In its 2023 M&A rankings, which recognize the best firms in Asia for M&A work, Asian Legal Business recommended Gibson Dunn in Singapore: International, China: International and in Hong Kong. The rankings were published on September 12, 2023.
Gibson Dunn’s Mergers and Acquisitions Practice Group is an international leader in mergers, acquisitions, divestitures, spin-offs, proxy contests and joint ventures. Our M&A clients include public and private companies, ranging from Fortune 100 and multinational corporations to smaller companies; private equity firms; boards of directors and special committees; selling shareholders; management teams; and financial advisors. Clients also regularly enlist Gibson Dunn to provide advice regarding takeover preparedness and the implementation of defensive measures.
Asian Legal Business has named Hong Kong partner Connell O’Neill in its Asia Top 15 TMT Lawyers 2023. The survey showcases “the top technology, media, and telecommunications lawyers across Asia who have powered through the pandemic, continuing to grow their practices at a remarkable pace while adapting to new markets, disruptive technology and ever-changing regulatory regimes.” The list was published on September 12, 2023.
Connell heads the firm’s technology practice in Asia, and advises clients throughout APAC and the Middle East on corporate and commercial transactions, privacy and cybersecurity, product counselling, and commercial intellectual property matters in the information technology, media and telecommunications sectors.
We are pleased to provide you with Gibson Dunn’s ESG monthly update for August 2023. This month, our update covers the following key developments. Please click on the links below for further details.
1. World Water Week and the announcement of the COP28 Water Agenda
Between August 20-24, 2023, the Stockholm International Water Institute (SIWI) hosted the annual World Water Week conference. The event brought together 15,000 business leaders, decision-makers, planners and researchers, from 193 countries and territories, to explore how the natural resource of water can be harnessed to address the climate crisis. This year’s theme, Seeds of Change: Innovative Solutions For a Water-Wise World, sought to promote the benefits of a mission-driven approach to global planning for the increasing scarcity of water world-wide. It also sought to raise awareness of the significance of designing policy to work with the water cycle.
SIWI identified some Key Trends from the week: (i) interconnectivity and inclusion being critical for progress; (ii) shifting perceptions of innovation away from conventional thought towards broader governance, finance, values and culture; (iii) learning from indigenous peoples for innovation; (iv) oceans, and the connectivity between freshwater, coasts and oceans as opposed to separate bodies of water; (v) urgency of global approaches to water governance, given current pressures on the global water cycle; and (vi) international processes to ensure collective action.
Additionally, the progress made so far on the UN’s Water Action Agenda, set out in March 2023, was analyzed, and participants were prepared for COP28 which takes place in the UAE from November 30 until December 12, 2023. The COP28 UAE Presidency announced its own Water Agenda and that the Netherlands and Tajikistan will serve as COP28 Water Champions. Both of these signal that the management of global water resources will be a top priority at COP28.
2. S&P Global Ratings Drops ESG Scores
S&P Global Ratings (S&P) announced on August 4, 2023, that it will no longer give alphanumeric ESG ratings when assessing creditworthiness. The scores were originally introduced in 2021 to supplement the narrative ESG reports which S&P provide. S&P has instead determined that these narrative reports are “most effective at providing detail and transparency on ESG credit factors material to our rating analysis.” The move is seen as a response to growing pressure from international policymakers on those bodies currently providing ESG rating standards.
The dropping of the rating system does not affect the S&P’s ESG General Criteria, which is still applied by S&P when incorporating ESG factors into its credit ratings analysis.
3. International Auditing Assurance Standards Board opens consultation on proposed global sustainability assurance standards
On August 2, 2023, the International Auditing and Assurance Standards Board (IAASB) opened a consultation on proposed new global sustainability assurance standards, focused on sustainability reporting. The IAASB’s proposed standards – ‘ISSA 5000’ – are based on principles intended to apply across different sectors and regions, and include proposals such as requiring practitioners to design and perform sustainability-related risk procedures. The standards aim to be the ‘most comprehensive sustainability assurance standard available to all assurance practitioners across the globe’. The consultation is open until December 1, 2023.
4. Vanguard and Blackrock report falls in support for ESG-related proposals
The world’s two biggest investment managers revealed sharp falls in their support for ESG-related shareholder proposals during the 2023 proxy season compared to 2022. Both Vanguard and Blackrock said that many ESG-related proposals had been rejected because the risks raised were already being addressed by the recipient companies’ boards, or the proposals did not improve on existing company disclosures. The investment stewardship reports show an increase in the volume of ESG-related shareholder proposals, but suggest an overall decrease in their viability. For a deeper discussion of ESG and other shareholder proposal developments during the 2023 proxy season, please see our client alert here.
Vanguard:
On August 28, 2023, Vanguard reported that it supported only 2% of environmental and social shareholder proposals submitted to its U.S. portfolio companies in 2023, down from 12% in the previous year. Vanguard stated this decline was ‘largely attributable’ to the increasing number of such proposals and the nature of their requests. Vanguard specifically noted the impacts of the SEC’s November 2021 changes to its no-action request standards, including when a proposal addresses a “significant social policy” and cannot be excluded as relating to the company’s “ordinary business” under Rule 14a-8(i)(7) Securities Exchange Act 1934. Vanguard reported that the number of environmental shareholder proposals rose 50% from the prior year, with target-setting for greenhouse gas emissions becoming an increasingly common request.
BlackRock:
On August 18, 2023, BlackRock reported a 34% increase in environmental and social shareholder proposals submitted to U.S. companies compared to 2022. Echoing the sentiments from Vanguard, Joud Abdel Majeid, BlackRock Global Head of Investment Stewardship, commented that “[b]ecause so many shareholder proposals were over-reaching, lacking economic merit, or simply redundant, they were unlikely to help promote long-term shareholder value and received less support from shareholders, including BlackRock, than in years past.”. BlackRock supported only 7% of the environmental and social shareholder proposals submitted globally.
1. UK Government increase in funding for renewable funding – multi-million backing for renewables
On August 3, 2023 the UK government published a press release announcing a £22m increase in the budget of the Contracts for Difference scheme, taking the total budget to £227m for this auction. The aim is to foster investment, growth, and diversity in the UK’s renewables industry and improve the UK’s energy security via reducing its exposure to potentially volatile global fossil fuel prices. The scheme is to encourage growth in established technologies such as solar and offshore wind via an increase in their budgets to £190m from £170m in the latest auction. Emerging technologies such as carbon capture are also seeing increased investment, with those increasing in budget from £35m to £37m, with a £10m ring-fenced budget for tidal stream projects. The target is to increase the proportion of the UK’s electricity generation, building on the existing trend which has seen an increase from 7% in 2010 to 42% in 2022.
2. Updates on UK moves to adopt the new ISSB Sustainability Disclosure Standards
The UK government has issued guidance on its Sustainability Disclosure Standards (SDS), which will set out corporate disclosures on the sustainability-related risks and opportunities faced by companies. They will include climate change related assessment of risks and opportunities and will be published by the Department for Business and Trade. SDS will be based on the IFRS Sustainability Disclosure Standards issued by the International Sustainability Standards Board (ISSB). The UK-endorsed standards will only divert from the global baseline if absolutely necessary for UK-specific matters. These SDS’s may be referenced in any legal or regulatory requirements for UK entities. Decisions to require disclosure will be taken independently by the UK government, for UK registered companies and limited liability partnerships, and by the Financial Conduct Authority (FCA) for UK listed companies. By adopting a global baseline for environmental standards (as envisioned when ISSB was announced at COP26), it is hoped that this will enable globally harmonised and comparable standards and be a useful metric for decision making by investors allocating capital.
The FCA has issued its own proposed approach to the implementation of the ISSB standards, noting that it expects to open a consultation in the first half of 2024. The FCA aims to finalise its policy position by the end of 2024, with a view to bringing new requirements into force for accounting periods beginning on or after January 1, 2025. The first reporting would begin from 2026.
3. UK Government Consultation: Role of biomass in achieving net zero: call for evidence
The Department for Energy Security & Net Zero had previously sought evidence from a range of stakeholders on how sustainable biomass should best support the UK’s Net Zero target, and has now issued its detailed analysis of responses and key findings. The information gathered will be used in connection with the development of the UK government’s Biomass Strategy. The consultation received 144 responses across 4 topics. Firstly ‘Supply’, focusing on underutilised waste, forestry, and energy crops. Secondly, ‘End Uses’ covering a variety of examples from heating to transport and electricity. Thirdly, ‘Sustainability and Accounting for Emissions’, which proposed a set of criteria and ideas for monitoring in accordance with potential international standards. Finally, ‘Innovation’, which covered waste processing technologies, BECCS (bioenergy with carbon capture and storage), and the regional innovation potential of different parts of the UK.
4. UK Charity Commission guidance on investing charity money for charity trustees
The UK Charity Commission has issued updated guidance and a summary of the legal framework on investing charity money for charity trustees. The guidance is intended to assist trustees in making financial and social investment decisions, whilst fulfilling their duties as trustees. The guidance intends to streamline and clarify existing guidance on trustee responsibilities, following a 2022 High Court decision on charity trustee investment duties, which established that it was possible for charities to adopt climate-conscious investment strategies.
5. Collective action claim against water companies in the UK’s Competition Appeal Tribunal
Collective action cases have been launched with the Competition Appeal Tribunal against water companies in the UK accused of falsely reporting sewage discharges in breach of environmental regulations. Around £330 million in damages are sought from Severn Trent (ST) on behalf of ST’s eight million customers, in the first of this series of claims, with up to five more such claims expected to be launched. Law firm Leigh Day brings the claims on behalf of household customers on the basis of alleged breach of competition laws by ST, who, it claims, abused its dominant market position to mislead regulators on the environmental damage caused by sewage discharges.
1. AFME report for Q2 2023
The Association for Financial Markets in Europe (AFME) has published its European environmental, social and governance (ESG) finance report for the second quarter of 2023 (Q2 2023), which provides detailed data trends alongside a regulatory and supervisory snapshot of the sustainable finance market in Europe. The report includes statistics on European ESG bond and loan issuance: half year volumes for ESG-labelled bonds increased 17% year-on-year, driven by the robust green bond issuance during Q1 2023. Sustainable-linked bond market witnessed a sharp decline with a 16.3% year-on-year decrease. The report also noted that UK carbon prices have declined by 35% since December 2022 with European Union Allowance carbon prices 10% higher over the same period. Global ESG Funds are noted as decreasing marginally since Q1 2023, but increasing by 25.3% since Q2 2022. Spreads of corporate ESG bonds against non-sustainable benchmarks are reported as increasing by c. 1.6bps between April and late July 2023. A primarily UK and EU regulatory update is also provided, with a quarter-by-quarter breakdown.
2. European Commission adoption of European Sustainability Reporting Standards and EFRAG’s Response
As summarised in the Gibson Dunn ESG Update of June 2023, the European Commission is in the process of implementing a set of European Sustainability Reporting Standards (ESRS), due to come into effect January 1, 2024. The ESRS aim to provide investors and other stakeholders with granular reporting on sustainability and climate-related issues, an essential prerequisite for informing investment decisions and allocating capital in line with sustainability goals, including those of the European Green Deal and the EU Climate Law.
On 31 July, 2023, the Commission adopted the Commission Delegated Regulation supplementing the Directive, which sets out the first set of sector-agnostic ESRS – as covered in the Gibson Dunn ESG Update of July 2023.
The Commission must adopt the ESRS taking into account the technical advice provided by EFRAG, who themselves issued a press release welcoming the adoption of the first set of ESRS. EFRAG’s advice focuses on streamlining the proposed reporting obligations to reduce the potential cost burdens. In response, the Commission has included phase-in provisions for the reporting obligations of smaller companies and changed some reporting requirements from mandatory to voluntary.
Additionally, EFRAG also highlighted its continuing efforts to ensure the interoperability of the ESRS with other relevant international standards of ESG reporting, such as the International Sustainability Standards Board (ISSB) and Global Reporting Initiative (GRI) standards. The ongoing collaboration between those setting ESG reporting standards suggests the potential for further convergence of the global reporting regimes, and increased clarity for those subject to them in future.
3. Appointment of new Executive Vice-President for the European Green Deal, Maroš Šefčovič
Following the resignation of Frans Timmermans as Member of the European Commission, Maroš Šefčovič has been appointed as his replacement to become Vice-President of the European Green Deal. In connection with the appointment, European Commission President, Ursula von der Leyen, has taken the opportunity to flag the Commission’s intentions to prioritise the European Green Deal and consolidate Europe’s leadership role on global renewables and energy efficiency targets. Von der Leyen notes the requirement for ‘more intensive dialogue with industry, key stakeholders like forest owners, farmers, as well as citizens’.
4. EU announces emissions reporting rules for Carbon Border Adjustment Mechanism (CBAM)
The European Commission adopted new rules on August 17, 2023 in connection with the initial trial phase of the Carbon Border Adjustment Mechanism (CBAM). These implement carbon emissions reporting obligations for EU importers of CBAM goods and set out fines for failures to satisfy such reporting requirements. The transitional phase begins on October 1 2023 until the end of 2025, during which time, traders will not be subject to the fines or taxes on emissions envisaged by the regulation, but must report on emissions, allowing for the ‘definitive methodology to be fine-tuned by 2026’, as the Commission reports. Guidance has been published in conjunction with the CBAM implementation and initial trial phase.
5. Denmark announces new carbon capture storage project plans
The Danish Ministry of Climate, Energy and Utilities has announced it has pioneered a scheme to promote carbon capture and storage (CCS) technology, by allocating the equivalent of almost USD4bn in government subsidies to companies over a period of 15 years. The initiative is set up to enable the capture of around 2.3 million tons of CO2 per year. The scheme proposes to function with 20 per cent state ownership of future carbon storage licences, meaning Danes will share in profits of the scheme.
1. Companies plea for climate disclosure legislation with the return to session of California lawmakers
As California lawmakers return to session, 15 companies have written a letter to the California Assembly Appropriations Committee Chair to express their support of the proposed Climate Corporate Data Accountability Act (SB 253), which would require U.S. companies with more than $1 billion in total annual revenues and doing business in California to annually report their Scope 1, 2, and 3 greenhouse gas emissions. The companies state in their letter that ‘consistent, comparable, and reliable emissions data at scale is necessary to fully assess the global economy’s risk exposure and to navigate the path to a net-zero future. All sectors and economic actors must work together to shift the entire economy …. we need legislation like SB 253 to cover privately held and midmarket companies to better ensure economy-wide accountability and action’.
2. U.S. antitrust agencies increasing scrutiny of ‘interlocking directorates,’ raising pressure on board members at competing companies
August has seen the U.S. Government increasingly focused on directors operating on boards of competing companies, a practice that violates Section 8 of the Clayton Act, a federal law designed to promote competition and avoid contraband co-ordination.
The Federal Trade Commission (FTC) on August 16, 2023 stepped in to re-structure a deal that would have given Quantum Energy Partners a board seat at EQT, its direct competitor in the sale and production of natural gas. The FTC issued its proposed consent agreement to settle ‘alleged violations of Federal law prohibiting unfair methods of competition’.
Similarly, the Department of Justice (DOJ) announced the resignation of two Nextdoor board members who were simultaneously directors on the board of its competitor, Pinterest, following the DOJ antitrust division’s ongoing enforcement efforts relating to the Clayton Act. Deputy Assistant Attorney General Andrew Forman of the Antitrust Division noted that ‘enforcement involving interlocking directorates will continue to be one of the top priorities of the Antitrust Division’.
3. New U.S. Department of Energy initiatives
The U.S. Department of Energy has announced a number of new environmental initiatives, including the availability of $350 million in grants to help states monitor and cut methane emissions, and to provide support to reduce inefficiencies. States must apply for funding by September 30, 2023.
The Department of Energy also announced the launch of a Responsible Carbon Management Initiative, which seeks to ensure the highest standards of management required for safety, environmental stewardship, accountability, community engagement and societal benefits related to carbon management projects.
It was also announced that $1.2 billion would be made available for the development of the first direct air capture facilities in Texas and Louisiana, aiming to start a nationwide network of commercial-scale carbon removal sites to reduce emissions. The investment would be the world’s largest to date in connection with carbon removal technology.
4. Government of Canada consultation on clean electricity regulations
As part of the nation’s broader electrification and decarbonisation strategy, the Government of Canada has published a consultation on its draft Clean Electricity Regulations, aimed to reduce emissions through the modification of electricity generation units and the requirement of reporting on all eligible units. The consultation remains open until November 2, 2023.
1. ASEAN to establish guidelines for company climate transition
A joint statement of the ASEAN Finance Ministers and Central Bank Governors (AFMGM) was issued on August 25, 2023, affirming that regulatory authorities across ASEAN countries are working on a voluntary corporate transition framework that is estimated to be released by the end of 2023. The forthcoming guidelines will adopt a principles-based approach, combining and taking inspiration from the most effective existing frameworks internationally. The primary objective is to assist companies in developing and sustaining transparency in their climate transition strategies, and to support an ‘affordable, credible and orderly transition’.
The meeting also outlined progress of the ASEAN Taxonomy Board’s consultation on the ASEAN Taxonomy version 2, which commenced in June 2023, and which is expected to complete by November 2023 (ahead of the UN Climate Change Conference in Dubai). The consultation will assist with the implementation of and the focus on particular sectors for Version 3, which is anticipated to be released over the next two years.
2. New investors have increased the AUM of sovereign climate engagement group to $8trn
Eighteen new investors joined the Australian pilot of the Collaborative Sovereign Engagement on Climate Change, raising the combined assets under management of the programme to $8trn. The initiative consists of a network of institutional investors who aim to support Australian governments to mitigate climate change in accordance with the Paris Agreement. The initiative runs under the aegis of the United Nations-supported Principles for Responsible Investment (UNPRI). The press release of the UNPRI, which announced the new members, also laid out the four goals which investors will seek to reach by improving sovereign climate change responses: (i) narrowing the gap between ongoing efforts and a path that aligns with the emission reduction goals of the Paris Agreement; (ii) developing comprehensive and credible net zero transition plans, including supportive policies, budget allocations and investment strategies; (iii) enhancing climate resilience across the economy and society to mitigate the harm and disruption caused by environmental threats; and (iv) enhancing transparency of sovereign exposure to climate-related risks and opportunities, following global standards.
3. Net zero organisation GFANZ sets up Hong Kong Chapter
The Glasgow Financial Alliance for Net Zero (GFANZ), a global coalition of financial institutions committed to the climate transition, issued a press statement of their intention to open a Hong Kong Chapter. The Hong Kong Chapter will serve as an extension of the GFANZ’s Asia-Pacific Network with the strategic goal of collaborating with financial institutions in Greater China on matters of comprehensive transition planning, scaling transition finance, and furthering net zero efforts.
4. New ESG standards coming into effect in South Korea
South Korea implemented new ESG evaluation standards on September 1, 2023. These ‘best practices for ESG evaluation work’ have been prepared and implemented by the ESG Standards Institute, Korea ESG Research Institude, and Sustinvest, and have the support of three major South Korean ESG rating agencies (Financial Services Commission (FSC), the Korea Exchange, and the Korea Capital Market Institute). The FSC has established a council composed of these evaluation agencies to assist in overseeing and enhancing the standards going forward.
5. New carbon markets registry launched in Singapore
The Asia Carbon Institute (ACI), a voluntary carbon credit registry and carbon standards organisation was launched in Singapore on August 29, 2023. The non-profit, established by Shell trader John Lo, seeks to scrutinise sustainability initiatives in the urban- and tech-space by issuing carbon credits that represent a quantifiable and permanent reduction in greenhouse gas emissions. ACI aims to provide independent and science-based reviews of project developments and expects to register around 100 projects per year.
6. India has issued a Green Hydrogen Standard
To advance the National Green Hydrogen Mission, the Ministry of New & Renewable Energy of India (MNRE) has announced a Green Hydrogen Standard that specifies emissions thresholds which need to be met in order to classify hydrogen production as ‘green’. The scope of the definition includes both biomass-based and electrolysis-based production methods and it characterises green hydrogen as having a well-to-gate emission not exceeding an average of 2 (two) kilograms of carbon dioxide equivalent per kilogram of hydrogen produced over 12 (twelve) months. The office memorandum dated August 18, 2023, sets out that a detailed methodology for the measurement, monitoring, reporting, on-site validation and certification of green hydrogen and its derivatives will be developed by the MNRE.
7. Taiwan opens carbon trading exchange
President Tsai Ing-wen launched Taiwan’s first carbon exchange in Kaohsiung on August 7, 2023, to assist the government’s goal of achieving net-zero emissions by 2050. In its initial phase, the exchange, set up jointly by the Executive Yuan’s National Development Fund and the Taiwan Stock Exchange, aims to support local businesses with carbon consultation and training on topics such as supply chain carbon neutrality, international carbon border taxes and domestic carbon fees. It is also expected that after pertinent sub-laws regarding carbon pricing are drafted by the Environmental Protection Administration, the exchange will begin to facilitate international carbon credit trading.
Please let us know if there are other topics that you would be interested in seeing covered in future editions of the monthly update.
Warmest regards,
Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam
Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP
The following Gibson Dunn lawyers prepared this client update: Lauren Assaf-Holmes, Elizabeth Ising, Grace Chong, Lily Loeffler, Patricia Tan Openshaw and Selina S. Sagayam.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Environmental, Social and Governance practice group:
Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, popenshaw@gibsondunn.com)
Selina S. Sagayam – London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)
© 2023 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
With five publicized agreements, the U.S. Department of Justice (“DOJ”) resolved significantly fewer cases using non-prosecution agreements (“NPAs”) and deferred prosecution agreements (“DPAs”) in the first half of 2023 than in similar periods in previous years.[1] At the same time, DOJ continued to refine its corporate enforcement policy, which addresses the factors DOJ considers when evaluating whether to prosecute a company, and if so, what form of resolution—if any—to offer the organization. Through July 31, 2023, four of the top five largest corporate resolutions in terms of dollars were negotiated plea agreements, and there were a total of 28 corporate plea agreements. As DOJ very publicly evolves its corporate enforcement policy and priorities, our discussion of NPAs and DPAs would be remiss outside of the context of their counterparts – guilty pleas on the one hand, and declinations-with-disgorgement on the other. Thus, beginning with this publication, Gibson Dunn’s client alerts on NPAs and DPAs also will track these important members of the family of corporate resolutions.
In this client alert, we: (1) report key statistics regarding NPAs and DPAs from 2000 through the present; (2) report key statistics on corporate guilty pleas from 2023; (3) discuss recent policy statements regarding corporate enforcement; and (4) summarize the 33 agreements through July 31, 2023.
Chart 1 below reflects the NPAs and DPAs that Gibson Dunn has identified through public-source research from 2000 through the end of July. Of the five total NPAs and DPAs thus far in 2023, three are NPAs and two are DPAs. The SEC, consistent with its trend since 2016, has not entered into any NPAs or DPAs in 2023 to date.
Chart 2 reflects total monetary recoveries related to NPAs and DPAs from 2000 through the end of July. At approximately $642 million, year-to-date recoveries associated with DPAs and NPAs are trending significantly higher than they were in the same period in 2022, but remain a fraction of the recoveries by mid-year in the last half-decade. For example, by this time in 2021, DOJ had recovered approximately $3.63 billion through NPAs and DPAs in the first half of the year; in 2020, the figure was approximately $6.03 billion. At the same time, we are not seeing plea agreements take up the slack; NPAs and DPAs still took the lion’s share of DOJ’s recoveries to date, at approximately 68% of the total approximately $944.6 million. The largest resolution thus far in 2023, in terms of dollar value, was a DPA.
Chart 3 reflects the relative mix of NPAs, DPAs, and declinations-with-disgorgement since DOJ first began issuing the latter agreements under the then-FCPA Pilot Program in 2016. Thus far in 2023 DOJ has issued one public declination-with-disgorgement pursuant to its Corporate Enforcement Policy; DOJ had also issued one such agreement by the end of July last year.
Charts 4 and 5 focus on specifically 2023 through the mid-year mark and show the numbers of DPAs, NPAs, plea agreements, and declinations-with-disgorgement in 2023 and the total dollar values associated with each type of resolution. As noted above, while plea agreements represented the majority of resolutions in terms of sheer number of agreements, DPAs dominated in terms of the dollar values of the government’s recoveries.
Continued Developments in DOJ Corporate Enforcement Policy
Introduction
On September 15, 2022, Deputy Attorney General (DAG) Lisa Monaco issued a memorandum detailing several updates to DOJ’s corporate criminal enforcement policies (the “Monaco Memorandum”).[2] She also delivered a speech on the same day expanding on the memorandum’s updates.[3] The updates addressed five key areas of corporate criminal enforcement in which DOJ planned to increase its emphasis on responsible corporate behavior:
- individual accountability;
- prior corporate misconduct;
- voluntary self-disclosures;
- compliance monitors; and
- compensation structure to promote compliance.
DAG Monaco also asked all DOJ components—i.e., divisions of Main Justice and the U.S. Attorneys’ Offices—to write voluntary self-disclosure policies and “to clarify the benefits of [corporations] promptly coming forward to self-report.”[4] These updates aimed to give businesses the tools they needed to promote responsible corporate behavior—in short, “empowering companies to do the right thing.”[5]
DOJ policies, speeches, and enforcement actions following the Monaco Memorandum and speech have continued to build on the message that DOJ will look favorably on corporations proactively identifying misconduct, voluntarily reporting it to DOJ, and driving the remediation process forward themselves. Companies failing to fully comply and cooperate will face harsher consequences. The message is clear that corporations hoping to benefit from these policies must keep their compliance, monitoring, self-disclosure, and remediation procedures robust and up-to-date.
Recent key changes, discussed below, include (1) the roll-out of a uniform voluntary self-disclosure program across U.S. Attorneys’ Offices; (2) updates to the Criminal Division’s Corporate Enforcement Policy; (3) a new DOJ pilot program on compensation incentives and clawbacks; (4) an increased focus on third-party communications platforms; and (5) a DOJ “resource surge” to address the intersection of national security and corporate crime.
A Uniform Program for Voluntary Self-Disclosure
On March 3, 2023, in a speech at the American Bar Association’s National Institute on White Collar Crime, DAG Monaco announced that, for the first time, DOJ has adopted a uniform self-disclosure policy, applicable across all 94 U.S. Attorney’s Offices, that is designed to put in place “an operative, predictable and transparent voluntary self-disclosure program” (the “USAO VSD”).[6] Under this policy, prosecutors generally will not seek a guilty plea where a company has voluntarily self-disclosed, cooperated, and remediated its misconduct, in the absence of aggravating factors.[7] Aggravating factors under the USAO VSD may include (but are not limited to) misconduct that “poses a grave threat to national security, public health, or the environment;” “is deeply pervasive throughout the company;” or “involved current executive management of the company.”[8]
The USAO VSD noticeably does not identify repeat misconduct as an aggravating factor, and indeed, DOJ officials have favorably cited the Criminal Division’s December 2022 DPA with ABB Ltd., a Swiss multinational engineering company, which settled an investigation into alleged violations of the Foreign Corrupt Practices Act (“FCPA”), as an example of leniency despite repeat misconduct.[9] ABB’s 2022 resolution was not its first DPA, and DOJ had previously articulated a strong disfavoring of successive agreements.[10] But, as Principal Associate Deputy Attorney General (PADAG) Marshall Miller noted in December 2022[11] and DAG Monaco reemphasized in March 2023,[12] DOJ nevertheless “assigned significant weight” to ABB’s efforts to self-disclose.[13] According to PADAG Miller, the company’s disclosure efforts, along with its commitment to further enhance its compliance program, “A+ cooperation” and extensive remediation, factored heavily into DOJ’s view that a DPA was the appropriate resolution. As noted by DAG Monaco, “had ABB not promptly come forward, the result would have been drastically different.”[14]
Updates to the Criminal Division’s Corporate Enforcement Policy
In a speech on January 17, 2023, then-Assistant Attorney General (AAG) for the Criminal Division, Kenneth Polite, announced revisions to the Criminal Division’s Corporate Enforcement Policy (CEP).[15] The revisions offer new incentives for companies to self-disclose misconduct. The policy revisions aim to incentivize companies to go “far above and beyond the bare minimum” when cooperating with DOJ. Department officials have further expanded and clarified the new CEP in subsequent speeches.
Clarification of Declination Policy
Like the USAO VSD that followed it, the Criminal Division’s CEP provides that a company that voluntarily self-discloses misconduct, fully cooperates with DOJ, and timely and appropriately remediates enjoys a presumption that DOJ will decline to prosecute, absent any aggravating circumstances.[16] Unlike the USAO VSD, the Criminal Division CEP has always included history of prior misconduct among the list of “aggravating circumstances” that may merit a guilty plea (others include “involvement by executive management of the company in the misconduct; a significant profit to the company from the wrongdoing; [and] egregiousness or pervasiveness of the misconduct within the company”).[17]
Before January 2023, the CEP articulated aggravating circumstances as a bar to declination.[18] After January 2023, companies that have engaged in misconduct involving any of these factors still do not enjoy the presumption of a declination, but prosecutors may, in their discretion, decline to prosecute if the company can demonstrate that it:
- Made a voluntary self-disclosure immediately upon becoming aware of the allegation of misconduct;
- Had an effective compliance program and system of internal accounting controls in place at the time of the misconduct and disclosure that enabled the identification of the misconduct and led to voluntary self-disclosure; and
- Provided extraordinary cooperation with DOJ’s investigation and undertook extraordinary remediation.[19]
Then-AAG Polite later explained in March that what constitutes “extraordinary” cooperation and remediation is subject to DOJ discretion.[20] He noted that in considering whether cooperation is “extraordinary,” DOJ evaluates the immediacy, consistency, degree, and impact of the cooperation.[21] Extraordinary remediation “includes conducting root cause analyses and taking action to prevent the misconduct from occurring, even in the face of substantial cost or pressure from the business.”[22] This can include, for example, significant organizational changes, suspensions or terminations, and recoupment of compensation.[23]
Then-AAG Polite also explained that the terms “immediate” and “extraordinary” in these revisions only apply when aggravating circumstances are present.[24] For companies without aggravating circumstances, DOJ still requires companies to voluntarily self-disclose only “within a reasonably prompt time after becoming aware of the misconduct.”[25]
DOJ has cited two recent declinations-with-disgorgement as exemplifying the Criminal Division’s current practices under the CEP. In December 2022, DOJ declined to prosecute Safran S.A., a French aerospace company, for alleged FCPA violations.[26] Safran voluntarily self-disclosed the conduct after discovering it during post-acquisition due diligence, fully cooperated, ensured remediation occurred, and disgorged ill-gotten profits.[27] Deputy Assistant Attorney General Lisa Miller pointed to the Safran declination in urging corporations to “call us before we call you.”[28] In March 2023, DOJ issued a declination-with-disgorgement to U.S.-based Corsa Coal following FCPA bribery violations.[29] Corsa fully cooperated with the investigation, remediated the misconduct by terminating a salesman involved in the scheme, disgorged a portion of the alleged ill-gotten profits (following a finding that it was unable to pay the full amount of $32.7 million), and substantially improved its compliance program and internal controls.[30]
DOJ’s message is clear that a proactive approach will best position the corporation to receive a declination under the CEP and avoid a more serious criminal resolution. A corporation that has self-identified misconduct, including conduct with aggravating circumstances present, should therefore carefully weigh the potential benefits flowing from proactively cooperating and providing DOJ with accurate information—including information otherwise unavailable to the Department.
Changes in Sentence Reductions Where Criminal Resolution is Warranted
Even where aggravating factors are too great to allow for a declination, the revised CEP provides that if a company voluntarily self-discloses, fully cooperates, and timely and appropriately remediates, the Criminal Division will accord or recommend at least 50% and up to 75% off the low end of the U.S. Sentencing Guidelines (“USSG”) fine range, except in the case of a “criminal recidivist.”[31] This is a significant increase from the previous potential maximum reduction of 50% off the Guidelines range. “Recidivist” companies that disclose, cooperate, and appropriately remediate will still be eligible for the reduction, but not off the low end of the range.[32]
The revised CEP provides for reductions even for those companies that do not voluntarily self-disclose. If such companies fully cooperate and timely and appropriately remediate, the Criminal Division will accord or recommend up to a 50% reduction off the low end of the USSG range, up from a maximum of 25% under the previous policy.[33] As in voluntary disclosure scenarios, “recidivist” companies are still eligible for this reduction, but not from the low end of the range. In his January remarks, then-AAG Polite lauded these changes as increasing the range of incentives for companies and providing prosecutors with a “greater range of options to distinguish among companies that commit crime,” but he also cautioned that a reduction of 50% will not be the new norm for companies that do not self-disclose; rather, he noted that “it will be reserved for companies that truly distinguish themselves and demonstrate extraordinary cooperation and remediation.”[34]
New DOJ Pilot Program on Compensation Incentives and Clawbacks
In an address at the ABA’s 38th Annual National Institute on White Collar Crime, DAG Monaco announced the Department’s first-ever Pilot Program on Compensation Incentives and Clawbacks, administered by the Criminal Division.[35] Then‑AAG Polite expanded on the program at the same conference the next day.[36] The two-part program, a three-year initiative that became effective March 15, 2023, fits with DOJ’s increased emphasis on corporate action in response to misconduct.
Part One requires that, as part of every criminal resolution entered into by the Criminal Division, companies shall be required to implement criteria related to compliance in their compensation and bonus systems to reward ethical behavior and to punish and deter misconduct.[37] As an example, DAG Monaco highlighted Danske’s December 2022 plea agreement, in which Danske, a Danish bank facing fraud allegations, agreed to revise its performance review and bonus system to include criteria related to compliance.[38] Part Two of the pilot program offers fine reductions for companies seeking to claw back compensation in appropriate cases.[39] These cases may include not only clawbacks from those employees who engaged in wrongdoing in connection with a given investigation, but also from those with supervisory authority over the culpable employees and who knew of, or were willfully blind to, the misconduct.[40] And the fine reductions accorded under the program equal 100% of the clawed-back compensation.[41] Moreover, even if companies are unsuccessful in clawing back compensation, prosecutors have discretion to grant a fine reduction of up to 25% of the compensation sought.[42]
The program will be in effect for three years, during which time DOJ will analyze its effectiveness. Please see our March 2023 publication on this, for further information.
