On February 14, 2022, the Department of Justice and U.S. Attorney’s Office for the Middle District of Florida announced they had reached a $5.5 million settlement with NCH Healthcare System (“NCH”) to resolve common law claims arising from NCH’s donations to local government entities—payments that the government alleged were used improperly to fund Florida’s share of Medicaid payments made to NCH.

NCH is a non-profit entity that operates two hospitals in Collier County, Florida. The government alleged that between October 2014 and September 2105, NCH provided free nursing and athletic training services to the Collier County School Board and paid other financial obligations on behalf of Collier County.[1] Under the government’s theory, these donations were designed to artificially increase Medicaid payments made to NCH without any corresponding expenditure of state or local funds on health care. Instead, the donations allowed the county and its local school board to avoid various expenditures, which left funds available to be paid to the State of Florida as its share of Medicaid payments owed to NCH. Under federal law, specifically 42 U.S.C. § 1396b(w)(2)(B), Florida’s share of Medicaid payments must consist of state or local government funds, and not “non-bona fide donations” from private health care providers. A non-bona fide donation triggers a corresponding federal expenditure for the federal share of Medicaid without any corresponding increase in state expenditures. This is prohibited by law to ensure that states pay their required share of Medicaid payments and are incentivized to prevent fraud, waste, and abuse in their Medicaid programs.[2]

Notably, the NCH settlement agreement released only common law claims of mistake and unjust enrichment, and the United States expressly reserved its rights to later bring claims under the False Claims Act (“FCA”) and other laws.[3] Of the $5.5 million settlement payment, just under $5 million was designated as “restitution” for tax purposes—suggesting that the parties agreed that NCH would pay a multiple of 1.1 times single damages, notwithstanding that the United States is limited to recovering single damages under common law theories.[4] By comparison, DOJ policy is to compromise False Claims Act claims for no less than double damages, with exceptions to go lower where the defendant demonstrates substantial cooperation with the government’s investigation. While it’s not necessarily the case that the narrow release in this case means that there will ultimately be subsequent FCA litigation, it does highlight that DOJ may be willing to pursue and settle cases involving potential allegations of health care fraud for less than double damages based on so-called “innocent” overpayments—albeit without an FCA release—where evidence of scienter may fail to meet the threshold for a viable FCA case.[5] Further, NCH agreed to fully cooperate with the government’s investigation of other potential defendants, including its officers and employees, and to provide the United States with all relevant non-privileged documents, including reports and interview memoranda, relating to the alleged conduct.[6]

The NCH settlement also signals that in-kind and monetary donations made to state and local entities may be at an increased risk of scrutiny by the Department of Justice. The NHS settlement comes amidst ongoing investigations and settlements involving donations made by pharmaceutical manufacturers to purportedly independent foundations and patient assistance programs, and could signal that the government might infer bad intent from a broader array of donations made by healthcare entities. Clearly, the government will not shy away from pursuing transactions under the fraud and abuse laws that it believes run afoul of regulatory requirements, even if such transactions confer public benefit. In light of these heightened risks, clients are advised to carefully scrutinize their donation practices, whether monetary or in-kind.

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[1] NCH Healthcare Settlement Agreement, Office of Pub. Affairs, U.S. Dep’t of Justice (Feb. 14, 2022) at recital B, https://www.justice.gov/opa/press-release/file/1471946/download; see also Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Florida’s NCH Healthcare System Agrees to Pay $55 Million to Settle Common Law Allegations (Feb. 14, 2022), https://www.justice.gov/opa/pr/florida-s-nch-healthcare-system-agrees-pay-55-million-settle-common-law-allegations.

[2] The federal government provides partial funding for state Medicaid programs through Federal Financial Participation (“FFP”) funding. 42 C.F.R. § 431.958. The amount of FFP funds each state is eligible for is based on the state’s own Medicaid expenditure amount, which may only include state or local government funds. 42 U.S.C. § 1396b(a). Non-bona fide donations from private health care providers, including in-kind services, may not be included in the calculation of the state’s own Medicaid expenditures. Id. §§ 1396b(w)(1)(a), (2)(B).

[3] NCH Healthcare Settlement Agreement, supra note 1, ¶ 3.

[4] See, e.g., U.S. ex rel. Robinson-Hill v. Nurses’ Registry & Home Health Corp., No. CIV.A. 5:08-145-KKC, 2015 WL 3403054, at *4 (E.D. Ky. May 27, 2015) (“Recovery on a claim for payment by mistake is limited to that portion of the payment in excess of the actual amount owed. Lastly, recovery on a claim for unjust enrichment is limited to the amount of the benefits improperly received by the defendant. Thus, with these common law claims, the United States may recover the amounts wrongfully or erroneously paid to defendants by the Medicare program, but the Government is not entitled to recover any penalties or punitive damages.”) (internal citations omitted).

[5] See also, e.g., Drakontas LLC Settlement Agreement, U.S. Atty’s Office for the Eastern Dist. of Pa. (May 3, 2016) at III.C–D, https://www.justice.gov/usao-edpa/file/849061/download (releasing only common law breach of contract, payment by mistake, and unjust enrichment claims when DOJ alleged defendant operated a non-compliant accounting system that resulted in the U.S. making improper and excessive payments).

[6] NCH Healthcare Settlement Agreement, supra note 1, ¶ 8.

The following Gibson Dunn lawyers assisted in the preparation of this alert: Jonathan M. Phillips, Winston Y. Chan, Brendan Stewart, and Emma Strong.

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 authors, or any member of the firm’s False Claims Act/Qui Tam Defense, FDA and Health Care, Government Contracts, or White Collar Defense and Investigations practice groups.

Washington, D.C.
Jonathan M. Phillips – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 202-887-3546, jphillips@gibsondunn.com)
F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com)
Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com)
Robert K. Hur (+1 202-887-3674, rhur@gibsondunn.com)
Geoffrey M. Sigler (+1 202-887-3752, gsigler@gibsondunn.com)
Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com)

San Francisco
Winston Y. Chan – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 415-393-8362, wchan@gibsondunn.com)
Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)

New York
Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com)
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A cross-office, cross-disciplinary Gibson Dunn team represents Shanghai Pudong Science and Technology Investment Co. (“PDSTI”) in matters related to its investment in ICON Aircraft, Inc. (“ICON”).

PDSTI, a Chinese investment company specializing in technology industries, obtained unconditional CFIUS approval in February 2022 for its 2017 investment in ICON, a U.S. manufacturer of recreational amphibious aircraft. Due to that investment, PDSTI holds 47% of ICON and has the right to appoint a majority of its board.

In June 2021, five U.S.-based ICON shareholders filed a derivative lawsuit against PDSTI and its affiliates, among others, in the Delaware Court of Chancery, alleging that the defendants are working to expropriate ICON’s assets to China. Before the PDSTI defendants moved to dismiss, the same shareholders reported PDSTI’s non-notified 2017 transaction to CFIUS, commencing a months-long process in August 2021. Gibson Dunn also represents the PDSTI defendants in the ongoing Delaware lawsuit.

Despite heightened U.S. government review of Chinese investments in recent years, PDSTI and ICON successfully obtained unconditional approval without any mitigation measures after a thorough and comprehensive review and investigation by CFIUS. The Wall Street Journal covered this matter and remarked that “[t]he outcome is … notable given how carefully [CFIUS] has been scrutinizing Chinese investment in U.S. technology in recent years.”

* * * *

The Gibson Dunn corporate team is led by Fang Xue. The Gibson Dunn CFIUS team includes Judith Alison Lee, Scott Toussaint, and Claire Yi, and former counsel Stephanie Connor. The Gibson Dunn litigation team includes Mark Kirsch, Jeffrey Rosenberg, Kevin White, and Andrew Ferguson. The Gibson Dunn restructuring team is led by David Feldman.

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The United States, the European Union, the United Kingdom, Australia, and Japan issued or announced sanctions targeting Russia and the Russia-backed separatist regions of Ukraine known as the Donetsk People’s Republic and the Luhansk People’s Republic. The United States took the first step by issuing broad jurisdiction-based sanctions on the two regions, similar to the existing sanctions on the Crimea region of Ukraine, and followed up with additional sanctions targeting Russia’s financial system. NATO allies also announced sanctions—including targeted designations by the United Kingdom and a sanctions package by the European Union—and non-NATO allies promised tough sanctions in close coordination. As tensions continue to rise, we will likely see more series of tools from the NATO countries and their allies to exert economic pressure on Russia to deescalate the ongoing crisis in Ukraine and withdraw its army from Ukraine’s borders.

Hear from our experts about these developments and how companies should proactively assess their exposure to the sanctions and export controls measures being discussed.

MODERATOR:

Judith Alison Lee is a partner in the Washington, D.C. office and Co-Chair of the firm’s International Trade Practice Group. Ms. Lee is a Chambers ranked leading International Trade, Export Controls, and Economic Sanctions lawyer practicing in the areas of international trade regulation, including USA Patriot Act compliance, economic sanctions and embargoes, export controls, and national security reviews (“CFIUS”). Ms. Lee also advises on issues relating to virtual and digital currencies, blockchain technologies and distributed cryptoledgers.

PANELISTS:

Patrick Doris is a partner in the London office whose practice includes transnational litigation, cross-border investigations, and compliance advisory for clients including major global investment banks, global corporations, leading U.S. operators in the financial sectors, and global manufacturing companies, among others. He advises financial sector clients and others on OFAC and EU sanctions violations, responses to major cyber-penetration incidents, and other matters relating to national supervisory and regulatory bodies.

Richard Roeder is an associate in the Munich office who was previously seconded to the Washington, D.C. office and worked with the firm’s U.S. sanctions and export control team and assisted clients in managing the challenges posed by the divergence between U.S. and EU economic and financial sanctions. He advises clients in the banking, insurance, automotive, mining, oil and gas, healthcare and information technology industries in the areas of sanctions, anti-money-laundering and anti-corruption compliance.

Adam Smith is a partner in the Washington, D.C. office and a highly experienced international trade lawyer. Mr. Smith previously served in the Obama Administration as the Senior Advisor to the Director of OFAC and as the Director for Multilateral Affairs on the National Security Council. Mr. Smith focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls.

Claire Yi is an associate in the Washington, D.C. office and a member of the firm’s International Trade and White Collar Defense and Investigations Practice Groups. Ms. Yi’s background includes having interned in the Compliance and Business Risk Department at the World Bank-International Finance Corporation, in the Office of the Inspector General at the State Department, and in the Office of the Legal Adviser at the State Department.

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Antitrust enforcers in the United States and abroad, traditionally, have applied relatively lenient scrutiny to mergers between a supplier or input provider and a customer (so-called “vertical transactions”). That stereotype, however, is now squarely in question. In the last year, the Federal Trade Commission (FTC) has challenged three proposed vertical transactions – two of which have been abandoned by the parties. And just last week, the Antitrust Division of the Justice Department filed suit to block another vertical transaction. This increased enforcement, combined with the 2021 withdrawal of the Vertical Merger Guidelines,[1] signals an era of uncertainty for certain kinds of vertical transactions that, in the past, would have closed with few if any remedies. In this alert, we discuss the agencies’ recent enforcement actions and the implications for companies considering vertical transactions.

Recent Challenges to Vertical Transactions

Lockheed-Aerojet. In January 2022, the FTC challenged Lockheed’s proposed acquisition of Aerojet, a supplier of missile propulsion systems used in missiles made by Lockheed and other defense prime contractors. The FTC alleged that the merger would lessen competition by giving Lockheed control over critical components that its rival prime contractors and propulsion suppliers need to compete. The FTC further alleged that Aerojet has access to competitively sensitive information about Lockheed’s rivals and the merger would grand Lockheed access to that proprietary information.[2]

In a similar transaction involving Northrop Grumman’s proposed acquisition of Orbital ATK, only a few years earlier in 2018, the parties settled similar agency concerns with behavioral remedies, including (i) a commitment to continue selling rocket motors to rivals; and (ii) an agreement to segregate the business with a firewall.[3] Reportedly, Lockheed and Aerojet proposed a firewall here, but the proposed remedy was rejected by the FTC.[4] The parties abandoned the transaction earlier this month after the FTC had filed suit, seeking to enjoin the deal.[5]

NVIDIA-Arm. In December 2021, the FTC sued to block semiconductor chip supplier NVIDIA Corp.’s acquisition of chip designer, Arm, Ltd. The FTC alleged the transaction would provide NVIDIA control over critical Arm technology and enable the merged firm to limit production and prevent Arm from licensing innovations that conflict with NVIDIA’s business interests. The FTC further alleged the merger would provide NVIDIA with competitively sensitive information regarding Arm licensees, many of which are NVIDIA competitors.[6]

This merger complaint was the first brought under the leadership of FTC Chair Lina Khan, after a lengthy investigation, in which, the Commission cooperated with other investigating authorities, including the United Kingdom’s Competition and Markets Authority (CMA), the European Commission (EC), and China’s State Administration for Market Regulations (SAMR).

Again, the parties offered remedies – here, to spin-off Arm’s licensing business as an independent entity, albeit under NVIDIA’s ultimate control – but they did not satisfy the FTC.[7] Reportedly, the FTC sought input from third-parties before rejecting the proposal, as it typically does.[8] In the UK, NVIDIA offered remedies during the Phase I review such as (i) equal access and open licensing for Arm’s intellectual property; and (ii) safeguards for confidential information. But these commitments were insufficient to prevent a Phase II investigation.[9] The parties abandoned the transaction earlier this month.

Illumina-Grail. In March 2021, the FTC challenged Illumina’s proposed acquisition of Grail, maker of a noninvasive, early cancer detection test. Illumina is the only provider of DNA sequencing products essential to these kinds of early detection tests, according to the FTC complaint. The FTC’s complaint further alleged that the merger would enable Illumina to raise the prices of Grail’s future competitors and impede their development of products that would rival Grail’s technology.[10] The agency originally filed a motion for preliminary injunction in federal court in May 2021, but withdrew the request, citing the reduced risk of the transaction in closing considering the ongoing EC review.^{^[11]} The EC took up a review upon a recommendation from several member states.

Illumina offered 12-year supply contracts to its customers with guarantees of continued supply and no price increases.[12] The companies also offered, supposedly, “far-reaching behavioral remedies” to the EC, but the details of these remedies were not made public.[13] The EC review remains ongoing and the FTC administrative trial is seeking to enjoin the transaction recently concluded, with a decision expected in the coming months.

Key Takeaways for Parties Considering Vertical Transactions

New Theories of Alleged Harm. While economic analysis has traditionally been used to demonstrate procompetitive benefits of vertical transactions to consumers (e.g., lower costs), the agencies in these cases allege that the potential for the merged firm to disadvantage market participants outweighs any potential benefits. The focus of the agencies’ claims appears to be on harm to others’ ability to compete. According to the agencies, such harm might arise where one or both of the merging parties has a high market share in its respective market.

Bipartisan Enforcement. Each of the three FTC challenges to a vertical transaction in the last year has followed a unanimous Commission vote. This bipartisan consensus indicates that we are likely to see a continued increase in challenges to M&A activity across all administrations.

Intra-Governmental Cooperation. Competition agencies regularly cooperate with other government agencies with relevant expertise. For example, in Lockheed’s proposed vertical acquisition of Aerojet, the U.S. Department of Defense reviewed the transaction and made undisclosed recommendations to the FTC.[14] In 2018, Broadcom’s hostile takeover of Qualcomm was halted by a presidential order because the transaction raised national security concerns.[15] In connection with NVIDIA’s proposed acquisition of Arm, the UK Secretary of State for Digital, Culture, Media, and Sports (DCMS) requested a public interest intervention and directed the CMA to review the transaction for national security concerns.[16] DCMS was particularly concerned with the integral role semiconductors play in the United Kingdom’s infrastructure, especially in defense and national security.

International Investigations and Cooperation. Vertical transactions are receiving heightened scrutiny from regulatory agencies around the world, including, most notably, the U.S. antitrust agencies, EC and European Union member states, and SAMR. Further, antitrust agencies across the globe are increasing cooperation. For example, in the NVIDIA-Arm transaction, the EC indicated it is “cooperating with competition authorities around the world.”[17] It appears that this increased cooperation may lengthen the merger review period. Coordination among agencies was the suspected reason behind the unprecedented eight-month SAMR pre-filing investigation.[18] And in the Illumina-Grail transaction, the EC has exercised the ability to take referrals from member states without those member states independently having jurisdiction to review the transaction under their own merger control regimes.[19]

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[1] Fed. Trade Comm’n, Statement of Chair Lina M. Khan, Commissioner Rohit Chopra, and Commissioner Rebecca Kelly Slaughter on the Withdrawal of the Vertical Merger Guidelines Commission File No. P810034 (Sept. 15, 2021), here.

[2] Compl. [Redacted-Public Version], In the Matter of Lockheed Martin Corp. and Aerojet Rocketdyne Holdings, Inc., Docket No. 9405 (Feb. 14, 2022), https://www.ftc.gov/system/files/documents/cases/d09405_-_assignment_of_joint_motion_to_dismiss_complaint_-_public_1.pdf, ¶¶ 12–15.

[3] Curtis Eichelberger, Confluence of government actors likely to place Lockheed, Aerojet merger under greater US scrutiny (Aug. 2, 2021), https://mlexmarketinsight.com/news-hub/editors-picks/area-of-expertise/antitrust/confluence-of-government-actors-likely-to-place-lockheed-aerojet-merger-under-greater-us-scrutiny.

[4] Lockheed Martin, Lockheed Martin Reports Fourth Quarter And Full Year 2021 Financial Results (Jan. 25, 2022), https://news.lockheedmartin.com/2022-01-25-Lockheed-Martin-Reports-Fourth-Quarter-and-Full-Year-2021-Financial-Results; Aerojet Rocketdyne, Aerojet Rocketdyne Holdings, Inc. Announces Update on Proposed Merger Transaction with Lockheed Martin (Jan. 25, 2022), https://www.rocket.com/article/aerojet-rocketdyne-holdings-inc-announces-update-proposed-merger-transaction-lockheed-martin.

[5] Aerospace, Lockheed Martin Cancels Aerojet Rocketdyne Merger After Antitrust Pressure (Feb. 14, 2022), https://dot.la/lockheed-martin-cancels-aerojet-rocketdyne-2656663782.html; see Fed. Trade Comm’n, Statement Regarding Termination of Lockheed Martin Corporation’s Attempted Acquisition of Aerojet Rocketdyne Holdings Inc. (Feb. 15, 2022), https://www.ftc.gov/news-events/press-releases/2022/02/statement-regarding-termination-lockheed-martin-corporations.

[6] Compl. [Redacted-Public Version], In the Matter of Nvidia Corp. SoftBank Group Corp., and Arm, Ltd., Dkt No. 9404 (Dec. 2, 2021), here, ¶¶ 7–12 .

[7] Flavia Fortes, Curtis Eichelberger and Austin Peay, Nvidia-Arm deal blocked by US FTC, remedies didn’t address concerns (Dec. 2, 2021), https://content.mlex.com/#/content/1341929.

[8] Id.

[9] Competition Markets and Authority, Digital Secretary asks CMA to carry out further investigation into NVIDIA’s takeover of Arm (Nov. 16, 2021), https://www.gov.uk/government/news/digital-secretary-asks-cma-to-carry-out-further-investigation-into-nvidias-takeover-of-arm.

[10] Compl. [Redacted-Public Version], In the Matter of Illumina Inc. and Grail Inc., Docket No. 9401 (March 13, 2021), here, ¶¶ 1, 11–14.

[11] Curtis Eichelberger and Austin Peay, Illumina closes Grail deal while EC continues review, US FTC trial starts Aug. 24 (Aug. 18, 2021), https://content.mlex.com/#/content/1317564.

[12] MLex, Illumina offers contract to customers for 12-year supply with guarantees of continued supply, no price increases (April 1, 2021), here; Curtis Eichelberger and Nicholas Hirst, Illumina, Grail fix for merger’s anticompetitive harms adopted by five companies (Nov. 2, 2021), https://content.mlex.com/#/content/1334057.

[13] Natalie McNellis, Illumina makes EU remedy offer for Grail acquisition; deadline extended to March 25 (Jan. 28, 2022), https://content.mlex.com/#/content/1354851.

[14] U.S. Dep’t of Defense, DoD Statement on Proposed Lockheed Martin and Aerojet Rocketdyne Merger (Jan. 25, 2022), https://www.defense.gov/News/Releases/Release/Article/2910941/dod-statement-on-proposed-lockheed-martin-and-aerojet-rocketdyne-merger/.

[15] Federal Register, Regarding the Proposed Takeover of Qualcomm Incorporated by Broadcom Limited (March 12, 2019), https://www.federalregister.gov/documents/2018/03/15/2018-05479/regarding-the-proposed-takeover-of-qualcomm-incorporated-by-broadcom-limited.

[16] Competition and Markets Authority, Proposed acquisition of ARM Limited by NVIDIA Corporation: public interest intervention (April 19, 2021), https://www.gov.uk/government/publications/proposed-acquisition-of-arm-limited-by-nvidia-corporation-public-interest-intervention.

[17] European Commission, Mergers: Commission opens in-depth investigation into proposed acquisition of Arm by NVIDIA (Oct. 27, 2021), https://ec.europa.eu/commission/presscorner/detail/pt/ip_21_5624.

[18] MLex Staff, Nvidia-Arm merger review clock officially begins in China (Jan. 25, 2022), https://content.mlex.com/#/content/1353624?referrer=content_seehereview.

[19] European Commission Press Corner, Mergers: Commission starts investigation for possible breach of the standstill obligation in Illumina / GRAIL transaction (Aug. 20, 2021), https://ec.europa.eu/commission/presscorner/detail/en/ip_21_4322.

The following Gibson Dunn lawyers prepared this client alert: Adam Di Vincenzo, Kirsten Limarzi, Rachel Brass, Stephen Weissman, Chris Wilson, and Jacqueline Sesia.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn attorney with whom you usually work in the firm’s Antitrust and Competition Practice Group, or the following:

Adam Di Vincenzo – Washington, D.C. (+1 202-887-3704, adivincenzo@gibsondunn.com)

Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, klimarzi@gibsondunn.com)

Chris Wilson – Washington, D.C. (+1 202-955-8520, cwilson@gibsondunn.com)

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

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

Ali Nikpay – Co-Chair, Antitrust & Competition Group, London (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)

Christian Riis-Madsen Co-Chair, Antitrust & Competition Group, Brussels (+32 2 554 72 05, criis@gibsondunn.com)

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In the current market environment, strong pre-IPO readiness can position companies to more swiftly access IPO market windows. This recorded presentation explores preliminary planning, structuring and governance considerations for private companies considering an IPO. Our lawyers also discuss alternative exit strategies and how steps taken to prepare for an IPO can be beneficial to companies that ultimately do not go public. Join our team of capital markets panelists in the first installment of our 2022 Series – IPO and Public Company Readiness.

PANELISTS:

Aaron Briggs is a partner in Gibson Dunn’s San Francisco office, where he works in the firm’s Securities Regulation and Corporate Governance practice group. Mr. Briggs’ practice focuses on advising public companies of all sizes (from pre-IPO to mega-cap), with a focus on technology and life sciences companies, on a wide range of disclosure, compliance, corporate governance, investor communications and ESG matters. Prior to re-joining the firm in 2018, Mr. Briggs served as Executive Counsel – Corporate, Securities & Finance at GE.

Evan M. D’Amico is a partner in Gibson Dunn’s Washington, D.C. office, where his practice focuses primarily on mergers and acquisitions. Mr. D’Amico advises companies, private equity firms, boards of directors and special committees in connection with a wide variety of complex corporate matters, including mergers and acquisitions, asset sales, leveraged buyouts, spin-offs and joint ventures. He also has experience advising issuers, borrowers, underwriters and lenders in connection with financing transactions and public and private offerings of debt and equity securities. Mr. D’Amico has particular expertise in advising special purpose acquisition companies (SPACs), operating companies and investors in connection with SPAC business combinations and financing transactions.

Julia Lapitskaya is a partner in Gibson Dunn’s New York office and a member of the firm’s Securities Regulation and Corporate Governance practice group. Ms. Lapitskaya advises clients on a wide range of securities and corporate governance matters, with a focus on SEC and listing exchanges’ compliance and reporting requirements, corporate governance best practices, annual meeting matters, shareholder activism, board and committee matters, ESG and executive compensation disclosure issues, including as part of initial public offerings and spin-off transactions.

Eric M. Scarazzo is a partner in Gibson Dunn’s New York office. He is a member of the firm’s Capital Markets, Securities and Regulation and Corporate Governance, Power and Renewables, Global Finance, and Mergers and Acquisitions practice groups. As a key member of the capital markets practice, Mr. Scarazzo is involved in some of the firm’s most complicated and high-profile securities transactions. Additionally, he has been a certified public accountant for over 20 years. His deep familiarity with both securities and accounting matters permits Mr. Scarazzo to play an indispensable role supporting practice groups and offices throughout the firm. He provides critical guidance to clients navigating the intersection of legal and accounting matters, principally as they relate to capital markets financings and M&A disclosure obligations.

Harrison Tucker is an associate in Gibson Dunn’s Houston office, where he currently practices with the firm’s Capital Markets, Mergers and Acquisitions and Securities Regulation and Corporate Governance practice groups. He represents public and private businesses in a broad range of corporate and securities matters. Mr. Tucker represents issuers and investment banking firms in both equity and debt offerings, including Rule 144A offerings. His practice also includes mergers and acquisitions and general corporate concerns, including Exchange Act reporting and corporate governance.

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The United States has now imposed additional new sanctions and sweeping export controls that not only target key pillars of the economies of Russia and Belarus but will also have significant collateral effects across a wide range of other sectors in Russia. These latest measures follow an initial tranche of sanctions announced on February 21 and 22, 2022, which we discussed in depth in our alert from last week. Following the surge of Russian troops into Ukraine in an invasion that the White House condemned as “an unprovoked and unjustified attack,” the new measures are significant in size and scope and range across targeting Russia’s largest financial institutions, restricting access to U.S. capital markets, restricting access to technology, and even designating President Vladimir Putin personally for blocking sanctions. Cumulatively, sanctions and export controls announced over the past week represent U.S. efforts to exert “unprecedented diplomatic and economic costs on Russia.” We enter the upcoming week with potentially more of these efforts in store—including the removal of select Russian banks from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) messaging system, as announced on February 26, 2022.

Sanctions on the Russian Economy

The new round of U.S. sanctions announced on February 24, 2022 includes “significant and unprecedented” action to impose a severe economic toll on the Russian economy, including measures that target almost 80 percent of all banking assets in Russia. The sanctions specifically target Russia’s two largest banks and also impose restrictions related to new debt and equity in more than a dozen Russian state-owned enterprises and large privately-owned financial institutions. Combined with the measures announced earlier in the week, these measures are designed to cut off large portions of the Russian economy from access to the U.S. financial system, crimping the ability of major Russian enterprises both to engage in dollar-denominated trade and to raise new capital.

Full Blocking Sanctions on VTB Bank and Other Financial Institutions

Pursuant to Executive Order (“E.O.”) 14024, the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) has enacted blocking sanctions on state-owned VTB Bank (“VTB”), Russia’s second-largest financial institution and the holder of almost 20 percent of Russia’s banking assets. As a result of this action, all of the bank’s property and interests in property that come within U.S. jurisdiction are frozen and, except as authorized by OFAC, U.S. persons are generally prohibited from engaging in transactions involving VTB. By operation of OFAC’s Fifty Percent Rule, similar restrictions apply to any entities that are owned, directly or indirectly, 50 percent or more by one or more blocked persons, including VTB. Notably, VTB is among the largest financial institutions that the United States has ever targeted with blocking sanctions.

In addition to VTB, the United States concurrently imposed blocking sanctions on Otkritie, Sovcombank, Novikombank, and dozens of their majority-owned subsidiaries.

Correspondent and Payable-Through Account Sanctions on Sberbank

In a further measure targeted at Russia’s financial sector, OFAC imposed correspondent and payable-through account (“CAPTA”) sanctions through new Directive 2 under E.O. 14024 on Sberbank, the largest financial institution in Russia and the main creditor of Russia’s economy. Although stopping short of full blocking sanctions like those imposed on VTB Bank—presumably on account of Sberbank’s sheer size and centrality to the Russian economy—effective as of March 26, 2022, U.S. financial institutions will be prohibited from opening or maintaining a correspondent or payable-through account for or on behalf of, or processing a transaction involving, Sberbank or any of its majority-owned subsidiaries. The practical effect of this measure is that Russia’s largest bank has been cut off from the U.S. financial system and U.S. dollar-denominated trade. The foreign financial institutions that are subject to CAPTA sanctions are identified on OFAC’s List of Foreign Financial Institutions Subject to CAPTA (“CAPTA List“).

Restrictions on New Debt and Equity

OFAC also issued Directive 3 under E.O. 14024 to place new debt and equity restrictions on 13 major Russian state-owned enterprises and financial institutions. Together, the targeted firms hold assets of nearly $1.4 trillion and will now be restricted from raising money in the U.S. capital market. In particular, these restrictions—which are broadly similar to the sectoral sanctions imposed on certain Russian enterprises in the wake of the Kremlin’s 2014 annexation of Crimea—prohibit transactions by U.S. persons or dealings within the United States involving new debt of longer than 14 days maturity and new equity issued by the following entities: Sberbank, AlfaBank, Credit Bank of Moscow, Gazprombank, Russian Agricultural Bank, Gazprom, Gazprom Neft, Transneft, Rostelecom, RusHydro, Alrosa, Sovcomflot, and Russian Railways. From a policy perspective, these measures are designed to severely limit Russia’s ability to raise new capital for its military activities in Ukraine.

Crucially, like existing sectoral sanctions on Russia, both of the new Directives announced by OFAC (Directives 2 and 3) are narrow in scope as both expressly provide that, absent some other prohibition, all other lawful U.S. nexus activities involving the targeted entities are permitted.

General Licenses

Concurrent with these sanctions, OFAC issued eight general licenses applicable under the Russian Harmful Foreign Activities Sanctions Program:

General License 5, “Official Business of Certain International Organizations and Entities,” authorizes transactions for the conduct of the official business of certain international organizations and entities.

General License 6, “Transactions Related to the Exportation or Reexportation of Agricultural Commodities, Medicine, Medical Devices, Replacement Parts and Components, or Software Updates, or the Coronavirus Disease 2019 (COVID-19) Pandemic,” authorizes certain transactions ordinarily incident and necessary to humanitarian trade in agricultural commodities, medicine, and medical devices.

General License 7, “Authorizing Overflight Payments, Emergency Landings, and Air Ambulance Services,” authorizes payment of charges for services rendered in connection with overflights of Russia or emergency landings in the Russia by aircraft registered in the United States or owned or controlled by U.S. persons.

General License 8, “Authorizing Transactions Related to Energy,” authorizes, until June 24, 2022, certain transactions related to energy involving five named Russian entities and their subsidiaries. Transactions “related to energy” is specifically defined to mean “the extraction, production, refinement, liquefaction, gasification, regasification, conversion, enrichment, fabrication, transport, or purchase of petroleum, including crude oil, lease condensates, unfinished oils, natural gas liquids, petroleum products, natural gas, or other products capable of producing energy, such as coal, wood, or agricultural products used to manufacture biofuels, or uranium in any form, as well as the development, production, generation, transmission, or exchange of power, through any means, including nuclear, thermal, and renewable energy sources.”

General License 9, “Authorizing Transactions Related to Dealings in Certain Debt or Equity,” authorizes, until May 25, 2022, dealings in debt or equity of five named Russian entities and their subsidiaries issued prior to February 24, 2022. Any divestment or transfer of debt or equity relying on this authority must be made to a non-U.S. person.

General License 10, “Authorizing Certain Transactions Related to Derivative Contracts,” authorizes, until May 25, 2022, the winding down of derivative contracts entered into with five named Russian entities and their subsidiaries prior to February 24, 2022. Any payments to a blocked person must be made into a blocked account.

General License 11, “Authorizing the Wind Down of Transactions Involving Certain Blocked Persons,” authorizes, until March 26, 2022, transactions ordinarily incident and necessary to the wind down of transactions involving Otkritie, Sovcombank, VTB, or any entity in which one of those persons owns a 50 percent or greater interest.

General License 12, “Authorizing U.S. Persons to Reject Certain Transactions,” authorizes, until March 26, 2022, U.S. persons to reject (rather than block) all transactions prohibited by E.O. 14024 involving certain blocked persons that are not authorized. Persons relying on this general license should review the implications for their rejected transaction reporting obligations to OFAC.

Sanctions on President Putin and Russian Elites

Following a meeting with NATO and other allies on Friday, February 25, 2022, OFAC designated Russian President Vladimir Putin, Minister of Foreign Affairs Sergei Lavrov, Minister of Defense Sergei Shoigu, and Chief of the General Staff Valery Gerasimov to the Specially Designated Nationals and Blocked Persons (“SDN”) List pursuant to E.O. 14024. With this designation, President Putin joins the “exceedingly rare” company—including North Korea’s Chairman Kim Jong Un, Syria’s President Bashar al-Assad, and Belarus’s President Alyaksandr Lukashenka—of sitting heads of states personally targeted by U.S. sanctions.

The announcement of sanctions against President Putin as an individual comes one day after OFAC also designated several members of the Russian elite—also called “enablers” of the President by OFAC—to the SDN List pursuant to E.O. 14024. Notably, OFAC designated Sergei Ivanov, Andrey Patrushev, and Ivan Sechin, all of whom are adult children of close Putin associates who had themselves either been previously designated or who were re-designated in connection with this latest round of sanctions. Additionally, OFAC designated several senior executives at state owned banks. In listing out the key Russian elites that have so far been designated, OFAC warned that it “will designate more in the future if Russia’s unprovoked campaign against Ukraine does not immediately conclude.”

Sanctions on Nord Stream 2 Pipeline

On February 23, 2022, OFAC designated to the SDN List Nord Stream 2 AG, the Swiss company in charge of an eponymous gas pipeline project that Germany halted the day before, as well as its chief executive officer. These designations were made under the authority provided by the Protecting Europe’s Energy Security Act of 2019, which the Biden administration had previously waived exercising in May 2021. In announcing this significant policy shift, President Biden applauded Germany for halting the certification of the pipeline project and noted that the two countries “closely coordinated our efforts to stop the Nord Stream 2 pipeline.” OFAC accompanied this designation with General License 4 that provides a short, one-week wind-down period that expires on March 2, 2022.

Sanctions on Belarusian Financial Institutions and Defense Sector

After Russian troops positioned in Belarus launched an invasion in Ukraine on February 24, 2022, OFAC responded that same day by imposing sanctions not just on Russia but also on 24 Belarusian entities and individuals. Compared to the sanctions imposed on Russia, these Belarus-focused sanctions remain highly targeted. However, designations of Belarusian entities and individuals indicate Treasury’s serious approach to any country that supports or facilitates Russia’s invasion of Ukraine. The sanctions issued on February 24, 2022 focus primarily on two sectors of the Belarusian economy: financial institutions and the defense sector.

Belarusian Financial Institutions

Pursuant to Executive Order 14038, OFAC designated the state-owned Bank Dabrabyt and Belarussian Bank of Development and Reconstruction Belinvestbank (“Belinvestbank”), along with two of Belinvestbank’s subsidiaries. E.O. 14038, issued in August 2021, authorizes blocking sanctions against persons determined by the U.S. Secretary of the Treasury, in consultation with the U.S. Secretary of State, “to be owned or controlled by, or to have acted or purported to act for or on behalf of, directly or indirectly, the Government of Belarus.” E.O. 14038 has previously been used to implement sanctions targeting “the degradation of democracy in Belarus” under the Lukashenka regime.

U.S. sanctions on certain Russian financial institutions (discussed above) are already expected to have a significant impact on the Belarusian economy. U.S. Secretary of the Treasury Janet Yellen commented that, “due to the interconnectedness between the two countries, the actions Treasury took against Russia [on Thursday, February 24, 2022] will also impose severe economic pain on the Lukashenka regime.” When combined with the designation of the two Belarusian banks, these sanctions targeted nearly 20 percent of Belarus’s entire financial sector.

Belarusian Defense Sector

OFAC also targeted Russia’s reliance on the Belarusian defense and related materiel sector by designating ten defense industry entities, as well as executives of some of those entities, pursuant to E.O. 14038. These designations build on OFAC’s December 2021 designation of five Belarusian defense firms “in response to the Lukashenka regime’s blatant disregard for international norms and the wellbeing of its own citizens.”

In addition to these entities, OFAC added two senior officials of the Belarusian government’s security apparatus—Belarusian Minister of Defense Viktor Khrenin and State Secretary of the Security Council of Belarus Aleksandr Volfovich—to the SDN List.

Belarusian Elites

Beyond targeting financial institutions and the defense sector, OFAC continues to target Belarusian elites who support the Lukashenka regime’s erosion of democracy in Belarus. The February 24, 2022 sanctions also included the designation of Aliaksandr Zaitsau and his company OOO Sokhra, which engages in gold mining and the promotion of Belarusian industrial products in Africa and the Middle East. According to OFAC, Zaitsau continues to maintain close ties to the Lukashenka family.

Concurrent with these designations of Belarusian entities and individuals, OFAC issued two general licenses related to the Belarus Sanctions Program:

General License 6, “Official Business of the United States Government,” authorizes all otherwise prohibited transactions for the conduct of the U.S. Government’s official business.

General License 7, “Official Business of Certain International Organizations and Entities,” authorizes transactions for the conduct of the official business of certain international organizations and entities.

Expansion of Export Controls Targeting Russia

The U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) on February 24, 2022 simultaneously issued a Final Rule on the Implementation of Sanctions Against Russia Under the Export Administration Regulations (“EAR”). The Final Rule uses several policy tools, each described below, to create a dramatic expansion of restrictions on exports, reexports, and in-country transfers to Russia.

Importantly, in a notable gesture of multilateral coordination, BIS incorporated several exclusions for “partner countries” in the restrictions. “Partner countries” refer to those countries that are adopting or have expressed intent to adopt substantially similar export controls measures to those the United States has adopted, and can be found in a list provided in Supplement No. 3 to Part 746 of the EAR. Currently, “partner countries” include the European Union member states, Australia, Canada, Japan, New Zealand, and the United Kingdom.

Expansion of Item-Based Licensing Requirements

The Final Rule imposes additional license requirements for export, reexport, and in-country transfer to Russia of all items with Export Control Classification Numbers (“ECCNs”) in Categories 3–9 of the Commerce Control List (“CCL”)—which include, among others, dual-use items used in electronics design, development and production, computers, telecommunications, manufacturing, aerospace, navigation, and marine applications. The new license requirements impact items described under 58 separate ECCNs that were not previously controlled for export to Russia, and BIS will review all such license applications with a presumption of denial unless the planned exports are in support of a short list of end uses, such as safety of flight. The expansion of items controlled for export to Russia also means that foreign-made items that incorporate U.S.-controlled content that were not previously subject to U.S. export control licensing requirements will now be subject to those requirements when destined for Russia, unless they are being exported from countries that are adopting export controls similar to those the United States has now adopted. As a result, companies exporting from many countries may now need to reassess whether their products have become subject to BIS licensing requirements due to these changes.

Additionally, in line with earlier sanctions announced on February 21, 2022, there are new license requirements that impose an effective trade embargo on all exports, reexports, and in-country transfers to the separatist regions of Ukraine—the so-called Donetsk People’s Republic (“DNR”) and Luhansk People’s Republic (“LNR”). The license requirements are applicable for all items subject to the EAR, other than food and medicine designated as EAR99 and certain EAR99 or ECCN 5D992.c software for Internet-based communications.

These changes went into effect on February 24, 2022.

Extension of Export Licensing Requirements to New Products Produced Using Controlled Software and Technology

The United States has long controlled certain foreign-made products that were produced directly from certain national security-controlled U.S. software and technology or from plants or components of plants that were produced from this software and technology. Because these controls, called Foreign Direct Product (“FDP”) rules, hinge on the use of controlled software and technology, they effectively extend U.S. export controls to products made outside of the United States that do not otherwise incorporate U.S. content. Under this rule, U.S. export controls could be applied not only to chips that incorporate U.S.-origin processors, but also to any chips that are manufactured using certain U.S. equipment.

In 2020, seeking a new way to restrict supply chains to Huawei affiliates designated on BIS’s Entity List, BIS created a new FDP rule to reach semiconductors, computers, and telecommunication items that were directly produced using U.S.-origin software, technology, plants, or major components of plants that were destined for supply chains that involved Huawei in almost any role. BIS defined the concept of “direct product” in an especially broad way to include not only any item that incorporates any part, component, or equipment produced using the defined items, but also to capture any item used in their production. Thus, even products that were merely tested using the controlled equipment would now require export licensing when Huawei-affiliated entities designated on BIS’s Entity List were involved. The few short regulatory provisions and footnotes that described this new rule sent trade compliance specialists scrambling, even within suppliers many tiers removed from Huawei, to determine whether the software, technology, or equipment they were using to make their products was export-controlled in ways that made their products suddenly subject to new U.S. export licensing requirements.

In the Final Rule announced on February 24, 2022, BIS has now created two new FDP rules that will impact not just a single company in Russia, but a broad swath of both low- and high-technology sectors in the Russian economy. The first is an FDP rule that applies to all exports, reexports, and in-country transfers ultimately destined for Russia (the “Russia FDP Rule”), and the second is an FDP rule that applies to all exports, reexports, and in-country transfers ultimately destined for Russian military end users (the “Russia MEU FDP Rule”). We compare these rules side-by-side in the below table.

Russia FDP Rule

Russia MEU FDP Rule

Export of foreign-produced item would require a license if it is:

Produced with certain U.S.-origin software or technology subject to the EAR (i.e., software or technology classified in CCL categories 3 through 9) or by certain plants or major components that are themselves the direct product of certain U.S.-origin software or technology subject to the EAR (again, software or technology classified in CCL categories 3 through 9);

AND

Ultimately destined to Russia or will be incorporated into or used in the production or development of any part, component, or equipment produced in or destined to Russia.

Export of foreign-produced item would require a license if it is:

Produced with any software or technology subject to the EAR that is on the CCL or by certain plants or major components that are themselves the direct product of any U.S.-origin software or technology on the CCL;

AND

Involves an entity with a “footnote 3 designation” on the Entity List as a party to the transaction, or there is knowledge that the item will be incorporated into or used in the production or development of any part, component, or equipment produced, purchased, or ordered by any entity with a “footnote 3 designation” on the Entity List.

Does not apply to foreign-produced items that would be designated as EAR99 (items not listed on the CCL), which includes many consumer items used by the Russian people.

Applies to all foreign-produced items, including those designated EAR99, with limited exceptions.

For the Russia MEU FDP Rule, the “footnote 3 designation” means that an entity will have, under the “license requirement” note on its Entity List designation, a citation that says “See § 734.9(g).³” Along with the creation of the Russia MEU FDP Rule, BIS immediately assigned the “footnote 3 designation” to nearly 50 entities, which means that a license is required to export, reexport, or transfer all FDP items to these entities and that license applications will be reviewed under a policy of denial. Forty-five of these entities, including the Ministry of Defence of the Russian Federation, were previously on the Commerce Department’s Military End User (“MEU”) List, but have now been moved to the Entity List, thus subjecting them to broader restrictions. Two new entities—the International Center for Quantum Optics and Quantum Technologies LLC, and SP Kvant—were newly added to the Entity List with footnote 3 designations.

Currently, all partner countries are fully excluded from the scope of both new FDP rules. This means that items produced in the partner countries would not be subject to the FDP rules’ licensing requirements.

Although BIS has given exporters until March 26, 2022 to comply with the new FDP rules, we expect that it will take many companies much longer to assess whether the items they are making are now subject to either of the two new Russia-specific FDP rules. Especially given the breadth of the Russia MEU FDP Rule, we expect that many companies outside of Russia will simply cease all supply to designated and potential military end users in Russia.

Expansion of Military End Use and Military End User Controls

The Final Rule also expands the existing Russia ‘military end use’ and ‘military end user’ controls to all items subject to the EAR, with limited exceptions. Previously, the ‘military end use’ and ‘military end user’ controls had applied only to a subset of items identified in Supplement No. 2 to Part 744 of the EAR. Now, these controls apply broadly, with limited exceptions for food and medicine designated as EAR99 and items classified as ECCN 5A992.c or 5D992.c, so long as they are not for Russian “government end users” or Russian state-owned enterprises.

License Review Policy and License Exceptions

License requests under these new requirements will be reviewed with a policy of denial with limited exceptions. Exceptions to the license review policy, which are specific to an ECCN’s reasons for control and would be reviewed on a case-by-case basis, are for applications related to safety of flight, maritime safety, humanitarian needs, government space cooperation, civil telecommunications infrastructure, government-to-government activities, and to support limited operations of partner country companies in Russia.

There may be certain license exceptions that apply to the exports, reexports, and in-country transfers to Russia, but many of these license exceptions are only available under limited circumstances. For example:

License exception TMP (Temporary Imports, Exports, Reexports, and Transfers in Country) is available for items for use by the news media.

License exception TSU (Technology and Software Unrestricted) is available for software updates to civil end users that are subsidiaries of, or joint ventures with, companies headquartered in the United States or partner countries.

License exception ENC (Encryption Commodities, Software, and Technology) is available for encryption items, but not if they are destined for Russian government end users and Russian state-owned enterprises.

License exception CCD (Consumer Communication Devices) is available for certain consumer communication devices, but not if they are destined for government end users or certain individuals associated with the government.

As a result, persons relying on these license exceptions would need to conduct due diligence on the end users to ensure that they are complying with the precise scope of the license exceptions.

No case-by-case license application review or license exceptions are available for items subject to licensing requirements under the Russia MEU FDP Rule.

Next Steps

On February 26, 2022, the White House, together with the European Commission, France, Germany, Italy, the United Kingdom, and Canada, issued a joint statement announcing their commitment to impose further sanctions in response to “Putin’s war of choice,” including the removal of select Russian banks from the SWIFT network, the principal messaging system for global financial institutions to send and receive transaction-related information. In response to concerns that Russia has built up its foreign reserves to withstand the blow of Western sanctions, the countries also committed to preventing the Russian Central Bank from deploying its international reserves in ways that undermine the impact of sanctions. Japan signed on the joint statement during its day on February 27, 2022, completing the entire G7’s support for these upcoming measures.

A constant subject of policy discussions since the 2014 annexation of Crimea, removal of Russian banks from SWIFT did not seem to be gathering global support until just days ago. The joint statement represents both a seismic shift in policy and an impressive example of multilateral coordination, and the countries will be launching a joint task force that would carry on the spirit of coordinated sanctions implementation by identifying and freezing assets of sanctioned persons. However, details of how to achieve the selective SWIFT removal or Central Bank restrictions are yet to be finalized, and we will be following closely for more announcements.

The next steps are now dependent on Russia’s next moves. In a matter of just one week, the U.S. Government has issued a new Executive Order, several directives, designations, and general licenses under three different sanctions programs, as well as new export controls regulations. These measures were an outcome of significant multilateral coordination, by what President Biden called “a coalition of partners representing well more than half of the global economy.” As Russia continues its military incursion further into Ukraine, more Western sanctions are on the horizon. Russia, in turn, will begin considering its counteractions to respond to Western financial pressure. Following the Western sanctions in 2014, Russia responded with restrictions on agricultural imports and gas flows to Europe—this time, more could be in store, including the criminalization of compliance with foreign sanctions. As industry strives to understand these wide-ranging and complex new sanctions and export controls, we are likely to see more guidance from the U.S. Government to help foreign investors and multinational companies navigate the changing—and challenging—regulatory landscape.

The following Gibson Dunn lawyers assisted in preparing this client update: Claire Yi, Scott R. Toussaint, Lindsay Bernsen Wardlaw, Jacob A. McGee, Sean J. Brennan, Judith Alison Lee, Adam M. Smith, and Christopher Timura.

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

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Decided February 24, 2022

Unicolors, Inc. v. H&M Hennes & Mauritz, LP., No. 20-915

Today, the Supreme Court held 6-3 that a copyright holder can file a copyright infringement suit even if its copyright registration application included inaccurate information that was the result of an innocent mistake of fact or law.

Background:

A copyright holder cannot bring an infringement suit unless it holds a valid copyright registration certificate. A certificate is valid even if it contains inaccurate information, unless the inaccuracy “was included on the application for copyright registration with knowledge that it was inaccurate” and, “if known, would have caused the Register of Copyrights to refuse registration.” 17 U.S.C. § 411(b). After Unicolors sued H&M for copyright infringement, H&M argued that Unicolors’ copyright registration certificate was invalid because Unicolors had knowingly included inaccurate information in its application by applying to register multiple works in a single application even though it had made those works separately available to clients and the public.

The district court ruled that a certificate is invalid under § 411(b) only if the applicant intended to defraud the Copyright Office, and Unicolors’ mistake of law did not evidence an intent to defraud. The Ninth Circuit reversed, holding that § 411(b) does not contain an intent-to-defraud requirement, and that Unicolors’ application contained factual information Unicolors knew was inaccurate. It was irrelevant, in the Ninth Circuit’s view, whether the inaccuracy was the result of Unicolors’ inadvertent misunderstanding of a principle of copyright law.

Issue:

Whether 17 U.S.C. § 411(b)’s “knowledge” requirement excuses inadvertent mistakes of fact or law.

Court’s Holding:

Yes. The “knowledge” element in § 411(b) requires a showing that the copyright registration applicant actually knew that the inaccurate information in its application was inaccurate, and excuses inaccuracies that were the result of an innocent mistake of fact or law.

“Lack of knowledge of either fact or law can excuse an inaccuracy in a copyright registration.”

