On November 1, 2021, the President’s Working Group on Financial Markets,[1] joined by the Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC), issued its expected report (Report) on stablecoins, a type of digital asset that has recently grown significantly in market capitalization and importance to the broader digital asset markets.[2]
Noting gaps in the regulation of stablecoins, the Report makes the following principal recommendations:
- Congress should promptly enact legislation to provide a “consistent and comprehensive” federal prudential framework for stablecoins –
- Stablecoin issuers should be required to be insured depository institutions
- Custodial wallet providers that hold stablecoins on behalf of customers should be subject to federal oversight and risk-management standards
- Stablecoin issuers and wallet providers should be subject to restrictions on affiliations with commercial entities.
- In the absence of Congressional action, the Financial Stability Oversight Council (FSOC) should consider steps to limit stablecoin risk, including designation of certain stablecoin activities as systemically important payment, clearing, and settlement activities.
The Report thus calls for the imposition of bank-like regulation on the world of stablecoins, and it does so with a sense of urgency. Below we summarize the Report’s key conclusions and recommendations, and then preview the path forward if the FSOC is to take up the Report’s call to action.
Stablecoins
A stablecoin is a digital asset that is created in exchange for fiat currency that a stablecoin issuer receives from a third-party; most stablecoins offer a promise or expectation that the stablecoin can be redeemed at par on request. Although certain stablecoins are advertised as being backed by “reserve assets,” there are currently no regulatory standards governing such assets, which can range on the risk spectrum from insured bank deposits and Treasury bills to commercial paper, corporate and municipal bonds, and other digital assets. Indeed, in October, the CFTC took enforcement action against the issuers of US Dollar Tether (USD Tether) for allegedly making untrue or misleading statements about USD Tether’s reserves.[3]
The market capitalization of stablecoins has grown extremely rapidly in the last year; according to the Report, the largest stablecoin issuers had, as of October, a market capitalization exceeding $127 billion.[4] The Report states that stablecoins are predominantly used in the United States to facilitate the trading, lending, and borrowing of other digital assets – they replace fiat currency for participants in the trading markets for Bitcoin and other digital assets and allow users to store and transfer value associated with digital asset trading, lending, and borrowing within distributed ledger environments.[5] The Report further notes that certain stablecoin issuers believe that stablecoins should be used in the payment system, both for domestic goods and services, and for international remittances.[6] Stablecoins, the Report asserts, are also used as a source of collateral against which participants in the digital assets markets can borrow to fund additional activity, “sometimes using extremely high leverage,” as well as to “earn yield,” by using stablecoins as collateral for extending loans and engaging in margined transactions.[7]
Perceived Risks of Stablecoins
The Report views the stablecoin market as currently having substantial risks not subject to regulation.
First, the Report asserts that stablecoins have “unique risks” associated with secondary market activity and market participants beyond the stablecoin issuers themselves, because most market participants rely on digital asset trading platforms to exchange stablecoins with national currencies and other stablecoins.[8] In addition, the Report states that the active trading of stablecoins is part of an essential stabilization mechanism to keep the price of the stablecoin close to or at its pegged value.[9] It further asserts that digital asset trading platforms typically hold stablecoins for customers in non-segregated omnibus custodial wallets and reflect trades on internal records only, and that such platforms and their affiliates may also engage in active trading of stablecoins and as market makers.[10]
Second, the Report argues that stablecoins play a central role in Decentralized Finance (DeFi). It gives two examples – first, stablecoins often are one asset in a pair of digital assets used in “automated market maker” arrangements, and second, they are frequently “locked” in DeFi arrangements to garner yield from interest payments made by persons borrowing stablecoins for leveraged transactions.[11]
As a result, the Report describes a range of risks arising from stablecoins, including risks of fraud, misappropriation, and conflicts of interest and market manipulation; the risk that failure of disruption of a digital asset trading platform could threaten stablecoins; the risk that failure or disruption of a stablecoin could threaten digital asset trading platforms; money laundering and terrorist financing risks; risks of excessive leverage on unregulated trading platforms; risks of non-compliance with applicable regulations; risks of co-mingling trading platform funds with funds of customers; risks flowing from information asymmetries and market abuse; risks from unsupervised trading; risks from distributed-ledger based arrangements, including governance, cybersecurity, and other operational risks; and risks from novel custody and settlement processes.[12]
The Report also notes the risk of stablecoin “runs” that could occur upon loss of confidence in a stablecoin and the reserves backing it, as well as risks to the payment system generally if stablecoins became an important part of the payment system. The Report notes that “unlike traditional payment systems where risk is managed centrally by the payment system operator,” some stablecoin arrangements feature “complex operations where no single organization is responsible or accountable for risk management and resilient operation of the entire arrangement.”[13]
Finally, the Report asserts that the rapid scaling of stablecoins raises three other sets of policy concerns. First is the potential systemic risk of the failure of a significant stablecoin issuer or key participant in a stablecoin arrangement, such as a custodial wallet provider.[14] Second, the Report points to the business combination of a stablecoin issuer or wallet provider with a commercial firm as raising economic concentration concerns traditionally associated with the mixing of banking and commerce.[15] Third, the Report states that if a stablecoin became widely accepted as a means of payment, it could raise antitrust concerns.[16]
Recommendations
The Report’s key takeaway is that the President’s Working Group, the OCC and the FDIC believe that there are currently too many regulatory gaps relating to stablecoins and DeFi. The Report does note that, in addition to existing anti-money laundering and anti-terrorist financing regulations, stablecoin activities may implicate the jurisdiction of the SEC and CFTC, because certain stablecoins may be securities or commodities. Indeed, the CFTC just recently asserted that Bitcoin, Ether, Litecoin and USD Tether are commodities.[17] Nonetheless, the Report states that as stablecoin markets continue to grow, “it is essential to address the significant investor and market risks that could threaten end users and other participants in stablecoin arrangements and secondary market activity.”[18]
The Report therefore calls for legislation to close what it sees as the critical gaps. First, it argues that stablecoin issuance, and the related activities of redemption and maintenance of reserve assets, should be limited to entities that are insured depository institutions: state and federally chartered banks and savings associations that are FDIC insured and have access to Federal Reserve services, including emergency liquidity.[19] Legislation should also ensure that supervisors have authority to implement standards to promote interoperability among stablecoins.[20] Given the global nature of stablecoins, the Report contends that legislation should apply to stablecoin issuers, custodial wallet providers, and other key entities “that are domiciled in the United States, offer products that are accessible to U.S. persons, or that otherwise have a significant U.S. nexus.”[21]
Second, given the Report’s perceived risks of custodial wallet providers, the Report argues that Congress should require those providers to be subject to “appropriate federal oversight,” including restricting them from lending customer stablecoins and requiring them to comply with appropriate risk-management, liquidity, and capital requirements.[22]
Third, because other entities may perform activities that are critical to the stablecoin arrangement, the Report argues that legislation should provide the supervisor of a stablecoin issuer with the authority to require any entity that performs activities “critical to the functioning of the stablecoin arrangement” to meet appropriate risk-management standards, and give the appropriate regulatory agencies examination and enforcement authority with respect to such activities.[23]
Finally, the Report advocates that both stablecoin issuers and wallet providers should, like banks, be limited in their ability to affiliate with commercial firms.[24]
Interim Measures
The Report characterizes the need for legislation as “urgent.” While legislation is being considered, the Report recommends that the Financial Stability Oversight Council (FSOC) consider taking actions within its jurisdiction, such as designating certain activities conducted within stablecoin arrangements as systemically significant payment, clearing, and settlement activities.[25] The Report states that such designation would permit the appropriate federal regulatory agency to establish risk-management requirements for financial institutions[26] that engage in the designated activities.
Such designations would occur pursuant to Title VIII of the Dodd-Frank Act, and it would be the first time that the FSOC would make them.[27] The procedure that the FSOC must follow is set forth in Title VIII, and, absent an emergency, it appears that it would not be a quick one. First, the FSOC must consult with the relevant federal supervisory agencies and the Federal Reserve.[28] Next, it must provide notice to the financial institutions whose activities are to be designated, and offer those institutions the opportunity for a hearing.[29] The institutions may then choose to appear, personally or through counsel, to submit written materials, or, at the sole discretion of FSOC, to present oral testimony or argument.[30] The FSOC must approve the activity designation by a vote of at least two-thirds of its members, including an affirmative vote by the Chair.[31] The FSOC must consider the designation in light of the following factors: (i) the aggregate monetary value of transactions carried out through the activity, (ii) the aggregate exposure of the institutions engaged in the activity to their counterparties, (iii) the relationship, interdependencies, or other interactions of the activity with other payment, clearing, or settlement activities, (iv) the effect that the failure of or a disruption to the activity would have on critical markets, financial institutions, or the broader financial system, and (v) any other factors that the FSOC deems appropriate.[32]
Conclusion
With the Report, Treasury and the relevant federal agencies – the Federal Reserve, the SEC, CFTC, OCC, and FDIC – have made it clear that they believe that the risks of stablecoin activities are not fully mitigated by existing regulation. Their recommendations for legislation look principally to bringing stablecoins within the banking system and to bank regulation as a means of addressing those risks. It is an open question, however, whether Congress will act, much less with the urgency that the Report desires. Action by the FSOC, moreover, will almost certainly take some time, given the statutory designation procedures. In the near term, therefore, it is likely to fall to the existing agencies with some jurisdiction over stablecoins – the CFTC and SEC – to address the gaps with the tools at their disposal.[33]
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[1] The Working Group comprises representatives of the Treasury Department (Treasury), Board of Governors of the Federal Reserve System (Federal Reserve), the Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC).
[2] See https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.
[3] See https://www.gibsondunn.com/digital-asset-developments-us-commodity-futures-trading-commission-asserts-that-tether-is-a-commodity/.
[4] Report, at 7. In addition to USD Tether, the most circulated stablecoins are USD Coin, Binance USD, Dai Stablecoin, and TrueUSD. All are pegged to the U.S. dollar.
[17] See https://www.gibsondunn.com/digital-asset-developments-us-commodity-futures-trading-commission-asserts-that-tether-is-a-commodity/.
[19] Id. at 16. Unless the insured depository institution in question is an industrial bank, requiring the stablecoin issuer to be an insured depository institution would also be a requirement for the issuer’s parent company, if any, to be a bank or thrift holding company supervised and regulated by the Federal Reserve.
[26] Title VIII defines “financial institution” broadly to reach “any company engaged in activities that are financial in nature or incidental to a financial activity, as described in section 4 of the Bank Holding Company Act,” in addition to banks, credit unions, broker-dealers, insurance companies, investment advisers, investment companies, futures commission merchants, commodity pool operators and commodity trading advisers.
[27] The FSOC has previously undertaken designations of systemically significant nonbank financial companies under Title I of the Dodd-Frank Act and systemically significant financial market utilities under Title VIII of the Dodd-Frank Act.
[33] In a press release issued just after the Report, the Director of the Consumer Financial Protection Bureau, Rohit Chopra, stated that “stablecoins may . . . be used for and in connection with consumer deposits, stored value instruments, retail and other consumer payments mechanisms, and in consumer credit arrangements. These use cases and others trigger obligations under federal consumer financial protection laws, including the prohibition on unfair, deceptive, or abusive acts or practices.” See https://www.consumerfinance.gov/about-us/newsroom/statement-cfpb-director-chopra-stablecoin-report/.
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and Jeffrey Steiner.
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, the author, or any of the following members of the firm’s Financial Institutions practice group:
Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202-955-8220, [email protected])
Mylan L. Denerstein – New York (+1 212-351- 3850, [email protected])
William R. Hallatt – Hong Kong (+852 2214 3836, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Matthew Nunan – London (+44 (0) 20 7071 4201, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
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This update provides an overview of key class action developments during the third quarter of 2021.
Part I covers two important decisions from the Third and Ninth Circuits regarding the scope of the Section 1 exemption under the Federal Arbitration Act.
Part II addresses a Ninth Circuit decision endorsing the use of a motion to deny class certification at the pleadings stage.
Part III reports on a Fourth Circuit decision vacating a class certification order because of the numerosity requirement.
Part IV discusses a Third Circuit decision rejecting the certification of an “issue” class under Rule 23(c)(4) where the district court did not find that one of the Rule 23(b) factors was satisfied.
And finally, Part V analyzes a Ninth Circuit decision clarifying that a defendant need not raise a personal jurisdiction defense as to a putative absent class member at the outset of a case, and instead can assert that defense for the first time at the class certification stage.
I. The Third and Ninth Circuits Address the Federal Arbitration Act’s Section 1 Exemption
The Third and Ninth Circuits both weighed in this past quarter on the so-called Section 1 exemption in the Federal Arbitration Act (“FAA”), which exempts “workers engaged in foreign or interstate commerce” from having to arbitrate their claims under federal law. 9 U.S.C. § 1. The Section 1 exemption has been the subject of substantial litigation in recent years, particularly in the context of class actions involving “gig” economy workers, and the decisions from the Third and Ninth Circuits provide additional clarity to litigants regarding the scope of this exemption. Gibson Dunn served as counsel to the defendants in both appeals.
In Harper v. Amazon.com Services, Inc., 12 F.4th 287 (3d Cir. 2021), a delivery driver claiming he was misclassified as an independent contractor asserted that he could not be compelled to arbitrate his claim because he and other New Jersey drivers made some deliveries across state lines and therefore qualified for the Section 1 exemption. Id. at 292. The district court deemed that contention to raise a question of fact and it ordered discovery, without examining Amazon’s contention that state law would also require arbitration even if the Plaintiff was exempt from arbitration under the FAA. Id. The Third Circuit vacated the district court’s order and “clarif[ied] the steps courts should follow––before discovery about the scope of § 1—when the parties’ agreement reveals a clear intent to arbitrate.” Id. at 296. Under this three-part framework, a district court must first determine, based on the allegations in the complaint, whether the agreement applies to a class of workers that fall within the exemption. If it is not clear from the face of the complaint, the court must assume § 1 applies and “consider[] whether the contract still requires arbitration under any applicable state law.” Id. If the arbitration clause is unenforceable under state law, only then does the court “return to federal law and decide whether § 1 applies, a determination that may benefit from limited and restricted discovery on whether the class of workers primarily engage in interstate or foreign commerce.” Id.
In Capriole v. Uber Technologies, Inc., 7 F.4th 854 (9th Cir. 2021), the Ninth Circuit addressed whether rideshare drivers are transportation workers engaged in foreign or interstate commerce; it joined the growing number of courts holding that such drivers do not fall within this Section 1 exemption. Although the plaintiffs claimed they fell under the Section 1 exemption because they sometimes cross state lines, and also pick up and drop off passengers from airports who are engaging in interstate travel, the Ninth Circuit held this was not enough to qualify for the exemption. Id. at 863. In particular, the Ninth Circuit cited the district court’s finding that only 2.5% of trips fulfilled by Uber started and ended in different states, and that only 10.1% of trips began or ended at an airport (and not all of the customers’ flights involved interstate travel). Id. at 864. This sporadic interstate movement “cannot be said to be a central part of the class member’s job description,” and thus a driver “does not qualify for the exemption just because she occasionally performs” work in interstate commerce. Id. at 865. The Ninth Circuit’s holding “join[s] the growing majority of courts holding that Uber drivers as a class of workers do not fall within the ‘interstate commerce’ exemption from the FAA.” Id. at 861.
II. The Ninth Circuit Affirms the Granting of a Motion to Deny Class Certification at the Pleadings Stage
The propriety of class certification is typically decided after discovery occurs and the plaintiff moves to certify a class. But in some cases, a defendant can properly move to deny class certification at the outset of a case. That is exactly what the Ninth Circuit endorsed this quarter in Lawson v. Grubhub, Inc., 13 F.4th 908 (9th Cir. 2021), a case in which Gibson Dunn served as counsel for the defendant.
In Lawson, the district court granted the defendant’s motion to deny class certification on the ground that the vast majority of putative class members were bound by arbitration agreements with class action waivers. Lawson, 13 F.4th at 913. The Ninth Circuit affirmed, explaining that because only the plaintiff and one other person had opted out of the arbitration clause and class action waiver in their contracts, the plaintiff was “neither typical of the class nor an adequate representative,” and the proceedings were “unlikely to generate common answers.” Id. The Ninth Circuit also rejected the plaintiff’s argument that the denial of class certification was premature because the plaintiff had not yet moved for certification, and specifically held that Rule 23 “allows a preemptive motion by a defendant to deny class certification.” Id.
III. The Fourth Circuit Addresses the Numerosity Requirement
Plaintiffs seeking class certification often have little trouble satisfying Rule 23(a)(1)’s requirement that “the class is so numerous that joinder of all members is impracticable.” With proposed classes commonly covering thousands or millions of members, appellate courts rarely have an opportunity to address this numerosity requirement. But in certain areas, including in pharmaceutical antitrust class actions, it has become increasingly common for plaintiffs to seek certification of small classes of sophisticated and well-resourced businesses claiming substantial damages. This past quarter, however, the Fourth Circuit vacated an order certifying such a class after finding that the district court had applied an erroneous standard for assessing numerosity. Gibson Dunn represented one of the defendants in this action.
In re Zetia (Ezetimibe) Antitrust Litigation, 7 F.4th 227 (4th Cir. 2021), rejected a district court’s conclusion that a putative class of 35 purchasers of certain prescription drugs had satisfied Rule 23’s numerosity requirement. The court explained that the district court’s numerosity analysis rested on “faulty logic” and neglected to consider that “the text of Rule 23(a)(1) refers to whether ‘the class is so numerous that joinder of all members is impracticable,’ not whether the class is so numerous that failing to certify presents the risk of many separate lawsuits.” 7 F.4th at 234–35 (quoting In re Modafinil Antitrust Litig., 837 F.3d 238 (3d Cir. 2016)). Accordingly, when evaluating numerosity, the question is whether a class action is preferable as compared to joinder—not as compared to the prospect of individual lawsuits. Id. at 235. And with respect to class members’ ability and motivation to litigate, the court emphasized that the proper comparison is not individual suits, but rather whether it is practicable to join class members into a single action. Significantly, the Fourth Circuit emphasized that Rule 23(a)(1) requires plaintiffs to produce evidence that, absent certification of a class, the putative class members would not join the suit and that it would be uneconomical for smaller claimants to be individually joined. Id. at 235–36 & nn. 5 & 6.
IV. The Third Circuit Heightens the Standard for the Certification of “Issue” Classes
Rule 23(c)(4) provides that, “[w]hen appropriate, an action may be brought or maintained as a class action with respect to particular issues.” Some courts have read this language as permitting the certification of classes without a separate showing that the requirements of Rule 23(b)(1), (b)(2), or (b)(3) are satisfied. In practice, this view of Rule 23(c)(4) can permit plaintiffs to bypass the need to establish that common questions predominate. The Third Circuit this quarter refused to adopt such a reading of Rule 23, and instead held that a certification of an “issue” class under Rule 23(c)(4) is not permissible unless one of the Rule 23(b) requirements is also satisfied.
In Russell v. Educational Commission for Foreign Medical Graduates, the Third Circuit reversed a district court’s certification of an “issue” class under Rule 23(c)(4) because the district court had not found that any subsection of Rule 23(b) was satisfied. 15 F.4th 259, 271 (3d Cir. 2021). The court explained that “[t]o be a ‘class action,’ a party must satisfy Rule 23 and all of its requirements,” and concluded that class certification was improperly granted because there had been no determination if Rule 23(b) could be met. Id. at 262, 271–73. Thus, plaintiffs in the Third Circuit seeking to certify an issue-only class under Rule 23(c)(4) must still satisfy the other requirements of Rule 23, including showing that “action is maintainable under Rule 23(b)(1), (2), or (3).” Id. at 267.
V. The Ninth Circuit Holds That a Defendant Does Not Waive a Personal Jurisdiction Defense to Absent Class Members by Not Raising It at the Pleadings Stage
In our First Quarter 2020 Update on Class Actions, we covered decisions from the Fifth and D.C. Circuits holding that the proper time to adjudicate whether a court has personal jurisdiction over absent class members is at the class certification stage, not at the pleading stage. This past quarter, the Ninth Circuit aligned itself with these other Circuits.
In Moser v. Benefytt, Inc., 8 F.4th 872 (9th Cir. 2021), the Ninth Circuit ruled that a defendant can raise a personal jurisdiction objection as to absent class members at the class certification stage, even if the defendant did not raise it in its first responsive pleading. In Moser, a California resident filed a putative nationwide class action alleging that the defendant, a Delaware corporation with its principal place of business in Florida, violated the Telephone Consumer Protection Act by making calls to persons across the country. Id. at 874. When the plaintiff moved to certify a nationwide class, the defendant argued that the district court could not certify a nationwide class because the court lacked personal jurisdiction over any of the non-California plaintiffs’ claims under the Supreme Court’s decision in Bristol-Myers Squibb v. Superior Court, 137 S. Ct. 1773 (2017). But the district court declined to consider the argument, holding that the defendant waived it by failing to raise the objection to personal jurisdiction in its first Rule 12 motion to dismiss. Moser, 8 F.4th at 875.
