during the normal course of business to determine if it has ‘knowledge’ that the item is ultimately destined for use in a prohibited activity.”[40] While the certification conveniently summarizes in one place which FDP rules apply to the product, note that completing such a certificate could require exporters to complete more than a dozen different permutations of the FDP rule analysis for every item the certificate is meant to accompany. We further discuss the unique burden of FDP rule analysis below.

Entity List. Alongside its 2023 Amendments, BIS also published a Federal Register notice adding 13 entities involved with developing large AI models and AI enabling ICs for defense purposes using U.S.-origin items to its Entity List. The additions were made in part to address public comments requesting that BIS publish a positive list of “semiconductor fabrication facilities” of concern.[41] BIS noted that while it intends to continue to “add additional entities to the Entity List as they are identified and approved by the End-User Review Committee,”[42] parties must still “do their own due diligence when dealing with parties not identified on the Entity List with a footnote 4 designation.”[43] BIS did not specifically respond to public comments that the due diligence would require significant efforts and may lead to disparate conclusions from exporter to exporter.

Although the 2023 Amendments provide some much-needed guidance, they also make it evident that BIS has high expectations for the private sector to be at the forefront of handling complex due diligence. Given the need to review multiple information sources, even including a counterparty’s aspirational development or production of technology, this type of screening is especially difficult to automate, and companies with relevant products will need to expend more compliance resources to fully address BIS’s heightened diligence expectations.

B.   BIS’s U.S. Person Support Clarifications Place Certain Kinds of U.S. Person Employees at Higher Risk of Noncompliance

As noted above, BIS’s 2022 Regulations and 2023 Amendments revised the EAR’s U.S. Persons controls to ensure that U.S. persons are prohibited from supporting advanced semiconductor manufacturing in China and Macau without specific authorization from BIS. “U.S. persons” can refer to both juridical persons organized under the laws of the United States and their foreign branches, natural persons who are U.S. citizens, permanent legal residents, or refugees and asylees, and any other person located in the United States.[44]  Note here that any persons located in the United States can include the U.S. located operations of non-U.S. companies.  For multinational companies, including those based in jurisdictions of U.S. allies, this creates the need to evaluate whether the involvement of any U.S.-based personnel or operations in their non-U.S. origin transactions might also bring them within the scope of these new U.S. person support prohibitions.

With respect to natural persons, BIS reaffirms in its guidance that U.S. natural persons employed by non-U.S. Persons must comply with these end-use controls but notes that if a non-U.S. employer engages in transactions that U.S. natural person employees are restricted from performing, employees can excuse themselves from those types of activities or obtain a BIS license as needed.[45] BIS specifically notes that these activities include the shipping, transmitting, or transferring (in-country) to or within China or Macau (and the facilitation and servicing thereof) any item not subject to the EAR that the employee knows will be used to develop integrated circuits at China and Macau advanced IC fabrication facilities.[46] BIS rejected a broader construal of “support” to include performing any contract, service, or employment that one would know may assist or benefit advanced semiconductor fabrication in China.[47] BIS also codified past guidance it had provided in FAQs, noting that restricted facilitation does not include:

• administrative, clerical, legal advice, or regulatory advice activities, including counseling on the requirements of the EAR (but does include other activities directly responsible for bringing about prohibited activity);
• the provision of back-office services helping the business function (including IT services, financial services, or human resource support);
• order intake and processing;
• invoicing and cash or receivables collection activities; and
• referring matters to non-U.S. persons.[48]

BIS also notes that the following two activities would typically be prohibited facilitation, but that BIS has authorized them so a U.S. person employee can engage in them:

• trade compliance clearance of licensed shipments with China semiconductor customers including Entity List parties; and
• providing administrative and limited servicing support for shipments to Entity List parties authorized by BIS licenses.[49]

BIS also lessened the compliance burdens for U.S. employees of companies that are headquartered in specified countries by excluding them from the requirement to obtain a license for these activities.[50] These countries include those in Country Group A:5 and A:6, provided that they are not majority-owned by an entity headquartered in Macau or Country Group D:5.

But for U.S. employees of companies whose roles do not meet the exclusion criteria, BIS does not address the possibility that employees may not be permitted to exclude themselves from performing their job requirements. Nor does BIS consider that their employers may not permit them to gather and provide the kind of information that BIS will require for its U.S. person support license applications, including detailed descriptions of planned production and sales of SME and Advanced ICs whose export BIS otherwise would not have jurisdiction to control. BIS was even less accommodating for U.S. natural persons who serve in executive roles in non-U.S. and non-Country Group A:5 and A:6 headquartered companies.

In response to a public comment asking whether BIS would presume that a company’s executives facilitated a restricted transaction even when they did not have knowledge of a violative transaction, BIS refused to provide a general response and went further to note that efforts by executives to limit the information that would normally come to them could result in an EAR violation if these steps were taken to avoid EAR licensing requirements.[51] We note BIS’s specific guidance on this point, like BIS’s guidance that restricted facilitation does not include referring opportunities to non-U.S. persons, is in direct opposition with the acceptable use recusal policies as compliance tools for U.S. economic sanctions, which allow U.S.-person executives and other decision makers to limit the executives’ access to information and their need to approve transactions that the company can engage in but a U.S. person cannot. As a result of BIS’s conflicting guidance on recusal, U.S. person executives who continue to work at non-U.S. semiconductor-focused companies could now find themselves at higher risk of violating U.S. export controls if they adopt more typical sanctions-focused recusal policies that limit the information they receive.

C.   BIS Has Provided Some (But Not Enough) New Foreign Direct Product Rule Guidance

One of most significant expansions of U.S. export control jurisdiction over the last decade has been accomplished through BIS’s introduction of new FDP rules. Indeed, the number of FDP Rules has grown from a single National Security FDP rule in 2013 to now nine different FDP rules (each with at least two permutations) and differing use cases. Through the operation of FDP rules, BIS deems certain non-U.S. origin items located outside of the United States to be subject to the EAR’s licensing requirements when the items are a “direct product” of specified “technology” or “software,” or are produced by a complete plant or “major component” of a plant that itself is a “direct product” of the specified “technology” or “software.”

Although the FDP rules vary in scope and target, by making non-U.S. origin items subject to the EAR, they give the U.S. Government the jurisdiction to control where and to whom the affected items can be exported. Moreover, the FDP rules can create the foundation to further extend U.S. jurisdiction to other non-U.S. origin items that incorporate qualifying foreign direct products. Once foreign items become subject to the EAR via an FDP rule, those who seek to incorporate or bundle them into or with other non-U.S. origin items need to further consider other bases of U.S. jurisdiction over the other item, such as the EAR’s De Minimis Rule, which controls non-U.S. origin items that contain controlled (i.e. license requiring) U.S. content above various thresholds depending on the content and the item’s destination. For example, in the SME IFR, BIS also amended its De Minimis Rule to set a 0% de minimis threshold for certain specialized lithography equipment, meaning that any non-U.S. origin system containing this kind of equipment is subject to U.S. export controls.

The 2023 Amendments make significant changes to the Advanced Computing FDP rule, which BIS introduced in its 2022 Regulations. First, BIS significantly expands jurisdictions and companies impacted by the Advanced Computing FDP Rule, which previously was only applicable to exports to China and Macau. Under the revised Advanced Computing FDP Rule, BIS has implemented a worldwide licensing requirement for the export of foreign direct product Advanced ICs when they are being exported to; incorporated into any parts, components, computers, or equipment destined to; or for any company that is headquartered in any destination subject to a U.S. arms embargo or whose ultimate parent company is headquartered in any of those countries.[52] As such, this expanded rule, in addition to adding licensing requirements applicable to both U.S. and non-U.S. persons related to exports destined for an additional 21 countries, also seeks to prevent companies from these countries from bypassing these restrictions and securing controlled ICs through their foreign subsidiaries and branches. Additionally, BIS uses the IFR to complete a bit of housekeeping to make parallel the different FDP rules, removing ambiguities caused by slight variations in phrasing that had accumulated over recent amendments to the EAR. [53]

However, BIS’s amendments did not include clarification of a fundamental concept that BIS uses in its FDP rules. FDP rule analyses are among the most complex required by the EAR and the burden of completing FDP analyses falls most squarely on non-U.S. companies or companies producing their products outside of the United States. FDP Rule analysis requires a detailed understanding of the software and technology that is being used to not only produce one’s own product, but also of any equipment one is using in the production process and this equipment’s development and production software and technology. Despite regular exporter confusion regarding what constitutes a “major component” sufficient to bring an item that is used in the production of an item within the scope of the FDP rules, the 2023 Amendments do not provide any meaningful additional guidance. Indeed, the included definition, which defines a “major component” as “‘equipment’ that is essential to the ‘production’ of an item,”[54] is largely identical to the vague definition included in previous iterations. Given the limited guidance BIS has provided regarding how to distinguish a “major component” from, say, a minor component or any other item that is used in a production process through rulemaking, informal FAQs, or other guidance, foreign companies will have to assess for themselves whether the function of any equipment they identify as essential to the production process may be a “major component” subject to the relevant FDP rule.

FDP rule analyses also impose other indirect costs. At least for now, many non-U.S. companies that make up IC supply chains use equipment that may be the product of U.S. software or technology. However, non-U.S. companies often do not have sufficient information regarding the development and production history of their equipment to determine whether it might be the direct product of controlled software or technology. As a result, different manufacturers of similar products may come to differing conclusions regarding the applicability of U.S. export control requirements, which not only undermines their efficacy, but also leaves companies that get the analysis wrong potentially subject to BIS enforcement. In light of the uncertainties and attendant risks associated with using U.S. equipment, many companies may opt to eliminate U.S. equipment from their production processes altogether.

D.   How Temporary General Licenses and Allied Country Exclusions Promote “Friend-shoring” of the Development and Production of Critical Technologies like SME and Advanced ICs

BIS is using several amendments to encourage the “friend-shoring”[55] of Advanced IC manufacturing. These include the two Temporary General Licenses discussed in Section II and BIS’s use of Country Group A:5 and A:6 exclusions.

Although the TGLs discussed in Section II allow companies headquartered in the United States or Country Group A:5 or A:6 countries continue exporting to and producing certain Advanced ICs in Group D countries, and to continue using facilities in these jurisdictions to develop and produce less restricted SME parts, components, and equipment at the direction of companies, the terms of these TGLs only extend through December 31, 2025.[56] The uncertainty surrounding whether BIS will extend these terms acts to incentivize companies located in the U.S. and in eligible countries to relocate their supply chains to their own or other allied jurisdictions during the TGL’s limited term.

BIS has also granted Group A:5 and A:6 headquartered companies varying exclusions from the presumption of denial for all licenses requests under its end-use controls on supercomputing and semiconductor manufacturing. Its updated license review policy includes a presumption of approval where the end user of the product is headquartered in Country Groups A:5 or A:6, provided that they are not majority-owned by an entity headquartered in either Macau or a destination specified in Country Group D:5.[57]  By applying restrictions on exports to Group D countries while simultaneously privileging allied countries and affording them more favorable license treatment, the U.S. signals that allied countries will remain a “safe harbor” for Advanced IC manufacturing.

Similarly, allowing exports by these companies of less restricted items used in the production of SME to Country Group D:5 countries can channel the development of more advanced SME away from these countries. These exclusions and more refined licensing requirements help to minimize the immediate effects of the U.S. Government’s unilateral controls on allied country companies, enabling them to continue using historical supply chains for certain activities while acting as a kind of carrot to lead their governments to adopt analogous controls going forward.

IV.   BIS Acknowledges a Big Gap in Its Regulations and Requests Public Comments

Despite the significant regulations implemented in October 2022 and October 2023, BIS acknowledges that regulatory gaps still exist. A significant one relates to use of datacenter Infrastructure as a Service (IaaS) offerings for AI training. Specifically, China and other countries impacted by the new rules can potentially bypass controls on “supercomputers” through the rental or leasing of the computing power required for training AI foundational models on IaaS platforms.

While current regulations restrict engagements with supercomputing efforts in China and Macau, and the 2023 Amendments expand the country scope of these restrictions, IaaS solutions can still enable the offloading of China’s computational workloads to computers in other countries, which would allow it to circumvent U.S. export controls on Advanced IC-enabled supercomputing. The risk is especially magnified in light of the absence of multilateral end-use/end-user controls in this arena. BIS continues to review the potential for such circumvention and how a regulatory response could mitigate the issue and notably, specifically seeks public comments on how it could use regulatory tools to address access to IaaS provided AI “development” by customers who might use them to develop large dual-use AI foundation models with potential capabilities of concern, such as models exceeding certain thresholds of parameter count, training compute, and/or training data.[58]

BIS also requests public comments on a number of other issues, including on how BIS could use technical parameters to distinguish Advanced ICs and computers more commonly used for small or medium scale training of AI foundational models from those used for large AI foundational models with different capabilities of concern.[59] BIS also asks companies to assess the impact of imposing licensing requirements on the use of foreign national employees to support Advanced IC and SME, and to share what practices they already use to safeguard technology and intellectual property, among other questions.[60]

Although BIS did not accept every commenter’s suggested revisions to the 2022 Regulations in this latest round of amendments, many of the amendments BIS did make reflect a recognition by BIS that EAR control parameters need to be regularly updated and that it should, whenever possible, try to minimize the unintended collateral impacts its new regulations are having on companies worldwide. BIS’s recent changes to its public comment process, which allow companies to submit both public and business confidential information that will not be published, now lower the risk that companies can provide technical and other business proprietary information to better inform BIS’s future rulemaking.  BIS will accept public comments on its 2023 Amendments until December 17, 2023.

* * *

We work every day to help companies apply complex export controls to their business operations and to build compliance and licensing strategies to address export controls in integrative and business savvy ways. We also regularly work with clients to monitor and filing public comments and to develop briefings that better inform BIS’s policies and licensing decisions. We welcome the opportunity to support you.

___________________________

[1] Dep’t of Comm. Bureau of Ind. and Sec., Export Controls on Semiconductor Manufacturing Items Interim Final Rule (Oct. 17, 2023) (hereinafter “SME IFR”); Dep’t of Comm. Bureau of Ind. and Sec., Implementation of Additional Export Controls: Certain Advanced Computing Items (Oct. 17, 2023); Dep’t of Comm. Bureau of Ind. and Sec., Supercomputer and Semiconductor End Use; Updates and Corrections Interim Final Rule (Oct. 17, 2023) (hereinafter “AC/S IFR”).

[2] Most of changes made to licensing requirements in the 2023 Amendments apply to exports, re-exports, and transfers (in country). For ease of reference, we refer to all three types of shipments as “exports” in this alert, and will only specific re-exports or transfers when an amended regulation applies to fewer shipment types.

[3] Press Release, U.S. Dep’t of Comm. Bureau of Ind. and Sec., “Commerce Strengthens Restrictions on Advanced Computing Semiconductors, Semiconductor Manufacturing Equipment, and Supercomputing Items to Countries of Concern” (Oct. 17, 2023), https://www.bis.doc.gov/index.php/component/docman/?task=doc_download&gid=3355.

[4] Id.

[5] Id.

[6] 15 C.F.R. § 742.6.

[7] 15 C.F.R. § 744.23.

[8] 15 C.F.R. §§ 742.4(a)(4), 742.6(a)(6)(i) (as of Nov. 17, 2023). BIS uses the long formulation “Group D:1, D:4 and D:5 countries, when the countries are not also specified in Group A:5 and A:6” in several places in the 2023 Amendments. As of today, there are only two countries, Cyprus and Israel, that appear in Groups A:5 or A:6 and also on any Group D list. Accordingly, we use the short hands “(excluding Cyprus)” when referring to targeted arms embargoed destinations and “(excluding Cyprus and Israel)” when referring to the broader targeting of Group D countries, throughout this alert. Please note that the Country Group lists are subject to revision. A full list of the Country Groups can be found in Supplement No. 1 to Part 740 of the EAR, linked here.

[9] The Export Administration Regulations (“EAR”) use Supplement No. 1 to 15 CFR Part 740 to identify groups of countries which are subject to different licensing policies based on United Nations sanctions, U.S. national security and foreign policy grounds, or as a result of their participation in different international treaties and other export control and non-proliferation focused plurilateral agreements. Supplement No. 1 is used not only to define licensing requirements, but also eligibility for different EAR license exceptions. Importantly, country groupings are nonexclusive and certain countries can appear in more than one group which complicates BIS’s efforts easily identify the subsets of countries to which different regulatory provisions apply.

[10] See 15 C.F.R. Part 740, Supplement No. 1.

[11] Some of the countries identified in Country Group D:5 are under United Nations-mandated arms embargoes.

[12] See SME IFR 54.