Personal Devices and Communications Platforms
The Criminal Division continues to examine what revisions may be warranted to its framework for evaluating corporate compliance programs to address one of the most vexing issues facing corporate America—the use of personal devices and third-party messaging applications, including those offering ephemeral messaging.[43] The Division is focused on ensuring that DOJ can access relevant data and communications stored on these applications during investigations. In his keynote address at the ABA’s 38th Annual National Institute on White Collar Crime, then‑AAG Polite stated that DOJ will consider whether corporate policies governing these messaging applications allow business-related electronic data and communications to be preserved and accessed, along with how well companies communicate and enforce these policies.[44] If a company fails to produce data from messaging applications, prosecutors will probe the company’s ability to access such communications, whether the company stores them on corporate devices or servers, and applicable privacy laws. The company’s answers—or lack thereof—“may very well affect the offer it receives to resolve criminal liability.”[45]
Given DOJ’s increased focus on access to corporate communications, clear corporate policies regarding personal devices and third-party messaging applications, including across international borders, are becoming increasingly important, and companies would be well advised to review their corporate communications policies with an eye to preservation requirements, prohibitions on uses of off-platform communication channels, and disciplinary measures in the event of noncompliance.
Surging Resources to Address Intersection of National Security and Corporate Crime
In a May 2023 speech, PADAG Miller noted the growing link between corporate criminal enforcement and national security risks.[46] In response, DOJ is “dramatically scaling up [its] investment in fighting national security-related corporate crime.”[47] The Department will add over two dozen new prosecutors to the National Security Division (“NSD”) to focus on corporate crime, including the first-ever Chief Counsel for Corporate Enforcement. It plans to “staff[] up” the Bank Integrity Unit of the Criminal Division’s Money Laundering & Asset Recovery Section to home in on complex and cross-border sanctions cases involving financial institutions.[48] And it is issuing joint advisories with the Commerce and Treasury Departments to inform the private sector about national security-related compliance trends and expectations. For example, on July 26, 2023, those three agencies issued a “Tri-Seal Compliance Note” setting forth their respective views on voluntary self-disclosure of “potential violations of U.S. national security laws, including those governing sanctions and export controls.”[49] The document is significant not only for its detailed summaries of each agency’s self-disclosure requirements, but also for its clear statement—on behalf of all three agencies—that “[t]he benefits of VSDs are clear” and include “making companies eligible for significant mitigation.”[50]
2023 Agreements to Date
The remainder of this alert summarizes corporate resolutions through July 31, 2023. The appendix at the end of the alert provides key facts and figures regarding these resolutions, along with links to the resolution documents themselves (where available). Although we have continued to see relative consistency in the approaches taken to resolutions involving Main Justice, U.S. Attorneys’ Offices around the country continue to enter into agreements that vary widely and lack the uniformity of approach taken by Main Justice.
ABC Polymer Industries LLC (Guilty Plea)
On January 3, 2023, ABC Polymer Industries LLC (“ABC Polymer”) entered into a plea agreement with the Environment and Natural Resources Division’s Environmental Crimes Section and the U.S. Attorney’s Office for the Northern District of Alabama to resolve allegations that ABC Polymer, a manufacturer of extruded plastic products and other goods, had failed to install machine guards on the side of an equipment’s roller drums—in violation of the Occupational Health and Safety Act (“OSHA”)—leading to the death of an employee in its Alabama plant who was operating the machine.[51] OSHA requires machinery “whose operations exposes an employee to injury” to be guarded or to be designed and constructed in such a way to “prevent the operator from having any part of his [or her] body in the danger zone during the operating cycle.”[52] The agreement cited that while ABC Polymer had written policies addressing machine guards, it had trained its employees in procedures that involved lowering the guard during operations, exposing the operators to risk of injury.[53]
In connection with the plea agreement, ABC Polymer agreed to pay a criminal fine of $167,928, as well as $242,928 plus funeral expenses in restitution to the decedent’s estate.[54] ABC Polymer also agreed to serve a two-year term of probation, during which time ABC Polymer would be required to comply with an OSHA Safety Compliance Plan (“SCP”).[55] The SCP, among other things, requires ABC Polymer to designate a Safety Compliance Manager; extend a contract with its third party auditor or submit a list of qualified candidates if ABC Polymer intends to substitute a new third party auditor; maintain mechanisms for reporting safety concerns; and provide policies and training in English, Spanish, and any other language necessary to ensure all employees are able to understand.[56] Three weeks after its guilty plea, ABC Polymer was sentenced to the fine, restitution amount, and probation term set forth in the plea agreement.[57]
Aifa Seafood Inc. (Guilty Plea)
On March 8, 2023, Aifa Seafood Inc. (“Aifa”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Florida, to resolve allegations that Aifa violated the Lacey Act, which punishes illegal trade in fish and wildlife.[58] According to the agreement, the government alleged that Aifa engaged in false labeling of lobster imported from Haiti and bound for China, by labeling the lobster as product of the United States.[59] While the plea agreement indicates that the maximum fine Aifa could face is $500,000 per count and that Aifa could be sentenced to probation for up to five years, the agreement does not contain a recommended sentence.[60] The agreement itself also does not impose any form of reporting or monitoring requirement on Aifa.[61]
On May 23, 2023, Aifa was sentenced to a five-year term of probation, one condition of which is that it “establish and maintain an effective compliance program,” including by employing “an appropriately qualified Compliance Officer.”[62] Another condition of Aifa’s probation is that it retain an independent third‑party auditor and “fund a Court Appointed Monitor.”[63] Both the auditor and the monitor are required to submit reports to the company’s probation officer, and the monitor must submit its reports to the court as well.[64] The court sentenced Aifa to pay a $250,000 fine.[65]
American Management and Administration Corporation (Guilty Plea)
On April 13, 2023, the American Management and Administration Corporation (“AMAC”) entered a plea agreement with the U.S. Attorney’s Office for the District of Puerto Rico to resolve one count of theft of federal program funds, in relation to the alleged misappropriation of operational funds provided by the U.S. Department of Housing and Urban Development for the administration of public housing projects by Puerto Rican authorities.[66] AMAC was one of the private companies that contracted with Puerto Rican authorities to operate and maintain the public housing projects, in return for a monthly fee.[67] According to the government, AMAC knowingly and intentionally stole $3.7 million in funds from 2014 to 2022, including by diverting funds to personal bank accounts and writing checks for services not rendered.[68]
The plea agreement does not contain an agreed-upon penalty, nor does it reflect an agreement on a term of probation or impose ongoing reporting obligations.[69] Under the agreement, AMAC agreed to pay $3,712,000 in restitution.[70] At sentencing, the court imposed restitution in that amount and sentenced AMAC to three years of probation, and included as a condition of probation that AMAC report periodically to the court or its probation officer regarding its financial condition and any new investigations, litigations, or administrative proceedings commenced against AMAC.[71]
Anyclo International Inc. (Guilty Plea)
On June 12, 2023, Anyclo International Inc. (“Anyclo”), a South Korean clothing manufacturer, entered into a plea agreement with the U.S. Attorney’s Office for the District of New Jersey, to resolve charges that the company evaded customs duties on clothing it imported into the United States between 2012 and 2019.[72] According to the agreement, Anyclo prepared one accurate invoice for U.S. purchasers of the imported merchandise, and prepared another invoice for its U.S. Customs broker that falsely undervalued the goods and thus caused Anyclo to underpay customs duties.[73]
In the agreement, Anyclo and the government agreed to recommend to the court a fine of $250,000, as well as restitution of $2.05 million.[74] The parties agreed not to recommend probation to the court, and the agreement does not contain an ongoing compliance program or reporting obligation.[75] In sentencing Anyclo, the court accepted the fine recommendation but reduced the restitution amount to $1,850,000.[76] The court did not impose probation.[77]
BDF Enterprises, Inc., Michelle’s DVD Funhouse, Inc., MJR Prime LLC, and Prime Brooklyn LLC (Guilty Plea)
In January 2023, four entities, including BDF Enterprises, Inc. (“BDF”), Michelle’s DVD Funhouse, Inc., MJR Prime LLC, and Prime Brooklyn LLC separately pleaded guilty to one count each of conspiring to fix prices for DVDs and Blu-Ray discs on Amazon Marketplace, in violation of the Sherman Act, 15 U.S.C. § 1.[78] The agreements state that, from approximately October 2016 to October 2019, these Amazon Marketplace vendors and their owners colluded to sell video media at non-competitive prices to suppress and eliminate competition.[79]
Pursuant to these agreements with the Antitrust Division and the U.S. Attorney’s Office for the Eastern District of Tennessee, the companies agreed to recommended criminal fines ranging from $68,000 to $234,000.[80] The agreements did not recommend any restitution payments, in light of the availability of civil causes of action through which damages may be sought.[81] The parties also agreed to recommend that no probationary period be assessed.[82] The two individual owners of these four entities separately pleaded guilty in connection with the alleged scheme.[83]
As of the publication of this alert, only BDF has been sentenced. The court imposed a fine of $185,250, compared to the $234,000 agreed upon in BDF’s plea agreement—the result of the court applying U.S. Sentencing Guideline Section 8C3.4, which permits fine offsets for closely-held companies where one or more owners of the company have been sentenced for the same offense conduct.[84]
British American Tobacco P.L.C. (DPA)
On April 25, 2023, British American Tobacco P.L.C. (“BAT”), a UK-based corporation, entered into a three-year DPA with DOJ NSD and the U.S. Attorney’s Office for the District of Columbia,[85] resolving allegations that BAT and its Singaporean subsidiary (“BATMS”) had conspired to commit bank fraud and to violate the International Emergency Economic Powers Act (“IEEPA”), 50 U.S.C. § 1705(a), in connection with prohibited sales of tobacco products in North Korea.[86] In particular, according to the Statement of Facts attached to the DPA, in 2005 BAT purported to divest itself of a North Korean joint venture established in 2001, but instead continued to exert significant control over the entity, using it to transact business in North Korea.[87] The DPA alleges that BATMS and BAT structured transactions with this entity in a manner that obfuscated BATMS’s sales to North Korea, thereby causing U.S. banks to process improper U.S. dollar transactions for BATMS’s benefit, in violation of the bank fraud statute.[88] Some of these transactions were also made through sanctioned North Korean entities in violation of the IEEPA.[89]
As a part of the DPA, BAT agreed to joint and several liability with BATMS for over $440 million in criminal penalties and over $189.5 million in forfeiture payments.[90] The company has also implemented, and agreed to continue to implement, a corporate compliance program designed to prevent and detect violations of the Bank Secrecy Act and U.S. sanctions laws, specifically including maintaining the electronic database of SWIFT MT payment messages and documents and materials relevant to the investigation during the term of the DPA. The company must also annually report on the status of its compliance measures.[91] Additionally, if BAT breaches its obligations under the agreement, the government may extend the term of the agreement by up to one year; if, conversely, BAT demonstrates that it is no longer necessary to enforce the terms of the agreement, it may be terminated after less than three years.[92] The BAT DPA also has several related actions announced or commenced on the same day as the DPA, including a guilty plea by BATMS to the same charges, a civil action against both BAT and BATMS brought by the Department of the Treasury’s Office of Foreign Assets Control,[93] and several actions brought by DOJ against individuals alleging related conduct.[94]
Davey Tree Expert Company and Wolf Tree, Inc. (NPA)
On July 13, 2023, Davey Tree Expert Company (“Davey Tree”)—a company that provides tree-trimming services for utility companies—and its wholly-owned subsidiary, Wolf Tree, Inc. (“Wolf Tree”), jointly entered into an NPA with the U.S. Attorney’s Office for the Southern District of Georgia.[95] The agreement resolved allegations that, in connection with a tree-trimming contract for an electric utility company in Savannah, Georgia, Davey Tree and Wolf Tree illegally employed persons unlawfully in the United States.[96] The government alleged that Davey Tree and Wolf Tree provided these employees with false names and social security numbers, falsified payroll records for the employees, and paid the employees in cash in order to avoid detection.[97] One employee was allegedly killed after reporting that his supervisor was unlawfully in the United States and was hiring other undocumented individuals.[98]
Davey Tree and Wolf Tree agreed to pay $1,326,000 in restitution to the estate of the deceased employee; $21,804 in restitution to another employee for back wages; and $1,136,521 in forfeiture of the proceeds of the alleged violations.[99] The NPA also resolves civil allegations against Davey Tree and Wolf Tree, and accordingly imposes $1,500,000 in civil penalties and releases the companies from both civil and administrative liability that could otherwise be pursued by the Department of Homeland Security.[100] Although the agreement imposes cooperation obligations on Davey Tree and Wolf Tree, it does not require them to self-report to the government and it does not impose a monitor.[101]
DES International Co. Ltd. and Soltech Industry Co. Ltd. (Guilty Plea)
On March 29, 2023, DES International Co. Ltd. (“DES”) and Soltech Industry Co. Ltd. (“Soltech”), electronics companies based in Taiwan and Brunei, respectively, entered into plea agreements with the U.S. Attorney’s Office for the District of Columbia and DOJ NSD, resolving allegations of conspiracy to defraud the United States and violate the IEEPA and Iranian Transactions and Sanctions Regulations (“ITSRs”)—which restrict the trade, export, or sales of U.S.-origin goods, technology, or services to Iran.[102]
[103] According to the agreements, a sales agent of both DES and Soltech conspired and agreed with DES, Soltech, and an Iranian entity to export a U.S.-originated power amplifier and its related components, as well as cybersecurity software to the Iranian entity without a required license from the U.S. Department of the Treasury.[104] This sales agent took steps to conceal the U.S. origin of the products, such as by removing stickers with the phrase “Made in USA” from the packaging. The agent also misled the two U.S. companies exporting the goods and software to believe that the items they sold were to be used in Taiwan or Hong Kong, or used by DES or Soltech.[105]
DES and Soltech each agreed to a five-year period of corporate probation and a criminal fine of $83,769—three times the value of goods unlawfully exported to Iran—based on a consideration of several factors, including an “absence of cooperation or of any known compliance or remediation efforts,” and the lack of timely and voluntary self-disclosure.[106] At sentencing, the court imposed the penalty amounts and probation period contained in the plea agreements.[107]
Diesel Tune-Ups of RI, Inc. and M&D Transportation, Inc. (Guilty Plea)
On January 26, 2023, Diesel Tune-Ups of RI, Inc. (“Diesel Tune-Ups”) and M&D Transportation, Inc. (“M&D”) jointly entered into a plea agreement with the U.S. Attorney’s Office for the District of Rhode Island to resolve allegations that the companies conspired to violate the Clean Air Act.[108] The government alleged that between 2014 and 2019, Diesel Tune-Ups and M&D conspired among themselves and others to tamper with emission monitoring systems on diesel vehicles.[109] The alleged scheme consisted of both disabling or removing emission controls on the vehicles, and installing software in the vehicles so that the built-in monitoring systems could not detect the modifications to the controls.[110]
In the plea agreement, the parties agreed to recommend to the court that it impose a term of probation of three years.[111] As a probation condition, Diesel Tune-Ups and M&D agreed to hire a third-party independent consultant within 30 days of sentencing “to conduct an audit of all vehicles owned or operated by M&D to determine that no aftermarket emissions alterations have been made and that there has been no emissions-related tampering.”[112] No later than 60 days after sentencing, M&D must certify that all its vehicles are in compliance with the Clean Air Act’s emission-related provisions.[113] The agreement does not contain a penalty recommendation, stating instead that “[t]he parties will be free to recommend [at sentencing] whatever fine . . . they feel [is] appropriate.”[114] The agreement also explicitly states that the government and the defendants had not reached agreement on which offense level and criminal history category are appropriate for purposes of Sentencing Guidelines calculations.[115] The agreement notes that each count charged against Diesel Tune-Ups and M&D carries a maximum of $500,000 in fines.[116] Sentencing has not yet occurred in the case.
E.I. du Pont de Nemours and Company Inc. (Guilty Plea)
On April 24, 2023, E.I. du Pont de Nemours and Company Inc. (“DuPont”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Texas, resolving allegations that it violated the Clean Air Act by negligently releasing an extremely hazardous substance.[117] The allegations arose out of a 2014 accident that released 24,000 pounds of highly toxic, flammable gas into the air, killing four company employees, injuring others, and causing harm to surrounding areas.
The plea agreement recommends a two-year probation term, a $12 million penalty, and a $4 million community service payment to the National Fish and Wildlife Foundation (“NFWF”).[118] The agreement directs NFWF to use the community service payment for air quality-related work in areas near the western shores of Galveston Bay, Texas.[119] The agreement recommends two years of probation but does not impose a reporting obligation on DuPont.[120] The agreement also recognizes DuPont’s cooperation and prior civil settlements related to the incident at issue.[121] DuPont was sentenced on the same day as its plea, and the court imposed the penalty, community service payment, and probation term recommended in the agreement.[122]
FeelGood Natural Health Stores Ltd. (Guilty Plea)
On April 14, 2023, FeelGood Natural Health Stores Ltd. (“FeelGood”), a Canadian corporation, pleaded guilty to violating the Lacey Act, 16 U.S.C. §§ 3371-3378, which prohibits trafficking wildlife taken in violation of state wildlife protection laws. In this case, FeelGood allegedly transported and sold marine mammal products in violation of the Marine Mammal Protection Act (“MMPA”).[123] As described in the agreement, FeelGood knowingly transported and sold harp seal oil capsules in the United States as a health supplement.[124]
The agreement states that, from April 2019 to May 2021, FeelGood offered harp seal oil capsules for sale on its own webpage and through third-party marketplaces, which it then shipped either directly or via third-party distributors to the United States.[125]
The DOJ Environmental and Natural Resources Division and the U.S. Attorney’s Office for the Eastern District of Michigan, pursuant to the agreement, recommended a $20,000 fine, representing twice the gross gain that FeelGood would have realized from the illegal sales.[126] Meanwhile, FeelGood, pursuant to the agreement, recommended a $5,000 fine, representing twice the actual profits it realized as a result of the sales.[127] The parties also agreed to recommend $1,373.43 in forfeiture payments stemming from covert purchases by U.S. law enforcement, as well as a three-year probationary period, during which time FeelGood agreed to establish and maintain a compliance program, assess whether it ships any products to the United States, and seek an import license if it does.[128] Sentencing has not yet occurred.
Genotox Laboratories Ltd. (DPA)
On March 21, 2023, Genotox Laboratories Ltd. (“Genotox”) entered into an eighteen-month DPA with the U.S. Attorney’s Office for the Western District of Texas, resolving allegations that Genotox had violated the Anti-Kickback Statute (“AKS”), 42 U.S.C. §§ 1320(a)-7(b), the False Claims Act (“FCA”), 31 U.S.C. §§ 3729-3733, and the Eliminating Kickbacks in Recovery Act (“EKRA”), 18 U.S.C. § 220, by using a volume-based commission incentive structure for third-party marketers and encouraging physician orders that were not medically necessary.[129]
According to the DPA, from approximately 2014 through March 2019, and at least in some instances until October 2020, Genotox paid its independent sales representatives, who were non-bona fide employees, on a commission basis to market its toxicological testing services.[130] The commission payments were calculated based on the revenue realized from billings to insurers, including Medicare and Tricare. Even after transitioning these independent sales representatives to a fixed-rate pay structure, Genotox allegedly continued tracking employee pay against the older commission structure.[131] Additionally, Genotox allegedly used form test orders to encourage test orders for patients that billed their insurance providers at the highest reimbursement categories, even if the tests were not necessary.[132]
Genotox received full cooperation credit but it did not receive voluntary disclosure credit.[133] The DPA did not assign any criminal penalty in light of Genotox’s payment of $477,774 pursuant to a parallel Civil Settlement Agreement (“CSA”) with the Civil Fraud Section, the U.S. Attorney’s Office for the Southern District of Georgia, the Office of Inspector General for the United States Department of Health and Human Services, and a qui tam relator.[134] The CSA, in addition to the $477,774 payment, imposed an additional $415,000 payment, to be made over five years. The CSA also provides for additional payments in the event that Genotox’s revenue exceeds certain thresholds, and contemplates that total payments under the agreement could exceed $29 million. The agreement states that all of these payments by Genotox are “restitution to the United States,” and the government stated in a press release that “[t]he settlement amount was based on the company’s ability to pay,” which likely explains the payment-over-time approach reflected in the agreement and the fact that some of the payments will be contingent on Genotox’s revenues.[135] Under the agreement, the government will not pay to Genotox nearly $5 million in Medicare payments that were suspended after the underlying qui tam action was filed.[136]
Notably, with respect to the DPA, the USAO for the Western District of Texas expressly retained discretion to find Genotox in breach of the DPA in the event that it breaches the parallel five-year Corporate Integrity Agreement (“CIA”) it entered into with the U.S. Department of Health and Human Services, Office of Inspector General.[137] The CIA imposed separate compliance requirements, including the retention of an Independent Review Organization – perhaps as a result, neither the CSA nor the DPA imposed an independent compliance monitor.[138]
Great Circle (NPA)
On January 27, 2023, Great Circle, a non‑profit provider of behavioral health services based in Missouri, entered into a three‑year NPA with the U.S. Attorney’s Office for the Eastern District of Missouri, resolving allegations that Great Circle made false statements in connection with the delivery of or payment for health care benefits.[139] According to the government’s allegations, Great Circle provided federally-reimbursed residential treatment services to children in the custody of the Children’s Division of the Missouri Department of Social Services.[140] Great Circle allegedly billed for services it did not provide, as well as for services that did not conform to contractual requirements.[141]
Under the agreement, Great Circle is obligated to undertake compliance program enhancements, but is not required to self-report or submit to a monitorship.[142] Great Circle entered into a parallel civil settlement with the government, in which it agreed to pay $1,866,000; apparently in recognition of that fact, the NPA does not impose a criminal penalty.[143] The NPA does not specify whether Great Circle voluntarily disclosed the alleged conduct to the government.[144]
Greater Boston Behavioral Health LLC (Guilty Plea)
On March 13, 2023, Greater Boston Behavioral Health LLC (“GBBH”) entered into a plea agreement with the U.S. Attorney’s Office for the District of Massachusetts, to resolve allegations that GBBH violated the federal Food, Drug and Cosmetic Act (“FDCA”).[145] According to the agreement, GBBH purchased Botox® that came from foreign sources and whose labels did not contain FDCA-required language indicating that the drugs were for prescription use only and explaining certain side effects.[146]
The plea agreement reflects an agreed disposition of $2,587,142 in penalties, allocated as $657,678 in fines and $1,929,464 in forfeiture.[147] The parties also agreed that GBBH should be put on probation for three years; unlike other plea agreements and many NPAs and DPAs, however, the agreement does not impose any reporting or monitor requirements on GBBH, and does not explicitly set forth any compliance or cooperation obligations.[148] The agreement does not include voluntary self-disclosure among the Sentencing Guideline factors that the government believed the court should consider at sentencing.[149]
GBBH was sentenced on May 12, 2023; the court imposed three years of probation and the same penalty and forfeiture amounts as in the plea agreement.[150]
Ground Zero Seeds International, Inc. (Guilty Plea)
On January 4, 2023, Ground Zero Seeds International, Inc. (“GZI”) entered into a plea agreement with the U.S. Attorney’s Office for the District of Oregon, to resolve one count of misprision of felony for allegedly paying kickbacks to a former employee of another company (Jacklin Seed Company) in connection with purchases of grass seed.[151] GZI allegedly paid a total of $191,790 to a former employee of the other company between April 2015 and September 2019, concealing the payments through inflated invoices.[152] In the plea agreement, the government agreed to recommend to the court a fine of $40,000 and a one-year term of probation.[153] GZI also agreed to pay restitution of $516,000, representing sales Jacklin Seed Company lost because of the kickbacks paid to its former employee.[154] Under the terms of the agreement, the government also agreed to “make available the evidence gathered in the investigation of this matter for on-site inspection,” and GZI accepted that offer—as well as the discovery the government had provided to date in the case—”in full satisfaction of the government’s discovery obligations in th[e] case.”[155]
Following the plea agreement, the court sentenced GZI to the probation, fine, and restitution terms contained in the plea agreement.[156] The plea agreement did not impose a monitor or compliance self-reporting as a condition of probation, and neither did the court in sentencing GZI.[157]
Interunity Management (Deutschland) GmbH (Guilty Plea)
On May 5, 2023, Interunity Management (Deutschland) GmbH (“Interunity”), a German shipping operator, entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of California and the DOJ Environment and Natural Resources Division, to resolve allegations that Interunity failed to maintain an accurate Oil Record Book, in violation of 33 U.S.C. § 1908.[158] The government alleged that, while in U.S. waters, a vessel operated by Interunity failed to record the transfer, discharge, and disposal of oily bilge water as required by U.S. law.[159] The government learned of the alleged conduct after a crewmember on the vessel reported to the U.S. Coast Guard via email concerning a discharge of oily bilge water by the vessel directly into the sea.[160]
The agreement contains a jointly recommended sentence of $1,250,000 in penalties, which Interunity agreed represented twice what it gained as a result of the alleged conduct.[161] The penalty is comprised of $937,500 in fines and a $312,500 “community service payment” to the NFWF.[162] As the agreement notes, NFWF is a Congressionally-created nonprofit with authority to administer community service payments that advance conservation of fish, wildlife, plants, and other natural resources.[163] This plea agreement requires the NFWF to use the community service payment for conservation efforts in or around the Tijuana River National Estuarine Research Reserve.[164]
The agreement contains a recommended probation period of four years, during which Interunity would be required to implement an Environmental Compliance Plan (“ECP”).[165] The ECP requires both a third-party auditor and a court-appointed monitor. The auditor is responsible for auditing Interunity’s vessels according to a detailed set of criteria and reporting audit findings to the government, while the court-appointed monitor is responsible for reporting to the government on the adequacy of the audits and on the relationship between the auditor and Interunity.[166] Sentencing has not yet occurred in the case.
IRB Brasil Resseguros SA (NPA)
On April 20, 2023, IRB Brasil Resseguros SA (“IRB”), a Brazilian reinsurance company listed on the Brazilian stock exchange, entered into a three-year NPA with the Fraud Section.[167] The NPA resolved allegations that IRB engaged in securities fraud in violation of 15 U.S.C. §§ 78j(b) and 78ff(a) and 17 C.F.R. § 240.10b-5.[168]
At the time of the relevant conduct, February through March 2020, 25% of IRB’s shareholders were U.S. investors.[169] According to the NPA, to counteract critical analyses of IRB’s financial position, IRB and its Chief Financial Officer (“CFO”) defrauded IRB’s investors by falsely claiming that Berkshire Hathaway Inc., an international conglomerate and well-known investment entity, was a shareholder.[170] The CFO allegedly furthered this scheme through falsified shareholder lists, fictitious emails between IRB and Berkshire Hathaway, and false oral statements.[171] Berkshire Hathaway issued a statement on March 3, 2020, disclaiming any relationship with IRB. On March 4, 2020, IRB’s stock price fell, causing significant losses to shareholders.[172] The CFO subsequently falsely claimed that his statements about Berkshire Hathaway had been in error.[173] IRB separated from the CFO that same day.
Pursuant to the NPA, IRB agreed to pay $5 million in shareholder compensation to the shareholders who sold IRB stock on March 4, 2020.[174] A Shareholder Payment Administrator is to be appointed to advise the Fraud Section on which shareholders should be compensated and in what amount. Similar to the process for selecting a corporate compliance monitor, the Fraud Section will select the Administrator from a pool of three candidates chosen by IRB.[175] While the NPA states that a criminal fine or penalty would be appropriate based on the law and facts, the agreement does not impose any additional criminal monetary penalties in light of IRB’s financial position.[176]
During the NPA’s term, IRB is obligated to provide periodic reports regarding the state of its compliance program.[177] As is typical of these agreements, the NPA’s term may be extended up to one year by DOJ or terminated early, as circumstances dictate.[178] One curiosity of this agreement is that it attaches executed versions of Attachments E and F, certifications by the company CEO and CFO that IRB’s reporting under various provisions of the NPA is accurate and complete. Presumably, because these reporting requirements apply for the life of the NPA, these certifications will be executed for a second time at the conclusion of the NPA’s term.
Kerry Inc. (Guilty Plea)
On February 3, 2023, Kerry Inc. (“Kerry”), a subsidiary of a manufacturing company headquartered in Ireland, pleaded guilty to one count of manufacturing breakfast cereal under insanitary conditions and introducing adulterated food into interstate commerce in violation of the FDCA, 21 U.S.C. § § 331(a) and 333(a)(1).[179] As of the date of this publication, the plea agreement remains under seal. However, as described in the Department of Justice, Civil Division’s Consumer Protection Branch’s press release, following Kerry’s guilty plea, from approximately June 2016 to June 2018, a Kerry facility in Illinois, which manufactures and distributes Kellogg’s Honey Smacks cereal, tested positive for salmonella 81 times.[180] According to the press release, the company failed to address the presence of salmonella, and the Director of Quality Assurance at the facility directed subordinates not to report the test results.[181] The press release states that the adulterated cereal manufactured by Kerry has been linked to over 130 cases of salmonellosis beginning in March 2018.[182]
In connection with this plea agreement, Kerry was sentenced to pay $10,488,000 in criminal monetary penalties and $8,740,000 million in forfeiture payments.[183] The former Director of Quality Assurance for the facility has also been charged with three misdemeanor counts.[184]
L5 Medical Holdings, LLC (Guilty Plea)
On July 26, 2023, L5 Medical Holdings, LLC d/b/a Pain Care Centers (“L5 Medical”), a medical practice and operator of pain clinics, entered into a plea agreement with the U.S. Attorney’s Office for the Western District of Virginia to resolve allegations related to a federal drug and health care fraud conspiracy.[185] According to the agreement, L5 Medical conspired with its owner and other physicians at the practice to use registration numbers that had been issued to others in the course of dispensing and distributing a controlled substance, and to execute a scheme to defraud government health care benefits programs.[186] The practice’s owner, a former mortgage broker, allegedly purchased pain clinics through L5 Medical in pursuit of a “recession proof” business model.[187] With the agreement, L5 Medical pleaded guilty to conspiracy to distribute and dispense fentanyl, hydrocodone, morphine, and oxycodone for non-legitimate purposes.[188]
In the agreement, L5 Medical and the government agreed to recommend restitution in the amount of $3.82 million to federal and state health care programs, as well as $250,000 in forfeiture.[189] The plea agreement did not include a recommended probation period, but it required L5 Medical to wind down or dissolve its business and to never again do business in the Western District of Virginia.[190]
Nine2Five, LLC (Guilty Plea)
On July 10, 2023, Nine2Five, LLC (“Nine2Five”), a Carlsbad, California–based importer and seller of herbal extract kratom, entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of California, to resolve allegations that Nine2Five imported kratom using false invoices stating that it was botanical soil conditioner.[191] According to the National Institutes of Health, kratom (scientific name Mitragyna speciose) is “an herbal substance that can produce opioid- and stimulant-like effects.”[192] After importing the kratom using false invoices, Nine2Five allegedly transferred $60,000 to a bank account in Indonesia for the purpose of kratom importation.[193]
The plea agreement contains a recommendation by the government that Nine2Five be placed on probation for three years.[194] No fine is recommended in the agreement because “the parties agree that it is readily ascertainable that [Nine2Five] has no ability to pay.”[195] Sentencing has not yet occurred in the case.
Onekey, LLC (Guilty Plea)
On February 2, 2023, Onekey, LLC (“Onekey”), a New Jersey construction company, and its principal, entered into plea agreements with the U.S. Attorney’s Office for the Southern District of New York, to resolve allegations that Onekey willfully violated OSHA regulations which led to a construction worker’s death.[196] The government alleged that, at a construction site in Poughkeepsie, New York, Onekey built a concrete retaining wall alongside large quantities of dirt called “surcharges,” without consulting with a qualified engineer, as required by OSHA, to see if the wall could withstand the surcharges’ weight.[197] On August 3, 2017, the wall collapsed, resulting the death of a construction worker.[198]
As of the date of this publication, the plea agreements are not publicly available. However, as described in Onekey’s Sentencing Memorandum, the plea agreement contains a recommendation that Onekey, throughout a three-year probationary period, retain a Certified Safety Professional for current and future major projects; implement a safety and health management system designed to identify, evaluate, analyze and control workplace safety and health hazards; and notify OSHA about its major projects for enhanced oversight.[199] The government did not seek restitution, because Onekey voluntarily paid for the worker’s funeral expenses and, in settlement of a civil lawsuit, paid the worker’s family $2.5 million.[200] Additionally, Onekey paid a fine of $281,583 to the Department of Labor.[201]
OneKey was sentenced on May 12, 2023; the court imposed the three years of probation with the conditions identified in the plea agreement and ordered the company to pay a $218,417 fine.[202] The company’s principal was sentenced to three months in prison and one year of supervised release.[203]
Partridge-Sibley Industrial Services, Inc. (Guilty Plea)
On January 11, 2023, Partridge-Sibley Industrial Services, Inc. (“PSI”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Mississippi to resolve allegations that it supervised the transportation and disposal of industrial waste to a site in Jackson, Mississippi and caused it to be taken to a discharge point that was not designated to receive such waste, in violation of the Clean Water Act.[204] The allegations stem from charges against Rebel High Velocity Sewer Services of Jackson, Mississippi (“Rebel”), namely that Rebel conspired to illegally discharge waste into the City of Jackson’s sewer system to avoid the cost of treating the waste, evade sewer usage fees, and avoid disposing of the waste at legal facilities.[205] PSI was responsible for transporting truckloads of the city’s industrial waste to Rebel for discharge.[206] After PSI transported the waste to Rebel, Rebel allegedly discharged the waste into the city’s sewer system, despite being prohibited from doing so, resulting in the illegal dispensation of millions of gallons of industrial waste.[207] PSI pleaded guilty to Count 1 of a ten-count misdemeanor Information for “negligently introducing and causing to be discharged trucked and hauled pollutants” into the city’s wastewater system.[208]
In the plea agreement, PSI and the government agreed on a $200,000 fine and a one-year term of probation.[209] Following the plea, PSI issued a statement noting that “all of the officers, managers and directors of PSI were cleared of any wrongdoing or involvement in Rebel’s illegal discharges,” and that PSI’s alleged negligence was a result of untrue representations and assurance made by Rebel.[210] The statement further clarified that none of the wastewater PSI transported was hazardous or acidic.[211] At sentencing, the court imposed the fine and probation terms recommended in the plea agreement.[212] Neither the plea agreement nor the court’s judgment contain any explicit requirement for voluntarily compliance self-reporting by PSI.