The Ninth Circuit reversed. It held that the defendant had not waived its personal jurisdiction objection to nationwide certification by not raising it in the first responsive pleading. Id. at 877. The court reasoned that because defendants do not yet have “available” a “personal jurisdiction defense to the claims of unnamed putative class members who were not yet parties to the case” at the pleadings stage, defendants could not waive such an objection before the certification stage. Id. This ruling clarifies that defendants in the Ninth Circuit do not need to raise personal jurisdiction challenges to putative absent class members at the outset of the case, and instead should raise such challenges at the class certification stage.
The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Wesley Sze, Emily Riff, Jeremy Weese, and Dylan Noceda.
Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers:
Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, [email protected])
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, [email protected])
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, [email protected])
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, [email protected])
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, [email protected])
Lauren M. Blas – Los Angeles (+1 213-229-7503, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Diversity and inclusion (“D&I”) in the workplace including at leadership levels of organisations is an ever prominent issue brought into sharp focus during the pandemic, intensified in the wake of the recent racially motivated crimes in the US and elsewhere, which had brought this critical issue on the agenda of many regulators, globally including the UK’s financial services regulators, the Financial Conduct Authority (“FCA”)[1] and the Prudential Regulatory Authority (“PRA”)[2]
Earlier this year, in July, the UK’s financial services regulators published a discussion paper and a consultation paper setting out proposals to enhance diversity and inclusion in the financial services and the UK listed company sectors respectively. The feedback period on both papers recently came to an end. This alert looks at some of the detail behind the proposals and considers whether in some aspects the FCA has missed an opportunity to push forward the broader D&I agenda and whether in other ways it has gone too far with certain proposals which may have a real and direct impact on the privacy of individuals and the qualitative impact of the proposals.
INTRODUCTION & OVERVIEW OF THE PROPOSALS
Joint Discussion Paper Impacting the UK Financial Services Sector
What?: On 7 July, the FCA, the PRA and the Bank of England[3] (together, the “Regulators”) issued a joint discussion paper – “Diversity and inclusion in the financial sector – working together to drive change” (“DP 21/2“)[4] expounding how meaningful change in respect of diversity and inclusion in the financial services sector can be accelerated and the paper should be viewed as the starting point for the implementation and formalisation of the related requirements. The Regulators’ make it clear that their primary focus is enhancing “diversity of thought” or “cognitive diversity” whilst recognising that diversity of thought can be influenced by many factors including demographic characteristics which are visible and measurable (e.g. gender, age, ethnicity) and invisible (e.g. disability, sexual orientation and education).
Which firms does it impact?: DP 21/2 affects the whole UK financial services sector including firms authorised and regulated jointly by the FCA and PRA (e.g. banks, building societies, designated investment firms, credit unions and insurance firms) or solely by the FCA. Payment services and e-money firms, credit rating agencies and recognised investment exchanges regulated by the FCA and FMIs regulated by the Bank of England fall within the broad reach of the paper.
Next steps: The proposals are only at a “discussion paper” stage but will be the foundations upon which further steps towards change in this area are built upon. Whilst the official deadline for feedback on the discussion paper passed on 30 September, the regulators propose to continue to engage with firms and other regulators on the topics presented in the paper and intend to gather further data to support their analysis and eventual recommendations with a view to issuing a formal consultation paper in Q1 2022 followed by a Policy Statement in Q3 2022.
Consultation Paper Impacting Listed Companies in the UK
What?: On 28 July 2021, the FCA has published a consultation paper – “Diversity and inclusion on company boards and executive committees” (CP 21/24)[5] which sets a number of proposals to enhance diversity-related reporting by certain listed companies in relation to gender and ethnic diversity at both board and executive management level.
Which types of companies does it impact?: The companies in the scope of the breath of the proposals are both UK and overseas issuers with equity shares, or certificates representing equity shares, admitted to either the premium or standard section of the FCA’s Official List (“In-scope Companies”). In addition, the corporate governance related proposals will also capture UK issuers admitted to UK regulated markets and certain overseas listed companies (subject to exemptions for small and medium companies). The FCA is proposing to exclude open-ended investment companies and shell companies. The FCA is also proposing at this stage, to exclude issuers of debt securities, securities derivatives or miscellaneous securities. The FCA estimates that there are about 1,106 issuers who would be In-scope Companies (766 large issuers and 340 small and medium-sized issuers).
Next steps: The consultation closed on 20 October 2021 and, subject to consultation feedback and approval by the FCA Board, the FCA aims to publish a policy statement along with the new Listing Rules and the Disclosure and Transparency Rules (“DTR”) before the end of 2021. This would mean that any new rules would apply to accounting periods beginning on or after 1 January 2022.
A MORE DETAILED LOOK AT THE PROPOSALS
Policy Options Under Consideration for the Financial Services Sector – DP 21/2
Which firms should be in scope? – The Regulators are seeking views on which of the entities identified as falling in the UK financial services sector above should be in scope and the extent that different categories of firms should fall in scope. For example, it is expected that firms which currently fall within the Senior Managers and Certification Regime (“SMCR”)[6] should fall in scope but potentially to different degrees depending on their classification for SMCR purposes (i.e. whether and ‘enhanced’, ‘core’ or ‘limited scope’ firm). The Regulators are keen also to include FMIs (even though they are not caught by the SMCR in the same way as other firms) given the important albeit unseen role they place in society and the UK financial markets. An alternative to utilising the SMCR regime as a foundation to introducing potentially new D&I rules would be to utilise existing size classifications under the UK Companies Act 2006 regime for accounting and reporting purposes (i.e. micro-entity, small, medium sized and large). The Regulators are also keen to gather views on the extent to which overseas firms operating in the UK (including through branches) should be caught – we consider that to the extent that these firms are providing financial services and products into the UK market, it would be appropriate that they fall in scope, albeit this should be in a proportionate manner.
Data Collection: One of the trickiest elements for the Regulators to navigate in putting together their proposals is in relation to data collation. The Regulators rightly see data collation (and related setting of targets or metrics) as key to driving impact and change D&I however recognise first that many firms are already collecting some data[7] (albeit not in a consistent manner) and that collection of meaningful D&I data (particularly in smaller firms) can run directly counter to data privacy rules and these will vary across different jurisdictions. In addition, the effectiveness of D&I data collation including data which requires individuals to self-identify for certain categories of diversity, is likely to be impacted by the culture of the individual firms and indeed the culture (and potentially laws and regulations e.g. rules which may prohibit certain sexual or romantic orientation) across different jurisdictions. Further, on the key diversity element of ethnicity, the appropriate ethnic categories for a firm may well be impacted by the jurisdictions in which those firms principally operate (albeit with UK operations or nexus), where they are incorporated or have their headquarters or key leadership teams. How should the regulations be structured to accommodate for this? This is also proving to be a key factor in the specific proposals for listed companies (see below). Finally, on data collation, whilst for purposes of the discussion paper, the Regulators are gathering feedback on collection of data across the nine “protected characteristics” recognised under the UK’s Equality Act 2010[8] plus socio-economic background, we do not expect this to result in proposals in the first instance which would cover all of these areas.
Key focus areas of the Discussion Paper: The following areas are the focus of the discussion paper and where the Regulators are actively considering developing policy options (including potentially mandatory proposals):
- Governance – The Regulators recognise that in order to drive effective change in D&I, the leadership and culture of a firm is critical and boards are ultimately responsible for setting strategy and culture and holding management to account for promoting D&I. The paper queries if targets for representation at board level should be set and clarification should be delivered around succession planning for boards and the specific role of nomination committees in driving D&I.
- Accountability – The Regulators are in favour of making senior leaders directly accountable for D&I alongside collective responsibility of the board – this could be done for example through aligning this with the prescribed responsibilities under the senior management function (SMF) in firms for leading the development of firm culture and/or overseeing adoption of the firm’s culture[9].
- Remuneration – As with other areas of environmental, social governance (ESG), the Regulators also see linking remuneration (in particular variable remuneration) with progress on D&I as a key tool for driving both accountability and to incentivise progress. The Regulators are also looking to introduce explicit rules about remuneration policies set by firms and the requirement to ensure that both fixed and variable remuneration do not give rise to discriminatory practices.
- D&I Policies – The Regulators consider having clearly set out D&I policies are essential and wish to explore a requirement for all firms to publish their D&I policies on their website – and whilst not intending to be prescriptive about the content of such policies the expectation is that at a minimum the policies include clear objectives and goals and the Regulators note that for smaller firms a proportionate and simpler approach would be appropriate.
- Progression, Development & Targets – The Regulators are keen to facilitate early consideration by firms about the progression of their talent from the time of entry to the top of the organisation. This should include consideration being given to recruitment practices and beyond. Linked to this, the Regulators are keen to get views on the merits of setting targets for under-represented groups for entry into management (whether senior-management or customer-facing roles)
- Training – The Regulators believe that all employees in firms should understand D&I and its importance and that accordingly firms should institute training for employees which is focussed on real business outcomes. The Regulators are cognisant of the mixed views on D&I training and the pros and cons of mandatory (potentially tick the box training) and voluntary training (which may run the risk of poor take up) and is seeking further insights in this area.
- Products and Services – Importantly, the Regulators want firms to focus on consumer outcomes and to take care to ensure that a firm’s target market is not defined in a way that can result in unlawful discrimination. Rules already require firms to ensure fair treatment of vulnerable customers – the Regulators however are seeking views on whether their rules should go further such that product governance requirements should specifically take into account consumers’ protected characteristics or other diversity characteristics.
- Disclosure – Research cited by the Regulators shows that greater disclosure is linked to increased diversity and accordingly they wish to consult on requirements for firms to publicly disclose a selection of aggregated diversity data about the firm’s senior management and employee population as a whole. Disclosure could potentially include pay gap information and the Regulators are also seeking views on whether a template form of disclosure would be beneficial for firms. Again the Regulators are cognisant of not imposing excessively burdensome disclosure requirements and ensuring a proportionate approach.
- D&I Audits – The Regulators consider that diversity audits should be considered to assist firms to measure and monitor D&I and in particular help boards judge whether measures put in place to change culture and thus behaviour are actually working.
- Regulatory Measures – The Regulators consider that non-financial misconduct (which could for example include evidence of sexual harassment, bullying and discrimination) should be embedded into fitness and propriety assessments of senior managers. The Regulators are also keen to understand further how a firm’s appointments at board and senior management level have considered and taken into account how such appointments will contribute to diversity (e.g. in a way that addresses risks arising as a result of lack of diversity and group think).
- Authorisation – Threshold Conditions – Finally, the Regulators are seeking views on whether and to what extent D&I should be embedded into the minimum conditions that a firm must meet to carry on regulated activities (both initially at authorisation stage and on an ongoing basis)
New Specific Proposals for Listed Companies – CP 21/24
Key new annual reporting requirements:
Unlike DP 21/2 which is looking at a broad range of D&I characteristics potentially across the whole population of a firm, the initial focus of the FCA in CP 21/24 is on gender and ethnicity at board and executive management level. Specifically, if the proposals are to be adopted, they will require In-scope Companies to make the following public annual disclosures:
- Targets – A “comply or explain statement” on whether they have achieved certain proposed targets for gender and ethnicity representation on their boards:
- At least 40% of the board are women (including individuals self-identifying as women);
- At least one of the senior board positions[10] is held by a woman (including individuals self-identifying as women); and
- At least one member of the board is from a non-White ethnic minority background.
Ethnic categories – The non-White ethnicity categories are to be based on the UK’s Official National Statistics (ONS) categories – which as readers will immediately appreciate would not appropriately reflect ethnic categories which may be more appropriate for companies either incorporated or based in overseas jurisdictions and where board or senior management teams are composed of persons and/or might more fairly reflect the demographics in such jurisdictions.
Where – The annual disclosure must be set out in the annual report and accounts of the issuer.
Failure to meet the targets – Where In-scope Companies have not met all of the targets, they will need to indicate which targets have not been met and explain the reasons for not meeting the targets.
- Numerical Disclosure – A standardised[11] numerical disclosure across five categories covering the gender and ethnic diversity of a company’s board, key board positions and “executive management team”[12].
- Optional Additional Disclosures – The FCA is also proposing to include guidance that In-scope Companies may in addition to the mandatory disclosures above, wish to include the following in their annual financial reports to provide potentially relevant context:
- Summary of existing key policies, procedures and processes;
- Mitigating factors or circumstances which make achieving diversity on its board more challenging (e.g. size of board or country where main operations are located); and
- Any risks foreseen in continuing to meet the board diversity targets in the next accounting period and/or plans to improve the diversity of its board.
We would recommend that issuers consider taking up the opportunity to provide further disclosure and context (whether or not they have failed to meet targets and/or perceive a risk in so doing) as this additional narrative can also serve to provide a helpful platform for setting out narratives which can support and distinguish an issuer’s efforts to enhance diversity in its board and leadership teams.
Enhancing existing corporate governance disclosure requirements:
In addition to amending the Listing Rules to reflect the above new annual reporting requirements, the FCA is proposing additional specificity and more information to be disclosed by certain issuers[13] who currently are required to publish a corporate governance statement which includes a description of diversity policies which apply to the their administrative, management and supervisory bodies (or, if they do not have one, explain not). The FCA is proposing to expand the disclosure of the diversity policy to cover the following elements:
- Scope – The diversity policy should also apply to a company’s remuneration, audit and nominations committees; and
- D&I Categories – The policy should also cover the following additional diversity elements ethnicity, sexual orientation, disability and socio-economic background.
POINTS OF NOTE ON THE PROPOSALS & SOME PRACTICAL CONSIDERATIONS FOR ORGANISATIONS
- Too much data and the increasing regulatory burden – Following the publication of the Discussion Paper, concern has been expressed and feedback provided to the Regulators on the scope of the D&I factors covered by the paper – the prospect of having to comply with new disclosure requirements across the nine protected characteristics and socio-economic factors would be overwhelming for the financial services sector industry. In addition, there is concern amongst both the financial services and listed company sectors regarding the already significant and growing data sets required and to the extent there is an opportunity to merge data collation requirements and/or to use existing frameworks (e.g. the senior managers or SCMR) as a foundation to develop for example new specific rules on individual accountability for D&I matters, the Regulators should try to do so.
- Overlap between the Proposals – There are overlaps between the proposals in DP 21/2 and CP 21/24 of course to the extent that any of the financial services firms are also In-scope (listed) Companies – the FCA recognises this and the Regulators will need to be cognisant of this when developing proposals for the financial services sector.
- Existing Reporting by In-Scope Companies – On the subject of overlap, there are some In-scope Companies which are already voluntarily reporting D&I data against other voluntary frameworks and will need to start to give consideration now as to whether these should continue and/or how reporting can be most efficiently aligned or integrated with the proposed new reporting requirements.
- Preparatory considerations & data collection challenges – On timing, the FCA’s proposals would as noted above, apply to accounting periods starting on or after 1 January 2022 so that reporting will start to emerge in annual reports published for 2022 on and from Spring 2023. The FCA is even encouraging companies to consider voluntary early disclosures in annual financial reports published before that time! This would potentially be a challenge for companies unless and to the extent that they are already collating the relevant data in the way prescribed by the FCA (including having given appropriate consideration as to who would fall within their “executive management” for these reporting purposes). To meet the official reporting timing, companies should already start actively considering how to collate the relevant information envisaged by the FCA. There are a number of “tricky” (potentially newer) elements in the proposals including gender data which covers persons self-identifying as women.
- Data Privacy – We understood the Regulators’ general stance on the importance of data collation in driving efforts on D&I. including allowing for comparisons to be made across companies and sectors (and monitoring progress against targets). However, the key crucial issue which has been flagged by market participants and advisers providing feedback on both sets of proposals is the issue of data privacy. Whilst the Proposals make touching reference to compliance with data privacy requirements, there does not appear to have been an adequate assessment or analysis of how the Proposals (in particular in CP 21/24) potentially cut across data privacy requirements (including but not limited to General Data Protection Regulations (“GDPR”). As we have seen, the Proposals place or consider placing obligations on companies to collect data and personal data revealing race, ethnicity, sexuality or disabilities background or concerning ”special categories of personal data” under the GDPR (which are subject to additional restrictions). We note there are provisions within the GDPR that allow processing of special category personal data for equality of opportunity monitoring purposes, however, this is something that will need to be carefully managed to ensure no data remains personally identifiable. Further, for the proposals to work in practice companies will need the support of employees themselves who will need to be willing to provide their personal information, which to some may be deemed sensitive.
- Modest targets … not quotas – We note that the proposed board diversity targets referred to in CP 21/24 reflect what is currently expected of FTSE 350 companies, on a voluntary basis, by virtue of the Hampton- Alexander and Parker[14] review reports, save that the FCA has increased the women on boards target from 33% to 40% and some consider that a more stretching target could have been imposed. Additionally, it is worth noting, that it is not envisaged by the consultation paper that the proposed Listing Rule targets become mandatory quotas, but instead the FCA makes it clear (assuaging any concerns that some issuers may have) that is seeking to provide a positive benchmark for firms to aim towards.
MIS-STEPS? – WHAT DO WE THINK ABOUT THE PROPOSALS?
We note that DP 21/2 is broad and sweeping in nature and makes reference to all protected characteristics under the Equality Act as an attempt to consider diversity & inclusion as a whole rather than focusing on any specific area of underrepresentation. Whilst the ambition is noteworthy, If the intention is to address a broad range of D&I, some market participants would be in favour of a qualitative, in-depth approach over a more modest range of criteria, mindful of overlaps and multiple data requests that firms are facing.
Conversely, CP 21/24, whilst making positive steps in its focus on gender and ethnicity does not cover all aspects of diversity & inclusion including some other key areas including disability and socio-economic background which some market participants view as a missed opportunity. A more ambitious set of proposals giving companies a longer lead time to start to consider, embed and eventually report on a slightly broader data set merited consideration by the FCA.
Finally, we note that neither of the papers have tackled the question of intersectionality[15] nor how the Proposals or development of new rules pursuant to the discussion paper would adequately address this. For example, the new and/or enhanced corporate governance disclosures could have specifically required companies to include disclosures on the extent to which they have identified and are addressing issues of intersectionality.
A QUICK LOOK ACROSS THE SEAS – GLOBAL COMPARISONS
The publication of papers with a focus on D&I is not unique to the UK or the UK Regulators, this is a current hot topic with regulators around the globe keen to ensure representation across companies to reflect all elements of diversity & inclusion. For example:
- In Hong Kong, the Stock Exchange of Hong Kong Limited published a consultation paper on its Corporate Governance Code and Listing Rules in April 2021 which considered gender diversity on boards;
- In April 2021, the Financial Services Agency in Japan published a consultation on proposals to revise its Corporate Governance Code to require companies to disclose a policy and voluntary measurable targets in respect of promoting diversity in senior management by appointing females, non-Japanese and mid-career professionals;
- In Australia, diversity and inclusion on boards’ obligations are set through the Corporate Governance Principles applicable to companies listed on the Australian Securities Exchange. Principle One, which applies to listed entities from financial years commencing on or after 1 January 2020, requires the entity to “lay solid foundations for management and oversight”. It includes the recommendation that the board sets “measurable objectives for achieving gender diversity in the composition of the board, senior executives and workforce generally”; and
- In Singapore, the Ministry of Social and Family Development has established the Council for Board Diversity to promote a sustained increase in the number of women on boards of listed companies, statutory boards and non-profit organisations. The Council has set a target for the 100 largest listed companies of 20% women on boards.
CONCLUSIONS
Whilst no formal changes have yet to be put into effect in the UK, it is clear to see through the publication of both CP 21/24 and DP 21/2, that the Regulators and the FCA are determined to follow and, potentially in a number of respects, lead the global momentum to drive enhancement of diversity & inclusion in business and this is welcome. As the detailed proposals are crystallised and finalised, we will continue to review whether some of the possible unintended consequences (particularly around possible compromises on data privacy) are identified and addressed and if a proportionate set of measures are rolled out across the financial services and listed company sectors.
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[1] The FCA regulates part of the financial services industry in the UK. Its role includes protecting consumers, keeping the industry stable, and promoting healthy competition between financial service providers. The FCA the conduct regulator for around 51,000 financial services firms and financial markets and the prudential supervisor for 49,000 firms, setting specific regulatory standards for around 18,000 firms.
[2] The PRA is the prudential regulator of around 1,500 financial institutions in the UK comprising banks, building societies, credit unions, insurance companies and major investment firms.
[3] The Bank of England’s input to the discussion paper is in its capacity of supervising financial market infrastructure firms (FMI).
[4] DP 21/2
[5] CP 21/24
[6] A new set of compliance regulations introduced in the UK to reduce harm to consumers and strengthen financial market integrity by making firms and individuals at those firms more accountable for their conduct and competence. The rules were rolled out across different parts of the UK financial services sector from 2016 and apply to a range of firms in a proportionate manner depending on size and business type, including banks, insurers, FCA-solo regulated firms, PRA-designated investment firms and deposit takers.