Justice Breyer, writing for the Court

What It Means:

The Court’s decision means that copyright holders can defend inaccuracies in registration certificates on the ground that they were the product of an innocent mistake of either fact or law. The Court’s ruling could provide additional protection for copyright registrants such as novelists, poets, and painters who may be unfamiliar with the complexities of the Copyright Act or who in good faith reach incorrect conclusions about what the law requires.
Although copyright holders can file new registration applications to fix innocent inaccuracies, copyright claims have a three-year statute of limitations, and statutory damages and attorneys’ fees are available only for infringements that occur after a valid registration is in place. Today’s ruling potentially expands the scope of cases involving inaccurate copyright registrations.
The Court emphasized that willful blindness to an inaccuracy may constitute actual knowledge under § 411(b), and that circumstantial evidence—such as the significance of the error, the complexity of the relevant rule, and the applicant’s experience with copyright law—could influence whether the applicant was actually aware of, or willfully blind to, the inaccuracy.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

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On February 21 and 22, 2022, the United States, the European Union, the United Kingdom, Australia, and Japan issued and/or announced sanctions targeting Russia and the Russia-backed separatist regions of Ukraine known as the Donetsk People’s Republic (“DNR”) and the Luhansk People’s Republic (“LNR”). The United States took the first step by issuing broad jurisdiction-based sanctions on the two regions, similar to the existing sanctions on the Crimea region of Ukraine, and followed up with additional sanctions targeting Russia’s financial system. NATO allies also announced sanctions—including targeted designations by the United Kingdom and a sanctions package by the European Union—and non-NATO allies promised tough sanctions in close coordination. These actions are only among a few of several tools we expect the United States and its allies will use in the coming days and weeks as Russia continues to stoke military tension in the region.

These actions follow nearly a decade of lasting conflict in eastern Ukraine and a quick escalation over the past few weeks. After the 2014 Ukrainian revolution and the Euromaidan movement, which saw a pro-Western government elected in Ukraine, pro-Russia protests against the new government began in eastern Ukraine. These protests in the DNR and LNR regions eventually developed into full-scale fighting, with Russia backing the separatists against the Ukrainian military and more than 10,000 people killed in the conflict. Shaky ceasefires between the two sides have existed for several years, but in recent days, artillery shelling has increased along with other violations of the ceasefire agreements, with the Ukrainian government claiming that these attacks were orchestrated by Russia or pro-Russia separatists in the region.

In response to formal appeals from the de facto leaders of the breakaway regions for sovereign recognition from Russia, Russian president Vladimir Putin convened a meeting of his security council on Monday, February 21, 2022 under the pretext of seeking recommendations on how to answer the requests. After the meeting of the council, Putin delivered a televised address to the public, referring to eastern Ukraine as “historically Russian territory” and saying that it is “necessary to take a long overdue decision to immediately recognize the independence and sovereignty of the Donetsk People’s Republic and the Luhansk People’s Republic.” Immediately thereafter, Putin ordered Russian troops to enter the regions for a “peacekeeping” mission under the treaties of “friendship and mutual assistance” that Russia ratified that same day with the individual regions. All diplomatic efforts to maintain the territorial integrity of Ukraine while the parties sought to ease building tensions thus suffered a serious setback.

US Issues New Executive Order Imposing Sweeping Sanctions on Separatist Regions

Just hours after Putin’s televised speech, President Biden signed a new Executive Order issuing broad sanctions on the DNR and LNR regions of Ukraine, and any other regions of Ukraine as may be determined by the Secretary of the Treasury, in consultation with the Secretary of State (collectively, the “Covered Regions”). The Executive Order is nearly identical to Executive Order 13685 that announced comprehensive sanctions on the Crimea region of Ukraine in 2014.

First, the Executive Order prohibits: (1) new investment in the Covered Regions by a U.S. person; (2) import of any goods, services, or technology from these regions to the United States; and (3) export of any goods, services, or technologies from the United States or by a U.S. person to these regions. The Executive Order further prohibits U.S. persons from financing, facilitating, or guaranteeing transactions by foreign persons that U.S. persons would be prohibited from engaging directly.

Second, the Executive Order authorizes blocking sanctions on any person determined by the Secretary of the Treasury, in consultation with the Secretary of State, to be: (1) a person operating in the Covered Regions; or (2) a leader, official, senior executive officer, or board member of an entity operating in the Covered Regions. The Executive Order also authorizes sanctions on an entity determined to be owned or controlled by a blocked person pursuant to the Executive Order, or any person who has provided material support for a blocked person pursuant to the Executive Order. No such individual designations have yet been made, which is very similar to how OFAC responded at the inception of Executive Order 13685.

Concurrent with the signing of the Executive Order, OFAC issued six general licenses:

General License 17, “Authorizing the Wind Down of Transactions Involving the So-called Donetsk People’s Republic or Luhansk People’s Republic Regions of Ukraine” authorizes all prohibited transactions “that are ordinarily incident and necessary to the wind down of transactions involving” the Covered Regions until March 23, 2022.

General License 18, “Authorizing the Exportation or Reexportation of Agricultural Commodities, Medicine, Medical Devices, Replacement Parts and Components, or Software Updates to Certain Regions of Ukraine and Transactions Related to the Coronavirus Disease 2019 (COVID-19) Pandemic” authorizes the export of agricultural commodities, medicine, medical devices, replacement parts and components, or software updates to the Covered Regions. This authorization is similar to that of the existing General License 4 with respect to the Crimea region, but is more expansive in that it does not include the exclusions that are in General License 4 (e.g., export to military or law enforcement purchasers, certain agricultural commodities, and certain medicines), that it expands the scope to software updates in addition to replacement parts, and that it includes a separate COVID-19 authorization.

General License 19, “Authorizing Transactions Related to Telecommunications and Mail” authorizes transactions that are ordinarily incident and necessary to the receipt or transmission of telecommunications in the Covered Regions. This authorization is similar to the existing General License 8 with respect to the Crimea region.

General License 20, “Official Business of Certain International Organizations and Entities” authorizes official business of certain international organizations and entities in the Covered Regions. Of note, the list of international organizations includes the Organization for Security and Co-operation in Europe, an entity that has been actively seeking to de-escalate the conflict in recent days.

General License 21, “Authorizing Noncommercial, Personal Remittances and the Operation of Accounts” authorizes transactions that are ordinarily incident and necessary to the transfer of noncommercial, personal remittances to or from the Covered Regions. This authorization is similar to the existing General License 6 with respect to the Crimea region.

General License 22, “Authorizing the Exportation of Certain Services and Software Incident to Internet-Based Communications” authorizes export of certain services incident to the exchange of personal communications over the internet or software necessary to enable such services in the Covered Regions. This is similar to the existing General License 9 with respect to the Crimea region, but is more expansive in that it does not require the services and software to be widely available to the public with no cost to the user.

The issuance of these expansive general licenses is in line with the White House’s repeated messaging that the sanctions “are not directed at the people of Ukraine” or “the innocent people who live in the so-called DNR and LNR regions.” Particularly during the COVID-19 pandemic, the Biden administration has continued to include broad humanitarian exceptions in new sanctions measures, including those taken in response to the situations in Myanmar and Ethiopia. It is noteworthy that OFAC further created an expansive COVID-19 authorization for transactions related to the prevention, diagnosis, or treatment of the COVID-19 pandemic, without any specific definition or exception.

General License 17 is also consistent with OFAC’s past practices of allowing parties a period of time to adjust to significant new sanctions measures to minimize the immediate disruption to the global economy. Similar to the more recent wind-down licenses from OFAC, there is no requirement for U.S. persons participating in authorized transactions to file a report with OFAC, which reduces the administrative burden of relying on the license. However, the 30-day wind-down period is much shorter than the typical 60- to 90-day periods that OFAC has granted in announcing other sanctions measures. It is likely that future wind-down licenses from OFAC regarding sanctions targeting Russia will be similarly brief.

Parties planning to rely on these general licenses should note that all six general licenses expressly limit their authorizations to transactions and activities that are prohibited by this particular Executive Order. The general licenses do not authorize transactions with persons or entities designated pursuant to other sanctions programs. As a result, parties should be careful not to engage in transactions and activities that are prohibited under another authority, such as the sectoral sanctions under Executive Order 13662. Parties should also take note of the differences between the general licenses granted with respect to the Crimea sanctions and to the DNR and LNR sanctions, in case a counterparty is sanctioned under both Executive Order 13685 and the new Executive Order.

US Imposes Sanctions on Russian Financial Services Sector

On February 22, 2022, OFAC designated to the SDN List two financial institutions that it determined are crucial to financing the Russian defense industry—Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank (VEB) and Promsvyazbank Public Joint Stock Company (PSB)—along with 42 of their subsidiaries. OFAC also designated three individuals—Denis Aleksandrovich Bortnikov, Petr Mikhailovich Fradkov, and Vladimir Sergeevich Kiriyenko—who OFAC determined were “powerful Russians in Putin’s inner circle.”

All of the designations were made under the authority of the Executive Order 14024, which we discussed in depth in a previous update. Importantly, Executive Order 14024 had authorized blocking sanctions against persons determined to operate in certain sectors of the Russian economy, with specific sectors to be determined by the Secretary of the Treasury, in consultation with the Secretary of State. When Executive Order 14024 was issued in April 2021, OFAC had identified the technology sectors and defense and related materiel sector as potential targets of future designations. In the most recent action taken on February 22, 2022, OFAC additionally identified the financial services sector of the Russian economy, making it easier for the United States to use a single, consolidated sanctions tool to target the entire financial services sector. OFAC accompanied this determination with FAQ 964, noting that its determination merely lays the groundwork for future sanctions against persons that operate in the financial services sector, rather than actually serving as sanctions on the entire financial services sector.

Additionally, OFAC issued Directive 1A, amending and superseding Directive 1 that was issued under Executive 14024. Importantly, Directive 1A includes restrictions on the participation in the secondary market for ruble or non-ruble denominated bonds issued after March 1, 2022 by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance of the Russian Federation. As a result of this new Directive 1A, the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation have been designated to the Non-SDN Menu-Based Sanctions List.

Concurrent with these additional sanctions, OFAC issued two general licenses:

General License 2, “Authorizing Certain Servicing Transactions Involving State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank” authorizes all prohibited transactions “that are ordinarily incident and necessary to the servicing of bonds issued before March 1, 2022 by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance of the Russian Federation,” but to the extent that such transaction is not prohibited by the new Directive 1A.

General License 3, “Authorizing the Wind Down of Transactions Involving State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank” authorizes all prohibited transactions “that are ordinarily incident and necessary to the wind down of transactions involving” VEB for a 30-day period until March 24, 2022.

Again, parties planning to rely on these general licenses should note that the general licenses expressly limit their authorizations to transactions and activities that are prohibited by Executive Order 14024.

EU Announces Sanctions Package to be Implemented

The EU has announced, yet not formally issued, new sanctions on Russia. While in the morning of February 22, 2022, the presidents of the European Council and the European Commission had welcomed “the steadfast unity of [EU] Member States and their determination to react with robustness and speed,” the subsequent announcement of the specific contemplated measures was more limited in scope than expected by many and only came after a surprisingly lengthy meeting of EU Foreign Affairs Ministers. The formal issuance and implementation of the contemplated measures is now expected in the course of the week.

First, in what the EU has now referred to as “solid package” of “calibrated measures,” EU financial sanctions (broadly comparable to U.S. SDN designations) will target individuals and entities involved in the violations of international law by the Kremlin, including in the recognition of the Donetsk and Luhansk regions as independent entities.

Second, the EU will target banks that finance the Russian military apparatus and contribute to the destabilization of Ukraine. Such banks have not yet been named and will either be targeted via EU financial sanctions or via more limited EU economic sanctions (broadly comparable to U.S. SSI designations).

Third, the EU has announced that it plans to ban trade between the EU and the Donetsk and Luhansk regions by implementing comprehensive EU Economic Sanctions comparable to those implemented after the annexation by Russia of Crimea in 2014.

Finally, the EU announced new measures to restrain Russian efforts to raise further capital on EU’s financial markets by limiting respective access for the Russian state and government. Such measures will likely take the form of targeted EU Economic Sanctions and prohibit or at least limit dealings with, for example, transferable securities and money-market instruments with a certain maturity and prohibit making loans or credit to those targeted.

The EU also announced that it had prepared and stands ready to adopt additional measures at a later stage if needed in the light of further developments.

Germany Stops Certification of Nord Stream 2

As a first reaction, the German Chancellor Olaf Scholz announced that the certification of the Nord Stream 2 pipeline has been stopped, and thus the pipeline will not become operational until further notice. This action was perhaps the least expected response and carries significant practical impact. The Nord Stream 2 project was intended to supply energy from Russia to the European Union, and Germany—along with other EU member states—had so far contested any attempts to impose sanctions on the Nord Stream 2 project in light of Russian aggression, in part due to the European Union’s heavy reliance on energy sources from Russia. With this action, Germany sent a clear message that it stands ready to join severe sanctions against Russia.

United Kingdom Sanctions Russian Banks and Oligarchs

On February 10, 2022, the UK pre-emptively amended its legislation on Russia sanctions—the Russia (Sanctions) (EU Exit) Regulations 2019 (S.I. 2019/855) (the “UK Russia Sanctions Regulations”)—via the enactment of The Russia (Sanctions) (EU Exit) (Amendment) Regulations 2022 (SI 2022/123) (the “Amended Regulations”).

The Amended Regulations widened the scope of the UK Russia Sanctions Regulations by expanding its designation criteria. The designation criteria now include entities and individuals that are involved in “obtaining a benefit from or supporting the Government of Russia.” Previously, the UK could only impose travels bans or asset freezes on those involved in “destabilising Ukraine or undermining or threatening the territorial integrity, sovereignty or independence of Ukraine.”

For the purposes of the Amended Regulations, being “involved in obtaining a benefit from or supporting the Government of Russia” includes, among other things, carrying on business “of economic significance” or “in a sector of strategic significance” to the Government of Russia, those sectors being the Russian chemicals, construction, defense, electronics, energy, extractives, financial services, information, communications, digital technologies, and transport sectors. This is therefore a very significant expansion in the scope of the designation criteria which empowers the UK to impose sanctions on a wide range of businesses that may not necessarily have a strong nexus to the Russian government, save that the nature of their business and/or the sector(s) in which they operate are of economic significance to the Russian government.

Using its new powers under the Amended Regulations, the UK government updated the UK Sanctions List on February 22, 2022 by designating five Russian banks (Bank Rossiya, Black Sea Bank for Development and Reconstruction, Joint Stock Company Genbank, IS Bank, Public Joint Stock Company Promsvyazbank) as well as three wealthy individuals (Gennadiy Nikolayevich Timchenko, Boris Romanovich Rotenberg and Igor Arkadyevich Rotenberg) as being subject to an asset freeze.

The UK’s Prime Minister, Boris Johnson, has described this sanctions package as “the first tranche, the first barrage“ of what the UK is prepared to do. Foreign Secretary, Liz Truss, said in her statement that “this first wave of sanctions will hit oligarchs and banks close to the Kremlin. It sends a clear message that the UK will use [its] economic heft to inflict pain on Russia and degrade their strategic interests.” She further stated that “in the event of further aggressive acts by Russia against Ukraine,” the UK has prepared “an unprecedented package of further sanctions ready to go. These include a wide-ranging set of measures targeting the Russian financial sector, and trade.” However, for some in the UK, these measures do not go far enough, and Boris Johnson is under pressure to impose tougher sanctions.

Allies Outside NATO Join in Announcing Tough Response

Japan’s Minister of Foreign Affairs Hayashi Yoshimasa stated that Japan would continue to monitor the development of the situation in Ukraine with serious concern and coordinate a tough response, including sanctions in cooperation with the international community.

Australia’s Minister of Foreign Affairs declared that the Australian Government was coordinating closely with the United States, United Kingdom, European Union, and other governments around the world to ensure there were severe costs for Russia’s aggression and that, along with its partners, Australia was prepared to announce swift and severe sanctions that would target key Russian individuals and entities responsible for undermining Ukraine’s sovereignty and territorial integrity.

Possible Next Steps

There has been much speculation in recent days about the sanctions packages that would be revealed upon Russia’s invasion of Ukraine. So far, many world leaders have stopped short of calling Russia’s recognition of the two regions and his deployment of the Russian military to these regions a full-scale invasion, perhaps in part as an effort to deescalate tension or to leave space for additional sanctions if the situation worsens. However, the recent measures allow more authority for the Western countries to issue additional sanctions in case of further escalation—such as a new Executive Order that authorizes sanctions on persons operating in the separatist regions of Ukraine and a financial services sector determination that authorizes sanctions on persons operating in the Russian financial services sector. As tensions continue to rise, we will likely see more series of tools from the NATO countries and their allies to exert economic pressure on Russia to deescalate the ongoing crisis in Ukraine and withdraw its army from Ukraine’s borders. Companies should continue to pay attention to the ongoing developments and proactively assess their exposure to the sanctions and export controls measures being discussed.

In the lead up to the recent sanctions, leaders of the NATO countries engaged in close coordination and dialogue and had reported that they have “wrapped up“ and are “unified“ on potential sanctions packages to be used. However, we have seen varying degrees of severity and speed in the measures that each of the governments were able to impose immediately following the action from Russia. We expect there to be continued effort for coordination and convergence across the various jurisdictions, but we are closely tracking the differences in the sanctions imposed in different jurisdictions and the resulting compliance impact for companies operating in the global market.

The following Gibson Dunn lawyers assisted in preparing this client update: Claire Yi, Jacob A. McGee, Richard Roeder, Julian Reichert, Alexander Stahl, Kanchana Harendran, David A. Wolber, Judith Alison Lee, Adam M. Smith, Christopher Timura, Michael Walther, Benno Schwartz, Patrick Doris, and Attila Borsos.

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
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Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

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This past year was another busy one for Employee Retirement Income Security Act (“ERISA”) litigation, including significant decisions from the United States Supreme Court and the federal courts of appeals on issues impacting retirement and healthcare plans, coupled with the change in presidential administrations that resulted in new rules affecting ERISA plan sponsors and administrators.

Last year, Gibson Dunn also welcomed back Eugene Scalia as a partner to the Firm’s Washington, DC office after he served as the 28th U.S. Secretary of Labor from September 2019 to January 2021. Scalia’s return adds further depth to Gibson Dunn’s bench of elite ERISA litigators, who take an interdisciplinary approach to their work resolving complex matters for our clients, and bring together the Firm’s deep knowledge base and significant experience from across a variety of its award-winning practice groups, including: Executive Compensation & Employee Benefits, Class Actions, Labor & Employment, Securities Litigation, FDA & Health Care, and Appellate & Constitutional Law.

This year’s Annual ERISA Litigation Update summarizes key legal opinions and developments to assist plan sponsors and administrators navigating the rapidly changing ERISA litigation landscape.

Section I highlights two notable opinions from the United States Supreme Court rejecting a challenge to the individual mandate in the Affordable Care Act on standing grounds, and addressing the pleading standard in ERISA “excessive fee” fiduciary-breach cases. We are also watching pending petitions for certiorari concerning the application of ERISA’s fiduciary requirements to business transactions between plan administrators and third-party service providers, and ERISA preemption of state-run IRA programs for private-sector workers.

Section II delves into how the federal courts have applied the Supreme Court’s decision in Thole v. U.S. Bank, 140 S. Ct. 1615 (2020), addressing Article III standing in ERISA cases. We also discuss the implications for ERISA litigants of the Court’s recent decision on Article III standing in TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021).

Section III addresses the continuing impact of the Supreme Court’s decision in Rutledge v. Pharmaceutical Management Association, 141 S. Ct. 474 (2020), on the issue of ERISA preemption.

Section IV provides an analysis of how the federal courts are assessing the enforceability of arbitration agreements in ERISA plans.

Section V discusses how the courts continue to grapple with the standard of review for ERISA benefits claims.

Section VI offers an overview of the Department of Labor’s rule changes concerning environmental, social, and governmental (“ESG”) investing, and the implications of those changes for ERISA plan fiduciaries.

I. Key 2021 Supreme Court Decisions & Cases to Watch

The United States Supreme Court decided two cases in 2021 with significant implications for ERISA plans and their sponsors and administrators. In California v. Texas, 141 S. Ct. 2104 (2021), the Court dismissed a challenge to the Affordable Care Act (“ACA”) by holding that the plaintiffs lacked Article III standing to bring the suit. In Hughes v. Northwestern University, the Court held that allegations that a defined-contribution retirement plan breached ERISA’s duty of prudence by offering high-cost investment options may be actionable even if the plan also offers lower-cost options. But the Court declined to adopt an ERISA-specific pleading standard for these fiduciary-breach claims.

The Court has also ordered further briefing on pending petitions for certiorari in ERISA cases concerning the application of ERISA’s fiduciary requirements to arms-length contracts between a plan administrator and third-party service providers, and the scope of ERISA preemption over state-run programs that enroll private sector employees in retirement savings programs.

A. California et al. v. Texas et al. and Texas et al. v. California et al. Uphold the Affordable Care Act

In California v. Texas, 141 S. Ct. 2104 (2021) (consolidated with Texas v. California), the Supreme Court rejected on Article III standing grounds the latest challenge to the constitutionality of the ACA. In 2012, the Court rejected constitutional challenges under the Commerce Clause to the requirement in the ACA that individuals must maintain health insurance coverage, also known as the individual mandate. Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519 (2012). The Court reasoned that the ACA was not a command to buy health insurance—which Congress would lack the power to enact—but merely a tax for not doing so. Id. at 574–75.

In December 2017, Congress amended the ACA to eliminate the penalty for not buying health insurance, but did not eliminate the ACA’s individual mandate. Two individuals and several states, including Texas, then challenged the individual mandate as unconstitutional, arguing that because it no longer carried a penalty, it no longer qualified as a tax. They also argued that because the individual mandate is essential to the ACA, the entire statute must be struck down. When the Trump Administration declined to defend the ACA’s constitutionality, several states, including California, intervened to defend the statute and challenge the plaintiffs’ Article III standing. The Fifth Circuit held that the plaintiffs possessed standing and held that the individual mandate is unconstitutional. Texas v. United States, 945 F.3d 355, 377–93 (5th Cir. 2019), as revised (Dec. 20, 2019), as revised (Jan. 9, 2020), rev’d and remanded sub nom. California v. Texas, 141 S. Ct. 2104 (2021).

The Supreme Court reversed, holding that neither the individual plaintiffs nor the plaintiff states had Article III standing to challenge the individual mandate. See California, 141 S. Ct. at 2114–2116. The individual plaintiffs claimed that they satisfied the standing requirements because of the payments they have made and will continue to make to carry the minimum essential coverage that the ACA requires. But the Court reasoned that even if payments necessary to hold the insurance coverage required by the ACA were an injury, that injury would not be traceable to the government, because without any penalty for noncompliance, the statute is unenforceable against the individual plaintiffs. Id.

The Court likewise concluded that the states did not have Article III standing because they failed to show that their injuries were fairly traceable to unlawful government conduct. Id. at 2116. The states claimed they were indirectly injured by the mandate because it would cause more people to enroll in Medicaid or state employee health insurance programs. But the states failed to demonstrate “that an unenforceable mandate will cause their residents to enroll in valuable benefits programs that they would otherwise forgo.” Id. at 2119. Texas also asserted that it would bear increased direct costs because of ACA reporting and administrative requirements, but the Court found that these costs were not caused by the mandate and would remain even if it were struck down. Id. at 2119–20.

Justice Alito, joined by Justice Gorsuch, dissented, concluding instead that (1) the state plaintiffs possess standing in light of the increased regulatory and financial burdens from complying with the ACA, and they did not forfeit these claims, and (2) the individual mandate is unconstitutional and not severable from the rest of the ACA. Id. at 2124 (Alito, J., dissenting).

The decision is a significant one for ERISA because it eliminates, for now, some of the uncertainty around the validity of the ACA, including the ACA’s ERISA-specific requirements such as the large employer health insurance mandate. But the decision leaves unresolved the merits questions presented in the case—i.e., whether the individual mandate is constitutional or whether it is severable from the rest of the ACA—which the Court may be asked to revisit in future cases.

B. Hughes v. Northwestern University Addresses Pleading Standard in ERISA Fiduciary-Breach Suits

In Hughes v. Northwestern University, the Supreme Court reiterated in an unanimous decision that a district court’s review of a pleading challenge in an ERISA “excessive fees” fiduciary breach suit is a context-specific inquiry that requires courts to assess whether plaintiffs plausibly allege—under Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007)—that plan fiduciaries failed to monitor all plan investments and remove imprudent ones.

Northwestern University offered its employees defined-contribution retirement plans, in which the employees maintain individual investment accounts and choose how to invest their contributions. Hughes v. Nw. Univ., 142 S. Ct. 737, 740 (2022). Former and current employees of Northwestern alleged that the plans’ fiduciaries violated the duty of prudence under ERISA by providing employees with a menu of investment options that included allegedly high cost and poorly performing options that caused plan participants to incur excessive fees. Id. at 741. The plans also included the types of low-fee options that plaintiffs preferred. Id. at 741–42.

The Seventh Circuit affirmed the dismissal of petitioners’ claims for failure to plausibly allege a breach of fiduciary duty. Divane v. Nw. Univ., 953 F.3d 980, 993 (7th Cir. 2020). The court held in relevant part that Northwestern had complied with its duty of prudence by offering a menu of investment options that included low-cost funds, along with the other higher-cost options challenged in the complaint. Id. at 991–92.

Relying on Tibble v. Edison Int’l, 575 U.S. 523 (2015), the Supreme Court reversed, holding that the Seventh Circuit erred in dismissing the plaintiffs’ claims without making a “context-specific inquiry” that “take[s] into account [a fiduciary’s] duty to monitor all plan investments and remove any imprudent ones.” Hughes, 142 S. Ct. at 740. The Supreme Court reasoned:

[E]ven in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options. . . . If the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.

Id. at 742 (citing Tibble, 575 U.S. at 529–30). The Court remanded the case to the Seventh Circuit so that it could “reevaluate the allegations as a whole” and “consider whether petitioners have plausibly alleged a violation of the duty of prudence as articulated in Tibble, applying the pleading standard discussed” in Iqbal and Twombly. Id. Under that standard, plaintiffs must plead “enough facts to state a claim to relief that is plausible on its face.” Twombly, 550 U.S. at 570; see also Iqbal, 556 U.S. at 679 (allegations must “permit the court to infer more than the mere possibility of misconduct”). The Court concluded its opinion by addressing the importance of affording deference to plan fiduciaries, stating: “At times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” Hughes, 142 S. Ct. at 742.

Ultimately, the Court’s decision in Hughes was narrow. It did not establish a new pleading standard for ERISA fiduciary-breach claims, as petitioners had sought, nor did it set out the specific allegations that would be sufficient to plead a claim under plaintiffs’ fiduciary-breach theories. It is thus left to be seen whether this decision will pave the way for more “excessive fee” suits, whether the district courts will rely on Hughes to permit more cases to proceed to discovery, or whether the Supreme Court’s guidance concerning deference to plan fiduciaries will prompt courts to find that allegations that other investment options were theoretically available at a lower cost are not alone enough to withstand a pleading challenge.

C. Supreme Court Petitions to Watch

We are also monitoring three pending petitions for certiorari implicating ERISA issues. John Doe 1 v. Express Scripts Inc. (No. 21-471) and OptumHealth Care Solutions LLC v. Peters (No. 21-761) address the application of ERISA’s fiduciary requirements to arms-length transactions between a plan administrator and a third-party that provides services to a plan. Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Program (No. 21-558), concerns whether California’s auto-IRA program, which enrolls private-sector employees in a state-run retirement savings program, is preempted by ERISA.

1. John Doe 1 v. Express Scripts Inc. (No. 21-471)

In John Doe 1 v. Express Scripts Inc., health insurance policyholders seek to revive a proposed class action accusing Anthem and Express Scripts of violating fiduciary duties under ERISA by entering into a self-interested contractual arrangement that resulted in the plans and participants paying above-market prices for prescription drugs. The case arose from Anthem’s decision, as administrator of self-insured ERISA health plans, to sell its in-house pharmacy benefit management business to Express Scripts. Plaintiffs allege that in exchange for a substantially higher purchase price for the business, Anthem agreed to delegate to Express Scripts discretion to set the drug prices charged to Anthem customers, including prices that plaintiffs claim far exceeded industry standards.

Plaintiffs petitioned the Supreme Court to hear the case after the Second Circuit affirmed dismissal, holding that Anthem and Express Scripts were not acting as fiduciaries under ERISA when executing and acting upon the drug pricing contract. See Doe 1 v. Express Scripts, Inc., 837 F. App’x 44 (2d Cir. 2020). The Second Circuit relied in part on the Sixth Circuit’s decision in DeLuca v. Blue Cross Blue Shield of Mich., which held that an insurer did “not act[ ] as a fiduciary when it negotiated” rate changes for certain medical services, “principally because those business dealings were not directly associated with the benefits plan at issue but were generally applicable to a broad range of health-care consumers.” 628 F.3d 743, 747 (6th Cir. 2010). As to Anthem, the court explained that even if Anthem’s decisions “may ultimately affect how much plan participants pay for drug prices,” they were business dealings not directly associated with the plans they may ultimately have affected. Doe 1, 837 F. App’x at 49. The Second Circuit also agreed with the district court that Express Scripts did not act as a fiduciary when it set prices for prescription drugs, even though it had “extraordinarily broad discretion,” because “at bottom the ability to set such prices is a contractual term, not an ability to exercise authority over plan assets.” Id.

Plaintiffs petitioned for certiorari, contending that the Second and Sixth Circuit decisions had established an invalid, extra-statutory “business decisions” exemption from ERISA’s definition of “fiduciary,” causing a split with the Fourth, Fifth, Seventh, Eighth, and Ninth Circuits, which do not apply such an exemption. On December 13, 2021, the Supreme Court invited the Solicitor General to file a brief expressing the views of the United States. If the Court takes up this case, it could impact whether plan administrators and their contractors may face liability as plan fiduciaries when making business decisions, such as executing service-provider contracts, that affect prices paid by the plan or its participants.

2. OptumHealth Care Solutions, LLC v. Peters (No. 21-761)

In OptumHealth Care Solutions, LLC v. Peters, the Supreme Court has called for a response to a petition for a writ of certiorari by OptumHealth Care Solutions LLC addressing ERISA section 406(a)’s prohibition against certain “transactions” by plan fiduciaries involving a “party in interest.” The petition challenges a Fourth Circuit decision holding that a non-fiduciary service provider, with no preexisting relationship to a plan, may qualify as a “party in interest” by contracting with a plan fiduciary and getting paid under those contracts.

The case arises from an agreement by Aetna to pay OptumHealth Care Solutions, Inc. (“Optum”) to provide access to Optum’s networks of chiropractors and physical therapists for members of a self-funded health plan administered by Aetna. Peters v. Aetna Inc., 2 F.4th 199, 210 (4th Cir. 2021). Plaintiff alleges that instead of paying Optum out of the fees Aetna received from the plan, Aetna requested that Optum add its administrative fee to the claims submitted by Optum’s downstream health care providers. Id. This arrangement allegedly caused Optum’s fees to be passed on to plan members, instead of being paid by Aetna, as the plan allegedly required. Id. Among other theories, plaintiff claimed that Aetna’s contract with Optum violated ERISA’s prohibition on transactions with parties in interest. Id. at 213. The district court disagreed, concluding that Optum could not be liable as a party in interest because it had no preexisting relationships with either the plan or Aetna. Id.

The Fourth Circuit reversed, holding that Optum could be held liable “based on its apparent participation in and knowledge of Aetna’s administrative fee billing model.” Id. at 240. Because Optum lacked a prior relationship with the plan, the Fourth Circuit concluded that it was not a party in interest at the time it entered into the service agreement with Aetna. But the Fourth Circuit nonetheless held that a reasonable factfinder could find Optum liable as a party in interest when it performed the contract by providing services to the plan allegedly with knowledge of circumstances that rendered the billing arrangement with Aetna unlawful. Id.

Optum filed a cert petition, asking the Supreme Court to resolve the question of whether a service provider can qualify as a party in interest under ERISA section 406(a) if the provider lacks a preexisting relationship with the plan that is independent of the relationship created by the allegedly prohibited transaction. In its petition, Optum contends that the Fourth Circuit’s decision exposes plan fiduciaries and non-fiduciary service providers to litigation simply by engaging in and being paid under an arms-length services agreement, and thereby creates a split with the Tenth Circuit, which held in Ramos v. Banner Health, 1 F.4th 769, 784, 787 (10th Cir. 2021), that ERISA does not categorically prohibit plan fiduciaries from contracting with third-party service providers, and that such an interpretation of the statute would lead to “absurd result[s]” that would extend to “run-of-the-mill service agreements, opening plan fiduciaries up to litigation merely because they engaged in an arm’s length deal with a service provider.” In Ramos, the Tenth Circuit concluded that “some prior relationship must exist between the fiduciary and the service provider to make the provider a party in interest” under ERISA. Id. at 787. The Fourth Circuit’s decision in Peters would appear not to require evidence of a “prior relationship” to trigger prohibited transaction liability.

The Supreme Court sought a response from respondent on Optum’s petition for a writ of certiorari, suggesting the Court may want to weigh in on whether a “preexisting relationship” is required before a third-party contractor providing administrative services to a plan may qualify as a “party in interest.”

3. Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Program (No. 21-558)

We are also monitoring a pending petition for a writ of certiorari that asks the Supreme Court to review a preemption challenge to CalSavers, California’s state-run auto-enrollment IRA program. CalSavers is one of a handful state-run IRA programs for private sector workers. It applies to eligible employees of certain private employers in California that do not provide their employees with a tax-qualified retirement savings plan. Eligible employees are automatically enrolled in CalSavers, but may opt out. If they do not opt out, their employers must remit certain payroll deductions to CalSavers, which then funds the employees’ IRAs. California manages and administers the IRAs and acts as the program fiduciary.

Howard Jarvis Taxpayers Association challenged the CalSavers program, arguing that it is preempted by ERISA. The Ninth Circuit rejected this argument, concluding that ERISA does not preempt CalSavers, and relying in part on the Supreme Court’s decision in Rutledge v. Pharmaceutical Care Management Association, 141 S. Ct. 474 (2020). See Howard Jarvis Taxpayers Ass’n v. California Secure Choice Ret. Sav. Program, 997 F.3d 848, 863 (9th Cir. 2021). As we discussed in last year’s ERISA update, the Supreme Court held in Rutledge that ERISA did not preempt an Arkansas statute regulating the rates at which pharmacy benefit managers (“PBMs”) reimburse pharmacies for prescription drug costs because the law “is merely a form of cost regulation . . . [that] applies equally to all PBMs and pharmacies in Arkansas,” and therefore is not subject to ERISA preemption because it did not have an impermissible connection with or reference to ERISA. Rutledge, 141 S. Ct. at 481. In Howard Jarvis, the Ninth Circuit relied on the Supreme Court’s reasoning in Rutledge to hold that ERISA did not preempt CalSavers, reasoning that:

CalSavers is not an ERISA plan because it is established and maintained by the State, not employers; it does not require employers to operate their own ERISA plans; and it does not have an impermissible reference to or connection with ERISA. Nor does CalSavers interfere with ERISA’s core purposes.

997 F.3d at 852–53. In so holding, the Ninth Circuit rejected plaintiff’s argument that CalSavers is preempted because it “competes with” ERISA plans and will “frustrate, not encourage the formation of” ERISA plans. Id. at 864. The court concluded that the Supreme Court’s decision in Rutledge made clear that “‘ERISA does not pre-empt’ state laws that ‘merely increase costs or alter incentives for ERISA plans without forcing plans to adopt any particular scheme or substantive coverage.’” Id. (quoting Rutledge, 141 S. Ct. at 480).

The Supreme Court requested the CalSavers program to respond to a petition for a writ of certiorari filed by Howard Jarvis Taxpayers Association. A decision by the Court in this case may have far-reaching impact for the viability of state-run auto-IRA programs that are proliferating throughout the country, including in Colorado, Connecticut, Illinois, Maryland, New Jersey, and Oregon. For further discussion of how courts of appeals have applied Rutledge, including further discussion of the Ninth Circuit’s decision in Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Program, see infra Section III.

II. Article III Standing in ERISA Cases Under Thole v. U.S. Bank and TransUnion LLC v. Ramirez

As we addressed in our update last year, Article III standing continues to be a key issue for ERISA litigants. Here we analyze how the federal courts are implementing the Supreme Court’s Article III standing decisions in Thole v. U.S. Bank, 140 S. Ct. 1615 (2020), and TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021), in the ERISA context.

In Thole, the Supreme Court held that participants in a fully funded defined-benefit pension plan lacked Article III standing to sue under ERISA for breach of fiduciary duties because, while the plan lost $750 million due to the fiduciaries’ alleged breach, the participants had no “concrete stake in the lawsuit.” Thole, 140 S. Ct. at 1618–19. Plaintiffs continued to receive all of their vested benefits to which they were legally entitled, and those “benefits are fixed and will not change, regardless of how well or poorly the plan is managed.” Id. at 1620, 1622. The Court’s decision in Thole means that plaintiffs do not have standing to bring a breach of fiduciary duty claim against a defined-benefit plan unless they have suffered a concrete injury such as the plan’s failure to make the required benefit payments. Id. at 1619.

In the year and a half since Thole came down, the courts of appeals have generally declined to extend Thole outside the defined-benefit plan context. However, at least one district court has taken a broader view and applied Thole in the context of employer-sponsored health plans, finding plaintiffs lacked standing because they could not allege that their own claims for benefits were impaired by cross-plan offsetting.

In Ortiz v. American Airlines, Inc., the Fifth Circuit declined to extend Thole to claims of breach of fiduciary duty brought by plan participants in a defined-contribution retirement plan. 5 F.4th 622, 629 n.9 (5th Cir. 2021). In relevant part, plaintiffs alleged that defendants should have offered a stable-value investment option in their plan, and that plaintiffs lost investment income by investing in the lower return option in their plan. Id. at 629. Defendants argued that Thole should preclude Article III standing because the plaintiffs did not have a cognizable injury giving them a concrete stake in the lawsuit. Id. The Fifth Circuit disagreed, explaining that Thole “explicitly drew a distinction between a defined-benefit plan and a defined contribution plan, such as a 401(k), in which the retirees’ benefits are typically tied to the value of their accounts, and the benefits can turn on the plan fiduciaries’ particular investment decisions.” Id. (quotation markss omitted). Here, however, the court noted that plaintiffs had presented evidence that the plan fiduciaries’ decisions, although affecting the plan as a whole, resulted in “lost investment income” to their individual accounts that was concrete and redressable for purposes of standing. Id. at 629.

The Third Circuit will have the opportunity to decide an appeal raising a similar issue in the near future. In Boley v. Universal Health Services, Inc., 498 F. Supp. 3d 715 (E.D. Pa. 2020), plaintiffs allege that fiduciaries for their defined-contribution retirement plan imprudently offered high-fee investment options in the plan, resulting in the plan and its participants paying excessive fees. Id. at 718. Plaintiffs alleged that they invested in only seven of the plan’s many fund offerings during the putative class period, and defendants argued that under Thole, plaintiffs lacked standing to bring claims as to the remaining funds, because plaintiffs could not show a personal injury to their individual account balances due to the performance of the funds in which they did not invest. Id. at 719. The district court disagreed, concluding that plaintiffs had standing to challenge funds in which they did not invest because, unlike in Thole, plaintiffs’ claims alleged, among other things, a “[p]lan-wide breach as to process,” and this “imprudent process forced [plaintiffs], and all Plan participants, to choose from an expensive menu of investment options” that injured all plan participants, including plaintiffs. Id. at 719, 721, 723–24 (quotation marks omitted). Defendants have appealed this decision, with argument held on February 11, 2022. See generally Boley v. Universal Health Svcs., Inc., No. 21-2014 (3d Cir.). Thus, like the Fifth Circuit in Ortiz, the Third Circuit will have to decide whether allegations of injury stemming from fiduciaries’ alleged retention of imprudent investment options—thereby causing a plan to generate less investment income for its participants—are sufficient to satisfy Article III standing even where the named plaintiffs do not allege they invested in the challenged funds.

Last year, the Second Circuit also had the opportunity to weigh in on the breadth of Thole. In Gonzales de Fuente v. Preferred Home Care of New York LLC, the court affirmed dismissal of plaintiffs’ complaint on standing grounds where plaintiffs were participants in a defined-benefit health plan who claimed breach of ERISA fiduciary duties due to alleged misappropriation of employer contributions to the plan, which plaintiffs contended should have been used to provide them a superior plan. 858 F. App’x. 432 (2d Cir. 2021). The case implicated New York’s wage parity law, which forbids employers from retaining any “portion of the dollars spent or to be spent to satisfy the wage or benefit portion” of employee compensation. Id. at 434 (quoting N.Y. Pub. Health Law § 3614-c(5)(a)). Plaintiffs argued that the New York law made their status under ERISA more like that of defined contribution plan participants, and they argued they suffered “concrete injuries in the form of increased out-of-pocket costs and reduced coverage.” Id. at 433. In rejecting this argument, the Second Circuit relied on Thole to hold that plaintiffs lacked standing to bring their ERISA claims because they had received, and would receive, all promised benefits under their health plan, and any compensation plaintiffs may have been entitled to under the New York law was separate from their ERISA claim. Id. at 434.

The United States District Court for the District of Minnesota reached a similar result in Scott v. UnitedHealth Group, Inc., 540 F. Supp. 3d 857, 859 (D. Minn. 2021). The court rejected plaintiffs’ argument that they had standing to challenge their employers’ health plans’ practice of cross-plan offsetting because their plans are funded in part by their payroll contributions. Id. at 862. The court found that, as in Thole, the “plaintiffs do not have any claim to the plans’ assets; instead, their only claim is to receive the benefits to which they are entitled” under the plans. Id. at 863. Thus, the court found that rather than being a defined contribution plan, an employer-sponsored health plan is “closely analogous” to a defined-benefit plan. Id. at 864. Applying Thole, the court held that plaintiffs did not have standing because they could not allege that any of their own claims for benefits had been denied due to the alleged cross-plan offsetting. Id. at 865.

The Supreme Court further clarified the requirements for Article III standing last year in TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021), limiting the size of a putative class action alleging violations of the Fair Credit Reporting Act (“FCRA”) for failing to ensure that information on TransUnion’s credit reports is accurate before disseminating them. Id. at 2200. Even though most class members did not suffer an injury from the disclosure of their credit reports to third parties, the Ninth Circuit affirmed certification of the class and concluded that all class members had Article III standing to recover damages because of the mere “risk of harm to their concrete privacy, reputational, and informational interests protected by the FCRA.” Id. at 2202; id. at 2216 (Thomas, J., dissenting) (emphasis added).

The Supreme Court reversed in part, narrowing the class to plaintiffs who could establish Article III standing, reasoning that “Article III does not give federal courts the power to order relief to any uninjured plaintiff” regardless of whether they are part of a class. Id. at 2208 (Kavanaugh, J.) (quoting Tyson Foods, Inc. v. Bouaphakeo, 577 U.S. 442, 466 (2016) (Roberts, C.J., concurring)). The Court explained that the violation of a federal statute is not, alone, sufficient to confer standing under Article III, id. at 2206, but may be sufficient if the harm alleged has a “‘close relationship’ to a harm traditionally recognized as providing a basis for a lawsuit,” id. at 2200. Here, the Court explained, plaintiffs whose credit reports bearing misleading information had been disclosed to third parties could establish Article III standing based on reputational harm analogous to the traditional tort of defamation. Id. at 2205, 2209. But the Court held that the rest of the plaintiffs—whose credit reports were not disseminated to third parties—lacked standing to seek damages because they merely faced, at most, a “risk of future harm.” Id. at 2210. Although “a person exposed to a risk of future harm may pursue forward-looking, injunctive relief to prevent the harm from occurring, at least so long as the risk of harm is sufficiently imminent and substantial,” the Court held that “in a suit for damages, the mere risk of future harm, standing alone, cannot qualify as a concrete harm—at least unless the exposure to the risk of future harm itself causes a separate concrete harm.” Id. at 2210–11.

These holdings may have significant consequences in ERISA cases. In ERISA class actions, TransUnion appears to require Plaintiffs to establish that each class member suffered an Article III injury, potentially raising individualized inquiries that could impede class certification. Further, TransUnion clarifies the standard for establishing Article III standing, potentially limiting ERISA claims premised on purely procedural injuries or risk of future harm in actions seeking damages or other retrospective relief. Taken together, the Thole and TransUnion decisions give ERISA defendants paths to argue (1) that plan participants lack concrete harm sufficient to confer Article III standing, and (2) for limits on available remedies.

III. Impact of the Supreme Court’s Decision in Rutledge v. Pharmaceutical Care Management Association on ERISA Preemption

As we anticipated in our 2020 ERISA Update, the Supreme Court’s decision in Rutledge v. Pharmaceutical Care Management Association, 141 S. Ct. 474 (2020) has played a significant role over the last year-and-a-half in litigation concerning ERISA preemption of state laws. Subject to certain exceptions, ERISA preempts any state law that “relate[s] to” an ERISA plan, 29 U.S.C. § 1144(a), meaning that the law has either a “connection with” or a “reference to” ERISA plans, Egelhoff v. Egelhoff ex rel. Breiner, 532 U.S. 141, 147 (2001) (citation omitted). A state law has an impermissible connection with ERISA plans if it “governs … a central matter of plan administration or interferes with nationally uniform plan administration.” Gobeille v. Liberty Mut. Ins. Co., 577 U.S. 312, 320 (2016) (internal quotation marks and citation omitted). And a state law impermissibly refers to ERISA plans if it “acts immediately and exclusively upon ERISA plans” or “the existence of ERISA plans is essential to the law’s operation.” Id. at 319–20 (citation omitted).

In Rutledge, the Court applied these principles to an Arkansas statute regulating the rates at which pharmacy benefit managers (PBMs), acting as middlemen between ERISA plans and pharmacies, reimburse pharmacies for prescription drug coverage. 141 S. Ct. at 478. Although PBMs generally pass drug prices on to plans, the Court held that “ERISA does not pre-empt state rate regulations that merely increase costs or alter incentives for ERISA plans without forcing plans to adopt any particular scheme of substantive coverage.” Id. at 480. The Court explained that the statute in question did not have an impermissible connection with ERISA plans because it merely regulated the cost of covered prescription drugs, not plan choices about which drugs to cover. Id. at 481. The Court also explained that the statute did not “refer to” ERISA plans because it affected plans only indirectly and it “regulate[d] PBMs whether or not the plans they service fall within ERISA’s coverage.” Id.

Last year, the Eighth, Seventh, and Ninth Circuits, as well as a number of district courts, had the opportunity to apply Rutledge, and these decisions suggest the courts are taking a narrower view of ERISA preemption.

In Pharmaceutical Care Management Association v. Wehbi, 18 F.4th 956, 964 (8th Cir. 2021), the Supreme Court vacated an earlier Eighth Circuit decision and directed the court to reconsider the case in light of Rutledge. As in Rutledge, Wehbi involved a preemption challenge to a state statute regulating in various ways the relationship between PBMs and pharmacies. Id. Most notably, the law “limit[ed] the accreditation requirements that a PBM may impose on pharmacies as a condition for participation in its network.” Id. at 968. The Eighth Circuit had initially held that the statute was preempted because it had an impermissible “reference to” ERISA, in that the statute’s “definitions of and references to ‘pharmacy benefits manager,’ ‘third-party payer,’ and ‘plan sponsor’” either referenced ERISA plans or were “taken verbatim” from ERISA. Pharm. Care Mgmt. Ass’n v. Tufte, 968 F.3d 901, 905 (8th Cir. 2020). But on remand neither party disputed that Rutledge had undercut any argument for “reference to” preemption. 18 F.4th at 969–70. The Eighth Circuit recognized this shift in the law, explaining that while “[p]reviously, circuit precedent held that the existence of ERISA plans is essential to a law’s operation if the law can apply to an ERISA plan,” now “the existence of ERISA plans is essential to a law’s operation only if the law cannot apply to a non-ERISA plan.” Id. at 969 (emphases added).

The briefing on remand focused on “connection with” preemption. The Eighth Circuit held, however, that the statute was not preempted on that basis. Id. at 970. Addressing a recurring issue, the panel explained that “the challenged provisions do not escape preemption” simply because “they regulate PBMs rather than plans.” Id. at 966. But the panel nonetheless concluded that the statute—including its limited accreditation requirements—was not preempted because it “constitute[d], at most, regulation of a noncentral ‘matter of plan administration’ with de minimis economic effects and impact on the uniformity of plan administration across states.” Id. at 968–69 (citation omitted). In upholding North Dakota’s authority to restrict the accreditation requirements a PBM may impose on pharmacies as a condition of participation in its network, the decision raises important questions about the ability of states to regulate membership in plan networks in both the pharmacy and medical treatment contexts.

Courts have also applied Rutledge in other contexts. For instance, in Halperin v. Richards, 7 F.4th 534 (7th Cir. 2021), the Seventh Circuit considered whether ERISA preempts state law claims against a company’s “directors and officers who serve[d] dual roles as both corporate and ERISA fiduciaries.” Id. at 539. The plaintiffs—creditors of a company undergoing bankruptcy proceedings—alleged that the company’s directors and officers had conspired with the trustee for the company’s ERISA-covered employee stock ownership plan to inflate the valuations of the company’s stock to drive up their own pay, which was tied to the stock ownership plan valuations. Id. The defendants argued that the claims were preempted because the company’s “valuations were governed by ERISA” and they acted solely in their ERISA roles when evaluating the company’s stock. Id. at 540. The Seventh Circuit concluded, however, that ERISA did not preempt these claims against the directors and officers, explaining that Rutledge stands for the proposition that “[s]ome parallel state rules … are not preempted,” id. at 541, and holding that “ERISA contemplates parallel state-law liability against directors and officers serving dual roles as both corporate and ERISA fiduciaries,” id. at 542. The court nonetheless held that ERISA preempted the claims against the trustee and its non-fiduciary contractor, as claims against those individuals “would interfere with the cornerstone of ERISA’s fiduciary duties.” Id. at 539.