Quick Tricks Automotive Performance, Inc. and Kloud9Nine, LLC (Guilty Pleas)
On January 31, 2023, Quick Tricks Automotive Performance, Inc. (“Quick Tricks”) and Kloud9Nine, LLC (“Kloud9Nine”) entered into plea agreements with the U.S. Attorney’s Office for the Southern District of Florida to resolve allegations that, between 2018 and 2021, the companies conspired to violate the Clean Air Act by tampering with diesel emissions control devices and “tuning” onboard monitoring systems so that they would not detect the modifications.[213] Both companies were sellers of products used for such “tuning.”[214] Each plea agreement recommends the imposition of three years of probation on the respective company, but does not reflect an agreement on a recommendation for monetary consequences of the alleged conduct.[215] All parties expressly reserved the right to advocate for an appropriate fine at sentencing.[216]
On May 5, 2023, the court sentenced both Quick Tricks and Kloud9Nine to three years of probation.[217] The conditions of both companies’ probations include establishing and maintaining effective compliance programs, as well as appointing a third-party auditor and funding a court-appointed monitor.[218] The companies are required to report, within 30 days of the third-party auditors’ reports, on the companies’ efforts to address auditors’ findings.[219] The court did not impose a fine on either company.[220]
Pure Addiction Diesel Performance, LLC (Guilty Plea)
On May 30, 2023, Pure Addiction Diesel Performance, LLC (“Pure Addiction”), a Portland, Oregon–area diesel repair shop, entered into a plea agreement with the U.S. Attorney’s Office for the District of Oregon, to resolve allegations that Pure Addiction violated the Clean Air Act by “deleting” or removing emissions controls from vehicles and “tuning” onboard monitoring systems so that they would not detect the modifications.[221] The government alleged that, between 2018 and 2020, Pure Addiction removed the emissions control systems, which are designed to reduce pollutants being emitted from vehicles, and modified on-board diagnostic systems, for approximately 245 diesel vehicles.[222] Pure Addiction allegedly collected over $400,000 for performing these services.[223]
In the plea agreement, Pure Addiction and the government stipulated to a sentence of three years of probation, and as a condition of probation agreed to pay a penalty of $148,733 to the Environmental Protection Agency (“EPA”), under the terms of a separate consent agreement.[224] The agreement did not contain a stipulated restitution obligation.
Pure Addiction was ordered to pay the $148,733 fine to the EPA, and was sentenced to three years’ probation.[225] In connection with Pure Addiction’s plea, its owner and operator pleaded guilty to being an accessory to the tampering of monitoring devices and was sentenced to six months in prison.[226]
Rhode Island Beef and Veal, Inc. (Guilty Plea)
On April 4, 2023, Rhode Island Beef and Veal, Inc. (“Rhode Island Beef and Veal”), a slaughterhouse based in Johnson, Rhode Island, entered into a plea agreement with the U.S. Attorney’s Office for the District of Rhode Island, to resolve allegations that the company violated the Federal Meat Inspection Act (“FMIA”).[227] Specifically, the government alleged that the company defrauded customers by failing to comply with FMIA inspection requirements, by falsely stating that meat had passed such inspection, and by unlawfully using the Secretary of Agriculture’s official inspection mark.[228] The plea agreement is not accompanied by a statement of facts, but according to the government’s press release, Rhode Island Beef and Veal continued to mark meat as having been inspected by the U.S. Department of Agriculture (“USDA”) for over a week after the USDA served the company with a notice of suspension and withdrew its inspector.[229]
The plea agreement does not contain a recommended fine or probation period; instead, it states that the government would recommend a fine within the applicable Sentencing Guidelines range, and that the government “is free to recommend a period of probation” within that range.[230] The agreement likewise does not specify any ongoing reporting or compliance requirements as part of Rhode Island Beef and Veal’s sentence.[231] Sentencing has not yet occurred in the case.
Sterling Bancorp, Inc. (Guilty Plea)
On March 15, 2023, Sterling Bancorp, Inc. (“Sterling”), a holding company offering residential and commercial loans and retail banking services through its wholly-owned subsidiary—Sterling Bank and Trust, F.S.B.—pleaded guilty to a charge of securities fraud for filing false securities statements relating to its initial public offering (“IPO”) in 2017, and in its annual filings in 2018 and 2019.[232] According to the agreement, from 2011 to 2019, Sterling, through its founder and certain members of senior management and loan officers, knowingly falsified and hid information causing loans to be offered to unqualified borrowers, which in turn increased Sterling’s revenue through its Advantage Loan Program (“ALP”).[233] Sterling then engaged in an IPO and subsequent securities filings, in the process making materially false statements regarding the quality of the ALP.[234] Consequently, between 2017 and 2019, the Sterling’s alleged fraud caused ALP non-insider shareholders to experience approximately $69 million in losses.[235]
Although Sterling voluntarily disclosed the ALP misconduct to the Office of Comptroller of the Currency (“OCC”) following an internal investigation, Sterling did not receive any disclosure credit because it did not voluntarily and timely disclose the fraudulent conduct to the Criminal Fraud Section.[236] Sterling did receive credit, however, for fully disclosing its findings from its internal investigation, cooperating with the Fraud Section’s investigation, and demonstrating recognition and affirmative acceptance of responsibility for its conduct, such as by engaging in extensive remedial measures including terminating the ALP and reorganizing its senior management and several related departments.[237]
Pursuant to the plea agreement, Sterling agreed to pay a criminal fine of approximately $62 million, a 25% discount off of the bottom of the USSG range based on Sterling’s cooperation and remediation.[238] After crediting Sterling’s civil monetary penalty payment to the OCC, the fine amount totaled approximately $56 million.[239] Similarly, credit was given for Sterling’s class action payments and thus restitution was calculated at approximately $56.5 million.[240] Following a finding that Sterling was unable to pay the full criminal penalty and restitution without facing bankruptcy, the Fraud Section required that only approximately $27 million be paid towards restitution.[241] The plea agreement specified that a Special Master would be appointed to oversee the proper administration and disbursement of the $27 million in restitution.[242]
As part of the agreement, Sterling will also be required to enhance its compliance program and provide quarterly reports to the Fraud Section throughout a three-year probationary period, which can be extended by up to one year if Sterling breaches its obligations.[243] In sentencing Sterling, the court imposed the probationary period and restitution obligation recommended by the plea agreement.[244]
Telefonaktiebolaget LM Ericsson (Guilty Plea)
On March 2, 2023, Telefonaktiebolaget LM Ericsson (“Ericsson”), a Swedish multinational telecommunications company, pleaded guilty to one count of conspiracy to violate the anti-bribery provisions of the FCPA, 15 U.S.C. § 78dd-1, and one count of conspiracy to violate the books and records provisions of the FCPA, 15 U.S.C. §§ 78m(b)(2)(A), 78m(b)(2)(B), and 78m(b)(5).[245] These counts were previously resolved in a 2019 DPA between Ericsson, the Fraud Section, and the U.S. Attorney’s Office for the Southern District of New York, in connection with which Ericsson paid more than $1 billion in penalties and disgorgement between the DPA and a related civil settlement with the SEC.[246] This year, DOJ determined, in its sole discretion, that Ericsson had breached the DPA by failing to promptly disclose all factual evidence and information related to certain pre-DPA conduct, as required by the DPA.[247] Accordingly, Ericsson pleaded guilty to the charges deferred by the 2019 DPA and agreed to an additional penalty of approximately $206.7 million.[248]
Zeus Lines Management S.A. (Guilty Plea)
On March 24, 2023, Zeus Lines Management S.A. (“Zeus”), a Liberian vessel operator with its principal place of business in Greece, pleaded guilty to violating the Act to Prevent Pollution from Ships (“APPS”), 33 U.S.C. § 1908, and the Ports and Waterways Safety Act (“PWSA”), 46 U.S.C. § 70036(b).[249] As to the APPS violations, the plea agreement states that, on three occasions between November 2021 and February 2022, one of Zeus’s ships illegally dumped 9,544 gallons of oily bilge water directly into the ocean, rather than through required pollution-prevention apparatus, and did not accurately report this discharge.[250] The agreement therefore states that Zeus failed to maintain accurate records as to its discharge of oily bilge water, in violation of the APPS.[251]
As to the PWSA violations, according to the agreement, Zeus did not report its discovery of an inoperable inert gas system on board on February 2, 2022.[252] The system’s failure, discovered while the ship was in the Netherlands, caused the ship’s oxygen levels to drastically exceed safe levels, posing a threat of fire and explosion.[253] The agreement states that Zeus sailed to the United States to retrieve a spare part during this time, and in so doing failed to report the system failure to the U.S. Coast Guard.[254] According to the agreement, after the Coast Guard became aware of the unsafe oxygen levels, Zeus falsified records to reflect that the oxygen levels were still safe during the ship’s voyage.[255]
Pursuant to its plea agreement with the Environmental and Natural Resources Division and the U.S. Attorney’s Office for the District of Rhode Island, Zeus agreed to a recommended criminal fine of over $1.6 million and $562,500 in community service to the NFWF.[256] Additionally, the agreement recommends a four-year probationary period, which can be extended by a period of time determined by the court if Zeus violates the agreement’s terms, during which Zeus must establish an Environmental Compliance Plan for all ships sailing to the United States.[257] Zeus must name a Compliance Manager who will report directly to Zeus’s Managing Director,[258] and retain a Third Party Auditor (“TPA”) to coordinate assessments of the fleet’s environmental safety practices and submit periodic reports to DOJ.[259] Zeus must also retain a Court Appointed Monitor that will oversee the audit process and Zeus’s compliance with applicable regulations, receiving reports from the TPA.[260] The court has not yet imposed sentence on Zeus.
The ship’s captain and chief engineer also pleaded guilty to charges under the APPS and PWSA.[261]
Appendix
The chart below summarizes the agreements concluded by DOJ through July 2023. The complete text of each publicly available agreement in hyperlinked in the chart.
The figures for “Monetary Recoveries” may include amounts not strictly limited to an NPA, DPA, or guilty plea, such as fines, penalties, forfeitures, and restitution requirements imposed by other regulators and enforcement agencies, as well as amounts from related settlement agreements, all of which may be part of a global resolution in connection with the NPA or DPA, paid by the named entity and/or subsidiaries. The term “Monitoring & Reporting” includes traditional compliance monitors, self-reporting arrangements, and other monitorship arrangements found in resolution agreements.
|
U.S. Deferred Prosecution Agreements, Non-Prosecution Agreements, and Plea Agreements in 2023 YTD |
||||||
|
Company |
Agency |
Alleged Violation |
Type |
Monetary Recoveries |
Monitoring & Reporting |
Term of Agreement (Months) |
|
N.D. Ala.; DOJ ENRD |
OSHA |
Guilty Plea |
$410,856 |
Yes |
24 |
|
|
S.D. Fla. |
Lacey Act |
Guilty Plea |
$0 |
No |
N/A |
|
|
D.P.R. |
Theft of Federal Funds |
Guilty Plea |
$3,712,000 |
No |
N/A |
|
|
D.N.J. |
Entry of Goods by Means of False Statements |
Guilty Plea |
$2,300,000 |
No |
N/A |
|
|
E.D. Tenn.; DOJ, Antitrust Division |
Sherman Act |
Guilty Plea |
$234,000 |
No |
0 |
|
|
D.D.C.; DOJ NSD |
Fraud (Bank) |
DPA |
$629,891,853 |
Yes |
36 |
|
|
S.D. Ga. |
Immigration Violations |
NPA |
$3,984,325 |
No |
N/A |
|
|
D.D.C.; DOJ NSD |
IEEPA |
Guilty Plea |
$83,769 |
No |
60 |
|
|
D.R.I. |
Clean Air Act |
Guilty Plea |
$0 |
Yes |
36 |
|
|
S.D. Tex. |
Clean Air Act |
Guilty Plea |
$16,000,000 |
No |
24 |
|
|
E.D. Mich.; DOJ ENRD |
Lacey Act |
Guilty Plea |
$21,373 |
Yes |
36 |
|
|
W.D. Tex.; S.D. Ga. |
Anti-Kickback Statute |
DPA |
$892,784 |
No |
18 |
|
|
E.D. Mo. |
Fraud (Healthcare) |
NPA |
$1,866,000 |
No |
36 |
|
|
D. Mass. |
FDCA |
Guilty Plea |
$2,587,142 |
No |
36 |
|
|
D. Or. |
Misprision of Felony |
Guilty Plea |
$556,000 |
No |
12 |
|
|
S.D. Cal.; DOJ ENRD |
Failure to Maintain an Accurate Oil Record Book |
Guilty Plea |
$1,250,000 |
Yes |
48 |
|
|
DOJ Fraud |
Fraud (Securities) |
NPA |
$5,000,000 |
Yes |
36 |
|
|
Kerry Inc. |
DOJ CPB; C.D. Ill. |
FDCA |
Guilty Plea |
$19,228,000 |
Unknown |
Unknown |
|
W.D. Va. |
Healthcare fraud |
Guilty Plea |
$4,070,000 |
No |
N/A |
|
|
D.R.I. |
Clean Air Act |
Guilty Plea |
$0 |
Yes |
36 |
|
|
E.D. Tenn.; DOJ, Antitrust Division |
Sherman Act |
Guilty plea |
$184,000 |
No |
N/A |
|
|
E.D. Tenn.; DOJ, Antitrust Division |
Sherman Act |
Guilty plea |
$130,000 |
No |
N/A |
|
|
S.D. Cal. |
Money Laundering |
Guilty Plea |
$0 |
No |
36 |
|
|
Onekey, LLC |
S.D.N.Y. |
OSHA |
Guilty Plea |
$218,417 |
Unknown |
36 |
|
S.D. Miss. |
Clean Water Act |
Guilty Plea |
$200,000 |
No |
12 |
|
|
E.D. Tenn.; DOJ, Antitrust Division |
Sherman Act |
Guilty Plea |
$68,000 |
No |
N/A |
|
|
D. Or. |
Clean Air Act |
Guilty Plea |
$148,733 |
No |
36 |
|
|
Quick Tricks Automotive Performance, Inc. and Kloud9Nine, LLC |
S.D. Fla. |
Clean Air Act |
Guilty Plea |
$0 |
No |
36 |
|
D.R.I. |
Federal Meat Inspection Act |
Guilty Plea |
$0 |
No |
N/A |
|
|
D.D.C.; DOJ NSD |
IEEPA |
Guilty Plea |
$83,769 |
No |
60 |
|
|
DOJ Fraud |
Fraud (Securities) |
Guilty Plea |
$39,739,000 |
Yes |
36 |
|
|
DOJ Fraud; S.D.N.Y. |
FCPA |
Guilty Plea |
$206,728,848 |
Yes |
12 |
|
|
D.R.I.; DOJ ENRD |
Failure to Maintain Accurate Oil Record Book |
Guilty Plea |
$2,250,000 |
Yes |
48 |
|
__________________________________________________________
[1] This update addresses developments and statistics through July 31, 2023. NPAs and DPAs are two kinds of voluntary, pre-trial agreements between a corporation and the government, most commonly used by DOJ. They are standard methods to resolve investigations into corporate criminal misconduct and are designed to avoid the severe consequences, both direct and collateral, that conviction would have on a company, its shareholders, and its employees. Though NPAs and DPAs differ procedurally—a DPA, unlike an NPA, is formally filed with a court along with charging documents—both usually require an admission of wrongdoing, payment of fines and penalties, cooperation with the government during the pendency of the agreement, and remedial efforts, such as enhancing a compliance program or cooperating with a monitor who reports to the government. Although NPAs and DPAs are used by multiple agencies, since Gibson Dunn began tracking corporate NPAs and DPAs in 2000, we have identified over 600 agreements initiated by DOJ, and 10 initiated by the U.S. Securities and Exchange Commission (“SEC”).
[2] Memorandum from Lisa O. Monaco, Deputy Attorney General, U.S. Dep’t of Justice, to Assistant Attorney General, Criminal Division, et al., Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.
[3] Deputy Attorney General Lisa O. Monaco Delivers Remarks on Corporate Criminal Enforcement (Sept. 15, 2022), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement.
[4] Id.
[5] Id.
[6] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national; see also DOJ, United States Attorneys’ Offices Voluntary Self-Disclosure Policy, https://www.justice.gov/d9/2023-03/usao_voluntary_self-disclosure_policy_2.21.23.pdf.
[7] Memorandum from DAG Monaco to DOJ on Further Revisions to Corporate Criminal Enforcement Policies (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.
[8] DOJ, United States Attorneys’ Offices Voluntary Self-Disclosure Policy at 4, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.justice.gov/d9/2023-03/usao_voluntary_self-disclosure_policy_2.21.23.pdf
[9] Press Release, ABB Agrees to Pay Over $315 Million to Resolve Coordinated Global Foreign Bribery Case (Dec. 2, 2022), https://www.justice.gov/opa/pr/abb-agrees-pay-over-315-million-resolve-coordinated-global-foreign-bribery-case.
[10] Memorandum from DAG Monaco to DOJ on Further Revisions to Corporate Criminal Enforcement Policies (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.
[11] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the American Bankers Association Financial Crimes Enforcement Conference (Dec. 6, 2022), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-american.
[12] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.
[13] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the American Bankers Association Financial Crimes Enforcement Conference (Dec. 6, 2022), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-american.
[14] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.
[15] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law; see also, U.S. Dep’t of Justice, Criminal Division Corporate Enforcement and Voluntary Self-Disclosure Policy, https://www.justice.gov/criminal-fraud/file/1562831/download.
[16] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.
[17] Id.
[18] Justice Manual § 9-47.120(1) (Nov. 2019).
[19] Id.
[20] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.
[21] Id.
[22] Id.
[23] Id.
[24] Id.
[25] Id.
[26] Letter from Glenn S. Leon, Chief, U.S. Dep’t of Justice, Fraud Section & E. Martin Estrada, U.S. Attorney for the Central District of California, to Peter Spivack, Counsel for Safran S.A. (Dec. 21, 2022), https://www.justice.gov/criminal-fraud/file/1559236/download.
[27] Id.
[28] Deputy Assistant Attorney General Lisa H. Miller Delivers Remarks at the University of Southern California Gould School of Law on Corporate Enforcement and Compliance (Feb. 16, 2023), https://www.justice.gov/opa/speech/deputy-assistant-attorney-general-lisa-h-miller-delivers-remarks-university-southern.
[29] Letter from Glenn S. Leon, Chief, U.S. Dep’t of Justice, Fraud Section & Troy Rivetti, Acting U.S. Attorney for the Western District of Pennsylvania, to Brian E. Spears et al., Counsel for Corsa Coal Corporation (Mar. 8, 2023), https://www.justice.gov/criminal-fraud/file/1573526/download.
[30] Id.; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.
[31] JM 9-47.120(2); see also Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.
[32] Id.
[33] Id.
[34] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.
[35] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.
[36] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.
[37] Id.; The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks (Mar. 3, 2023), chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.justice.gov/criminal-fraud/file/1571941/download.
[38] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.
[39] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.
[40] Id.; The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks 2 (Mar. 3, 2023).
[41] Id.
[42] Id.
[43] See Deputy Assistant Attorney General Lisa H. Miller Delivers Remarks at the University of Southern California Gould School of Law on Corporate Enforcement and Compliance (Feb. 16, 2023), https://www.justice.gov/opa/speech/deputy-assistant-attorney-general-lisa-h-miller-delivers-remarks-university-southern; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.
[44] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.
[45] Id.
[46] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Ethics and Compliance Initiative IMPACT Conference (May 3, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-ethics-and.
[47] Id.
[48] Id.
[49] Dep’t of Commerce, Dep’t of the Treasury, and Dep’t of Justice Tri-Seal Compliance Note: Voluntary Self-Disclosure of Potential Violations (July 26, 2023), https://ofac.treasury.gov/media/932036/download?inline.
[50] Id. at 5.
[51] Plea Agreement, United States v. ABC Polymer Indus., LLC, No. 22-cr-294 (N.D. Ala. Jan. 9, 2023), at 2-6.).
[52] Id. at 3 (citing 29 C.F.R. § 1910.212(a)(3)(ii)).).
[53] Id. at 5.
[54] Id. at 1, 7.
[55] Id.
[56] Id., Attach. A at 2-8.
[57] Press Release, U.S. Dep’t of Justice, Alabama Company Sentenced in Worker Death Case (Jan. 24, 2023), https://www.justice.gov/usao-ndal/pr/alabama-company-sentenced-worker-death-case.
[58] Plea Agreement, United States v. Aifa Seafood Inc., No. 1:22-CR-20479-FAMCR (S.D. Fla. Mar. 8, 2023).
[59] Id. at I.A.
[60] See id. at B.
[61] See generally id.
[62] Judgment, United States v. Aifa Seafood Inc., No. 1:22-CR-20479-FAM (S.D. Fla. May 25, 2023).
[63] Id.
[64] Id.
[65] Id.
[66] Plea Agreement, United States v. AMAC, No. 3:23-CR-00148-CVR (D.P.R. Apr. 13, 2023), at 13–19.
[67] Id.
[68] Id. at 17–18.
[69] See generally id.
[70] Id. at 3.
[71] Judgment, United States v. AMAC, No. 23-cr-00148-CVR (D.P.R. July 13, 2023).
[72] Plea Agreement, United States v. Anyclo Int’l, Inc., No. 23-cr-00419-ES (D.N.J. Feb. 6, 2023), at Sched. A.
[73] Id.
[74] Id. at 2.
[75] Id.
[76] Judgment, United States v. Anyclo Int’l, Inc., No. 23-cr-00419-ES (D.N.J. June 12, 2023).
[77] Id.
[78] Press Release, U.S. Dep’t of Justice, Two Amazon Marketplace Sellers and Four Companies Plead Guilty to Price Fixing DVDs and Blu-Ray Discs (Feb. 13, 2023), at 1, https://www.justice.gov/opa/pr/two-amazon-marketplace-sellers-and-four-companies-plead-guilty-price-fixing-dvds-and-blu-ray (hereinafter “BDF Enterprises et al. Press Release”).
[79] Plea Agreement, United States v. BDF Enterprises, Inc., No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (e) (“BDF Plea Agreement”); Plea Agreement, United States v. Prime Brooklyn, LLC, No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (e) (“Prime Brooklyn Plea Agreement”); Plea Agreement, United States v. Michelle’s DVD Funhouse, Inc., No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (c) (“Michelle’s DVD Plea Agreement”); Plea Agreement, United States v. MJR Prime, LLC, No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (c) (“MJR Prime Plea Agreement”).
[80] BDF Plea Agreement ¶ 10; Prime Brooklyn Plea Agreement ¶ 10; Michelle’s DVD Plea Agreement ¶ 10; MJR Prime Plea Agreement ¶ 10.
[81] BDF Plea Agreement ¶ 13; Prime Brooklyn Plea Agreement ¶ 14; Michelle’s DVD Plea Agreement ¶ 14; MJR Prime Plea Agreement ¶ 14.
[82] BDF Plea Agreement ¶ 10; Prime Brooklyn Plea Agreement ¶ 10; Michelle’s DVD Plea Agreement ¶ 10; MJR Prime Plea Agreement ¶ 10.
[83] BDF Enterprises et al. Press Release.
[84] Judgment, United States v. BDF Enters., Inc., No. 22-cr-00024-KAC-DCP (E.D. Tenn. July 24, 2023); U.S.S.G. § 8C3.4.
[85] Deferred Prosecution Agreement, United States v. Brit. Am. Tobacco P.L.C., No. 23-cr-118 (D.D.C. Apr. 25, 2023), at ¶ 1.
[86] Id.
[87] Id., at Attach. A ¶¶ 31, 36-41.
[88] Id., at Attach. A ¶¶ 30-31.
[89] Id., at Attach. A ¶¶ 4-11, 59-73.
[90] Id. at ¶ 7.
[91] Id. at ¶¶ 12-17.
[92] Id. at ¶ 3.
[93] OFAC Enforcement Release (Apr. 25, 2022), chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://ofac.treasury.gov/media/931666/download?inline.
[94] See DOJ Press Release, “British American Tobacco to Pay $629 Million in Fines for N. Korean Tobacco Sales; Charges Unsealed Against Tobacco Facilitators” (Apr. 25, 2023), https://www.justice.gov/usao-dc/pr/british-american-tobacco-pay-629-million-fines-n-korean-tobacco-sales-charges-unsealed.
[95] Non-Prosecution Agreement, Davey Tree and Wolf Tree, Inc. (July 13, 2023).
[96] Id. at 3–4.
[97] Id. at 4.
[98] Id. at 5.
[99] Id. at 6–7.
[100] Id. at 7.
[101] Id. at 10.
[102] Plea Agreement, United States v. Des International Co., Ltd., 1:23-cr-00107 (D.D.C. Mar., 23, 2023) (hereinafter “DES Plea Agreement”); Plea Agreement, United States v. Soltech Industry Co. Ltd., 1:23-cr-00107 (D.D.C. Mar., 23, 2023) (hereinafter “Soltech Plea Agreement”).
[103] Statement of Offense, DES Plea Agreement at 3–4; Statement of Offense, Soltech Plea Agreement at 3–4.
[104] Statement of Offense, DES Plea Agreement at 2, 4–8; Statement of Offense, Soltech Plea Agreement at 2, 4–8. Id. at 2, 4.
[105] Statement of Offense, DES Plea Agreement at 4–8; Statement of Offense, Soltech Plea Agreement at 4–8. Id. at 4–8.
[106] DES Plea Agreement at 4; Soltech Plea Agreement at 4.
[107] Judgment, United States v. Soltech Indus. Co., Ltd., No. 23-cr-00107-JMC (D.D.C. Apr. 26, 2023); Judgment, United States v. DES Int’l Co., Ltd., No. 23-cr-00107-JMC (D.D.C. Apr. 26, 2023).
[108] Plea Agreement, United States v. M&D Transp., Inc. & Diesel Tune-Ups of RI, Inc., No. 23-cr-00008-MSM-LDA (D.R.I. Jan. 26, 2023).),
[109] Id. at 8.
[110] Id. at 8–9.
[111] Id. at ¶ 5.
[112] Id.
[113] Id.
[114] Id.
[115] Id. at ¶ 6.
[116] Id. at ¶ 4.
[117] Plea Agreement, United States v. E.I. Du Pont De Nemours and Co. (April 24, 2023) (hereinafter “DuPont Plea Agreement”); Press Release, U.S. Dep’t of Justice, DuPont and former employee sentenced for gas release that killed four (April 24, 2023), https://www.justice.gov/usao-sdtx/pr/dupont-and-former-employee-sentenced-gas-release-killed-four.
[118] DuPont Plea Agreement at 2-3.
[119] Id. at 3.
[120] Id.
[121] Id. at 11.
[122] Judgment, United States v. E.I. Du Pont De Nemours and Co., No. 21-cr-00016 (S.D. Tex. May 2, 2023).
[123] 16 U.S.C. §§ 3372(a)(1), 3372(a)(4), and 3373(d)(1)(B); see also Press Release, U.S. Dep’t of Justice, Canadian Company Pleads Guilty to Selling Harp Seal Oil in the United States (June 5, 2023), at 1, https://www.justice.gov/opa/pr/canadian-company-pleads-guilty-illegally-selling-harp-seal-oil-united-states#:~:text=All%20News-,Canadian%20Company%20Pleads%20Guilty%20to%20Illegally%20Selling,Oil%20in%20the%20United%20States&text=FeelGood%20Natural%20Health%20Stores%20Ltd,Mammal%20Protection%20Act%20(MMPA).
[124] Plea Agreement, United States v. FeelGood Natural Health Stores, No. 2:23-cr-20189 (E.D.M.I. June 5, 2023), ¶¶ 4(1)-(5).
[125] Id. ¶¶ 5(B), (C).
[126] Id. ¶ 9(D)(a).
[127] Id.
[128] Id. ¶¶ 9(D)(a), (b)(i)-(ii).
[129] Deferred Prosecution Agreement, United States v. Genotox Lab’ys Ltd., No. 1:23-cr-00062 (W.D. Tex. Apr. 5, 2023), at 1 (hereinafter “Genotox DPA”).
[130] Id. at 2-3.
[131] Id.
[132] Id. at 4-5; see also DOJ Press Release, “Texas Laboratory Agrees to Pay $5.9 Million to Settle Allegations of Kickbacks to Third Party Marketers and Unnecessary Drug Tests” (Apr. 4, 2023), https://www.justice.gov/opa/pr/texas-laboratory-agrees-pay-59-million-settle-allegations-kickbacks-third-party-marketers-and.
[133] Genotox DPA at 13.
[134] Id. at 15.
[135] Settlement Agreement, United States v. Genotox Lab’ys Ltd., No. 2:20-cv-97 (S.D. Ga. Mar. 19, 2023), at 5 (hereinafter “Genotox Settlement Agreement”); Press Release, U.S. Dep’t of Justice, Texas Laboratory Agrees to Pay $5.9 Million to Settle Allegations of Kickbacks to Third Party Marketers and Unnecessary Drug Tests (Apr. 4, 2023), https://www.justice.gov/opa/pr/texas-laboratory-agrees-pay-59-million-settle-allegations-kickbacks-third-party-marketers-and.
[136] Genotox Settlement Agreement at 1, 3-5.
[137] Id. at 14.
[138] Genotox Settlement Agreement at 7, 12.
[139] Non-Prosecution Agreement, Great Circle (Jan. 27, 2023), at 1–2.
[140] Id., Statement of Facts, at ¶ 2.
[141] See id., Statement of Facts, at ¶¶ 3–6.
[142] See id., Attach. B.
[143] See id. at 1.
[144] See generally id.
[145] Plea Agreement, United States v. Greater Boston Behavioral Health LLC, No. 23-cr-10112-DLC (Mar. 13, 2023).
[146] Id., Statement of Facts, at ¶ 4–5.
[147] Id. at 3–4.
[148] Id. at 4.
[149] See id. at 2–3.
[150] Judgment, United States v. Greater Boston Behavioral Health, No. 23-cr-10112-DLC (D. Mass. May 16, 2023).
[151] Plea Agreement, United States v. Ground Zero Seeds Int’l, Inc., No. 3:22-cr-00073-IM (D. Or.) (hereinafter “GZI Plea Agreement”), at 2–3.
[152] Id.
[153] Id. at 3.
[154] Id. at 4.
[155] Id. at 3.
[156] See Judgment, United States v. Ground Zero Seeds Int’l, Inc., No. 3:22-cr-00073-IM (D. Or.).
[157] See generally id.; GZI Plea Agreement.
[158] Plea Agreement, United States v. Interunity Mgmt. (Deutschland) GmbH, No. 23-cr-01044-TWR (S.D. Cal. May 30, 2023) (hereinafter “Interunity Plea Agreement”), at 3.
[159] Id. at 4.
[160] Id. at 6.
[161] Id. at 14.
[162] Id. at 12.
[163] Id. at 13.
[164] Id.
[165] Id. at Attach. A.
[166] Id. at Attach. A., at 16.
[167] Non-Prosecution Agreement, United States v. IRB Brasil Resseguors SA (Apr. 20, 2023), at ¶ 1.
[168] Id. at ¶ 4.
[169] Id., Attach. A at A-1.
[170] Id., Attach. A at A-2.
[171] Id., Attach. A at A-3.
[172] Id., Attach. A at A-3, A-4.
[173] Id., Attach. A at A-3.
[174] Id. at ¶ 3.
[175] Id. at ¶¶ 11-13.
[176] Id. at ¶ 3.
[177] Id., Attach. C ¶¶ 1-15.
[178] Id. at ¶¶ 5, 15.
[179] Press Release, U.S. Dep’t of Justice, Kerry Inc. Pleads Guilty and Agrees to Pay $19.228 Million in Connection with Insanitary Plant Conditions Linked to 2018 Salmonella Poisoning Outbreak (Feb. 3, 2023), https://www.justice.gov/opa/pr/kerry-inc-pleads-guilty-and-agrees-pay-19228-million-connection-insanitary-plant-conditions (hereinafter “Kerry Press Release”).
[180] Id.
[181] Id.
[182] Id.
[183] Judgment, United States v. Kerry, Inc., No. 22-cr-10051-001 (C.D. Ill. Mar. 23, 2023) at 1, 3.
[184] Kerry Press Release.
[185] Plea Agreement, United States v. L5 Medical Holdings, LLC, d/b/a/ Pain Care Centers, No. 6:23-cr-12 (W.D. Va. (July 26, 2023) (hereinafter “L5 Medical Plea Agreement”).
[186] Id. at 1.
[187] See DOJ Press Release, “Pain Clinic Owner, L5 Medical Holdings Plead Guilty-Agree to Pay $4 Million in Restitution,” (July. 28, 2023), https://www.justice.gov/usao-wdva/pr/pain-clinic-owner-l5-medical-holdings-plead-guilty-agree-pay-4-million-restitution.
[188] Id.; see also L5 Medical Plea Agreement at 1.
[189] L5 Medical Plea Agreement at 4.
[190] Id. at 7.
