Richard Manfredi, Author at Gibson Dunn

As many countries continue to loosen COVID-19 related restrictions, lawmakers and regulators around the world face corruption challenges accompanying renewed economic activity and aggressive market expansion, while starting to address the unique bribery and corruption cases that arose during a near-global shutdown that was accompanied by record levels of government spending. This webcast will explore the approach taken by emerging markets in addressing these challenges and examine the trends seen in FCPA and local anti-corruption enforcement actions.

PANELISTS:

Kelly Austin leads Gibson, Dunn & Crutcher’s White Collar Defense and Investigations practice for Asia, is a global co-chair of the Firm’s Anti-Corruption & FCPA practice, and is a member of the Firm’s Executive Committee. Ms. Austin is ranked annually in the top-tier by Chambers Asia Pacific and Chambers Global in Corporate Investigations/Anti-Corruption: China. Her practice focuses on government investigations, regulatory compliance and international disputes. Ms. Austin has extensive expertise in government and corporate internal investigations, including those involving the FCPA and other anti-corruption laws, and anti-money laundering, securities, and trade control laws.

Joel M. Cohen is a partner in Gibson Dunn & Crutcher’s New York office and Co-Chair of the firm’s global White Collar Defense and Investigations Practice Group. Mr. Cohen’s successful defense of clients has been noted in numerous feature articles in the American Lawyer and the National Law Journal, including for pretrial dismissal of criminal charges and trial victories. He is highly-rated in Chambers and named by Global Investigations Review as a “Super Lawyer” in Criminal Litigation. He has been lead or co-lead counsel in 24 civil and criminal trials in federal and state courts, and he is equally comfortable in leading confidential investigations, managing crises or advocating in court proceedings. Mr. Cohen’s experience includes all aspects of FCPA/anticorruption issues, in addition to financial institution litigation and other international disputes and discovery.

Benno Schwarz is a partner in the Gibson, Dunn & Crutcher Munich office and Co-Chair of the firm’s Anti-Corruption & FCPA Practice Group, where his practice focuses on white collar defense and compliance investigations. Mr. Schwarz is ranked annually as a leading lawyer for Germany in White Collar Investigations/Compliance by Chambers Europe and was named by The Legal 500 Deutschland 2021 and The Legal 500 EMEA 2021 as one of four Leading Individuals in Internal Investigations, and also ranked for Compliance. He is noted for his “special expertise on compliance matters related to the USA and Russia.” Mr. Schwarz advises companies on sensitive cases and investigations involving compliance issues with international aspects, such as the implementation of German or international laws in anti-corruption, money laundering and economic sanctions, and he has exemplary experience advising companies in connection with FCPA and NYDFS monitorships or similar monitor functions under U.S. legal regimes.

Patrick Stokes is a partner in Gibson, Dunn & Crutcher’s Washington, D.C. office. He is the Co-Chair of the Anti-Corruption and FCPA Practice Group and a member of the firm’s White Collar Defense and Investigations, Securities Enforcement, and Litigation Practice Groups. Mr. Stokes’ practice focuses on internal corporate investigations, government investigations, enforcement actions regarding corruption, securities fraud, and financial institutions fraud, and compliance reviews. He has tried more than 30 federal jury trials as first chair, including high-profile white-collar cases, and handled 16 appeals before the U.S. Court of Appeals for the Fourth Circuit. Mr. Stokes regularly represents companies and individuals before DOJ and the SEC, in court proceedings, and in confidential internal investigations.

Oliver Welch is a partner in the Hong Kong office, where he represents clients throughout the Asia Pacific region on a wide variety of compliance and anti-corruption issues and trade control laws. Mr. Welch regularly counsels multi-national corporations regarding their anti-corruption compliance programs and controls, and assists clients in drafting policies, procedures, and training materials designed to foster compliance with global anti-corruption laws. Mr. Welch frequently advises on anti-corruption due diligence in connection with corporate acquisitions, private equity investments, and other business transactions

Katharina Humphrey is a partner in Gibson, Dunn & Crutcher’s Munich office. She advises clients in Germany and throughout Europe on a wide range of compliance and white collar crime matters. Ms. Humphrey regularly represents multi-national corporations in connection with cross-border internal corporate investigations and government investigations. She also has many years of experience in advising clients with regard to the implementation and assessment of compliance management systems.

Ning Ning, an associate in the Hong Kong office, advises clients on government and internal investigations, compliance counseling, and compliance due diligence matters across the Asia-Pacific region. Ms. Ning is a native Mandarin speaker and has extensive experiences in China-related investigations and compliance matters.

Karthik Ashwin Thiagarajan, an of counsel in the Singapore office, assists clients with investigations in the financial services, information technology, electronics and fast-moving consumer goods sectors in India and Southeast Asia. He advises clients on internal investigations and anti-corruption reviews in the region. A client praised him for being “on top of his trade” in the India Business Law Journal’s 2019 “Leaders of the pack” report.

MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 2.0 credit hour, of which 2.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 2.0 hour.

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

We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q4 2022. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

PCAOB Confirms China Access as Congress Shortens HFCAA Period
PCAOB Proposes New Quality Control Standard
2023 SEC and PCAOB Budgets and Strategic Plans Finalized
PCAOB Bars Indemnification in Certain Enforcement Orders
New York State and City Employment Regulations Move Forward
FAR Council Proposes to Require GHG Emissions Reporting
Supreme Court to Address ’33 Act Standing in Direct Listings
Important Privilege Cases Heard in the European Court of Justice and Supreme Court
Monica Loseman Named to Financial Accounting Standards Advisory Council
Other Recent SEC and PCAOB Regulatory Developments

Read More

Accounting Firm Advisory and Defense Group:

James J. Farrell – Co-Chair, New York (+1 212-351-5326, [email protected])

Ron Hauben – Co-Chair, New York (+1 212-351-6293, [email protected])

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, [email protected])

Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. Please note, prior results do not guarantee a similar outcome.

On 12 January 2023, the Singapore International Commercial Court (SICC) launched a model clause for arbitration-related matters under the International Arbitration Act, confirming that parties may select the SICC as their choice of court.

The clause, which the Singapore International Arbitration Centre (SIAC) will adopt as part of its model arbitration clause,[1] reads:

“In respect of any court proceedings in Singapore commenced under the International Arbitration Act 1994 in relation to the arbitration, the parties agree (a) to commence such proceedings before the Singapore International Commercial Court (“the SICC”); and (b) in any event, that such proceedings shall be heard and adjudicated by the SICC.”

The model clause was promulgated by a Working Group which included Paul Tan, Partner in Gibson Dunn’s Singapore office. The Working Group is chaired by Justice Philip Jeyaretnam SC, the current President of the SICC.

The launch event was held at the Singapore Supreme Court, and was attended by Singapore’s Second Minister for Law Edwin Tong SC, Justice Philip Jeyaretnam SC, SAIC’s Chief Executive Officer Gloria Lim, and around 100 other leading figures in the Singapore arbitration community. It was also livestreamed to an international audience.

The SICC and its advantages to international parties

The SICC is a division of the Singapore High Court established in 2015 and has the jurisdiction to hear international commercial cases.

In general, cases can be filed directly with the SICC (if it is international in nature) or the General Division of the High Court, and the court has the power to transfer cases from the General Division to the SICC. It is also possible to select the SICC specifically in one’s jurisdiction clause. The latest model clause confirms the ability of parties to also choose the SICC to be supervisory court for international arbitrations seated in Singapore.

The SICC has been hearing an increasing number of arbitration-related matters, although they have generally been transferred from the General Division.

There are several advantages of the SICC to international parties.

First, proceedings before the SICC will be heard by judges drawn from a bench comprising Singapore judges and international judges. They include many former or sitting judges from both the civil law and common law jurisdictions. Depending on the complexity of the matter, a case may be heard before 1 or 3 judges at first instance. Matters decided by the SICC may also be appealed to the Court of Appeal, unless this has been expressly excluded.
Second, cost recovery is higher in the SICC. A recent decision by the Court of Appeal has confirmed that successful parties will be awarded their reasonable costs by reference to what has in fact incurred, in line with the practice of arbitral tribunals.[2]
Third, the procedural rules are more inline with international best practices. For example, rules on discovery follow those usually adopted in international arbitrations. In particular, it does not provide for general discovery; only specific discovery. It is also possible to either apply for or agree to the proceedings being confidential and private.
Fourth, parties in cases before the SICC may also be represented by registered foreign lawyers of their choice in “offshore cases”. Offshore cases are defined as either being governed by a law other than Singapore law, or having no other connection to Singapore other than Singapore law as the governing law.

Although arbitration-related matters are not generally considered offshore cases, where foreign law is relevant, registered foreign lawyers or legal experts are also permitted to appear as co-counsel in the SICC without parties having to file expert reports.

Last year, the SICC expanded its jurisdiction to hear restructuring and insolvency matters and also appointed Christopher Scott Sontchi, the former Chief Judge of the United States Bankruptcy Court, City of Delaware. In such matters, parties may be represented by registered foreign lawyers, save in relation to any specific Singapore law arguments.[3]

Gibson Dunn’s experience before the SICC

Gibson Dunn’s lawyers have experience representing clients in the SICC. Paul Tan, who joined Gibson Dunn’s Singapore office in November 2022, argued the first commercial trial in the SICC to reach a full judgment, and has successfully defended and challenged arbitral awards in the SICC.

____________________________

[1] https://www.sicc.gov.sg/docs/default-source/guide-to-the-sicc/sicc-siac-media-release_launch-of-the-jurisdiction-model-clause-(final).pdf

[2] Senda International Capital Ltd v Kiri Industries Ltd [2022] SGCA(I) 10

[3] https://www.sicc.gov.sg/docs/default-source/sicc-resources/media-release_new-sicc-rules-(without-contact-details)-(1).pdf

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

Paul Tan – Singapore (+65 6507 3677, [email protected])
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden KC – London (+44 (0) 20 7071 4226, [email protected])
Jeff Sullivan KC – London (+44 (0) 20 7071 4231, [email protected])
Philip Rocher – London (+44 20 7071 4202, [email protected])
Rahim Moloo – New York (+1 212-351-2413, [email protected])

For Singapore-related disputes news, you may subscribe to Paul Tan’s channel at https://t.me/singaporedisputes.

In this recorded webcast, Gibson Dunn provides an in-depth discussion of the latest trends and hot topics in internal investigations. The webcast covers recent developments around maintaining privilege during investigations – including a discussion of In re Grand Jury, which the Supreme Court has agreed to hear and that could reshape the law applicable to mixed business and legal, or “dual-purpose” communications – as well as best practices for conducting internal investigations via video-conference in a post-COVID world. We also dive deep into thorny questions of how to structure and conduct an investigation, including who at the company should be involved, how quickly investigations should be completed, what should and should not be shared with Executive Branch agencies, and when to provide separate counsel for employees. Finally, we also discuss the trends we are seeing from the government – including DOJ, SEC, FTC, Congress and state attorneys general – in terms of how they are conducting investigations and what they expect out of internal investigations.

PANELISTS:

F. Joseph Warin is chair of the 250-person Litigation Department of Gibson, Dunn & Crutcher’s Washington, D.C. office, and he is co-chair of the firm’s global White Collar Defense and Investigations Practice Group. Mr. Warin’s practice includes representation of corporations in complex civil litigation, white collar crime, and regulatory and securities enforcement – including Foreign Corrupt Practices Act investigations, False Claims Act cases, special committee representations, compliance counseling and class action civil litigation.

Michael Bopp is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher. He chairs the Congressional Investigations Subgroup and he is a member of the White Collar Defense and Investigations Crisis Management Practice Groups. He also co-chairs the firm’s Public Policy Practice Group and is a member of its Financial Institutions Practice Group. Mr. Bopp’s practice focuses on congressional investigations, internal corporate investigations, and other government investigations.

Laura Jenkins Plack is a senior associate in the Denver office of Gibson, Dunn & Crutcher. Ms. Plack is a member of the firm’s Litigation Department, with an emphasis on white collar defense and investigations and complex commercial litigation. Ms. Plack represents companies and executives in federal and state court, and before the U.S. Department of Justice, the U.S. Securities and Exchange Commission, the U.S. Federal Trade Commission, congressional committees, and various international authorities.

Reid Rector is a senior associate in the Denver office of Gibson, Dunn & Crutcher, where he is a member of the firm’s Litigation Department. His practice focuses on government investigations and litigation with DOJ, the FTC, and state attorneys general for companies in the health care and technology industries, including health care fraud and abuse investigations, data security and consumer protection investigations, and related complex civil litigation and class actions.

MCLE CREDIT INFORMATION:

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

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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

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

Under the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”; Art. 5 Art. V (2) lit. b)) and German law (Section 1059 of the German Procedural Code (“ZPO”), corresponding to Article 34 UNCITRAL Model Law), state courts are, in principle, prohibited from fully reviewing an arbitral award on the merits (prohibition of a révision au fond). German state courts can only examine whether the arbitral award violates German public policy (ordre public). The traditional standard applied in this context has been whether the recognition and enforcement was “obviously incompatible with essential principles of German law”.

Overview

While in its decision of September 27, 2022, Case No. KZB 75/21, the Cartel Senate of the German Federal Court of Justice (“BGH”) implicitly reaffirmed the jurisdiction of arbitral tribunals over alleged violations of certain antitrust provisions, it also held that arbitral awards in case of alleged violations of such provisions are subject to a full judicial review on the merits by the state courts, thus in practice diluting the general prohibition of a révision au fond. In other words, while the ruling strengthens arbitration agreements in relation to a potentially anti-competitive behavior, the German courts will review awards like they would with state court decisions to ensure compliance with German public policy. Although the BGH’s decisions was rendered in a setting aside procedure, it is very likely that it would also apply to proceedings on the recognition and enforceability of an arbitral award.

Factual Background

Respondent is the owner of a quarry leased to Claimant. Respondent terminated the lease agreement with Claimant as threatened after Claimant – contrary to Respondent’s “suggestion” – did not merge with another company. Subsequently, the German Federal Cartel Office (“BKArtA”) imposed a fine on Respondent for violating Section 21 (2) No. 1 of the German Act against Restraints of Competition (“GWB”).

Respondent, nonetheless, initiated arbitration proceedings against Claimant for eviction from the property and re-terminated the lease agreement. The arbitral tribunal in its award ruled that Claimant had to vacate the property, because the second termination validly terminated the lease. The tribunal found that the second termination did not violate Section 21 (2) No. 1 GWB.[1]

Claimant then requested before the Frankfurt Higher Regional Court to set aside the arbitral award. The Frankfurt Higher Regional Court, however, dismissed this motion (decision of April 22, 2021 – 26 Sch 12/20). It ruled that, although the provisions of Sections 19, 20, 21 GWB were part of the substantive public policy (ordre public), the arbitral award would not obviously violate antitrust provisions.

The Decision of the German Federal Court of Justice

Upon Claimant’s further appeal, the BGH ruled that an arbitration award relating to antitrust provisions is effectively subject to a full judicial review on the merits by the state courts, with regard to both the factual findings and the interpretation of antitrust law. It put forward the following reasons:

Sections 19, 20 and 21 GWB which allow the cartel authorities to prohibit (and ultimately fine) certain anti-competitive behavior are fundamental rules of the German legal system and protect not only the interests of the parties, but also the public interest of effective competition in markets for goods and services. If such fundamental rules are in question, the prohibition of a révision au fond does not apply. Thus, the recognition and enforcement of arbitral awards is excluded if Sections 19, 20, 21 of the GWB have been applied incorrectly.
Unlike in state court proceedings, in arbitration proceedings the public interest in effective competition is neither sufficiently protected by the cartel authorities and their enforcement proceedings, nor by the European Court of Justice. Only state courts are entitled to refer a matter to the ECJ to obtain its decisions on the binding interpretation of European anti-trust law. Arbitral tribunals, in contrast thereto, are not entitled to make such a referral.
Sections 19, 20, 21 of GWB require a more extensive scrutiny because such matters are regularly characterized by complex factual and legal circumstances.
A full judicial review by state courts is in line with the intention of the legislator: By eliminating the old Section 91 GWB (according to which certain contracts with anti-competitive effect were not arbitrable) in 1997, the German legislator wanted to ensure that arbitral tribunals considered violations of competition law in the same way as state courts, and that subsequently arbitral awards were fully reviewed in terms of their compliance with competition law in recognition and enforcement proceedings.

In the case at hand, this full judicial review concluded that the arbitral award had violated the German ordre public, because the arbitral tribunal had failed to apply antitrust law correctly. The termination of the lease agreement had violated Section 21 (2) GWB.

Relevance of This Ruling for Arbitration in Germany, and Further Perspectives

This ruling is the first ruling of the BGH which allows a full judicial review of arbitral awards in the case of potential violation of fundamental rules of the German legal system. This category is new and had not played any role in the recognition and enforcement of arbitral awards (both under Section 1059 ZPO and Art. 5 Art. V (2) lit. b ) in the past. Also, the BGH seems to have effectively abolished the statutory requirement that such violations have to be obvious.

It is unclear what other provisions are fundamental rules of the German legal system, or whether such rules only originate from the sphere of antitrust law; this remains to be seen in the future. In light of the murky standards the BGH seems to apply in this respect, German courts are in jeopardy to step out of line with the state courts in other jurisdictions when it comes to granting arbitral awards recognition and enforceability. However, it is also well possible that this decision of the Cartel Senate of the BGH is an “outlier”. It is difficult to imagine that the Senate of the BGH, which normally has the BGH-internal jurisdiction over the review of arbitration cases, would go as far as the Cartel Senate and dilute the prohibition of révision au found in a similar way.

_____________________________

[1] Sec. 21 (2) GWB: “Undertakings and associations of undertakings may not threaten or cause disadvantages, or promise or grant advantages, to other undertakings in order to induce them to engage in [anti-competitive] conduct…”

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

Finn Zeidler – Frankfurt (+49 69 247 411 530, [email protected])
Annekathrin Schmoll – Frankfurt (+49 69 247 411 533, [email protected])

Please also feel free to contact the following practice leaders:

International Arbitration Group:
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden KC – London (+44 (0) 20 7071 4226, [email protected])
Jeff Sullivan KC – London (+44 (0) 20 7071 4231, [email protected])

In recent years, regulatory action has been on the upswing in New York, with state and city administrative agencies and officials adopting increasingly aggressive roles in governing virtually every industry across the state. As a result, now more than ever it is essential for those working in regulated industries—whether on the legal or business side—to understand their legal options in challenging New York state and city agency rules, regulations, determinations, and other executive actions and policies. The primary vehicle for mounting such a challenge is the Article 78 action, a type of summary proceeding brought in New York State Supreme Court.

In this one-hour webcast, three of our most experienced attorneys in the field of challenging government action in New York—partners Mylan Denerstein and Akiva Shapiro, and of counsel Paul Kremer—provide practical and strategic guidance for the successful prosecution of Article 78 actions. Drawing on real-world examples from their practice, they discuss the primary strategic issues that should be considered in deciding whether to bring an Article 78 challenge (versus, for example, a suit in federal court); provide a roadmap for litigating Article 78 proceedings and keys to success; and discuss the procedural hurdles government actors often raise in defending against these actions, and ways of overcoming those hurdles. The program is beneficial to anyone working in a regulated industry or otherwise affected by actions taken by New York city and state agencies and officials, as well as for practitioners.

PANELISTS:

Mylan L. Denerstein is a litigation partner in the New York office of Gibson, Dunn & Crutcher. Ms. Denerstein is a Chair of the Public Policy Practice Group and a member of the Crisis Management, White Collar Defense and Investigations, Financial Institutions, Labor and Employment, Securities Litigation, and Appellate Practice Groups. Ms. Denerstein leads complex litigation and internal investigations, representing companies confronting a wide range of legal issues, in their most critical times. Ms. Denerstein is known not only for her effective legal advocacy, but also for her ability to solve problems. In addition, Ms. Denerstein is Global Chair of the Firm’s Diversity Committee and Co-Partner-in-Charge of the New York office. Ms. Denerstein was previously a member of the Firm’s Executive Committee. In 2022, Ms. Denerstein was appointed to serve as the independent NYPD Monitor to oversee the court ordered reform process. Previously, Ms. Denerstein has served in a wide variety of roles in government, including as Counsel to the New York State Governor, as an Executive Deputy Attorney General in the New York Attorney General’s Office, and as Deputy Commissioner for Legal Affairs for the New York City Fire Department.

Akiva Shapiro is a litigation partner in Gibson, Dunn & Crutcher’s New York office, Chair of the Firm’s New York Administrative Law and Regulatory Practice Group, Co-Chair of its Religious Liberty Working Group, and a member of the Firm’s Appellate and Constitutional Law, Media, Entertainment and Technology, and Securities Litigation Practice Groups, among others. Mr. Shapiro’s practice focuses on a broad range of high-stakes constitutional, administrative, commercial, and appellate litigation matters. He is regularly engaged in front of New York’s trial courts, federal and state courts of appeal, and the U.S. Supreme Court.

Paul J. Kremer is Of Counsel in the New York office of Gibson, Dunn & Crutcher. He is a member of Gibson Dunn’s Litigation, Intellectual Property, and Crisis Management Practice Groups, where he focuses on contract, lease, and license disputes; patent infringement cases; and state and local regulatory challenges. Mr. Kremer represents a diverse array of clients engaged in high-stakes commercial litigation, from New York City park trustees and private real estate developers to Fortune 100 technology companies and prestige television networks. In 2019, he was instrumental in defending against Article 78 challenges seeking to halt construction of the New York Islanders’ arena project.

MCLE CREDIT INFORMATION:

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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

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

On December 21, 2022, Governor Hochul signed into law Senate Bill S9427A, which amends the New York Labor Law requiring covered employers to list salary ranges in job postings and advertisements. The State law, which is scheduled to go into effect on September 17, 2023, largely tracks the New York City Pay Transparency Law that went into effect on November 1, 2022, but it has some notable differences.

Covered Employers

The law covers employers in New York with at least four employees, without specifying whether all employees, or only those employed in New York, count toward the threshold. Significantly, unlike the New York City law, independent contractors are not counted.

Covered Positions

The law applies to jobs that can or will be performed, at least in part, in New York State. The law likely covers job postings for remote positions performed from New York. However, it does not elaborate on the extent to which it applies to remote positions that could conceivably be performed from New York, even if they are ultimately performed from other states.

Employer Obligations

The law requires employers to disclose “compensation ranges” in advertisements and job postings for such positions, including those for new hires and internal promotions. The compensation range is the lowest and highest annual salary or hourly range of compensation that the employer believes in “good faith” to be accurate at the time of the advertisement or posting. For commission-based positions, employers may satisfy the disclosure requirement by stating in writing that the compensation shall be based on commission.

Unlike the City law, the State law also requires covered employers to: (1) include the job description in the posting or advertisement, if a job description exists; and (2) maintain a history of compensation ranges and job descriptions, if the descriptions exist, for covered positions. The law does not specify for how long employers must maintain these records.

The law also expressly prohibits employers from retaliating against applicants or employees who exercise their rights, including by filing a complaint with the New York State Department of Labor (NYDOL) regarding an actual or potential violation of the pay transparency requirements.

Enforcement and Penalties

The sole enforcement mechanism under the State law resides with the NYDOL, which can impose civil penalties for violations of the pay transparency requirements. NYDOL penalties are capped at one thousand dollars for an initial violation, two thousand dollars for second violations, and three thousand dollars for subsequent violations. Notably, unlike the City law, the State law does not give employers an opportunity to cure first-time violations before the imposition of any civil penalty.

The State law does not provide a private right of action for a violation. This contrasts with the City law, which permits employees (but not applicants) to file civil lawsuits against employers.

Compliance With The Patchwork of Pay Transparency Laws

New York’s law is part of a recent wave of pay transparency laws enacted at the state and local level. In addition to states like California and Colorado, localities in New York, including New York City, Albany County, Westchester County, and Ithaca, have adopted pay transparency requirements.

Significantly, the State law contains an express provision stating it shall not supersede or preempt any local laws, rules or regulations. Therefore, by way of example, employers in New York City will be required to comply with both the state and city pay transparency requirements. Employers in Westchester County, however, will likely only be covered by the State law since the Westchester pay transparency law states that it “shall be null and void on the day that State-wide legislation goes into effect” that is “either the same or substantially similar” to the local ordinance.

Key Takeaways

The State law directs the NYDOL to promulgate applicable rules and regulations, so guidance may be forthcoming. Until then, covered employers in New York State should take steps to ensure compliance with the new pay transparency requirements starting in September.

The following Gibson Dunn attorneys assisted in preparing this client update: Harris Mufson, Danielle Moss, Alex Downie, and Michael Wang.

Zainab N. Ahmad – New York (+1 212-351-2609, [email protected])

Mylan Denerstein – New York (+1 212-351-3850, [email protected])

Gabrielle Levin – New York (+1 212-351-3901, [email protected])

Danielle J. Moss – New York (+1 212-351-6338, [email protected])

Harris M. Mufson – New York (+1 212-351-3805, [email protected])

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, [email protected])

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, [email protected])

As has been the case for the last few years, 2023 will bring a variety of employment law changes for California employers. Below, we outline several new laws that require attention from California employers for the new year: (1) pay scale disclosure requirements, (2) pay data and recordkeeping requirements, (3) expanded leave protections, (4) expanded anti-discrimination and retaliation laws, (5) minimum wage increases, and (6) local and industry specific changes. California employers should review their policies and practices to evaluate whether any updates need to be made.

I. Pay Scale Disclosure Requirements

As of January 1, 2023, employers of 15 or more employees (with at least one in California) are now required to publish pay scales for open positions in any job postings, regardless of whether such postings appear on an internal or external job site.[1] The statute does not specify who qualifies as an employee for purposes of meeting the “15 or more employees” threshold, but the California Labor Commissioner interprets this requirement to mean at least one employee currently located in California.[2] Further, the pay scale must be included in the job posting “if the position may ever be filled in California, either in-person or remotely.”[3]

Additionally, all employers, regardless of their size, must provide the pay scale for an employee’s current position upon request, and must also provide a pay scale for the position to which an applicant has applied “upon reasonable request.”[4]

For additional details on these measures, and the potential penalties for failing to abide by them, see Gibson Dunn’s October 11, 2022, client alert.

II. Pay Data Report and Recordkeeping Requirements

Beginning on May 10, 2023, all employers with 100 or more employees (with at least one in California) must submit an annual pay data report to the California Civil Rights Department (previously known as the Department of Fair Employment and Housing) that is based on a “snapshot” of W-2 earnings during a single pay period from October through December of the previous calendar year.[5] Although the Department has not yet published guidance interpreting the new law, the Department’s guidance for the law’s prior iteration provides that employers are covered if they have 100 or more employees total with at least one employee in California.[6] The guidance also directs employers to include remote employees in pay data reports if the employees are assigned to a California establishment, regardless of whether they reside in California, or if the employees reside in California but are assigned to an establishment in another state.[7]

Previously, pay data reports were only required from employers with 100 or more employees who were covered by annual EEO-1 Employer Information Report requirements. These employers were permitted to submit their annual EEO-1 report to satisfy California’s pay data reporting obligations, if desired. The revised California law creates an independent obligation for employers with 100 or more employees to provide a pay data report regardless of their federal EEO-1 reporting status, and removes the option to submit an EEO-1 report in lieu of the California pay data report.[8] Practically this means that, absent an applicable exception, almost all employers of 100 or more employees with at least one employee in California will be required to create and provide both an annual EEO-1 report and a California pay data report on a yearly basis.

Employers who are required to submit a pay data report must break out the number of employees by race, ethnicity, and sex in a series of job categories, and must report the number of employees by race, ethnicity, and sex whose earnings fall within each of the pay bands prescribed in the Bureau of Labor Statistics’ Occupational Employment Statistics survey.[9] Note for employers who have previously been complying with this reporting requirement, there is a new mandate that employers identify the median and mean hourly pay rate for each combination of race, ethnicity and sex (inter-sectionally) for each job category.[10]

In addition, employers with multiple establishments must continue to submit a separate report for each establishment.[11] Employers will no longer be required to submit a consolidated report that includes all employees across establishments as the existing law required.[12]

For additional details on these measures, and the potential penalties for failing to abide by them, see Gibson Dunn’s October 11, 2022, client alert.