[7] Research quoted DP 21/2 notes that gender is the most commonly collected data with some firms now also collecting and mapping data across the lifecycle of employees. More sophisticated firms are also now starting to collect data on ethnicity.
[8] These are age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion or belief, sex and sexual orientation.
[9] Prescribed Responsibilities (PR) (I) and (H).
[10] i.e. Chair, Chief Executive Officer (CEO), Senior Independent Director (SID) or Chief Financial Officer (CFO).
[11] A reporting template (in tabular form) has been proposed and is laid out in the discussion paper.
[12] The Listing Rules would be amended to include a new definition of executive management – “executive committee or most senior executive or managerial body below the board (or where there is no such formal committee or body, the most senior level of managers reporting to the chief executive) including the company secretary but excluding administrative and support staff”. We note that whilst there is merit in including the company secretary, this role would not normally carry executive responsibilities, hence different terminology e.g. “management” may be a more accurate and representative definition.
[13] This obligation is set out in the Disclosure and Transparency Rules (DTR) of the FCA’s Handbook and the relevant DTR applies to certain UK and overseas issuers admitted to UK regulated markets but exempts small and medium issuers.
[14] Hampton-Alexander Review: FTSE women leaders – initial report and Hampton-Alexander Review: FTSE women leaders – Improving gender balance – 5 year summary report – February 2021.
[15] The concept of intersectionalism is credited to Kimberlé Crenshaw, a legal scholar at Columbia University. The term is used today more broadly to refer to any individuals with multiple self-identities. Specifically, intersectionalism in the workplace does not refer only to the factors of a person’s identity. It is a concept that recognizes the multiple identity factors and how they influence privilege and marginalization, power and influence, emotional impact, and individual and intersecting behaviour (Source: DiversityCan).
This alert has been prepared by Selina Sagayam and Shannon Pepper.
Ms. Sagayam, a corporate partner in the London office of Gibson Dunn, co-chairs Gibson Dunn’s global ESG Practice, is a member of its Global Diversity Committee and chairs its London Diversity Talent & Inclusion Committee.
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) practice, or the following in London:
Selina S. Sagayam – International Corporate Group (+44 (0) 20 7071 4263, [email protected])
James A. Cox – Labour & Employment Group (+44 (0) 20 7071 4250, [email protected])
Michelle M. Kirschner – Global Financial Regulatory Group (+44 (0) 20 7071 4212, [email protected])
Please also feel free to contact the following practice leaders:
Environmental, Social and Governance (ESG) Practice:
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])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Summary
- On 22 October, 2021, Executive Vice President Margrethe Vestager delivered a speech in which she stated for the first time that the European Commission (Commission) is going to expand its cartel enforcement to labor markets, including no-poach and wage-setting agreements.
- The U.S. authorities have already been active in pursuing naked no-poach and other labor market agreements, but to date the Commission has not taken any enforcement action in this area.
- The Commissioner’s statement signals a new enforcement priority and companies should prepare. We recommend that companies review their recruitment policies and HR practices in the EU to identify and remediate potential competition law risks.
- Companies should also expand compliance programs to include anticompetitive conduct in labor markets and ensure human resources personnel are receiving competition law training on a regular basis.
Background
The EU turns its attention to labor market agreements
On 22 October, Margrethe Vestager, the Commission’s Competition Commissioner and Executive Vice President, delivered a speech in which she signaled a new area of cartel enforcement for the Commission: anticompetitive labor market agreements.[1] Vestager highlighted wage-fixing and no-poach agreements as two examples of labor market agreements that could create a cartel. Under a no-poach agreement, companies mutually commit not to recruit and/or hire one another’s workers, or at least certain types of workers. Vestager argued that such arrangements can depress salaries, but she cautioned that labor market agreements could be seen as a broader threat to innovation and market entry. She explicitly shared her belief that labor market agreements can “restrict talent from moving where it serves the economy best” and can “effectively be a promise not to innovate.”
While the Commission has historically not focused its enforcement efforts on labor market arrangements such as naked no-poach agreements, Vestager’s speech is an indication that change is coming in the near future. This is part of a broader action plan with respect to EU cartel enforcement, which has historically given rise to high fines. Companies should be taking steps now to ensure they are prepared.
EU labor market interest follows growing international momentum
Vestager’s interest in labor market cartel enforcement is consistent with the growing enforcement efforts in several other jurisdictions. In 2016, the U.S. became the first jurisdiction to announce that it would treat labor market agreements as a criminal cartel matter.[2] In the subsequent five years, the U.S. Department of Justice (“DOJ”) has pursued numerous criminal investigations into potential wage-fixing, no-poach, and non-solicitation agreements. However, these investigations have only recently led to the first criminal charges, and the DOJ is now preparing for a series of criminal trials in 2022 that will test whether courts agree that such labor market agreements can amount to a cartel.
- Healthcare Providers: In 2021, the DOJ indicted two healthcare providers and a former CEO for their alleged participation in non-solicitation agreements. The DOJ charged both companies and the executive with agreeing not to solicit certain “senior-level employees” from one another. Additionally, the DOJ charged one of the companies and its former CEO with entering a separate agreement in which an unidentified healthcare company agreed not to solicit its employees—without any reciprocal commitment from the other company. Both companies and the executive have filed motions to dismiss the charges, arguing that such labor market agreements should not be treated as a criminal matter under U.S. law and that imposing criminal liability in the absence of judicial precedent would violate due process. The trial courts will first rule on these threshold legal issues and, if the DOJ prevails, the cases are scheduled for trial in March and May 2022, respectively.
- Physical Therapists: Neeraj Jindal and John Rodgers were charged in December 2020 and April 2021, respectively, as part of the DOJ’s first criminal wage-fixing case. Both individuals are alleged to have participated in a conspiracy among companies in northern Texas to lower rates paid to in-home physical therapists. Jindal and Rodgers are also charged with obstruction of justice for their actions during an earlier investigation into the same conduct by the U.S. Federal Trade Commission. The case is currently scheduled for trial in April 2022.
- School Nurses: The DOJ secured criminal charges against VDA OC and its regional manager, Ryan Hee, for participating in a conspiracy to fix wages and restrain their recruitment efforts for school nurses in Las Vegas, Nevada. During a ten-month period that began in October 2016, VDA OC and Hee allegedly agreed with a competitor not to solicit or hire each other’s nurses and to resist nurses’ efforts to increase wages. The case is currently scheduled for trial in late February 2022.
In Europe, the Portuguese Competition Authority moved to the forefront on labor market enforcement earlier this year. On April 13, the Portuguese Competition Authority announced a statement of objections against the Portuguese Professional Football League and 31 of its teams for an alleged agreement not to hire any player who terminated his agreement with another team for reasons related to the pandemic.[3] More importantly, the Portuguese authority used the case as an opportunity to outline its enforcement policies for labor market conduct. The authority released a policy paper on labor market enforcement[4] and published a Good Practice Guide entitled “Prevention of Anticompetitive Agreements in the Labor Market,” which sets out the various ways labor market agreements might be viewed as anticompetitive.[5]
Companies should prepare for a new era of labor market enforcement
Vestager’s comments suggest that the Commission is turning its enforcement efforts to labor markets. Companies should therefore be taking steps now to ensure they are identifying potential risks and working to remediate them before an investigation occurs.
As a starting point, companies should review their recruitment practices in the EU to determine whether their HR teams avoid recruiting or hiring from specific companies. In many instances, these restraints can be identified quickly in communications with external recruiters in which they receive instructions about the company’s specific hiring needs. Any such hiring restraint should be assessed to ensure it is permissible in its specific context. Any hiring restrictions agreed upon between companies or among members of a trade association that are unrelated to a legitimate commercial relationship are particularly high risk.
Companies would also benefit from reviewing their processes for setting employees’ compensation and benefits. Each company should be competing independently in setting its package of cash compensation (e.g., salaries, hourly wages, bonuses) and non-cash benefits (e.g., insurance, vacation and family policies). Any agreements or informal understandings with another company about the amount of compensation or the types of benefits that will be offered should be immediately discussed with legal counsel. Additionally, companies should be cautious about directly exchanging HR-related information with other companies in an effort to benchmark their compensation practices.
Companies should also expand the scope of their antitrust compliance programs, which have historically been focused on sales and marketing personnel and senior executives. As antitrust enforcers move into labor markets, compliance programs should be extended to human resources personnel and any other employees involved in recruiting. The programs themselves must also be updated to ensure the company’s competition law policy addresses labor market risks, competition training materials reflect labor market conduct, and employees have pathways to internally report suspected competition violations.
In the event that companies do encounter a potential antitrust breach, they should immediately seek legal counsel. The European Commission operates a leniency program that encourages companies to self-report a suspected cartel in exchange for full immunity (for the first company to report the breach). If other companies involved in the cartel can provide evidence of “significant added value,” they will be eligible for a fine reduction (between 30% to 50% for the first company, 20% to 30% for the second, and up to 20% thereafter).
Conclusion
Executive Vice-President Vestager’s statement is a clear signal that the Commission is shifting its attention to anticompetitive labor market conduct, such as wage-fixing and no-poach agreements. To prepare, companies must promptly review their HR-related practices to ensure they address any existing conduct that creates competition law risks and educate their HR employees to minimize the risk of a future infringement.
Gibson Dunn will be hosting a Webcast in November to discuss labor market enforcement in the U.S. and other jurisdictions, including the EU, as well as practical steps that companies should be taking to minimize HR-related competition law risks. Invitations to join the Webcast will follow shortly.
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[1] Margrethe Vestager, A new era of cartel enforcement, Speech at the Italian Antitrust Association Annual Conference (Oct. 22, 2021), available at https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/speech-evp-m-vestager-italian-antitrust-association-annual-conference-new-era-cartel-enforcement_en.
[2] U.S. Dep’t of Justice & Fed. Trade Comm’n, Antitrust Guidance for Human Resources Professionals (October 2016), https://www.justice.gov/atr/file/903511/download.
[3] Autoridade da Concorréncia, AdC issues Statements of Objections for anticompetitive agreement in the labour market for the first time (Apr. 18, 2021), https://www.concorrencia.pt/en/articles/adc-issues-statements-objections-anticompetitive-agreement-labour-market-first-time.
[4] Autoridade da Concorréncia, Acordos no Mercado de trabalho e política de concorréncia (Apr. 2021), here.
[5] Autoridade da Concorréncia, Guia De Boas Práticas: Prevenção De Acordos Anticoncorrenciais Nos Mercados De Trabalho (Apr. 2021), here.
The following Gibson Dunn lawyers prepared this client alert: Scott Hammond, Jeremy Robison, Christian Riis-Madsen, Stéphane Frank, Katie Nobbs, and Sarah Akhtar.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Antitrust and Competition or Labor and Employment practice groups:
Antitrust and Competition Group:
Brussels
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 72 10, [email protected])
Stéphane Frank (+32 2 554 72 07, [email protected])
Alejandro Guerrero (+32 2 554 72 18, [email protected])
Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])
Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])
London
Ali Nikpay (+44 20 7071 4273, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])
United States
Scott D. Hammond – Washington, D.C. (+1 202-887-3684, [email protected])
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Jeremy Robison – Washington, D.C. (+1 202-955-8518, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Caeli A. Higney – San Francisco (+1 415-393-8248, [email protected])
Veronica S. Lewis – Dallas (+1 214-698-3320, [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])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On October 25, 2021, the Equal Employment Opportunity Commission (“EEOC”) expanded its guidance on religious exemptions to employer vaccine mandates under Title VII of the Civil Rights Act of 1964 (“Guidance”). This Guidance describes in greater detail the framework under which the EEOC advises employers to resolve religious accommodation requests.
The EEOC emphasizes that whether an employee is entitled to a religious accommodation is an individualized determination to be made in light of the “particular facts of each situation.” Guidance at L.3. The agency also was careful to note that the Guidance is specific to employers’ obligations under Title VII and does not address rights and responsibilities under the Religious Freedom Restoration Act or state laws that impose a higher standard for “undue hardship” than Title VII.
The EEOC provided its views on the following questions.
Who makes a religious accommodation request, and what form must it take?
- Only sincerely held religious beliefs, practices, or observances qualify for accommodation. Id. at L.1.
- A religious accommodation request need not use “magic words,” but it must communicate to the employer that there is a conflict between the employee’s religious beliefs and a workplace COVID-19 vaccination requirement. Id.
- The EEOC encourages employers to create processes and/or designate particular employees to handle such religious accommodations requests. Id. Employers also should provide employees and applicants with information about whom to contact, and the procedures to follow, to request a religious accommodation, the EEOC advises.
May an employer ask an employee for more information regarding a religious accommodation request?
Yes. An employer may ask for an explanation of how an employee’s religious beliefs conflict with a COVID-19 vaccination requirement. Id. at L.2. Furthermore, an employer may make a “limited factual inquiry” if there is an objective basis for questioning either: (1) the religious nature of the employee’s belief; or (2) the sincerity of an employee’s stated beliefs. Id.
- The religious nature of the employee’s belief. Employers are not prohibited from inquiring whether a belief is religious in nature, or based on unprotected “social, political, or economic views, or personal preferences.” Id. However, the EEOC cautions employers that even unfamiliar or nontraditional beliefs are protected under Title VII. Id.
- The sincerity of an employee’s stated beliefs. The EEOC explains that “[t]he sincerity of an employee’s stated religious beliefs … is not usually in dispute,” but provides factors that may “undermine an employee’s credibility.” Id. These factors are:
- actions the employee has taken that are inconsistent with the employee’s professed belief;
- whether the accommodation may have a non-religious benefit that is “particularly desirable”;
- the timing of the request; and
- any other reasons to believe the accommodation is not sought for religious reasons. Id.
No single factor is determinative. Id. The EEOC cautions that religious beliefs “may change over time,” “employees need not be scrupulous in their [religious] observance,” and “newly adopted or inconsistently observed practices may nevertheless be sincerely held.” Id.
What is an undue hardship under Title VII?
The Supreme Court has held that an employer is not required to provide an accommodation if the accommodation would impose more than a de minimis cost. Id. at L.3. The Guidance takes an expansive view of what types of costs might justify denying an accommodation. The EEOC suggests that such costs may include:
- “[D]irect monetary costs”;
- “[T]he burden on the conduct of the employer’s business—including, in this instance, the risk of spread of COVID-19 to the public”;
- Diminished efficiency in other jobs;
- Impairments to workplace safety; and
- Causing coworkers to take on the accommodated employee’s “share of potentially hazardous or burdensome work.” Id.
Furthermore, an employer “may take into account the cumulative cost or burden of granting accommodations to other employees,” but may not rely on the “mere assumption” that “more employees might seek religious accommodation” with respect to a vaccine requirement. Id. at L.4. Likewise, an employer cannot rely on “speculative hardships” to deny an accommodation, according to the EEOC, but must rely “on objective information,” considering factors such as whether the employee making the request works indoors or outdoors, in a solitary or group setting, or has close contact with others, especially “medically vulnerable individuals.”
If an employer grants one religious accommodation request from a COVID-19 vaccination requirement, must it grant all religious accommodation requests?
No. Religious accommodation determinations are individualized in nature and must focus on a specific employee’s request and whether accommodating the specific employee would impose an undue hardship. Id. When assessing whether granting an exemption would impair workplace safety, the EEOC advises considering, among other factors, the number of employees who are fully vaccinated, physically enter the workplace, and will need a particular accommodation.
Must an employer provide a requesting employee’s preferred religious accommodation?
No. An employer may choose any reasonable accommodation that would “resolve the conflict” between the a vaccination requirement and an employee’s sincerely held religious belief, though it “should consider the employee’s preference.” Id. at L.5. If an employer does not choose an employee’s preferred accommodation, it should explain to the employee why that accommodation is not granted. Id.
Can an employer discontinue a previously granted religious accommodation?
Yes. An employer may be able to discontinue an accommodation if the accommodation is no longer used for religious purposes or the accommodation subsequently imposes more than a de minimis cost. Id. at L.6. Employers also should be aware that an employee’s “religious beliefs and practices may evolve or change over time and may result in requests for additional or different religious accommodations.”
Questions the EEOC did not address include what steps large employers faced with tens of thousands of reasonable accommodation requests must take to satisfy the individualized-determination requirement; what may constitute reasonable accommodations for employees entitled to exemptions, particularly when community transmission is high; and how employers can comply with recordkeeping and privacy concerns under state and federal statutes, including how to receive and store employee vaccine and testing records.
The following Gibson Dunn attorneys assisted in preparing this client update: Eugene Scalia, Katherine V.A. Smith, Jason C. Schwartz, Jessica Brown, Andrew G. I. Kilberg, Zoë Klein, Chad C. Squitieri, Hannah Regan-Smith, and Kate Googins.
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, or any of the following in the firm’s Administrative Law and Regulatory or Labor and Employment practice groups.
Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8543, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [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])
© 2021 Gibson, Dunn & Crutcher LLP
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On October 13, 2021, the Securities and Exchange Commission (the “SEC”) adopted amendments to modernize filing fee disclosure for certain forms and schedules, as well as update payment methods for fees related to these filings. The final rule highlighted three primary goals of the amendments: (i) update disclosure requirements related to filing fees in order to provide more certainty to filers that the proper fee was calculated and facilitate the SEC staff’s review of such fee; (ii) modernize the payment method for filing fees and reduce the cost and burden on processing fee payments; and (iii) permit filers to reallocate previously paid filing fees in more situations than what was previously permitted. An overview of these changes is provided below. The amendments also contained certain technical, conforming and clarifying changes related to filing fee-related instructions and information.
The amendments will become effective January 21, 2022, with the changes to fee payment methods becoming effective May 31, 2022. The requirements for filing fee disclosures will be phased in over time as summarized below.
The following Gibson Dunn attorneys assisted in preparing this update: Ronald Mueller, Andrew Fabens, Peter Wardle, and James Moloney.
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Second of four industry-specific programs
The False Claims Act (FCA) is one of the most powerful tools in the government’s arsenal to combat fraud, waste, and abuse involving government funds. After several years of statements and guidance indicating that the Department of Justice (DOJ) might alter its approach to FCA enforcement, the Biden Administration appears to be taking a different, more aggressive approach. Meanwhile, newly filed FCA cases remain at historical peak levels, and the government has recovered nearly $3 billion or more annually under the FCA for a decade. The government also continues to pursue new, large spending projects in COVID-related stimulus and infrastructure—which may bring yet more vigorous efforts by DOJ to pursue fraud, waste, and abuse in government spending. As much as ever, any company that receives government funds—especially in the government contracting sector—needs to understand how the government and private whistleblowers alike are wielding the FCA, and how they can defend themselves.
Please join us to discuss developments in the FCA, including:
- The latest trends in FCA enforcement actions and associated litigation affecting government contractors;
- Updates on the Biden Administration’s approach to FCA enforcement, including developments impacting DOJ’s use of its statutory dismissal authority;
- New proposed amendments to the FCA introduced by Senator Grassley; and
- The latest trends in FCA jurisprudence, including developments in particular FCA legal theories affecting your industry and the continued evolution of how lower courts are interpreting the Supreme Court’s Escobar decision.
View Slides (PDF)
PANELISTS:
Jonathan M. Phillips is a partner in the Washington, D.C. office where he is co-chair of the False Claims Act/Qui Tam Defense practice. Mr. Phillips focuses on compliance, enforcement, and litigation in the government contracting and health care fields, as well as other white collar enforcement matters and related litigation. A former Trial Attorney in DOJ’s Civil Fraud section, he has particular experience representing clients in enforcement actions by the DOJ, Department of Health and Human Services, and Department of Defense brought under the False Claims Act and related statutes.
Nicola Hanna is a partner in the Los Angeles office and co-chair of the firm’s global White Collar Defense and Investigations practice. Mr. Hanna previously served as the presidentially appointed and Senate-confirmed United States Attorney for the Central District of California for three years. In this role, he was the chief federal law enforcement officer for the Los Angeles-based district, the largest Department of Justice office outside of Washington, D.C., and oversaw approximately 280 Assistant U.S. Attorneys. Under his leadership, the Central District brought and litigated some of the most impactful cases in the country and recovered nearly $4.5 billion in criminal penalties, civil recoveries, forfeited assets, and restitution. During his tenure as U.S. Attorney, Mr. Hanna served as the Chair of the Attorney General’s Advisory Committee’s White Collar Fraud Subcommittee. He also was a member of the Department of Justice Corporate Enforcement and Accountability Working Group, and one of two U.S. Attorneys on the Task Force on Market Integrity and Consumer Fraud chaired by the Deputy Attorney General.
James Zelenay is a partner in the Los Angeles office where he practices in the firm’s Litigation Department. He is experienced in defending clients involved in white collar investigations, assisting clients in responding to government subpoenas, and in government civil fraud litigation. He also has substantial experience with the federal and state False Claims Acts and whistleblower litigation, in which he has represented a breadth of industries and clients, and has written extensively on the False Claims Act.