The Ninth Circuit also relied on Rutledge in the decision at issue in the petition for a certiorari in Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Program, which is discussed supra in Section 1.C.2. See Petition for Writ of Certiorari, Howard Jarvis Taxpayers Ass’n v. CA Secure Choice Ret. Program (No. 20-15591).

A number of district court decisions have also applied Rutledge to find that ERISA does not preempt various state laws and claims. See, e.g., ACS Primary Care Physicians Sw., P.A. v. UnitedHealthcare Ins. Co., 514 F. Supp. 3d 927, 941–42 (S.D. Tex. 2021) (emergency care statutes); Emergency Physician Servs. of New York v. UnitedHealth Grp., Inc., 2021 WL 4437166, at *2, 8–9 (S.D.N.Y. Sep. 28, 2021) (breach of implied-in-fact contract and unjust enrichment claims for failing to reimburse emergency services at a reasonable rate ); Emergency Servs. of Oklahoma, PC v. Aetna Health, Inc., 2021 WL 3914255, at *1–3 (W.D. Okla. Aug. 24, 2021) (same); Elena v. Reliance Standard Life Ins. Co., 2021 WL 2072373, at *2–4 (S.D. Cal. May 24, 2021) (intentional infliction of emotional distress claim based on post-traumatic stress disorder intensified by “ridicule” suffered from third-party claim administrator’s agent with regards to disability coverage claim); Sarasota Cnty. Pub. Hosp. Bd. v. Blue Cross & Blue Shield of Florida, Inc., 511 F. Supp. 3d 1240, 1243–44, 1249 (M.D. Fla. 2021) (breach of preferred provider agreement); Florida Emergency Physicians Kang & Assocs., M.D., Inc. v. United Healthcare of Florida, Inc., 526 F. Supp. 3d 1282, 1289, 1298–99 (S.D. Fla. 2021) (conspiracy to “manipulate and depress the usual or customary reimbursement rate” for medical services).

We expect ERISA preemption will continue to be a highly litigated area this year, with courts being asked to apply Rutledge to a broad array of state regulations and common law claims. And should the Supreme Court grant the pending petition in Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Program, it would have the opportunity to further define the parameters of ERISA preemption.

IV. Arbitrability of ERISA Fiduciary-Breach Claims

The arbitrability of ERISA section 502(a)(2) fiduciary-breach claims continued to generate contentious litigation in 2021. As we detailed in our 2020 ERISA Update, the Ninth Circuit’s 2019 decision in Dorman v. Charles Schwab Corp., 934 F.3d 1107, 1111–12 (9th Cir. 2019) struck down decades of case law holding that fiduciary-breach lawsuits under ERISA could not be arbitrated. This in turn led many companies to write new arbitration language into their plans. We can now shed more light on the enforceability of these arbitration terms as additional courts of appeal have weigh in, including the Seventh and Second Circuits, as well as district courts in Ohio and Florida. As these cases suggest, federal courts continue to struggle with whether and how to enforce arbitration agreements in ERISA plans, and we expect arbitrability to continue to be a hotly litigated issue this year.

In September, the Seventh Circuit decided Smith v. Board of Directors of Triad Manufacturing, Inc., 13 F.4th 613, 615 (7th Cir. 2021), a case brought by an individual on his own behalf, and on behalf of a putative class, alleging a claim for fiduciary breach under ERISA section 502(a)(2) for mismanagement of his retirement plan and seeking removal of the plan fiduciaries. However, plaintiff’s suit ran headlong into his plan’s arbitration provision, which in relevant part, provided that plaintiff could not “seek or receive any remedy which has the purpose or effect of providing additional benefits or monetary or other relief to any Eligible, Employee, Participant or Beneficiary other than the Claimant.” Id. at 616. The district court denied defendants’ motion to compel arbitration, and the Seventh Circuit affirmed. The appellate court “[j]oin[ed] every other circuit to consider the issue” in holding that “ERISA claims are generally arbitrable.” Id. at 620. But the court concluded that the particular arbitration provision at issue ran afoul of the effective vindication doctrine, which holds that an arbitration provision may be held unenforceable on public policy grounds when it “operate[s] … as a prospective waiver of a party’s right to pursue statutory remedies.” Id. at 620–21 (citing Am. Exp. Co. v. Italian Colors Rest., 570 U.S. 228, 235 (2013)). Deploying the doctrine—which “rare[ly]” applies—the Seventh Circuit reasoned that the plan’s arbitration provision precluded certain remedies that ERISA “expressly permit[s].” Id. at 623. Specifically, the provision precluded plaintiff from seeking relief that extended beyond himself, even though ERISA expressly contemplates “such other equitable or remedial relief as the court may deem appropriate.” Id. at 621. Because the provision would preclude plaintiff from pursuing the remedy of removing the plan fiduciary, which “would go beyond just [plaintiff] and extend to the entire plan,” the provision operated as a waiver of statutory remedies and could not be enforced. Id. at 621–623. However, the court was careful to explain that “the problem with the plan’s arbitration provision is its prohibition on certain plan-wide remedies, not plan-wide representation,” signaling that the court took no issue with the provision’s class action waiver. Id. at 622. The Seventh Circuit also saw “no conflict” between its decision and the Ninth Circuit’s decision in Dorman because the Dorman arbitration provision “lacked the problematic language present here.” Id. at 623.

The Second Circuit’s recent decision in Cooper v. Ruane Cunniff & Goldfarb Inc., 990 F.3d 173 (2d Cir. 2021), provides yet another example of the emerging and divergent approaches to assessing the arbitrability of section 502(a)(2) fiduciary-breach claims. There, a split panel reversed a district court order compelling arbitration. Id. at 175–76. Rather than taking issue with the enforceability of the clause itself (as in Smith) the court noted that the plaintiff’s claims did not fall within the scope of the arbitration provision. Id. at 179. The provision covered “all legal claims arising out of or relating to employment,” but the defendant had not argued that plaintiff’s claim for fiduciary breach arose out of his employment, so the question before the Court was limited: did plaintiff’s fiduciary breach claim “relat[e] to [his] employment”? Id. at 180. The majority answered in the negative, reasoning that arbitration was only required when the “merits of th[e] claim involve facts particular to an individual plaintiff’s own employment.” Id. at 184. Writing in dissent, Judge Sullivan articulated a more expansive view of the arbitrability of fiduciary-breach claims. He argued that “[w]here, as here, an arbitration agreement uses broad language that is ambiguous about whether an issue in dispute is arbitrable, we must resolve that ambiguity in favor of arbitration.” Id. at 186 (Sullivan, J., dissenting).

This year, the Sixth Circuit will also hear an appeal in Hawkins v. Cintas Corp., No. 19-1062, 2021 WL 274341 (S.D. Ohio Jan. 27, 2021), wherein the district court declined to compel arbitration of breach of fiduciary duty claims brought on behalf of the plaintiffs’ plan. Id. at *7. The district court reasoned that the claims were not arbitrable because they were brought on behalf of the plan and there was “no agreement” between the plan and the defendant to arbitrate plan disputes. Id. at *3–4. Specifically, while the plaintiffs’ participant agreements stated that “‘the rights and claims of Employee’ will be arbitrated,” that language bound only the individual employee, not the plan. Id. at *6. The court explicitly distinguished Dorman, emphasizing that the defendant had provided no evidence that any plan document actually bound the plan to arbitration. Id. Separately, the court rejected defendant’s argument that, as sponsor of the plan, it could either consent to arbitration via the filing of a motion to compel, or otherwise “modify Plan documents to require Plan claims to proceed to arbitration.” Id. at *5, 7. Because the court found no valid agreement to arbitrate existed between the plan and the defendant, it ruled that the claims must proceed in federal court absent intervention by the Sixth Circuit.

These approaches to the arbitrability of section 502(a)(2) claims may be sowing seeds for a potential circuit split. By way of example, a Florida district court recently rejected the Seventh Circuit’s reasoning in Smith and enforced the arbitrability of fiduciary-breach claims over an effective vindication challenge. See Holmes et al. v. Baptist Health So. Florida, No. 21-22986, 2022 WL 180638 (S.D. Fla. Jan. 20, 2022). The Holmes plaintiffs brought fiduciary breach claims on their own behalf, and on behalf of the plan, and a putative class of those similarly situated. Plaintiffs’ plans contained an arbitration clause providing that “[a]ny claim … which arises out of, or relates to, or concerns the Plan … shall be resolved exclusively by binding arbitration.” Id. at *1. Relying on Smith, plaintiffs argued that the provision was unenforceable under the effective vindication doctrine because it forbade “Plan-wide relief—such as removal of the plan’s fiduciaries and appointment of new fiduciaries, which is authorized under § 1109(a),” but precluded by the arbitration clause. Id. at *2. The district court disagreed. It pointed to the absence of any Eleventh Circuit authority applying the effective vindication doctrine to void an arbitration clause and reasoned that unlike the provision in Smith which “completely denied some types of statute-authorized relief to the Plan, the clause here does not, as individual claimants can each recover the harm to their defined contribution accounts, and they can recover Plan-wide relief that does not provide additional benefits or monetary relief to others.” Id. at *3.

We expect to see more litigation over the arbitrability of section 502(a)(2) claims as courts continue to flesh out the enforceability, scope, and application of plan arbitration provisions.

V. The Standard of Review of ERISA Benefits Claims

As we discussed last year, federal courts continue to examine the scope and standard of review for ERISA benefits claims. In general, courts review a plan administrator’s benefits decision de novo unless the terms of the plan grant the administrator discretion to interpret the plan and award benefits, in which case courts review the claims decisions under a deferential “abuse of discretion” standard (sometimes called “arbitrary and capricious” review). See Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989). Benefit plans commonly grant this discretion to their administrators, so the deferential standard often applies to ERISA benefits claims, with the Supreme Court repeatedly parrying attempts by plaintiffs to strip administrators of this deference. See, e.g., Metro. Life Ins. Co. v. Glenn, 554 U.S. 105, 115 (2008); Conkright v. Frommert, 559 U.S. 506, 522 (2010). Nonetheless, lower courts continue to grapple with how to apply these standards of review at different stages of litigation and the appropriate burden on each party under each standard.

A recent appellate decision confronted this issue and provided potentially helpful guidance while deepening a circuit split and leaving questions concerning whether courts may make factual determinations at summary judgment, and the standard of review when there is evidence that a plan administrator acted under a conflict of interest.

A. Circuits Appear Split Over the Permissibility of Factual Determinations at Summary Judgment

The Eighth Circuit’s recent decision in Avenoso v. Reliance Standard Life Ins. Co., 19 F.4th 1020 (8th Cir. 2021), deepens a circuit split over the role of summary judgment in ERISA benefits disputes. Because there is no right to a jury trial in ERISA cases and review of benefits determinations is generally limited to the administrative record, see id. at 1025, benefits cases are often decided on cross-motions for summary judgment without need for a trial. The First Circuit has thus held that summary judgment in ERISA cases “is simply a vehicle for teeing up the case for decision on the administrative record,” allowing the court to “weigh the facts, resolve conflicts in evidence, and draw reasonable inferences.” Doe v. Harvard Pilgrim Health Care, Inc., 974 F.3d 69, 72 (1st Cir. 2020) (citations omitted). In Avenoso, however, the Eighth Circuit joined the Second, Sixth, Seventh, Ninth, and Eleventh Circuits in rejecting this approach and holding that district courts are not permitted to make factual determinations when reviewing ERISA benefits claims at the summary judgment stage, under either the de novo or abuse of discretion standards. See 19 F.4th at 1025–26; O’Hara v. Nat’l Union Fire Ins. Co. of Pittsburgh, 642 F.3d 110, 116 (2d Cir. 2011); Patton v. MFS/Sun Life Fin. Distribs., Inc., 480 F.3d 478, 484 n.3 (7th Cir. 2007); Shaw v. Conn. Gen. Life Ins., 353 F.3d 1276, 1282, 1286 (11th Cir. 2003); Kearney v. Standard Ins., 175 F.3d 1084, 1095–96 (9th Cir. 1999) (en banc); Wilkins v. Baptist Healthcare Sys., Inc., 150 F.3d 609, 619 (6th Cir. 1998). The court explained that when considering these claims at summary judgment, “weigh[ing] the evidence, mak[ing] credibility determinations, or attempt[ing] to discern the truth of any factual issue” is improper. Avenoso, 19 F.4d at 1024.

Avenoso preserves an important but limited role for bench trials in ERISA benefits cases. The Eight Circuit explained that a bench trial may be necessary when the district court needs to review evidence from outside the administrative record to determine, for example, the degree of deference owed to the administrator’s decision, or to resolve a dispute over whether a piece of information was part of the administrative record. Id. at 1026. Because such instances could involve “new evidence, including witness testimony[,] [s]ummary judgment . . . serve[s] the important function of sparing the court, the parties, and the witnesses the time and expense of a bench trial in the event that the case can be resolved without one.” Id.; see also Wilkins, 150 F.3d at 619 (“The district court may consider evidence outside of the administrative record only if that evidence is offered in support of a procedural challenge to the administrator’s decision, such as an alleged lack of due process afforded by the administrator or alleged bias on its part.”). Other circuits have also agreed that a bench trial may sometimes be necessary to resolve factual disputes—such as choosing between competing physician reports—when a plan does not grant discretion to the administrator and the district court therefore reviews the administrator’s decisions de novo. See Avenoso, 19 F.4d at 1026–28; Shaw, 353 F.3d at 1282, 1286; see also, e.g., Kearney, 175 F.3d at 1095.

B. Plaintiffs Have Achieved Mixed Results Challenging Decisions Based on Alleged Conflicts of Interest of Plan Administrators

This past year courts also continued to grapple with how to handle deference to an administrator’s benefits decision when there is evidence of a conflict of interest—i.e., where the administrator both makes eligibility determinations and pays benefits. Courts generally agree that the mere existence of a conflict of interest does not establish an abuse of discretion, and the effect of a conflict of interest depends on a case-specific inquiry. Several decisions in the past year nonetheless provide guidance as to the circumstances in which a conflict of interest may prove to be a key driver of the outcome.

As a general matter, recent decisions have described the impact of a conflict of interest in various ways. In Boyer v. Schneider Elec. Holdings, Inc., 993 F.3d 578 (8th Cir. 2021), for example, the Eight Circuit stated that “a tie . . . might be resolved against a conflicted administrator,” but it ultimately upheld the decision at issue because the administrator’s interpretation of the plan was reasonable, its fact findings were “supported by substantial evidence,” and there was no evidence that the company “permit[ted] outcomes on claims decisions to influence the company’s evaluation and compensation of those who make the decisions.” Id. at 581–84. In Weiss v. Banner Health, 846 F. App’x 636 (10th Cir. 2021), meanwhile, the Tenth Circuit stated that an administrator’s conflict may “decrease[] the level of deference to which its decision is entitled,” but it upheld the administrator’s decision even “[t]aking the conflict of interest into account” because the administrator could reasonably rely on the medical guidelines used to interpret the plan and the decision was supported by both internal and external reviewers who considered all of the relevant evidence. Id. at 640–41.

Other notable decisions suggest circumstances in which a plaintiff may overcome deference to the plan fiduciary based in part on the presence of a conflict of interest. In Noga v. Fulton Financial Corp. Employee Benefit Plan, 19 F.4th 264 (3d Cir. 2021), the plaintiff had twice been determined eligible for disability benefits by insurer-affiliated medical professionals, and each time the insurer had engaged a third-party consultant to review the claim, leading the plan to overturn its initial favorable determination. Id. at 277–78. In finding an abuse of discretion, the Third Circuit emphasized the “unusual timing of, impetus for, and scope of requests for outside review.” The first request occurred more than a year after the insurer learned of the facts that supposedly prompted the request, and less than a month after a nurse employed by the insurer recertified that the plaintiff remained totally disabled. Id. at 268–69, 277. The other occurred during plaintiff’s administrative appeal of this initial denial, a day after a benefits analyst overturned the termination of benefits relying on records from both his physicians and a different insurer-employed nurse, who determined plaintiff lacked “consistent work function at any level.” Id. at 269, 278. Because these facts suggested that the review requests were “tied” to the insurer’s “structural” conflict of interest, and the record otherwise “favor[ed] the continued award of benefits,” the Third Circuit held that the insurer had abused its discretion, and it affirmed the order that plaintiffs’ benefits be reinstated. Id. at 278–29.

In Roehr v. Sun Life Assurance Co. of Canada, meanwhile, the Eighth Circuit held that, while an administrator can mitigate the effect of a conflict of interest with outside review of the record, it cannot solely “rel[y] on the same evidence to both find a disability and later discredit that disability.” 21 F.4th 519, 525–26 (8th Cir. 2021). There, plaintiff’s physicians had diagnosed no specific cause for plaintiff’s tremors and also noted that these tremors were intermittent, and the plan administrator relied on these evaluations to provide benefits for ten years. Id. at 521–24. With no particular triggering medical reason, the plan administrator, seeking “to reduce any potential conflict of interest or bias,” then had third-party physicians review the plaintiff’s file, who determined that the lack of a diagnosis and the absence of references to tremors in periodic medical evaluations showed that plaintiff was able to work, which the plan administrator relied upon to deny benefits. Id. 523–25. The court found this reversal of course to be an abuse of discretion because the new, non-physical evaluations’ medical findings were entirely consistent with the diagnosis the defendant had relied upon to provide benefits for a decade (intermittent tremors with no known cause), and the defendant “pointed to no information available to it that altered in some significant way its previous decision to pay benefits.” Id. at 525–26. Specifically, although the court held that third-party medical review of the record can preserve deferential review despite a conceded conflict of interest, it noted that “‘the previous payment of benefits is a circumstance’ weighing against the termination of benefits.” Id. at 525 (quoting McOsker v. Paul Revere Life Ins., 279 F.3d 586, 589 (8th Cir. 2002)). A plan administrator should therefore not wait “almost a decade” to use such review to support a “change in decision,” especially when the decision is not supported by new medical evidence, such as an “independent medical exam.” Id. at 526

Nonetheless, as in Boyer and Weiss, circuit courts continue to be unreceptive to overturning discretionary decisions by plan administrators even in the face of a conflict of interest if the plaintiff cannot point to evidence that the conflict played a role in the eligibility determination. As the Sixth Circuit emphasized in Lloyd v. Procter & Gamble Disability Benefit Plan, Plan #501, the mere presence of a conflict of interest typically is insufficient to overturn an administrator’s determination absent “‘significant evidence’ that the conflict actually affected or motivated the decision at issue.” No. 20-4329, 2021 WL 4026683, at *11 (6th Cir. Sept. 3, 2021). Thus, the presence of a conflict of interest and conflicting medical opinions can be insufficient to support a finding of an abuse of discretion where a plan and administrator justifiably relied on at least some medical evaluations, and that decision did not appear to be specifically tainted. See id. at *6–11.

In the absence of a conflict of interest, plaintiffs continue to face steep obstacles to recovery, particularly when a plan vests its administrator with discretion in resolving contested claims issues. In Michael J. P. v. Blue Cross & Blue Shield of Texas, for example, the Fifth Circuit reversed summary judgment in favor of the plaintiff, concluding that the denial of benefits was supported by substantial evidence. No. 20-30361, 2021 WL 4314316, at *6 (5th Cir. Sept. 22, 2021). The court stated that “even if an ERISA plaintiff supports his claim with substantial evidence, or even with a preponderance, he will not prevail” as long as defendants can support their decision with “more than a scintilla” of evidence with “a rational connection between the known facts and the decision or between the found facts and the evidence.” Id. at *2 2 (quoting Foster v. Principal Life Ins. Co., 920 F.3d 298, 304 (5th Cir. 2019)). Finding that defendants met this burden by proffering physicians and reports demonstrating the lack of need for the sought medical treatment, id. at *4–6, it was “beside the point” what evidence plaintiffs had to the contrary, id. at *7.

Notably, Michael J. P. featured a significant concurrence by Judge Oldham, who agreed that the majority had correctly applied the circuit’s “substantial evidence” standard, but questioned the ultimate validity of that standard. See id. at *8 (Oldham, J., concurring). He first suggested that “substantial evidence” review was derived from practice under the Labor Management Relations Act of 1947 (“LMRA”), but the Supreme Court in Firestone had questioned importing the LMRA’s review standard into ERISA. Michael J. P., 2021 WL 4314316, at *8–9 (citing Firestone, 489 U.S. at 109–10); see also Glenn, 554 U.S. at 121 (Roberts, C.J., concurring in part and concurring in the judgment). He also suggested that the Fifth Circuit’s version of substantial evidence review in ERISA cases—requiring only more than a “scintilla” of evidence supporting the decision—is radically different from substantial evidence review conducted elsewhere, including administrative law challenges, which ordinarily entail a more “holistic” analysis of the record, “taking into account contradictory evidence . . . .” Id. at *9–10 (quoting Universal Camera Corp. v. NLRB, 340 U.S. 474 (1951); citing Dish Network Corp. v. Nat’l Lab. Rels. Bd., 953 F.3d 370, 377 (5th Cir. 2020), as revised (Mar. 24, 2020)). Ultimately, Judge Oldham expressed concern that the current form of substantial evidence review used in ERISA cases to assess whether an administrator has abused its discretion in making benefits determinations, adopted through legal, logical, and historical errors, may “make[] it particularly difficult for ERISA beneficiaries to vindicate their rights under the cause of action created by Congress.” Id. at *10. While it is unclear whether Judge Oldham’s views will gain traction in the Fifth Circuit or elsewhere, it is indicative of the kind of skepticism that courts sometimes exhibit towards deferential review of decisions by administrators exercising discretionary authority over ERISA plans.

VI. Changing Department of Labor Rules for ESG Investing

In closing, we highlight an important rule change proposed in 2021 by the Department of Labor (“DOL”) concerning environmental, social, and governance (“ESG”) investing. As we predicted last year, a new rule proposed and adopted by the DOL late in the Trump administration was targeted for significant revisions by the Biden administration. The new proposed rule purports to provide guidance to plan fiduciaries on the factors they must consider when assessing whether to add or retain investment options in ERISA retirement plans, and states that ESG factors “often” should be among those considerations.

As we discussed last year, in the final days of the Trump administration, the DOL proposed and adopted a rule that ERISA fiduciaries must make investment decisions “based solely on pecuniary factors”; and an investment intended “to promote non-pecuniary objectives” at the expense of sacrificing returns or taking on additional risk would constitute a breach of fiduciary duty under ERISA. Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72,846, 72,851, 72,848 (Nov. 13, 2020). Though the final version of the rule did not explicitly reference ESG funds, the DOL’s press release announcing the rule expressly stated that the rule’s purpose was to provide further guidance “in light of recent trends involving [ESG] investing.” U.S. Dep’t of Labor, U.S. Department of Labor Announces Final Rule to Protect Americans’ Retirement Investments (Oct. 30, 2020), https://www.dol.gov/newsroom/releases/ebsa/ebsa20201030. The new rule took effect on January 12, 2021. 85 Fed. Reg. at 72,885.

On October 14, 2021, the DOL published a new proposed rule, entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” which specifies that a fiduciary’s assessment of whether an investment option or decision is prudent “may often” require “an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action.” 85 Fed. Reg. 57,272, 57,276 (Oct. 14, 2021). The proposed rule explains that “this provision is intended to counteract negative perception of the use of climate change and other ESG factors in investment decisions caused by the 2020 Rules.” 85 Fed. Reg. 57,276.

While some fiduciaries and plan beneficiaries have welcomed the proposed rule and the opportunity to consider ESG factors in the investment selection process, others have expressed concern that the proposed rule may go too far and require fiduciaries to show why ESG were not considered in the selection of investments, and thus may open fiduciaries to yet another avenue of litigation. See, e.g., Ellen Meyers, Retirement advisers group, AARP wary of Labor Department’s ESG proposal, Roll Call (Jan. 6, 2022), https://rollcall.com/2022/01/06/retirement-advisers-group-aarp-wary-of-labor-departments-esg-proposal/.

In a December 2021 letter to Labor Secretary Marty Walsh, several Senate Republicans emphasized the potential “traps for plan fiduciaries” and “increased litigation risk” that the new rule would create, stating that the rule establishes “a de facto mandate on fiduciaries of retirement plans, requiring them to consider ESG factors.” Pat Toomey, Mike Crapo, Richard Burr & Tim Scott, Re: Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights [RIN 1210-AC03] (Dec. 10, 2021), https://www.scott.senate.gov/imo/media/doc/2021-12-10%20Ranking%20Members%20Letter%20to%20DOL.pdf. In their letter, the Senators asked the DOL to withdraw the proposed rule, but this would appear to be an unlikely outcome under the current democratic administration. Id.

The period for commenting on the proposed rule closed on December 13, 2021. We will continue to track developments in the rule as it goes into effect.

The following Gibson Dunn lawyers assisted in the preparation of this alert: Eugene Scalia, Karl Nelson, Geoffrey Sigler, Heather Richardson, Matthew Rozen, Jennafer Tryck, Lana El-Farra, Tessa Gellerson, Alex Ogren, Amanda Sansone, Clare Steinberg, Luke Zaro, and Yan Zhao.

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, or any of the following:

Eugene Scalia – Washington, D.C. (+1 202-955-8543, escalia@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Geoffrey Sigler – Washington, D.C. (+1 202-887-3752, gsigler@gibsondunn.com)
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Heather L. Richardson – Los Angeles (+1 213-229-7409,hrichardson@gibsondunn.com)
Matthew S. Rozen – Washington, D.C. (+1 202-887-3596, mrozen@gibsondunn.com)
Jennafer M. Tryck – Orange County (+1 949-451-4089, jtryck@gibsondunn.com)

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Where a contract specifies its governing law, but is silent as to the governing law of the arbitration agreement, the question arises as to which law governs the arbitration agreement – the governing law of the contract, or the law of the seat?

The UK Supreme Court recently delivered its second judgment in as many years on this question in Kabab-Ji SAL (Lebanon) (Appellant) v Kout Food Group (Kuwait) (Respondent) [2021] UKSC 48.

In 2020, the Supreme Court in Enka Insaat Ve Sanayi AS v OOO ‘Insurance Company Chubb’ [2020] UKSC 38 (“Enka”) held that where the parties have expressly or impliedly made a choice of law to govern a contract that contains an arbitration clause, that would generally be sufficient indication of the parties’ choice of law to govern the arbitration agreement as well.

In its much-anticipated Kabab-Ji decision, the UK Supreme Court recently reached the same conclusion in the context of proceedings to enforce an arbitral award. In a decision that directly contradicted the findings of the Paris Court of Appeal in parallel annulment proceedings, the UK Supreme Court found that the arbitration agreement was governed by English law, being the governing law of the contract—not French law, being the law of the seat, as found by the Paris Court of Appeal. The Supreme Court found that the tribunal had wrongly asserted jurisdiction over the respondent on that basis. This decision is an example of “exceptional circumstances”, where the English courts have refused the enforcement of an arbitral award under the New York Convention. Although the decision provides useful guidance on the process under English law for determining the law governing the arbitration agreement, it further entrenches the divide between the UK and French courts’ approaches to the jurisdiction of arbitral tribunals.

The key takeaways for parties considering arbitration clauses in their transaction documents following these decisions are:

The English law approach to determining the law applicable to an arbitration agreement is now clear, as first confirmed by the Enka decision and now by the Kabab-Ji decision, having previously been unresolved for many years.

However, there remains uncertainty at the international level. The Paris Court of Appeal considered the same award that the English courts considered in Kabab-Ji, and reached the opposite conclusion on which governing law applied to the parties’ arbitration agreement. In the underlying award, the English-qualified arbitrator and the two civil law arbitrators had also reached different conclusions. An appeal is currently pending before the French Cour de Cassation, but it is expected that the Paris Court of Appeal’s decision will be upheld.

In order to achieve certainty, contracting parties should ensure that they identify the law specifically governing their arbitration agreement, whether or not that is the same law that governs the main contract.

Stated differently, contracting parties should not assume that the law of the seat will govern the validity of the arbitration agreement, particularly as a matter of English law.

Background

The case related to a Franchise Development Agreement (“FDA”) between Kabab-Ji SAL (Lebanon) (“Kabab-Ji”) and Al Homaizi Foodstuff Company (“AHFC”), a subsidiary of Kout Food Group (Kuwait) (“KFG”).

In 2015, following a dispute under the FDA, Kabab-Ji commenced arbitration proceedings against the parent company KFG (who was not a party to the FDA) but not its subsidiary AHFC. The FDA was expressly said to be governed by English law. The FDA also contained an arbitration agreement, which provided that the seat of arbitration would be Paris and that the ICC Rules would apply. The arbitration agreement did not specify the applicable governing law, but stated that “[t]he arbitrator(s) shall also apply principles of law generally recognised in international transactions”,[1] which the parties agreed referred to the UNIDROIT Principles of International Commercial Contracts (“UNIDROIT Principles”). Notably, the FDA included ‘no oral modification’ clauses.

Arbitration Proceedings

Although KFG took part in the arbitration, it did so whilst maintaining that it was not a party to the FDA or the arbitration agreement it contained. Nevertheless, the tribunal issued an award in favour of Kabab-Ji in 2017. A majority of the tribunal decided that:

French law (the law of the seat of arbitration) was the governing law of the arbitration agreement;
Applying French law, KFG was a party to the arbitration agreement;
English law (the governing law of the FDA) was the relevant body of law to determine whether KFG had acquired substantive rights and obligations under the FDA; and
KFG was also a party to the FDA as there had been a novation and KFG was in breach of the FDA, with the result that the tribunal awarded USD 6,734,628.19 to Kabab-Ji.

Parallel proceedings were then commenced by KFG in France (to annul the award) and by Kabab-Ji in England (to enforce the award).

French Annulment Proceedings

KFG brought an action in the French courts to annul the award on jurisdictional grounds, submitting that KFG was not a party to the arbitration agreement, which was to be governed by English law. The Paris Court of Appeal referred to principles of international substantive arbitration law and held that, under those principles: (i) an arbitration agreement is independent from the underlying contract, and (ii) the law of the seat is the appropriate governing law to determine the validity and existence of the arbitration agreement, unless the parties intended otherwise. There was no contrary intention suggesting that a governing law other than the law of the seat (French law) should be applied. Jurisprudence from the French courts stated that a non-signatory party to an arbitration agreement “should be deemed to have agreed to the [arbitration] clause if the arbitral tribunal finds that this party had the will to participate in the performance of the agreement”.[2] The Paris Court of Appeal therefore upheld the arbitral tribunal’s finding that KFG was party to the arbitration agreement with reference to multiple factors, including that: (i) KFG’s organisational chart included personnel in charge of the performance of the FDA, and (ii) KFG was involved in the performance of the FDA for a number of years, including in their termination and renegotiation.[3] The court therefore upheld the award, finding that French law (the law of the seat) was the governing law of the arbitration agreement and that KFG was a party to it. KFG appealed to the Cour de Cassation, whose decision is pending.

English Enforcement Proceedings

Alongside the French proceedings, proceedings were brought by Kabab-Ji in the English Commercial Court to enforce the award under s. 101 of the Arbitration Act 1996. At first instance, the court found that English law governed the validity of the arbitration agreement. The court considered it likely that under English law, KFG was not party to the FDA or, therefore, the arbitration agreement, but this was left open for further determination. The proceedings were stayed pending the annulment proceedings in the Paris Court of Appeal.

Both Kabab-Ji and KFG appealed. The English Court of Appeal dismissed Kabab-Ji’s appeal and gave summary judgment in favour of KFG, finding that there was an express choice of English law as the governing law of the arbitration agreement. As a matter of English law, KFG could not have become a party to the FDA and its arbitration agreement without either consenting to this in writing (as required by the ‘no oral modification’ clauses in the FDA) or there being circumstances giving rise to an estoppel. This had not occurred, and the English Court of Appeal found that the judge at first instance should have made a final determination on this issue. On that basis, recognition and enforcement was refused.

UK Supreme Court Ruling

Kabab-Ji was given permission to appeal on various grounds, which the court condensed into the following issues:

(1) Which law governed the validity of the arbitration agreement?

(2) If English law was the applicable governing law, was there any real prospect that KFG had become a party to the arbitration agreement?

(3) Was the Court of Appeal justified in giving summary judgement refusing recognition and enforcement of the award, as a matter of procedure?

In a unanimous judgment, the Supreme Court found in favour of KFG and held that:

(1) English law governed the validity of the arbitration agreement;

(2) Under English law, there was no real prospect that a court would find KFG had become a party to the arbitration agreement; and

(3) Procedurally, the Court of Appeal was justified in giving summary judgement refusing recognition and enforcement of the award.

The Supreme Court’s reasoning was as follows:

Issue 1: Which law governed the validity of the arbitration agreement?

The Supreme Court referred to the summary in Enka of Article V(1)(a) of the New York Convention[4] (“Article V(1)(a)”), which established that the validity of an arbitration agreement is governed by:

the law chosen by the parties; and
in the event no choice has been made, the law of the country where the award is made.[5]

In Enka, the Supreme Court found that where an arbitration agreement does not specify the applicable governing law, a choice of governing law in the contract containing the arbitration agreement would generally be sufficient indication of the governing law. Importantly, in Kabab-Ji, the Supreme Court confirmed that the principle in Enka applied not only prior to the issuance of the award but also at the enforcement stage. As such, the governing law specified in the FDA—English law—was the applicable law of the arbitration agreement.

Kabab-Ji unsuccessfully advanced arguments that the law of the seat (French law) should apply. The arbitration agreement stated that the UNIDROIT Principles were applicable. Kabab-Ji argued that when this was read alongside the governing law clause (which specified that English law governed the contract), there was “no sufficient indication of the law which is to govern the validity of the arbitration agreement”[6], as the blend of English law and UNIDROIT Principles did not qualify as “law” under Article V(1)(a) and s. 103(2)(b) of the Arbitration Act 1996. As the parties had not chosen a “law” to govern the arbitration agreement, Kabab-Ji argued that the law of the seat was to be applied pursuant to Article V(1)(a).[7] The court rejected this argument as “illogical and inconsistent with the principle of party autonomy”,[8] as parties who opted for a certain governing law supplemented by additional principles would be denied their choice of both. Instead a different governing law (the law of the seat) would apply to their arbitration agreement, contrary to what the parties had chosen.

Kabab-Ji also sought to rely upon the ‘validation principle’[9] to argue that the choice of English law as the governing law would not extend to the arbitration agreement if the application of English law would result in there being no valid arbitration agreement between Kabab-Ji and KFG. The Supreme Court noted that the validation principle was a method of contractual interpretation and Kabab-Ji’s argument sought to “extend the validation principle beyond its proper scope”.[10] The Supreme Court concluded that the principle does not apply to questions of validity where the court has to determine whether an arbitration agreement exists at all.

Issue 2: If English law is the applicable governing law, had KFG become a party to the arbitration agreement?

The Supreme Court held that there was no real prospect of evidence being adduced that the KFG had become party to the arbitration agreement. In reaching this conclusion, particular attention was paid to the requirements in the FDA’s ‘no oral modification’ clauses. These placed the burden on Kabab-Ji to prove that there was a sufficiently arguable case that KFG had consented to becoming a party to the arbitration agreement in writing, or that KFG was estopped from relying on the failure to comply with those requirements. No evidence was adduced by Kabab-Ji beyond evidence of an informal unwritten promise and so the Supreme Court held that Kabab-Ji had failed to discharge this burden.

Issue 3: Was the Court of Appeal justified in giving summary judgement refusing recognition and enforcement of the award, as a matter of procedure?

The Supreme Court held that Article V(1) of the New York Convention and s. 103 of the Arbitration Act 1996 did not prevent the Court of Appeal from giving summary judgment refusing recognition and enforcement of the award. The English courts will decide whether determination should be made by summary judgment or a full evidential hearing in accordance with the Civil Procedural Rules. The Court of Appeal was therefore entitled to summarily determine the case, given it was in the interests of justice and the overriding objective to do so.

Commentary

The Supreme Court in Kabab-Ji confirmed the general principle established in Enka that, as a matter of English law, the governing law of a contract will govern an arbitration agreement within that contract where there is no express provision in the arbitration agreement itself. However, this has put the UK Supreme Court at odds with the French courts, with the Paris Court of Appeal having dismissed annulment proceedings against the award, finding that, under French law, the respondent was a party to the arbitration agreement. In its judgment, the Supreme Court emphasised that “the risk of contradictory judgments cannot be avoided”[11] and there is no universal consensus regarding the interpretation of Article V(1)(a) by the courts of contracting states

It remains to be seen what the French Cour de Cassation will decide. Kabab-Ji may also be inclined to attempt to enforce the Paris-seated award in another civil law jurisdiction, where a civil law court may find similarly to the French courts. This highlights that the international division in approach to Article V(1)(a) is unsatisfactory, and increases the risk of parallel proceedings in different jurisdictions and enforcement challenges. It may also prompt parties to ‘shop’ for arbitrators who will take a particular view of the governing law of arbitration agreements.

Perhaps the biggest lesson is for contracting parties to always incorporate an express choice of governing law of the arbitration agreement when drafting arbitration clauses. This is especially important when the seat of arbitration is in a different jurisdiction to that of the governing law. This is an oft-overlooked part of arbitration clauses, but one that can have serious consequences in international arbitration and enforcement. The experienced team at Gibson Dunn are well placed to assist on specific drafting queries.

Procedurally, the case also highlights the fact that the English courts will be prepared to use summary procedures in enforcement proceedings where appropriate, which saves both time and costs. The English courts will determine whether a case is suitable for summary determination on a case-by-case basis, having regard to procedural factors such as the overriding objective.

______________________________

[1] [2021] UKSC 48, [37]

[2] Judgment of Paris Court of Appeal (23 June 2020), Kabab-Ji S.A.L Company v. Kout Food Group Company [36]

[3] Judgment of Paris Court of Appeal (23 June 2020), Kabab-Ji S.A.L Company v. Kout Food Group Company [33]-[48]

[4] Convention on the Recognition and Enforcement of Foreign Arbitral Awards adopted by the United Nations Conference on International Commercial Arbitration on 10 June 1958 (“New York Convention”).

[5] The court noted that where the parties have chosen the seat of arbitration, the award will be deemed to be made at the place of the seat. See [2021] UKSC 48, [26].

[6] [2021] UKSC 48, [40].

[7] Kabab-Ji also relied on s. 103(2)(b) of the Arbitration Act 1996 which replicates Article V of the New York Convention

[8] [2021] UKSC 48, [44].

[9] The UKSC defined the validation principle as “the principle that contractual provisions, including any choice of law provision, should be interpreted so as to give effect to, and not defeat or undermine, the presumed intention that an arbitration agreement will be valid and effective”. See [2021] UKSC 48, [49].

[10] [2021] UKSC 48, [51].

[11] [2021] UKSC 48, [90].

The following Gibson Dunn lawyers assisted in the preparation of this client update: Cyrus Benson, Penny Madden QC, Nooree Moola, Michael Stewart and Sophia Cafoor-Camps.

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 practice leaders and members:

Cyrus Benson – London (+44 (0) 20 7071 4239, CBenson@gibsondunn.com)
Penny Madden QC – London (+44 (0) 20 7071 4226, PMadden@gibsondunn.com)
Jeff Sullivan QC – London (+44 (0) 20 7071 4231, Jeffrey.Sullivan@gibsondunn.com)
Nooree Moola – Dubai (+971 (0) 4 318 4643, nmoola@gibsondunn.com)

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Federal securities filings continued to slow during the second half of 2021. The volume of new securities cases filed in 2021 fell by 36% compared to 2020, and 51% compared to 2019. Nonetheless, federal and state securities laws continue to develop in the courts. This year-end update summarizes major developments since our last update in August 2021:

The second half of 2021 was relatively quiet with regard to noteworthy securities litigation activity from the Supreme Court. We discuss the settlement of a case that would have asked the Court to decide whether the PSLRA’s discovery-stay provision applies in state court, and a ruling that ERISA plan fiduciaries must conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.
Three recent decisions from Delaware courts will impact how stockholder derivative claims are investigated and litigated. We also discuss two decisions that enforced an advance notice bylaw and a contractual waiver of statutory appraisal rights.
We continue to monitor courts’ application of the disseminator theory of liability recognized by the Supreme Court’s 2019 decision in Lorenzo, including differing interpretations regarding whether liability under Lorenzo applies to a broad swath of misrepresentations, or only in the more limited context of fraudulent dissemination.
We again survey securities-related lawsuits arising out of, or otherwise related to, the COVID-19 pandemic, including securities class actions, stockholder derivative actions, and SEC enforcement actions. As courts have begun issuing decisions on motions to dismiss filed earlier in the pandemic, plaintiffs continue bringing new securities cases, including against pharmaceutical and biotechnology companies based upon representations made concerning the development of new COVID-19 vaccines.
In the second half of 2021, several cases interpreted and applied the Supreme Court’s 2015 Omnicare decision regarding liability based on a false opinion. During this period, a notable portion of claims survived motions to dismiss in which defendants asserted that the misrepresentations or omissions at issue were non-actionable statements of opinion under Omnicare. Although these cases illustrate that some courts are willing to let certain complaints play out, even where the allegedly false or misleading statements include explicit language noting that the content is mere belief and opinion, other cases demonstrate that Omnicare still presents a significant pleading barrier. We will continue to monitor developments in this important area.
We continue monitoring the development of price impact theory following last year’s remand of Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System. Despite considering the “mismatch” between alleged misstatements and alleged corrective disclosures on a “sliding scale,” the trial court held that defendants failed to sever the link plaintiff established between stock price drops, alleged misstatements, and corrective disclosures.
Finally, we address notable developments in the federal courts, including (1) the Second Circuit’s vacating the dismissal of a securities class action because Section 10(b) liability may be premised on misstatements that concern unsustainable rather than fraudulent conduct, (2) the Ninth Circuit’s holding that purchasers of shares sold in a direct listing have statutory standing, (3) a federal district court’s holding that transactions in unlisted American Depositary Receipts are not domestic under the “irrevocable liability” test, and (4) the Second Circuit’s affirming the dismissal of an event driven securities action, finding the claim was only one of corporate mismanagement rather than fraud.

I. Filing And Settlement Trends

Data from a newly released NERA Economic Consulting (“NERA”) study shows that 2021 represented a continuation of the securities litigation trends begun in 2020. 2021 was the second year of decreased filings after the steady upward figures we saw from 2017-2019. A sharp decrease in the number of merger-objection cases filed in 2021 (down to 14 from 103 in 2020) drove a decline in the number of new federal class actions filed in 2020 (down to 205 from 321 in 2010). The “Electronic Technology and Technology Services” and “Health Technology and Services” sectors now represent 57% of all filings.

The median settlement value of federal securities cases in 2021—excluding merger-objection cases and cases settling for more than $1 billion or $0 to the class—decreased substantially from prior years (at $8 million, down from $14 million in 2020 and $13 million in 2019). Consistent with this trend, average settlement values (excluding merger-objection and zero-dollar settlements) also declined in 2021 (at $21 million, down from $47 million in 2020 and $29 million in 2019).

A. Filing Trends

Figure 1 below reflects the filing rates of 2021 (all charts courtesy of NERA). 205 cases were filed last year, down considerably from the peak in 2017-2019. Note, however, that this figure does not include class action suits filed in state court or state court derivative suits, including those in the Delaware Court of Chancery.

Figure 1:

B. Mix Of Cases Filed In 2021

1. Filings By Industry Sector

Even though the number of filings decreased in 2021 compared to 2020, the distribution of non-merger filings, as shown in Figure 2 below, was relatively consistent with the previous two years. Notably, the “Electronic Technology and Technology Services” and “Health Technology and Services” sectors now account for more than 50% of all filings, continuing the steady upward trend since 2016. “Finance” filings experienced the steepest decline, dropping by 6% (after rising by 6% in 2020).

Figure 2:

2. Merger Cases

As shown in Figure 3 below, there were 14 merger-objection cases filed in federal court in 2021. This represents an 86% year-over-year decrease from 2020, a 94% year-over-year decrease from 2019, and the lowest number of such filings since 2010. This figure is significantly lower than in 2016, when the Delaware Court of Chancery put an effective end to the practice of disclosure-only settlements in In re Trulia Inc. Stockholder Litigation, 29 A.3d 884 (Del. Ch. 2016), which helped drive the increase in merger-objection filings between 2015 and 2017.

Figure 3:

C. Settlement Trends

As reflected in Figure 4 below, the average settlement value declined by over 50% in 2021, reaching $21 million, after rebounding from $29 million in 2019 to $47 million in 2020.

Figure 4:

Turning to the median settlement value, Figure 5 shows that the consistency of 2018 to 2020, when median settlement value remained $13-14 million, came to an end in 2021. Last year saw the median value drop to $8 million. (Note that median settlement value excludes settlements over $1 billion, merger objection cases, and zero-dollar settlements.)

Figure 5:

Finally, as shown in Figure 6, Median NERA-Defined Investor Losses were steady in 2021, rising to $731 million from $698 million in 2020. The Median Ratio of Settlement to Investor Losses also held steady at 1.8% in both years.

Figure 6:

II. What To Watch For In The Supreme Court

The second half of 2021 was relatively quiet with regard to noteworthy activity from the Supreme Court in the area of securities litigation. Two developments of note are discussed below.

A. Pivotal Settlement

As we previewed in our 2021 Mid-Year Securities Litigation Update, on July 2, 2021, the Supreme Court granted certiorari in Pivotal Software, Inc. v. Superior Court of California, No. 20-1541. That case involved the question whether the discovery-stay provision in the Private Securities Litigation Reform Act (“PSLRA”)—which requires a stay prior to adjudication of a motion to dismiss—also extends to stockholder actions brought in state court. State courts have been increasingly divided on the issue since the Supreme Court’s 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), affirming potential state court jurisdiction over Securities Act claims.

On January 13, 2022, the parties in Pivotal notified the Court that they have finalized a settlement, and filed a motion for preliminary approval with the Superior Court of California. See Letter from the Parties Updating Clerk on Settlement Proceedings, Pivotal Software, Inc. v. Superior Court of Cal., No. 20-1541 (Jan. 13, 2022). As a result, the question whether the PSLRA’s discovery-stay provision applies to private actions in state court will not be answered by the Supreme Court in Pivotal. Although the provision will remain a known quantity in federal court, until such time as the Supreme Court has another opportunity to revisit the issue, parties in state courts will be left to grapple with the meaning of the PSLRA’s instruction that the discovery stay is required “[i]n any private action.” 15 U.S.C. § 77z-1-(b)(1).

B. Northwestern University ERISA Decision

On January 24, 2022, the Supreme Court issued its decision in Hughes v. Northwestern University, — S. Ct. —-, 2022 WL 199351 (U.S. Jan. 24, 2022). In a unanimous decision, the Court held that offering low-cost investment options alongside the other allegedly high-cost options in a defined-contribution retirement plan does not, in and of itself, categorically foreclose a claim for breach of ERISA’s duty of prudence. Id.

Petitioners—former and current employees of Northwestern University—alleged that Northwestern University violated its ERISA-imposed duty of prudence by providing employees with a menu of investment options for their defined-contribution plans, some of which were high-cost options that caused employees to incur excessive fees. Id. at *2. Northwestern responded that the plan also offered low-cost investment options alongside the higher-cost options. Id. at *3. The Seventh Circuit affirmed the dismissal of petitioners’ claims for failure to plausibly allege a breach of fiduciary duty, primarily relying on the inclusion of low-cost options. Id. at *4.

The issue presented to the Supreme Court was whether participants in a defined-contribution retirement plan may state a claim for breach of ERISA’s fiduciary duty of prudence on the theory that investment options offered in the plan were too numerous and that many of the options were too costly, notwithstanding that the plan’s fiduciaries offered low-cost investment options in the plan as well. Relying on the obligation to monitor plan investment options articulated in Tibble v. Edison International, 575 U.S. 523 (2015), the Court ruled that the Seventh Circuit had erred in dismissing the claims without making a “context-specific inquiry” that “take[s] into account [a fiduciary’s] duty to monitor all plan investments and remove any imprudent ones.” Hughes, 2022 WL 199351, at *2. Justice Sotomayor, writing for the Court, noted that “even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.” Id. at *4.

As a case-specific application of Tibble, the Northwestern decision likely does not significantly change the litigation landscape for ERISA claims involving plan investment options. The decision does make clear that merely making available alternative investment options does not categorically prevent ERISA plaintiffs from stating a plausible claim for breach of the duty of prudence. At the same time, the Court recognized that “[a]t times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” Hughes, 2022 WL 199351, at *4.

III. Delaware Developments

A. Delaware Supreme Court Adopts A Universal Three-Part Test For Demand Futility In Derivative Actions

In September, the Delaware Supreme Court in United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034 (Del. 2021) (en banc), adopted a three-part demand futility test that blended the long-standing tests set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984) (for affirmative decisions made by a majority of the same board considering the demand, which focused on the substance of the challenged transaction), and Rales v. Blasband, 634 A.2d 927 (Del. 1993) (for all other situations, which focused on the independence of the decision on a litigation demand).