[191] Plea Agreement, United States v. Nine2Five, LLC, No. 23-cr-179-TWR (July 10, 2023) (hereinafter “Nine2Five Plea Agreement”), at 3.
[192] Kratom, National Institute on Drug Abuse (March 25, 2022), https://nida.nih.gov/research-topics/kratom.
[193] Nine2Five Plea Agreement at 3.
[194] Id. at 8.
[195] Id. at 7.
[196] Press Release, U.S. Dep’t of Justice, General Contractor and Real Estate Developer Plead Guilty In Connection With Worker Death On Construction Site In Poughkeepsie (Feb. 2, 2023), https://www.justice.gov/usao-sdny/pr/general-contractor-and-real-estate-developer-plead-guilty-connection-worker-death.
[197] Id.
[198] Id.
[199] Sentencing Memorandum on Behalf of Onekey, LLC, United States v. Onekey LLC et al., No. 22-cr-000414 (PED) (S.D.N.Y. Apr. 28, 2023), at 2, 7.
[200] Id. at 1–2.
[201] Id. at 2.
[202] Judgment, United States v. One Key, LLC et al., No. 7:22-cr-00414-VR (S.D.N.Y. May 17, 2023); see also Press Release, U.S. Dep’t of Justice, Construction Company Principal Sentenced To Three Months In Prison In Connection With Worker Death On Construction Site In Poughkeepsie (May 12, 2023), https://www.justice.gov/usao-sdny/pr/construction-company-principal-sentenced-three-months-prison-connection-worker-death.
[203] Judgment, United States v. Finbar O’Neill, No. 7:22-cr-00414-VR (S.D.N.Y. May 12, 2023).
[204] See Press Release, U.S. Dep’t of Justice, “Mississippi Wastewater Hauling Business Pleads Guilty to Clean Water Act Violation,” (Jan. 11, 2023), https://www.justice.gov/usao-sdms/pr/mississippi-wastewater-hauling-business-pleads-guilty-clean-water-act-violation.
[205] See Press Release, U.S. Dep’t of Justice, “Owner of Jackson Business Pleads Guilty to Illegally Discharging Industrial Waste into Jackson’s Sewer System,” (Jan. 27, 2021), https://www.justice.gov/usao-sdms/pr/owner-jackson-business-pleads-guilty-illegally-discharging-industrial-waste-jackson-s.
[206] Information, United States v. Partridge-Sibley Industrial Services, Inc., No. 3:22-cr-131-CWR-FKB, at 3 (Dec. 19, 2022).
[207] See Press Release, U.S. Dep’t of Justice, “Owner of Jackson Business Pleads Guilty to Illegally Discharging Industrial Waste into Jackson’s Sewer System,” (Jan. 27, 2021), https://www.justice.gov/usao-sdms/pr/owner-jackson-business-pleads-guilty-illegally-discharging-industrial-waste-jackson-s.
[208] Plea Agreement, United States v. Partridge-Sibley Industrial Services, Inc., No. 3:22-cr-131-CWR-FKB, at 1 (Jan. 11, 2023, S.D. Miss.).
[209] Id. at 4.
[210] See Press Release, PSI, “Response to Gold Coast Commodities and Rebel High Velocity Case,” http://partridgesibley.com/downloads/Partridge_Sibley_Press_Release.pdf.
[211] Id.
[212] Judgment, United States v. Partridge-Sibley Indus. Servs., Inc., No. 22-cr-00131-FKB (S.D. Miss. Feb. 17, 2023).
[213] Plea Agreement, United States v. Quick Tricks Automotive Performance, Inc., 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023); Plea Agreement, United States v. Kloud9Nine, LLC, 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023) (hereinafter jointly “Quick Tricks and Kloud9Nine Plea Agreement”).
[214] Joint Statement of Facts, United States v. Quick Tricks Automotive Performance, Inc., 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023), at 4–5 (hereinafter “Quick Tricks and Kloud9Nine Joint Statement of Facts”). Id. at 4–5.
[215] Quick Tricks and Kloud9Nine Plea Agreements, at 5.
[216] Id.
[217] Judgment, United States v. Quick Tricks Auto. Perf., Inc., 22-cr-20516-KMW (S.D. Fla. May 10, 2023) (hereinafter “QuickTricks Judgment”); Judgment, United States v. Kloud9Nine, LLC, 22-cr-20516-KMW (S.D. Fla. June 13, 2023) (hereinafter “Kloud9Nine Judgment”).
[218] QuickTricks Judgment; Kloud9Nine Judgment.
[219] QuickTricks Judgment; Kloud9Nine Judgment.
[220] QuickTricks Judgment; Kloud9Nine Judgment.
[221] Plea Agreement, United States v. Pure Addiction Diesel Performance, LLC, No. 3:23-cr-00189-SI (D. Or. May 30, 2023).
[222] Id. at 2-3.
[223] Id. at 3.
[224] Id. at 3–4.
[225] Id.
[226] Plea Agreement, United States v. Travis Turner, No. 3:23-cr-00189-SI (D. Or. May 30, 2023).
[227] Plea Agreement, United States v. Rhode Island Beef and Veal, No. 20-cr-00093-MSM-PAS (D.R.I. Apr. 4, 2023) (hereinafter “Rhode Island Beef and Veal Plea Agreement”).).
[228] Id. at 1.
[229] Press Release, U.S. Dep’t of Justice, Rhode Island Beef Slaughterhouse, Owner Admit to Violating the Federal Meat Inspection Act (June 8, 2023), https://www.justice.gov/usao-ri/pr/rhode-island-beef-slaughterhouse-owner-admit-violating-federal-meat-inspection-act.
[230] Rhode Island Beef and Veal Plea Agreement at 2.
[231] Id.
[232] Plea Agreement, United States v. Sterling Bancorp, Inc., 5:23-CR-20174 (E.D. Mich. Mar. 15, 2023) (hereinafter “Sterling Plea Agreement”).).
[233] Id. at 4–5; Attach. A-4–A-6.
[234] Id.
[235] Sterling Plea Agreement at 4–5; Attach. A-4–A-6.
[236] Id.
[237] Id. at 6–7.
[238] Id. at 21.
[239] Id.
[240] Id. at 22.
[241] Id. at 23–24.
[242] Id. at 25.
[243] Id. at 7–8.
[244] Judgment, United States v. Sterling Bancorp, Inc., No. 23-cr-20174-LVP-DRG (July 21, 2023), ECF No. 14.
[245] Plea Agreement, United States v. Telefonaktiebolaget LM Ericsson, No. 1:19-CR-00884-LTS (S.D.N.Y. Mar. 20, 2023), at ¶ 2 (hereinafter “Ericsson Plea Agreement”).
[246] Id., Attach. A-1, Factual Basis for Breach.
[247] Id.
[248] Ericsson Plea Agreement at 19.
[249] Plea Agreement, United States v. Zeus Lines Management S.A., No. 1:23-CR-00028-MSM-LDA-01 (D.R.I. Mar. 24, 2023), (hereinafter “Zeus Plea Agreement”).
[250] Id. at 8-9.
[251] Id. at 3-4.
[252] Id. at 6-7.
[253] Id. at 7.
[254] Id. at 3-4.
[255] Id. at 8-9.
[256] Press Release, U.S. Dep’t of Justice, Vessel Operator, Captain and Chief Engineer Convicted of Environmental Crimes (May 3, 2023), at 2, https://www.justice.gov/opa/pr/vessel-operator-captain-and-chief-engineer-convicted-environmental-crimes.
[257] Zeus Plea Agreement, at 16.
[258] See id., Attach A, at 2.
[259] Id., Attach A, at 4-5.
[260] Id., Attach A, at 10.
[261] Press Release, U.S. Dep’t of Justice, United States v. Zeus Lines Mgmt. S.A. et al., No. 1:23-CR-00028 (May 10, 2023), https://www.justice.gov/enrd/case/united-states-v-zeus-lines-management-sa-et-al.
[262] As discussed in this alert’s full summary of the Genotox resolutions, the Genotox civil resolution included $4,995,278.85 as a “suspended” amount. While the settlement agreement refers to Genotox’s “payments” to the government as “restitution to the United States,” the suspended amount is not a payment by Genotox but rather is a sum the government retained after the underlying lawsuit was filed. See Genotox CSA at 1, 3–5. Accordingly, we have not counted the “suspended” amount in the total monetary recoveries for the Genotox resolutions. Similarly, the Genotox CSA calls for additional, contingent restitution depending upon Genotox’s future revenues. Id. at 4–5. Because of the contingent nature of those obligations, we have not accounted for them in the total monetary recoveries figure for Genotox.
The following Gibson Dunn lawyers participated in preparing this client update: F. Joseph Warin, M. Kendall Day, Courtney Brown, Melissa Farrar, Michael Dziuban, Benjamin Belair, Alexandra Buettner, Sarah Hafeez, Erika Suh Holmberg, Teddy Kristek, Madelyn La France, Andrea Lattanzio, Allison Lewis, Jacob McGee, Kelly Skowera, Alyse Ullery-Glod, Mike Ulmer, and Blair Watler.
Gibson Dunn’s White Collar Defense and Investigations Practice Group successfully defends corporations and senior corporate executives in a wide range of federal and state investigations and prosecutions, and conducts sensitive internal investigations for leading companies and their boards of directors in almost every business sector. The Group has members across the globe and in every domestic office of the Firm and draws on more than 125 attorneys with deep government experience, including more than 50 former federal and state prosecutors and officials, many of whom served at high levels within the Department of Justice and the Securities and Exchange Commission, as well as former non-U.S. enforcers. Joe Warin, a former federal prosecutor, is co-chair of the Group and served as the U.S. counsel for the compliance monitor for Siemens and as the FCPA compliance monitor for Alliance One International. He previously served as the monitor for Statoil pursuant to a DOJ and SEC enforcement action. He co-authored the seminal law review article on NPAs and DPAs in 2007. M. Kendall Day is a partner in the Group and a former white collar federal prosecutor who spent 15 years at the Department of Justice, rising to the highest career position in the DOJ’s Criminal Division as an Acting Deputy Assistant Attorney General.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, the authors, or any of the following leaders and members of the White Collar Defense and Investigations practice group:
Washington, D.C.
F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com)
Stephanie Brooker (+1 202-887-3502, sbrooker@gibsondunn.com)
Courtney M. Brown (+1 202-955-8685, cmbrown@gibsondunn.com)
David P. Burns (+1 202-887-3786, dburns@gibsondunn.com)
John W.F. Chesley (+1 202-887-3788, jchesley@gibsondunn.com)
Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com)
M. Kendall Day (+1 202-955-8220, kday@gibsondunn.com)
David Debold (+1 202-955-8551, ddebold@gibsondunn.com)
Michael S. Diamant (+1 202-887-3604, mdiamant@gibsondunn.com)
Gustav W. Eyler (+1 202-955-8610, geyler@gibsondunn.com)
Richard W. Grime (+1 202-955-8219, rgrime@gibsondunn.com)
Scott D. Hammond (+1 202-887-3684, shammond@gibsondunn.com)
George J. Hazel (+1 202-887-3674, ghazel@gibsondunn.com)
Judith A. Lee (+1 202-887-3591, jalee@gibsondunn.com)
Adam M. Smith (+1 202-887-3547, asmith@gibsondunn.com)
Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com)
Oleh Vretsona (+1 202-887-3779, ovretsona@gibsondunn.com)
Amy Feagles (+1 202-887-3699, afeagles@gibsondunn.com)
David C. Ware (+1 202-887-3652, dware@gibsondunn.com)
Ella Alves Capone (+1 202-887-3511, ecapone@gibsondunn.com)
Nick Murphy (+1 202-777-9504, nmurphy@gibsondunn.com)
Melissa Farrar (+1 202-887-3579, mfarrar@gibsondunn.com)
Nicole Lee (+1 202-887-3717, nlee@gibsondunn.com)
Jason H. Smith (+1 202-887-3576, jsmith@gibsondunn.com)
Pedro G. Soto (+1 202-955-8661, psoto@gibsondunn.com)
New York
Zainab N. Ahmad (+1 212-351-2609, zahmad@gibsondunn.com)
Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com)
Mylan L. Denerstein (+1 212-351-3850, mdenerstein@gibsondunn.com)
Barry R. Goldsmith (+1 212-351-2440, bgoldsmith@gibsondunn.com)
Karin Portlock (+1 212-351-2666, kportlock@gibsondunn.com)
Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com)
Orin Snyder (+1 212-351-2400, osnyder@gibsondunn.com)
Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com)
Brendan Stewart (+1 212-351-6393, bstewart@gibsondunn.com)
Denver
Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com)
Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com)
John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com)
Laura M. Sturges (+1 303-298-5929, lsturges@gibsondunn.com)
Houston
Gregg J. Costa (+1 346-718-6649, gcosta@gibsondunn.com)
Los Angeles
Michael H. Dore (+1 213-229-7652, mdore@gibsondunn.com)
Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com)
Diana M. Feinstein (+1 213-229-7351, dfeinstein@gibsondunn.com)
Douglas Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com)
Nicola T. Hanna (+1 213-229-7269, nhanna@gibsondunn.com)
Poonam G. Kumar (+1 213-229-7554, pkumar@gibsondunn.com)
Marcellus McRae (+1 213-229-7675, mmcrae@gibsondunn.com)
Eric D. Vandevelde (+1 213-229-7186, evandevelde@gibsondunn.com)
Debra Wong Yang (+1 213-229-7472, dwongyang@gibsondunn.com)
San Francisco
Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com)
Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)
Michael Li-Ming Wong (+1 415-393-8333, mwong@gibsondunn.com)
Palo Alto
Benjamin Wagner (+1 650-849-5395, bwagner@gibsondunn.com)
London
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Michelle Kirschner (+44 20 7071 4212, mkirschner@gibsondunn.com)
Matthew Nunan (+44 20 7071 4201, mnunan@gibsondunn.com)
Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com)
Paris
Benoît Fleury (+33 1 56 43 13 00, bfleury@gibsondunn.com)
Bernard Grinspan (+33 1 56 43 13 00, bgrinspan@gibsondunn.com)
Frankfurt
Finn Zeidler (+49 69 247 411 530, fzeidler@gibsondunn.com)
Munich
Katharina Humphrey (+49 89 189 33 155, khumphrey@gibsondunn.com)
Benno Schwarz (+49 89 189 33 110, bschwarz@gibsondunn.com)
Mark Zimmer (+49 89 189 33 115, mzimmer@gibsondunn.com)
Hong Kong
Kelly Austin (+852 2214 3788/+1 303-298-5980, kaustin@gibsondunn.com)
Oliver D. Welch (+852 2214 3716, owelch@gibsondunn.com)
Singapore
Joerg Biswas-Bartz (+65 6507 3635, jbiswas-bartz@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.
Lawdragon named 44 Gibson Dunn partners to its 500 Leading Litigators in America 2024 guide, featuring the “advisors you want to send into battle.” The partners named as Leading Litigators are: Trey Cox and Veronica Moyé in Dallas; Monica Loseman in Denver; Gregg Costa and Collin Cox in Houston; Lauren Blas, Theodore Boutrous Jr., Christopher Chorba, Scott Edelman, Theane Evangelis, Perlette Michèle Jura, Sam Liversidge, Marcellus McRae, Ilissa Samplin, Julian Poon, Deborah Stein, Daniel Swanson, and Debra Wong Yang in Los Angeles; Reed Brodsky, Anne Champion, Lauren Goldman, Benjamin Hershkowitz, Charlotte Jacobsen, Josh Krevitt, Adam Offenhartz, Orin Snyder, Eric Stock, and Lawrence Zweifach in New York; Ashlie Beringer in Palo Alto; Rachel Brass, Kristin Linsley, and Rosemarie Ring in San Francisco; and Svetlana Gans, Scott Hammond, Joshua Lipshutz, Joshua Lipton, Matthew McGill, Ted Olson, Elizabeth Papez, Michael Perry, Cynthia Richman, Helgi Walker, F. Joseph Warin, and Stephen Weissman in Washington, D.C. The list was published September 8, 2023.
The National Law Journal named Gibson Dunn to its 2023 Appellate Hot List, which “highlights law firms that have handled exemplary appellate matters.” The list was published on August 31, 2023.
The Gibson Dunn Appellate and Constitutional Law Practice Group’s lawyers participate in appeals in all 13 federal courts of appeals and state appellate courts throughout the United States and have presented arguments in front of the Supreme Court of the United States nearly 160 times. The group has broad experience in complex appellate litigation at all levels of the U.S. federal and state court systems and has been involved in matters that cover a wide array of constitutional, statutory, regulatory and common-law issues.
The Los Angeles Superior Court has granted a two-year domestic violence restraining order in favor of Gibson Dunn’s pro bono client, a low-income mother of a developmentally delayed child, who suffered years of physical, psychological and financial abuse from her husband. Before Gibson Dunn joined the case, our client’s temporary restraining order did not include a move-out order against her husband or an order for possession of her vehicle, leaving our client without stable housing or reliable transportation. Our team successfully amended the request for a temporary restraining order to seek the additional relief.
At the evidentiary hearing, our lawyers presented compelling evidence that our client suffered abuse from her husband throughout their 11-year marriage. After the hearing, including cross-examination of the husband—who testified that he had never physically or otherwise abused our client, and attempted to argue that our client was the abuser—the court sided with our client, concluding that she was more credible than her husband. In addition to the restraining order against her husband, the court awarded our client sole legal and physical custody of their child, exclusive use of the residence and immediate return of her vehicle. The court also ordered limited professionally monitored child visitation with the husband.
Los Angeles associate Summer Wall led the team and conducted the examinations, with valuable assistance from associates Camille Houle and Chelsea D’Olivo (Washington, D.C.), and supervision from partner Michael Holecek and senior associate Patrick Murray. The team received outstanding support from our pro bono partners at the Los Angeles Center for Law and Justice and from Gibson Dunn support staff, including Austin Kang.
Originally published by PLI Chronicle
Much ink has been spilled about the role of artificial intelligence (AI) in employment, especially in light of the developing menagerie of laws seeking to govern automated decision tools in the workplace. And rightly so—this is a burgeoning area with daily developments that must be carefully monitored. From enforcement of New York City’s AI employment law beginning on July 5, 2023 to a barrage of proposed bills like U.S. Senator Casey’s No Robot Bosses Act, there has seldom been a dull moment in 2023. However, amidst all of the buzz around automation in the workplace, privacy regulations have emerged as yet another piece of the employment puzzle.
Where Does Privacy Come In?
Privacy regulations play a key role in the effective governance of AI in the workplace. AI systems are increasingly processing personal data—ranging from demographic data to biometric data—by using algorithms to analyze and extract insights from various types of information to make predictions, recommendations, or even decisions for an employer. By implementing an AI system that collects and processes this personal data, the employer may be responsible for ensuring compliance with the evolving patchwork of laws governing the use of AI in employment decision making but also with many existing data protection laws, depending on their geographical scope and use.
Reproduced with permission. Originally published in PLI Chronicle: Insights and Perspectives for the Legal Community (August 2023).
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 Artificial Intelligence, Labor & Employment, or Privacy, Cybersecurity & Data Innovation practice groups, or the authors:
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)
Emily Maxim Lamm – Washington, D.C. (+1 202-955-8255, elamm@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.
Ms. X fled to the U.S. from El Salvador in 2016 to escape targeted gang violence. Her family staunchly and vocally opposed the gang’s control of their community and reported the gang’s activities to the police. In retaliation, the gang threatened the family with death. One of Ms. X’s cousins was murdered and dismembered by gang members, and Ms. X herself was directly threatened. After being assaulted by the gang’s local leader, Ms. X fled to the U.S.
Over the next seven years, Gibson Dunn represented Ms. X in partnership with Kids In Need of Defense (KIND). Her case was shuffled among three different judges at three different immigration courts.
Gibson Dunn faced difficult strategic choices along the way. In particular, the team learned that neither of Ms. X’s primary persecutors remained in El Salvador: one had been killed by the police, and one had traveled to the U.S. The team disclosed this information to the Court and burnished Ms. X’s asylum application with the testimony of two expert witnesses who detailed the risk of persecution Ms. X would still face at the hands of gang members who remained in El Salvador.
El Salvador’s recent Régimen de Excepción (State of Exception) also raised unexpected challenges. Under the State of Exception, the Salvadoran military has arrested and detained more than 68,000 purported gang members, often solely on the basis of anonymous tips. In the wake of these mass arrests, the Department of Homeland Security (DHS) has begun arguing that El Salvador no longer has a gang problem and that asylum seekers who fled gang-based violence, like Ms. X, should be returned to El Salvador. In fact, the opposite is true: individuals like Ms. X now face two separate persecutors—the gangs, and the Salvadoran government itself, which has been arresting deportees and individuals previously targeted by gangs for so-called “association” or “collaboration” with the very gangs that persecuted them.
On the day of the hearing, Ms. X provided powerful direct-examination and cross-examination testimony, and Gibson Dunn secured DHS’s stipulation to refrain from challenging her experts’ testimony and, notably, her application for asylum. The court entered an oral grant of asylum from the bench, and DHS waived its right to appeal.
Washington, D.C. associate Tessa Gellerson was the lead attorney during the individual merits hearing, with Joseph West as supervising partner. The team, which included former associates Ariel Fishman, Nicholas Fuenzalida, Haley Morrisson, Alison Friberg, and Nanding Chen, received outstanding support from its pro bono partners at KIND and several members of the Gibson Dunn support staff, including Ileana Rivera and Sandra Andrade, who provided invaluable assistance with translation, and the D.C. Copy Center team, who saved the day more than once with monumental printing requests.
On August 30, 2023, the IRS and Treasury published proposed Treasury regulations (the “Proposed Regulations”) providing expansive guidance on the prevailing wage and apprenticeship requirements (the “PWA Requirements”) that taxpayers must[1] satisfy to receive the full credit amount[2] available under various revised and new tax credits provided for in the Inflation Reduction Act of 2022 (the “IRA”).[3] Taxpayers are permitted to rely on the Proposed Regulations with respect to a facility[4] on which construction began on or after January 29, 2023 but before final regulations are published.[5]
The Proposed Regulations are detailed, and a comprehensive discussion of them is beyond the scope of this alert. Instead, this alert begins with some background regarding these requirements, then provides a short summary of the Prevailing Wage Requirement and the Apprentice Requirements (including, with respect to each requirement, a short description of the consequences of noncompliance, remediation opportunities, and recordkeeping obligations), and concludes with observations regarding key implications of the guidance for market participants.
Background
The IRA introduced the PWA Requirements with the intent of “creating good-paying union jobs” in the clean energy, manufacturing, and construction sectors.[6] At a high level, the “Prevailing Wage Requirement” requires that all laborers and mechanics employed by a taxpayer (or a contractor or subcontractor of such taxpayer) claiming an applicable credit[7] are paid wages for construction, alteration, or repair of the applicable facility that are not less that the “prevailing” wage for that type of work. The Apprenticeship Requirements (as defined below) are focused on making sure that project developers make on-the-job training opportunities available to the next generation of skilled tradesmen.
Key Prevailing Wage Requirements
The Proposed Regulations provide substantial practical guidance on compliance with the Prevailing Wage Requirement. The Proposed Regulations clarify which workers must be paid prevailing wages, describe the types of work that constitutes construction, alteration, or repair of a facility, and explain how to determine and pay prevailing wages. The subsections below describe some of the most significant aspects of the guidance on these topics.
Workers Subject to the Prevailing Wage Requirement
Workers engaging in construction, alteration, or repair of a facility (described below) must be paid at or above the prevailing wage if they are laborers or mechanics employed by the taxpayer or its contractor or subcontractor. The Proposed Regulations provide clarity on the meaning of these terms.
- A laborer or mechanic is any worker whose duties are manual or physical in nature and includes apprentices and helpers. Generally, this definition excludes individuals with roles that are primarily administrative, executive, or clerical. The IRS and Treasury are seeking comments regarding the treatment of persons whose roles are not primarily physical in nature, such as a foreperson, owner, or administrator, but who perform certain duties that are physical in nature.[8]
- A person is employed if the person performs the duties of a laborer, mechanic, contractor, or subcontractor. The term “employed” is intended to be significantly broader in the prevailing wage context than in the employment tax context.[9] Accordingly, workers, regardless of whether they would be viewed as employees or independent contractors for other purposes of the Code, may be “employed” by the taxpayer, its contractor, or its subcontractor.
- The taxpayer[10] can be any person subject to taxation under the Internal Revenue Code (including a partnership and an entity that is permitted to make a “direct pay” election under section 6417[11]).
- A contractor is any person that enters into a contract with the taxpayer for construction, alteration, or repair of a qualified facility and a subcontractor is any person that agrees to perform or be responsible for any part of such a contract.
Scope of Construction, Alteration, or Repair of the Facility
The Proposed Regulations clarify that “construction, alteration, or repair” (i.e., the types of work covered by the Prevailing Wage Requirement) should be construed expansively, but do clarify that ordinary maintenance work (i.e., work that is intended to sustain the existing functionality of the facility) is not covered by the Prevailing Wage Requirement.[12] In addition, work that would fit within the broad definition of “construction, alteration, or repair” is subject to the Prevailing Wage Requirement only if the physical work occurs at the physical site of the facility (including any adjacent or virtually adjacent dedicated support site) or at a secondary site that is established specifically for or dedicated exclusively to the construction of such facility for a meaningful time.[13]
For example, if a taxpayer builds a wind farm, the construction at the site where the wind farm will be located would be subject to the Prevailing Wage Requirement. If a significant portion of the facility is constructed at an off-site warehouse that was established specifically to assist with, or dedicated exclusively for a specific period of time to, the construction of the wind farm, work completed at the off-site warehouse also would be subject to the Prevailing Wage Requirement. However, if the step-up transformer is constructed at an off-site location that (during the transformer’s construction) is building transformers for other wind farms, the labor performed on the transformer at that location is generally not subject to the Prevailing Wage Requirement, at least with respect to the construction of the taxpayer’s wind farm.
How to Determine Prevailing Wages
The Wage and Hour Division of the Department of Labor is responsible for making prevailing wage determinations. The prevailing wage is based on the type of construction, the type of labor performed, and the geographic area in which the labor is performed. The Proposed Regulations indicate that, when a taxpayer plans to construct, alter, or repair a facility, the taxpayer (and its contractors or subcontractors) will be able to find the prevailing wage for the applicable type of construction and location for each type of labor they expect to require on a website approved by the Department of Labor (currently www.sam.gov), rather than being required to seek an individualized, project-specific ruling.
In general, taxpayers can pay registered apprentices less than the prevailing wage rate that would need to be paid to a journeyworker[14] performing the same type of work, but not less than the rate (and fringe benefits) specified by the registered apprenticeship program.[15] For any hours worked by an apprentice in excess of the ratio permitted by the Ratio Requirement (a requirement described below requiring an appropriate ratio of apprentices to more experienced workers), the Proposed Regulations provide that the apprentice must be paid not less than the wage rate that would need to be paid to a journeyworker for the same type of work.
As noted above, the IRS and Treasury expect that prevailing wages will be available from the website approved by the Department of Labor. The Proposed Regulations make clear, however, that a supplemental, facility-specific wage determination can be requested from the Department of Labor if (i) the facility spans more than one geographic area,[16] (ii) there is no general wage determination currently available for a particular geographic area or type of work, or (iii) the wages for certain labor classifications are not listed on the generalized Department of Labor website.[17] If a taxpayer only discovers that it has not paid prevailing wages when the Department of Labor subsequently makes a determination of the prevailing wage rate, the taxpayer has 30 days from the date of determination to remediate the failure by making “catch-up” payments to the laborers and mechanics who have received insufficient wages.
The Proposed Regulations helpfully clarify that, in general, applicable prevailing wages are required to be determined only at the outset of the work, although wage rates must be refreshed if a contract is expanded to cover additional work not within its original scope. In addition, for any alteration or repair work on a facility that occurs after the facility is placed in service, taxpayers must use the prevailing wage in effect at the time the alteration or repair work begins.
How to Pay and How Long to Pay the Prevailing Wage
After determining both which workers are subject to the Prevailing Wage Requirement and the prevailing wage rates applicable to those workers, employers must pay workers prevailing wages through regular payroll practices, without subsequent deduction or rebate of any kind (except as required by law or permitted by regulations issued by the Secretary of Labor). For production tax credit facilities, the Prevailing Wage Requirement generally applies during the life of the production tax credit, whereas for an investment tax credit facility the relevant period is, in general, five years (i.e., the recapture period).
Apprenticeship Requirements
In addition to the Prevailing Wage Requirement, taxpayers must abide by three apprenticeship requirements (the “Apprenticeship Requirements”) in connection with construction, alteration, or repair of a facility to receive full tax amounts for certain tax credits.[18] First, the “Labor Hours Requirement” specifies the required percentage of labor hours that must be performed by qualified apprentices.[19] Second, the “Ratio Requirement” mandates that the taxpayer abide by the applicable apprentice-to-journeyworker ratio, as determined by the Department of Labor or applicable state apprenticeship agency. Third, under the “Participation Requirement,” each taxpayer, contractor, or subcontractor that employs four or more individuals to perform construction, alteration, or repair work with respect to the construction of the qualified facility must employ one or more qualified apprentices to perform that work. The Proposed Regulations clarify the relationship among the Apprenticeship Requirements and provide further explanation and rules that generally tighten the requirements.
Labor Hours Requirement
The Proposed Regulations reiterate that, under the Labor Hours Requirement, the “applicable percentage”[20] of total labor hours must be performed by qualified apprentices.[21] The Proposed Regulations make clear that the Labor Hours Requirement is subject to the Ratio Requirement, meaning that hours worked by a qualified apprentice that do not comply with the Ratio Requirement will not be counted as labor hours by a qualified apprentice for purposes of meeting the Labor Hours Requirement.
Ratio Requirement
The Ratio Requirement is intended to ensure there are sufficient supervising journeyworkers onsite.[22] The applicable apprentice-to-journeyworker ratio for a particular apprentice will be determined by the registered apprenticeship program in which that apprentice is participating, and also would be subject to the requirements of the Department of Labor and applicable state apprenticeship agencies. The Proposed Regulations clarify that the Ratio Requirement applies on a daily basis.
Participation Requirement
The Participation Requirement requires that each taxpayer, contractor, or subcontractor who employs four or more individuals to perform construction, alteration, or repair work with respect to the construction of a qualified facility must employ one or more qualified apprentices to perform such work. The Proposed Regulations clarify that the Participation Requirement is not a daily requirement. Because the Participation Requirement is designed to prevent taxpayers from satisfying the Labor Hours Requirement by only hiring apprentices to perform one type of work, the Proposed Regulations provide that the Participation Requirement must be satisfied separately by the taxpayer and each contractor and subcontractor (if any such person has four or more employees who perform relevant work on the facility); however, the taxpayer ultimately must ensure that each of its contractors and subcontractors (if applicable) has satisfied the Participation Requirement.
Noncompliance Rules and Remedies
Prevailing Wage Requirement – Penalties and Correction Payments
Under the Proposed Regulations, if a taxpayer fails to satisfy the Prevailing Wage Requirement, the taxpayer may cure that failure and retain the credit by making a correction payment to all impacted laborers and mechanics, as well as paying any applicable penalties.
For any period during which a laborer or mechanic was paid wages that failed to satisfy the Prevailing Wage Requirement, the correction payment is calculated as the difference between the wages that should have been paid under the Prevailing Wage Requirement and all wages paid to that laborer or mechanic for the period, plus interest.[23] The Proposed Regulations require that a correction payment must be made even if the taxpayer is not able to locate one or more of the impacted laborers or mechanics, requiring taxpayers to comply with, for example, state-administered unclaimed wage programs.
In addition to any back wages and interest, taxpayers are required to pay a $5,000 penalty for each laborer or mechanic who was underpaid for each applicable year. Helpfully, the Proposed Regulations provided that this penalty is waived automatically in certain quickly discovered and corrected situations. The automatic waiver has two conditions:
- The taxpayer makes the correction payment not later than the earlier of (i) 30 days after the date taxpayer becomes aware of the error and (ii) the date on which the tax return claiming the credit is filed; and
- Either (i) the laborer or mechanic was underpaid for not more than 10 percent of all relevant periods or (ii) the underpayment was not greater than 2.5 percent of what the laborer or mechanic should have been paid under the Prevailing Wage Requirements.
If the IRS determines that any failure to satisfy the Prevailing Wage Requirements was due to intentional disregard, the required correction payment amount is increased by a multiple of three and the penalty rate is increased from $5,000 to $10,000.[24] The Proposed Regulations provide a non-exclusive list of facts that might be considered in the determination of whether a failure to meet the Prevailing Wage Requirements is due to intentional disregard, including whether (i) the failure to pay prevailing wages by the taxpayer is part of a pattern of conduct, (ii) the taxpayer promptly cured any failures to pay prevailing wages, (iii) the taxpayer included (and caused to be included) provisions in contracts with contractors and subcontractors ensuring compliance with the Prevailing Wage Requirement, and (iv) the taxpayer provided notice to laborers and mechanics of the Prevailing Wage Requirement (such as by posting information prominently at the site of work). Notably, the Proposed Regulations provide a rebuttable presumption that a failure was not intentional with respect to the Prevailing Wage Requirements if the taxpayer makes all correction and penalty payments before receiving a notice from the IRS, giving taxpayers a meaningful incentive to take steps proactively to monitor compliance with the Prevailing Wage Requirement.[25]
The Proposed Regulations also clarify that, for credits sold pursuant to section 6418, credit sellers would be responsible for any correction payments and penalties with respect to the Prevailing Wage Requirements, although credit buyers would still remain liable for any resulting excessive credit transfer tax resulting from the failure to meet the Prevailing Wage Requirements.
