Privacy, Cybersecurity and Data Innovation co-chair Ahmed Baladi discusses GDPR enforcement actions in Europe with practice partners Vera Lukic (Paris) and Joel Harrison (London). They review enforcement actions over the past five years and anticipate future trends, look at Brexit’s impact on the GDPR and on its application in the UK, and examine issues arising from the enforcement of the e-privacy directive, with its lack of a one-stop-shop mechanism.

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HOSTS:

Ahmed Baladi is a partner in the Paris office of Gibson, Dunn & Crutcher, where he is co-chair of the firm’s Privacy, Cybersecurity and Data Innovation practice and a member of the Artificial Intelligence practice. Ahmed has developed renowned experience in a wide range of privacy and cybersecurity matters including compliance and governance programs in light of the GDPR. He regularly represents companies and corporate executives on investigations and procedures before Data Protection Authorities. He also advises a variety of clients on data breach and national security matters including handling investigations, enforcement defense and crisis management.

Joel Harrison is a partner in the London office of Gibson, Dunn & Crutcher and a member of the firm’s Privacy, Cybersecurity and Data Innovation and Technology Transactions Practice Groups. Joel advises on everything technology-related, including transactions, disputes and renegotiations, as well as regulatory issues. He also specializes in data protection and cybersecurity, advising on the full range of regulatory, transactional and contentious matters. Joel’s clients include some of the world’s leading corporations and financial institutions.

Vera Lukic is a partner in the Paris office of Gibson, Dunn & Crutcher, where she serves as a member of the Privacy, Cybersecurity and Data Innovation Practice Group. She is also a member of the Strategic Sourcing and Commercial Contracts Practice Group. She focuses on information technology, digital transactions, cybersecurity, and data privacy.

On July 27, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published a “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (the “Circular”).[1] Trustees and custodians of SFC-authorised collective investment schemes (the “relevant CIS”) will have to be licensed or registered with the SFC for the new Type 13 regulated activity (“RA 13”) from October 2, 2024.

The Circular should be read in tandem with the soon to be enacted Schedule 11 to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Schedule 11”).[2] Together, the Circular and Schedule 11 provide guidance on the SFC’s expectations regarding RA 13 licensing arrangements.

The new RA 13 regulatory regime intends to remedy what the SFC has previously described as a “patchy” approach to the regulation of depositories, whereby the SFC was unable to directly supervise depositaries. Instead, the SFC could only exercise indirect oversight through the requirements under the Product Codes.[3]  The RA 13 regulatory framework was proposed by the SFC in September 2019 to fill this void left by a lack of specific, direct supervision mechanism over trustees and custodians of public funds.[4] In doing so, the new RA 13 regulatory regime will also align Hong Kong’s fund custody framework with international standards; most major jurisdictions (such as the United Kingdom and Singapore) have some form of direct regulatory powers over entities providing trustee, custodian or depositary services for public funds (at a minimum). Viewed broadly, the introduction of RA 13 is also consistent with the SFC’s focus on regulating entities providing custody services – for instance, its recent decision to regulate virtual assets custody under its new virtual assets trading platform (“VATP”) regime by requiring custody be undertaken by a wholly owned subsidiary of a licensed VATP operator.

I. Who needs a RA 13 license?

The amendments made to the Securities and Futures Ordinance (“SFO”) to introduce RA 13 define it as “providing depositary services for relevant CISs”.[5] In essence, what this means is that trustees and custodians (i.e. depositaries as defined under the amendments to the SFO) of a relevant CIS at the “top level” of the custodian chain will be required to be licensed or registered for RA 13 in order to provide the following services:

• the custody and safekeeping of the CIS property, including property held on trust by the relevant CIS (“CIS Property”); and
• the oversight of the CIS to ensure that it is operated according to scheme documents.[6]

In practice, many of these depositaries were not previously supervised by the SFC until the introduction of the new RA 13 regime. This suggests that individuals who will now be required to be licensed to undertake RA 13 activities will be subjected to direct SFC supervision for the first time, and may not be accustomed to being licensed.

II. What are the RA 13 regulatory requirements?

In the table below, we highlight the key regulatory requirements applicable to depositaries licensed for RA 13 (“RA 13 Depositaries”):

Capital thresholds	RA 13 Depositaries are required to maintain a paid-up share capital of not less than $10,000,000 and a liquid capital of not less than $3,000,000.[7]
Treatment of Scheme Money	RA 13 Depositaries that hold or receive scheme money under a relevant CIS (“Scheme Money”) must deposit such Scheme Money into segregated and designated trust accounts or client accounts within three business days after receipt. Each segregated account must be established and maintained for one relevant CIS only.[8] RA 13 Depositaries must not pay Scheme Money out of the segregated account unless such payment is (i) instructed in writing, or (ii) for the purpose of meeting payment, distribution, redemption settlement, or margin requirements, or (iii) to settle any charges or liabilities on behalf of the relevant CIS, as per the scheme documents.[9]
Treatment of Scheme Securities	Similarly, an RA 13 Depositary must deposit client securities which it holds or receives when providing depositary services (“Scheme Securities”) into a segregated and designated trust account or client account. Alternatively, the RA 13 Depositary can register the Scheme Securities in the name of the relevant CIS.[10] An RA 13 Depositary can only deal with Scheme Securities in accordance with written instructions or scheme documents. It must take reasonable steps to ensure that Scheme Securities are not otherwise deposited, transferred, lent or pledged.[11]
Record keeping obligations	In line with the record keeping requirements generally applicable to licensed intermediaries, RA 13 Depositaries are required to keep accounting, custody and other records to sufficiently explain and reflect the financial position and operation of the business, and support accurate profits and loss or income statements.  Specifically, RA 13 Depositaries must also account for all relevant CIS Property, and make sure that its accounting systems can trace all movements of relevant CIS Property.[12]
OTCD reporting	RA 13 Depositaries are exempted from reporting specified over-the-counter (“OTC”) derivative transactions to the Hong Kong Monetary Authority (“HKMA”) when acting as a counterparty to the OTC derivative transaction.[13] Similarly, authorized institutions need not report the OTC derivative transaction to the HKMA if the counterparty of the transaction is an RA 13 Depositary acting in its capacity as a trustee of the relevant CIS.[14]

Further, the SFC has previously clarified that the Managers-In-Charge (“MIC”) requirements under the current licensing framework extend to RA 13 licensees.[15]

III. Are there any additional requirements applicable to specific classes of RA 13 Depositaries?

Schedule 11 sets out additional requirements applicable to specific classes of RA 13 Depositaries. In the table below, we summarize the key requirements applicable to RA 13 Depositaries authorized under the Code on Unit Trusts and Mutual Funds[16] and Code on Pooled Retirement Funds (“UT/RF RA 13 Depositaries”).[17] These are mostly RA 13 Depositaries operating Chapter 7 Funds (i.e. plain vanilla funds investing in equity and/or bunds), specialized schemes (such as hedge funds, listed open-ended funds), and pooled retirement funds.

Appointment and oversight of delegates or third parties	UT/RF RA 13 Depositaries should establish internal control policies and procedures to oversee appointed delegates or third parties. These internal control policies and procedures should cover the following: the selection of a delegate or third party, including assessment procedures and criteria on the delegate or third party’s competence, regulatory and financial status, capabilities and the effectiveness of their internal controls and systems; ongoing and regular monitoring of the delegate or third party to ensure compliance with regulatory requirements and maintenance of effective internal controls and systems; and management of actual or potential conflicts of interests arising from the appointment and oversight of delegates or third parties (where applicable). UT/RF RA 13 Depositaries should also establish appropriate contingency plans to cater for instances of breaches or insolvency of these delegates or third parties.[18]
Oversight of the relevant CIS	UT/RF RA 13 Depositaries should have oversight over the operations of the relevant CIS, and ensure that the CIS is operated or administered in accordance with the relevant constitutive documents.[19]
Subscription and redemption	UT/RF RA 13 Depositaries should monitor the relevant operators of each CIS to ensure (among other things): timely processing of subscription and redemption transactions; execution of subscription and redemption orders in accordance with the constitutive documents of the relevant CIS; timely deposits of subscription and redemption proceeds into a segregated bank account designated as a trust account or client account holding relevant CIS Property; reconciliation of subscription and redemption, and that the frequency of such reconciliation is consistent across subscription and redemption; and proper documentation of reasons for (i) suspension of dealing of unit or shares of the relevant CIS, and (ii) suspension of valuation, price or net asset value calculations of the relevant CIS.[20]
Distribution payments	UT/RF RA 13 Depositaries should supervise the relevant operators of each CIS to ensure that: distributions are calculated in accordance with the constitutive documents of the relevant CIS; and complete and accurate distribution payments are made on a timely basis. With respect to each relevant CIS, UT/RF RA 13 Depositaries should ensure that distribution proceeds are transferred according to the operator’s instruction on a timely basis into a designated and segregated or omnibus bank account.[21]
Custody and safekeeping of CIS Property	UT/RF RA 13 Depositaries can adopt the safeguards to ensure the safekeeping of CIS Property: assess and manage custody risk by making adequate organisational arrangements to minimise the risks of loss of the CIS Property; register the CIS Property in the name of the UT/RF RA 13 Depositary; verify ownership of the CIS Property using reliable sources; maintain updated and comprehensive records of the CIS Property; and ensure reconciliation is carried out daily for CIS Property in cash form.[22]

Notwithstanding the above, there are specific requirements applicable to RA 13 Depositaries authorized under the Code on Real Estate Investment Trusts (“REIT RA 13 Depositaries”).[23] These are RA 13 Depositaries operating closed-ended funds primarily investing in real estate. REIT RA 13 Depositaries are under a fiduciary duty to hold assets of Real Estate Investment Trusts (“REIT”) on trust for the benefit of the unitholders of the REIT. While the requirements applicable to UT/RF RA 13 Depositaries summarized above are generally applicable to REIT RA 13 Depositaries, Schedule 11 tailors some of these requirements to account for the unique features and product structure of REITs. The key modifications are summarized as follows:

Cash flow monitoring and cash reconciliation

Under the Code on Real Estate Investment Trusts (“REIT Code”), the management company of a REIT bears the obligation to manage cash flows. Schedule 11 modifies the custody requirements – which require UT/RF RA 13 Depositaries to carry out cash reconciliation of CIS Property daily – to instead require REIT RA 13 Depositaries to ensure that the management company has put in place proper cash flow management policies and controls, and supervise the implementation of such policies and controls.

Custody and safekeeping of CIS Property

REIT RA 13 Depositaries should ensure that all REIT assets (including the title documents of REIT-owned real estate) are properly segregated and held for the benefit of the unitholders in accordance with the REIT Code and the constitutive document of the REIT. Where the REIT RA 13 Depositary considers it in the interests of the REIT for certain assets of the REIT to be held by the management company on behalf of the REIT, the REIT RA 13 Depositary should make sure that the management company has established proper safeguards and controls to properly segregate REIT assets. Additionally, the REIT RA 13 Depositary must maintain on-going oversight and control over the relevant assets.

IV. What are the next steps?

The SFC has begun accepting licensing applications for RA 13 since July 27, 2023. Depositaries are reminded to submit RA 13 applications on or before November 30, 2023. The RA 13 regime will take effect on October 2, 2024.

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[1] “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (July 27, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC32

[2] The final text of Schedule 11 can currently be found at Appendix C, “Consultation Conclusions on Proposed Amendments to Subsidiary Legislation and SFC Codes and Guidelines to Implement the Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (March 24, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=22CP1

[3] Namely, the Code on Unit Trusts and Mutual Funds, the Code on Open-Ended Fund Companies, the Code on Real Estate Investment Trusts, and the Code on Pooled Retirement Funds.

[4] “Consultation Paper on the Proposed Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (September 27, 2019) (“2019 Consultation Paper”), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/openFile?lang=EN&refNo=19CP3

[5] Section 3, “Securities and Futures Ordinance (Amendment of Schedule 5) Notice 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271262.pdf

[6] “Scheme document” refers to (i) the trust deed constituting or governing the relevant CIS if the CIS is constituted in the form of a trust, (ii) the documents governing the formation or constitution of the relevant CIS if the CIS is constituted in any other form other than a trust, or (iii) other documents setting out the requirements relating to (a) the custody and safekeeping of any CIS Property, or (b) the oversight of the operations of the relevant CIS.

[7] Amended Schedule 1 of the Securities and Futures (Financial Resources) Rules, set out under section 10 of the “Securities and Futures (Financial Resources) (Amendment) Rules 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271256.pdf

[8] Amended rule 10B of the Securities and Futures (Client Money) Rules, set out under section 7 of the “Securities and Futures (Client Money) (Amendment) Rules 2023” (“CMR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln055-e.pdf

[9] Amended rule 10C of the of the Securities and Futures (Client Money) Rules, set out under section 7 of the CMR Amendment Rules

[10] Amended rule 9B of the Securities and Futures (Client Securities) Rules, set out under section 6 of the “Securities and Futures (Client Securities) (Amendment) Rules 2023” (“CSR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln054-e.pdf

[11] Amended rules 9C and 10A of the Securities and Futures (Client Securities) Rules, set out under sections 6 and 7 of the CSR Amendment Rules respectively

[12] Amended rule 3A of the Securities and Futures (Keeping of Records) Rules, set out under section 5 of the “Securities and Futures (Keeping of Records) (Amendment) Rules 2023” (“KKR Amendment Rules) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln057-e.pdf

[13] Amended rule 10 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 4 of the “Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) (Amendment) Rules 2023” (“OTCD Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln061-e.pdf

[14] Amended rule 11 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 5 of the OTCD Amendment Rules

[15] Paragraph 26, 2019 Consultation Paper. The SFC’s MIC requirements are listed in the “Circular to Licensed Corporations Regarding Measures for Augmenting the Accountability of Senior Management” (December 16, 2016), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=16EC68, and the related Frequently Asked Questions published by the SFC (last updated on January 26, 2022), available at https://www.sfc.hk/en/faqs/intermediaries/licensing/Measures-for-augmenting-senior-management-accountability-in-licensed-corporations

[16] “Code on Unit Trusts and Mutual Funds” (January 1, 2019), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/section-ii-code-on-unit-trusts-and-mutual-funds/section-ii-code-on-unit-trusts-and-mutual-funds.pdf

[17] “Code on Pooled Retirement Funds” (December 2021), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-on-pooled-retirement-funds/code-on-pooled-retirement-funds.pdf?rev=9badf81950734ee08c799832be6ff92b

[18] Section 6, Schedule 11

[19] Section 8, Schedule 11

[20] Section 9, Schedule 11

[21] Section 11, Schedule 11

[22] See section 14, Schedule 11 for the full list of safeguards.

[23] “Code on Real Estate Investment Trusts” (August 2022), published by the SFC, available at https://www.sfc.hk/-/media/EN/files/COM/Reports-and-surveys/REIT-Code_Aug2022_en.pdf?rev=572cff969fc344fe8c375bcaab427f3b

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The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

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 any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

William R. Hallatt (+852 2214 3836, whallatt@gibsondunn.com)
Emily Rumble (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun (+852 2214 3838, apun@gibsondunn.com)
Becky Chung (+852 2214 3837, bchung@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 Financial Times recognized Gibson Dunn at the Europe Innovative Lawyer Awards 2023. The firm was selected as overall winner in the Responsible Business category for our work securing the release of Nazanin Zaghari-Ratcliffe from illegal detention in Iran. The firm was also recommended in the Private Capital category for our work advising KKR on its purchase of a minority stake in the fiber network spin-off of Telenor, and in connection with our work on behalf of a German client that was seeking to sell to a private equity buyer, in which our lawyers cut the time required to draft the legal “fact book” from weeks to three days. In addition, the firm was also recognized in the Supporting Refugees and Migrants category as part of the Afghan Pro Bono Initiative. The awards were presented on September 21, 2023.

The German weekly FOCUS recognized Gibson Dunn’s Frankfurt and Munich offices in its annual special issue, “Law and Advice.” The firm is recommended as “Top-Wirtschaftskanzlei 2023″ (top commercial law firm) in the Compliance, Corporate Law, and Mergers & Acquisitions categories. The feature was published on September 16, 2023.

Los Angeles partner Tiaunia Henry was honored at CenterForce’s 2023 Diversity, Equity & Inclusion Impact Awards with the DEI Leadership Award. CenterForce’s Driving Diversity in Law & Leadership Summit and Awards program took place on September 21, 2023 and recognized exceptional leaders throughout Los Angeles for their unwavering commitment to championing diversity, equity and inclusion. Tiaunia was also featured in a panel titled “Pulse Check: Benchmarking DEI Post Pandemic and What Does Success Look Like.”

Tiaunia has been an active member of the LA Area Diversity Committee since joining the firm in 2007. She has served as Co-Chair of Gibson’s LA Area Diversity Committee since 2012 and as Chair of the Affinity Groups for Black attorneys and Women of Color in Los Angeles as well as being actively involved in the Los Angeles Parenting Group. Tiaunia is also responsible for one of the Firm’s most successful diversity programs. She worked closely with Gibson’s Global Diversity Team to spearhead and launch the Diverse Perspectives in the Law Speaker Series, a firmwide program that explores our diverse attorneys’ experiences in navigating issues around race and inclusion throughout their lives and how it has shaped their careers in the legal profession.

Gibson Dunn antitrust practitioners discuss the proposed changes to the DOJ-FTC Merger Guidelines, along with potential implications for the HSR merger review process. The speakers also share practical advice and considerations for M&A going forward.

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The National Law Journal named Theane Evangelis as an Employment Law Trailblazer​ for her work on “the first and only successful challenge to California’s AB5.” The report was published on September 5, 2023.

Theane Evangelis is Co-Chair of the firm’s global Litigation Practice Group. She has served as lead counsel in a wide range of bet-the-company appellate, constitutional, class action, labor and employment, media and entertainment, and crisis management matters in trial and appellate courts across the country.

Starting January 1, 2024, California will be broadening its already expansive prohibitions on employee non-compete agreements.  Senate Bill (SB) 699, signed into law on September 1, 2023, added Section 16600.5 to the Business & Professions Code, which expands California’s existing restrictions on non-competes to agreements created out-of-state and creates new enforcement rights for employees to challenge non-compete clauses.

California’s Business and Professions Code section 16600 currently voids contracts that restrain an employee from engaging in a lawful profession, trade, or business of any kind.  State courts have historically applied Section 16600 to bar agreements made in California restricting post-employment competition, with limited exceptions.[1]

Section 16600.5 will prohibit enforcement of any contract previously forbidden under Section 16600 “regardless of where and when the contract was signed.”  Plaintiffs may capitalize on this broad phrasing to argue that the new law should apply retroactively to any contract with non-compete provisions, and courts will likely have to clarify whether California’s presumption against retroactivity applies.[2]  The new law will further bar “an employer or former employer from attempting to enforce a contract that is void regardless of whether the contract was signed and the employment was maintained outside of California.”[3]  Employers that enter into a contract that is void or attempt to enforce a contract forbidden by Section 16600 will have committed a civil violation.  The expanded restrictions are intended to (i) respond to an increasingly remote talent market, in which “California employers increasingly face the challenge of employers outside of California attempting to prevent the hiring of former employees”; and (ii) to preserve the state’s “competitive business interests” by “protecting the freedom of movement of persons whom California-based employers wish to employ to provide services in California, regardless of the person’s state of residence.”[4]

It remains to be seen how broadly Section 16600.5 will apply in practice, and whether jurisdictional challenges may limit its effect within and outside California.  For example, employees who recently moved to California may cite Section 16600.5 in California courts to try to invalidate non-competes that they previously agreed to, even if such clauses were legally negotiated out-of-state with a non-California employer.  Alternatively, remote workers employed in other states by California employers may try to invoke the provision in their local jurisdictions to invalidate non-competes formed outside of California, even if the employee never set foot in California.  Of course, this raises the question of whether a non-California court will find Section 16600.5 to apply to an employee outside California.  Section 16600.5 also raises the question of whether a California court has the authority to rule a non-compete is unenforceable even if the agreement complies with the law of the state in which it was made or has already been held enforceable by a non-California court.  Employers should monitor whether and to what extent courts apply judicial principles of comity and extraterritoriality in adjudicating these types of cases.[5]

Employers should also be aware that the law authorizes employees, former employees, and prospective employees to seek injunctive relief, actual damages, or both, and entitles a prevailing plaintiff to recover reasonable attorneys’ fees and costs.  But employers who prevail in litigation over restrictive covenants are not entitled under the new law to recover their fees against the losing individuals.  Employers with ties to California are encouraged to review their employee agreements in light of this new law.

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[1] Statutory exceptions to Section 16600 include restrictive covenants in the sale or dissolution of corporations, partnerships, and limited liability corporations.  See Cal. Bus. & Prof. Code §§ 16601, 16602, 16602.5.

[2] Cal. Civ. Code, § 3; Evangelatos v. Super. Ct., 44 Cal. 3d 1188, 1208 (1988) (holding that a statute will not be applied retroactively unless it contains “an express retroactivity provision” or it is “very clear from extrinsic sources that the Legislature . . . must have intended a retroactive application”).

[3] 2023 Cal. S.B. No. 699 (2023-2024 Regular Session).

[4] Id. §§ 1 (d) & (f).

[5] See, e.g., Advanced Bionics Corp. v. Medtronic, Inc., 29 Cal. 4th 697, 706–07 (2002), as modified (Mar. 5, 2003) (applying the comity principle to reason that while “California has a strong interest in protecting its employees from noncompetition agreements” under section 16600, “[a] parallel action in a different state presents sovereignty concerns that compel California courts to use judicial restraint when determining whether they may properly issue a TRO against parties pursuing an action in a foreign jurisdiction.”); Ward v. United Airlines, Inc., 986 F.3d 1234, 1240 (9th Cir. 2021) (discussing the breadth of the extraterritoriality principle).

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The following Gibson Dunn lawyers prepared this client alert: Tiffany Phan, Joseph Rose, Jason C. Schwartz, Katherine V. A. Smith, Stephen Weissman, and Yekaterina Reyzis.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition or Labor and Employment practice groups, or the following authors and practice leaders:

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

Joseph R. Rose – San Francisco (+1 415-393-8277, jrose@gibsondunn.com)

Rachel S. Brass – Co-Chair, Antitrust & Competition, San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)

Stephen Weissman – Co-Chair, Antitrust & Competition, Washington, D.C. (+1 202-955-8678, sweissman@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.

Gibson Dunn has advised Zensho Holdings Co., Ltd., Japan’s premier food service company based on sales, on its acquisition of The Snowfox Group, a multi-channel international Japanese food service platform, for $621 million. The Snowfox Group’s global brands include Snowfox, Bento, Taiko and YO! in North America and the United Kingdom.

The Gibson Dunn M&A team was led by Scott Jalowayski, Till Lefranc, and Michelle Gourley. Rachel Brass, Sébastien Evrard, and Steve Pet advised on competition aspects, Carrie LeRoy advised on intellectual property, and Sandy Bhogal advised on tax. Joanne Hughes, Jordan Rex, Dominic Kinsky, and Luisa de Belgique advised on corporate aspects.

New York partner Mylan Denerstein and associate Lee Crain are authors of “Accessing the Courts: Why New York Should Eliminate the Dreaded, Needless and Unduly Complex ‘Certificate of Conformity” [PDF] published by the New York Law Journal on September 6, 2023.

We are pleased to provide you with the next edition of Gibson Dunn’s digital assets regular update. This update covers recent legal news regarding all types of digital assets, including cryptocurrencies, stablecoins, CBDCs, and NFTs, as well as other blockchain and Web3 technologies. Thank you for your interest.