III. Expanded Leave Protections

A. Leave to Care for “Designated Person”

As of January 1, 2023, qualifying employees are now eligible to take leave under the California Family Rights Act (“CFRA”) and sick time under the California Labor Code to care for a “designated person.”[13] Under the CFRA, a designated person is “any individual related by blood or whose association with the employee is the equivalent of a family relationship.”[14] Under Labor Code section 245.5(c)(8), however, a designated person is any “person identified by the employee at the time the employee requests paid sick days.” Under both the CFRA and Labor Code, employers may limit employees to one designated person per 12-month period.[15]

B. Bereavement Leave

As of January 1, 2023, employers with five or more employees must provide eligible employees with at least five days of unpaid bereavement leave upon the death of the employee’s family member, defined as a spouse, child, parent, sibling, grandparent, grandchild, domestic partner or partner-in-law.[16] The five days need not be taken consecutively.[17] Eligible employees are those who have been employed for at least 30 days prior to the start of the leave, and the leave must be completed within three months of the death.[18]

IV. Expanded Anti-Discrimination and Retaliation Laws

A. Contraceptive Equity

As of January 1, 2023, the Contraceptive Equity Act prohibits employers from requiring applicants or employees to disclose information relating to reproductive health decision-making, and from discriminating against applicants or employees based on reproductive health decision-making.[19] “Reproductive health decision-making” includes but is not limited to “a decision to use or access a particular drug, device, product, or medical service for reproductive health.”[20]

B. Emergency Conditions

As of January 1, 2023, employers may not take adverse action or threaten adverse action against employees who refuse to report to or leave a workplace due to a “reasonable belief that the workplace or worksite is unsafe” because of an “emergency condition.”[21]

An emergency condition includes: “(i) conditions of disaster or extreme peril to the safety of persons or property at the workplace or worksite caused by natural forces or a criminal act,” and “(ii) an order to evacuate a workplace, a worksite, a worker’s home, or the school of a worker’s child due to natural disaster or a criminal act.”[22] “Health pandemic[s]” are explicitly excluded from the definition of emergency condition.[23] A “reasonable belief that the workplace or worksite is unsafe means that a reasonable person, under the circumstances known to the employee at the time, would conclude there is a real danger of death or serious injury if that person enters or remains on the premises.”[24]

Additionally, employers are prohibited from preventing “any employee from accessing the employee’s mobile device or other communications device for seeking emergency assistance, assessing the safety of the situation, or communicating with a person to verify their safety.”[25]

V. Minimum Wage Increases

As of January 1, 2023, all California employers must offer a minimum wage of at least $15.50.[26] As a reminder, several localities, cities, and counties have higher minimum wages than the state’s rate, including, at present: Alameda, Belmont, Berkeley, Burlingame, Cupertino, Daly City, East Palo Alto, El Cerrito, Emeryville, Foster City, Fremont, Half Moon Bay, Hayward, Los Altos, Los Angeles (city and unincorporated county), Malibu, Menlo Park, Milpitas, Mountain View, Novato, Oakland, Palo Alto, Pasadena, Petaluma, Redwood City, Richmond, San Carlos, San Diego, San Francisco, San Jose, San Leandro, San Mateo, Santa Clara, Santa Monica, Santa Rose, Sonoma, South San Francisco, Sunnyvale, and West Hollywood.[27]

VI. Local and Industry-Specific Changes

California employers should also double check whether there are any new ordinances effective in localities in which they operate or whether there are any new, industry-specific laws. For example, while the below does not cover all of the 2023 local and industry-specific changes, retailers operating in the City of Los Angeles should be aware that there are new rules for scheduling retail workers, and agricultural employers throughout the state will be required to comply with new union certification rules and overtime requirements.

A. Predictive Scheduling for City of Los Angeles Retail Workers

Effective April 1, 2023, retail employers in the City of Los Angeles must provide retail workers with their schedules at least two weeks in advance under the Fair Work Week Ordinance.[28] Among other requirements, employers must also provide a good faith estimate of a schedule within 10 days of an employee’s request, and must allow employees to decline any changes made to their schedule following the 14 day advance notice period.[29]

B. Unionization and Overtime Changes for Agricultural Workers

Under Assembly Bill 2183, agricultural workers now have the right to vote for or against union representation either by mail or by completing ballot cards to be dropped off by the union at the state Agricultural Labor Relations Board (“ALRB”).[30] Previously, secret ballot elections were exclusively held at a polling place selected by the ALRB. Under the new law, agricultural workers may also receive assistance filling out their ballots.[31] The new law is set to expire in five years on January 1, 2028.[32]

As of January 1, 2023, agricultural employers who employ 25 or fewer employees in California must compensate employees who work over 50 hours per week, or nine hours per day, with overtime (which is 1.5 times their regular rate of pay).[33] The amount of hours that triggers overtime pay requirements for agricultural employers with 25 or fewer employees in California will continue to decrease until 2025, at which point such employees will be entitled to overtime for work over 40 hours per week or eight hours per day.[34] This change comes a year after California began requiring agricultural employers with 26 or more employees in California to provide overtime to workers who work over 40 hours per week or eight hours per day.[35]

_____________________________

[1] Cal. Lab. Code § 432.3(c)(3), (5).

[2] See California Equal Pay Act: Frequently Asked Questions, Department of Industrial Relations, https://www.dir.ca.gov/dlse/california_equal_pay_act.htm.

[3] Id.

[4] Id. § 432.3(c)(1), (2).

[5] Cal. Gov. Code § 12999.

[6] See California Pay Data Reporting: Frequently Asked Questions, Civil Rights Department, available at https://calcivilrights.ca.gov/paydatareporting/faqs/.

[7] Id.

[8] See Legislative Counsel’s Digest, SB 1162.

[9] Id.

[10] Id. § 12999(b)(3).

[11] See Legislative Counsel’s Digest, SB 1162.

[12] Id.

[13] Cal. Lab. Code § 12945.2(b)(5)(B).

[14] Id. § 12945.2(b)(2).

[15] Id. § 12945.2(b)(2); see also Lab. Code § 245.5(c)(8).

[16] Cal. Gov. Code § 12945.7(b).

[17] Id. § 12945.7(c).

[18] Id. § 12945.7(a)(1)(A), (d).

[19] Cal. Gov. Code §§ 12921(a); 12940(a), (c).

[20] Cal. Gov. Code § 12926(y).

[21] Cal. Lab. Code § 1139(b)(1).

[22] Id. § 1139(a)(1)(A).

[23] Id. § 1139(a)(1)(B).

[24] Id. § 1139(a)(2).

[25] Id. § 1139(b)(2)(A).

[26] Cal. Lab. Code § 1182.12(b).

[27] See, e.g., Inventory of US City and County Minimum Wage Ordinances, UC Berkeley Labor Center, available at https://laborcenter.berkeley.edu/inventory-of-us-city-and-county-minimum-wage-ordinances/#s-2.

[28] See generally, Fair Work Week Ordinance, available at https://clkrep.lacity.org/onlinedocs/2019/19-0229_ord_draft_06-23-22.pdf.

[29] Id.

[30] Cal. Lab. Code §§ 1156.35, 1156.36.

[31] Cal. Lab. Code § 1156.36(b)(3)(C)(vi).

[32] Cal. Lab. Code §§ 1156.35(i), 1156.36(n).

[33] Cal. Lab. Code § 860(b)(2).

[34] Id. §§ 860(c)(2), (d)(2).

[35] Id. § 860(d)(1).

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments. Please contact the lawyer with whom you usually work in the firm’s Labor and Employment practice group, the authors, or the practice group leaders.

Tiffany Phan – Los Angeles (+1 213-229-7522, [email protected])

Lauren M. Fischer – Los Angeles (+1 213-229-7983, [email protected])

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, [email protected])

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, [email protected])

The U.S. Equal Employment Opportunity Commission (“EEOC”) released a draft strategic enforcement plan for 2023 through 2027 (the “SEP”), which outlines its areas of priority and enforcement goals.[1]Within these priorities, the SEP calls out a range of emerging topics including artificial intelligence (“AI”), the recently enacted Pregnant Workers Fairness Act of 2022 (“PWFA”), and lingering issues relating to the COVID-19 pandemic. The draft is open for a comment period until February 9, 2023 to gather further input from stakeholders.

10 Key Takeaways for Employers

Artificial Intelligence (AI): The EEOC plans to focus on the use of AI tools in recruitment, screening, hiring, promotion, and other employment decisions. Since launching its initiative on algorithmic fairness in October 2021, the EEOC has been increasing its focus on AI. In May 2022, for example, the EEOC issued its first technical guidance on AI and filed its first enforcement action alleging algorithmic discrimination.[2] The EEOC also announced a public hearing scheduled for January 31, 2023 regarding the use of automated systems and AI in employment decisions.[3] The federal government is not the only regulator in this space. New York City, for example, passed a law that requires employers using AI tools to perform a bias audit and fulfill certain posting requirements.[4] Employers can expect more cases to be brought by the EEOC in addition to ongoing regulation at the state and local levels.
Pay Equity: The EEOC has signaled that it intends to use pay data to identify employers for pay equity cases, using directed investigations and Commissioner charges. In addition, the SEP suggests that the EEOC will challenge the use of salary history and requests for desired salary when setting pay. This follows on the heels of many local and state pay transparency laws, including in New York City, California, and Colorado, which require employers to post salary ranges in job advertisements and aim to enable workers to ask about and share their pay with coworkers.[5]
Pregnancy Discrimination: The EEOC plans aggressive enforcement of the newly-enacted PWFA, which requires employers to make reasonable accommodations for pregnancy-related medical conditions.[6] The PWFA also specifically prohibits employers from requiring pregnant employees to take paid or unpaid leave if another reasonable accommodation can be provided. Notably, the PWFA explains that the EEOC will issue regulations, which will include “examples of reasonable accommodations addressing known limitations related to the pregnancy, childbirth, or related medical conditions,” by December 23, 2023.
Current Events: The EEOC will aim to address the discrimination based on race, religion, national origin and gender influenced by or arising as backlash in response to local, national, or global events.
Settlement, Confidentiality, Non-Disparagement, and Arbitration Agreements: The EEOC plans to target releases, confidentiality agreements, and arbitration agreements that it believes improperly restrict access to the legal system. This is part of a broader trend at the state and local level, as well as with other federal agencies like the National Labor Relations Board (“NLRB”), Securities Exchange Commission (“SEC”), and the Federal Trade Commission (“FTC”).[7] Additionally, the Speak Out Act, which prohibits the enforcement of pre-dispute non-disclosure and non-disparagement clauses in disputes relating to claims of sexual assault or sexual harassment, was signed into law just last month on December 7, 2022.[8] Although the EEOC’s authority in this area is questionable (and it lost a prior challenge regarding the use of severance agreements[9]), the EEOC will likely continue to bring attention to these types of agreements.
Targeted Industries: The SEP identifies the purported lack of diversity in certain industries, such as construction and “high tech” (without any cited evidence), as areas of particular concern. Indeed, EEOC Chair Burrows has previously spearheaded a hearing to examine purported discrimination in the construction sector with a particular emphasis on women and people of color.[10] The EEOC has already begun targeting these industries in 2022 and employers can expect the EEOC to continue bringing enforcement actions in this space.
Vulnerable Populations: The EEOC defines vulnerable populations who it believes cannot easily obtain relief on their own behalf to include immigrants, individuals with arrest or conviction records, LGBTQI+ individuals, older workers, low-wage workers, Native Americans, and individuals with limited literacy or English proficiency. This is not a new area of focus, as the EEOC has been focused on expanding access to jobs for workers from underrepresented communities through its Hiring Initiative to Reimagine Equity (“HIRE”) launched in January 2022.[11]
Recruitment and Hiring: The EEOC will place special emphasis on recruitment and hiring, aiming to eliminate barriers arising from purportedly exclusionary job advertisements or restrictive or inaccessible application systems. This focal point is likely to dovetail with the use of emerging technologies such as AI and machine learning.
Systemic Harassment: The EEOC likely will look to bring systemic harassment cases on all protected bases as one of its “key subject matter priorities.” The SEP underscores that the EEOC is determined to “combat this persistent problem,” as over 34 percent of the charges it received between 2017 and 2021 included an allegation of harassment.
COVID Again: The EEOC says that while it hopes discrimination directly associated with COVID-19 will decline as the nation recovers from the pandemic, it will maintain its focus on COVID-19-related employment discrimination, including cases relating to vaccine accommodations, medical inquiries, and pandemic-related stereotyping.

__________________________

[1] Draft Strategic Enforcement Plan (Jan. 10, 2023), https://www.federalregister.gov/documents/2023/01/10/2023-00283/draft-strategic-enforcement-plan.

[2] For more information, please see Gibson Dunn’s Client Alert, Keeping Up with the EEOC: Artificial Intelligence Guidance and Enforcement Action.

[3] EEOC, Navigating Employment Discrimination in AI and Automated Systems: A New Civil Rights Frontier, https://www.eeoc.gov/next-commission-meeting.

[4] The law’s enforcement has been postponed until April 15, 2023 (from January 1, 2023) as the City’s Department of Consumer Worker Protection will host a second public hearing on January 23, 2023 regarding the proposed rules aimed at clarifying the many ambiguities in the law. For more information, please see Gibson Dunn’s Client Alerts, New York City Proposes Rules to Clarify Upcoming Artificial Intelligence Law for Employers, New York City Enacts Law Restricting Use of Artificial Intelligence in Employment Decisions.

[5] For more information, please see Gibson Dunn’s Client Alerts, New York City Enacts Pay Transparency Law Requiring Salary Ranges in Job Postings, California Enacts Pay Transparency and Disclosure Requirements Effective January 1, 2023, Colorado’s Department of Labor and Employment Takes Hard Line on Remote Jobs that Exclude Colorado Applicants to Escape Challenging Aspects of the Equal Pay for Equal Work Act’s Posting Requirements.

[6] For more information, please see Gibson Dunn’s Client Alert, Complying With The Pregnant Workers Fairness Act: Considerations For Employers (Forthcoming).

[7] See, e.g., Non-Compete Clause Rulemaking, Fed. Trade Comm’n (Jan. 5, 2023). For more information, please see Gibson Dunn’s Client Alert, FTC Proposes Rule to Ban Non-Compete Clauses.

[8] For more information, please see Gibson Dunn’s Client Alert, Biden Signs “Speak Out Act” Limiting the Enforceability of Non-Disclosure and Non-Disparagement Clauses in Sexual Harassment Cases.

[9] EEOC v. CVS Pharmacy, Inc., 809 F.3d 335, 343 (7th Cir. 2015) (affirming dismissal of EEOC’s claim that CVS’ allegedly confusing severance agreements violated Title VII by leading former employees to believe they were prohibited from filing charges with the EEOC). The Seventh Circuit underscored that the EEOC’s authority under Title VII “does not create a broad enforcement power for the EEOC to pursue non-discriminatory employment practices that it dislikes.” Id. at 341.

[10] EEOC, EEOC Shines Spotlight on Discrimination and Opportunities in Construction (May 17, 2022), https://www.eeoc.gov/newsroom/eeoc-shines-spotlight-discrimination-and-opportunities-construction.

[11] EEOC, Hiring Initiative to Reimagine Equity (HIRE) Fact Sheet, https://www.eeoc.gov/hiring-initiative-reimagine-equity-hire-fact-sheet.

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Katherine Smith, Harris Mufson, Molly Senger, Naima Farrell, and Emily Maxim Lamm.

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

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, [email protected])

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, [email protected])

With Republicans taking control of the U.S. House of Representatives during the 118th Congress, congressional investigations in the House will shift focus from climate change and the Trump Administration to environmental, social, and corporate governance (“ESG”) investing, social media censorship, China, COVID-19 origins and government preventative measures, and the Biden Administration. With an effective one-seat majority in the Senate, Democrats will have more authority to pursue their ongoing reviews of climate change, healthcare, big tech, and prescription drug costs. And although both parties are far apart on many issues, it is likely they will find common ground in investigations of the power of technology companies, international corporate and military competition and espionage, and cybersecurity breaches.

Unlike litigation or executive branch investigations, congressional investigations can arise with little warning and immediately attract the media spotlight. Potential targets must be prepared to respond quickly and appropriately. Upon receipt of a congressional subpoena or information request letter, targets must develop a full-fledged response strategy, including taking steps to appropriately answer the inquiry as well as create a consistent messaging strategy for media, shareholders, and other investigative bodies that may take an interest once Congress has raised the alarm. It is critical that targets of congressional investigations understand the norms, rules, and procedures that govern their potential courses of action and know how these unique investigations typically unfold.

To assist potential targets and interested parties in assessing their readiness for responding to a congressional investigation, Gibson Dunn offers our views on the future course of the 118th Congress—its new leadership, rules, and areas of focus. We also provide a brief overview of how congressional investigations often are conducted, Congress’s underlying legal authorities to investigate, and various defenses that targets and witnesses can raise in response. In addition, we discuss missteps that investigative targets and witnesses sometimes make, as well as best practices for responding to a congressional request for information.

I. Lay of the Land in the 118th Congress

House of Representatives

As we explained at the start of 116th and 117th congresses, the House adopts new rules and investigative authorities each Congress as part of its organizing process. The House passed a new Rules package on January 9, 2023, after a historic 15 rounds of voting to elect Speaker Kevin McCarthy (R-CA). The hard-fought Rules package includes a number of provisions added or modified to secure support from different factions within the Republican Party.

Although Democratic control of a chamber of Congress usually portends more private sector investigations, the new House Republican majority is poised to investigate parts of the private sector with equal vigor. Big tech, financial services, fintech companies, and corporations with ties to China all are likely to face congressional scrutiny this year.

The House Republican majority is well-equipped to conduct these investigations. When Democrats took the majority in 2019 after eight years of GOP control, they expanded their investigative tools and continued to add new ones in 2021. Now that Republicans are in charge, they will have the advantage of those expanded tools. And, under the Rules package, the House created new investigative bodies that will have authority to review private sector activities. Moreover, committees will organize over the coming weeks, and additional investigative tools could be added to their arsenals.

Investigative Rules: Republicans will maintain rules Democrats have implemented over the last two congresses that expanded the House’s investigative authorities. For example, Republicans will retain broad deposition authority. Democrats previously expanded the House’s deposition authority by removing the requirement that a member be present during the taking of a staff deposition. As we previously noted, such broad authority makes it more difficult for minority members to influence or hinder investigations to which they are opposed. It is also important to remember that, unlike in the Senate, nearly every House standing committee chair is empowered to issue a deposition subpoena unilaterally, that is, without the ranking member’s consent or a committee vote, after mere “consultation” with the ranking member.

New investigative bodies: In the 118th Congress Rules package and related resolutions, the House has created three new investigative bodies. The Committee on Oversight and Accountability—formerly known as the Committee on Oversight and Reform—will have a Select Subcommittee on the Coronavirus Pandemic. The House Judiciary Committee will have a Select Subcommittee on the Weaponization of the Federal Government. And the Rules package and a separate House resolution add a new full investigative committee: the Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party.[1] Although each of these bodies, discussed further below, will aggressively seek information from the Biden Administration, we anticipate they also will gather information from the private sector.

The Select Subcommittee on the Coronavirus Pandemic will investigate the origins of the pandemic, “including . . . the Federal Government’s funding of gain-of-function research”; the use of taxpayer funds to address the pandemic; the implementation and effectiveness of laws and regulations to address the pandemic; the development of vaccines and treatments; the implementation of vaccine policies applied to federal employees and the military; the economic impact of the pandemic; the societal impact of decisions to close schools; executive branch policies related to the pandemic; protection of whistleblowers related to the pandemic; and cooperation by the Executive Branch with oversight of the pandemic response.[2] Unlike the Select Subcommittee on the Coronavirus Crisis, created by the Democratic-controlled House in the last Congress, this Select Subcommittee will not have its own subpoena authority. Instead, it will need to request that the chair of the full Committee on Oversight and Accountability issue subpoenas for it.[3]

Likely private sector targets of the Select Subcommittee on the Coronavirus Pandemic include healthcare research companies; medical and pharmaceutical companies; hospitals; and recipients and conduits of various financial aid programs such as the Paycheck Protection Program; the Homeowner Assistance Fund; the airline and national security relief programs; and the Coronavirus Economic Relief for Transportation Services program.

The resolution establishing the Select Subcommittee on the Weaponization of the Federal Government directs it to study and issue a final report on its findings regarding executive branch collection of information on and investigation of U.S. citizens, including criminal investigations; “how executive branch agencies work with, obtain information from, and provide information to the private sector, non-profit entities, or other government agencies to facilitate action against American citizens . . .”; and how the Executive Branch collects and disseminates information about U.S. citizens.[4] The Select Subcommittee will not have its own subpoena authority, but the chair of the full Judiciary Committee may issue subpoenas for it.[5] Further, the resolution authorizes the Select Subcommittee to receive information available to the Permanent Select Committee on Intelligence.[6] Although the Select Subcommittee on the Weaponization of the Federal Government is authorized to investigate ongoing executive branch investigations, we do not expect agencies to provide information on these ongoing investigations.

Although the focus of the Select Subcommittee is on executive branch activity, we anticipate it will gather information from social media companies, financial institutions, fintech companies, telecommunication companies, consulting firms, and non-profit organizations. The inquiries likely will focus on any collaboration with the federal government in its investigations and any activity that appeared to happen in parallel with government action, as well as financial activity of various targets of the investigations.

The Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party’s “sole authority” will be to “investigate and submit policy recommendations on the status of the Chinese Communist Party’s economic, technological, and security progress and its competition with the United States.”[7] Unlike the Select Committee on the Climate Crisis, created by the Democrat-controlled House in the 116th Congress, this Select Committee will have the same authorities as standing committees, including subpoena and deposition authority.[8] As a result, we can expect more of an investigative approach by this new body. Representative Mike Gallagher (R-WI), a veteran with a background in strategic intelligence and international relations, will chair the Select Committee.

The Select Committee likely will seek information from companies and individuals engaged in business activity in China, including social media companies and software companies; any organizations that have taken steps to appease the CCP in relation to their positions on Taiwan, Nepal, or other interests; and educational and corporate institutions that may have been infiltrated by agents or sympathizers of the CCP. We also anticipate that they will seek information from financial institutions and telecommunications companies serving any of those previously listed organizations.

Other likely investigative priorities: The Republican majority in the House has announced its plans to focus on a wide variety of topics. Big tech will face scrutiny for censorship on various platforms. Financial companies will have to address their investment strategies in light of Republican opposition to ESG investing. Fintech companies will face questions regarding de-platforming users, as well as privacy and cybersecurity concerns. The House also will focus on the Biden Administration, including Hunter Biden’s business dealings, as well as the administration’s border policy, student loan forgiveness program, IRS enforcement priorities and funding, and withdrawal from Afghanistan.

Senate

The Senate Democrats’ new one-seat majority gives them substantially more power to pursue investigations in the 118th Congress than they had previously. During the last Congress, which was evenly divided between Republicans and Democrats, subpoenas required bipartisan support. In the 118th Congress, Democratic chairs will be able to issue subpoenas with the majority vote of their committees. It will take Senate committees several weeks to organize and publish their rules, but the 117th Congress gave them two years to define their priorities, hire staff, and build investigative muscle. We expect them to get an early and strong start to their investigative agenda in the 118th Congress.

Key committees to watch: We expect three Senate bodies to be more active than others in their investigations: the Senate Finance Committee, the Senate Homeland Security and Governmental Affairs Committee, and the Permanent Subcommittee on Investigations.

Senator Ron Wyden (D-OR) will continue to serve as Chairman of the Senate Finance Committee. During the 117th Congress, he investigated pharmaceutical company tax practices; companies that use offshore account reporting; and potential Trump Administration conflicts of interest in international trade. We anticipate he will continue many of those investigations into the 118th Congress and will use his new subpoena authority as needed. We also expect to see him pursue investigations into big tech and oil companies.

Senator Gary Peters (D-MI) will continue to serve as Chairman of the Senate Homeland Security and Governmental Affairs Committee (“HSGAC”). In the last Congress, HSGAC held hearings on COVID-19 preparedness, ransomware attacks enabled by cryptocurrency, and social media’s impact on homeland security. We expect the Committee to continue its focus on these issues, with potential investigations into cryptocurrencies and social media companies. Under its jurisdiction over government waste, fraud, and abuse, HSGAC also likely will investigate pandemic relief fraud and ways to mitigate fraud in government programs going forward.

The Senate Permanent Subcommittee on Investigations (“PSI”), a subcommittee of HSGAC, has some of the broadest investigative authorities and jurisdiction in the Senate. PSI has the responsibility of studying and investigating the efficiency and economy of operations relating to all branches of the government and is also tasked with studying and investigating the compliance or noncompliance with rules, regulations, and laws, investigating all aspects of crime and lawlessness within the United States, which have an impact upon or affect the national health, welfare, and safety, including syndicated crime, investment fraud schemes, commodity and security fraud, computer fraud, and the use of offshore banking and corporate facilities to carry out criminal objectives. Chaired by Senator Jon Osoff (D-GA), PSI was less active last Congress than under previous Democratic chairmen, but it is likely that he will take advantage of Democrats’ increased authority in the Senate to advance his party’s agenda.

Other investigative bodies to note include the Senate Health, Education, Labor, and Pensions Committee and the Senate Commerce, Science, and Transportation Committee.

Senator Bernie Sanders (I-VT) will be taking over the chairmanship of the Senate Health, Education, Labor, and Pensions (“HELP”) Committee, and we expect he will wield his investigative authorities aggressively. In particular, he is likely to focus on drug prices, healthcare executive salaries, workers’ rights, and educational and medical debt.

As Chairwoman of the Senate Commerce, Science, and Transportation Committee, Senator Maria Cantwell (D-WA) already has announced hearings related to December’s airline flight cancellations. She also may find bipartisan support for investigating and legislating on the threats social media platforms pose to children.

Potential Changes to Subpoena and Deposition Authority: We will be closely watching whether Senate Democrats strengthen their investigative arsenal, particularly when it comes to subpoena and deposition authority. With respect to subpoenas, currently only the Chair of PSI is authorized to issue a subpoena unilaterally, a significant difference with the House where nearly all committee chairs may do so. Because Senate investigations have historically been more bipartisan than those in the House, there has been a longstanding hesitation on both sides to expand unilateral subpoena power. It remains to be seen if that philosophy will continue to hold sway in the 118th Congress.

It is also important to keep a close watch on Senate deposition authority. In the last Congress, ten Senate bodies included deposition provisions in their rules: (1) Judiciary; (2) HSGAC; (3) PSI; (4) Aging; (5) Agriculture, Nutrition, and Forestry; (6) Commerce, Science, and Transportation; (7) Ethics; (8) Foreign Relations; (9) Indian Affairs; and (10) Intelligence. Staff is expressly authorized to take depositions in each of these committees other than the Agriculture, Nutrition, and Forestry, Commerce, Science, and Transportation, Indian Affairs, and Intelligence Committees. Note that Senate Rules do not authorize committees to take depositions. Hence, Senate committees cannot delegate that authority to themselves through committee rules, absent a Senate resolution or a change in Senate rules. The committee funding resolution for the 117th Congress, S. Res. 70, explicitly provides deposition authority only for PSI and the Senate Judiciary Committee.

II. Unique Features of Congressional Investigations

As a practical matter, numerous motivations often drive a congressional inquiry, including: advancing a chair’s political agenda or public profile, developing support for a legislative proposal, exposing alleged criminal wrongdoing or unethical practices, pressuring a company to take certain actions, and responding to public outcry. Recognizing the presence of these underlying objectives and evaluating the political context surrounding an inquiry can therefore be a key component of developing an effective response strategy.

Congress’s power to investigate is broad—as broad as its legislative authority. The “power of inquiry” is inherent in Congress’s authority to “enact and appropriate under the Constitution.”[9] And while Congress’s investigatory power is not a limitless power to probe any private affair or to conduct law enforcement investigations, but rather must further a valid legislative purpose,[10] the term “legislative purpose” is understood broadly to include gathering information not only for the purpose of legislating, but also for overseeing governmental matters and informing the public about the workings of government.[11]

Congressional investigations present a number of unique challenges not found in the familiar arenas of civil litigation and executive branch investigations. Unlike the relatively controlled environment of a courtroom, congressional investigations often unfold in a hearing room in front of television cameras and on the front pages of major newspapers and social media feeds.

III. Investigatory Tools of Congressional Committees

Congress has many investigatory tools at its disposal, including: (1) requests for information; (2) interviews; (3) depositions; (4) hearings; (5) referrals to the Executive Branch for prosecution; and (6) subpoenas for documents and testimony. If these methods fail, Congress can use its contempt power in an effort to punish individuals or entities who refuse to comply with subpoenas. It is imperative that targets be familiar with the powers (and limits) of each of the following tools to best chart an effective response:

Requests for Information: Any member of Congress may issue a request for information to an individual or entity. A request may seek documents or other information.[12] Absent the issuance of a subpoena, responding to such requests is entirely voluntary as a legal matter (although of course there may be public or political pressure to respond). As such, recipients of such requests should carefully consider the pros and cons of different degrees of
Interviews: Interviews also are voluntary, led by committee staff, and occur in private (in person or remotely). They tend to be less formal than depositions and are sometimes transcribed. Committee staff may take copious notes and rely on interview testimony in subsequent hearings or public reports. Although interviews are typically not conducted under oath, false statements to congressional staff can be criminally punishable as a felony under 18 U.S.C. § 1001.
Depositions: Depositions can be compulsory, are transcribed, and are taken under As such, depositions are more formal than interviews and are similar to those in traditional litigation. The number of committees with authority to conduct staff depositions has increased significantly over the last few years. During the 117th Congress, the then-Democratic House majority eliminated the requirement that one or more members of Congress be present during a deposition,[13] which increased the use of depositions as an investigative tool, and we expect this trend will continue in the 118th Congress. In the 117th Congress, staff of six Senate committees and subcommittees were authorized to conduct staff depositions: Judiciary; HSGAC; PSI; Aging; Ethics; and Foreign Relations.[14] Judiciary, however, required that a member be present during deposition, unless waived by agreement of the chair and ranking member.The House Rules Committee’s regulations for staff depositions in the 118th Congress will likely mirror in many respects the regulations issued by that Committee in the 117th Congress. Significantly, those regulations changed past practice by authorizing the immediate overruling of objections raised by a witness’s counsel and immediate instructions to answer, on pain of contempt. Those regulations also appeared to eliminate the witness’s right to appeal rulings on objections to the full committee (although committee members may still appeal). Assuming these changes are preserved in the 118th Congress, as seems likely, they will continue to enhance the efficiency of the deposition process, as prior to the 116th Congress the staff deposition regulations required a recess before the chair could rule on an objection. Additionally, the regulations for the 116th Congress expressly allowed for depositions to continue from day to day and permit, with notice from the chair, questioning by members and staff of more than one committee. Finally, the regulations removed a prior requirement that allowed objections only by the witness or the witness’s lawyer. This change appears to allow objections from staff or members who object to a particular line of questioning.[15]
Hearings: While both depositions and interviews allow committees to acquire information quickly and (at least in many circumstances) confidentially,[16] testimony at hearings, unless on a sensitive topic, is conducted in a public session led by the members themselves (or, on occasion, committee counsel).[17] Hearings can either occur at the end of a lengthy staff investigation or take place more rapidly, often in response to an event that has garnered public and congressional concern. Most akin to a trial in litigation (though without many of the procedural protections or the evidentiary rules applicable in judicial proceedings), hearings are often high profile and require significant preparation to navigate successfully.
Executive Branch Referral: Congress also has the power to refer its investigatory findings to the Executive Branch for criminal prosecution. After a referral from Congress, the Department of Justice may charge an individual or entity with making false statements to Congress, obstruction of justice, or destruction of evidence. Importantly, while Congress may make a referral, the Executive Branch retains the discretion to prosecute, or not.