In Zuckerberg, Plaintiff filed a derivative complaint in the Court of Chancery, seeking damages related to Facebook’s expenditures in a class action suit that challenged a stock reclassification that was ultimately abandoned. Zuckerberg, 262 A.3d at 1040. Plaintiff did not make a pre-suit demand on Facebook’s board, arguing demand was futile under Aronson because the negotiation and approval of the reclassification was an invalid exercise of the board’s business judgment and because a majority of directors were allegedly beholden to Facebook’s CEO. Id. The Court of Chancery found Aronson’s framework “not up to the task,” and instead applied a new three-part blended test and dismissed the complaint for failure to plead that demand was futile. Id. at 1057–58.

Under this new test, courts will consider whether a complaint pleads particularized facts demonstrating that each director (1) “received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;” (2) would face “a substantial likelihood of liability on any of the claims that are the subject of the litigation demand;” and (3) “lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.” Id. at 1058. Demand is excused as futile under this test if the answer to any of these questions is “yes” for at least half of the members of the board. Id. at 1059.

The Delaware Supreme Court affirmed, adopting the Court of Chancery’s blended three-part test as the “universal test for assessing whether demand should be excused as futile.” Id. at 1058. The Court explained that “changes in the law have eroded the ground upon which [the Aronson] framework rested . . . and it is both appropriate and necessary that the common law evolve in an orderly fashion to incorporate these developments.” Id. In particular, where a corporation has a Section 102(b)(7) clause in its charter that exculpates directors from liability for breaches of the duty of care, directors do not face a “substantial likelihood of liability” that would excuse a pre-suit demand under Aronson’s second prong. Id. at 1050–54.

The ruling provides clarity and simplifies the process for determining demand futility by offering a “universal test” that focuses the “inquiry on the decision regarding the litigation demand, rather than the decision being challenged,” and eliminating the complexity over whether to apply the Aronson or Rales tests. Id. at 1058–59.

B. Delaware Court Of Chancery Demonstrates The “High Hurdle” Of Pleading Wrongful Demand Refusal Is Not Insurmountable

In October, the Court of Chancery in Drachman v. Cukier, 2021 WL 5045265 (Del. Ch. Oct. 29, 2021), issued a rare decision declining to dismiss a complaint that alleged a board wrongfully refused a litigation demand, finding that it was reasonable to infer from the pleading that “the directors just did not care about complying with the legal requirements of Delaware law.” Id. at *8. In Drachman, plaintiffs made a pre-suit demand notifying the company’s board that proposals at an annual stockholder meeting failed to receive the requisite votes and thus the company erred in approving the proposals. Id. at *2. The board responded that the demand was without merit and declined to take remedial action, id.; indeed, the company did not take corrective action until one year later, when it obtained the requisite votes to ratify the challenged amendments, id. at *3.

To meet the “high hurdle” necessary to plead wrongful refusal under Court of Chancery Rule 23.1, as the Drachman plaintiffs did, plaintiffs must allege particular facts raising a reasonable doubt that “(1) the board’s decision to deny the demand was consistent with its duty of care to act on an informed basis, that is, was not grossly negligent; or (2) the board acted in good faith, consistent with its duty of loyalty.” Id. at *6, 8. The Drachman court reasoned that “the [d]emand pointed out a straightforward violation of Section 242(b), yet—despite the language of the [proxy materials] explaining how votes would properly be tabulated—the Board rejected the [d]emand and waited nearly a year to remedy the mistake.” Id. at *8. This opinion serves as a reminder that although directors enjoy wide discretion in exercising their business judgment with respect to stockholder demand letters—and plaintiffs face a “steep road” in pleading wrongful refusal, id. at *6—a board’s decision declining to take correction in the face of a valid demand may not be entitled to deference in court.

C. Delaware Supreme Court Overrules Gentile In Favor Of Simple Test To Distinguish Direct From Derivative Claims

In a re-examination of the law on overpayment claims, the Delaware Supreme Court overruled its 15-year-old precedent set forth in Gentile v. Rossette, 906 A.2d 91 (Del. 2006), holding that “equity overpayment/dilution claims, absent more, are exclusively derivative.” Brookfield Asset Mgmt., Inc. v. Rosson, 261 A.3d 1251, 1267 (Del. 2021). We discussed this possibility in our 2020 Year-End Securities Litigation Update. In Rosson, former minority stockholders brought a claims for breach of fiduciary duty to challenge TerraForm Power’s private placement of common stock to controlling stockholder Brookfield for alleged inadequate value. Id. at 1255.

The Court of Chancery denied defendants’ motion to dismiss, which sought to classify the dilution claims as derivative and thus extinguished by a recent merger. Id at 1260. The lower court turned first to the “simple test” of Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004), under which the question of whether a stockholder’s claim is direct or derivative “must turn solely on the following questions: (1) who suffered the alleged harm (the corporation of the stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually?).” Relying on Tooley, the court held that “dilution claims are classically derivative,” even where “a controlling stockholder allegedly causes a corporate overpayment in stock and consequent dilution of the minority interest.” Rosson, 261 A.3d at 1260. Nevertheless, the lower court found that the stockholders properly stated direct claims under Gentile’s “unsatisfying” exception to Tooley’s rule when a controlling stockholder is involved in transactions that resulted in an improper transfer of value and voting power from minority stockholders. Id. at 1261.

On appeal, the Delaware Supreme Court agreed with the Chancery Court’s analysis that the direct claims would not survive without Gentile’s carveout because the stockholders’ overpayment claim alleged derivative harm to the corporation. Id. at 1266. After examining the “clear conflict between Gentile and Tooley, the confusion Gentile imposes on Tooley’s straightforward analysis, and the policy reasons for removing the exception,” the court overruled Gentile and reversed the lower court’s denial of defendants’ motion to dismiss. Id. at 1267. The court recognized three issues with Gentile: (1) economic and voting dilution is not an injury to stockholders independent of injury to the corporation; (2) Gentile applied “confusing” standards, including an out-of-date “special injury test” that detracts from Tooley’s “goal of adding clarity to a difficult and important area of our law”; and (3) the focus of a court’s inquiry should be on who suffered the harm and who would receive the benefit of the recovery, not on the identity of the wrongdoer. Id. at 1267–74. The Supreme Court further observed that Gentile “creates the potential practical problem of allowing two separate claimants to pursue the same recovery.” Id. at 1277.

As it did just three days later in Zuckerberg, discussed supra Section III.A, in Rosson, the Court provided a much needed simplification of Delaware law on derivative claims and demonstrated a willingness to adapt the common law to meet real-world developments.

D. Court of Chancery Relies On Equitable Principles To Enforce Advance Notice Bylaw

In October, the Court of Chancery declined to apply both the enhanced scrutiny of Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988), and the business judgment rule in examining a board’s decision to enforce an advance notice bylaw and reject a rival slate of board nominees. Plaintiff dissident stockholders submitted advance notice of their intent to nominate a slate of candidates for pharmaceutical company CytoDyn Inc.’s board, which the board rejected as contrary to CytoDyn’s bylaws. Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *1 (Del. Ch. Oct. 13, 2021). After a paper trial on the stockholders’ request for injunctive relief allowing their candidates to stand for election, the court adopted the company’s argument that the stockholders’ notice was deficient because it failed to disclose who supported their efforts and failed to disclose that one of the nominees might seek to facilitate an insider transaction. Id. at *2.

The parties advocated for competing standards of review on the board’s refusal to put the nominations to a vote. The stockholders argued that under Blasius, the board bore “the heavy burden of demonstrating a compelling justification” because it acted “for the primary purpose of impeding the exercise of stockholder voting power.” Id. at *13 (citing Blasius, 564 A.2d at 661). The company argued that the proper standard was the deferential business judgment rule because the board’s decision is covered by contract, namely the bylaws. Id. The court rejected both approaches.

First, the Court of Chancery held that Blasius should not be held so broadly as to apply to “all cases where a board of directors has interfered with a shareholder vote.” Id. at *14. Instead, its exacting standard should be used “sparingly” when “self-interested or faithless fiduciaries” engaged in “manipulative conduct” to “deprive stockholders of a full and fair opportunity to participate in the matter. Id. (citing In re MONY Group, Inc. S’holder Litig., 853 A.2d 661, 674 (Del. Ch. 2004)). Though the board delayed responding to the nomination notice, the court credited the fact that the advance notice bylaw was reasonable, “commonplace,” and was adopted years earlier. Id. The court also rejected the company’s preferred business judgment standard due to the inherent “structural and situational conflict” present when a board enforces bylaws against stockholders. Id.

Instead, the court drew on longstanding principles of equity to examine whether the board unreasonably applied the validly enacted bylaws under the circumstances. Id. at *15. The court held that stockholders played “fast and loose” by submitting their deficient nominations on the eve of the deadline, leaving themselves with no opportunity to cure under bylaws that did not contain an express process to do so. Id. at *2. Had the stockholders provided their nominations earlier, they “might have a stronger case that the Board’s prolonged silence upon receipt of the notice was evidence of manipulative conduct.” Id. at *17. But under the circumstances, it was incumbent upon the stockholders to submit a compliant notice, and the court found that the board was justified in rejecting their slate.

E. Delaware Supreme Court Enforces Ex Ante Waiver of Statutory Appraisal Rights

Over a rare dissent, the Delaware Supreme Court recently enforced a provision in a stockholder agreement waiving corporate stockholders’ right to pursue statutory appraisal for certain transactions. Manti Holdings, LLC v. Authentix Acquisition Co., Inc., 261 A.3d 1199 (Del. 2021). In 2017, Authentix Acquisition Company, Inc. (“Authentix”) merged with a third-party entity. Minority stockholders filed a petition for appraisal of their stock under Section 262 of the Delaware General Corporation Law (“DGCL”). Id. at 1199. As we discussed in our 2018 Year End Securities Litigation Update, upon Authentix’s motion, the Court of Chancery enforced the stockholders’ agreement “that they ‘refrain’ from exercising their appraisal rights with respect to the merger” and dismissed the petition. Id. at 1203 (quoting agreement).

On appeal, the majority, with Justice Montgomery-Reeves writing, held that “neither statutory law nor public policy prohibits Authentix from enforcing the [waiver] against the petitioners.” Id. at 1214 (cleaned up). Although the majority agreed with petitioners that “the DGCL has mandatory provisions that are fundamental features of the corporate entity’s identity” that “cannot be varied by a contract,” it was cognizant of “Delaware’s strong policy favoring private ordering.” Id. at 1203, 1216. Thus, the majority did not read Section 262’s provision that stockholders “shall be entitled to an appraisal” as creating an unassailable right, since case law permits mandatory rights to be waived unless prohibited. Id. at 1219 (citing Graham v. State Farm Mut. Auto. Ins. Co., 565 A.2d 908, 912 (Del. 1989)). It was also “unconvinced” that “the fundamental nature of appraisal rights” “play a sufficiently important role in regulating the balance of power between corporate constituencies” to justify forbidding their waiver as a matter of public policy. Id. at 1223, 1224. Instead, the majority held that “Section 262 does not prohibit sophisticated and informed stockholders, who were represented by counsel and had bargaining power, from voluntarily agreeing to waive their appraisal rights in exchange for valuable consideration.” Id. at 1204; see also id. at 1224. Such was the case here, as the court repeatedly noted.

The majority’s ruling may permit ex ante contractual waivers of other stockholder rights set forth in the DGCL. In dicta, it recognizes that “there may be other stockholder rights that are so fundamental to the corporate form that they cannot be waived ex ante.” Id. at 1226. Except for “certain rights designed to police corporate misconduct or to preserve the ability of stockholders to participate in corporate governance,” however, the majority stops short of providing a ready list. In dissent, Justice Valihura would have held that Section 262 appraisal rights are fundamental, mandatory features of corporate governance that cannot be waived, but even if they could be modified, such a provision should, at the very least, be contained within the corporate charter. Id. at 1250–51 (Valihura, J., dissenting).

IV. Further Development Of Disseminator Liability Theory Upheld In Lorenzo

As initially discussed in our 2019 Mid-Year Securities Litigation Update, the Supreme Court held in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), that those who disseminate false or misleading information to the investing public with the intent to defraud can be liable under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Rules 10b-5(a) and 10b-5(c), even if the disseminator did not “make” the statement within the meaning of Rule 10b-5(b). In the wake of Lorenzo, secondary actors—such as financial advisors and lawyers—could face “scheme liability” under Rules 10b-5(a) and 10b-5(c) simply for disseminating the alleged misstatement of another, if a plaintiff can show that the secondary actor knew the alleged misstatement contained false or misleading information.

Since our 2021 Mid-Year Securities Litigation Update, courts in the Second and Eleventh Circuits have wrestled with the scope of Lorenzo, considering whether Lorenzo allows a plaintiff to bring Rule 10b-5(a) and (c) scheme liability claims based on the same conduct as Rule 10b-5(b) misrepresentation claims absent allegations of dissemination.

Applying Lorenzo broadly, district courts in Florida and New York have denied motions to dismiss Rule 10b-5(a) and (c) claims after holding that scheme liability can now arise from the same conduct forming the basis for a Rule 10b-5(b) claim. For example, in SEC v. Complete Business Solutions Group, Inc, 538 F. Supp. 3d 1309, 1317, 1340 (S.D. Fla. 2021), the SEC accused defendants of selling unregistered securities—backed by small business loans—to investors and making several misrepresentations about the underlying loans’ risk. The district court determined that the SEC had adequately alleged that the defendants made misrepresentations or omissions under Rule 10b-5(b). The court also denied the defendants’ motion to dismiss the Rule 10b-5(a) and (c) claims of scheme liability, which were based on the very same statements that formed the 10b-5(b) claims, reasoning that, after Lorenzo, a plaintiff no longer has to plead “deceptive acts distinct from the alleged misrepresentation forming the basis of a Rule 10b-5(b) claim.” Id. at 1339–40.

Similarly, in SEC v. Sequential Brands Group., Inc., 20-CV-10471 (JPO), 2021 WL 4482215, at *6 (S.D.N.Y. Sept. 30, 2021), the SEC alleged that Sequential Brands Group engaged in a deceptive scheme by covering up quantitative evidence of an impairment to its goodwill. When multiple quantitative analyses showed that its goodwill had fallen by millions of dollars, Sequential Brands Group did not disclose those calculations but instead changed its methodology to a purportedly “biased” qualitative assessment that suggested goodwill had not been impaired. This withholding of information and change of methodology “resulted in regular misleading statements on public filings.” Id. The district court held that such allegedly fraudulent accounting practices could form the basis for scheme liability, analogizing to the deceptive dissemination at issue in Lorenzo. Gibson Dunn represents Sequential Brands Group in this matter. In SEC v. GPL Ventures LLC, 21 Civ. 6814 (AKH), 2022 WL 158885, at *9 (S.D.N.Y. Jan. 18, 2022), the SEC charged GPL Ventures (“GPL”), an issuer, and others with participating in a pump and dump fraud scheme in connection with the purchase of more than 1.5 billion shares of HempAmericana, Inc. The district court concluded that, because GPL was accused of being a “puppetmaster[] of a scheme to launder their investments for profit,” it could potentially be held liable for the misleading promotions, despite not making or disseminating the alleged misrepresentations itself. Id. at *10.

But on the other side of the coin, in SEC v. Rio Tinto PLC, another court in the Southern District of New York dismissed the SEC’s scheme liability claims after concluding that the SEC failed to “allege that Defendants disseminated [the] false information, only that they failed to prevent misleading statements from being disseminated by others.” See 17 Civ. 7994 (AT) (DCF), 2021 WL 818745, at *2 (S.D.N.Y. Mar. 3, 2021). Since we discussed this case in our 2021 Mid-Year Securities Litigation Update, the district court certified an interlocutory appeal to the Second Circuit on this issue. The appeal is fully briefed and should provide the Second Circuit with an opportunity to weigh in on Lorenzo’s reach. Gibson Dunn represents Rio Tinto in this and other litigation.

As these developments suggest, the application of the Lorenzo disseminator liability theory continues to evolve among and within the circuits. We will continue to monitor closely the changing applications of Lorenzo and provide a further update in our 2022 Mid-Year Securities Litigation Update.

V. Survey Of Coronavirus-Related Securities Litigation

As the third year of the COVID-19 pandemic begins, we are seeing new trends in coronavirus-related securities litigation. With the continuing development of vaccines, tests, and treatments for COVID-19, there has been a shift from cases focused on safety and travel to suits against pharmaceutical and biotechnology companies based on claims regarding the efficacy and authorization of their drugs.

As vaccines have been approved and businesses have reopened, we are also seeing more suits against companies related to statements made about their pandemic-related successes or losses and whether those trends should be expected to continue post-pandemic.

Courts have begun to issue orders on motions to dismiss in some of the pandemic-related cases we identified in previous updates. We report on notable decisions in this section, but it is still too early to identify any lasting COVID-specific jurisprudence in how courts have treated these cases. We will continue to monitor developments in these and other coronavirus-related securities litigation cases. Additional resources regarding company disclosure considerations related to the impact of COVID-19 can be found in the Gibson Dunn Coronavirus (COVID-19) Resource Center.

A. Securities Class Actions

1. False Claims Concerning Commitment To Safety

Hartel v. GEO Grp., Inc., No. 20-cv-81063, 2021 WL 4397841 (S.D. Fla. Sept. 23, 2021): In our 2020 Year-End Securities Litigation Update, we reported on the filing of this lawsuit, in which the plaintiffs alleged that GEO Group, a private corrections facilities operator, misled investors about the effectiveness of its COVID-19 response—exposing residents and employees to health risks and leaving the company “vulnerable to significant financial and/or reputational harm.” Dkt. No. 1 at 3, 9, 12. After a COVID-19 outbreak was reported in one GEO-run facility, GEO’s stock price fell by ten percent in two days. 2021 WL 4397841, at *2. In December 2020, the defendants filed a motion to dismiss, arguing in part that the complaint ignored material, explicit disclosures of risks during the relevant period; that the forward-looking statements that formed the basis for some claims were not actionable; and that the plaintiffs failed to plead falsity, loss causation, and scienter. Dkt. No. 36 at 8–13, 15–19. On September 23, 2021, Judge Rodney Smith granted the defendants’ motion to dismiss in part—as to certain statements and certain individual defendants—and directed the filing of a second amended complaint that did not include any claims based on non-actionable forward-looking statements, puffery, corporate optimism, or opinion. 2021 WL 4397841, at *15. The plaintiffs filed a second amended complaint on October 4, see Dkt. No. 46, and in November the parties completed briefing on a new motion to dismiss, which remains pending, see Dkt. No. 53.

2. False Claims About Vaccinations, Treatments, And Testing For COVID-19

a. Updates On Previously Reported Cases

Yannes v. SCWorx Corp., No. 1:20-cv-03349, 2021 WL 2555437 (S.D.N.Y. June 21, 2021): As we discussed in our 2020 Mid-Year Securities Litigation Update, this case involved allegations that the company artificially inflated its stock price with a false claim that it had received a purchase order for millions of COVID-19 rapid testing kits. Dkt. No. 1 at 1. In September 2020, this case was consolidated with other stockholder class actions. Dkt. No. 40. Judge Koeltl denied a motion to dismiss in June 2021, finding that the complaint adequately pleaded a strong inference of defendants’ scienter and alleged that the statements were materially misleading. 2021 WL 2555437, at *3–8. On January 5, 2022, the action was stayed to allow the parties to prepare a joint stipulation of settlement. Dkt. No. 74.

In re Sorrento Therapeutics, Inc. Sec. Litig., No. 20-cv-00966, 2021 WL 6062943 (S.D. Cal. Nov. 18, 2021): We previously discussed this case in our 2020 Mid-Year Securities Litigation Update, under the name Wasa Medical Holdings v. Sorrento Therapeutics, Inc. As we described in that Update, a stockholder filed this lawsuit against Sorrento after Sorrento allegedly claimed that it had discovered a “cure” for COVID-19. In November 2021, Judge Battaglia granted the defendants’ motion to dismiss, in part because the challenged statement that “there is a cure” for COVID-19 was a “statement of corporate optimism” that could not be the basis for a claim under Section 10(b) of the Securities Exchange Act. 2021 WL 6062943, at *7. The plaintiffs filed an amended complaint on November 30, 2021, Dkt. No. 58, and defendants filed a motion to dismiss on December 30, 2021, Dkt. No. 61.

b. Newly Filed Cases

Sinnathurai v. Novavax, Inc., No. 21-cv-02910 (D. Md. Nov. 12, 2021): A stockholder of Novavax, a company that develops and produces vaccines, alleges that the company and certain officers made false and misleading statements about the timeline and prospects for the company’s COVID-19 vaccine. Dkt. No. 1 at 1–2. As alleged in the complaint, in March 2021, Novavax announced that it had been in dialogue with the FDA to obtain an Emergency Use Authorization (“EUA”) for its product NVX-CoV2373, which was “in development as a vaccine for COVID-19.” Id. at 1, 6. In that announcement, Novavax specified that the EUA filing could occur as early as the second quarter of 2021 and that it expected to have capacity to manufacture “over 2 billion annualized doses” in mid-2021. Id. at 6–7. In May 2021, a newspaper reported that Novavax’s EUA filing would be delayed until at least June, due to “a regulatory manufacturing issue,” and Novavax announced that day that its EUA filing was delayed until at least July 2021. Id. at 8–9. In August 2021, Novavax announced further delay of its EUA filing until the fourth quarter of 2021. Id. at 12. And in October 2021, another news article reported on manufacturing issues at Novavax that had been “so severe that they strained global COVID-19 vaccination efforts.” Id. at 15. Thereafter, in November 2021, the stockholder filed suit, alleging that after each of these disclosures, Novavax’s share price declined. Id. at 2–3. In December 2021, the defendants filed a notice of intent to file a motion to dismiss. Dkt. No. 13.

In re Emergent Biosolutions Inc. Sec. Litig., No. 8:21-cv-00955, 2021 WL 6072812 (D. Md. Dec. 23, 2021): In this suit, stockholders allege that Emergent, a biopharmaceutical company, and certain officers and high-level employees misled the public about the company’s business and operations though misrepresentations and omissions. Dkt. No. 1 at 14. In June 2020, Emergent received funds through the federal government’s Operation Warp Speed program, which was created to “encourage rapid development, manufacturing, and distribution of COVID-19 vaccines.” 2021 WL 6072812, at *1. The Operation Warp Speed funding was provided to reserve space for vaccine manufacturing at Emergent’s facilities in Baltimore and for Emergent to upgrade those facilities. Id. Emergent also signed agreements with Johnson & Johnson and AstraZeneca to support the mass production of their vaccines, once they were approved for distribution. Id. As alleged in the complaint, in the press releases announcing these agreements and in other statements, Emergent drew attention to its “manufacturing strength” and “expertise in development and manufacturing.” Dkt. No. 1 at 7–9. But Emergent failed to disclose “myriad issues” at the Baltimore facilities, which had been identified in FDA inspections but not disclosed to the public until after a March 31, 2021 article reported on the Baltimore facilities’ contamination of up to 15 million doses of the Johnson & Johnson vaccine. Id. at 2–3, 9–10. After additional reporting revealed the severity of the contamination and Emergent’s “history of violations,” Emergent’s stock price declined “precipitously.” Id. at 10. In December 2021, the court consolidated three class action suits, appointed a lead plaintiff, and selected lead counsel. 2021 WL 6072812, at *6–7.

3. Failure To Disclose Specific Risks

Martinez v. Bright Health Grp. Inc., No. 1:22-cv-00101 (E.D.N.Y. Jan. 6, 2022): This putative class action alleges that Bright Health’s June 25, 2021 offering documents overstated Bright Health’s post-IPO business and financial prospects and failed to disclose that Bright Health was ill-equipped to handle the impact of COVID-19 related costs, which led to a 32.33% fall in stock price on November 11, 2021. Dkt. No. 1 at 2–4. Bright Health has not yet responded to the complaint.

4. False Claims About Pandemic And Post-Pandemic Prospects

In re Progenity, Inc., No. 20-cv-1683, 2021 WL 3929708 (S.D. Cal. Sept. 1, 2021): This putative class action alleges that Progenity, a biotechnology company that develops testing products, made misleading statements and omitted material facts in its registration statement. Dkt. No. 1 at 2. Specifically, the complaint alleges that Progenity allegedly failed to disclose that it had overbilled government payors and that it was suffering from negative trends in Progenity’s testing volumes, selling prices, and revenues as a result of the COVID-19 pandemic. Id. The complaint further alleges that Progenity falsely emphasized its “resilient” business and that it had already “observed positive signs of recovery” from the COVID-linked slowdown. Id. at 8. On September 1, 2021, the court dismissed the case with leave to file a second amended complaint, finding no actionable false or misleading statements. Dkt. No. 48. Plaintiffs filed a second amended complaint on September 22, 2021. Dkt. No. 49. The case was transferred on January 3, 2022 to Judge Lopez, who is currently considering a second motion to dismiss. Dkt. Nos. 52–54.

Dixon v. The Honest Co., Inc., No. 2:21-cv-07405 (C.D. Cal. Sept. 15, 2021): Stockholders of the Honest Co., a seller of “clean lifestyle” products, filed this putative class action alleging that the company’s registration statement omitted the fact that the company’s results were impacted by a multimillion-dollar COVID-19 stock-up of diapers, wipes, and household and wellness products, and that at the time of its IPO the company was experiencing decelerating demand for the products. Dkt. No. 1 at 1, 3. The complaint alleges that as a result, the company’s statements about “its business, operations, and prospects, were materially misleading and/or lacked a reasonable basis.” Id. The court recently granted a motion to consolidate this case with other, similar cases brought against the Honest Co. Dkt. No. 47.

Douvia v. ON24, Inc., No. 21-cv-08578 (N.D. Cal. Nov. 3, 2021): This putative class action by stockholders of ON24, Inc., a “cloud-based digital experience platform,” alleges that the company’s offering documents were materially inaccurate, misleading, and incomplete because they failed to disclose that the company’s surge in new customers due to COVID-19 did not fit the company’s traditional customer profile and thus the customers were unlikely to renew their contracts, leading to a decrease in the company’s financial results. Dkt. No. 1 at 1, 2. Motions to consolidate, appoint a lead plaintiff, and appoint lead counsel are currently before the court. Dkt. No. 65.

Hollywood Police Officers’ Ret. Sys. v. Citrix Sys., Inc., No. 21-cv-62380 (S.D. Fla. Nov. 19, 2021): The plaintiffs allege that Citrix made materially false and misleading statements that caused substantial losses to investors. Dkt. No. 1 at 2. Citrix, a software company that provides users with secure remote access to computer networks, decided to shift to a subscription license model. Id. Due to the COVID-19 pandemic, however, Citrix offered shorter duration, on-premise licenses that would later transition to subscription licenses. Id. According to the complaint, because of this offer and the COVID-19 pandemic, Citrix’s sales were boosted, and the company touted its success to investors. Id. The plaintiffs allege that, in reality, the company’s transition to subscription licenses was not as successful as the company had disclosed, as customers failed to make the transition, instead preferring short-term on-premise licensing due to the COVID-19 pandemic. Id. at 3. Motions to appoint lead plaintiff and to appoint lead counsel are currently before the court. Dkt. Nos. 16–21.

Leventhal v. Chegg, Inc., No. 5:21-cv-09953 (N.D. Cal. Dec. 22, 2021): This putative class action alleges that Chegg, a textbook, tutoring, and online research provider, falsely claimed that as a result of its “unique position to impact the future of the higher education ecosystem” and “strong brand and momentum,” Chegg would continue to grow post-pandemic. Dkt. No. 1 at 2. The complaint alleges that Chegg knew that its growth was a temporary effect of the pandemic and was not sustainable. Id. at 2–3. As a result, the plaintiff alleges that Chegg took advantage of its artificially inflated stock price by selling $1 billion of common stock to investors in its secondary offering. Id. at 3.

Collins v. DocuSign, Inc., No. 21-cv-07071 (E.D.N.Y. Dec. 22, 2021): The plaintiffs allege that DocuSign, a software company that “enables users to automate the agreement process and provide legally binding e-signatures from nearly any devise,” made false and misleading statements and failed to disclose the impact of COVID-19 on the company’s business. Dkt. No. at 1, 2, 13. Specifically, plaintiffs allege that Docusign failed to disclose that COVID-19 had a positive impact of the company and that DocuSign downplayed the impact that a “return to normal” would have on the company’s growth and business. Id.

5. Insider Trading And “Pump and Dump” Schemes

In re Eastman Kodak Co. Sec. Litig., No. 6:21-cv-6418, 2021 WL 3361162 (W.D.N.Y. Aug. 2, 2021): We discussed the first in the series of cases that have now been consolidated under the heading In re Eastman Kodak Co. Securities Litigation in our 2020 Year-End Securities Litigation Update and then followed up on it in our 2021 Mid-Year Securities Litigation Update. Tang v. Eastman Kodak Co., No. 20-cv-10462 (D.N.J. Aug. 13, 2020), was a putative class action in which stockholders alleged Eastman Kodak violated Sections 10(b) and 20(a) of the Exchange Act by failing to disclose that the company’s officers were granted stock options before the company’s public announcement that it had received a loan to produce drugs for the treatment of COVID-19. Dkt. No. 1 at 2. As we noted in our 2021 Mid-Year Update, Tang v. Eastman Kodak Co. was transferred from the District of New Jersey to the Western District of New York. Around the same time, another class action against Eastman Kodak, McAdams v. Eastman Kodak Co., No. 21-cv-6449 (S.D.N.Y. Aug. 26, 2020), was transferred from the Southern District of New York to the same court. 2021 WL 3361162, at *1. In late June 2021, the court in the Western District of New York consolidated the two actions, and in August, the court appointed lead plaintiff and lead counsel. Id.

In re Vaxart Inc. Sec. Litig., 3:20-cv-05949, 2021 WL 6061518 (N.D. Cal. Dec. 22, 2021): Stockholders allege that Vaxart insiders—directors, officers, and a major stockholder—profited from misleading statements that (1) overstated Vaxart’s progress toward a successful COVID-19 vaccine; and (2) implied that Vaxart’s “supposed vaccine” had been “selected” by the federal government’s Operation Warp Speed program. Dkt. No. 1 at 6–7. After Vaxart’s stock price rose in response to these statements, the insiders “cashed out,” exercising options and warrants worth millions of dollars. Id. at 7–8.

After this case was consolidated with other, related stockholder class actions (including Hovhannisyan v. Vaxart, Inc., No. 20-cv-06175 (N.D. Cal. Sept. 1, 2020), which we first discussed in our 2020 Year-End Securities Litigation Update), Judge Chhabria issued a decision on the defendants’ motion to dismiss on December 22, 2021, and, in doing so, observed that the case is an “unusual” one. 2021 WL 6061518. The court noted that the plaintiffs easily satisfied the pleading requirement for scienter, which can be a high hurdle for private plaintiffs. Instead, the court observed plaintiffs faced a challenge pleading that the statements at issue were materially misleading to a reasonable investor, where the press releases and other statements at issue “included several accurate passages alongside highly misleading ones,” so that an investor might have been able to “sift through” them and find the false statements untrustworthy. Id. at *1. Judge Chhabria ultimately concluded, however, that, considering the totality of the statements and the “unique context” of the Operation Warp Speed program, the plaintiffs had sufficiently alleged that the statements were materially misleading. Id. at *1, *4–5. The motion to dismiss was granted only as to the major-stockholder defendant, as the plaintiffs had failed to allege that the entity was a “maker” of the misleading statements or controlled Vaxart’s public statements. Id. at *8.

B. Stockholder Derivative Actions

Equity-League Pension Tr. Fund v. Great Hill Partners, L.P., No. 2020-0992-SG, 2021 WL 5492967 (Del Ch. Nov. 23, 2021): In November 2020, Wayfair stockholders initiated this derivative action asserting that (1) the directors had breached their fiduciary duties in connection with a private investment in a public equity (“PIPE”) transaction undertaken during the COVID-related economic downturn in early 2020, see 2021 WL 5492967, at *4; (2) noteholders had been unjustly enriched by that transaction, id. at *5; and (3) a private equity investor and its designee director had been unjustly enriched in an early March 2020 purchase of Wayfair stock, id. In November 2021, the Court of Chancery granted defendants’ motion to dismiss in its entirety because the plaintiffs had failed to plead demand futility. Id. at *1.

In re Vaxart, Inc. Stockholder Litig., No. 2020-0767-PAF, 2021 WL 5858696 (Del. Ch. Nov. 30, 2021): Unlike the Vaxart class action securities litigation discussed above, this case was filed derivatively on behalf of the Vaxart corporate entity. In particular, Vaxart stockholders alleged that the officers, directors, and purported controlling stockholder kept private the announcement regarding the company’s selection to participate in Operation Warp Speed so that they could keep the stock price artificially low before exercising their options. 2021 WL 5858696, at *1, *13. Because the plaintiffs failed to plead demand futility as to their derivative claims, on November 30, 2021, the court granted the defendants’ motion to dismiss as to the derivative claims, and requested supplemental briefing on other issues. Id. at *24.

C. SEC Cases

SEC v. E*Hedge Sec. Inc., No. 1:20-cv-22311 (S.D. Fla. June 3, 2020): We previously discussed this case in our 2020 Mid-Year Securities Litigation Update. The SEC filed suit against an internet investment advisor firm and its president for failing to turn over its books and records while touting investment opportunities related to treatments and vaccines for COVID-19. Dkt. No. 1 at 1–2, 6. Although the defendants responded to the initial complaint, they subsequently failed to answer or otherwise respond to the SEC’s amended complaint. See Dkt. No. 29 at 1. On March 9, 2021, the court issued an order granting the SEC’s motion for default judgment for a permanent injunction restraining E*Hedge Securities from violating Sec. 204 of the Investment Advisor’s Act of 1940 by failing to turnover books and records as required by the statute, and being registered with the SEC as an investment adviser while it is statutorily prohibited from doing so under Sec. 203A of the same statute. Dkt. No. 29 at 2.

SEC v. Berman, No. 20-cv-10658, 2021 WL 2895148 (S.D.N.Y. June 8, 2021): We previously discussed a related criminal case in our 2020 Year-End Securities Litigation Update. In the criminal case, a federal grand jury indicted the CEO of Decision Diagnostics Corp. (also a defendant in this civil case) on December 15, 2020, for allegedly attempting to defraud investors by making false and misleading statements about the development of a new COVID-19 rapid test, which the CEO falsely claimed was on the verge of FDA approval. Dkt. No. 1 at 6–7. As alleged, the product in question was actually still in its conceptual stage. Id. at 9. On December 17, 2020, two days after the indictment in the criminal case, the SEC filed a civil enforcement action based on the same underlying facts and alleging that both Decision Diagnostics Corp. and its CEO, Keith Berman, violated Section 10(b) of the Exchange Act and Rule 10b-5. 2021 WL 2895148, at *1. In this civil case, the court stayed discovery in June 2021 in light of the parallel criminal case against the CEO. Id.

SEC v. Wellness Matrix Grp., Inc., No. 21-cv-1031, 2021 WL 6104812 (C.D. Cal. Oct. 14, 2021): We previously discussed this case in our 2021 Mid-Year Securities Litigation Update. The SEC charged Wellness Matrix, a wellness company, and its controlling stockholder with violations of Section 10(b) and Rule 10b-5 by allegedly misleading investors regarding the availability and approval status of the corporation’s at-home COVID-19 testing kits. Dkt. No. 1 ¶¶ 6–7, 9. On August 23, 2021, the controlling stockholder filed his answer in which he asserted several counterclaims against the SEC, including for trademark infringement, libel, and slander. 2021 WL 6104812, at *1. On October 14, 2021, the court granted the SEC’s motion to dismiss defendants’ counterclaims but denied the SEC’s motion to strike defendant’s unclean hands defense and challenges to the court’s jurisdiction. Id. The SEC’s motion was unopposed and the court’s decision to dismiss the defendant controlling stockholder’s counterclaims validated the SEC’s argument that Section 21(g) of the Exchange Act “bars defendants from bringing a counterclaim in an SEC enforcement action without the SEC’s consent.” Id. at *2. The court chose to deny the SEC’s motion as to the defendant’s unclean hands and jurisdictional defenses, however, because the SEC failed to identify the language in the answer it was seeking to strike, and the court “decline[d] to sift through the Answer and guess.” Id. at *3.

VI. Falsity Of Opinions – Omnicare Update

There was significant activity in the second half of 2021 with respect to “opinion” liability under the federal securities laws. Lower courts continue to examine the standard for imposing liability based on a false opinion as set forth by the Supreme Court in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015). In Omnicare, the Supreme Court held that “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong,” but that an opinion statement can form the basis for liability in three different situations: (1) the speaker did not actually hold the belief professed; (2) the opinion contained embedded statements of untrue facts; or (3) the speaker omitted information whose omission made the statement misleading to a reasonable investor. Id. at 184–89.

In the second half of 2021, courts continued the trend of applying Omnicare to claims under the Exchange Act (Omnicare was decided in the context of a Section 11 claim), including in numerous actions under Section 10(b) and Rule 10b-5. For example, in Villare v. Abiomed, Inc., No. 19 CIV. 7319 (ER), 2021 WL 4311749, at *19–20 (S.D.N.Y. Sep. 21, 2021), the Southern District of New York applied, without discussion or note, the Omnicare analysis to claims under the Exchange Act. See also Del. Cnty. Emps. Ret. Sys. v. Cabot Oil & Gas Corp., No. CV H-21-2045, 2022 WL 112029, at *10 (S.D. Tex. Jan. 12, 2022) (applying Omnicare to a claim brought under Section 10(b) of the Securities Exchange Act); Constr. Indus. & Laborers Joint Pension Tr. v. Carbonite, Inc., 22 F.4th 1, 7(1st Cir. 2021) (holding that the plaintiff adequately stated a Section 10(b) claim under Omnicare).

A notable portion of claims survived motions to dismiss in which defendants asserted that the misrepresentations or omissions at issue were non-actionable statements of opinion under Omnicare. For example, the First Circuit in Carbonite, Inc., 22 F.4th 1, held that a plaintiff adequately stated a Section 10(b) claim against a software company based on misleading statements by the company’s executives. Id. at 7. The plaintiffs in that case alleged that a software company misstated and misled investors as to the capabilities of a new data-backup product. Id. at 4-5. The complaint cited a statement made by the chief financial officer touting that the company “put something out that we think is just completely competitive and just a super strong product.” Id. at 7. The plaintiffs painted a different picture, claiming that the product “never worked.” Id. at 5. Despite being phrased in the form of a belief (“we think”), the First Circuit noted that the CFO’s opinion was precisely the type of actionable statement contemplated by Omnicare. Id. at 7–8. The court explained that the CFO’s statement “plausibly conveyed” several facts: first, that the CFO actually believed the product would be “completely competitive” and “super strong;” second, that the CFO’s belief “fairly align[ed] with the information” he possessed at the time; and third, that the CFO’s opinion was based on “the type of reasonable inquiry that an investor in context would expect to have been made.” Id. at 7 (citing Omnicare, 575 U.S. at 188–89). Because the complaint plausibly alleged that “at least one and possibly all three of these facts must be false,” it “sufficiently allege[d] that [the CFO] misled investors.” Id. at 8.

In Sheet Metal Workers Loc. 19 Pension Fund v. ProAssurance Corp., No. 2:20-CV-00856-AKK, 2021 WL 5866731, at *15 (N.D. Ala. Dec. 10, 2021), the court held that plaintiffs plausibly alleged that defendants’ statements of opinion “contained embedded statements of fact that the defendants allegedly knew were false or misleading,” which nullified the fact that “the defendants used the word ‘belief’ to couch some of their statements.” Similarly, in In re 2U, Inc. Sec. Class Action, No. CV TDC-19-3455, 2021 WL 3418841 (D. Md. Aug. 5, 2021), the District of Maryland found that some forward looking statements of opinion were nonetheless actionable where an officer expressed confidence in continued growth rates that were inconsistent with internal projections. Id. at *11. The officer noted that the positive projections were based on “information currently available,” despite the officer knowing that the growth rates were in fact declining. Id. Thus, the statement was materially misleading because the speaker “provided no warnings or other information that would have corrected a reasonable person’s reading of those statements.” Id.; see also Enzo Biochem, Inc. v. Harbert Discovery Fund, LP, No. 20-CV-9992 (PAC), 2021 WL 4443258, at *12 (S.D.N.Y. Sept. 27, 2021) (“Even if the [statements regarding the qualifications of the board candidates] were statements of opinion, liability could still attach under Section 14(a) if a jury were to find that [defendant] failed to accurately state its opinion in the proxy solicitations.”).

Although these cases illustrate that courts are willing to let certain complaints play out, even where the allegedly false or misleading statements include explicit language noting that the content is mere belief and opinion, Omnicare still presents a significant pleading barrier. For example, in Turnofsky v. electroCore, Inc., No. CV 19-18400, 2021 WL 3579057 (D.N.J. Aug. 13, 2021), the District of New Jersey relied on Omnicare to dismiss a Section 11 claim against a bioelectronic medicine company. Id. at *5. The plaintiffs alleged that electroCore, a company seeking to develop nerve stimulation technology, misrepresented its “competitive strengths” in its registration statement. Id. at *4. Although the registration statement noted that the company’s proprietary technology was “novel,” the complaint alleged that the opposite was true: “several other competitors were also being granted FDA clearance for the same [technology].” Id. The court disagreed, noting that the plaintiffs had not demonstrated the statements “were plausibly false” or even “materially misleading.” Id. at *5. The court also noted that the statements highlighted by the plaintiffs were opinions protected under Omnicare. Id. For example, the preamble to the registration statement included the language “we believe” immediately prior to the statements concerning the company’s “competitive strengths” and “novel” technology. Id. Additionally, the company’s statements did “not imply that similar medical devices were not entering the market” or that “competitors had not been granted FDA clearance.” Id.; see also, e.g., Sayce v. Forescout Techs., Inc., No. 20-CV-00076-SI, 2021 WL 4594768, at *6 (N.D. Cal. Oct. 6, 2021) (holding that a general belief in a favorable outcome, such as statements that the company “expect[ed]” and “look[ed] forward” to a closing, “[did] not create an affirmative impression or promise that [the closing]” would actually occur); In re Progenity, Inc., No. 20-CV-1683-CAB-AHG, 2021 WL 3929708, at *9 (S.D. Cal. Sept. 1, 2021) (finding the statement “we believe our business is resilient and we have observed positive signs of recovery so far” was not actionable under Omnicare); Employees’ Ret. Sys. of City of Baton Rouge & Par. of E. Baton Rouge v. MacroGenics, Inc., No. GJH-19-2713, 2021 WL 4459218, at *13 (D. Md. Sept. 29, 2021) (“[T]he statement that ‘we anticipate’ a positive trend to continue is also protected as a ‘sincere statement of pure opinion’ under Omnicare.”).

Another category of cases have held that an opinion is not actionable solely because there are underlying facts cutting against the opinion. In In re Philip Morris International, Inc. Securities Litigation, No. 1:18-CV-08049 (RA), 2021 WL 4135059, at *9 (S.D.N.Y. Sept. 10, 2021), the plaintiffs alleged that the defendants made false and misleading statements to the effect that studies of a cigarette alternative were “very encouraging,” and the product “has the potential to reduce the risk of smoking-related diseases.” The court considered the statements to be opinions because of the use of qualifiers such as “potential” or “likely” in connection with statements about the product’s reduction in harm from smoking cigarettes. Id. The defendants’ failure to disclose certain adverse test results was not actionable because “[i]t is well-established that a statement of opinion is not misleading simply because the issuer knows, but fails to disclose, some fact cutting the other way.” Id. (internal quotation marks omitted); see also Villare, 2021 WL 4311749 at *20 (explaining that “failure to include a fact that would have potentially undermined Defendants’ optimistic projections,” was not actionable because “Defendants were only tasked with making statements that fairly aligned with the information in the issuer’s possession at the time”) (internal quotation marks omitted)).

Courts continue to sort through what qualifies as a statement of opinion versus a statement of fact. A recent decision notes that the absence of language such as “I think” or “I believe” suggests that the statement is, indeed, a statement of fact. In re Quantumscape Securities Class Action Litig., No. 3:21-CV-00058-WHO, 2022 WL 137729, at *16 (N.D. Cal. Jan. 14, 2022) (“None of these statements use opinion-qualifying language such as ‘I think’ or ‘I believe.’ All express ‘certainty’ about an existing thing or occurrence.”). Other courts have taken a categorical approach, holding, for example, that “[a] goodwill determination is a statement of opinion.” SEC v. Sequential Brands Grp., Inc., No. 20-CV-10471 (JPO), 2021 WL 4482215, at *7 (S.D.N.Y. Sept. 30, 2021).

A recent federal district court decision also highlighted a “split in authority regarding whether” an audit report is an “opinion” subject to Omnicare. Hunt v. Bloom Energy Corp., No. 19-CV-02935-HSG, 2021 WL 4461171, at *13 (N.D. Cal. Sept. 29, 2021); compare Special Situations Fund III QP, L.P. v. Marrone Bio Innovations, Inc., 243 F. Supp. 3d 1109, 1116 (E.D. Cal. 2017) (“Omnicare did nothing to upset prior caselaw holding auditors liable for erroneous financial statements in registration statements.”) with Querub v. Hong Kong, 649 F. App’x 55, 58 (2d Cir. 2016) (applying Omnicare to an auditor’s report in a summary order), and Johnson v. CBD Energy Ltd., No. CV H-15-1668, 2016 WL 3654657, at *10 (S.D. Tex. July 6, 2016) (collecting cases).

Finally, several recent decisions have emphasized the significance of the context surrounding the statements in question to determine whether the opinion is actionable under Omnicare. In Delaware County Employees Retirement System v. Cabot Oil & Gas Corporation, No. CV H-21-2045, 2022 WL 112029, at *10 (S.D. Tex. Jan. 12, 2022), the Southern District of Texas granted a motion to dismiss a Section 10(b) claim because the context surrounding the allegedly impermissible statement mitigated any potential misunderstanding. There, plaintiffs alleged that an oil and gas company had misled investors by providing a general explanation of the “legal [and] regulatory requirements” in the industry. Id. The complaint alleged that these general statements of applicable regulations had “hid[den] the fact that [the company] had received Notices of Violation.” Id. The court rejected this notion by pointing to the fact the company, in the very same document as the statements the plaintiffs took issue with, had disclosed the “substantial costs and liabilities related to environmental compliance issues” it may face. Id. The court cited Omnicare for the proposition that an investor would read a statement “in light of all its surrounding text.” Id.; see also Turnofsky, 2021 WL 3579057 at *5 (finding that other sections of a registration statement had “disclosed competitors’ advantages,” thereby undermining the plaintiffs’ claim that the defendant had omitted that information; the court also noted that Omnicare commanded lower courts to “address the statement’s context”).

We will continue to monitor developments in these and similar cases.

VII. Halliburton II Market Efficiency And “Price Impact” Cases

We continue to follow developments as the federal courts interpret the Supreme Court’s 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (“Halliburton II”), preserving the “fraud-on-the-market” presumption of class-wide reliance in Rule 10b-5 cases, but also permitting defendants to rebut this presumption at the class certification stage with evidence that the alleged misrepresentation did not impact the issuer’s stock price. As detailed in our 2021 Mid-Year Securities Litigation Update, the Supreme Court’s decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, 141 S. Ct. 1951 (2021) (“Goldman Sachs”), has resolved a number of recurring questions lower courts struggled with following the Halliburton II decision. There, the Court confirmed that in deciding whether to certify a class after defendants challenge the Basic presumption of reliance, the need to consider all evidence of price impact extends to considering the generic nature of allegedly fraudulent statements, even if such evidence overlaps with merits issues, such as loss causation or materiality. See id. at 1955, 1960–61. The Court also held that at the class certification stage defendants bear the burden of persuasion on the issue of price impact in order to rebut the presumption of reliance. Id. at 1962–63.

Another issue that was addressed by the Court in Goldman Sachs but not resolved was the so-called “inflation-maintenance theory,” used by plaintiffs to show price impact where the statement itself does not induce inflation but a later “corrective disclosure” is accompanied by a drop in the stock price. See Goldman Sachs, 141 S. Ct. at 1959 n.1, 1961. Although the Court expressly declined to take a position on the “validity or . . . contours” of the inflation-maintenance theory, it noted that the mismatch between generic misrepresentations and later, specific corrective disclosures will be a key consideration in the price-impact analysis, and that where such a mismatch exists, “there is less reason to infer front-end price inflation . . . from the back-end price drop.” Id.

On remand, the Second Circuit found that it was unclear whether the district court considered the generic nature of the alleged misrepresentations, and therefore remanded the case for the district court to consider the parties’ price impact arguments a third time. Arkansas Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., 11 F.4th 138, 143 (2d Cir. 2021).

Back in the District Court, Judge Crotty considered the parties’ price impact evidence again in light of the Supreme Court’s enhanced guidance, including the extent of the “mismatch” between the alleged misstatements and alleged corrective disclosures on a “sliding scale.” In re Goldman Sachs Grp., Inc. Sec. Litig., 2021 WL 5826285, at *13–14 (S.D.N.Y. Dec. 8, 2021). The court again held that plaintiff linked the stock price drops to both the corrective disclosures and the alleged misstatements and that defendants failed to sever that link. Id. at *9–10. It also held that the statements were not so generic “as to diminish their power to maintain pre-existing price inflation,” but rather “did in fact maintain price inflation.” Id. at *11. Judge Crotty also held that, although the challenged statements and corrective disclosures “do not present equivalent levels of genericness,” defendants failed to identify a sufficient “mismatch” to undermine the inference of price impact. Id. at *14. Following Judge Crotty’s third certification order, Goldman Sachs has appealed the decision to the Second Circuit for the third time.

We will continue to follow the Goldman Sachs case and other developments in this area. We anticipate that upcoming opinions will continue to address the extent to which a mismatch between the challenged statement and corrective disclosure can undermine the evidence of price impact in cases based on inflation-maintenance theory, and we will report on significant matters in future updates.