Enforcement Actions

United States

1. Feds Charge Tornado Cash Developers Facilitated $1 Billion in Money Laundering

On August 23, the Manhattan U.S. Attorney’s Office brought charges in the Southern District of New York against two developers of Tornado Cash, Roman Storm and Roman Semenov. Tornado Cash is a crypto application that obscures the source of assets transferred through it. Prosecutors allege that more than $1 billion was laundered through Tornado Cash, including hundreds of millions by North Korea’s Lazarus Group. Charges include conspiracy to engage in money laundering, conspiracy to violate U.S. sanctions targeting North Korea, and conspiracy to operate an unlicensed money transmitting business. Storm was arrested and released after posting bond. Also on August 23, the Office of Foreign Asset Control (OFAC) sanctioned Semenov and eight Ethereum addresses allegedly controlled by Semenov. Law360; Forbes; Indictment

2. SEC Brings First Enforcement Actions Alleging NFTs Are Securities

On August 28, the U.S. Securities and Exchange Commission (SEC) issued an order simultaneously filing and settling charges against Impact Theory, LLC, a Los Angeles-based media company, related to its sales of non-fungible tokens (NFTs). Applying the Howey test, the SEC concluded that Impact Theory’s KeyNFTs were investment contracts primarily because Impact Theory’s marketing statements promised “tremendous value” and “massive” appreciation. As part of a settlement of the charges, the SEC ordered Impact Theory to disgorge over $5 million. SEC Commissioners Hester Pierce and Mark Uyeda issued a joint dissent from the order, arguing in part that the tokens were not investment contracts because they were not shares of the company and did not generate any type of dividend for purchasers. Order; Law360; CoinWire

Weeks later, on September 13, the SEC issued an order simultaneously filing and settling charges against Stoner Cats 2 LLC (SC2), alleging an unregistered securities offering in the form of profile-picture NFTs. The order states that SC2 raised approximately $8 million from the sale of around 10,000 NFTs to finance the animated web series Stoner Cats, starring Mila Kunis and Ashton Kutcher. In an accompanying press release, the SEC stated that the offering led “investors to expect profits because a successful web series could cause the resale value of the Stoner Cats NFTs in the secondary market to rise.” SC2 agreed to pay a $1 million fine and destroy all remaining NFTs in its possession. Commissioners Pierce and Uyeda dissented from this order as well, arguing that “the Stoner Cats NFTs are not that different from Star Wars collectibles sold in the 1970s” and that the order “carries implications for creators of all kinds.” Order; Press Release; CoinDesk

3. CFTC Charges DeFi Platforms Over Crypto Derivatives

On September 7, the Commodity Futures Trading Commission (CFTC) issued orders simultaneously filing and settling charges against three decentralized finance (DeFi) trading platforms—Opyn, Inc., ZeroEx (0x), Inc., and Deridex, Inc.—for offering digital asset derivatives trading. The orders require Opyn, ZeroEx, and Deridex to pay civil penalties of $250,000, $200,000, and $100,000, respectively, and “cease and desist from violating the Commodity Exchange Act (CEA) and CFTC regulations.” The companies were all said by the CFTC to have cooperated in the investigation, getting a reduced penalty as a result. “The DeFi space may be novel, complex, and evolving, but the Division of Enforcement will continue to evolve with it and aggressively pursue those who operate unregistered platforms that allow U.S. persons to trade digital asset derivatives,” said Director of Enforcement Ian McGinley. Release; CoinDesk

4. LBRY to Appeal Ruling That It Violated U.S. Securities Law

On September 7, crypto file-sharing protocol LBRY filed a notice of appeal of a New Hampshire federal court’s decision that it failed to register the sale of its native LBRY tokens (LBC) with the SEC. The court’s final judgment ordered LBRY to pay a $111,614 civil penalty and barred it from participating in any unregistered crypto securities offerings in the future. “LBRY is appealing the [court’s] decision because it is unjust and incorrect,” said CEO Jeremy Kauffman. LBRY previously indicated that it would shut down following the July 11 ruling. Notice of Appeal; CoinDesk; CoinTelegraph

5. Former FTX Executive Ryan Salame Pleads Guilty Ahead of Bankman-Fried Trial

On September 7, former top FTX executive Ryan Salame pleaded guilty to one count of conspiracy to operate an unlicensed money transmitting business and one count of conspiracy to make unlawful political contributions and defraud the Federal Election Commission. Salame faces a maximum of 10 years in prison. He also has agreed to forfeit up to $1.5 billion and make restitution of $5.6 million to FTX debtors. His sentencing is set for March 6, 2024. This plea comes less than one month before Sam Bankman-Fried, co-founder of FTX, is set to go to trial on October 2. Salame’s attorney previously told prosecutors he would invoke his Fifth Amendment rights against self-incrimination if called as a witness against Bankman-Fried at trial. CNN; Reuters; New York Times

6. Former OpenSea Head of Product Receives Three-Month Prison Sentence for NFT Insider Trading

On August 23, Nate Chastain, the former Head of Product at OpenSea, the NFT trading platform, was sentenced to three months in prison for making around $50,000 by trading NFTs that he knew would be featured on the OpenSea homepage. In May, he was convicted by a jury of wire fraud and money laundering in what is considered the first insider-trading case involving digital assets. Prosecutors had sought a two-year prison sentence, but U.S. District Judge Jesse Furman imposed a shorter sentence based on Chastain’s limited profits. Judge Furman also sentenced Chastain to 200 hours of community service following his imprisonment, a $50,000 fine, and forfeiture of 15.98 ether. Reuters; Crypto News

Regulation and Legislation

United States

7. Treasury and IRS Propose Tax-Reporting Rules for Crypto Industry

On August 25, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) released controversial proposed regulations governing tax-reporting requirements for the crypto industry. The long-awaited regulations would broaden the definition of “broker” to encompass digital asset trading platforms, payment processors, wallet providers, and “some” DeFi platforms. Under the proposed regulations, starting on January 1, 2025, these entities would be subject to similar tax reporting rules as brokers for securities and other financial instruments. The proposal exempts crypto miners from these requirements. The proposed regulations are open for public comment until October 30. The proposed regulations were criticized by Chairman Patrick McHenry (R-NC) of the House Financial Services Committee as “an attack on the digital asset ecosystem.” Treasury; IRS; Axios; WSJ

8. FASB Announces New Bitcoin Accounting Rules

On September 6, the Financial Accounting Standards Board (FASB) announced forthcoming accounting rules under which companies that hold or invest in cryptocurrencies will be required to report their holdings at fair value. This would allow companies to recognize gains and losses in cryptocurrencies immediately, as they would with other financial assets. This change is widely seen as an improvement over the current practice of treating cryptocurrencies as indefinite-lived intangible assets. The forthcoming rules include other requirements as well, including that companies must make a separate entry in their financial statements for cryptocurrencies. The accounting rules will be mandatory for all companies—public and private—for fiscal years beginning after December 15, 2024, including interim periods within those years. WSJ; Bloomberg

International

9. UK Crypto Firms Can Apply for Extra Time to Comply with New Restrictions on Crypto Promotions

On September 7, the UK’s Financial Conduct Authority (FCA) announced that UK crypto firms could be given an extra three months to implement new restrictions on crypto promotions. The “[t]ough new rules designed to make the marketing of cryptoasset products clearer and more accurate” are set to take effect on October 8, but can be delayed until January 2024 for otherwise compliant firms to develop the right technical setup. The FCA said that it still intends to take enforcement action against overseas or unregulated firms that continue to unlawfully market to UK consumers starting October 8. Release; CoinDesk

10. Travel Rule Regulation Goes into Force in the UK for Crypto Asset Firms

On September 1, a new rule requiring crypto firms in the UK to comply with the Financial Action Task Force’s Travel Rule went into effect. The UK Travel Rule requires UK-based Virtual Asset Service Providers (VASPs) to collect, verify, and share information on domestic and cross-jurisdictional transactions. According to an FCA statement, crypto businesses domiciled in the UK are required to “comply with the rule when sending or receiving a cryptoasset transfer to a firm that is in the UK, or any jurisdiction that has implemented the Travel Rule.” If information is missing or incomplete, businesses must make a risk-based assessment before releasing the cryptoassets to the beneficiary. FCA Statement; The Block

Civil Litigation

United States

11. D.C. Circuit Vacates SEC Denial of Grayscale Bitcoin ETF as Arbitrary and Capricious

On August 29, the U.S. Court of Appeals for the D.C. Circuit ruled that the SEC will have to take another look at Grayscale Investments’ application to list a bitcoin exchange-traded product (ETP), because the SEC’s rejection of the submission was “arbitrary and capricious” and thus violated the Administrative Procedure Act. The three-judge panel’s unanimous ruling was authored by Judge Neomi Rao (a President Trump appointee) and was joined by Judges Edwards and Srinivasan (President Carter and Obama appointees, respectively). The court concluded that the SEC “failed to adequately explain why it approved the listing of two bitcoin futures ETPs but not Grayscale’s” proposed spot product, and rejected every rationale offered by the SEC for treating bitcoin spot ETPs differently than comparable bitcoin futures products. “In the absence of a coherent explanation,” the court concluded, “this unlike regulatory treatment of like products is unlawful.” The court’s ruling requires the SEC to reconsider Grayscale’s application, but it does not require the SEC to approve the application. Opinion; Law360; Barron’s

12. Federal Court Dismisses Uniswap Class Action

On August 30, U.S. District Court Judge Katherine Polk Failla dismissed a class action suit brought against Uniswap and its developers and investors by users claiming that they lost money on scam tokens sold on the Uniswap platform. In dismissing the claims, Judge Failla reasoned in part that “the identities of the Scam Token issuers are basically unknown and unknowable” due to Ethereum’s “decentralized nature,” and that the plaintiffs’ claims therefore were akin to “attempting to hold an application like Venmo or Zelle liable for a drug deal that used the platform to facilitate a fund transfer.” Judge Failla also rejected the plaintiffs’ claims that Uniswap was liable for the losses under the Securities Exchange Act of 1934, refusing to “stretch the federal securities laws to cover the conduct alleged.” In rejecting the securities-law claims, Judge Failla stated in passing that ether and bitcoin are “crypto commodities,” potentially suggesting that she believes those assets are not subject to the securities laws at all. Judge Failla also is presiding over the SEC’s enforcement action against Coinbase. Opinion; Fortune; Bitcoinist

13. New York Federal Court Holds that Electronic Fund Transfer Act Does Not Apply to Certain Crypto Transactions

On August 11, Judge Lewis J. Liman dismissed a claim asserting that the Electronic Fund Transfer Act (EFTA) applies to cryptocurrency transactions. In Yuille v. Uphold HQ, Inc., No. 1:22-cv-07453 (S.D.N.Y. Aug. 11, 2023 ), a Michigan retiree sued Uphold HQ, a crypto trading platform and wallet provider, after a hacker drained $5 million from his account. The plaintiff argued in part that Uphold HQ failed to meet the requirements of the EFTA, which imposes obligations on financial institutions to expeditiously investigate and correct errors related to electronic fund transfers. Earlier this year, a different judge in separate suit against Uphold held that the term “electronic funds transfer” in the EFTA was capacious enough to include crypto transactions. Rider v. Uphold HQ Inc., 2023 WL 2163208 (S.D.N.Y. Feb. 22, 2023) (Cote, J.). Instead of resolving that issue, Judge Liman held that the plaintiff’s transactions fell outside the EFTA because his crypto wallet was not an “account,” which is defined under the Act to include only accounts “established primarily for personal, family, or household purposes.” Judge Liman held that the plaintiff’s crypto wallet account was instead established primarily for profit-making purposes. Opinion; Law360

14. Gemini Earn Customers Could Recover All Funds in New Proposed Renumeration Scheme

On September 13, bankrupt crypto lender Genesis and its parent company Digital Currency Group (DCG) filed a new proposed remuneration plan. Genesis and DCG stated that, under the proposal, over 230,000 creditors who used Gemini’s Earn program “are estimated to recover approximately 95-110% of their claims.” Gemini Earn was an investment program implemented by crypto exchange Gemini with financing from Genesis. Gemini Earn customers were affected when Genesis was forced to freeze withdrawals and its lending arm—Genesis Global Holdco LLC—filed for bankruptcy in January 2023. DCG hopes to file an amended version of the proposed plan by October 6, and solicit votes by December 5. On September 15, Gemini issued a statement criticizing the proposed plan as “misleading at best and deceptive at worst.” Gemini stated that “[r]eceiving a fractional share of interest and principal payments over seven years from an incredibly risky counterparty . . . is not even remotely equivalent to receiving the actual cash and digital assets owed today by Genesis to the Gemini Lenders.” Proposed Agreement; CoinTelegraph; CoinDesk; Gemini Filing

Speaker’s Corner

United States

15. Former SEC Chair Says Spot Bitcoin ETF Approval Is ‘Inevitable’

On September 1, former SEC chair Jay Clayton appeared on CNBC Television to discuss the SEC’s deferral of bitcoin ETP applications: “It is clear that bitcoin is not a security. It is clear that bitcoin is something that retail investors want access to, institutional investors want access to, and, importantly, some of our most trusted providers who are fiduciaries or have duties of best interest want to provide this product to the retail public. So I think [spot bitcoin ETP] approval is inevitable,” Clayton told CNBC. Clayton’s comments follow a federal court’s ruling in Grayscale v. SEC (discussed above) that there was no justification for the SEC to allow bitcoin futures-based ETPs but deny spot bitcoin ETPs. CNBC; The Block; Grayscale Opinion

16. SEC Chair Gary Gensler Testifies Before Senate Banking Committee

On September 12, SEC Chair Gary Gensler testified before the Senate Banking Committee in an SEC oversight hearing. In his prepared testimony, Gensler maintained his stance that most cryptocurrencies qualify as securities that should be regulated by the SEC: “As I’ve previously said, without prejudging any one token, the vast majority of crypto tokens likely meet the investment contract test.” Gensler also reiterated his strong criticism of the crypto industry: “I’ve never seen a field that’s so rife with misconduct,” said Gensler. “It’s daunting.” The most substantive discussion on digital assets came during questioning from Senator Cynthia Lummis (R-WY), who expressed concerns over Gensler issuing an SEC staff bulletin that would require companies to report customer crypto assets on their balance sheets. Also during the hearing, Chairman Sherrod Brown (D-OH) was highly critical of the crypto industry. “The problems we saw at FTX are everywhere in crypto—the failure to provide real disclosure, the conflicts of interest, the risky bets with customer money that was supposed to be safe,” said Brown. Brown also praised the SEC’s approach to regulating crypto: “I’m glad the SEC is using its tools to crack down on abuse and enforce the law.”

Gensler is scheduled to testify next before the House Financial Services Committee on September 27. These scheduled appearances follow mounting criticism from lawmakers over the SEC’s approach to regulating crypto, which they argue prioritizes enforcement over providing clear guidance. Sept. 12 Prepared Testimony; Sept. 12 Hearing; CryptoSlate; CryptoNews

International

17. Chinese Central Bank Official Says China’s Digital Yuan Must Be Available in All Retail Scenarios

During a trade forum in Beijing on September 3, Changchun Mu, the head of the digital currency research institute at the People’s Bank of China, said that an essential step for the development of China’s digital yuan “is to use digital yuan as the payment tool for all retail scenarios.” Although the digital yuan is being tested in pilot regions across China, it remains far from achieving widespread adoption. “In the short term, we can start by unifying QR code standards on a technical level to achieve barcode interoperability,” Mu added. Mu’s comments follow the Chinese central bank’s pledge last year to push for universal QR payment codes. The use of QR code payment systems, dominated by WeChat Pay and Alipay, is already widespread in China. The Block; CoinTelegraph

Other Notable News

18. SEC Defers Decisions on All Bitcoin ETFs

On August 31, the SEC delayed until October its decisions on all pending applications for a spot bitcoin exchange-traded product, which have been filed by BlackRock, Grayscale Investments, and others. The SEC’s decisions come days after Grayscale won a key victory over the SEC (discussed above), which many have viewed as clearing a path for the long-awaited product. Bloomberg; CoinDesk; PiOnline

19. Visa to Use Solana and USDC Stablecoin to Boost Cross-Border Payments

On September 5, Visa announced that it has expanded its stablecoin settlement capabilities with Circle’s USDC stablecoin to the Solana (SOL) blockchain. According to its statement, Visa is one of the first major financial institutions to use the Solana network at scale for settlements. “By leveraging stablecoins like USDC and global blockchain networks like Solana and Ethereum, we’re helping to improve the speed of cross-border settlement and providing a modern option for our clients to easily send or receive funds from Visa’s treasury,” said Cuy Sheffield, head of crypto at Visa, in a statement. CoinDesk; The Block

20. Vitalik Buterin Co-Authors Paper on Regulation-Friendly Tornado Cash Alternative

On September 9, Ethereum co-founder Vitalik Buterin published a research paper that he co-authored with Ethereum core developer Ameen Soleimani, researcher Jacob Illum from blockchain analytics firm Chainalysis, and academics Matthias Nadler and Fabian Schar. The paper proposes a privacy protocol called Privacy Pools. The core idea of the proposal is to allow users to publish a zero-knowledge proof, demonstrating that their funds do not originate from unlawful sources, without publicly revealing their entire transaction graph. The authors argue that this proposal, if implemented, could allow financial privacy and regulation to co-exist. SSRN; The Block

21. FTX, BlockFi, and Genesis Claimant Data Breached in Cyberattack

On August 25, Kroll LLC, announced that cybercriminals exposed data belonging to claimants in the FTX, BlockFi, and Genesis Global Holdco bankruptcies following a sophisticated cyberattack directed against Kroll employees. Kroll stated that a cybercriminal targeted a cell phone account belonging to one of its employees “in a highly sophisticated ‘SIM swapping’ attack.” Law360; CoinDesk

22. Ant Group Launches Overseas Blockchain Brand ZAN

On September 8, Ant Group—the owner of the world’s largest mobile payment platform, Alipay—launched ZAN, a new blockchain service aimed at Hong Kong and overseas markets. According to the official press release, ZAN “comprises of a full suite of blockchain application development products and services for both institutional and individual Web3 developers.” ZAN will also provide “a series of technical products, including electronic Know-Your-Customer (eKYC), Anti-Money Laundering (AML) and Know-Your-Transactions (KYT), to help Web3 businesses build up their capabilities in customer identity authentication, security protection and risk management.” Press Release; CoinTelegraph; The Block

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The following Gibson Dunn lawyers prepared this client alert:  Ashlie Beringer, Stephanie Brooker, Jason Cabral, M. Kendall Day, Jeffrey Steiner, Sara Weed, Ella Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Apratim Vidyarthi, Alexis Levine, Zachary Montgomery, and Tin Le.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s FinTech and Digital Assets practice group, or the following:

FinTech and Digital Assets Group:

Ashlie Beringer, Palo Alto (650.849.5327, aberinger@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Ella Alves Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)

M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)

Michael J. Desmond, Los Angeles/Washington, D.C. (213.229.7531, mdesmond@gibsondunn.com)

Sébastien Evrard, Hong Kong (+852 2214 3798, sevrard@gibsondunn.com)

William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)

Martin A. Hewett, Washington, D.C. (202.955.8207, mhewett@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Stewart McDowell, San Francisco (415.393.8322, smcdowell@gibsondunn.com)

Mark K. Schonfeld, New York (212.351.2433, mschonfeld@gibsondunn.com)

Orin Snyder, New York (212.351.2400, osnyder@gibsondunn.com)

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Eric D. Vandevelde, Los Angeles (213.229.7186, evandevelde@gibsondunn.com)

Benjamin Wagner, Palo Alto (650.849.5395, bwagner@gibsondunn.com)

Sara K. Weed, Washington, D.C. (202.955.8507, sweed@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.

Asian Legal Business named Gibson Dunn the “Tax and Trusts Firm of the Year” at the ALB Hong Kong Law Awards 2023. The awards recognize the exceptional performance of private practitioners and in-house counsel in Hong Kong. The awards were presented on September 15, 2023.

Gibson, Dunn & Crutcher’s Hong Kong office provides an extensive range of U.S., Hong Kong and English legal advice to global and Asia-based clients. We offer our clients all the advantages of deep local expertise combined with the strengths of a global firm. Our lawyers handle some of the most challenging and complex transactions, regulatory matters and disputes across Asia. Lawyers in the office have lived and worked in the region for many years and possess an in-depth understanding of Hong Kong’s legal and business culture. The Hong Kong team works closely with our Beijing and Singapore offices to provide complete and seamless legal services throughout Asia.

Gibson, Dunn & Crutcher LLP is pleased to announce that Kavita Davis has joined its Global Finance Practice Group as a partner in the London office.

Kavita focuses on cross-border debt finance matters, and has significant experience in advising on leveraged buyouts representing sponsors, including sponsors focusing on infrastructure transactions. She received her B.A., LL.B. (Hons) from the W.B. National University of Juridical Sciences in India, and is admitted as a solicitor in England and Wales.

Federico Fruhbeck, Co-Chair of Gibson Dunn’s Projects and Infrastructure Practice Group and Head of Private Equity in Europe, said: “Our lawyers know Kavita well, having worked closely with her on complex cross-border deals. Her practice has a great number of synergies with groups around the firm, as is evident, for example, with her significant experience representing sponsor clients in private equity acquisitions in the infrastructure, industrial and real assets space.” Doug Horowitz, Co-Chair of Gibson Dunn’s Global Finance Practice Group added: “Beyond being especially well known in the global infrastructure finance world, Kavita’s broad finance skill set allows her to be immediately impactful to our clients around the globe with English law finance needs.”

Penny Madden, Co-partner in charge of Gibson Dunn’s London office, said: “We are excited to welcome Kavita to the firm and to the London office. Over the last few years we have attracted fantastic talent to join our growing transactional practices in London, and her arrival strengthens our finance bench, allowing us to expand our offering to clients around the globe.”

Kavita noted: “It is a fantastic time to be joining Gibson Dunn’s growing finance practice and the firm’s focus on infrastructure transactions was a particular draw.”

Kavita’s hire follows a period of growth for Gibson Dunn’s Finance Practice Group over the past year, including with the arrivals of partners Doug Horowitz and Jin Hee Kim in New York; Frederick Lee in Dallas; Chad Nichols in Houston/New York; Ben Shorten and Trinh Chubbock in London; and Darko Adamovic in Paris. Her arrival also complements the strategic build out of the Projects and Infrastructure Practice Group, with high profile hires including Federico Fruhbeck, Alice Brogi, Rob Dixon, Wim De Vlieger, Till Lefranc and Isabel Berger in London; and Marwan Elaraby, Renad Younes, Laleh Shahabi, Jade Chu and Samuel Ogunlaja in the UAE.

Over the last two weeks, both the House of Commons and the House of Lords have considered the Economic Crime and Corporate Transparency Bill (“the Bill”). The government has described the Bill as the most significant reform of the identification doctrine in more than 50 years and the proposals have been welcomed by the UK’s Serious Fraud Office.

Although there is an outstanding point of contention for corporate criminal liability reform relating to the scope of the failure to prevent fraud offence, and in particular, whether it should be limited to large organisations, or expanded to non-micro organisations, the Bill is now in the final stages of its passage through Parliament and some commentators have indicated it could receive royal assent before the end of this year.

Key Takeaways The Bill proposes a number of changes to the current law including an expansion of the identification principle and a new offence of failure to prevent fraud. Organisations can be held liable for actions of “senior managers” for the purposes of prosecuting relevant economic crimes.  Organisations should identify and train individuals who fall within this definition. In anticipation of the new offence of failure to prevent fraud coming into force, organisations must ensure reasonable procedures are in place to prevent fraud.  This could include: carrying out a fraud risk assessment; updating existing policies to identify and mitigate fraud risk; ensuring staff are properly trained and retaining training records; and ongoing monitoring of risk and compliance with policies.

The identification principle – the current position

With the exception of a small number of specific offences, including the existing failure to prevent offences under the Bribery Act 2010 and the Criminal Finances Act 2017, in order for a corporate entity to be held criminally liable for the actions of an individual, that individual must be the “directing mind and will” of the corporate entity. This is called the “identification principle”.