[13] Id.

[14] 15 C.F.R. § 744.6(c)(2)(i) (as of Nov. 17, 2023).

[15] 15 C.F.R. § 744.6(c)(2)(iii) (as of Nov. 17, 2023).

[16] 15 C.F.R. § 744.23(a)(5) (as of Nov. 17, 2023).

[17] 15 C.F.R. § 744.23(a)(3) (as of Nov. 17, 2023).

[18] See 15 C.F.R. Part 740, Supplement No. 1 for a full list of destinations within Country Groups A:5 and A:6.

[19] Supplement No. 1 to Part 736(d)(2) (as of Nov. 17, 2023).

[20] SME IFR 6-7, 70.

[21] BIS defines performance density as Total Processing Performance (“TPP”) divided by “applicable die area.” TPP is “2 x ‘MacTOPS’ x ‘bit length of the operation’, aggregated over all processing units on the integrated circuit.” The applicable die area for the ECCN 3A090 measurement is measured in millimeters squared and includes all die area of logic dies manufactured with a process node that uses a non-planar transistor architecture.

[22] 15 CFR §§ 734.9(h), (i) (as of Nov. 17, 2023).

[23] 15 C.F.R. § 746.2 (as of Nov. 17, 2023). Expanding the requirement that previously applied only to China and Macau.

[24] AC/S IFR 68.

[25] 15 CFR § 742.6(a)(10) (as of Nov. 17, 2023).

[26] 15 CFR § 740.8 (as of Nov. 17, 2023).

[27] 15 CFR § 740.8(a)(2) (as of Nov. 17, 2023).

[28] 15 CFR § 740.8(a)(1) (as of Nov. 17, 2023).

[29] Supplement no. 1 to part 736(d)(2) (as of Nov. 17, 2023).

[30] Id.

[31] See SME IFR, supra note 1, 51.

[32] AC/S IFR, Topic 62.

[33] AC/S IFR, Topic 61; see also SME IFR, Topic 51.

[34] Supplement No. 3 to Part 732.

[35] AC/S IFR, Topic 48;  BIS, FAQs for Interim Final Rule, https://www.bis.doc.gov/index.php/documents/product-guidance/3181-2022-10-28-bis-faqs-advanced-computing-and-semiconductor-manufacturing-items-rule-2/file.

[35] AC/S, Topic 53.

[36] AC/S IFR, Topic 53.

[37] Supplement No. 1 to Part 734.

[38] See AC/S IFR, Topic 47.

[39] See SME IFR, Topic 49.

[40] SME IFR, Topic 49.

[41] SME IFR, Topic 23.

[42] SME IFR, Topic 23; AC/S, Topic 47.

[43] SME IFR, Topic 23.

[44] 15 C.F.R. § 772.1.

[45] SME IFR, Topic 63.

[46] 15 C.F.R. §746.6(c)(2) (as of Nov. 17, 2023).

[47] SME IFR, Topic 58.

[48] SME IFR, Topic 60.

[49] Id.

[50] Id.

[51] SME IFR, Topic 62.

[52] 15 C.F.R. § 734.9(h) (as of Nov. 17, 2023). BIS specifically exempts companies located in Cyprus and Israel through its exclusion note on Group A:5 and A:6 countries.

[53] See AC/S IFR, 100.

[54] BIS, Foreign-Produced Direct Product (FDP) Rule as it Relates to the Entity List §736.2(b)(3)(vi) and footnote 1 to Supplement No. 4 to Part 744, updated October 28, 2021.

[55] The “Friend-shoring” concept first appeared in a speech by Secretary of the Treasury Janet Yellen to the Atlantic Council in April 2022.  In that speech “friend-shoring” is described a form of trade integration that prevents countries from using their market position in key raw materials, technologies, or products to have the power to disrupt the U.S. economy or exercise unwanted geopolitical leverage. Janet Yellen, Remarks by Secretary of the Treasury Janet L. Yellen on Way Forward for the Global Economy, April 13, 2022.

[56] SME IFR 19.

[57] SME IFR 35.

[58] AC/S IFR 103-104.

[59] AC/S IFR 106.

[60] AC/S IFR 105.

---

The following Gibson Dunn attorneys prepared this alert: Christopher Timura, Mason Gauch, Chris Mullen, Claire Yi, Sarah Pongrace, Lauren Trujillo, Gerti Wilson, Alana Sheppard, Nikita Malevanny, and Adam M. Smith.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s International Trade practice group:

United States
Judith Alison Lee – Co-Chair, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Hayley Lawrence – Washington, D.C. (+1 202-777-9523, hlawrence@gibsondunn.com)
Annie Motto – New York (+1 212-351-3803, amotto@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212-351-3972, spongrace@gibsondunn.com)
Anna Searcey – Washington, D.C. (+1 202-887-3655, asearcey@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Claire Yi – New York (+1 212-351-2603, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia
Kelly Austin – Hong Kong/Denver (+1 303-298-5980, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Hong Kong (+852 2214 3731, qyue@gibsondunn.com)
Felicia Chen – Hong Kong (+852 2214 3728, fchen@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)

Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 160, nmalevanny@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

On October 18, 2023, following the signing of an electoral roadmap between Venezuela’s opposition and the regime of President Nicolás Maduro, the Biden administration announced a major relaxation of U.S. sanctions on Venezuela.  The broad package of measures—which eases restrictions on Venezuela’s oil and gas sector, gold sector, and secondary trading in certain Government of Venezuela securities—represents a seismic shift from the “maximum pressure” campaign that since 2019 has prohibited virtually all U.S. nexus dealings involving key sectors of Venezuela’s energy-driven economy.  From a policy perspective, such incremental, and in some cases time-limited, sanctions relief appears calculated to incentivize the Maduro regime to take concrete steps toward the restoration of Venezuelan democracy with an eye toward holding a free and fair presidential election late next year.

Notably, most U.S. sanctions on Venezuela, including a prohibition on most U.S. nexus transactions involving the Government of Venezuela, remain in effect.  Moreover, the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) has indicated that the continued availability of even partial sanctions relief is contingent upon the Maduro regime meeting its commitments under the country’s electoral roadmap, as well as with respect to individuals wrongfully detained in Venezuela.  If the Maduro regime reneges on those commitments, OFAC reserves the right to amend or revoke existing licenses at any time.  Those limitations notwithstanding, by authorizing a wide range of transactions involving Venezuela’s crucial oil and gas sector, the Biden administration has unveiled the most economically consequential easing of restrictions on Caracas since the advent of the Venezuela sanctions program—and opened the door to possible further sanctions relief in the months ahead.

Oil and Gas Sector

Among the measures announced in October 2023, the most impactful is Venezuela General License (“GL”) 44 which authorizes U.S. persons, until April 18, 2024, to engage in all transactions related to oil or gas sector operations in Venezuela, including transactions involving state-owned oil giant Petróleos de Venezuela, S.A. (“PdVSA”), subject to certain conditions.  Crucially, that general license sets forth a non-exhaustive list of authorized activities that includes:  (1) the production, lifting, sale, and exportation of oil or gas from Venezuela, and the provision of related goods and services; (2) payment of invoices for goods or services related to oil or gas sector operations in Venezuela; (3) new investment in oil or gas sector operations in Venezuela; as well as (4) delivery of oil and gas from Venezuela to creditors of the Government of Venezuela, including creditors of PdVSA entities, for the purpose of debt repayment.

The limitations included in GL 44 are relatively modest in scope.  For example, that license expressly does not authorize transactions involving certain blocked Venezuelan financial institutions; transactions involving certain Russian-owned or -controlled entities; or transactions involving “new” debt that are unrelated to the payment of invoices or the delivery of oil and gas to the Government of Venezuela’s creditors.  The license also excludes from its authorizations transactions involving Venezuela’s digital currency, known as the petro; dealings in debts owed to the Government of Venezuela; and the unblocking of property—which, as a practical matter, prevents the Maduro regime from accessing its holdings of cash and securities in the United States, which remain frozen.

Although GL 44 on its face is limited to an initial period of six months, with the possibility that it could at a later date be renewed if the Maduro regime delivers on its electoral promises, the license nevertheless marks the most substantial easing of U.S. sanctions on Venezuela to date.

Under the Trump administration, the United States during 2019 sharply escalated restrictions on Venezuela by imposing blocking sanctions on numerous substantial enterprises, including the state-owned oil company PdVSA, the state-owned gold mining company, the country’s central bank, and ultimately the entirety of the Government of Venezuela.  Expanding on those earlier measures, the United States sought to further restrict the Maduro regime’s access to energy revenue by on multiple occasions in 2020 designating non-U.S. parties, including shipping companies and vessels, to OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List for engaging in dealings involving Venezuelan-origin oil.

With the notable exception of a general license issued in November 2022 that authorizes certain specified transactions related to the operation and management by one named U.S. energy company of its joint ventures in Venezuela involving PdVSA, the United States had until this month continued to maintain sanctions pressure on Venezuela’s oil and gas sector.  With the issuance of GL 44, U.S. persons and non-U.S. persons can potentially engage in a wide variety of U.S. nexus transactions involving Venezuela’s oil and gas sector, including exporting Venezuelan crude, investing in new energy projects, and recovering sums owed by the Government of Venezuela and PdVSA entities—including old, new, and future debts incurred in covered activities—through payments in the form of Venezuelan-origin petroleum and petroleum products.

Gold Sector

In addition to easing sanctions on Venezuelan oil and gas, the Biden administration further broadened the Maduro regime’s access to potential sources of hard currency by easing sanctions on Venezuela’s gold sector.  In particular, OFAC issued a general license that authorizes, without any time limitation, most U.S. nexus transactions involving Venezuela’s state-owned gold mining company, CVG Compania General de Mineria de Venezuela CA (“Minerven”), and its majority-owned entities.  Underscoring the apparent U.S. policy interest in permitting such gold-related transactions to proceed, that license authorizes U.S. persons to engage in dealings involving Minerven entities, including with the involvement of certain blocked Venezuelan financial institutions, namely the Banco Central de Venezuela or the prominent commercial lender Banco de Venezuela SA Banco Universal.

Concurrent with the issuance of that license, OFAC published guidance indicating that non-U.S. persons no longer risk becoming designated to an OFAC restricted party list such as the SDN List solely for operating in the gold sector of the Venezuelan economy.  Taken together, these measures suggest a willingness on the part of the current U.S. administration to allow the Maduro regime to monetize Venezuela’s considerable natural resources.

Government of Venezuela and PdVSA Securities

Finally, in a key development for investors and financial institutions, the measures announced in October 2023 extend beyond Venezuela’s extractive industries to include an easing of sanctions on secondary trading in certain securities issued by the Government of Venezuela or PdVSA.

Since August 2017, in an effort to limit the Maduro regime’s access to long-term financing, the United States has restricted U.S. persons from dealing in certain Venezuelan sovereign bonds, plus certain debt of, and equity in, PdVSA entities.  During that period, OFAC issued and repeatedly extended a pair of general licenses that until this month authorized U.S. persons to engage in all transactions related to certain specified Government of Venezuela or PdVSA securities, subject to the condition that any divestment or transfer of such securities had to be to a non-U.S. person.  On October 18, 2023, OFAC further amended those two licenses by issuing GL 3I and GL 9H, which presently authorize U.S. persons to both sell and purchase such securities—thereby permitting secondary trading in specified Venezuelan sovereign bonds and specified PdVSA debt and equity.

Although the Biden administration has substantially expanded the circumstances under which U.S. persons can deal in financial instruments issued by the Government of Venezuela, two key limitations remain.  Prospective investors should be mindful that, except as separately authorized by OFAC, secondary market transactions involving specified Government of Venezuela or PdVSA securities generally cannot involve blocked persons (e.g., selling such securities to, or purchasing such securities from, an SDN).  Further, U.S. persons continue to be prohibited from participating in the primary market for newly issued Government of Venezuela or PdVSA securities.

Next Steps Between Washington and Caracas

In short, the recent easing of U.S. sanctions on Venezuela is noteworthy both for its breadth and for the fact that much of the relief extended to Caracas rests on a promise by the Maduro regime to in the future take further steps toward the restoration of Venezuelan democracy.  As it remains to be seen whether the Maduro regime will ultimately hold up its end of the bargain, a further easing of U.S. sanctions on Venezuela appears unlikely, at least in the near term.  However, in the event that the Maduro regime indeed takes concrete steps toward holding free and fair elections—such as lifting a ban on certain opposition candidates holding public office, allowing opposition candidates reasonable access to state-run media outlets, and permitting international observers to monitor the casting and counting of ballots—it is not out of the question that the United States could next year further ease certain remaining sanctions on Venezuelan financial institutions, Venezuelan financial instruments, or conceivably the Government of Venezuela itself.

---

The following Gibson Dunn lawyers prepared this client alert: Erika Suh Holmberg, Scott Toussaint, Annie Motto, Adam M. Smith, and Rahim Moloo.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s International Trade or International Arbitration practice groups:

International Trade Group:

United States
Judith Alison Lee – Co-Chair, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Hayley Lawrence – Washington, D.C. (+1 202-777-9523, hlawrence@gibsondunn.com)
Annie Motto – New York (+1 212-351-3803, amotto@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212-351-3972, spongrace@gibsondunn.com)
Anna Searcey – Washington, D.C. (+1 202-887-3655, asearcey@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Claire Yi – New York (+1 212-351-2603, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia
Kelly Austin – Hong Kong/Denver (+1 303-298-5980, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Hong Kong (+852 2214 3731, qyue@gibsondunn.com)
Felicia Chen – Hong Kong (+852 2214 3728, fchen@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)

Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 160, nmalevanny@gibsondunn.com)

International Arbitration Group:

Cyrus Benson – Co-Chair, London (+44 20 7071 4239, cbenson@gibsondunn.com)
Penny Madden KC – Co-Chair, London (+44 20 7071 4226, pmadden@gibsondunn.com)
Rahim Moloo – Co-Chair, New York (+1 212-351-2413, rmoloo@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

This quarterly newsletter aggregates the knowledge and experience of Gibson Dunn attorneys around the globe as we help our clients across all sectors navigate the ever-changing landscape of voluntary carbon markets.

Worldwide Carbon Markets Continue to Grow

In May, the World Bank published its 2023 State and Trends of Carbon Pricing. Almost a quarter of the world’s emissions are now covered by carbon credits, up from just 7% a decade ago. The voluntary market remains the primary driver behind carbon credit market activity.

But regulatory mechanisms are becoming increasingly common, with several nations implementing new carbon regulations this year and many more teeing up for future rollouts. While the United States federal government has recently favored funding green supply chains, the European Union and the rest of the world are increasingly adopting carbon trading schemes and carbon taxes.

The World Bank noted that carbon offset prices and issuances fell relative to the prior year. Some of this is likely due to concerns and criticisms about carbon offsets, tougher economic conditions, and supply bottlenecks. Additionally, standardizing contracts within the marketplace appears to be increasing liquidity and putting downward pressure on carbon trading. Among regulatory carbon markets, prices for the EU emissions trading system (“ETS”) fell mid-year before bouncing back, for example, while both New Zealand’s and Korea’s ETS prices remain low. Within the voluntary carbon market, buyers tended to prefer newer vintages over old ones and renewable energy projects over nature-based credits. Prices for credits are expected to rise once again.

Read More

---

The following Gibson Dunn lawyers assisted in the preparation of this alert: Abbey Hudson, Brad Roach, Lena Sandberg, Arthur Halliday, Yannis Ioannidis, Alexandra Jones, Virginia Somaweera, Mark Tomaier, Richie Vaughan, and Alwyn Chan.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Environmental, Social and Governance (ESG), Environmental Litigation and Mass Tort, Global Financial Regulatory, Energy, or Tax practice groups, or the following authors:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)

Environmental Litigation and Mass Tort Group:
Abbey Hudson – Los Angeles (+1 213-229-7954, ahudson@gibsondunn.com)

Global Financial Regulatory Group:
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)

Energy, Regulation and Litigation Group:
Lena Sandberg – Brussels (+32 2 554 72 60, lsandberg@gibsondunn.com)

Oil and Gas Group:
Brad Roach – Singapore (+65 6507 3685, broach@gibsondunn.com)

Tax Group:
Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202-887-3567, mjdonnelly@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Gibson Dunn and the nine other law firms that form the Domestic Abuse Response Alliance (DARA) have received the PILnet Local Impact Award for the best, innovative pro bono legal project with an impact felt at the local or national level.