Lindsay Paulin is an associate in the Washington, D.C. office. Her practice focuses on a wide range of government contracts issues, including internal investigations, claims preparation and litigation, bid protests, and government investigations under the False Claims Act. Ms. Paulin’s clients include contractors and their subcontractors, vendors, and suppliers across a range of industries including aerospace and defense, information technology, professional services, private equity, and insurance.
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 1.5 credit hours, of which 1.5 credit hours 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 1.5 hours.
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.
RELATED WEBCASTS IN THIS SERIES:
- The False Claims Act – 2021 Update for Financial Services (October 6, 2021)
- The False Claims Act – 2021 Update for Drug & Device Manufacturers (October 20, 2021)
- The False Claims Act – 2021 Update for Health Care Providers (October 26, 2021)
On this episode of the podcast, Gibson Dunn’s Ted Olson and Ted Boutrous discuss the firm’s work on behalf of “Dreamers,” beneficiaries of the Deferred Action for Childhood Arrivals (“DACA”) program, in multiple high-stakes court cases. Learn more about the strategies and the personal stakes at play during these important cases.
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HOSTS:
Ted Boutrous – Theodore J. Boutrous, Jr., a partner in the Los Angeles office of Gibson, Dunn & Crutcher LLP, is global Co-Chair of the firm’s Litigation Group and previously led the firm’s Appellate, Crisis Management, Transnational Litigation and Media groups. He also is a member of the firm’s Executive and Management Committees. Recognized for a decade of excellence in the legal profession, the Daily Journal in 2021 named Mr. Boutrous as a Top Lawyer of the Decade for his victories. As a tireless advocate and leader for high-stakes and high-profile cases, Mr. Boutrous was also named the 2019 “Litigator of the Year, Grand Prize Winner” by The American Lawyer.
Ted Olson – Theodore B. Olson is a Partner in Gibson, Dunn & Crutcher’s Washington, D.C. office; a founder of the Firm’s Crisis Management, Sports Law, and Appellate and Constitutional Law Practice Groups. Mr. Olson was Solicitor General of the United States during the period 2001-2004. From 1981-1984, he was Assistant Attorney General in charge of the Office of Legal Counsel in the U.S. Department of Justice. Except for those two intervals, he has been a lawyer with Gibson, Dunn & Crutcher in Los Angeles and Washington, D.C. since 1965.
From October 11 to 15, 2021, the most significant global biodiversity summit in over a decade convenes in Kunming, China. The Kunming conference marks the 15th meeting of the Conference of the Parties (COP15) to the United Nations Convention on Biological Diversity (CBD), and aspires to do for biodiversity what the Paris Agreement did for climate change—namely, producing a landmark multinational accord to address one of the most pressing ecological and economic issues of our time.
COP15 is anticipated to finalize a Post-2020 Global Biodiversity Framework, outlining what countries need to do going forward, individually and collectively, to align humanity’s trajectory with CBD’s overall vision of “living in harmony with nature” by 2050. The world has continued veering off-course to date, failing to meet any of the 20 Aichi biodiversity targets[i] which CBD set in 2010.
However, optimists will observe that the goals proposed in the draft Post-2020 Framework[ii] are more outcome-oriented than CBD’s previous goals, buttressed by targeted, time-bound measures to address the drivers of biodiversity loss. The draft goals are as ambitious as they are potentially far-reaching, including proposals to conserve 30% of the world’s oceans and land by 2030, reduce pollution from pesticides, plastic waste, and nutrient excess by 50% by 2030, support integration of biodiversity-related information into business reporting, and promote the sustainable harvest of wild species.
Addressing biodiversity loss is by no means viewed solely as a responsibility of nation-states and governments. Corporations are increasingly under pressure from investors, the communities in which they operate, and other stakeholders to address biodiversity loss and account for their biodiversity impacts. In this alert, we discuss the significance of global action on biodiversity, and also provide a landscape overview of the modern regulatory developments (with our initial focus on Europe and the United States) and voluntary disclosure frameworks, reporting standards, initiatives, and performance assessment tools that are reshaping how the business community views, discloses, and addresses biodiversity risk.
- The Import of COP15 and Biodiversity
Biodiversity – Why it is so important – A quick recap: Encompassing the variety of life, ecosystems, and species on Earth and the natural patterns they form,[iii] biodiversity is critical to the quality and function of the ecosystem services that society derives from nature. The World Economic Forum estimated that more than half the world’s GDP (around US$44 trillion) is moderately or highly dependent on these services, and accordingly found that biodiversity loss is among the existential threats facing society today, in terms of both impact and likelihood.[iv]
Scientists have warned that human activity is currently driving a sixth mass extinction of life on Earth.[v] Such biodiversity loss and consequent damage to ecosystems could drain nearly US$10 trillion from the global economy by 2050[vi], with the deterioration of crop yields, buffers against the physical effects of climate change, soil and water quality, and other biodiversity-related forms of natural capital depreciation translating into lower productivity, supply chain disruptions, higher raw material costs, social instability, and other negative ramifications for many businesses.
The IPCCC Report: The recently published[vii] Sixth Assessment Report by the Intergovernmental Panel on Climate Change (IPCCC) stresses that climate change, disaster risk, economic development, biodiversity conservation, and human well-being are tightly interconnected. Biodiversity loss has nevertheless been overshadowed, somewhat understandably, by the threat of climate change. But as data collection methods, metrics, and technologies used to identify and evaluate both biodiversity degradation and the value of natural capital have advanced, so too has the business community—investors, businesses, lenders, credit agencies, and ESG raters alike—awakened to the reality that biodiversity loss is a serious systemic economic risk in its own right.[viii]
Perhaps more significantly, biodiversity risk is also climbing up the agenda of global regulators and supervisors.
- Modern Regulatory Action on Biodiversity
Should COP15 produce a Paris Agreement analogue for biodiversity, we expect an increase in momentum behind the introduction of next generation regulations requiring businesses to disclose, diligence, and/or mitigate their risks relating to and impacts on biodiversity, paralleled by an increase in shareholder/stakeholder pressure of equal measure.
Global Finance: The Network for Greening the Financial System (NGFS), a group of central banks and financial supervisors, published an interim report[ix] jointly with INSPIRE (the International Network for Sustainable Financial Policy Insights, Research and Exchange) on Biodiversity and Financial Stability on October 8, 2021. The report highlights growing evidence that biodiversity loss could have significant economic and financial implications and recommends that central banks and financial supervisors undertake a series of measures to upskill in the area, develop methodologies to capture the risks of impacts, and importantly, start to take actions in relation to the financial institutions they supervise, including encouraging institutions to seek information from borrowers on biodiversity plans, exposures, and performance. Whilst it may take time for some of the specific recommended actions of the NGFS to filter through to financial institutions, other more immediately applicable regulations impacting the investment management industry and larger corporations have already surfaced.
European Union: The biodiversity ball has been rolling at some pace in Europe. This past summer, the European Union (EU) approved a report concluding that a new EU biodiversity governance framework is needed to set enforceable biodiversity protection targets and support the formation of Europe-specific biodiversity reporting rules (EU Biodiversity Strategy for 2030).[x] In addition, the EU is set to propose and adopt further technical screening criteria[xi] for environmental objectives, including biodiversity, under its Taxonomy Regulation (EU Taxonomy) by December 2021 and the first half of 2022, respectively.
This “Green Taxonomy” is, in part, designed to enable the designation of company activities as either sustainable or unsustainable based on whether a company’s activities meet to-be-determined “substantial contribution” and “do no significant harm” criteria with respect to biodiversity. Consequently, companies required to report sustainability information under the EU’s existing Non-Financial Reporting Directive (NFRD) or the proposed Corporate Sustainability Reporting Directive—which would expand upon the NFRD’s biodiversity disclosure mandates and scope of applicability—will also have to disclose the share of their activities that are aligned with the EU Taxonomy’s biodiversity protection criteria. Similarly, in connection with the EU’s recently enacted Sustainable Finance Disclosure Regulation (SFDR), “financial market participants” will need to determine and disclose whether their economic activities, if linked to financial products offered as sustainable, qualify as taxonomy-aligned with respect to biodiversity.
European countries (including the UK): Further, on an individual basis, France[xii] and the Netherlands[xiii] have promulgated non-financial reporting laws for businesses and/or investors which require the consideration and/or disclosure of biodiversity impacts, with the United Kingdom (UK) appearing poised to follow suit. Biodiversity-related funds and initiatives[xiv], as well as legislation for the adoption of biodiversity net-gain principles for new significant infrastructure[xv], have gained considerable traction since the publication of the findings of the watershed “Dasgupta Review” of the economics of biodiversity.[xvi] In particular, the Dasgupta Review argues that institutional change is required (particularly in finance) such that (i) financial institutions and businesses are required to report on their dependencies and impacts on nature, and (ii) investors are provided with credible, decision-grade data based on measurement and disclosure of both climate- and nature-related financial risks.
Separately, the UK has announced plans to mandate the adoption of the Taskforce on Climate-related Financial Disclosures (TCFD) across the major segments of the UK economy by 2025. Changes have already been implemented to the UK Listing Rules introducing a requirement for all UK premium listed companies to comply with the TCFD recommendations and disclose how they are considering the impacts of climate change, and on a comply or explain basis report against the TCFD framework. Consultations also recently closed on extending these requirements to issuers of standard listed equity shares, certain regulated firms, and certain large UK registered companies and LLPs, with rules expected to come into force in 2022.[xvii] Whilst the efforts to mandate the TCFD across the UK are to be lauded, the TCFD in and of itself touches but does not adequately cover biodiversity loss. Certain aspects of the TCFD, including categories of physical and transition risk, are relevant to biodiversity loss, but there is a clear need for a distinct framework designed to focus on nature-related financial risks and incorporate the concept of natural capital (see 3 below for recent developments involving the Taskforce on Nature-related Financial Disclosures).
United States: The United States Securities Exchange Commission (SEC) is expected to propose similar climate disclosure rules, or updated disclosure guidance, this month, and its request for public comment on its potential rulemaking has elicited calls for separate mandatory biodiversity risk disclosures.[xviii] The advent of such disclosures cannot be ruled out during the Biden Administration, which signaled its interest in preserving biodiversity when setting a target to conserve 30% of the nation’s land and water by 2030.
In the meantime, voluntary disclosure frameworks, reporting standards, initiatives, and performance assessment tools addressing biodiversity risk are proliferating, providing inspiration and bases for nascent biodiversity regulations, supporting compliance with existing rules, and gradually equipping investors with much needed data to facilitate effective engagement and stewardship on biodiversity loss issues.
- Voluntary Biodiversity Disclosure Frameworks, Reporting Standards, Initiatives, and Performance Assessment Tools
Disclosure Frameworks and Reporting Standards
Existing Standards & Frameworks – How Biodiversity Loss is Incorporated: A number of voluntary disclosure frameworks and reporting standards addressing businesses’ biodiversity risks and impacts have been developed to date. Sustainability reporting standard No. 304 of the Global Reporting Initiative, for example, directs companies to report on their significant biodiversity impacts, how they manage such impacts, and the habitats they have protected and restored.[xix] CDP (formerly the Carbon Disclosure Project) has also begun incorporating biodiversity-focused questions into its business questionnaires, to date adding questions on biodiversity impacts, risks and/or opportunities to its forests questionnaires for the metals and mining and coal sectors. More recently, the Climate Disclosure Standards Board (CDSB) closed public consultation on its nascent biodiversity application guidance,[xx] which will support companies in reporting material land use and biodiversity-related information through the CDSB disclosure framework. The new guidance will focus on the first six reporting elements of the CDSB framework, including the topics of governance, management’s environmental policies, strategies and targets, risks and opportunities, and sources of impact.
New Initiative – Taskforce on Nature-related Financial Disclosures: The disclosure framework that has received the most attention from observers, however, is not expected to be finalized until 2023. The recently-formed Taskforce on Nature-related Financial Disclosures (TNFD) is developing a framework specifically for nature-related disclosures, modelled on its climate-focused cousin, the TCFD. On October 6, 2021, in the run-up to COP15, the TNFD officially kicked-off their work on developing the TNFD framework.[xxi] Accordingly, the TNFD’s recommendations are expected to focus on company disclosures around certain biodiversity impact metrics and targets as well as governance around the strategic impact of, and the assessment and management of, biodiversity risks and opportunities. More broadly, the TNFD aims to align with CBD’s target of no net biodiversity loss by 2030 and net gain by 2050. Given the broad endorsement the TCFD has received from the business community, and the extent to which governments crafting climate risk disclosure regulations have referred to the TCFD as a model, it is widely expected that the TNFD (which already has the backing of the G7) will become an equally influential model for biodiversity disclosures.
Initiatives – Coalitions & Networks
Corporations seeking to elevate biodiversity loss on their ESG agendas and to meaningfully commit to actions in this area should actively consider participation in and support of one or more of the initiatives, charters, and coalitions noted below.
Among the growing chorus of initiatives calling for science-based biodiversity protection targets, the Science Based Targets Network[xxii] and U.N. Principles for Responsible Banking[xxiii] have each recently developed guidance for companies setting such objectives. Financial institutions in particular are coming under pressure to set targets, and the Finance for Biodiversity Pledge, for its part, has sought to commit its signatories to commit to science-based targets by 2024 (in addition to suggesting that financial institutions become legally liable for their impacts on ecosystems).
Members of the broader business and investor community are also uniting behind the biodiversity agenda through initiatives such as Act4Nature, One Planet Business for Biodiversity, and Business for Nature. Representing more than 900 companies with a cumulative revenue exceeding US$4 trillion, the Business for Nature Coalition, for example, has called on governments to adopt policies to reverse nature loss in this decade. Hundreds of coalition members have already made commitments to support three biodiversity-related U.N. Sustainable Development Goals (SDGs)[xxiv], and investor-oriented initiatives such as the U.N. Principles of Responsible Investment (which has been adopted by leading global asset owners and investment managers) have similarly recognized the business case for preserving biodiversity and the importance of biodiversity to achieving the SDGs generally.[xxv]
Other common initiatives focus more narrowly on the biodiversity effects of the cultivation of high-impact soft commodities such as palm oil, beef, and soy. Companies with ties to these industries have increasingly adopted “No Deforestation, No Peat, No Exploitation” (NDPE) procurement or lending policies, creating stranded asset risk for certain industry members. We expect NPDE policies to continue gaining traction going forward and other sector-specific biodiversity initiatives to rise to similar prominence.
Performance Assessment Tools for Organizations & Asset Managers – Nascent Stages of Development
As with all ESG factors—as asset owners and managers are acutely aware—you cannot manage what you do not measure. Hence, the growing importance of performance assessment tools and measures in the biodiversity loss and impact space.
Historically, biodiversity value and/or business impacts on diversity have been measured on a location-by-location basis or on a nation-by-nation basis (based on national biodiversity indicators, for example). Important improvements in satellite imagery and other technologies used to measure localized impacts, and advancements toward a common lexicon to discuss impacts (e.g., coalescence around metrics such as Mean Species Abundance), are currently being made with greater urgency. But perhaps more significantly, tools designed to measure organization-level biodiversity impact have recently multiplied.
In 2020, the Mission Économie de la Biodiversité presented its Global Biodiversity Score, a tool designed to assess the biodiversity footprint of business and financial assets. The U.N. Environment Programme Finance Initiative and Center for Sustainable Organizations then made their own contributions to the assessment cause in 2021 in launching the “ENCORE”[xxvi] module and Biodiversity Performance Index (BPI) prototype, respectively. Focused on the mining and agricultural sectors, the ENCORE module aims to allow banks and investors to explore the extent to which their financial portfolios indirectly drive species extinction risk and impact on ecological integrity. Over 30 financial institutions are currently testing the module. The BPI prototype, meanwhile, holds itself out as the world’s first context-based biodiversity metric designed for companies and investors, using a composite of 10 biodiversity-related indicators to weigh organization-level performance in relation to ecological thresholds.
Continuing on the Road to Biodiversity
Understandably governments around the world are focused on achieving net zero deadlines, pushing ahead with decarbonization projects, and low-carbon strategies, and the intense “buzz” around COP26 will continue for weeks to come. These steps are not only critical to the reduction of greenhouse gas emissions, but also create local jobs, assist in retraining (and retaining) the existing workforce and help grow economies.
However, much like climate change, the loss of biodiversity is irreversible and immediate action is necessary. Let’s see if natural capital receives the attention it requires this week and Kunming brings about global alignment for urgent action on biodiversity loss.
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[i] 20 Aichi biodiversity targets available at: https://www.cbd.int/sp/targets/.
[ii] The first detailed draft of the new Post-2020 Global Biodiversity Framework is available at: https://www.cbd.int/conferences/post2020.
[iii] The United Nations Environment Programme defines biological diversity or biodiversity as the variety of life on Earth and the natural patterns it forms. See: https://www.unep.org/unep-and-biodiversity.
[iv] The World Economic Forum’s 2021 Global Risks Report is available at: https://www.weforum.org/reports/the-global-risks-report-2021.
[v] The World Wide Fund for Nature’s (WWF) 2020 Living Planet Report, for example, shows a 68% decline in animal population size and 84% decline in freshwater wildlife in the past few decades. The report is available at: https://livingplanet.panda.org/en-us/.
[vi] As detailed in WWF’s 2020 Global Futures report, available at https://wwf.panda.org/?359334.
[vii] The IPCC Sixth Assessment Report was published on August 7, 2021 and is available at https://www.ipcc.ch/assessment-report/ar6/.
[viii] See, for example, the opening statement of the U.N. Principles for Responsible Investment Association’s (UNPRI) “Investor Action on Biodiversity” discussion paper, available here.
[ix] https://www.ngfs.net/sites/default/files/medias/documents/ngfs-press-release_2021-10-08_interim-report.pdf
[x] The report is available here.
[xi] Technical screening criteria have already been adopted for climate change.
[xii] France passed its Law on Climate and Energy in 2019, which includes an update to the 2015 Energy Transition Law’s requirements on non-financial reporting by investors. Only climate issues are covered under the 2015 law, but the 2019 law takes into account the preservation of the biodiversity of the ecosystems.
[xiii] The Netherlands passed legislation on the mandatory disclosure of non-financial information in 1997 and, in 2003, produced a reporting guide stating that sustainability reporting should disclose information on the effects of business operations on biodiversity and the measures taken to mitigate these effects.
[xiv] Initiatives and funds include the England Trees Action Plan, Peat Action Plan, Benyon Review on Highly Protected Marine Areas (and the response to it), development of a Nature for Climate Impact Fund (£640 million announced at Budget 2020), Blue Planet Fund (£500 million), International Biodiversity Fund (£220 million), Green Recovery Challenge Fund (proposed to increase to £80 million) to deliver up to 100 nature projects in two years, and 25 Year Environment Plan.
[xv] Amendments to the Environment Bill to legislate (among other matters) for the introduction of: (i) biodiversity net gain for new nationally significant infrastructure are currently pending (requiring all new developments to demonstrate a 10% net gain in biodiversity at or near their sites); (ii) biodiversity credits allowing developers to purchase credits from the UK Government to be used to fund the creation of conservation sites; and (iii) prohibition on the use by large businesses of illegally produced commodities, due diligence requirements in relation to forest-risk commodities, and reporting on compliance. The Environment Bill still remains in the House of Lords and has not yet progressed to the final stages of receiving Royal Assent.
[xvi] The final report of the independent review (commissioned in 2019 by Her Majesty’s Treasury (HMT)) on the Economics of Biodiversity led by Professor Sir Partha Dasgupta (Dasgupta Review) was published in February 2021. The report restarted the conversation on biodiversity in the UK, with HMT publishing the UK Government’s response to the Dasgupta Review in July 2021 and emphasizing its commitment to (among other matters) delivering a nature positive future and to reverse biodiversity loss by 2030.
[xvii] From January 1, 2021, the UK Financial Conduct Authority (FCA) implemented changes to the Listing Rules (Listing Rule 9.8.6) introducing a requirement for all UK premium listed companies to comply with the TCFD recommendations and disclose how they are considering the impacts of climate change, and on a comply or explain basis report against the TCFD framework. The FCA also recently consulted on extending these requirements to issuers of standard listed equity shares and certain regulated firms. The UK Government’s Department for Business, Energy & Industrial Strategy also recently concluded a consultation relating to mandatory climate-related financial disclosures by publicly quoted and large private companies and LLPs and the TCFD. The Government response is still pending. The proposals apply to UK companies currently required to produce a non-financial information statement, those being UK companies with more than 500 employees and transferable securities admitted to trading on a UK regulated market, and relevant public interest entities; UK registered companies with securities admitted to AIM with more than 500 employees; UK registered companies which are not included in the categories above with more than 500 employees and a turnover of more than £500 million; and LLPs with more than 500 employees and a turnover of more than £500 million. These rules are expected to come into force for accounting periods on or after April 6, 2022.