Subpoena Power

As noted above, Congress will usually seek voluntary compliance with its requests for information or testimony as an initial matter. If requests for voluntary compliance meet with resistance, however, or if time is of the essence, it may compel disclosure of information or testimony through the issuance of a congressional subpoena.[18] Like Congress’s power of inquiry, there is no explicit constitutional provision granting Congress the right to issue subpoenas.[19] But the Supreme Court has recognized that the issuance of subpoenas is “a legitimate use by Congress of its power to investigate” and its use is protected from judicial interference in some respects by the Speech or Debate Clause.[20] Congressional subpoenas are subject to few legal challenges,[21] and “there is virtually no pre-enforcement review of a congressional subpoena” in most circumstances.[22]

The authority to issue subpoenas is initially governed by the rules of the House and Senate, which delegate further rulemaking to each committee.[23] While nearly every standing committee in the House and Senate has the authority to issue subpoenas, the specific requirements for issuing a subpoena vary by committee. These rules are still being developed by the committees of the 118th Congress, and can take many forms.[24] For example, several House committees authorize the committee chair to issue a subpoena unilaterally and require only that notice be provided to the ranking member. Others, however, require approval of the chair and ranking member, or, upon the ranking member’s objection, require approval by a majority of the committee.

Contempt of Congress

Failure to comply with a subpoena can result in contempt of Congress or a civil enforcement action. Although Congress does not frequently resort to its contempt power to enforce its subpoenas, it has three potential avenues for seeking to implement its authority to compel testimony and production of documents.

Inherent Contempt Power: The first, and least relied upon, form of compulsion is Congress’s inherent contempt power. Much like the subpoena power itself, the inherent contempt power is not specifically authorized in the Constitution, but the Supreme Court has recognized its existence and legitimacy.[25] To exercise this power, the House or Senate must pass a resolution and then conduct a full trial or evidentiary proceeding, followed by debate and (if contempt is found to have been committed) imposition of punishment.[26] As is apparent in this description, the inherent contempt authority is cumbersome and inefficient, and it is potentially fraught with political peril for legislators. It is therefore unsurprising that Congress has not used it since.[27]
Statutory Criminal Contempt Power: Congress also possesses statutory authority to refer recalcitrant witnesses for criminal contempt prosecutions in federal court. In 1857, Congress enacted this criminal contempt statute as a supplement to its inherent authority.[28] Under the statute, a person who refuses to comply with a subpoena is guilty of a misdemeanor and subject to a fine and imprisonment.[29] “Importantly, while Congress initiates an action under the criminal contempt statute, the Executive Branch prosecutes ”[30] This relieves Congress of the burdens associated with its inherent contempt authority. The statute simply requires the House or Senate to approve a contempt citation. Thereafter, the statute provides that it is the “duty” of the “appropriate United States attorney” to prosecute the matter, although the Department of Justice maintains that it always retains discretion not to prosecute, and often declines to do so.[31] Although Congress rarely uses its criminal contempt authority, the Senate used it in 2016 against Backpage.com, and the House Democratic majority employed it against a flurry of Trump administration officials, including Attorney General Bill Barr, Secretary of Commerce Wilbur Ross, Secretary of Homeland Security Chad Wolff, political adviser Steve Bannon, and White House Chief of Staff Mark Meadows. The Department of Justice prosecuted Bannon for defying a subpoena from the Select January 6 Committee. A jury found him guilty, and his conviction is now on appeal.
Civil Enforcement Authority: Finally, Congress may seek civil enforcement of its subpoenas, which is often referred to as civil contempt. The Senate’s civil enforcement power is expressly codified.[32] This statute authorizes the Senate to seek enforcement of legislative subpoenas in a S. District Court. In contrast, the House does not have a civil contempt statute, but most courts have held that it may pursue a civil contempt action “by passing a resolution creating a special investigatory panel with the power to seek judicial orders or by granting the power to seek such orders to a standing committee.”[33] In the past, the full House has typically “adopt[ed] a resolution finding the individual in contempt and authorizing a committee or the House General Counsel to file suit against a noncompliant witness in federal court.”[34] In the 116th Congress, however, the Chairman of the House Rules Committee took the position that the House rules empower the Bipartisan Legal Advisory Group (“BLAG”; consisting of the Speaker, the Majority and Minority Leaders, and the Majority and Minority Whips) to authorize a civil enforcement action without the need for a House vote.[35] The House subsequently endorsed that position, and the BLAG authorized at least one civil enforcement action during the 116th Congress.[36] It seems likely that this authority will be continued in the 118th Congress.

IV. Defenses to Congressional Inquiries

While potential defenses to congressional investigations are limited, they are important to understand. The principal defenses are as follows:

Jurisdiction and Legislative Purpose

As discussed above, a congressional investigation is required generally to relate to a legislative purpose, and must also fall within the scope of legislative matters assigned to the particular committee at issue. In a challenge based on these defenses, the party subject to the investigation must argue that the inquiry does not have a proper legislative purpose, that the investigation has not been properly authorized, or that a specific line of inquiry is not pertinent to an otherwise proper purpose within the committee’s jurisdiction. Because courts generally interpret “legislative purpose” broadly, these challenges can be an uphill battle. Nevertheless, this defense should be considered when a committee is pushing the boundaries of its jurisdiction or pursuing an investigation that arguably lacks any legitimate legislative purpose.

Constitutional Defenses

Constitutional defenses under the First and Fifth Amendments may be available in certain circumstances. While few of these challenges are ever litigated, these defenses should be carefully evaluated by the subject of a congressional investigation.

When an investigative target invokes a First Amendment defense, a court must engage in a “balancing” of “competing private and public interests at stake in the particular circumstances shown.”[37] The “critical element” in the balancing test is the “existence of, and the weight to be ascribed to, the interest of the Congress in demanding disclosures from an unwilling witness.”[38] Though the Supreme Court has never relied on the First Amendment to reverse a criminal conviction for contempt of Congress, it has recognized that the First Amendment may restrict Congress in conducting investigations.[39] Courts have also recognized that the First Amendment constrains judicially compelled production of information in certain circumstances.[40] Accordingly, it would be reasonable to contend that the First Amendment limits congressional subpoenas at least to the same extent. First Amendment issues arose in several investigations during the 117th Congress and are likely to be implicated by certain investigations in the 118th Congress as well.

The Fifth Amendment’s privilege against self-incrimination is available to witnesses—but not entities—who appear before Congress.[41] The right generally applies only to testimony, and not to the production of documents,[42] unless those documents satisfy a limited exception for “testimonial communications.”[43] Congress can circumvent this defense by granting transactional immunity to an individual invoking the Fifth Amendment privilege.[44] This allows a witness to testify without the threat of a subsequent criminal prosecution based on the testimony provided. Supreme Court dicta also suggests the Fourth Amendment can be a valid defense in certain circumstances related to the issuance of congressional subpoenas.[45] The Fourth Amendment has never been successfully employed to quash a congressional subpoena, however.

Attorney-Client Privilege & Work Product Defenses

Although House and Senate committees have taken the position that they are not required to recognize the attorney-client privilege, in practice the committees generally acknowledge the privilege as a valid protection. Moreover, no court has ruled that the attorney-client privilege does not apply to congressional investigations. Committees often require that claims of privilege be logged as they would in a civil litigation setting. In assessing a claim of privilege, committees balance the harm to the witness of disclosure against legislative need, public policy, and congressional duty. Notably, in 2020, the Supreme Court for the first time acknowledged in dicta that the attorney-client privilege is presumed to apply in congressional investigations. In Trump v. Mazars, the Supreme Court stated that “recipients [of congressional subpoenas] have long been understood to retain common law and constitutional privileges with respect to certain materials, such as attorney-client communications and governmental communications protected by executive privilege.”[46] It remains to be seen if members and committee staffers will take the same view going forward.

The work product doctrine protects documents prepared in anticipation of litigation. Accordingly, it is not clear whether or in what circumstances the doctrine applies to congressional investigations, as committees may argue that their investigations are not necessarily the type of “adversarial proceeding” required to satisfy the “anticipation of litigation” requirement.[47]

V. Top Mistakes and How to Prepare

Successfully navigating a congressional investigation requires mastery of the facts at issue, careful consideration of collateral political events, and crisis communications.

Here are some of the more common mistakes we have observed:

Facts: Failure to identify and verify the key facts at issue;
Message: Failure to communicate a clear and compelling narrative;
Context: Failure to understand and adapt to underlying dynamics driving the investigation;
Concern: Failure to timely recognize the attention and resources required to respond;
Legal: Failure to preserve privilege and assess collateral consequences;
Rules: Failure to understand the rules of each committee, which can vary significantly; and
Big Picture: Failure to consider how an adverse outcome can negatively impact numerous other legal and business objectives.

The consequences of inadequate preparation can be disastrous on numerous fronts. A keen understanding of how congressional investigations differ from traditional litigation and executive branch or state agency investigations is therefore vital to effective preparation. The most successful subjects of investigations are those that both seek advice from experienced counsel and employ multidisciplinary teams with expertise in government affairs, media relations, e-discovery, and the key legal and procedural issues.

* * *

The change in control of the House portends a shift in investigative focus, and this particular Republican majority appears keen to investigate both public and private sector entities. Senate Democrats will use their enhanced authority to pick up their investigative tempo, as well. Gibson Dunn lawyers have extensive experience in both running congressional investigations and defending targets of and witnesses in such investigations. If you or your company become the subject of a congressional inquiry, or if you are concerned that such an inquiry may be imminent, please feel free to contact us for assistance.

______________________________

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

[2] H.R. Res. 5, 118th Cong. § 4(a)(2)(A) (2023).

[3] H.R. Res. 5, 118th Cong. § 4(a)(3)(A)(ii) (2023).

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

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

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

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

[8] H.R. Res. 11, 118th Cong. § 1(c)(3) (2023).

[9] Barenblatt v. United States, 360 U.S. 109, 111 (1957).

[10] See Wilkinson v. United States, 365 U.S. 399, 408-09 (1961); Watkins v. United States, 354 U.S. 178, 199-201 (1957).

[11] Michael D. Bopp, Gustav W. Eyler, & Scott M. Richardson, Trouble Ahead, Trouble Behind: Executive Branch Enforcement of Congressional Investigations, 25 Corn. J. of Law & Pub. Policy 453, 456-57 (2015).

[12] Id.

[13] See H.R. Res. 6, 116th Cong. § 103(a)(1) (2019).

[14] See U.S. Senate Committee on Rules and Administration, Authority and Rules of Senate Committees, 2021–2022, S. Doc. No. 117-6 (117th Cong. 2022), https://www.govinfo.gov/content/pkg/CDOC-117sdoc6/pdf/CDOC-117sdoc6.pdf.

[15] See 165 Cong. Rec. H1216 (Jan. 25, 2019) (statement of Rep. McGovern).

[16] Bopp, supra note 11, at 457.

[17] Id. at 456-57.

[18] Id. at 457.

[19] Id.

[20] Eastland v. U.S. Servicemen’s Fund, 421 U.S. 491, 504 (1975).

[21] Bopp, supra note 11, at 458.

[22] Id. at 459. The principal exception to this general rule arises when a congressional subpoena is directed to a custodian of records owned by a third party. In those circumstances, the Speech or Debate Clause does not bar judicial challenges brought by the third party seeking to enjoin the custodian from complying with the subpoena, and courts have reviewed the validity of the subpoena. See, e.g., Trump v. Mazars, 140 S. Ct. 2019 (2020); Bean LLC v. John Doe Bank, 291 F. Supp. 3d 34 (D.D.C. 2018).

[23] Bopp, supra note 11, at 458.

[24] Gibson Dunn will detail these rules when they are finalized in an upcoming publication.

[25] Bopp, supra note 11, at 460 (citing Anderson v. Dunn, 19 U.S. 204, 228 (1821)).

[26] Id.

[27] Id. at 466.

[28] Id. at 461.

[29] See 2 U.S.C. §§ 192 and 194.

[30] Bopp, supra note 11, at 462.

[31] See 2 U.S.C. § 194.

[32] See 2 U.S.C. §§ 288b(b), 288d.

[33] Bopp, supra note 11, at 465. A panel of the U.S. Court of Appeals for the D.C. Circuit ruled in August of 2020 that the House may not seek civil enforcement of a subpoena absent statutory authority. Committee on the Judiciary of the United States House of Representatives v. McGahn, 951 F.3d 510 (D.C. Cir. 2020). On rehearing en banc, the D.C. Circuit reversed, concluding that “the Committee on the Judiciary of the House of Representatives has standing under Article III of the Constitution to seek judicial enforcement of its duly issued subpoena.” Committee on Judiciary of United States House of Representatives v. McGahn, 968 F.3d 755, 760 (D.C. Cir. 2020) (en banc).

[34] Bopp, supra note 11, at 465.

[35] See 165 Cong. Rec. H30 (Jan. 3, 2019) (“If a Committee determines that one or more of its duly issued subpoenas has not been complied with and that civil enforcement is necessary, the BLAG, pursuant to House Rule II(8)(b), may authorize the House Office of General Counsel to initiate civil litigation on behalf of this Committee to enforce the Committee’s subpoena(s) in federal district court.”) (statement of Rep. McGovern); House Rule II.8(b) (“the Bipartisan Legal Advisory Group speaks for, and articulates the institutional position of, the House in all litigation matters”).

[36] See H. Res. 430 (116th Cong.) (“a vote of [BLAG] to authorize litigation . . . is the equivalent of a vote of the full House of Representatives”); Br. for House Committee at 33, Committee on Ways and Means, United States House of Representatives v. U.S. Dep’t of the Treasury, No. 1:19-cv-01974 (D.D.C. 2019) (stating BLAG authorized suit by House Ways & Means Committee to obtain President Trump’s tax returns pursuant to 26 U.S.C. § 6103(f)).

[37] Barenblatt, 360 U.S. at 126.

[38] Id. at 126-27.

[39] See id.

[40] See, e.g., Perry v. Schwarzenegger, 591 F.3d 1147, 1173 (9th Cir. 2009).

[41] See Quinn v. United States, 349 U.S. 155, 163 (1955).

[42] See Fisher v. United States, 425 U.S. 391, 409 (1976).

[43] See United States v. Doe, 465 U.S. 605, 611 (1984).

[44] See 18 U.S.C. § 6002; Kastigar v. United States, 406 U.S. 441 (1972).

[45] Watkins, 354 U.S. at 188.

[46] See Mazars, 140 S. Ct. at 2032.

[47] See In re Grand Jury Subpoena Duces Tecum, 112 F.3d 910, 924 (8th Cir. 1997).

The following Gibson Dunn attorneys assisted in preparing this client update: Michael D. Bopp, Thomas G. Hungar, Roscoe Jones Jr., Amanda Neely, Daniel P. Smith, Megan B. Kiernan, and Timofey Velenchuk.

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 or the following lawyers in the firm’s Congressional Investigations group in Washington, D.C.:

Michael D. Bopp – Chair, Congressional Investigations Group (+1 202-955-8256, [email protected])

Thomas G. Hungar (+1 202-887-3784, [email protected])

Roscoe Jones, Jr. – Co-Chair, Public Policy Group (+1 202-887-3530, [email protected])

Each year we offer our observations on new developments and highlight select considerations for calendar-year filers as they prepare their Annual Reports on Form 10-K. This alert touches upon recent rulemaking from the U.S. Securities and Exchange Commission (“SEC”), comments letters issued by the staff of the SEC’s Division of Corporation Finance (the “Staff”), and trends among reporting companies that have emerged throughout the last year.

An index of the topics described in this alert is provided below.

I. Trends in Human Capital Disclosure.

II. Trends in Climate Change Disclosure.

III. Disclosure Trends and Considerations Related to Macroeconomic Issues and Current Events.

A. Tailoring of COVID-19 Disclosure.
B. Increased Discussion of Geopolitical Conflict.
C. Expanded Disclosure of Supply Chain Disruptions and Mitigation Efforts.
D. More Detailed Discussion of Inflation Risks and Impacts.
E. Increased Discussion of Rising Interest Rates.
F. Inflation Reduction Act of 2022.

IV. Updated Staff Guidance on Non-GAAP Measures.

A. Question 100.01 – Misleading Adjustments.
B. Question 100.04 – Individually Tailored Accounting Principles.
C. Question 100.05 – Improper Labels and Descriptions.
D. Question 100.06 – Limits of Explanatory Disclosure.
E. Question 102.10 – Equal or Greater Prominence.

V. Cybersecurity Disclosure Considerations.

VI. Reminder Regarding Past Amendments to Financial and Business Disclosure Requirements in Regulation S-K.

VII. Technical and Other Considerations.

A. New Filing Requirement for Glossy Annual Reports.
B. Clawback Check Boxes on Cover Page.
C. Item 201(e) Performance Graph and Pay-vs-Performance.

I. Trends in Human Capital Disclosure

Since 2021, companies have been required to include in their Form 10-K[1] a description of the company’s human capital resources, to the extent material to an understanding of the business taken as a whole, including the number of persons employed by the company, and any human capital measures or objectives that the company focuses on in managing the business (such as, depending on the nature of the company’s business and workforce, measures or objectives that address the development, attraction and retention of personnel).

The rule adopted by the SEC did not define “human capital” or elaborate on the expected content of the disclosures beyond the few examples provided in the rule text. This principles-based approach has resulted in significant variation among companies’ disclosures. With two years of human capital disclosure now available, we recently conducted a survey of the substance and form of human capital disclosures made by the S&P 100 in their Forms 10-K for their two most recently completed fiscal years. While company disclosures continued to vary widely, we saw companies generally expanding the length of their disclosures (79% of S&P 100 companies) and covering more topics (66% of S&P 100 companies), and also noted a slight increase in the amount of quantitative information provided in some areas. For a more detailed summary of our findings from this survey, please see our recently published client alert, “Evolving Human Capital Disclosures.”[2]

Our survey looked at seven primary categories of human capital disclosure, which were broken down further into 17 different disclosure topics.

Workforce Composition and Demographics. Nearly all S&P 100 companies discussed workforce composition and demographics to some degree. Diversity, equity, and inclusion continued to be the most common disclosure topics, with 96% of S&P 100 companies including a qualitative discussion of their commitment to diversity, equity, and inclusion. The level of discussion ranged from generic statements expressing support of diversity in the workforce to detailed examples of actions taken to support underrepresented groups and increase representation in the workforce. Of S&P 100 companies, 61% included statistics related to gender representation and 59% included statistics related to racial representation (compared to 47% and 43% in the previous year, respectively). Most of these companies provided statistics for their workforce as a whole; however, an increased subset (37% in the most recent year, compared to 22% in the previous year) included separate statistics for different classes of employees and/or their boards of directors. We continue to see only a relatively small number of companies disclose full-time/part-time employee metrics (17% of the S&P 100) and workforce turnover rates (23% of the S&P 100).
Recruiting, Training, Succession. Over 90% of S&P 100 companies discussed talent attraction, retention, and development. These were mostly qualitative disclosures discussing programs and benefits in place to recruit and maintain talent. There was no increase in the number of companies that covered succession planning.
Employee Compensation. Of companies surveyed, 85% included disclosure relating to employee compensation, generally providing a qualitative description of the compensation and benefits program offered to employees. Although 41% of companies surveyed included a discussion of pay equity practices in their 2021 Form 10-K (compared to 30% in 2021), quantitative measures of pay gaps based on gender or racial representation continued to be uncommon (12% of companies surveyed in 2022 compared to 11% in 2021).
Health and Safety. Of S&P 100 companies, 78% included disclosures relating to workplace health and safety. Disclosures primarily focused on the companies’ commitment to safety in the workplace and compliance with applicable regulatory and legal requirements, but quantitative disclosures on workplace safety, such as historical and/or target incident or safety rates, were uncommon (10% of companies surveyed in 2022).
Culture and Engagement. Discussions on culture and engagement increased from the prior year, with a majority of S&P 100 companies explaining how they monitor culture and employee engagement. Some companies also included disclosures centered on practices and initiatives undertaken to build and maintain culture, including diversity-related and inclusion initiatives.
COVID-19. Companies continued to include information regarding COVID-19 and its impact on company policies and procedures or on employees generally (71% of companies surveyed in 2022, compared to 66% in 2021). We expect that some companies may slim down their disclosure related to COVID-19 impacts in their next Form 10-K.
Human Capital Management Governance and Organizational Practices. The percentage of S&P 100 companies discussing human capital management governance and/or organizational practices (such as oversight by the board of directors or a committee and the organization of the human resources function) increased from 41% in 2021 to 57% in 2022.

While we anticipate that human capital disclosure will continue to evolve under the existing principles-based requirements, per the SEC’s recently released Fall 2022 Regulatory Flexibility Agenda, we expect the SEC to propose more prescriptive rules in the first quarter of 2023 that will significantly change the landscape. SEC chair Gary Gensler has instructed the Staff “to propose recommendations for the Commission’s consideration on human capital disclosure…. This could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.”

II. Trends in Climate Change Disclosure

In March 2022, the SEC issued proposed rules on climate change disclosure requirements that, if adopted as proposed, will require disclosure of extensive and detailed climate-related information, including climate-related risks and opportunities, board oversight of climate-related risks, amount of greenhouse gas emissions, attestation of reporting on emissions, and a separate financial statement footnote on the impact of climate change. The proposed rules generated extensive positive and negative feedback from investors, companies, politicians, and others, and we believe it is unlikely that the SEC will adopt the rules as proposed. For a summary of the proposed climate change disclosure rules, please see our prior client alert, “Summary of and Considerations Regarding the SEC’s Proposed Rules on Climate Change Disclosure.”[3]

While there are no new SEC requirements on climate change disclosure that directly impact the 2022 Form 10-K, Form 10-K comment letters issued by the Staff over the past year underscore the Staff’s expectation of climate-related disclosures in response to existing requirements. The Staff initially issued a number of comment letters relating exclusively to climate-change disclosure issues in the fall of 2021. This was followed by the Staff publishing a sample comment letter related to climate-change disclosure issues on its website in September 2021.[4] Based on a review of comment letters issued in 2022, a growing trend we saw was the SEC asking for more quantification around climate-related disclosures. Resolution of comments often required more than one round of responses as the Staff honed in on a company’s analysis of whether a specific disclosure item was material.

The general focus of these climate-related comments fall under four general areas:

The impact of climate legislation, regulation, and international accords. For example, the Staff has asked companies to disclose the risks they face as a result of climate-change legislation, regulation, or treaties to the extent such risks are reasonably likely to have a material effect on the company’s business, financial condition, and results of operations.
The indirect consequences of climate-related regulation or business trends. For example, the Staff has asked for additional detail on indirect consequences, such as increased demand for goods that may produce lower emissions, increased competition to develop new products, and any anticipated reputational risks resulting from operations or services that produce material emissions.
The physical effects of climate change. For example, the Staff has placed a particular emphasis on quantifying material weather-related damage to property, weather-related impacts on major customers and suppliers, and cost and availability of insurance.
The material expenditures for climate-related projects and increase in compliance costs. For example, the Staff has requested quantification of any material past and/or future capital expenditures for climate-related projects for each of the periods for which financial statements are presented.

For companies reviewing their existing climate-related disclosures in their Form 10-K, a few items to consider in light of these Staff comments include:

Tailor climate-related disclosures to the company’s business and financial condition, rather than generic discussions on climate change. For example, the Staff may ask a company to provide specific disclosure, if material, as to the impact on the company’s business of climate change risks disclosed in the risk factor section.
Consider whether certain climate-related matters should be disclosed not only qualitatively, but also quantitatively. For example, if climate-related capital projects have become a significant portion of overall capital expenditures spending, the comment letters indicate that quantitative disclosure may be warranted.
As part of the disclosure controls and procedures for the 2022 Form 10-K filing, review ESG materials publicly disclosed by the company, such as the company’s sustainability report, to determine whether any of the information in them is material under federal securities laws. Based on Staff comments, the Staff may look at these additional disclosures outside a company’s SEC filings and ask what consideration was given to including these disclosures in the Form 10-K. To the extent information disclosed in sustainability reports is not material for purposes of SEC rules, as we previously advised in our prior client alert, “Considerations for Climate Change Disclosures in SEC Reports,”[5] appropriate disclaimers to that effect should accompany such disclosures.

III. Disclosure Trends and Considerations Related to Macroeconomic Issues and Current Events

An increased Staff focus on current events and macroeconomic trends kicked off in 2020 as public companies began disclosing impacts of the COVID-19 pandemic on their operations. At the time, the Staff issued CF Disclosure Guidance: Topic No. 9 (published March 25, 2020)[6] and CF Disclosure Guidance: Topic No. 9A (published June 23, 2020),[7] specifically regarding how companies should assess and disclose the impact of COVID-19; however, the guidance provides helpful instruction as companies evaluate the impact of other macroeconomic events, such as ongoing geopolitical conflicts, increased inflation, rising interest rates, and recessionary concerns. Below are a few general tips when drafting disclosure around current events and macroeconomic trends:

Avoid generic disclosure of current events; be specific as to how these factors impact financial performance and operations.
Avoid static disclosure of current events; update prior year disclosure to reflect impact during fiscal year 2022, as well as any known trends and uncertainties for 2023 and beyond.
Confirm disclosure of current events and macroeconomic trends is consistent through the relevant parts of Form 10-K, such as the business section, risk factors, management’s discussion and analysis of financial condition and results of operations (“MD&A”), forward-looking statement disclaimer, and notes to the financial statements.

Set forth below are discussions of some of the major current events and macroeconomic trends that may impact a company’s disclosure in the upcoming Form 10-K.

A. Tailoring of COVID-19 Disclosure

The COVID-19 pandemic continues to impact public companies, though the direct and indirect impacts on a company’s operations or financial condition or on its industry may have changed significantly since the 2021 Form 10-K filing. As companies take a fresh look at their existing COVID-19 disclosure, discussions should be tailored to highlight actual impacts realized in 2022, and risk factors may need to be slimmed down to focus on the material risks that COVID-19 still presents. For some companies or select industries, discussion of COVID-19 as a trend or risk may still be a prominent disclosure for the 2022 Form 10-K, particularly for companies and industries whose supply chains continue to be impacted.

B. Increased Discussion of Geopolitical Conflict

With the ongoing Russian invasion of Ukraine, public companies may need to discuss the conflict’s direct and indirect impacts on their operations and financial condition. In May 2022, the Staff published a “Sample Comment Letter Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues.”[8] In the letter, the Staff emphasized that companies should provide detailed disclosure, to the extent material, regarding (i) direct or indirect exposure to Russia, Belarus, or Ukraine through operations or investments in such countries, securities trading in Russia, sanctions imposed or legal or regulatory uncertainty associated with operating in or existing in Russia or Belarus, (ii) direct or indirect reliance on goods or services sourced in Russia or Ukraine, (iii) actual or potential disruptions in the company’s supply chain, or (iv) business relationships, connections to, or assets in, Russia, Belarus, or Ukraine. Similar to Staff comment letters on climate-related disclosure, comment letters received by public companies in the fall of 2022 on the Russia-Ukraine conflict have requested more specific, including quantified, information on the impacts to the company’s operations and financial condition.

Companies should undertake similar disclosure analyses to determine whether direct or indirect impacts of emerging geopolitical conflicts, such as rising tensions between China and Taiwan, should be discussed in any sections of the upcoming Form 10-K.

C. Expanded Disclosure of Supply Chain Disruptions and Mitigation Efforts

In a somewhat related vein, companies experiencing supply chain difficulties should consider whether discussion of those issues in their risk factors and MD&A is sufficient. In comment letters recently issued to companies that mentioned supply chain disruptions, the Staff requested that the companies specify whether these challenges materially impacted the company’s results of operations or capital resources and quantify, to the extent possible, how the company’s sales, profits, and/or liquidity have been impacted. Several comment letters have also requested that companies discuss any known trends or uncertainties resulting from mitigation efforts undertaken and whether those efforts have introduced new material risks, including those related to product quality, reliability, or regulatory approval of products.

D. More Detailed Discussion of Inflation Risks and Impacts

With the rise of inflation in 2022, companies should consider whether their disclosures regarding inflation impacts and risks are adequate. Depending on the effect on a company’s operations and financial condition, additional disclosure in risk factors, MD&A, or the financial statements may be necessary. In recent comment letters, the Staff has focused on how current inflationary pressures have materially impacted a company’s operations and sought disclosure on any mitigation efforts implemented with respect to inflation. If inflation is identified as a significant risk, the Staff requested companies to quantify, where possible, the extent to which revenues, expenses, profits, and capital resources were impacted by inflation.

For example, one company received the following comment: “We note your risk factor indicating that inflation can have an adverse impact on your business and on [y]our customers. Please update this risk factor if recent inflationary pressures have materially impacted your operations. In this regard, if applicable, discuss how your business has been materially affected by the various types of inflationary pressures you are facing” (emphasis added). Another company received this comment: “In various sections of your filings as well as earnings releases, you identify inflation as a significant risk you are experiencing, and indicate that there are various sources for the inflation you are experiencing. Please revise your future filings to discuss and quantify, where possible, the extent to which your revenues, expenses, profits, and capital resources have been impacted by inflation. Identify the drivers of inflation that most affected your options, and discuss your mitigation efforts. Provide us with your proposed disclosures in your response” (emphasis added).