DARA is the largest pro bono project ever assembled in England and Wales to provide end-to-end representation and advocacy support for domestic abuse survivors seeking protective orders against their abusers. It represents survivors of domestic abuse who are not eligible for legal aid but who cannot afford to pay for private representation. DARA comprises a special combination of expertise to deliver social justice: legal prowess and support from 10 of the world’s top law firms, governance from LawWorks, clients from the National Centre for Domestic Violence and FLOWS (Finding Legal Options for Women Survivors), and specialist family law oversight on every case from Beck Fitzgerald.

Since DARA was launched in 2022, Gibson Dunn lawyers have obtained 12 final non-molestation orders for their DARA clients.

Established in 1997 as the Public Interest Law Initiative in Transitional Societies at Columbia University in New York, PILnet provides free legal assistance to hundreds of civil society organizations around the world every year in partnership with law firms and independent practitioners. The PILnet Local Impact Award was announced on October 17 during PILnet’s 2023 Global Forum in Brussels.

We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q3 2023. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

• PCAOB Continues Aggressive Standard-Setting Activity
• PCAOB Staff Report Finds 40 Percent of Audits Have Part I.A Deficiencies
• SEC Chief Accountant Issues Statements on Crypto Assurance Work and Risk Assessment
• Second Circuit Decertifies Investor Class in Long-Running Dispute
• UK Supreme Court Strikes Down Litigation Funding
• NYSE and Nasdaq Listing Standards on Clawbacks Take Effect
• New York DFS Proposes Second Amendment to Cybersecurity Regulation
• California Broadens Restrictions on Employee Non-Competes
• California Passes Legislation Establishing Climate-Related Reporting Requirements
• Other Recent SEC and PCAOB Regulatory Developments

Please let us know if there are topics that you would be interested in seeing covered in future editions of the Update.

Read More

---

Accounting Firm Advisory and Defense Group:

James J. Farrell – Co-Chair, New York (+1 212-351-5326, jfarrell@gibsondunn.com)

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)

Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, mscanlon@gibsondunn.com)

In addition to the Accounting Firm Advisory and Defense Practice Group Chairs listed above, this Update was prepared by David Ware, Timothy Zimmerman, Benjamin Belair, Adrienne Tarver, Monica Limeng Woolley, Douglas Colby, and Nicholas Whetstone.

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

On August 9, 2023, the Biden Administration issued Executive Order (“EO”) 14,105, outlining proposed controls on outbound U.S. investment in certain foreign entities.[1] The EO was accompanied by an Advance Notice of Proposed Rulemaking (“ANPRM”) issued by the U.S. Department of the Treasury (“Treasury”) seeking information regarding implementation of the EO.[2] In an earlier update, Gibson Dunn explained Treasury’s ANPRM and the complicated compliance landscape it proposed to create.

As part of the rulemaking process, Treasury opened a 45-day window to allow for public comment on the ANPRM that closed on September 28, 2023. Treasury requested feedback on a broad list of 83 questions.[3] The comment period generated significant interest from industries that will be affected by the potential outbound investment regime (the comments may be viewed in full at Regulations.gov). Major actors in the investment community; manufacturers; semiconductor, microelectronics, and quantum companies; financial institutions; and trade associations all weighed in with broad and specific comments. Across industries, commenters emphasized the need for more clarity, narrower coverage to prevent chilling of investment and spill-over into non-targeted industries, and wider exemptions.

As discussed in our previous update, it is very rare for Treasury to conduct a notice and comment rulemaking process under the International Emergency Economic Powers Act (“IEEPA”), the authority offered in the EO. Thus, significant uncertainty remains surrounding the proposed rule’s implementation or how comments will factor in. The discussion below lays out certain key unresolved issues and concerns raised in the submitted comments.

I. Clearer definitions and guidance regarding covered U.S. persons, covered foreign persons, and “country of concern”:

First, many commenters noted that the definitions are vague with respect to which U.S. actors or investors, foreign partners, and types of investments and transactions are subject to the restrictions.

1. Clarify which “U.S. persons” are covered by the rule.

The ANPRM proposes to adopt the definition of “U.S. person” set out in the EO, which comports with the standard definition in U.S. sanctions practice, and includes “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of any such entity, and any person in the United States.”[4]

• Commenters asked Treasury to clarify that the obligation to comply with the EO applies only to the U.S. person entity or individual undertaking the covered transaction and not to other parties involved in or tangential to the transaction, including third-party financial institutions.[5]
• Commenters also recommended Treasury clarify the status of dual citizens under the regulations.[6]
• Commenters further noted that the definitions of U.S. persons and covered foreign person should be made mutually exclusive to prevent situations where a company is classified as both.[7]
• Similarly, many commentators noted that the definition of U.S. person creates ambiguity as to whether non-U.S. companies that have U.S. nationals as board members or senior employees will be affected by the regulations, and requested more clarity.[8]
• Commenters representing European parent companies of U.S. subsidiaries also expressed concern that they might erroneously be considered “U.S. persons.”[9]

2. Clarify the indicia for identifying a “covered foreign person”.

Treasury has proposed to define “covered foreign person” to mean either (1) a “person of a country of concern” that is engaged in, or that a U.S. person knows or should know will be engaged in, an identified activity with respect to a “covered national security technology or product”; or (2) a person whose direct or indirect subsidiaries or branches are referenced in item (1) and which, individually or in the aggregate, comprise more than 50 percent of that person’s consolidated revenue, net income, capital expenditure, or operating expenses.[10]

• Many commenters indicated that the kind of information needed to make either of these two determinations is often unavailable for various reasons, meaning it will be hard for U.S. persons to comply and properly conduct due diligence. Commenters emphasized that access to Chinese banking and ownership information is not readily available, and in some cases is obscured or prohibited by China’s legal regime; thus, U.S. persons may not be able to fully assess whether covered activity comprises more than 50 percent of a foreign person’s revenue, net income, or other metrics in the ANPRM.[11]
• Others noted that the 50 percent rule would fail to capture various loophole situations—for example, where a large company has a small subsidiary that is only a small portion of a large company’s revenue—making the regulations less effective.[12] They noted that the definition similarly does not clarify whether it refers to an operating company employing the personnel engaged in the covered activity, or whether a holding company may be considered “engaging in” the covered activity.[13]
• Many commenters indicated that it may be hard for companies to monitor for changes in these already hard-to-get metrics over time.[14] As a solution to these issues, many urged Treasury to publish and maintain a fixed list of entities determined to be “covered foreign persons,” following the example of existing Department of Commerce restricted party lists (such as the Entity List) or Treasury sanction lists (such as the List of Specially Designated Nationals and Blocked Persons (SDN) List).[15] If Treasury does not rely on such lists, many suggested that Treasury should draw very narrow categories, including a de minimis standard that covers only entities “primarily” or “substantially” engaged in a covered activity.[16]

3. Definition of “person from a country of concern” is similarly vague and as written might create overlaps or loopholes.

Treasury has proposed multiple broad definitions of “person of a country of concern.”[17]

• Many noted that these definitions are overly broad and could unintentionally restrict, for example, the formation of a joint venture or the founding of a startup between U.S. persons and individuals who have Chinese backgrounds but are lawfully resident in the United States, and suggested exempting lawful U.S. residents from this definition.[18]
• To address this, some commentators encouraged Treasury to establish a greenfield and young startup exception to the definition of “person of a country of concern” as in the CFIUS context to ensure innovative businesses are founded in the U.S.[19] Others suggested Treasury clarify whether the presence of a minority investor from a country of concern will trigger restrictions on the entity.[20]

II. Compliance and obligations under the regulations:

To determine whether a transaction will be covered by the new regime, Treasury has proposed that a U.S. person would “need to know, or reasonably should know” from an appropriate amount of due diligence “that it is undertaking a transaction involving a covered foreign person and that the transaction is a covered transaction.”[21]

• Commenters overwhelmingly requested clear steps and extensive guidance to make it easier for investors to comply, in addition to requests for other details on how compliance standards will be applied.

1. The due diligence obligations & “knowledge” standard are vague and should be clarified.

Many commenters feel that Treasury’s proposed due diligence standard is speculative. For example, the ANPRM standard would require U.S. persons to assess whether an entity “will foreseeably be engaged in regulated conduct.”[22]

• Commenters requested more clarity for these vague phrases.
• In addition, given the difficulty of determining the criteria that define covered persons and activities, multiple commenters called for Treasury to use an “actual knowledge” standard as opposed to a “constructive knowledge” standard.[23]
• Many commenters also recommended Treasury adopt a “safe harbor” or a “reasonable reliance” standard, which would allow U.S. persons to rely on diligence responses from the prospective investee or foreign partner.[24]
• Other commenters sought a standard that would require knowledge to be based only on information available to the U.S. person at the time of the transaction, not based on information available later.[25]To clear up ambiguity for complying parties, commenters urged Treasury to publish extensive guidance that describes relevant due diligence steps, red flags, and other specific examples of sufficient practices to meet the standard for “reasonable and appropriate” due diligence.[26]
• Others suggested Treasury simply adopt the existing diligence requirements of the Export Administration Regulations (“EAR”), which would not require a new compliance standard.[27]

2. The ANPRM should be prospective, not retroactive.

Almost all commenters agreed that the EO and the regulation should be prospective, not retroactive, and most agreed that it should be applied only to transactions and investments made after finalization of the rule. One trade association for institutional limited partners urged that the final regulation only apply to financial commitments made after the finalization of the rule, as opposed to previously made commitments.[28] Some commenters highlighted that the rule is ambiguous as to whether Treasury would seek to exercise authority to unwind transactions, and urged that investments once made should not be able to be unwound or divested.[29]

3. Clarify who is liable for failure to comply with the reporting requirements.

Commenters requested Treasury confirm explicitly that such liability resides solely with the U.S. person undertaking a covered transaction, as imposing an obligation on third parties who are not legally responsible for the transaction will create practical problems, disadvantage U.S. financial institutions vis-à-vis their competitors, and will not advance the national security objectives of the EO.[30] Some commentators wanted to clarify that the filings would be a post-closing notification requirement (so as to not disadvantage U.S. investors and introduce regulatory uncertainty regarding pending transactions).[31]

III. Covered transactions and excepted/exempted transactions:

Commenters sought to clarify Treasury’s proposed covered transactions and expand its exemptions to prevent overbroad coverage. In particular, commenters sought to ensure that passive investments by both limited partners and non-limited partners, venture capital and private equity investments, and other transactions are not covered by the regulations. In addition, major financial institution and investment commenters urged Treasury to clarify that coverage does not indiscriminately restrict services provided by financial institutions to their customers with respect to covered transactions.

1. Multiple sectors request exemptions for passive investments and clarification regarding limited partners.

Most groups representing financial institutions, private equity, and venture capital urged Treasury to clarify and expand exemptions for passive investments.

Commenters representing investors urged Treasury to permit limited partners to invest beyond the proposed de minimis threshold, arguing that the nature of limited partner investments are passive and thus not the kind of investments the regulations are meant to target.[32] Commenters urged exemptions for most or all passive investments that do not exceed a certain de minimis threshold (multiple commenters proposed a below-10 percent equity and voting interest) or that do not grant rights in the target company should be exempted, including investments into a venture capital fund, private equity fund, or other pooled investment funds.[33] If not, they urged Treasury to clarify the “knowledge” and “directing” standard for limited partners to ensure that U.S. persons do not automatically meet these criteria merely by serving on a Limited Partnership Advisory Committee or an Investment Committee.[34] Finally, commenters recommended Treasury align exceptions and definitions for publicly traded securities with Treasury’s Chinese Military-Industrial Complex Companies (“CMIC”) List and generally parallel securities language with other existing regulatory programs.[35]

2. Commenters requested clear and broad exemptions for financial institutions, including as third parties providing services to their customers during transactions.

Many financial, private equity, and venture capital commenters encouraged Treasury to clarify that the scope of “covered transactions” does not include services provided by financial institutions to their clients with respect to covered transactions. Commenters urged the exemption of a long list of transactions, including when a third party institution is serving as an advisor, underwriter, source of debt financing, sponsor, arranger, issuer, or in any other capacity as a U.S. financial institution acting in an intermediary or other capacity.[36] Generally, commenters requested clarification of the treatment of categories like debt financing, investments in index funds, and “indirect” transactions.[37]

3. Commenters suggested other key areas for exemptions.

Commenters requested four more main categories of exemptions. Many sought a clear exception for intracompany transfers, whether just for existing subsidiaries that are already covered foreign persons or regardless of domicile. Relatedly, some recommended exempting (or clarifying the treatment of) corporate restructuring transactions.[38] Second, multiple commenters sought a blanket exemption for joint research ventures unless they are tied to military security concerns; others sought blanket exemptions for intellectual property licensing and sales activities.[39] Third, others requested that “teaching partnerships” be excluded as part of the category of research collaborations that are exempted.[40] And fourth, technology and manufacturing groups sought clarification that certain activities, such as contract manufacturing of consumer technology products, or simple conveyance of national security products, are exempt from the regulations.[41]

IV. Covered national security products and technologies:

Many commenters identified two main categories of covered technology that were defined overbroadly, which could significantly chill investment: AI and quantum technology. In general, commenters urged Treasury to regulate more precisely and with greater awareness of the importance of non-military uses of these technologies.

1. Covered technologies should be narrowly and clearly defined.

Commenters mostly agreed that the definitions of covered products and technologies were vague and overly broad, but disagreed on the best alternative. Some debated whether coverage should depend on a technology’s “primary” or “exclusive” use.[42] Others argued that the final rule should focus on end users rather than end uses, and should rely on existing lists of actors such as the CMIC List maintained by Office of Foreign Assets Control or the Entity List maintained by the Department of Commerce.[43] Still others suggested that the definitions be based on objective features such as technical parameters of products or technology, or their export control classification numbers.[44]

2. The definition of “AI Systems”.

Several commenters across industries viewed the definition of “AI system” as overly broad, and were concerned that the proposed regulations would cover technologies designed for commercial use and without military application. These commenters predicted that the proposed definition would chill investment in cutting-edge technologies. They suggested that the scope of coverage be limited to technology that has a dual military and commercial use, or that is specifically or exclusively designed for military or surveillance applications.[45] Other commenters proposed that Treasury employ categorical exemptions for particular industries (such as for AI used in medical technology)[46] or that it focus on restricting specific end users.[47]

3. Quantum technologies.

Quantum technology companies requested more clarity and nuance in the scope of coverage of “quantum computers and components.” These commenters pointed out that the coverage of “components” could be overbroad and risks expanding the scope of the rule to cover any piece of hardware that might go into a quantum computer, including some household items and technologies.[48] Others recommended either removing the term “component” or defining it more narrowly based on technical capabilities. One international quantum company suggested looking to regulations enacted by the Spanish government in May 2023 for workable definitions.[49] Yet other commenters urged that the definitions of “quantum sensors,” “quantum networking,” and “quantum communications systems,” be narrowed or qualified to recognize that these technologies have commercial, non-military applications.[50]

V. Other implementation concerns:

Some commenters weighed in on enforcement procedures, coordination with other agencies and governments, and the scope of the regulation as a whole.

1. Alternative enforcement mechanisms.

Many requested that Treasury create a mechanism to apply for waivers, under which an otherwise prohibited transaction might be approved if in the public interest.[51] Others proposed an advisory opinion process, through which Treasury could provide advance notice of whether a particular transaction would be notifiable or prohibited. Commenters pointed to similar processes offered by the SEC, CFIUS, and other agencies.[52]

2. Alignment with allies and other federal programs.

Several commenters urged Treasury to encourage allies to establish similar regulations, so as not to put the United States or U.S. persons at a competitive disadvantage. Manufacturers and trade associations raised the concern that without coordination, manufacturing demand would flow to foreign jurisdictions without similar investment controls.[53]

Other commenters suggested that the new regulations be aligned with existing mechanisms such as the CHIPS Act guardrails, the EAR, and sanctions regimes.[54] Some recommended that the definition of “countries of concern” be aligned with the definitions used by the Defense Department and included in the CHIPS Act.[55] Finally, others stated that existing export control and sanctions regimes are sufficiently effective and significantly less invasive, and urged Treasury to rely on those programs rather than implementing an outbound investment regime.[56]

3. The scope of the regulatory project.

A few commenters, including manufacturing groups and unions, urged “a broad view as to the scope of coverage” and “encourage[d] its expansion over time.”[57] Former U.S. Deputy National Security Advisor Matt Pottinger even recommended that certain software and AI transactions be entirely prohibited (as opposed to permitted with notification) because the Chinese government has the legal power to access technologies developed by “any firm operating in China,” rendering notification ineffective.[58]

Most commenters, however, suggested Treasury narrow the scope of coverage. Some even questioned the wisdom of regulating outgoing investment at all. China-based organizations objected to the regulations as a whole,[59] and, as discussed below, House Financial Services Committee Chairman Patrick McHenry questioned the policy and legal authority behind the regulatory program.