VIII. Other Notable Developments

A. Second Circuit Revives Class Action Because Section 10(b) Does Not Require That Misstatements Concern An Underlying “Fraudulent Scheme Or Practice”

In In re Hain Celestial Group, Inc. Securities Litigation, 20 F.4th 131 (2d Cir. 2021), the Second Circuit vacated the dismissal of securities fraud claims brought under Section 10(b) of the Exchange Act and Rule 10b-5. The plaintiff investors alleged that the defendant health food product company had engaged in “channel stuffing,” “whereby valuable and unsustainable sales incentives—including price reductions and grants of an absolute right to return unsold merchandise—were given near the end of each quarter to Hain’s largest distributors to induce them to buy more product than needed so that Hain would meet its quarterly sales targets and analysts’ estimates.” Id. at 132–33. The plaintiff class argued both that the defendants’ failure to attribute Hain’s performance to channel stuffing in various financial statements rendered those statements materially misleading, in violation of Rule 10b-5(b), and that the channel stuffing itself constituted an unlawful scheme to defraud investors, in violation of Rule 10b-5(a) and (c). In re Hain Celestial Grp. Inc. Sec. Litig., 2020 WL 1676762, at *9 (E.D.N.Y. Apr. 6, 2020). The district court rejected these arguments and dismissed the complaint entirely. It first held that the alleged channel stuffing constituted a legitimate business practice, and therefore could not be the predicate for liability under Rule 10b-5(a) or (c). Id. at *12. The district court also rejected the Rule 10b-5(b) claim, because “its predicate is the illegitimacy of the channel stuffing practices the Court already found to be legitimate” and “the Defendants were under no generalized obligation to disclose wholly legal sales incentives simply because the Lead Plaintiffs allege those incentives to be unsustainable.” Id.

On appeal, the plaintiffs challenged only the Rule 10b-5(b) dismissal. In re Hain, 20 F.4th at 136. The Second Circuit vacated the dismissal of that claim, holding that “[t]he district court mistakenly imported the requirement of clauses (a) and (c) of a fraudulent scheme or practice into clause (b), which includes no such requirement.” Id. The appellate court explained that “[t]he success of . . . a complaint in alleging a violation of clause (b) does not depend on whether the alleged channel stuffing practices themselves were fraudulent or otherwise illegal.” Id. at 137. In doing so, however, the Second Circuit did not address the district court’s analysis of prior Circuit precedent holding that, “up to a point, companies must be permitted to operate with a hopeful outlook, and that as a result, executives are not required to take a gloomy, fearful or defeatist view of the future.” In re Hain, 2020 WL 1676762, at *13 (internal quotation marks omitted). Nor did the Second Circuit address the district court’s reliance on past district court decisions finding that companies are not obligated to disclose “unsustainable” practices “where [they] engaged in no misconduct and the statements at issue attributed the company’s growth to broad trends and corporate strengths, without pointing to any specific factors or sources of revenue.” Id. at *14 (internal quotation marks and alterations omitted). Instead, the Second Circuit only instructed the district court to consider anew whether a Rule 10b-5(b) claim had been adequately pleaded. See In re Hain, 20 F.4th at 138. This decision indicates that corporations and executives could be exposed to securities fraud liability if they fail to accurately attribute financial performance to unsustainable practices, even if those practices are wholly legitimate.

B. Ninth Circuit Finds Statutory Standing For Purchaser In Direct Listing

In Pirani v. Slack Technologies, Inc., 13 F.4th 940 (9th Cir. 2021), the Ninth Circuit became the first court of appeals to address whether purchasers of shares sold in a direct listing had statutory standing to assert claims under Sections 11 and 12 of the Securities Act. In a 2-1 decision, the panel majority affirmed the district court’s holding that shareholders do have standing to bring such claims.

In 2018, the New York Stock Exchange introduced a rule, approved by the SEC, that allows companies to go public through a Selling Shareholder Direct Floor Listing (a “direct listing”). Id. at 944. Under this procedure, the company does not issue or sell any new shares. Instead it files a registration statement “solely for the purpose of allowing existing shareholders to sell their shares on the exchange.” Id. at 944. This procedure differs from a traditional initial public offering (“IPO”), in which all of the shares sold to the public are newly issued shares that are all registered under a registration statement. Id. at 943. Another major difference between a direct listing and an IPO is that in a direct listing, both shares registered under the registration statement and shares that are not registered (because they are exempt from the registration requirements of the Securities Act pursuant to SEC Rule 144) may be sold as soon as the company goes public. See id. By contrast, in an IPO, unregistered shares typically are subject to a lock-up period which prevents them from being sold when a company first goes public. Id. This means that all of the shares that initially trade after an IPO are registered. Id. at 943. Therefore, whereas an investor would know that any shares purchased following an IPO must be registered, an investor who purchased shares following a direct listing would have no way of knowing whether the shares he purchased were registered or unregistered. Id. at 944.

In June 2019, Slack went public through a direct listing, which permitted its existing shareholders to sell up to 118 million registered shares and 165 million unregistered shares. Id. The plaintiff purchased 30,000 Slack shares on the day of the public listing, and 220,000 additional shares in ensuing months. Id. He later brought claims under Sections 11 and 12 of the Securities Act, alleging that the registration statement Slack issued in connection with the direct listing omitted material information that rendered Slack’s disclosures misleading. Id. at 944–45. The question presented to the Ninth Circuit was whether the plaintiff had statutory standing to bring these claims despite the fact that he had no knowledge of whether the shares he purchased were registered under the challenged registration statement. Id. at 945.

Under well-settled precedent, a plaintiff must be able to trace the shares he purchased to those registered under the registration statement being challenged in order to have statutory standing. Courts have consistently held that it is nearly impossible for plaintiffs to trace in cases involving “successive registrations, whereby a company issues a secondary offering to the public such that there are multiple registration statements under which a share may be registered,” because plaintiffs will not know whether the shares they purchased came from the challenged registration statement instead of another registration statement. Id. at 946. Slack argued this same problem was present in its direct listing because the market contained both shares registered under the challenged registration statement (which may confer standing) and many more shares that were unregistered (which may not). Id. at 948. Nevertheless, the panel majority concluded that the plaintiff had standing “[b]ecause this case involves only one registration statement” and “does not present the traceability problem identified by [the Ninth Circuit] in cases with successive registrations.” Id. at 947. The panel majority reasoned that both registered and unregistered shares could confer standing because, under NYSE direct listing rules, both could be sold on the exchange only because Slack had an effective registration statement. Id. The panel majority further reasoned that a contrary interpretation would “create a loophole” exempting issuers from Section 11 and Section 12 liability so long as they go public via a direct listing. Id. at 948.

Judge Miller dissented, arguing that the majority improperly based its holding on the text of NYSE rules instead of the text of the statutes at issue; that there was no principled distinction between successive-registration cases and this one; and that the majority’s reliance on policy arguments was improper. Id. at 952–53 (Miller, J., dissenting). Defendants have petitioned for rehearing and rehearing en banc, and that petition remains pending. Gibson Dunn represents Slack in this litigation.

C. California Court Finds Transactions In Unlisted American Depositary Receipts Not Domestic Under “Irrevocable Liability” Test

Judge Pregerson of the District Court for the Central District of California denied a motion for class certification in a putative class action brought by two pension funds against Toshiba. Stoyas v. Toshiba Corp., 2022 WL 220920, at *1 (C.D. Cal. Jan. 25, 2022). The action began in 2015, when plaintiffs brought claims under Sections 10(b) and 20(a) of the Exchange Act against Toshiba, alleging substantial accounting improprieties. Stoyas v. Toshiba Corp., 896 F.3d 933, 937–38 (9th Cir. 2018). The case was initially dismissed on extraterritoriality grounds, but the Ninth Circuit revived the case in a widely covered 2018 opinion. See id. at 938, 952. On remand, the plaintiffs, who purchased Toshiba’s American Depositary Receipts (“ADRs”) on the over-the-counter (“OTC”) market, moved to certify a class on behalf of two groups of purchasers: OTC purchasers of Toshiba securities and all citizens and residents of the U.S. who purchased Toshiba common stock. Stoyas, 2022 WL 220920, at *2.

The court denied plaintiffs’ motion for class certification on Rule 23(a) typicality grounds, concluding that there was no typicality because at least one of the named plaintiffs had purchased its ADRs in foreign transactions. Id. at *3. In reaching this conclusion, the court specifically noted that that plaintiff’s “ability to acquire ADRs was contingent upon the purchase of underlying shares of common stock [in Japan] that could be converted into ADRs,” and that, once the underlying common stock was acquired, the plaintiff was “bound to take and pay for the ADRs, once converted.” Id. at *4. Thus, the “triggering event” that caused that plaintiff to “incur irrevocable liability occurred in Japan,” and, thus, that plaintiff’s purchase of ADRs was a “foreign transaction” as defined by the Ninth Circuit’s Stoyas opinion. Id. at *5. Accordingly, the court denied the plaintiffs’ motion for class certification. Id.

D. Second Circuit Upholds Dismissal Of Class Action Reaffirming That Corporate Mismanagement Is Not Securities Fraud

On August 25, 2021, the Second Circuit in Plumber & Steamfitters Local 773 Pension Fund v. Danske Bank A/S, 11 F.4th 90 (2d Cir. 2021), affirmed a district court decision dismissing a securities class action complaint brought by three pension funds, which alleged that Danske Bank had covered up a money-laundering scandal. Id. at 95, 106. In 2016, “the Danish Financial Supervisory Authority (DFSA) reprimanded and later fined Danske Bank for compliance shortcomings” related to its Estonian branch, and in the next few years it came to light that “over $200 billion worth of [that branch’s] transactions were suspect.” Id. at 95, 97. In their complaint, the plaintiffs argued that Danske Bank had made actionable misstatements or omissions in its financial statements. Id. at 98. Specifically, the plaintiffs alleged that “ill-gotten profits from the Estonian Branch were baked into” the bank’s financial results and that it was “misleading for Danske to release those numbers without simultaneously disclosing what it knew about possible money laundering at the branch.” Id.

The Second Circuit affirmed the dismissal of the action in full, stating that “the allegations do not move the claims outside the realm of corporate mismanagement and into the realm of securities fraud.” Id. at 96. The court emphasized that “companies do not have a duty to disclose uncharged, unadjudicated wrongdoing” and noted that “accurately reported financial statements do not automatically become misleading by virtue of the company’s nondisclosure of suspected misconduct that may have contributed to the financial results.” Id. at 98–99. To hold otherwise would mean that “every company whose quarterly financial reports include revenue from transactions that violated [anti-money laundering or] AML regulations could be sued for securities fraud.” Id. at 99. With regard to alleged omissions in statements made by Danske Bank in 2014 concerning a $326 million goodwill impairment, the court noted that “[o]ld information tends to become less salient to a prospective purchaser as the market is influenced by new information,” meaning “materiality can have a half-life.” Id. at 101. Thus, the court concluded that the 2014 statements made by Danske Bank were “too remote in time to have assumed actual significance in the deliberations of a purchaser in 2018” given the “intervening load of information” about the Estonian branch’s AML issues between 2016 and 2018. Id. at 102 (internal quotation marks omitted).

The following Gibson Dunn attorneys assisted in preparing this client update: Jefferson Bell, Shireen Barday, Chris Belelieu, Michael Celio, Monica Loseman, Brian Lutz, Mark Perry, Craig Varnen, Lissa Percopo, Mark H. Mixon, Jr., Alisha Siqueira, Tim Deal, Marc Aaron Takagaki, Lindsey Young, Katy Baker, Andrew G. Barron, Andrew Bernstein, Lizzy Brilliant, Priya Datta, Leon S. Freyermuth, Brenna L. Gibbs, Nathalie Gunasekera, Andrew Howard, Erica L. Jansson, Cody Johnson, Ina Kosova, Lydia Lulkin, Adrian Melendez-Cooper, Zachary Montgomery, Megan R. Murphy, Jeffrey Myers, Zachary Piaker, Hannah Regan-Smith, Mari Vila, and Jasmine L. Vitug.

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

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)
Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Christopher D. Belelieu – New York (+1 212-351-3801, cbelelieu@gibsondunn.com)
Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com)
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Celio – Palo Alto (+1 650-849-5326, mcelio@gibsondunn.com)
Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com)
Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com)
Thad A. Davis – San Francisco (+1 415-393-8251, tadavis@gibsondunn.com)
Ethan Dettmer – San Francisco (+1 415-393-8292, edettmer@gibsondunn.com)
Mark A. Kirsch – New York (+1 212-351-2662, mkirsch@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)
Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com)
Robert F. Serio – New York (+1 212-351-3917, rserio@gibsondunn.com)
Robert C. Walters – Dallas (+1 214-698-3114, rwalters@gibsondunn.com)
Avi Weitzman – New York (+1 212-351-2465, aweitzman@gibsondunn.com)

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

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What you need to know now.

On Wednesday, February 9, 2022, the SEC proposed changes to its rules for investment advisers to private funds. The proposal, if adopted, will be a seismic shift in the regulatory landscape for private fund advisers.

We plan to share a detailed analysis soon. For now, please find below a quick Q&A update.

Q1: What is in the proposal?

A1: New requirements and prohibitions.

New Requirements

The new rules, if adopted as proposed, will require a private fund adviser to:

Provide fund investors with quarterly statements that include standardized disclosures on fees and expenses (generated at the fund and portfolio investment levels) and investment performance (with distinct requirements for liquid and illiquid funds);

For purposes of calculating IRR and MOIC, performance must be presented on an unlevered basis;

Obtain annual audited financial statements for each fund advised by the adviser, and deliver the audited financial statements to each of the fund’s investors;

Obtain an independent, professional fairness opinion for all “adviser-led secondary transactions” and deliver copies of the opinion to investors participating in the transaction;

Prepare and retain a written report of the adviser’s annual compliance program review;

Disclose to all prospective investors in a fund, prior to investment, the details of any preferential rights granted to any of the fund’s investors;* and

Disclose annually to all fund investors the details of any preferential rights granted to any of the fund’s investors.*

*The last two bullets apply to all private fund advisers, including those that are not required to register.

New Prohibitions

The new rules, if adopted as proposed, will prohibit all registered and exempt-reporting advisers to private funds from:

Providing preferential treatment to one or more investors with respect to (i) redemption or other liquidity rights, or (ii) access to information regarding portfolio investments and exposures;

Accelerating the payment of portfolio company monitoring fees;

Allocating to a fund costs related to government examinations or investigations of the adviser;

Allocating to a fund adviser-level regulatory or compliance related costs;

Allocating costs related to portfolio investments held by multiple funds and co-investment vehicles on a non pro rata basis;

Returning clawbacks of carried interest net of taxes;

Benefiting from any indemnification or limitations of liability for breach of fiduciary duty, willful malfeasance, bad faith, recklessness or simple negligence; and

Borrowing from a fund.

Q2: I am an adviser that already prepares audited financial statements for our fund(s). How does the new audit requirement differ from the Custody Rule’s audit requirement?

A2: The proposed audit requirement differs from the Custody Rule’s audit requirement in a number of respects. For example, the proposed rules:

Require the adviser to take “all reasonable steps” to cause funds advised but not controlled by the adviser (e.g., sub-advised funds) to prepare and deliver audited financial statements;

Require advisers to “promptly” deliver statements after completion of the audit (instead of within 120 days of the fund’s fiscal year end);

Require the auditor to notify the SEC if (i) the auditor resigns or is terminated, or (ii) the auditor is unable to deliver a clean opinion.
If you do not already prepare audited financial statements for the fund(s) you manage: The new rules do not have a surprise audit alternative.

Q3: What is an “adviser-led secondary transaction” that requires a professional, independent fairness opinion?

A3: An adviser-led secondary transaction is defined as a transaction in fund interests initiated by the investment adviser that offers fund investors a choice to either:

sell all or a portion of their interests in the fund; or

convert or exchange all or a portion of their interests in the fund for interests in another vehicle advised by the adviser or its related persons.

Secondary transactions in which an adviser provides assistance on an LP’s request, but is not involved in setting the price for the transaction, would not be considered “adviser-led.”

Q4: What about my business would change under the proposed rules?

A4: It depends. Much of the proposal aligns with current industry best practices and is already part of business-as-usual for private fund advisers with sophisticated institutional clients. For example, many advisers already:

Provide quarterly statements (albeit the form and content of these statements may have to change to comply with the new proposed requirements);

Prepare and provide audited financial statements for their funds; and

Obtain fairness opinions in connection with fund restructurings, continuation funds and other secondary transactions;

Document the results of their annual compliance program reviews in writing.
However, other aspects of the proposal represent costly, time consuming and logistically challenging undertakings. For example:

The proposed new disclosure requirements with respect to preferential treatment will be burdensome and logistically challenging to implement as compared to current practices regarding side letters and fund closing processes; and

The prohibitions on returning clawbacks net of taxes and indemnification for simple negligence are inconsistent with market practice.

Q5: When will we know whether the rules will be adopted?

A5: We will not know for months, perhaps years. Market participants will have 30 days after the proposal is published in the Federal Register or until April 11, 2022, whichever is later, to submit comments on the proposal to the SEC. There is no proscribed timeline thereafter by which final rules must be completed and released.

Q6: If the proposed rules are not yet adopted, why should I care now?

A6: You should care for at least two reasons:

In a recent Risk Alert, the SEC’s Examination Division highlighted a number of the issues identified in the rules proposal. The SEC could regulate through examination and enforcement in advance of the Commission completing a final rulemaking.

The proposal has been a long time coming and many significant components of the proposal are likely to be adopted. Chair Gensler, Commissioners Lee and Crenshaw all issued similar, full-throated endorsements of the proposal. However, Commissioner Pierce issued a dissenting statement and voted against the proposal. The proposal has been met with nearly instantaneous and strenuous objections from the private fund industry. Accordingly, we expect a robust comment process that may lead to modifications before the final rules are adopted.

Q7: How did we get here?

A7: The SEC’s focus on the private fund industry has steadily grown since 2010 and has dramatically intensified over the last year.

In December 2020, the SEC replaced the advertising and solicitation rules for advisers, with the new Marketing Rule. The new rule significantly impacts communications between private fund advisers and investors in private funds. Compliance is required by November 2022.

In the SEC’s Spring 2021 regulatory agenda, the new SEC Chair included increased regulation of the private fund industry – alongside cryptocurrency, SPACs, and ESG disclosures – as one of his top regulatory priorities.

In November 2021, Chair Gensler told the ILPA Summit that the time has come to “take stock” and “bring sunshine and competition to the private fund space” because private funds – which manage $17 trillion – play an important role in the country’s capital markets.

On January 26, 2022, the SEC proposed updates to reporting requirements on Form PF.

On January 27, 2022, the Examination Division released the Risk Alert referenced above, entitled “Observations from Examinations of Private Fund Advisers.”

On February 9, 2022, the SEC issued its 341-page rules proposal for increased regulation of advisers to private funds.

On February 9, 2022, the SEC also proposed cybersecurity-related rules for investment advisers that would, among other things, require firms to (1) disclose cybersecurity risks and incidents on the Form ADV 2A and (2) report significant cybersecurity incidents on a new Form ADV-C. The comment period for the proposal is the same as described in A5 above.

Q8: Is there anything else I need to know?

A8: Yes. We will soon publish a more detailed analysis of the Feb. 9 proposals. In the meantime, we note that all investment advisers are required to comply with the new Marketing Rule by no later than November 5, 2022. We strongly recommend that you begin planning for this deadline now. As a practical matter, we suggest drafting any offering documents or marketing materials with new Rule’s disclosure standards in mind, especially if you anticipate using the materials after your firm converts over to compliance with the new Rule.

The following Gibson Dunn attorneys assisted in preparing this client update: Gregory Merz, Lauren Cook Jackson, and Crystal Becker.

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 in the firm’s Investment Funds practice group, or any of the following:

Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)
Albert S. Cho – Hong Kong (+852 2214 3811, acho@gibsondunn.com)
Candice S. Choh – Los Angeles (+1 310-552-8658, cchoh@gibsondunn.com)
John Fadely – Hong Kong (+852 2214 3810, jfadely@gibsondunn.com)
A.J. Frey – Washington, D.C. (+1 202-887-3793, afrey@gibsondunn.com)
Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)
John Senior – New York (+1 212-351-2391, jsenior@gibsondunn.com)
Roger D. Singer – New York (+1 212-351-3888, rsinger@gibsondunn.com)
Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)
C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)
Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com)
Lauren Cook Jackson – Washington, D.C. (+1 202-955-8293, ljackson@gibsondunn.com)
Crystal Becker – New York (+1 212-351-2679, cbecker@gibsondunn.com)

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

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On February 9, 2022, the Securities and Exchange Commission (the “Commission”) announced a proposed rule to shorten the standard settlement cycle for most broker-dealer transactions from two business days after the trade date (“T+2″) to one business day after the trade date (“T+1″), while soliciting comments regarding challenges and possible approaches to achieving settlement by the end of trade date (“T+0″). To facilitate a T+1 settlement process, the Commission is proposing new requirements designed to protect investors, reduce risk between a transaction and its completion, and increase operational efficiency. The proposed rules and rule amendments would establish a compliance date of March 31, 2024.

Read More

The following Gibson Dunn attorneys assisted in preparing this update: Alan Bannister, Boris Dolgonos, Andrew Fabens, Hillary Holmes, Peter Wardle, Rodrigo Surcan, Thomas Canny, Harrison Tucker, and Justine Robinson.

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

The real estate leasing market is booming in some locations and industries, but restructurings may be on the horizon with rising interest rates and the ongoing impact of COVID. Join our panel of experts for a recorded discussion on how leases could be treated in bankruptcy, including (a) whether the leases will be treated as “residential” or “non-residential” and why you should care; (b) whether your master lease will withstand an attempt to treat it as severable, capable of partial rejection and assumption; (c) whether your lease could be recharacterized as an unsecured disguised financing; (d) the enforceability of a right of first refusal; and (e) the impact of bankruptcy on a month-to-month tenancy, as well as strategies you can implement now to mitigate risks in the next cycle.

PANELISTS:

Robert A. Klyman is a Partner in the Los Angeles office of Gibson, Dunn & Crutcher and Co-Chair of Gibson Dunn’s Business Restructuring and Reorganization Practice Group. In his international practice, Mr. Klyman represents companies, lenders, ad hoc groups of secured and unsecured creditors, acquirers and boards of directors in all phases of restructurings and workouts. His experience includes representing lenders and bondholders in complex workouts; advising debtors in connection with traditional, prepackaged and ‘pre-negotiated’ bankruptcies; counseling strategic and financial players who acquire debt or provide financing as a path to take control of companies in bankruptcy; structuring and implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on appeal.

Steven Klein is a Partner in the New York office of Gibson, Dunn & Crutcher and is a member of Gibson Dunn’s Real Estate Practice Group. Mr. Klein’s practice covers a broad range of real estate transactions, including acquisitions and dispositions, joint ventures, financings, leasing, construction and development, restructurings and recapitalizations. He also has substantial experience in REIT offerings, REIT mergers and formation of investment funds. He has advised clients on securitized funding agreements, permanent and mezzanine loan agreements, loan restructuring agreements, partnership and limited liability company agreements, private placement memoranda, property management agreements, retail and office leases and regional shopping centre agreements.

Kim Schlanger is a Partner in the Houston office of Gibson, Dunn & Crutcher and a member of the firm’s Real Estate Practice Group. Ms. Schlanger’s practice covers a broad range of commercial real estate transactions, including advising developers and investors in connection with the development, financing, acquisition and disposition of a variety of asset classes, including office buildings, multi-family developments, hotels and mixed-use projects throughout the United States. She has been involved in the development of many landmark buildings across the country. Ms. Schlanger has extensive experience in the structuring and negotiation of joint venture agreements (both single-asset and “programmatic”) for the purpose of commercial and residential real estate acquisition and development.

Matthew G. Bouslog is Of Counsel in the Orange County office of Gibson, Dunn & Crutcher LLP where he practices in the firm’s Business Restructuring and Reorganization Practice Group. Mr. Bouslog specializes in representing companies in complex restructuring matters. Mr. Bouslog was recognized in 2021 Best Lawyers: Ones to Watch for his work in (i) Bankruptcy and Creditor Debtor Rights / Insolvency and Reorganization Law and (ii) Real Estate Law. Mr. Bouslog frequently represents debtors, creditors, and other interested parties in out-of-court and in-court restructurings, distressed acquisitions, and bankruptcy-related litigation.

Michael Farag is an associate in the Los Angeles office of Gibson, Dunn & Crutcher. He currently practices with the firm’s Business Restructuring and Reorganization Practice Group. Mr. Farag focuses on complex restructuring and insolvency proceedings. Prior to joining the firm, Mr. Farag served as a judicial law clerk in the United States Bankruptcy Court for the Central District of California, first for the Honorable Martin R. Barash, then for the Honorable Robert N. Kwan.

MCLE CREDIT INFORMATION:

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

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

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In what one Member of Congress described as “the most significant labor legislation of this century,” Congress just passed a bill that would allow employees to avoid enforcement of any pre-dispute agreements that require employees to arbitrate sexual assault or harassment claims, which President Biden seems prepared to sign into law. While there have been several unsuccessful attempts over the years to pass such a law, this bill appears to be headed for enactment.

On Monday, February 7, the U.S. House of Representatives passed HR 4445, titled the “Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021,” by a vote of 335 to 97, and the Senate just passed it by voice vote yesterday morning. The bill renders unenforceable with respect to sexual assault or harassment claims at the employee’s discretion any predispute arbitration agreement that requires employees to arbitrate disputes involving nonconsensual and/or unwanted sexual acts or contact, advances, physical contact that is sexual in nature, sexual attention, sexual comments and propositions for sexual activity, conditioning employment benefits on sexual activity, or retaliation for rejecting unwanted sexual attention. This limitation would cover any agreement involving such conduct regardless of whether the claims at issue arise under federal, state, local, or tribal law. For context, this bill expands upon the laws of certain states, such as New York, which bar the forced arbitration of sexual assault and harassment claims, as well as the federal Franken Amendment, which does the same for federal contractors under certain circumstances.

In addition, HR 4445 would render unenforceable, again at the employee’s discretion and with respect to the above claims, predispute joint-action waivers that bar employees from participating in joint, class, or collective actions concerning sexual assault or harassment claims brought in a judicial, arbitral, administrative, or any other forum. This limitation would apply to such waivers found in arbitration agreements, as well as to waivers found elsewhere in other employment agreements. The bill would also explicitly require courts, rather than arbitrators, to determine both the applicability of HR 4445 to a given arbitration agreement and the validity and enforceability of any agreement to which the bill applies, regardless of whether the agreement at issue delegates such authority to an arbitrator.

Significantly, the bill specifies that it will not apply retroactively to any claims that arose or accrued prior to its enactment. The bill also gives potential plaintiffs the option to pursue arbitration if they so elect.

As previewed above, in a Statement of Administration Policy issued on February 1, the White House stated that it supports the bill’s passage, and that it looked forward to “broader legislation” to address “other forced arbitration matters, including arbitration of claims regarding discrimination on the basis of race, wage theft, and unfair labor practices.” Otherwise stated, HR 4445 will soon be law, and might well be a harbinger of other changes to come relating to arbitration agreements in other contexts.

Given its significance, it is likely that these new requirements will be litigated in the near future, which could bring some clarity regarding the precise scope of this bill. As always, Gibson Dunn attorneys are available to answer any questions you may have regarding HR 4445, including but not limited to how it might relate to your company’s existing arbitration agreements.

The following Gibson Dunn lawyers contributed to this client update: Jason C. Schwartz, Katherine V.A. Smith, Joshua S. Lipshutz, Jesse A. Cripps, Theane Evangelis, Michael Holecek, Gabrielle Levin, Danielle J. Moss, Harris M. Mufson, Tiffany Phan, Hayley Fritchie, and Jacob Rierson.

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

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)
Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com)
Jesse A. Cripps – Los Angeles (+1 213-229-7792, jcripps@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Michael Holecek – Los Angeles (+1 213-229-7018, mholecek@gibsondunn.com)
Gabrielle Levin – New York (+1 212-351-3901, glevin@gibsondunn.com)
Danielle J. Moss – New York (+1 212-351-6338, dmoss@gibsondunn.com)
Harris M. Mufson – New York (+1 212-351-3805, hmufson@gibsondunn.com)
Tiffany Phan – Los Angeles (+1 213-229-7522, tphan@gibsondunn.com)

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Happy New Year of the Tiger to our clients and friends!

2021 was the year where the PRC Government launched a broad regulatory assault on Chinese “Big Tech” companies. The State Administration for Market Regulation (“SAMR”) did its part by imposing significant fines on Alibaba and Meituan for abuses of dominance, and administrative penalties in more than 100 cases for failure to notify, over 80 of which involved platform companies, such as Alibaba, Baidu, Didi, Meituan, Suning, and JD.com. The Government also released the Anti-Monopoly Guidelines for the Platform Economy Sector in February 2021 to provide guidance on enforcement in the tech space.

On the merger front, SAMR reviewed approximately 700 transactions, imposed remedies on four of them, and, more significantly, blocked one transaction – this is only the third time that China’s antitrust authority has ever done so.

2022 should see a continued increase in antitrust enforcement. In this respect, SAMR’s Anti-Monopoly Bureau has been elevated in the Chinese bureaucracy, which signals its importance to the Government.

The Government also published its Draft Amendment to the Anti-Monopoly Law (“AML”) for public comment in October 2021 and the proposed changes could be adopted in 2022.

1. Legislative / Regulatory Developments

Anti-Monopoly Guidelines for the Platform Economy Sector (“Platform Guidelines”). In February 2021, SAMR issued specific guidance on the applicability of the AML to digital platforms, including e-commerce and social media companies. The Platform Guidelines confirm that transactions involving variable interest entities (“VIE”) are subject to merger review, and grant SAMR broad discretion to investigate transactions involving digital platforms. They also set out the types of agreements that may constitute monopoly agreements in the platform economy context, some of which go beyond the traditional written or verbal agreements or meeting of minds. For example, under the Platform Guidelines, the use of technical methods, data, and algorithms may constitute a horizontal or vertical monopoly agreement, and a most favoured nation (“MFN”) clause may constitute a vertical monopoly agreement. In addition, the Platform Guidelines provide that an undertaking’s ability to control and process data will be taken into account by SAMR when reviewing abuse of dominance cases, both in assessing market dominance and in analysing conduct (e.g. an undertaking penalizing uncooperative operators with traffic restrictions or search downgrades).

For more detail on the Platform Guidelines, please refer to our client alert, Antitrust in China – 2020 Year in Review, published on March 4, 2021.

Draft Amendment to the Anti-Monopoly Law (“Draft Amendments to the AML”). After over a decade, China has taken a major step towards introducing critical changes to the AML, which came into force in 2008. Following SAMR’s publication of the first draft of the amendments to the AML in early 2020, the Standing Committee of the National People’s Congress (“NPCSC”) released its Draft Amendments to the AML for public consultation on October 23, 2021. The public consultation period closed on November 21, 2021.

The Draft Amendments to the AML propose changes that affect all aspects of the AML, including merger control, non-merger enforcement, and procedural rules. In particular, they impose significantly harsher penalties on undertakings for failure to file, and introduce fines against individuals for engaging in anticompetitive behaviour.

Moreover, the Draft Amendments to the AML propose new provisions targeting platform companies, specifically noting that (1) undertakings “shall not exclude or restrict competition by abusing the advantages in data and algorithms, technology and capital and platform rules,” and that (2) it would be considered an abuse of dominance if an undertaking with a dominant market position “uses data, algorithms, technologies and rules of the platform to erect obstacles and impose unreasonable restrictions on other undertakings.” The new provisions signal the continued focus of China’s antitrust enforcement on the platform economy.

Other notable proposed amendments include the introduction of the “stop-the-clock” mechanism (thus giving SAMR greater flexibility to extend the merger review process), abandoning the per se treatment of resale price maintenance (though the burden of proof lies with undertakings), providing a safe harbour for monopoly agreements, and expressly imposing liability on cartel facilitators.

In terms of next steps, the NPCSC will review the feedback received and further deliberate on the amendments before signing them into law. While there is no official announcement on the timing, it is expected that the NPCSC would finalize and pass the amendments in 2022.

For more detail on the Draft Amendments to the AML, please refer to our client alert, China Publishes Draft Amendment to the Anti-Monopoly Law, published on October 27, 2021.

Elevation of Status of Anti-Monopoly Bureau. In November 2021, the Anti-Monopoly Bureau, which was a subdivision under SAMR, was promoted to the deputy ministerial level. While the Bureau remains subject to SAMR supervision, this elevated status ensures that it will benefit from increased manpower and budget and demonstrates the Chinese government’s commitment to further strengthening antitrust enforcement.

Under the revamped organization, the deputy ministerial-level agency contains three divisions that focus on (1) policy implementation, (2) merger control and investigation of gun-jumping, and (3) supervision of monopoly agreements and abuse of market dominance. Most notably, in the latter two divisions, there is a subdivision that specifically targets the platform economy, further underscoring China’s determination to closely scrutinize potential anticompetitive behaviour in the technology sector.

2. Merger Control

In 2021, SAMR unconditionally approved more than 99% of approximately the 700 deals it reviewed and imposed conditions in only four transactions. However, it blocked one transaction—the proposed merger between HUYA Inc. (“Huya”) and DouYu International Holdings Limited (“DouYu”). This is only the third time that a Chinese antitrust authority has blocked a merger since the inception of China’s merger control regime in 2008.

Like in 2020, SAMR took on average 14-15 days to complete its review of cases under the simplified procedure. It took an average of 288 days to complete its review of conditionally approved cases, and 187 days to complete its review of the single blocked transaction.

Separately, SAMR announced that they penalized parties in almost 100 transactions for failure to notify. This represents a nearly sevenfold increase in the number of failure to notify cases compared with 2020.

2.1 Prohibition Decision

In July 2021, SAMR prohibited the proposed merger between Huya, a company controlled by Tencent, and DouYu, in which SAMR found Tencent exercised joint control with DouYu’s founder team. Both companies provide videogame live-streaming services. According to SAMR, the proposed merger effectively gave Tencent sole control over DouYu.

In its review, SAMR found that the proposed merger would result in the merged entity having a market share of over 70% by turnover, 80% by number of active users, and 60% by number of live streamers. Given the significant post-merger market shares and that the videogame live-streaming market has high entry barriers, SAMR concluded that the proposed merger would strengthen Tencent’s dominant position and restrict or eliminate competition in the videogame live-streaming market.

SAMR’s review also found that post-merger, Tencent would have the ability and incentive to implement a two-way vertical foreclosure in both the upstream online-game operator market and the downstream videogame live-streaming market, given Tencent’s existing market share of over 40% in the upstream market and the merged entity’s significant market share in the downstream market noted above. Specifically, SAMR contended that:

Tencent, as an online-game operation service provider, owns online-game copyright licenses that are critical for the downstream videogame live-streaming market. Post-merger, Tencent would have the ability and incentive to foreclose downstream competitors by, for example, precluding their access to copyright licenses, thereby restricting or eliminating competition in the downstream videogame live-streaming market.
As videogame live-streaming is an effective channel to promote videogames of upstream online-game operation service providers, Tencent would have the ability and incentive to preclude upstream competitors from having the live-streaming channels promote their games, thereby restricting or eliminating competition in the upstream online-game operation service provider market.

2.2 Conditional Approval Decisions

Cisco Systems Inc. (“Cisco”) / Acacia Communications Inc. (“Acacia”). In January 2021, SAMR imposed behavioural conditions on Cisco’s proposed acquisition of Acacia. SAMR found competition concerns resulting from the vertical relationship between the parties, namely Acacia being in the upstream global market for coherent digital signal processors (“DSP”) and Cisco being in the downstream Chinese market for optical transmission systems. To remedy these concerns, the parties offered a number of commitments, to which SAMR agreed, including the following: (1) to continue performing all existing contracts; (2) to continue supplying coherent DSP to Chinese customers on fair, reasonable and non-discriminatory (“FRAND”) terms; and (3) not to bundle, tie, or impose unreasonable conditions in the supply of coherent DSP.

Danfoss A/S / Eaton Corporation. In June 2021, SAMR imposed structural conditions on Danfoss’s acquisition of Eaton’s hydraulic business. SAMR concluded that the proposed transaction would increase the concentration in China’s orbital motor market given that, among other considerations, (1) the parties are the two largest players in the market with a combined market share of 50% to 55%, such that the combined entity would have a dominant position in the market; (2) the parties are each other’s closest competitor and the proposed transaction would remove competitive restraints; and (3) the proposed transaction would raise market entry barriers given the parties’ existing advantages (e.g. reputation). To resolve these competition concerns, Danfoss agreed to divest its orbital motor business in China.

Illinois Tool Works Inc. (“ITW”) / MTS Systems Corporation (“MTS”). In November 2021, SAMR imposed behavioural conditions on ITW’s proposed acquisition of MTS. The proposed transaction would result in ITW obtaining sole control over MTS. SAMR identified competition concerns in the high-end electrohydraulic servo material testing equipment market, as the parties have a combined market share of 65% to 70%. SAMR imposed a range of behavioural remedies on the parties, including (1) to continue performing all existing contracts with Chinese customers and maintaining the same level of service quality for them; and (2) to maintain prices for the relevant testing products in China no higher than their average price within the past 24 months.

SK Hynix Inc. (“SK Hynix”) / Intel Corporation (“Intel”). In December 2021, SAMR imposed behavioural conditions on SK Hynix’s acquisition of Intel’s NAND memory chip business. In its review, SAMR defined the relevant markets as the worldwide and China markets of (1) peripheral component interconnect express (“PCIe”) enterprise-class solid-state disk (“SSD”); and (2) serial advanced technology attachment (“SATA”) enterprise-class SSD. It concluded that the proposed transaction would give rise to competition concerns given the higher degree of market concentration post-acquisition (over 30% globally and over 50% in China), a decrease in the number of major players in the relevant markets post-acquisition (from three to two in the PCIe enterprise-class SSD market and from four to three in the SATA enterprise-class SSD market), and high barriers to entry.

To resolve these concerns, SAMR imposed a number of behavioural conditions on the combined entity, including the following: (1) to continue expanding the quantity of production of the two types of SSDs in the next five years; (2) to maintain prices for the relevant products at or below their average price over the past 24 months; (3) to continue supplying all products in China on FRAND terms; (4) to refrain from exclusive dealing, bundling, or tying when supplying products in China; (5) to refrain from entering into any agreement, or engage in any concerted act, with major competitors in China on price, output, or sales volume; and (6) to assist a third-party competitor to enter the two markets.

2.3 Enforcement Against Non-Notified Transactions

In 2021, SAMR issued a fine for failure to notify in almost 100 cases, 84 of which involved platform companies. Approximately 90% of all cases received the maximum fine of RMB 500,000 (~USD 78,642), while the remaining cases received a fine of at least RMB 150,000 (~USD 23,593). SAMR also imposed remedies in one failure to file case.

3. Non-Merger Enforcement

As they have done in recent years, SAMR and its local bureaus continued to target the pharmaceutical sector in a wide range of enforcement actions, including abuse of a dominant position, resale price maintenance, price fixing, and market allocation. SAMR’s enforcement against pharmaceutical companies in 2021 remained focused on Chinese Active Pharmaceutical Ingredients (“API”) manufacturers, such as the imposition of a RMB 100.7 million (~USD 15.8 million) fine on the country’s leading supplier of batroxobin API, the Hong Kong-listed Simcere Pharmaceutical, for abuse of a dominant position in China’s batroxobin API market through refusal to supply.

Moreover, there were a series of enforcement actions targeting platform companies in 2021, once again demonstrating SAMR’s close regulatory scrutiny of the platform economy sector. Two of the cases stood out in particular due to the scale of the business and the significant amount of fine:

In April 2021, SAMR imposed a fine of RMB 18.228 billion (~USD 2.87 billion) on Alibaba for abuse of a dominant position. The fine amounted to 4% of Alibaba’s annual sales in China in 2019. SAMR’s investigation concluded that Alibaba prohibited merchants from operating stores or participating in promotional activities on Alibaba’s rival platforms, and implemented a reward and penalty mechanism on the merchants’ compliance (e.g. by downgrading online ratings of merchants who refused to comply).
In October 2021, SAMR imposed a fine of RMB 3.44 billion (~USD 541 million) on China’s food delivery giant, Meituan, for abusing its dominant position. This amounted to 3% of Meituan’s 2020 turnover in China. SAMR found that Meituan punished merchants who refused to comply with Meituan’s exclusivity agreements by charging these merchants high commission rates and granting them less exposure on Meituan’s platform.

Gibson Dunn 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 Antitrust and Competition Practice Group, or the following authors in the firm’s Hong Kong office:

Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com)
Bonnie Tong (+852 2214 3762, btong@gibsondunn.com)

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

Join our panelists from Gibson Dunn’s Environmental Litigation and Mass Tort practice group and Environment, Social, and Governance (ESG) practice area as they discuss significant developments in federal and California environmental law and forecast what to expect for 2022. This webcast covers a range of topics of significant interest to regulated industries, including ongoing and anticipated rulemakings, federal enforcement targets and initiatives, the evolving ESG landscape, and more.

PANELISTS:

Rachel Levick Corley is a partner in the Washington, D.C. office and a member of the Environmental Litigation and Mass Tort Practice Group. Ms. Corley represents clients in a wide range of federal and state litigation, including agency enforcement actions, cost recovery cases, and administrative rulemaking challenges.

David Fotouhi is a partner in the Washington D.C. office and a member of the Environmental Litigation and Mass Tort Practice Group. Mr. Fotouhi rejoined the firm in 2021 after serving as Acting General Counsel at the EPA, where he helped to develop the litigation strategy to defend the Agency’s actions from judicial challenge. Mr. Fotouhi combines his expertise in administrative and environmental law with his litigation experience and a deep understanding of EPA’s inner workings to represent clients in enforcement actions, regulatory challenges, and other environmental litigation.

Abbey Hudson is a partner in the Los Angeles office and a member of the Environmental Litigation and Mass Tort Practice Group. Ms. Hudson’s practice focuses on helping clients navigate environmental and emerging regulations and related governmental investigations. She has handled all aspects of environmental and mass tort litigation and regulatory compliance. She also provides counseling and advice to clients on environmental and regulatory compliance for a wide range of issues, including supply chain transparency requirements, comments on pending regulatory developments, and enforcement.

Michael Murphy is a partner in the Washington, D.C. office, a co-lead of the firm’s Environmental, Social and Governance (ESG) practice area, and a member of the Environmental Litigation and Mass Tort and Administrative Law and Regulatory Practice Groups. Mr. Murphy counsels clients on environmental, ESG and sustainability matters, including corporate disclosures, policies, reporting and integration issues. He also represents clients in a wide variety of investigation and litigation matters, including toxic tort , and class actions, as well as administrative litigation, rulemaking proceedings, and permit actions to obtain government approval for infrastructure projects.

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

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In a further step towards the regulation of virtual assets (including digital tokens, stablecoins, and other crypto assets, “VAs”) in Hong Kong, on 28 January 2022, the Securities and Futures Commission (“SFC”) and the Hong Kong Monetary Authority (“HKMA”, collectively the “Regulators”) published a joint circular (the “Joint Circular”) and appendix document (the “Appendix”) on intermediaries’ VA-related activities. “VA-related activities” covers:

Distribution of VA-related products;
Provision of VA-dealing services; and
Provision of VA-advisory services.

On the same day, the HKMA published a further circular (the “HKMA Circular”) to provide regulatory guidance to authorised institutions (“AIs”) when dealing with VAs and virtual asset service providers.

This client alert provides an overview of the key requirements set out in these two circulars and our views on the regulatory direction of travel in Hong Kong.

I. Scope of the Joint Circular and the HKMA Circular

The Joint Circular refers to “intermediaries”, which covers corporations licensed by the SFC to carry on regulated activities and AIs registered with the SFC. The HKMA Circular only applies to AIs. Therefore companies engaged in VA-related activities that are neither intermediaries nor AIs (i.e. “Unregulated VASPs”) are not directly subject to the requirements and guidance set out in these circulars.

However, these two circulars will significantly affect intermediaries and AIs’ ability to deal with Unregulated VASPs, including for their customers. For example, pursuant to the regulatory guidance in the HKMA Circular, AIs may implement systems and controls that could potentially restrict their customers from engaging in certain VA-related activities through their Hong Kong bank accounts. Furthermore, such Unregulated VASPs must ensure that their business activities do not require license, registration and/or authorisation, or else they could be found to be in breach of the Securities and Futures Ordinance (Cap. 571) (“SFO”) and other laws, and be subject to enforcement action by the Regulators.

II. Distribution of VA-related products

“VA-related products” refers to investment products which:

Have a principal investment objective or strategy to invest in VAs;
Derive their value principally from the value and characteristics of VAs; or
Track or replicate the investment results or returns which closely match or correspond to VAs.

According to the Joint Circular, VA-related products are very likely to be considered “complex products” because, in the Regulators’ view, the risks of investing in VAs are not reasonably likely to be understood by a retail investor.

As such, the SFC’s investor protection measures for the sale of complex products apply when intermediaries distribute VA-related products. This means that intermediaries must ensure the suitability of transactions in VA-related products, even where there has been no solicitation or recommendation (i.e. execution-only transactions). The regulators also considered it necessary to set out additional investor protection measures for the distribution of VA-related products.

In summary, intermediaries distributing VA-related products must observe the following existing and new requirements:

Suitability: intermediaries must comply with the suitability obligations, taking into consideration the SFC’s guidance in the Suitability FAQ.[1] There are many aspects to the suitability obligations, including requiring intermediaries to ‘know their clients’ (e.g. have knowledge of clients’ financial situation, investment experience, knowledge of investment products, purposes of investment, etc.) and to understand the investment product (i.e. by undertaking product due diligence). In respect of product due diligence, the Joint Circular prescribes additional due diligence requirements for unauthorised VA funds (i.e. VA funds not authorised by the SFC).[2]
Professional investors only: VA-related products regarded as complex products should only be offered by intermediaries to professional investors.
VA-knowledge test: except for institutional professional investors and qualified corporate professional investors,[3] intermediaries must assess whether their clients have sufficient knowledge of investing in VAs or VA-related products (with reference to the criteria prescribed by the SFC[4]) before effecting transactions in such products on clients behalf. If a client does not possess the required knowledge, an intermediary may only proceed if, by doing so, it is acting in the client’s best interests and the intermediary has provided training to the client on the nature and risks of VAs. Intermediaries must also ensure that their clients have sufficient net worth to be able to assume the risks and to bear the potential losses of trading VA-related products.
VA-related derivative products: before intermediaries offer VA-related derivative products to their clients, they must assess their clients’ knowledge of derivatives (including the nature and risks of derivatives), and assure themselves that their clients have sufficient net worth to assume the risks and to bear the potential losses of trading VA-related derivative products.[5] Intermediaries are also required to provide the client a warning statement specific to VA futures contracts (as prescribed by the SFC in Appendix 5), where applicable.
Financial accommodation: intermediaries should be cautious in providing financial accommodation to clients for investing in VA-related products, and should only do so in circumstances where they have assured themselves that their clients have the financial capacity to meet potential obligations arising from leveraged or margined positions.
Provision of information and warning statements: intermediaries should ensure that information on VA-related products is provided in a clear and easily comprehensible manner to clients, and intermediaries should also provide VA warning statements to clients.

Note that, while not expressly stated in the Joint Circular, some of the requirements above (e.g. suitability) should not be applicable when intermediaries deal with institutional professional investors and qualified corporate professional investors, which aligns with the regulatory expectations for traditional securities products.

While the Joint Circular prescribes limited exemptions to the above requirements for VA-related derivative products traded on regulated exchanges specified by the SFC,[6] and to exchange-traded VA derivative funds authorised or approved for offering to retail investors by a regulator in a designated jurisdiction specified by the SFC.[7] However, at this time, this exemption will apply to a very small number of VA-related products because many VA-related derivative products are currently traded on unregulated VA trading platforms.

Finally, although not a new requirement, the Joint Circular reminds intermediaries to observe the provisions in Part IV of the SFO which prohibits the offering to the Hong Kong public of investments which have not been authorised by the SFC. Intermediaries are also reminded to strictly adhere to the Hong Kong selling restrictions applicable to VA-related products.