E. Increased Discussion of Rising Interest Rates

In the current environment of relatively high interest rates, companies should also consider whether the recent rate increases and uncertainty regarding future rate changes are adequately discussed. In recent comment letters, the Staff has asked companies to expand their discussion of rising interest rates in the Risk Factors and MD&A sections to specifically identify the actual impact of recent rate increases on the business’s operations and how the business has been affected.

It is also critical that companies confirm that their disclosures in Item 7A (Quantitative and Qualitative Disclosures About Market Risk) are up-to-date and responsive to the requirements of Item 305 of Regulation S-K.

F. Inflation Reduction Act of 2022

In August 2022, the Inflation Reduction Act of 2022 (the “Act”) was signed into law. One of the aspects of the Act was the introduction of a 1% excise tax on certain corporate stock buybacks. More specifically, the Act would impose a nondeductible 1% excise tax on the fair market value of certain stock that is “repurchased” during the taxable year by a publicly traded U.S. corporation or acquired by certain of its subsidiaries. The taxable amount is reduced by the fair market value of certain issuances of stock throughout the year. The Act also imposes a 15% corporate minimum tax and extends and expands tax incentives for clean energy. To the extent any provisions of the Act may impact a company’s business or financial condition, additional disclosure regarding the impact of the Act may need to be added to the risk factors, MD&A or the financial statements for the 2022 Form 10-K. For more information regarding the Act, please see our prior client alert, “Update: Senate Passes Revised Version of Inflation Reduction Act of 2022; Carried Interest Changes Omitted and Tax on Corporate Stock Buybacks Added.”[9]

IV. Updated Staff Guidance on Non-GAAP Measures

In 2022, the Staff, through comment letters issued during Form 10-K reviews, continued to focus on whether non-GAAP measures disclosed in periodic reports, earnings releases, and other earnings materials complied with Regulation G and Item 10(e) of Regulation S-K, as applicable. Issues emphasized in those comment letters include (i) whether certain performance measures should have been identified as non-GAAP measures, (ii) whether identified non-GAAP measures were presented with the most directly comparable GAAP measure at the appropriate prominence level, and (iii) the appropriateness of adjustments in non-GAAP measures. With respect to adjustments, care must be taken when deciding whether to adjust for current events, such as COVID-19 or the Russia-Ukraine conflict. Adjustments are typically only appropriate when they directly relate to a nonrecurring event and are clearly calculable and separable.

On December 13, 2022, the Staff announced an update to its Compliance and Disclosure Interpretations (“C&DI”) on Non-GAAP Financial Measures. Many of the changes memorialize positions taken by the Staff in recent comment letters or provide additional detail about those positions. A discussion of the significant changes is provided below, and a marked version of the impacted C&DIs is available in our prior post on the Gibson Dunn Securities Regulation and Corporate Governance Monitor, “SEC Updates Non-GAAP C&DIs.”[10]

A. Question 100.01 – Misleading Adjustments

Question 100.01 was revised to emphasize that a company’s individual facts and circumstances affect whether an adjustment makes a non-GAAP measure misleading. Using the pre-update example (i.e., a non-GAAP performance measure that excludes normal, recurring, cash operating expenses may be misleading), the updated C&DI illustrates this by noting that:

When evaluating what is a “normal, operating expense,” the Staff considers the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry, and regulatory environment.
The Staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as “recurring.”

B. Question 100.04 – Individually Tailored Accounting Principles

Question 100.04, which was completely rewritten, continues to include a prohibition on individually tailored accounting principles, but has now been supplemented with the following additional examples of adjustments that would run afoul of this prohibition:

accelerating the recognition of revenue as though it was earned when customers were billed, when GAAP requires it to be recognized ratably over time;
presenting revenue on a net basis when GAAP requires it to be presented on a gross basis (and vice versa); and
changing the basis of accounting for revenue or expenses to a cash basis when GAAP requires it to be accounted for on an accrual basis.

C. Question 100.05 – Improper Labels and Descriptions

New Question 100.05 memorializes the Staff’s position, often expressed through comment letters, that a non-GAAP measure can be misleading if it (or any adjustment made to the GAAP measure) is not appropriately labeled and clearly described. Three examples are provided of labels that would be misleading because they do not reflect the nature of the non-GAAP measure:

a contribution margin that is calculated as GAAP revenue less certain expenses, labeled “net revenue”;
a non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as “Gross Profit” or “Sales”; and
a non-GAAP measure labeled “pro forma” that does not meet the pro forma requirements in Article 11 of Regulation S-X.

D. Question 100.06 – Limits of Explanatory Disclosure

New Question 100.06 explains that a non-GAAP measure could be so inherently misleading that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent it from being materially misleading. No examples are provided.

E. Question 102.10 – Equal or Greater Prominence

Question 102.10, which relates to the equal or greater prominence rule, was broken into subparts and supplemented with more detailed explanations and additional examples of disclosures that the Staff believes violate Item 10(e) of Regulation S-K, including the following situations:

Ratios. When a ratio is calculated using a non-GAAP financial measure and the most directly comparable GAAP ratio is not presented with equal or greater prominence.
Charts/tables/graphs. When charts, tables, or graphs of non-GAAP financial measures are used and charts, tables, or graphs of the comparable GAAP measures are not presented with equal or greater prominence.
Reconciliations. When a reconciliation begins with the non-GAAP financial measure or appears to constitute a non-GAAP income statement.
Non-GAAP Income Statements. When a non-GAAP income statement is presented, even if it is not a full income statement; “most of the line items and subtotals found in a GAAP income statement” is objectionable to the Staff.

V. Cybersecurity Disclosure Considerations

Cybersecurity risks and incidents continue to remain a focus for the SEC. In March 2022, the SEC proposed amendments to its existing rules to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting by public companies. The proposed amendments would require, among other things, disclosure about (i) material cybersecurity incidents, (ii) a company’s policies and procedures to identify and manage cybersecurity risks, (iii) the board of directors’ oversight of cybersecurity risk, (iv) the board of directors’ cybersecurity expertise, and (v) management’s role and expertise in assessing and managing cybersecurity risk and implementing cybersecurity policies and procedures. For more information about the proposed rules, please see our prior client alert, “SEC Proposes Rules on Cybersecurity Disclosure.”^[11]

While the final rules have not yet been adopted, companies should review their existing cybersecurity risk disclosure and confirm that their disclosure controls, particularly related to incident reporting, are sufficient. In addition, when considering disclosure, companies may want to be mindful of the October 2022 updates that Institutional Shareholder Services (“ISS”) made to its Governance QualityScore methodology, which added new factors on information security, including whether the company discloses its third-party information security risks and whether the company experienced a third-party information security breach.[12] We note that comments issued by the Staff in the fall of 2022 reflect a heighted focus on cyberattacks (both in terms of potential risks and actual incidents), particularly in light of the ongoing Russia-Ukraine conflict.

VI. Reminder Regarding Past Amendments to Financial and Business Disclosure Requirements in Regulation S-K

For calendar year-end reporting companies, the 2021 Form 10-K was the first Form 10-K incorporating the SEC’s amendments to certain financial and business disclosure requirements of Regulation S-K, including Item 303 for MD&A. Adopted in November 2020, these amendments generally emphasized a principles-based approach to disclosure and eliminated certain prescriptive disclosure requirements. While virtually all reporting companies took advantage of certain of these disclosure requirements in their 2021 Form 10-K, such as removing the selected financial data in Item 6, many companies did not make drastic changes to their existing disclosure and opted to retain other disclosures notwithstanding the eliminated mandates, such as the tabular disclosure of contractual obligations.

Recent comment letters show that the Staff continues to seek additional disclosures responsive to certain aspects of the Regulation S-K amendments, including the requirement to discuss underlying reasons for material changes in line items and the requirements regarding critical accounting estimates. For example, companies that cited multiple factors impacting their financial results in MD&A have been requested by the Staff to revise future disclosures to further describe material line item changes and the underlying reasons for such changes in both quantitative and qualitative terms, including the impact of offsetting factors. In addition, companies whose disclosure of critical accounting estimates did little more than repeat portions of their significant accounting policy disclosure were asked to revise future disclosures to explain why each critical accounting estimate is subject to uncertainty and, to the extent the information is material and reasonably available, how much each estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amounts to the material methods, assumptions and estimates underlying its calculation.

For more information about the amendments to Regulation S-K, see our prior post, “Summary Chart and Comparative Blackline Reflecting Recent Amendments to MD&A Requirements Now Available.”[13]

VII. Technical and Other Considerations

A. New Filing Requirement for “Glossy” Annual Reports

In June 2022, the SEC adopted amendments mandating that annual reports sent to shareholders pursuant to Exchange Act Rule 14a-3(c) (i.e., “glossy” annual reports) must also be submitted to the SEC in the electronic format in accordance with the EDGAR Filer Manual. The amendments supersede the Staff guidance provided in 2016 stating that the SEC would not object if companies post their glossy annual reports to security holders on their corporate websites for at least one year in lieu of furnishing paper copies to the SEC.

These annual reports will be in PDF format and filed using EDGAR Form Type ARS. One technical concern with submitting “glossy” annual reports through EDGAR is file size limitations. The “glossy” annual reports are typically larger files as compared to other EDGAR filings because they tend to contain extensive graphics. In the final rule, the SEC noted that electronic submission in PDF format of the glossy annual report should capture the graphics, styles of presentation, and prominence of disclosures (including text size, placement, color, and offset, as applicable) contained in the reports. Accordingly, companies should be mindful of the file size of their glossy annual report and conduct test runs in advance to make sure that EDGAR is able to handle the file size or evaluate whether the PDF file can be compressed.

B. Clawback Check Boxes on Cover Page

As part of the final clawback rules adopted by the SEC on October 26, 2022, new checkboxes will be added to the cover pages of Forms 10-K, 20-F, and 40-F. Companies must indicate by check boxes on their annual reports whether the financial statements included in the filings reflect a correction of an error to previously issued financial statements and whether any such corrections are restatements that required a recovery analysis. The SEC’s adopting release noted that, “[p]articularly as it relates to ‘little r’ restatements which typically are not disclosed or reported as prominently as ‘Big R’ restatements, the check boxes provide greater transparency around such restatements and easier identification for investors of those that triggered a compensation recovery analysis.”

While the effective date for the SEC’s clawback rule is January 27, 2023, companies do not need to adopt a clawback policy until after the stock exchanges’ listing standards implementing the SEC rule are proposed, adopted, and become effective, which could be as late as November 28, 2023. In the meantime, it is not clear whether the SEC will require companies to include these checkboxes on the Form 10-K cover page. Each check box will constitute an inline XBRL element, so once EDGAR is set up to expect these new elements, it is possible that filings could get rejected unless the elements are included. (A similar issue cropped up last year for companies that tried to file their Form 10-K without tagging the independent auditor name, location, and/or PCAOB ID number.) As of this writing, the official Form 10-K available through the Forms List on the SEC website[14] has not been updated to include these new check boxes.

C. Item 201(e) Performance Graph and Pay Versus Performance

As a reminder, companies have the option of including the stock price performance graph required by Item 201(e) of Regulation S-K, which shows the company’s total shareholder return (TSR), in the Rule 14a-3 annual report to security holders (distributed in connection with the proxy statement) or the Form 10-K itself (assuming a “10-K wrap” is used to comply with Rule 14a-3). Beginning in this year’s proxy statements, companies will be required to provide disclosure that satisfies the new pay versus performance disclosures required by Regulation S-K Item 402(v). (For a summary of the final pay versus performance rules, please see our prior client alert, “SEC Releases Final Pay Versus Performance Rules.”)[15] These new disclosure requirements include comparisons to a peer group that may be the peer group identified in the Regulation S-K Item 201(e) performance graph. To the extent companies would like to use the Item 201(e) peer group in their pay versus performance disclosures, they will want to make sure the group identified in last year’s Form 10-K or Rule 14a-3 annual report is the one that they want to use for their initial pay versus performance disclosure in the proxy statement. If a company wants to use a different peer group in the 2022 Form 10-K (and the pay versus performance disclosure) than the one in last year’s performance graph, it will need to, per Regulation S-K Item 201(e)(4), “explain the reason(s) for this change and also compare the [company’s] total return with that of both the newly selected index and the index used in the immediately preceding fiscal year.”

__________________________

[1] See Modernization of Regulation S-K Items 101, 103, and 105, Release No. 33-10825 (August 26, 2020), available at https://www.sec.gov/rules/final/2020/33-10825.pdf.

[2] Available at https://www.gibsondunn.com/evolving-human-capital-disclosures.

[3] Available at https://www.gibsondunn.com/summary-of-and-considerations-regarding-the-sec-proposed-rules-on-climate-change-disclosure/.

[4] See Sample Letter to Companies Regarding Climate Change Disclosures (September 22, 2021), available at https://www.sec.gov/corpfin/sample-letter-climate-change-disclosures.

[5] Available at https://www.gibsondunn.com/considerations-for-climate-change-disclosures-in-sec-reports/.

[6] Available at https://www.sec.gov/corpfin/coronavirus-covid-19.

[7] Available at https://www.sec.gov/corpfin/covid-19-disclosure-considerations.

[8] See Sample Letter to Companies Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues (May 3, 2021), available at https://www.sec.gov/corpfin/sample-letter-companies-pertaining-to-ukraine.

[9] Available at https://www.gibsondunn.com/update-senate-passes-revised-version-of-inflation-reduction-act-of-2022-carried-interest-changes-omitted-tax-on-corporate-stock-buybacks-added/.

[10] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=468.

[11] Available at https://www.gibsondunn.com/sec-proposes-rules-on-cybersecurity-disclosure/.

[12] Interestingly, under the current QualityScore methodology, companies that disclose an immaterial information security breach in the last three years may see an improvement in their Audit & Risk Oversight score as a result of ISS’s preference for more, rather than less, disclosure of cyber incidents, even if immaterial.

[13] Available at https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=432.

[14] Available at https://www.sec.gov/forms.

[15] Available at https://www.gibsondunn.com/sec-releases-final-pay-versus-performance-rules/.

The following Gibson Dunn attorneys assisted in preparing this client update: Justine Robinson, Mike Titera, David Korvin, and Thomas Kim.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance and Capital Markets practice groups, or any of the following practice leaders and members:

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County, CA (+1 949-451-4343, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [email protected])
Brian J. Lane – Washington, D.C. (+1 202-887-3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Michael A. Titera – Orange County, CA (+1 949-451-4365, [email protected])
Aaron Briggs – San Francisco, CA (+1 415-393-8297, [email protected])
Julia Lapitskaya – New York, NY (+1 212-351-2354, [email protected])

Capital Markets Group:
Andrew L. Fabens – New York, NY (+1 212-351-4034, [email protected])
Hillary H. Holmes – Houston, TX (+1 346-718-6602, [email protected])
Stewart L. McDowell – San Francisco, CA (+1 415-393-8322, [email protected])
Peter W. Wardle – Los Angeles, CA (+1 213-229-7242, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

A Survey of Disclosures from the S&P 100 During the Two Years Following Adoption of the Securities and Exchange Commission Rule

Human capital resource disclosures by public companies have continued to be a focus since the U.S. Securities and Exchange Commission adopted the new rules in 2020; not only for companies making the disclosures, but employees, investors, and other stakeholders reading them. This alert serves as an update to the alert we issued in 2021, “Discussing Human Capital: A Survey of the S&P 500’s Compliance with the New SEC Disclosure Requirement One Year After Adoption,” and reviews disclosure trends among S&P 100 companies, each of which has now included human capital disclosure in their past two annual reports on Form 10-K. This alert also provides practical considerations for companies as we head into 2023.

The overall takeaway from our survey, which categorized disclosures into 17 topic areas, was that companies are generally expanding the length of their disclosures, covering more topics, and including slightly more quantitative information in some areas. We note the following trends regarding the S&P 100 companies’ disclosures compared to the previous year:

Seventy-nine companies increased the length of their disclosures, though the increases were generally modest.
Sixty-six companies increased the number of topics covered.
The prevalence of 16 topics increased and one remained the same.
- The most significant year-over-year increases in frequency involved the following topics: talent attraction and retention (67% to 91%), employee compensation (68% to 85%), quantitative diversity statistics on race/ethnicity (43% to 59%) and gender (47% to 61%), workplace health and safety (51% to 65%), and pay equity (30% to 41%).
- The only topic that did not see an increase in frequency was succession planning, which remained at 17%.
Eight-five companies included more qualitative details in their disclosures compared to the previous year, including information relating to diversity, equity, and inclusion (“DEI”) initiatives and programs and the board’s role in overseeing human capital initiatives, although the depth of the additional detail provided varied greatly between companies.
- In this most recent year, DEI was discussed by 96% of companies (89% in the previous year), and 37% of companies (22% in the previous year) went beyond qualitative DEI information and disclosed quantitative data regarding the breakdown of DEI statistics by job type or level (executive level, etc.).
- Disclosure regarding the role of the board (or a human capital-focused committee) in overseeing human capital jumped to 44% of companies this most recent year from 26% the previous year.
The topics most commonly discussed this most recent year generally remained consistent with the previous year. For example, DEI, talent development, talent attraction and retention, COVID-19, and employee compensation and benefits remained the five most frequently discussed topics, while succession planning, full-time/part-time employee split, quantitative pay gaps, culture initiatives, and quantitative workforce turnover rates continued to be the five least frequently covered topics.
Within each industry, the trends that we saw in the previous year regarding the frequency of topics disclosed generally remained the same.

I. Background on the Requirements

On August 26, 2020, the U.S. Securities and Exchange Commission (the “Commission”) voted three to two to approve amendments to Items 101, 103, and 105 of Regulation S-K, including the principles-based requirement to discuss a registrant’s human capital resources to the extent material to an understanding of the registrant’s business taken as a whole.[1] Specifically, public companies’ human capital disclosure must include “the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the development, attraction and retention of personnel).” One dissenting commissioner criticized the amendment for failing to even require disclosure of “commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity.”[2]

As discussed below, following the change in presidential administration, the Commission has indicated that it plans to revisit the human capital disclosure requirements and potentially adopt more prescriptive rules in the future.[3]

While companies disclosures under the principles-based rules varied widely, our survey was able to introduce some comparability. The next two sections show the relevant data from our survey.[4]

II. Disclosure Topics

Our survey classifies human capital disclosures into 17 topics, each of which is listed in the following chart, along with the number of companies that discussed the topic in 2021 and the number of additional companies that discussed the topic in 2022. Each topic is described more fully in the sections following the chart.

A. Workforce Composition and Demographics

Of the 100 companies surveyed, 99 included disclosures relating to workforce composition and demographics in one or more of the following categories:

Diversity and inclusion. This was the most common type of disclosure, with 96% of companies including a qualitative discussion regarding the company’s commitment to diversity, equity, and inclusion, up slightly from 89% the previous year. The depth of these disclosures varied, ranging from generic statements expressing the company’s support of diversity in the workforce to detailed examples of actions taken to support underrepresented groups and increase the diversity of the company’s workforce. Many companies also included a quantitative breakdown of the gender or racial representation of the company’s workforce: 61% included statistics on gender and 59% included statistics on race (compared to 47% and 43% in the previous year, respectively). Most companies provided these statistics in relation to their workforce as a whole; however, an increased subset (37% in the most recent year compared to 22% in the previous year) included separate statistics for different classes of employees (e.g., managerial, vice president and above, etc.) and/or for their boards of directors. Some companies also included numerical goals for gender or racial representation—either in terms of overall representation, promotions, or hiring—even if they did not provide current workforce diversity statistics.
Full-time/part-time employee split. While most companies provided the total number of full-time employees, only 17% of the companies surveyed included a quantitative breakdown of the number of full-time versus part-time employees the company employed, up only slightly from 14% the previous year. Similarly, we saw a number of companies that provided statistics on the number of seasonal employees and/or independent contractors or a breakdown of employees by geographical location.
Unionized employee relations. Of the companies surveyed, 34% stated that some portion of their workforce was part of a union, works council, or similar collective bargaining agreement, up slightly from 32% the previous year.[5] These disclosures generally included a statement providing the company’s opinion on the quality of labor relations, and in many cases, disclosed the number of unionized employees.
Quantitative workforce turnover rates. Although a majority of companies discussed employee turnover and the related topics of talent attraction and retention in a qualitative way (as discussed in Section II.B. below), only 23% of companies surveyed provided specific employee turnover rates (whether voluntary or involuntary), up slightly from 18% the previous year.

B. Recruiting, Training, Succession

Of the companies surveyed, 96% included disclosures relating to talent and succession planning in one or more of the following categories:

Talent attraction and retention. These disclosures were generally qualitative and focused on efforts to recruit and retain qualified individuals. While providing general statements regarding recruiting and retaining talent were relatively common, with 91% of companies including this type of disclosure (compared to 67% in 2021), quantitative measures of retention, like workforce turnover rate, were uncommon, with less than 23% of companies disclosing such statistics (as noted above).
Talent development. The most common type of disclosure in this area related to talent development, with 93% of companies including a qualitative discussion regarding employee training, learning, and development opportunities, up from 80% the previous year. This disclosure tended to focus on the workforce as a whole rather than specifically on senior management. Companies generally discussed training programs such as in-person and online courses, leadership development programs, mentoring opportunities, tuition assistance, and conferences, and a minority also disclosed the number of hours employees spent on learning and development.
Succession planning. Only 17% of companies surveyed addressed their succession planning efforts (unchanged from 2021), which may be a function of succession being a focus area primarily for executives rather than the human capital resources of a company more broadly.

C. Employee Compensation

Of the companies surveyed, 85% included disclosures relating to employee compensation, up from 68% the previous year. All of those companies included a qualitative description of the compensation and benefits program offered to employees. Of the companies surveyed, 41% addressed pay equity practices or assessments (compared to 30% in 2021), and substantially fewer companies (12% of companies surveyed in 2022 and 11% in 2021) included quantitative measures of the pay gap between diverse and nondiverse employees or male and female employees.

D. Health and Safety

Of the companies surveyed, 78% included disclosures relating to health and safety in one or both of the following categories:

Workplace health and safety. Of the companies surveyed, 65% included qualitative disclosures relating to workplace health and safety, up from 51% in the previous year, typically with statements around the company’s commitment to safety in the workplace generally and compliance with applicable regulatory and legal requirements. However, 10% of companies surveyed provided quantitative disclosures in this category, generally focusing on historical and/or target incident or safety rates or investments in safety programs. These disclosures tended to be more prevalent among industrial and manufacturing companies. Many companies also provided disclosures on safety initiatives undertaken in connection with COVID-19, which is discussed separately below.
Employee mental health. In connection with disclosures about standard benefits provided to employees, or additional benefits provided as a result of the pandemic, 41% of companies disclosed initiatives taken to support employees’ mental or emotional health and wellbeing, up from 31% the prior year.

E. Culture and Engagement

In addition to the many instances where companies mentioned a general commitment to culture and values, 62% of the companies surveyed discussed specific initiatives they were taking related to culture and engagement in one or more of the following categories:

Culture and engagement initiatives. Of the companies surveyed, 23% included specific disclosures relating to practices and initiatives undertaken to build and maintain their culture and values, up from 14% in the previous year. These companies most commonly discussed efforts to communicate with employees (e.g., through town halls, CEO outreach, trainings, or conferences and presentations) and to recognize employee contributions (e.g., awards programs and individualized feedback). Many companies also discussed culture in the context of diversity-related initiatives to help foster an inclusive culture.
Monitoring culture. Disclosures about the ways that companies monitor culture and employee engagement were much more common, with 56% of companies providing such disclosure, up from 51% the previous year. Companies generally disclosed the frequency of employee surveys used to track employee engagement and satisfaction, with some reporting on the results of these surveys, sometimes measured against prior year results or industry benchmarks.

F. COVID-19

A majority of companies (71% of those surveyed compared to 66% in 2021) included information regarding COVID-19 and its impact on company policies and procedures or on employees generally. COVID-19-related topics addressed ranged from work-from-home arrangements and safety protocols taken for employees who worked in person to additional benefits and compensation paid to employees as a result of the pandemic and contributions made to organizations supporting those affected by the pandemic.

G. Human Capital Management Governance and Organizational Practices

Over half of the companies (57% of those surveyed compared to 41% in 2021) addressed their governance and organizational practices (such as oversight by the board of directors or a committee and the organization of the human resources function).

III. Industry Trends

One of the main rationales underlying the adoption of principles-based—rather than prescriptive—requirements for human capital disclosures is that the relative significance of various human capital measures and objectives varies by industry. This is reflected in the following industry trends that we observed:[6]

Technology Industries (E-Commerce, Internet Media & Services, Hardware, Software & IT Services and Semiconductors). For the 20 companies in the Technology Industries, 90% discussed talent development and training opportunities, talent attraction, recruitment and retention, employee compensation, and diversity. Relatively uncommon disclosures among this group included part-time and full-time employee statistics (10%), culture initiatives (15%), succession planning (10%), and quantitative pay gap (10%).
Finance Industries (Asset Management & Custody Activities, Consumer Finance, Commercial Banks and Investment Banking & Brokerage). For the 13 companies in the Finance Industries, a large majority included quantitative diversity statistics regarding race (85%) and gender (85%). The same number of companies also included qualitative disclosures regarding employee compensation (85%), and, compared to other industries discussed below, a relatively higher number discussed pay equity (62%) and quantified their pay gap (38%). Relatively uncommon disclosures among this group included part-time and full-time employee statistics, unionized employee relations, quantitative workforce turnover rates, and succession planning (in each case less than 16%).

IV. Disclosure Format

The format of human capital disclosures in companies’ annual reports continued to vary greatly.

Word Count. The length of the disclosures ranged from 109 to 1,995 words, with the average disclosure consisting of 960 words and the median disclosure consisting of 949 words. Compare this to 2021, which saw a range of 105 to 1,931 words, with an average of 823 words and median of 818 words.

Metrics. While the disclosure requirement specifically asks for a description of “any human capital measures or objectives that the registrant focuses on in managing the business” (emphasis added), our survey revealed that 25% of companies determined not to include disclosure in any of the quantitative categories we discuss above, and 10% did not include any type of quantitative metrics in their disclosure beyond headcount numbers (down from 36% and 14%, respectively, in 2021). Given the materiality threshold included in the requirement and the fact that it is focused on what is actually used to manage the business, this is not a surprising result. It was common to see companies identify important objectives they focus on, but omit quantitative metrics related to those objectives; however, that group has been shrinking as more companies include metrics. For example, while 96% of companies discussed their commitment to diversity, equity, and inclusion (compared to 89% in 2021), only 61% and 59% of companies disclosed quantitative metrics regarding gender and racial diversity, respectively (compared to 47% and 43%, respectively, in 2021).

Graphics. Although the minority practice, 24% of companies surveyed also included charts or other graphics, up from 21% the previous year, which were generally used to present statistical data, such as diversity statistics or breakdowns of the number of employees by geographic location.

Categories. Most companies organized their disclosures by categories similar to those discussed above and included headings to define the types of disclosures presented.

V. Comment Letter Correspondence

Comment letter correspondence from the staff of the Division of Corporation Finance (the “Staff”), which often helps put a finer point on principles-based disclosure requirements like this one, has shed relatively little light on how the Staff believes the new requirements should be interpreted. Consistent with what we found at this time last year, the comment letters, all of which involved reviews of registration statements, were generally issued to companies whose disclosures about employees were limited to the bare-bones items companies have discussed historically, such as the number of persons employed and the quality of employee relations. From these companies, the Staff simply sought a more detailed discussion of the company’s human capital resources, including any human capital measures or objectives upon which the company focuses in managing its business. There were also a few comment letters where the Staff asked companies to clarify statements in their human capital disclosures. Based on our review of the responses to those comment letters, we have not seen a company take the position that a discussion of human capital resources was immaterial and therefore unnecessary.

VI. Conclusion

During the most recent year, we generally saw companies expanding the length of their human capital disclosures, covering more topics, and including slightly more quantitative information in some areas; however, the principles-based nature of the disclosure requirements has continued to result in companies providing a wide variety of disclosures, with significant differences in depth and breadth.

Given how high the Human Capital Management Disclosure rulemaking appears on the Fall 2022 Reg Flex Agenda (it appears as an action item for the first quarter of 2023), it seems unlikely we will see another year pass without more prescriptive rules being proposed and possibly adopted.

There has been no shortage of investors, politicians, and activists chiming in with input on the forthcoming rules. For example, earlier this year, several members of Congress wrote a letter asking the Commission to resist requests for more specific and quantitative disclosures on human capital, which expressed particular concerns about requiring metrics on full-time employees, part-time employees, independent contractors, subcontractors, or contingent employees.[7] In June 2022, the Working Group on Human Capital Accounting Disclosure, a group composed of academics and former SEC officials, submitted a rulemaking petition requesting the Commission to require more financial information about human capital in companies’ disclosures.[8]

Until the Commission proposes and adopts new rules governing the disclosure of human capital management, however, we expect the wide variance in Form 10-K human capital disclosures to continue. As companies prepare for the upcoming Form 10-K reporting season, they should consider the following:

Confirming (or reconfirming) that the company’s disclosure controls and procedures support the statements made in human capital disclosures and that the human capital disclosures included in the Form 10-K remain appropriate and relevant. In this regard, companies may want to compare their own disclosures against what their industry peers did these past two years, including specifically any notable additional disclosures made in the past year.
Setting expectations internally that these disclosures likely will evolve. As shown by the measurable increase in disclosure in the second year of reporting, companies should expect to develop their disclosure over the course of the next couple of annual reports in response to peer practices, regulatory changes, and investor expectations, as appropriate. The types of disclosures that are material to each company may also change in response to current events.
Addressing in the upcoming disclosure, if not already disclosed, the progress that management has made with respect to any significant objectives it has set regarding its human capital resources as investors are likely to focus on year-over-year changes and the company’s performance versus stated goals.
Addressing significant areas of focus highlighted in engagement meetings with investors and other stakeholders. In a 2021 survey, 64% of institutional investors surveyed cited human capital management as a key issue when engaging with boards (second only to climate change at 85%).^[9]
Revalidating the methodology for calculating quantitative metrics and assessing consistency with the prior year. Former Chairman Clayton commented that he would expect companies to “maintain metric definitions constant from period to period or to disclose prominently any changes to the metrics.”