VI. A high-ranking House leader raised significant policy disagreements and legal concerns with the ANPRM’s approach:

On September 27, 2023, House Financial Services Chairman (and current Acting Speaker of the House of Representatives) Patrick McHenry wrote a letter to Treasury Secretary Yellen commenting on the ANPRM.

First, Chairman McHenry raised legal issues with the proposed regulations, asserting that the Office of Investment Security cannot statutorily implement the regulation, and also questioned the ANPRM’s reliance on the International Emergency Economic Powers Act (IEEPA) as part of the authority for the regulation, describing its use as “novel.”[60] Second, he questioned the Biden Administration’s policy of decreasing U.S.-driven investment in China, arguing that instead public policy should be to increase private U.S. investment and control of Chinese entities.[61] Third, he questioned whether the program should be administered through Treasury’s OFAC sanctions regime, rather than through the CFIUS regime.[62] Chairman McHenry’s comments are significant because they may identify grounds for parties to challenge the final regulations and because they highlight a sharp disagreement in the top levels of government regarding the role of U.S. investment in China.

Gibson Dunn attorneys are monitoring the outbound investment regime developments closely and are available to counsel clients regarding potential or ongoing transactions and other compliance or public policy concerns.

____________________________

[1] Exec. Order No. 14,105, 88 Fed. Reg. 54,867 (Aug. 11, 2023).

[2] Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern, 88 Fed. Reg. 54,961 (Aug. 14, 2023) [hereinafter ANPRM].

[3] ANPRM, 88 Fed. Reg. at 54,962.

[4] See ANPRM, 88 Fed. Reg. at 54,963–64.

[5] See, e.g., Securities Industry and Financial Markets Association (“SIFMA”), Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 1–2 (Sept 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0042.

[6] See, e.g., Semiconductor Industry Association, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 6–7 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0056.

[7] Id. at 7.

[8] See, e.g., The Confederation of the Netherlands Industry and Employers, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2 (Sept. 25, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0011.

[9] See, e.g., Transatlantic Business Initiative, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3–4 (Sept. 27, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0010.

[10] See ANPRM, 88 Fed. Reg. at 54,964.

[11] See, e.g., SIFMA, supra note 5, at 8 (“Treasury should consider the possibility of potential conflicts of law from other jurisdictions that may place restrictions on the export of data from China and create other challenges in obtaining research on investment targets in China . . . .”).

[12] See, e.g., Hewlett Packard Enterprise, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0032.

[13] See, e.g., SIFMA, supra note 5, at 6–7.

[14] See, e.g., Hewlett Packard Enterprise, supra note 12, at 2.

[15] See, e.g., Business Roundtable, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 6–7 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0028.

[16] See, e.g., id. at 7.

[17] See ANPRM, 88 Fed. Reg. at 54,962.

[18] See, e.g., Quantum Economic Development Consortium, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 4 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0057.

[19] See, e.g., National Venture Capital Association, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 6–7 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0054.

[20] See, e.g., Information Technology Industry Council, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0035.

[21] See ANPRM, 88 Fed. Reg. at 54,969–70.

[22] Id. at 54,969.

[23] See, e.g., American Investment Council, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0053.

[24] See, e.g., id. at 3; see also Goldman Sachs, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 4 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0036.

[25] See, e.g., Goldman Sachs, supra note 24, at 4.

[26] See, e.g., American Investment Council, supra note 23, at 3.

[27] See, e.g., Squire Patton Boggs LLP, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 7 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0060.

[28] See, e.g., Institutional Limited Partners Association (“ILPA”), Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 9-10 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0055.

[29] See, e.g., U.S. Chamber of Commerce, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 6 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0038.

[30] See, e.g., Business Roundtable, supra note 15, at 4–5.

[31] See, e.g., Squire Patton Boggs LLP, supra note 27, at 8–9.

[32] See, e.g., Institutional Limited Partners Association, supra note 28, 2–4.

[33] See, e.g., National Venture Capital Association, supra note 19, at 4–5; SIFMA, supra note 5, at 11; Business Roundtable, supra note 15, at 13.

[34] See, e.g., British Private Equity & Venture Association, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2-3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0034.

[35] See, e.g., Investment Company Institute, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3-4 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0027; see also SIFMA, supra note 5, at 10–11.

[36] See, e.g., SIFMA, supra note 5, at 2-5; U.S. Chamber of Commerce, supra note 29, at 13–15.

[37] See, e.g., Investment Company Institute, supra note 35, at 5, 11–12.

[38] See, e.g., Investment Company Institute, supra note 35, at 5; U.S. Chamber of Commerce, supra note 29, at 17; SIFMA, supra note 5, at 10.

[39] See, e.g., SEMI, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0029; Information Technology Industry Council, supra note 20, at 3-5.

[40] See, e.g., Eastern Michigan University, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 1–2 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0033.

[41] See, e.g., National Association of Manufacturers, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 4 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0021.

[42] See, e.g., Squire Patton Boggs LLP, supra note 27, at 2–3.

[43] See, e.g., National Venture Capital Association, supra note 19, at 8.

[44] See, e.g., Business Roundtable, supra note 15, at 2–3.

[45] See, e.g., Hewlett Packard Enterprise, supra note 12, at 5–6.

[46] See, e.g., Advanced Medical Technology Association, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2–3 (Sept. 29, 2023).

[47] See, e.g., National Venture Capital Association, supra note 19, at 8.

[48] See, e.g., Quantum Economic Development Consortium, supra note 18, at 4–6.

[49] Bluefors Oy, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0062.

[50] See, e.g., Infleqtion, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2-3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0050.

[51] See, e.g., SIFMA, supra note 5, at 12.

[52] See, e.g., U.S. Chamber of Commerce, supra note 29, at 4–5.

[53] See, e.g., Semiconductor Industry Association, supra note 6, at 4–6.

[54] See, e.g., National Association of Manufacturers, supra note 41, at 2.

[55] See, e.g., MEMA, Comments by MEMA, The Vehicle Suppliers Association, on Notice of Advanced Rulemaking on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0048.

[56] See, e.g., Transatlantic Business Initiative, supra note 9, at 1.

[57] Alliance for American Manufacturing, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2–3 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0022; AFL-CIO, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 2 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0040.

[58] Matt Pottinger, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern (Sept. 29, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0061.

[59] See, e.g., China Chamber of International Commerce, Comments on Executive Order 14105 and ANPRM 5–7 (Sept. 28, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0018.

[60] Representative Patrick McHenry, Comment Letter on Proposed Rule on Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern 1–2 (Sept. 27, 2023), https://www.regulations.gov/comment/TREAS-DO-2023-0009-0013.

[61] Id. at 3–4.

[62] Id.

---

The following Gibson Dunn lawyers prepared this client alert: Stephenie Gosnell Handler, Adam M. Smith, Amanda Neely, Chris Mullen, Samantha Sewall, Teddy Rube,* and Justin Fishman.*

Gibson Dunn’s International Trade lawyers are highly experienced in advising companies about the potential legal implications of their international transactions and regularly assist clients in their efforts to comply with the shifting legal landscape and to implement best practices. The firm’s Congressional Investigations team has represented numerous clients responding to congressional inquiries regarding national security issues, and its Public Policy Practice Group frequently works with clients to monitor developments on Capitol Hill and the Administration in real time and to ensure their voices are heard in the policy debate. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Gibson Dunn attorneys also have vast experience preparing effective submissions to government regulators and remain ready to assist with this process as well as to help prepare stakeholders for discussions with members of the Treasury or other federal agencies on the proposed regulations.

Please contact the Gibson Dunn lawyer with whom you usually work, the following practice leaders and members, or the authors in Washington, D.C. for additional information about how we may assist you:

Stephenie Gosnell Handler (+1 202-955-8510, shandler@gibsondunn.com)
Adam M. Smith (+1 202-887-3547, asmith@gibsondunn.com)
Amanda H. Neely (+1 202-777-9566, aneely@gibsondunn.com)
Chris R. Mullen (+1 202-955-8250, cmullen@gibsondunn.com)
Samantha Sewall (+1 202-887-3509, ssewall@gibsondunn.com)

International Trade Group:

United States
Judith Alison Lee – Co-Chair, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Hayley Lawrence – Washington, D.C. (+1 202-777-9523, hlawrence@gibsondunn.com)
Annie Motto – Washington, D.C. (+1 212-351-3803, amotto@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212-351-3972, spongrace@gibsondunn.com)
Anna Searcey – Washington, D.C. (+1 202-887-3655, asearcey@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Claire Yi – New York (+1 212-351-2603, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia
Kelly Austin – Hong Kong/Denver (+1 303-298-5980, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Hong Kong (+852 2214 3731, qyue@gibsondunn.com)
Felicia Chen – Hong Kong (+852 2214 3728, fchen@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)

Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 160, nmalevanny@gibsondunn.com)

*Justin Fishman and Teddy Rube are associates working in the firm’s Washington, D.C. office who are not yet admitted to practice law.

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Join CFIUS practitioners from Gibson Dunn as we examine CFIUS trends and mid-year updates, as well as key aspects of the forthcoming outbound investment regime targeting U.S. investments abroad. Topics to be discussed include the following:

• Overview of CFIUS’s Expanding View of National Security Factors
• CFIUS Recent Developments: Springing Rights, Limited Partners, and Real Estate
• The Rise of State Restrictions on Foreign Investment in Real Estate
• Outbound Investment Review: How the New Regime is Shaping Up
• De-coupling v. De-risking: Practical Guidance in an Interconnected World

---

---

PANELISTS:

Stephenie Gosnell Handler is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher, where she is a member of the International Trade and Privacy, Cybersecurity, and Data Innovation practices. She advises clients on complex legal, regulatory, and compliance issues relating to international trade, cybersecurity, and technology matters. Ms. Handler has significant experience advising clients on CFIUS and national security matters, as well as advising clients on diverse global cybersecurity and technology matters.

Amanda H. Neely is of counsel in the Washington, D.C. office of Gibson, Dunn & Crutcher and is a member of the Public Policy and Congressional Investigations practice groups. Ms. Neely regularly advises clients regarding their interactions with Congress, including developing affirmative messages and defending them in the course of congressional investigations. Ms. Neely served as Director of Governmental Affairs for the Senate Homeland Security and Governmental Affairs, Deputy Chief Counsel of the Permanent Subcommittee on Investigations, and General Counsel to Senator Rob Portman, as well as Oversight Counsel on the House Ways & Means Committee. She has represented clients undergoing investigations by numerous congressional committees.

Annie Motto is an associate in the New York office of Gibson, Dunn & Crutcher where she currently practices in the firm’s Litigation Department, and is a member of the International Trade practice group. Ms. Motto advises clients on compliance with U.S. customs laws, the Uyghur Forced Labor Prevention Act (UFLPA), foreign investment reviews (CFIUS), export controls (ITAR and EAR), and economic sanctions. She also defends clients before the U.S. Department of Commerce and the U.S. International Trade Commission in antidumping and countervailing duty proceedings and sunset reviews. She also advises companies on international trade matters related to corporate mergers and acquisitions.

Chris R. Mullen is an associate in the Washington, D.C. office of Gibson, Dunn & Crutcher and a member of the International Trade practice group. Mr. Mullen’s practice focuses on international trade and white collar investigations. He advises clients on a wide variety of matters, including navigating export controls under the ITAR and EAR, global economic sanctions, anti-money laundering regulations, CFIUS review, customs regulations, and FCPA compliance. He also advises companies on international trade matters related to corporate mergers and acquisitions, and compliance with anti-money laundering obligations at the state and federal levels.

---

MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

We are pleased to provide you with Gibson Dunn’s ESG monthly update for September 2023. This month, our update covers the following key developments. Please click on the links below for further details.

I. INTERNATIONAL

1. UN publishes climate change report concluding that global emissions are not in line with Paris Agreement goals

The UN Framework Convention on Climate Change published a report ahead of an upcoming global stocktake at the UN climate change conference COP28 being held in Dubai in November and December. The report assesses collective progress towards achieving the long-term goals of the Paris Agreement in a series of 17 findings from technical deliberations in 2022 and 2023. Among other things, the report finds that global emissions are not in line with modelled global mitigation pathways consistent with the temperature goal of the Paris Agreement and that greater action is needed “on all fronts”, including in the implementation of domestic mitigation measures.

2. Credit ratings agencies take further steps to increase ESG transparency for investors

S&P Global Ratings announced on September 14, 2023 that it has updated its analytical approach for use of proceeds Second Party Opinions (SPOs), in order to provide more transparency to investors in the sustainable bond market. The update outlines the process for providing SPOs, defines an S&P Global Ratings Shade of Green, and explains how the latter is assigned to environmental projects.

Lloyds’ and Moody’s Analytics announced a new collaboration on September 15, 2023 to develop a solution that will help with quantifying greenhouse gas emissions across managing agents’ underwriting and investment portfolios, aiding managing agents in meeting expected regulatory reporting requirements under frameworks such as Streamlined Energy and Carbon Reporting for insurers.

3. ICMA and IFC publish global practitioner guidance on “blue bonds”

The International Capital Market Association and International Finance Corporation issued a Practitioner’s Guide on Bonds to Finance the Sustainable Blue Economy on September 6, 2023. “Blue bonds” are defined as green bonds focused on the sustainable use of maritime resources and the promotion of related sustainable economic activities. The guidance is intended for broad use by issuers, investors and underwriters, and builds on existing standards for the global sustainable bond markets which have been in circulation since 2014 (namely, the Green Bond Principles, Social Bond Principles, Sustainability Bond Guidelines and Sustainability-linked Bond Principles). It defines blue economy typology and eligibility criteria, suggests key performance indicators, showcases latest case studies, and highlights the critical need for increased financing to achieve UN Sustainable Development Goal No. 14.

4. Network for Greening the Financial System publishes conceptual framework for nature-related financial risks to guide policies and action by central banks and financial supervisors

The Network for Greening the Financial System published a technical document containing a beta version of an NGFS Conceptual Framework for nature-related financial risks on September 7, 2023. It aims to establish a common and mainstream understanding of the risks presented by the environmental degradation and climate change crisis, and to take the first step towards an integrated assessment of broader nature-related risks in addition to climate change risks, setting out a principle-based approach to help operationalize that understanding.

5. World Federation of Exchanges publishes guidance note on its Green Equity Principles

On September 14, 2023, the World Federation of Exchanges published a guidance note on its Green Equity Principles—a voluntary global framework for designating stocks and shares as green, which is intended to counter greenwashing and support funding towards sustainable economies. The Principles and the guidance note are open for public consultation until January 15, 2024.

6. Taskforce on Nature-related Financial Disclosures publishes final recommendations

The Taskforce on Nature-related Financial Disclosures (comprising 40 members representing financial institutions, corporates and market service providers, and supported by national governments), published its final Recommendations on nature-related risk management and disclosure on September 18, 2023. The recommendations provide companies and financial institutions with a set of (i) general requirements for nature-related disclosures and (ii) recommended disclosures structured around the four pillars of governance, strategy, risk and impact management, and metrics and targets.

The recommendations have been welcomed by the UK Parliamentary Environmental Audit Committee, which proposes that they be made mandatory for companies in the UK.

An executive summary of the recommendations is available here.

7. Glasgow Financial Alliance for Net Zero (GFANZ) launches consultation on its four transition finance strategies

On September 19, 2023, GFANZ announced that it had launched consultations seeking market feedback on its work to further refine the definitions of its transition finance strategies and support financial institutions to forecast the impact of these strategies on reducing emissions. The four strategies were developed last year with the goal of financing a whole economy transition to net zero, and include (i) developing and scaling climate solutions, (ii) financing assets that are already aligned to a 1.5C pathway, (iii) financing transitioning assets and (iv) phasing out high-emitting assets.

8. International Accounting Standards Board (IASB) announces it is exploring targeted actions to improve reporting of climate-related uncertainties

The IASB announced on September 20, 2023 that it is exploring targeted actions to improve reporting of climate-related and other uncertainties in financial statements, including publishing education materials and making targeted amendments to IFRS Accounting Standards. IASB materials relating to this project can be found here.

9. Intercontinental Exchange (ICE) announces plans to launch a physically delivered futures contract for carbon credits in the aviation industry

ICE announced on September 21, 2023 that it plans to launch a physically delivered futures contract for carbon credits eligible for use under the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), an ICAO global market-based carbon credit scheme which allows airline operators to offset carbon dioxide emissions by retiring carbon credits. The contract launch is planned for October 9, 2023.