The leading case on the identification principle is Tesco Supermarkets Ltd v Nattrass,[1] which states that one has to identify “those natural persons who by the memorandum and articles of association or as a result of action taken by the directors, or by the company in general meeting pursuant to the articles, are entrusted with the exercise of the powers of the company”, also referred to as the primary rule of attribution.

The principle has been narrowly applied and prosecutors have had difficulty satisfying the test in a number of high profile cases including The Serious Fraud Office v Barclays PLC and Barclays Bank PLC.[2] In that case, Davis LJ found that despite the defendants being senior executive directors and two of those defendants being on the board, their actions could not be attributed to Barclays because they had not been delegated entire authority to complete the relevant acts. Davis LJ noted that the “status” of an individual is a relevant consideration, but the focus should be on the particular authority bestowed by the company for the performance of the particular function in question.

The Barclays case and others like it have triggered debate about whether the identification principle, now over fifty years old, is fit for purpose when dealing with large multinational companies with complex management structures. As it stands, smaller companies with simpler structures are more exposed to criminal prosecution given the relative ease in demonstrating which individuals control and direct the company’s actions. This has prompted concern that larger companies are not being held to account for criminal wrongdoing carried out on their behalf. The proposals to reform corporate criminal liability laws, discussed below, seek to address these difficulties.

Proposed reforms

1. New approach to “attributing criminal liability for economic crimes to certain bodies”

Rather than relying on the identification principle, under the new legislation, the corporate entity will be liable for actions committed by a “senior manager” acting within the actual or apparent scope of their authority.

“Senior manager” is defined as an individual who plays a significant role in:

• the making of decisions about how the whole or a substantial part of the activities of the body corporate or partnership are to be managed or organised, or
• the actual managing or organising of the whole or a substantial part of those activities.[3]

This definition is adopted from the Corporate Manslaughter and Corporate Homicide Act 2007. The Explanatory Notes to the Corporate Manslaughter and Corporate Homicide Act 2007 state that this covers both individuals in the direct chain of management, and those in, for example, strategic or regulatory compliance roles.[4] The practical impact is that the pool of potential employees whose criminal conduct could be attributed to a corporate body is widened potentially very substantially.

At this stage, the reforms to the way in which liability is attributed to an organisation will only apply to economic crimes specified in the Bill, such as offences relating to fraud, bribery, theft, false accounting and concealing criminal property.[5] However, whilst the current focus is on economic crimes (which reportedly make up over 40% of crime in the UK[6]), the government has “committed in the Economic Crime Plan 2 and the Fraud Strategy to introduce reform of the identification principle to all criminal offences in due course”.[7]

The explanatory notes to amendments made by the House of Lords following the third reading in July 2023 state that the Bill “ensures that criminal liability will not attach to an organisation based and operating overseas for conduct carried out wholly overseas, simply because the senior manager concerned was subject to the UK’s extraterritorial jurisdiction: for instance, because that manager is a British citizen […] However, certain offences, regardless of where they are committed, can be prosecuted against individuals or organisations who have certain close connections to the UK. Any such test will still apply to organisations when the new rule applies”.[8]

The reform of the identification principle is intended to make it easier for authorities to pursue corporates for primary fraud and bribery offences rather than just failure to prevent offences. Although “senior manager” is now defined, it will still be subject to judicial interpretation and the courts may favour a narrow interpretation, as in The Serious Fraud Office v Barclays PLC and Barclays Bank PLC.[9] The government has also concluded in its Impact Assessment that whilst the reforms to the identification principle are expected to increase the number of corporate prosecutions, the number of additional cases is expected to be low.[10]

2. Failure to prevent fraud

In addition to broadening the general scope for corporate criminal liability, a new corporate offence of failure to prevent fraud will also be introduced. This new offence borrows from both the existing offences of failure to prevent bribery under the Bribery Act 2010 and failure to prevent the facilitation of tax evasion under the Criminal Finances Act 2017.

Under the new offence, if they meet specific criteria, large corporates and partnerships will be held criminally liable where:

• a specified fraud offence is committed by an employee or agent (such as fraud by false representation, fraud by abuse of position or fraud by failing to disclose information); and
• the offence benefits the organisation.

The prosecution must establish both limbs of the offence set out above. However the company will have a defence if it can show it either had “reasonable procedures” in place to prevent the fraud, or that it was not reasonable to have relevant procedures at all. This is said to place a lesser burden on organisations than the requirement to have “adequate procedures” under the Bribery Act 2010.[11] As with the Bribery Act and the Criminal Finances Act there is a requirement for the government to issue “guidance about procedures that relevant bodies can put in place to prevent persons associated with them from committing fraud offences”.[12] This has not yet been issued but it is likely to include detailed policies, procedures and training.

The House of Lords disagreed with the House of Commons that the failure to prevent fraud offence should only apply to large organisations. They voted to amend the Bill so that the offence applies to “non-micro organisations” which satisfy two or more of the following conditions in a financial year: (i) turnover of more than £632,000 and less than £36 million; (ii) a balance sheet total of more than £316,000 and less than £18 million; and (iii) more than 10 but less than 250 employees.[13] In support of this amendment, Lord Garnier referred to the fact there is no exemption for small and medium enterprises for the offence of failure to prevent bribery and proposed that only the very smallest and newest commercial organisations should be exempted from the failure to prevent regime.[14] The Commons rejected these amendments on Wednesday 13 September and the Bill has been returned to the Lords for further consideration.

Extraterritorial reach

The failure to prevent fraud offence has wide extraterritorial effect, applying to a body corporate or a partnership wherever they are incorporated or formed.[15] The government factsheet summarising the failure to prevent fraud offence explains that: “if an employee commits fraud under UK law, or targeting UK victims, their employer could be prosecuted, even if the organisation (and the employee) are based overseas”.[16]

Impact

The failure to prevent fraud offence is making headlines and will inevitably need to be given serious consideration by large organisations. The new legislation is designed to close “loopholes that have allowed organisations to avoid prosecution in the past”.[17]

The government believes that the changes will “result in a deterrent effect where increased awareness and corporate liability may deter would-be fraudsters”. [18] Perhaps most compellingly, the government intends that the legislation will create cultural change and encourage the development of an anti-fraud culture within organisations.[19]

Post-legislative scrutiny of the Bribery Act 2010 identified a changing and improved corporate anti-bribery culture following the introduction of the failure to prevent bribery offence. The government hopes that the proposed changes will have a similar impact for fraud and will promote a corporate culture in which fraud detection and prevention are encouraged.[20]

It is not clear how many prosecutions the failure to prevent fraud offence will give rise to – the Serious Fraud Office (“SFO”) has only prosecuted two corporations for failure to prevent bribery since the Bribery Act came into force in 2011.[21] On the other hand, the offence of failure to prevent bribery has featured in nine of the twelve deferred prosecution agreements (“DPAs”) entered into since DPAs were introduced in February 2014.  The SFO is likely to take a similar approach to prosecuting failure to prevent fraud offences.

Practical steps

In anticipation of the Economic Crime and Corporate Transparency Act coming into force, we have set out some practical steps to be considered:

• Risk assessments: carry out and document appropriate risk assessments, identifying relevant fraud risks.
• Reasonable policies and procedures: identify and update relevant existing policies or introduce new policies to ensure the new offences are taken into account and to mitigate the fraud risks identified in the risk assessment.
• Reporting: ensure appropriate channels are in place for reporting suspicions of fraud.
• Identification of potential senior managers: identify which individuals and roles may fall into the definition of “senior manager”. Ensure those individuals receive adequate training on fraud risk and applicable policies and procedures and are appropriately monitored.
• Raising awareness within the company: provide adequate training to employees to embed fraud policies and procedures and ensure that employees are aware of appropriate channels for reporting suspicions of fraud. Records of this training should be retained.
• Ongoing monitoring: procedures should be put in place for the ongoing monitoring of fraud risk, compliance with relevant policies and procedures (including the effectiveness of fraud detection processes), and the conduct of individuals. Companies should monitor and review their effectiveness on a regular basis to ensure that necessary improvements are made when required.

Whilst the timeline for the Bill receiving royal assent and being implemented is uncertain, it is important to understand the proposed changes and how to prepare for their implementation. The reforms demonstrate a cultural change and appetite for greater scrutiny of corporate entities. It will be interesting to see how they are used by law enforcement authorities once the Bill is passed.

Irrespective of the final content of the Bill, there is no doubt that it is a significant change for the corporate criminal liability landscape within the UK.
_____________________________

[1] [1972] AC 153.

[2] [2018] EWHC 3055 (QB).

[3] https://bills.parliament.uk/publications/51963/documents/3729.

[4] https://www.legislation.gov.uk/ukpga/2007/19/section/1/notes?view=plain.

[5] https://bills.parliament.uk/publications/51963/documents/3729.

[6] https://www.gov.uk/government/publications/fraud-strategy/fraud-strategy-stopping-scams-and-protecting-the-public.

[7] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-identification-principle-for-economic-crime-offences.

[8] https://hansard.parliament.uk/lords/2023-06-27/debates/EF8264AF-6478-470E-8B37-018C4B278F6E/EconomicCrimeAndCorporateTransparencyBill.

[9] [2018] EWHC 3055 (QB).

[10] See attachment here.

[11] See attachment here.

[12] Section 203 of the Bill https://bills.parliament.uk/publications/51963/documents/3729.

[13] https://publications.parliament.uk/pa/bills/cbill/58-03/0363/220363.pdf.

[14] https://hansard.parliament.uk/Lords/2023-09-11/debates/181F85C9-5619-4DAF-BD42-327C0DAF036F/EconomicCrimeAndCorporateTransparencyBill.

[15] https://bills.parliament.uk/publications/52462/documents/3896.

[16] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-failure-to-prevent-fraud-offence.

[17] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-failure-to-prevent-fraud-offence.

[18] See attachment here.

[19] https://bills.parliament.uk/publications/50688/documents/3279.

[20] https://bills.parliament.uk/publications/50688/documents/3279.

[21] https://bills.parliament.uk/publications/50688/documents/3279.

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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 White Collar Defense and Investigations practice group, or the following authors in London:

Michelle M. Kirschner (+44 20 7071 4212, mkirschner@gibsondunn.com)
Matthew Nunan (+44 20 7071 4201, mnunan@gibsondunn.com)
Allan Neil (+44 20 7071 4296, aneil@gibsondunn.com)
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Maria Bračković (+44 20 7071 4143 mbrackovic@gibsondunn.com)
Amy Cooke (+44 20 7071 4041, acooke@gibsondunn.com)
Rebecca Barry (+44 20 7071 4086, rbarry@gibsondunn.com)

We have seen many notable developments in securities law during the first half of 2023 across a number of different areas.  This update provides an overview of those major developments in federal and state securities litigation since our 2022 Year-End Securities Litigation Update:

• We discuss major Supreme Court decisions from October Term 2022, and preview several significant grants of certiorari. In addition, we examine circuit court-level developments that may end up before the Supreme Court.
• We review significant developments in Delaware corporate law, including a number of decisions concerning fiduciary duties in the context of a merger or acquisition, and the intersection of Unocal, Schnell, and Blasius when board action implicates the stockholder franchise.
• We examine developments in federal securities litigation involving special purpose acquisition companies (“SPACs”). As fewer SPAC IPOs and de-SPAC transactions occur, relative to the peak in 2021, we have also seen fewer new SPAC-related cases filed.  Earlier SPAC-related litigation continues to proceed through courts—we discuss a proposed class action settlement and two recent decisions on statutory standing.
• We examine developments in securities litigation involving environmental, social, and corporate governance (“ESG”) allegations.
• We survey litigation in the cryptocurrency space as courts continue to grapple with the application of securities laws to cryptocurrencies.
• We discuss the shareholder activism landscape, including recent proxy battles and new SEC regulations related to shareholder proposals and proxy elections that could potentially encourage shareholder activists going forward.
• We continue to monitor the emergence of a potential circuit split regarding the Supreme Court’s 2019 decision in Lorenzo, which allows scheme liability under Rule 10b-5(a) and (c) even if the disseminator did not “make” the statement within the meaning of Rule 10b-5(b). As discussed in our 2022 Mid-Year Securities Litigation Update, a number of courts have grappled with the effects of Lorenzo.  In particular, the Second Circuit in SEC v. Rio Tinto provided some clarity for district courts within the Circuit by finding that “something extra” is required beyond misstatements for there to be scheme liability.  A recent district court opinion in California, however, acknowledged that the Ninth Circuit has not adopted Rio Tinto.
• Finally, we discuss the Second Circuit’s long-awaited decision in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., and a district court’s application of Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System in denying class certification in part.

I. Filing and Settlement Trends

With thanks to analysis from Cornerstone Research, new filings have increased from 93 total securities class action filings in the first half of 2022 to 114 filings in the first half of 2023.  Although the median value of settlements has increased compared to the same period in 2022, the number and total value of settlements are lower than any year since 2017.  SPAC-, COVID-19-, and cryptocurrency-related filings continue to be a focus, even as the nature of such suits continues to evolve.

A. Filing Trends

Figure 1 below reflects the semiannual filing rates dating back to 2014 (all charts courtesy of Cornerstone Research).  For the fourth six-month period in a row, new filings remained at or below the historical semiannual average.  Notably, at 114, filings in the first half of 2023 barely top 50% of the average semi-annual filing rates seen between 2017 and 2019, though this deficit is largely driven by a substantial decrease in M&A-related filings.  The 110 total new “core” cases—i.e., securities cases without M&A allegations—filed in the first half of 2023 represent a modest increase from the semi-annual periods since the first half of 2021.

Figure 1:

Semiannual Number of Class Action Filings (CAF Index®)
January 2014 – June 2023

As illustrated in Figure 2 below, cryptocurrency-related actions are nearly on pace to match the record high set in 2022.  The annualized number of COVID-19 and SPAC-related filings are markedly lower than prior years.  Cybersecurity-related actions are on pace to be in line with historical averages.

Figure 2:

Summary of Trend Cases—Core Federal Filings
2019 – June 2023

B. Settlement Trends

The first half of 2023 has seen fewer settlements and less total settlement value than any semi-annual period since 2017.  Just 32 settlements have been approved through June 2023.  Similarly, as reflected in Figure 3, the total settlement value in the first half of 2023 is just $700 million, down from a high of $4.4 billion in the first half of 2018 and $2.3 billion in the previous semi-annual period.  The low total settlement value is largely a product of fewer settlements and fewer large settlements (there has only been one settlement greater than or equal to $100 million through June 2023).  The median value of settlements approved in the first half of 2023 is nonetheless $16.3 million, however, an increase of over 25% from the median value for the same period in 2022.

Figure 3:

II. What to Watch for in the Supreme Court

A. Recent Supreme Court Decisions

1. Slack Prevails at the Supreme Court

On June 1, 2023, the Supreme Court unanimously held that in a direct listing (as in traditional initial public offerings), a plaintiff who claims that a company’s registration statement is misleading and who sues under Section 11 of the Securities Act of 1933 must plead and prove that they bought shares registered under that registration statement.  Slack Techs., LLC v. Pirani, 143 S. Ct. 1433 (2023).  See our 2022 Year-End Securities Litigation Update for additional background on the case.

The Court’s opinion adopted the longstanding “tracing” requirement, noting that although “direct listings are new, the question how far § 11(a) liability extends is not,” and that “every court of appeals to consider the issue . . . reached the . . . conclusion”—like the Court—that “[t]o bring a claim under § 11, the securities held by the plaintiff must be traceable to the particular registration statement alleged to be false or misleading.”  Slack Techs, 143 S. Ct. at 1440–41.  In so concluding, the Court rejected Pirani’s textual argument—that the key phrase, “such security,” “should [be] read . . . to include other securities that bear some sort of minimal relationship to a defective registration statement”—and his arguments “from policy and purpose.”  Id. at 1441.  And in rejecting Pirani’s view of Section 11, the Court avoided an interpretation that could have unsettled the scope of liability under that section in cases beyond direct listings, including traditional IPOs and follow-on offerings.  The Court’s holding thus protects reasonable expectations and avoids a potentially massive increase in litigation for companies that recently went public.

The Court, however, declined to resolve whether Section 12 of the ‘33 Act, which enforces the Act’s prospectus requirement and permits anyone who buys “such security” from the defendant to sue, 15 U.S.C. § 77l(a)(1), likewise requires proof of purchase of registered shares.  It “express[ed] no views” about that question and remanded the matter to the lower courts to decide that question in the first instance.  Id. at 1442 n.3.  Gibson Dunn will provide further updates on this case and related issues as they arise.

Gibson Dunn represented Slack Technologies, LLC in the case.  Thomas Hungar, a Gibson Dunn partner in the Washington, D.C. office, argued the case on its behalf.

2. Axon and Cochran Prevail at the Supreme Court

As detailed in our 2022 Year-End Securities Litigation Update, the Supreme Court heard oral argument in Securities and Exchange Commission v. Cochran, No. 21-1239, and a companion case, Axon Enterprise, Inc. v. Federal Trade Commission, No. 21-86, on November 7, 2022.

On April 14, 2023, the Supreme Court issued its decision and determined that “the review schemes set out in the Exchange Act and the FTC Act do not displace district court jurisdiction over Axon’s and Cochran’s far-reaching constitutional claims.”  Axon Enter., Inc. v. Fed. Trade Comm’n, 143 S. Ct. 890, 900 (2023).  In reaching its conclusion, the Court considered the three factors set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994):  (1) whether precluding district court jurisdiction could “foreclose all meaningful judicial review” of the claim, (2) whether the claim is “wholly collateral” to the statute’s review provisions, and (3) whether the claim is “outside the agency’s expertise,” Axon, 143 S. Ct. at 900.

In an opinion authored by Justice Kagan, the Court found all three factors weighed in favor of federal court jurisdiction.  First, relying on internal administrative review would “foreclose all meaningful judicial review” because Cochran and Axon would lose their “rights not to undergo the complained-of agency proceedings if they cannot assert those rights until the proceedings are over.”  Id. at 904.  Second, Axon’s and Cochran’s claims had “nothing to do with either the enforcement-related matters the Commissions regularly adjudicate or those they would adjudicate in assessing the charges against Axon and Cochran,” and were thus wholly collateral.  Id. at 904–05.  Finally, Axon’s and Cochran’s constitutional assertions were “outside the agency’s expertise.”  Id. at 905.

B. Grants of Certiorari

1. Murray v. UBS Securities, LLC – Retaliation Under Sarbanes-Oxley

On May 1, 2023, the Supreme Court granted certiorari in Murray v. UBS Securities LLC, et al., a case arising from the Second Circuit that could impact the ability of whistleblowers to bring claims of retaliation under 18 U.S.C. § 1514A of the Sarbanes-Oxley Act (“SOX”).  See 143 S. Ct. 2429 (2023).  The case is scheduled to be argued on October 10, 2023.

The case concerns a SOX retaliation claim by former UBS employee Trevor Murray.  See Murray v. UBS Securities LLC, et al., 43 F.4th 254, 256 (2d Cir. 2022).  UBS had hired Murray as a strategist supporting its commercial mortgage-backed securities business.  Id.  After “a shift in strategy prompted by financial difficulties,” which resulted in a “series of reductions in force,” UBS terminated his employment.  Id. at 257.  Murray alleged that he was terminated because he had reported being pressured “to skew his research and to publish reports to support their business strategies.”  Id. at 256–57.

In 2014, Murray sued UBS, and a jury returned a verdict in his favor.  Id. at 258.  UBS appealed, arguing the district court committed reversible error when it failed to instruct the jury that a SOX whistleblower claim requires a showing of the employer’s retaliatory intent.  Id. at 256.  The Second Circuit agreed with UBS, finding “retaliatory intent is an element of a section 1514A claim,” a conclusion that “flow[ed] from the plain meaning of the statutory language and [wa]s supported by [the Second Circuit’s] interpretation of nearly identical language in the [Federal Railroad Safety Act].”  Id. at 262–63.  The Second Circuit thus vacated the district court’s judgment and remanded for a new trial.  Id. at 263.

The Supreme Court subsequently granted review.  In his opening brief filed on June 27, 2023, Murray argued that a plaintiff under the burden-allocation regime applicable to SOX retaliation claims need not prove “retaliatory intent.”  In response, in its brief filed on August 8, 2023, UBS argued that SOX’s statutory language—which prohibits “discrimination … because of” protected activity—requires a plaintiff to show discriminatory intent and that the burden-allocation framework does not alter that requirement.

Gibson Dunn attorneys Eugene Scalia, Thomas Hungar, and Gabrielle Levin represent UBS Securities LLC and UBS AG.

2. SEC v. Jarkesy – Constitutional Challenges to the SEC’s Enforcement Powers

On June 30, 2023, the Supreme Court granted the SEC’s petition for writ of certiorari in Securities and Exchange Commission v. Jarkesy, 2023 WL 4278448, at *1 (U.S. June 30, 2023).  The case presents three questions:  (1) “Whether statutory provisions that empower the Securities and Exchange Commission (SEC) to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violate the Seventh Amendment”; (2) “Whether statutory provisions that authorize the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine”; and (3) “Whether Congress violated Article II by granting for-cause removal protection to administrative law judges in agencies whose heads enjoy for-cause removal protection.”  See Petition for a Writ of Certiorari, Securities and Exchange Commission v. Jarkesy, No. 22-859, at (ii) (Mar. 8, 2023).

On May 18, 2022, the Fifth Circuit issued an opinion holding that (1) the Jarkesy parties were deprived of their Seventh Amendment right to a jury trial, (2) Congress “unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power,” and (3) the “statutory removal restrictions on SEC ALJs violate Article II.”  Jarkesy v. SEC, 34 F.4th 446, 451 (5th Cir. 2022).  As to the first, the court reasoned that because the right to a jury trial attaches to “traditional actions at law,” and enforcement proceedings carrying civil penalties are “akin” to those “traditional actions,” parties to such enforcement proceedings have a jury trial right.  Id. at 451.  In addition, the Court rejected the SEC’s argument that “the action [it] brought . . . [wa]s . . . the sort that may be properly assigned to agency adjudication under the public-rights doctrine.”  Id. at 455–57.  As to the second, the Fifth Circuit explained that because “Congress . . . delegated to the SEC what would be legislative power absent a guiding intelligible principle”—i.e., the power to bring securities fraud actions for monetary penalties within the agency instead of in an Article III court—and Congress failed to “provide the SEC with an intelligible principle by which to exercise that power,” “Congress unconstitutionally delegated legislative power to the SEC.”  Id. at 460–62.  Finally, the Court reasoned that because ALJs “perform substantial executive functions,” the two layers of for-cause removal restrictions are an unconstitutional impediment to the Article II requirement that the President “take Care that the Laws be faithfully executed.”  Id. at 463.

In its petition for certiorari, the SEC argued that all three of these “highly consequential” conclusions warrant the Court’s review, as they “call[] into question longstanding practices at the SEC and many other agencies.”  Petition for a Writ of Certiorari, at 9.  Among other things, the SEC argued that “[u]nder [a] long line of precedent, SEC administrative adjudications seeking civil penalties qualify as matters involving public rights,” id. at 11; “[t]he Commission’s decision whether to pursue an administrative or judicial remedy in a particular case is a core executive function” rather than an “exercise of legislative power,” id. at 13; ALJs are not improperly insulated because, inter alia, they “perform adjudicative rather than enforcement or policymaking functions,” id. at 18 (quoting Free Enter. Fund v. PCAOB, 561 U.S. 477, 507 n.10 (2010)), and the standard for their removal is “less stringent than the removal standard . . . held invalid in Free Enterprise Fund;” and the Merit Systems Protection Board’s “involvement in reviewing the removal of ALJs” does not “contribute[] to the violation of Article II,” id. at 18–19.