[xviii] From the Commonwealth Climate and Law Imitative, for example. Comments submitted to the SEC are available at: https://www.sec.gov/comments/climate-disclosure/cll12.htm.
[xix] The Global Reporting Initiative (GRI) provides the most widely used sustainability reporting standards in the world. The GRI standards are available at: https://www.globalreporting.org/how-to-use-the-gri-standards/gri-standards-english-language/.
[xx] The CDSB’s draft Biodiversity Guidance and further information on the consultation is available at: https://www.cdsb.net/biodiversity.
[xxi] The Agence Française de Développement (AFD) launched the TNFD Development Finance Hub at the first plenary meeting, which will sit under the umbrella of the TNFD’s broader Knowledge Hub. Further information is available at: https://tnfd.global/news/first-plenary-launch-of-development-finance-hub/.
[xxii] The Science Based Targets Network’s initial guidance on science-based targets for nature is available at: https://sciencebasedtargetsnetwork.org/wp-content/uploads/2020/09/SBTN-initial-guidance-for-business.pdf.
[xxiii] The Principles for Responsible Banking’s Guidance on Biodiversity Target-setting is available at: https://www.unepfi.org/publications/guidance-on-biodiversity-target-setting/.
[xxiv] The three SDGs are: SDG6 (Clean water and sanitation), SDG 14 (Life below Water) and SDG 15 (Life on Land). The commitments of Business for Nature Coalition members involve acting and advocating for more ambitious nature policies and work on protecting and restoring nature. Before making commitments, companies are encouraged to understand their dependencies and impacts on biodiversity as they relate to their direct operations or supply chain.
[xxv] As reflected in UNPRI’s “Investor Action on Biodiversity” discussion paper.
[xxvi] ENCORE stands for Exploring Natural Capital Opportunities, Risks and Exposure.
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 of the following leaders and members of the firm’s Environmental, Social and Governance (ESG) practice group, or the following authors:
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])
Mitasha Chandok – London (+44 (0)20 7071 4167, [email protected])
Kyle Neema Guest – Washington, D.C. (+1 202-887-3673, [email protected])
Please also feel free to contact the following practice leaders:
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])
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In Horror Inc. v. Miller, the Second Circuit affirmed that Victor Miller had successfully reclaimed his rights in the screenplay for Friday the 13th by invoking the Copyright Act’s termination provisions, notwithstanding his assignment of those rights to a film production company in 1980. The Court reached that conclusion after finding that Miller’s assignment was made as an independent contractor, rather than as an employee.[1]
In certain situations, an author of a copyrighted work that has been transferred to another can terminate the transfer and reclaim the copyright. A transfer of a copyrighted work created as a work-for-hire, however, cannot be terminated. For purposes of determining if a work is a work-for-hire under the Copyright Act, Horror Inc. held that copyright law—not labor law—determines whether the creator and a hiring party are in an employer-employee relationship. The court further held that, because Miller wrote the screenplay as an independent contractor under copyright law, the screenplay was not a work-for-hire and Miller was entitled to terminate his decades-earlier transfer of the screenplay’s copyright.
Statutory Background
The Copyright Act of 1976[2] provides that copyright ownership “vests initially in the author or authors of the work.”[3] Under well-established case law, the person who “actually creates the work, that is, the person who translates an idea into a fixed, tangible expression entitled to copyright protection,” is generally considered to be the work’s “author.”[4] But the Copyright Act creates an exception for “a work made for hire,” which is defined as one “prepared by an employee within the scope of his or employment,” or, in certain instances, “a work specially ordered or commissioned for use as contribution to a collective work.”[5] In the case of a work-for-hire, “the employer or other person for whom the work was prepared is considered the author.”[6]
Authors can transfer ownership of any or all of the exclusive rights comprised in a copyright,[7] but Section 203 of the Copyright Act permits an author (or his or her successors) in certain circumstances to terminate prior transfers of copyrights during a specified window of time.[8] Congress added this termination right to the Copyright Act to address “the unequal bargaining position of authors” in negotiations over conveyance of their ownership rights “resulting . . . from the impossibility of determining the work’s value until the value has been exploited.”[9] A creator of a work-for-hire cannot take advantage of this provision, however, because the termination right expressly does not apply to works-for-hire.[10]
Factual Background
Victor Miller, a professional screenplay writer, has long been a member of the Writers Guild of America (“WGA”), a labor union representing writers in the film and television industries. In 1979, Miller agreed to write the screenplay for a horror film, which would eventually be titled Friday the 13th and introduce the iconic character of Jason Voorhees.[11] Friday the 13th opened on May 9, 1980 and enjoyed “unprecedented box office success for a horror film,” leading to eleven sequels to-date and a host of other derivative products.[12] But before that took place, in exchange for only $9,000, Miller assigned his rights in the screenplay to a film production and distribution company.
In 2016, Miller sought to reclaim copyright ownership of the screenplay by serving notices of termination pursuant to Section 203(a) of the Copyright Act. The companies to whom the copyrights had been transferred then sued Miller in the United States District Court for the District of Connecticut, seeking a declaration that Miller wrote the screenplay as an employee and that the screenplay therefore was a work-for-hire, which would prevent Miller from terminating the companies’ rights. On cross-motions for summary judgment asserting largely undisputed facts, the District Court concluded that Miller did not create the screenplay as a work-for-hire. Because he was the “author” of the screenplay, his termination notices were valid and served to restore his ownership of the copyright for the Friday the 13th screenplay. After the companies appealed, the Second Circuit affirmed the District Court’s ruling in Miller’s favor.
The Second Circuit’s Decision
Because the Copyright Act’s termination provision is not applicable to works-for-hire, the courts had to resolve whether Miller was an employee or independent contractor of the film production company to which he assigned his rights at the time that he wrote the screenplay for Friday the 13th. This required the Second Circuit to decide as a matter of first impression what body of federal law governed Miller’s employment status under the Copyright Act.
The production companies first argued that “Miller’s WGA membership ‘inherently’ created an employer-employee relationship” pursuant to the National Labor Relations Act (the “NLRA”), under which screenwriters are permitted to unionize because they are classified as production companies’ employees.[13] The Second Circuit rejected that argument because “the definition of ‘employee’ under copyright law is grounded in the common law of agency” and “serves different purposes than do the labor law concepts regarding employment relationships,” such that there was “no sound basis for using labor law to override copyright law goals.”[14]
In reaching this conclusion, the Court provided a thorough overview of the Supreme Court’s decision in Community for Creative Non-Violence v. Reid, which set forth a thirteen-factor test for determining in the copyright context whether the creator of a work did so as an employee or as an independent contractor.[15] As explained in Reid, the Copyright Act provides a “restrictive definition of employment, one aimed at limiting the contours of the work-for-hire determination and protecting authors.”[16] In the labor and employment law context, on the other hand, “the concept of employment is broader, adopting a more sweeping approach suitable to serve workers and their collective bargaining interests and establishing rights” related to their compensation and safety, among other issues.[17] Stated otherwise, “[t]hat labor law was determined to offer labor protections to independent writers does not have to reduce the protections provided to authors under the Copyright Act.”[18] The Court of Appeals thus found that in analyzing whether the Friday the 13th screenplay was a work-for-hire, “[t]he District Court correctly set aside NLRA-based doctrine in favor of common law principles and the Reid factors” “regardless of Miller’s employment status under the NLRA and his membership in the WGA.”[19]
Having failed to persuade the Second Circuit to follow principles of labor law to find that Miller was an employee when he wrote the script, the production companies next argued that Miller’s WGA membership should have been considered as an additional factor in applying the Reid multi-factor work-for-hire test. The Second Circuit deemed this argument “simply another attempt to shift Reid’s analytic focus from agency law to labor law and convince us the labor law framework governs here.”[20] Because Reid “instructs [courts] to look at the overall context of the parties’ relationship based on . . . specific factors,” Miller’s WGA membership did “not alter or control [the Second Circuit’s] analysis of the Reid factors for copyright purposes.”[21] Rather, it was “relevant only insofar as it informs [the] analysis of other factors, namely whether Miller received benefits commonly associated with an employment relationship.”[22]
Applying the Reid factors, the Second Circuit proceeded to analyze whether Miller created the screenplay as an employee or as an independent contractor. In doing so, it found that only three of Reid’s thirteen factors—that the hiring party exercised some control over Miller’s writing, that the hiring party was a business entity, and that soliciting the screenplay was part of its regular business—supported the production companies’ arguments for classifying the screenplay as a work-for-hire under the Copyright Act. On balance, however, the Second Circuit found that the factors “weigh[ed] decisively in Miller’s favor,” leading the Court of Appeals to affirm the District Court’s finding that Miller had created the screenplay as an independent contractor.[23] Accordingly, under the Copyright Act, Miller had the right to terminate his decades-earlier transfer of the copyright to the screenplay for Friday the 13th.
Conclusion
For purposes of applying the Copyright Act’s termination provisions, Horror Inc. held that whether a work was “made for hire”—which in this case turned on the creator’s status as an employee or independent contractor—is strictly governed by copyright law principles, rather than labor and employment law. Accordingly, it further held that to the extent the creator of a work is a union member, that fact has no independent weight in determining whether the creator was in an employment relationship with the entity for whom the work was created. These determinations may have significant implications for a broad array of copyrighted works, the ownership of which may be similarly subject to the Copyright Act’s termination provisions.
___________________________
[1] Horror Inc. v. Miller, No. 18-3123-cv, 2021 WL 4468980 (2d Cir. Sept. 30, 2021).
[4] Community for Creative Non-Violence v. Reid, 490 U.S. 730, 737 (1989).
[9] H.R. Rep. No. 94-1476, 24th Cong. 2d Sess. at 124 (1976)
[10] 17 U.S.C. § 203(a) (termination right applies “[i]n the case of any work other than a work made for hire”).
[11] Horror Inc., 2021 WL 4468980, at *1-2.
[16] Horror Inc., 2021 WL 4468980, at *8.
The following Gibson Dunn lawyers assisted in the preparation of this client update: Brian Ascher, Ilissa Samplin, Michael Nadler, and Doran Satanove.
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 the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:
Media, Entertainment and Technology Group:
Scott A. Edelman – Co-Chair, Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Co-Chair, Los Angeles (+1 213-229-7872, [email protected])
Benyamin S. Ross – Co-Chair, Los Angeles (+1 213-229-7048, [email protected])
Orin Snyder – New York (+1 212-351-2400, [email protected])
Brian C. Ascher – New York (+1 212-351-3989, [email protected])
Anne M. Champion – New York (+1 212-351-5361, [email protected])
Michael H. Dore – Los Angeles (+1 213-229-7652, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Ilissa Samplin – Los Angeles (+1 213-229-7354, [email protected])
Nathaniel L. Bach – Los Angeles (+1 213-229-7241,[email protected])
Please also feel free to contact the following practice leaders:
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])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
To continue assisting US companies with planning for SEC reporting and capital markets transactions into 2022, we offer our annual SEC Desktop Calendar. This calendar provides both the filing deadlines for key SEC reports and the dates on which financial statements in prospectuses and proxy statements must be updated before use (a/k/a financial staleness deadlines).
You can download a PDF of Gibson Dunn’s SEC Desktop Calendar for 2022 at the link below.
https://www.gibsondunn.com/wp-content/uploads/2021/09/SEC-Filing-Deadline-Calendar-2022.pdf
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Join us to listen to this interactive discussion with an exceptional panel comprising some of the key people at the Loan Market Association (LMA), Asia Pacific Loan Market Association (APLMA) and Loan Syndications and Trading Association (LSTA) who were responsible for developing their 2021 Revised Sustainability-Linked Loan Principles together with three finance practitioners from Gibson Dunn’s US, U.K. and Asian finance and ESG practices.
View Slides (PDF)
PANELISTS:
Ben Myers – Panelist
London, Partner, Gibson Dunn
Ben Myers is a partner in Gibson Dunn’s global finance and business restructuring teams. His practice focuses on advising funds, sponsors, corporates and financial institutions with a particular focus on leveraged finance, special situations and restructuring transactions. Mr. Myers is one of the leaders of the firm’s UK ESG practice and a member of the firm’s global ESG practice.
Patricia Tan Openshaw – Panelist
Hong Kong, Partner, Gibson Dunn
Patricia is a partner in Gibson Dunn’s energy, infrastructure and global finance teams. Her practice focuses on project development and finance, mergers and acquisitions, and banking and finance transactions in the energy and infrastructure sector. She has substantial experience representing developers, sponsors, contractors, lenders, government agencies and offtakers in connection with the development, financing, and restructuring of power, rail, toll road, water, casinos and other infrastructure projects. She also advises on financings involving commercial banks, export credit agencies, multilateral agencies, private equity funds and Rule 144A/Regulation S offerings and private placements. She has handled transactions in Africa, Australia, China, Fiji, India, Indonesia, Korea, Myanmar, Pakistan, Philippines, Singapore, Thailand, Vietnam and the United States. Ms. Openshaw is a member of the firm’s global ESG practice.
Yair Galil – Panelist
New York, Of Counsel, Gibson Dunn
Yair is of counsel in Gibson Dunn’s global finance team. His experience includes representation of sponsors, corporate issuers, financial institutions and investment funds in a variety of complex financing transactions. The business contexts for these transactions have ranged from corporate finance (including sustainability‐linked credit facilities), to leveraged acquisitions and dividend recaps, to debt buybacks and other out‐of‐court capital restructuring transactions, to debtor‐in‐ possession and bankruptcy exit financings. Mr. Galil is a member of the firm’s global ESG practice.
Hannah Vanstone – Panelist
London, Legal Associate, Loan Market Association
Hannah joined the LMA’s legal team in November 2018 and assists with the Association’s documentation projects, education and training events and regulatory and lobbying matters. Hannah leads the LMA’s real estate finance work and is also involved in all the LMA’s ESG initiatives. Prior to joining the LMA, Hannah was a banking and finance solicitor at Osborne Clarke LLP where she acted for numerous domestic and international corporate banks and UK and international borrowers on a variety of syndicated finance transactions, with a particular focus on real estate finance.
Rosamund Barker – Panelist
Hong Kong, Head of Legal, Asia Pacific Loan Market Association
Rosamund is currently Head of Legal at the Asia Pacific Loan Market Association based in Hong Kong. She has spent much of her career working in the Banking and Finance and Capital Markets teams at Linklaters in London and Hong Kong, most recently as Counsel. She was also Director of Knowledge for Asia Pacific at Baker McKenzie. She is responsible for green and sustainable lending initiatives at the APLMA and has been active in raising awareness of the Green Loan Principles, Sustainability Linked Loan Principles and Social Loan Principles to Borrowers and Lenders alike. Rosamund read law at Churchill College, Cambridge University and is a qualified solicitor both in Hong Kong and England and Wales.
Tess Virmani – Panelist
New York, Associate General Counsel, Executive Vice President, Public Policy of the Loan Syndications and Trading Association (LSTA)
Tess has a broad range of responsibilities at the LSTA. She leads the LSTA’s sustainable finance and ESG initiatives which seek to foster the development of sustainable lending as well as promote greater ESG disclosure in the loan markets. In addition, Tess engages in the LSTA’s policy initiatives, including market advocacy and spearheading industry solutions to market developments, such as the transition to replacement benchmarks. Tess focuses on maintaining and augmenting the LSTA’s extensive suite of documentation, which includes templates, market standards, and market and regulatory guidance. Finally, she is involved in the development and presentation of the LSTA’s robust education programs. Prior to joining the LSTA, Tess practiced as a finance attorney at Skadden, Arps, Slate, Meagher & Flom LLP in New York. She received a B.S. in International Politics from the Walsh School of Foreign Service at Georgetown University and a J.D. from Fordham University School of Law. She is admitted as an attorney in New York. Tess is an FSA Level II Candidate.
Recently, the SEC’s Division of Corporation Finance has issued a number of comment letters relating exclusively to climate-change disclosure issues. The letters we have seen to date comment on companies’ most recent Form 10-K filings, including those of calendar year companies who filed their Form 10-K more than 6 months ago, and have been issued by a variety of the Division’s industry review groups, including to companies that are not in particularly carbon-intensive industries. Many of the climate change comments appear to be drawn from the topics and considerations raised in the SEC’s 2010 guidance on climate change disclosure, as reflected in the sample comments that we have attached in the annex to this alert. We expect this is part of a larger Division initiative because the letters are similar (although not identical), contain relatively generic comments, and have been issued in close proximity to one another. Accordingly, it is reasonable to expect that additional comment letters will be issued in the coming weeks and months.
The issuance of these comments and their focus comes as no surprise given the SEC’s Chair and several commissioners have indicated that climate change disclosures are a priority. As detailed in Gibson Dunn’s client alert of June 21, 2021, the SEC also recently announced its anticipated rulemaking agenda, which includes a near-term focus on rules that would prescribe climate change disclosures.
The following Gibson Dunn attorneys assisted in preparing this update: Andrew Fabens, Brian Lane, Courtney Haseley, Elizabeth Ising, James Moloney, Lori Zyskowski, Michael Titera, Thomas Kim, and Ronald Mueller.
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The California Court of Appeal last week issued the first published California appellate decision to expressly confirm that trial courts have the authority to strike an unmanageable Private Attorneys General Act (“PAGA”) claim. In Wesson v. Staples the Office Superstore, LLC, No. B302988, — Cal.App.5th — (Sept. 9, 2021), the Court of Appeal held that trial courts have the inherent authority to manage complex litigation, and under this authority can evaluate whether PAGA claims can be manageably adjudicated at trial; if a PAGA claim cannot be manageably tried, the court may strike the claim. This is a critical ruling for California employers who are litigating PAGA actions in California state courts.
Wesson involved a PAGA claim on behalf of over 300 store managers who contended that Staples had misclassified them as exempt executive employees. After defeating class certification, Staples moved to strike the PAGA claim on the ground that individual variations in evidence relevant to each manager’s proper classification also rendered the PAGA claim unmanageable. The trial court granted Staples’s motion, and the Court of Appeal affirmed.
The Court of Appeal’s opinion emphasized that courts have “inherent authority to fashion procedures and remedies as necessary to protect litigants’ rights and the fairness of trial.” Slip op. at 25. Representative claims under PAGA pose challenges for efficient and fair case management, particularly where adjudicating the claims would require “minitrials . . . with respect to each” represented person. Id. at 28–29. The Court of Appeal further explained that “PAGA claims may well present more significant manageability concerns than those involved in class actions,” because PAGA lacks many of the protections associated with class litigation. Id. at 30 (emphasis added). The court also made clear that trial courts faced with those issues are not “powerless to address the challenges presented by large and complex PAGA actions” or “bound to hold dozens, hundreds, or thousands of minitrials involving diverse questions.” Id. at 31. Instead, if a trial court determines that a PAGA claim would be unmanageable at trial, it “may preclude the use of th[at] procedural device.” Id. at 32.
The California Supreme Court in Williams v. Superior Court, 3 Cal. 5th 531 (2017), had previously suggested in discussing the scope of discovery under PAGA that the “trial of the action” needed to be “manageable.” Id. at 559. And a number of federal district court decisions have recognized that courts have the inherent authority to strike PAGA claims as unmanageable, often based on Williams; Wesson, however, is the first published California appellate decision expressly recognizing that authority. After Wesson, employers who have active PAGA litigation may consider whether to move to strike the PAGA claim on manageability grounds.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these matters. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors:
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, [email protected])
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, [email protected])
Megan Cooney – Orange County (+1 949-451-4087, [email protected])
Matt Aidan Getz – Los Angeles (+1 213-229-7754, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Yesterday, September 9, President Biden announced several initiatives regarding COVID-19 vaccine requirements for U.S. employers. This alert provides a brief overview of the content and timing of the principal initiatives, and previews certain objections likely to be raised in legal challenges that some governors and others have said they will file.
- OSHA rule requiring all employers with 100+ employees to ensure their workers are vaccinated or tested weekly, and to pay for vaccination time.
The President announced that the Department of Labor’s Occupational Safety and Health Administration (OSHA) is developing an Emergency Temporary Standard (ETS) that will require all employers with 100 or more employees to ensure that their workforce is fully vaccinated or to require any workers who remain unvaccinated to produce a negative test result at least weekly before coming to work. The rule—which is expected to issue within weeks—will require employers with more than 100 employees to provide paid time off for the time it takes for workers to get vaccinated and to recuperate if they experience serious side effects from the vaccination.
OSHA ETS’s are authorized by statute, which permits the Secretary of Labor to promulgate an ETS when he determines (1) “that employees are exposed to grave danger from exposure to substances or agents determined to be toxic or physically harmful or from new hazards,” and (2) “that such emergency standard is necessary to protect employees from such danger.”[1] An ETS may be in place for up to six months, at which point OSHA must issue a permanent standard that has been adopted through ordinary rulemaking processes.[2] This would be OSHA’s second COVID ETS, following an ETS adopted in June that was limited to the health care sector.[3]
OSHA likely does not plan a notice-and-comment process for the forthcoming rule, which is not required for an ETS. As a consequence, the standard’s specific requirements likely will become known the day of publication, with an effective date shortly thereafter. Uncertainties that issuance of the rule should resolve include how it would apply to employees working at home, or to workers at remote locations without contact with other employees.