10. Nature Action identifies 100 companies to be targeted in an investor engagement process

Nature Action 100 published list of 100 target companies in which 190 institutional investor participants will engage to drive greater corporate ambition and action in key sectors with environmental impact. The companies have been selected on the basis that they have large market capitalization in sectors deemed to be systemically important in reversing nature loss, and analysis conducted by the Biodiversity Foundation indicates that they have a high potential impact on nature. Current actions to mitigate nature-based risks are not taken into account. US and Chinese companies are at the top of the list.

II. UNITED KINGDOM

1. UK government confirms it will consider withdrawing from Energy Charter Treaty if vital modernisation is not agreed

On 1 September 1, 2023, the UK government announced it is reviewing its Energy Charter Treaty membership and considering withdrawal if vital modernisation to the treaty, which has historically provided protections for fossil fuel investors, is not agreed. Members of the multilateral treaty, signed in 1994 to promote international investment in the energy sector, have been in negotiations since 2020 to modernise the treaty to reflect modern energy priorities and support the green transition, but this is being hampered by the decisions of several member states to leave the treaty.

2. Green Finance Institute publishes technical advice to UK government on developing and implementing a UK Green Taxonomy

On September 8, 2023, the Green Finance Institute’s Green Technical Advisory Group (GTAG) published two reports containing recommendations to the government as part of its ongoing provision of non-binding advice on market, regulatory and scientific considerations for developing and implementing a UK Green Taxonomy.

The report on operational considerations for taxonomy reporting advises on how to ensure data gaps are minimised to support more robust and decision-useful taxonomy disclosures without placing undue burden on businesses. It includes considerations on the use of proxies and estimates in taxonomy. reporting.

The report on treatment of green financial products under an evolving UK Green Taxonomy advises, firstly, on how activities previously considered environmentally sustainable are affected when the UK Green Taxonomy is implemented, and, secondly, on how taxonomy-aligned activities, products and investments are treated when the taxonomy evolves over time.

3. UK government announces plans to invest up to £650 million in new alternative R&D programmes

Following its decision not to associate to Euratom Research and Training Programme, the UK government announced on September 7, 2023 that it plans to implement a suite of new, alternative R&D programmes to support the UK’s nuclear fusion sector and strengthen international collaboration in support of the UK Fusion Strategy. This is in addition to the £126 million announced in November 2022 to support UK fusion R&D programmes. Further details on the alternative programmes will be set out later in the Autumn.

4. UK government announces £45.7 million for businesses to cut emissions and boost home-grown energy through government-backed projects

The UK government announced on September 13, 2023 that 26 businesses will receive a share of £45.7 million in an effort to clean up industrial processes and reduce business energy costs whilst supporting the UK’s transition to a cleaner more secure energy system. The UK’s largest malting site, a leading supplier of household paper and an innovative green fuel producer in Belfast are among those receiving part of this funding.

5. UK Treasury publishes draft statutory instrument updating the UK Emissions Trading Scheme

On September 19, 2023 HM Treasury published a draft statutory instrument amending the Greenhouse Gas Emissions Trading Scheme Order 2020, which established the UK ETS Scheme. The instrument seeks to update the UK ETS Scheme by (i) providing for the capping of aviation free allocation at 100% of emissions, (ii) clarifying the treatment of Carbon Capture and Storage plants in order to resolve some inconsistencies in how capture activities and installations are currently dealt with by the legislation, and (iii) amending free allocation rules for electricity generation so that operators can change their classification as an electricity generator if they have recently stopped exporting electricity.

According to the accompanying explanatory memorandum, the capping of aviation free allocation is intended to support the UK’s decarbonisation objectives and increased climate ambition in a way that maintains the market signal the UK ETS sends and supports a viable market. In 2021, aviation free allocation represented around 127% of the sector’s verified emissions, representing an over-allocation of more than 900,000 ETS allowances worth around £50 million, which the operators were able to sell for profit. The cap will operate by requiring aircraft operators to return allowances in excess of emissions at the beginning of a scheme year.

6. UK Prime Minister announces delay to ban on sale of new petrol and diesel cars

On 20 September Prime Minister Rishi Sunak announced the postponement of a series of policies that form part of the UK’s wider net zero targets, including a ban on the sale of new diesel and petrol cars from 2030 to 2035. This shift in policy has prompted a backlash from the UK automotive industry, which warned it would undermine investment certainty and complicate their plans to boost EV sales in the country this decade.  The prime minister stated that the five-year delay aligns the UK with EU policy on the phase out of diesel and petrol cars.

7. UK financial regulators set out proposals to boost diversity and inclusion in regulated financial services firms

On September 25, 2023 the Financial Services Authority and Prudential Regulation Authority published consultation papers on proposals aimed at boosting diversity and inclusion to support healthy working cultures, reduce groupthink and unlock talent; enhancing the safety and soundness of firms; and improving understanding of diverse consumer needs. The proposed measures include requirements on firms to develop a diversity and inclusion strategy, disclose data against certain characteristics, and set targets to address under-representation.

The FCA’s consultation paper is available here and the PRA’s consultation paper is available here. The consultation is open until 18 December 2023.

III. EUROPE

1. European Parliament publishes study on establishing a horizontal European climate label for all products

The European Parliament released a study on September 5, 2023 which concludes that further preparation is required before a voluntary climate labelling scheme across all product categories can be established under EU law, including harmonizing and simplifying European product environmental footprint (PEF) methodology. Most current labelling schemes only supports comparisons within specified product groups, not between products of different categories; and the study refers to general agreement that it is desirable that it is important for consumers to be provided with information allowing them to directly compare products rather than just identifying the “best in class” products. However, the study also considers that it remains an open question as to whether a climate labelling scheme is desirable or whether it would be preferable to have a broader coverage of environmental impact categories, as suggested in the proposal for a Green Claims Directive.

2. European Parliament adopts revised Renewable Energy Directive

On September 12, 2023, the European Parliament passed the revised Renewable Energy Directive, (RED III), which updates the previous RED II. The updates are driven by the REPowerEU strategy presented on May 18, 2022, which seeks to reduce the EU’s reliance on Russian fossil fuel imports, as well as by the EU’s Green Deal and “Fit for 55” legislative package. The new directive stipulates the increase of the share of renewables in the EU’s final energy consumption by 2030 to a new binding target of 42.5% , but asks Member States to collectively strive to achieve a target of 45%, in line with the RePowerEU Plan.

Among other changes, the new directive provides that industry will need to increase the share of renewable sources in the amount of energy sources used for final energy and non-energy purpose at an annual rate of 1.6%.

The Council of the European Union formally adopted the directive on 9 October 2023.

3. European Commission proposes to raise monetary size threshold under Accounting Directive by 25% to account for inflation, removing micro- and SMEs from scope of Corporate Sustainability Reporting Directive

On September 13, 2023, the Commission issued an initiative to adjust upwards the thresholds in the Accounting Directive for determining the size category of a company, in order to account for the impact of inflation. The Commission states that the proposed increase would result in micro, small and medium-sized enterprises falling outside the scope of many EU sustainability (as well as financial) reporting provisions applicable to larger companies. The thresholds under the Accounting Directive have remained unchanged since 2013.

A public consultation on the initiative closed in early October.

Separately, Germany is pushing for the definition of SMEs to be expanded by raising the thresholds from 250 to 500 employees in order to exclude between 7,500 and 8,000 companies from the scope of the sustainability reporting rules (as reported by the Financial Times on September 18, 2023 on the basis of a government coalition document seen by the newspaper). France has been consulted on the proposal but has not yet divulged its position, while EU lawmakers are resistant to making late changes to the reporting rules adopted only this year.

4. European Parliament approves law requiring 70% green jet fuels at EU airports by 2050

The European Parliament announced on September 13, 2023 that MEPs have adopted a legislative proposal to accelerate the use of sustainable fuels in the aviation sector (position paper here). It is part of the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 and achieve climate neutrality by 2050 as part of its “Fit for 55” package. The law will require EU airports and fuel suppliers to ensure that, from 2025, at least 2% of aviation fuels are green, increasing every five years to reach 70% by 2050. “Green fuels” include synthetic fuels, specific biofuels, recycled jet fuels, and renewable hydrogen, and exclude feed and food crop-based fuels and those derived from palm and soy materials.

The proposal includes introduction of a voluntary EU label for flight environmental performance 2025, to allow passengers to compare flights based on carbon footprint and efficiency.

Once approved by the European Council, the new regulations will take effect from 1 January 2024 and 1 January 2025.

5. European Commission launches consultation on the functioning of the Sustainable Finance Disclosures Regulation

On September 14, 2023, the Commission launched a targeted consultation and a public consultation seeking feedback on whether the Sustainable Finance Disclosure Regulation (SFDR) meets stakeholders needs and expectations and is fit for purpose—in particular, whether there are shortcomings in terms of legal certainty, useability of the regulation and its ability to help tackle greenwashing. The targeted consultation is addressed to public bodies and stakeholders who are more familiar with the SFDR and the EU’s sustainably finance framework as a whole, including financial market participants, investors, NGOs, relevant public authorities and national regulators. The public consultation is addressed to individuals and organisation with more general knowledge of the SFDR. The consultation is open until December 15.

6. Regulations for Carbon Border Adjustments Mechanism (CBAM) reporting published in the Official Journal of the European Union (OJEU)

The European Commission’s Implementing Regulation on the Rules for the application of CBAM was released in the OJEU on September 15, 2023 and came into effect on September 16, 2023 across all EU member states. Guidance documents are available here.

The CBAM will require EU-based importers of goods in certain sectors to purchase certificates for carbon emissions at a price equivalent to the weekly EU Emissions Trading System carbon price (which applies to EU-based producers). By applying a carbon price on imports equivalent to the carbon price of EU production, CBAM aims to levels the playing field of the price of carbon for CBAM products inside and outside the EU. The Implementing Regulation outlines the reporting requirements for importers of CBAM goods within the EU and provides a temporary method for calculating the emissions integrated into the production of these goods during the transitional period, which will last from 1 October 2023 to 31 December 2025. The first report is to be submitted by 31 January 2024.

The transitional period, and the reports from importers received during such period, will be used to assess the scope of CBAM and how it will apply during the definitive period from 1 January 2026.

7. EU provisionally agrees to ban “climate neutral” and other greenwashing claims by 2026

The Parliament and Council announced on September 19, 2023 that they have reached a provisional agreement on the proposed directive to empower consumers for the green transition, which is designed to ban misleading advertisements and provide consumers with better information on product durability. Among other things, it has been agreed that generic environmental claims such as “environmentally friendly”, “natural”, “biodegradable”, “climate neutral” or “eco” will be banned where there is not proof of recognised excellent environmental performance relevant to the claim; and claims that a product has neutral, reduced or positive impact on the environment that are based on emissions offsetting schemes will be banned outright. Prompting the consumer to replace consumables such as printer ink cartridges earlier than necessary, and presenting goods as repairable when they are not, will also be proscribed.

8. The Energy Efficiency Directive for the European Union has been published in the Official Journal of the European Union

The Energy Efficiency Directive (EU) 2023/1791 was published in the OJEU on 20 September, 2023 and will enter into force on 10 October, 2023, following which EU member states have two years to incorporate most of its provisions into their national law. The directive, which is part of the ‘Fit for 55’ package and the REPowerEU strategy, introduces key measures to boost energy efficiency, emphasising the ‘energy efficiency first’ principle which prioritises the consideration of cost-effective energy efficiency measures when formulating energy policies and making investment decisions.

The directive contains notable changes from previous directives, including the establishment of a legally binding EU target to reduce final energy consumption by 11.7% by 2030, with each EU member state required to set its indicative national contribution.

It further requires that members states prioritise vulnerable customers and social housing within their energy-saving efforts, introduces an annual energy consumption reduction target of 1.9% for the public sector, extends the annual 3% building renovation obligation to all levels of public administration, and introduces a new approach for businesses to implement energy management systems and conduct energy audits.

9. France becomes first EU member state to set deadline for implementation of Corporate Sustainability Reporting Directive

The French Ministry of Justice announced on September 20, 2023 that the Corporate Sustainability Reporting Directive (CSRD) will be transposed into law in early December, making France the first EU member state to set a deadline for implementation of the directive. It has been one of the leading members states on efforts to implement the new sustainability reporting rules. Under the current French draft law, French companies will engage their financial auditors, other auditors, or an independent assurance provider for CSRD assurance in order to comply with the new reporting obligations.

The Finnish Government announced on September 28, 2023 that it has submitted its CSRD transposition proposal to the Finnish parliament.

10. Europeans Court of Human Rights hears complaint from six young people suing 32 European states for climate change

On September 27, 2023, six young Portuguese people aged between 11 and 24 appeared before the European Court of Human Rights in Duarte Agostinho and Others v. Portugal and 32 Other States,

accusing European states of failing to tackle the human-caused climate crisis in violation of Article 2 (right to life) and Article 8 (right to respect for private and family life) of the ECHR especially when those obligations are read in the light of international climate treaties requiring signatory states to take steps to adequately regulate their contributions to climate change. Ukraine was among the original respondents but the case against it has been discontinued.

The applicants are asking the court to find that countries contributing to the climate crisis have obligations not only to protect their own citizens but also those outside their borders. The claim, which was filed in September 2020, was granted priority treatment by the Court. A ruling is expected in the first half of 2024.

11. European Supervisory Authorities publish report on extent of voluntary disclosure of principal adverse impacts under Article 18 of Sustainable Finance Disclosures Regulation

On September 28, 2023, the Joint Committee of the three European Supervisory Authorities (EBA, EIPOA and ESMA) published its second annual report on extent of voluntary disclosure of principal adverse impacts under SFDR, based on a survey of National Competent Authorities to assess the current state of entity-level and product-level voluntary principal adverse impact (PAI) disclosures under the SFDR.

The first annual report, which was published on July 28, 2022, concluded that the extent of take-up of the voluntary disclosures of principal adverse impact of investment decisions on sustainability factors varied significantly across jurisdictions and Financial Market Participants (FMPs) in the scope of the SFDR, making it difficult to identify definite trends.

The second report finds that while there is still significant variation across FMPs and jurisdictions, there has been an overall improvement in the application of voluntary disclosures, which are also easier to find on company websites. It identifies areas for improvement, however: firstly, explanations of non-consideration of PAIs are not yet fully complete and satisfactory; and secondly, where these have been considered, the disclosures on the degree of alignment with the Paris Agreement are still vaguely formulated. Finally, the report identifies voluntary disclosures of PAI considerations by financial products as an area for future analysis in subsequent reports.

IV. United States

State Law Updates:

1. California passes legislation mandating climate-related disclosure and regulating “green” claims

In October, California enacted two bills that impose significant and mandatory climate-related reporting requirements on any public or private U.S. business entity meeting certain annual revenues levels and doing business in the state.  The Climate Corporate Data Accountability Act (Senate Bill No. 253) requires companies with total annual revenues over $1 billion to publicly and annually report their Scope 1, 2, and 3 greenhouse gas emissions, and the Greenhouse Gases: Climate-Related Financial Risk (Senate Bill No. 261) requires companies (except insurance companies) with total revenues greater than $500 million to biennially report their climate-related financial risks and the measures taken to reduce and adapt to them. At signing, Governor Gavin Newsom expressed concerns regarding the timing and cost of the legislation, among others, and signalled his Administration would work to address these concerns in 2024. For further detail, please see our client alert and blog post.

California also enacted Assembly Bill No. 1305, Voluntary Carbon Market Disclosures, which requires companies that market or sell voluntary carbon offsets (VCOs) in California to disclose on their website certain information about the applicable carbon offset project, including accountability measures for incomplete or unsuccessful projects.  Companies operating in California that purchase or use VCOs and make “net zero” and “carbon neutral” claims would also be required to disclose information regarding the VCOs and support for their claims.

Securities and Exchange Commission (SEC) Updates:

2. SEC Chair gives testimony to Congressional committee on the SEC’s role in climate risk disclosure

On September 12, 2023, during testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs SEC Chair Gary Gensler said that while the SEC has no role as to climate risk itself and is neutral as to the merit of the climate-related risks taken by investors, it plays an important role in relation to the disclosures of those risks. Gensler added that the SEC is currently considering more than 15,000 comments on its March 2022 proposed climate change disclosure rules.

3. SEC amends the “Names Rule,” with expected impact on ESG funds

On September 20, 2023, the SEC announced that it adopted amendments to modernize and enhance the Investment Company Act “Names Rule,” which prohibits fund names from misrepresenting the fund’s investment and risks. The amendments are designed to increase investor protection by (among other things) broadening and enhancing the requirement for certain funds to adopt a policy to invest at least 80% of the value of their assets in accordance with the focus that the fund’s name suggests; targeting, in particular, fund names that indicate an ESG focus in the fund’s investment decisions.