3. Loper Bright Enterprises v. Raimondo – Chevron’s Vitality

On May 1, 2023, the Supreme Court granted certiorari in Loper Bright Enterprises v. Raimondo.  It presents the question of whether the Supreme Court should overrule Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984), “or at least clarify that statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute an ambiguity requiring deference to the agency.”  Petition for Writ of Certiorari, Loper Bright Enters. v. Raimondo, No. 22-451 (Nov. 10, 2022); Loper Bright Enters. v. Raimondo, 143 S. Ct. 2429 (2023).

The case involves a group of commercial fishing companies and certain actions taken by the National Marine Fisheries Service (“the Service”).  Loper Bright Enters., Inc. v. Raimondo, 45 F.4th 359, 363 (D.C. Cir. 2022).  Specifically, “[i]n implementing an Omnibus Amendment that establishes industry-funded monitoring programs in New England fishery management plans, [the Service] promulgated a rule that required industry to fund at-sea monitoring programs.”  Id.  The group of commercial fishing companies then sued, “contend[ing] that the [Magnuson-Stevens Fishery Conservation and Management Act of 1976 (the “Act”)] does not specify that industry may be required to bear such costs and that the process by which the Service approved the Omnibus Amendment and promulgated the Final Rule was improper.”  Id.

The district court ruled in favor of the Government, and the D.C. Circuit, relying partly on the limited scope of review permitted by Chevron, 467 U.S. 837, affirmed.  Chevron requires courts to evaluate the Government’s interpretation of certain statutes by asking first “whether Congress has spoken clearly,” and if not, then, second, “whether the implementing agency’s interpretation is reasonable.”  Loper Bright, 45 F.4th at 365.  Here, the D.C. Circuit concluded that “[a]lthough the Act may not unambiguously resolve whether the Service can require industry-funded monitoring, the Service’s interpretation of the Act as allowing it to do so [wa]s reasonable.”  Id.; see also id. at 370.

C. Circuit-Level Developments

1. Lee v. Fisher – Potential Circuit Split on Forum Selection Clauses and Section 14

On June 1, 2023, an en banc panel of the Ninth Circuit issued its opinion in Lee v. Fisher, thereby furthering a potential split with the Seventh Circuit.  70 F.4th 1129 (9th Cir. 2023).  As discussed in our 2022 Year-End Securities Litigation Update, Lee concerns whether investors can file derivative suits in federal court when a company’s bylaws contain a forum-selection clause that mandates such cases be filed in Delaware state court.  In Seafarers Pension Plan v. Bradway, the Seventh Circuit held that a forum-selection clause similar to the one at issue in Lee was not enforceable.  23 F.4th 714, 724 (7th Cir. 2022).

In contrast to the Seventh Circuit, the Ninth Circuit held that the at-issue forum selection clause contained in the company’s bylaws, which required “any derivative action or proceeding brought on behalf of the Corporation” to be adjudicated in the Delaware Court of Chancery, was enforceable.  Lee, 70 F.4th at 1138.  First, the Court held that the forum selection clause did not waive substantive compliance with the Exchange Act, i.e., compliance with the obligation not to make false or misleading statements in a proxy statement.  The court explained that Lee could enforce substantive compliance through direct claims that are outside the ambit of the forum selection clause.  See Lee, 70 F.4th at 1139; see also id. at 1139 n.5 (“Lee can also enforce the substantive obligation to refrain from making false or misleading statements in a proxy statement under Delaware law.”).  It also rejected Lee’s argument that “the forum selection clause conflicts with § 29(a)’s antiwaiver provision” because it forecloses the “right to bring a derivative § 14(a) action,” explaining, among other things, that § 29(a) does not “forbid . . . waiver of a particular procedure for enforcing such duties.”  Id. at 1141.  Next, the court rejected Lee’s argument—which relied largely on J.I. Case Co. v. Borak, 337 U.S. 426 (1964)—that there is a strong public policy “of allowing shareholders to bring a § 14(a) derivative action.”  Id. at 1143.  The court observed, among other things, that “the [Supreme] Court now looks to state law rather than federal common law to fill in gaps relating to federal securities claims, and under Delaware law, a § 14(a) action is direct, not derivative.”  Id. at 1149.  The court further noted that the Supreme Court “now views implied private rights of action with disapproval, construing them narrowly, and casting doubt on the viability of a corporation’s standing to bring a § 14(a) action.”  Id.  The court also rejected Lee’s argument that enforcement of the forum selection clause would conflict with “the federal forum’s strong public policy of giving federal courts exclusive jurisdiction over Exchange Act claims under § 27(a).”  Id. at 1150–51.  Last, the court held that because “the Delaware Supreme Court has indicated that federal claims like Lee’s derivative § 14(a) action are not ‘internal corporate claims’ as defined in Section 115, and because no language in [Delaware precedent], Section 115, or the official synopsis operates to the limit the scope of what constitutes a permissible forum-selection bylaw under Section 109(b),” the forum-selection clause was valid under Delaware law.  Id. at 1156.

Some had criticized the original Lee opinion for potentially foreclosing federal courts as a forum to hear federal derivative suits.  Under the en banc court’s reasoning, however, that criticism rests on a mistaken premise.  Whereas Seafarers concluded that “Section 14(a) may be enforced . . . in derivative actions asserting rights of a corporation harmed by a violation,” 23 F.4th at 719 (citing Borak, 337 U.S. at 431–32), the en banc panel all but held that federal derivative actions are outside the scope of the Exchange Act, see, e.g., Lee, 70 F.4th at 1147 (“[T]he injury caused by a violation of § 14(a) gives rise to a direct action under Delaware law, not a derivative action.”); id. at 1149 (“Virginia Bankshares casts grave doubt on whether a shareholder can bring a derivative § 14(a) action on behalf of a corporation. . . .  [T]he [Supreme] Court now views implied private rights of action with disapproval, construing them narrowly, and casting doubt on the viability of a corporation’s standing to bring a § 14(a) action.”); id. at 1158 (“The Seventh Circuit . . . misread Borak.”).

2. Chamber of Commerce v. SEC – Challenges to the SEC’s Share-Repurchase Final Rule

On May 12, 2023, the U.S. Chamber of Commerce filed a Petition for Review challenging the SEC’s recently announced share-repurchase rule.  Petition For Review, Chamber of Com. of the United States v. SEC, No. 23-60255 (May 16, 2023).  As detailed in a recent Client Update, it requires companies to:  (1) disclose daily repurchase data in a new table filed as an exhibit to Form 10-Q and Form 10-K, (2) indicate by a check box whether any executives or directors traded in the company’s equity securities within four business days before or after the public announcement of the repurchase plan or program or the announcement of an increase of an existing share repurchase plan or program, (3) provide narrative disclosure about the repurchase program, including its objectives and rationale, in the filing, and (4) provide quarterly disclosure regarding the company’s adoption or termination of any Rule 10b5-1 trading arrangements.  Share Repurchase Disclosure Modernization, Release Nos. 34-97424; IC-34906; File No. S7-21-21.  The Chamber of Commerce contends that the rule disincentivizes companies from using stock buybacks and violates both the Administrative Procedure Act and the First Amendment.  Press Release, U.S. Chamber of Commerce, U.S. Chamber Sues the Securities and Exchange Commission Over Stock Buyback Rule (May 12, 2023).

3. Update on Goldman Sachs Group v. Arkansas Teacher Retirement System

On August 9, 2023, the Second Circuit issued its long-awaited decision in Arkansas Teacher Retirement System v. Goldman Sachs Group Inc., No. 22-484.  As noted in our 2022 Year-End Securities Litigation Update, oral argument was held on September 21, 2022, before a panel consisting of Judges Richard Sullivan, Denny Chen, and Richard Wesley.  In an opinion by Judge Wesley, the Second Circuit concluded that Goldman successfully rebutted Basic’s presumption of reliance and decertified the class.  For a detailed discussion of the case, see the Market Efficiency and “Price Impact” Cases section in Part IX, infra.  We will report on any future developments.

III. Delaware Developments

The Delaware Supreme Court has said that Delaware’s “corporate law is not static,” Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del. 1985), and that was certainly true in the last half-year.  In some areas, Delaware courts held steady, affirming, for example, that controllers who distance themselves from conflicted transactions can win court approval, that transactions that are fair to minority stockholders can withstand scrutiny under the entire fairness standard, and that backchanneled mergers may fail to pass muster.  In other areas, Delaware law marched forward with trends that began last year.  For example, the Court of Chancery continued its developing trend of applying entire fairness to SPAC deals.  And still elsewhere, Delaware courts broke new ground, raising the bar for merger-disclosure strike suits and reshaping the standards for board measures in control contests.

A. Delaware Carves Path for Conflicted Controllers in Oracle

In May 2023, the Delaware Court of Chancery ruled in favor of Oracle founder Larry Ellison in a lawsuit arising from Oracle’s $9.3 billion acquisition of NetSuite.  In re Oracle Corp. Derivative Litig., 2023 WL 3408772 (Del. Ch. May 12, 2023).  The court held that Ellison was not a controlling stockholder and therefore the transaction was governed by the business judgment rule.  Id. at *27.

In January 2016, Oracle’s board of directors created a special committee to assess a potential takeover of NetSuite, a company co-founded and partly owned by Ellison.  Id. at *4, *6.  Oracle announced a tender offer for NetSuite in July 2016 for $109 per share.  Id. at *14–15.  After the purchase, Oracle stockholders sued, alleging that, in spite of the independent committee, Ellison’s status as Oracle’s controller meant the board lacked independence and that Ellison had forced the company to overpay for NetSuite for his personal benefit.  Id. at *18.  In 2018, the court denied Ellison’s motion to dismiss.  Id. at *16.

After trial, the court issued a decision holding that even though “[p]laintiff-friendly presumptions” that Ellison’s roughly 25% holdings in Oracle and control over its actions meant the board was conflicted “were sufficient to carry this matter to trial,” the post-trial evidence did not support this theory.  Id. at *2.  The court distinguished earlier cases holding that minority stockholders caused a conflict because of a “combination of [their] stock holdings” and “affirmative actions taken to control the transaction.”  Id. at *26.  It noted that Ellison “neither possessed voting control, nor ran the company de facto,” and emphasized that even though he “had the potential to control the transaction at issue . . . he scrupulously avoided influencing the transaction.”  Id. at *27.  Accordingly, the business judgment rule applied.  Id. 

Oracle demonstrates that although Delaware courts may find that a minority holder is a controller and entire fairness applies for pleading-stage purposes, it is still possible for a putative controller to avoid application of that exacting standard at trial where he or she actively removes him or herself from the transaction at issue.

B. Mixed Verdict for Drag-Along Covenants Not to Sue

In May 2023, the Delaware Court of Chancery refused to enforce an explicit covenant not to sue over a drag-along sale.  New Enter. Assocs. 14, L.P. v. Rich, 295 A.3d 520 (Del. Ch. 2023).  The court explained that as a matter of public policy, a covenant not to sue cannot insulate defendants from tort liability based on intentional wrongdoing.  Id. at 536.  The court clarified that covenants not to sue for fiduciary-duty breaches are not facially invalid and signaled a continued receptiveness to some tailoring of fiduciary duties, despite the outcome of this decision.  Id. at 530–31.  We discussed the decision and its implications in more detail in our May 8, 2023 M&A Report.

C. Court Finds Merger Backchannelling Caused Conflict

In April 2023, Chancellor McCormick held that the CEO of software company Mindbody Inc. violated his fiduciary duties by tilting the company’s sales process in favor of a private-equity buyer.  In re Mindbody, Inc. S’holder Litig., 2023 WL 2518149 (Del. Ch. Mar. 15, 2023).  The suit followed Mindbody’s 2019 take-private transaction by Vista Equity Partners.  Id.  According to the court, the CEO was motivated by a personal need for liquidity and had been partial to Vista throughout the process.  Id. at *2, *35.  His backchanneling with Vista as the company’s formal sale process continued was, the court concluded, a breach of fiduciary duties.  Id. at *35–38.  He also breached his duty of disclosure by failing to disclose several meetings he had with Vista, including attending a private summit that it hosted.  Id. at *1, *9, *12, *36.  This case is discussed further in our April 10, 2023 M&A Report.

D. Supreme Court Affirms Tesla’s Acquisition of SolarCity Was Entirely Fair

The Delaware Supreme Court recently affirmed the Delaware Court of Chancery’s holding that Tesla’s 2016 acquisition of SolarCity was entirely fair to Tesla’s stockholders.  In re Tesla Motors, Inc. S’holder Litig., — A.3d —, 2023 WL 3854008 (Del. June 6, 2023) (Tesla II).  In 2016, Tesla stockholders accused Elon Musk of forcing Tesla’s board to overpay for SolarCity, a producer of solar panels that the plaintiffs claimed was insolvent at the time.  Id. at *1.  In addition to his Tesla leadership role, Musk was the chairman of SolarCity and the company’s largest stockholder.  Id. at *2.  The Court of Chancery had held, after trial, that the transaction process and price were ultimately fair despite Musk’s participation.  In re Tesla Motors, Inc. S’holder Litig., 2022 WL 1237185, at *2 (Del. Ch. Apr. 27, 2022) (Tesla I).  The high court’s June opinion in Tesla II affirmed that finding.  2023 WL 3854008, at *2.

The Delaware Supreme Court’s opinion reaffirms and clarifies several aspects of the entire fairness analysis.  The plaintiffs had made a number of arguments on appeal as to why the trial court erred in applying that standard, but the court rejected each in turn.  See Tesla II, 2023 WL 3854008, at *24, *33, *44.  First, the court affirmed that a conflicted board’s decision not to utilize a special committee to negotiate a merger “does not automatically result in a finding of liability.”  Id. at *26.  A board may choose to subject itself to the “expensive, risky, and ‘heavy lift’” of satisfying entire fairness for a number of strategic reasons, including to avoid “transaction execution risk,” to maintain flexibility, and “to access the technical expertise and strategic vision and perspectives of the controller.”  Id. at *27.

Second, the Supreme Court held that although the Court of Chancery’s analysis placed too much weight on Tesla’s pre-merger stock price—which, the Supreme Court concluded, failed to factor in material nonpublic information—the court’s overall focus on the merger price was not misplaced, and there was sufficient evidence establishing that the price was fair.  Tesla II, 2023 WL 3854008, at *34.  The plaintiffs had argued that the trial court “applied a bifurcated entire fairness test, concluding that its separate fair price analysis alone satisfied entire fairness.”  Id.  The Supreme Court disagreed, pointing out that the trial court had, in fact, made “extensive fact and credibility findings relating to the Acquisition’s process.”  Id.  The Supreme Court further concluded that the trial court was correct to put great weight on price because although a fair price “is not a safe-harbor that permits controllers to extract barely fair transactions,” it is “the paramount consideration” in deciding whether the merger as a whole was fair.  Id. (citations omitted).

The Supreme Court, however, departed from the Court of Chancery in how the price analysis should be conducted, agreeing with the plaintiffs that the trial court should not have relied on a pre-merger stock price that did not factor in later-revealed nonpublic information.  Id. at *44.  Indeed, the court “cautioned against reliance on a stock price that did not account for material, nonpublic information” and “sole reliance on the unaffected market price.”  Id. at *46 (citation omitted).  Nonetheless, the Supreme Court found that other evidence “amply supports the [trial] court’s finding that the price was fair”; in addition to the stock price, the trial court had relied on “an array of valuation and fair price evidence,” such as its financial advisor’s analysis and evidence of SolarCity’s financial performance.  Id.

E. Court of Chancery Again Holds Entire Fairness Governs De-SPAC Transactions

The Delaware Court of Chancery again affirmed that de-SPAC mergers are subject to the entire fairness standard of review.  In Laidlaw v. GigAcquisitions2, LLC, stockholders brought fiduciary duty claims against the directors and controlling stockholder of GigCapital2, Inc., a special purpose acquisition company (“SPAC”).  2023 WL 2292488, at *1 (Del. Ch. Mar. 1, 2023).  SPACs are publicly traded corporations created with the sole purpose of merging with a private business before a set deadline, which allows the private business to go public.  When the merger takes place, the investors of the SPAC can choose to redeem their investments or invest in the post-merger company.  In Laidlaw, the stockholders alleged that the defendants had issued a false and misleading proxy statement that prevented the stockholders from making an informed decision about whether to redeem their investments in the SPAC.  Id.

The opinion by Vice Chancellor Will followed her earlier decisions in In re MultiPlan Corporation Stockholders Litigation, 268 A.3d 784 (Del. Ch. 2022) and Delman v. GigAcquisitions3, LLC, 288 A.3d 692 (Del. Ch. Jan 4, 2023).  These earlier cases held that mergers between SPACs and their targets, also referred to as de-SPAC transactions, were inherently conflicted because the sponsors of the SPACs would lose their investments if they did not consummate the mergers before the given deadlines.  Each of the earlier decisions held that the at-issue de-SPAC transaction was subject to the entire fairness standard.  In re Multiplan, 268 A.3d at 813; Delman, 288 A.3d at 709.

In her recent decision, Vice Chancellor Will noted that the legal questions presented in Laidlaw were “largely indistinguishable” from those in Delman.  Laidlaw, 2023 WL 2292488, at *1.  The court held that the sponsors were conflicted because of the way the de-SPAC was structured:  the sponsors allegedly preferred a bad merger to no merger because they would lose their Founder Shares and Private Placement Units if the SPAC did not merge with another company, while public stockholders would prefer no deal to a bad one because they would still receive their full investment plus liquidation interest if there were no merger.  Id. at *8.  And even after the merger agreements were signed, the sponsor had an interest in minimizing redemptions by stockholders because the deals required the SPAC to have $150 million in cash.  Id.  The court further noted that it was reasonably conceivable that the de-SPAC transaction was conflicted because a majority of the board members lacked independence from the owner and controller of the sponsor.  Id. at *9.

As a result, the court rejected the defendant’s motion to dismiss and the plaintiffs’ claims that the defendant issued a false and misleading proxy statement were allowed to proceed.  Id. at *14.

F. Supreme Court Clarifies Standard for Voting Control Measures

In Coster v. UIP Companies, Inc., the Delaware Supreme Court clarified the standards applicable to board action in a contest for corporate control that interferes with stockholders’ voting rights.  ‌— A.3d —, 2023 WL 4239581 (Del. June 28, 2023) (Coster IV).  As we wrote in our 2022 Year-End Securities Litigation Update, this case arose when the plaintiff became a 50% stockholder in UIP and deadlocked with the company’s other half-owner regarding UIP’s board composition.  Coster v. UIP Companies, Inc., 2022 WL 1299127, at *1 (Del. Ch. May 2, 2022) (Coster III).  The plaintiff brought an action to appoint a custodian with full control over the company, and the board responded by issuing one-third of the total outstanding shares to an “essential” employee who broke the deadlock.  Id. at *3.  After unsuccessfully challenging the stock issuance in the Court of Chancery, the plaintiff appealed to the Delaware Supreme Court, which remanded with instructions to apply the standards laid out in Blasius Industries, Inc. v. Atlas Corporation, 564 A.2d 651 (Del. Ch. 1988), and Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971).  Coster IV, 2023 WL 4239581, at *4.  The trial court again ruled for the defendants, and she again appealed.  Id. at *5.

On June 28, 2023, the Supreme Court reconciled the various applicable standards:  Schnell for board-entrenchment measures, Blasius for interference with the stockholder franchise, and Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), for antitakeover strategies.  Where the board “interferes with the election of directors or a shareholder vote in a contest for corporate control”—that is, where both entrenchment or antitakeover measures and the stockholder franchise are at issue—courts should apply “Unocal . . . with the sensitivity Blasius review brings.”  Coster IV, 2023 WL 4239581, at *12.  First, courts should judge whether there was a threat to “an important corporate interest” that was “real and not pretextual,” such that the board’s motivation was “proper and not . . . disloyal.”  Id.  Per Blasius, boards cannot rely on the justification that they know what is best for stockholders.  Id.  Second, courts should review, per Unocal, whether the board’s response was “reasonable in relation to the threat” and “not preclusive or coercive to the stockholder franchise.”  Id.  Applied in this fashion, the standard also “subsume[s] the question of loyalty” and “thus address[es] issues of good faith such as were at stake in Schnell.”  Id. at *11.

Judged by this standard, the court affirmed the Court of Chancery’s decision, finding the company’s actions passed muster.  Id. at *17.  As the trial court held, the plaintiff’s broad request for a custodian posed significant risks to the company, and even though the trial court found that “some of the board’s reasons for approving the Stock Sale were problematic, on balance[,] . . . the board was properly motivated in responding to the threat.”  Id. at *14.

G. Delaware Raises the Bar for Merger Plaintiffs’ Fees

The Delaware Court of Chancery raised the bar for attorneys’ fees in cases where a plaintiff’s suit over allegedly inadequate merger disclosures causes the defendant to supplement those disclosures.  Anderson v. Magellan Health, Inc., 298 A.3d 734 (Del. Ch. 2023).  In Anderson, a stockholder sued the selling company in a merger saying that its proxy materials were inadequate and its deal protections stood in the way of getting the best price; in response, the company loosened the deal protections and made new disclosures.  Id.  In July 2023, the court held that the loosened deal protections, as a practical matter, did not create a “corporate benefit” allowing the plaintiff to collect attorneys’ fees because they had no effect on the ultimate deal price.  Id. at *741–45.  And the court changed the standard for when supplemental disclosures justify a fee award—previously, these only had to be “helpful,” whereas the Court of Chancery held that fees are justified “only when the information is material.”  Id. at *747–51.  We discussed this decision in greater detail in our August 2, 2023 Client Alert.

IV. Federal SPAC Litigation

The number of SPAC IPOs and the value of de-SPAC transactions have decreased significantly since their peak in 2021, as noted in our 2022 Mid-Year Securities Litigation Update.  De-SPAC transactions, however, have given rise to significantly more securities class actions than other IPOs, and plaintiffs have generally had more success in surviving the motion to dismiss stage.

A. Clover Health: Settlement Offer Proposed in Fraud-on-the-Market SPAC Litigation

Our 2022 Mid-Year Securities Litigation Update highlighted Bond v. Clover Health Investments, Corp., 587 F. Supp. 2d 641 (M.D. Tenn. Feb. 28, 2022), as a prototypical example of the Section 10(b) class actions that survived the motion-to-dismiss stage after the 2021 SPAC boom.  We also noted that, in denying the motion to dismiss in that case, the district court for the Middle District of Tennessee expressly credited a fraud-on-the-market theory, see id. at 664–66, and was apparently the first federal court to do so in the context of claims arising from a SPAC-related offering.  In April 2023, less than three months after the court granted the plaintiffs’ motion for class certification, Bond v. Clover Health Invs., Corp., 2023 WL 1999859 (M.D. Tenn. Feb. 14, 2023), Clover Health announced that the parties had agreed to a proposed settlement.  Under the parties’ agreement, which is subject to final court approval, the class will receive $22 million and the defendants will receive customary releases.  Press Release, Clover Health, Clover Health Announces Agreement to Settle Securities Class Action Litigation (Apr. 24, 2023), https://investors.cloverhealth.com/news-releases/news-release-details/clover-health-announces-agreement-settle-securities-class-action.  In May, the court preliminarily approved the agreement and scheduled a settlement hearing for October 2, 2023.  Bond v. Clover Health Invs., Corp., 3:21-CV-00096 (M.D. Tenn. May 26, 2023), Dkt. No. 132.

B. Statutory Standing in the SPAC Context

Our 2022 Year-End Securities Litigation Update highlighted a decision, In re CCIV/Lucid Motors Securities Litigation, 2023 WL 325251 (N.D. Cal. Jan. 11, 2023), addressing the standing requirements for bringing a Section 10(b) action in the SPAC context.  In two recent cases, lower courts continued to examine how statutory standing requirements apply in the context of SPAC litigation.