Apprenticeship Requirements – Penalties
If a taxpayer does not satisfy the Apprenticeship Requirements or the Good Faith Effort Exception (discussed below), the taxpayer may still receive the full tax credit amount if the taxpayer pays a $50 penalty ($500 for intentional disregard) for each labor hour for which the taxpayer failed to meet the Labor Hours Requirement or the Participation Requirement. For the Labor Hours Requirement, the penalty is applied to the shortfall by which the “applicable percentage” of labor hours exceeded the hours actually worked by qualified apprentices (a single aggregate computation). For the Participation Requirement, the penalty is computed separately for the taxpayer and each of its contractor(s) and subcontractor(s) (but the penalty is payable only by the taxpayer) and is applied to the quotient of the total number of relevant labor hours worked by all individuals employed by the non-compliant employer divided by the total number of such individuals employed by such non-compliant employer.
Similar to the Prevailing Wage Requirement, the Proposed Regulations provide a non-exclusive list of facts that might be considered in the determination of whether a failure to meet the Apprenticeship Requirements is due to intentional disregard, including whether (i) the failure was part of a pattern of conduct by the taxpayer, (ii) the taxpayer promptly cured the failure, (iii) the taxpayer included (and caused to be included) provisions in contracts with contractors and subcontractors ensuring compliance with the Apprenticeship Requirements, and (iv) the taxpayer had been required to make a penalty payment in respect of the Apprenticeship Requirements in prior tax years. As with the Prevailing Wage Requirements, the Proposed Regulations also provide a rebuttable presumption that a failure was not intentional if the taxpayer makes all penalty payments before receiving a notice from the IRS.
As is the case for the Prevailing Wage Requirements, credit sellers under section 6418 would be responsible for any penalties with respect to the Apprenticeship Requirement, but credit buyers would still remain liable for any resulting excessive credit transfer tax resulting from the failure to meet the Apprenticeship Requirements.
Qualifying Project Labor Agreement
The Proposed Regulations would provide that penalty payments will not be required if there is a Qualifying Project Labor Agreement in place and if a correction payment is paid to a laborer or mechanic on or prior to the date on which the tax credit is claimed. In general, a Qualifying Project Labor Agreement is a pre-hire collective bargaining agreement with one or more labor organizations for a specific construction project that meets criteria detailed in the Proposed Regulations.[26]
Good Faith Effort Exception
The Code excuses taxpayers from complying with the Apprenticeship Requirements if they have requested qualified apprentices from a registered apprenticeship program and either the request is denied for a reason other than noncompliance with the standards or requirements of the program or the program does not acknowledge receipt of the request or otherwise respond to the taxpayer within five business days after receiving a request (the “Good Faith Effort Exception”).[27]
Generally, the Proposed Regulations would require additional effort by a taxpayer to satisfy the Good Faith Effort Exception. One key modification is that the Proposed Regulations would require a written request be made to at least one registered apprenticeship program that trains apprentices in the necessary occupation(s) and has a customary business practice of entering into agreements with employers to place apprentices in their trained occupation.[28] In addition, the registered apprenticeship program to which the taxpayer submits the written request either must (i) operate within the geographic area that includes the location of the facility or (ii) reasonably be expected to be able to provide apprentices to the facility’s location. The IRS expects that taxpayers may need to submit requests to multiple apprenticeship programs, depending on the number of occupations involved in the project and the anticipated number of required apprentice labor hours.
Under the Proposed Regulations, a denial of a written request from a registered apprenticeship program, or a non-response to such a written request, will permit a taxpayer to rely on the Good Faith Effort Exception only for 120 days after the date on which the request was submitted. Thereafter, the taxpayer would be required to submit an additional request to continue to rely on the Good Faith Effort Exception. As a result, to continue to rely on the Good Faith Effort Exception, a taxpayer would have to submit requests to a registered apprenticeship program and have those requests be denied by the registered apprenticeship program on a rolling 120-day basis. Further, a partially denied request is to be treated as a denial solely with respect to that part of the request that is denied.
Recordkeeping and Reporting Requirements
The Proposed Regulations specify certain records that taxpayers must maintain to substantiate that the Prevailing Wage Requirement and Apprenticeship Requirements have been satisfied, including (at a minimum) payroll records that reflect the wages paid to laborers, mechanics and qualified apprentices engaged in the construction, alteration, or repair of the facility, regardless of whether the laborers and mechanics are employed by the taxpayer, a contractor, or a subcontractor.
For the Prevailing Wage Requirement, sufficient records “may include” the labor classification(s) used for determining the prevailing wage rate (and documentation supporting the applicable classification), the hourly rate(s) of wages paid for each applicable labor classification, records supporting fringe benefit calculations (detailed in the Proposed Regulations), the total number of labor hours worked and wages paid per pay period, records to support wages paid to any apprentices (including records reflecting the registration of the apprentices, the applicable wage rates and apprentice-to-journeyworker ratios), and the amount and timing of any correction payments (and documentation reflecting their calculation).
For the Apprenticeship Requirements, records sufficient to establish compliance may include copies of any written requests for apprentices, any agreements with a registered apprenticeship program, documents verifying participation in a registered apprenticeship program by each apprentice, and the payroll records for any work performed by apprentices. Like the Prevailing Wage Requirement, the Proposed Regulations would provide that it is the responsibility of the taxpayer to maintain the relevant records for each apprentice, regardless of whether the apprentice is employed by the taxpayer, a contractor, or a subcontractor.
The Proposed Regulations do not include detailed reporting requirements, but the preamble indicates that the IRS and Treasury expect that taxpayers will be required to report, at the time of filing a return: (i) the location and type of qualified facility; (ii) the applicable wage determinations for the type and location of the facility; (iii) the wages paid (including any correction payments) and hours worked for each of the laborer or mechanic classifications engaged in the construction, alteration, or repair of the facility; (iv) the number of workers who received correction payments; (v) the wages paid and hours worked by qualified apprentices for each of the laborer or mechanic classifications engaged in the construction, alteration, or repair of the facility; (vi) the total labor hours for the construction, alteration, or repair of the facility by any laborer or mechanic employed by the taxpayer or any contractor or subcontractor; and (vii) the total credit claimed.[29]
Commentary
Many aspects of the Proposed Regulations will facilitate efficient administration of the IRA, though other aspects of the guidance could be clarified further to provide taxpayers with greater guidance as to their obligations under the PWA Requirements.
- Allocation of Legal Responsibility for PWA Requirements. The Proposed Regulations make clear that the taxpayers who claim or transfer tax credits (and not the contractors or subcontractors of those taxpayers) are ultimately responsible for complying with the PWA Requirements. Thus, the onus is on the taxpayer to carefully monitor compliance with the PWA Requirements, ensure its contractors and subcontractors comply with the PWA Requirements, and maintain adequate records demonstrating compliance with the PWA Requirements. Well-advised taxpayers likely will seek to include provisions in their agreements with contractors to ensure that the PWA Requirements are satisfied and that necessary records and information substantiating the satisfaction of those requirements is maintained.
- Incentives for Self-Policing. The Proposed Regulations encourage taxpayers to carefully monitor failures to meet the PWA Requirements, proactively report these failures to the IRS, and then affirmatively and timely make correction payments. If taxpayers take these steps, as long as the noncompliance is relatively minor, then the Proposed Regulations generally allow taxpayers to avoid the application of penalties. Given these benefits, taxpayers will want to put in place procedures for monitoring compliance, including compliance by contractors and their subcontractors.
- Useful Begun Construction Rule, with Limits. Under the Proposed Regulations, prevailing wage determinations generally have to be made only once, in connection with the commencement of construction. This rule does not apply, however, if there is a change in the scope of work originally envisioned. Given that scope changes are relatively common in the course of constructing a facility, this exception could apply relatively frequently. It would be useful if the exception were adjusted to apply in more limited circumstances (g., to major changes that result in a more than 10 percent adjustment to the contract price).[30]
- Enhanced Apprenticeship Requirements. The Proposed Regulations would tighten significantly the rules applicable to the Apprenticeship Requirements, including by limiting the scope of the Good Faith Effort Exception by providing that denial of a request for qualified apprentices lasts only 120 days after the submission of the request. This rule will make it necessary for developers to approach registered apprenticeship programs repeatedly. The IRS and Treasury’s further clarification that it may be necessary to make inquiries to multiple registered apprenticeship programs suggests that the IRS and Treasury are very focused on making sure that apprentices receive training opportunities, even if doing so imposes incremental compliance burdens.
- Incentives for Entering into Qualifying Project Labor Agreement. Under the Proposed Regulations, if a Qualifying Project Labor Agreement (e.g., collective bargaining agreement meeting certain criteria) is entered into, various penalties can be eliminated as long as any needed correction payment is made before the credit is claimed. This rule will provide some level of incentive for developers to pursue these types of agreements.
- Helpful Rule for Offshore Wind Projects. The Proposed Regulations include a helpful convention for offshore wind projects. Rather than requiring that each offshore wind project make a request for an individualized supplemental wage determination (given that general Department of Labor data is unlikely to cover offshore sites), the Proposed Regulations allow use of the generalized information prepared by the Department of Labor for the closest geographical area.
- Scope of Apprenticeship Requirements. The Code contains an ambiguity concerning whether the Labor Hours Requirement and Participation Requirements apply only to the “construction” of a facility (as opposed to the Prevailing Wage Requirements, which apply to both the construction phase of a facility and alteration and repair work performed after the construction phase with respect to the facility). Interestingly, the Proposed Regulations suggest that the Participation Requirement would apply only to the construction phase of a facility (but would apply to all alteration and repair work, if any, occurring during that construction phase). In contrast, the Proposed Regulations suggest that the Labor Hours Requirement would apply to both the construction of the facility and alteration and repair work performed after the construction phase with respect to the facility. It would be helpful for the IRS and Treasury to state its interpretation explicitly and to clarify this apparent discrepancy in the preamble to the final regulations. Further, more examples of the application of these and other rules that are more fact-intensive in application (including, for example, the secondary site rule) would be especially helpful.
____________________________
[1] Compliance with the prevailing wage and apprenticeship requirements is not required for facilities (i) that have a maximum net output or storage capacity of less than one megawatt or (ii) the construction of which began before January 29, 2023.
[2] Technically, the baseline tax credit is multiplied by five if the PWA Requirements are met, resulting in a tax credit amount that traditionally has been considered the full amount of the federal income tax credits that may be claimed in respect of clean energy technologies. This full credit amount also can be increased by so-called adders, such as the domestic content adder and the energy community adder. Please see our prior client alerts on these adders, which can be found here and here, respectively.
[3] As was the case with the so-called Tax Cuts and Jobs Act, the Senate’s reconciliation rules prevented Senators from changing the Act’s name, and the formal name of the so-called Inflation Reduction Act is actually “An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.” In addition to tax credit guidance, the proposed regulations also include guidance regarding the PWA Requirements under section 179D, which provides a deduction for the cost of energy efficient commercial building property placed in service during the taxable year.
[4] Depending on the type of credit at issue, the applicable facility may be a qualified facility, property, project, or certain other equipment or facilities. For the purposes of this alert, we use the term “facility” to refer generally to those assets in respect of which a taxpayer is permitted to claim an applicable credit.
[5] Unless indicated otherwise, all section references are to the Internal Revenue Code of 1986, as amended (the “Code”).
[6] See Fact Sheet: One Year In, President Biden’s Inflation Reduction Act is Driving Historic Climate Action and Investing in America to Create Good Paying Jobs and Reduce Costs, The White House, Aug. 16, 2023, here.
[7] Tax credits with a prevailing wage or apprenticeship requirement include those credits provided for under sections 30C, 45, 45L, 45Q, 45U, 45V, 45Y, 45Z, 48, 48C, and 48E.
[8] Under the Proposed Regulations, working forepersons who devote more than 20 percent of their time during a workweek to laborer or mechanic duties, and who do not meet the criteria for exemption of 29 CFR part 541, would be considered laborers and mechanics for the time spent conducting laborer and mechanic duties.
[9] The preamble to the Proposed Regulations expressly provides that the term “employed,” as used in connection with the PWA Requirements, is not intended to apply for other purposes of the Code.
[10] In the case of any credits that were transferred pursuant to section 6418, the “taxpayer” is the credit transferor, not the transferee. Please see our prior alert on the proposed regulations on credit transferability, which is found here.
[11] Please see our prior client alert on the proposed regulations on direct pay, found here.
[12] The Proposed Regulations provide that maintenance expressly does not include work that improves a facility, adapts it for a different use, or restores functionality as a result of inoperability.
[13] The Proposed Regulations clarify that the work performed by a manufacturer that focuses on constructing components for a particular facility for some limited period of time (measured in hours or days) in order to meet a deadline is not subjected to the Prevailing Wage Requirement. A longer period of exclusive dedication (measured in weeks or months) to the preparation of products made to specifications would potentially subject this type of work to the Prevailing Wage Requirement.
[14] For these purposes, a journeyworker is an individual who has attained a level of skill, abilities, and competencies recognized within an industry as having mastered the skills and competencies required for the occupation (regardless as to whether such skills are acquired through formal apprenticeship or through practical on-the-job experience and formal training).
[15] Registered apprentices are those employed pursuant to an apprenticeship program registered with the Department of Labor’s Office of Apprenticeship (or with a state apprenticeship agency recognized by that office). If the apprenticeship program does not require the payment of bona fide fringe benefits, then the Proposed Regulations would require that apprentices be paid the full amount of bona fide fringe benefits listed on the applicable wage determination.
[16] If, however, construction, alteration, or repair of a facility occurs in more than one geographic area, then the Proposed Regulations generally would require that the applicable wage determination for the work performed in each geographic area be used for the work performed in that area, though the preamble to the Proposed Regulations suggests that taxpayers can ensure compliance with the Prevailing Wage Requirement by paying the highest rate for each classification in both geographic areas. The Proposed Regulations also include an important rule that benefits developers of offshore wind projects, providing that taxpayers may rely on the general wage determination for the relevant category of construction that is applicable in the geographic area closest to the location of the facility.
[17] The IRS and Treasury generally expect that supplemental wage determinations would be requested no more than 90 days before the beginning of construction, alteration, or repair of a facility.
[18] Section 45L (new energy efficient home credit) and section 45U (zero-emission nuclear power production credit) do not have apprenticeship requirements.
[19] Under the Proposed Regulations, a “qualified apprentice” is “an individual who is employed by the taxpayer or by any contractor or subcontractor and who is participating in a registered apprenticeship program.” The preamble to the Proposed Regulations indicate that participants in pre-apprenticeship programs would not be considered “qualified apprentices.”
[20] For a facility on which construction begins during 2023, the applicable percentage is 12.5 percent. For a facility on which construction begins in 2024 or later, the applicable percentage is 15 percent.
[21] Under the Proposed Regulations, “labor hours” means the total number of hours devoted to the performance of construction, alteration, or repair work by any individual employed by the taxpayer or by any contractor or subcontractor. Labor hours would not include hours worked by foremen, superintendents, owners, or persons employed in bona fide executive, administrative, or professional capacities.
[22] Under the Proposed Regulations, a journeyworker is any laborer or mechanic that has mastered the skills and competencies required for the applicable occupation. A journeyworker can acquire these skills and competencies either through experience or through a formal apprenticeship.
[23] Interest is imposed at the federal short-term rate as determined under section 6621, but substituting “6 percentage points” for “3 percentage points” in section 6621(a)(2).
[24] The Proposed Regulations do not address specifically whether an automatic waiver of the penalty would potentially be available in the case of intentional disregard, although in practice we do not anticipate automatic waiver relief would be available in that case.
[25] A taxpayer generally is not be permitted to cure non-compliance with the Prevailing Wage Requirement if the taxpayer does not make the penalty payment on or prior to the date that is 180 days after the IRS makes a final determination that a penalty is due.
[26] The agreement needs (i) to be a collective bargaining agreement with a labor organization (i.e., a union), (ii) to include provisions obligating taxpayers to pay prevailing wages and to use qualified apprentices to perform work, and (iii) to provide guarantees against strikes, lockouts, and other similar job disruptions.
[27] Under the Proposed Regulations, a “registered apprenticeship program” is defined as “a program that has been registered by the U.S. Department of Labor’s Office of Apprenticeship or a recognized State apprenticeship agency, pursuant to the National Apprenticeship Act and its implementing regulations for registered apprenticeship at 29 CFR parts 29 and 30, as meeting the basic standards and requirements of the Department of Labor for approval of such program for Federal purposes.”
[28] The Proposed Regulations also provide additional specificity as to what the contents of such a written request would need to be.
[29] The IRS and Treasury affirmatively decided not to require certified weekly reporting of payroll records.
[30] There is precedent for using a ten percent standard in determining whether a contract modification is significant. See, e.g., PLR 8930013 (concluding that a taxpayer was eligible for transitional relief provisions in the Tax Reform Act of 1986 that exempted property from new depreciation and investment tax credit rules if that property was constructed, reconstructed, or acquired pursuant to a written contract binding on March 1, 1986, notwithstanding later adjustments to the contract that increased its cost by 10.02 percent, relying on legislative history suggesting design changes made for reasons of technical or economic efficiencies of operation that caused an insignificant increase in cost nevertheless were treated as insignificant).
This alert was prepared by Mike Cannon, Matt Donnelly, Josiah Bethards, Alissa Fromkin Freltz, Blake Hoerster, and Hayden Theis.
Gibson Dunn 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 Tax or Power and Renewables practice groups, or the following authors:
Tax Group:
Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202-887-3567, mjdonnelly@gibsondunn.com)
Josiah Bethards – Dallas (+1 214-698-3354, jbethards@gibsondunn.com)
Alissa Fromkin Freltz – Washington, D.C. (+1 202-777-9572, afreltz@gibsondunn.com)
Blake Hoerster – Dallas (+1 214-698-3180, bhoerster@gibsondunn.com)
Hayden Theis – Houston (+1 346-718-6695, htheis@gibsondunn.com)
Power and Renewables Group:
Peter J. Hanlon – New York (+1 212-351-2425, phanlon@gibsondunn.com)
Nicholas H. Politan, Jr. – New York (+1 212-351-2616, npolitan@gibsondunn.com)
© 2023 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
This edition of Gibson Dunn’s Federal Circuit Update summarizes the current status of several petitions pending before the Supreme Court, additional materials released from the ongoing investigation by the Judicial Council of the Federal Circuit, and recent Federal Circuit decisions concerning claim construction, secondary considerations, and obviousness-type double patenting.
Federal Circuit News
Noteworthy Petitions for a Writ of Certiorari:
A couple potentially impactful petitions were filed before the Supreme Court in August 2023:
- Intel Corp. v. Vidal (US No. 23-135): “The question presented is whether 35 U.S.C. § 314(d), which bars judicial review of “[t]he determination … whether to institute an inter partes review,” applies even when no institution decision is challenged to preclude review of [the United States Patent & Trademark Office] rules setting standards governing institution decisions.”
- HIP, Inc. v. Hormel Foods Corp. (US No. 23-185): The questions presented are: “1. Whether joint inventorship requires anything more than a contribution to conception that is stated in a patent claim. Whether, under Section 116(a), a claimed and enabled contribution to conception can be deemed insignificant in quality based on the quantity of disclosure in the specification.” The Federal Circuit opinion being petitioned was summarized in our May 2023 update.
As we summarized in our July 2023 update, the Court will consider Killian v. Vidal (US No. 22-1220) and Ingenio, Inc. v. Click-to-Call Technologies, LP (US No. 22-873) during its September 26, 2023 conference. In CareDx Inc. v. Natera, Inc. (US No. 22-1066), after the respondents waived their right to file a response, retired Federal Circuit Judge Paul R. Michel and Professor John F. Duffy filed an amici curiae brief in support of Petitioners. The Court thereafter requested a response, which was filed on August 9, 2023. The Court will also consider this petition during its September 26, 2023 conference.
Other Federal Circuit News:
Report and Recommendation in Judicial Investigation. As we summarized in our July 2023 update, there is an ongoing proceeding by the Judicial Council of the Federal Circuit under the Judicial Conduct and Disability Act and the implementing Rules involving Judge Pauline Newman. On August 16, 2023, the Special Committee released additional materials in the investigation. The materials may be accessed here.
Upcoming Oral Argument Calendar
The list of upcoming arguments at the Federal Circuit is available on the court’s website.
Key Case Summaries (August 2023)
Axonics, Inc. v. Medtronic, Inc., Nos. 22-1532, 22-1533 (Fed. Cir. Aug. 7, 2023): Axonics filed petitions for inter partes review (“IPR”) challenging Medtronic’s patents directed to transcutaneous (through the skin) charging of implanted medical devices through inductive coupling. After institution, Medtronic advanced for the first time a construction of a claim term in its Patent Owner Response, which Axonics disagreed with, and argued in reply that the claims would be unpatentable even under Medtronic’s construction. Medtronic then argued in its sur-reply that it would be prejudicial for the Board to consider Axonics’s new reply arguments. The Board agreed with Medtronic and refused to consider Axonics’s new reply arguments, because these arguments had not been made in its petition.
The Federal Circuit (Dyk, J., joined by Lourie and Taranto, JJ.) vacated and remanded. The Court explained that, under the Board’s rules and the Supreme Court’s decision in SAS Inst., Inc. v. Iancu, 138 S. Ct. 1348, 1345 (2018), a petitioner is entitled to respond to new arguments made in a patent owner response. Additionally, under the Administrative Procedure Act (“APA”), the Board may adopt a new construction after institution, if it gives the petitioner an opportunity to respond to constructions that are not sufficiently similar to one disputed by the parties. Consistent with this precedent, the Court held that the petitioner must have adequate notice and an opportunity to respond to post-institution claim constructions, including a reasonable opportunity in reply to present argument and evidence under that new construction.
Rembrandt Diagnostics, LP v. Alere, Inc., No. 21-1796 (Fed. Cir. Aug. 11, 2023): Alere sought an IPR challenging Rembrandt’s patent directed to test assay devices and methods for testing biological fluids. Alere initially identified “efficiency” as a reason that a relevant artisan would have been motivated to combine the asserted prior art. In response, Rembrandt challenged Alere’s motivation arguments, but did not submit expert testimony. In reply, Alere submitted an expert declaration and argued that combining the prior art references would save cost and time, and that there was thus a motivation to combine them, as well as a reasonable expectation of success. The Board found all the claims unpatentable, relying on Alere’s cost and time savings arguments and unrebutted expert testimony.
The Federal Circuit (Reyna, J., joined by Moore, C.J., and Dyk, J.) affirmed. Rembrandt argued that Alere improperly raised the benefit of cost and time savings for the first time in its reply. However, the Court determined that Rembrandt had forfeited this argument by only lodging a “generic objection” to Alere’s reply generally and not to that specific benefit argument, which was insufficient to constitute a proper objection. The Court also held that Alere’s cost and time savings arguments were not new arguments raised for the first time in its reply, but arguments that responded to Rembrandt’s opposition and also properly expands on and is a fair extension of its efficiency arguments raised in the petition.
Volvo Penta of the Americas, LLC v. Brunswick Corp., No. 22-1765 (Fed. Cir. Aug. 24, 2023): In 2015, Volvo launched the Forward Drive embodying its patent directed to a tractor-type stern drive for a boat. In 2020, Brunswick launched a similar product called the Bravo Four S, and on the same day as its launch, filed an IPR petition challenging Volvo’s patent. The Board determined that the challenged claims would have been obvious over the asserted prior art. The Board also found a lack of nexus with the embodying products, but determined that even if there had been nexus, Brunswick’s strong evidence of obviousness outweighed Volvo’s evidence of nonobviousness.
The Federal Circuit (Lourie, J., joined by Moore, C.J. and Cunningham, J.) vacated and remanded. The Court explained that there were two ways to prove nexus: (1) via a presumption of nexus or (2) via a showing that the evidence is a direct result of the unique characteristics of the claimed invention. While the Court agreed that Volvo’s arguments regarding presumption were insufficient, the Court determined that Volvo had put forth evidence that Brunswick recognized the success of Forward Drive was directly tied to the unique characteristics of the claimed tractor-type stern drive. Indeed, the Court noted that the Board found that boat manufacturers strongly desired Volvo’s Forward Drive and urged Brunswick to bring a similar product to market. The Court therefore concluded that there was a nexus between the unique features of the claimed invention and the evidence of secondary considerations.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this update:
Blaine H. Evanson – Orange County (+1 949-451-3805, bevanson@gibsondunn.com)
Audrey Yang – Dallas (+1 214-698-3215, ayang@gibsondunn.com)
Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:
Appellate and Constitutional Law Group:
Thomas H. Dupree Jr. – Washington, D.C. (+1 202-955-8547, tdupree@gibsondunn.com)
Allyson N. Ho – Dallas (+1 214-698-3233, aho@gibsondunn.com)
Julian W. Poon – Los Angeles (+ 213-229-7758, jpoon@gibsondunn.com)
Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, kdominguez@gibsondunn.com)
Y. Ernest Hsin – San Francisco (+1 415-393-8224, ehsin@gibsondunn.com)
Josh Krevitt – New York (+1 212-351-4000, jkrevitt@gibsondunn.com)
Jane M. Love, Ph.D. – New York (+1 212-351-3922, jlove@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 August 29, 2023, the federal banking agencies (the Board of Governors of the Federal Reserve System (“Federal Reserve”), the Federal Deposit Insurance Corporation (“FDIC”) and the Office of the Comptroller of the Currency (“OCC”)) issued a joint notice of proposed rulemaking that would require certain large banking organizations to issue and maintain minimum amounts of long-term debt (“LTD”).[1] The Proposed Rule represents another major step in the federal banking agencies’ continued efforts to impose heightened enhanced prudential standards on banking organizations with $100 billion or more in total consolidated assets and align those enhanced prudential standards with those currently applicable to global systemically important banking organizations (“GSIBs”).
As anticipated, the Proposed Rule would require Category II, III and IV bank holding companies (“BHCs”), savings and loan holding companies (“SLHCs”) and U.S. intermediate holding companies (“IHCs”) of foreign banking organizations (“FBOs”) that are not GSIBs (collectively, “covered entities”) to issue and maintain minimum amounts of LTD that satisfies certain requirements.[2]
The Proposed Rule also would require four categories of insured depository institutions (“IDIs”) that are not consolidated subsidiaries of U.S. GSIBs to issue and maintain minimum amounts of LTD. Those “covered IDIs” are:
- any IDI that has at least $100 billion in total consolidated assets and that is a consolidated subsidiary of a covered entity or a U.S. IHC of a foreign GSIB;
- any IDI that has at least $100 billion in total consolidated assets and is not controlled by a parent entity;
- any IDI that has at least $100 billion in total consolidated assets and (i) is a consolidated subsidiary of a company that is not a covered entity, a U.S. GSIB or a foreign GSIB subject to the Federal Reserve’s total loss-absorbing capacity (“TLAC”) rule or (ii) is controlled but not consolidated by another company; and
- any IDI (regardless of size) that is affiliated with an IDI in one of the foregoing three categories.[3]
IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the Proposed Rule because their parent holding companies are subject to LTD requirements under the Federal Reserve’s TLAC rule and the most stringent capital, liquidity and other enhanced prudential standards.[4] However, covered IDIs that are consolidated subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the Proposed Rule and would be required to issue and maintain minimum amounts of LTD.
The Proposed Rule follows closely the federal banking agencies’ release of the Basel III endgame reforms in July 2023 (see our prior Client Alert). The Basel III endgame proposal would significantly reduce the differences that apply across the four categories established by the federal banking agencies in 2019 for determining the applicability and stringency of regulatory capital requirements for large banking organizations. Like the Basel III endgame proposal, the Proposed Rule would align LTD requirements applicable to large banking organizations with total assets of $100 billion or more in a similar manner across the four categories—although, as noted above, IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the Proposed Rule.
Unlike the Basel III endgame proposal, the Proposed Rule was adopted unanimously. However, Federal Reserve Governors Bowman and Waller raised concerns with the Proposed Rule, including concerns that the Proposed Rule, like the Basel III endgame proposal, would not comply with the tailoring requirements of Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), as amended by the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”).[5]
As with prior rulemakings, the Proposed Rule, if finalized, would include a three-year transition period and the LTD requirements under any final rule would be fully phased in over that three-year period. Entities that become subject to the Proposed Rule after the effective date also would benefit from a three-year transition period. The Proposed Rule also would allow banking organizations to include, as part of the required minimum amounts, certain “grandfathered” existing LTD.
Comments on the Proposed Rule are due by November 30, 2023 – the same date that comments to the Basel III endgame proposal are due.[6] The agencies have included 67 questions as prompts (almost all of which include multiple related sub-prompts) to solicit comments on all aspects of the Proposed Rule.
I. Key Aspects of the Proposed Rule
Scope of Application. The Proposed Rule would apply to all non-U.S. GSIBs with $100 billion or more in total consolidated assets. Large banking organizations subject to the Proposed Rule would be required to comply with LTD requirements at both the holding company level and IDI level. U.S. GSIBs would not be subject to the LTD requirements at the IDI level, though IDI subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the Proposed Rule.
|
Application of the Proposed Rule |
||
|
U.S. GSIBs and their IDI subsidiaries |
Category II, III and IV BHCs and SLHCs and their IDI subsidiaries |
Category II, III and IV U.S. IHCs and their IDI subsidiaries |
|
U.S. GSIBs are already subject to LTD requirements under the TLAC rule. |
Category II, III and IV BHCs and SLHCs would be subject to the LTD requirements. |
Category II, III and IV U.S. IHCs of FBOs would be subject to the LTD requirements. U.S. IHCs controlled by foreign GSIBs are already subject to LTD requirements under the TLAC rule. |
|
IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the LTD requirements. |
IDIs with at least $100 billion in total consolidated assets and their affiliated IDIs would be subject to the LTD requirements. IDI subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the LTD requirements. |
|
Minimum LTD Levels. Under the Proposed Rule, covered entities and covered IDIs would be subject to the same minimum LTD levels as U.S. IHCs of foreign GSIBs under the TLAC rule:
|
Minimum LTD Levels |
||
|
U.S. GSIBs under TLAC Rule |
U.S. IHCs of foreign GSIBs under TLAC Rule |
Covered Entities and Covered IDIs under Proposed Rule |
|
Outstanding eligible external LTD in an amount not less than the greater of: – 6% of total risk-weighted assets plus the surcharge applicable under the GSIB surcharge rule; and – 4.5% of total leverage exposure. |
Outstanding eligible external LTD in an amount not less than the greater of: – 6% of total risk-weighted assets; – 3.5% of average total consolidated assets; and – 2.5% of total leverage exposure if subject to the supplementary leverage ratio (“SLR”). |
Outstanding eligible LTD in an amount not less than the greater of: – 6% of total risk-weighted assets; – 3.5% of average total consolidated assets; and – 2.5% of total leverage exposure if subject to the SLR. |
As with the LTD requirements applicable to U.S. GSIBs and the U.S. IHCs of foreign GSIBs, the Proposed Rule’s eligible LTD requirement was calibrated primarily on the basis of a “capital refill” framework. The Proposed Rule would not tailor the LTD requirements for Category II, III or IV banking organizations or their IDI subsidiaries.
The Proposed Rule would prohibit a covered entity from redeeming or repurchasing any outstanding eligible LTD without the prior approval of the Federal Reserve if after the redemption or repurchase the covered entity would not meet its minimum LTD requirement. Additionally, the Proposed Rule would authorize the agencies, after providing an external LTD issuer with notice and an opportunity to respond, to order the external issuer to exclude from its outstanding eligible LTD amount any otherwise eligible debt securities “with features that would significantly impair the ability of such debt securities to absorb losses in resolution.”[7]
Externally/Internally Issued LTD. Under the Proposed Rule, certain covered entities and covered IDIs would be required or permitted to issue eligible LTD externally, while others would be required or permitted to issue eligible LTD internally.
|
Externally/Internally Issued LTD |
|
|
Covered U.S. Holding Companies |
|
|
Covered IHCs of FBOs |
|
|
Covered IDIs |
|
Eligible External and Internal LTD. The Proposed Rule would generally align the requirements for externally issued LTD with the requirements for eligible LTD under the Federal Reserve’s TLAC rule.
|
Eligible External LTD |
||
|
Category II, III and IV BHCs and SLHCs, covered IDIs required or permitted to issue external LTD and “resolution IHCs” |
||
|
Principal due to be paid on eligible external LTD in one year or more and less than two years would be subject to a 50% haircut for purposes of the external LTD requirement and principal due to be paid on eligible external LTD in less than one year would not count toward the external LTD requirement.
|
Eligible Internal LTD |
||
|
Covered IDIs required or permitted to issue internal LTD and “non-resolution IHCs” |
||
|
Grandfathering of Legacy External LTD. The Proposed Rule would permit some legacy external LTD to count towards the minimum LTD requirements, even where such legacy external LTD does not meet certain eligibility requirements:
- instruments that contain impermissible acceleration clauses;
- instruments issued with principal denominations that are less than the proposed $400,000 minimum amount; and
- in the case of legacy instruments issued externally by a covered IDI, are not contractually subordinated to general unsecured creditors (collectively, “eligible legacy external LTD”).
Notably, eligible legacy external LTD issued by a consolidated subsidiary IDI of a covered entity may be used to satisfy the minimum external LTD requirement applicable to both its covered parent holding company or covered resolution IHC and any internal LTD requirement applicable to the subsidiary IDI itself. However, eligible legacy external LTD cannot be used to satisfy the internal LTD requirement for non-resolution covered IHCs. To qualify as “eligible legacy external LTD,” an instrument must be issued prior to the date that notice of the final rule is published in the Federal Register. The Proposed Rule would authorize the federal banking agencies, after providing a covered entity or covered IDI with notice and an opportunity to respond, to order the covered entity or covered IDI to exclude from its outstanding eligible LTD amount any eligible legacy external LTD.[13]
Transition Period. The Proposed Rule would provide a transition period for covered entities and covered IDIs that would be subject to the rule upon its effectiveness, and a transition period for covered entities and covered IDIs that become subject to the rule after it becomes effective. Over that three-year period, covered entities and covered IDIs would need to meet:
- 25% of their LTD requirements by one year after the effective date of the final rule (or one year after becoming subject to the rule);
- 50% after two years of the effective date of the final rule (or two years after becoming subject to the rule); and
- 100% after three years of the effective date of the final rule (or three years after becoming subject to the rule).