The final rule is available here, and the fact sheet is available here.

4. SEC Investor Advisory Committee approves recommendations for human capital management disclosure standards

At a meeting on September 21, 2023, the SEC Investor Advisory Committee (IAC) made recommendations to the SEC to expand the existing human capital management disclosure rules adopted by the SEC in August 2020 and to a July 2023 proposal by the Financial Accounting Standards Board (FASB) to require that companies show employee compensation costs included in their income statement. The IAC views these existing initiatives as insufficient to give investors the full information needed for accurate valuation of human capital. The IAC recommended that the SEC’s new rules (which are expected to be proposed soon) require (i) narrative disclosure of how a company’s labor practices, compensation incentives and staffing fit within the company’s broader strategy, and (ii) disclosure of specific items including:

• the number of employees who are full-time, part-time or contingent;
• turnover or comparable workforce stability metrics;
• total cost of the issuer’s workforce, broken down into major components of compensation; and
• workforce demographic data sufficient to allow investors to understand the company’s efforts to access and develop new sources of talent, and to evaluate the effectiveness of these efforts.

U.S. Government Updates:

5. S. Treasury publishes nine principles highlighting emerging best practices for private sector financial institutions with net-zero commitments

On September 19, 2023, the U.S. Treasury issued a series of voluntary Principles for Net-Zero Financing & Investment as part of an effort to accelerate the green transition by catalyzing more private sector investment into climate change projects. The Principles are focused on financial institutions’ Scope 3 financed and facilitated greenhouse gas emissions (i.e., those for which the institutions are not directly responsible, but which are produced in their upstream and downstream value chains) – and are directed in particular at those firms that have made or are considering making a net-zero commitment.

6. President Biden approves Interagency Working Group recommendations to federal government agencies for expanded use of Social Cost of Greenhouse Gases metric in budgeting decisions

On September 21, 2023, the Biden Administration announced the approval of Interagency Working Group recommendations to expand use of the Social Cost of Greenhouse Gases metric—which has been in use by federal agencies for over a decade—in budgeting, procurement, and other agency decisions. This follows an estimate by the Office of Management and Budget that annual federal spending could increase by over $1 billion from climate-related disasters and annual federal revenue could be reduced by up to $2 trillion by 2100.

V. APAC

1. ESG Book and Sustainable Finance Institute Asia to collaborate on pilot ESG data disclosure initiative

On August 30, 2023, ESG Book (a digital platform for ESG data management disclosure and analytics) announced it would be partnering with Sustainable Finance Institute Asia on the Single Accesspoint for ESG Data (“SAFE”) Initiative – a pilot initiative to address ESG data requirements and disclosure gaps in Asian markets. Leading financial organisations in Asia have been invited to participate in the pilot.

2. South Korea proposes bill on human rights and environmental protection for corporate sustainable management

On September 1, 2023, the Democratic Party of South Korea proposed a Bill on Human Rights and Environmental Protection for Sustainable Business Management to make annual human rights and environmental due diligence on companies’ supply chains mandatory. The proposal cites recent legislative developments in the EU as evidence of an “international movement” to introduce non-financial performance indicators into management for the goal of corporate social responsibility and sustainability. In its current form, the proposal would apply to companies with more than 500 full time employees or generating profits of more than KRW 200B in a year.

3. Singapore expands CO2 extraction project to enhance ocean carbon absorption

Singapore is set to scale up a pioneering pilot initiative led by the Public Utilities Board (PUB),  Singapore’s national water agency, and operated by US technology start-up Equatic, to harness electricity for carbon dioxide extraction from seawater, in order to boost the ocean’s capacity to absorb emissions. PUB aims to secure funding by the end of 2023 for a demonstration facility capable of handling 10 tons per day, with plans for further expansion. This endeavour aligns with Singapore’s commitment to achieving net-zero emissions by 2050 and reflects the growing recognition, as recognised by the Intergovernmental Panel on Climate Change, of the necessity of deploying carbon dioxide removals in addition to reducing emissions.

4. Shanghai Stock Exchange and owner of Saudi Exchange sign agreement to collaborate on various initiatives including ESG

Shanghai Stock Exchange and Saudi Tadawul Group, owner of the Saudi Exchange, signed a memorandum of understanding on September 3, 2023 to explore various avenues of cooperation on cross-listing, fintech and ESG initiatives, data exchange, and research. Saudi Arabia boasts the world’s seventh-largest stock market with a total market cap of US$ 3 trillion, while China ranks second with a total market cap of approximately US$ 9.9 trillion.

5. Beijing Private Equity Association publishes set of principles for sustainable investment disclosure by private fund managers

The Beijing Private Equity Association (a voluntary joint initiative in the equity investment fund industry) published General Principles for Disclosure of Sustainable Investment Information for  Private Investment Fund Managers on September 4, 2023. The principles are designed to provide guidance to private fund managers on disclosing sustainable investment information that meetings regulatory and stakeholder requirements, to standardise the disclosure of sustainable investment-related information within the sector, and to encourage fund managers to provide more comprehensive, transparent and accurate sustainable investment-related data and information for the capital markets.

6. China adopts in principle rules for management of voluntary greenhouse gas emission reduction trading

The Ministry of Ecology and Environment has approved in principle Management Measures for Voluntary Greenhouse Gas Emission Reduction Trading, in anticipation of the launch of China’s voluntary greenhouse gas emission reduction trading market.

7. Philippines financial regulators propose green finance taxonomy

The Financial Sector Forum—a cross-industry regulator made up of the Bangko Sentral ng Pilipinas, the Insurance Commission, and Securities and Exchange Commission—has issued a proposed framework for a principles-based sustainable finance taxonomy, based in part on the ASEAN Taxonomy (as to which, see our previous alert here). Unlike other taxonomies that rely on specific environmental screening criteria, this approach allows issuers to use their judgment to assess compliance with high-level objectives, initially focusing on climate mitigation and adaptation. The taxonomy also incorporates social performance requirements, including human rights and the rights of the Indigenous community. A public consultation on the draft taxonomy was closed on October 6, 2023.

8. Malaysian Joint Committee on Climate Change meets to discuss climate-change reporting by financial institutions and newly established SME Focus Group

The Joint Committee on Climate Change (a collaboration formed in 2019 between Bank Negara Malaysia, Securities Commission, Bursa Malaysia and industry players known as “JC3” ) met on September 20, 2023, to review its progress and action plans—in particular of those of the committee’s new SME Focus Group, which is tasked with taking action aimed at ensuring that SMEs are not left behind in the transition to a greener economy. Other items for discussion included supporting financial institution’s implementation of the central bank’s Policy Document on Climate Risk Management and Scenario Analysis, and intensified engagements with industry in advance of the upcoming industry-wide Climate Risk Stress Test.

9. Indonesian Stock Exchange launches first carbon exchange

On September 26, 2023, President Joko Widodo announced that Indonesia has launched the Indonesia Carbon Exchange (IDX Carbon). This follows the release by the Indonesian Financial Services Authority (OJK) of Regulation No. 14/2023, which provides a general regulatory framework for carbon trading in Indonesia. The President emphasised that carbon trading in Indonesia should reference international standards but that these should not obstruct Indonesia’s achievement of its Nationally Determined Contribution target.

Please let us know if there are other topics that you would be interested in seeing covered in future editions of the monthly update.

Warmest regards,

Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam

Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP

---

The following Gibson Dunn lawyers prepared this client update: Lauren Assaf-Holmes, Sophy Helgesen, Elizabeth Ising, Grace Chong, Patricia Tan Openshaw, and Selina S. Sagayam.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Environmental, Social and Governance practice group:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, popenshaw@gibsondunn.com)
Selina S. Sagayam – London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

CFIUS practitioners from Gibson Dunn examine CFIUS trends and mid-year updates, as well as key aspects of the forthcoming outbound investment regime targeting U.S. investments abroad. Topics discussed include:

– Overview of CFIUS’s Expanding View of National Security Factors
– CFIUS Recent Developments: Springing Rights, Limited Partners, and Real Estate
– The Rise of State Restrictions on Foreign Investment in Real Estate
– Outbound Investment Review: How the New Regime is Shaping Up
– De-coupling v. De-risking: Practical Guidance in an Interconnected World

---

---

PANELISTS:

On 14 September 2023, the European Commission published “targeted“ and “public“ consultations on Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (the “SFDR”). While the European Commission states that the views reflected in the consultation papers do not indicate its final position on the future shape of the SFDR, the tenor of both consultations provide useful insights into the potential implications of future reform for those financial market participants (“FMPs”) (which includes alternative investment fund managers (“AIFMs”)) who fall within the scope of the current regime.

The scope and detail of the questions asked in the consultation papers speak to Brussels’ serious concerns about the implementation of the SFDR since its introduction in March 2021, as well as its increasing contemplation of an overhaul of the existing framework. While any proposed changes would not come into force for several years, AIFMs and other FMPs should expect continuing legal uncertainty as it relates to future obligations under the SFDR.

The European Commission has set a deadline of 15 December 2023 for feedback on four distinct areas addressed in the consultations: (a) the current requirements of the SFDR; (b) its interaction with other sustainable finance legislation; (c) potential changes to disclosure requirements for financial market participants; and (d) the potential establishment of a categorisation system for financial products. The Commission aims to publish a finalised report on the SFDR in Q2 2024.

We set out below the future reforms seemingly under consideration by the European Commission and which AIFMs and other FMPs should follow with interest.

Topic 1: Current requirements of the SFDR

The first topic focuses on whether the SFDR has so far met its objective of “strengthening transparency through sustainability-related disclosures in the financial services sector” to support the transition to “a sustainable, climate-neutral economy”. The questions acknowledge recurring criticisms of the SFDR, chiefly relating to the extent to which the disclosures required by the SFDR are “sufficiently useful” to investors. The consultation also queries whether the current reporting obligations “prevent capital from being allocated to sustainable investments as effectively as it could be”.

Addressing potential issues with the implementation of the SFDR, the European Commission asks whether the costs of compliance with the SFDR framework are “proportionate to the benefits generated” and requests detailed breakdowns of the internal and external costs AIFMs have resultingly incurred.

In a welcome development, the European Commission also recognises the continuing difficulties FMPs face sourcing reliable data. The shortage of comprehensive, quality data has been a criticism levelled frequently against the SFDR. The consultation seeks to offer potential solutions, including allowing the use of estimates to fill data gaps where required.

Topic 2: Interaction with other sustainable finance legislation

Respondents to the consultation are invited to give views on any “potential inconsistencies or misalignments” which exist between the SFDR and other sustainable finance legislation, including the Taxonomy Regulation, the Benchmarks Regulation, the Corporate Sustainability Reporting Directive, the Markets in Financial Instruments Directive, the Insurance Distribution Directive and the Regulation on Packaged Retail Investment and Insurance Products.

Topic 3: Potential changes to the disclosure requirements for financial market participants

The European Commission seeks to assess the utility of entity-level disclosures to prospective investors. Given that a number of pieces of European Union legislation require sustainability-related entity-level disclosures, the consultation asks whether such requirements could be streamlined—a potential reform which could result in the removal of such requirements from the SFDR.

The consultation goes on to consider product-level disclosure requirements under the SFDR. Here, the European Commission indicates a preference to expand the scope of SFDR reporting obligations. It seeks feedback on whether uniform disclosure requirements should be imposed on all financial products offered within the EU, as opposed to only those making sustainability-related claims. This proposal is made on the basis that the implementation of uniform requirements could aid prospective investors in seeking to understand a product’s sustainability performance by enabling useful comparisons against products that are not designed to achieve any sustainability-related outcomes. The list of uniform disclosure requirements for all financial products which the consultation suggests includes taxonomy-related disclosures, engagement strategies, exclusions and information about how ESG-related evidence is used in the investment process.

Topic 4: Potential establishment of a categorisation system for financial products

Although the SFDR was designed as a disclosure regime, the European Commission acknowledges that “Articles 8 and 9 of the SFDR are being used as de facto product labels”. While this use “suggests there is a market demand for such tools in order to communicate the sustainability performance of financial products”, the consultation also notes “a labelling scheme might lead to risks of greenwashing”.

In order to mitigate against these risks, the European Commission seeks views on “the merits of developing a more precise product categorisation system based on precise criteria”. It outlines two potential strategies for the development of a product categorisation system:

• build on the existing concepts within Articles 8 and 9, with additional (minimum) criteria for products to make clear the scope of each article; or
• focus instead on the types of investment strategies chosen, with the existing concepts within Articles 8 and 9 likely disappearing from the current legal framework.

The target consultation also considers the introduction of specific prohibitions relating to the labelling and communication of financial products, such as banning products that do not fall under the relevant product categories from using such terms as “sustainable” and “green”.

Given the page space given to this topic in the consultation, it is evident that the Commission is giving genuine consideration to a product categorisation system. The development of a labelling system would have the effect of aligning the SFDR more closely with the UK’s (yet to be finalised) sustainable finance regulatory framework. We are also expecting the US Securities and Exchange Commission to publish proposals for its ESG rules for investment advisers which will include a labelling system. Greater alignment is of course to be welcomed, but interoperability is vital for those AIFMs operating globally.

Conclusion

Despite having been introduced less than three years ago, the wide-ranging scope of the European Commission consultation on the SFDR demonstrates that Brussels is increasingly receptive to a substantial, if not complete, overhaul of the existing regime. The potential implications for AIFMs falling within the scope of the current SFDR regime, including non-EU AIFMs marketing funds into the EU, could be highly significant—particularly if the European Commission chooses to expand the current disclosure obligations to all financial products. While the European Commission’s final proposals will not be revealed until Q2 2024 at the earliest, AIFMs can contribute to the policymaking process by providing feedback here.

---

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Global Financial Regulatory or Investment Funds teams, or the following authors:

Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
James M. Hays – Houston (+1 346 718 6642, jhays@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

As of 13 October 2023, Germany has adopted a new type of class action. The new law is an incremental step towards more collective redress in Germany. The new regime maintains the existing restriction that requires qualified consumer protection organizations to bring the action. However, these entities may now seek damages from defendants directly on behalf of the class. Together with the several coinciding factors detailed below, the new class action might lead to a more fundamental change in the German litigation landscape.

The previous collective redress regime only allowed for declaratory judgments. After obtaining a judgment, plaintiffs had to file individual lawsuits to get the desired relief, i.e. payment of damages. This two-tier mechanism was one of several factors that evoked substantial criticism in Germany. It also made the so called “Declaratory Model Action” (“DMA”) unpopular with plaintiffs. In the five years since its inception in 2018, only roughly 35 DMAs were filed. The German legislator estimated in 2018 that 450 DMAs would be filed per year.

The new class action aims to address the deficiencies of the existing regime. It is based on the EU Directive 2020/1828 on Representative Actions (which we discussed in a prior client alert). The EU Directive requires all EU member states to implement new class action regimes by 2023 while allowing them considerable leeway to implement the directive’s broad requirements into their national legal systems. The Netherlands, for example, have created a plaintiff-friendly class action system with an opt-out mechanism.

Germany, on the other hand, has opted for a cautious evolution of its collective redress provisions. The hallmarks of the new German regime and our predictions for its future relevance are set forth below:

Qualified Entities as Plaintiffs

Just like under the previous regime, the new class action can only be brought by qualified consumer protection organizations under German law as well as qualified entities from other EU member states (so-called qualified entities – QEs). This requirement is meant to prevent frivolous class actions.

The consumer protection organizations are required to inform consumers on their homepages about all representative actions they are planning to or have already filed, as well as the status of all pending actions. Potential defendants may be able to use this as an early-warning system for new class actions against them.

Permissible Relief

Qualified entities can now directly sue defendants for damages or other forms of relief on behalf of the consumers concerned. After a favorable verdict for the class, the court will request the parties to devise a settlement on how to distribute the funds. If no settlement is reached, the court will appoint a claims administrator to distribute the funds. Funds which are not claimed by consumers or cannot be distributed to class members are transferred back to the defendant. There is no potential for a cy-pres award like in the U.S.

Broad Scope

Under the EU Directive, the member states are only obliged to allow class actions with regard to an exhaustive list of EU provisions on consumer protection. Germany has not restricted the scope of collective redress. All matters that could be litigated in an individual civil lawsuit in Germany can be litigated in the new class action. This includes classic subject matters for collective redress such as product safety and mass torts as well as the emerging litigation issues around ESG, data privacy, and private enforcement of new EU legislation (i.e. the EU Digital Markets Act or its proposed AI Regulation).

Class Definition

Unlike many class actions in the U.S., consumers have to opt-in to join a German class action and there is no requirement for class certification. However, the qualified entity acting as plaintiff will have to show in its statement of claim that at least 50 consumers are affected by the class action and that the consumers’ claims present substantially similar questions of law or fact. These two prongs are reminiscent of the numerosity and commonality requirements in U.S. class actions under Rule 23 (a) FRCP.