III. Provision of VA-dealing services

According to the Joint Circular, the Regulators’ are concerned that the majority of VA trading platforms are either unregulated, or are regulated only for anti-money laundering and counter-financing of terrorism (“AML/CFT”) purposes. Therefore, these VA trading platforms may not be subject to regulatory standards comparable to the SFC’s own regulatory framework for VA trading platforms.[8] As such, the Regulators will require licensed intermediaries that provide VA-dealing services to comply with the following requirements:

SFC-licensed platforms only: intermediaries can only partner with SFC-licensed VA trading platforms to provide VA-dealing services, whether by way of introducing clients to the platform for direct trading or establishing an omnibus account with the platform. Currently, this would cover trading platforms licensed by the SFC under the voluntary opt-in regime for virtual asset trading platforms. In future, this should also expand to cover trading platforms licensed by the SFC under the future virtual asset services providers (“VASP”) regulatory regime.
Professional investors only: intermediaries can only provide VA-dealing services to professional investors.
Compliance with regulatory requirements for securities: although many VA may not be regarded as “securities” under the SFO, and therefore fall outside the SFC’s jurisdiction, intermediaries are expected to comply with the regulatory requirements for dealing in securities, irrespective of whether or not the VAs are securities.
Type 1 licence or registration: the Regulators are only prepared to allow intermediaries licensed or registered for Type 1 regulated activity to provide VA-dealing services (and such services can only be provided to intermediaries’ existing clients to whom they currently provide Type 1 dealing services).
Terms and conditions: intermediaries providing VA-dealing services will be required to comply with the SFC’s licensing or registration conditions set out in Appendix 6 to the Joint Circular. Intermediaries providing VA-dealing services under an omnibus account arrangement will also be subject to the prescribed terms and conditions as set out in Appendix 6 to the Joint Circular (the “VA T&Cs”). One of the many conditions set out in the VA T&Cs is that intermediaries providing VA-dealing services under an omnibus account arrangements should only permit their clients to deposit or withdraw fiat currencies (and not VAs) from their accounts.
Discretionary account management services: for intermediaries providing VA discretionary account management services, where the investment objective is to invest 10% or more of gross asset value of a portfolio in VAs, the intermediaries will be required to comply with the requirements set out in the Proforma Terms and Conditions for Licensed Corporation which Management Portfolios that Invest in Virtual Assets published by the SFC in October 2019.[9] [10]

IV. Provision of VA-advisory services

According to the Joint Circular, the regulatory requirements for providing VA-advisory services can be summarised as follows:

Compliance with regulatory requirements for securities: similar to the requirements for VA-dealing services, intermediaries are expected to comply with the regulatory requirements for advising on securities, irrespective of whether or not the VAs are securities.
Type 1 or Type 4 licence or registration: the Regulators are only prepared to allow intermediaries licensed or registered for Type 1 or Type 4 regulated activity to provide VA-advisory services (and such services can only be provided to intermediaries’ existing clients to whom they provide services in Type 1 or Type 4 regulated activity).
SFC’s VA T&Cs: intermediaries providing VA-advisory services will need to comply with the requirements prescribed in the VA T&Cs, including the requirement to comply with the suitability obligations.
VA-knowledge test: intermediaries providing VA-advisory services are subject to the same VA-knowledge test requirements as intermediaries which distribute VA-related products (see above).
Professional investors only: intermediaries can only provide VA-advisory services to professional investors.
Advisory services in VA-related products: intermediaries providing advisory services in VA-related products are required to observe the same requirements applicable to the distribution of VA-related products (see above), including that intermediaries must ensure the suitability of their recommendations.

V. Implementation of requirements in the Joint Circular

For intermediaries that already engage in VA-related activities, there will be a six-month transition period for intermediaries serving existing clients of its VA-related activities to revise their systems and controls to align with the updated requirements in the Joint Circular.

For intermediaries that do not currently engage in VA-related activities, they should ensure that they comply with the requirements in the Joint Circular before providing such services.

Intermediaries are required to notify the SFC (and the HKMA, where applicable) before they engage in VA-related activities.

VI. HKMA Circular

The HKMA Circular provides regulatory guidance for AIs when dealing with VAs and VASPs. The guidance can be summarised as follows:

AIs are expected to keep abreast of ongoing international developments, including those of international forums and standard-setting bodies such as the Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the International Organisation of Securities Commissions (IOSCO), etc.
In addition to Hong Kong laws and regulations, AIs should ensure that their VA activities do not breach applicable laws and regulations in other jurisdictions, and should seek legal advice from competent advisers in relevant jurisdictions outside of Hong Kong as necessary.
AIs should undertake risk assessments to identify and understand the risks before engaging in VA activities, and should take appropriate measures to manage and mitigate the identified risks, taking into account legal and regulatory requirements. The three risk areas which are in focus are: (a) prudential supervision; (b) AML/CFT and financial crime risk; and (c) investor protection. In particular, the HKMA Circular provides guidance on the regulatory expectations on AIs to establish and implement effective AML/CFT policies, procedures and controls to manage and mitigate money-laundering and terrorist-financing risks that may arise from: (i) customers engaging in VA-related activities through their bank accounts; and (ii) AIs establishing and maintaining business relationships with VASPs. Further guidance is provided in the HKMA Circular.
AIs intending to engage in VA activities should discuss with the HKMA and obtain the HKMA’s feedback on the adequacy of the institution’s risk-management controls before launching VA products or services.

VII. Conclusion

The Joint Circular and the HKMA Circular reflect the SFC’s and the HKMA’s ongoing efforts to regulate the VA sector, particularly from the perspective of investor protection, mitigating AML/CFT risk, and addressing prudential risk in the case of AIs. This is reflected in both existing requirements (e.g. suitability obligations) and new requirements (e.g. VA-knowledge test). For intermediaries already providing or planning to provide VA-related services, there will likely need to be considerable changes to policies and procedures, and systems and controls, to ensure compliance with the latest regulatory requirements and guidance.

While the Joint Circular and the HKMA Circular are not directly applicable to Unregulated VASPs, it can be anticipated that these two circulars will have a commercial impact on these companies, as intermediaries and AIs are likely to implement systems and controls that limit their dealings with such companies (including on behalf of the customers of intermediaries and AIs). In the medium to long-term, these companies which operate VA trading platforms in or from Hong Kong, or provide services marketed to the Hong Kong public, will likely need to be licensed by the SFC under the virtual asset services providers regime and/or under a future regulatory regime to be supervised by the HKMA.

For further information on the future regulatory regimes, please refer to our earlier client alerts:

Licensing Regime for Virtual Asset Services Providers in Hong Kong (June 7, 2021); and
Another Step Towards the Regulation of Cryptocurrency in Hong Kong: HKMA Releases Discussion Paper on Stablecoins (January 18, 2022).

_________________________

[1] SFC’s FAQ on Compliance with Suitability Obligations by Licensed or Registered Persons (last updated 23 December 2020) (the “Suitability FAQ”).

[2] See Appendix 4 to the Joint Circular.

[3] “Institutional professional investors” is defined under paragraph 15.2 of the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code of Conduct) as persons falling under paragraphs (a) to (i) of the definition of “professional investor” in section 1 of Part 1 of Schedule 1 to the SFO. “Qualified corporate professional investors” refers to corporate professional investors which have passed the assessment requirements under paragraph 15.3A and gone through the procedures under paragraph 15.3B of the Code of Conduct.

[4] See Appendix 1 to the Joint Circular.

[5] These are existing requirements under paragraphs 5.1A and 5.3 of the Code of Conduct.

[6] This refers to the list of specified exchanges set out in Schedule 3 to the Securities and Futures (Financial Resources) Rules (Cap. 571N).

[7] The list of designated jurisdictions is set out in Appendix 2 to the Joint Circular.

[8] This refers to the voluntary opt-in regime set out in the SFC’s Position Paper on Regulation of Virtual Asset Trading Platforms (6 November 2019).

[9] Proforma Terms and Conditions for Licensed Corporation which Management Portfolios that Invest in Virtual Assets (4 October 2019).

[10] For completeness, according to the Joint Circular, for intermediaries licensed or registered for Type 1 regulated activity that are authorised by its clients to provide VA-dealing services on a discretionary basis as an ancillary service, these intermediaries should only invest less than 10% of gross asset value of its clients’ portfolio in VA.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Crypto Taskforce (cryptotaskforce@gibsondunn.com) or the Global Financial Regulatory team, including the following authors in Hong Kong:

William R. Hallatt (+852 2214 3836, whallatt@gibsondunn.com)
Grace Chong (+65 6507 3608, gchong@gibsondunn.com)
Emily Rumble (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun (+852 2214 3838, apun@gibsondunn.com)
Becky Chung (+852 2214 3837, bchung@gibsondunn.com)

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Since 6 March 2018, the EU institutions have been sending EU investors a clear message regarding the protection of their investments within the EU under so-called ‘intra-EU’ bilateral investment treaties (BITs), as well as now the Energy Charter Treaty (the ECT).

As we have reported here, the Court of Justice of the European Union (the CJEU) concluded in Achmea B.V. (formerly known as Eureko B.V.) v Slovakia that EU investors could not have recourse to arbitration under a BIT between two EU Member States. The CJEU held that arbitration under intra-EU BITs was contrary to EU law. Following Achmea, and a call from the European Commission (the Commission), twenty-three EU Member States signed an agreement purporting to terminate approximately 130 intra-EU BITs on 5 May 2020 (the Termination Agreement), as we reported here. The door remained open as to whether the ruling in Achmea would be extended to the ECT.

On 2 September 2021 came the CJEU’s decision in Republic of Moldova v Komstroy (reported on here). Adopting the policy views expressed by the Commission, and broadening the scope of its findings in Achmea, the CJEU determined that intra-EU arbitration (i.e., between an EU investor and an EU Member State) under the ECT is also incompatible with EU law.

On 26 October 2021, the CJEU went even further in its decision in Republic of Poland v PL Holdings S.à.r.l.[1] (PL Holdings). The CJEU ruled that EU Member States are precluded from entering into ad hoc arbitration agreements with EU-based investors, where such agreements would replicate the content of an arbitration agreement in a BIT between EU Member States.

Finally, and most recently, on 25 January 2022, the CJEU overturned a decision by the General Court in Micula v Romania[2] (Micula) that had quashed a Commission State aid ruling from 2015 declaring payment of compensation to claimants as per their ICSID award unlawful State aid and ordering recovery of amounts paid to them. Contrary to the General Court’s decision, in CJEU’s view, EU State aid rules can be triggered at the time of payment of an arbitral award even though all the State measures that the ICSID award compensated the claimants for were taken before Romania’s accession to the EU. The CJEU also held (inter alia) that any consent that may have been given by an EU Member State to arbitration pre-accession lacks any force, to the effect that the system of judicial remedies provided for by the EU and the Treaty on the Functioning of the EU (the TFEU) replace the arbitration procedures upon accession to the EU.

These last two developments in the intra-EU arbitration saga, which we address further below, raise yet further alarm bells for EU investors who may have contemplated relying on existing intra-EU BITs as a means of protecting their investments within the EU, or are looking to enforce intra-EU arbitral awards that pre-date Achmea. That is: despite the unanimous stance of over 50 investment arbitration tribunals so far[3] which consider Achmea not to be a bar to their jurisdiction under international law to hear treaty claims and award compensation for investors’ injuries, the European Courts and the Commission are actively taking steps to weaken that protection, at least as a matter of EU law. Hence, investors need to think carefully about how to structure (or restructure) their investments to maximise treaty protection and ensure successful enforcement of any favourable arbitral awards with an EU connection.

PL Holdings: An intra-EU arbitration agreement found in a BIT and replicated as an ad hoc agreement between the investor and a Member State is invalid under EU law

Background

PL Holdings (a Luxembourg entity) brought arbitration proceedings against Poland under the BIT between the Belgium-Luxembourg Economic Union (BLEU) and Poland after a Polish regulator ordered the compulsory sale of its interests in a Polish bank. The seat of the arbitration was Stockholm, and the case was administered by the Stockholm Chamber of Commerce. The tribunal concluded in 2017 that Poland had expropriated PL Holdings’ investment and ordered damages.

In September 2017, Poland brought set-aside proceedings before the Swedish courts, arguing that the arbitration clause in the Poland-BLEU BIT was incompatible with EU law post-Achmea.

In 2019, the Swedish Court of Appeal accepted that, in light of Achmea, the arbitration agreement in the BIT was indeed invalid. However, the court held that this invalidity did not prevent an EU Member State and an EU investor from concluding an ad hoc arbitration agreement at a later date to resolve the same dispute. The court relied on the awkward distinction made in Achmea (and also Komstroy) between commercial arbitration and investment treaty arbitration, which we reported on before—namely, that commercial arbitration “originate[s] in the freely expressed wishes of the parties [concerned]” (in contrast to investment arbitrations, which do not).[4] In the court’s view, Poland tacitly accepted PL Holding’s offer to arbitrate by failing to raise an objection based on Achmea earlier on in the proceedings, thus creating an ad hoc arbitration agreement between Poland and PL Holdings under Swedish law, as the law of the seat. This was said to be derived from the parties’ common intention to resolve the dispute in the same manner as a commercial arbitration agreement.

Poland appealed to the Swedish Supreme Court, which resulted in a preliminary ruling from the CJEU on the following question: whether Articles 267 and 344 of the TFEU as interpreted in Achmea mean that an intra-EU arbitration agreement (concluded between two Member States) is invalid even if a Member State (by free will) refrains from raising objections to jurisdiction after arbitration proceedings were commenced by the investor.

The CJEU’s ruling

The CJEU ruled that it is: “[a]ny attempt by a Member State to remedy the invalidity of an arbitration clause by means of a contract with an investor from another Member State would run counter to the first Member State’s obligation to challenge the validity of the arbitration clause”.[5] In those circumstances, the Court added, it was for the national court to uphold an application seeking to set aside an arbitration award made on the basis of an arbitration agreement infringing Articles 267 and 344 TFEU and the principles of mutual trust, sincere cooperation and autonomy of EU law.[6]

Like in Achmea, the CJEU underscored that an agreement to remove from the jurisdiction of their own courts disputes which may concern the application or interpretation of EU law may prevent those disputes from being resolved in a manner that guarantees the full effectiveness of EU law.[7] In the CJEU’s view, any ad hoc arbitration agreement, on the same terms as the investment treaty, would have the same effect, meaning that the legal approach envisaged by PL Holdings could be adopted in a multitude of disputes which may concern the application and interpretation of EU law; “thus allowing the autonomy of that law to be undermined repeatedly”.[8]

The CJEU also said, it follows from Achmea, the principles of the primacy of EU law and of sincere cooperation, that EU Member States not only may not undertake to remove disputes from the EU judicial system, but also that, where there is a PL Holdings-type situation, they are required to challenge, before the competent arbitration body or the court, the validity of the arbitration clause or the ad hoc arbitration agreement. This is further confirmed in Article 7(b) of the Termination Agreement which states that Contracting Parties “shall”—where they are party to judicial proceedings concerned an arbitral award issued on the basis of a BIT—”ask the competent national court, including in any third country, as the case may be, to set the arbitral award aside, annul it or to refrain from recognising and enforcing it”.[9] According to the CJEU, that rule is also applicable mutatis mutandis in a PL Holdings-type scenario.[10] In effect, therefore, this requirement to challenge jurisdiction represents a deemed challenge that will be interpreted as having effect at any further stage of the arbitral process, including enforcement of any ultimate award.

The latest development in Micula: a further delay to enforcement by reviving the Commission’s State aid decision; and Achmea is relevant for assessing the case

Background

The Micula saga has now been running for over fifteen years. The ICSID arbitration proceedings commenced in 2005, prior to Romania’s accession to the EU, whereby the Micula brothers argued (and the ICSID tribunal agreed) that Romania had impaired the Micula brothers’ investments by repealing certain economic incentives with a view to eliminate measures that could constitute State aid shortly before its accession to the EU. In 2013, the same ICSID tribunal ordered Romania to pay EUR 178 million in compensation.

Romania partially paid the ICSID award. In 2015, however, the Commission ruled that such payment constituted unlawful State aid, precluding Romania from making further payments and ordering recovery of amounts already paid. In short, it is the Commission’s view that payment of the award would re-establish the situation in which the Micula brothers would have found themselves had the relevant incentives not been repealed by Romania, and that this constituted operating State aid.

In June 2019,[11] post-Achmea, the General Court quashed the Commission’s ruling on the basis that all events relating to the incentive took place before Romania’s accession to the EU in 2007, and the right to receive compensation arose at the time Romania repealed the incentives in 2005 and the ICSID award was intended to compensate the revocation of the incentive retroactively. The right to receive compensation arose, therefore, when Romania repealed the incentive. As EU State aid rules were not applicable in Romania pre-accession, the Commission could not exercise powers conferred to it under those rules.[12] Moreover, the Court found that payment of the compensation after accession is irrelevant in that context, because those payments made in 2014 represent the enforcement of a right which arose in 2005.[13]

In that respect, the General Court could avoid discussing the relationship between EU law and intra-EU investment arbitration, given that “in the present case, the arbitral tribunal was not bound to apply EU law to events occurring prior to the accession before it, unlike the situation in the case which gave rise to the judgment [in Achmea]”.[14]

Undeterred, the Commission then filed an appeal before the CJEU in August 2019. Not altogether surprisingly, Spain—the respondent State in over 50 ECT cases involving the removal of renewables incentives—filed a cross-appeal supported by the Commission (the Cross-Appeal). Spain (and the Commission) claimed that the award breached the EU principle of mutual trust and autonomy of EU law as interpreted in Achmea. In parallel, the Micula brothers sought to enforce the ICSID award following the General Court’s decision, including before the courts of England and Wales, as previously reported on here.

The opinion of Advocate General Szpunar and the decision of the CJEU

Notably, in July 2021, Advocate General (AG) Szpunar to the CJEU opined that the Cross-Appeal must be dismissed on the basis that Achmea could not be applied in arbitration proceedings initiated pursuant to Sweden-Romania BIT concluded before Romania’s accession to the EU, and when those proceedings were still pending at the time of that accession.[15] Yet, when it came to analysing the Commission’s competence regarding the application of EU State aid rules, the AG suggested that the alleged aid should be deemed granted at a time when Romania was required to pay that compensation, i.e. after the issuance of the arbitral award, at the time of its implementation by Romania.[16] As the time of award payment post-dated Romania’s accession to the EU, EU law was indeed applicable to that measure and the Commission was competent to make the ruling it did.

The dispute then reached the CJEU:

As to the question of when the alleged aid measure should be deemed granted, the Court agreed with AG Szpunar and held that EU State aid rules were applicable to the compensation paid by Romania and therefore upheld the competence of the Commission.
As to the relevance of Achmea, because the CJEU had already concluded to overturn the General Court’s decision as per the first question, the CJEU thought it was not necessary for it to rule on the Cross-Appeal.[17] The CJEU did state, however, that the General Court had erred in considering that Achmea was irrelevant.[18] Indeed, since the compensation sought by the Micula brothers did not relate exclusively to the damage allegedly suffered before Romania’s accession in 2007 (as the relevant period for such damage extended until 2009), the arbitral proceedings could not be considered as completely confined to the pre-accession period. As such, “with effect from Romania’s accession to the European Union, the system of judicial remedies provided for by the EU and FEU Treaties replaced that arbitration procedure, the consent given to that effect by Romania, from that time onwards, lacked any force”.[19]

The case will now be remanded to the General Court which will determine: (i) whether the Commission was right to consider that the compensation granted by the ICSID award did constitute incompatible State aid; and (ii) the relevance of Achmea. In that respect, whilst this decision is highly fact specific, it does signal further issues for any EU investor looking to enforce intra-EU arbitral awards within the EU where the Commission may invoke Achmea arguments in the State aid context. In fact, even if an EU investor tries to enforce a favourable award outside the EU, there is now a risk that the Commission may require the Member State to recover amounts paid which it concludes constitute incompatible State aid.

In that vein for example, the Commission recently announced its investigation into the arbitral award in Infrastructure Services v Spain in July 2021,[20] which it considers, on a preliminary view, constitutes State aid.[21]

What options do investors with investments in the EU have in light of these developments?

The decisions in PL Holdings and Micula have slightly different ramifications for EU investors, even though both underscore that the CJEU is not going to step away from its original stance in Achmea. Although investment treaty tribunals that have ruled on the impact of Achmea on investor-State arbitration so far remain unanimously adamant that Member State consent to arbitration in intra-EU investment treaties is valid under international law,[22] both cases demonstrate the hostile position that the EU has taken towards investor protection. Hence, EU-based investors should consider structuring (or restructuring, depending on whether there is a dispute already on the horizon) their investments via non-EU Member State entities (such as through the UK post-Brexit) in order to secure the benefit of investment treaties.

Further, in the event a dispute does arise in an intra-EU context, investors may consider opting for arbitration procedures which would allow a non-EU Member State to be designated as the seat of the arbitration, thus limiting the scope for the potential application of EU law.

From an enforcement perspective, investors with existing or planned EU-investments should also consider whether the EU Member State that hosts the investment has assets in non-EU Member States whose courts reliably enforce arbitral awards and would not necessarily consider themselves bound by CJEU rulings and Commission’s jurisdiction.

As regards PL Holdings specifically, the decision has other practical implications which require careful consideration by investors depending on their circumstances. For example:

National courts of EU Member States will now be expected to interpret their national legislation so that no Achmea-style arbitration clause is upheld to be valid. In other words, the CJEU and national courts may (in effect) overrule basic principles of domestic arbitration law regarding what a binding arbitration agreement looks like.

On its face, the reasoning in PL Holdings could, theoretically, be extended to commercial contracts with States or State Owned Enterprises whereby the arbitration clause effectively replicates the provisions in an investment treaty. However, the judgment does not appear aimed at, for example, concession agreements or other types investor-State direct contractual arrangements. If, say, a PL Holdings-based challenge were to arise in the context of a private commercial agreement between an EU Member State and an EU investor, and a preliminary reference was made to CJEU, it is likely that the Court would be inclined not to extend the reach of Achmea to commercial arbitration agreements, following the artificial distinction it drew between commercial and investment arbitration agreements in Achmea and Komstroy.

_________________________

[1] See Judgment of the Court (Grand Chamber), Case C‑109/20, Republiken Polen (Republic of Poland) v PL Holdings S.à.r.l., ECLI:EU:C:2021:875, 26 October 2021, available here.

[2] See Judgment of the Court (Grand Chamber), Case C‑638/19 P, Viorel Micula and others v Romania, ECLI:EU:C:2022:50, 25 January 2022, available here.

[3] As of the time of publication, we are aware of at least 76 investment treaty tribunals that have considered the intra-EU objection and all have unanimously rejected it (whether under intra-EU BITs or the ECT). At least 50 of these 76 tribunals have rejected the intra-EU objection specifically founded on the basis of CJEU’s Achmea decision.

[4] 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, ¶ 55 ; see further our client alerts on Achmea (available here) and Komstroy (available here).

[5] Judgment of the Court (Grand Chamber), Case C‑109/20, Republiken Polen (Republic of Poland) v PL Holdings S.à.r.l., ECLI:EU:C:2021:875, 26 October 2021, ¶ 54.

[6] Id., see ¶ 55.

[7] Id., see ¶¶ 44-47.

[8] Id., ¶ 49.

[9] See Agreement for the termination of Bilateral Investment Treaties between the Member States of the European Union, 5 May 2020, Article 7(b).

[10] Judgment of the Court (Grand Chamber), Case C-109/20, Republiken Polen (Republic of Poland) v PL Holdings S.à.r.l., ECLI:EU:C:2021:875, 26 October 2021, see ¶ 53.

[11] See Judgment of the General Court (Second Chamber), Cases T-624/15, T-694/15 and T-704/15, Viorel Micula and others v European Commission, ECLI:EU:T:2019:423, 18 June 2019, available here.

[12] Id., ¶ 79.

[13] Id., ¶ 80.

[14] Id., ¶ 87.

[15] Opinion of Advocate General Szpunar, Case C‑638/19 P, European Commission v Viorel Micula and others, 1 July 2021, ¶ 107.

[16] There are, in other words, two ways that the Commission can assess the Award under the State aid rules: (i) either the Award is assessed by considering the underlying reason for the payment of the damages; or (ii) the Award is assessed in isolation, i.e., on a standalone basis as ad hoc aid.

[17] See Judgment of the Court (Grand Chamber), Case C‑638/19 P, Viorel Micula and others v Romania, ECLI:EU:C:2022:50, 25 January 2022, ¶ 148.

[18] Id., see ¶ 137.

[19] Id., ¶ 145 (emphasis added).

[20] See Infrastructure Services Luxembourg S.à.r.l. and Energia Termosolar B.V. (formerly Antin Infrastructure Services Luxembourg S.à.r.l. and Antin Energia Termosolar B.V.) v Kingdom of Spain, ICSID Case No. ARB/13/31.

[21] See European Commission Press Release, State aid: Commission opens in-depth investigation into arbitration award in favour of Antin to be paid by Spain, available here: https://ec.europa.eu/commission/presscorner/detail/en/IP_21_3783.

[22] See fn.3 above.

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, the following practice leaders and members, or the authors:

Cyrus Benson – London (+44 (0) 20 7071 4239, CBenson@gibsondunn.com)
Jeff Sullivan QC – London (+44 (0) 20 7071 4231, Jeffrey.Sullivan@gibsondunn.com)
Rahim Moloo – New York (+1 212-351-2413, rmoloo@gibsondunn.com)
Ceyda Knoebel – London (+44 (0) 20 7071 4243, CKnoebel@gibsondunn.com)
Stephanie Collins – London (+44 (0) 20 7071 4216, SCollins@gibsondunn.com)

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International Arbitration Group:
Cyrus Benson – London (+44 (0) 20 7071 4239, cbenson@gibsondunn.com)
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The Biden administration made its mark on U.S. sanctions and export controls in 2021—reviewing, revising, maintaining, augmenting, and in some cases revoking various trade restrictive measures created during the Trump era. China remained at the forefront of the U.S. national security dialogue as the administration sought to solidify measures to protect U.S. communications networks and sensitive personal data and blunt the development of China’s military capabilities after numerous earlier efforts by the Trump administration were blocked or limited by U.S. courts. China showed few signs of backing down in the face of U.S. pressure, instituting new restrictions that could potentially require multinational companies to choose between compliance with U.S. or Chinese law—creating a potential compliance minefield for global firms.

In October 2021, the U.S. Department of the Treasury published findings from its nine-month long review of the sanctions administered and enforced by the Office of Foreign Assets Control (“OFAC”), setting forth a policy framework to guide the imposition of new sanctions. The principles articulated in that review were apparent in major sanctions developments throughout the year—including new targeted sanctions on Myanmar, Belarus, and Ethiopia; the issuance of general licenses to facilitate the flow of humanitarian aid to Afghanistan after the Taliban takeover; termination of the sanctions with respect to the International Criminal Court; revocation of terrorist designations on the Revolutionary Armed Forces of Colombia (“FARC”) and the Yemen-based Houthis; and the first designation of a virtual currency exchange for its role in facilitating ransomware payments. Negotiations over the future of the Joint Comprehensive Plan of Action (“JCPOA”)—the 2015 Iran nuclear agreement abandoned by the Trump administration in 2018—continued, and the United States waived sanctions related to the Nord Stream 2 gas pipeline to appease European allies. In total, OFAC issued a total of 765 new designations and de-listed another 787 parties. By Treasury’s own estimate, there were roughly 9,421 sanctioned parties by late 2021—a 933 percent increase since 2000.

Source: U.S. Dep’t of Treasury, The Treasury 2021 Sanctions Review (Oct. 18, 2021)

OFAC sanctions developments tell only part of the story, as the United States continued to rely on export controls, foreign direct investment reviews, import restrictions, and restrictions with respect to the information and communications technology and services supply chain to accomplish foreign policy goals—often with a renewed emphasis on multilateral action. As in prior years, confronting the national security concerns associated with China remained a central focus of developments in U.S. export controls, especially those administered by the Department of Commerce’s Bureau of Industry and Security (“BIS”). In addition to confronting national security challenges, BIS took substantial steps to update the Export Administration Regulations, including addressing concerns associated with emerging and foundational technologies. As of this writing, the United States and its European allies were hammering out the details of an aggressive package of sanctions and export controls targeting Russia should the Kremlin follow through on threats to further invade Ukraine—presenting a key test of the Atlantic alliance and the ability of multilateral trade controls to deter a threatened use of force.

I. U.S. Trade Restrictions on China

A. Protecting Communications Networks and Sensitive Personal Data
B. Slowing the Advance of China’s Military Capabilities
C. Promoting Human Rights in Xinjiang
D. Promoting Human Rights in Hong Kong
E. Trade Imbalances and Tariffs

II. U.S. Sanctions

A. Treasury Department Sanctions Review
B. Myanmar
C. Russia
D. Belarus
E. Iran
F. Cuba
G. Ethiopia
H. Other Sanctions Developments

III. Information and Communications Technology and Services (ICTS)

A. Executive Order 13873: ICTS Supply Chain Framework
B. Executive Order 14034: Connected Software Applications
C. Executive Order 14017: Supply Chain Security
D. Executive Order 14028: Cybersecurity
E. Transatlantic Dialogues

IV. U.S. Export Controls

A. Commerce Department
B. Antiboycott Developments
C. White House Export Controls and Human Rights Initiative
D. State Department

V. European Union

A. Sanctions Developments
B. Export Controls Developments
C. Noteworthy Judgments and Enforcement Actions

VI. United Kingdom

A. Sanctions Developments
B. Export Controls Developments
C. Noteworthy Judgments and Enforcement Actions

VII. People’s Republic of China

A. Countermeasures on Foreign Sanctions
B. Export Controls Regime
C. Restrictions on Cross-Border Transfers of Data
D. Security Review of Foreign Investments

______________________________

I. U.S. Trade Restrictions on China

Despite the transition from the Trump to the Biden administration, U.S. trade policy toward China in 2021 was marked by a striking degree of continuity. As under the prior administration, the dozens of new China-related trade restrictions announced this year were generally calculated to advance a handful of longstanding U.S. policy interests for which there is broad bipartisan support within the United States, including protecting U.S. communications networks and sensitive personal data; slowing the advance of China’s military capabilities; promoting human rights in Xinjiang and Hong Kong; and narrowing the bilateral trade deficit. As the Biden administration enters its second year in office and tensions between Washington and Beijing show few signs of abating, those core objectives of U.S. policy toward China appear unlikely to change, at least in the near term.

Meanwhile, as discussed more fully in Section VII, below, China this year deepened its already considerable efforts to resist U.S. pressure by adopting a host of new or expanded measures, including counter-sanctions, export controls, restrictions on cross-border data transfers, and a rigorous foreign investment review regime. In light of these new instruments in Beijing’s policy arsenal, multinational enterprises seeking to do business in both of the world’s largest economies now face the unenviable task of navigating between two competing, and often conflicting, sets of trade controls.

A. Protecting Communications Networks and Sensitive Personal Data

Spurred by concerns about Chinese espionage, the United States during 2021 sought to solidify trade restrictions designed to protect U.S. communications networks and sensitive personal data.

Notably, President Biden on June 9, 2021 issued Executive Order (“E.O.”) 14034 to restrict the ability of “foreign adversaries,” including the People’s Republic of China, to access U.S. persons’ sensitive data. That measure revokes three Executive Orders that targeted by name certain Chinese connected software applications, including TikTok and various mobile payment platforms. In place of those restrictions, E.O. 14034 articulates a more neutral set of criteria that U.S. Executive branch agencies are to use in evaluating threats to sensitive data of U.S. persons. The Order also sets forth a more rigorous process, including the preparation of two reports by the U.S. Secretary of Commerce, for recommending policy options to address the purported threat posed by such apps. From a policy perspective, these changes appear calculated to put the earlier, Trump-era restrictions on certain Chinese apps—which were effectively unenforceable, having been enjoined by multiple federal courts in September and October 2020—on firmer footing.

For a more detailed discussion of U.S. measures to secure information and communications technology and services against foreign interference, please see Section III, below.

B. Slowing the Advance of China’s Military Capabilities

Another key feature of the Biden administration’s trade policy in 2021 was its attempt to blunt the development of China’s military capabilities, including by restricting exports of U.S.-origin items to certain Chinese end-users, prohibiting U.S. persons from investing in the securities of dozens of “Chinese military-industrial complex companies,” and subjecting potential Chinese acquisitions of and investments in sensitive U.S. businesses to stringent foreign investment reviews.

Export controls this year remained a core element of U.S. efforts to slow Beijing’s emergence as a strategic competitor as the Biden administration frequently used Entity List designations to target PRC-based firms. In its expanding size, scope, and profile, the Entity List has begun to rival OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List as a tool of first resort when U.S. policymakers seek to wield coercive authority, especially against major economies and significant economic actors. Among the more than 80 Chinese firms added to the Entity List during 2021 were substantial enterprises such as China National Offshore Oil Corporation Ltd. and the Xinjiang Production and Construction Corps (“XPCC”).

Entities can be designated to the Entity List upon a determination by the End-User Review Committee (“ERC”)—which is composed of representatives of the U.S. Departments of Commerce, State, Defense, Energy and, where appropriate, the Treasury—that the entities pose a significant risk of involvement in activities contrary to the national security or foreign policy interests of the United States. Through Entity List designations, BIS prohibits the export of specified U.S.-origin items to designated entities without BIS licensing. BIS will typically announce either a policy of denial or ad hoc evaluation of license requests.

The practical impact of any Entity List designation varies in part on the scope of items BIS defines as subject to the new export licensing requirement, which could include all or only some items that are subject to the U.S. Export Administration Regulations (“EAR”). Those exporting to parties on the Entity List are also precluded from making use of any BIS license exceptions. However, because the Entity List prohibition applies only to exports of items that are “subject to the EAR,” even U.S. persons are still free to provide many kinds of services and to otherwise continue dealing with those designated in transactions that occur wholly outside of the United States and without items subject to the EAR.

The ERC has over the past several years steadily expanded the bases upon which companies and other organizations may be designated to the Entity List to include activities like enabling human rights violations and producing surveillance technology. During 2021, BIS continued this trend by announcing six rounds of Entity List designations tied to activities in support of China’s military. Among those designated in January, April, June, July, November, and December 2021 were more than 40 PRC entities for their alleged involvement in developing, for example, supercomputers, quantum computing technology, and biotechnology (including purported brain-control weaponry) for Chinese military applications.

As part of the growing use of export controls to slow the advance of China’s military capabilities, pursuant to the Military End Use / User Rule, exporters of certain listed items subject to the EAR require a license from BIS to provide such items to China, Russia, Venezuela, Burma, and Cambodia if the exporter knows or has reason to know that the exported items are intended for a “military end use” or “military end user.” In April 2020, BIS announced significant changes to these military end use and end user controls that became effective on June 29, 2020. In particular, where the prior formulation of the Military End Use / User Rule only captured items exported for the purpose of using, developing, or producing military items, the rule now covers items that merely “support or contribute to” those functions. The scope of “military end uses” subject to control was also expanded to include the operation, installation, maintenance, repair, overhaul, or refurbishing of military items.

The expanded Military End Use / User Rule has presented a host of compliance challenges for industry, prompting BIS in December 2020 to publish a new, non-exhaustive Military End User (“MEU”) List to help exporters determine which organizations are considered military end users. The 71 Chinese companies identified to date appear to be principally involved in the aerospace, aviation, and materials processing industries. Although no new Chinese entities have been added to the MEU List since state-owned Beijing Skyrizon Aviation Industry Investment Co., Ltd. was named in the final days of the Trump administration, the Biden administration has continued to administer and enforce the MEU List (as well as the underlying Military End Use / User Rule). As such, that policy tool remains readily available and could be used by BIS in coming months to target additional entities with alleged links to China’s security services.

In addition to expanding U.S. export controls targeting China, the Biden administration in June 2021 announced updated restrictions on the ability of U.S. persons to invest in publicly-traded securities of certain companies determined to operate in the defense and related materiel sector or the surveillance technology sector of China’s economy.

In place of earlier Trump-era restrictions, an Executive Order promulgated on June 3, 2021—which OFAC is calling E.O. 13959, as amended—prohibits U.S. persons from engaging in “the purchase or sale of any publicly traded securities, or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities” of certain companies named by the U.S. Secretary of the Treasury. In particular, persons may now be designated a Chinese Military-Industrial Complex Company (“CMIC”) if they are determined by the Secretary of the Treasury: (1) to operate or have operated in the defense and related materiel sector or the surveillance technology sector of the economy of the People’s Republic of China, or (2) to own or control, or to be owned or controlled by, such a company. The designation criteria in E.O. 13959, as amended, are therefore broader than under the Trump-era restrictions in that they target surveillance technology companies. Indeed, the White House has indicated that it intends to use E.O. 13959, as amended, to target Chinese companies that “undermine the security or democratic values of the United States and our allies”—including especially by targeting Chinese surveillance technology companies whose activities enable surveillance beyond China’s borders, repression, and/or serious human rights abuses.

The investment restrictions set forth in E.O. 13959, as amended, take effect 60 days after a company becomes designated as a CMIC. U.S. persons have 365 days from a company’s designation date to divest their interest in that CMIC. Those investment restrictions presently target 68 companies that appear by name on a new Non-SDN Chinese Military-Industrial Complex Companies List (the “NS-CMIC List”) administered by OFAC. For the initial tranche of 59 companies that were added to the NS-CMIC List in June 2021, the investment restrictions came into effect on August 2, 2021, and U.S. persons have until June 3, 2022 to divest their interest in such firms.

From a policy perspective, the updated investment restrictions appear designed to provide greater clarity regarding precisely which PRC companies are being targeted. In that sense, E.O. 13959, as amended, seems to be a reaction to widespread market uncertainty concerning which entities were covered by the prior administration’s restrictions, along with a series of successful court challenges by companies like the smartphone maker Xiaomi that were previously named on the basis of a surprisingly thin evidentiary record. In our view, the updated restrictions appear calculated to put those earlier, Trump-era measures on firmer footing to withstand legal challenges—suggesting that the Biden administration is recalibrating investment restrictions targeting companies linked to China’s military-industrial complex to survive for the long term.

Although the Entity List, the MEU List, and the NS-CMIC List are analytically distinct from one another, all three measures appear to be driven by similar concerns among U.S. officials regarding the use of U.S. resources—namely, technology and capital—to engage in activities contrary to U.S. national security interests, including facilitating the expansion of China’s military capabilities. In addition to their shared policy underpinnings, the three lists are similar in that they are each tailored to restrict only certain narrow categories of transactions. Unlike a designation to OFAC’s SDN List—which generally results in U.S. persons being prohibited from engaging in substantially all transactions involving a targeted entity—the three lists discussed above are each less sweeping in their effects. The Entity List and the MEU List both impose a licensing requirement on exports, reexports, and transfers of certain U.S.-origin goods, software, and technology to named companies, many of which are located in China. The NS-CMIC List restricts U.S. persons from having investment exposure to publicly-traded securities of certain named Chinese companies. In each case, absent some other prohibition, U.S. and non-U.S. persons are permitted to continue engaging in all other lawful dealings with the listed entities. In that sense, these three lists each offer a potentially attractive option for U.S. officials looking to impose meaningful costs on large non-U.S. firms that act contrary to U.S. interests while avoiding the economic disruption of designating such enterprises to OFAC’s SDN List.

Consistent with a whole-of-government approach to limiting China’s access to sophisticated technologies with potential military applications, the United States during 2021 also leveraged the expanded authorities available to the Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”) to target sensitive investments by Chinese acquirers. Notably, a lengthy CFIUS investigation led the South Korea-based chipmaker Magnachip Semiconductor Corporation in December 2021 to abandon its planned acquisition by a PRC-based private equity firm, suggesting that the Committee is likely to remain intensely focused on blunting efforts by Chinese buyers to acquire advanced technologies in general and semiconductors in particular.

Meanwhile, the U.S. Congress has in parallel sought to bolster the United States’ ability to develop the technologies of the future. The U.S. Senate in June 2021 approved a sprawling bill authorizing approximately $250 billion in spending to better position the United States to compete technologically with China, including through investments in research and development and semiconductor manufacturing. The measure, called the United States Innovation and Competition Act of 2021 (“USICA”), passed the Senate by a wide bipartisan majority—suggesting that countering China’s growing influence remains one of the few areas of agreement between congressional Republicans and Democrats. Debate over the USICA will soon shift to a conference committee between the Senate and the House of Representatives, where the measure is expected to undergo further changes during coming months. Although it is uncertain whether and in what form the bill will ultimately be approved by both chambers of Congress, in light of the bill’s broad base of support—including from President Biden—some version of the USICA appears likely to be passed by Congress and signed into law later this year.

C. Promoting Human Rights in Xinjiang

During 2021, the United States continued to ramp up legislative and regulatory efforts to address and punish reported human rights abuses, including high-tech surveillance of Muslim minority groups and forced labor, in China’s Xinjiang Uyghur Autonomous Region (“Xinjiang”).

The Biden administration took a number of executive actions against Chinese individuals and entities implicated in the alleged Xinjiang repression campaign. In March and December 2021, OFAC—acting in concert with the European Union, the United Kingdom, and Canada— designated to the SDN List four current or former PRC government officials for their ties to mass detention programs and other abuses. In December 2021, OFAC followed up on those designations by adding to the NS-CMIC List a total of nine Chinese surveillance technology companies for their role in enabling surveillance beyond China’s borders, repression, and/or serious human rights abuses. Specifically, OFAC on December 10, 2021 named China-based SenseTime Group Limited a CMIC for owning a company alleged to have developed facial recognition programs “that can determine a target’s ethnicity, with a particular focus on identifying ethnic Uyghurs.” The following week, OFAC on December 16, 2021 named a further eight Chinese technology companies to the NS-CMIC List for operating in the surveillance technology sector of China’s economy and/or for owning or controlling such an entity. Those eight firms were similarly targeted for their alleged involvement in developing technologies that have been used to—and, some cases, were specifically designed to—track members of ethnic and religious minority groups in Xinjiang, including especially ethnic Uyghurs. In addition to enabling the biometric tracking and surveillance of minorities in China, a further risk factor for designation to the NS-CMIC List appears to be the export of such surveillance technologies to regimes with troubling human rights records, for which several of the entities identified by OFAC were cited.

In tandem with sanctions designations, the United States during 2021 leveraged export controls to advance the U.S. policy interest in curtailing human rights abuses in Xinjiang—most notably through expanded use of the Entity List. Continuing a trend begun in October 2019, the ERC on two separate occasions this past year—in June and July 2021—added a total of 19 Chinese organizations to the Entity List for their involvement in human rights violations against Uyghurs, Kazakhs, and other members of Muslim minority groups in Xinjiang. Entities so designated included the silicon producer Hoshine Silicon Industry (Shanshan) Co., Ltd. (“Hoshine”) and the Chinese state-owned paramilitary organization XPCC, each for participating in the practice of, accepting, or utilizing forced labor in Xinjiang.

Consistent with the Biden administration’s whole-of-government approach to trade with China, the United States also used import restrictions—including multiple withhold release orders issued by U.S. Customs and Border Protection (“CBP”) and enactment of the Uyghur Forced Labor Prevention Act—to deny certain goods produced in Xinjiang access to the U.S. market.

CBP is authorized to enforce Section 307 of the Tariff Act of 1930, which prohibits the importation of foreign goods produced with forced or child labor. Upon determining that there is information that reasonably, but not conclusively, indicates that goods that are being, or are likely to be, imported into the United States may be produced with forced or child labor, CBP may issue a withhold release order, or WRO, which requires the detention of such goods at any U.S. port. To overcome a WRO and have its goods released into the United States, the importer bears the burden of demonstrating by evidence satisfactory to the Commissioner of CBP that the goods were not made, in whole or in part, with a prohibited form of labor—which, as a practical matter, is a difficult showing to make.

After issuing a record number of withhold release orders during 2020, CBP in January 2021 continued its aggressive use of this policy instrument by imposing a region-wide WRO targeting all cotton products and tomato products produced in whole or in part in Xinjiang. In June 2021, CBP issued a company-specific WRO targeting silica-based products—which are commonly used in solar panels and electronics—made by the Xinjiang-based company Hoshine and its subsidiaries. Underscoring the degree to which U.S. trade controls targeting China overlap and intersect, Hoshine was concurrently added to the Commerce Department’s Entity List, thereby constraining the company’s ability to both source inputs from, and sell goods into, the U.S. market.

Concerns regarding the PRC’s activities in Xinjiang appear to be shared by bipartisan majorities within the U.S. Congress. In December 2021, Congress passed and President Biden signed into law the Uyghur Forced Labor Prevention Act (the “Uyghur Act”), which in effect subjects all goods sourced from Xinjiang to a withhold release order. A key feature of that legislation is the creation of a rebuttable presumption—which takes effect on June 21, 2022—that all goods mined, produced, or manufactured even partially within Xinjiang are the product of forced labor and are therefore not entitled to entry at U.S. ports. Although the presumption can be overcome by “clear and convincing” evidence, the nature of which is to be articulated in formal guidance later this year, importers may face substantial practical hurdles to conducting due diligence into their supply chains as PRC entities have historically been unwilling to submit to audits of their labor practices. (Moreover, PRC entities may be prohibited by local law from cooperating with such requests in light of China’s new counter-sanctions measures, discussed in Section VII, below.) In addition to imposing import restrictions, the new law also amends the Uyghur Human Rights Policy Act of 2020 to authorize the President to impose sanctions on persons determined to be responsible for serious human rights abuses in connection with forced labor. For a more detailed description of the Uyghur Act and its implications for companies doing business in or related to Xinjiang, please see our January 2022 client alert.

As a complement to the legislative and regulatory changes described above, the Biden administration published guidance to assist the business community in conducting human rights due diligence related to Xinjiang. On July 13, 2021, the U.S. Departments of State, Treasury, Commerce, Homeland Security, and Labor, together with the Office of the U.S. Trade Representative, issued an updated Xinjiang Supply Chain Business Advisory. That document spotlights practices by PRC authorities that the U.S. Government considers objectionable, including especially related to forced labor and mass surveillance. The Advisory identifies “red flags” that individuals or entities linked to Xinjiang may be using forced labor, including dealing in certain types of goods (such as cotton and polysilicon) or operating facilities located within or near known internment camps and prisons.

D. Promoting Human Rights in Hong Kong

As Beijing continued to tighten its grip on the Hong Kong Special Administrative Region, the territory remained an area of focus for U.S. sanctions policy under the Biden administration. Building on policy measures announced during the preceding year—including revocation of Hong Kong’s special trading status under U.S. law, passage of the Hong Kong Autonomy Act, and the imposition of blocking sanctions against the territory’s chief executive, Carrie Lam—2021 witnessed multiple rounds of Hong Kong-related sanctions designations. Among those added to the SDN List for their alleged involvement in eroding Hong Kong’s autonomy were numerous current PRC government officials.

Additionally, the Biden administration on July 16, 2021 published a new Hong Kong Business Advisory that describes the potential financial, legal and reputational risks that can arise from operating in Hong Kong. The Advisory, which was timed to coincide with the one-year anniversary of the Hong Kong national security law, spotlights in particular the possibility of arrest under the national security law, warrantless electronic surveillance, and restrictions on the free flow of information. The Advisory also provides a helpful compilation of the U.S. legal authorities pursuant to which Hong Kong and mainland Chinese individuals and entities may be sanctioned and warns that U.S. businesses may suffer consequences for complying with those measures under China’s new counter-sanctions law, which we discuss in more detail in Section VII.A, below.

E. Trade Imbalances and Tariffs

Also in 2021, the Biden administration continued to make broad use of its authority to impose tariffs on Chinese-made goods. This policy approach—which was launched during the Trump era—remains the subject of substantial and ongoing litigation at the U.S. Court of International Trade. Among the mechanisms that the new administration has employed to retain significant tariffs targeting Beijing is Section 301 of the Trade Act of 1974 (“Section 301”), which allows the President to direct the U.S. Trade Representative to take all “appropriate and feasible action within the power of the President” to eliminate unfair trade practices or policies by a foreign country.

Although the Trump administration initiated Section 301 tariff investigations involving multiple jurisdictions, the Section 301 tariffs that have dominated the headlines are the tariffs imposed on China in retaliation for practices with respect to technology transfer, intellectual property, and innovation that the Office of the U.S. Trade Representative has determined to be unfair (“China 301 Tariffs”). The China 301 Tariffs were imposed in a series of waves in 2018 and 2019, and as originally implemented they together cover over $500 billion in products from China.

As we predicted in our 2020 Year-End Sanctions and Export Controls Update, although the China 301 Tariffs were a hallmark of the Trump administration’s trade policy, they have so far remained in place under President Biden and the new administration appears disinclined to relax those measures without first extracting concessions from Beijing.

II. U.S. Sanctions

A. Treasury Department Sanctions Review

In early 2021, the incoming Biden administration signaled its intent to evaluate the way the United States utilizes sanctions as a tool of foreign policy—often putting aside questions regarding the fate of a long list of Trump-era policies while the review was ongoing. The Treasury Department released the findings from its sanctions review in October 2021. In that document, Treasury articulates both the emerging challenges to the efficacy of sanctions as a national security tool, as well as a set of principles to guide U.S. sanctions policymaking in the future.

As part of a broader effort to ensure that sanctions—the use of which has sharply expanded during the past two decades—remain a durable and effective policy instrument, Treasury in its review emphasized that U.S. sanctions policies should be tied to clear, discrete objectives that are consistent with relevant Presidential guidance. To accomplish that goal, Treasury indicated that it would on a going-forward basis adopt the use of a structured policy framework—similar to the rigorous process that informs the use of force by the U.S. military—by asking whether a proposed sanctions action:

supports a clear policy objective within a broader U.S. Government strategy;
has been assessed to be the right tool for the circumstances;
incorporates anticipated economic and political implications for the sanctions target(s), U.S. economy, allies, and third parties and has been calibrated to mitigate unintended impacts;
includes a multilateral coordination and engagement strategy (where possible); and
will be easily understood, enforceable, and, where possible, reversible.

These principles were broadly apparent in the sanctions policy decisions made by the U.S. administration throughout 2021 as OFAC often announced new sanctions actions in coordination with close U.S. allies and issued numerous humanitarian general licenses to minimize the collateral consequences of U.S. measures on vulnerable populations such as the people of Afghanistan.

B. Myanmar

As we wrote in February and April 2021, the Biden administration imposed new sanctions on Myanmar (also called “Burma”) in response to the Myanmar military’s coup against the country’s elected civilian government on February 1, 2021. Since then, the military (called the “Tatmadaw”) has maintained tight control over the country by, among other things, using lethal force on protesters, issuing a series of martial law orders, and imprisoning civilian leaders like State Counselor Aung San Suu Kyi. As the situation worsened, the Biden administration continued to enhance sanctions, notably opting for a targeted, list-based approach instead of jurisdiction-wide measures like those on Cuba, Iran, North Korea, Syria, and the Crimea region of Ukraine.