In March 2023, a SPAC-related class action in the Southern District of New York, In re CarLotz, Inc. Securities Litigation, 2023 WL 2744064 (S.D.N.Y. Mar. 31, 2023), was dismissed on standing grounds, based on the fact that the plaintiffs did not own shares of the privately held, pre-merger target, id. at *1, *5.  The de-SPAC transaction in CarLotz concerned Acamar, a SPAC that went public and then identified CarLotz, a used vehicle marketplace, as a target company.  Id. at *1.  The plaintiffs alleged that officers of pre-merger CarLotz made materially false and misleading statements, and that the falsity of those statements was revealed in disclosures that were made after the merger.  Id. at *2.  In dismissing the case, the CarLotz court followed Second Circuit precedent that the CCIV court had considered, Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., 54 F.4th 82 (2d. Cir. 2022), but was not “compell[ed]” to follow, 2023 WL 2744064, at *4–5; see also In re CCIV/Lucid Motors, 2023 WL 325251, at *7–8.

The court applied the rule from an earlier Second Circuit decision that did not directly concern SPACs, Menora Mivtachim, 54 F.4th 82, which held that shareholders of an acquiring company could not sue the target company for alleged misstatements that had been made prior to the merger between the two companies, id. at 86.

The plaintiffs argued that applying Menora to companies acquired by SPACs would create a “loophole” that shields from liability the pre-merger statements of parties to SPAC transactions.  CarLotz, 2023 WL 2744064, at *5.  Although the court acknowledged this policy concern, it stated that it was bound by the Menora precedent.  Id.  The court also noted alternative means of accountability for pre-merger actions taken by a target company, such as SEC enforcement actions, shareholder derivative suits, or actions brought under state law.  Id.

CarLotz and another case, Mehedi v. View, Inc., 2023 WL 3592098 (N.D. Cal. May 22, 2023), also addressed requirements for standing under Section 11 of the Securities Act, which imposes strict liability for any materially misleading statements or omissions in a registration statement, see CarLotz, 2023 WL 2744064, at *5–8; Mehedi, 2023 WL 3592098, at *5–7.  Section 11 requires each plaintiff to demonstrate that he or she can trace the shares he or she purchased to the offering related to the allegedly misleading document or statement, rather than from some other source.  Mehedi, 2023 WL 3592098, at *5.

In Mehedi, the plaintiffs did not allege that they had purchased securities that were directly traceable to the relevant registration statement.  Id. at *5–7.  In CarLotz, the plaintiffs conceded that one named plaintiff had purchased shares in Acamar, the public company, even before the de-SPAC registration statement and prospectus were effective, but argued that his shares were still traceable to the registration statement because the merger itself “functionally transformed” his Acamar shares into shares of the new public company, CarLotz.  2023 WL 2744064, at *7.  The court acknowledged this theory was “creative,” but found it foreclosed by Second Circuit precedent on Section 11 traceability, which requires the plaintiff to have purchased shares “under” “the same registration statement” being challenged.  Id.  The plaintiffs again identified policy reasons for loosening these standing requirements in the context of SPAC transactions, including a proposed SEC regulation that, “if promulgated, would subject registration statements for de-SPAC transactions to Section 11 liability.”  Id. at *8.  But the court found that proposed non-final rule and other policy considerations insufficient to overcome the current binding precedent.  Id.

V. ESG Civil Litigation

For the past several years, a number of lawsuits have been filed against public companies or their boards related to the companies’ environmental, social, and governance (“ESG”) disclosures and policies.  The following section surveys notable developments in pending cases that involve ESG allegations.

A. Environmental Litigation

Fagen v. Enviva Inc., No. 8:22-CV-02844 (D. Md. Nov. 3, 2022):  We first reported on this case in our 2022 Year-End Securities Litigation Update.  After the court appointed a lead plaintiff in January 2023, an amended complaint was filed in April 2023. ECF No. 34. In the amended complaint, the plaintiff alleges that Enviva made false or misleading statements in offering documents and other communications to investors that exaggerated the sustainability of Enviva’s wood pellet production and procurement methods.  Id. at 1–4.  The amended complaint claims Enviva’s stock price dropped after various third parties published reports challenging Enviva’s environmental claims.  Id. at 3.  The defendants have filed motions to dismiss the amended complaint.  ECF Nos. 62, 63.  In those motions, the defendants argue that the alleged “misrepresentations” are merely part of “an ongoing public debate about the environmental benefits of using wood pellets—rather than fossil fuels—to generate heat and electricity,” which cannot give rise to securities fraud.  ECF No. 62-1 at 1.  The motions to dismiss are fully briefed and pending before the court.

Wong v. New York City Emp. Ret. Sys., No. 652297/2023 (N.Y. Sup. Ct., N.Y. Cnty. May 11, 2023):  In Wong, the plaintiffs have brought breach of fiduciary duty claims against three New York City pension funds that divested approximately $4 billion in fossil fuel investments.  NYSCEF No. 2.  The plaintiffs allege that the retirement boards impermissibly prioritized political goals unrelated to the financial health of the plans over their obligation to pursue the best financial returns for plan participants, declaring the pension fund’s actions an “utter abandonment of fiduciary responsibilities.”  Id. at 2–3.  The divestment allegedly caused the pension fund to lose out on the energy’s sector significant growth, and therefore lucrative returns, over the past few years.  Id. at 18.  The plaintiffs sought an injunction, requiring the pension fund to cease the ongoing divestment and make decisions regarding fuel-related and other potential investments “exclusively on relevant risk-return factors” going forward.  Id. at 24.  The defendants filed a motion to dismiss the complaint on August 7, 2023.  NYSCEF No. 20 at 1.  Gibson Dunn is representing Plaintiffs in this case.

B. Social Litigation

City of St. Clair Shores Police and Fire Ret. Sys. v. Unilever PLC, No. 22-CV-05011 (S.D.N.Y. June 15, 2022): As reported in our 2022 Year-End Securities Litigation Update, in at least one action, investors challenged corporate commitments on ESG-related topics.  The allegations in Unilever arose from a Ben & Jerry’s board resolution purporting to end the sale of Ben & Jerry’s products in areas deemed “to be Palestinian territories illegally occupied by Israel.”  ECF No. 1 at 6.  The plaintiffs alleged that Ben & Jerry’s parent company made misleading statements to investors by failing to adequately disclose the business risks associated with the resolution.  Id. at 10–18.  The defendants filed a motion to dismiss in late 2022, arguing, among other things, that the plaintiffs failed to plead an actionable misstatement or omission and failed to plead scienter.  See, e.g., ECF No. 31 at 3.  The motion to dismiss is now fully briefed and pending before the court.

C. Diversity and Inclusion

Ardalan v. Wells Fargo & Co., No. 22-CV-03811 (N.D. Cal. July 28, 2022):  In this putative class action, the plaintiffs alleged that Wells Fargo announced an initiative which required that 50 percent of interviewees be diverse for most roles above a certain salary threshold, and then purported to meet that requirement by conducting interviews for positions that had already been filled.  ECF No. 1 at 2–4.  These practices, the plaintiffs allege, made the bank’s statements about its diversity initiatives materially misleading.  Id.  The plaintiffs alleged that the bank’s stock price fell by more than ten percent after the New York Times published an article purporting to reveal that certain of the bank’s employees were holding interviews for filled positions.  Id.  In April 2023, the defendants filed a motion to dismiss the complaint.  In that motion, the defendants argued that the plaintiffs’ allegations of isolated incidents of employee misconduct cannot render the bank’s general statements about its diversity program false or misleading.  ECF No. 100 at 2–3.  The district court agreed.  In an August 18, 2023 opinion granting the defendants’ motion to dismiss, the district court held that the PSLRA “requires particularized allegations sufficient to infer that sham interviews took place during the Class Period and that they were widespread.”  ECF No. 112 at 8.  The district court dismissed the complaint without prejudice.  Id. at 15.

* * * * *

Gibson Dunn will continue to monitor developments in ESG-related securities litigation.  Additional resources relating to ESG issues can be found on Gibson Dunn’s ESG practice group page.

VI. Cryptocurrency Litigation

A growing number of both class action and regulatory lawsuits are being filed against cryptocurrency platforms and their operators.  Many of these lawsuits seek to classify cryptocurrencies as “securities” under existing federal securities law, and courts continue to grapple with the application of securities laws to cryptocurrency.  Defendants have crafted multiple arguments in favor of dismissing these actions, with varying levels of success.

A. Class Actions

Underwood v. Coinbase Glob., Inc., 2023 WL 1431965 (S.D.N.Y. Feb. 1, 2023):  A putative class of users of Coinbase’s trading platform, a platform which facilitates cryptocurrency transactions, brought claims under Sections 12(a)(1) and 15 of the Securities Act, Section 29(b) of the Exchange Act, and state law, alleging that they suffered damages in connection with the defendants’ sale and solicitation of allegedly unregistered securities.  2023 WL 1431965 at *1.  The defendants filed a motion to dismiss arguing that under the terms of Section 12, Coinbase was not the “statutory seller” of the tokens sold to the plaintiffs.  Id. at *1, 6.  The court concluded in ruling on a motion to dismiss the Section 12 claims that Coinbase did not directly sell tokens to the plaintiffs because the company did not hold title to the cryptocurrency traded on its platform during the transaction.  Id. at *6–8.  The court also reasoned that Coinbase did not “solicit” transactions because it did not partake in the “direct and active participation in the solicitation of the immediate sale.”  Id. at *9.  Based on this reasoning, the court dismissed the plaintiffs’ Section 12 claim as Coinbase was not the “statutory seller” of the tokens.  The court also dismissed the plaintiffs’ control-person claim, which was predicated on the Section 12 violation.  Id. at *10.  The court likewise dismissed the plaintiffs’ claim under Section 29(b) of the Exchange Act, holding that the plaintiffs failed to demonstrate that their user agreements with Coinbase’s platform involved a “prohibited transaction” under Section 29(b).  Id. at *11–12.  The court declined to exercise supplemental jurisdiction over the plaintiffs’ state law claims.  Id. at *12–13.  The plaintiffs are currently appealing the district court’s decision to the Second Circuit.  See Underwood v. Coinbase Glob., Inc., 2023 WL 1431965 (S.D.N.Y. Feb. 1, 2023), appeal docketed, No. 23-184 (2d Cir. Feb. 9, 2023).

De Ford v. Koutoulas, 2023 WL 2709816 (M.D. Fla. Mar. 30, 2023), reconsideration denied, 2023 WL 3584077 (M.D. Fla. May 22, 2023):  The plaintiffs represent a group of individuals who purchased the token “LGBCoin.”  The plaintiffs brought a putative class action asserting multiple claims, including a claim under Section 12 of the Securities Act.  2023 WL 2709816 at *13–16.  Section 12(a)(1) of the Securities Act provides a private right of action against any person who offers or sells a security in violation of Section 5 of the Securities Act.  The plaintiffs allege in their complaint that LGBCoin is a security, and that the defendants created, marketed, and offered the tokens for sale to customers in the United States.  See ECF No. 1 at ¶¶ 173–83.  Two defendants filed motions to dismiss the Section 12 claims for failure to state a claim.  ECF Nos. 101, 104.  While ruling on the motions to dismiss, the court held that, when drawing “all reasonable inferences in Plaintiffs’ favor . . . it is at least plausible that LGBCoin is a security.”  2023 WL 2709816, at *13–15.  The court then concluded that the plaintiffs had plausibly alleged that one of the defendants, an executive at LGBCoin who made social media posts promoting the token, could be held liable as a “seller” of a security under Section 12.  Id. at *15.  The court reasoned that because of this defendant’s “extensively documented alleged promotion of LGBCoin in-person or online in videos, on social media, and on podcasts,” he was a seller and was “plausibly alleged to have made the[] solicitations to serve his own financial interests.”  Id.  The court found, however, that a separate defendant-executive of the company who was not alleged to have made similar public solicitations for his own financial interest, was not a seller.  Id.  The court thus denied the former executive’s motion to dismiss the securities fraud claim, while granting the latter executive’s motion to dismiss.  Id. at *16–17.  On April 14, 2023, the plaintiffs filed a third amended complaint.  ECF No. 245.

B. Regulatory Lawsuits

SEC v. Arbitrade Ltd., 2023 WL 2785015 (S.D. Fla. Apr. 5, 2023):  The SEC brought claims under Sections 5 and 17 of the Securities Act and under Section 10b of the Exchange Act, alleging that Arbitrade Ltd., Cryptobontix Inc., SION Trading FZE, and their respective control persons were operating “a classic pump and dump scheme” involving the crypto asset “Dignity” (“DIG”).  2023 WL 2785015 at *1–2.  Specifically, the SEC alleged that defendants generated artificial demand for DIG tokens by claiming that they had received title to $10 billion in gold bullion that they would use to back the tokens.  Id.  The defendants then sold their DIG tokens and converted the proceeds to cash.  DIG tokens reached a zero dollar valuation soon after.  Id. at *2.  On April 5, 2023, the court denied two separate motions to dismiss brought by individual defendants.  Id. at *11.  In doing so, the court held that the SEC had jurisdiction over the case because, based on the facts alleged in the complaint, DIG tokens could be considered securities from which investors expected to derive profits.  Id. at *3–6.

SEC v. Payward Ventures, No. 23-CV-0588 (N.D. Cal. Feb. 9, 2023):  The SEC charged Payward Ventures, Inc. and Payward Trading, Ltd., both commonly known as “Kraken,” for their crypto staking service.  ECF No. 1 at 1–2.  Crypto staking is a process that crypto networks use to process and validate transactions.  Id. at 2.  The SEC alleged that Kraken’s staking service, which launched in 2019, caused investors to lose control of their assets and assume the risk of the staking platform.  Id. at 3, 9.  The SEC alleged that Kraken did not provide sufficient information to substantiate the staking program’s representations of certain program features.  See id. at 10–17.  The complaint further claimed that because crypto investors entrust money to the staking service with expectations of profit, Kraken’s staking program was marketed as an investment opportunity, and that the service was offered and sold as a security.  Id. at 16, 19–22.  The SEC complaint concluded that Kraken needed to register the offers and sales on the platform with the SEC and make adequate disclosures under the Securities Act because it used interstate commerce to offer investment contracts in exchange for investors’ cryptocurrency.  Id. at 22.  Kraken settled the case by ceasing the offering and selling of alleged securities through its staking program, and by agreeing to pay $30 million in disgorgement, prejudgment interest, and civil penalties.  See Press Release, Kraken to Discontinue Unregistered Offer and Sale of Crypto Asset Staking-As-A-Service Program and Pay $30 Million to Settle SEC Charges (Feb. 9, 2023), https://www.sec.gov/news/press-release/2023-25.

SEC v. Binance Holdings Ltd., No. 23-CV-01599 (D.D.C. June 5, 2023):  On June 5, 2023, the SEC filed a 13-claim complaint against Binance Holdings Limited, BAM Trading Services Inc., BAM Management Holdings Inc. and Changpeng Zhao in D.C. federal court, alleging they engaged in unregistered offers and sales of crypto asset securities.  ECF No. 1.  The SEC claims Binance Holdings Limited and BAM were both acting as exchanges, broker-dealers, and clearing agencies, and that they intentionally chose not to register with the SEC.  Id. at 2.  A day after filing the complaint, the SEC filed a motion for a TRO, seeking to freeze BAM’s assets.  ECF No. 4.  On June 13, 2023, consistent with the arguments set forth in the defendants’ briefing, the government admitted that it had no evidence that customer assets have been misused or dissipated and, as a result, the defendants successfully prevented the SEC from obtaining the extensive relief it sought.  Instead, at the court’s direction, Binance, the SEC, and the other defendants in the action negotiated a consent order that will remain in place while the action is pending.  ECF No. 71.  Gibson Dunn is representing Binance Holdings Limited.

SEC v. Coinbase, Inc., No. 23-CV-4738 (S.D.N.Y. June 6, 2023):  On June 6, 2023 the SEC filed a 5-count complaint against Coinbase and its parent company Coinbase Global.  ECF No. 1.  The SEC alleges that Coinbase has violated the securities laws since 2019 by failing to register as an exchange, broker, or clearing agency despite facilitating trading and settlement of several digital assets that the SEC alleges are securities, including ADA, SOL, MATIC, and others.  Id. at 1, 33.  The SEC also alleges that Coinbase has operated as an unregistered broker by offering its Coinbase Prime and Coinbase Wallet services, and that Coinbase’s staking service for several digital assets, including Ethereum, constitutes unregistered securities offerings.  Id. at 2.  On June 28, 2023, Coinbase filed a 177-page answer to the SEC’s complaint, calling the suit an “extraordinary abuse of process” that “offends due process and the constitutional separation of powers.”  ECF No. 22. at 2.  On August 4, 2023, Coinbase filed its motion for judgment on the pleadings claiming both that in bringing the action the “SEC has violated due process, abused its discretion, and abandoned its own earlier interpretations of the securities laws” and that “[t]he subject matter falls outside the agency’s delegated authority” because none of the digital assets identified in the complaint qualify as securities under the Securities Act.  ECF No. 36 at 1.

SEC v. Ripple Labs, Inc., 2023 WL 4507900 (S.D.N.Y. July 13, 2023):  In 2020, the SEC sued Ripple in the Southern District of New York for the unregistered offer and sale of securities in violation of Section 5 of the Securities Act related to Ripple’s offer and sale of XRP, a crypto token.  2023 WL 4507900 at *1–4.  In September 2022, the parties filed cross-motions for summary judgment.  Id.  at *4.  On July 13, U.S. District Judge Analisa Torres ruled that the SEC could not establish as a matter of law that a crypto token was a security in and of itself.  In a partial victory for Ripple, the court determined that Ripple’s XRP sales on public exchanges were not offers of securities.  In a partial victory for the SEC, the ruling also found that sales to sophisticated investors did amount to unregistered sales of securities.  On August 17, 2023, the court permitted the SEC to file a motion for leave to file an interlocutory appeal.  ECF No. 891.  Briefing on the motion is set to conclude on September 8, 2023.  ECF No. 892.

SEC v. Terraform Labs Pte. Ltd., 2023 WL 4858299 (S.D.N.Y. July 31, 2023):  The SEC brought an enforcement action in February of this year alleging that Terraform Labs and its founder, Do Hyeong Kwon, perpetrated a multi-billion dollar crypto asset securities fraud scheme by offering and selling crypto asset securities in unregistered transactions and misleading investors about the Terraform blockchain and its crypto assets.  ECF No. 1.  The complaint alleges violations of the anti-fraud provisions of the Securities Act and Exchange Act and the securities-offering-registration and security-based swap provisions of the federal securities laws.  Id. at 4.  On July 31, 2023, Judge Rakoff denied the defendants’ motion to dismiss, finding that the court had personal jurisdiction over the defendants and that the complaint plausibly alleged that “the defendants used false and materially misleading statements to entice U.S. investors to purchase and hold on to the defendants’ products;” the products being “unregistered investment-contract securities that enabled investors to profit from the supposed investment activities of the defendants and others.”  2023 WL 4858299 at 1–2.  Notably, Judge Rakoff agreed with the Ripple ruling’s holding that the SEC could not establish as a matter of law that a crypto token was a security in and of itself.  But Judge Rakoff rejected Judge Torres’s distinction between institutional and retail purchasers as to whether a token was offered as a security.  Id. at *15.  Instead, Judge Rakoff found that “secondary-market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf,” and thus held that “the SEC’s assertion that the crypto assets at issue here are securities . . . survives the defendants’ motion to dismiss.”  Id.

VII. Shareholder Activism

Activists have continued targeting large U.S. companies in the first half of 2023, and recent changes to SEC regulations related to shareholder proposals and proxy elections could potentially encourage shareholder activists going forward.

A. Activist Campaigns Persist, with Companies Responding Swiftly

Four out of the six largest activist campaigns by volume in the first half of 2023 were resolved prior to formal proxy fights.  The remaining contests have had different outcomes: one activist investor successfully replaced an incumbent director, and the final campaign has litigation in progress.

Salesforce, Inc.:  In January 2023, Elliott Management announced a multibillion-dollar stake in Salesforce and nominated a slate of directors pushing for changes in corporate governance in light of Elliott Management’s view of the company’s performance.  See Lauren Thomas and Laura Cooper, Elliott Management Takes Big Stake in Salesforce, Wall Street Journal (Jan. 23, 2023).  The activists dropped the campaign in light of the company’s “announced ‘New Day’ multi-year profitable growth framework, strong fiscal year 2023 results, fiscal year 2024 transformation initiatives, Board and management actions and clear focus on value creation.”  Salesforce and Elliott Issue Joint Statement, Salesforce (Mar. 27, 2023).

The Walt Disney Company:  In January 2023, Trian Partners, led by activist investor Nelson Peltz, announced a $900 million position in Disney and released a detailed press release describing its intention to nominate Peltz to the Disney board of directors.  Trian Nominates Nelson Pretz for Election to Disney Board, Trian Partners (Jan. 11, 2023).  In the press release, Trian described examples of what it viewed as poor corporate governance, strategic decisions, and capital allocation decisions that had caused Disney to underperform its peers.  A week after the launch of the proxy fight, Disney replaced its then-CEO, Bob Chapek, with former CEO Bob Iger, whom Trian said it would not oppose.  Trian Applauds Recent Initiatives Announced by Disney as a Win for All Shareholders and Concludes Proxy Campaign, Trian Partners (Feb. 9, 2023).  Trian abandoned Peltz’s board nomination after Disney announced corporate restructuring and cost-cutting plans.  Id.

Fleetcor Technologies, Inc.:  In March 2023, Fleetcor Technologies, Inc., a business payments company operating in the fuel, corporate payments, toll and lodging spaces, reached a cooperation agreement with its longstanding shareholder D. E. Shaw to add two new directors and form an ad hoc strategic review committee to explore possible divestiture.  See Fleetcor Technologies, Inc., Cooperation Agreement (Mar. 15, 2023).  Following the agreement, the ad hoc strategic review committee will assess alternatives for Fleetcor’s portfolio, including a possible separation of one or more of its businesses.  See FLEETCOR Enters into Cooperation Agreement with the D. E. Shaw Group, FleetCor (Mar. 20, 2023).

Bath & Body Works, Inc.:  In March 2023, Bath & Body Works avoided a proxy fight with the hedge fund Third Point, led by Third Point’s founder and CEO, Dan Loeb.  At Third Point’s request, Bath & Body Works agreed to appoint Lucy Brady as a director and hire a technology services firm, and agreed with Third Point’s feedback that the Board would benefit from additional financial and capital allocation expertise.  See Bath & Body Works Board of Directors Sends Letter to Shareholders Highlighting Transformative Value-Creating Actions and Responding to Third Point’s Potential Proxy Contest, Bath & Body Works (Feb. 27, 2023).  Bath & Body Works also agreed to appoint Thomas J. Kuhn to the board in exchange for Third Point’s promise not to nominate other candidates at the 2023 annual shareholder meeting.  See Bath & Body Works Announces Appointment of Thomas J. Kuhn to Board of Directors, Bath & Body Works (Mar. 6, 2023).  Third Point ultimately opted to abandon its proxy contest.

Illumina, Inc.:  In May 2023, gene sequencing company Illumina faced a proxy fight led by activist investor Carl Icahn.  Icahn protested Illumina’s decision to acquire a cancer test developer company, Grail, Inc., without informing the shareholders of European and U.S. regulatory opposition.  See Carl Icahn, Carl C. Icahn Issues Open Letter to Shareholders of Illumina, Inc. (Mar. 13, 2023).  Icahn nominated three new director candidates to prevent the current board from further pursuing the deal.  Id.  The European Commission ultimately blocked the acquisition due to antitrust concerns last year, a result Illumina has now appealed.  Annika Kim Constantino, Biotech Company Illumina Pushes Back against Carl Icahn’s Proxy Fight over $7.1 Billion Grail Deal, CNBC (Mar. 20, 2023).  An unsuccessful appeal could result in a fine of up to 10% of Illumina’s annual revenues.  Id.  Illumina set aside $453 million in case of an EU fine.  See Foo Yun Chee, Exclusive: Illumina to face EU fine of 10% of turnover over Grail deal-sources, Reuters (Jan. 11, 2023).  The two-month proxy contest resulted in the board appointment of Andrew Teno, portfolio manager at Icahn Capital LP.  See Illumina Announces Preliminary Results of Annual Meeting, Illumina (May 25, 2023).