The federal banking agencies would be authorized to accelerate or extend the transition period. The transition period would not re-start for a covered IDI that converts its charter or any holding company thereof. Finally, covered entities that transition from being subject to the final rule to the Federal Reserve’s TLAC rule would have three years to comply with the requirements imposed under the TLAC rule.[14]
Clean Holding Company Requirements. The Proposed Rule also would include “clean holding company” requirements like those that apply to U.S. GSIBs and U.S. IHCs of foreign GSIBs subject to the Federal Reserve’s TLAC rule. In particular, the Proposed Rule would prohibit covered entities from:
- externally issuing short-term debt instruments (i.e., instruments with an original maturity of less than one year);
- entering into qualified financial contracts, or “QFCs”, with third parties;[15]
- guaranteeing (including by providing credit support for) a subsidiary’s liabilities with an external counterparty if the covered entity’s insolvency or entry into a resolution proceeding (other than resolution under Title II of the Dodd-Frank Act) would create default rights for a counterparty of the subsidiary; and
- having outstanding liabilities that are guaranteed by a subsidiary of the covered entity or that are subject to rights that would allow a third party to offset its debt to a subsidiary upon the covered entity’s default on an obligation owed to the third party.
The Proposed Rule would amend the QFC prohibition of the clean holding company requirements so that holding companies subject to the TLAC rule may enter into underwriting agreements, fully paid structured share repurchase agreements and employee and director compensation agreements. These changes also would be applied to the clean holding company requirements proposed for covered BHCs and SLHCs (not covered IHCs) under the Proposed Rule. The Proposed Rule would authorize the Federal Reserve to determine that additional agreements would not be subject to the QFC prohibition.
Capital Deduction Framework. Under the current capital rule, U.S. GSIBs, their subsidiary depository institutions and Category II banking organizations are required to deduct investments in LTD issued by banking organizations that are required to issue LTD to the extent that aggregate investments by the investing banking organization in the capital and LTD of other financial institutions exceed a specified threshold. The Proposed Rule would expand the existing capital deduction framework for LTD issued by U.S. GSIBs and the IHCs of foreign GSIBs to include external LTD issued by covered entities and external LTD issued by covered IDIs by amending the capital rule’s definition of “covered debt instrument.” The Proposed Rule would not otherwise amend the capital rule’s deduction framework.
Notably, the Basel III endgame proposal would subject Category III and IV banking organizations to the LTD deduction framework that currently only applies to U.S. GSIBs, their subsidiary depository institutions and Category II banking organizations and would apply a heightened risk weight to investments in LTD that are not deducted.
Changes to the Existing TLAC Rule. The Proposed Rule would make conforming and certain other changes to the TLAC rule, including:
- conforming changes to require minimum denominations for eligible LTD;[16]
- changes to the haircuts that are applied to eligible LTD for purposes of compliance with the TLAC requirement to conform to haircuts that apply for purposes of the LTD requirement – accordingly, the Proposed Rule would allow only 50% of the amount of eligible LTD with a maturity of one year or more but less than two years to count towards the TLAC requirement;
- clarifications to the clean holding company requirements so that U.S. GSIBs and U.S. IHCs of foreign GSIBs may enter into underwriting agreements, fully paid structured share repurchase agreements and employee and director compensation agreements; and
- enhanced disclosure requirements.
Finally, the Proposed Rule would authorize the Federal Reserve to require LTD and TLAC levels greater than or less than the minimum requirement currently required under the TLAC rule.[17]
II. Issues with the Proposed Rule
As they did with the Basel III endgame proposal, each of Federal Reserve Governors Bowman and Waller—although voting in support of the Proposed Rule—raised concerns with the authority for the Proposed Rule being in conflict with the tailoring requirements under Section 165 of the Dodd-Frank Act, as amended by EGRRCPA, and the federal banking agencies’ tailoring rules implementing Section 165. These statements raise the prospects that the Proposed Rule could be subject to challenge if adopted substantially as proposed.
- Governor Bowman: “Today’s proposal would weaken the current risk-based, tailored approach to regulation by applying the same regulatory requirements to firms from $100 billion to $1 trillion regardless of their activities and potential risks to the financial system. I am concerned that collapsing Categories II, III, and IV into a single prudential category may call into question whether the Federal Reserve is complying with the statutory requirements to tailor prudential requirements for large firms.[2] … In 2017, when the rules addressing total loss-absorbing capacity and long-term debt for GSIBs and the U.S. intermediate holding companies of foreign GSIBs were adopted, the [Federal Reserve] expressly noted that the application of the rules were limited, ‘in keeping with the Dodd-Frank Act’s mandate that more stringent prudential standards be applied to the most systemically important bank holding companies.’[3] In my view, there is a legitimate question about whether the proposal meets the statutory bar for tailoring the stringency of enhanced prudential standards, and applying such standards to banks with $100 billion to $250 billion in assets. I look forward to receiving feedback from commenters on this issue.”[18]
- Governor Waller: “More importantly, I am concerned that our regulatory framework for large banks is moving in a direction that does not tailor requirements in a manner consistent with the spirit of the Dodd-Frank Act, as amended by Congress in 2018.”[19]
Governor Bowman also focused on the potential impacts of the Proposed Rule on competition and highlighted that the joint implementation of the Basel III endgame proposal and LTD requirements would have unclear effects. On competition, she noted:
In my view, as the differences between the regulatory requirements for GSIBs and firms with more than $100 billion in assets continue to be eroded, it will become less economically rational for firms to remain in Category IV and creates an even steeper “cliff” effect for regional banks that seek to grow into this category. Ultimately, the cumulative effect of these proposals and others to be considered in the coming months could exacerbate the pressure on banks to grow larger through acquisition resulting in harmful effects on competition, the reduction of banking options in some geographic or product markets, and rendering some institutions competitively unviable.[20]
Governor Bowman has long stressed that enhanced supervision should be the federal banking agencies’ focus, consistently highlighting that the Dodd-Frank Act provides regulators the toolkit they need to supervise banking organizations through the cycle, and that as banks grow, those tools are in place for supervision and regulation to become more stringent. In her statement accompanying the release of the Proposed Rule, she again reiterated the need for enhanced supervision, rather than a “belt, suspenders, and elastic waistband approach” to regulatory reform.[21]
Finally, as the federal banking agencies acknowledge in the preamble to the Proposed Rule, “there is a risk that efforts by covered entities and covered IDIs to issue a large volume of LTD over a limited period could strain the market capacity to absorb the full amount of such issuance if issuance volume exceeds debt market appetite for LTD instruments,” particularly in periods of adverse funding market conditions.[22] In recent years, a number of large banking organizations have been issuing LTD instruments in the market in anticipation of LTD requirements similar to those imposed on U.S. GSIBs under the TLAC rule being imposed on firms with $100 billion in more in total assets. It will be important for organizations that could become subject to the Proposed Rule to contemplate further LTD issuances in anticipation of the Proposed Rule being adopted substantially as proposed and taking advantage of the grandfathering provisions for eligible legacy external LTD and the Proposed Rule’s three-year transition period to satisfy expected LTD requirements going forward.
III. Conclusions
As with the Basel III endgame proposal, it is imperative that all stakeholders actively engage in the rulemaking process with the federal banking agencies and other policymakers to facilitate a thoughtful approach to the final rule. The comment process will play a critical role in shaping the substance of the final rule and the federal banking agencies’ consideration of the myriad issues raised by the Proposed Rule, its interaction with the Basel III endgame proposal, its potentially broader unintended consequences, including impacts on competition, and may also form the basis for any future legal challenges to the federal banking agencies’ final rule.
________________________
[1] Federal Reserve, FDIC, OCC, Long-term Debt Requirements for Large Bank Holding Companies, Certain Intermediate Holding Companies of Foreign Banking Organizations, and Large Insured Depository Institutions (July 27, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20230829a1.pdf (the “Proposed Rule”). The Proposed Rule follows an advance notice of proposed rulemaking issued in October 2022 by the Federal Reserve and FDIC seeking input on a long-term debt requirement for certain large banking organizations that are not GSIBs. See Federal Reserve, FDIC, Resolution-Related Resource Requirements for Large Banking Organizations, 87 Fed. Reg. 64170 (Oct. 24, 2022).
[2] Proposed Rule, p. 9. This part of the Proposed Rule is issued by the Federal Reserve.
[3] Proposed Rule, p. 10. This part of the Proposed Rule is issued by the Federal Reserve, FDIC and OCC.
[4] Proposed Rule, p. 9, n. 2.
[5] See 12 U.S.C. § 5365(a)(1), (2)(A), (2)(C). As it relates to covered IDIs, Director Chopra argued in his statement in support of the Proposed Rule that the proposal “for an [IDI] to issue minimum amounts of long-term debt is not a Dodd-Frank Act Section 165 ‘enhanced prudential standard,’ and is therefore not tied to the [EGRRCPA’s] $100 billion asset threshold.” Statement of CFPB Director Rohit Chopra Member, FDIC Board of Directors Regarding Proposals to Improve the FDIC’s Options for Managing Large Bank Failures (Aug. 29, 2023), available at: https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-regarding-proposals-to-improve-the-fdics-options-for-managing-large-bank-failures/#6 (“Director Chopra Statement”).
[6] The Basel III endgame proposal provided for a 126-day comment period; the Proposed Rule provides for a 93-day comment period.
[7] See Proposed Rule, p. 42.
[8] “Resolution IHCs” are “covered IHCs of FBOs with a top-tier group-level resolution plan that contemplates their covered IHCs or subsidiaries of their covered IHCs entering into resolution, receivership, insolvency, or similar proceedings in the United States.” Proposed Rule, p. 60.
[9] “Non-resolution IHCs” are “covered IHCs of FBOs with top-tier group-level resolution plans that do not contemplate their covered IHCs or the subsidiaries of their covered IHCs entering into resolution, receivership, insolvency, or similar proceedings.” Proposed Rule, p. 60.
[10] See Proposed Rule, pp. 43-44.
[11] Eligible external LTD instruments would be permitted to give the holder a put right as of a future date certain (such an instrument would be treated as if it were due to be paid on the day on which it first became subject to the put right, regardless of whether the put right would be exercisable on that date only if another event occurred (e.g., a credit rating downgrade)). See Proposed Rule, p. 52, n. 48.
[12] The conversion provision may be triggered if both (a) the Federal Reserve determines that the covered IHC is “in default or in danger of default,” and (b) any of the following circumstances apply: (i) the top-tier FBO or any subsidiary of the top-tier FBO has been placed into resolution proceedings in its home country; (ii) the home country supervisory authority consents to the conversion or exchange or does not object to the conversion or exchange following 24 hours’ notice; or (iii) the Federal Reserve makes a written recommendation to the Secretary of the Treasury that the FDIC should be appointed as receiver of the covered IHC under the “orderly liquidation authority” under Title II of the Dodd-Frank Act. The terms of the contractual conversion provision in the debt instrument would have to be approved by the Federal Reserve. See Proposed Rule, p. 63.
[13] See Proposed Rule, pp. 65-66.
[14] See Proposed Rule, pp. 83-85.
[15] The proposed requirement would only apply prospectively to new agreements entered into after the post-transition period effective date of a final rule. See Proposed Rule, p. 73.
[16] Question 59 asks: “Should the [Federal Reserve] impose a higher minimum denomination for TLAC companies subject to the TLAC rule? Should the minimum denomination be higher (e.g., $1 million) for companies subject to the TLAC rule than for covered entities subject to the newly proposed LTD requirement?” Proposed Rule, p. 90.
[17] See Proposed Rule, pp. 86-97.
[18] Statement by Federal Reserve Governor by Michelle W. Bowman (August 29, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20230829.htm. (citing to 12 U.S.C. § 5365(a)(1), (2)(C) and 82 Fed. Reg. 8266, 8288 (Jan. 24, 2017), respectively) (“Governor Bowman Statement”).
[19] Statement by Federal Reserve Governor Christopher J. Waller (August 29, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/waller-statement-20230829.htm. In contrast, Director Chopra proposed whether “we should determine whether institutions below $100 billion, such as those with high levels of ‘uninsured’ deposits or those that have grown very rapidly, should also be subjected to a similar requirement.” Director Chopra Statement.
[20] Governor Bowman Statement.
[21] See id.
[22] See Proposed Rule, p. 114.
Gibson Dunn’s Distressed Banks Resource Center provides resources and regular updates to our clients. Please check the Resource Center for the latest developments.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Global Financial Regulatory, Financial Institutions, Capital Markets, Securities Regulation and Corporate Governance, Public Policy or Administrative Law and Regulatory practice groups, or the following authors:
Jason J. Cabral – New York (+1 212-351-6267, jcabral@gibsondunn.com)
Zach Silvers – Washington, D.C. (+1 202-887-3774, zsilvers@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 August 30, 2023, the U.S. Department of Labor issued a proposed rule to revise its regulations implementing minimum wage and overtime exemptions for executive, administrative, and professional employees, among others, under the Fair Labor Standards Act (“FLSA”). The proposal, if finalized, would revise the minimum wage and overtime exemptions issued by the Trump Administration in 2019, which have been in effect since January 1, 2020.
Among other things, the proposal would increase the compensation thresholds that are used when determining whether an employee qualifies for the executive, administrative, or professional exemptions. Under the Department’s existing regulations an employee qualifies for an exemption if: (1) she is paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed; (2) the amount of salary paid meets a minimum specified amount; and (3) her job duties are primarily executive, administrative, or professional. The Department has periodically revised the minimum salary component of the test, most recently in 2019, when it set the minimum salary at $684 per week ($35,568 on an annual basis).
The Department’s proposal would increase the salary threshold substantially. The Department proposes to increase the threshold to at least $1,059 per week, which is approximately $55,000 per year, representing a nearly 55 percent increase over the current threshold. The proposal also leaves open the possibility that the Department might use more recent wage data when it finalizes the rule, which means the compensation thresholds could easily be as high as $1,140 or $1,158 per week, or approximately $60,000 per year. (A higher threshold applies under state law in only a handful of states, such as California which requires that exempt employees earn at least $1,240 per week.) These increases are the result of the Department’s proposal to tie the compensation thresholds to the 35th percentile of wage survey data of full-time salaried workers in the lowest-wage Census Region—as opposed to 20th percentile of wage survey data of full-time salaried workers in the lowest-wage Census Region and of retail workers nationally.
The proposal would also increase the compensation threshold for the highly compensated employees exemption. Employees earning at least $107,432 annually currently qualify for this exemption if they regularly perform at least one executive, administrative, or professional duty. The Department proposes to increase the compensation threshold to $143,988, an increase of approximately 34 percent.
These changes to the Department’s compensation thresholds would, if implemented, have significant consequences for many employers. It is estimated that the changes will expand the number of workers who would be eligible for overtime wages by at least 3.6 million.
The Department also proposes to automatically increase the compensation thresholds every three years to account for changes in wage survey data collected by the Bureau of Labor Statistics. If implemented, the automatic increase mechanism would likely result in significantly higher compensation thresholds in the coming years.
Increases to the compensation threshold, including automatic increases, were included in the Obama Administration’s 2016 rule. That rule, which would have increased the compensation threshold to $913 per week ($47,476 on an annual basis), was enjoined before it took effect. It was later struck down by the U.S. District Court for the Eastern District of Texas on the grounds that the Department’s reliance on salary thresholds to the exclusion of an analysis of employees’ job duties exceeded the Department’s authority under the statute. A similar challenge should be expected to any final rule resulting from the Department’s new rulemaking, particularly in light of Justice Kavanaugh’s dissent in Helix Energy Solutions Group, Inc. v. Hewitt, 598 U.S. 39 (2023), which suggested that the Department’s compensation threshold test may be inconsistent with the FLSA.
Interested parties will have 60 days to submit comments on the proposed rule after it is published in the Federal Register. The Department may issue a final rule as soon as early-to-mid 2024. As noted, legal challenges are possible once a final rule is adopted.
The following Gibson Dunn attorneys assisted in preparing this client update: Eugene Scalia, Jason Schwartz, Katherine Smith, Andrew Kilberg, and Blake Lanning.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment or Administrative Law and Regulatory practice groups, or the following authors and practice leaders:
Eugene Scalia – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-955-8210, escalia@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)
Helgi C. Walker – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-887-3599, hwalker@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 secured a six-figure settlement awarding attorneys’ fees for its representation of the New Jersey Chapter of the American Immigration Lawyers Association (AILA-NJ) against the federal Executive Office for Immigration Review (EOIR) in the District of New Jersey.
The settlement follows a February 2023 ruling that held that immigration judges at the Newark Immigration Court violated a stipulation by failing to timely adjudicate motions made by immigration attorneys to appear remotely and neglecting to provide adequate reasoning when denying those motions. The judge dismissed EOIR’s explanation that “bandwidth issues” compelled the Newark Immigration Court’s sudden switch to default in-person hearings or justified denying motions for WebEx hearings, finding that it was unsupported by the evidence.
After stipulating in February 2021 to timely adjudicate requests to appear remotely, EOIR abruptly changed course in August 2022, citing “bandwidth issues” at the court. The Gibson Dunn team filed an Emergency Motion to Enforce the Stipulation in October 2022, alleging that the policy change was a violation of EOIR’s commitment. At a two-day evidentiary hearing, the Gibson Dunn team presented two witnesses, AILA-NJ’s Chapter President and a Department of Homeland Security attorney and union representative. Both testified that their members faced an impossible choice between representing their clients in person or risking their or their immunocompromised loved ones’ safety. The Gibson Dunn team also cross-examined the government’s IT expert, who conceded that there was no factual basis for EOIR’s “bandwidth issues” rationale.
In its March 2023 Final Order, the Court granted AILA-NJ permission to file a motion for attorneys’ fees as the prevailing party. Following negotiations, EOIR then agreed to a substantial settlement.
The Gibson Dunn team included partner Akiva Shapiro and associates Seton Hartnett O’Brien, Salah Hawkins, Dasha Dubinsky, Tawkir Chowdhury, and Edmund Bannister.
Because of an expiring transition rule, a partner that currently relies on a “bottom dollar guarantee” to support an allocation of liabilities may be required to recognize gain under section 731(a) unless that partner takes action before October 4, 2023.[1] After a brief overview and discussion of the applicable Treasury regulations, we describe the action that should be taken.
I. Overview
In October 2019, the IRS and Treasury issued final regulations (the “2019 Regulations”) that provide that “bottom dollar payment obligations” (commonly referred to as “bottom dollar guarantees”) do not cause a partnership’s liabilities to be treated as recourse with respect to the partner providing the guarantee. The result of this rule is that a bottom dollar guarantee does not cause the guaranteed liability to be allocated to the partner providing the guarantee.[2] The absence of such an allocation may cause the partner providing the guarantee to recognize gain in an amount up to the amount of the liabilities. The 2019 Regulations are effective for partnership liabilities incurred and guarantees entered into on or after October 5, 2016.
The 2019 Regulations include a seven-year transition rule for a partner that had a “negative tax capital account” immediately before October 5, 2016 and was relying on an allocation of recourse liabilities to avoid gain recognition. In general, a partner would have a “negative tax capital account” to the extent that the partner has previously been allocated losses or deductions or received distributions from the partnership in excess of the partner’s capital investment in the partnership (i.e., capital contributions to the partnership and previous allocations of income or gain by the partnership to the partner). The transition rule also applies to liabilities incurred and payment obligations entered into before October 5, 2016 that were subsequently refinanced or modified.
When the transition rule expires on October 4, 2023, bottom dollar guarantees will no longer be effective to cause partnership liabilities to be treated as recourse with respect to the partner providing the guarantee. As a result, absent other action, the partner may recognize gain under section 731(a) to the extent of the partner’s remaining “negative tax capital account.”
II. Discussion
A. Background on the Allocation of Partnership Liabilities
An entity that is classified as a partnership for U.S. federal income tax purposes allocates its liabilities among its partners in accordance with section 752 and the regulations interpreting section 752. Any liability that is allocated to a partner increases that partner’s basis in its partnership interest. A partner with a share of liabilities may, therefore, be able to receive greater distributions of money from the partnership without recognizing gain under section 731(a) or claim deductions for a greater amount of partnership deductions than would be possible without the share of liabilities.
When a partner’s share of a liability decreases—whether because the liability is repaid or because it is allocated to a different partner—the partner whose share decreases is treated as receiving a distribution of money in an amount equal to the reduction. If the amount of the reduction exceeds the partner’s basis in its interest, the partner recognizes taxable gain under section 731(a).
Whether a partnership liability is allocated to a particular partner depends, in the first instance, on whether the liability is “recourse” or “nonrecourse.” A liability that is “recourse” to a particular partner is allocated to that partner. A liability that is not recourse to any particular partner is considered “nonrecourse” and generally is allocated among all partners (though, in many cases, there is substantial flexibility with respect to the allocation of nonrecourse liabilities under Treas. Reg. § 1.752-3).
For this purpose, a liability is a recourse liability when a partner or related person bears the “economic risk of loss” with respect to that liability. To determine whether any partner or related person bears the economic risk of loss with respect to a liability, the Treasury regulations require the partnership to determine whether any partner would have a “payment obligation” if all of the assets of the partnership (including cash) became worthless and the liabilities became due (this is sometimes referred to as the “atom bomb test”).[3]
B. Use of Guarantees to Cause Allocations of Liabilities
A partner that wishes to be allocated a share of partnership liabilities in excess of its share of nonrecourse liabilities sometimes will guarantee repayment of some or all of the partnership’s liabilities. For example, if a partner with a $0 basis in its interest is entitled to a distribution of money from the partnership, and the partner does not want to recognize taxable gain on the distribution, the partner might guarantee a partnership liability before the distribution. If the amount of the guarantee is at least equal to the amount of money to be distributed, the distribution does not cause the partner to recognize gain under section 731(a) because the liability “supports” the distribution by providing additional basis.
This well-understood and perfectly acceptable planning technique, of course, is not without economic risk; a partner that guarantees a liability may be called upon to satisfy that guarantee. With lower-leverage partnerships, this can be relatively low risk. In a higher-leverage partnership—for example, certain real estate joint ventures—however, the risk can be more significant.
Before the issuance of temporary Treasury regulations in October 2016, a partner that sought to be allocated a share of liabilities while reducing the associated economic exposure sometimes entered into a so-called “bottom dollar guarantee.” Unlike other guarantees (in which the guarantor is liable for the amount guaranteed beginning with the first dollar of the unsatisfied outstanding principal balance), a bottom dollar guarantee requires the guarantor to make a payment only to the extent that the lender ultimately collects less than the amount guaranteed. That is, a bottom dollar guarantee exposes the guarantor to the last dollars of loss rather than the first. A bottom dollar guarantee thus caused a liability to be a recourse liability that exposed the guarantor to lower risk while still constituting sufficient risk exposure to support an allocation of liabilities (in an amount equal to the guarantee). This allowed the partner providing the guarantee to avoid gain recognition to the extent of the associated liabilities.
C. IRS and Treasury Response to Bottom Dollar Guarantees
The IRS and Treasury perceived bottom dollar guarantees as lacking commercial substance and, in January 2014, proposed an initial set of regulations seeking to curb their use. Under the final 2019 Regulations, “bottom dollar payment obligations” are not recognized (i.e., a bottom dollar guarantee does not result in the guarantor partner being treated as having the economic risk of loss with respect to the liability). Under the regulations, a bottom dollar payment obligation generally includes any payment obligation under a guarantee or similar arrangement with respect to which the partner (or a related person) is not liable for up to the full amount of the payment obligation in the event of non-payment by the partnership. In other words, the lender must be able to recover from the guarantor beginning with the lender’s first dollar of loss. In determining whether a guarantee meets the definition of a bottom dollar payment obligation, and, relatedly, whether the partner (or a related person) bears the economic risk of loss, every aspect of the guarantee must be considered, including whether, by reason of contract, state law, or common law, the partner has a reimbursement or contribution right (for example, by claiming reimbursement or contribution from the joint venture on a priority basis relative to the other partners, from the other partners, or from third parties).
The determination of whether a particular guarantee meets the definition of “bottom dollar payment obligation” is, therefore, a mixed issue of law and transaction-specific facts.
D. Special Rule for “Vertical Slice” Guarantees
One important clarification of the bottom dollar guarantee rules is the rule for so-called “vertical slice” guarantees. The 2019 Regulations provide that a guarantee is not a bottom dollar guarantee if the guaranteed obligation equates to a fixed percentage of every dollar of the guaranteed partnership liability. That is, a partner does not need to guarantee the entire liability but rather can guarantee a “vertical slice” of the entire liability. For example, suppose a partner agrees to guarantee ten percent of a $100 million partnership liability, which would be $10 million. In a typical guarantee, the partner would be liable for the first $10 million of the lender’s losses—that is, if the lender recovers less than $100 million, the guarantor is liable for up to $10 million. If, however, the partner enters into a “vertical slice guarantee” for ten percent of the lender’s loss up to the same $10 million amount, the partner would be liable for ten percent of each dollar of the lender’s loss, thus reducing its effective economic exposure in the event of a loss. That is, if the lender recovered only $60 million from the partnership, the guarantor would be liable for $4 million (ten percent of the $40 million loss). Unlike a bottom dollar guarantee (which, in the example, would not have resulted in a payment obligation because the lender recovered in excess of the $10 million guaranteed amount), a “vertical slice guarantee” exposes a guarantor partner to liability from the first dollar of loss.
Accordingly, a partner seeking to provide a guarantee of only a portion of a partnership liability may be able to use a “vertical slice guarantee” to accomplish this goal while reducing economic exposure in the event of a loss.
E. Anti-Abuse Rule
The 2019 Regulations contain an anti-abuse rule pursuant to which a payment obligation is disregarded if the facts and circumstances indicate a plan to circumvent or avoid the obligation. Factors cited by the regulations as evidence of such a plan include the partner (or a related person) not being subject to commercially reasonable contractual restrictions that protect the likelihood of payment and that the terms of the partnership liability would be substantially the same had the partner (or related person) not agreed to provide the guarantee. These rules should be considered if entering into a guarantee or other payment obligation.
III. How May The Expiration Of The Transition Rule Impact You?
If you:
- are a partner in an entity classified as a partnership for U.S. federal income tax purposes;
- guaranteed one or more partnership liabilities before October 5, 2016; and
- your share of partnership liabilities exceeded your basis in your partnership interest at that time;
then you should consult your tax lawyers to determine whether the guarantee is a bottom dollar payment obligation. If it is, the transition rule described above will expire on October 4, 2023, and you should consider whether to take any action before that date. Actions that can be taken include entering into a replacement guarantee that complies with the 2019 Regulations before October 4, 2023. If you do not, you may recognize gain equal to all or a portion of your current “negative tax capital account,” either in 2023 or later.
____________________________
[1] Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”), and all “Treas. Reg. §” references are to the Treasury regulations promulgated under the Code.
[2] The 2019 Regulations finalized temporary regulations promulgated in T.D. 9788 on October 5, 2016.
[3] There is a special rule for liabilities with respect to which the lender may look only to specific partnership assets. In that case, the liability is treated as satisfied by transferring the property to the lender.
This alert was prepared by Emily Leduc Gagné,* Evan M. Gusler, James Jennings, Andrew Lance, and Eric B. Sloan.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Tax or Real Estate practice groups:
Tax Group:
Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com)
Sandy Bhogal – Co-Chair, London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com)
Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com)
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, jdelauriere@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, mdesmond@gibsondunn.com)
Anne Devereaux* – Los Angeles (+1 213-229-7616, adevereaux@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202-887-3567, mjdonnelly@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212-351-2474, pendreny@gibsondunn.com)
Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com)
Kathryn A. Kelly – New York (+1 212-351-3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)
Loren Lembo – New York (+1 212-351-3986, llembo@gibsondunn.com)
Jennifer Sabin – New York (+1 212-351-5208, jsabin@gibsondunn.com)
Hans Martin Schmid – Munich (+49 89 189 33 110, mschmid@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, esloan@gibsondunn.com)
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), jtrinklein@gibsondunn.com)
Edward S. Wei – New York (+1 212-351-3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213-229-7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)
Emily Leduc Gagné* – New York (+1 212-351-6387, eleducgagne@gibsondunn.com)
Evan M. Gusler – New York (+1 212-351-2445, egusler@gibsondunn.com)
James Jennings – New York (+1 212-351-3967, jjennings@gibsondunn.com)
Real Estate Group:
Andrew Lance – New York (+1 212-351-3871, alance@gibsondunn.com)
*Anne Devereaux is of counsel in the firm’s Los Angeles office who is admitted only in Washington, D.C.; Emily Leduc Gagné is an associate in the firm’s New York office who is admitted in Ontario, Canada.
© 2023 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) by a 3-2 vote adopted final rules (the “Final Rules”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which modify certain aspects of the rules initially proposed on February 9, 2022 (the “Proposed Rules”) and adopt others largely as proposed. The Final Rules reflect the SEC’s asserted goal of bringing “transparency” to the inner workings of private funds and their sponsors by restricting or requiring extensive disclosure of preferential treatment granted in side letters, as well as imposing numerous additional reporting and other compliance requirements.[1] While several of the Final Rules require further clarification, and industry practice will undoubtedly evolve as the Final Rules are further analyzed and, to the extent possible, implemented, the following table sets forth a high-level overview of key requirements and restrictions reflected in the Final Rules. Following the table is a Q&A addressing some of the most frequently asked questions sponsors and other industry participants have asked us. These materials are a general, initial summary and do not assess the legality of the Final Rules, which remain subject to potential challenge.
Private Funds Rules – Overview of Key Requirements and Restrictions
|
Requirement or Restriction |
High-Level Observations |
|
|
Preferential Treatment Rule (Disclosure Requirements): An adviser may not admit an investor into a fund unless it has provided advance disclosure of material economic terms granted preferentially to other investors, and must disclose all other preferential treatment “as soon as reasonably practicable” after the end of the fundraising period (for illiquid funds) or the investor’s investment (for liquid funds) and at least annually thereafter (if new preferential terms are granted since the last notice). |
As set forth below, this requirement fundamentally changes the rules of the game with respect to a fund’s typical MFN process and requires advance disclosure of material economic terms, including to those investors who are not entitled to elect them, and to those who would not typically see them (e.g., smaller investors who do not have side letters).Because the disclosure requirements apply to existing funds, older funds will need to disclose preferential treatment previously granted but not yet disclosed. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers) Existing funds grandfathered? No. |
|
Quarterly Statement Rule: Registered advisers must issue quarterly statements detailing information regarding fund-level performance; the costs of investing in the fund, including itemized fund fees and expenses; the impact of any offsets or fee waivers; and an itemized accounting of all amounts paid to the adviser or its related persons by each portfolio company. |
As set forth below, the requirement to show performance metrics for illiquid funds, both with and without the impact of fund-level subscription facilities, and to spell out clearly all fund-level and portfolio company-level special fees and expenses (e.g., monitoring fees) and provide a cross-reference to the section of the private fund’s organizational and offering documents setting forth the applicable calculation methodology with respect to each is extremely burdensome and could provide another basis for the SEC staff to review performance calculations and fee and expense allocations during exams. We also expect the timing deadlines for the quarter- and year-end statements to present significant operational challenges for sponsors. |
Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No |
|
Private Fund Audit Rule: Registered advisers must obtain an annual audit for each private fund that meets the requirements of the audit provision in the Advisers Act custody rule (Rule 206(4)-2), and will no longer be able to opt out of the requirement using surprise examinations. |
Many private fund sponsors are already providing audited financial statements in compliance with the custody rule. Sponsors who opt out of this requirement in favor of surprise examinations will be affected. We note that the SEC has re-opened its comment period with respect to its proposal regarding safeguarding client assets to allow commenters to assess its interplay with the Private Fund Audit Rule. |
Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No |
|
Adviser-Led Secondaries Rule: Registered advisers must obtain and distribute an independent fairness opinion or valuation opinion in connection with an adviser-led secondary transaction, and disclose material business relationships the adviser has had in the last two years with the opinion provider.
|
We believe that a U.S. market norm has likely developed in recent years where many sponsors are already providing fairness opinions or valuation opinions as a best practice in GP-led secondaries. This requirement will, however, increase expenses for transactions that have not historically relied on such opinions (such as where a third-party bid establishes the price), and ultimately such expenses will be passed onto investors. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? No |
|
Books and Records Rule Amendments: Requirement to maintain certain books and records demonstrating compliance with the Final Rules. |
We believe that the books and records amendments generally clarify that sponsors must maintain specific records of compliance with the new rules. We anticipate the SEC staff will focus on this requirement in considering possible deficiencies related to the new rules as part of routine exams. |
Compliance Date: Based on the compliance date of the underlying rule for which records are required Existing funds grandfathered? No |
|
Restricted Activities Rule (Investigation Costs): An adviser may not allocate to the private fund any fees or expenses associated with an investigation of the adviser without disclosing as much and receiving consent from a majority in interest of fund investors (excluding the adviser and its related persons), and is prohibited from charging the fund for fees and expenses for an investigation that results or has resulted in a sanction for a violation of the Advisers Act or the rules thereunder. |
We believe this rule will adversely affect and burden sponsors.[4] Sponsors will no longer be able to allocate costs of an investigation to a fund unless a majority in interest of unaffiliated investors consent. The adopting release makes clear that the SEC intends that sponsors seek separate consents for each investigation, which would suggest that the practice of describing such costs with generality in the fund’s governing document would not be sufficient. Even if sponsors obtain consent to allocate costs related to an investigation to a fund, they will not be able to do so if the investigation results in sanctions for violations of the Advisers Act. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes, if disclosed.[5] |
|
Restricted Activities Rule (Regulatory/Compliance Costs): Advisers may not charge or allocate to the private fund regulatory, examination, or compliance fees or expenses unless they are disclosed to investors within 45 days after the end of the fiscal quarter in which such charges occur. |
The adopting release makes clear that the SEC continues to view advisers charging to the fund “manager-level” expenses that it feels should more appropriately be borne by the adviser as “contrary to the public interest and the protection of investors.” As is currently the case, an adviser that allocates its regulatory, compliance and examination costs to a fund should ensure that this practice is clearly permitted under the fund’s governing documents. However, even with such authority, the level of granular disclosure regarding such costs that the Final Rule seemingly requires could have a chilling effect on the practice (where applicable) and discourage investment in compliance. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Disclosure requirement generally applies |
|
Restricted Activities Rule (After-tax Clawback): Advisers may not reduce the amount of a GP clawback by amounts due for certain taxes unless the pre-tax and post-tax amounts of the clawback are disclosed to investors within 45 days after the end of the fiscal quarter in which the clawback occurs. |
Advisers who wish to reduce their GP clawback amount by their actual or hypothetical taxes (the latter being a common practice permitted by most fund governing documents) will need to provide investors with notice of having done so and disclosure of specific dollar amounts. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes, with disclosure |
|
Restricted Activities Rule (Non-pro rata investment-level allocations): Advisers may not charge or allocate fees or expenses related to a portfolio investment on a non-pro rata basis when multiple funds and other clients are invested, unless the allocation is “fair and equitable” and the adviser distributes advance notice describing the charge and justifying its fairness and equitability. |
We believe that this requirement will put additional pressure on advisers to determine, at the outset of a fundraise, whether certain costs, such as those related to AIVs or feeder funds set up to accommodate particular investors’ unique tax or regulatory profiles, will be allocated across the fund or instead allocated exclusively to such investors. Increased disclosure will likely lead to more allocation of these costs across the fund. This rule also places additional pressure on the practice of disproportionately allocating broken deal expenses to the fund as opposed to investors who were proposed to have invested alongside the fund, which is a longstanding focus of the SEC. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Disclosure requirement generally applies |
|
Restricted Activities Rule (Borrowing from the fund): Advisers may not borrow or receive an extension of credit from a private fund without disclosure to and consent from fund investors. |
This rule does not apply to the more typical practice of sponsors lending money to the fund. In light of the clarification that disclosure and consent are required, a minority of sponsors may seek to include the ability to borrow from the fund on certain pre-defined terms in the fund’s governing documents. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[6] |
|
Preferential Treatment Rule (Redemption Rights): An adviser may not offer preferential treatment to investors regarding their ability to redeem if the adviser reasonably expects such terms to have a material, negative effect on other investors, unless such ability is required by law or offered to all other investors in the fund without qualification. |
State pension funds and sovereign wealth funds, in particular, often negotiate special redemption rights. Sponsors are being placed in the difficult position of determining whether such rights have a material, negative effect on other investors, when they are not driven by laws, rules or regulations applicable to the investor. The SEC has provided little guidance to assist in this determination, which must be examined on a case-by-case basis. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[7] |
|
Preferential Treatment Rule (Portfolio Holdings Information): An adviser may not provide preferential information about portfolio holdings or exposures if the adviser reasonably expects that providing the information would have a material, negative effect on other investors, unless such preferential information is offered to all investors. |
Attention should be given to information required by bespoke reporting templates to determine whether this provision applies. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[8] |
|
Compliance Rule Amendment: All registered advisers (including those without private fund clients) must document in writing the required annual review of their compliance policies and procedures. |
We believe this codifies an informal position that the SEC examinations staff has already imposed on advisers. |
Compliance Date: 60 days after publication of the Final Rules in the Federal Register Existing funds grandfathered? N/A |
Frequently Asked Questions:
The following Q&A sets forth our answers to questions to frequently asked questions:
| Question: Which of the Final Rules apply to various types of sponsors? |
-
- Registered investment advisers to private funds are subject to all of the rules and restrictions set forth in the table above.