The turmoil in Myanmar marks an unfortunate echo of the past. Suu Kyi had been detained by the military in the 1990s and early 2000s and the international community, led by the United States, had previously responded with sanctions. Myanmar eventually moved toward democratization, with one key pivot point being the overwhelming victory of Suu Kyi’s political party, the National League for Democracy, in the country’s November 2015 elections. As we noted back in May 2016, the U.S. Government responded by easing sanctions pressure on Myanmar, eventually dismantling the country-specific sanctions program administered by OFAC. While there was no longer a Myanmar sanctions program, in the ensuing years OFAC continued to sanction Myanmar-based actors under other programs targeting specific behaviors such as narcotics trafficking, weapons proliferation, and human rights abuses—with an emphasis on the military-linked perpetrators of violence against the Rohingya, a religious minority group, in 2016 and 2017.

In the wake of the February 2021 military coup, rather than revive the former Myanmar sanctions program, President Biden created a new one by issuing Executive Order 14014. Under this authority, OFAC may designate to the SDN List individuals and entities determined to be directly or indirectly causing, maintaining, or exacerbating the situation in Myanmar, and/or leading Myanmar’s military or current government, or operating in the country’s defense sector. Under E.O. 14014, OFAC may also designate the adult relatives of a designee, the entities owned or controlled by a designee, or those providing material support to a designee.

The breadth of the designation criteria in E.O. 14014 affords the administration considerable flexibility in selecting its targets. The Biden administration has taken full advantage. During the past year, OFAC has sanctioned, among others, leaders of the Tatmadaw and their relatives, military-run governmental entities and their leaders, and military-linked businesses operating across economic sectors.

The March 2021 designation of two military conglomerates—Myanmar Economic Holdings Public Company Limited (“MEHL”) and Myanmar Economic Corporation Limited (“MEC”)—is arguably the most consequential of the designations thus far. As we discussed in April 2021, by operation of OFAC’s Fifty Percent Rule, the sanctioned status of MEHL and MEC automatically flows down to their dozens of majority-owned subsidiaries that play foundational roles throughout the country’s economy, implicating the Myanmar-based operations of numerous foreign companies with touchpoints with the United States. Recognizing the potential collateral impact of targeting such key economic actors, OFAC issued a set of four general licenses authorizing the wind down of transactions involving MEHL or MEC for a set time period (which has since lapsed), and authorizing activities conducted by the U.S. Government and certain international organizations and non-profits.

It is also worth noting that OFAC in May 2021 designated the State Administrative Council (the “SAC”), the governmental body established by the Tatmadaw to govern Myanmar. The consequences of the SAC’s designation have been challenging to discern for companies doing business in Myanmar that deal directly or indirectly with the government. In our view, some clarity can be gained by looking to OFAC’s historical practices. When OFAC imposed sanctions on the Government of Venezuela, for example, it was explicit in the underlying authority, Executive Order 13884, that the entire Maduro regime was being targeted. The agency also promulgated numerous Venezuela-related general licenses to protect innocent third parties from what was a massively impactful measure. In contrast, the SAC designation, on its face, singled out one governmental entity, with no corresponding general licenses issued. The intended effect here appears to us to have been targeted, as opposed to sweeping, restrictions.

Over the past year or so, OFAC has designated 87 individuals and entities pursuant to E.O. 14014—not all at once but in recurring waves of designations, often prompted by particular atrocities committed by the Tatmadaw. President Biden has to date taken a calibrated and incremental approach to exerting economic pressure on Myanmar, but the tools used have been wide-ranging—extending beyond sanctions to include export controls, import controls, anti-money-laundering, and labor measures. Indeed, on January 26, 2022, the U.S. Departments of Treasury, State, Commerce, Labor, and Homeland Security, plus the Executive Office of the President, jointly published a Burma Business Advisory summarizing these measures and highlighting sectors, activities, and actors that the U.S. Government considers high risk. Absent dramatic developments on the ground, we would expect this gradual and whole-of-government approach to continue so long as the Tatmadaw remains in power in Myanmar. If the Biden administration decides to further increase pressure, the expected departure of major Western energy firms with a longtime presence in the country could soon open the way to sanctions on state-owned Myanmar Oil and Gas Enterprise, or MOGE, which is a key source of revenue for the military regime in Yangon.

C. Russia

Russia featured prominently in President Biden’s first year of foreign policy developments and challenges, as demonstrated by a range of sanctions actions aimed at the Kremlin. These actions—largely geared toward addressing Russia’s meddling abroad, including the annexation of Crimea, foreign election interference, and the SolarWinds cyberattack—have been relatively measured to date, reflecting concerns about potential impacts on European allies. However, an open question as of this writing is whether the Russian military buildup along the Ukrainian border will escalate into a further incursion into Ukrainian territory, which could trigger the imposition of biting sanctions and export controls by the United States and its North Atlantic Treaty Organization (“NATO”) allies.

1. Nord Stream 2

In May 2021, the Biden administration waived sanctions on Nord Stream 2 AG, the Russian-controlled company developing the Nord Stream 2 gas pipeline between Russia and Germany, along with the company’s chief executive. A State Department press release noted that the agency determined that, with respect to those two parties, “it is in the national interest of the United States to waive” sanctions authorized by the Protecting Europe’s Energy Security Act of 2019. The waiver came at the behest of Germany, with which the Biden administration has sought to strengthen ties. However, the action drew sharp criticism within the United States, including from both sides of the aisle in the U.S. Congress. Opponents of the project contend that, once complete, the Nord Stream 2 pipeline could strengthen Russia’s hand by positioning the Kremlin to withhold gas supplies from European consumers and deprive Ukraine of gas transit fees, a key source of government revenue. The waiver subsequently gave rise to a blockade by Senate Republicans of dozens of Biden administration national security-related nominations, as well as vigorous debate in the halls of Congress concerning the amount of discretion that should be afforded to the Executive branch in determining whether to impose further sanctions on Russia.

2. Navalny Sanctions

In two separate actions taken in March and August 2021, the United States imposed sanctions on Russia in response to the 2020 poisoning of the Russian dissident and activist Aleksey Navalny. The measures, which were implemented pursuant to the Chemical and Biological Weapons Control and Warfare Elimination Act of 1991 and various other U.S. legal authorities, expanded on sanctions imposed three years earlier in connection with a similar chemical attack on Sergei Skripal in the United Kingdom.

The March 2021 action consisted of the designation to the SDN List of seven Russian government officials involved in the attack and Navalny’s subsequent arrest and imprisonment. At the same time, the Department of Commerce added 14 entities to the Entity List based on their support to Russia’s chemical and weapons of mass destruction industries, and the Department of State expanded existing sanctions against multiple individuals and entities in Russian’s chemical weapons sector. In connection with this action, the U.S. Government is also now prohibited from providing foreign assistance or authorizing arms sales, arms sales financing, U.S. Government credit, and exports of national security-sensitive goods and technology to Russia. EAR license exceptions GOV, ENC, BAG, TMP, and AVS remain available, and the U.S. Government will consider licenses necessary for flight safety, certain deemed exports, exports to wholly owned subsidiaries of U.S. and foreign companies in Russia, and exports in support of government space cooperation on a case-by-case basis. Commercial end users, state-owned enterprises, and exports in support of commercial space launches are subject to a presumption of denial.

In August 2021, the State Department, acting pursuant to Executive Order 14024 (described below), imposed restrictions on two Russian Ministry of Defense scientific institutes and OFAC designated to the SDN List additional individuals associated with Russia’s foreign intelligence agency, the Federal Security Service (commonly referred to by its Russian acronym, the FSB), for their role in the Navalny poisoning.

3. Russian Harmful Foreign Activities Sanctions

As described in more detail in an earlier client alert, the United States on April 15, 2021 announced a significant expansion of sanctions on Russia for a range of harmful foreign activities such as the annexation of Crimea and interference with U.S. elections. The sanctions included new restrictions on the ability of U.S. financial institutions to deal in Russian sovereign debt and the designation of more than 40 individuals and entities for supporting the Kremlin’s malign activities abroad. The basis for these actions, Executive Order 14024, relied in large part on earlier Executive Orders and actions, but also expanded Treasury’s authorities to, for example, designate the spouse and adult children of sanctioned individuals, which could enable the future targeting of members of the Russian oligarchy and their close relatives. Other provisions in these and related actions taken by the Treasury Department suggest the Biden administration stopped short of adopting more draconian measures such as blacklisting either Russia’s sovereign wealth fund or the Russian government itself. Those policy options therefore remain available in the event of a further significant deterioration in relations between Washington and Moscow.

4. Possible Ukraine-Related Sanctions and Export Controls

Meanwhile, as tens of thousands of Russian troops continue in early 2022 to mass on the border with Ukraine, the United States and its NATO allies have threatened a barrage of sanctions and export controls should Russia mount a further invasion of its western neighbor. As diplomatic talks regarding the security of Eastern Europe unfold, the White House has suggested that the United States and its allies could respond to Russian military aggression in Ukraine by barring Russian access to the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) messaging system that underlies global financial transactions. Additional possible consequences such as sanctions on major Russian banks and stringent controls on exports to Russia of semiconductors and electronics—all of which the White House has suggested could be imposed within hours of a Russian incursion—could severely disrupt the global economy in the near term.

D. Belarus

In keeping with one of the key recommendations of the Treasury Department’s sanctions review, discussed above, the United States, in close collaboration with the European Union, United Kingdom, and Canada, imposed coordinated sanctions against individuals and entities associated with the deterioration in democratic norms and human rights in Belarus. OFAC emphasized that this effort “reflects the United States’ commitment to acting with its allies and partners to demonstrate a broad unity of purpose” because “sanctions are most effective when coordinated where possible with allies and partners who can magnify the economic and political impact.”

On April 19, 2021, subject to a wind-down period that has since expired, OFAC revoked a longstanding general license that authorized U.S. persons to engage in certain transactions involving nine sanctioned Belarusian state-owned enterprises. As described by the U.S. Department of State, that authorization was withdrawn in light of the human rights record of Belarusian leader Aleksandr Lukashenka and his regime, including the ongoing detention of hundreds of political prisoners following the country’s August 2020 presidential election.

Following the May 2021 forced diversion of a commercial airliner by the Lukashenka regime and the subsequent arrest of dissent journalist Raman Pratasevich—described by some observers as a state-sponsored hijacking—OFAC on June 21, 2021 designated an additional 16 individuals and five entities. Among those added to the SDN List were senior Belarusian government officials and government agencies, including the State Security Committee of the Republic of Belarus (the “Belarusian KGB”) and its chairman. OFAC concurrently issued a general license authorizing U.S. persons to engage in certain transactions involving the Belarusian KGB in its administrative capacity such as complying with law enforcement actions and investigations.

To mark the one-year anniversary of Belarus’ fraudulent presidential election, President Biden on August 9, 2021 signed Executive Order 14038 authorizing sanctions on Belarusian government agencies and officials, as well as individuals and entities determined to operate or have operated in certain identified sectors of the Belarusian economy. Targeted industries include the defense and related material, security, energy, potassium chloride (potash), tobacco products, construction, and transportation sectors, plus any other sector of the Belarusian economy that may subsequently be determined by the U.S. Secretary of the Treasury. In parallel, OFAC designated a further 23 individuals and 21 entities, including numerous parties identified as “wallets” for Lukashenka and his regime.

In late 2021, relations between Minsk and the West continued to spiral downward as the Lukashenka regime encouraged waves of vulnerable migrants to transit Belarusian territory and cross into the European Union. Following this development, OFAC on December 2, 2021 added Belarus to the short list of countries (including Russia and Venezuela) that are subject to sectoral sanctions. In particular, OFAC issued Directive 1 Under Executive Order 14038 prohibiting U.S. persons from transacting in, providing financing for, or participating in other dealings in the primary and secondary markets for “new” debt with a maturity of greater than 90 days issued by the Ministry of Finance or the Development Bank of the Republic of Belarus. OFAC indicated in published guidance that these sectoral restrictions apply only to the two named entities (and not their subsidiaries), and that absent some other prohibition, U.S. persons may continue engaging in all other lawful dealings with those two entities. OFAC concurrently designated a further 20 individuals and 12 entities, and identified three aircraft as blocked property. These designations targeted parties that financially prop up the regime, and those implicated in the Lukashenka regime’s smuggling of migrants into the European Union.

E. Iran

The advent of the Biden administration brought to the foreground the question of the future of the JCPOA. In 2021, events unfolded much as we anticipated in our 2020 Year-End Sanctions and Export Controls Update. Consistent with the interest that both President Biden and then-Iranian President Hassan Rouhani had signaled in returning to the JCPOA, negotiations resumed in April 2021 against a tense backdrop as Iran announced plans to begin enriching uranium to 60 percent purity. Tehran’s unveiling of new centrifuges was soon followed by an explosion at the Natanz nuclear enrichment facility that has been widely attributed to Israeli sabotage.

Although talks initially appeared to progress, negotiations stalled following the June 2021 election of current Iranian President Ebrahim Raisi—a hardliner who was previously (and remains) designated to the SDN List. Raisi was initially targeted in 2019 for his role as head of the Iranian judiciary in overseeing human rights abuses and, in an earlier role as prosecutor general, participating in a “death commission” that ordered the extrajudicial killing of thousands of political prisoners. Since assuming the presidency, Raisi has expressed support for a return to the JCPOA, and indirect talks resumed at the end of November 2021.

Progress in the resumed negotiations remains limited, and Iran meanwhile continues to advance its nuclear program—a trend that U.S. and European officials have indicated is not sustainable. On January 20, 2022, Secretary of State Antony Blinken said that it is “really now a matter of weeks” to “determine whether or not we can return to mutual compliance with the agreement,” a sentiment echoed by his French and German counterparts.

In the absence of a return to or renegotiation of the nuclear deal, the architecture of the Iran sanctions program has thus far not substantially changed since President Biden took office. However, OFAC continued to make use of its existing counter-terrorism authority to issue a significant set of designations in September 2021 targeting Hizballah and Iran’s Islamic Revolutionary Guard Corps-Qods Force. Both organizations had already been designated to the SDN List pursuant to OFAC’s counter-terrorism authority. The new designations target individuals and companies providing financial support to them, including the operation of a network for smuggling and selling valuable commodities, including gold, electronics, and currency, and laundering the proceeds through the international financial system. This action suggests that, with or without progress in the JCPOA talks, OFAC is likely to continue using its existing authorities to target Iran’s perceived malign activities.

F. Cuba

First established six decades ago following Cuba’s Communist Revolution, U.S. sanctions on the regime in Havana have lately oscillated between easing under President Obama and tightening under President Trump. Despite early speculation that the Biden administration might seek a renewed thaw in relations with Havana, prospects for relaxed U.S. sanctions were dashed as the Cuban government in July 2021 cracked down on a wave of peaceful protects by Cuban citizens.

The Biden administration in July and August 2021 soon announced four rounds of sanctions against Cuban government entities and senior officials, including the country’s defense minister, pursuant to OFAC’s Global Magnitsky sanctions authority which targets perpetrators of serious human rights abuse and corruption. On August 11, 2021, OFAC and BIS jointly issued a fact sheet highlighting the U.S. Government’s longstanding policy commitment to ensuring the free flow of information to the Cuban people. In the wake of these developments, U.S. sanctions on Cuba—including the country’s designation as a State Sponsor of Terrorism by the outgoing Trump administration—have remained substantially unaltered over the past year and show few signs of changing in the near term as the United States enters a pivotal election year.

G. Ethiopia

On September 17, 2021, OFAC launched a new Ethiopia-related sanctions program in response to the ongoing humanitarian and human rights crisis in Ethiopia, particularly in the country’s Tigray region. This program, which we discuss in depth in a recent client alert, authorizes OFAC to impose sanctions measures of varying degrees of severity without those sanctions necessarily flowing down to entities owned by sanctioned parties, suggesting that the United States is aiming to limit ripple effects on the Ethiopian economy.

Executive Order 14046 permits the Department of the Treasury to choose from a menu of blocking and non-blocking sanctions measures, allowing for a targeted application of restrictions. In keeping with recent Executive Orders of its kind, the criteria for designation under the E.O. are exceedingly broad. The Secretary of the Treasury can designate foreign persons for a wide range of activities related to the crisis in northern Ethiopia. These criteria range from obstructing access to humanitarian assistance and targeting civilians through acts of violence to being a political subdivision, agency, or instrumentality of the Ethiopian or Eritrean governments or of certain political parties. Upon designation of any such foreign person, the Secretary of Treasury may select from a menu of sanctions, including both blocking and non-blocking measures such as prohibiting U.S. persons from engaging in certain transactions with sanctioned persons involving significant amounts of equity or debt instruments, loans, credit, or foreign exchange.

Notably, unlike nearly all other sanctions programs administered by OFAC, E.O. 14046 stipulates that OFAC’s Fifty Percent Rule does not automatically apply to any entity “owned in whole or in part, directly or indirectly, by one or more sanctioned persons, unless the entity is itself a sanctioned person” and the sanctions outlined within the E.O. are specifically applied. OFAC has indicated in published guidance that E.O. 14046’s restrictions do not automatically “flow down” to entities owned in whole or in part by sanctioned persons unless such persons appear by name on either OFAC’s SDN List or the agency’s Non-SDN Menu-Based Sanctions (“NS-MBS”) List.

Concurrent with the announcement of its Ethiopia-related sanctions, OFAC issued three general licenses in recognition of the importance of ongoing humanitarian efforts to address the crisis in northern Ethiopia. These general licenses authorize a wide range of transactions and activities carried out by enumerated international organizations and non-governmental organizations to address this humanitarian and human rights crisis, as well as humanitarian trade in agricultural commodities, medicine, and medical devices.

Nearly two months after the program was created, OFAC announced its first (and so far only) round of Ethiopia-related designations on November 12, 2021, issuing blocking sanctions against four entities and two individuals. Among those targeted were the People’s Front for Democracy and Justice, Eritrea’s sole legal political party, and the Eritrean Defense Force (“EDF”), Eritrea’s military. OFAC in making that announcement highlighted reports of EDF looting, sexual assault, killing of civilians, and blocking of humanitarian aid.

H. Other Sanctions Developments

1. Virtual Currency and Ransomware

OFAC this year intensified its focus on digital currencies and ransomware by issuing multiple rounds of industry guidance and announcing the first U.S. sanctions designation of a virtual currency exchange. As cybercrime and ransomware schemes proliferate, OFAC appears poised to continue pursuing investigations and enforcement actions in the virtual currency space.

The total dollar value of ransomware-related reports filed with the U.S. Department of the Treasury more than doubled in 2021 compared against the prior year, according to information published by Treasury’s Financial Crimes Enforcement Network (“FinCEN”). As reported by FinCEN, financial institutions filed over 600 ransomware-related suspicious activity reports during the first half of 2021, and the average payment amount for ransomware-related transactions was over $100,000. Of course, the May 7, 2021, ransomware attack on the Colonial Pipeline, the largest pipeline system for refined oil products in the United States, involved a much larger sum—nearly $5 million, paid via Bitcoin—and focused global attention on the connection between cybercrime and digital currencies.

At the end of 2020 and in early 2021, OFAC published two enforcement actions against virtual currency services providers, BitPay and BitGo. BitPay, headquartered in Atlanta, provides a payment processing solution for merchants to accept digital currency as payment for goods and services. While BitPay screened its direct customers, the merchants, against OFAC restricted party lists, the company failed to use information it received about the merchants’ customers at the time of a transaction, including a buyer’s name, address, email address, phone number, and Internet Protocol (“IP”) address, to determine whether buyers were located in sanctioned jurisdictions. BitGo, headquartered in California, failed to use IP address information it obtained regarding its direct customers for security purposes to also determine whether its customers were located in comprehensively sanctioned jurisdictions.

Both enforcement actions demonstrate OFAC’s expectation that best practices with respect to sanctions compliance, including IP address geo-blocking and sanctions list screening, apply to virtual currency services providers to the same extent as traditional financial institutions. Additional details on those two enforcement actions can be found in our February 2021 client alert.

On September 21, 2021, OFAC took more severe action against SUEX OTC (“SUEX”), a virtual currency exchange headquartered in Moscow, by adding SUEX to the SDN List, essentially barring SUEX from transactions that utilize the U.S. financial system and prohibiting U.S. persons from engaging in transactions involving the company. According to OFAC, SUEX facilitated transactions involving illicit proceeds from at least eight ransomware variants and over 40 percent of SUEX’s known transaction history is associated with illicit actors. That action—which marked the first time that OFAC has designated a virtual currency exchange to the SDN List—was soon followed by the SDN designation of the Chatex virtual currency exchange in November 2021.

Underscoring the agency’s heightened focus on this space, in addition to pursuing enforcement actions and blacklisting alleged bad actors, OFAC in September 2021 published an updated Advisory on Potential Sanctions Risks for Facilitating Ransomware Payments. That document emphasizes that ransomware payments carry an elevated risk of dealing with prohibited parties. Expanding on earlier guidance, the Advisory also notes that, should an apparent sanctions violation occur in connection with a ransomware payment, OFAC will now take into account both the subject person’s cybersecurity practices and whether the ransomware attack was timely self-reported to U.S. authorities in determining what enforcement response to impose. OFAC in October 2021 also published an industry-specific handbook, titled Sanctions Compliance Guidance for the Virtual Currency Industry, that provides a comprehensive overview of OFAC’s sanctions programs, requirements, and resources for establishing a sanctions compliance program. Among other measures, OFAC suggests that virtual currency industry participants, consistent with a risk-based approach to sanctions compliance, consider implementing IP address geo-blocking, restricted party screening, and periodic “lookback” reviews after the agency adds new virtual currency addresses to the SDN List.

2. Reversal of International Criminal Court Sanctions

A major reversal of Trump-era sanctions policy occurred on April 5, 2021 when the Biden administration announced the revocation of Executive Order 13928, which had authorized sanctions against foreign persons determined to have engaged in any effort by the International Criminal Court (“ICC”) to investigate, arrest, detain, or prosecute United States or any U.S. ally personnel without the consent of the United States or that ally. As previously mentioned in our 2020 Year-End Sanctions and Export Controls Update, that earlier Executive Order came in retaliation for the ICC’s 2020 announcement of a human rights investigation into potential war crimes committed by U.S. troops, the Taliban, and Afghan forces in Afghanistan. As part of the Biden administration’s revocation, OFAC announced the elimination of the International Criminal Court-Related Sanctions Regulations and the removal from the SDN List of ICC Prosecutor Fatou Bensouda and Phakiso Mochochoko, the Head of the Jurisdiction, Complementarity, and Cooperation Division of the Office of the Prosecutor.

The reasoning for this reversal, according to the State Department, was that although the U.S. “maintain[s] our longstanding objection to the Court’s efforts to assert jurisdiction over personnel of non-States Parties such as the United States and Israel,” the new administration felt that those concerns “would be better addressed through engagement with all stakeholders in the ICC process rather than through the imposition of sanctions.” Given that the ICC sanctions were enacted without coordination with or support from traditional U.S. allies, this action appears to have been part of the Biden administration’s broader push to normalize and improve strained relationships between the United States and its foreign partners.

3. Taliban Sanctions and Impact on Afghanistan

In the wake of the Taliban’s de facto takeover of Afghanistan in August 2021, two longstanding sets of U.S. sanctions substantially complicated efforts by outside aid organizations to deliver humanitarian relief to the Afghan people.

Although Afghanistan itself is not subject to comprehensive U.S. sanctions, the Taliban have since 2001 been designated pursuant to E.O. 13224, which is administered through the Global Terrorism Sanctions Regulations and targets named foreign individuals, groups, and entities “associated with” designated terrorists. U.S. persons are generally prohibited from engaging in transactions involving the targeted individuals and entities—referred to as Specially Designated Global Terrorists (“SDGTs”)—and all property and interests in property of an SDGT that come within U.S. jurisdiction are frozen.

The Taliban’s designation as an SDGT presents serious practical challenges now that, as of August 2021, the organization exercises de facto control over the Afghan state. By operation of OFAC’s Fifty Percent Rule, the prohibitions on dealing with an SDGT (or other type of blocked person) extend to entities owned fifty percent or more in the aggregate by one or more SDGTs (or other type of blocked persons). That longstanding OFAC policy raises substantial questions as to whether the Taliban’s status as an SDGT applies by operation of law to dealings involving the Government of Afghanistan or perhaps more broadly the entire jurisdiction of Afghanistan. OFAC between September and December 2021 issued six general licenses authorizing U.S. persons to engage in various transactions to facilitate the provision of humanitarian aid to the people of Afghanistan; however, there is increasing concern that such humanitarian-focused authorizations may not be sufficient to protect the country’s fragile economy and the livelihoods of ordinary Afghans. While the accompanying guidance states that “[t]here are no OFAC-administered sanctions that generally prohibit the export or reexport of goods or services to Afghanistan, moving or sending money into and out of Afghanistan, or activities in Afghanistan,” the agency remains firm that such transactions cannot “involve sanctioned individuals, entities, or property in which sanctioned individuals and entities have an interest,” thereby leaving much of this ambiguity unanswered. The paucity of guidance on this point is further complicated by the lack of precedent for the circumstance in Afghanistan in which a sanctioned terrorist entity has seized control of an entire state, thereby offering the private sector few other points of reference.

In addition to U.S. sanctions targeting SDGTs, Section 302 of the Antiterrorism and Effective Death Penalty Act of 1996 (“AEDPA”) authorizes the U.S. Secretary of State to designate an organization as a Foreign Terrorist Organization (“FTO”) based on its status as a non-U.S. organization engaged in “terrorist activity” that poses a threat to U.S. nationals or national security. Under AEDPA, the Secretary of State may designate FTOs after consultation with the Secretary of the Treasury and the Attorney General. AEDPA also authorizes the Secretary of the Treasury to require financial institutions to block funds in their possession or control in which a designated FTO maintains an interest. Section 303 of the Act makes it a crime for persons within the United States or under U.S. jurisdiction to knowingly provide material support to an FTO, which term encompasses nearly all forms of property, as well as the provision of services such as transportation. OFAC implements Section 302 of AEDPA through the Foreign Terrorist Organizations Sanctions Regulations. Presently, 75 organizations are designated FTOs. Although the Taliban is not itself an FTO as of this writing, various organizations closely affiliated with the Taliban, including the Haqqani Network, members of which now occupy key Afghan government posts, are subject to such restrictions.

Uncertainty regarding the applicability of these two sets of sanctions restrictions, together with de-risking by multinational financial institutions, appears to have exacerbated one of the worst humanitarian crises in modern history, with more than 20 million Afghans reportedly on the brink of famine. Afghan banks have closed and, while some financial services have resumed in key cities, currency is in short supply and the movement of funds even internally within Afghanistan is challenging. The Afghan government has scant official assets located domestically and, given the Taliban sanctions, the country has been shut off from its modest assets domiciled abroad.

Notably, OFAC has maintained a freeze on the approximately $9.4 billion of Afghanistan’s foreign reserves located at the Federal Reserve Bank of New York, and to date has only issued general licenses that apply to the provision of medical and humanitarian aid to non-governmental instrumentalities. A significant degree of uncertainty remains for the private sector regarding to what extent it would be permitted to engage with anyone within Afghanistan, if at all, beyond the confines of applicable licenses.

4. Notable SDN De-Listings

Although OFAC continued to designate new sanctions targets at a steady clip, there were also a number of significant removals from the SDN List during 2021, highlighting that OFAC views sanctions as reversible and designed to change behavior. One of the most consequential recent de-listings took place in December 2021 when OFAC removed 274 individuals and entities associated with the Revolutionary Armed Forces of Colombia, or the FARC, from the SDN List. These entities and individuals had previously been designated under the Foreign Narcotics Kingpin Sanctions Regulations and the Global Terrorism Sanctions Regulations. However, according to the State Department, in acknowledgement of the fact that the FARC had formally dissolved and disarmed following the 2016 peace deal with the Colombian government, it “no longer exists as a unified organization that engages in terrorism or terrorist activity or has the capability or intent to do so.”

Another notable de-listing took place on February 16, 2021, when the State Department announced that it would be lifting the FTO and SDGT designations of the Yemen-based organization Ansarallah (commonly known as the Houthis) and its key leaders. The Houthis were designated just weeks earlier during the waning days of the Trump administration, triggering bipartisan concern about deepening the already significant practical challenges of delivering aid to the Yemeni people. This reversal, according to a State Department press release, came as “a recognition of the dire humanitarian situation in Yemen.” However, recent attacks by the Houthis against the United Arab Emirates—a close U.S. partner and host to a major U.S. military installation—have led some observers to suggest that the organization’s counter-terrorism designations should be reinstated.

In total, 787 persons and entities were removed from the SDN List during 2021, primarily as a result of the Foreign Narcotics Kingpin Sanctions Regulations removals and the Narcotics Trafficking Sanctions Regulation removals. These removals appear to be in accord with the underlying policy rationale of sanctions designations—namely, to alter the behavior of malign actors.

III. Information and Communications Technology and Services (ICTS)

During the past several years, the United States has increasingly used a novel and still evolving policy tool—controls on the information and communications technology and services (“ICTS”) supply chain—to shield sensitive U.S. data and communications. Years of malicious cyber activities targeting the United States have exposed both the significance of the ICTS industry to the national security and foreign policy interests of the United States and the vulnerabilities deep in the ICTS supply chain. Because a supply chain is only as strong as its weakest link, the ICTS supply chain controls regime seeks to identify the vulnerabilities down the supply chain to ensure the integrity of the ICTS industry.

The ICTS supply chain controls regime is built upon a number of Executive Orders—each addressing separate yet interrelated topics such as software applications, supply chain security, and cybersecurity—as well as accompanying regulations, reports, and initiatives by several government agencies, including the Department of Commerce and the Department of Homeland Security (“DHS”). What results is an emerging regulatory regime that has the potential to bring about significant compliance challenges for global companies operating in the ICTS industry. Below we summarize the major developments from the past year.

A. Executive Order 13873: ICTS Supply Chain Framework

On May 15, 2019, acting under the authorities provided by the International Emergency Economic Powers Act—the statutory basis for most U.S. sanctions programs—then-President Trump issued Executive Order 13873 (the “ICTS E.O.”), declaring a national emergency with respect to the ability of foreign adversaries to create and exploit vulnerabilities in the ICTS supply chain. The ICTS E.O. charged the Commerce Department with implementing a new regulatory framework to control risks in the ICTS supply chain. Although the Commerce Department published a Proposed Rule pursuant to the ICTS E.O. in November 2019, there was not much movement in this new regulatory framework until the beginning of this year.

1. ICTS Interim Final Rule

Just one day before the Biden administration’s start, on January 19, 2021, the Commerce Department published an Interim Final Rule establishing the processes and procedures that the Secretary of Commerce will use to evaluate ICTS transactions covered by the ICTS E.O. The Interim Final Rule provides the Department of Commerce with a broad, CFIUS-like authority to prohibit or unwind transactions or order mitigation measures. Specifically, it authorizes the Secretary of Commerce to prohibit ICTS transactions if the following three conditions are met:

First—The transactions must involve the acquisition, importation, transfer, installation, dealing in, or usage of certain ICTS. ICTS is broadly defined as any technology product or service used for the purpose of “information or data processing, storage, retrieval, or communication by electronic means, including transmission, storage, and display.” Despite many commenters’ requests to narrow the scope of the rules, the Commerce Department declined to provide categorical exemptions to specific industries or locations. Instead, the Commerce Department identified six main types of ICTS transactions that will fall under the scope of this rule, which include critical infrastructure, networks and satellites, data hosting or computing, surveillance or monitoring, communications software, and emerging technology.

Second—The ICTS must be designed, developed, manufactured, or supplied by companies owned by, controlled by, or subject to the jurisdiction or direction of a “foreign adversary.” The Interim Final Rule identifies six specific “foreign adversaries”: (1) China, including the Hong Kong Special Administrative Region; (2) Cuba; (3) Iran; (4) North Korea; (5) Russia; and (6) the Maduro regime of Venezuela. This list is subject to change, however—the Secretary of Commerce may revise the list to go into effect immediately without prior notice and comment. The “person owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary” may include:

Any agent, representative, or employee of a foreign adversary;
Any person who acts at the order, request, or under the direction or control of a foreign adversary, or of a person whose activities are directly or indirectly supervised, directed, controlled, financed, or subsidized in whole or in majority part by a foreign adversary;
Any person who is a citizen or resident of a nation-state controlled by a foreign adversary;
Any corporation, partnership, association, or other organization organized under the laws of a nation-state controlled by a foreign adversary; and
Any corporation, partnership, association, or other organization that is owned or controlled by a foreign adversary, regardless of the location.

Third—The ICTS transaction must “pose an undue or unacceptable risk”—an area that affords the Secretary of Commerce much discretion. The Interim Final Rule outlined broad criteria which the Secretary of Commerce may consider in assessing potential risks posed by the ICTS transaction:

The nature and characteristics of the ICTS at issue in the transaction, including technical capabilities, applications, and market share considerations;
The nature and degree of the ownership, control, direction, or jurisdiction exercised by the foreign adversary over the design, development, manufacture, or supply at issue in the ICTS transaction;
The statements and actions of the foreign adversary at issue in the ICTS transaction;
The statements and actions of the persons involved in the design, development, manufacture, or supply at issue in the ICTS transaction;
The statements and actions of the parties to the ICTS transaction;
Whether the ICTS transaction poses a discrete or persistent threat;
The nature of the vulnerability implicated by the ICTS transaction;
Whether there is an ability to otherwise mitigate the risks posed by the ICTS transaction;
The severity of the harm posed by the ICTS transaction on health, safety, and security, critical infrastructure, sensitive data, the economy, foreign policy, the natural environment, or National Essential Functions; and
The likelihood that the ICTS transaction would in fact cause threatened harm.

Although the Interim Final Rule’s detailed lists of definitions and factors were an improvement from the 2019 Proposed Rule, the Interim Final Rule still left much room for discretion in the application of each of the three tests. Between the publication in January 2021 and the planned effective date in March, a number of U.S. trade associations submitted letters to the Commerce Department noting their concerns regarding the Rule’s sweeping scope and vague language and seeking to pause the Rule going into effect. Commentators also speculated as to the actions that the Biden administration might take to delay or reduce the impact of this midnight regulation from the prior administration. Despite the many doubts and unresolved questions, on March 22, 2021, the Interim Final Rule went into effect as planned.

2. Review Process

Under the Interim Final Rule, the Secretary of Commerce may initiate a review of an ICTS transaction at his or her own discretion or upon written request from an appropriate agency head. If an ICTS transaction meets the criteria above, the Secretary of Commerce will make an initial determination as to whether to prohibit the ICTS transaction or propose mitigation measures. Within 30 days of receiving a notice of the Commerce determination, the parties may challenge the initial determination or propose remedial steps (such as corporate reorganization, disgorgement of control of the foreign adversary, or engagement of a compliance monitor). Upon review, the Commerce Department must issue a final determination stating whether the transaction is prohibited, not prohibited, or permitted subject to mitigation measures. The final determination is generally to be issued within 180 days of commencing the initial review.

This review process is similar to that of CFIUS—another tool that is designed to protect U.S. national security interests in transactions involving foreign entities. In fact, the Interim Final Rule exempts transactions that CFIUS is actively reviewing or has reviewed, possibly recognizing that the two set of reviews are intended to address similar risks. However, the Interim Final Rule warns “that CFIUS review related to a particular ICTS, by itself, does not present a safe harbor for future transactions involving the same ICTS that may present undue or unnecessary risks as determined by the [Commerce] Department.” Under the current construction, the Commerce Department can get a second chance to review a transaction even if CFIUS finds that it does not have jurisdiction or that the national security risks involved in the transaction are not significant.

To date, no transaction review has officially begun. However, the Commerce Department has made clear its intent to actively implement the Interim Final Rule. On March 17, 2021, the Commerce Department announced that it served subpoenas on multiple unnamed Chinese companies that provide ICTS in the United States. This announcement was coupled with an unequivocal statement from the Secretary of Commerce Gina Raimondo that the “Biden-Harris Administration has been clear that the unrestricted use of untrusted ICTS poses a national security risk” and that “Beijing has engaged in conduct that blunts our technological edge and threatens our allies.” On April 13, 2021, the Commerce Department followed up with another subpoena on an unnamed Chinese company. The fact that the only subpoenas served to date were to Chinese companies is telling—the scrutiny that CFIUS has shown toward transactions involving Chinese entities might hold true for the ICTS supply chain controls regime, as well.

3. Safe Harbor Licensing Process

The Interim Final Rule also suggested that the Commerce Department will set forth a procedure for parties to seek a license for a proposed or pending ICTS transaction. The license application review would be conducted on a fixed timeline, not to exceed 120 days from accepting an application, such that if the Department of Commerce does not issue a license decision within 120 days from accepting the application, it will be deemed granted. The Department of Commerce noted, however, that it would not issue a license decision on a transaction that would reveal sensitive information to foreign adversaries or others who may seek to undermine U.S. national security.

On March 29, 2021, the Commerce Department published a Proposed Rule seeking input on establishing licensing procedures for the ICTS supply chain controls regime, including a question concerning whether the licensing process should model that of a CFIUS notification or a voluntary disclosure to BIS. Unsurprisingly, the possibility of the Commerce Department going through license applications for countless ICTS transactions within 120 days garnered much concern regarding the practicality of such an arrangement. While the Commerce Department was slated to publish procedures for a licensing process by May 19, 2021, this did not happen, and the Commerce Department has not communicated a new timeline or specific plan to do so.

B. Executive Order 14034: Connected Software Applications

On June 9, 2021, President Biden issued Executive Order 14034 (the “Applications E.O.”), which revoked three Trump-era Executive Orders that targeted by name TikTok and various other applications developed by Chinese companies. Instead, the Applications E.O. directed the Secretary of Commerce to undertake further consideration of the risks posed by “connected software applications” under the ICTS Supply Chain regulations, including potential undue or unacceptable risk to the ICTS, critical infrastructure, or national security of the United States.

On November 26, 2021, the Commerce Department published a Proposed Rule seeking to amend the Interim Final Rule. The Proposed Rule suggested two main amendments. One was to revise the definition of ICTS to include “connected software applications.” The definition of the term “connected software applications” would mirror the language in the Applications E.O.

Another was to provide for additional criteria that the Secretary of Commerce “may consider specifically when determining whether ICTS Transactions . . . that involve connected software applications present an undue or unacceptable risk.” The new criteria articulated in the Proposed Rule are:

Ownership, control, or management by persons that support a foreign adversary’s military, intelligence, or proliferation activities;
Use of the connected software application to conduct surveillance that enables espionage, including through a foreign adversary’s access to sensitive or confidential government or business information, or sensitive personal data;
Ownership, control, or management of connected software applications by persons subject to coercion or cooption by a foreign adversary;
Ownership, control, or management of connected software applications by persons involved in malicious cyber activities;
A lack of thorough and reliable third-party auditing of connected software applications;
The scope and sensitivity of the data collected;
The number and sensitivity of the users of the connected software application; and
The extent to which identified risks have been or can be addressed by independently verifiable measures.

The Commerce Department sought public comments on the effectiveness of the criteria, as well as the definition of various key terms, such as “ownership, control, or management”; “reliable third-party auditing”; and “independently verifiable measures.” The public comments reiterated many of the concerns that industry raised for the Interim Final Rule, especially noting the broad and vague nature of certain criteria. Once the Commerce Department has reviewed the comments, we anticipate there may be further changes, revisions, and additions. Further information on what the Commerce Department views as “thorough and reliable third-party auditing” and “independently verifiable measures” is going to be particularly significant as companies develop compliance measures to minimize the risk of an ICTS review.

C. Executive Order 14017: Supply Chain Security

On February 24, 2021, President Biden signed Executive Order 14017 (the “Supply Chain E.O.”), which seeks to prepare the United States to address vulnerabilities in U.S. supply chains against unexpected threats, including cyber-attacks and geopolitical and economic competition.

Section 3 of the Supply Chain E.O. initiated a 100-day process of reviewing and assessing the strengths and weaknesses of supply chains across key industries (i.e., semiconductor manufacturing and advanced packaging; large capacity batteries; critical minerals and materials; and pharmaceuticals and active pharmaceutical ingredients). On June 8, 2021, the White House issued a Report from the 100-day review. While the Report mostly focused on recommendations to develop domestic capacity and gain a competitive edge, it also recognized that “[t]he United States cannot address its supply chain vulnerabilities alone.” For each key industry, the Report included the commitment to work with allies and partners—to promote production and investment and to strengthen supply chain transparency.

Section 4 of the Supply Chain E.O. also designated the Secretary of Commerce and the Secretary of Homeland Security to provide a report on supply chains for critical sectors and subsectors of the ICT industrial base within one year (expected by February 24, 2022). On September 20, 2021, BIS and DHS published a Request for Public Comments regarding priority areas for the U.S. ICT supply chains. The Request sought comments not only on the general resilience and capacity of American manufacturing supply chains, but also specific policy recommendations. Examples of policy recommendations (e.g., “sustainably reshoring supply chains and developing or strengthening domestic design, components, and supplies”; “cooperating with allies and partners to identify alternative supply chains”; and “building redundancy into domestic supply chains”) provide some window into the agencies’ preliminary inclinations.

On October 29, 2021, BIS hosted a public-private Virtual Forum regarding the Request for Public Comments, during which some of these policy options were discussed. The industry panelists, including the Telecommunications Industry Association and the Information Technology Industry Council, generally argued against restricting the ICT supply chain or requiring the disclosure of sensitive proprietary data in the name of security. They instead supported efforts to streamline supply chain security rules, leverage public-private dialogues, and cooperate with allies and partners. The public comments received will very likely shape how the ICTS supply chain controls regime will be enforced.

D. Executive Order 14028: Cybersecurity

On May 12, 2021, President Biden issued Executive Order 14028 (the “Cybersecurity E.O.”), setting out an ambitious schedule of reviews and rulemakings with respect to cybersecurity of software provided to the U.S. Government. The Cybersecurity E.O. calls for the federal agencies to modernize their cybersecurity practices and for federal contractors to share more information on cyber incidents. Of relevance to the ICTS supply chain regime, Section 4 of the Cybersecurity E.O. notes that “[t]he development of commercial software often lacks transparency, sufficient focus on the ability of the software to resist attack, and adequate controls to prevent tampering by malicious actors” and thus charges the federal agencies to “rapidly improve the security and integrity of the software supply chain” of critical software sold to the government.

The requirements under the Cybersecurity E.O. apply only to federal agencies and contractors. However, in a statement announcing the Cybersecurity E.O., President Biden expressly “encourage[d] private sector companies to follow the Federal Government’s lead” in adopting comparable measures because “federal action alone is not enough” to protect against cybersecurity risks. As a result, the standards established for government contractors may come to be seen as what is “reasonable” or “standard” cyber and supply chain security in other related data and technology protection domains. In fact, on September 30, 2021, the Commerce Department’s National Institute of Standards and Technology (“NIST”) published draft preliminary guidelines on improving software supply chain security, pursuant to the Cybersecurity E.O. (final publication expected by February 6, 2022). The guidelines are addressed to software producers including commercial-off-the-shelf product vendors, as well as software purchasers and consumers including non-federal agency organizations.

E. Transatlantic Dialogues

On September 29, 2021, the U.S.-EU Trade and Technology Council (“TTC”) held its inaugural meeting. There, the TTC established ten working groups, one of which was tasked with “work[ing] towards ensuring security, diversity, interoperability and resilience across the ICT supply chain, including sensitive and critical areas such as 5G, undersea cables, data centers, and cloud infrastructure,” as well as data security. The TTC expects the working group to “develop a common vision and roadmap for preparing the next generation of communication technologies.” While the TTC is still in its beginning stages, there are growing expectations for the TTC’s role given the broader willingness that governments on both sides of the Atlantic have shown to rebuild cooperation. Forthcoming discussions from the TTC working groups will likely have direct and indirect impact on the U.S. Government’s stance on ICTS companies and transactions.

IV. U.S. Export Controls

A. Commerce Department

1. Military End Use / User Rule

The Department of Commerce tested a set of new tools and recalibrated old ones during the Trump administration with the aim of ensuring that dual-use U.S. products and technology are not used by companies and other entities located in countries with military-civil fusion policies to help build out their military research and development and production capabilities. In a development reported in our May 2020 client alert, the Commerce Department amended the Military End Use / User Rule to more broadly restrict dual-use products and technology and to broaden the definition of who should be considered a military end user.

As discussed more fully under Section I.B, above, on December 23, 2020, BIS further amended the MEU Rule to add a new MEU List for purposes of identifying specific military end users in China, Russia, and Venezuela. While the MEU Rule previously restricted exports, reexports, or transfers of items subject to the EAR to military end users or for military end use in specific countries, this change marked the first time that BIS identified specific entities of concern. BIS issued the MEU List in partial response to a flood of advisory opinion and licensing requests submitted by exporters who were uncertain as to whether their counterparty was a military end user. Designation to the MEU List subjects an entity to the export controls applied to more traditional military end users and military end uses, including requiring export licenses for certain items subject to the EAR that otherwise would not require authorization to be exported to end users in MEU List countries.

While Commerce’s issuance of the MEU List is welcome, frequent updates to the list in 2021 have meant that exporters, and others whose supply chain sourcing from MEU List countries requires the export of technology to suppliers, have needed to stay vigilant. Moreover, because the list is not exhaustive—exporters are still obligated to perform due diligence to determine whether they might be exporting to a military end user or for a military end use—compliance with the MEU Rule has become one of the most challenging aspects of export control counterparty diligence. Such challenges are compounded by China’s growing body of laws and regulations, discussed in Section VII, below, that restrict the ability of PRC companies to comply with U.S. sanctions.

For reasons specified in greater detail below, Burma and Cambodia were added to the list of countries subject to MEU controls in March 2021 and December 2021, respectively. Although, to date, BIS has only identified specific military end users located in China and Russia.

2. Military-Intelligence End Use / User Rule

Efforts to curtail exports to military end users were further expanded effective March 16, 2021, when BIS issued similar regulations to cover certain military-intelligence end uses and end users (“MIEUs”). This action added to the EAR a new MIEU Rule, which places significant restrictions on exports for a “military-intelligence end use” or to a “military-intelligence end user” in Burma, Cuba, China, Iran, North Korea, Russia, Syria, and Venezuela. Cambodia was subsequently added to this list on December 9, 2021. Significantly, in addition to prohibiting exports to MIEUs without a license—applications for which are subject to a presumption of denial—this rule prohibits U.S. persons from providing “support” to specified MIEUs, even if such support does not involve items subject to the EAR. “Support” is broadly defined to include certain shipments and transfers involving any items destined for MIEUs, the facilitation of such shipments and transfers, and performing any contract, service, or employment that may benefit or assist MIEUs, including but not limited to, “[o]rdering, buying, removing, concealing, storing, using, selling, loaning, disposing, servicing, financing, transporting, freight forwarding, or conducting negotiations in furtherance of.” The breadth of the new MIEU Rule imposes significant responsibility on U.S. persons to conduct sufficient due diligence to get comfort that they are not directly or indirectly supporting MIEUs, even when non-U.S. goods are involved. In light of the substantial compliance challenges that the MIEU Rule presents for industry, some observers have speculated that BIS may during the year ahead look to create a non-exhaustive MIEU List—similar to the MEU List that was introduced in December 2020—to help exporters determine which organizations are considered military-intelligence end users.

3. Sudan Moved to Less Restrictive Country Group B

On January 19, 2021, BIS removed anti-terrorism (“AT”) controls on Sudan in conjunction with the State Department’s rescission of Sudan’s designation as a State Sponsor of Terrorism. This action moved Sudan from Country Group E:1 to Country Group B, substantially reducing export restrictions applied to the country and raising the de minimis level of foreign-manufactured goods incorporating U.S.-origin content that can be exported, reexported, or transferred to Sudan from 10 percent to 25 percent. However, Sudan still remains subject to arms control limitations due to its continued placement in Country Group D:5, and exports to Sudan are not eligible for License Exceptions GBS and TSR.

4. Burma Added to More Restrictive Country Group D:1

In the wake of the February 2021 military coup in Burma, BIS on February 17, 2021 suspended license exceptions LVS, GBS, TSR, and APP for exports to Burma, which due to Burma’s Country Group B placement, would otherwise have been available. Pressure on the Burmese government was increased on March 8, 2021, when BIS moved Burma from Country Group B to Country Group D:1, a more restricted control group based on national security concerns. This designation removes several license exceptions that were previously available to Burma and subjects the country to the more restrictive national security licensing policy. Additionally, as noted above, the MEU Rule and MIEU Rule were extended to include military end uses and end users within that country in a further effort to restrict Burma’s access to U.S.-origin goods. The ERC concurrently designated to the Entity List four substantial Burmese entities, including the country’s Ministries of Defense and Home Affairs, plus the military conglomerates MEC and MEHL. Additional Entity List designations of four Burmese entities associated with copper mining followed on July 6, 2021.

5. Cambodia Subjected to More Restrictive Licensing Policy

Reflecting growing concerns among U.S. policymakers regarding Cambodia’s deepening ties with the Chinese military, as well as allegations of corruption and human rights abuses leveled against the Cambodian government, BIS on December 9, 2021 amended its license policy for Cambodia by adding a presumption of denial for national security (“NS”) controlled items that could be diverted to a military end user or military end use. As part of that same action, BIS added Cambodia to Country Group D:5, thereby subjecting the country to a U.S. arms embargo.