__________________________

[1] See 17 C.F.R. § 229.101(c)(2)(ii).

[2] See Regulation S-K and ESG Disclosures: An Unsustainable Silence, available at https://www.sec.gov/news/public-statement/lee-regulation-s-k-2020-08-26.

[3] Commission Chair Gary Gensler’s Fall 2022 Unified Agenda of Regulatory and Deregulatory Actions (the “Fall 2022 Reg Flex Agenda”) shows “Human Capital Management Disclosure” as being in the proposed rule stage. Available at https://www.reginfo.gov/public/do/eAgendaMain?operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode&showStage=active&agencyCd=3235.

[4] Note that companies often include additional human capital management-related disclosures in their ESG/sustainability/social responsibility reports and websites and sometimes in the proxy statement, but these disclosures are outside the scope of the survey.

[5] While never expressly required by Regulation S-K, as a result of disclosure review comments issued by the Division of Corporation Finance over the years and a decades-old and since-deleted requirement in Form 1-A, it has been a relatively common practice to discuss collective bargaining and employee relations in the Form 10-K or in an IPO Form S-1, particularly since the threat of a workforce strike could be material.

[6] For purposes of our survey, we grouped companies in similar industries based on both their four-digit Standard Industrial Classification code and their designated industry within the Sustainable Industry Classification System. The industry groups discussed in this section cover 33% of the companies included in our survey.

[7] Available at https://www.warner.senate.gov/public/index.cfm/2022/2/warner-brown-call-on-sec-to-update-human-capital-disclosures-so-that-companies-report-the-number-of-employees-who-are-not-full-time-workers.

[8] Available at https://www.sec.gov/rules/petitions/2022/petn4-787.pdf.

[9] See Morrow Sodali 2021 Institutional Investor Survey, available at https://morrowsodali.com/insights/institutional-investor-survey-2021.

The following Gibson Dunn attorneys assisted in preparing this update: Meghan Sherley and Mike Titera.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance practice group, or any of the following practice leaders and members:

Labor and Employment Group:
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On December 27, 2022, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) issued Notice 2023-7 (the “Notice”) to provide important interim guidance on the new corporate alternative minimum tax (the “CAMT”) enacted under the Inflation Reduction Act of 2022.[1] The Notice describes forthcoming regulations that are expected to be consistent with the interim guidance provided in the Notice and retroactive to January 1, 2023 (the date that the CAMT became effective). Taxpayers may rely on the interim guidance until the proposed regulations are issued. Accordingly, we expect this guidance to inform Q1 2023 estimated tax payments and financial reporting for affected taxpayers.

The Notice provides necessary and welcome guidance in many respects, but there remain significant open issues.

The Statute

For taxable years beginning after December 31, 2022, the CAMT requires certain corporations (each, an “Applicable Corporation”) to pay U.S. federal income tax on their adjusted financial statement income (“AFSI”) at a rate of at least 15 percent.[2] A corporation is an Applicable Corporation if it — together with the other members of its controlled group — averages more than $1 billion of AFSI over a three-year testing period. For a U.S. subsidiary of a foreign-parented multinational group to be an Applicable Corporation, the subsidiary also must have AFSI of $100 million or more over the same three-year testing period (taking into account the AFSI only of the domestic members of the group and the “effectively connected” AFSI of each foreign member), with certain adjustments.[3]

Key Provisions of the Notice

The Notice provides a safe harbor for determining whether a corporation will constitute an Applicable Corporation for the corporation’s first taxable year beginning after December 31, 2022. In addition, the Notice includes interim guidance regarding (i) a safe harbor for determining Applicable Corporation status and certain rules relating to controlled groups, (ii) how certain acquisitive and divisive transactions are taken into account, (iii) the calculation of AFSI for certain distressed corporations, and (iv) the treatment of depreciable property and certain tax credits for purposes of calculating AFSI. Below is a high-level summary of the key provisions of the Notice.

1. Applicable Corporation Determination – Safe Harbor and Certain Group Rule

a. Safe Harbor

For purposes of calculating AFSI to determine Applicable Corporation status, the statute requires a number of complex adjustments to the income or loss reported on a corporation’s financial statements. To simplify this determination, the Notice includes a safe harbor that allows a corporation, for its first taxable year beginning after December 31, 2022, to disregard the numerous adjustments required by the statute. Under the safe harbor, the corporation can simply use the income or loss reported on the corporation’s consolidated financial statements, with limited adjustments, but must apply a reduced AFSI threshold of $500 million (or $50 million in the case of a U.S. corporate subsidiary of a foreign-parented multinational group).

For corporations that are under the $500 million AFSI threshold of the safe harbor, the safe harbor simplifies what otherwise could be a burdensome (and time-sensitive, given upcoming estimated tax payments) determination. Note that if a corporation does not satisfy the safe harbor, it can still avoid being an Applicable Corporation under the statutory computational and threshold rules.

b. Consolidated Groups, Corporate Partners, and Foreign-Parented Multinational Groups

The application of the CAMT to consolidated groups, partnerships, and multinational corporations is of critical importance. The Notice clarifies some aspects of these rules but leaves open several questions.

Single-entity treatment for consolidated groups. The Notice provides that a consolidated group is treated as a single entity for purposes of computing AFSI—both for determining Applicable Corporation status as well as for calculating CAMT liability.[4]

Corporate partners – manner of taking into account partnership AFSI to determine Applicable Corporation status. Section 56(c)(2)(D)(i) contains a “distributive share” rule that provides that, for purposes of calculating AFSI to determine an Applicable Corporation’s CAMT liability, an Applicable Corporation that is a partner in a partnership takes into account only its distributive share of the partnership’s AFSI.[5] The Notice clarifies that the distributive share rule is disregarded for purposes of determining whether a corporation is an Applicable Corporation regardless of whether the partnership is part of the corporate partner’s controlled group.[6] The Notice does not provide any guidance regarding how a taxpayer should determine its distributive share. The IRS and Treasury have requested comments on the application of this distributive share rule.

Foreign-parented multinational groups. The Notice addresses how the safe harbor applies to entities in a foreign-parented multinational group and also seeks comments in this area.

Although the determination of Applicable Corporation status in the context of investment fund structures involving partnerships and portfolio companies similarly raises significant issues, the Notice does not address any of these issues.[7]

2. Certain M&A and Restructuring Transactions – Combinations and Divisions

The Notice addresses how M&A and restructuring transactions affect the determination of Applicable Corporation status and the computation of CAMT liability.

a. Entirely Tax-free transactions disregarded

The Notice provides that any financial accounting gain or loss resulting from specified tax-free transactions is disregarded for purposes of calculating AFSI — both to determine Applicable Corporation Status and to calculate CAMT liability for the taxable years in which the applicable financial statements take into account the relevant nonrecognition transaction.[8] This guidance is particularly welcome in clarifying that both spin-offs and split-offs do not affect AFSI if they are otherwise tax-free even though split-offs can result in financial statement gain or loss. It is important to note that this rule applies only to transactions that are wholly tax-free (i.e., that do not have any “boot”).[9] The IRS and Treasury have requested comments regarding how to treat transactions that are partially taxable.

In addition, the Notice requires that each component transaction of a larger transaction be examined separately for qualification as a tax-free transaction that is covered by the Notice. The Notice nonetheless also provides that general step transaction doctrine principles apply.

Taxpayers will need to consider these rules when structuring acquisitions and divestitures.

b. Impact on Applicable Corporation Determination

The Notice provides three sets of rules regarding the determination of AFSI for a party to an applicable M&A transaction for purposes of determining Applicable Corporation status.

Acquisition of Standalone Target or Entire Target Group. If a corporation acquires a standalone target or entire target group to form a new group, the acquirer group takes into account the AFSI of the acquired target (or target group) for the three-year taxable period ending with the taxable year in which the acquisition takes place (the “Three-Year Period”). The Applicable Corporation status (if it existed immediately prior to the transaction) of the target or target group terminates.
Carve-Out. If a corporation acquires only a portion of a target group, the acquiring corporation takes into account only the portion of the AFSI of the target group allocated to the target (based on any reasonable method until proposed regulations are issued that specify a required allocation method) for the Three-Year Period, and the AFSI of the remaining target group is not adjusted. In other words, the AFSI allocated to the target is included in the AFSI for both the target’s group and the acquiror’s group for the Three-Year Period. If Applicable Corporation status existed for the target immediately prior to the transaction, it terminates.
Spin-off or Split-off. If a corporation distributes a controlled corporation to its shareholders, the controlled corporation is allocated a portion of the AFSI of the distributing corporation (or the applicable group of which the distributing corporation is the parent) for the Three-Year Period (based on any reasonable allocation method until proposed regulations are issued that specify a required allocation method).[10] The AFSI of the distributing corporation (or the applicable group of which the distributing corporation is the parent) is not adjusted. Rather, as in the carve-out situation, the AFSI allocated to the controlled corporation is included in the AFSI for both the distributing and the controlled groups. If Applicable Corporation status existed for the controlled entity immediately prior to the transaction, it terminates.

Although the application of the CAMT rules to M&A and restructuring transactions is rife with complexity and ambiguity, the interim guidance provides taxpayers with much needed clarity regarding the application of the CAMT to these transactions and is a very helpful starting point for future regulations. It is not surprising that this is a key area in which the IRS and Treasury have requested comments.

3. Distressed Situations

The Notice provides relief for certain distressed corporations. Specifically, the Notice excludes from the calculation of AFSI—for purposes of both determining Applicable Corporation status and calculating CAMT liability—financial accounting gain that is excluded from income for U.S. federal income tax purposes under section 108(a)(1). The Notice also requires a reduction to the taxpayer’s CAMT tax attributes to the extent of the amount of the excluded cancellation of indebtedness income that results in a reduction of tax attributes under section 108(b) or Treas. Reg. § 1.1508-28.

The IRS and Treasury have requested comments regarding what CAMT attributes should be adjusted and what methodology should be used to adjust the CAMT attributes (and in what order).

4. Depreciable property and new refundable and transferable tax credit rules

The statute provides that tax depreciation deductions, rather than financial statement depreciation expense, are taken into account in computing AFSI for purposes of both determining Applicable Corporation status and calculating CAMT liability. The Notice includes various rules clarifying the application of this rule to certain tangible property. For example, the Notice provides that this rule applies only to depreciation deductions allowed under section 167 with respect to property that is in fact depreciated under section 168.[11] The Notice also makes clear that AFSI is reduced by tax depreciation that is capitalized to inventory under section 263A and recovered as part of cost of goods sold in computing gross income under section 61.

In addition, the Notice includes guidance regarding the new refundable and transferable tax credit rules for clean energy and advanced manufacturing projects. Specifically, the Notice provides that AFSI (again, for purposes of both determining Applicable Corporation status and calculating CAMT liability) is determined by taking into account appropriate adjustments to disregard amounts (i) that the taxpayer elects to treat as a payment of tax under section 48D(d) or 6417, (ii) treated as tax-exempt income under sections 48D(d) or 6417), and (iii) received from the transfer of an eligible credit that is not includible in the gross income of the transferring taxpayer under section 6418(b) or is treated as tax-exempt income under section 6418(c). Although the Notice does not provide color on the meaning of “appropriate adjustments,” the guidance is helpful in clarifying that the imposition of the CAMT is not intended to undermine the new energy incentives enacted last year.

__________________________

[1] As was the case with Tax Cuts and Jobs Act, the Senate’s reconciliation rules prevented changing the Act’s name. Therefore, the Inflation Reduction Act is actually “An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.” Pub. L. No. 117–169, tit. I, § 10201(d), 136 Stat. 1831 (Aug. 16, 2022).

The IRS issued a second notice on December 27, 2022, that provides important initial guidance on the new stock buyback excise tax. See our January 3, 2022, client alert “IRS and Treasury Issue Interim Guidance on New Stock Buyback Excise Tax,” available at https://www.gibsondunn.com/irs-and-treasury-issue-interim-guidance-on-new-stock-buyback-excise-tax/.

[2] The CAMT increases a taxpayer’s tax only to the extent that the 15 percent minimum tax (computed after taking into account applicable foreign tax credits) exceeds the taxpayer’s regular tax plus the base erosion and anti-abuse tax.

[3] A U.S. corporation is a member of a foreign-parented multinational group if it is included in the applicable financial statements of a group that has a foreign parent.

[4] Importantly, not all AFSI computational rules apply for both purposes.

[5] Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended, and all “Treas. Reg. §” references are to the Treasury regulations promulgated thereunder.

[6] This guidance was necessary because the statute alone does not make clear whether the distributive share rule applies only in circumstances in which the corporate partner and the partnership are aggregated for purposes of calculating AFSI or in all cases.

[7] What is clear is that the typical private equity partnership is not required to take into account the book income of its portfolio companies. This position was proposed by Senate Democrats before the Act was passed in August of 2022, but Finance Committee member John Thune’s amendment removed that language from the bill.

[8] The list of specified transactions has notable exclusions. For example, it does not include tax-free capital contributions under section 118, like-kind exchanges under section 1031, involuntary conversions under section 1033, stock-for-stock exchanges under section 1036, or conversions of convertible debt under Revenue Ruling 72-265.

[9] The Notice requires the transaction not “result” in any amount of gain or loss for U.S. federal income tax purposes. The proposed regulations should clarify that “result” in this context means recognition (and not realization) of gain or loss.

[10] The IRS and Treasury have requested comments on how to allocate AFSI of the distributing group to the controlled corporation.

[11] The precise meaning of the depreciation rule is not entirely clear.

This alert was prepared by Anne Devereaux, Pamela Lawrence Endreny, Adam Gregory, Kathryn A. Kelly, Jennifer Sabin, and Eric 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 and Global Tax Controversy and Litigation practice groups:

Tax Group:
Dora Arash – Los Angeles (+1 213-229-7134, [email protected])
Sandy Bhogal – Co-Chair, London (+44 (0) 20 7071 4266, [email protected])
Michael Q. Cannon – Dallas (+1 214-698-3232, [email protected])
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, [email protected])
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Anne Devereaux* – Los Angeles (+1 213-229-7616, [email protected])
Matt Donnelly – Washington, D.C. (+1 202-887-3567, [email protected])
Pamela Lawrence Endreny – New York (+1 212-351-2474, [email protected])
Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])
Brian R. Hamano – Los Angeles (+1 310-551-8805, [email protected])
Kathryn A. Kelly – New York (+1 212-351-3876, [email protected])
Brian W. Kniesly – New York (+1 212-351-2379, [email protected])
Loren Lembo – New York (+1 212-351-3986, [email protected])
Jennifer Sabin – New York (+1 212-351-5208, [email protected])
Hans Martin Schmid – Munich (+49 89 189 33 110, [email protected])
Eric B. Sloan – Co-Chair, New York/Washington, D.C. (+1 212-351-2340, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), [email protected])
John-Paul Vojtisek – New York (+1 212-351-2320, [email protected])
Edward S. Wei – New York (+1 212-351-3925, [email protected])
Lorna Wilson – Los Angeles (+1 213-229-7547, [email protected])
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, [email protected])

Global Tax Controversy and Litigation Group:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Saul Mezei – Washington, D.C. (+1 202-955-8693, [email protected])
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202-887-3650, [email protected])
C. Terrell Ussing – Washington, D.C. (+1 202-887-3612, [email protected])

*Anne Devereaux is an of counsel working in the firm’s Los Angeles office who is admitted only in Washington, D.C.

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On 19 December 2022, representatives from 188 countries adopted a new agreement at the United Nations (“UN”) Biodiversity Conference in Montreal, Canada, to guide global action on nature.[1] The agreement, the Kunming-Montreal Global Biodiversity Framework (“GBF”), is the result of several years of negotiations under the auspices of the UN Convention on Biological Diversity (“CBD” or the “Convention”),[2] the first summit having taken place in Kunming, China, in October 2021.[3] The GBF aims to “halt and reverse” biodiversity loss through a series of specific goals and targets.[4] Its cornerstone is the target to conserve 30% of the world’s land and 30% of the world’s oceans by 2030, widely known as the 30×30 pledge.

The GBF is one of a handful of CBD agreements[5] but has the potential to become one of the most significant in moving the dial on nature loss and degradation to date. Described as a “landmark” agreement,[6] a “huge, historic moment,”[7] and a “major win for our planet and for all of humanity”[8], the GBF was signed against a backdrop of global regulatory developments and investor pressure urging action to address climate change and the interconnected biodiversity loss crisis.

We share below our insights on the new framework and how it is expected to shape national and international policies and regulations relating to biodiversity, with implications for global organizations and financial firms.

Key Highlights

In December 2022 at COP 15, 188 countries adopted a new Global Biodiversity Framework (“GBF”) under the UN Convention for Biological Diversity to “halt and reverse” biodiversity loss.
GBF includes four “overarching global” goals and 23 targets for 2030 to protect nature.
Seen as a landmark agreement, the GBF aims to conserve 30% of the world’s land and 30% of the world’s oceans by 2030.
A number of the GBF target will impact the private sector-including those related to disclosure and transparency, reduction of pollution risks “from all sources,” reduction of subsidies “harmful to biodiversity” by at least $500 billion per year by 2030, and mobilization of at least $200 billion per year to implement national biodiversity goals.
GBF is likely to spur additional actions at the domestic and international levels and lead to enhanced and new voluntary (and eventually mandatory) rules on nature-related issues.
A number of initiatives across the financial sector have already expressed support for the GBF and its objectives. For example, a new coalition of institutional investors (Nature Action 100) was announced at COP 15 and will focus on identifying and supporting critical private sector actors in key sectors.

I. Background to COP15

The meeting of the Conference of the Parties (“COP”) to the CBD takes place every two years with a view to advancing the goals of the Convention. The CBD, which opened for signature in 1992 at the Earth Summit in Rio de Janeiro[9] and entered into force in 1993, is an international treaty with three objectives—(i) the conservation of biological diversity; (ii) the sustainable use of the components of biodiversity; and (iii) the fair and equitable sharing of the benefits derived from the use of genetic resources.[10] The CBD has nearly universal participation, with 196 States Parties including Belgium, Brazil, China, France, Germany, Singapore, the UAE, and the United Kingdom. The United States signed the treaty in 1993 but has not ratified it. (The U.S. nonetheless participates at the COPs and, as we discuss below, COP15 has implications for U.S. entities and other global organizations.)

In 2010, at COP10 in Nagoya, Japan, the Parties adopted a revised and updated Strategic Plan for Biodiversity, including the Aichi Biodiversity Targets for 2011–2020 (“Aichi Targets”), to achieve a goal of “living in harmony with nature” by 2050.[11]

In 2019, however, a report by the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (“IPBES”) concluded that nature was declining globally at rates unprecedented in human history. In 2020, the Global Biodiversity Outlook 5, a CBD report, found that, despite progress in some areas, governments had failed to meet the Aichi Targets.[12]

These findings set the tone for the next COP—COP15—whose key purpose was to agree on global nature targets for 2030 and 2050. The meeting opened on 7 December 2022 and, following a “sometimes fractious” two-week meeting[13] and reservations voiced by several States including on the sensitive and critical topic of financing, the GBF was adopted and the updated draft agreement published in the last few hours of COP15.[14] Alongside the GBF, COP15 adopted a number of other decision texts that spell out more technical details, including monitoring mechanisms, resource mobilization, and areas for future work.[15]

II. Why are COP15 and Biodiversity Important to Organizations and Investors?

In our previous alert, we touched on some of the key reasons why biodiversity loss poses a risk to companies and investors. Most businesses depend on ecosystem services underpinned by biodiversity. For example, a 2020 report from the World Economic Forum (“WEF”) found that more than 50% of the world’s GDP ($44 trillion) is moderately or highly dependent on nature and its ecosystems—and is therefore at risk of disruption due to nature loss.[16]

Today, the WEF ranks biodiversity loss as a top three risk to the global economy.[17]

Chart 1. Examples of Global Biodiversity Risks[18]

Up to $577 billion in annual global crop production is at risk from pollinator loss

Around 40% of the global population is adversely affected by land degradation

100-300 million people are at increased risk of floods and hurricanes due to coastal habitat loss

Collapse of wild pollinator populations, marine fisheries, and timber production alone could reduce global GDP by $2.7 trillion annually by 2030

Wildlife is the source of 70% of novel pathogens and loss of natural habitats substantially increases the risk of global pandemics via human encroachment

Coral reefs alone generate $36 billion per year for the global tourism industry.

60% of coffee varieties are in danger of extinction due to climate change, disease and deforestation.

25% of drugs used in modern medicine are derived from rainforest plants

Companies and investors are increasingly appreciating and focusing on these material, systemic risks posed by biodiversity loss.[19]

With these global risks, however, also come opportunities for both the public and private sectors. A recent World Bank report estimates that “nature-smart” policies can reduce the risk of ecosystem collapse and are “win-win” policies in terms of biodiversity and economic outcomes. Meanwhile, the WEF’s Future of Nature and Business Report[20] found that “nature-positive” solutions could create over $10 trillion in business opportunities and provide 395 million more jobs by 2030. Investment in nature can prove to be not just a cost-effective but even a profitable solution for addressing the broader societal objective of biodiversity loss.[21] This growing awareness is reflected in investment in “nature-based solutions” (“NbS”),[22] which is expected to grow in the light of the GBF’s package of actions relating to resource mobilization, mechanisms for planning, and capacity-building and development, and technical and scientific cooperation, as discussed below.

Against this backdrop of urgency and interest, it was no surprise to many that, for the first time, the conference featured a dedicated Finance Day. There were a number of initiatives and developments emanating from the financial sector both in the run up to, at, and following the COP15, including:

The UN Principles of Responsible Investment (“UN PRI”), a UN-supported international network of financial institutions, coordinated a call by 150 global financial institutions with more than $24 trillion in assets under management, on governments to adopt the GBF and committed to work within their own organizations to support the effective alignment of the proposed vision from the CBD of “Living in Harmony with Nature by 2050.”[23]
The topic of “biodiversity credits” and establishing a voluntary market for these developing financial instruments was keenly debated at the COP, and in parallel the WEF and the Biodiversity Credit Alliance are exploring market options for biodiversity credits.[24]
A new coalition of institutional investors, Nature Action 100, was announced at COP15. The group will identify most critical private-sector actions and work with companies to address nature loss and degradation, focusing initially on 100 companies in key sectors (i.e., those deemed to be systemically important to the GBF’s goal of reversing nature and biodiversity loss by 2030).
The World Benchmarking Alliance (“WBA”) published a new Nature Benchmark at COP15—an assessment of 389 companies—which found that just 5% understand their impact on nature and less than 1% know how much their operations depend on nature.

III. The GBF’s Global Roadmap to 2030

The overarching aim of the GBF is for people to “liv[e] in harmony with nature” by 2050. To achieve this vision, the GBF has set out a “mission” to “halt and reverse” biodiversity loss by 2030. It adopted four “overarching global” goals and 23 targets for 2030 to protect nature, which are described in more detail below:

(A) The GBF’s Four Goals

The GBF’s four overarching global goals include:

Goal	Goal Summary
Goal A	Halting “human-induced extinction” of known threatened species and reducing the rate and risk of extinction of all species “tenfold” by 2050
Goal B	Sustainable use and management of biodiversity to ensure that “nature’s contributions to people . . . are valued, maintained and enhanced,” for the benefit of present and future generations by 2050
Goal C	Fair and equitable sharing of the “benefits from the utilization of genetic resources, and digital sequence information on genetic resources” and protection of traditional knowledge associated with genetic resources
Goal D	Ensuring that adequate means of implementing the GBF are accessible to all Parties, and in particular the Least Developed Countries and Small Island Developing States

Although Goal D does not specifically mention either the public or the private sector, is it regarded as one of the most relevant goals for the corporate and financial services sector. Adequate means of implementation, including financial resources, capacity-building, and technical and scientific cooperation are seen as key to ensure the success of the GBF and “progressively clos[e] the biodiversity finance gap of 700 billion dollars per year.”

(B) The GBF’s 23 Targets

The GBF’s targets (of which nine incorporate specific 2030 targets) cover the following areas:

Target	Target Summary
Target 1	Spatial planning to bring the loss to areas of high biodiversity importance to close to zero by 2030
Target 2	Effective restoration of at least 30% of degraded terrestrial, inland water, and coastal/marine ecosystems by 2030
Target 3	Effective conservation of at least 30% of degraded terrestrial, inland water and coastal/marine ecosystems by 2030 (i.e., 30 x 30), recognizing indigenous and traditional territories, where applicable
Target 4	Ensure urgent management actions to stop human-induced extinction of species and restore genetic diversity
Target 5	Ensure that the use, harvesting, and trade of wild species is sustainable, safe, and legal, and reduce the risk of pathogen spill-over
Target 6	Eliminate, reduce, or mitigate impacts of invasive alien species on biodiversity
Target 7	Reduce pollution risks and negative impact of pollution “from all sources” to non-harmful levels by 2030, including reducing excess nutrients lost by at least 50% including through more efficient nutrient cycling and use, reducing the “overall risk from pesticides and highly hazardous chemicals” by at least 50% including through integrated pest management, and working towards “eliminating plastic pollution”
Target 8	Minimize the impact of climate change and ocean acidification on biodiversity
Target 9	Ensure that the management and use of wild species is sustainable, thereby supporting especially those most dependent on biodiversity
Target 10	Ensure that areas under agriculture, aquaculture, fisheries, and forestry are managed sustainably
Target 11	Restore, maintain, and enhance contributions to people, such as regulation of air, water, and climate, soil health, pollination and reduction of disease risk, through nature-based solutions and ecosystem-based approaches
Target 12	Significantly increase the area, quality, and connectivity of access to and benefits from green and blue spaces in urban and densely populated areas, including by ensuring biodiversity-inclusive urban planning, enhancing native biodiversity, ecological connectivity and integrity
Target 13	Take effective legal, policy, administrative, and capacity-building measures to ensure the fair and equitable sharing of benefits from genetic sources
Target 14	Ensure the full integration of biodiversity into policies and regulations, including environmental impact assessments (“EIAs”), across all levels of government and sectors, and progressively align all public and private activities, fiscal and financial flows with the GBF
Target 15*	Take legal, administrative, or policy measures to encourage and enable large and transnational companies and financial institutions to “monitor, assess, and transparently disclose” their biodiversity risks, dependencies, and impacts through their operations, portfolios, supply, and value chains, including by providing more information to consumers and reporting on compliance with regulations
Target 16	Ensure that people are encouraged to make sustainable consumption choices, including by establishing supportive policy, legislative, and regulatory frameworks, and, by 2030, reduce “the global footprint of consumption,” halve global food waste, and reduce waste generation
Target 17	Establish, strengthen capacity for, and implement biosafety measures
Target 18	Eliminate or reform incentives which are “harmful to biodiversity” (e.g. subsidies) by 2050, by progressively reducing them by at least $500 billion per year by 2030, while scaling up positive incentives for biodiversity conservation and sustainable use
Target 19	Increase the level of financial resources to implement national biodiversity strategies and action plans by mobilizing at least $200 billion per year (from public and private sources) and increasing international financial flows from developed to developing countries to at least $20 billion per year by 2025 and $30 billion by 2030
Target 20	Strengthen capacity-building, access to, and transfer of technology and R&D for the conservation and sustainable use of biodiversity
Target 21	Ensure that the best available data, information, and knowledge accessible to decision-makers and the public to guide governance, awareness-raising, education, monitoring, and R&D management
Target 22	Ensure the full, equitable, inclusive gender-responsive representation and participation in decision-making related to biodiversity
Target 23	Ensure gender equality in the implementation of the GBF

* Target 15 is the GBF’s private sector-focused target for businesses and financial institutions. However, as the WEF has noted in its most recent report, multiple other goals and targets are relevant to the private sector and create both risks and opportunities for global organizations and financial institutions.[25]

(C) The CBD’s Next Steps

The next UN biodiversity conference will be held in Turkey in 2024. In the interim, the CBD’s subsidiary bodies will continue to meet and develop the scientific, reporting, and monitoring foundations for the GBF. Meanwhile, the Global Environment Facility (“GEF”) will create a new biodiversity-specific trust fund, as outlined in the final agreement.[26]

In parallel, at the domestic level, States Parties to the CBD will be expected to revise their National Biodiversity Strategies and Action Plans (“NBSAPs”) to “align” them with the goals and targets set out in the GBF (Art. 34(a)) by COP16—the next biodiversity summit.[27] COP15 also agreed that the CBD Parties should submit national reports containing agreed headline indicators in 2026 and 2029.[28]

Implementation of the GBF, however, will also likely continue outside of the narrow context of the CBD. For example, about 60% of the Earth’s ocean surface lies outside national jurisdictions—and beyond the reach of national legislation. To preserve biodiversity on the high seas (and on the seafloor), States would need to adopt a complementary sets of biodiversity rules and targets.[29]

IV. Broader Implications and Developments of Note for Corporations and Financial Institutions

The GBF is not a legally binding international treaty, but it is nonetheless expected to affect national policies, regulations, and plans globally as governments seek to give effect to their new biodiversity commitments. As we have seen, global financial institutions are already both supporting and urging such actions.