- Exempt reporting advisers and other unregistered advisers are not affected by the Quarterly Statement Rule, the Private Fund Audit Rule, the Adviser-Led Secondaries Rule or the Compliance Rule Amendment.
- Offshore advisers whose principal place of business is outside the U.S., whether registered or unregistered, are technically subject to the Final Rules, but the SEC has indicated that it will not extend the requirements of these rules to the adviser’s activities with respect to their offshore private fund clients, even if the offshore funds have U.S. investors.
- The Final Rule states that Quarterly Statement Rule, Private Fund Audit Rule, Adviser-Led Secondaries Rule, Restricted Activities Rule and Preferential Treatment Rules do not apply to investment advisers with respect to securitized asset funds they advise; real estate funds relying on Section 3(c)(5)(C), and other collective investment vehicles that are not “private funds”[9] are also outside the technical scope of those rules.
- Real estate fund managers that are not registered with the SEC (or filing reports as an exempt reporting adviser) on the basis that they are not advising on “securities” are not subject to the Advisers Act or the Final Rules.
| Question: What do sponsors have to disclose before and after admitting investors, and how will the current MFN process change? |
Sponsors will now have to disclose (i) fee and carry breaks or other material economic arrangements preferentially granted to other investors ahead of admitting new investors into their private funds, and (ii) all preferential treatment as soon as reasonably practicable after the final closing of a closed end fund or the admission of the new investor in an open-end fund, and at least annually thereafter if preferential terms are provided that were not previously disclosed. This disclosure requirement applies to existing funds, even if they have held a final closing prior to the compliance date.
In a statement released concurrently with the release of the Final Rule, Commissioner Caroline A. Crenshaw stated that “collective action problems appear to prevent coordination among investors to bargain for uniform baseline terms.”[10] The SEC’s decision to require disclosure of material economic terms ahead of admitting investors to the fund and disclosure of all preferential treatment post-final closing takes aim at that purported collective action problem.
Notably, the SEC seemingly narrowed its original proposal by opting to require advance written disclosure of “any preferential treatment related to any material economic terms,” as opposed to advance disclosure of all preferential treatment, as originally proposed.[11] Notwithstanding that concession, all preferential treatment (notably, without the materiality qualifier) must invariably be disclosed as soon “as reasonably practicable” following the end of the private fund’s fundraising period (for illiquid funds) or the investor’s investment in the private fund (for liquid funds).[12]
The SEC notes that “as soon as reasonably practicable” will be a facts and circumstances analysis, but suggests that it believes that “it would generally be appropriate for advisers to distribute the notices within four weeks.”[13] We find this proposed timeline ambitious and, in the absence of a hard deadline, would predict that many sponsors will continue take additional time to complete their MFN process. The “as soon as reasonably practicable” requirement would, however, cut against conducting an MFN process an excessive number of months after the final closing, as sometimes happens at present.
Material economic terms that require prior disclosure include, without limitation, “the cost of investing, liquidity rights, fee breaks, and co-investment rights.”[14] The SEC cited excuse rights as an example of non-economic preferential terms which must be disclosed post-closing. Providing a summary of preferential treatment provisions with sufficient specificity to convey its relevance will satisfy this requirement, as will providing the actual provisions granted, and in each case this may be done on an anonymized basis.[15]
In our experience, most investors in private funds with commitments in excess of a certain threshold negotiate side letters with sponsors that contain a “most favored nations” (“MFN”) clause entitling them to view all or part of the side letters granted to other investors and, most frequently, to opt into those more favorable terms negotiated by other investors who make commitments that are equal to or lesser than their capital commitment (and are not otherwise inapplicable to them). This process (the “MFN Process”) typically happens after the fund’s final closing in the closed-end fund context. Accordingly, the Final Rules essentially require sponsors to conduct a portion of their MFN Process in piecemeal fashion, with part of the process conducted prior to the final closing and the rest conducted post final closing, and to do so with respect to each investor regardless of whether such investor negotiated a side letter with an MFN clause or is entitled to elect any of the disclosed provisions. This will curtail the common practice of only showing other investors’ side letter provisions to those investors with MFN provisions and of only showing investors those provisions which they are eligible to elect. Due to the ongoing disclosure requirements, those sponsors of closed-end funds which already held their final closings and ran a more limited MFN process will now be required to disclose any preferential treatment granted to other investors, regardless of size, that had not been previously disclosed. There is no requirement to offer the election of such provisions to the investors who receive the disclosure.
While, as a technical matter, only disclosure of the key terms is required (and not an opportunity to elect such terms), the natural consequence of disclosure is that investors may ask sponsors at the time they are informed of key terms (regardless of whether they have a side letter with an MFN provision) to be granted the same terms as other similarly situated investors.
We expect that these disclosure requirements will present a substantial logistical challenge and may affect previously negotiated commercial arrangements. The SEC has not prescribed a method of delivery for electronic notices, so sponsors will be able to choose whether to do so in the private placement memorandum (the “PPM”), as a standalone disclosure document in an electronic data room, via email or otherwise. PPM supplements may be a natural place to make this disclosure, since private funds typically accept investors across multiple closings over the course of a fundraising and already provide supplements to PPMs, although virtual data rooms may also be an attractive alternative delivery method.
Sponsors will face the issue of how to handle their first closing and how to handle disclosure of terms that are being negotiated concurrently in the final hours before a later closing. In a typical fund closing, multiple side letters are negotiated concurrently with investors in the days leading up to the closing date. Time will tell where the industry lands on this point, but one potential reading of the Final Rules suggests that a sponsor concerned about managing these closing dynamics could take the position that any preferential terms granted as of the same date and at a given closing can be deemed not to have been granted prior to the capital commitments made by any other investor in that closing, and therefore may be disclosed later. It remains to be seen, however, whether this approach is consistent with the intent of the Final Rules and whether, alternatively, the Final Rules would effectively obligate sponsors to communicate two dates to their prospective investors for their closings: one being the “drop dead” date when all side letter terms need to be agreed to, and the second being a later date when commitments will be accepted and the closing will occur. This approach would give the fund, and legal counsel, time to disclose any additional material economic terms to all investors and make any last-minute updates to their side letters in response to any requests to opt into those terms that they are eligible for. In any event, we expect that the Preferential Treatment Rule’s disclosure requirement, assuming it can be practically implemented, will increase organizational expense costs for sponsors. Many sponsors agree to organizational expense caps with their investors, and some are able to negotiate that the MFN Process falls outside of those caps. If at least a portion of the MFN Process, which can be lengthy and expensive, must take place ahead of closing investors, then sponsors are likely to seek increases to their organizational expense caps to accommodate these added costs. The Final Rules will also allow smaller investors, including those that did not themselves negotiate a “most favored nations” clause (or even have a side letter), to view the provisions negotiated by larger investors. This may result in more protracted negotiations with investors who are making capital commitments at sizes which, in the view of sponsors, do not typically entitle them to a side letter arrangement, or to propose in the fund’s PPM fee breakpoints and other means of giving preference based on size, timing and other pre-determined criteria instead of doing so through the side letter process.
| Question: How will sponsors’ quarterly and annual reports be affected? |
Under the Final Rules, registered investment advisers are required to prepare quarterly statements for each of their private funds that include (A) a table with a detailed accounting of all fees, compensation and other amounts paid to the adviser or any of its related persons by the fund as well as all other fees and expenses paid by the fund during the relevant reporting period, (B) a table with a detailed accounting of all fees and compensation paid to the adviser or any of its related persons by the fund’s covered portfolio investments and (C) performance measures of the fund for the relevant reporting period.[16] Advisers must comply with the quarterly statement requirement for a new fund once it has had two full fiscal quarters of operating results. The Final Rule goes into granular detail about what information needs to be clearly and prominently disclosed in the quarterly statements, including the methodologies used and assumptions relied upon in the quarterly statement, as further described below.
(A) Quarterly Statement: Fund-Level Fee, Compensation and Expense Disclosure
The Quarterly Statement Rule requires registered investment advisers to disclose on a quarterly basis (1) a detailed accounting of all compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons by the private fund during the reporting period, including, but not limited to, management, advisory, sub-advisory, or similar fees or payments, and performance-based compensation (e.g., carried interest), (2) a detailed accounting of all fees and expenses allocated to or paid by the private fund during the reporting period other than those listed in (1), including, but not limited to, organizational, accounting, legal, administration, audit, tax, due diligence, and travel fees and expenses, and (3) the amount of any offsets or rebates carried forward during the reporting period to subsequent quarterly periods to reduce future payments or allocations to the adviser or its related persons.
The SEC emphasizes in several places throughout its commentary to the Final Rules that there should be separate line items for each category of compensation, fee or expense and that the exclusion of de minimis expenses, the grouping of smaller expenses into broad categories or the labeling of any expenses as miscellaneous is prohibited, which will require significant effort on the part of advisers. Additionally, they advise that to the extent a certain expense could be categorized as either adviser compensation or a fund expense, the Final Rule requires that such payment or allocation be categorized as adviser compensation. For example, if an adviser or its related persons provide consulting, legal or back-office services to a private fund as a permitted expense under the private fund’s governing documents, such amounts should be categorized as compensation as opposed to an expense. This highlights the technicalities that the Final Rule imposes upon advisers and the potential pitfalls that may arise in compliance.
The SEC also noted in its commentary that the definitions of “related person” and “control” adopted under the Final Rules are consistent with the definitions used on Form ADV and Form PF, which registered investment advisers are familiar with.
This set of disclosure must be done before and after the application of any offsets, rebates or waivers to fees or compensation received by the adviser, including, but not limited to, any fees an adviser or its related person receives for management services provided to a fund’s portfolio company.
(B) Quarterly Statement: Portfolio Investment-Level Fee and Compensation Disclosure
Similar to the above, the Quarterly Statement Rule requires registered investment advisers to disclose a detailed accounting of all portfolio investment compensation allocated or paid by each covered portfolio investment during the reporting period in a single, separate table from the disclosure table noted above.
The definition of a portfolio investment is broad and is intended to cover any entity through which a private fund holds an investment, including through holding vehicles, subsidiaries, acquisition vehicles, special purpose vehicles or the like. In its commentary to the Final Rules, the SEC recognizes that this may impose challenges specifically for funds of funds, as it may be difficult to determine portfolio investment compensation arrangements at the underlying fund level.
This prong of the Final Rule also similarly requires a detailed line-by-line itemization of all portfolio investment compensation. Additionally, the SEC also notes in its commentary to the Final Rules that advisers are required to list the portfolio investment compensation allocated or paid with respect to each covered portfolio investment both before and after the application of any offsets, rebates or waivers. However, it is not clear how this is intended to apply at this level, as such offsets are taken into account at the fund level, not the portfolio company level.
“Portfolio investment compensation” includes any compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons by the portfolio investment attributable to the private fund’s interest in the portfolio investment, including, but not limited to, origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees or similar fees or payments. Notably, this requirement could cause some sponsors to consider transitioning in-house or affiliated operating groups to unaffiliated entities (e.g., owned by the operating advisors themselves).
(C) Quarterly Statement: Performance Disclosure
Under the Final Rule, registered investment advisers are required to provide standardized fund performance information in each quarterly statement. The performance metrics shown will depend on whether a private fund is classified as a liquid fund or an illiquid fund. An “illiquid fund” is defined as a private fund that does not have investor redemption mechanisms and that has limited opportunities for investor withdrawal other than in exceptional circumstances. A “liquid fund” is defined as a private fund that is not an illiquid fund.
(1) Liquid Funds
For liquid funds, registered investment advisers are required to show performance based on (A) annual net total return for each fiscal year for the 10 fiscal years prior to the quarterly statement or since inception (whichever is shorter), (B) average annual net total returns over one-, five-, and 10-fiscal year periods, and (C) cumulative net total return for the current fiscal year as of the end of the most recent fiscal quarter. It is anticipated that estimations may need to be made for liquid funds that have been operating for lengthy periods of time that did not keep adequate records of the earlier years.
(2) Illiquid Funds
For illiquid funds, registered investment advisers of illiquid funds are required to (i) show performance based on internal rates of return and multiples of invested capital (both gross and net metrics shown with equal prominence) (A) since inception and (B) for the realized and unrealized portions of the illiquid fund’s portfolio, with the realized and unrealized performance shown separately and (ii) present a statement of contributions and distributions. The Final Rule defines the terms “internal rate of return” and “multiple of invested capital”, on both a gross and net basis, and provides color on what is expected to be included in the statement of contributions and distributions.[17] This illustrates the granular and prescriptive nature of the Final Rule, which will require concerted effort on behalf of fund sponsors to ensure compliance.
Advisers are required to consider the impact of fund-level subscription facilities on returns and disclose such performance information for illiquid funds on both a levered and an unlevered basis. In its commentary to the Final Rules, the SEC is repeatedly focused on standardizing information across private funds as much as possible, and as such has provided no room for exclusions to this rule, such as possibly exempting advisers from providing unlevered returns on short-term subscription facilities or excluding subscription line fees and expenses from the calculation of net performance figures.
The SEC notes in its commentary to the Final Rules that to the extent that certain funds rely on information from portfolio investments to generate the required performance data and such information is not available prior to the distribution of the quarterly statement, an adviser would be expected to use the performance measures “through the most recent practicable date”, which is likely the end of the immediately preceding quarter.
An additional prong to the quarterly statement rule is to include clear and prominent disclosure of the methodologies and assumptions made in calculating performance information. This includes, but is not limited to, whether dividends were reinvested in a liquid fund, or whether any fee rates or fee discounts were assumed in the calculation of net performance measures.
This Final Rule also requires the quarterly statement to include cross-references to the sections of the private fund’s organizational and offering documents that set forth the applicable calculation methodology for all expenses, payments, allocations, rebates, waivers, and offsets. This will likely result in significant changes to how private placement memoranda and the operating agreements of private funds are drafted going forward. Furthermore, to the extent that the allocation and methodology provisions in existing operating agreements are not adequately detailed, this requirement under the Final Rule may prompt future LPA amendments that require limited partner consent.
This consequence of the Final Rules is in tension with the legacy status (i.e. grandfathering) that the Final Rules afford governing agreements entered into prior to the date that the Final Rules take effect. The cross-reference requirement of the Quarterly Statement Rule may effectively eliminate the protections provided by the legacy status concept if sponsors will be required to amend their governing agreements to include sufficient allocation and methodology provisions according to the SEC’s new standards. Notwithstanding the fact that many sponsors may already disclose some of the information required under the Quarterly Statement Rule to their investors, it is anticipated that compliance with the Quarterly Statement Rule will result in significant increased cost to advisers and funds, especially at the outset in establishing compliant quarterly statement templates and disclosures.
Such disclosures must be included in the quarterly statement itself as opposed to in a separate document. The SEC noted that while advisers are not required to provide all supporting calculations in quarterly statements, such information should be made available to investors upon request.
With regards to timing, the Final Rule mandates that registered investment advisers must distribute the quarterly statements to the private fund’s investors within 45 days after the end of the first three fiscal quarters of each fiscal year and within 90 days after the end of each fiscal year, and in the case of fund of funds, within 75 days after the end of the first three fiscal quarters of each fiscal year and within 120 days after the end of each fiscal year.
| Question: Which of the Proposed Rules were not adopted or were modified by the Final Rules? |
While the Final Rules will require sponsors to provide investors with significantly more “transparency” regarding preferential economic arrangements granted in side letters (notably, with respect to material economic terms, before closing new investors into their funds) and fees received by the adviser and related persons, as well as providing new rules on quarterly statements, fund audits, adviser-led secondaries, books and records, annual compliance reviews and certain restricted activities, and some of the “disclose and consent” requirements may operate in practical effect as prohibitions on the relevant conduct, it is worth noting that the Final Rules do not specifically adopt the following items which had been set forth in the Proposed Rules.
In particular, the Final Rules do not:
(i) require all preferential rights granted by side letter to be disclosed prior to investment (only material economic terms must be disclosed prior, the rest must be disclosed later);
(ii) eliminate sponsors’ ability to be indemnified, or limit liability, for simple negligence (preserving the “gross negligence” standard for indemnification);
(iii) prohibit clawbacks of carried interest net of taxes (as noted above, this was replaced by a disclosure requirement);
(iv) expressly prohibit allocating portfolio investment fees and expenses to funds on a non-pro rata basis, subject to disclosure requirements; or
(v) prohibit borrowing from a fund (which may done with disclosure and consent).
Further, the Final Rules also do not provide the specific prohibition against charging accelerated monitoring fees that was noted in the Proposed Rules; although members of the SEC staff clarified during the open meeting held on the Final Rules on August 23, 2023 (the “Open Meeting”) that they did not feel specific language on accelerated monitoring fees was necessary because they believe such fees are already prohibited under applicable guidance. The Final Rules also do not expressly prohibit charging an adviser’s regulatory, compliance, examination and certain investigation costs to the fund (except, in some cases, with consent and disclosure and excluding those investigations that result from a violation of the Advisers Act). Our view, however, is that the SEC’s consistent messaging on the impropriety of such charges, combined with burdensome disclosure requirements, could function as a de-facto prohibition of such charges.
___________________________
[1] Resources:
– Link to the Final Rule and the Adopting Release (Release No. IA-6383; File No. S7-03-22 , RIN 3235-AN07, 17 CFR Part 275, Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews: Final Rule)
– Link to the SEC’s Fact Sheet concerning Final Rules
[2] For purposes of the compliance date, the SEC recognized that smaller advisers will require more time to implement certain rules and provided size-based deadlines for implementation, which will be staggered starting from the publication of the Final Rule in the Federal Register. “Larger Advisers” means advisers with assets under management attributable to private funds (“Private Funds AUM”) of $1.5 billion or more. “Smaller Advisers” means advisers with Private Funds AUM of less than $1.5 billion.
[3] The Final Rules grandfather in certain existing arrangements if the private fund has “commenced operations” and has made contractual arrangements related to the provision that were entered into prior to the compliance date, and if the Final Rules would require amending such agreements.
[4] Note that the term “investigation” does not appear to include examinations of the adviser, which are addressed in the row immediately below.
[5] Except that costs associated with investigations resulting in Advisers Act sanctions may not be allocated to new or existing funds even with disclosure and consent.
[6] For loan agreements entered into prior to the compliance date if compliance would require an amendment to such agreements
[7] With respect to contractual obligations entered into prior to the compliance date.
[8] With respect to contractual obligations entered into prior to the compliance date.
[9] Issuers that would be investment companies but for the exclusions contained in Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.
[10] “Statement Regarding Private Fund Adviser Rulemaking”, Aug. 23, 2023, Commissioner Caroline A. Crenshaw (https://www.sec.gov/news/statement/crenshaw-statement-private-fund-advisers-082323?utm_medium=email&utm_source=govdelivery)
[11] Release, page 292.
[12] Release, page 294.
[13] Release, page 299.
[14] Id.
[15] Id at 297.
[16] 17 C.F.R. § 275.211(h)(1)-2(b)-(c).
[17] See 17 C.F.R. § 275.211(h)(1)-1. “Multiple of invested capital” means (i) the sum of: (A) the unrealized value of the illiquid fund; and (B) the value of distributions made by the illiquid fund; (ii) divided by the total capital contributed to the illiquid fund by its investors. “Internal rate of return” means the discount rate that causes the net present value of all cash flows throughout the life of the private fund to be equal to zero. Gross metrics are calculated gross of all fees, expenses and performance-based compensation borne by the private fund, whereas net metrics are calculated net of all fees, expenses and performance-based compensation borne by the private fund.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding the issues and considerations discussed above, and we will continue to monitor developments in the coming months. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Investment Funds practice group, or any of the individuals listed below:
Investment Funds Group:
Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)
Kevin Bettsteller – Los Angeles (+1 310-552-8566, kbettsteller@gibsondunn.com)
Albert S. Cho – Hong Kong (+852 2214 3811, acho@gibsondunn.com)
Candice S. Choh – Los Angeles (+1 310-552-8658, cchoh@gibsondunn.com)
John Fadely – Singapore/Hong Kong (+65 6507 3688/+852 2214 3810, jfadely@gibsondunn.com)
A.J. Frey – Washington, D.C./New York (+1 202-887-3793, afrey@gibsondunn.com)
Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)
James M. Hays – Houston (+1 346-718-6642, jhays@gibsondunn.com)
Kira Idoko – New York (+1 212-351-3951, kidoko@gibsondunn.com)
Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com)
Eve Mrozek – New York (+1 212-351-4053, emrozek@gibsondunn.com)
Roger D. Singer – New York (+1 212-351-3888, rsinger@gibsondunn.com)
Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)
William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)
Tax Group:
Pamela Lawrence Endreny – New York (+1 212-351-2474, pendreny@gibsondunn.com)
Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)
The following Gibson Dunn attorneys assisted in preparing this client update: Kevin Bettsteller, Shannon Errico, Greg Merz, and Rachel Spinka.
© 2023 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
This Client Alert provides an update on shareholder activism activity involving NYSE- and Nasdaq-listed companies with equity market capitalizations in excess of $1 billion and below $100 billion (as of the last date of trading in 2022) during 2022.
Announced shareholder activist activity increased relative to 2021. The number of public activist actions (82 vs. 76), activist investors taking actions (54 vs. 48) and companies targeted by such actions (72 vs. 69) each increased. The period spanning January 1, 2022 to December 31, 2022 also saw several campaigns by multiple activists targeting a single company, such as the campaigns involving: Alphabet Inc. that included activity by NorthStar Asset Management and Trillium Asset Management; C.H. Robinson Worldwide, Inc. that included Ancora Advisors and Pacific Point Wealth Management; and SpartanNash Company that included Ancora Advisors and Macellum Advisors. In addition, certain activists launched multiple campaigns during 2022, including Ancora Advisors, Carl Icahn, Elliott Investment Management, Engine Capital, JANA Partners, Land & Buildings, Starboard Value and Third Point Partners, which each launched three or more campaigns in 2022 and collectively accounted for 32 out of the 82 activist actions reviewed, or 39% in total. Proxy solicitation occurred in 17% of campaigns in 2022—a slight decrease from the amount of solicitations in 2021 (18%).
By the Numbers—2022 Public Activism Trends
*Study covers selected activist campaigns involving NYSE- and Nasdaq-listed companies with equity market capitalizations of greater than $1 billion as of December 31, 2022 (unless company is no longer listed), and all information is derived from publicly available sources
**Ownership is highest reported ownership since the public action date and includes economic exposure to derivatives where applicable.
Additional statistical analyses may be found in the complete Activism Update linked below.
Notwithstanding the increase in activism levels, the rationales for activist campaigns during 2022 were generally consistent with those undertaken in 2021. Over both periods, board composition and business strategy represented leading rationales animating shareholder activism campaigns, representing 63% and 39% of rationales in 2022 and 58% and 34% of rationales in 2021, respectively. M&A (which includes advocacy for or against spin-offs, acquisitions and sales) increased in importance relative to 2021, as the frequency with which M&A animated activist campaigns was 40% in 2022 and 33% in 2021. At the opposite end of the spectrum, management changes, return of capital and control remained the most infrequently cited rationales for activist campaigns, as was also the case in 2021. (Note that the above-referenced percentages total over 100%, as certain activist campaigns had multiple rationales.)
23 settlement agreements pertaining to shareholder activism activity were filed during 2022, which is an increase from the 17 filed in 2021. Those settlement agreements that were filed had many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum-share ownership and/or maximum-share ownership covenants. Expense reimbursement provisions were included in less than half of those agreements reviewed, which is a decrease from previous years. We delve further into the data and the details in the latter half of this Client Alert.
We hope you find Gibson Dunn’s 2022 Annual Activism Update informative. If you have any questions, please reach out to a member of your Gibson Dunn team.
The following Gibson Dunn lawyers prepared this client alert: Barbara Becker, Richard Birns, Dennis Friedman, Andrew Kaplan, Saee Muzumdar, Kristen Poole, Daniel Alterbaum, and Joey Herman.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following practice leaders, members, and authors:
Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com)
Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com)
Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com)
Andrew Kaplan (+1 212.351.4064, akaplan@gibsondunn.com)
Daniel S. Alterbaum (+1 212.351.4084, dalterbaum@gibsondunn.com)
Kristen P. Poole (+1 212.351.2614, kpoole@gibsondunn.com)
Joey Herman (+1 212.351.2402, jherman@gibsondunn.com)
Mergers and Acquisitions Group:
Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com)
Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com)
Brian J. Lane – Washington, D.C. (+1 202.887.3646, blane@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, rmueller@gibsondunn.com)
Lori Zyskowski – 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.
Gibson Dunn’s Public Policy Practice Group is closely monitoring the debate in Congress over potential oversight of artificial intelligence (AI). We have previously summarized major federal legislative efforts and White House initiatives regarding AI in our May 19, 2023 alert Federal Policymakers’ Recent Actions Seek to Regulate AI. We have also covered two U.S. Senate hearings that focused on AI in our June 6, 2023 alert “Oversight of AI: Rules for Artificial Intelligence” and “Artificial Intelligence in Government” Hearings.
On July 25, 2023, the Senate Judiciary Committee’s Subcommittee on Privacy, Technology, and the Law held the second in a series of “Oversight of AI” hearings, following its May 16, 2023 hearing on “Rules for Artificial Intelligence,” with a focus on “Principles for Regulation.”[1] A bipartisan group of Senators, led by Chair Richard Blumenthal (D-CT) and Ranking Member Josh Hawley (R-MO), emphasized the urgent need for AI legislation in the face of rapidly advancing AI technology, including generative algorithms and large language models (LLMs).
Witnesses included:
- Stuart Russell, Professor of Computer Science, The University of California – Berkeley;
- Yoshua Bengio, Founder and Scientific Director, Mila – Québec AI Institute; and
- Dario Amodei, Chief Executive Officer, Anthropic.
I. Points of Particular Interest from July 25, 2023 Hearing
We provide a full hearing summary and analysis below. Of particular note, however:
- Chair Blumenthal opened the hearing by noting that, when speaking to constituents about AI, the word he heard most often was “scary.” He pointed to the hearing’s witnesses as “provid[ing] objective, fact-based views to reinforce those fears.” Although he recognized these fears as existential threats, Chair Blumenthal continued to emphasize AI’s enormous potential for good and reiterated the need not to stifle innovation and to maintain U.S. leadership in the AI sector.
- Both Chair Blumenthal and Ranking Member Hawley extolled the rare bipartisan support for AI regulation. In particular, Chair Blumenthal and Ranking Member Hawley highlighted their recent introduction of a bill to waive immunity under Section 230 of the Communications Act of 1934 for claims related to generative AI, following the Subcommittee’s May 19 discussion of whether such immunity should apply to actors in the AI sector.[2]
- Senator Amy Klobuchar (D-MN) emphasized the need to act quickly to capitalize on this bipartisan appetite for AI regulation and avoid “decay[ing] into partisanship and inaction.”
- Ranking Member Hawley emphasized AI’s potential impact, questioning whether it will be an innovation more like the Internet or the atom bomb. Ranking Member Hawley thought the question facing society, and Congress specifically, is whether Congress will “strike that balance between technological innovation and our ethical and moral responsibility to humanity, to liberty, to the freedom of this country.”
- The subcommittee and its witnesses invoked recent efforts by the White House to secure voluntary commitments from leading AI companies—including Mr. Amodeo’s company, Anthropic—to safeguard against key risks.[3] However, Chair Blumenthal stated that many of these commitments are non-enforceable and relatively unspecific. Chair Blumenthal emphasized that this hearing, in contrast, sought to develop legislation and regulations that would create specific, enforceable obligations on actors in the AI sector.
II. Alleged Risks of Particular Concern
In his opening statement, Ranking Member Hawley commented that he had no doubt that AI will be good for large companies, but that he was less confident that AI would be good for the American people. Much of the hearing, therefore, discussed key areas of risks or alleged harms posed by unregulated AI.
The witnesses testifying before the subcommittee typically divided these risks between immediate or short-term risks that may currently exist in AI—such as privacy concerns, copyright issues, alleged bias in algorithms, and possible misinformation—and more medium-term or long-term risks that may present themselves as AI technology advances. The witnesses emphasized the need for Congress to act urgently to prevent these longer term risks from materializing. Professor Bengio drove home this need, explaining that many AI experts had previously “placed a plausible timeframe for [the] achievement of [human-level AI] somewhere between a few decades and a century” but now considered “a few years to a couple of decades” to be the appropriate estimate.
Throughout the hearing, senators focused on a number of short-term and longer term risks, primarily relating to: (i) misinformation and political influence, (ii) national security, (iii) privacy, and (iv) intellectual property.
a. Misinformation and Political Influence
As in the subcommittee’s previous hearing, concerns about misinformation—particularly in the context of elections—took center stage, with Chair Blumenthal noting that “[i]f there’s nothing else that focuses the attention of Congress, it’s an election.” Both the lawmakers and witnesses highlighted risks associated with “deep fakes” and other forms of misinformation or external influence campaigns using AI.
While Mr. Amadeo noted that his company, Anthropic, trains its AI not to generate misinformation or politically biased content, Ranking Member Hawley pushed back on the idea that AI companies can be trusted to police these lines in the face of business pressures commenting that certain decisions about ethics may be “in the eye of the beholder.” Ranking Member Hawley expressed that, in his view, the control that a relatively small number of companies exercise over the AI sector creates a “serious structural issue” regarding who makes decisions about ethics and misinformation.
Other lawmakers and witnesses echoed Ranking Member Hawley’s concerns about the difficulty of policing AI-generated misinformation, with Senator Klobuchar noting the need to comply with the First Amendment’s protections for free speech and Professor Russell invoking the Orwellian specter of “Ministry of Truth.” Professor Russell proposed, however, that Congress could look to other highly regulated industries like banks and credit cards for guidance on how to balance effective and truthful disclosure requirements with free speech concerns.
b. National Security
Concerns about AI’s implications for national security permeated the hearing, with Ranking Member Hawley listing this issue as one of his top four priorities.
Some of these alleged national security risks related to the use of lethal weapons. For example, Chair Blumenthal noted agreement between the U.S. and China that on limiting certain uses of AI in connection to nuclear weapons, and Professor Russell echoed the popular position against the creation of lethal autonomous weapons systems (LAWS) with the ability to kill in the absence of direction or input from a human actor.
Mr. Amodei specifically addressed concerns that AI could enable malicious actors to develop sophisticated biological weapons. His company had, he explained, conducted a six month study that found that current AI systems are capable of filling in some, but not all, steps in the highly technical process of developing biological weapons. This study extrapolated, however, that AI systems may be able to fill in all steps of these processes within two to three years, allowing malicious actors that lack specialized expertise to weaponize biology.