The decision to adopt the rule as an “emergency” and “temporary” standard, without notice and comment, could be one focus of a legal challenge. A challenge may also target the rule’s wage-payment requirement; wages are not a subject that OSHA ordinarily regulates, and the requirement arguably contrasts with Congress’s decision to let the COVID-related paid leave programs established by the Families First Coronavirus Response Act expire after December 31, 2020. If the ETS requires vaccination for workers who recently had and recovered from COVID-19, that could be targeted also.
- Executive Orders requiring vaccinations for employees of federal contractors, and for all federal workers.
In announcing the OSHA ETS, the President also issued separate Executive Orders regarding vaccination of employees of federal contractors, and regarding vaccination of federal workers.
The federal contractor Order imposes no immediate workplace requirements. Rather, the requirements—which the White House has said will include a vaccine mandate—are to be delineated by September 24 by the White House’s “Safer Federal Workforce Task Force” (Task Force), established by the President in January. Under the Order, by September 24, the Task Force is to provide “definitions of relevant terms for contractors and subcontractors, explanations of protocols required of contractors and subcontractors to comply with workplace safety guidance, and any exceptions to Task Force Guidance that apply to contractor and subcontractor workplace locations and individuals in those locations working on or in connection with a Federal Government contract.”[4] The Task Force Guidance is to be accompanied by a determination, issued by the Director of the Office of Management and Budget (OMB), that the Guidance “will promote economy and efficiency in Federal contracting, if adhered to by Government contractors and subcontractors.”[5] The Order cites the Federal Property and Administrative Services Act (the Procurement Act), as authority for the new federal contractor mandate.[6]
The Order is effectuated by requiring federal agencies to include a clause in contracts requiring “the contractor and any subcontractors (at any tier)” to “comply with all guidance for contractor or subcontractor workplace locations published by the Safer Federal Workforce Task Force,” “for the duration of the contract.”[7] This clause is to be included in new contracts and extensions and renewals of existing contracts, and “shall apply to any workplace locations . . . in which an individual is working on or in connection with a Federal Government contract.”[8]
A legal challenge to the Order is likely to focus on the President’s authority under the Procurement Act to use a White House Task Force to develop workplace safety rules for federal contractors. As discussed in a prior alert, presidents of both parties increasingly use the Procurement Act to regulate terms and conditions of employment at federal contractors, including most recently a $15 minimum wage requirement.[9] A challenge to this COVID Executive Order could produce an important legal precedent on presidential authority in this area.
Separate from the Order regarding contractors, President Biden also signed an Executive Order requiring that all federal executive branch workers be vaccinated, with minimal exceptions.[10] The Order requires federal agencies to “implement, to the extent consistent with applicable law, a program to require COVID-19 vaccination for all of [their] Federal employees.”[11] The Order does not allow employees to avoid vaccination through frequent testing. Instead, “only” those “exceptions . . . required by law” will be permitted.[12] Those exceptions are likely to concern disabilities and religious objections.[13] The President directed the Task Force to “issue guidance within 7 days . . . on agency implementation of” the Order’s requirements for federal employees.[14]
- COVID-19 vaccinations for health care workers at Medicare and Medicaid participating hospitals, and at other health care settings.
The President announced that the Centers for Medicare & Medicaid Services (CMS) will require COVID-19 vaccinations for workers in most health care settings that receive Medicare or Medicaid reimbursement, including but not limited to hospitals, dialysis facilities, ambulatory surgical settings, and home health agencies. This action is an extension of a vaccination requirement for nursing facilities recently announced by CMS, and will apply to nursing home staff as well as staff in hospitals and other CMS-regulated settings, including clinical staff, individuals providing services under arrangements, volunteers, and staff who are not involved in direct patient, resident, or client care.[15]
* * *
We anticipate providing further updates later this month, as actions on the President’s directives proceed.
_______________________
[3] See OSHA National News Release, US Department of Labor’s OSHA issues emergency temporary standard
to protect health care workers from the coronavirus (June 10, 2021), https://www.osha.gov/news/newsreleases/national/06102021.
[4] Executive Order on Ensuring Adequate COVID Safety Protocols for Federal Contractors (Sept. 9, 2021), https://www.whitehouse.gov/briefing-room/presidential-actions/2021/09/09/executive-order-on-ensuring-adequate-covid-safety-protocols-for-federal-contractors/.
[6] Id. (citing 40 U.S.C. 101 et seq).
[9] Gibson Dunn, Department of Labor Initiates Rulemaking to Raise the Minimum Wage to $15 Per Hour For Federal Contractors (July 29, 2021), https://www.gibsondunn.com/wp-content/uploads/2021/07/department-of-labor-initiates-rulemaking-to-raise-the-minimum-wage-to-15-dollars-per-hour-for-federal-contractors.pdf.
[10] Executive Order on Requiring Coronavirus Disease 2019 Vaccination for Federal Employees (Sept. 9, 2021), https://www.whitehouse.gov/briefing-room/presidential-actions/2021/09/09/executive-order-on-requiring-coronavirus-disease-2019-vaccination-for-federal-employees/.
[13] Press Briefing by Press Secretary Jen Psaki (September 9, 2021), https://www.whitehouse.gov/briefing-room/press-briefings/2021/09/09/press-briefing-by-press-secretary-jen-psaki-september-9-2021/ (stating that there would be exceptions for “legally recognized reasons, such as disability or religious objections”).
[14] Executive Order on Requiring Coronavirus Disease 2019 Vaccination for Federal Employees (Sept. 9, 2021) at § 2; see also Safer Federal Workforce, https://www.saferfederalworkforce.gov/.
[15] See also CMS, Press Release, Biden-Harris Administration Takes Additional Action to Protect America’s Nursing Home Residents From COVID-19 (Aug. 18, 2021), https://www.cms.gov/newsroom/press-releases/biden-harris-administration-takes-additional-action-protect-americas-nursing-home-residents-covid-19.
The following Gibson Dunn attorneys assisted in preparing this client update: Eugene Scalia, Helgi C. Walker, Katherine V.A. Smith, Jason C. Schwartz, Jessica Brown, Karl G. Nelson, Amanda C. Machin, Lindsay M. Paulin, Zoë Klein, Chad C. Squitieri, and Marie Zoglo.
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, or any of the following in the firm’s Administrative Law and Regulatory, Labor and Employment or Government Contracts practice groups.
Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8543,[email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [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])
Government Contracts Group:
Dhananjay S. Manthripragada – Los Angeles (+1 213-229-7366, [email protected])
Joseph D. West – Washington, D.C. (+1 202-955-8658, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On August 20, 2021, the Standing Committee of China’s National People’s Congress passed the Personal Information Protection Law (“PIPL”), which will take effect on November 1, 2021. We previously reported on this development here, when the law was in draft form. An unofficial translation of the newly enacted PIPL is available here and the Mandarin version of the PIPL is available here.[1]
The PIPL applies to “personal information processing entities (“PIPEs”),” defined as “an organisation or individual that independently determines the purposes and means for processing of personal information.” (Article 73). The PIPL defines “personal information” broadly as “various types of electronic or otherwise recorded information relating to an identified or identifiable natural person,” excluding anonymized information, and defines “processing” as “the collection, storage, use, refining, transmission, provision, public disclosure or deletion of personal information.” (Article 4).
The PIPL shares many similarities with the EU’s General Data Protection Regulation (the “GDPR”), including its extraterritorial reach, restrictions on data transfer, compliance obligations and sanctions for non-compliance, amongst others. The PIPL raises some concerns for companies that conduct business in China, even where such companies’ data processing activities take place outside of China, and the consequences for failing to comply could potentially include monetary penalties and companies being placed on a government blacklist.
Below, we describe the companies subject to the PIPL, key features of the PIPL, and highlight critical issues for companies operating in China in light of this important legislative development.
I. Which Companies are Subject to PIPL?
- The PIPL applies to cross-border transmission of personal information and applies extraterritorially. Where PIPEs transmit personal information to entities outside China, they must inform the data subjects of the transfer, obtain their specific consent to the transfer, and ensure that the data recipients satisfy standards of personal information protection similar to those in the PIPL.The PIPL applies to organisations operating in China, as well as to foreign organisations and individuals processing personal information outside China in any one of the following circumstances: (1) the organisation collects and processes personal data for the purpose of providing products or services to natural persons in China; (2) the data will be used in analysing and evaluating the behaviour of natural persons in China; or (3) under other unspecified “circumstances stipulated by laws and administrative regulations” (Article 3). This is an important similarity between the PIPL and GDPR, as the GDPR’s data protection obligations apply to non-EU data controllers and processors that track, analyze and handle data from visitors within the EU. Similarly, under the PIPL, a foreign receiving party must comply with the PIPL’s standard of personal information protection if it handles personal information from natural persons located in China.
- The PIPL gives the Chinese government broad authority in processing personal information. State organisations may process personal information to fulfil statutory duties, but may not process the data in a way that exceeds the scope necessary to fulfil these statutory duties (Article 34). Personal information processed by state organisations must be stored within China (Article 36).
II. Key Features of PIPL
- The PIPL establishes guiding principles on protection of personal information. According to the PIPL, processing of personal information should have a “clear and reasonable purpose” and should be directly related to that purpose (Article 6). The PIPL requires that the collection of personal information be minimized and not excessive (Article 6), and requires PIPEs to ensure the security of personal information (Articles 8-9). To that end, the PIPL imposes a number of compliance obligations on PIPEs, including requiring PIPEs to establish policies and procedures on personal information protection, implement technological solutions to ensure data security, and carry out risk assessments prior to engaging in certain processing activities (Articles 51 – 59).
- The PIPL adopts a risk-based approach, imposing heightened compliance obligations in specified high-risk scenarios. For instance, PIPEs whose processing volume exceeds a yet-to-be-specified threshold must designate a personal information protection officer responsible for supervising the processing of personal data (Article 52). PIPEs operating “internet platforms” that have a “very large” number of users must engage an external, independent entity to monitor compliance with personal information protection obligations, and regularly publish “social responsibility reports” on the status of their personal information protection efforts (Article 58).The law mandates additional protections for “sensitive personal information,” broadly defined as personal information that, once disclosed or used in an illegal manner, could infringe on the personal dignity of natural persons or harm persons or property (Article 28). “Sensitive personal information” includes biometrics, religious information, special status, medical information, financial account, location information, and personal information of minors under the age of 14 (Article 28). When processing “sensitive personal information,” according to the PIPL, PIPEs must only use information necessary to achieve the specified purpose of the collection, adopt strict protective measures, and obtain the data subjects’ specific consent (Article 28-29).
- The PIPL creates legal rights for data subjects. According to the new law, PIPEs may process personal information only after obtaining fully informed consent in a voluntary and explicit statement, although the law does not provide additional details regarding the required format of this consent. The law also sets forth certain situations where obtaining consent is unnecessary, including where necessary to fulfil statutory duties and responsibilities or statutory obligations, or when handling personal information within a reasonable scope to implement news reporting, public opinion supervision and other such activities for the public interest (Articles 13-14, 17). Where consent is required, PIPEs should obtain a new consent where it changes the purpose or method of personal information processing after the initial collection (Article 14). The law also requires PIPEs to provide a convenient way for individuals to withdraw their consent (Article 15), and mandates that PIPEs keep the personal information only for the shortest period of time necessary to achieve the original purpose of the collection (Article 19).If PIPEs use computer algorithms to engage in “automated decision making” based on individuals’ data, the PIPEs are required to be transparent and fair in the decision making, and are prohibited from using automated decision making to engaging in “unreasonably discriminatory” pricing practices (Article 24, 73). “Automated decision-making” is defined as the activity of using computer programs to automatically analyze or assess personal behaviours, habits, interests, or hobbies, or financial, health, credit, or other status, and make decisions based thereupon (Article 73(2)).When individuals’ rights are significantly impacted by PIPEs’ automated decision making, individuals can demand PIPEs to explain the decision making and decline automated decision making (Article 24).
III. Potential Issues for Companies Operating in China
The passage of the PIPL and the uncertainty surrounding many aspects of the law creates a number of potential issues and concerns for companies operating in China. These include the following:
- Foreign organisations may be subject to the PIPL’s regulatory requirements. The PIPL applies to data processing activities, even where those activities take place outside of China, provided they are carried out for the purpose of conducting business in China or evaluating individuals’ behavior in the country. The law is currently silent on how close the nexus must be between the data processing and Chinese business activities. The law also mandates that data processing activities taking place outside of China are subject to the PIPL under “other circumstances stipulated by laws and administrative regulations.” At present there is no guidance as to what these circumstances will be.Foreign organisations subject to the PIPL will need to comply with requirements including security assessments, assigning local representatives to oversee data processing, and reporting to supervisory agencies in China, though the exact parameters of these requirements remain unclear (Articles 51–58).
- The PIPL creates penalties for organisations that fail to fulfil their obligations to protect personal information (Article 66). These penalties include disgorgement of profits and provisional suspension or termination of electronic applications used by PIPEs to conduct the unlawful collection or processing. Companies and individuals may be subject to a fine of not more than 1 million RMB (approximately $154,378.20) where they fail to remediate conduct found to be in violation of the PIPL, with responsible individuals subject to fines of 10,000 to 100,000 RMB (approximately $1,543.81 to $15,438.05).Companies and responsible individuals face particularly stringent penalties where the violations are “grave,” a term left undefined in the statute. In these cases, the PIPL allows for fines of up to 50 million RMB (approximately $7,719,027.00) or 5% of annual revenue, although the PIPL does not specify which parameter serves as the upper limit for the fines. Authorities may also suspend the offending business activities, stop all business activities entirely, or cancel all administrative or business licenses. Individuals responsible for “grave” violations may be fined between 100,000 and 1 million RMB (approximately $15,438.29 to $154,382.93), and may also be prohibited from holding certain job titles, including Director, Supervisor, high-level Manager or Personal Information Protection Officer, for a period of time. In contrast, fines for severe violations of the GDPR can be up to €20 million (approximately $23,486,300.00) or up to 4% of the undertaking’s total global turnover of the preceding fiscal year (whichever is higher).
- Foreign organisations may also be subject to consequences under the PIPL for violating Chinese citizens’ personal information rights or harming China’s national security or public interest. The state cybersecurity and informatization department may place offending organisations on a blacklist, resulting in restrictions on receiving personal information for blacklisted entities (Article 42). The PIPL does not provide clarity on what constitutes a violation of Chinese citizens’ personal information rights or what qualifies as harming China’s national security or public interest.
Companies operating in China should pay particular attention to the cross-border data transfer issues raised by the PIPL:
- Foreign organisations will need to disclose certain information when transferring personal information outside of China’s borders. Under the PIPL, PIPEs must obtain the data subject’s consent prior to transfer, although the required form and method of that consent is not clear (Article 39). Entities seeking to transfer data must also provide the data subject with information about the foreign recipient, including its name, contact details, purpose and method of the data processing, the categories of personal information provided and a description of the data subject’s rights under the PIPL (Article 39).
- Certain companies may need to undergo a government security assessment prior to cross-border data transfers. In addition to the consent and disclose requirements under Article 39, “critical information infrastructure operators” and PIPEs processing personal information in quantities exceeding government limits must pass a government security assessment prior to transferring data outside of China (Article 40). The term “critical information infrastructure operator” is not further defined within the PIPL, the term is, however, broadly defined within the newly passed Regulations on the Security and Protection of Critical Information Infrastructure (the “Regulations on Critical Information Infrastructure”), which come into effect on September 1, 2021 (the Mandarin version is available here). Under Article 2 of the Regulations on Critical Information Infrastructure, a “critical information infrastructure operator” is a company engaged in important industries or fields, including public communication and information services, energy, transport, water, finance, public services, e-government services, national defense and any other important network facilities or information systems that may seriously harm national security, the national economy and people’s livelihoods, or public interest in the event of incapacitation, damage or data leaks.The PIPL also does not specify the data thresholds beyond the quantities provided by the state cybersecurity and information department or the nature of the security assessment, nor does it reference any specific legislation issued by the state cybersecurity and informatization department for purposes of determining such data thresholds (Article 40).
- PIPEs outside China that conduct personal data processing activities for the purpose of conducting business in China or evaluating individuals’ behaviour in the country must establish an entity or appoint an individual within China to be responsible for personal information issues. Such foreign organisations must report the name of the relevant entity or the representative’s name and contact method to the departments fulfilling personal information protection duties, although the PIPL does not specify or name to which departments foreign organisations must report in such instances (Article 53).
- Companies and individuals may not provide personal information stored within China to foreign judicial or enforcement agencies, without prior approval of the Chinese government. As summarized in our prior client alert, the PIPL adds to a growing list of laws that restrict the provision of data to foreign judiciaries and government agencies, which could have a far-reaching impact on cross-border litigation and investigations. Chinese authorities will process requests from foreign judicial or enforcement agencies for personal information stored within China in accordance with applicable international treaties or the principle of equality and reciprocity (Article 41). The PIPL does not provide any guidance on how a company should seek approval if it wishes to export personal data in response to a request from a foreign government agency or a foreign court.
IV. Next Steps
The passage of the PIPL comes during a time where China has increased its regulatory scrutiny on technology companies and other entities with large troves of sensitive public information, and their data usage. Given the broad scope of the PIPL and its extraterritorial reach, organisations inside and outside of China will need to review their data protection and transfer strategies to ensure they do not run afoul of this network of legislation.
Even for companies that currently have GDPR compliance programs in place, the PIPL introduces new requirements not currently required under the GDPR. Examples of such requirements unique to the PIPL include, amongst others, establishing a legal entity within China and passing a security review prior to exporting personal data that reaches a certain undisclosed threshold. How the government enforces the statute and interprets its provisions remain to be seen, and a PIPL compliance program will likely require a nuanced understanding of Chinese cultural and business practices.
Companies operating in China should pay close attention to regulations, guidance documents and enforcement actions related to the PIPL as the Chinese government continues to bolster its data protection legal infrastructure, and seek guidance from knowledgeable counsel.
___________________________
[1] Please note that the discussion of Chinese law in this publication is advisory only.
This alert was prepared by Connell O’Neill, Kelly Austin, Oliver Welch, Ning Ning, Felicia Chen, and Jocelyn Shih.
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 in the firm’s Privacy, Cybersecurity and Data Innovation practice group, or the following authors:
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Connell O’Neill – Hong Kong (+852 2214 3812, [email protected])
Oliver D. Welch – Hong Kong (+852 2214 3716, [email protected])
Privacy, Cybersecurity and Data Innovation Group:
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])
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])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Alejandro Guerrero – Brussels (+32 2 554 7218, [email protected])
Vera Lukic – Paris (+33 (0)1 56 43 13 00, [email protected])
Sarah Wazen – London (+44 (0) 20 7071 4203, [email protected])
United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [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])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Ashley Rogers – Dallas (+1 214-698-3316, [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])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
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 new petitions for certiorari in cases originating in the Federal Circuit concerning the Patent Trial and Appeal Board’s NHK-Fintiv Rule. This Update also discusses recent Federal Circuit decisions. Notably, starting with the September 2021 court sitting, the court has now resumed in-person arguments.
Federal Circuit News
Supreme Court:
The Court did not add any new cases originating at the Federal Circuit.
Noteworthy Petitions for a Writ of Certiorari:
There are two new certiorari petitions currently before the Supreme Court concerning the Patent Trial and Appeal Board’s NHK-Fintiv Rule, under which the Board may deny institution of inter partes review proceedings when the challenged patent is subject to pending district court litigation.
- Apple Inc. v. Optis Cellular Technology, LLC (U.S. No. 21-118): “Whether the U.S. Court of Appeals for the Federal Circuit may review, by appeal or mandamus, a decision of the U.S. Patent & Trademark Office denying a petition for inter partes review of a patent, where review is sought on the grounds that the denial rested on an agency rule that exceeds the PTO’s authority under the Leahy-Smith America Invents Act, is arbitrary or capricious, or was adopted without required notice-and-comment rulemaking.”
- Mylan Laboratories Ltd. v. Janssen Pharmaceuticals, N.V. (U.S. No. 21-202): “Does 35 U.S.C. § 314(d) categorically preclude appeal of all decisions not to institute inter partes review?” 2. “Is the NHK-Fintiv Rule substantively and procedurally unlawful?”
The following petitions are still pending:
- Biogen MA Inc. v. EMD Serono, Inc. (U.S. No. 20-1604) concerning anticipation of method-of-treatment patent claims. Gibson Dunn partner Mark A. Perry is counsel for the respondent.
- American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891) concerning patent eligibility under 35 U.S.C. § 101, in which the Court has invited the Solicitor General to file a brief expressing the views of the United States.