With its more measurable targets and an “enhanced implementation mechanism,” the GBF is thought to be more robust—and more likely to be successfully implemented—than its predecessor, the 2010 Aichi Targets.[30] The GBF’s system of reporting, monitoring, and “ratcheting up” of ambition over time is expected to result in more concrete actions.[31] This approach draws on the implementation framework underpinning the 2015 Paris Agreement on Climate Change (“Paris Agreement”). The Paris Agreement—which requires countries to regularly submit their national climate plans for review and increase their climate targets over time—has already had significant impact both on domestic legislation (across all levels of government) and voluntary measures by the private sector. The GBF, already (aspirationally) described as the “Paris Agreement for Nature,” could potentially be as far-reaching.

At the same time, while the GBF contains some specific targets, not all are quantitative. Quantifying and standardizing national commitments (both in targets and in financial investment) is seen as necessary to ensure implementation.

Depending on the degree of implementation by governments and/or voluntary adoption by the private sector, there are a number of specific aspects of the GBF which could lead to changes in the scope, nature, and increased costs of business and compliance for various organizations as illustrated below.[32] It will be important for individual businesses, management, and boards to track and proactively consider the potential impact of these developments on their operations, investment decisions, and compliance. For instance:

Impact of GBF Substantive Targets – Expansion of Protected Areas: The GBF’s substantive targets could have significant implications for business, in particular those that already enjoy a significant degree of support among governments.[33] Currently, around 17% of land and 8% of marine areas globally are protected.[34] The GBF commitment in Target 3 to expand protected areas to at least 30% of the world’s land, coastal areas, and oceans by 2030 is likely to have material implications for a number of businesses, including agriculture, fisheries, mining, and logging, which may see a contraction in areas available for their operations, while other sectors, such as tourism, consumer products, cosmetics, and pharmaceuticals, may see growth. Moreover, it is expected that the 30% target may be revised upwards in the future in view of other scientific assessments suggesting that protecting biodiversity requires 30-50% of Earth’s land and sea to be set aside for nature.[35]
Finance – Phasing out of Subsidies: The implementation of Target 18 could reshape international financial flows by redirecting $500 billion every year in subsidies that are seen to have a negative impact on biodiversity and putting those funds to a different use. While specific sectors are not named in the GBF, this commitment is expected to target subsidies for agriculture, fisheries, and hydrocarbons.
Respecting Indigenous Rights – Implications for Land Use and Operations: The GBF incorporates Indigenous Rights into various targets.[36] This will shape how governments and the private sector conduct operations in areas with an Indigenous population and heighten the need for securing their free, prior, and informed consent.
Respecting Human Rights: The GBF also expressly states that implementation should follow a human rights-based approach and acknowledges the human right to a clean, healthy, and sustainable environment in line with the U.N. General Assembly Resolution 76/300 of 28 July 2022.
Disclosure, Increased Transparency, and Commitments: Finally, Target 15 calls on large and transnational companies and financial institutions to “monitor, assess, and transparently disclose” their risks and impacts on biodiversity throughout their operations, portfolios, supply, and value chains by 2030. Many Parties, as well as Business for Nature, a corporate coalition, had called on the COP15 delegates to make Target 15 mandatory for all companies. While the GBF did does not make the target “mandatory” or set concrete benchmarks and does not bind private actors, it may nonetheless have significant impacts and enhance impetus in this area, which has already seen some development.

The disclosure-related Target 15 builds on a growing number of existing regulations and standards and will likely spur additional actions, as summarized below:

Existing National and Regional Regulations – As noted in our previous alert, a number of regulations already apply to corporates and/or investment funds in Europe (for example in the UK, France, and the EU[37]) and globally that already incorporate specific biodiversity and nature-related disclosures. As with other ESG-related disclosures and standards, alignment across regulatory and industry sectors in the development of further or enhanced biodiversity disclosures will be key for industry generally. Organizations should, however, be prepared to encounter a host of new and potentially inconsistent rules and regulations across countries.
Global Standards and Frameworks – Prior to COP15, the Taskforce on Nature-Related Financial Disclosure (“TNFD”) released the third version of its beta framework (v0.3) for nature-related risk management and disclosures, which includes guidance on target-setting developed with the Science Based Targets Network (“SBTN”).[38] Calls on business and financial institutions to assess and disclose their biodiversity impacts and risks have only increased since COP15. In response, the International Sustainability Standards Board (“ISSB”) announced that it will research “incremental enhancements” to complement the Climate-Related Disclosures Standard (S2) (currently under development), including in relation to “natural ecosystems.”[39] There are already calls to make the ISSB standard (once completed) mandatory.[40]

While mandatory disclosure may be some years away, in the meantime the GBF may result in the enhancement of existing national and regional regulations and accelerate the development and proliferation of new voluntary (and eventually mandatory) rules on nature-related disclosure across different jurisdictions and regulatory regimes. This could in turn affect long-term investment decisions and regulatory compliance for businesses across the value chain.

V. Conclusion

There have already been a number of private-sector related developments relating to biodiversity, which indicate that these issues are gaining real momentum and traction in the financial markets. These include the launch of a number of new biodiversity funds,[41] the expansion and enhancement of biodiversity criteria in sustainable bonds and sustainability-linked loans, and the developments in the voluntary biodiversity credits market.

The Global Biodiversity Framework reflects a further, important milestone in this journey. The full impact of COP15 may not be visible until COP16, when CBD Parties are called to publish their national biodiversity action plans. However, the private sector is rightly taking note of the key emerging operational impacts on business (such as respect for Indigenous and human rights, and transparency and reporting of risks and impacts on biodiversity) and its corresponding complexities and costs of implementation alongside the growth and economic opportunities for market participants.

____________________________

[1] Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.25, Kunming-Montreal Global Biodiversity Framework, Draft Decision Submitted by the President (Dec. 18, 2022) [hereinafter “GBF”].

[2] Convention on Biological Diversity, opened for signature, June 5, 1992, 1760 U.N.T.S. 79 (entered into force Dec. 29, 1993) [hereinafter “CBD”].

[3] See Gibson Dunn’s Client Alert on COP 15 (Part I) and related regulatory developments published in October 2021: COP 15 Biodiversity Firmly Back On The Regulatory Agenda.

[4] See CBD, Nations Adopt Four Goals, 23 Targets for 2030 in Landmark UN Biodiversity Agreement, CBD Press Release (Dec. 19, 2022) [hereinafter “CBD Press Release”].

[5] See, e.g., Cartagena Protocol on Biosafety to the Convention on Biological Diversity, opened for signature, May 15, 2000, 2226 U.N.T.S. 208 (entered into force Sept. 11, 2003); Nagoya Protocol on Access to Genetic Resources and the Fair and Equitable Sharing of Benefits Arising from their Utilization to the Convention on Biological Diversity, opened for signature Feb. 2, 2011, 3008 U.N.T.S. 3 (entered into force Oct. 12, 2014).

[6] See CBD Press Release.

[7] UK International Environment Minister Zac Goldsmith, quoted in CarbonBrief, COP15: Key outcomes agreed at the UN biodiversity conference in Montreal, 20 Dec. 2022 [hereinafter CarbonBrief, COP15: Key outcomes].

[8] Canadian Environment Minister Steven Guilbeault, quoted in id.

[9] The other key Rio Summit treaties include the UN Framework Convention on Climate Change (“UNFCCC”) and the UN Convention to Combat Desertification (“UNCCD”).

[10] CBD, art. 1.

[11] CBD, Decision X/2, “The Strategic Plan for Biodiversity 2011-2020 and the Aichi Biodiversity Targets,” Doc. No. UNEP/CBD/COP/DEC/X/2, 29 October 2010.

[12] The Global Biodiversity Outlook 5 found, inter alia, that “[b]iodiversity is declining at an unprecedented rate, and the pressures driving this decline are intensifying. None of the Aichi Biodiversity Targets will be fully met, in turn threatening the achievement of the Sustainable Development Goals and undermining efforts to address climate change.”

[13] CBD, Nations Adopt Four Goals, 23 Targets for 2030 in Landmark UN Biodiversity Agreement, CBD Press Release, 19 Dec. 2022.

[14] CarbonBrief, COP15: Key outcomes.

[15] See, e.g., Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.26, Monitoring framework for the Kunming-Montreal global biodiversity framework, Draft Decision Submitted by the President (Dec. 18, 2022); Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.27, Mechanisms for Planning, Monitoring, Reporting and Review, Draft Decision Submitted by the President (Dec. 18, 2022); Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.29, Resource Mobilization, Draft Decision Submitted by the President (Dec. 18, 2022); Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.34, Long-term strategic approach to mainstreaming biodiversity within and across sectors, Draft Decision Submitted by the Chair of Working Group I (Dec. 19, 2022).

[16] See World Economic Forum, Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy (2020).

[17] See World Economic Forum, The Global Risks Report (2022). The top two global risks over a 10-year horizon are “climate action failure” and “extreme weather.”

[18] See Global Environment Facility, Land Degradation; Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES), Nature’s Dangerous Decline ‘Unprecedented’; Species Extinction Rates ‘Accelerating’, Media Release (May 5, 2019); OECD, Biodiversity: Finance and the Economic and Business Case for Action (Report prepared by the OECD for the French G7 Presidency and the G7 Environment Ministers’ Meeting, 5-6 May 2019) (2019); World Economic Forum, Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy (2020); World Bank, Protecting Nature Could Avert Global Economic Losses of $2.7 Trillion Per Year, Press Release (July 1, 2021); UK Government Office for Science, COP15 International Science Advisors’ Statement (Dec. 5, 2022).

[19] For example, a recent assessment (November 2022) conducted by CDP showed almost half the companies covered recognising biodiversity as a risk and considering it in their strategies and circa 31% making public commitments and/or endorsements of biodiversity-related initiatives.

[20] See World Economic Forum, The Future of Nature and Business, New Nature Economy Report II (2020). “Nature-positive” refers to the goal that calls for zero net loss of nature from 2020, a net increase by 2030 and full recovery by 2050.

[21] See studies by Verdone and Seidl on the value of investing in restoration and degraded landscapes who estimate that at a global level each US dollar invested in restoring degraded forests gives back between US$7 and US$30 in economic benefits. (Verdone, M., Seidl, A. (2017). Time, space, place, and the Bonn Challenge global forest restoration target Restoration Ecology 25(6): 903–911).

[22] U.N. Env’t Prog., State of Finance for Nature (2021).

[23] UNPRI, 150 financial institutions, managing more than $24 trillion, call on world leaders to adopt ambitious Global Biodiversity Framework at COP15, COP 15 Announcement (Dec. 13, 2022).

[24] A financial instrument which can be used by organizations to help finance activities that deliver absolute positive biodiversity gains. See also World Economic Forum, How biodiversity credits can deliver benefits for business, nature and local communities (Dec. 9, 2022).

[25] See World Economic Forum, The Post-2020 Global Biodiversity Framework and What it Means for Business (Dec. 2022) [hereinafter “WEF, The Post-2020 GBF”].

[26] Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.29, Resource Mobilization, Draft Decision Submitted by the President (Dec. 18, 2022) (requesting the GEF to establish a Special Trust Fund called the Global Biodiversity Framework Fund (“GBF Fund”) “in 2023, and until 2030” to support the framework).

[27] See Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.27, Mechanisms for Planning, Monitoring, Reporting and Review, Draft Decision Submitted by the President (Dec. 18, 2022), Art. 1(a).

[28] See id., Art. 1(b).

[29] This could take the form of a separate treaty instrument, like Biodiversity Beyond National Jurisdictions (“BBNJ”), which is currently being negotiated within the framework of the United Nations Convention on the Law of the Sea (“UNCLOS”), while the exploitation of the seafloor would be governed by the International Seabed Authority.

[30] CarbonBrief, COP15: Key Outcomes.

[31] See, e.g., GBF, Sec. J (“Responsibility and Transparency”) (setting out “effective mechanisms for planning, monitoring, reporting and review”). See also Conf. of the Parties to the Convention on Biological Diversity, U.N. Doc. CBD/COP/15/L.27, Mechanisms for Planning, Monitoring, Reporting and Review, Draft Decision Submitted by the President (Dec. 18, 2022) (adopting an “enhanced multidimensional approach to planning, monitoring, reporting and review” in order to “enhanc[e] implementation” of the CBD and the GBF).

[32] In particular, the WEF expects that these changes will help level the playing field for businesses that have been proactive in addressing their impacts on nature, while imposing “growing transition risks” on those who have not worked on adopting a nature-positive approach. Some of the regulator- and business-driven approaches to halting and reversing biodiversity decline include: 1. Deforestation-free supply chains and supply-chain environmental and social due diligence; 2. Net positive impact (NPI) approaches; 3. Financial institutions’ policies to address drivers of biodiversity loss; 4. Extended producer responsibility (EPR) schemes; 5. Payment for ecosystem services (PES); and, 6. Regenerative agriculture. See WEF, The Post-2020 GBF.

[33] See, e.g., High Ambition Coalition, More than 100 Countries Now Formally Support the Global Target to Protect at Least 30% of the Planet’s Land and Ocean by 2030, Statement (June 30, 2022).

[34] See U.N. Env’t Prog. et al., Protected Planet Report 2020 (May 19, 2021).

[35] This is at the same time seen as key to tackling climate change. A joint report by the IPBES (referenced above) and the Intergovernmental Panel on Climate Change (“IPCC”) in 2021 emphasized that biodiversity and climate challenges can only be solved in tandem. See also WEF, The Post-2020 GBF, at 45.

[36] This includes Goal C, as well as spatial planning (Target 1), conservation (Target 3), customary sustainable use (Target 5 and 9), financial resources (Target 19), data, information, and knowledge (Target 21), access to justice, information, and participation (Target 22). There are also specific references to “traditional knowledge” (Goal C, & Targets 13, 21, 22). More generally, implementation of the GBF must ensure Indigenous rights and knowledge, including traditional knowledge associated with biodiversity (GBF, Art. 8 – “Contribution and rights of indigenous peoples and local communities”).

[37] See, e.g., (i) French Law No. 2019-1147 of 8 November 2019 Regarding Energy and Climate, Art. 29 (Loi n° 2019-1147 du 8 novembre 2019 relative à l’énergie et au climat); (ii) EU Sustainable Finance Disclosure Regulation 2019/2088 (“SFDR”)-required Statement of Principal Adverse Impacts (“PAI”) of investment decisions on sustainability factors, such as PAI 7 (Biodiversity): “Activities negatively affecting biodiversity-sensitive areas”; (iii) EU Taxonomy Regulation 2020/852‘s Environmental Objective 6 (Protection and Restoration of Biodiversity and Ecosystems) and the EU’s Do No Significant Harm (“DNSH”) principle, which is meant to ensure that economic activities are not damaging to any environmental objective, where relevant, within the meaning of Article 17 of Regulation (EU) 2020/852.

[38] On the COP15 Finance Day, Germany committed new funding of EUR 29 million to the TNFD, to be used to complete the technical design work of the TNFD’s recommendations, encourage global uptake, and aid alignment with emerging sustainability standards and regulations around the world. The TNFD is based on the format adopted for the Task Force on Climate-Related Financial Disclosures (“TCFD”).

[39] ISSB has stated that it would build on the work of market-led initiatives grounded in current-best practice and thinking and consider in particular the work of the TNFD and other existing nature-related standards and disclosures (including TNFD’s recent work on the intersection of climate and biodiversity disclosures).

[40] For example, Mark Carney, Co-Chair of the Glasgow Financial Alliance for Net-Zero (“GFANZ”) and founder of the Taskforce on Scaling Voluntary Carbon Markets, has called on the CBD Parties to establish a mandate within Goal D and Target 15 to align financial flows with nature goals and in particular to use these as a base to “establish credible policies to hold finance and other sectors to account for aligning with the goals of halting and reversing nature loss and scaling nature-based solutions.” See Mark Carney speech at the COP15 Finance and Biodiversity Day on 13 December 2022.

[41] Examples include a number of new equity funds launched such as AXA WF ACT Biodiversity Fund, BNP Paribas Easy ESG Eurozone Biodiversity Leaders PAB UCITS ETF and BNP Paribas Ecosystem Restoration fund, Federated Hermes Biodiversity Equity Fund, Fidelity Biodiversity Equity Fund, RobecoSAM Biodiversity Equities, and UBAM Biodiversity Restoration fund.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Selina Sagayam, Susy Bullock, and Maria L. Banda.

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 Environmental, Social and Governance (ESG), Transnational Litigation, or International Arbitration practice groups, or the authors:

Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])
Maria L. Banda – Washington, D.C. (+1 202-887-3678, [email protected])

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Perlette M. Jura – Los Angeles (+1 213-229-7121, [email protected])
Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])

Transnational Litigation Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Perlette Michèle Jura – Los Angeles (+1 213-229-7121, [email protected])
Andrea E. Neuman – New York (+1 212-351-3883, [email protected])
William E. Thomson – Los Angeles (+1 213-229-7891, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The legislative and regulatory landscape concerning electric vehicles (EVs) continues to undergo significant changes. EV regulation shares many elements of traditional automobile regulation, but the technologies involved also create new areas of regulatory coverage and manufacturer concern. This alert discusses California’s industry-shaping Advanced Clean Car II regulations, California’s technology-forcing electric truck regulations, NHTSA reporting and recall enforcement risks, other federal regulatory updates, developments in EV supply chain regulations, the developing space of battery recycling regulation, privacy and cybersecurity concerns, and charging infrastructure incentives and regulation.

For vehicle manufacturers, this alert is meant to act as a quick guide to the current EV regulatory landscape and as a map for spotting where regulatory currents are heading. For additional detail on these topics, please contact the attorneys who assisted in preparing this alert.

Read More

The following Gibson Dunn attorneys assisted in preparing this client update: Gustav Eyler, Abbey Hudson, Vivek Mohan, Arthur Halliday, Raquel Alexa Sghiatti, and Mark Tomaier, with contributions by Stacie Fletcher, Rachel Levick, Thomas Manakides, and Julie Sweeney.

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, the authors, or any of the following leaders and members of the firm’s Environmental Litigation & Mass Tort, Privacy, Cybersecurity & Data Innovation, or White Collar Defense & Investigations practice groups:

Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, [email protected])
Abbey Hudson – Los Angeles (+1 213-229-7954, [email protected])
Rachel Levick – Washington, D.C. (+1 202-887-3574, [email protected])
Thomas Manakides – Orange County (+1 949-451-4060, [email protected])

Privacy, Cybersecurity and Data Innovation Group:
Vivek Mohan – Palo Alto (+1 650-849-5345, [email protected])

White Collar Defense and Investigations Group:
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, [email protected])

On Dec. 14, the Federal Trade Commission hosted an open meeting featuring a staff presentation on cybersecurity.

Alex Gaynor, the FTC’s deputy chief technology officer, discussed the implications of the FTC’s approach to data security enforcement over the past year, specifically highlighting four security best practices.

He noted that the FTC’s latest orders signaled an important new focus on addressing flaws in the nuts and bolts of companies’ cyber programs that leave user and employee data vulnerable in an increasingly digital economy.

The presentation gives important context by reviewing the FTC’s enforcement actions over the course of 2022 and in light of broader federal government trendlines as stipulated in President Joe Biden’s Executive Order No. 14028 on improving the nation’s cybersecurity.

This review indicates the FTC is exerting heightened focus on assessing certain technical security safeguards, the absence of which can create exploitable gaps that undermine appropriate management of data.

The FTC’s emphasis on certain core technical measures is instructive for all companies, regardless of size or industry, in order to minimize cyber risk and regulatory scrutiny.

Read More

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Privacy, Cybersecurity & Data Innovation practice group:

Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])

Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])

Kunal Kanodia – San Francisco (+1 415-393-8207, [email protected])

Apratim Vidyarthi, a recent law graduate in New York not admitted to practice law, also contributed to this article.

Please also feel free to contact the following leaders and members of the firm’s Data Privacy, Cybersecurity and Data Innovation Group:

United States
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, [email protected])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])
Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])
Lauren R. Goldman– New York (+1 212-351-2375, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Robert K. Hur – Washington, D.C. (+1 202-887-3674, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Vivek Mohan – Palo Alto (+1 650-849-5345, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Rosemarie T. Ring – San Francisco (+1 415-393-8247, [email protected])
Ashley Rogers – Dallas (+1 214-698-3316, [email protected])
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
Deborah L. Stein – Los Angeles (+1 213-229-7164, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0) 1 56 43 13 00, [email protected])
James A. Cox – London (+44 (0) 20 7071 4250, [email protected])
Patrick Doris – London (+44 (0) 20 7071 4276, [email protected])
Kai Gesing – Munich (+49 89 189 33-180, [email protected])
Bernard Grinspan – Paris (+33 (0) 1 56 43 13 00, [email protected])
Joel Harrison – London (+44(0) 20 7071 4289, [email protected])
Vera Lukic – Paris (+33 (0) 1 56 43 13 00, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Connell O’Neill – Hong Kong (+852 2214 3812, [email protected])
Jai S. Pathak – Singapore (+65 6507 3683, [email protected])

On January 5, 2023, the Federal Trade Commission (FTC) issued a Notice of Proposed Rulemaking (NPRM) to prohibit employers from entering non-compete clauses with workers.[1] The proposed rule would extend to all workers, whether paid or unpaid, and would require companies to rescind existing non-compete agreements within 180 days of publication of the final rule.[2] The FTC will soon publish the NPRM in the Federal Register, triggering a 60-day public comment period.‎[3] The rule could be finalized by the end of the year; court challenges to the final rule are likely to follow.

The rule proposal follows recent FTC settlements with three companies and two individuals for allegedly illegal non-compete agreements imposed on workers – the first time the FTC has claimed that non-compete agreements constitute unfair methods of competition under Section 5 of the FTC Act.‎[4]

The Proposed Rule Would Broadly Ban Non-Compete Agreements

The proposed rule provides:

(a) Unfair methods of competition. It is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.‎[5]

The proposed rule broadly defines non-compete agreements as: “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.”‎[6] It proposes a functional test to determine if a clause is a non-compete provision: to qualify, the provision would have “the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”‎[7] The proposed rule identifies two types of agreements that would constitute impermissible “non-competes”:

A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer; and
A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.‎[8]

While the proposed rule would not expressly prohibit non-disclosure and intellectual property agreements with employees, those agreements could be deemed impermissible non-competes if, pursuant to the provision excerpted above, they are deemed to be written “so broadly” that they “effectively preclude[ ] the worker from working in the same field.”‎[9] Further, the term “worker” would be defined as “a natural person who works, whether paid or unpaid, for an employer,” but would not include a franchisee in a franchisee/franchisor relationship.‎[10]

Rescission Requirement, Safe Harbors, and Federal Preemption

The proposed rule would require employers to rescind all existing non-compete provisions within 180 days of publication of the final rule, and to provide current and former employees notice of the rescission.‎[11] If employers comply with these two requirements, the rule would provide a safe harbor from enforcement.‎[12]‎ Further, the proposed rule would exempt from its scope certain non-competes entered in connection with the sale of businesses where “the seller of the business is a substantial owner of . . . the business at the time the person enters into the non-compete clause.”‎[13] For this exception to apply, “substantial owner” is defined as an “owner, member, or partner holding at least a 25% ownership interest in a business entity.”‎[14] This exception also applies under California law, recognizing the need to protect the goodwill of a business.‎[15]

The proposed rule would preempt all state and local rules inconsistent with its provisions, but not preempt State laws or regulations that provide greater protections.‎[16] As a practical matter, the proposed rule would override existing non-compete requirements and practices in the vast majority of states.

Concerned Parties Should Submit Public Comments

A sixty-day public comment period will begin once the FTC publishes the NPRM in the Federal Register. After the notice-and-comment period concludes, the FTC will consider the comments and then publish a final version of the rule. Enforcement may begin 180 days after publication of the final rule (although, as discussed below, the final rule is likely to be challenged in court).

The final rule’s terms will depend in part on the FTC’s response to comments submitted by interested parties during this notice-and-comment period, including legal and practical objections raised to the rule. Thus, concerned parties are advised to submit robust comments thoroughly explaining their concerns, including potential costs and adverse effects.

Legal Challenges to the Rule Are Likely Once It Is Finalized

The proposed rule represents a significant expansion of the FTC’s regulatory reach in two respects: First, the Commission had not previously held non-compete agreements to be unfair methods of competition under the Federal Trade Commission Act, until its recently-announced settlements. Second, substantial doubt exists that the FTC possesses rulemaking authority in this area.‎[17] As Gibson Dunn partners have explained and Commissioner Christine S. Wilson notes in her statement dissenting to the Notice of Proposed Rulemaking, any final rule is likely subject to several potentially significant legal challenges. Commissioner Wilson notes three concerns:

Congress did not intend to grant authority to promulgate substantive competition rules under the FTC Act provisions on which the FTC purports to rely to promulgate the proposed rule.‎[18]

The rule may exceed the limits imposed by the Supreme Court’s major questions‎ doctrine.[19]

The rule may exceed the limits imposed by the Supreme Court’s non-delegation doctrine.‎[20]

Takeaways

This new proposed rule is part of a larger trend toward more vigorous federal regulation of the employment relationship, including by the FTC, National Labor Relations Board, and Department of Labor (DOL), as we have noted in previous Client Alerts addressing the FTC’s approach to no-poach and non-solicit agreements, the DOL’s rulemaking on who qualifies as an independent contractor under the FLSA, and the FTC’s broader vision of its authority to address unfair methods of competition under Section 5.

Gibson Dunn attorneys are closely monitoring these developments and available to discuss these issues as applied to your particular business or assist in preparing a public comment for submission on this proposed rule.

___________________________________

[1] Non-Compete Clause Rulemaking, Fed. Trade Comm’n (Jan. 5, 2023). The Commission vote to publish the Notice of Proposed Rulemaking was 3-1 along party lines. Chair Khan and Commissioners Slaughter and Bedoya released a joint statement. See Joint Statement, Fed. Trade Comm’n (Jan. 5, 2023). Commissioner Wilson dissented. See Dissenting Statement of Commissioner Christine S. Wilson, Fed. Trade Comm’n (Jan. 5, 2023) (objecting because the proposed rule fails to consider factual context, the fact that “the need for fact-specific inquiry aligns with hundreds of years of precedent,” and the business justifications for such clauses).

[2] Notice of Proposed Rulemaking, Fed. Trade Comm’n (last visited Jan. 5, 2023) (outlining the text of the rule as will be published in the Federal Register at 16 CFR Part 910). Notably, prior FTC workshops on this subject focused on low-wage employees, but this proposed rule goes beyond that scope. Workshops, Making Competition Work: Promoting Competition in Labor Markets, Fed. Trade Comm’n (Dec. 6–7, 2021).

[3] Id. at 1.

[4] Press Release, FTC Cracks Down on Companies That Impose Harmful Noncompete Restrictions on Thousands of Workers, Fed. Trade Comm’n, (Jan. 4, 2023). See also Client Alert, FTC Announces Broader Vision of Its Section 5 Authority to Address Unfair Methods of Competition, Gibson, Dunn & Crutcher LLP (Nov. 14, 2022) (noting that “this development at a minimum adds uncertainty for businesses that heightens the need for vigilance in how they operate”).

[5] Notice of Proposed Rulemaking at 215 (§ 910.2(a)).

[6] Id. at 4.

[7] Id. at 214 (§ 910.1(b)(2)).

[8] Id. (§ 910.1(b)(2)(i)-(ii)).

[9] Id.

[10] Id. at 214–15 (§ 910.1(f)).

[11] Id. at 215–17 (§ 910.2(b)(1)-(2)).

[12] Id. at 217 (§ 910.2(b)(3)).

[13] Id. at 131 (§ 910.3). See also id. at 128–131 (explaining the scope of § 910.3).

[14] Id. at 131.

[15] Cal. Bus. & Prof. Code § 16601.

[16] Notice of Proposed Rulemaking at 217 (§ 910.4).

[17] See Svetlana Gans & Eugene Scalia, The FTC Heads for Legal Trouble, W.S.J. (Aug. 8, 2022) (Gibson Dunn partners explaining why “FTC regulation of employment noncompete agreements would run headlong into the major questions doctrine” and other issues with the FTC’s approach).

[18] Dissenting Statement of Commissioner Christine S. Wilson, Fed. Trade Comm’n, at 10–11 (Jan. 5, 2023) (discussing Sections 5 and 6(g) of the FTC Act and how the FTC’s authority should be interpreted in light of the Magnuson-Moss Act).

[19] Id. at 11–12 (discussing West Virginia v. EPA, 142 S. Ct. 2587 (2022) and its implications).

[20] Id. at 12–13, 12 n.61 (noting recent writing from most of the Supreme Court’s justices that would indicate a willingness to reconsider and broaden the scope of the Supreme Court’s non-delegation doctrine) (citing Gundy v. United States, 139 S. Ct. 2116, 2131 (2019) (Alito, J. concurring) (stating with respect to the nondelegation doctrine that “[i]f a majority of this Court were willing to reconsider the approach we have taken for the past 84 years, I would support that effort”); Gundy, 139 S. Ct. at 2131 (Gorsuch, J., dissenting, joined by Chief Justice Roberts and Justice Thomas) (expressing desire to “revisit” the Court’s approach to the nondelegation doctrine); Paul v. United States, 140 S. Ct. 342, 342 (2019) (statement of Kavanaugh, J, respecting the denial of certiorari); Amy Coney Barrett, Suspension and Delegation, 99 Cornell L. Rev. 251, 318 (2014)).