Ranking Member Hawley and Mr. Amodei also discussed national security risks that could arise if the U.S. fails to secure the AI supply chain, with Mr. Amodei noting the significant number of bottle necks that currently exist in the semiconductor manufacturing process. (For more detailed discussion of U.S. efforts to secure the semiconductor supply chain, see our previous client alerts on the implementation of the CHIPS Act, here and here.) Ranking Member Hawley expressed particular concern about the U.S.’s reliance on Taiwan-origin chips, in light of the possibility of a Chinese invasion of Taiwan.
Some witnesses, however, provided comfort by emphasizing the leadership of the U.S. and its allies in the AI sector. When asked about the AI capabilities of U.S. adversaries, Professor Russell indicated that the U.S., the UK, and Canada currently have the most advanced AI technology in the world whereas, in his view, China’s capabilities have been “slightly overstated.” While he acknowledged China’s extensive investments in AI and its strength in voice and face recognition technology, he suggested that numerical publication requirements on China’s academic sector have limited the country’s ability to produce technological breakthroughs.
c. Privacy
Several senators raised the potential privacy risks that could result from the deployment of AI, often invoking Congress’s perceived failure to address the privacy implications of social media proactively to emphasize an urgent need for AI guardrails. Ranking Member Hawley pointed out that these privacy concerns, if left unchecked, could exacerbate other alleged risks if, for example, an AI program gained access to voter files and used them to target certain voters with misinformation.
Senator Marsha Blackburn (R-TN) stressed her view that the U.S. is “behind” its allies on issues of online consumer privacy, pointing to the digital privacy regimes of the EU, UK, New Zealand, Australia, and Canada as examples. Specifically, she expressed concern that consumers’ personal data was being used to train AI systems, often without their knowledge. Senator Blackburn queried whether a federal privacy standard would help address this concern without interfering with the U.S.’s position as a global leader in generative AI. Professor Russell supported a federal standard, including an absolute requirement to disclose whether systems are harvesting data from users’ conversations.
Mr. Amodei pointed to his own company as an example of how to navigate these concerns, explaining that it relies primarily on publicly available information to train its AI and that the program is trained not to produce results containing certain types of private information.
d. Intellectual Property
Senator Blackburn emphasized the profound impact that unregulated AI could have on the creative sector, suggesting that AI is “robbing [authors, actors, and musicians] of their ability to make a living off of their creative work.” Senator Blackburn queried whether artists whose artistic creations are used to train algorithms are or will be compensated for the use of their work. Professor Russell agreed that existing intellectual property laws may not always be sufficient to address these concerns.
III. Key Regulatory Proposals
As indicated by the hearing’s title, “Principles for Regulation,” the lawmakers and witnesses focused not just on potential risks associated with AI but also with concrete policy measures that could mitigate these risks.
At the end of the hearing, Ranking Member Hawley asked each witness for “one or two recommendations for what Congress should do right now” to regulate the AI industry.
- Professor Russell would establish a federal agency tasked with regulating the AI sector. He would also remove from the market any AI systems that violate a designated set of “unacceptable” behaviors associated with the risks and alleged harms discussed above. Professor Russell described this latter recommendation as creating not just positive effects for consumer protection but also as incentivizing companies to conduct rigorous research and testing to ensure their products are effective and controllable before putting them on the market.
- Professor Bengio would invest in the safety of AI systems, both at the levels or hardware and cybersecurity measures, through a mix of direct investments and incentives for companies. Professor Bengio emphasized that U.S. investment in AI safety should be “at or above the level of investment” that goes into developing AI programs.
- Mr. Amodei would develop rigorous testing and auditing regimes for the AI sector, stressing that “without such testing, we’re blind” to the capabilities and future risks that AI may pose. He also reiterated the importance of an enforcement mechanism for these measures, although he was agnostic on whether that should come from a new federal agency or from existing authorities.
Beyond these high-level recommendations, the subcommittee and witnesses discussed the following regulatory and legislative measures: (a) a potential AI federal agency and auditing regime, (b) labeling and watermarking requirements for information generated by AI, (c) limitations on the release of pre-trained, open source AI models, and (d) the creation of private rights of action authorizing lawsuits against AI companies.
e. AI Federal Agency
Building on conversations from the subcommittee’s May 19, 2023 hearing, the lawmakers and witnesses discussed the possibility of a new federal agency focused on regulating AI, with Chair Blumenthal stating that he had “come to the conclusion that we need some kind of regulatory agency” focused on AI. Chair Blumenthal stressed that this should not be a “passive body” and should instead invest proactively in research to develop countermeasures that can effectively address potential AI risks.
While Chair Blumenthal was the only subcommittee member whose questions focused expressly on the creation of a new federal agency, the witnesses voiced support for the idea throughout the hearing. Noting the rapid development of new AI technology, Professor Bengio observed that legislation alone will be insufficient to mitigate against future AI risks. “We don’t know yet” what regulations might be necessary in one, two, or three years, Professor Bengio commented, and “having an agency is a tool toward [the] goal” of responding agilely to evolving technology. Mr. Amodei also agreed with Chair Blumenthal that this new agency should play a proactive role in researching countermeasures, rather than simply responding to new risks. Mr. Amodei stressed that centralizing research efforts in a new agency, or even through the Department of Commerce’s National Institute of Standards and Technology (NIST) would allow the U.S. to create consistent standards against which to measure risks and benefits associated with AI.
The witnesses believed that one centralized agency focused on AI would provide benefits beyond streamlined domestic implementation of AI regulation. For example, Professor Bengio was of the view that a single agency could better coordinate with the U.S.’s international allies, allowing the U.S. to speak with a single voice while advocating for global standards.
The witnesses emphasized, however, that a federal agency will not, by itself, be sufficient to tackle AI-related risk. Professor Russell observed that “no government agency” will be able to match the tremendous resources—which he estimated at more than $10 billion—that the private sector invests in the creation of AI systems. He suggested that his proposal for involuntary recall provisions could bridge this gap by incentivizing robust testing of AI models by the private sector before these models are released commercially.
f. Labeling and Watermarking Requirements
One of the most frequently mentioned methods of tackling AI-generated misinformation was a regime of labeling and watermarking materials produced by an AI system. As Mr. Amodei and Professor Russell explained, labeling requirements would require as a matter of policy that AI outputs be clearly labeled as produced by AI wherever they are published; watermarking, on the other hand, is a technical measure by which the provenance of both original and AI-generated content can be established. Professor Russell emphasized the need for international coordination to avoid fragmented enforcement, suggesting the creation of an encrypted global escrow system capable of verifying the provenance of any piece of media uploaded to the system.
Chair Blumenthal noted a growing bipartisan consensus on this issue and stressed that labeling and watermarking would be necessary to address election-related misinformation. Senator Klobuchar likewise pointed out that her recently introduced REAL Political Advertisement Act would require election materials produced by AI to be labeled as such.[4]
g. Limitations on Open-Source Model Releases
All three witnesses raised concerns related to the availability to the public of pre-trained open source AI models, because, as Mr. Amodei observed, “when a model is released in an uncontrolled manner, there is no ability to [control it.] It is entirely out of your hands.” This prompted discussion of whether open source AI should be restricted in any way.
Despite the tremendous benefit open source programs may offer in scientific fields, Professor Bengio warned that these could open the door for exploitation by malicious actors who would not otherwise have the technical expertise and computing power necessary to create their own models. He observed that many of these open source systems were being developed at universities and proposed the creation of ethics review boards for university AI programs that could ensure future releases are carefully evaluated for potential risks before they are released. Professor Russell also suggested that “the open source community” may need to face some form of liability “for putting stuff out there that is ripe for misuse.”
h. Private Rights of Action Against AI Companies
The subcommittee and its witnesses focused not just on the legal frameworks necessary to protect against AI-related risk but also on mechanisms for enforcing these laws.
One key enforcement mechanism highlighted by Ranking Member Hawley was the private right of action authorized by the “No Section 230 Immunity for AI Act” that he recently introduced alongside Chair Blumenthal.[5] Ranking Member Hawley described this as an important mechanism to allow Americans to vindicate their privacy rights in court. Specifically, the bill would allow civil actions—as well as criminal prosecutions—“if the conduct underlying the claim or charge involves the use or provision of generative artificial intelligence.”[6]
IV. How Gibson Dunn Can Assist
Gibson Dunn’s Public Policy, Artificial Intelligence, and Privacy, Cybersecurity and Data Innovation Practice Groups are closely monitoring legislative and regulatory actions in this space and are available to assist clients through strategic counseling; real-time intelligence gathering; developing and advancing policy positions; drafting legislative text; shaping messaging; and lobbying Congress. Gibson Dunn also offers holistic support representing our clients in, and ensuring our clients are prepared to respond effectively to, any civil, criminal, or congressional investigations or litigation relating to the development and/or deployment of AI systems.
___________________________
[1] Oversight of A.I.: Principles for Regulation: Hearing Before the Subcomm. on Privacy, Tech., and the Law of the S. Comm. on the Judiciary, 118th Cong. (2023), https://www.judiciary.senate.gov/committee-activity/hearings/oversight-of-ai-principles-for-regulation.
[2] No Section 230 Immunity for AI Act, S. 1993, 118th Cong. (2023).
[3] See Press Release, Fact Sheet: Biden-Harris Administration Secures Voluntary Commitments from Leading Artificial Intelligence Companies to Manage the Risks Posed by AI, The White House (Jul. 21, 2023), https://www.whitehouse.gov/briefing-room/statements-releases/2023/07/21/fact-sheet-biden-harris-administration-secures-voluntary-commitments-from-leading-artificial-intelligence-companies-to-manage-the-risks-posed-by-ai/.
[4] Real Political Advertisements Act, S. 1596, 118th Cong. (2023).
[5] No Section 230 Immunity for AI Act, S. 1993, 118th Cong. (2023).
[6] Id.
The following Gibson Dunn lawyers prepared this client alert: Michael Bopp, Roscoe Jones, Jr., Vivek Mohan, Cassandra Gaedt-Sheckter, Amanda Neely, Daniel Smith, and Sean Brennan.
Gibson, Dunn & Crutcher’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, the authors, or any of the following in the firm’s Public Policy, Artificial Intelligence, or Privacy, Cybersecurity & Data Innovation practice groups:
Public Policy Group:
Michael D. Bopp – Co-Chair, Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Roscoe Jones, Jr. – Co-Chair, Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, aneely@gibsondunn.com)
Daniel P. Smith – Washington, D.C. (+1 202-777-9549, dpsmith@gibsondunn.com)
Artificial Intelligence Group:
Cassandra L. Gaedt-Sheckter – Co-Chair, Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)
Vivek Mohan – Co-Chair, Palo Alto (+1 650-849-5345, vmohan@gibsondunn.com)
Eric D. Vandevelde – Co-Chair, Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Frances A. Waldmann – Los Angeles (+1 213-229-7914, fwaldmann@gibsondunn.com)
Privacy, Cybersecurity and Data Innovation Group:
S. Ashlie Beringer – Co-Chair, Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Jane C. Horvath – Co-Chair, Washington, D.C. (+1 202-955-8505, jhorvath@gibsondunn.com)
Alexander H. Southwell – Co-Chair, New York (+1 212-351-3981, asouthwell@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 July 31, 2023, the European Commission (the “Commission”) adopted the first set[1] of European Sustainability Reporting Standards (the “ESRSs”)[2] for use by all entities subject to the Corporate Sustainability Reporting Directive (the “CSRD”)[3]. The ESRSs are now subject to a two month scrutiny period (extendable by up to two months), during which the European Parliament and the Council of the European Union (“EU”) may approve (in its entirety) or reject the ESRSs. If approved, the ESRSs will apply, in the first instance, to companies that are already subject to the EU’s non-financial reporting framework (based on the Non-Financial Reporting Directive (the “NFRD”)[4]) for reporting periods beginning January 1, 2024: namely, so-called “large” EU undertakings exceeding an average of 500 employees during the financial year that either have securities admitted to an EU-regulated market or are regulated financial entities (e.g., banks or insurance companies). The CSRD and the ESRSs will be phased-in for other categories of entities, including companies outside the EU, over the next five years.
The ESRSs now provide a detailed basis for in-scope entities to begin to assess their potential reporting obligations, including assessing which aspects are material under the new, broad “double materiality” standard of the CSRD, looking both at the impact of the company (inside-out) as well as the financial impact on the company (outside-in). Such analysis will allow companies to undertake the requisite due diligence on material topics and integrate changes to their reporting process. Effective implementation will require substantial resources and a thorough analysis of the ESRSs and the CSRD reporting obligations resulting thereof.
In this alert, we provide context and an overview of the 12 standards in the first set of ESRSs, along with a review of key changes as compared to earlier ESRSs drafts.
Background
The CSRD came into force on January 5, 2023, and the Commission mandates that each EU member state implement the CSRD into national law by July 6, 2024. The CSRD extends the scope of non-financial reporting under the NFRD to include sustainability reporting and requires such disclosures from an expanded range of entities, including large companies, listed small and medium-sized companies (“SMEs”) and even non-EU parent companies of such in-scope companies, and certain branches. The NFRD’s requirements remain in force until companies have to comply with the national laws implementing the CSRD. More detailed discussions of the CSRD, including its impact for non-EU entities with a significant presence in the EU, can be found in our client alert available here.
The CSRD, as a directive, requires the Commission to develop standards for what a reporting entity must disclose about its material impacts, risks and opportunities in relation to certain environmental, social and governance (“ESG”) matters. In accordance with the CSRD, the ESRSs are based on draft standards developed by EFRAG (previously known as the European Financial Reporting Advisory Group), a non-profit organization dedicated to the advancement and advocacy of European perspectives in financial and sustainability reporting.
EFRAG submitted its first draft ESRSs to the Commission on November 22, 2022 (the “Draft ESRSs”).[5] The Draft ESRSs were developed based on input that EFRAG had received from public consultation on exposure drafts of the ESRSs developed from April to August 2022.[6] Following EFRAG’s submission of the Draft ESRSs, the Commission carried out further consultations leading to the publication for consultation of the first set of Draft ESRSs for a four-week public feedback period from June 9 to July 7, 2023.
The consultation process confirmed that the Draft ESRSs broadly met the CSRD’s mandate. However, various stakeholders drew attention to potential issues with the Draft ESRSs, including the challenging nature of disclosure requirements against a backdrop of limited primary source data and the lack of coherence between disclosures under the ESRSs and the disclosure obligations under other European regulations including the Sustainable Finance Disclosure Regulation or ‘SFDR,’ the Benchmarks Regulation and the Capital Requirements Regulation (cumulatively, the “Financial Regulations”).[7]
The Commission made a number of modifications to the Draft ESRSs in response to this feedback. The Commission published and adopted their final version of the ESRSs on July 31, 2023.
Overview of First Set of ESRSs
The first 12 standards in the ESRSs include two “cross-cutting” standards that apply across all ESG topics and 10 topical standards divided across ESG matters. Compared to the Draft ESRSs, the final set of ESRSs reflect a reduction in both the number of disclosure requirements (from 136 to 84) and the number of qualitative and quantitative data points (from 2,161 to 1,144).
“Cross-Cutting” Standards
ESRS 1 General Requirements
ESRS 2 General Disclosure
Environmental Standards
ESRS E1 Climate Change
ESRS E2 Pollution
ESRS E3 Water and Marine Resources
ESRS E4 Biodiversity and Ecosystems
ESRS E5 Resource Use and Circular Economy
Social Standards
ESRS S1 Own Workforce
ESRS S2 Workers in the Value Chain
ESRS S3 Affected Communities
ESRS S4 Consumers and End-Users
Governance Standards
ESRS G1 Business conduct
The ESRSs include descriptions of the disclosure requirements under each standard. For example, for the disclosure requirement related to ESRS 2’s integration of sustainability-related performance in incentive schemes, the ESRSs state that reporting entities shall disclose whether and how climate-related considerations are factored into the renumeration of members of the administrative, management and supervisory bodies, including any assessment against GHG emissions reductions targets.
Another example includes the disclosure requirements under ESRS E1’s transition plan for climate change mitigation. The ESRSs instruct reporting entities to disclose their transition plans, including explanations of how it’s targets are compatible with the limiting of global warming to 1.5°C in line with the Paris Agreement and explanations of the decarbonization levers identified, and key actions planned, including changes in the reporting entity’s product and service portfolio and the adoption of new technologies in its own operations, or the upstream and/or downstream value chain.
Key Changes from the Draft ESRSs
The Commission received 604 comments and pieces of feedback on the Draft ESRSs. The top five categories of respondents were companies (26.66%), business associations (24.17%), non-governmental organizations (“NGOs”) (14.07%), EU citizens (13.25%) and others (10.60%) and the top five countries where respondents provided feedback were Germany (18%), Belgium (17%), Netherlands (13%), France (10%) and the United Kingdom (5%).[8]
The Commission responded to stakeholder feedback with the following modifications in the ESRSs:[9]
Most Disclosures Limited by Materiality (But Double Materiality Standard Retained)
The Draft ESRSs would have required companies to report on the following standards regardless of whether they were material to their business: the “Climate Change” standard (ESRS E1), certain data points under the “Own Workforce” standard (ESRS S1) for companies with more than 250 employees, and certain data points that correspond to information required by the Financial Regulations.
The ESRSs will now only mandate that all reporting companies to address the “General Disclosure” standard (ESRS 2). Otherwise, all other standards, disclosure requirements and data points must only be disclosed if they are assessed to be material[10] to the company.
The Commission expects these changes will lessen the burden of implementing and complying with the ESRSs by requiring companies to focus on those ESG impacts, risks and opportunities that are material.[11] However, companies should not underestimate the potential reporting burden and compliance costs presented by this approach. The ESRSs’ “double materiality” standard for assessing materiality (taken from the CSRD) represents for many reporting entities, a significant departure from the investment-decision-based or financial materiality tests under U.S. securities law and other reporting standards.
Double materiality assesses matters from two perspectives: (1) an ‘inside-out’ impact perspective, meaning a company’s actual or potential impact on people or the environment; and (2) an ‘outside-in’ financial perspective, meaning how social and environmental issues create financial risks and opportunities for the company. Matters that are material under one or both of these standards must be disclosed. Notably, companies will not be making these determinations in a vacuum, as materiality assessments are subject to external, third-party assurance in accordance with the CSRD.[12] When certain matters are determined to be immaterial, the company must also affirmatively state that determination and its analysis in its reports.
For example, a reporting entity is required to provide a thorough explanation if it concludes that the “Climate Change” standard (ESRS E1) is not a material topic for its business. In a similar vein, if a reporting entity concludes that a certain data point corresponding to information required by the Financial Regulations is not material, it must explicitly state that the data point is “not material.” The ESRSs also indicate that reporting entities should include a table in their disclosures with all such data points, with either the location of the data point in the report or stating it is “not material,” as applicable.
The Commission asked EFRAG to prepare additional guidance on the ESRSs for reporting entities, including on the materiality assessment.[13] During its August 23, 2023 public session, EFRAG will provide an update on the first draft “EFRAG Implementation Guidance and FAQ” regarding the materiality assessment and value chain. In addition, EFRAG will consider responses from the Commission’s four-week public feedback period on the Draft ESRSs to identify priority areas for further guidance. EFRAG will also soon have a place on its website for stakeholders to submit ESRSs application questions.[14]
Additional Phase-In Requirements
The Commission included further phase-ins, in addition to those provided in the Draft ESRSs, to support applicable reporting entities in transitioning from existing methodologies or frameworks to the ESRSs. Under these phase-ins:
- Reporting entities with fewer than 750 employees may omit:
- for its first year of applying the ESRSs – Scope 3 GHG emissions data (included in ESRS E1) and the disclosure requirements specified in the “Own Workforce” standard (ESRS S1), and
- for its first two years of applying the ESRSs – the requirements in the standards on Biodiversity and Ecosystems (ESRS E4), Workers in the Value Chain (ESRS S2), Affected Communities (ESRS S3) and Consumers and End-Users (ESRS S4).
- All reporting entities (regardless of the number of employees) may omit, for the first year of applying the ESRSs:
- financial effects related to non-climate environmental issues, such as Pollution (ESRS E2), Water (ESRS E2), Biodiversity (ESRS E4) and Resource Use (ESRS E5), and
- certain data points related to their own workforce (ESRS S1) (social protection, persons with disabilities, work-related ill-health, and work-life balance).
Desired Interoperability with Global Standard Setting Initiatives
Comments to the Draft ESRSs raised concerns that the standards would not be consistent with the EU’s sustainability ambitions and other pieces of sustainability legislation, and did not ensure the interoperability of global standards such that companies could use the same sustainability-related information for multiple legislations or standards. The Commission noted that it worked to ensure a “very high degree of interoperability” among the ESRSs, the global reporting framework under development by the International Sustainability Standards Board (the “ISSB”) and the Global Reporting Initiative (“GRI”). The ESRSs were also created in parallel with the first two standards under the ISSB, IFRS S1 and IFRS S2, which were published on June 26, 2023. The Commission, EFRAG and the ISSB discussed the standards at length in an effort to provide a high degree of alignment where the standards overlap. For example, companies that are required to disclose under the requirements of the “Climate Change” standard (ESRS E1) of the ESRSs are expected, to a large degree, to be able to report the same information under the ISSB climate-related disclosures (IFRS S1).
While the ESRSs and the ISSB standards are built on existing reporting frameworks, including the Task Force on Climate-Related Financial Disclosures (“TCFD”)[15], it is important to note that the ESRSs and the ISSB requirements are not interchangeable, so if and when the ISSB Sustainability Standards come to be adopted by national regulators, reporting entities will need to review each set of standards to confirm that all requirements are being applied and met.
The ESRSs’ anticipated adoption of the CSRD’s double materiality standard[16] is a principal area of divergence from the ISSB’s financial materiality standard. While the ESRSs use the broad double materiality standard discussed above, the ISSB standard is modeled on the financial materiality standard used by the IFRS international accounting standards: that information is material if its omission, obfuscation or misstatement could be reasonably expected to impact investor decisions. This reflects in part the purpose of each standard. ISSB intends to address the needs of financial stakeholders (e.g., investors and lenders) for a global ESG reporting framework while the CSRD and ESRSs intend to address the needs of a broader range of stakeholders, including investors, NGOs, trade unions, civil society organizations, consumers, community and value chain and indeed when undertaking their materiality assessment for CSRD purposes, reporting entities are required to consult with their broader base of stakeholders.
EFRAG has created a TCFD recommendations and Draft ESRSs reconciliation table and they are working on a mapping table that includes requirements for each of the ESRSs and the ISSB standards. The TCFD/ESRSs reconciliation table and the draft version of the ESRSs/ISSB table are available on their website.
Expanded Voluntary Disclosures and Further Reporting Options
Although the Draft ESRSs included several voluntary data points, the Commission included even more in the ESRSs by converting a limited number of reporting requirements from mandatory to voluntary. These modifications included, for example, biodiversity transition plans, specific indicators related to “non-employees” in the reporting entity’s own workforce and an explanation as to why a particular sustainability topic is not material.
The Commission also introduced certain flexibilities for disclosure against some mandatory data points instead of converting them to voluntary data points. For example, there are additional flexibilities in the disclosure requirements on the financial effects stemming from sustainability risks and engagement with stakeholders, as well as in the methodology used for the materiality assessment process.[17] Furthermore, the Commission modified the data points concerning corruption and bribery, as well as the protection of whistle-blowers, which the Commission was concerned could be perceived as impairing the right to refrain from self-incrimination.[18]
Final Approval Pending
In the second half of August 2023, the ESRSs will be formally transmitted to the European Parliament and to the Council of the EU for a two month scrutiny period (extendable by up to two months). The European Parliament and the Council of the EU may approve (in its entirety) or reject the ESRSs, but neither can amend it. If approved by the European Parliament and the Council of the EU, the ESRSs may apply for some companies as early as January 1, 2024 (for reporting in 2025).
Reporting obligations for in scope companies begin as early as the 2024 reporting period. Companies or reporting entities that fall within the scope of the CSRD need to review these standards to begin assessing potential reporting obligations and compliance costs.
What’s Next
In the ESRSs, the Commission responded to feedback and reduced the weight of the reporting burden by allowing reporting entities to focus more on meaningful materiality assessments and the quality of disclosures. However, the ESRSs have received a mix reception from the market. Various stakeholder groups, including some groups of investors[19], have bemoaned the dilution introduced by the Commission in the ESRSs. Despite these complaints, it is expected that stakeholders will benefit in the mid-longer term if material reliable disclosures are made by reporting entities.
In addition to developing guidance to support companies disclosing against the standards, EFRAG has been tasked with developing sector-specific standards. First drafts of standards for eight sectors are already up and running. The CSRD requires the Commission to adopt additional sets of ESRSs by June 2024, including at least eight sector-specific standards, proportionate standards for listed SMEs and standards for non-EU companies. EFRAG is currently developing draft sector-specific standards from the following sectors: (1) Oil and Gas, (2) Coal, Quarries and Mining, (3) Road Transport, (4) Agriculture Farming and Fisheries, (5) Motor Vehicles, (6) Energy Production and Utilities, (7) Good and Beverages and (8) Textiles, Accessories, Footwear and Jewelry. Any decisions taken to start new sector work will be published on EFRAG’s website.[20] The final work stream in relation to the development of standards will be the formation of specific standards for reporting at the level of non-EU company parent companies, which will commence for financial year 2028 (for reporting in 2029).
_________________________
[1] The CSRD requires the Commission to adopt a second set of sustainability reporting standards by June 30, 2024, specifying sector-specific standards, standards for small and medium sized enterprises and to take account of the development of international standards.
[2] Commission Delegated Regulation supplementing Directive 2013/34/EU as regards sustainability reporting standards (available here), including Annex 1 (available here) and Annex 2 (available here).
[3] Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, available here.
[4] Accounting Directive by Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, available here.
[5] Draft Commission Delegated Regulation supplementing Directive 2013/34/EU as regards sustainability reporting standards (available here), including Draft Annex 1 and Draft Annex 2.
[6] Exposure drafts of the ESRSs are published on EFRAG’s website, available here.
[7] All comments and feedback on the Draft ESRSs are published on the European Commission website, available here.
[8] The European Commission, Total of valid feedback instances received: 604, available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13765-European-sustainability-reporting-standards-first-set/feedback_en?p_id=32180832.
[9] Additional information can be found in our client alert “European Union’s Corporate Sustainability Reporting Directive — What Non-EU Companies with Operations in the EU Need to Know,” accessible at the following link.
[10] EFRAG is developing additional guidance on the materiality assessment, the process to determine material matters and material information. Additional information is below.
[11] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.
[12] Under the CSRD, the Commission must adopt legislation requiring independent assurance of sustainability reports and metrics by a third-party auditor. This has the goal of raising the quality of sustainability reporting to the same level as financial reporting. See Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, starting at point sixty (60) of Article 1, available here.
[13] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.
[14] EFRAG, Press Release, EFRAG Welcomes the Adoption of the Delegated Act on the First Set of European Sustainability Reporting Standards (ESRS) by the European Commission(July 31, 2023), available at efrag.org/News/Public-439/EFRAG-welcomes-the-adoption-of-the-Delegated-Act-on-the-first-set-of-E.
Sustainability Reporting Standards, EFRAG Sector Specific ESRS, available at https://www.efrag.org/lab5.
[15] In addition to the TCFD, the ESRSs and ISSB standards are built on existing frameworks from the Sustainability Accounting Standards Board (SASB) and Climate Disclosure Standards Board (CDSB).
[16] Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, at point twenty-nine (29) of Article 1, available here.
[17] An example of the additional flexibilities is included in General Disclosure (ESRS 2): disclosure of “the undertaking’s understanding of the interests and views of its key stakeholders” –”key” added.
[18] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.
[19] See, Better Finance (The European Federation of Investors and Financial Services Users), Diluted European Sustainability Reporting Standards Raise Greenwashing Concerns (August 7, 2023), available here; World Wildlife Fund for Nature (WWF), EU Commission undermines standards for sustainability reporting (July 31, 2023), available here; Reuters, EU confirms watering down of corporate sustainability disclosures (August 1, 2023), available here.
[20] EFRAG Sustainability Reporting Standards, EFRAG Sector Specific ESRS, available at https://www.efrag.org/lab5.
The following Gibson Dunn lawyers prepared this client update: Elizabeth Ising, Cynthia Mabry, Sarah Phillips, Selina S. Sagayam, Ferdinand M. Fromholzer, David Woodcock, Robert Spano, Judith Raoul-Bardy, and Lauren M. Assaf-Holmes.
Gibson Dunn 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, the authors, or any of the leaders and members of the firm’s Environmental, Social and Governance (ESG) or Securities Regulation and Corporate Governance practice groups:
Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Ferdinand Fromholzer – Munich (+49 89 189 33 170, ffromholzer@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Cynthia M. Mabry – Houston (+1 346-718-6614, cmabry@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, popenshaw@gibsondunn.com)
Judith Raoul-Bardy – Paris (+33 (0) 1 56 43 13 00, jraoul@gibsondunn.com)
Selina S. Sagayam – London (+44 20 7071 4263, ssagayam@gibsondunn.com)
Robert Spano – London/Paris (+44 20 7071 4902, rspano@gibsondunn.com)
David Woodcock – Dallas (+1 214-698-3211, dwoodcock@gibsondunn.com)
Securities Regulation and Corporate Governance Group:
Aaron Briggs – San Francisco (+1 415-393-8297, abriggs@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com)
Julia Lapitskaya – New York (+1 212-351-2354, jlapitskaya@gibsondunn.com)
James J. Moloney – Orange County (+1 949-451-4343, jmoloney@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, mscanlon@gibsondunn.com)
Michael Titera – Orange County (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – 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.
Decided August 21, 2023
Raines v. U.S. Healthworks Medical Group, S273630
This week, the California Supreme Court held that a business entity acting as an agent of an employer may be held directly liable as an “employer” for alleged violations of California’s Fair Employment and Housing Act.
Background: Plaintiffs Kristina Raines and Darrick Figg were job applicants who received offers of employment contingent upon passing a medical screening. The screening included a detailed health history questionnaire that the applicants were required to complete.
These pre-employment screenings were not conducted by the plaintiffs’ prospective employers, but instead by third-party occupational health services providers. Plaintiffs sued these providers on behalf of a putative class, alleging that the questions were intrusive and overbroad in violation of California’s Fair Employment and Housing Act, or the FEHA. Plaintiffs sued in state court, and the providers removed the case to federal court.
The FEHA generally precludes “any employer or employment agency” from “requir[ing] a medical or physical examination” of a job applicant. Cal. Gov’t Code § 12940(e)(1). It does, however, allow employers to require such examinations of a “job applicant after an employment offer has been made,” so long as the examination is “job related and consistent with business necessity.” Id. § 12940(e)(3). The statute elsewhere defines “employer” as “any person regularly employing five or more persons, or any person acting as an agent of an employer, directly or indirectly.” Id. § 12926(d).
The providers argued that even if they were “agents” of the plaintiffs’ prospective employers, agents could not be held directly liable for FEHA violations separately from their employer-principals. The district court agreed. On appeal, the Ninth Circuit observed the significance of the issue on employment litigation throughout the state, and that the California Supreme Court had previously reserved judgment on the issue in Reno v. Baird, 18 Cal. 4th 640 (1998). The Ninth Circuit accordingly certified the question of an agent’s direct liability under the FEHA to the California Supreme Court.
Issue: California’s Fair Employment and Housing Act defines “employer” as “any person regularly employing five or more persons, or any person acting as an agent of an employer.” Can a business acting as an agent of an employer be held directly liable for employment discrimination?
Court’s Holding:
Yes. Businesses with at least five employees that carry out FEHA-regulated activities as an agent of an employer may be held directly liable for employment discrimination under the FEHA.
“[W]e conclude that legislative history, analogous federal court decisions, and legislative policy considerations all support the natural reading of [the FEHA] advanced here, which permits business-entity agents to be held directly liable for FEHA violations in appropriate circumstances.”
Justice Jenkins, writing for the Court
What It Means:
- By interpreting the FEHA’s definition of “employer” to include an employer’s agents in a manner beyond simply incorporating the ordinary principles of respondeat superior, the opinion opens up businesses acting as agents to potential FEHA litigation that was otherwise not clearly available to employees under the statute.
- Still, the California Supreme Court clarified that its decision was limited to answering the specific question posed by the Ninth Circuit: “whether a business-entity agent may ever be held directly liable under the FEHA.” The court therefore declined to “identify the specific scenarios” in which a business-entity agent could face direct liability under the statute. And it stated that it was not ruling on the “significance, if any,” of the degree of employer control over the agent’s acts on the ultimate question of liability.
- The court observed that a large business acting as an agent, like the screening providers, may have the bargaining power either “to avoid contractual obligations that will force it to violate the FEHA” or to secure agreements from employers to indemnify it for any FEHA liability. But the court left open the question whether businesses acting as agents and having fewer than five employees could be held directly liable for FEHA violations.
The Court’s opinion is available here.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the California Supreme Court. Please feel free to contact the following practice leaders:
Appellate and Constitutional Law Practice
| Thomas H. Dupree Jr. +1 202.955.8547 tdupree@gibsondunn.com |
Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com |
Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com |
| Blaine H. Evanson +1 949.451.3805 bevanson@gibsondunn.com |
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com |
Michael J. Holecek +1 213.229.7018 mholecek@gibsondunn.com |
Related Practice: Labor and Employment
| Jason C. Schwartz +1 202.955.8242 jschwartz@gibsondunn.com |
Katherine V.A. Smith +1 213.229.7107 ksmith@gibsondunn.com |
Related Practice: Litigation
| Theodore J. Boutrous, Jr. +1 213.229.7804 tboutrous@gibsondunn.com |
Theane Evangelis +1 213.229.7726 tevangelis@gibsondunn.com |