- PersonalWeb Technologies, LLC v. Patreon, Inc. (U.S. No. 20-1394) concerning the Kessler doctrine.
Upcoming Oral Argument Calendar
The court has now resumed in-person arguments for the September 2021 court sitting.
The list of upcoming arguments at the Federal Circuit is available on the court’s website.
Live streaming audio is available on the Federal Circuit’s new YouTube channel. Connection information is posted on the court’s website.
Key Case Summaries (August 2021)
Qualcomm Incorporated v. Intel Corporation (Fed. Cir. No. 20-1589): Intel petitioned for six inter partes reviews (IPRs) challenging the validity of a patent owned by Qualcomm. During the IPRs, neither party disputed that the challenged claims required signals that increased user bandwidth. The PTAB, however, construed the claims in a way that omitted any requirement that the signals increase bandwidth. Qualcomm appealed the PTAB’s decision and argued that it was not afforded notice and an opportunity to respond to the PTAB’s construction.
The Federal Circuit (Moore, C.J., joined by Reyna, J. and Stoll, J.) vacated and remanded the PTAB’s decisions. Although the PTAB may adopt a different construction from a disputed, proposed construction, the court held that the Board may not adopt a claim construction that diverges from an agreed-upon requirement for a term. Because neither party could have anticipated the PTAB’s deviation, especially where the International Trade Commission had adopted the increased bandwidth requirement, the court held that the Board needed to provide notice and an adequate opportunity to respond. Because all briefing included the increased bandwidth requirement, the court rejected Intel’s argument that Qualcomm was not prejudiced. The court also found that a single question relating to the bandwidth requirement at the PTAB hearing did not provide adequate notice. Finally, the court found that the ability to seek rehearing from the PTAB’s decision was not a substitute for notice and an adequate opportunity to respond.
Personal Web Technologies LLC v. Google LLC (Fed. Cir. No. 20-1543): PersonalWeb sued Google and YouTube (collectively, “Google”) in the Eastern District of Texas, asserting three related patents directed to data-processing systems. After the cases were transferred to the Northern District of California, that district court granted Google’s motion for judgment on the pleadings that the asserted claims were ineligible under 35 U.S.C. § 101.
The panel (Prost, J., joined by Lourie and Reyna, J.J.) affirmed. At step one, the panel agreed with the district court that the asserted claims are directed to a three-step process: “(1) using a content-based identifier generated from a ‘hash or message digest function,’ (2) comparing that content-based identifier against something else, [that is,] another content-based identifier or a request for data; and (3) providing access to, denying access to, or deleting data.” The panel held that this claimed process amounted to the abstract idea of using “an algorithm-generated content-based identifier to perform the claimed data-management functions.” The panel explained that these functions are ineligible mental processes. Pointing to its prior cases, the panel explained that each of the three functions—generating, comparing, and using content-based identifiers to manage data—are concepts the Federal Circuit previously described as abstract. At step two, the Court concluded that the alleged inventive concept—“making inventive use of cryptographic hashes”—is simply a restatement of the abstract idea itself. The panel agreed with the district court that “using a generic hash function, a server system, or a computer does not render these claims non-abstract,” and explained that each of the supposed improvement disclosed in the specification was likewise abstract.
GlaxoSmithKlein LLC v. Teva Pharmaceuticals USA, Inc. (Fed. Cir. No. 18-1976): GlaxoSmithKline (“GSK”) sued Teva in the District of Delaware. After a jury returned a verdict of induced infringement against Teva, the district court granted Teva’s renewed JMOL, holding that Teva could not induce infringement with its “skinny label” because that label carved out the patented use of carvedilol. The district court also held that GSK had failed to prove that Teva caused inducement because it did not show that it was Teva’s actions that actually caused doctors to directly infringe by prescribing generic carvedilol to treat CHF.
The panel majority (Moore, C.J., and Newman, J.) vacated the grant of the JMOL and reinstated the jury’s verdict of induced infringement, with Judge Prost dissenting. Teva petitioned for rehearing, which the panel granted. The panel issued a new decision, in which the same majority once more reinstated the jury’s verdict of induced infringement against Teva. The majority held that whether a carve-out indication instructs a patented use is a question of fact. Considering the evidence in the record, the majority concluded that substantial evidence supported the jury’s determination that Teva induced infringement by not effecting a section viii carve-out because Teva advertised its drug as a generic equivalent and thereby actively encouraged a patented therapeutic use. The majority warned that this was a decision based on a “narrow, case-specific review of substantial evidence,” and agreed with amici that a “generics could not be held liable for merely marketing and selling under a ‘skinny’ label omitting all patented indications, or for merely noting (without mentioning any infringing uses) that FDA had rated a product as therapeutically equivalent to a brand-name drug.”
Judge Prost dissented again, arguing that the majority’s decision weakens the section viii carve-out by creating confusion for generic companies as to when they may face liability. Judge Prost pointed out that GSK expressly told the FDA that only one use was patented, and so Teva carved out that use. Judge Prost also argued that the majority’s decision changes the law of inducement by blurring the line between merely describing an infringing use and actually encouraging, recommending, or promoting an infringing use. Judge Prost explained that unlike direct infringement, induced infringement requires a showing of intent, and argued that no such intent by Teva could be shown because by carving out the patented use, it was actually taking steps to avoid infringement.
Andra Group, LP v. Victoria’s Secret Stores, LLC (Fed. Cir. No. 20-2009): Andra Group sued several related Victoria’s Secret entities in the Eastern District of Texas. Three entities (“Non-Store Defendants”)—corporate parent L Brands, Inc., Victoria’s Secret Direct Brand Management, LLC, and Victoria’s Secret Stores Brand Management, Inc.—do not have any employees, stores, or any other physical presence in the Eastern District of Texas. The fourth entity (“Store Defendant”) operates retail stores in the Eastern District of Texas. The Non-Store Defendants moved to dismiss the infringement suit for improper venue, and the district court granted the motion. Andra Group appealed.
The Federal Circuit (Hughes, J., joined by Reyna, J. and Mayer, J.) affirmed. The court held that the Store Defendant’s retail stores were not a regular and established place of business of the Non-Store Defendants. The court noted that the evidence showed that the Non-Store Defendants did not have the right to direct or control the Store Defendant’s employees. The court also found that the Store Defendant’s acceptance of returns for merchandise purchased on the website (which was run by a Non-Store Defendant) was a discrete task insufficient to establish an agency relationship. The court also rejected Andra’s argument that the Non-Store Defendants ratified the Store Defendant’s retail stores as their own place of business. The court held that a defendant must actually engage in business from that location and simply advertising a place of business is not sufficient to make it a place of business.
Omni MedSci, Inc. v. Apple Inc. (Fed. Cir. No. 20-1715): In a patent infringement suit brought by Omni against Apple, Apple filed a motion to dismiss for lack of standing. Apple contended that the asserted patents were not owned by Omni, but by University of Michigan (“UM”). Dr. Islam, the named inventor, was employed by UM and had signed an employment agreement that stated, inter alia, that intellectual property developed using university resources “shall be the property of the University.” Dr. Islam took a leave of absence during which he filed multiple provisional patent applications, which ultimately issued as the asserted patents. Dr. Islam then assigned these patents to Omni. The district court determined that the provision in Dr. Islam’s employment agreement “was not a present automatic assignment of title, but, at most, a statement of a future intention to assign.” Apple requested the district court grant certification of the standing question to the Federal Circuit, which was granted.
The majority (Linn, J., joined by Chen, J.) affirmed, and agreed that Dr. Islam’s employment agreement did not constitute a present automatic assignment or a promise to assign in the future. The majority found that the agreement did not include language such as “will assign” or “agrees to grant and does hereby grant,” which have been previously held to constitute a present automatic assignment of a future interest. At most, UM’s agreement with phrases such as “shall be the property of the University” and “shall be owned as agreed upon in writing,” was a promise of a potential future assignment, not as a present automatic transfer. The majority also found a lack of present tense words of execution, such as “hereby grants and assigns,” supported its interpretation.
Judge Newman dissented. She reasoned that because the employment agreement necessarily applies only to future inventions, in which future tense is used, the future tense “shall be the property of the University” is appropriate, and should have vested ownership of the patents in the University. Thus, she concluded that Omni did not have standing to bring the infringement suit.
Campbell Soup Company v. Gamon Plus, Inc. (Fed. Cir. No. 20-2344): Gamon sued Campbell Soup and Trinity Manufacturing (together, “Campbell”) for infringing two design patents, the commercial embodiment of which was called the iQ Maximizer. Campbell petitioned for inter partes review on the grounds that Gamon’s patents would have been obvious over another design patent (“Linz”). The Patent Trial and Appeal Board concluded that Campbell failed to prove unpatentability based on Linz, reasoning that although Linz had the same overall visual appearance as the claimed designs, it was outweighed by objective indicia of nonobviousness. The Board presumed a nexus between those objective indicia and the claimed designs because it found that the iQ Maximizer was coextensive with the claims.
Campbell appealed, and the Federal Circuit (Moore, C.J., Prost and Stoll, JJ.) reversed. The Court held that substantial evidence supported the Board’s finding that Linz creates “the same overall visual appearance as the claimed design[s].” However, under the next step of the design patent obviousness analysis, the Court held that the Board failed to answer the question of “whether unclaimed features are ‘insignificant,’” and that “[u]nder the correct legal standard, substantial evidence does not support the Board’s finding of coextensiveness.” The Court wrote, “We do not go so far as to hold that the presumption of nexus can never apply in design patent cases. It is, however, hard to envision a commercial product that lacks any significant functional features such that it could be coextensive with a design patent claim.” Finally, the Court held that Gamon failed to show that the objective indicia are the “direct result of the unique characteristics of the claimed invention,” because, for example, characteristics of the iQ Maximizer that led to commercial success “were not new.”
Venue in the Western District of Texas:
In re: Hulu, LLC (Fed. Cir. No. 21-142): The panel (Taranto, Hughes, and Stoll, JJ.) granted Hulu’s petition, holding that Judge Albright clearly abused his discretion in evaluating Hulu’s transfer motion and denying transfer. In particular, the panel held that the district court at least erred in its analysis for each factor that it found weighed against transfer: (1) the availability of compulsory process to secure the attendance of witnesses; (2) the cost of attendance for willing witnesses; and (3) the administrative difficulties flowing from court congestion.
In re: Google LLC (Fed. Cir. No. 21-144): The panel (O’Malley, Reyna, and Chen, JJ.) denied Google’s petition because it did not “ma[k]e a clear and indisputable showing that transfer was required.” The district court had found that one or more Google employees in Austin, Texas were potential witnesses, and the panel was “not prepared on mandamus to disturb those factual findings.”
In re: Apple Inc. (Fed. Cir. No. 21-147): The panel (Reyna, Chen, and Stoll, JJ.) denied Apple’s petition because Apple did not show entitlement to the “extraordinary relief.” The panel did not, however, find that the district court’s analysis was free of error. For example, the panel explained, the district court “improperly diminished the importance of the convenience of witnesses merely because they were employees of the parties.”
In re: Dish Network L.L.C. (Fed. Cir. No. 21-148): The panel (O’Malley, Reyna, and Chen, JJ.) denied Dish’s petition but held that it “do[es] not view issuance of mandamus as needed here because” the panel was “confident the district court will reconsider its determination in light of the appropriate legal standard and precedent on its own.” The panel explained that, in light of In re Apple Inc., 979 F.3d 1332 (Fed. Cir. 2020), the district court erred in relying on Dish’s general presence in Western Texas without tying that presence to the events underlying the suit. The panel also explained that “[t]he need for reconsideration here” is additionally confirmed by In re Samsung Electronics Co., 2 F.4th 1371 (Fed. Cir. 2021), because the district court here improperly diminished the convenience of witnesses in the transferee venue because of their party status and by presuming they were unlikely to testify despite the lack of relevant witnesses in the transferor venue.
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 alert:
Blaine H. Evanson – Orange County (+1 949-451-3805, [email protected])
Jessica A. Hudak – Orange County (+1 949-451-3837, [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:
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])
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])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
This week the UK Government published yet more updates on the application of the new National Security and Investment Act 2021 (NSI Act), which will come into effect on 4 January 2022.
Now seemed like a good time to take stock of all of the developments and guidance to date and to provide a helpful overview of the new regime, with all of the draft legislation and guidance in one place.
The big question is, what do companies need to take into account right now?
1. Background
In November last year, we reported on the UK Government’s announcement to overhaul the UK’s approach to foreign investment review and the introduction of its National Security and Investment Bill. The Bill received Royal Assent in April to become the NSI Act.
The NSI Act will introduce a new standalone hybrid regime of mandatory and voluntary notifications for certain acquisitions that could harm the UK’s national security. The regime also includes a Government power to call in any deal which raises a “national security risk”.
In late July 2021, the UK Government confirmed that the NSI Act will take effect from 4 January 2022 and also published four new pieces of guidance[1] as well as an updated draft of sector definitions for the mandatory notification regime under the NSI Act and a statement on how it proposes to exercise its new call-in powers.
This week the UK Government published a further updated draft of sector definitions for the mandatory notification regime and an explanatory note. Other than an amendment to state they will come into force on 4 January 2022, the draft definitions are in substantially the same form as the July draft. The Government also published draft regulations on monetary penalties under the NSI Act, together with an explanatory memorandum. These regulations are broadly in line with the rules for calculating penalties under the Enterprise Act 2002 (EA2002), but there are some differences.
2. Impact for companies
The introduction of the NSI Act forms part of a trend towards stricter control of foreign direct investment seen elsewhere in the world, including in the U.S. and in Europe. As far as foreign investment in the UK is concerned, the NSI Act will afford the UK Government one of the highest levels of scrutiny of any regime globally.
Although it is expected to be rare that a deal will be blocked (or require remedies) under the NSI Act, the impact for investors will be significant in terms of deal certainty and timeline.
The Government initially estimated that there will be 1,000–1,800 transactions notified each year, and 70 – 95 of those transactions are expected to be called in for a full national security assessment. This compares to a total of less than 25 transactions which have been reviewed by the Government since 2003 under the EA2002 public interest regime.[2] Since these estimates were made, the Government has increased the threshold for mandatory notification from the acquisition of 15% of shares or voting rights to 25%. Nonetheless, given the broad nature of the regime and the current uncertainty around its application, we would anticipate that a high number of notifications will be made, at least initially.
Faced with mandatory notification obligations in many cases, as well as severe criminal and civil consequences for non-compliance, companies must pay close attention to national security risks when investing in the UK.
3. What do companies need to consider right now?
Consider the existing public interest regime
Over the next four months, transactions which raise national security concerns are still subject to the existing public interest intervention regime under the EA2002 and, accordingly, parties should ensure their transaction documents adequately cater for both regimes. For example, in relation to conditions and the process and approach to preparing and securing relevant regulatory approvals.
The risk of intervention under the current regime is not theoretical. In the last few years, the numbers and the nature of intervention in UK transactions on public interest grounds has increased. In December 2019, the CMA issued a Public Interest Intervention Notice (PIIN) in relation to the proposed acquisition of Mettis Aerospace by Aerostar following which the parties decided not to proceed with the acquisition. In that same month the CMA issued a PIIN in relation to Gardener Aerospace’s proposed acquisition of Impcross Limited which was subsequently blocked.
More recently, in April of this year, Digital Secretary Oliver Dowden issued instructions in relation to the proposed acquisition of ARM Limited by NVIDIA Corporation. The Secretary of State for Business, Energy and Industrial Strategy (BEIS) is reported as taking an active interest in Parker-Hannafin’s proposed acquisition of British defence technology firm, Meggitt. In August of this year, Director of National Security & International, Jacqui Ward, issued a PIIN in relation to Cobham’s proposed acquisition of the defence aerospace and security solutions provider, Ultra Electronics plc.
Once the NSI Act enters into force, the existing national security ground under the EA2002 will be repealed. However, the public health, media plurality and financial stability heads of intervention will remain in place and apply in parallel after commencement of the new NSI Act regime.
Make a jurisdictional assessment
Parties who are currently contemplating a deal that will complete after the commencement date (4 January 2022) need to assess whether their deal falls within the new mandatory notification regime. If so, the deal will need to be notified to the Investment Security Unit (ISU) of the Secretary of State for BEIS before closing.
An acquisition which is subject to the mandatory notification regime will be void if is completed without notifying and gaining approval from the Government. In such cases, parties need to ensure that their transaction documents contain appropriate conditions and that the long stop date is sufficient. Parties will need to take account of the time-frames that the ISU has to (i) determine whether to accept or reject a notification, (ii) assess whether they wish to issue a call-in notice and (iii) make its substantive assessment of the transaction, if it decides to call-in or screen the transaction.
Assess the risk of retrospective call-in for deals between 12 November 2020 and 4 January 2022
The NSI Act affords BEIS the power to retrospectively call-in deals and carry out a full national security assessment. These retroactive call-in powers apply to deals closed between 12 November 2020 and commencement of the NSI Act on 4 January 2022 (the interim period). They do not apply to deals closed before 12 November 2020.
This means that for deals contemplated now, even if they will close before 4 January 2022, parties have to carry out a risk assessment of the likelihood that BEIS will use its call-in powers post 4 January.
The call-in powers may be exercised where the Government reasonably suspects that a “trigger event” (see below) has occurred and that the trigger event has given rise or may give rise to a national security risk. If a transaction that closed in the interim period would have fallen within the mandatory regime had the NSI Act been in force at the time, it could be a prime candidate for call-in by BEIS once the NSI Act commences.[3]
For deals which closed in the interim period but would not have been caught by the mandatory regime, parties will still need to consider whether their deal may reasonably be considered to raise national security concerns within the meaning of the NSI Act. And, as such, whether the deal is a likely candidate for call-in by BEIS.
The period during which the Government can call-in a deal is five years from completion. This period is reduced to six months from the date at which the BEIS becomes aware of the transaction. For deals closing during the interim period, the call-in power will be available for a five year period from the date of closing, or six months from 4 January, if the parties informed BEIS of the transaction during the transitional period.
This is important because parties to a transaction which closes during the interim period and which could reasonably be considered to give rise to a national security, should consider whether to discuss the transaction informally with the ISU. Making BEIS aware through consultation with the ISU would have the effect of shortening the window for call-in to six months from commencement of the Act. It may also help parties decide whether a voluntary notification would be prudent once the Act commences. Such an approach may be advantageous from a deal certainty view point, in particular in terms of mitigating buy-side transactional risk.
4. A quick recap on the rules
4.1 What type of transactions does the NSI Act apply to?
The NSI Act applies to acquisitions of control over qualifying entities or assets – this is called a “trigger event” – where BEIS reasonably suspects that there is a risk to national security as a result of the acquisition.
The definition of control under the NSI Act is broad and applies to the acquisition of more than 25%, 50% and 75% of votes or shares in a qualifying entity (or the acquisition of voting rights that allow the acquirer to pass or block resolutions governing the affairs of the entity). In addition, outside of the mandatory regime, BEIS will also be able to call-in or accept voluntary notifications in relation to transactions falling below this 25% threshold where there is “material influence”. This can mean acquisitions of shareholdings as low as 10-5%.[4]
A qualifying entity must be a legal person, that is not an individual. It must have a tie to the UK, either because it is registered in the UK or because it carries on activities in the UK or supplies goods or services to persons in the UK.
Acquisitions of qualifying assets such as land and IP may be subject to call-in or the voluntary regime (but not the mandatory regime).[5]
4.2 Mandatory notifications
Notifications will be mandatory for acquisitions of control over a qualifying entity active in 17 defined sectors designated as particularly sensitive for national security. These are wide-ranging: from energy, defence and transport to AI, quantum technologies, and satellite and space technologies.[6] In these sectors, such transactions must receive Government approval before completion and so the NSI Act has a suspensory effect.
Failure to notify under the mandatory regime will render completion of the acquisition void. There are also civil and criminal penalties for completing a notifiable acquisition without approval. Civil penalties can be up to 5% of the organization’s global turnover or £10 million (whichever is greater).[7]
The Government has engaged extensively with stakeholders on the mandatory sector definitions, since the publication of the first draft in November 2020. Throughout this process, the Government has refined and developed the proposed definitions. The latest set of definitions were published on 6 September and are set out in the draft notifiable acquisition regulation. These are broadly in line with what the Government has published previously. The Government has indicated that it will continue to refine its definitions, even after commencement of the NSI Act in January.
One important point in the guidance issued in July[8] is that a qualifying entity falls within a description of the 17 mandatory sectors only if it carries on the activity specified in the UK or supplies relevant goods or services in the UK.[9]
4.3 Call-in and voluntary notifications
Acquisitions of control over qualifying entities outside of the 17 mandatory regime sectors do not need to be notified. But, if the Government reasonably suspects that an acquisition has given rise to, or may give rise to, a risk to national security, it can be scrutinized by the Government using its call-in powers.
Given these expansive call-in powers, parties may decide to voluntarily notify their transactions where there is a perceived risk of call-in and a desire for deal certainty. A voluntary notification forces BEIS to decide within 30 business days whether to proceed with a review.