The following Gibson Dunn lawyers prepared this client alert: Rachel Brass, Svetlana Gans, Kristen Limarzi, Ilissa Samplin, Eugene Scalia, Katherine V. A. Smith, Stephen Weissman, Chris Wilson, Jamie France, and Connor Leydecker.

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

Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8673, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [email protected])

Antitrust and Competition Group:
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

Labor and Employment Group:
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, [email protected])

Trade Secrets Group:
Harris M. Mufson – New York (+1 212-351-3805, [email protected])
Ilissa Samplin – Los Angeles (+1 213-229-7354, [email protected])

On December 29, 2022, the Integrity, Notification, and Fairness in Online Retail Marketplaces for Consumers Act (the “INFORM Consumers Act” or the “Act”) was signed into law as a last-minute addition to the Consolidated Appropriations Act of 2023, an omnibus bill that authorizes federal government spending for the upcoming year.[1] The INFORM Consumers Act applies to online marketplaces – broadly defined to include “consumer-directed” platforms that “facilitate or enable third party sellers to engage in the sale, purchase, payment, storage shipping or delivery of a consumer product” – and requires them to collect, verify, and make available to buyers certain identification information for “high-volume third party sellers” on their platforms (i.e., sellers with more than 200 transactions and $5,000 in revenues in a 12 month period). The Federal Trade Commission (“FTC”) is responsible for enforcing the INFORM Consumers Act, and state attorneys general are provided with the right to bring civil actions against online marketplaces whose noncompliance with the Act affects residents of their states. Online marketplaces must implement policies, procedures, and controls to comply with the INFORM Consumers Act’s requirements by June 27, 2023, the date the requirements go into effect.

This alert summarizes the INFORM Consumers Act and discusses its new diligence and disclosure requirements, including the:

Collection of seller identification and bank account information within ten days of the seller qualifying as a “high-volume third party seller,” verification of the information within ten days of receipt, and collection of seller certifications regarding the accuracy of the information at least annually;
Maintenance of data security measures to protect seller information that the marketplace collects;
Disclosure to buyers of identification information for sellers with $20,000 or more in annual revenue from marketplace sales;
Suspension of seller accounts if requested information, certifications, or disclosures are not provided within ten days of a marketplace’s request; and
Implementation of a reporting feature on product listing pages for high-volume third party sellers that allows for electronic and telephonic reports.

While some online marketplaces may already comply with some of these requirements, it is likely that many will need to implement new measures to avoid the substantial liability risks that the Act creates for non-compliance. In particular, requirements to collect and verify bank account and identification information and to obtain annual certifications – and to suspend sellers who fail to comply within 10 days – may present a significant operational lift for online marketplaces. Covered marketplaces may also need to update their platform agreements, including, for instance, Merchant and Seller Terms of Service, Privacy Policies, Payment Processer Terms, and Purchaser Terms to reflect new requirements under the Act. Moreover, the Act’s information collection and verification requirements may increase practical risks for online marketplaces by potentially exposing them to red flags of unlawful seller or buyer conduct that may give rise to liability in other contexts.

Gibson Dunn has extensive experience advising online marketplaces and commerce platforms on a wide variety of regulatory, product and commercial counseling, and enforcement matters. We stand ready to advise companies on compliance with the INFORM Consumers Act.

I. Background on the INFORM Consumers Act

In March 2021, Senators Dick Durbin (D-IL) and Bill Cassidy (R-LA) introduced the INFORM Consumers Act as a bipartisan bill intended “to combat the online sale of stolen, counterfeit, and dangerous consumer products by ensuring transparency of high-volume third party-sellers in online retail marketplaces.”[2] In recent years, similar bills were also introduced in many states, and several of them have passed into law. Various online marketplaces and other companies initially opposed the Senate bill based on concerns that it would have a disproportionate impact on individual and small-business sellers. In October 2021, Rep. Jan Schakowsky (D-IL) and Rep. Gus Bilirakis (R-FL) introduced a new version of the INFORM Consumers Act in the House.[3] In announcing the bill, Rep. Bilirakis said it would “provide a layer of enhanced protections for consumers from stolen and counterfeit goods without adding undue burdens on small mom-and-pop businesses.”[4] This version of the INFORM Consumers Act, which is nearly identical to the enacted version, received broader support than the Senate version. Although the information collection and disclosure requirements generally remained the same, new supporters of the Act welcomed the House version’s decreased burden on individual and small business sellers and anticipated preemption of state laws.

On December 19, 2022, the INFORM Consumers Act was added to the Consolidated Appropriations Act of 2023, which passed Congress on December 23, 2022, and was signed into law by President Biden on December 29, 2022.

II. The INFORM Consumers Act’s Scope

The INFORM Consumers Act applies to “online marketplaces” where third parties sell “consumer products.” “Online marketplaces” is broadly defined to include any “consumer-directed” platform that—(A) includes features that allow for, facilitate, or enable third party sellers to engage in the sale, purchase, payment, storage, shipping, or delivery of a consumer product in the United States; (B) is used by one or more third party sellers for such purposes; and (C) has a contractual or similar relationship with consumers governing their use of the platform to purchase consumer products.”[5]

Online marketplaces must comply with the Act’s information collection and verification, data security, and reporting requirements for “high-volume third party sellers” on their platforms; whereas, the Act’s disclosure requirements apply only to a subset of those sellers with higher annual revenues. “High-volume third party sellers” is defined as “third party sellers [that] in any continuous 12-month period during the previous 24 months, ha[ve] entered into 200 or more discrete sales or transactions of new or unused consumer products and an aggregate total of $5,000 or more in gross revenues.”[6] The Act’s disclosure requirements apply only to high-volume third party sellers that have at least $20,000 in annual gross revenue through the marketplace.[7]

The INFORM Consumers Act adopts, by reference, the Magnuson-Moss Warranty Act’s (“Mag-Moss”) definition of “consumer products,” which is “any tangible personal property which is distributed in commerce and which is normally used for personal, family, or household purposes (including any such property intended to be attached to or installed in any real property without regard to whether it is so attached or installed).”[8] Notably, this definition has been interpreted as applying only to physical, retail goods, and as not including digital goods or other intangible items, services, or goods purchased for a commercial purpose.

III. The INFORM Consumers Act’s Requirements

The INFORM Consumers Act requires online marketplaces to: (i) collect and verify bank account and identification information for high-volume third party sellers and obtain periodic certifications from those sellers regarding the accuracy of the information; (ii) ensure the disclosure of certain seller information to buyers; (iii) provide clear and conspicuous reporting mechanisms on product listing pages for high-volume third party sellers; and (iv) comply with data privacy and security requirements for information received pursuant to the Act. Marketplaces are further required to suspend sales activity for sellers that do not provide the required information, certifications, or disclosures within ten days.

These requirements go into effect 180 days after the Act’s enactment – i.e. by June 27, 2023.[9]

The following sections detail each of the Act’s requirements and highlight considerations for implementing measures to comply with those requirements.

a. Diligence Requirements: Collection, Certification, and Verification of High-Volume Third Party Seller Information

i. Information Collection

The INFORM Consumers Act requires an online marketplace to collect:

A seller’s name, email address, phone number, tax identification number, and banking account information within ten days of the seller meeting the transaction and revenue thresholds to qualify as a “high-volume third party seller.”[10]
For entity sellers, marketplaces must also obtain either a copy of a valid government-issued identification for an individual acting on the seller’s behalf or a copy of a government-issued record or tax document that includes the business name and physical address of the seller.

The Act provides that the required bank account information may be collected either by the marketplace itself or by a “payment processor or other third party contracted by the online marketplace to maintain such information, provided that the online marketplace ensures that it can obtain such information within 3 business days . . . .”[11] If a seller does not have a bank account, the Act permits marketplaces to instead collect the “name of the payee for payments issued by the online marketplace to such seller.”[12] Although the Act requires the collection of bank account information, it does not include language limiting permissible payment methods that an online marketplace may accept.

Importantly, if a seller does not provide the required information within ten days of qualifying as a high-volume third party seller, the marketplace must suspend sales activity by the seller until the information is received.[13]

Although not as arduous, these collection requirements are similar, in some respects, to customer due diligence and know-your-customer requirements imposed on financial institutions under the Bank Secrecy Act (“BSA”), the anti-money laundering regulatory regime applicable to financial services entities. Lessons learned from that regulatory regime might be informative as to what online marketplaces can expect in implementing these requirements and what factors may be considered in assessing compliance with the requirements. As seen in the context of the BSA, such information collection requirements can prove quite challenging to implement, particularly to a high volume of existing relationships. In addition, as discussed below, information collected to comply with these requirements could, in certain cases, create heightened liability risk for marketplaces to the extent that the information raises red flags that the seller may be engaged in, or facilitating, unlawful activities.

Although many marketplaces already have information collection procedures for their sellers, it is likely that the Act’s specific requirements will require changes or additions to processes for nearly all marketplaces. Many marketplaces that already collect seller information, for example, rely on third party payment processors or other third parties to gather and store at least some of that information. Although the Act allows marketplaces to rely on third parties for the collection and storage of bank account information, there is not similar language for the records and other information that marketplaces need to collect, suggesting that marketplaces may be expected to collect and store that information themselves. In addition, marketplaces that would like to rely on payment processors or other third parties for the collection and storage of bank account information should consider whether existing or new agreements have sufficient provisions regarding the collection and prompt accessibility of that data, as required by the Act. Marketplaces may also need to consider implementing measures to identify efforts by sellers to evade the collection thresholds by seeking to establish multiple seller accounts on the marketplace.

The requirement to collect bank account information from sellers may also require a variety of new processes and controls. Many marketplaces allow their sellers to receive payments to non-bank online accounts or wallets. Some marketplaces may not collect information about those accounts and may simply allow sellers to link the accounts via APIs. Marketplaces may now need to request, either themselves or through a third party, bank account information for high-volume sellers. Although there is an exception for sellers that “do not have a bank account,” it remains to be seen what level of validation a marketplace would need to engage in to establish that a seller does not have a bank account in order to rely on this exception.

Marketplaces must also consider how and when they will collect the required information for new sellers, as well as how they will upgrade collection and verification for existing sellers.

ii. Seller Certifications

The Act also requires that platforms “periodically, but not less than annually,” notify high-volume third party sellers of their need to update information provided to the marketplace if there are any changes and obtain electronic certifications from those sellers that the information on file is accurate and up-to-date.[14] If a seller does not provide a certification within ten days of a request for one, the marketplace must suspend the seller’s sales activity pending receipt of a certification.[15] This requirement could create substantial disruption on marketplaces if seller accounts are frequently suspended and reactivated.

iii. Information Verification

The INFORM Consumers Act requires marketplaces to “verify” information collected from sellers within ten days of receipt. The Act defines “verify” as “to confirm information provided to an online marketplace pursuant to [the Act], which may include the use of one or more methods that enable the online marketplace to reliably determine that any information and documents provided are valid, corresponding to the seller or an individual acting on the seller’s behalf, not misappropriated, and not falsified.”[16] There is a presumption of verification for information contained in a “copy of a valid government-issued tax document.” By providing a presumption of verification, the Act may encourage the collection of those records, even when not required by the Act. However, the Act does not include a similar presumption of verification for information contained in “government-issued identification,” which is a separate term used within the Act.

In the context of the BSA, which has similar requirements, there are a wide variety of methods that financial institutions use to verify identities, including, among others, running the information through third party identification verification solutions, using taxpayer identification matching tools, requesting copies of supporting records from the other party, and/or searching publicly available information. It is possible that factors used to assess adequate identification verification under the BSA could be considered to assess compliance with the INFORM Consumers Act.

Notably, the Act provides that marketplaces must obtain a “working phone number” and “working email address” for high-volume sellers, which suggests that marketplaces may also be expected to verify the functionality and accuracy of that information.

As discussed below, these verification requirements could increase practical risks for online marketplaces by potentially exposing them to red flags or knowledge that they will need to act on to avoid liability in other contexts.

b. Disclosure Requirements: Make High-Volume Third Party Seller Information Available to Consumers

Per the Act’s disclosure requirements, marketplaces must require that sellers with $20,000 or more in annual gross revenue provide “clear and conspicuous” information to consumers either on the seller’s product listing pages or in order confirmations and the consumer’s transaction history, including: (i) seller name; (ii) seller’s physical address; (iii) “contact information for the seller, to allow for the direct, unhindered communication with high-volume third party sellers by users of the online marketplace, including…a current working phone number; [] a current working email address; or [] other means of direct electronic messaging (which may be provided to such seller by the online marketplace)…”; and (iv) whether a different seller was used to supply the product purchased, and if so, upon purchaser request, all of the information in (i), (ii), and (iii) for that sub-seller. Marketplaces must also collect this information from these sellers. There are limited exceptions to the disclosure requirements where a seller certifies that it has only a personal address and/or phone number. Marketplaces must suspend sales activity for sellers that do not comply with these disclosure requirements within ten days of receiving notification of the requirement from a marketplace. As with the Act’s other collection requirements, marketplaces will need to consider when and how to gather necessary information and any needed authorizations from sellers and sub-sellers to share the required information.

c. Mandatory Seller Account Suspensions

As noted above, the Act requires that sellers provide requested information and certifications and disclose required information within ten days of receiving such requests from an online marketplace. If a seller does not comply within ten days, the marketplace must suspend the seller’s account from any further sales activity pending the seller’s compliance.

d. Reporting Mechanism Requirement for High-Volume Third Party Sellers

Under the Act, marketplaces also must incorporate a “clear and conspicuous” reporting mechanism on each product listing page for a high-volume third party seller.[17] The mechanism must provide for both electronic and telephonic reports to the marketplace about “suspicious marketplace activity.” Notably, information acquired through submitted reports may further increase risks under the other laws and regulations, as discussed below. In response to this requirement, marketplaces should consider whether they have adequate and sufficient processes and resources to investigate and disposition these reports. Marketplaces may also want to consider whether to implement or enhance policies regarding voluntary notifications to law enforcement upon learning about particularly high-risk conduct on their platforms.

e. Data Privacy and Security Requirements

The Act prohibits marketplaces from using information gathered “solely” to comply with its provisions for any other purpose than compliance with the Act, unless required by law, and it requires marketplaces to implement security measures to protect collected information.[18] As to the latter, the Act provides that marketplaces “shall implement and maintain reasonable security procedures and practices, including administrative, physical, and technical safeguards, appropriate to the nature of the data and the purposes for which the data will be used, to protect the data collected to comply with the requirements of this section from unauthorized use, disclosure, access, destruction, or modification.” Violations of this provision can be enforced in the same manner as those for the collection and disclosure of seller information. This requirement may require significant cybersecurity and data-privacy assessment and enhancement efforts for many marketplaces, particularly those that have not previously collected or stored tax identification numbers, bank account information, or copies of government-issued records.

IV. Enforcement of the INFORM Consumers Act

The INFORM Consumers Act treats violations of its provisions “as a violation of a rule defining an unfair or deceptive act or practice prescribed under section 18(a)(1)(B) of the Federal Trade Commission Act (15 U.S.C. 57a(a)(1)(B)),” with the effect that violations will be subject to a statutory civil penalty of $46,517 per violation.[19] Online marketplaces can expect that the government will seek to count each alleged failure to collect, verify, protect, or report required information as a violation of the Act, potentially giving rise to substantial civil penalty exposure. Online marketplaces may also expect an increase in government investigations and potentially third party subpoenas for seller information as a result of the Act.

Because it is likely that the FTC will seek a civil penalty for most violations of the Act, the Act will add to the growing number of actions referred by the FTC to DOJ’s Consumer Protection Branch, which litigates civil penalty actions on behalf of the FTC. The number of such actions has increased steadily over the last few years, especially following the Supreme Court’s decision in AMG Capital Management, LLC v. FTC.[20] In addition to seeking civil penalties, the FTC may pursue injunctive relieve[21] and relief “to redress injury to consumers,” including the “rescission or reformation of contracts, the refund of money or return of property, the payment of damages, and public notification.”[22]

The FTC also has authorization to engage in certain types of rulemaking regarding the Act’s requirements. In particular, the Act provides that “the [FTC] may promulgate regulations…with respect to the collection, verification, or disclosure of information under this [Act], provided that such regulations are limited to what is necessary to collect, verify, and disclose [required] information.”[23]

The INFORM Consumers Act further provides that any state attorney general may bring a civil action in district court against any marketplace where there is reason to believe the marketplace has violated or is violating any of the Act’s requirements and the violation affects one or more residents of that state.[24] State civil actions may seek to enjoin further violations, enforce compliance with the Act, obtain civil penalties under the Act, obtain other remedies pursuant to state law, and obtain damages, restitution, or other compensation on behalf of the state’s residents.[25] The FTC may intervene in any action brought by a state, and states may join an action filed by the FTC.[26] Consequently, we may see more partnerships between the FTC and states seeking to enforce provisions of the Act.

While the INFORM Consumers Act preempts states from enacting or enforcing laws that “conflict[] with the requirements of [the Act],” it continues to allow states to enforce complementary laws, including those that may impose requirements in addition to the Act’s terms. This may lead to a patchwork regulatory scheme.

V. Additional Enforcement Risks Created by the INFORM Consumers Act

In addition to imposing new compliance burdens and direct enforcement risks, the Act’s collection and verification requirements increase practical risks for online marketplaces by potentially exposing them to red flags or knowledge that they will need to act on to avoid liability in other contexts.

Marketplaces, for instance, could face criminal and civil liability under various consumer protection statutes if they are deemed to have knowingly sold or distributed unlawful drugs or other products based on information they learned about sellers through complying with the Act. Indeed, regulators already are increasingly focused on online marketplaces for their alleged roles in the sale or distribution of products that are unlawful or used for unlawful purposes. As FTC Chair Lina Khan recently explained, regulators are “looking upstream at the firms that are enabling and profiting from [unlawful] conduct.”[27] Recent examples of this trend include agency warnings to, and litigation against, marketplaces for their alleged distribution of unlawful products.[28] And the trend is largely driven by many of the same factors that motivated passage of the INFORM Consumers Act, including a proliferation of smaller, anonymized, and foreign sellers against whom enforcement actions often are impractical or ineffective.[29]

The Act also could increase marketplaces’ exposure under anti-money laundering statutes if they ignore red flags of transactions involving criminal activity identified through compliance with the Act’s verification requirements. Generally, anti-money laundering statutes prohibit conducting, attempting to conduct, or otherwise facilitating a financial transaction with knowledge that the proceeds involved are the proceeds of “unlawful activity” if the government can prove that the proceeds were derived from a “specified unlawful activity.”[30] “Unlawful activity” can be a violation of any federal, state, or foreign law that constitutes a felony; whereas, “specified unlawful activity” includes over 200 types of U.S. crimes and certain foreign crimes, including trafficking in counterfeit goods, sanctions offenses, fraud, and controlled substances offenses. Courts have found that knowledge for purposes of establishing a money laundering offense can be based on willful blindness or conscious avoidance, which may arise where one turns a blind eye or deliberately avoids gaining positive knowledge when faced with a high likelihood of criminal activity, e.g., ignoring red flags.[31] If online marketplaces obtain information that raises suspicions that a seller is engaged in criminal activity, there could, in certain circumstances, be increased risk of liability under the anti-money laundering criminal statutes, particularly when they do not conduct additional diligence to resolve those suspicions.

As a result, online marketplaces should thoughtfully approach the design and implementation of systems to comply with the Act’s requirements, including consideration of processes where potentially problematic information is learned about a seller. Marketplaces should also consider sanctions screening for information received pursuant to the Act, and procedures for parsing false positive results from true matches – particularly given the policy goals leading to the Act.

___________________________

[1] Consolidated Appropriations Act of 2023, H.R. 2617, 117th Cong. Div. BB, Title III, § 301 (2022), https://www.govinfo.gov/content/pkg/BILLS-117hr2617enr/pdf/BILLS-117hr2617enr.pdf (“INFORM Consumers Act”).

[2] Press Release, Committee on the Judiciary, Durbin, Cassidy, Grassley, Hirono, Coons, Tillis Introduce Bill to Ensure Greater Transparency for Third-Party Sellers of Consumer Products Online (Mar. 23, 2021), https://www.judiciary.senate.gov/press/dem/releases/durbin-cassidy-grassley-hirono-coons-tillis-introduce-bill-to-ensure-greater-transparency-for-third-party-sellers-of-consumer-products-online; see also INFORM Consumers Act, S. 936, 117th Cong. (2021).

[3] INFORM Consumers Act, H.R. 5502, 117th Cong. (2021).

[4] Press Release, Congresswoman Jan Schakowsky, Schakowsky Introduces Bill To Protect Consumers Making Online Purchases, (Oct. 5, 2021), https://schakowsky.house.gov/media/press-releases/schakowsky-introduces-bill-protect-consumers-making-online-purchases.

[5] INFORM Consumers Act at (f)(4).

[6] Id. at (f)(3).

[7] The Act does not include a provision providing for automatic adjustments to these thresholds for inflation.

[8] 15 U.S.C. § 2301(1).

[9] INFORM Consumers Act at (f).

[10] Id. at (a).

[11][11] Id. at (a)(1)(A)(i)(II).

[12] Id. at (a)(1)(A)(i)(I).

[13] Id. at (a)(1)(A) and (a)(1)(C).

[14] Id. at (a)(1)(B).

[15] Id. at (a)(1)(C).

[16] Id. at (f)(7).

[17] Id. at (b)(3).

[18] Id. at (a)(3-4).

[19] Id. at (c)(1).

[20] 593 U.S. ___ (2021).

[21] See 15 U.S.C. § 53(b).

[22] 15 U.S.C. § 57b(b).

[23] INFORM Consumers Act at (c)(3).

[24] Id. at (d)(1).

[25] Id. at (h).

[26] Id. at (3).

[27] Oversight of the Enforcement of the Antitrust Laws, Hearing Before the Subcommittee on Antitrust, Competition Policy and Consumer Rights of the S. Comm. on the Judiciary, 117th Cong. (Sept. 20, 2022), https://content.mlex.com/Attachments/2022-12-20_O426MIOT4L28LWDK%2fP210100SenateAntitrustTestimony09202022+(1).pdf.

[28] See, e.g., FDA, Warning Letter – 631751 (Oct. 28, 2022), https://www.fda.gov/inspections-compliance-enforcement-and-criminal-investigations/warning-letters/amazoncom-inc-631751-10282022; FDA, Warning Letter – 631755 (Oct. 28, 2022), https://www.fda.gov/inspections-compliance-enforcement-and-criminal-investigations/warning-letters/walmart-inc-631755-10282022; Order on Motion to Dismiss and Motion for Summary Decision, In the Matter of Amazon, Inc., CPSC No. 21-2 (Jan. 19, 2022), https://www.cpsc.gov/s3fs-public/pdfs/recall/lawsuits/abc/027-Order-on-Motion-to-Dismiss-and-Motion-for-Summary-Judgement.pdf?VersionId=fgW05hge.c7FvPZZOijVWVapvJBQKudZ; Press Release, EPA, EPA Issues Order to eBay to Stop Selling 170 Unregistered, Misbranded Pesticides (June 17, 2021), https://www.epa.gov/newsreleases/epa-issues-order-ebay-stop-selling-170-unregistered-misbranded-pesticide.

[29] See, e.g., https://www.fda.gov/international-programs/global-perspective/fdas-top-cop-adapting-challenges-globalization-and-e-commerce.

[30] See 18 U.S.C. §§ 1956-57.

[31] See, e.g., U.S. v. Nektalov, 461 F.3d 309, 313-14 (2d Cir. 2006).

The following Gibson Dunn lawyers prepared this client alert: Ryan Bergsieker, Ashlie Beringer, Gustav Eyler, Svetlana Gans, Roscoe Jones, Alexander H. Southwell, Ella Alves Capone, and Amanda Neely.

Gibson Dunn has extensive experience advising online marketplaces on a wide variety of enforcement, regulatory, and compliance matters, and we stand ready to help guide industry players through complex challenges posed by increased regulation, enforcement focus, and technical innovation impacting the space. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Privacy, Cybersecurity and Data Innovation, Anti-Money Laundering, FinTech and Digital Assets, Public Policy, and Administrative Law and Regulatory teams, or any of the following:

Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Ashlie Beringer – Palo Alto (+1 650-849-5327, [email protected])
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, [email protected])
Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Ella Alves Capone – Washington, D.C. (+1 202-887-3511, [email protected])
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

This edition of Gibson Dunn’s Federal Circuit Update summarizes a petition for certiorari granted by the Supreme Court concerning enablement under 35 U.S.C. § 112. This Update also discusses recent Federal Circuit decisions concerning claim construction at the Patent Trial and Appeal Board, nonjoinder of a co-inventor under 35 U.S.C. § 102(f), and more Western District of Texas venue issues.

Federal Circuit News

Supreme Court:

The Supreme Court has granted certiorari in the following case:

Amgen Inc. v. Sanofi (U.S. No. 21-757): The Federal Circuit affirmed the district court’s determination that the specification of the patent-at-issue did not enable preparation of the full scope of the claims without undue experimentation. The Supreme Court granted certiorari on the following issue: “Whether enablement is governed by the statutory requirement that the specification teach those skilled in the art to ‘make and use’ the claimed invention, 35 U.S.C. § 112, or whether it must instead enable those skilled in the art ‘to reach the full scope of claimed embodiments’ without undue experimentation—i.e., to cumulatively identify and make all or nearly all embodiments of the invention without substantial ‘time and effort.’”

Noteworthy Petitions for a Writ of Certiorari:

The Supreme Court is currently considering certiorari in a number of potentially impactful cases.

Juno Therapeutics, Inc. v. Kite Pharma, Inc. (US No. 21-1566): “Is the adequacy of the ‘written description of the invention’ to be measured by the statutory standard of ‘in such full, clear, concise, and exact terms as to enable any person skilled in the art to make and use the same,’ or is it to be evaluated under the Federal Circuit’s test, which demands that the ‘written description of the invention’ demonstrate the inventor’s ‘possession’ of ‘the full scope of the claimed invention,’ including all ‘known and unknown’ variations of each component?” This petition frames its question similar to the one presented in Amgen, except regarding written description instead of enablement. It has been scheduled for the January 6, 2023 conference.

Interactive Wearables, LLC v. Polar Electro Oy (US No. 21-1281) and Tropp v. Travel Sentry, Inc. (US No. 22-22) present questions regarding 35 U.S.C. § 101. Both petitions have been considered in conference by the Court. The Court has called for the views of the Solicitor General in both cases.

Apple Inc. v. Cal. Institute of Tech. (US No. 22-203) and Jump Rope Systems, LLC v. Coulter Ventures, LLC (US No. 22-298) present questions regarding estoppel effects of Patent Trial and Appeal Board (“Board”) institution and final written decisions. The Court requested a response in both cases; the briefing in Apple is complete, and the response in Jump Rope is due January 19, 2023.

Other Federal Circuit News:

In the past year, the Federal Circuit has welcomed two new judges: Judge Tiffany P. Cunningham (who was most recently a partner at Perkins Coie LLP in Chicago) and Judge Leonard P. Stark (who was most recently a district court judge of the District of Delaware).

Federal Circuit Practice Update

On December 1, 2022, the Federal Circuit updated its Rules of Practice. The update incorporates December 1, 2022 amendments to Federal Rules of Appellate Procedure 25 and 42, which do not impact the Federal Circuit’s local rules or procedures.

Upcoming Oral Argument Calendar

The list of upcoming arguments at the Federal Circuit is available on the court’s website.

Key Case Summaries (November–December 2022)

American National Manufacturing Inc. v. Sleep Number Corp., Nos. 21-1321, 21-1323, 21-1379, 21-1382 (Fed. Cir. Nov. 14, 2022): American National Manufacturing Inc. filed two inter partes reviews (“IPRs”) against patents owned by Sleep Number Corp. related to adjusting pressure in an air bed. After the IPRs were instituted, Sleep Number sought to amend the claims to make the claims more consistent and accurate in terminology and phrasing. American National argued that the amendments were not proper because they were not for the purpose of overcoming the instituted ground.

The Federal Circuit (Stoll, J., joined by Schall and Cunningham, JJ.) affirmed, agreeing with the Board that the patent owner can amend the claims to correct perceived issues, and not just overcome the instituted grounds, so long as the amendment does not enlarge the scope of the claims or introduce new matter. The petitioner is free to challenge the proposed amended claims on grounds beyond §§ 102 and 103, including § 112.

VLSI Technology LLC v. Intel Corp., Nos. 21-1826, 21-1827, 21-1828 (Fed. Cir. Nov. 15, 2022): VLSI Technology LLC sued Intel Corp. for allegedly infringing a patent related to integrated circuits. The district court construed the term “force region” to mean a “region within the integrated circuit in which forces are exerted on the interconnect structure when a die attach is performed.” Intel filed an IPR, and proposed a construction of “force region” consistent with the construction that the district court adopted. However, the Board uncovered a disagreement between the parties as to the meaning of “die attach,” and therefore, adopted its own construction.

The Federal Circuit (Bryson, J., joined by Chen and Hughes, JJ.) affirmed-in-part, reversed-in-part, and remanded for further proceedings. VLSI argued that the Board failed to consider the district court’s claim construction as required under 37 C.F.R. § 42.100(b). The Court disagreed, however, determining that while the Board did not specifically mention the district court’s claim construction in its Final Written Decision, it was extensively discussed in the parties’ briefing and oral argument. Moreover, the Board recognized that the true dispute between the parties turned on interpretation of the term “die attach.” Thus, it was proper for the Board to adopt its own construction rather than the parties’ purported agreed construction.