Freshpet, Inc.:  In May and June 2023, JANA Partners (the largest shareholder of Freshpet, Inc.) and James Panek (a putative stockholder of Freshpet) filed two separate actions against Fresphet, Inc. and its directors for allegedly interfering with Freshpet, Inc.’s shareholders’ right to nominate directors for the upcoming election, and thereby entrenching the incumbent directors.  See Compl. ¶¶ 12, 19, 102, 120, JANA Partners LLC v. Norris, 2023 WL 3764931 (Del. Ch. June 1, 2023); and Compl. ¶¶ 4, 9, 32, 40, 44, Panek v. Cyr, 2023 WL 3738885 (Del. Ch. May 30, 2023).  JANA Partners intended to nominate four candidates for election at Freshpet’s 2023 annual meeting.  See Compl. ¶¶ 1, 81, JANA Partners LLC v. Norris, 2023 WL 3764931 (Del. Ch. June 1, 2023).  Amid settlement discussions regarding board composition, Freshpet accelerated the 2023 annual meeting to an earlier date and reduced the number of directors up for election from four to three.  Id. ¶ 1.  JANA subsequently filed a lawsuit alleging a breach of the duty of loyalty, and seeking declaratory relief that (1) JANA has an opportunity to nominate, and the shareholders have an opportunity to elect, four directors at the 2023 annual meeting; and (2) the Freshpet directors breached their fiduciary duties.  See id. at Prayer for Relief.  Freshpet has postponed the 2023 annual meeting to October.  Freshpet Provides Update on 2023 Annual Meeting of Stockholders, Freshpet (June 6, 2023).  Gibson Dunn will continue to monitor developments on the two ongoing cases.

B. Two Regulatory Changes over SEC Proxy Rules Could Potentially Embolden Activist Investors

A new SEC rule and proposed amendments to Rule 14a-8 of the Securities Exchange Act of 1934 could potentially encourage activist campaigns to nominate new board members or submit shareholder proposals ahead of upcoming shareholder meetings.  The SEC’s new “Universal Proxy” rule provides activist campaigns with potential support in efforts to elect new board members and bring provisions to a vote at corporate meetings.  And proposed SEC amendments to Rule 14a-8, which could take effect in October 2023, would require companies to include with greater specificity why shareholder proposals should be excluded on implementation, duplication, or resubmission grounds.

The “Universal Proxy” rule that went into effect in January 2022 requires the issuer of a proxy card to list all candidates rather than the slate of candidates they support only.  Universal Proxy, 86 Fed. Reg. 68330 (Dec. 1, 2021).  The use of a  “universal proxy card” is required in all non-exempt solicitations involving director election contests.  Id.  With universal proxies, shareholders can more easily vote for nominees from a combination of two slates, potentially increasing the chance for activist investors to have at least one of their dissident nominees elected.  SEC Adopts Rules Mandating Use of Universal Proxy Card, Gibson Dunn (Nov. 18, 2021).

Among other things, incumbent boards have responded to the Universal Proxy rule by implementing advance notice bylaw provisions that include additional disclosure requirements.  For example, medical device maker Masimo enacted and subsequently withdrew a bylaw amendment in 2022 that required “any person (including any hedge fund) seeking to nominate a candidate for election to the board to disclose,” among other things, “the identity of . . . any limited partner or other investor who owned 5% or more of the hedge fund, as well as all investors in any sidecar vehicle.”  John C. Coffee, Jr., Proxy Tactics Are Changing: Can Advance Notice Bylaws Do What Poison Pills Cannot?, The CLS Blue Sky Blog (Oct. 19, 2022); see Masimo Corp., Current Report (Form 8-K) (Feb. 5, 2023).  The case law in this area is still developing.  See Coffee, supra; see also Jorgl v. AIM ImmunoTech Inc., 2022 WL 16543834 at *11 (Del. Ch. Oct. 28, 2022); Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *12 (Del. Ch. Oct. 13, 2021).

The SEC is poised to finalize its proposed amendments to SEC Rule 14a-8 in October 2023.  Substantial Implementation, Duplication, and Resubmission of Shareholder Proposals Under Exchange Act Rule 14a-8, Release No. 34-95267, SEC (July 13, 2022); Office of Information and Regulatory Affairs, Agency Rule List – Spring 2023, RIN: 3235-AM91 .  The new amendments, if enacted, would heighten the bar for a company to exclude shareholder proposals on substantial implementation, duplication, and resubmission grounds.  Id.  The amendments could potentially build on the recent rise in shareholder proposals reaching a shareholder vote.  From 2021 to 2023, there was an 18% increase in shareholder proposals and a 40% increase on proposals that were voted on.  Mark T. Uyeda, Commissioner, SEC, Remarks at the Society for Corporate Governance 2023 National Conference (June 21, 2023).

VIII. Lorenzo Disseminator Liability

As discussed in our 2019 Mid-Year Securities Litigation Update, in Lorenzo v. Securities and Exchange Commission, the Supreme Court expanded scheme liability to encompass “those who do not ‘make’ statements” but nevertheless “disseminate false or misleading statements to potential investors with the intent to defraud.”  139 S. Ct. 1094, 1099 (2019).  In the wake of Lorenzo, secondary actors—such as financial advisors and lawyers—face potential scheme liability under SEC Rules 10b-5(a) and 10b-5(c) for disseminating the alleged misstatement of another if a plaintiff can show that the secondary actor knew the alleged misstatement contained false or misleading information.

In 2022, the Second Circuit, interpreting Lorenzo, held in Securities and Exchange Commission v. Rio Tinto plc, that the defendants must do “something extra” beyond making material misstatements or omissions to be subject to scheme liability under SEC Rule 10b-5(a) and (c).  41 F.4th 47, 54 (2d Cir. 2022); see Client Alert (Gibson Dunn represents Rio Tinto in this litigation.) Although the Supreme Court and other circuit courts have not directly addressed the requirements for scheme liability after Lorenzo, several recent district court decisions have added to the debate.  Specifically, one California district court has explicitly refused to apply Rio Tinto’s “something extra” requirement, another California district court has adopted a less onerous standard for plaintiffs than the Rio Tinto court, and one district court in Massachusetts engaged in an analysis similar to the Rio Tinto decision without specifically adopting the Second Circuit’s analysis.

In Securities and Exchange Commission v. Earle, a California district court declined to adopt Rio Tinto and noted that the Ninth Circuit “has not adopted” the “something extra” requirement, while denying an individual defendant’s motion to dismiss the SEC’s scheme liability claims.  2023 WL 2899529, at *7 (S.D. Cal. Apr. 11, 2023).  In Earle, the defendant, citing Rio Tinto, moved to dismiss the SEC’s 10b-5(a) and (c) claims on the grounds that the SEC had not alleged “something extra” beyond a “recitation of allegations of a violation of Rule 10b-5(b).”  Id.  The court disagreed with the defendant.  The court reasoned that the Supreme Court in Lorenzo had “recognized the ‘considerable overlap’ between the subsections of Rule 10b-5,” and that the Ninth Circuit made “clear that the argument that Rule 10b-5(a) and (c) claims cannot overlap with Rule 10b-5(b) statement liability claims is foreclosed by Lorenzo.”  Id. (citation and quotation marks omitted).  The court also found that the SEC alleged that the defendant disseminated misstatements, which the Supreme Court in Lorenzo held was enough to establish scheme liability.  Id. 

In another recent order rejecting defendants’ motion to dismiss 10b-5(a) and (c) claims, a different district court in California also emphasized the “‘considerable overlap’ between the subsections of Rule 10b-5.”  In re Vaxart, Inc. Sec. Litig., 2023 WL 3637093, at *3 (N.D. Cal. May 25, 2023).  The court stated that, although Lorenzo established that the dissemination of material misstatements can serve as the basis of 10b-5 scheme liability, “Rule 10b-5(a) and (c) prohibit more than just the dissemination of misleading statements; the language of these provisions is ‘expansive.’”  Id. (quoting Lorenzo, 139 S. Ct. at 1102).  Although the court did not mention Rio Tinto in its order, the court found that the defendants had allegedly committed many acts beyond misstatements and omissions—acts that were potentially sufficient to establish a claim for scheme liability even under a “something extra” requirement.  Id.

In Securities and Exchange Commission v. Wilcox, the district court denied an individual defendant’s motion to dismiss, concluding that “the allegation that [the defendant] provided false support to an external audit firm constitute[d] a deceptive act that, even if related to the making of a false statement by another, may establish her liability under . . . Rule 10b-5(a) and (c).”  2023 WL 2617348, at *9 (D. Mass. Mar. 23, 2023).  The defendant, citing Rio Tinto, had moved to dismiss the SEC’s Rule 10b-5(a) and (c) claims, arguing that the SEC alleged only that she prepared and provided support for misstatements.  Id. at *8.  The defendant claimed that these actions could not operate as the basis for scheme liability because they were not distinct, or “something extra,” from the misstatements themselves.  Id.  The court disagreed.  Although the court did not explicitly address the Rio Tinto “something extra” requirement, it mirrored Rio Tinto’s analysis in denying the motion to dismiss by holding that the alleged corruption of an auditing process, in conjunction with alleged misstatements, “may form the basis for scheme liability.”  Id.

These cases indicate that the landscape of Rule 10b-5 scheme liability remains dynamic in the wake of Lorenzo, with many circuits yet to address the issue.

IX. Market Efficiency and “Price Impact” Cases

As we explained in our recent Client Alert, the Second Circuit recently decertified a class of investors in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., No. 22-484, — F.4th —, 2023 WL 5112157 (2d Cir. 2023), in the highly awaited decision following the fourth time this long-running class certification dispute has reached that court.

Two years ago, the Supreme Court considered questions regarding price-impact analysis for the first time since its 2014 decision preserving the “fraud-on-the-market” theory which enables a presumption of classwide reliance in Rule 10b-5 cases, but also permits defendants to rebut that presumption with evidence that the challenged statements did not impact the issuer’s stock price.  In that 2021 decision, which we detailed in our 2021 Mid-Year Securities Litigation Update, the Supreme Court confirmed that the generic nature of statements should be a part of the pre-certification price impact analysis, even though the same evidence may also be relevant to the merits question of materiality.  Goldman Sachs Grp., Inc. v. Ark. Tchr. Ret. Sys., 141 S. Ct. 1951, 1960–61 (2021).  The Supreme Court also observed that where the plaintiffs’ price impact theory is based on “inflation maintenance”—i.e., the alleged misstatement did not cause the stock price to increase but instead merely prevented it from dropping—any mismatch between generic challenged statements and specific alleged corrective disclosures will be a key consideration.  Id. at 1961.  After the Supreme Court’s decision, the Second Circuit remanded the case to the district court, which certified the proposed class again.  With this latest decision, the Second Circuit reversed the class certification order and remanded with instructions to decertify the class.

The plaintiffs in this long-running dispute alleged that the defendants’ general statements about Goldman’s business principles and conflict-of-interest management procedures were false and misleading, which artificially maintained Goldman’s stock price, and that the “truth” was “revealed” through announcements about regulatory enforcement actions and investigations into certain transactions.  At class certification, the plaintiffs relied on the Basic presumption of reliance, arguing that because Goldman’s stock trades in an efficient market, anyone purchasing the stock implicitly relied on all public, material information incorporated into the current price, including defendants’ alleged misstatements.  The defendants argued that the statements about Goldman Sachs’s business principles and conflict-of-interest management procedures—which included statements such as “[i]ntegrity and honesty are at the heart of our business” and “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest”—were so generic that they could not have affected Goldman’s stock price.

In this most recent decision, the Second Circuit decertified the class, holding that there was “an insufficient link between the corrective disclosures and the alleged misrepresentations” and that “Defendants have demonstrated, by a preponderance of the evidence, that the misrepresentations did not impact Goldman Sachs’ stock price, and, by doing so, rebutted Basic’s presumption of reliance.”  Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., 2023 WL 5112157, at *24.  The Second Circuit concluded that when plaintiffs rely on inflation maintenance theory, they cannot just “identify a specific back-end, price-dropping event,” “find a front-end disclosure bearing on the same subject,” and then “assert securities fraud, unless the front-end disclosure is sufficiently detailed in the first place.”  Id. at *21.  The specificity of the statement and alleged correction must “stand on equal footing.”  Id.

The Second Circuit is not the only court to apply the Supreme Court’s guidance from Goldman and find a mismatch between generic alleged misrepresentations and specific corrective disclosures sufficient to defeat the presumption of reliance.  In In re Qualcomm Inc. Securities Litigation, 2023 WL 2583306 (S.D. Cal. Mar 20, 2023), the plaintiffs alleged that Qualcomm, a company that sells computer chips and licenses its patents to device manufacturers, made misrepresentations about its licensing and bundling practices.  Id. at *1–2.  In denying class certification regarding the licensing-related statements, the court credited Qualcomm’s argument that statements describing its licensing practices as “broad,” “fair,” and “nondiscriminatory” were too generic to be “corrected” by disclosures confirming Qualcomm licensed only at the device level.  Id. at *11–12.  The court explained “the generic nature of the alleged misrepresentations makes it less likely that those misrepresentations deceived the market in the way Plaintiffs theorize, and therefore, less likely that they caused ‘front-end price inflation.’”  Id.  The court was also persuaded by Qualcomm’s argument that the alleged corrective disclosure amounted to information that was already publicly available and known in the market.  Id. at *12–13.  Taken together, the court concluded that Qualcomm successfully rebutted the Basic presumption of reliance and established a lack of price impact by a preponderance of the evidence.  Id.  The court, however, certified the class as to the bundling-related statements.  Id. at *14.

These two cases suggest that courts are following the Supreme Court’s approach in Goldman and conducting holistic analyses taking into account all evidence presented and applying “common sense” about the generic nature of statements when assessing whether defendants have rebutted the Basic presumption of reliance.  We will continue to monitor this developing line of caselaw.

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The following Gibson Dunn attorneys assisted in preparing this client update: Monica K. Loseman, Brian M. Lutz, Craig Varnen, Jefferson E. Bell, Christopher D. Belelieu, Michael D. Celio, Johnathan D. Fortney, Mary Beth Maloney, Jessica Valenzuela, Allison Kostecka, Lissa Percopo, H. Chase Weidner, Luke A. Dougherty, Trevor Gopnik, Tim Kolesk, Mark H. Mixon, Jr., Megan R. Murphy, Kevin Reilly, Marc Aaron Takagaki, Dillon M. Westfall, Kevin J. White, Eitan Arom, Angela A. Coco, Dasha Dubinsky, Graham Ellis, Mason Gauch, Nathalie Gunasekera, Amir Heidari, Tin Le, Lydia Lulkin, Michelle Lou, and Nicholas Whetstone.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the developments in the Delaware Court of Chancery. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Securities Litigation practice group:

Securities Litigation Group:
Christopher D. Belelieu – New York (+1 212-351-3801, cbelelieu@gibsondunn.com)
Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com)
Michael D. Celio – Palo Alto (+1 650-849-5326, mcelio@gibsondunn.com)
Jonathan D. Fortney – New York (+1 212-351-2386, jfortney@gibsondunn.com)
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)
Mary Beth Maloney – New York (+1 212-351-2315, mmaloney@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)
Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com)
Jessica Valenzuela – Palo Alto (+1 650-849-5282, jvalenzuela@gibsondunn.com)
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)
Mark H. Mixon, Jr. – New York (+1 212-351-2394, mmixon@gibsondunn.com)

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Gibson Dunn & Crutcher LLP advised private equity firm Cinven on the disposal of its stake in the Planasa Group, a global leader in the agri-food sector, to EW Group, a family-owned international group with key businesses in genetics, health, diagnostics, nutrition and food.

This transaction will allow EW Group to strategically expand its breeding activities into the area of fruit and vegetable breeding.

Gibson Dunn & Crutcher team was led by European Co-Chair of Private Equity Federico Fruhbeck, M&A and Private Equity partners Alice Brogi, Ariel Harroch and Judith Raoul-Bardy, as well as Labor & Employment partner Nataline Fleury.

The firm acted alongside Spanish firm Perez-Llorca on this transaction.

On June 29th, 2023, the Department of the Interior (“DOI”), acting through the Bureau of Ocean Energy Management (“BOEM”), published a proposed rule that would modify the criteria it uses to determine financial assurance and bond requirements for the offshore oil and gas industry in the Outer Continental Shelf (“OCS”).[1] This proposed rule modifies and does away with a proposed joint rulemaking with the Bureau of Safety and Environmental Enforcement (“BSEE”) from October 16, 2020 which also sought to update BOEM’s financial assurance criteria, along with other BSEE-administered regulations (further described in Section II below). This latest iteration is intended by BOEM to be more protective of taxpayers by ensuring that OCS lessees have sufficient resources to meet their lease and regulatory obligations.

The publication of the proposed rule triggered a 60-day comment period during which BOEM sought comments from the public and offshore oil and gas industry (further described in Section IV below). The comment period closed on September 7, 2023, and BOEM will now review and analyze all comments that were submitted during the comment period and may choose to modify the proposed rule, issue a final rule to be effective no sooner than 30 days after publication in the Federal Register, withdraw the proposal, or re-open the comment period. This alert will discuss (a) the history and current state of BOEM’s financial assurance regulations and the proposed changes thereto, (b) potential industry impacts as a result of the proposed changes, and (c) a general overview of the significant comments received by BOEM during the comment period.

History of Financial Assurance Rules and Proposed Changes

BOEM’s current regulations contemplate two forms of financial assurance to ensure that a grant holder or lessee can fulfill its regulatory and contractual obligations, including decommissioning liabilities: (a) base bonds in amounts prescribed by the regulations and (b) supplemental financial assurance, determined on the basis of a five-factor test. The posting of base bonds and any additional financial assurance is intended to cover the costs of clean-up and the decommissioning of offshore wells and infrastructure once they are no longer in use and to ensure that the federal government does not have to perform such activities, with taxpayers footing the bill.[2]

BOEM requires all lessees of an OCS oil and gas or sulfur lease to post base bonds at the time of (a) issuance of a new lease or (b) assignment of an existing lease. Base bonds can range from $50,000 for a lease-specific bond with no approved operational activity up to $3,000,000 for an area-wide bond that includes a development production plan.[3]

BOEM’s Regional Director may determine that additional security above the base bond is necessary. This additional security is often referred to as supplemental financial assurance and is determined based on the Regional Director’s evaluation of a lessee or grant holder’s ability to carry out present and future financial obligations demonstrated by a five-factor test. The five factors that the Regional Director will consider are (a) financial capacity, (b) projected financial strength (initial proposals that were done away with would have considered net worth in determining financial strength), (c) business stability, (d) record of compliance with current regulations, laws, and lease terms, and (e) reliability in meeting credit rating obligations. The Regional Director will determine the amount of supplemental financial assurance required to guarantee compliance, considering potential underpayment of royalty and cumulative decommissioning obligations.[4]

In October of 2020, BOEM and BSEE issued a joint-proposed rule with the intention of revising BOEM’s financial assurance regulations and BSEE’s decommissioning orders. This joint-proposed rule would have modified BOEM’s financial assurance requirements such that BOEM would consider a lessee’s credit rating from certain recognized rating agencies and proved reserves to determine whether supplemental financial assurance would be required. BOEM proposed an S&P Global Ratings (“S&P”) credit rating threshold of BB or a Ba3 from Moody’s Investor Service (“Moody’s”). Under the proposed framework, BOEM would waive supplemental financial assurance requirements of lessees in the event their predecessors had strong credit ratings. Ultimately, however, in response to comments received by BOEM and BSEE, they decided not to proceed with the joint-proposed rule.[5]

BOEM’s 2023 iteration of the proposed rule would update its criteria for determining whether oil, gas, and sulfur lessees, Rights-of-Use Easement grant holders, and Right-of-Way grant holders may be required to provide supplemental financial assurance. The change is intended to better protect taxpayers from bearing the cost of facility decommissioning and financial risks associated with OCS development, such as oil spill cleanup and other environmental remediation by switching to a metric more predictive of financial stress and bankruptcy (as discussed below), thus allowing BOEM to ensure vulnerable lessees and grant holders are providing adequate security for their decommissioning obligations and protecting the federal government, and, in-turn, the taxpayer from having to absorb said obligations in the event of default. In its latest form, the proposed rule does away with the five-factor test and, similar to the 2020 proposal, instead considers an OCS lessee’s (a) credit rating and (b) proved oil reserves in determining whether a grant holder or lessee in the OCS is required to obtain supplemental financial assurance.

Based on its credit rating and the valuation of its proved oil reserves, an OCS lessee would not be required by BOEM to provide supplemental financial assurance in any of the following cases: (a) if the lessee has an investment grade credit rating (greater than or equal to either BBB- from S&P or Baa3 from Moody’s),[6] (b) if there are multiple co-lessees on a lease, if any one lessee meets the credit rating threshold, or (c) for leases where all lessees are below investment grade, if the value of the lease’s proved oil and gas reserves is three times the decommissioning cost estimate for such lease. The shift from relying primarily on the net worth of a lessee to its credit rating to determine whether supplemental financial assurance is needed is based on studies that suggest a strong correlation between credit rating and the probability of default due to credit ratings being based on cash flow, debt-to-earnings ratios, debt-to-funds ratios, and past performance, amongst other financial metrics.[7] The ability of an entity’s credit rating to predict financial distress and, in turn, an inability to absorb future decommissioning liabilities better than its net worth will allow BOEM to ensure those lessees and grant holders that are most vulnerable to defaulting will have provided sufficient security to cover their liabilities in the form of supplemental financial assurance.

Further, under the proposed rules, BOEM will no longer set a lower supplemental financial assurance requirement for lessees with financially strong predecessor lessees, as was proposed by BOEM and BSEE in their 2020 joint-proposed rule. While BOEM will retain the authority to pursue predecessor lessees for the performance of decommissioning, the proposed rule would not allow BOEM to rely upon the financial strength of predecessor lessees when determining whether, or how much, supplemental financial assurance should be provided by current OCS leaseholders, thus ensuring that current lessees have the financial capability to fulfill decommissioning obligations and discouraging lessees from ignoring end-of-life decommissioning costs, further reducing the likelihood that such obligations would fall upon the federal government and taxpayers in the event of default.

In order to value the proved oil and gas reserves, the proposed rules require lessees to submit a reserve report that complies with the SEC’s accounting and reporting standards valuing the oil and gas reserves located on a given lease. Leases for which the value of the reserves exceeds three times the cost of the associated decommissioning estimate (using BSEE’s P70 decommissioning level, which provides a 70% likelihood of covering the full cost of decommissioning) would not be required to obtain supplemental financial assurance. Under the proposal, the P70 value would be used to set the amount of any required supplemental financial assurance.

In order to ease the significant financial burden on impacted lessees and grant holders, BOEM proposes to phase in its new bonding requirements over a three-year period, whereby a lessee receiving a supplemental financial assurance demand will be required to post 33% of the total financial assurance amount by the deadline listed in the demand and a second 33% of the total financial assurance amount by the end of the second year after receipt of the demand letter, with the final 33% of the total assurance amount due within 36 months after receipt of the demand letter. If a lessee’s credit rating improves to investment grade during the three-year period, BOEM will no longer collect the remaining financial assurance and will return any supplemental financial assurance previously provided.

Industry Impacts

BOEM’s proposed rule changes will be at the front of OCS lessees’ minds for the next few years. Investment grade companies will have new opportunities because they will be more attractive as lease partners. Meanwhile, sub-investment grade companies, particularly “small businesses” (which have less than 1,250 to 1,500 employees),[8] will have to figure out how to navigate the costs and challenges of complying with these new changes.