As noted above, the voluntary regime may also apply to asset acquisitions and to transactions falling below this 25% threshold where there is “material influence”.[10]
5. How to assess the call-in risk
The Government published a new draft statement in July, setting out how it expects to exercise the power to give a call-in notice. This is referred to as the draft statement for the purposes of section 3. The Government again consulted on this statement, with the consultation closing on 30 August.
Whilst qualifying acquisitions across the whole economy are technically in scope, the call-in power will be focussed on acquisitions in the 17 areas of the economy subject to mandatory notification and areas of the economy which are closely linked to these 17 areas. Acquisitions which occur outside of these areas are unlikely to be called in because national security risks are expected to occur less frequently in those areas. This is new compared to the previous statement of intent of policy, which split areas of the economy into three risk levels (core areas, core activities and the wider economy), and is a welcome clarification.
The risk factors have stayed largely the same as in previous iterations, with some tweaks. Essentially, to assess the likelihood of a risk to national security, the Secretary of State will consider three risk factors:
- Target risk: whether the target is being used, or could be used, in a way that poses a risk to national security. BEIS will consider what the target does, is used for, or could be used for, and whether that could give rise to a risk to national security. BEIS will also consider any national security risks arising from the target’s proximity to sensitive sites.
- Acquirer risk: whether the acquirer has characteristics that suggest there is, or may be, a risk to national security from the acquirer having control of the target. Characteristics include sector(s) of activity, technological capabilities and links to entities which may seek to undermine or threaten the interests of the UK. Threats to the interests of the UK include the integrity of democracy, public safety, military advantage and reputation or economic prosperity. Some characteristics, such as a history of passive or longer-term investments, may indicate low or no acquirer risk.
- Control risk: whether the amount of control that has been, or will be, acquired poses a risk to national security. A higher level of control may increase the level of national security risk.
The risk factors will be considered together, but an acquisition may be called in if any one risk factor raises the possibility of a risk to national security.
The same risk factors will be applied to qualifying acquisitions of assets as to qualifying acquisitions of entities.
At present there are no turnover or market share safe-harbours for investors (below which transactions would fall outside the scope of the NSI Act). The Government has, to date, firmly rejected calls from industry professionals and practitioners to introduce such a safe-harbour or exemption.
6. What’s next?
We expect the Government to publish final regulations and guidance as the year draws to an end. We do not expect the scope of the 17 sensitive sectors to change now, before the NSI Act comes into effect.
In the meantime, parties should consider the possible impact of the new regime on any proposed divestments or acquisitions which are in the mandatory sectors or which are not in one of these designated sectors but which may nonetheless give rise to national security concerns. The ISU has encouraged parties to contact them to discuss possible acquisitions and how the NSI Act may impact their transaction or their responsibilities.
More generally, the Government has emphasised that the UK remains open for investment and that the new regime aims to proportionately mitigate national security risks. It is keen to stress its ambition that the new regime will enable the fastest, most proportionate foreign investment screening in the world, while not undermining predictability and certainty.
_______________________
[1] (i) How to Prepare for the New NSIA Rules on Acquisitions; (ii) Application of the NSIA to People or Acquisitions Outside the UK; (iii) Guidance for the Higher Education & Research Intensive Sectors; and (iv) NSIA and Interaction with Other UK Regulatory Regimes.
[2] The Government’s powers to review transactions on public interest grounds are currently set out in the Enterprise Act 2002. The Government can issue a Public Interest Intervention Notice (PIIN) on certain strictly defined public interest considerations. It can only do so where a transaction meets the jurisdictional thresholds under the UK merger control rules (with limited exceptions).
[3] For such transactions, which were legitimately closed before commencement, the suspension obligation does not apply and there can be no fines for failing to notify.
[4] The Government has stated that any assessment of an acquisition of material influence under the NSI Act will follow the CMA’s guidance on material influence in a merger control context.
[5] The Government has indicated that investigations of asset acquisitions that are not linked to the 17 mandatory sectors are expected to be rare and, generally, the Secretary of State expects to call-in acquisitions of assets rarely and significantly less frequently than acquisitions of entities.
[6] The full list is: Advanced Materials, Advanced Robotics, Artificial Intelligence, Civil nuclear, Communications, Computing hardware, Critical suppliers to Government, Critical suppliers to the emergency services, Cryptographic Authentication, Data Infrastructure, Defence, Energy, Military and Dual-use, Quantum technologies, Satellite and space technologies, Synthetic biology, Transport.
[7] See draft regulations on monetary penalties and the accompanying explanatory memorandum published on 6 September 2021.
[8] See guidance referred to in item (i) in footnote 1.
[9] The guidance also the proposed Section 3 statement (see section 4 of this alert below) provides helpful examples and case studies of the types of entities and assets both in and outside of the UK which may fall within scope of the new regime.
Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition, Mergers and Acquisitions, or International Trade practice groups, or the authors:
Ali Nikpay – Antitrust and Competition (+44 (0) 20 7071 4273, [email protected])
Deirdre Taylor – Antitrust and Competition (+44 (0) 20 7071 4274, [email protected])
Selina S. Sagayam – International Corporate (+44 (0) 20 7071 4263, [email protected])
Attila Borsos – Competition and Trade (+32 2 554 72 11, [email protected])
Mairi McMartin – Antitrust and Competition (+32 2 554 72 29, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On 2 September 2021, the Court of Justice of the European Union (the “CJEU”) issued its ruling in Republic of Moldova v Komstroy[1] (the “Decision” or “Komstroy”) concluding that, as a matter of EU law, Article 26 of the Energy Charter Treaty (the “ECT”) is not applicable to “intra-EU” disputes (that is, disputes between an investor of an EU Member State on the one hand, and an EU Member State on the other).
The CJEU’s Decision largely follows the CJEU’s controversial reasoning in Achmea BV v Slovak Republic[2] (“Achmea”) (2018), which concerned a bilateral investment treaty (“BIT”) between two EU Member States (as opposed to a multilateral treaty such as the ECT). Achmea was addressed in a previous client alert here.[3]
Background
In October 2019, the Paris Court of Appeal (cour d’appel de Paris) made a request to the CJEU for a preliminary ruling addressing three questions.[4] These pertained to set-aside proceedings brought by Moldova in respect of an UNCITRAL arbitral award rendered against it for certain breaches of obligations under the ECT. Paris was the seat of the underlying arbitration.
The CJEU’s Decision
Only one of the three questions referred by the Paris Court of Appeal ultimately was addressed by the CJEU. That question asked the CJEU to determine whether the definition of “investment” in Article 1(6) of the ECT requires any economic contribution on the part of the investor in the host State. The Decision found, in essence, that an economic contribution was required in its view.
The CJEU also set out its views on whether Article 26 of the ECT is compatible with EU law insofar as it provides for arbitration between EU based investors and EU Member States.[5] This question was not referred by the Paris Court of Appeal, nor was it directly relevant to the questions before the CJEU (which concerned investments in a non-EU Member State (Moldova)). This separate question had been raised by the European Commission, together with certain EU Member States,[6] acting as interveners in the CJEU proceedings. The Decision indicates that intra-EU arbitration under the ECT is incompatible with EU law. The CJEU’s reasoning is summarised below.
First, following its reasoning in Achmea, the CJEU explained that in order to preserve the autonomy of EU law, as well as its effectiveness, national courts of EU Member States may make a preliminary reference to the CJEU pursuant to Article 267 of the Treaty on the Functioning of the European Union (the “TFEU”). This referral procedure was described as the “keystone” of the EU judicial system with the “objective of securing the uniform interpretation of EU law, thereby ensuring its consistency, its full effect and its autonomy”.[7]
Second, the CJEU reasoned that because the EU is a Contracting Party to the ECT, the ECT itself is a so-called “act of EU law”.[8] Having reached this conclusion, the CJEU then determined that because the ECT is an “act of EU law”, an ECT tribunal would necessarily be required to interpret, and even apply, EU law when deciding a dispute under Article 26.[9] This reasoning appears to be directly at odds with the CJEU’s Opinion 1/17, in which it accepted that CETA tribunals[10]– though standing outside the judicial system of the EU – could nonetheless interpret and apply the CETA itself without running afoul of EU law.[11] The Decision does not explain how CETA, to which the EU is also a party and must likewise be considered an “act of the EU” by the CJEU, can be compatible with EU law, but the ECT cannot. Likewise, the CJEU did not explain how its finding that the ECT is an “act of EU law” would not apply equally in the extra-EU context (i.e., where a dispute involves an EU Member State and an investor from a third State), leaving these questions unanswered.
Third, having found that an ECT tribunal would need to apply EU law on the basis that the ECT is an “act of EU law”, the CJEU then ascertained whether an ECT tribunal is situated within the judicial system of the EU such that a preliminary reference could be made to the CJEU to ensure the effectiveness of EU law.[12] In the CJEU’s view – in “precisely the same way” as in Achmea – ECT tribunals are outside the EU legal system, thus preventing effective control over EU law.[13] The CJEU found that the judicial review that arises in the context of EU-seated investor-state arbitration is limited since the referring court can only perform a review insofar as its domestic law permits.[14] In other words, according to the CJEU, the full effectiveness of EU law cannot be guaranteed.
Finally, given that commercial arbitration tribunals routinely interpret and apply EU law outside of the EU legal system (which could mean that any arbitration would be incompatible with EU law), the Decision attempts to distinguish investor-state arbitration from commercial arbitration. The distinction, according to the CJEU, is that commercial arbitration is different because it “originate[s] in the freely expressed wishes of the parties concerned”, whereas investor-state arbitration apparently is not based on the parties’ “freely expressed wishes”.[15] Unfortunately, however, the CJEU did not elaborate on its conclusion in this regard. That conclusion appears to be inconsistent with well-established principles of public international law, which confirm that States can (and must) enter into treaties such as the ECT of their own free will.
In light of the foregoing, the CJEU concluded that Article 26 of the ECT is incompatible with EU law insofar as it provides for arbitration between EU investors and EU Member States.[16]
Implications of the CJEU’s Decision
The ECT remains in force between all Contracting Parties, which includes all EU Member States, as well as the EU. Indeed, a modification of the ECT to remove its application as between EU Member States would require the participation not just of the EU and its Member States, but of all 53 Contracting Parties to the ECT. The CJEU’s Decision does not (and cannot) modify the express terms of the ECT itself.
To date, all ECT tribunals that have considered jurisdictional objections based on the intra-EU nature of the dispute have rejected the suggestion that the ECT does not apply on an intra-EU basis. That is unlikely to change in light of the Decision. Indeed, the CJEU did not offer any analysis under the Vienna Convention on the Law of Treaties (the “VCLT”), which governs the interpretation of the ECT. Nor did the CJEU address the substantial body of case law under the ECT on the interpretation of Article 26 of the ECT, all of which reaches the opposite conclusion to the CJEU. Those cases set forth what is now a well-established principle that EU law is not relevant to the question of jurisdiction under the ECT. Thus, the Decision (which is limited to an analysis under EU law) should have no bearing on an ECT tribunal’s jurisdiction.
Another implication of the Decision is that EU-based investors considering energy investments in EU Member States may now view these investments as more risky. First, the applicability of Article 26 to intra-EU disputes was not a question that was before the CJEU and it had no impact on the Komstroy case, which (paradoxically) did not involve an intra-EU dispute. The Decision provides scant and inconsistent reasoning and may therefore be considered to be based on political considerations rather than a sound and reasoned interpretation of the law. The Decision thus has the potential to undermine investor confidence in the EU judicial system and the rule of law within the EU.
Second, the CJEU’s Decision may create uncertainty regarding the extent of investor protection within the EU for energy investments as EU Member States may believe that they can (or must) disapply the ECT to investors from other EU Member States. This, of course, would make investments by EU investors into EU Member States both less attractive and more expensive (as it will drive up risk premiums). The CJEU’s decision may, therefore, undermine investor confidence at a time when the EU is seeking substantial private investment in its energy sector as part of its efforts to de-carbonise. In other words, the Decision ultimately could be an “own goal” for the EU and its Member States.
____________________________
[1] Judgment of the Court (Grand Chamber), Case C‑741/19, Republic of Moldova v Komstroy, a company the successor in law to the company Energoalians, ECLI:EU:C:2021:655, 2 September 2021 (the “Decision”), available here.
[2] Judgment of the Court (Grand Chamber), Case C‑284/16, Slowakische Republik (Slovak Republic) v Achmea BV, ECLI:EU:C:2018:158, 6 March 2018, available here.
[3] In short, in Achmea, the CJEU determined that arbitration provisions such as the one found in the intra-EU BIT at issue in that case (which, in contrast to the ECT, explicitly required a tribunal to consider EU law) are not compatible with EU law.
[4] Request for a preliminary ruling from the Cour d’appel de Paris, Case C-741/19, Republic of Moldova v Komstroy, a company the successor in law to the company Energoalians, 8 October 2019, available here.
[6] France, Germany, Spain, Italy, The Netherlands and Poland.
[10] I.e., tribunals established to hear disputes arising under the under the EU-Canada Comprehensive Economic and Trade Agreement (“CETA”).
[11] Opinion 1/17 of the Full Court (CETA), ECLI:EU:C:2019:341, 20 April 2019, ¶¶ 116-118, available here.
[12] See Article 267 TFEU (the preliminary reference procedure).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Jeff Sullivan QC, Ceyda Knoebel, Stephanie Collins and Theo Tyrrell.
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, Judgment and Arbitral Award Enforcement or Transnational Litigation practice groups, or any of the following in London:
Cyrus Benson (+44 (0) 20 7071 4239, [email protected])
Penny Madden QC (+44 (0) 20 7071 4226, [email protected])
Jeff Sullivan QC (+44 (0) 20 7071 4231, [email protected])
Ceyda Knoebel (+44 (0) 20 7071 4243, [email protected])
Stephanie Collins (+44 (0) 20 7071 4216, [email protected])
Theo Tyrrell (+44 (0) 20 7071 4016, [email protected])
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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1. |
INTRODUCTION |
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1.1 |
Singapore has become an increasingly popular destination for trust listings in the recent years. Real estate investment trusts (“REITs”), business trusts (“BTs”) and stapled trusts are some of the more popular vehicles that property players opt for to tap capital on Singapore Exchange Securities Trading Limited (the “SGX-ST”). |
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1.2 |
This primer provides an overview of the structure of such vehicles, the main regulations regulating them, the process to getting listed on the SGX-ST as well as the various ways of acquiring control of these vehicles post-listing. This primer also explores the lessons to be learnt from the controversy surrounding Eagle Hospitality Trust (“EHT”) and the failed merger between ESR REIT and Sabana REIT. |
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2. |
STRUCTURE |
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2.1 |
REIT |
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2.1.1 |
A REIT may generally be described as a trust that invests primarily in real estate and real estate-related assets with the view to generating income for its unitholders. | |||||||||
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2.1.2 |
It is constituted pursuant to a trust deed entered into between the REIT manager and the REIT trustee. | |||||||||
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2.1.3 |
The REIT manager manages the assets of the REIT while the REIT trustee holds the assets on behalf of the unitholders and generally helps to safeguard the interests of the unitholders. | |||||||||
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2.1.4 |
REITs are popular with investors as the income from the assets (after deducting trust expenses) is distributed to the unitholders at regular intervals. A REIT which distributes at least 90% of its taxable income to its unitholders in the same year in which the income is derived can enjoy tax transparency treatment under the Income Tax Act, Chapter 134 of Singapore. It is also not uncommon for REITs to pledge to distribute the entire of its annual distributable income in the initial period post-listing. | |||||||||
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2.1.5 |
The typical roles in a REIT structure are as follows: | |||||||||
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Typical REIT Structure |
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2.1.6 |
SGX-ST-listed REITs typically adopt an external management model where the REIT manager is owned by the sponsor of the REIT. This is in contrast to an internal management model (adopted by a majority of REITs in the United States of America) where the REIT manager is instead owned by the REIT itself. Proponents of an internal management model in Singapore argue that an internal management model avoids conflicts of interest and lowers the fees payable to the REIT manager (which ultimately translates to better returns for unitholders). The success of the Hong Kong-listed internally managed Link REIT, Asia’s largest REIT in terms of market capitalization, may bear testament to this. However, whether an internal management model takes off in Singapore remains to be seen. Singapore investors could well prefer sponsor participation due to the various advantages that a sponsor can bring, such as marketability, expertise, support and pipeline of assets. |
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2.2 |
BT |
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2.2.1 |
A BT is a trust that can generally engage in any type of business activity, including the management of real estate assets or the management or operation of a business. | |||||||
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2.2.2 |
It is constituted pursuant to a trust deed entered into by the trustee-manager, a single entity that has the dual responsibility of safeguarding the interests of the unitholders of the BT and managing the business conducted by the BT. | |||||||
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2.2.3 |
BTs, unlike companies, can make distributions out of operating cash flows (instead of profits). They suit businesses which involve high initial capital expenditures with stable operating cash flows, such as real estate assets. | |||||||
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2.2.4 |
Compared to REITs, BTs are also more lightly regulated and may therefore be preferred for their flexibility. Property BTs often also pledge to provide REIT-like distributions to the unitholders. | |||||||
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2.2.5 |
The typical roles in a BT structure are as follows: | |||||||
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Typical Property BT Structure |
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2.3 |
Stapled Trust |
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2.3.1 |
A stapled trust on the SGX-ST typically comprises a REIT and a BT. Pursuant to a stapling deed, units of the REIT and units of the BT are stapled together and cannot be traded separately. The REIT and the BT would continue to exist as separate structures, but the stapled securities would trade as one counter and share the same investor base. | |
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2.3.2 |
A stapled trust structure may be preferred when an issuer wishes to bundle two distinct (but related) businesses into a single tradeable counter. Such stapled trust structure is commonly adopted for hospitality assets which provide both a passive (through the receipt of rental income from the lease of such assets) and an active (through the management and operation of such assets) income stream. | |
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2.3.3 |
In such cases, the REIT will be constituted to hold the income-producing real estate assets and the BT will be constituted to either (a) be the master lessee of the real estate assets who will manage and operate these assets or (b) remain dormant and only step in as a “master lessee of last resort” to manage and operate these assets when there are no other suitable master lessees to be found. The presence of a BT also offers flexibility for the stapled trust to undertake certain hospitality and hospitality-related development projects, acquisitions and investments which may not be suitable for the REIT. | |
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2.3.4 |
Investors who value the business and income diversification may therefore find such a model attractive. | |
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2.3.5 |
The typical roles in a REIT and a BT have been discussed above. |
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Typical Stapled Trust Structure |
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3. |
REGULATIONS | ||||||||||||||||||||||||
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3.1 |
REIT | ||||||||||||||||||||||||
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3.2 |
BT | ||||||||||||||||||||
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3.3 |
Stapled Trust | ||||
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4. |
LISTING | ||||||||||||||||||||||||||||||||||||||||||||||||||||
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4.1 |
Due Diligence | ||||||||||||||||||||||||||||||||||||||||||||||||||||
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4.2 |
Listing Process | ||||||||||||||||||||||||||
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4.3 |
Prospectus | ||||||||||||||||||||||||||||||||||||||||||||||||
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4.4 |
Continuing Listing Obligations | ||||||||||||||||||||||||||||||||||||||||||||
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Post-listing, REITs, BTs and stapled trusts are subject to continuing listing obligations under the Listing Manual, such as the requirement to announce specific and material information, requirements relating to secondary offerings, interested person transactions and significant transactions, as well as requirements relating to circulars and annual reports. | |||||||||||||||||||||||||||||||||||||||||||||
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4.5 |
Case Study of EHT | ||||||||||||||||||||||||||||||||||||||||||||
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5. |
Acquiring Control of a REIT, BT or Stapled Trust | ||||||||||||||||||||||||||||||||||||||||||||
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5.1 |
An acquisition of all the units of a REIT or BT or all the stapled securities of a stapled trust listed on the SGX-ST (“Target Entity”) may be effected in various ways, such as a take-over offer, a trust scheme of arrangement (“Trust Scheme”) and a reverse take-over (“RTO”). | ||||||||||||||||||||||||||||||||||||||||||||
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5.2 |
Any merger or acquisition involving a Target Entity would be subject to the Listing Manual, the CIS Code (in the case of a REIT) and the Singapore Code on Take-overs and Mergers (the “Take-over Code”). The Take-over Code is enforced by the Securities Industries Council (the “SIC”), which is part of the MAS. | ||||||||||||||||||||||||||||||||||||||||||||
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5.3 |
Take-over Offer | ||||||||||||||||||||||||||||||||||||||||||||
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5.4 |
Trust Scheme | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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5.5 |
RTO | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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5.6 |
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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors of this primer in the firm’s Singapore office:
Robson Lee (+65.6507.3684, [email protected])
Kai Wen Chua (+65.6507.3658, [email protected])
Zan Wong (+65.6507.3657, [email protected])
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