CUPP Computing AS v. Trend Micro Inc., Nos. 20-2262, 20-2263, 20-2264 (Fed. Cir. Nov. 16, 2022): CUPP Computing AS appealed three IPR decisions by the Board, concluding that three patents were unpatentable as obvious. The claims at issue involved a “mobile security system processor” that was “different than” the mobile devices processor.

The Federal Circuit (Dyk, J., joined by Taranto and Stark, JJ.) affirmed the Board’s obviousness finding as adequately explained. CUPP argued that the Board erred by rejecting its disclaimer arguments during the IPRs. The Federal Circuit disagreed with CUPP, holding that: “[t]he Board is not required to accept a patent owner’s arguments as disclaimer when deciding the merits of those arguments.” In other words, disclaimers in an IPR proceeding are not binding on the Patent Office in the proceeding in which they are made; otherwise, the patent owner could freely modify their claims via argument in an IPR.

Treehouse Avatar LLC v. Valve Corp., No. 22-1171 (Fed. Cir. Nov. 30, 2022): Treehouse Avatar LLC sued Valve Corp. accusing two video games (Dota 2 and Team Fortress 2) of infringing its patent. The parties adopted the Board’s construction of “character-enabled network sites” from a previous IPR. However, Treehouse’s infringement expert submitted a report that applied the plain and ordinary meaning for “character-enabled network sites.” The district court subsequently granted Valve’s motion to strike portions of the infringement expert report that applied the plain and ordinary meaning instead of the parties’ agreed-upon construction.

The Federal Circuit (Reyna, J., joined by Lourie and Stoll, JJ.) affirmed. The Court held that it was not an abuse of discretion for the district court to strike portions of the infringement expert report that did not rely on the agreed-upon construction. Even though Treehouse argued that the expert witness relied on a construction that was not materially different from the agreed-upon construction, the Court held that any expert theory relying on a different construction is “suspect.”

Plastipak Packaging, Inc. v. Premium Waters, Inc., No. 21-2244 (Fed. Cir. Dec. 19, 2022): Plastipak Packaging, Inc. sued Premium Waters, Inc. for alleged infringement of two groups of patents directed to plastic bottles. The district court granted summary judgment to Premium Waters, concluding that all asserted patents were invalid for nonjoinder of a co-inventor (Falzoni) under 35 U.S.C. § 102(f).

The Federal Circuit (Stark, J., joined by Newman and Stoll, JJ.) reversed and remanded. The Court held that, for both groups of patents, summary judgment was improper because there was a genuine dispute of material fact as to whether Falzoni had sufficiently contributed to the claimed inventions. The Court determined that Premium Waters presented sufficient evidence that “a reasonable fact-finder may find clear and convincing evidence that Falzoni was a joint inventor.” However, nothing required that conclusion making summary judgment improper.

Genentech, Inc. v. Sandoz Inc., No. 22-1595 (Fed. Cir. Dec. 22, 2022): Genentech, Inc. sued Sandoz, Inc., who had submitted two Abbreviated New Drug Applications (“ANDAs”) on a generic version of pirfenidone, asserting that Sandoz’s generic product would induce the infringement of two sets of Genentech’s patents. The first set of patents (“LFT patents”) claim methods for managing certain side effects when using pirfenidone, which is a drug used to treat idiopathic pulmonary fibrosis (“IPF”). The second set of patents (“DDI patents”) are directed to methods for avoiding adverse interactions between pirfenidone and fluvoxamine, which is a drug that may inhibit the ability of certain enzymes from metabolizing drugs such as pirfenidone. The district court determined that the LFT patents would have been obvious over prior art and standard medical practice disclosed in the prior art, and that the DDI patents were not infringed.

The majority (Lourie, J., joined by Prost, J.) affirmed. The majority agreed that the LFT patents would have been obvious over the prior art and standard medical practices, because the claims “do not represent the invention of a new drug, nor do they recite a novel application of an existing drug.” Instead, the claims “recite adjusting doses in the presence of side effects,” which the majority reasoned “clinicians routinely do.” Turning to the DDI patents, the majority determined that the district court did not clearly err in “considering all the evidence, including Sandoz’s proposed label and physician practice” in finding no infringement. Physicians had testified that in practice they had never prescribed pirfenidone to an IPF patient taking fluvoxamine. But if they found themselves in that position, they would have chosen a noninfringing response—prescribing nintedanib (another drug that treats IPF) instead.

Judge Newman dissented without opinion.

Venue in the Western District of Texas:

In re Apple Inc. (Fed. Cir. No. 22-162): The Federal Circuit (Reyna, J., joined by Dyk, J. and Taranto, J.) granted Apple’s petition, directing the district court to vacate a scheduling order that would require the parties to complete fact discovery and re-briefing of Apple’s motion to transfer venue. Under the district court’s scheduling order, by the time the district court considered Apple’s motion to transfer, the motion would have been pending for a year. The Court explained that consideration of venue motions should be prioritized and requiring the extra effort by the parties would lead to unnecessary expenditure of resources by the parties, the transferring court, and the potential transferee court.

In re Cloudfare, Inc. (Fed. Cir. No. 22-167): The panel (Reyna, J., joined by Dyk and Taranto, JJ.) denied Cloudfare’s petition, holding no clear abuse of discretion in denying Cloudfare’s motion to transfer. The Court determined that Cloudfare’s declarant “lacked credibility and admitted to not investigating facts relevant to Cloudfare’s Austin office.” The Court also determined that the district court had found that Cloudfare’s “employees [in the Western District of Texas] helped research, design, develop, implement, test, and market the accused products,” and the Western District of Texas “had a localized interest and would be convenient for potential sources of proof and party witnesses.” The Court was not prepared to disturb these findings.

In re Amazon.com, Inc. (Fed. Cir. No. 22-157): The panel (Hughes, Wallach, and Stoll, JJ.) granted Amazon.com, Inc.’s petition, holding that the district court abused its discretion by denying Amazon’s motion to sever and motion to transfer. Flygrip Inc. sued Amazon alleging infringement of device cases manufactured by PopSockets LLC and Otter Products LLC. The panel determined that the district court erred because (1) the addition of Coghlan Family Enterprises LLC (CFE), a small local business based in the Western District of Texas, after Amazon filed its motion to transfer to be “suspect,” (2) the claims against CFE were peripheral to the claims against Amazon, and (3) the transfer factors weigh heavily in favor of transferring to the District of Colorado, where PopSockets and Otter were headquartered and had filed a declaratory judgment of noninfringement.

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, [email protected])
Audrey Yang – Dallas (+1 214-698-3215, [email protected])

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, [email protected])
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Julian W. Poon – Los Angeles (+ 213-229-7758, jpoon@gibsondunn.com)

Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, [email protected])
Y. Ernest Hsin – San Francisco (+1 415-393-8224, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
Jane M. Love, Ph.D. – New York (+1 212-351-3922, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On December 29, 2022, the IRS and Treasury issued (1) proposed regulations for determining whether a real estate investment trust (a “REIT”) or registered investment company (a “RIC”) qualifies as a “domestically controlled qualified investment entity” (the “Proposed QIE Regulations”); (2) proposed regulations revising the definition of a “controlled commercial entity” for purposes of section 892[1] (the “Proposed Section 892 Regulations”); and (3) final regulations relating to qualified foreign pension funds (“QFPFs” and the “Final QFPF Regulations”) and their exemption from the application of FIRPTA (as defined below).

Proposed QIE Regulations

Background

Subject to certain exceptions discussed below, section 897 and related sections added to the Code by the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) require foreign persons who recognize gain from the sale or disposition of United States real property interests (“USRPIs”) to file U.S. federal income tax returns reporting those gains and pay U.S. federal income tax on those gains at regular graduated rates, even if the gains are not otherwise effectively connected with the conduct of a U.S. trade or business.

The definition of USRPIs is broad. In addition to including a wide range of interests in U.S. real estate (defined broadly), USRPIs include equity interests in domestic corporations that are United States real property holding corporations (“USRPHCs”) and interests in disregarded entities and certain partnerships that own U.S. real estate. Generally, a USRPHC is any corporation, including a REIT, if the value of its USRPIs represents at least 50 percent of the aggregate value of its real estate (both U.S. and non-U.S.) and business assets.

Domestically Controlled REIT Exception

Notwithstanding that equity interests in domestic USRPHCs generally are treated as USRPIs, section 897(h)(2) provides that an interest in a domestically controlled qualified investment entity (a “QIE”) is not a USRPI. A QIE is a REIT or RIC (i.e., mutual fund) that is a USRPHC.[2] Under section 897(h)(4), a QIE is domestically controlled if less than 50 percent of the value of its stock is held “directly or indirectly” by “foreign persons” at all times during the shorter of (1) the 5-year period ending on the relevant determination date or (2) the period during which the QIE was in existence (the “Testing Period”). Under these rules, gain recognized by a foreign person on the disposition of an interest in a domestically controlled REIT (a “DREIT”) is not subject to U.S. federal income tax under FIRPTA, even if the DREIT is a USRPHC.

Foreign persons often seek to invest in U.S. real estate through DREITs because, in these structures, foreign persons can exit the investment via a sale of DREIT stock without being subject to U.S. tax on the gain or being required to file a U.S. tax return.

In the 2015 PATH Act,[3] Congress added section 897(h)(4)(E) to the Code, which treats QIE stock held by another, publicly traded, QIE as held by a foreign person unless that publicly traded QIE is domestically controlled, in which case the QIE stock is treated as held by a U.S. person. Section 897(h)(4)(E) also provides an express look through-rule for QIE stock owned by another, private QIE. Apart from these narrow exceptions, section 897 does not otherwise clarify when QIE stock owned by one person should be treated as owned “indirectly” by another person for purposes of determining DREIT status.[4]

Notwithstanding the lack of guidance, it is our experience that many taxpayers generally look through domestic partnerships for purposes of determining DREIT status and treat the partners of the domestic partnership as indirectly owning the QIE stock owned by the domestic partnership. In contrast, it is our experience that many taxpayers treat stock of a QIE held by a domestic C corporation as held by the domestic C corporation (and not indirectly by its shareholders) for purposes of determining DREIT status, in part because, unlike a domestic partnership or a REIT, a domestic C corporation is fully subject to U.S. taxation on any gain from disposition of its REIT stock.

This view is consistent with Treasury’s previous guidance on the subject. Existing regulations provide that, for purposes of determining DREIT status, the actual owners of stock, as determined under Treas. Reg. § 1.857-8, must be taken into account.[5] Treas. Reg. § 1.857-8(b) provides that the actual owner of stock of a REIT is the person who is required to include the dividends received on the stock in gross income, and that such person generally is the shareholder of record of the REIT. Although this language suggests that a domestic partnership that owns REIT stock should be treated as the actual owner of the stock, as discussed above most practitioners have been unwilling to take this position, partly on the basis that the partnership’s partners would also be required to take into account their distributive shares of the REIT dividends on their returns.[6] However, in the case of a domestic C corporation, only the C corporation would take into account the REIT dividends on its return and pay taxes on those dividends. Relying in part on these regulations, in a 2009 private letter ruling (PLR 200923001), the IRS ruled that REIT stock owned by a foreign person through a domestic C corporation is to be treated as owned by the domestic C corporation, and not as owned “indirectly” by the foreign person, to determine DREIT status.

Proposed QIE Regulations Treat Certain Foreign-Owned Domestic C Corporations as Transparent

The Proposed QIE Regulations depart from the guidance discussed above in significant respects. The Proposed QIE Regulations provide a broad look-through rule for purposes of determining DREIT status that applies to various types of pass-through entities, including REITs, partnerships (whether U.S. or non-U.S., other than publicly traded partnerships), S corporations, and RICs, to determine DREIT status (the “Look-Through Rule”).[7] The Look-Through Rule is implemented by imputing QIE stock to owners of entities that are “look-through persons” on a pro rata basis based on the owners’ proportionate interests in the look-through person.[8]

Surprisingly, the Proposed QIE Regulations further extend the Look-Through Rule to “foreign-owned domestic C corporations.” A “foreign-owned domestic C corporation” is defined as any non-publicly traded domestic C corporation if foreign persons hold directly or indirectly 25 percent or more of the value of its outstanding stock, after applying look-through rules analogous to the ones that apply to QIEs.[9]

For instance, assume that 51 percent of the stock of a REIT is owned by a non-publicly traded domestic C corporation and that the remaining 49 percent is owned by foreign individuals. The stock of the non-publicly traded domestic C corporation is owned as follows: 20 percent by a foreign corporation, 5 percent by a foreign individual, and 75 percent by U.S. persons. In this case, the non-publicly traded domestic C corporation is a “foreign-owned domestic C corporation” because 25 percent of its stock is owned by a foreign corporation or foreign individuals. One must therefore look through this domestic corporation to its shareholders. Under these facts, the REIT would not be a DREIT because 61.75 percent of its stock would be treated as owned by foreign persons (10.2 percent by the foreign corporation through the domestic corporation, plus 2.55 percent by the foreign individual through the domestic corporation, plus 49 percent directly by foreign persons).[10]

The preamble to the Proposed QIE Regulations does not mention the contrary view taken by the IRS in the 2009 private letter ruling.[11] The preamble does acknowledge the existing regulations, which provide that the actual owners of a REIT’s stock, as determined under Treas. Reg. § 1.857-8, must be taken into account to determine DREIT status. But the preamble explains that, in the government’s view, reliance on those regulations for purposes of determining DREIT status is misplaced because “the determination of actual ownership pursuant to §1.857-8 is only intended to ensure the beneficial owner of stock is taken into account when different from the shareholder of record, and §1.897-1(c)(2)(i) does not state or otherwise suggest that the actual owners of QIE stock as determined under §1.857-8 are the only relevant persons for determining whether a QIE is domestically controlled or provide any guidance on the meaning of ‘held directly or indirectly by foreign persons.’” In support of that view, the preamble describes an example where foreign persons own REIT stock through a domestic partnership. The preamble explains that looking through the domestic partnership is necessary because otherwise, foreign persons could “dispose of USRPIs held indirectly through certain intermediate entities, such as domestic partnerships, to avoid taxation under section 897(a).”

As discussed above, many taxpayers were already looking through domestic partnerships in determining DREIT status. But the example in the preamble is not analogous to a situation where foreign persons own REIT stock through a domestic C corporation that would be subject to tax on a disposition of DREIT shares. Accordingly the preamble’s reasoning is less persuasive in this context. Moreover, even if the reference to the “actual owner” of REIT shares in Treas. Reg. § 1.857-8 is merely intended to ensure that beneficial ownership is taken into account where the shareholder of record is not the beneficial owner, and is not meant to imply that the “actual owner” is the sole owner to take into account to determine DREIT status, there is no suggestion in the existing and long-standing regulations regarding DREITs, or anywhere else in the FIRPTA or REIT rules, that one must look through a domestic C corporation that is the beneficial owner of REIT shares.

Further, given that the phrase “directly or indirectly,” has many different meanings under the Code depending on the context, and that Congress declined to explicitly require looking through domestic C corporations despite requiring looking through non-public QIEs, it is far from clear that the preamble’s interpretation is consistent with Congressional intent.

The preamble also does not explain the significance, in the absence of any statutory guidance, of the 25 percent foreign ownership threshold for applying the Look-Through Rule to domestic C corporations.

As discussed above, the Look-Through Rule also applies to foreign partnerships and makes these partnerships “look-through persons.” Before the release of the Proposed QIE Regulations, many practitioners had been unwilling to look through a foreign partnership to determine DREIT status. Thus, in this context, the Look-Through Rule provides a welcome clarification for taxpayers.

Proposed QIE Regulations Also Clarify Status of QFPFs

The Proposed QIE Regulations also provide that a QFPF or a QCE (as defined below) will always be treated as a foreign person for purposes of determining DREIT status. This clarification was in response to a suggestion by some commentators that, because a QFPF or QCE is not treated as a “nonresident alien individual or a foreign corporation” for purposes of being subject to U.S. tax under FIRPTA, it also should not be treated as a foreign person for DREIT purposes.

Effective Date

The Proposed QIE Regulations apply to dispositions of interests in QIEs that occur after the date on which the Proposed QIE Regulations are finalized. However, the preamble indicates that “the IRS may challenge positions” taken by taxpayers that are contrary to the Proposed QIE Regulations prior to the regulations’ being finalized.

Taxpayers may have limited flexibility to seek to restructure investments to reflect the Proposed QIE Regulations. The Testing Period for determining DREIT status extends up to 5 years before the relevant determination date, so if an investor were seeking to sell an interest in a DREIT after the regulations are finalized, the investor would need to prove DREIT status using the finalized regulations for the 5 years prior to the date of sale.

Further Takeaways

In light of the issuance of the Proposed QIE Regulations, sponsors of, and investors in, REITs intended to qualify as DREITs should reevaluate whether those REITs would qualify as DREITs under the proposed regulations. Sponsors should also review the information, representations, and covenants that they request from investors in order to determine whether a REIT will qualify as a DREIT. In that regard, REIT sponsors should also consider any obligations they may have to cause a REIT to qualify as a DREIT.

Any foreign investors who invested in a REIT assuming that it was a DREIT should re-examine their investment to determine whether their assumptions continue to be valid and whether restructuring is advisable before the date that the Proposed QIE Regulations become effective.

Proposed Section 892 Regulations

Background

Section 892(a)(1) exempts from U.S. federal taxation certain income derived by a foreign government. However, this exemption does not apply to income that is (1) derived from the conduct of a commercial activity, (2) received by or from a controlled commercial entity of the foreign government, or (3) derived from the disposition of an interest in a controlled commercial entity of the foreign government.

Generally, a controlled commercial entity is an entity that is controlled by the foreign government and is engaged in commercial activities. Under Temp. Treas. Reg. § 1.892-5T(b)(1), a USRPHC (whether a foreign or domestic corporation) is treated as engaged in commercial activity regardless of its actual activities, and, therefore, any USRPHC that is controlled by a foreign government is treated as a controlled commercial entity. As a result, under the current regulations, an entity controlled by a foreign government is treated as a controlled commercial entity if 50 percent or more of its assets consist of USRPIs, including interests in USRPHCs. This aspect of the current regulations can be a trap for the unwary and requires foreign governments that seek section 892 benefits for the entities they control to carefully monitor the value of the USRPIs those entities own.

Proposed Section 892 Regulations Relax the “Per Se” Rule for USRPHCs

The proposed regulations would modify current Temp. Treas. Reg. § 1.892-5T(b)(1). Under the Proposed Section 892 Regulations, the per se rule that treats a USRPHC as being engaged in commercial activity would be modified to include an exception for any corporation that is a USRPHC solely by reason of its direct or indirect ownership in one or more other corporations not controlled by the relevant foreign government. As a result, the Proposed Section 892 Regulations would prevent entities from being treated as controlled commercial entities solely because they are USRPHCs as a result of their ownership of minority interests in other USRPHCs.

Prop. Treas. Reg. § 1.892-5(b)(1) also would exempt foreign USRPHCs that are QFPFs or are wholly owned by one or more QFPFs from being treated as engaged in commercial activity solely as a result of their USRPHC status.

The Proposed Section 892 Regulations are proposed to apply to taxable years ending on or after December 29, 2022. Taxpayers may rely on the Proposed Section 892 Regulations until they are finalized.

Additional Notice on Section 892 Regulations

In addition to releasing the Proposed Section 892 Regulations, the IRS and Treasury published a notice on December 29, 2022 stating that they are considering finalizing regulations proposed under section 892 in 2011 that provide additional guidance on what constitutes commercial activities. Treasury and the IRS are accordingly reopening the comment period with respect to the 2011 proposed regulations through February 27, 2023.[12]

Final QFPF Regulations

Background

Under section 897(l), QFPFs and their wholly owned subsidiaries are exempt from having to file U.S. federal income tax returns and pay U.S. federal income tax on gain attributable to the disposition of USRPIs, unless that gain is otherwise effectively connected with the conduct of a U.S. trade or business.

In 2019, the IRS and Treasury published proposed regulations containing rules relating to the qualification for the exemption under section 897(l), as well as rules relating to withholding requirements under sections 1441, 1445, and 1446 for dispositions of USRPIs by QFPFs (the “2019 Proposed Regulations”). The Final QFPF Regulations finalize these 2019 Proposed Regulations with certain changes, some of which are discussed below.

A QCE Must Be a Wholly Owned Subsidiary of a QFPF

The 2019 Proposed Regulations had provided that gain or loss from the disposition of a USRPI by a “qualified holder” is not subject to tax under FIRPTA. A “qualified holder” is either a QFPF or a qualified controlled entity (“QCE”) that, in each case, satisfies the “qualified holder” rules under Treas. Reg. § 1.897(l)-1(d). A “QCE” is defined as a trust or corporation that is organized under the laws of a foreign country and all of the interests of which are held directly or indirectly by one or more QFPFs. The 2019 Proposed Regulations would have required that all of the interests in a QCE be held, directly or indirectly, by one or more QFPFs, with no exceptions. Commentators had suggested that Treasury include certain de minimis exceptions to this strict requirement, for example an exception for small ownership interests awarded to management of the QCE.

In promulgating the Final QFPF Regulations, the IRS and Treasury rejected those comments. Accordingly, the Final QFPF Regulations require that, for a trust or corporation to qualify as a QCE, all of the interests in the QCE must be held, directly or indirectly, by one or more QFPFs. For this purpose, an “interest” is defined as an interest other than an interest solely as a creditor and includes (but is not limited to) stock of a corporation, an interest in a partnership as a partner, an interest in a trust or estate as a beneficiary, and certain option instruments. The IRS and Treasury declined to provide express guidance as to whether a non-economic interest[13] held by a non-QFPF in an entity that otherwise qualifies as a QCE would cause that entity not to qualify as a QCE. Instead, in the preamble to the Final QFPF Regulations, the IRS and Treasury indicated that the determination as to whether such a non-economic interest would be an interest in the entity (and thus render that entity a non-QCE) would be made on the facts and circumstances, taking into account general tax principles.

Testing for Qualified Holder Status

Under the Final QFPF Regulations, a QFPF or a QCE must satisfy one of two tests on the relevant determination date to be a qualified holder. Under the first test, a QFPF or a QCE is a qualified holder if it owned no USRPIs as of the date it became a QFPF or QCE and has remained qualified as a QFPF or QCE since then. Under the second test, if a QFPF or a QCE held USRPIs when it became a QFPF or QCE, it is a qualified holder if it was a QFPF or QCE during the entire “testing period” applicable to the entity. This testing period is the shortest of (i) the period beginning on December 18, 2015 and ending on the determination date, (ii) the ten-year period ending on the determination date, and (iii) the period beginning on the date the entity (or its predecessor) was created or organized and ending of the determination date. Although the Final QFPF Regulations reformulated the description of this test, these requirements generally are substantively unchanged from the 2019 Proposed Regulations.

The Final QFPF Regulations provide a limited transition period safe harbor for determining whether a QFPF or a QCE is a qualified holder: with respect to any period from December 18, 2015 to December 29, 2022 (for a QFPF) or to June 6, 2019 (for a QCE), the QFPF or QCE is deemed to be a qualified holder if the QFPF or QCE satisfies the requirements under section 897(l)(2) (which generally defines and describes a QFPF) based on a reasonable interpretation of those requirements. The Final QFPF Regulations further provide that, in determining whether a QCE is a qualified holder from December 18, 2015 to February 27, 2023,[14] a QCE is permitted to disregard a 5 percent or smaller interest owned by any person that provides services to the QCE. This safe harbor does not apply to disregard a 5 percent or smaller interest in the QCE at the time the QCE disposes of a USRPI; instead, the safe harbor only provides that an entity that otherwise would have failed to qualify as a QCE (and therefore as a qualified holder) during the transition period as a result of a 5 percent or smaller interest owned by a service provider will not be treated as having failed to qualify as a QCE if that owner is divested from its ownership in such entity no later than February 27, 2023. Accordingly, QCEs that have de minimis service provider ownership should consider causing those service providers to dispose of their interests in the QCE before February 27, 2023 and not disposing of any USRPIs in the interim.

Treatment of Eligible Fund as a QFPF

In general, a trust, corporation, or other organization or arrangement that maintains segregated accounts for retirement or pension benefits to participants or certain other beneficiaries (such as current or former employees) is treated as a QFPF (and, therefore, an “eligible fund”) if both (i) all of the benefits that the entity provides are qualified benefits for qualified participants (the “100 percent threshold”) and (ii) at least 85 percent of the present value of the benefits that the eligible fund reasonably expects to provide in the future are retirement or pension benefits (the “85 percent threshold”).

The 2019 Proposed Regulations would have required that an eligible fund must measure the present value of benefits to be provided during each year of the entire period during which the fund is expected to be in existence. The Final QFPF Regulations retain this requirement but add a taxpayer-friendly alternative 48-month test as another means to meet the 85-percent threshold. The 48-month alternative calculation test is satisfied if the weighted average of the present values of the retirement and pension benefits that the eligible fund reasonably expects to provide over its life, as determined by the valuations performed over the 48 months preceding (and including) the most recent present valuation, satisfies the 85-percent threshold. If an eligible fund has been in existence for fewer than 48 months, the 48-month alternative calculation is applied to the period the eligible fund has been in existence.

Withholding Related to Qualified Holders

The Final QFPF Regulations provide that a foreign partnership that is owned solely by qualified holders is not treated as a foreign person for purposes of withholding under section 1445 and, to the extent applicable under FIRPTA, section 1446 (such a foreign partnership, a “withholding qualified holder”). In addition, even if a qualified holder is a partner in a foreign partnership that is not a withholding qualified holder (because the partnership has partners that are not qualified holders), the qualified holder is still eligible for exemption from taxation on its distributive share of USRPI items.

A withholding qualified holder may submit a certification of non-foreign status to establish withholding qualified holder status. This certificate must state that the transferor is not a foreign person because it is a withholding qualified holder, and the transferor may provide its foreign taxpayer identification number if it does not have a U.S. taxpayer identification number. The preamble to the Final QFPF Regulations clarifies that, once a revised IRS Form W-8EXP is released, this revised IRS Form W-8EXP can be used to make this certification by a withholding qualified holder.

Effective Dates

The Final QFPF Regulations generally apply with respect to dispositions of USRPIs occurring on or after December 29, 2022, although certain provisions (including the qualified holder rule) apply as of June 7, 2019 (the date the 2019 Proposed Regulations were published). An eligible fund may choose to apply the Final QFPF Regulations with respect to dispositions and distributions occurring on or after December 18, 2015 and before the effective date of the Final QFPF Regulations, if the eligible fund and all persons bearing a relationship to the eligible fund described in section 267(b) or 707(b) consistently apply all of the rules in the Final QFPF Regulations for all relevant years.

_____________________________

[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] Even though the rules discussed below apply to both REITs and RICs, our discussion focuses on REITs and DREITs given that foreign persons are more likely to invest in U.S. real estate through REITs than RICs.

[3] Protecting Americans from Tax Hikes Act of 2015, § 133, Pub. L. No. 114-113 (Dec. 18, 2015).

[4] The expression “directly or indirectly,” used to qualify ownership, is used throughout the Code and the regulations with a variety of intended meanings in different contexts. For example, in subpart F (sections 951-965), “indirectly” does not imply ownership by attribution but rather beneficial ownership. Likewise, sections 318, 544, 881, and 883 provide for attribution rules that apply to stock held “directly or indirectly” by or for a person but, because those sections contain specific attribution provisions, the implication is that “indirect” ownership does not include ownership by attribution other than as a result of the specific attribution rules. By contrast, under section 447(d)(2)(B) (before repeal in 2017), “indirect” ownership was interpreted to include ownership by attribution, even absent specific attribution rules.

[5] Treas. Reg. § 1.897-1(c)(2)(i).

[6] See § 702(a)(5); Treas. Reg. § 1.702-1(a)(5).

[7] Prop. Treas. Reg. § 1.897-1(c)(3)(ii)(B); Prop. Treas. Reg. § 1.897-1(c)(3)(v)(D). Note that the Look-Through Rule does not override the 2015 look-through rule for QIEs previously mentioned.

[8] Prop. Treas. Reg. § 1.897-1(c)(3)(ii)(B).

[9] Prop. Treas. Reg. § 1.897-1(c)(3)(v)(D); Prop. Treas. Reg. § 1.897-1(c)(3)(v)(B).

[10] Prop. Treas. Reg. § 1.897-1(c)(3)(vi)(B), Ex. 2.

[11] The IRS and Treasury sometimes acknowledge contrary private letter rulings when issuing regulations. See, e.g., T.D. 9932 (regarding final regulations under section 162(m)), fn. 12 (Dec. 30, 2020) (acknowledging a conflicting private letter ruling).

[12] See 87 FR 80108 (Dec. 29, 2022) (The IRS Notice may be found here: https://www.federalregister.gov/documents/2022/12/29/2022-27969/income-of-foreign-governments-and-international-organizations-comment-period-reopening); REG-146537-06 (Nov. 3, 2011) (The 2011 Proposed Regulations may be found here: https://www.govinfo.gov/content/pkg/FR-2011-11-03/pdf/2011-28531.pdf).

[13] For example, a noneconomic general partner interest in a foreign partnership that elects to be classified as a corporation for U.S. federal income tax purposes.

[14] The Final QFPF Regulations noted that this period concludes 60 days after the date the Final QFPF Regulations were published in the Federal Register. Because the Final QFPF Regulations were published on December 29, 2022, the 60-day time frame concludes on February 27, 2023.

This alert was prepared by Josiah Bethards, Emily Brooks, Evan M. Gusler, Brian W. Kniesly, Yara Mansour, James Manzione, Alex Marcellesi, Jeffrey M. Trinklein, and Daniel A. Zygielbaum.

*Anne Devereaux is an of counsel working in the firm’s Los Angeles office who is admitted only in Washington, D.C.

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.