The most obvious impact will be the new premiums for the supplemental financial assurance that lessees will have to acquire in order to comply with the rule, which is expected to cost sub-investment grade companies an additional $319 million per year (assuming 7% discounting).[9] The costs of these new premiums will fall disproportionately on the 76% of OCS lessees that are small businesses which, without the support from an investment grade co-lessee, may have difficulty satisfying either prong of the revised financial assurance rule. The average investment grade company has a net worth of approximately $115 billion,[10] which is a hurdle that most small businesses are unlikely to meet. Small businesses also tend to focus on late-stage wind down of assets to extract value from marginal wells and will have a harder time meeting the 3x ratio of reserve value to decommissioning liability than larger entities that are drilling new reserves.[11] Relying on the ratio of reserve value to decommissioning liability likely may not be a long-term solution because (a) the lessee would be actively producing the asset (and lowering the ratio) and (b) in the event of a downturn in oil prices, the reserve value could get marked down and the lessee would be forced to secure a bond in a time of relative economic distress.

For some small businesses, these rules may change the calculus on whether to seek an investment grade partner for any current or future offshore projects. The current method of determining whether a lessee needed to provide additional financial security relied on a mix of objective and non-objective measures (see the five-factor test described in Section II above) that afforded small businesses the opportunity to avoid the need to post additional bonds by showing a history of sound operatorship and regulatory compliance without looking exclusively to hard financial metrics or a rating from a credit agency. The proposed rule may eliminate this opportunity. Seeking an investment grade partner may be a more attractive alternative than paying for additional bonding, securing an adequate credit rating, or relying on the ratio of reserves to decommissioning liabilities.

BOEM assesses that, based on P70 levels, there is approximately $42.8 billion of offshore decommissioning liability, $20.2 billion of which is held by sub-investment grade companies.[12] The revised bonding requirements would result in a $9.2 billion increase in the amount of bonds to cover that liability (on top of the approximately $3.0 billion that is currently in place).[13] BOEM cited the need to protect taxpayers from potential decommissioning liability as a justification for revising the rule and pointed to the more than 30 lessee bankruptcies since 2009, which resulted in $7.5 billion of un-bonded decommissioning liabilities. The ultimate risk to the taxpayer was not near that figure (BSEE requested a mere $30 million in its FY2023 budget to address unbonded liabilities).[14] In the vast majority of cases, the decommissioning costs were covered by either co-lessees or predecessors or acquired by entities who purchased the related assets out of bankruptcy. Ultimately, the biggest winner of these changes may be predecessors to the leases who sought a “clean exit” and may now have greater barriers between outstanding decommissioning liabilities and their balance sheets.

Significant Comments/Overview of Comments

During the comment period, BOEM sought comments on, amongst other things, (a) the wisdom in setting the supplemental financial assurance requirements based on each of the P50, P70, and P90 decommissioning liability levels, (b) the appropriateness of relying on S&P’s Credit Analytics credit model, or other similar, widely accepted credit rating models to generate proxy credit ratings and the appropriateness of relying on lessee and grant holder credit ratings, including whether BOEM has proposed an appropriate credit rating threshold of BBB-, and if not, what threshold would best protect taxpayer interests while balancing burdens on the industry, (c) whether financial assurance should be required of all companies, regardless of credit rating, and the impacts such a requirement might have on OCS investment and on potential taxpayer liabilities, (d) whether the elimination of the current five-factor test would create a disincentive to comply with regulations, (e) whether the use of a minimum number of years of production remaining is an appropriate criteria to qualify for an exemption from supplemental financial assurance as an alternative to the 3:1 ratio of value of reserves to decommissioning costs, and (f) the costs and benefits of considering the financial capacity of predecessor lessees or grantees in determining the level of supplemental financial assurance required.

BOEM received close to 1,200 comments during the public comment period which closed on September 7 after the initial August 28 deadline was extended. The comments received were generally opposed to the proposed rule, questioning the validity of BOEM’s claims and highlighting the lack of supporting evidence provided by BOEM. The submitted public comments generally claimed that BOEM (a) did not adequately account for adverse economic consequences, (b) conducted an inadequate cost-benefit analysis, and (c) overstated the current impact to taxpayers, and the claimed benefits to the taxpayer, of the proposed rule. The public comments further claimed that the proposed rule will disproportionately burden smaller businesses, and will “create more emissions harm than benefit by making it more expensive to explore in the Gulf of Mexico, resulting in more demand for higher carbon intensity oil from global sources.”[15]

One comment of note cited a study which independently calculated OCS plugging and abandonment liability, assessed the risk it presents to the U.S. taxpayer, and performed a cost-benefit analysis of the proposed rule’s economic impact on the offshore oil and gas industry, the Gulf Coast, and the United States. According to the study, additional bonding requirements will spur bankruptcies as surety markets have threatened to exit the offshore sector, reducing available bonding capacity and driving up costs, which will in turn guarantee that small independent lessees will not be able to obtain the required supplemental bonding. Further, the study claims that additional bonding will reduce offshore drilling and related production to the tune of approximately 55 million barrels of oil equivalent over a 10-year period, reducing associated U.S. royalty revenues by approximately $573 million over the 10-year period. Moreover, according to the study, additional bonding requirements will cause reduced revenues and operations for companies serving the OCS, resulting in a loss of jobs and tax revenues along the Gulf Coast, with the study estimating the impact of the additional bonding requirements on the U.S. Gross Domestic Product to be a reduction of approximately $9.9 billion over a 10-year period.[16]

Conclusion

BOEM’s proposed rule is intended to safeguard U.S. taxpayers by strengthening bonding and financial assurance requirements for the offshore oil and gas industry in the OCS; however, as seen in the volume and content of public comments BOEM has received, those in the industry are skeptical and fear that it may do more harm than good. How BOEM proceeds from here bears close scrutiny.

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[1] Risk Management and Financial Assurance for OCS Lease and Grant Obligations, 88 Fed. Reg. 42136-42176 (June 29, 2023).

[2] Id.

[3] 30 CFR 556.900.

[4] 30 CFR 556.901.

[5] BSEE instead issued a stand-alone final rule (88 Fed. Reg. 23569) effective as of May 18, 2023, which (a) included Rights-of-Use and Easements (“RUEs”) and RUE grant holders in the agency’s decommissioning regulations for the first time, and (b) formalized BSEE’s procedures for enforcement of decommissioning orders issued to predecessors when a subsequent assignee defaults on its obligations. RUE grants are authorizations from BOEM to use a portion of the seabed not encompassed by the holder’s lease to construct, modify, or maintain platforms, artificial islands, facilities, installations, and other devices that support exploration, development, or production from another lease. Pursuant to the BSEE rule, RUE holders and prior lessees or owners of operating rights are jointly and severally liable for meeting accrued decommissioning obligations for infrastructure installed subject to a lease and maintained after lease expiration under a RUE. Further, when BSEE issues a decommissioning order to predecessors, it requires them to monitor, maintain, and decommission all wells, pipelines, and facilities by (a) initiating maintenance and monitoring within 30 days of receipt, (b) designating an operator or agent for decommissioning activities within 90 days, and (c) submitting a decommissioning plan to BSEE within 150 days. BSEE did not promulgate previous proposals (x) requiring parties appealing decommissioning orders to file an appeal bond or (y) requiring the proceeding up the chain of title in “reverse chronological order” against predecessor lessees, grant holders, and owners of operating rights when subsequent assignees fail to perform.

[6] For entities not rated by a major credit rating agency, BOEM proposes using an “equivalent proxy credit rating.” Such entities would be required to submit audited financial statements, which BOEM would use to determine its equivalent proxy credit rating using a commercially available credit model. (88 Fed. Reg. 42143).

[7] 88 Fed. Reg. 42136-42176 (June 29, 2023).

[8] See Id. (BOEM is required to analyze the impact of its regulations on “small” entities pursuant to the Regulatory Flexibility Act, 5 U.S.C. 601–12. The Small Business Administration (SBA) defines a small entity as one that is “independently owned and operated and which is not dominant in its field of operation.” What constitutes a “small business” varies by industry, but in the context of offshore hydrocarbon development, the SBA defines a small business as one with fewer than (i) 1,250 employees for upstream companies and (ii) 1,500 employees for midstream companies.)

[9] Id.

[10] Id.

[11] See Id.

[12] Id.

[13] Id.; BOEM Collateral List Report.

[14] Id.

[15] For comments, please see: https://www.regulations.gov/document/BOEM-2023-0027-0001/comment.

[16] https://opportune.com/insights/news/a-cost-benefit-analysis-of-increased-ocs-bonding-july-2023.

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The following Gibson Dunn attorneys assisted in preparing this client update: Michael P. Darden, Rahul D. Vashi, Graham Valenta, Zain Hassan, and Luke Strother.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about 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 Oil and Gas practice group, or the following authors:

Oil and Gas Group:
Michael P. Darden – Co-Chair, Houston (+1 346-718-6789, mpdarden@gibsondunn.com)
Rahul D. Vashi – Co-Chair, Houston (+1 346-718-6659, rvashi@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 September 11, 2023, the Chief Judge of the U.S. District Court for the Eastern District of Washington issued a strongly worded order confirming his August 11, 2023 dismissal of a stockholder derivative suit, National Center for Public Policy Research v. Schultz et al., No. 2:22-cv-00267.  The suit, brought by a conservative think tank as a derivative claim purportedly on behalf of Starbucks Corporation against certain of its officers and directors, sought declaratory judgment and injunctive relief on the grounds that some of Starbucks’ diversity initiatives allegedly violated Section 1981 of the 1866 Civil Rights Act, Title VII of the Civil Rights Act of 1964, and state anti-discrimination laws, and further alleged that the policies constituted a breach of directors’ fiduciary duties.

A.   Allegations

In its August 30, 2022 complaint (which was removed to federal court on November 7), the National Center for Public Policy Research (“NCPPR”) took aim at certain of Starbucks’ diversity, equity, and inclusion (“DEI”) policies, including (1) Starbucks’ goal to “achiev[e] BIPOC representation of at least 30% at all corporate levels and at least 40% [of] all retail and manufacturing roles by 2025” and various initiatives aimed at achieving that goal (Compl. ¶ 51); (2) its commitment to increase its spending with diverse suppliers from $800 million “to $1.5 billion by 2030” (id. ¶ 53); (3) its goal of allocating 15% of Starbucks’ 2022 advertising budget to minority-owned and targeted media companies (id.); and (4) its internal “Leadership Accelerator Program,” which would initially only be open to certain racially and ethnically diverse employees, and which aimed to improve those employees’ “capacity for self-promotion, advocacy and career navigation” and help them access “the leadership pipeline at Starbucks” (id).

According to NCPPR, these policies “facially violate § 1981” because they “expressly require the ‘but-for’ exclusion of individuals and businesses from contracts because of their race” (Compl. ¶ 88), and “facially violate Title VII” because they purport to make hiring, firing, compensation, and promotional decisions on the basis of race.  See id. ¶ 98.  The plaintiff also argued that the policies “expose Starbucks to potential litigation” and other liabilities (id. ¶ 110), and that implementing the policies breached Starbucks directors’ fiduciary duties, as they “knew or should have known that the [p]olicies were illegal.”  Id. ¶ 127.

B.   Opinion

Chief Judge Stanley A. Bastian granted Starbucks’ and the individual defendants’ motion to dismiss on August 11, 2023.  Chief Judge Bastian indicated in an oral decision that a stockholder derivative suit was an improper forum for making political statements, and observed, “If the plaintiff doesn’t want to be invested in ‘woke’ corporate America, perhaps it should seek other investment opportunities rather than wasting this court’s time.”  He also stated that “[t]he plaintiffs have ignored the fundamental rules of corporate law, including the business judgment rule.  Courts of law have no business involving themselves with legitimate and legal decisions made by the board of directors of public corporations.”

The written order, issued on September 11, echoed these sentiments, noting that “Plaintiff is apparently unhappy with its investment decisions in so-called ‘woke’ corporations. This Court is uncertain what that term means but Plaintiff uses it repeatedly as somehow negative.”  Order at 8.  The court disapproved of the political nature of the complaint, stating, “This Complaint has no business being before this Court and resembles nothing more than a political platform,” and “[w]hether DEI and ESG initiatives are good for addressing long simmering inequalities in American society is up for the political branches to decide.  If Plaintiff remains so concerned with Starbucks’ DEI and ESG initiatives and programs, the American version of capitalism allows them to freely reallocate their capital elsewhere.”  Id.  Notably, the court considered the context of NCPPR’s overall mission, explaining that “Plaintiff has a clear goal of dismantling what it sees as destructive DEI and ESG initiatives in corporate America.  Contempt for DEI and ESG programming and practices is clear in Plaintiff’s publications and literature.”  Id. at 7.  The court concluded that, “[b]ased on the briefing and nature of Plaintiff’s self-described political interests, it is clear to the Court that Plaintiff did not file this action to enforce the interests of Starbucks, but to advance its own political and public policy agendas.”  Id.

In its opinion, the court found it “unnecessary” to address the adequacy of the plaintiff’s factual and legal allegations under a Fed. R. Civ. P. 12(b)(6) standard (id. at 8), and instead analyzed “whether a derivative plaintiff  fairly and adequately represents the interests of a corporation or its shareholders.”  Id. at 5.  The court explained that “[i]n Washington corporate law [where Starbucks is incorporated], a corporation’s board of directors have exclusive authority to make decisions concerning the management of the corporation’s business” and that “[s]hareholder derivative lawsuits are disfavored and may be brought only in exceptional circumstances.”  Id. at 6 (citations and quotations omitted).  Thus, the court declined to allow NCPPR to litigate these claims on behalf of Starbucks and its stockholders, adding, “It is clear Plaintiff is pursuing its personal interests rather than those of Starbucks.”  Id.  The court further determined that, far from representing the interests of most Starbucks stockholders, the plaintiff “has shown obvious vindictiveness toward Starbucks,” aimed to “cause significant harm to Starbucks and other investors,” and “lacks the support of the vast majority of Starbucks shareholders.”  Id. at 6-7.

C.   Implications

The Starbucks suit predated the Supreme Court’s decision in Students for Fair Admissions v. President & Fellows of Harvard Coll., No. 20-1199 (U.S. Jun. 29, 2023) (“SFFA”), which struck down the use of affirmative action in college and university admissions.  Nevertheless, this case has been closely watched by companies that have been affected by increasing scrutiny of corporate DEI post-SFFA.  The SFFA decision incited a flurry of reverse-discrimination litigation and other challenges to corporate DEI policies, as well as a warning from a group of 13 Republican attorneys general to Fortune 100 companies, threatening “serious legal consequences” over certain DEI policies.

The opinion in NCPPR suggests that, despite increasing scrutiny of DEI policies, there will be substantial defenses to shareholder derivative litigation in this area, as courts tend to disfavor judicial meddling “with reasonable and legal decisions made by the board of directors of public corporations.”  Order, at 6.  Indeed, two other recent high profile shareholder cases challenging corporate diversity initiatives or alleging failure to abide by those initiatives—including in Delaware, where many companies are incorporated—have not survived beyond the motion to dismiss stage.[1]

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[1] See Simeone v. Walt Disney Co., 2023 WL 4208481, at *1 (Del. Ch. Jun. 27, 2023) (in lawsuit where plaintiff requested records to determine whether Disney breached its fiduciary duties by failing to withdraw its public opposition to Florida’s so-called “Don’t Say Gay” bill, declining to grant books and records request on the grounds that Disney’s “business decision” “cannot provide a credible basis to suspect potential mismanagement irrespective of its outcome”); Lee v. Fisher et al., 70 F.4th 1129 (9th Cir. 2023) (dismissing on procedural grounds a lawsuit alleging that Gap Inc. and its directors breached fiduciary duties by ignoring public promises to increase management-level diversity).

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The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Jessica Brown, Brian Lutz, Elizabeth Ising, Ronald Mueller, Lori Zyskowski, 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, Securities Litigation, or Securities Regulation and Corporate Governance practice groups, the authors, or the following practice leaders and partners:

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

Elizabeth A. Ising – Partner & Co-Chair, Securities Regulation & Corporate Governance Group, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)

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

Brian Lutz – Partner & Co-Chair, Securities Litigation Group, San Francisco (+1 415-393-8379, blutz@gibsondunn.com)

Jason J. Mendro – Partner, Securities Litigation Group, Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)

Ronald O. Mueller – Partner, Securities Regulation & Corporate Governance Group, Washington, D.C. (+1 202-955-8671, rmueller@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)

Jessica Valenzuela – Partner, Securities Litigation Group, Palo Alto (+1 650-849-5282, jvalenzuela@gibsondunn.com)

Craig Varnen – Partner & Co-Chair, Securities Litigation Group, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)

Lori Zyskowski – Partner & Co-Chair, Securities Regulation & Corporate Governance Group, New York (+1 212-351-2309, lzyskowski@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.

For the seventh successive Congress, Gibson Dunn is pleased to release a table of authorities summarizing the oversight and investigative (“O&I”) authorities of each House and Senate committee.  Congressional investigations can arise with little warning and immediately attract the media spotlight.  Understanding the full extent of a committee’s investigative arsenal is crucial to successfully navigating a congressional investigation.

Congressional committees have broad investigatory powers, including the power to issue subpoenas to compel witnesses to produce documents, testify at committee hearings, and, in some cases, appear for depositions.  Committees may adopt their own procedural rules for issuing subpoenas, taking testimony, and conducting depositions, and many committees update their rules each Congress.  Committees are also subject to the rules of the full House or Senate, and, in the House, the Chair of the Committee on Rules issues regulations prescribing general deposition procedures applicable to all committees.

Failing to comply with a subpoena from a committee or to otherwise adhere to committee rules during an investigation may have severe legal, strategic, and reputational consequences.  If a subpoena recipient refuses to comply with a subpoena, committees may resort to additional demands, initiate judicial enforcement or contempt proceedings, and/or generate negative press coverage of the noncompliant recipient.  Although rarely used, criminal contempt prosecutions can also be brought in the event of willful refusals to comply with lawful congressional subpoenas.  As we have detailed in previous client alerts,[1] however, defenses exist to congressional subpoenas, including challenging a committee’s jurisdiction, asserting attorney-client privilege and work product claims, and raising constitutional challenges.

With Republicans in control of the House, committee investigations to date have focused on environmental, social, and corporate governance (“ESG”) investing, social media censorship, collusion between the government and private parties to censor conservative speech, China, and COVID-19 origins and the government’s response to the pandemic.  In the Senate, where Democrats have an effective one-seat majority, investigations have centered on climate change, healthcare, prescription drug costs and labor-related issues.  We also anticipate that committees in both chambers will pursue investigations regarding the power of technology companies, international corporate and military competition and espionage, cybersecurity breaches, and supply chain issues, including forced and child labor.

Attached you will find a table that presents key investigative powers and authorities for each House and Senate committee.  The table includes information for each committee that answers key O&I related questions, including:

• What is the scope of the committee’s investigative authority?
• What are the procedures for exercising the committee’s subpoena power?
• Can the chair of the committee issue a subpoena unilaterally?
• Does the committee permit staff to question witnesses at a hearing?
• Can the committee compel a witness to sit for a deposition? If so, what are the procedures for doing so?
• What are the rules that apply to depositions before the committee?

The table includes hyperlinks to the sources of committee rules and jurisdiction and is meant to be a one-stop-shop for information relevant to O&I activities.

Below, we have highlighted noteworthy changes in the committee rules, which House and Senate committees of the 118th Congress adopted earlier this year.

If you see something missing from our discussion or the table, please let us know.  We welcome your feedback.

Some items of note:

House:

• As we detailed in earlier this year,[2] the House Republican majority is well-equipped to conduct investigations. In 2019, the new Democratic majority expanded their set of investigative tools and continued to add new ones in 2021.  Republicans are taking full advantage of those expanded tools.
• The Rules of the 118th Congress authorized three new investigative committees in the House: The Committee on Oversight and Accountability (formerly known as the Committee on Oversight and Reform) now has a Select Subcommittee on the Coronavirus Pandemic; the House Judiciary Committee now has a Select Subcommittee on the Weaponization of the Federal Government; and the Rules package and a separate House resolution created a new full investigative committee, the Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party.
  • The Select Subcommittee on the Coronavirus Pandemic is tasked with investigating and reporting on the origins of the COVID-19 pandemic, waste or fraud involving pandemic-relief funds, vaccine development, and COVID-related school closings. The Select Subcommittee does not have subpoena power nor legislative authority and, thus, cannot report legislation.  However, the full Oversight and Accountability Committee or its Chair “may authorize and issue subpoenas to be returned at the select subcommittee,” and the select subcommittee can from “time to time” report to the House or any House committee the results of its investigations or legislative recommendations.[3]  To date, the Select Subcommittee has focused on the origins of COVID-19, allegations of government cover-ups regarding its origins, and the consequences of school closures.
  • The Select Subcommittee on the Weaponization of the Federal Government is directed to study and issue a final report on its findings regarding executive branch collection of information on and investigation of U.S. citizens as well as “how executive branch agencies work with, obtain information from, and provide information to the private sector, non-profit entities, or other government agencies to facilitate action against American citizens.”[4] The Select Subcommittee does not have its own subpoena authority, but the Chair of the full Judiciary Committee may issue subpoenas for the Subcommittee.[5] The Subcommittee has cast a wide net and has issued document and information requests to a broad range of companies, non-profits, and government entities.
  • The Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party is directed to investigate and submit policy recommendations concerning the status of the economic, technological, and security progress of the Chinese Communist Party and its competition with the United States.[6] The Chair has the power to authorize and issue subpoenas for testimony and documents.[7]  Thus far, the Select Committee has held seven hearings on a variety of topics relating to China’s economic aggression, human rights record, and threat to the security of the United States.

Senate:

• In the Senate, the Democrats’ one-seat majority gives them significantly more power to investigate in the 118th Congress. During the 117th Congress, subpoenas required bipartisan support in the evenly divided Senate.  Now, Democratic chairs can issue subpoenas with the consent of their ranking members or by majority vote of their committees.  We’ve already seen a strong start to their investigative agenda in the 118th Congress, as evidenced by investigations into technology companies,[8] labor practices,[9] and bank failures.[10]
• Although its rules have not meaningfully changed since last Congress, the Senate Health, Labor, Education and Pensions (“HELP”) Committee has interpreted its Rule 17(a) to require a separate vote to authorize an investigation prior to voting on authorizing a subpoena.
• The Senate Budget Committee issued its first subpoena in decades in a congressional investigation. The move, which had bipartisan support, signals a possible expansion or congressional use to subpoenas to committees beyond those we typically see active in the investigatory space.  The move indicates that Senate Democrats are actively strengthening their investigative arsenal across committees, particularly regarding subpoena and deposition authority.

Our table of authorities provides an overview of how individual committees can compel a witness to cooperate with their investigations.  But each committee conducts congressional investigations in its own particular way, and investigations vary materially even within a particular committee.  While our table of authorities provides a general overview of what rules apply in given circumstances, it is essential to look carefully at a committee’s rules and be familiar with its practices to understand how its authorities apply in a particular context.

Gibson Dunn lawyers have extensive experience defending targets of and witnesses in congressional investigations.  They know how investigative committees operate and can anticipate strategies and moves in particular circumstances because they also ran or advised on congressional investigations when they worked on the Hill.  If you have any questions about how a committee’s rules apply in a given circumstance or the ways in which a particular committee tends to exercise its authorities, please feel free to contact us for assistance.  We are available to assist should a congressional committee seek testimony, information, or documents from you.

Table of Authorities of House and Senate Committees

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[1] Michael Bopp, Thomas Hungar, and Megan Kiernan, 118th Congress: Investigative Tools And Potential Defenses, Law 360 (March 3, 2023), https://www.gibsondunn.com/wp-content/uploads/2023/03/Bopp-Hungar-Kiernan-118th-Congress-Investigative-Tools-And-Potential-Defenses-Law360-03-03-2023.pdf.