Consumers will have a longer period for considering an opt-in than before. They can opt into the class until three weeks after the conclusion of the oral hearing. This allows consumers to react to positive developments late in the proceedings.

Limitations on Third-Party Funding

The new law allows third-party funding for class actions, but imposes fairly strict requirements. If the requirements are not met, the class action will be dismissed. Any third party funding a class action may not be a competitor of the defendant or in any way (economically) dependent on the defendant. More importantly, the third-party funder must not be promised more than ten percent of the proceeds from the class action. If a class action is funded by a third-party, the plaintiff is obliged to disclose its arrangements with the funder.

These prerequisites will likely deter many third-party funders from entering the German class action litigation market.

No Additional Discovery Provisions

Germany has not made use of the leeway under the EU Directive to allow for more discovery in consumer class actions. While courts can order a party to produce certain documents clearly defined by the other party, there will be no U.S.-style discovery in German class actions.

However, courts may now repeatedly fine parties up to EUR 250,000 if they fail to comply with a court order to produce the requested document or item.

Parallel Individual Actions

Consumers who have not opted into the class action will be able to sue the same defendant individually for the same claims as in the class action. Defendants will, therefore, have to prepare to defend numerous individual lawsuits in parallel to the new class action.

Cost Recovery

As is customary in Germany and the EU, the losing party will be required to bear the costs of the class action. This again is meant to discourage frivolous lawsuits. In theory, this also includes the opposing party’s legal fees. However, the recoverable amount is limited by statute and depends on the amount in dispute. The new German law caps the amount in dispute at EUR 300,000. This equals a maximum amount for recoverable legal fees in the range of EUR 10,000.

Tolling of Statutes of Limitations

Opting into a class action suspends the statute of limitations for consumers – even for consumers who later opt out again.

Therefore, consumers can toll the statute of limitations by opting into a class action as a mere precaution. They are free to opt out at a later stage and pursue individual claims against the defendant, as long as they opt out before the cut-off point three weeks after the first oral hearing on the merits.

Settlements

Similar to U.S. class actions, all settlements in German class actions must be scrutinized by the court. The court will reject the settlement if it is not “fair”. Settlements are final and binding for the parties as well as the consumers who have opted into the class action. However, consumers may opt out of a settlement within a month after the settlement was published in the class action register.

Outlook

The new law has been met with both approval and criticism from stakeholders and interested parties. For the time being, the new class action regime as such will certainly not turn Germany into a class action hot spot. However, in combination with ever increasing regulatory activity by national and European rule makers, an increasing focus on private enforcement of regulations, and a German judiciary that is generally willing to create consumer-friendly law, such as in the context of the diesel emissions cases, this may provide to be just the perfect mix for a more fundamental change of the German litigation landscape in the long run. Companies are certainly well advised to monitor closely whether they may be the target of class actions under the new German regime, and to prepare accordingly.

---

The following Gibson Dunn lawyers prepared this client alert: Alexander Horn, Markus Rieder, Friedrich Wagner, and Annekathrin Schmoll.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions, Litigation, or Appellate and Constitutional Law practice groups, the authors, or any of the following leaders and members of the Class Actions Group:

Frankfurt:
Alexander Horn (+49 69 247 411 537, ahorn@gibsondunn.com)

Munich:
Markus Rieder (+49 89 189 33 162, mrieder@gibsondunn.com)
Friedrich A. Wagner (+49 89 189 33-262, fwagner@gibsondunn.com)

Brussels:
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)

Paris:
Eric Bouffard (+33 (0) 1 56 43 13 00), ebouffard@gibsondunn.com)
Jean-Pierre Farges (+33 (0) 1 56 43 13 00, jpfarges@gibsondunn.com)
Pierre-Emmanuel Fender (+33 (0) 1 56 43 13 00, pefender@gibsondunn.com)

London:
Susy Bullock (+44 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Osma Hudda (+44 20 7071 4247, ohudda@gibsondunn.com)
Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com)
Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com)
Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com)
Doug Watson (+44 20 7071 4217, dwatson@gibsondunn.com)

United States:
Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Lauren R. Goldman – New York (+1 212-351-2375, lgoldman@gibsondunn.com)
Kahn A. Scolnick – Co-Chair, Class Actions Group – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
Lauren M. Blas – Los Angeles (+1 213-229-7503, lblas@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

The False Claims Act (FCA) is one of the government’s chief tools to address false claims involving government funds, imposing liability on “any person who… knowingly presents, or causes to be presented, a false or fraudulent claim for payment” to the federal government or who “knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.”[1] Through its qui tam provisions, the FCA also allows private citizens to file suit on behalf of the government for  statutory violations.[2]

The FCA has been increasingly used to address cybersecurity concerns for companies receiving government reimbursement. In October 2021, the DOJ announced its Civil Cyber-Fraud Initiative (the Initiative), emphasizing its intent to use the FCA to hold accountable entities that knowingly (1) provide deficient cybersecurity products or services, (2) misrepresent their cybersecurity practices or protocols, or (3) violate obligations to monitor and report cybersecurity incidents and breaches.[3] Since announcing the Initiative, the DOJ has acted on its commitment by introducing a range of new cybersecurity obligations in government contracts and pursuing various investigations into whether companies have made false statements regarding their cybersecurity compliance.

Digital health companies and drug and device makers are no exception. Recent cases and investigations have been brought against digital health companies and manufacturers of “cyber devices” whose products are directly or indirectly reimbursed by the government.  Accordingly, digital health and cyber device companies need to be diligent regarding their cybersecurity systems and claims.

In light of recent enforcement trends, in this alert we discuss:

• Recent Federal Food, Drug, and Cosmetic Act (FDCA) amendments requiring cybersecurity information in premarket submissions for cyber devices, as well as the potential implications for FCA liability, and
• The rise of FCA cases for claims relating to cybersecurity in the healthcare industry more generally.

Cyber Devices and False Claims in the FDA Approval Process  

Recent developments have expanded the risk of cybersecurity-related FCA claims against companies making submissions to the FDA for premarket approval or clearance of cyber devices. On December 29, 2022, the Consolidated Appropriations Act, 2022 (CAA), amended the FDCA to add section 524B, which requires that premarket submissions for cyber devices contain cybersecurity information, including the company’s plans to address cybersecurity vulnerabilities, processes to provide a reasonable assurance that the devices are cybersecure, a software bill of materials, and other information as the Secretary requires.[4] Under the new regulations, cyber devices are defined as any device that: (1) includes software validated, installed or authorized by the sponsor as a device or in a device; (2) has the ability to connect to the internet; and (3) contains any technological characteristics validated, installed, or authorized by the sponsor that could be vulnerable to cybersecurity threats.[5] FDCA section 524B became effective on March 29, 2023, 90 days after enactment of the CAA.[6]   However, FDA announced a seven-month transition period of enforcement discretion during which FDA offered support to applicants to navigate the cybersecurity requirements.[7] FDA has stated that, as of October 1, 2023, it expects companies will have had sufficient time to adapt and comply with the new cybersecurity requirements.[8]

More extensive cybersecurity disclosures to FDA expand the potential for cybersecurity-related false statements and subsequent FCA risk. FCA cases for false statements to FDA rely on the “fraud-on-the-FDA” theory. Under the theory, a company may be liable under the FCA if false statements to FDA are material to FDA’s approval or clearance of the device, rendering later claims to a governmental entity, such as the Centers for Medicaid and Medicare Services, false.

The “fraud-on-the FDA” theory was rejected by the First Circuit in D’Agostino v. EV3, Inc., in 2016.[9] In that case, the court held that there was no causal link between false representations to FDA and subsequent payments by the Centers for Medicare and Medicaid Services (CMS).[10] However, since D’Agostino, cases in the Ninth Circuit and statements from the DOJ have suggested that the possibility of FCA liability based on false statements to FDA is not null.

In cases in 2017 and 2021, the Ninth Circuit allowed two FCA cases to go forward in cases where it found that 1) alleged false claims made FDA clearances or approvals fraudulent in the first instance, rendering the subsequent payments to be false, or 2) the false claims rendered the drug at issue not approved or cleared for any proper purpose, making the subsequent claims for payment false.[11]  Following the Ninth Circuit’s decisions, the DOJ also filed a statement of interest in U.S. ex rel. Crocano v. Trividia, expressing its stance that “[compliance with the] FDCA may, in certain circumstances, be material to the government’s decision whether to pay for the affected product, and thus relevant in an FCA case.” [12] The Statement explains that per the DOJ’s understanding of the FCA, FDCA violations may be relevant where the violations are “significant, substantial, and give rise to actual discrepancies in the composition, function, safety, or efficacy of the affected product,” such that the product’s “quality, safety, and efficacy fell below what was specified to by the Food and Drug Administration through its approval process.” [13] The Second Circuit ultimately dismissed the case in Trividia, but left open the possibility that fraudulent statements to the FDA could result in FDA liability.[14]

While the courts have made it clear that there must be a very high showing of materiality between the false statement to FDA, FDA clearance or approval, and subsequent government payments, the possibility of FCA liability for false statements during the FDA approval process has not been entirely foreclosed. If a company’s false or fraudulent statement in a premarket submission to FDA regarding a company’s cybersecurity system is material to FDA’s approval of the device, such that in light of the misstatement, the “quality, safety, and efficacy of the device fell below what was specified to by the Food and Drug Administration through its approval process,” the statement may draw the attention of the government and FCA plaintiffs. Similarly, false or fraudulent statements in a premarket notification could be material to clearance of a 510(k) device. Information such as companies’ plans to address cybersecurity vulnerabilities, which are specifically required under the new statutory provision, and which FDA has stressed in guidance are critical to patient safety, may be considered material for the purposes of FCA claims.[15]

With this increased focus on cybersecurity for FCA investigations and the potential reopening of the fraud-on-the-FDA theory of liability, companies should take significant care in the statements made to FDA regarding their cybersecurity practices and procedures.

Cybersecurity-Related FCA Claims Since the Civil Cyber-Fraud Initiative

 FCA claims involving cyber devices would fall readily into the line of enforcement actions brought against other companies for false claims relating to cybersecurity systems and disclosures. Prior to the launch of the Initiative, in U.S. ex rel. Delaney v. eClinicalWorks, eClinicalWorks, one of the largest vendors of electronic health records software, agreed to pay $155 million to resolve claims that it had allegedly misrepresented the security capabilities of its software as part of the certification process for the Department of Health and Human Services’ Electronic Health Records Incentive Program.[16]  In U.S. ex rel. Awad v. Coffey Health System, the hospital system, Coffey Health, agreed to pay $250,000 to settle claims alleging that it falsely attested that it had conducted security risk analyses as part of the same Electronic Health Records Incentive Program.[17]

In the DOJ’s first resolution under the Initiative, United States ex rel. Lawler v. Comprehensive Health Servs., Inc. et al. and United States ex rel. Watkins et al. v. CHS Middle East, LLC, global medical services provider Comprehensive Health Services LLC agreed to pay $930,000 to settle claims that it allegedly failed to comply with contract requirements for medical services, including the use of a secure electronic medical records system.[18] More recent cases, such as a June 2023 settlement by Jelly Bean Communications Design LLC for alleged failures to maintain the ongoing cybersecurity of a health insurance website, suggest that the DOJ’s spotlight on cybersecurity and healthcare companies only stands to grow.[19]

Takeaways

Cybersecurity is a major focus area for government FCA investigations. In light of recent new cybersecurity requirements, content in premarket submissions to FDA on cybersecurity procedures and disclosures constitute another area of increasing risk for companies. It is critical for companies with products or services that may receive government reimbursement to ensure that their cybersecurity systems are up-to-date and any statements made regarding those systems are accurate. Doing so will be central to managing FCA risk in the rapidly-changing cybersecurity landscape.

_____________________________

[1] False Claims Act (FCA), 31 U.S.C. § 3729(a)(1)(A)–(B).

[2] Id. at § 3730(c)-(d).

[3] U.S. Dep’t of Justice, Press Release, “Deputy Attorney General Lisa O. Monaco Announces New Civil Cyber-Fraud Initiative” (Oct. 6, 2021).

[4] See U.S. Food & Drug Admin., “Cybersecurity in Medical Devices: Frequently Asked Questions” (Sept. 26, 2023).

[5] 21 U.S.C. § 360n-2(c); see also U.S. Food & Drug Admin., “Cybersecurity in Medical Devices: Frequently Asked Questions” (Sept. 26, 2023). A “device” is more generally defined by FDCA section 201(h) as an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including a component part, or accessory which is: (A) recognized in the official National Formulary, or the United States Pharmacopoeia, or any supplement to them; (B) intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals, or (C) intended to affect the structure or any function of the body of man or other animals, and which does not achieve its primary intended purposes through chemical action within or on the body of man or other animals and which is not dependent upon being metabolized for the achievement of its primary intended purposes. The term “device” does not include software functions excluded pursuant to section 520(o). Food, Drug & Cosmetic Act, section 201(h); U.S. Food & Drug Admin., “How to Determine if Your Product is a Medical Device” (March 29, 2022).

[6] CAA § 3305(c), 21 U.S.C. § 331 note.

[7] U.S. Food & Drug Admin., “Cybersecurity in Medical Devices: Frequently Asked Questions” (Sept. 26, 2023); 88 Fed. Reg. 19148 (Mar. 30, 2023).

[8] U.S. Food & Drug Admin., “Cybersecurity in Medical Devices: Frequently Asked Questions” (Sept. 26, 2023); 88 Fed. Reg. at 19149.

[9] D’Agostino v. EV3, Inc., 845 F.3d 1 (1st Cir. 2016).

[10] Id., at 7.

[11] Dan Abrams Co. v. Medtronic Inc., No. 19-56377 (9th Cir. 2021); US ex rel. Campie v. Gilead Sciences, Inc., 862 F. 3d 890 (9th Cir. 2017).

[12] U.S. Statement of Interest in U.S. ex rel. v. Trividia Health Inc., CASE NO. 22-CV-60160-RAR (S.D. Fla.).

[13] Id., at 2.

[14] United States of America ex rel., Patricia Crocano v. Trividia Health Inc., Order Granting Mot. to Dismiss (S.D. Fla. 2022).

[15] 21 U.S.C. § 360n-2(b)(1); U.S. Food & Drug Admin., Guidance for Industry and Food & Drug Admin. Staff, Cybersecurity in Medical Devices: Quality System Considerations and Content of Premarket Submissions (Sept. 27, 2023), at 11.

[16] U.S. Dep’t of Justice, Press Release, “Electronic Health Records Vendor to Pay $155 Million to Settle False Claims Act Allegations” (May 31, 2017).

[17] U.S. Dep’t of Justice, Press Release, “Kansas Hospital Agrees to Pay $250,000 To Settle False Claims Act Allegations” (May 31, 2019).

[18] U.S. Dep’t of Justice, Press Release, “Medical Services Contractor Pays $930,000 to Settle False Claims Act Allegations Relating to Medical Services Contracts at State Department and Air Force Facilities in Iraq and Afghanistan” (March 8, 2022).

[19] U.S. Dep’t of Justice, Press Release, “Jelly Bean Communications Design and its Manager Settle False Claims Act Liability for Cybersecurity Failures on Florida Medicaid Enrollment Website” (March 14, 2023).

---

The following Gibson Dunn lawyers assisted in preparing this alert: Winston Chan, Jonathan Phillips, Gustav Eyler, John Partridge, Christopher Rosina, Carlo Felizardo, and Nicole Waddick.*

Gibson Dunn lawyers regularly counsel clients on the False Claims Act issues. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s False Claims Act/Qui Tam Defense Group:

False Claims Act/Qui Tam Defense Group:

Washington, D.C.
Jonathan M. Phillips – Co-Chair (+1 202-887-3546, jphillips@gibsondunn.com)
F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com)
Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com)
Geoffrey M. Sigler (+1 202-887-3752, gsigler@gibsondunn.com)
Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com)
Gustav W. Eyler (+1 202-955-8610, geyler@gibsondunn.com)

San Francisco
Winston Y. Chan – Co-Chair (+1 415-393-8362, wchan@gibsondunn.com)
Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)

New York
Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com)
Mylan Denerstein (+1 212-351-3850, mdenerstein@gibsondunn.com)
Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com)
Christopher Rosina – New York (+1 212-351-3855, crosina@gibsondunn.com)
Brendan Stewart (+1 212-351-6393, bstewart@gibsondunn.com)

Denver
John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com)
Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com)
Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com)
Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com)

Dallas
Andrew LeGrand (+1 214-698-3405, alegrand@gibsondunn.com)

Los Angeles
Nicola T. Hanna (+1 213-229-7269, nhanna@gibsondunn.com)
Jeremy S. Smith (+1 213-229-7973, jssmith@gibsondunn.com)
Deborah L. Stein (+1 213-229-7164, dstein@gibsondunn.com)
James L. Zelenay Jr. (+1 213-229-7449, jzelenay@gibsondunn.com)

Palo Alto
Benjamin Wagner (+1 650-849-5395, bwagner@gibsondunn.com)

*Nicole Waddick is an associate practicing in the firm’s San Francisco office who currently is not admitted to practice law.

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Gibson Dunn recently advised a cross-holder group of term loan lenders and noteholders (Cross-Holder Group) on the comprehensive cross-border recapitalization of Venator Materials PLC through a prepackaged Chapter 11 process. Venator is a leading global manufacturer and marketer of chemical products.

Pre-petition, our team led the negotiation of a restructuring support agreement, which included a $275 million DIP financing facility and a debt-for-equity swap by the Cross-Holder Group. Post-petition, the team participated in Venator’s contested confirmation hearing, helping to secure a favorable outcome. Following confirmation, we negotiated an Exit ABL Facility secured by Venator’s North American assets; an Exit Term Loan Facility, secured by the remaining international assets, that was provided by members of the Cross-Holder Group; and a Shareholders’ Agreement to memorialize the Cross-Holder Group’s equity stake in the reorganized company, all of which paved the way for Venator’s successful emergence from Chapter 11.

The transaction involved multiple Gibson Dunn offices across the United States, United Kingdom, Germany, Asia and France, and complex cross-border considerations including international restructuring, finance, tax, and regulatory issues and novel emergence mechanics due to Venator’s international presence.

The Gibson Dunn team included Restructuring partners Scott J. Greenberg, Steven A. Domanowski and AnnElyse Scarlett Gains, and Restructuring associates Tommy Scheffer, Matthew Breen, Clint M. Carlisle, and Matthew Sunday; Corporate partners Mark Sperotto, Sebastian Schoon and Amar Madhani, Corporate of counsel Alexander Klein, and Corporate associates Rodrigo Surcan and Tamas Lorinczy; Finance partners Linda Curtis, Chad M. Nichols, Ben Myers and Jamie Thomas, and Finance associates Jennifer Zhou, Charlie Osborne, Alex Plaia, John Cheah, and Phil Chang; Tax partners Edward S. Wei and Benjamin J. Fryer, and Tax associates Sophie Walshe, Yixue Gong and Michael A. Benison; Capital Markets partner Harrison Tucker; Antitrust and Competition partner Attila Borsos, Antitrust and Competition associates Jan Vollkammer, and Alana Tinkler, and Antitrust and Competition associate director Justin Woodward; and Litigation partners Mary Beth Maloney and C. Lee Wilson, and Litigation associate Trevor Gopnik.

Gibson Dunn’s summary of director education opportunities has been updated as of October 2023. A copy is available at this link. Boards of Directors of public and private companies find this a useful resource as they look for high quality education opportunities.

This quarter’s update includes a number of new opportunities as well as updates to the programs offered by organizations that have been included in our prior updates. Some of the opportunities include unique events for members of private boards.

Read More

The following Gibson Dunn attorneys assisted in preparing this update: Hillary Holmes, Lori Zyskowski, Elizabeth Ising, and Ronald Mueller, with assistance from Mason Gauch and To Nhu Huynh from our Houston office.

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Singapore’s highest court rendered decision in Kuvera Resources Pte Ltd v JPMorgan Chase Bank, N.A. [2023] SGCA 28, holding that the interpretation of a sanctions clause in the context of a letter of credit was to be strictly and objectively construed. In this case, the court held that the bank’s concern of a potential adverse finding by the US Office of Foreign Assets Control (“OFAC”) did not suffice to excuse it from paying on an otherwise complying presentation. The court further expressed doubt as to whether such a clause was compatible with the commercial purpose of a letter of credit.

Background Facts

In 2019, a contract for the sale of coal to be delivered in two shipments was entered into between an Indonesian seller and a UAE buyer. The appellant, Kuvera Resources Pte Ltd, had advanced funds to the seller to purchase coal for on-selling to the buyer and was the beneficiary of two irrevocable letters of credit payable at sight (“the LCs”). Both LCs were issued by a bank in Dubai, subject to the Uniform Customs and Practice for Documentary Credits, 2007 Revision (“UCP600”). JPMorgan (“the Bank”) was the advising and nominated bank for both LCs.

At the time, all of the Bank’s advices and confirmations contained a sanctions clause in the following terms:

[The Bank] must comply with all sanctions, embargo and other laws and regulations of the U.S. and of other applicable jurisdictions to the extent they do not conflict with such U.S. laws and regulations (“applicable restrictions”). Should documents be presented involving any country, entity, vessel or individual listed in or otherwise subject to any applicable restriction, we shall not be liable for any delay or failure to pay, process or return such documents or for any related disclosure of information.

Kuvera subsequently made complying presentations to the Bank, which were then screened for potential sanctions issues. It transpired that the vessel in this case was on an internal list maintained by the bank, on the basis that it might have been Syrian-owned despite its non-Syrian registration. The Bank’s list was different to the list published by OFAC on its website, as it included other entities that the Bank had determined had known businesses in sanctioned countries. On the basis of the vessel being on the Bank’s list, it declined to pay on the LCs.

The Decision

Interpretation of the sanctions clause

The Court of Appeal, which is Singapore’s highest court, found that the sanctions clause did not afford a basis to decline payment. The court held that the sanctions clause only permitted the bank to decline payment if the vessel was “listed in or otherwise subject to any applicable restriction.” The vessel, not being listed by OFAC and only in the bank’s internal document, did not qualify as having been “listed in…any applicable restriction.” The court then considered whether the vessel might be said to be “otherwise subject to any applicable restriction.”

The court rejected a subjective approach to this question, finding that it did not suffice even if it could be shown that OFAC may or would have found that paying Kuvera was a breach of US sanctions; nor did it matter that the Bank was reasonably concerned that making payment could or would have been found by OFAC to be a breach of US sanctions.

Instead, an objective approach was required. Accordingly, the only relevant question was whether, as a matter of objective determination, the vessel had been Syrian-owned at all material times.

The court explained that:

(a) Allowing a nominated bank to decline payment based on what OFAC (which was not identified in the sanctions clause) may eventually find was considered arbitrary and speculative. This did not afford a beneficiary any certainty as to payment. The court noted evidence that the OFAC process itself was elaborate and long-drawn.

(b) The list maintained by the Bank reflected its own judgment, and an entity could be listed even if the risk of violation of US sanctions was less than even. The court went on to opine that even the presence of ‘red flags’ surrounding the ownership of the vessel, but which could not be resolved entirely, did not suffice to demonstrate that the vessel was in fact subject to an applicable restriction.

(c) Even though there was correspondence with OFAC that resulted in OFAC opining that there would have been “an apparent violation of OFAC regulations” based on information provided by the Bank, the court viewed the request as seeking support from OFAC for a decision the Bank had already made.

The court went on to analyze the evidence put forward on the ownership of the vessel and found it insufficient to displace the presumption of ownership arising from the vessel’s non-Syrian registration. Accordingly, the Bank was unable to discharge its burden of justifying its non-payment.

Whether sanctions clauses are enforceable

The court accepted that additional conditions stipulated in a confirmation could be binding and need not be separately offered and accepted so long as they did not contradict the commercial purpose of the LCs. In this regard, the court expressed doubt whether the sanctions clause in question was inconsistent with the commercial purpose of the LCs, particularly in a situation concerning the nomination of a vessel. This was because the beneficiary would not be involved in nominating the vessel, and therefore would have no knowledge at the time of contracting whether the letter of credit would be enforceable.

The court also noted the lack of any direct authority expressly upholding the validity of a sanctions clause in the context of UCP600 or documentary letters of credit generally. While there was English authority recognizing sanctions clauses, these were in respect of general commercial transactions. The court was particularly focused on the fact that letters of credit had a unique characteristic as autonomous contracts, and that confirmations (which, in this case, contained the sanctions clause) were often unilateral and would not have been negotiated or agreed by the beneficiaries.

Lessons 

The primary takeaway from this decision is that, at least under Singapore law, a sanctions clause will be construed strictly and objectively. If greater discretion is desired to decline payment based on an internal assessment by the bank, or even correspondence with OFAC, this needs to be spelt out clearly in the clause.

However, the greater the discretion afforded to decline payment, the greater the likelihood the court may also find the sanctions clause to be incompatible or inconsistent with the purpose of the letter of credit, which is to give the beneficiary “an assured right to be paid”. It may be that a sanctions clause agreed to by the parties to the underlying transaction, including the beneficiary, would be viewed more favorably. This, of course, changes how such transactions are presently carried out.

---

The following Gibson Dunn lawyers prepared this client alert: Paul Tan and David Wolber.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration, International Trade, or Financial Institutions practice groups, or any of the following:

International Arbitration Group:
Cyrus Benson – London (+44 20 7071 4239, cbenson@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Rahim Moloo – New York (+1 212-351-2413, rmoloo@gibsondunn.com)
Philip Rocher – London (+44 20 7071 4202, procher@gibsondunn.com)
Paul Tan – Singapore (+65 6507 3677, ptan@gibsondunn.com)

International Trade Group:
Kelly Austin – Hong Kong/Denver (+1 303-298-5980, kaustin@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Hong Kong (+852 2214 3731, qyue@gibsondunn.com)

Financial Institutions Group:
Stephanie Brooker – Washington, D.C.(+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Matthew Nunan – London (+44 20 7071 4201, mnunan@gibsondunn.com)
Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

On October 4, 2023, Colorado’s Attorney General Philip J. Weiser issued a formal legal opinion (“Opinion”) confirming the legality and praising the benefits of diversity, equity, and inclusion (“DEI”) programs and policies in the workplace.  The Opinion makes clear that, despite the increase in legal challenges to DEI programs after the Supreme Court struck down affirmative action in college admissions (Students for Fair Admissions v. President & Fellows of Harvard Coll., 600 U.S. 181 (2023) (“SFFA”)), the Colorado Attorney General’s Office is highly unlikely to challenge the DEI policies or programs of companies under its jurisdiction.

A.   Background

Attorney General Weiser first affirmed his office’s commitment to workplace DEI initiatives on July 19, 2023, when he signed a joint letter to Fortune 100 companies from 21 Democratic attorneys general, reassuring companies that efforts to recruit diverse workforces and create an inclusive work environment are still legal after the SFFA decision.  That letter was issued just six days after a group of 13 Republican state attorneys general published a letter to the same Fortune 100 companies, which threatened “serious legal consequences” for the use of race-based employment preferences and diversity policies.

In an October 4 press release, the Colorado Attorney General’s Office explained that AG Weiser issued the Opinion in an effort “to respond to questions and concerns about the constitutionality of DEI programs in the wake of the recent U.S. Supreme Court decision in [SFFA],” and to clarify that the Supreme Court decision was limited to colleges’ and universities’ admissions policies—not private workplaces, which are subject to Title VII of the Civil Rights Act of 1964 (“Title VII”).

B.   Legal Opinion

The Colorado Attorney General’s five-page opinion poses the question, “Are Diversity, Equity, and Inclusion programs (‘DEI programs’) used by employers now unlawful following the recently decided [SFFA] decision[?]”  AG Weiser’s short answer is “No.”  He clarifies that “[w]orkplace DEI programs were not addressed and were not held unconstitutional by the U.S. Supreme Court in SFFA,” because that decision applied only to college and university admissions, and interpreted the Equal Protection Clause of the U.S. Constitution and Title VI of the Civil Rights Act of 1964, neither of which governs private companies that do not receive federal funds.

The Opinion further explains that the Supreme Court in SFFA “relied exclusively on case law developed in the context of university admissions programs” and found that the admissions policies at issue (1) failed the “strict scrutiny” test applicable to government policies that discriminate on the basis of race; (2) impermissibly used race as a negative or a stereotype; and (3) lacked an “end point.”  The SFFA decision, therefore, “did not address the law governing consideration of race in the employment context, nor did it address the validity of DEI programs in hiring practices and in the workplace.”

AG Weiser observes that, by contrast, “[e]mployer DEI programs remain valid under federal law.”  Irrespective of SFFA, he explains, it has long been illegal for an employer to discriminate on the basis of “race, color, religion, sex, or national origin.”  42 U.S.C. § 2000e-2(a)(1).  Under this standard, DEI programs that “ensure that all employees receive access to the same opportunities in the workplace—not to ‘adversely affect’ or ‘deprive’ employees of opportunities—do not violate Title VII.”  AG Weiser notes that a policy aimed at expanding an organization’s outreach “to historically underrepresented groups,” for instance, would be legal, as it would not adversely impact other applicants.

The Opinion also underscores the validity of the “valid affirmative action” defense, which, as AG Weiser explains, means that “employers may take protected status into account in employment decisions in certain limited circumstances,” where the affirmative action is taken to correct a “manifest imbalance” in a given position and does not “unnecessarily trammel” the rights of employees not subject to the affirmative action program.  See United Steelworkers v. Weber, 443 U.S. 193, 208 (1979); Johnson v. Transportation Agency, 480 U.S. 616, 626-27 (1987).

AG Weiser further argues that, far from paring down DEI programs, employers may need to take additional steps to avoid policies that “have a disparate impact on protected classes of employees,” to avoid claims under Title VII.  He therefore advises employers to “carefully monitor their policies to ensure that they are not inadvertently disadvantaging protected classes of employees through facially neutral policies.”

AG Weiser also offers a policy defense of DEI programs.  The Opinion’s “Factual Background” section contends that Title VII exists to address “well documented” “inequities” in the workplace which persist to this day, including the facts that “[o]n average, women are paid less than men,” that “[w]omen, and particularly women of color, are less likely to hold executive positions,” and that “Black and Hispanic employees suffer workplace discrimination at a 60% higher rate than white employees.”  “In order to combat these persistent inequities and achieve the benefits of a diverse workforce,” AG Weiser asserts, “public and private employers of all types have adopted DEI programs.”  AG Weiser notes that such programs help “remove barriers” for underrepresented groups, while increasing diversity, equity, and inclusion.  The Opinion lists what the AG views as valid DEI programs, including the hiring of “chief diversity officers who ensure that all employees enjoy access to mentoring and career development opportunities”; mentorship programs “to increase employee engagement and opportunities for advancement,” especially for underrepresented groups; recruiting efforts aimed at “ensur[ing] a diverse pipeline of applicants”; and employee affinity groups “that can help employees feel a sense of belonging, community, and worth in the workplace.”

The press release accompanying the Opinion confirms the AG’s commitment to DEI in clear terms: “Research demonstrates compelling reasons for why public and private employers would be interested in better meeting the needs of an increasingly diverse world.  Organizations with diverse teams are more profitable and companies with diversity across the board are more innovative.  The law permits DEI efforts to achieve these benefits of diversity, and employers should periodically review their policies to ensure they are in compliance with the law.”

C.   Implications

AG Weiser already took a stance on private-sector DEI programs when he signed the Democratic AGs’ letter to Fortune 100 companies in July.  This additional Opinion solidifies AG Weiser’s view on the value and legality of certain workplace DEI programs, signaling to Colorado employers that—at least from the Attorney General’s perspective—they may maintain existing, lawful DEI programs, and take appropriate steps to avoid “a disparate impact on protected classes of employees.”  At the same time, depending on the nature of their DEI programs, employers still face legal risk from private plaintiffs and other government agencies who may challenge the legality of DEI programs and allege that they are discriminatory under Title VII or Section 1981 of the 1866 Civil Rights Act.  Gibson Dunn has formed a DEI Task Force to assist employers with these issues.

---

The following Gibson Dunn attorneys assisted in preparing this client update: Jessica Brown, Jason C. Schwartz, Katherine V.A. Smith, and Anna Ziv.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, the authors, or the following practice and DEI Task Force leaders and partners:

Jessica Brown – Partner, Labor & Employment Group, Denver
(+1 303-298-5944, jbrown@gibsondunn.com)

Mylan L. Denerstein – Partner, Labor & Employment Group, Chair, Public Policy Group, New York
(+1 212-351-3850, mdenerstein@gibsondunn.com)

Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer, Washington, D.C.
(+1 202-955-8503, zswilliams@gibsondunn.com)

Molly T. Senger – Partner, Labor & Employment Group, Washington, D.C.
(+1 202-955-8571, msenger@gibsondunn.com)

Jason C. Schwartz – Partner & Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)

© 2023 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials.  The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel.  Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.