[2] Congressional Investigations in the 118th Congress: ESG, China, and the Biden Administration Take Center Stage, (Jan. 13, 2023), https://www.gibsondunn.com/wp-content/uploads/2023/01/congressional-investigations-in-118th-congress-esg-china-and-the-biden-administration-take-center-stage.pdf.

[3] H.R. Res. 5, 118th Cong. § 4(a)(2).

[4] H.R. Res. 12, 118th Cong. § 1(b)(1) (2023).

[5] H.R. Res. 12, 118th Cong. § 1(c)(1)(B) (2023).

[6] H.R. Res. 11, 118th Cong. § 1(b)(2) (2023).

[7] House Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party, Committee Rule VI.

[8] Sen. Cruz Launches Sweeping Big Tech Oversight Investigation, (Feb. 13, 2023) https://www.commerce.senate.gov/2023/2/sen-cruz-launches-sweeping-big-tech-oversight-investigation.

[9] Chairman Sanders Questions Howard Schultz in HELP Committee Hearing and Calls on Starbucks to End the Illegal Union Busting, (Mar. 29, 2023) https://www.help.senate.gov/chair/newsroom/press/prepared-remarks-chairman-sanders-questions-howard-schultz-in-help-committee-hearing-and-calls-on-starbucks-to-end-the-illegal-union-busting.

[10] Recent Bank Failures and the Federal Regulatory Response, (Mar. 28, 2023) https://www.banking.senate.gov/hearings/recent-bank-failures-and-the-federal-regulatory-response.

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The following Gibson Dunn attorneys assisted in preparing this client update:  Michael D. Bopp, Thomas G. Hungar, Roscoe Jones, Jr., Amanda H. Neely, Daniel P. Smith, Tommy McCormac, Hayley Lawrence, and Wynne Leahy.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work or the following lawyers in the firm’s Congressional Investigations group in Washington, D.C.:

Michael D. Bopp – Chair, Congressional Investigations Group (+1 202-955-8256, mbopp@gibsondunn.com)

Thomas G. Hungar (+1 202-887-3784, thungar@gibsondunn.com)

Roscoe Jones, Jr. (+1 202-887-3530, rjones@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.

Geopolitical tensions and strategic competition between the United States and China have increasingly influenced the investment landscape in recent years, implicating established regulatory frameworks such as that of the Committee on Foreign Investment in the United States (“CFIUS”), as well as driving non-traditional government actors to take action.  Recently, plans to build a corn milling plant in North Dakota have caused states governments to consider their role in protecting both state and national security.  In December 2022, CFIUS determined that it did not have jurisdiction to review the proposed acquisition of North Dakota land by a Chinese company, Fufeng Group, with the intent to build a $700 million corn milling plant.  The Fufeng case generated significant national security and geopolitical debate in Washington given the proximity of the land to the Grand Forks Air Force Base.[1] These debates rapidly radiated beyond the beltway to state legislatures.

Since that CFIUS determination, lawmakers in a growing number of U.S. states have been quick to introduce and, in some cases, pass legislation that restricts foreign ownership of land within their states by governments, individuals, and/or entities associated with certain identified “foreign adversaries” of the United States.  While the bills often include other “foreign adversaries,”  most of the bills are particularly focused on China and Chinese investments.  The list of states that have enacted such legislation in 2023 includes Alabama, Arkansas, Florida, Idaho, Indiana, Louisiana, Mississippi, Montana, North Dakota, Oklahoma, South Dakota, Tennessee, Utah, West Virginia, and Virginia—an additional 20 states have introduced bills that would regulate foreign ownership of real estate if enacted.[2]

In this alert, we discuss:

• The typical contours of state legislation relating to certain foreign real estate activities;
• The emerging trendline of state legislation regulating the acquisition of real estate by certain foreign persons;
• A spotlight on Florida SB 264;
• The closely watched case of Shen v. Simpson; and
• Federal activity in this space, and the potential impact on state initiatives.

I. General Contours of State Legislation Restricting Certain Foreign Real Estate Activities

The bills introduced in state legislatures across the country in recent months vary in scope.  They tend, however, to share certain core areas of focus:

• The type of land restricted—e.g., agricultural land, land with proximity to military installations, or all real property;
• The class of foreign persons restricted—e.g., foreign governments; government officials and political parties; designated military companies; foreign companies; foreign nationals; or a combination of the above;
• The jurisdictions targeted—e.g., federally designated “foreign adversaries,” which includes China and the Hong Kong Special Administrative Region (“Hong Kong”), Cuba, Iran, North Korea, Russia, and the Nicolás Maduro Regime (“Maduro Regime”) of Venezuela;[3] a broader list which could also include countries such as Burma, Saudi Arabia, or Syria; or restrictions solely focused on China and Hong Kong;
• The types of activities restricted—e.g., whether the restrictions apply to ownership/purchases, direct and indirect investments, and/or leaseholds;
• Retroactivity and forced divestments; and
• Specific exceptions and carve outs.

II. A New Trendline—With an Established Precedent

While the trendline of state governments imposing restrictions on certain foreign ownership of real estate is new, there is established precedent for state government involvement in the broader foreign policy sphere.  Specifically, these laws are similar in type to the scores of state statutes that impose various restrictions on the ability of state actors (including pension funds and procurement offices) to do business with Iran or Sudan or with parties who refuse to do business with Israel.  Such laws have withstood judicial challenge in large part because Congress has granted states the authority to impose such restrictions—to effectively legislate their own foreign policy in this narrow lane.[4]  However, as of yet, Congress has not authorized the same powers to states regarding dealings with China or some of the other foreign states that these bills frequently address, such as Russia, Venezuela, and others.  In addition, by implicitly or explicitly targeting nationals of foreign countries or seeking to force divestment of current interests, many of these state property laws may be vulnerable to other constitutional challenges based on equal protection or due process grounds, as discussed further in Section IV.

III.   Spotlight on Florida SB 264

Of the various bills that have been introduced, Florida Senate Bill 264 (2023) (“SB 264”), has garnered significant attention as it is one of the most restrictive of this new wave of legislation.[5]  SB 264 was codified at Florida Statutes § 692.201–.204, and took effect on July 1, 2023.  As we discuss further in Section IV, SB 264 is also the subject of  a constitutional and statutory challenge in the federal courts in the case of Shen v. Simpson (“Shen”).[6]

In particular, SB 264 contains three separate sections prohibiting covered foreign persons from owning or acquiring interests in land in Florida:

• Section 692.202 states that “foreign principals” cannot “directly or indirectly own, have a controlling interest in, or acquire by purchase, grant, devise, or descent” any “agricultural land” in the state.[7]
  • The term “foreign principal” captures, inter alia, governments and government officials; political parties and their members; partnerships or corporations organized under the laws of or having its principal place of business in, or persons (other than U.S. citizens or lawful permanent residents) domiciled in, a “foreign country of concern.”[8]  The term “foreign country of concern” includes China, Russia, Iran, North Korea, Cuba, the Maduro Regime of Venezuela, and Syria, as well as “any agency of or any other entity of significant control of such foreign country of concern.”[9]
• Section 692.203 applies the same prohibition to real property within ten miles of any “military installation”[10] or “critical infrastructure facility” (such as airports, seaports, power plants, or refineries).[11]
• Section 692.204 goes further, specifically targeting China by prohibiting certain China-related persons from “directly or indirectly own[ing], hav[ing] a controlling interest in, or acquir[ing] by purchase, grant, devise or descent” any real property in Florida, including land, buildings, fixtures, and all other improvements to land.[12] This prohibition applies to the PRC government and the Chinese Communist Party, respective officials or members thereof; any partnership or corporation organized under the laws of or having its principal place of business in China, and its subsidiaries; and any person who is domiciled in China and who is not a U.S. citizen or lawful permanent resident, and “any person, entity, or collection of persons or entities described [above] having a controlling interest in a partnership, association, corporation, organization, trust, or any other legal entity or subsidiary formed for the purpose of owning real property in this state” (collectively, “Relevant Chinese Persons”).[13]

There are four exceptions provided under SB 264 that are applicable to the restrictions set out above (under Sections 692.202, 692.203 and 692.204).  In summary, these are:

• Ownership and interests in land or real property acquired prior to July 1, 2023—a foreign principal or Relevant Chinese Person that owns or acquires interests in land or real property that is subject to the restrictions set out above before July 1, 2023, may continue to own or hold such land or real property.[14] However, such foreign principal must register their property ownership with the Department of Agriculture and Consumer Services by January 1, 2024 (with respect to the restriction on agricultural land), or with the Department of Economic Opportunity by December 31, 2023 (with respect to real property that is not agricultural land).[15]
• De minimis indirect interest—a foreign principal or Relevant Chinese Person may own or acquire land or real property that is subject to the restrictions set out above provided that the foreign principal or Relevant Chinese Person only has a “de minimus [sic] indirect interest” in such land or real property. A foreign principal or Relevant Chinese Person has a de minimis indirect interest if “any ownership is the result of [their] ownership of registered equities in a publicly traded company owning the land and if [their] ownership interest in the company is either: (a) less than 5 percent of any class of registered equities or less than 5 percent in the aggregate in multiple classes of registered equities; or (b) a noncontrolling interest in an entity controlled by a company that is both registered with the United States Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended, and is not a foreign entity.”[16]
• Land or real property interests acquired by certain means—a foreign principal or Relevant Chinese Person may, on or after July 1, 2023, acquire land or real property that is subject to the restrictions set out above provided that such acquisition was by “devise or descent, through the enforcement of security interests, or through the collection of debts,” and provided that such foreign principal or Relevant Chinese Person “sells, transfers, or otherwise divests itself of such real property within 3 years after acquiring the real property.”[17] A Relevant Chinese Person relying on this exception, and who owns or acquires more than a de minimis indirect interest in real property in Florida on or after July 1, 2023, is required to register their real property within 30 days after the property is acquired.[18]
• Residential real property—a foreign principal or a Relevant Chinese Person who is a natural person may purchase one residential real property that is up to two acres in size if all of the following apply: “(a) The parcel is not on or within 5 miles of any military installation in [Florida]. (b) The person has a current verified [U.S.] Visa that is not limited to authorizing tourist-based travel or official documentation confirming that the person has been granted asylum in the United States, and such visa or documentation authorizes the person to be legally present within [Florida]. (c) The purchase is in the name of the person who holds the visa or official documentation described in paragraph (b).”[19] Such foreign principles and Relevant Chinese Persons are required to register with the Department of Economic Opportunity within 30 days of owning or acquiring such residential real estate on or after July 1, 2023.[20] This exception only applies to residential real property, and is therefore not applicable to the restriction under Section 692.202 that applies with respect to agricultural land.

SB 264 remains untested in terms of enforcement, and the state has yet to provide significant regulatory guidance.  At this point, the law appears to be broad in scope, seemingly restricting not only direct purchases of covered land but also indirect investments, such as through investment funds.

Moreover, SB 264 leaves important nuances  unclear.  For example, it is not clear from the plain language of SB 264 whether its restrictions extend to leasehold interests in addition to purchases and investments.  However, we have seen some indications that the law does not.  In August 2023, the Florida Department of Commerce released a Notice of Development of Rulemaking,[21] stating that it planned to “create a rule that aligns with new legislative changes from [SB 264] that prohibits the purchase of real property […] by foreign principals.”  In the same notice, the Department explained that the subject area to be addressed is the “purchase of real property […] by foreign principals.”  The fact that the Notice only refers to rulemaking regarding the purchase of real property, while making no mention of leases, could indicate that SB 264 will likely, at least at this stage, not apply to leasehold interests.[22]

Another question is whether Hong Kong, a popular place of incorporation for many companies (including those not based in a foreign country of concern) due to the ease of incorporation and favorable tax regime, will be treated as part of China for the purposes of SB 264.  Although there is no Florida guidance on this point, the U.S. government revoked Hong Kong’s special status in 2020.[23]  It now treats Hong Kong as part of China for trade and security purposes.  For example, as we noted in our client alert, the Biden Administration’s recent Executive Order regarding outbound investment restrictions included Hong Kong as part of China.  And, the U.S. Secretary of Commerce has explicitly included Hong Kong as part of China under U.S. export controls as well as federal regulation that designates China a “foreign adversary” for information security purposes.[24]  Many of the other states that have passed or are considering legislation in this area have adopted the Department of Commerce definition, which includes Hong Kong as part of China.

IV. Shen v. Simpson—Key Developments and Areas to Watch

In May 2023, four Chinese citizens residing in Florida and a real estate brokerage firm that does business with Chinese citizens launched a constitutional challenge against SB 264, contending that it violates the Fourteenth Amendment’s Equal Protection and Due Process Clauses and the Supremacy Clause, as well as the Fair Housing Act.[25]  Plaintiffs sought declaratory relief and a preliminary injunction to preclude the enforcement of SB 264.  On August 17, 2023, the U.S. District Court for the Northern District of Florida denied the motion for a preliminary injunction, ruling that Plaintiffs had not shown that their case had a “substantial likelihood of success on the merits,” of their various causes of action, including the constitutional challenges.

Subsequently, on August 21, 2023, the Plaintiffs filed an emergency motion for an injunction against the implementation of SB 264 pending appeal.[26]  The district court also denied this motion on August 23, 2023.[27]  On August 26, 2023, the Plaintiffs-Appellants filed an emergency motion for an injunction pending appeal and motion for expedited appeal to the Eleventh Circuit to halt the implementation of portions of SB 264 with respect to the restrictions on the ability of people whose “domicile” is in China to purchase residential real estate in Florida.[28]  This motion is still pending as of the date of this alert.

Many interested parties are tracking developments in Shen as an indication not only of whether SB 264 will survive the constitutional challenge, but also as an indication of the potential viability of other similar state laws that have been or are in the process of being enacted.

Twelve other U.S. states collectively filed an amicus brief in Shen opposing Plaintiffs’ challenge to SB 264.[29]  State legislatures in some of those states have proposed laws similar to SB 264 and therefore would have an interest in the outcome of the constitutional challenge in Shen.  Conversely the U.S. federal government filed an amicus brief supporting Plaintiffs’ motion in this case, underlining the federal government’s opposition to SB 264 and similar state laws, and potentially highlighting that a challenge to SB 264 or other such state law may eventually make its way to the U.S. Supreme Court.[30]

Courts will need to decide the extent to which federal law preempts state law in this area.  Given the existing laws and regulations governing foreign investment at the federal level—and pending legislation in Congress that would enhance restrictions on real estate investments by foreign persons as described further below—it is not clear how the courts will navigate a preemption challenge in this context.  An important question here is whether courts will apply the finding in Crosby v. National Foreign Trade Council[31] in which the U.S. Supreme Court unanimously struck down a Massachusetts state law prohibiting State business with Burma as unconstitutional under the Supremacy Clause.  In Crosby, the Court held that Congress had preempted the subject matter and delegated the application of economic sanctions against Burma to the President.[32]

In addition to preemption concerns, other potential constitutional challenges may undermine these state laws, including potential challenges based on Equal Protection concerns due to a focus on national origin, or due process failings.  In the meantime, however, in light of the district court’s refusal to enjoin the law (despite requests from the federal government), the Florida law and others like it may cause significant upheaval regarding real estate investment throughout the United States.  We do not expect these issues to be resolved quickly, and it is reasonable to anticipate it could be several years before a final resolution by the Supreme Court.

V. The Federal Landscape Continues to Evolve Regarding Foreign Investment in Real Estate

While state legislatures are increasingly active, the Fufeng CFIUS case has also spurred action at the federal level.  On May 5, 2023, the Department of the Treasury published a proposed rule expanding the list of military installations covered under the CFIUS regulations; Grand Forks Air Base, the military base at issue in the Fufeng was included amongst the eight new installations subject to CFIUS jurisdiction.  Members of Congress have also introduced bills that would restrict foreign ownership of agricultural land at the federal level.  For example, on July 25, 2023, with a broad bipartisan majority, the Senate voted to include the Promoting Agriculture Safeguards and Security Act (“PASS Act”) of 2023 into the National Defense Authorization Act (“NDAA”) for Fiscal Year 2024.[33]  The PASS Act would expand CFIUS jurisdiction to certain agricultural transactions involving investments by a foreign person.  If such an agricultural transaction would result in control over such agricultural land or business by a “covered foreign person,” the President would be required to prohibit the transaction.[34]  The “covered foreign persons” who are targeted by the restrictions captures, inter alia, persons who are citizens or residents of, entities registered in or organized under the laws of, or entities that have a principal place of business in, China, Russia, Iran, or North Korea.[35]  The PASS Act does provide a waiver process for the President on a case-by-case basis if the waiver is deemed “vital” to U.S. national security interests.[36]  It is not yet clear if the PASS Act will become law as part of the FY 2024 NDAA, which will require the Senate and House versions to be reconciled in conference committee.  Regardless of the outcome, the bipartisan support it received in the Senate is reflective of the broader U.S. political climate regarding certain foreign investments into the United States and the continuing trendline of heightened restrictions for foreign persons acquiring certain real estate.  Should the PASS Act be enacted, it could reinforce the preemption challenges discussed in Section IV.

VI. Conclusions

The passage of SB 264 and similar state legislation throughout the United States is a manifestation of the increasingly complex and rapidly evolving geopolitical rivalry between Beijing and Washington.  These state regulations add another complex layer to the various and broad U.S. restrictions at the federal level targeting trade and financial flows with China. While Biden Administration officials have sought to decrease tensions during recent visits to Beijing, simultaneous Biden Administration initiatives, such as the issuance of the long-awaited executive order outlining an outbound investment regime, have reinforced the strategic competition between the two countries and have tempered the salutary effect of these senior-level engagements.[37]

Given the controversy surrounding SB 264, we anticipate further challenges like Shen.  These state developments mean that international investors and multinational businesses must not only consider federal law when undertaking transactions in the United States, but must factor in state-specific restrictions that may also play increasingly important roles in managing their commercial engagements and exposure in the country.

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[1]    TJ Nelson, Fufeng USA Looking To Move Ahead With Grand Forks Project After Federal Agency Review Suddenly Ends, KVRR Local News (Dec. 13, 2022), https://www.kvrr.com/2022/12/13/fufeng-usa-looking-to-move-ahead-with-grand-forks-project-after-federal-agency-review-suddenly-ends/ (publishing CFIUS letter).

[2]    Anderson, Mulligan, Hawkins, State Regulation of Foreign Ownership of U.S. Land: January to June 2023, Cong’l Research Service (July 28, 2023), chrome-https://crsreports.congress.gov/product/pdf/LSB/LSB11013.

[3]    See 15 C.F.R. § 7.4 (determination of foreign adversaries), https://www.ecfr.gov/current/title-15/subtitle-A/part-7/subpart-A/section-7.4.

[4]    See Crosby v. National Foreign Trade Council, 530 U.S. 363 (2000) (unanimously striking down as unconstitutional under the Supremacy Clause a Massachusetts state law prohibiting State business with Burma, holding that subject matter had been preempted by federal statute and the delegation of application of economic sanctions against Burma to the President).  See also Cong. Rsch. Serv., State and Local Economic Sanctions: Constitutional Issues (Feb. 20, 2013), here.

[5]    S. B. 245, 2023 Leg. (Fla. 2023), https://www.flsenate.gov/Session/Bill/2023/264/BillText/er/PDF.

[6]    See Shen v. Simpson, 2023 WL 5517253 (N.D. Fla. Aug. 17, 2023), appeal docketed, No. 23-12737 (11th Cir. Aug. 23, 2023).

[7]    Defined separately under Fla. Stat. § 193.461.

[8]    Fla. Stat. § 692.201(4).

[9]    Fla. Stat. § 692.201(3).

[10]   Fla. Stat. § 692.201(5) (“military installation” means a base, camp, post, station, yard, or center encompassing at least 10 contiguous acres that is under the jurisdiction of the Department of Defense or its affiliates).

[11]   Fla. Stat. § 692.201(2).

[12]   Fla. Stat. §§ 692.204(1), 692.201(1)(6).

[13]   Id.

[14]   Fla. Stat. §§ 692.202(2); 692.203(2); 692.204(3).

[15]   Fla. Stat. §§ 692.202(3); 692.203(3); 692.204(4).

[16]   Fla. Stat. §§ 692.201(1); 692.203(1); 692.204(1).

[17]   Fla. Stat. §§ 692.201(4); 692.203(5); 692.204(5).

[18]   Fla. Stat. § 692.204(4).

[19]   Fla. Stat. §§ 692.203(4); 692.204(2).

[20]   Fla. Stat. §§ 692.203(3); 692.204(4).

[21]   Notice of Development of Rulemaking No. 27393496, https://www.flrules.org/Gateway/View_Notice.asp?ID=27393496.

[22]   In the same vein, the court in Shen, though not legally binding, described SB 264 as a law that restricts “land purchases” and requires “anyone purchasing real property ..[…] [to] sign an affidavit attesting that he is not a foreign principal.” Ord. Denying Preliminary Injunction Mot. at 2-3, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 17, 2023), ECF No. 69.

[23]   Exec. Ord. No. 13936, 85 Fed. Reg. 138 (July 14, 2020).

[24]   See 15 C.F.R. § 7.4.

[25]   42 U.S.C. §§ 3604, 3605.

[26]   Emergency Mot. for Injunction Pending Appeal, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 21, 2023), ECF No. 71.

[27]   Ord. Denying Mot. for Injunction Pending Appeal, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 23, 2023), ECF No. 72.

[28]   Time-Sensitive Mot. for Injunction Pending Appeal and For Expedited Appeal, Shen v. Simpson, No. 23-12737 (11th Cir. Aug. 26, 2023), ECF No. 4.

[29]   The 12 states are:  Idaho, Arkansas, Georgia, Indiana, Mississippi, Missouri, Montana, New Hampshire, North Dakota, South Carolina, South Dakota, and Utah.

[30]   Statement of Int. of the U.S. in Support of Plaintiffs’ Mot. for Preliminary Injunction, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. June 27, 2023),  ECF No. 54.

[31]   Crosby v. National Foreign Trade Council, 530 U.S. 363 (2000).

[32]   Id.

[33]   S. Amdt. 813 to S. Amdt. 935, 118th Congress (2023-2024), https://www.congress.gov/amendment/118th-congress/senate-amendment/813.

[34]   Id.

[35]   Id.

[36]   Id.

[37]   For further detailed background on these various issues, see several recent Gibson Dunn sample client alerts addressing U.S. China trade issues: With Biden Executive Order, a U.S. Outbound Investment Control Regime Takes an Important Step Forward – Focused on China, but Significant Steps Remain Before Implementation, Gibson Dunn (Aug. 14, 2023), https://www.gibsondunn.com/with-biden-executive-order-us-outbound-investment-control-regime-takes-important-step-forward-focused-on-china/; 2022 Year-End Sanctions and Export Controls Update, Gibson Dunn (Feb. 7, 2023), https://www.gibsondunn.com/2022-year-end-sanctions-and-export-controls-update/#_Toc126615914; Biden’s National Security Strategy Reinforces Tech Decoupling and Increased Regulatory Focus, Gibson Dunn (Nov. 18, 2022), https://www.gibsondunn.com/bidens-national-security-strategy-reinforces-tech-decoupling-and-increased-regulatory-focus/; Webcast: U.S. Export Controls: New Sweeping Tech Controls on China – What You Need to Know, Gibson Dunn (Nov. 15, 2022) https://www.gibsondunn.com/webcast-u-s-export-controls-new-sweeping-tech-controls-on-china-what-you-need-to-know/.

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The following Gibson Dunn lawyers prepared this client alert: Adam M. Smith, Stephenie Gosnell Handler, David Wolber, Amanda Neely, Arnold Pun, Sarah Pongrace, Dasha Dubinsky, and Jane Lu.

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 or any of the following authors for additional information about how we may assist you:

Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@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)
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Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
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Claire Yi – New York (+1 212-351-2603, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

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Kelly Austin – Hong Kong/Denver (+1 303-298-5980, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
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Qi Yue – Hong Kong (+852 2214 3731, qyue@gibsondunn.com)
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