6. BIS Eases Restrictions of Exports of Vaccines

On January 7, 2021, BIS amended the EAR to clarify the scope of export controls that apply to certain vaccines and medical products. This update was meant to more closely align the controls under the EAR with the release (i.e., exclusion) notes in the “Human and Animal Pathogens and Toxins for Export Control” common control list published by the Australia Group—a multilateral forum consisting of 42 participating countries and the European Union that maintain export controls on a list of chemicals, biological agents, and related equipment and technology that could be used in a chemical or biological weapons program. The January 2021 rule made a number of technical changes to Export Control Classification Number (“ECCN”) 1C991 in an attempt to clarify the controls that apply to certain vaccines. Most notably, the rule amends the vaccine controls in paragraph (a) of ECCN 1C991 to more closely align with the Australia Group release notes to minimize controls on certain vaccines (though AT controls still apply), which is expected to help facilitate the development of new vaccines. Additionally, the changes clarify that the more stringent chemical/biological (“CB”) controls which apply to medical products described under ECCN 1C991.c do not also apply to medical products described under ECCN 1C991.d. As a result of this rule change, some COVID vaccines containing genetic elements of items controlled by ECCN 1C353 are now controlled under ECCN 1C991, which permits their export to all countries except for those subject to AT controls (as of this writing, Iran, North Korea, and Syria).

7. Implementation of Wassenaar Arrangement Controls

As discussed in greater detail in our 2020 Year-End Sanctions and Export Controls Update, on January 3, 2020, BIS imposed new unilateral export controls on artificial intelligence software specially designed to automate the analysis of geospatial imagery through an interim final rule, designating such items under the rarely-used temporary ECCN 0Y521. Under 15 C.F.R. § 742.6(a)(8)(iii), such items remain so classified for only one year, but the classification can be extended for two additional one-year periods. BIS utilized these extensions in January 2021 and again in January 2022 with the hope that it can persuade fellow Wassenaar Arrangement (“WA”) members to adopt their own controls on this technology once the WA Plenary, which has been postponed due to pandemic-related travel restrictions, is able to meet again. The next plenary session is scheduled to convene in Vienna in December 2022. Through its participation in the 42-member WA, the United States seeks to advance national and international security and foreign policy objectives through the promotion of multilateral controls over the use and transfer of conventional arms and dual-use goods and technologies.

As part of its membership in the WA, the United States commits to implement certain mutually agreed-upon export controls, including controls on cybersecurity items, which have been actively under discussion by WA members since 2013. On October 21, 2021, BIS solicited comments on an interim final rule that would establish new NS and AT controls on most cybersecurity items—implementing in part controls agreed upon by WA members in 2013 and further modified in 2017. As part of this interim final rule, BIS also solicited comments on a revised License Exception Authorized Cybersecurity Exports (“ACE”), which would authorize exports, reexports, and transfers of cybersecurity items to most destinations and for many end users and end uses, so long as such items were not subject to surreptitious listening (“SL”) controls under Category 5 – Part 2 of the Commerce Control List (“CCL”). While the proposed rule was meant to go into effect on January 19, 2022, BIS subsequently delayed implementation of the rule until March 7, 2022. BIS cited potential modifications to the rule as the reason for the delay and credited the public comments the agency received for prompting certain reconsiderations—underscoring the importance of public comments in agency deliberations.

On March 29, 2021, BIS also implemented revisions to the CCL to implement changes from the December 2019 WA Plenary meeting. These changes included revisions to 22 ECCNs and eliminated encryption reporting requirements under License Exception ENC in the following circumstances: (1) eliminates the email notification requirement for ‘publicly available’ encryption source code and beta test encryption software, except for ‘publicly available’ encryption source code and beta test encryption software implementing “non-standard cryptography”; (2) eliminates the self-classification reporting requirement for certain ‘mass market’ encryption products under 15 C.F.R. § 740.17(b)(1); and (3) allows self-classification reporting for ECCN 5A992.c or 5D992.c components of ‘mass market’ products (and their ‘executable software’). While this rule does not change License Exception ENC requirements for any non-’mass market’ encryption item or for any encryption items that implement “non-standard cryptography,” it has eliminated filing requirements for many companies using standard cryptography and has lightened the burden on others.

8. Emerging and Foundational Technology Controls

The Commerce Department’s Emerging Technology Technical Advisory Committee held partially closed meetings on March 19, May 21, and October 28, 2021. The announced topics included discussions of public comments, as well as presentations on cyber defense, foreign engagement risks in research enterprise, and work at the human-technology frontiers—signaling the broad approach that BIS is taking to fulfill its mandate under the Export Control Reform Act of 2018 to establish controls on emerging and foundational technologies. As part of this effort, on October 5, 2021, BIS published a final rule to implement a decision from the Advisory Committee’s Virtual Implementation session held in May 2021 to add controls on nucleic acid assembler and synthesizer “software” that is capable of designing and building functional genetic elements from digital sequence data. This software was identified as an emerging technology by BIS and given new ECCN 2D352.

In 2021, BIS continued its efforts to engage the public as it continues to assess the appropriate level of controls that should be applied to emerging and foundational technologies. On October 26, 2021, BIS issued an advance notice of proposed rulemaking (“ANPRM”) to solicit comments on the potential application of export controls to brain-computer interface (“BCI”) technology, including, among other things, neural-controlled interfaces, mind-machine interfaces, direct neural interfaces, and brain-machine interfaces. Previously, on November 19, 2018, BIS issued a similar ANPRM to broadly address a longer list of potential emerging technologies, including BCI technology. In this new ANPRM, BIS requested responses to a series of questions tailored specifically to BCI technology, signaling that the agency may be especially focused on placing export controls on such technology in the near future.

9. Solicitation of Public Comments on Issues Related to Supply Chains

As noted above, on February 24, 2021, President Biden issued Executive Order 14017 to address concerns associated with U.S. supply chains. As part of this E.O., the Secretary of Commerce was directed to submit reports on (1) the semiconductor manufacturing and advanced packaging supply chains and policy recommendations to address these risks and (2) the supply chains for critical sectors and subsectors of the information and communications technology industrial base.

In an effort to implement these measures, BIS solicited comments from the public on March 15, 2021 (concerning semiconductor manufacturing and advanced packaging supply chains); September 20, 2021 (concerning ICT supply chains); and September 24, 2021 (concerning technical questions associated with the semiconductor product supply chain). On January 25, 2022, the Department of Commerce released the results of its semiconductor supply chain request for information, which provided an overview of some of the underlying causes of supply shortages and committed the agency to “engage industry on node-specific problem-solving in the coming weeks.”

On January 24, 2022, BIS announced a further request for information concerning methods for strengthening the U.S. semiconductor industry. Secretary of Commerce Gina Raimondo has also urged Congress to pass the United States Innovation and Competition Act of 2021, which includes $52 billion to enhance domestic semiconductor production. Such efforts by Commerce exemplify a whole-of-government approach to identifying and loosening bottlenecks in semiconductor supply chains and increasing U.S. production capabilities.

10. Entity List Designations

As in previous years, BIS continued its liberal use of designations to the Entity List to curtail activities contrary to the national security or foreign policy interests of the United States. As noted above, BIS requires exporters to obtain a license before exporting, reexporting, or transferring specified items subject to the EAR (which, depending on the Entity List designation, can include all items subject to the EAR) to entities appearing on the Entity List. Each such entity is subject to a specific license review policy—most often a presumption of denial. As seen through past designations of such large companies as Huawei, addition to the Entity List can severely restrict a company’s access to much-needed goods and can significantly disrupt global supply chains.

Many of BIS’s Entity List designations in 2021—as discussed under Section I.B, above—were aimed at countering threats that the United States sees China posing to national security and foreign policy on several fronts. However, the tool was also frequently deployed against actors located beyond the PRC. On March 4, 2021, BIS issued designations for activities in support of Russia’s weapons of mass destruction program, followed by additional designations on July 12 for unauthorized support to Russian military programs and on July 19 for unauthorized support to Russian intelligence services. Additionally, on June 1, July 12, and November 26, 2021, BIS announced Entity List designations of entities involved in the proliferation of “unsafeguarded nuclear activities.”

BIS also acted to combat cybersecurity threats when, on November 4, 2021, the agency designated two Israeli companies, including NSO Group, for developing and supplying spyware to “foreign governments that used this tool to maliciously target government officials, journalists, businesspeople, activists, academics, and embassy workers” and one Russian entity for “cyber exploits” which threatened the “privacy and security of individuals and organizations worldwide.”

In our view, robust use of the Entity List is likely to remain a durable feature of U.S. trade policy, as it has of late become a favored tool across administrations of both political parties to combat a wide range of U.S. national security threats.

B. Antiboycott Developments

Effective June 8, 2021, BIS’s Office of Antiboycott Compliance (“OAC”) recognized the United Arab Emirates’ (“UAE”) termination of its participation in the Arab League’s boycott of Israel. Part 760 of the EAR and Section 999 of the Internal Revenue Code specifically discourage, and in some circumstances explicitly prohibit, U.S. persons from engaging in activity that would support the Arab League’s boycott of Israel, including agreeing to contractual language that directly or indirectly implicates this boycott. OAC’s official recognition of the UAE’s termination of participation added a new interpretation section to 15 C.F.R. Part 760 which explicitly states that a request from the UAE that an exporter certify that a vessel is eligible to enter UAE ports will no longer carry the presumption that this language was in furtherance of the Arab League’s boycott of Israel, and companies can consequently agree to such language as long as no other antiboycott red flags are present. This interpretation comes on the heels of the UAE’s normalization of relations with Israel under the Abraham Accords signed on August 16, 2020, and should reduce companies’ antiboycott compliance burdens in connection with transactions involving the UAE. We note, however, that sufficient due diligence remains necessary to ensure general compliance with the antiboycott provisions of the EAR. Although BIS does not maintain an official list of boycotting countries, other members of the Arab League (including such countries as Algeria, Iraq, Kuwait, and Saudi Arabia) are widely considered states that frequently include antiboycott restrictions within commercial language.

C. White House Export Controls and Human Rights Initiative

On December 9 and 10, 2021, President Biden convened the first of two Summits for Democracy, which brought together leaders from government, civil society, and the private sector to address threats faced by modern democracies. The virtual summit gathered representatives from over 100 countries and the European Union to address the topics of (1) strengthening democracy and defending against authoritarianism; (2) fighting corruption; and (3) promoting respect for human rights. In connection with the gathering, the United States unveiled its first-ever Strategy on Countering Corruption, which we describe in detail in an earlier client alert.

Notably, the Biden administration used the Summit for Democracy to emphasize its use of export controls to advance human rights. During the Summit, the United States, Australia, Denmark, and Norway jointly announced the Export Controls and Human Rights Initiative, with support from Canada, France, the Netherlands, and the United Kingdom. The initiative aims to create a voluntary code of conduct for states to use in crafting export controls to combat the use of cyber-intrusion and surveillance tools and related technologies by authoritarian governments, both within their countries and across international borders, to track dissidents, censor political opposition, and engage in transnational repression. While WA states have already imposed export controls on tools for military offensive cyber operations and IP network communications systems—the United States announced its own version of the Wassenaar controls on “cybersecurity items” in October 2021—the initiative appears likely to focus on creating a framework for coordinated unilateral controls on technologies such as biometrics, facial recognition, and other forms of artificial intelligence-assisted surveillance and repression of individuals and ethnic groups.

D. State Department

1. Revisions to ITAR Proscribed Country List

During 2021, the U.S. Department of State’s Directorate of Defense Trade Controls (“DDTC”), which administers and enforces the International Traffic in Arms Regulations (“ITAR”), added several new countries to the list of jurisdictions for which the United States prohibits trade in defense articles and defense services. Russia, Ethiopia, and Cambodia were all added to the list of proscribed countries set forth at 22 C.F.R. § 126.1, and the existing entry for Eritrea was updated to codify a broad policy of denial. Accordingly, it is the U.S. Government’s policy to deny licenses and other approvals for exports and imports of defense articles and defense services to these countries, except on a case-by-case basis to Cambodia if in furtherance of conventional weapons destruction or humanitarian mine action activities or to Russia if for government space cooperation. Exports of defense articles and services to Ethiopia and Eritrea are only prohibited when destined to or for the armed forces, police, intelligence, or other internal security forces.

2. Revisions to United States Munitions List

DDTC continued to revise the United States Munitions List (“USML”) in 2021. Effective August 30, 2021, DDTC extended the temporary modification of Category XI(b) to ensure that certain intelligence-analytics software remained controlled under the USML. This rule extended the temporary revision until August 30, 2026, while DDTC considers a wholesale revision of Category XI. Separately, DDTC was finally able to effect the transfer of software and technical data related to 3-D printing of firearms or components to the EAR, which the State Department first announced in January 2020. This transfer was stayed by a preliminary injunction by the Western District of Washington in March 2020. On May 26, 2021, this injunction was vacated by the Ninth Circuit Court of Appeals, and these items are now exclusively controlled by the EAR. Finally, on September 30, 2021, the State Department extended the temporary modification of the ITAR removing prohibitions on exports, reexports, retransfers, and temporary imports of non-lethal defense articles and defense services destined for or originating in Cyprus. This temporary final rule is effective through September 30, 2022.

3. Changes to Regulations in Light of Remote Work Future

Importantly in a world still significantly impacted by remote working, DDTC has indefinitely authorized “regular employees” to work from remote locations (other than in a country listed in 22 C.F.R. § 126.1) and to send, receive, and access technical data authorized by the U.S. Government for export, reexport, or retransfer to their employer in their country of remote work even if the employer’s authorization is for exports to a different country. On May 27, 2021, DDTC solicited comments on the definition of “regular employee” to allow some employees who are contract employees to be treated as regular employees, provided those individuals are sufficiently subject to the employer’s control such that the agency can hold the regulated employer responsible for the individual’s actions.

V. European Union

A. Sanctions Developments

1. Belarus

2021 saw a major uptick in European Union sanctions, or “restrictive measures,” against Belarus. In particular, the EU adopted several rounds of (additional) sanctions packages in response to the Lukashenka regime’s human rights violations; violent repression of the opposition; the May 2021 forced landing of a commercial aircraft in Minsk and the resulting arrest of a dissident journalist and his companion; and the instrumentalization of migrants for political purposes.

Of note, the EU Belarus financial sanctions now also target individuals and entities organizing or contributing to activities that facilitate illegal crossing of the EU’s external borders, including selected Belarusian travel agencies. Further, the EU, on June 4, 2021, decided to strengthen the existing restrictive measures in view of the situation in Belarus by introducing a ban on the overflight of EU airspace and on access to EU airports by Belarusian carriers of all kinds.

To recall, EU financial sanctions are broadly comparable to U.S. SDN listings. Accordingly, any business dealings with Belarus, specifically any with proximity to the Government of Belarus, but also any travel arrangements for meetings in Belarus or with individuals and entities from Belarus, should undergo additional scrutiny to ensure no funds or economic resources are being made available to those subject to EU financial sanctions.

2. Russia

As tensions between, collectively, the European Union, the United Kingdom, and the United States, and the Russian Federation continue to intensify over a possible impending Russian military intervention in Ukraine, on January 24, 2022, the Council of the European Union (the “Council”) issued the Council Conclusions on the European Security Situation. In that document, the Council emphasizes its commitment to the sovereign equality and territorial integrity of states, as well as the inviolability of frontiers and the freedom of states to choose or change their own security arrangements—in this case especially, Ukraine’s choice to potentially join NATO. In this context, the Council further elaborates that any further military aggression against Ukraine will have “massive consequences and severe costs,” including a wide array of sectoral and individual restrictive measures, in close alignment with the EU’s partners. However, the Council does not at this juncture enumerate what specific consequences the EU is prepared to impose. As such, it is challenging to predict the implications for EU sanctions on Russia should the Kremlin launch a further military incursion into Ukraine.

In light of the unstable and fast-developing situation in Ukraine, firms with exposure to Russia may wish to review their existing Russian counterparties to identify possible sanctions targets among their business partners and prepare for the possible imposition of coordinated sanctions by the United States, the United Kingdom, and the European Union. Should Russian troops—thousands of which are presently massed on the border—cross into Ukraine, the wide range of possible sanctions that may be put into effect on a permanent member of the United Nations Security Council likely would be unprecedented and disruptive. Businesses should therefore consider preparing a contingency plan in the event that sanctions targeting substantial Russian enterprises, including major Russian financial institutions, are issued on short notice.

B. Export Controls Developments

When referring to “EU export controls,” we actually refer to a hybrid set of EU and EU member state legislation that together form the export control-related set of rules that apply to parties that undertake business with an EU nexus.

In order to keep up with the latest technological developments and to mitigate national security concerns, the European Union and its member states regularly update its export control regimes. While many of those regular updates cover rather technical aspects, 2021 was different. On September 9, 2021, “Regulation (EU) 2021/821 of the European Parliament and of the Council of 20 May 2021 setting up a Union regime for the control of exports, brokering, technical assistance, transit and transfer of dual-use items (recast)” (the “New EU Dual-Use Regulation“) came into effect. The New EU Dual-Use Regulation not only modernizes, but also substantially expands, the scope and breadth of the EU / EU member state system for the control of exports, brokering, technical assistance, transit, and transfer of dual-use products and technologies.

1. Overview

Recasting Council Regulation (EC) No. 428/2009 (the “Old EU Dual-Use Regulation“) in its entirety, the New EU Dual-Use Regulation (1) strengthens controls on a wider range of emerging dual-use technologies, including cyber-surveillance tools; (2) specifies due diligence obligations and compliance requirements for exporters, recognizing the role of the private sector in addressing the risks to international security posed by trade in dual-use items; and (3) increases coordination between member states and the European Commission (the “EU Commission”) in support of the effective enforcement of controls throughout the EU.

The New EU Dual-Use Regulation is the result of a long period of negotiations between the European Parliament and the Council of the European Union, which started when the reform of EU export controls was initially proposed by the EU Commission in September 2016. Observers have long noted the need for an updated framework due to abundant technological developments, the growing importance of human rights considerations, and growing security risks.

2. Human Rights Considerations

First and foremost, the New EU Dual-Use Regulation specifically includes stronger human rights considerations, resulting in the implementation of stricter controls on exports from the EU of certain surveillance and intrusion technologies that have the potential to contribute to human rights abuses. As Member of the European Parliament Bernd Lange put it, with this update “respect for human rights will become an export standard.”

To address the risk that certain cyber-surveillance items exported from EU territory might be misused by persons involved in serious violations of human rights or international humanitarian law, the New EU Dual-Use Regulation now includes a list of such items exceeding international lists in its revised Annex I, making them subject to export control restrictions enforced by the competent authorities of EU member states.

In particular, an authorization may be required even for certain unlisted cyber-surveillance items, if the exporter has been informed by the competent authority that the items in question are or may be intended for use in connection with internal repression and/or committing serious violations of human rights and international humanitarian law. We expect to see increased outreach efforts by the competent authorities of the EU member states in the months to come. In addition, in case an exporter is aware that unlisted cyber-surveillance items proposed for export are or may be intended for human rights violations, exporters are obligated to inform the competent authority.

3. Due Diligence Obligations and Compliance Requirements for Exporters

The New EU Dual-Use Regulation recognizes as vital the contributions of exporters, brokers, providers of technical assistance, and other relevant stakeholders to the overall aim of export controls. As such, the Regulation introduces due diligence obligations and compliance requirements that should be put in place through transaction-screening measures as part of an internal compliance program (“ICP”), which is to be implemented unless the competent national authority of an EU member state considers it unnecessary.

For instance, under the New EU Dual-Use Regulation, exporters using global export authorizations (broadly comparable to U.S. general licenses) should implement an ICP unless the competent national authority considers it unnecessary when processing the application for a global export authorization submitted by the exporter. In that regard, the size and organizational structure of exporters have to be considered when developing and implementing ICPs.

Yet, reporting and specific ICP requirements relating to the use of global export authorizations will be defined by EU member states. The competent authority in Germany has recently done so in published guidance. We assume this guidance will be updated in due course to reflect the New EU Dual-Use Regulation.

In recognition of the importance of sharing research data, academic and industrial research organizations have been included in the new EU regulations and are specifically addressed in Commission Recommendation (EU) 2021/1700, which provides guidance in order to help identify, manage, and mitigate risks associated with the New EU Dual-Use Regulation.

4. Increased Coordination Between EU Member States

To promote a common approach with regard to specific provisions, the New EU Dual-Use Regulation determines that EU member states and the EU Commission should raise awareness and promote tailored guidance to address challenges in the application of this new regime, as well as work together by sharing information among themselves, especially concerning the technological development of cyber-surveillance items.

5. EU-U.S. Trade and Technology Council

Finally, the New EU Dual-Use Regulation also provides a strong basis for the EU to engage with third countries in order to support a level playing field and enhance international security through more convergent approaches to export controls at the global level.

An example is the U.S.-EU Trade and Technology Council which, as discussed under Section III.E, above, held its inaugural meeting on September 29, 2021. The TTC serves as a forum for both jurisdictions to coordinate approaches to key global trade, economic, and technology issues, as well as to deepen transatlantic trade and economic relations more broadly. The meeting set up various working groups that focus on specific topics including export controls. Additionally, a joint statement was published, stipulating shared principles and areas for export cooperation. The TTC recognizes, among other things, the importance of a multilateral approach to export controls and lays a focus on dual-use items as such may be misused for violations of human rights. These areas of cooperation may also suggest that the European Union and the United States plan to use the TTC to further communicate and potentially synchronize their efforts on export controls as part of a joint approach to trade with China.

Under the New EU Dual-Use Regulation, companies will be burdened with the additional task to support the EU’s endeavor to protect and secure human rights. As a major amendment, companies will, even more so than before, be well advised to screen their transactions for possible dual-use technology, now including cyber-surveillance tools that could be used to violate human rights. Which specific standards will need to be applied to comply with such due diligence and ICP obligation remains to be seen, as such standards are currently being finally determined by the EU and its EU member states.

C. Noteworthy Judgments and Enforcement Actions

1. EU Blocking Statute Regulation

Following Advocate General Gerard Hogan’s Opinion of May 12, 2021, the European Court of Justice (“ECJ”) on December 21, 2021 delivered its highly anticipated decision in Bank Melli Iran, Aktiengesellschaft nach iranischem Recht v. Telekom Deutschland GmbH (C-124/20), involving interpretation of Council Regulation (EC) No 2271/96 (the “Blocking Statute Regulation”).

In its judgment—which adds to the growing body of case law concerning the circumstances under which parties can be judicially compelled to comply with the Blocking Statute Regulation—the ECJ provided guidance on three questions brought before the court:

First, the Blocking Statute Regulation impedes a contractual party from unilaterally terminating a contract with another party that is subject to U.S. “secondary” sanctions because the terminating party seeks to comply with such U.S. sanctions. This principle applies even without any prior compelling request by the U.S. administration for compliance with U.S. sanctions.

Second, under the Blocking Statute Regulation, a party that wishes to terminate a contract with a person subject to U.S. sanctions is not per se obliged to put forward a reason for such termination. However, if the termination is subject to proceedings before an EU member state court, the terminating party will have the burden of proof to demonstrate that such termination was not induced by compliance with the U.S. sanctions listed in the Blocking Statute Regulation if the evidence available to the national court suggests prima facie that the terminating party in fact complied with U.S. sanctions.

Third, the ECJ ruled that, in principle, the annulment of a termination by a national court shall be compatible with the fundamental right of freedom to conduct a business (Article 16 of the Charter of Fundamental Rights of the European Union (“CFR”)) and the principle of proportionality (Article 52 CFR) if the national court concluded that the notice of termination was given for the purpose of compliance with certain specified U.S. sanctions.

However, the ECJ also held that it is ultimately up to the national court to determine whether further performance of the contract could lead to disproportionate economic or financial consequences for the terminating party. In this regard, it is important to note that the ECJ stressed that one of the factors to take into consideration is whether or not the terminating entity applied for an exemption from the Blocking Statute Regulation prior to termination.

In addition, more on a side note, the ECJ gives its opinion on the Guidance Note to the Blocking Statute issued by the European Commission, stating that the document does not establish binding rules or interpretations. The ECJ further notes that only the Blocking Statute Regulation is binding and only the ECJ has the power to provide legally binding interpretations of that regulation. Although we believe the Guidance Note still provides some valuable guidance for the de facto interpretation of the Statue, its persuasive power in court is likely to be greatly reduced.

2. Denmark

On December 14, 2021, the Court of Odense sentenced Danish fuel supplier A/S Dan-Bunkering Ltd. and its parent company Bunker Holdings A/S to payments of 45 million Danish Crowns ($6.9 million) and 4 million Danish Crowns ($600,000) for violating EU sanctions. The holding company’s chief executive officer has also been sentenced to a suspended prison sentence of four months.

The court found that Dan-Bunkering, via its Kaliningrad office, purposely violated EU Regulation No. 36/2012 of 18 January 2012, as amended, which implemented restrictive measures against Syria. Dan-Bunkering had sold 172,000 tons of jet fuel worth over $100 million through a total of 33 trades between October 2015 and May 2017. The deals were made with two Russian companies listed on the U.S. sanctions list that ultimately acted as agents for the Russian Navy. The traded jet fuel was later used to execute Russian bombing runs near the Syrian city of Banias. The fines set by the court’s judgment ultimately are equivalent to double the profit Dan-Bunkering achieved from the deals. The court ruled that Dan-Bunkering must have been aware of a possible usage of their products for Russian interference in the Syrian war.

Notably, the verdict affirms that EU courts do not hesitate to hold business managers personally accountable for their company’s breach of sanctions. The decision also highlights the importance of maintaining an effective sanctions compliance program.

3. Germany

In 2021, the German Federal Court of Justice (Bundesgerichtshof) (“BGH”) dealt with multiple cases regarding payments made to members of the Islamic State. In the context of these judgments, the court clarified its interpretation of the scope of “mak[ing] available, directly or indirectly, to, or for the benefit of, a natural or legal person, group or entity designated” under Article 2.II of Regulation (EC) No. 881/2002.

The main focus of these cases was whether a private benefit to an individual is also “made available” to an organization of which that individual is a member or with which that individual is associated. The BGH used the rulings to emphasize that the wording at issue should be interpreted broadly. While the court leaves open the possibility that payments could be made to individuals regardless of their affiliation with organizations on the sanctions list, it sets a high bar for such defense. Any kind of economic benefit to the organization results in the good or service being considered as “made available” to the organization. In this context, it is also deemed irrelevant whether the service is provided in direct exchange for a service in return.

These rulings develop their practical relevance in that they shed light on how much distance should be maintained from organizations and persons appearing on the EU sanctions list in order to avoid running afoul of EU sanctions.

VI. United Kingdom

A. Sanctions Developments

Following the end of the Brexit transition period on December 31, 2020, the United Kingdom is no longer bound by EU sanctions law. The Sanctions and Anti-Money Laundering Act 2018 (the “Sanctions Act”) now provides the legislative framework for the UK’s post-Brexit sanctions regime. The year of 2021 constitutes the first full year that the UK’s autonomous sanctions regime has been underway.

1. OFSI Annual Review 2020-2021

On October 14, 2021, the UK Office of Financial Sanctions Implementation (“OFSI”) published its annual review for the financial year April 2020 to March 2021 (the “OFSI Annual Review”). The OFSI Annual Review comments on the impact of the end of the Brexit transition period on its activity levels, stating that “OFSI has had a stretching year, working across government and with both private sector and international partners as it transitioned out of the EU and into a UK autonomous sanctions framework.” Other key takeaways of the OFSI Annual Review include:

Changes to the Consolidated List: OFSI added 278 new designated persons to the consolidated list in the financial year 2020 to 2021, 159 of which implemented EU and UN legislation, outside of the period before the end of the Brexit transition period on December 31, 2020. Furthermore, 119 designations were made under the new Sanctions Act.
Licensing: The OFSI Annual Review highlights how the transition to an autonomous sanctions framework led to changes to licensing, including new licensing grounds (derogations) in respect of non-UN designated persons and adjustments to existing licensing grounds. For example, the existing licensing grounds for “maintenance of frozen funds and economic resources” and for payment of legal fees and expenses now require “reasonableness.” Under the Sanctions Act, OFSI was also granted new powers to provide for issuing General Licences under all regimes; previously, it could only issue these under the Terrorist Asset-Freezing etc. Act 2010. A General License allows multiple parties to undertake specified activities that would otherwise be prohibited without the need for a specific licence. In the financial year 2020 to 2021, OFSI issued 43 new licenses and made 75 amendments across 11 regimes; 64 out of the 75 amendments to licenses issued were issued under the Libya regime.
Compliance and Enforcement: The OFSI Annual Review makes clear that OFSI investigates every reported suspected breach of UK sanctions regulations, the result of which can vary depending on whether a breach has occurred and, if so, the nature of the breach. Where a breach has occurred, proportionate action can include the issuance of a warning letter, a civil monetary penalty, or escalation to law enforcement partners. In the financial year 2020 to 2021, OFSI considered 132 reports of potential financial sanctions breaches. This is a slight decrease from the previous financial year; however, generally the number of cases considered remains on an upwards trajectory from earlier years.

2. Sanctions Regulations Report on Annual Reviews 2021

The Sanctions Regulations Report on Annual Reviews 2021 has been published by the UK Foreign, Commonwealth & Development Office (the “Report”). The review is required under Section 30 of the Sanctions and Anti Money Laundering Act 2018, to assess whether the regulations are still appropriate for the purpose for which they were created. The report summarizes and reviews activity under the UK’s sanctions policy during 2021. The Report highlights the fact that the UK has become “more agile and has real autonomy to decide how [it] use[s] sanctions and where it is in our interests to do so” since leaving the EU and moving to an independent sanctions policy.

The Report observes the value of this in two recently established UK autonomous sanctions regimes: (1) the launch of the Global Human Rights sanctions regime on July 6, 2020; and (2) the launch of the Global Anti-Corruption sanctions regime on April 26, 2021. At the time of the Report, 106 designations have been made under these two regimes, “ensuring and sending a clear message that the UK is not a safe haven for those individuals and entities involved in serious corruption and human rights violations or abuses, including those who profit from such activities.”

3. Changes to Sanctions Lists

OFSI announced in December 2021 that, with effect from February 2022, the structure and data fields included in the UK sanctions list and the OFSI consolidated list will be changing.

The key changes to the UK sanctions list include the standardization of data (where possible) to remove duplications, unnecessary punctuation, and improve consistency; the creation of new fields to improve the detail and structure of the data; and changes to some field names to make their purpose clearer.

The key changes to the OFSI sanctions list include the addition of seven new fields, the introduction of a new group type “Ship,” and the retirement of the .xls format.

Organizations that regularly use the UK sanctions list and OFSI consolidated list in order to conduct sanctions checks should ensure that they understand these changes with a view to updating their systems, processes, and compliance policies accordingly.

B. Export Controls Developments

The UK’s status in relation to the EU has changed following the end of the Brexit transition period on December 31, 2020. Though the UK regime has similarities to the New EU Dual-Use Regulation, it now has its own sanctions and export control regimes, separate from those of the EU. In light of these changes, the UK Government published guidance on exporting military or dual-use technology (the “UK Guidance”).

1. Overview

In the UK export regime, “dual-use” means useable for both civil and military purposes. This includes dual-use goods, along with software or technology. In contrast to the human rights rhetoric used in describing the New EU Dual-Use Regulation, the UK dual-use export controls focus primarily on national security. The UK Guidance describes the basis of the UK’s export controls as aimed at preventing transfers that can lead to goods causing national security concerns for the UK and its allied forces, but doing so without “inhibiting legitimate trade [and] knowledge acquisition.”

Though the fines for dual-use export control violations pre-Brexit have been relatively low in the UK, with fines for export control violations in 2020 amounting to GBP 700,368 in total, the position post-Brexit and in light of the UK Guidance remains unclear.

2. Open Export General License

Broadly speaking, the EU and UK have sought to keep their respective post-Brexit trade control regimes aligned to minimize disruption to the pre-Brexit status quo. While the main features of the EU dual-use regime are seen in the UK regime, they are applied in the UK as a matter of English law rather than EU law. As such, when developing and implementing ICPs, the UK should be considered separately from the EU.

Furthermore, as the UK is no longer a member of the EU, the UK is now treated as a “third country” with respect to the EU’s export controls. This means that whereas previously most exports of dual-use items between the UK and EU member states did not require licenses, now exports from the UK to EU member states of dual-use goods or technology will require export authorization by way of an Open General Export License (an “OGEL”).

This new requirement, along with the heightened focus on technology, will not only impact companies that export dual-use goods, but also will have a bearing on how a company will transfer its “controlled technology” (i.e., information necessary to develop, produce, or use goods or software subject to UK dual-use export controls) within its international offices or employees, along with how such information is stored and accessed remotely (i.e., cloud storage).

3. Guidance on Exporting Military or Dual-Use Technology

The UK Guidance provides clarification regarding UK dual-use export controls including their applicability and scope, confirming that UK dual-use export controls apply to any entity in the UK and, in some circumstances, UK persons overseas.

In particular, the UK Guidance confirms that an OGEL for dual-use items will now be required for the transfer of controlled technology. A “transfer” includes sharing information via phone or video conferencing, emails, or laptops, phone or memory devices. Transfers can also include where the information is read out loud, shared via screensharing presentations, sent via email, or taken overseas on a memory device. Given the rise in remote working and the increased usage of video conferencing services, companies will need to be conscious of what information and data is shared overseas from their UK bases, and whether an OGEL will be required.

The Guidance also addresses the storage of controlled technology on servers that can be accessed remotely. It confirms that the location of the exporter and intended recipient, and not the location of the servers containing the controlled technologies themselves, will determine the need for an OGEL. As such, an OGEL is required if controlled technology is uploaded by persons in the UK and subsequently accessed by a recipient overseas.

This is of particular importance to multinational companies that transfer and store controlled technology through common IT systems and utilize intranets or cloud services. Companies falling into this category will now require an OGEL in order to share controlled technology from within the UK to their overseas offices, regardless of where that information is subsequently stored.

4. Updates to the Export Control Regime

On December 8, 2021, an update on the UK export control regime was released by the Secretary of State for International Trade, comprising three new measures.

Firstly, the UK Strategic Export Licensing Criteria have been amended, which will be applied with immediate effect to all license decisions on goods, software, and technology which are subject to control for strategic reasons for export, transfer, trade, and transit. For example, they lay a stronger focus on risks of violation of humanitarian law and misuse of items for internal repression, similar to the New EU Dual-Use Regulation.

In addition, a broader definition of military end-use will be established in early 2022, which will now permit control (on a case-by-case basis) of non-listed items intended for use by military and other security forces, apart from the previously covered listed items. However, the control will only be imposed when the government informs the exporter that a proposed export is intended for a military end use. To minimize the impact on legitimate trade, there will be exemptions for medical supplies and equipment, food, clothing, and other consumer goods.

Last but not least, China is expected to be added to the list of destinations subject to military end-use controls by spring 2022.

C. Noteworthy Judgments and Enforcement Actions

On August 5, 2021, OFSI announced a GBP 50,000 monetary penalty against the UK fintech company TransferGo Limited (“TransferGo”) for multiple breaches of The Ukraine (European Union Financial Sanctions) (No. 2) Regulations 2014. As stated in OFSI’s penalty report, the penalty related to 16 transactions made between March 2018 and December 2019, where TransferGo issued instructions to make payments to accounts held at the Russian National Commercial Bank (“RNCB”), a designated party under Council Regulation (EU) No 269/2014. The total value of the transactions was GBP 7,764.77.

OFSI imposed a monetary penalty because it was satisfied, on the balance of probabilities, that TransferGo breached a prohibition imposed by financial sanctions legislation and either knew or had reasonable cause to suspect that it was in breach of that prohibition. OFSI further elaborated that TransferGo erred in its assessment of whether the payments to RNCB were subject to financial sanctions restrictions. TransferGo asserted that payments to the accounts with RNCB were not breaches of financial sanctions restrictions since the relevant clients and beneficiaries were not themselves subject to such restrictions. However, OFSI considered that funds held in bank accounts ultimately belong to those banks.

VII. People’s Republic of China

China continued building up its legal arsenal against the continuing pressure from the United States. As we reported in our 2020 Year-End Sanctions and Export Controls Update, China had already begun establishing a sanctions blocking law and an export controls system. However, the myriad PRC policy developments that took place in 2021 extended even more broadly to include blocking laws and counter-sanctions, export controls, data security laws, national security reviews of foreign investments, and cybersecurity reviews. Importantly, these measures appear to be a symbolic statement against the United States and its allies that China will not back down in the strategic competition between Washington and Beijing. These measures also appear to be part of China’s efforts to build a resilient economic and business ecosystem and further establish itself as a major power in setting alternative global norms and standards.

The ink on these measures is barely dry and, because these measures were written in broad strokes and afford considerable discretion to PRC regulators, the compliance implications for global businesses are not yet clear. However, one certainty is that the new measures unveiled by PRC authorities have already increased the complexity and risk of doing business globally, especially when taken together with the various U.S. policy changes discussed above, such as heightened supply chain due diligence expectations and the ever-growing list of sanctioned Chinese entities. Global businesses with operations touching China now must monitor the developments in not only the U.S. legal regimes targeting China, but also the increasingly intricate set of Chinese legal rules.

A. Countermeasures on Foreign Sanctions

As the United States continued to impose a litany of trade restrictions on China in 2021, China showed few signs of backing down. In January and June 2021, China issued a set of laws that would allow the Chinese government to prohibit compliance with certain foreign laws. These laws could potentially require companies active in the global supply chain to choose whether to comply with U.S. sanctions or to comply with Chinese law. Although the practical impact of these developments is yet unclear, we are already seeing Chinese companies balk at agreeing to traditional representations and warranties in agreements, which may compel Western firms to reconsider how to obtain assurances regarding sanctions compliance going forward. Using its new legal tools, China has also counter-sanctioned several U.S. and other Western officials and entities in response to sanctions related to Xinjiang and Hong Kong. This cycle of sanctions and counter-sanctions appears likely to proliferate so long as relations between the United States and China remain fraught and the two superpowers continue their competition for global primacy.

1. Blocking Rules

As discussed in an earlier client alert, the Chinese Ministry of Commerce (“MOFCOM”) on January 9, 2021 issued the Rules on Blocking Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the “Blocking Rules”), which took immediate effect. (The Blocking Rules are available in both a Chinese-language version and an English translation.) The Blocking Rules established a mechanism for the Chinese government to designate “unjustified extraterritorial applications of foreign legislation and other measures” and issue prohibitions on Chinese persons’ and entities’ compliance with these foreign laws (Articles 4 & 7). Whether a foreign law constitutes “unjustified extraterritorial applications” is determined on an open-ended set of factors, including whether the law violates “international law or the basic principles of international relations,” impacts China’s “national sovereignty, security and development interests,” or impacts the “legitimate rights and interests” of Chinese individuals and entities, as well as a catch-all for “other factors that should be taken into account” (Article 6).

Under the Blocking Rules, Chinese individuals and entities—including, critically, Chinese subsidiaries of multinational companies—must report any restrictions they face from foreign governments (Article 5). Failure to comply may result in government warnings, orders to rectify, or fines (Article 13). Chinese individuals and entities also have a private right of action to sue in Chinese courts for compensation from any restrictions (Article 9). If carried out effectively, the Blocking Rules have the potential to create significant compliance risks for multinational enterprises.

Although the Blocking Rules went into effect immediately, they will only become enforceable in substance once the Chinese government designates the specific “unjustified extraterritorial applications”—a step that, as of this writing, has not yet been taken. Nevertheless, the Blocking Rules by their publication have forcefully communicated the Chinese government’s intention to establish a legal regime for countering foreign sanctions.

2. Anti-Foreign Sanctions Law

On June 10, 2021, the National People’s Congress further bolstered the message by passing the Law of the People’s Republic of China on Countering Foreign Sanctions (the “Anti-Foreign Sanctions Law”), which took immediate effect. (The Anti-Foreign Sanctions Law is available in both a Chinese-language version and an English translation.) The legislation formalizes previous administrative measures taken by China, such as the Blocking Rules and the Export Control Law (discussed below), by providing legal grounds for the countermeasures. Coming one day before the start of the G7 summit in the United Kingdom, the legislation was widely believed to be, at least in part, China’s challenge to President Biden’s objective at the G7 to build a coalition against China’s rising global influence.

Importantly, the Anti-Foreign Sanctions Law allows Chinese authorities to designate on the “Countermeasures List” and take a menu of counter-sanctions—including denial of visas, seizure of assets, blocking of transactions, and other necessary measures—against individuals (as well as their spouses and immediate relatives) or entities (as well as their senior management and controllers) involved in creating, deciding, or implementing “discriminatory restrictive measures” by foreign governments (Articles 4 to 6). The term “discriminatory restrictive measure” is left undefined—but it is likely to include China-related sanctions and export controls by foreign governments.

In announcing the Anti-Foreign Sanctions Law, China hinted that enforcement of this legislation may be limited to those involved in drafting and advocating for sanctions targeting China as “[t]he law only takes aim at those entities and individuals who grossly interfere in China’s internal affairs and spread rumors about and smear, contain and suppress China.” That said, like the Blocking Rules, the Anti-Foreign Sanctions Law also prohibits Chinese persons and entities from complying with foreign “discriminatory restrictive measures” and allows a private right of action for Chinese persons and entities that are negatively impacted by sanctions to seek injunctive relief and compensatory damages (Article 12). Even if the Countermeasures List designations may be reserved for those closer to the formulation of U.S. sanctions measures, private companies seeking to comply with U.S. sanctions must now carefully navigate between the conflicting regulatory requirements of the world’s two largest economies.

3. Impact on Entities in Hong Kong

Even before the introduction of the measures described above, multinational businesses and financial institutions in Hong Kong were faced with a dilemma. The Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region (the “National Security Law”), which has been in effect in Hong Kong since June 30, 2020, established the crimes of secession, subversion, terrorist activities, and collusion with a foreign country or external elements to endanger national security. At the time of the National Security Law’s enactment, about 54 percent of businesses in a Hong Kong General Chamber of Commerce survey expressed concern about potential foreign sanctions risks—albeit in the short term—arising from the National Security Law.

On August 8, 2020, the Hong Kong Monetary Authority issued guidance instructing regulated institutions that “unilateral sanctions imposed by foreign governments are not part of the international targeted financial sanctions regime and have no legal status in Hong Kong.” However, the guidance did not expressly prohibit companies from complying with U.S. sanctions and instead advised that companies’ policies should be “informed by a thorough assessment of any legal, business and commercial risks involved and based on a balanced approach. In assessing whether to continue to provide banking services to an individual or entity designated under a unilateral sanction which does not create an obligation under Hong Kong law, boards and senior management of [regulated institutions] should have particular regard to the ‘treat customers fairly’ principles.”

Naturally, the enactment of the Anti-Foreign Sanctions Law again created a quagmire for Western businesses and financial institutions in Hong Kong. At the same time, however, China seems to be treading lightly to avoid discouraging foreign business activities in Hong Kong. In the August 2021 session, the National People’s Congress postponed a vote on extending the Anti-Foreign Sanctions Law to Hong Kong. On October 5, 2021, Hong Kong Chief Executive Carrie Lam provided some comfort to businesses by further clarifying that Beijing has shelved the extension of the Anti-Foreign Sanctions Law to Hong Kong and would take into account Hong Kong’s status as an international financial center even if the extension were to occur in the future.

4. Application of Counter-Sanctions

In part aided by the new legal regimes, the Chinese Ministry of Foreign Affairs (“MOFA”) issued counter-sanctions against major Western decisionmakers throughout the year. From March 22-27, 2021, MOFA announced counter-sanctions against 22 individuals and ten entities from the European Union, the United Kingdom, and the United States and Canada “in response” to sanctions imposed days earlier for alleged human rights abuses in Xinjiang. On July 23, 2021, MOFA announced a further round of counter-sanctions against seven individuals and one entity in the United States (including former Commerce Secretary Wilbur Ross) in response to the sanctions imposed on Chinese officials in connection with repression of protests in Hong Kong. On December 21, 2021, MOFA announced additional counter-sanctions against four members of the U.S. Commission on International Religious Freedom shortly after the United States imposed sanctions and announced a diplomatic boycott of the 2022 Beijing Winter Olympics related to the situation in Xinjiang. Although Chinese counter-sanctions have to date principally focused on Western government officials and agencies, such measures have also targeted scholars and non-profit organizations known for their advocacy of human rights.

Such tit-for-tat sanctions are likely to continue. Despite the November 2021 virtual meeting between President Biden and President Xi in which the two leaders discussed “the importance of managing competition responsibly,” the U.S.-China relationship remains tense. As the United States continues to impose sanctions and other policy measures targeting China, China may not simply let its newest policy tool gather dust.

B. Export Controls Regime

China’s first comprehensive Export Control Law (Chinese version here and English translation here), which went into effect on December 1, 2020, included a notable expansion of extraterritorial applicability, as we previously reported in an August 2020 client alert. In the intervening months, China has issued a number of regulations in relation to export controls, especially for dual-use items (i.e., items with both civil and military applications). For example, China announced new rules on commercial cryptographic products, updated the catalog of dual-use items and technologies subject to import and export license administration, and implemented paperless management of import and export licenses for dual-use items and technologies. While not a “sea change” per se, these regulations are evidence of China’s ongoing efforts to solidify and modernize its export controls regime.

On April 28, 2021, MOFCOM issued Guiding Opinions on Establishing the Internal Compliance Mechanism for Export Control by Export Operators of Dual-Use Items (the “Guiding Opinions”), answering the Export Control Law’s call for official internal compliance guidelines. The Guiding Opinions’ core elements of a sound internal compliance mechanism largely parallel those found in the U.S. Export Compliance Guidelines, thus allowing global companies to maintain consistency in their global compliance programs. The core elements of the Chinese Guiding Opinions include, among others: (1) issuing a statement of policy (equivalent to the “management commitment” in the U.S. Export Compliance Guidelines); (2) assigning a department and personnel responsible for export controls compliance; (3) conducting a comprehensive risk assessment; (4) establishing a set of internal controls to screen for red flags; and (5) conducting periodic compliance audits.

C. Restrictions on Cross-Border Transfers of Data

Prior to 2021, China already maintained several restrictions on the provision of data to foreign governments. For example, the International Criminal Judicial Assistance Law (Chinese version here and English translation here) bars Chinese individuals and entities from providing foreign enforcement authorities with evidence, materials, or assistance in connection with criminal cases without the consent of the Chinese government, and the China Securities Law (Chinese version here and English translation here) prohibits “foreign regulators from directly conducting investigations and collecting evidence” in China. In 2021, China issued the Data Security Law and the Personal Information Protection Law, thereby clamping down on the sharing of broader swaths of personal and corporate data outside its borders. With these recent developments, the restrictions now also apply in the context of civil enforcement actions and litigation, as well as general corporate practices including due diligence. Coupled with the blocking measures discussed above, these data restrictions could have a far-reaching impact on multinational companies.

1. Data Security Law

On the same day in June 2021 that China’s Anti-Foreign Sanctions Law was passed, the National People’s Congress also passed the Data Security Law (Chinese version here and English translation here), which took effect on September 1, 2021. As described in our June 2021 client alert, the legislation contains sweeping requirements and severe penalties for violations. It governs not only data processing and management activities within China, but also those outside of China that “damage national security, public interest, or the legitimate interests of [China’s] citizens and organizations.”

The Data Security Law generally creates strict data localization and data transfer requirements for entities and individuals operating within China, depending upon the category of data (e.g., “core data” or “important data”). Crucially, the Data Security Law prohibits the provision of any “data stored within the People’s Republic of China to foreign judicial or law enforcement bodies without the approval of the competent authority of the People’s Republic of China” (Article 36). Failure to obtain this prior approval may result in significant fines and, in some “serious” cases, suspension of business operations and revocation of business licenses (Article 48). The need to seek prior approval for any cross-border transfer of data creates substantial barriers to responding to government enforcement actions and lawsuits.

The Data Security Law also authorizes the Chinese government to implement “equal countermeasures” when a foreign country enacts any “discriminatory, restrictive, or other similar measures” with respect to investment or trade related to data and technology for data development and utilization (Articles 26). This provision appears to be a reference to recent U.S. sanctions and export controls targeting China’s technology sector and provides the Chinese government another sanctions tool under the data security regime.

The Data Security Law, like other PRC measures discussed above, leaves certain important terms undefined. In our experience, it is likely that the PRC authorities will issue additional guidance and implementation rules that provide further clarity, similar to the Provisions on the Management of Automobile Data Security that were issued on August 16, 2021 and which provide some insight into the definition of “important data” in the context of the automobile industry.

2. Personal Information Protection Law

On August 20, 2021, the National People’s Congress further built out the data protection regime when it passed the Personal Information Protection Law (Chinese version here and English translation here), which took effect on November 1, 2021. As described more fully in our September 2021 client alert, the legislation asserts an extensive extraterritorial reach. It governs not only domestic companies, but also foreign companies that process or use the personal information of individuals located within China for the purpose of providing products or services to individuals in China, analyzing or assessing the behavior of individuals in China, or under other unspecified circumstances provided in laws or regulations (Article 3). Foreign companies without a physical presence in China must appoint a designated representative in China for personal information protection (Article 53).

The Personal Information Protection Law generally requires personal information processing entities to adopt certain protective measures. Processing entities are only allowed to transfer personal information overseas if they: (1) pass a security assessment administered by the Cyberspace Administration of China (“CAC”); (2) obtain a certification from professional institutions in accordance with the rules of the CAC; (3) enter into a transfer agreement with the transferee using the standard contract published by the CAC; or (4) adhere to other conditions set forth by law, administrative regulations, or the CAC, unless any relevant international treaties to which China is a party stipulate otherwise (Article 38). Violations of the law’s requirements may lead regulators to take corrective actions, issue warnings, confiscate unlawful income, suspend services, revoke operating permits or business licenses, and/or issue fines (Article 66). Moreover, individuals may bring civil tort claims if the processing entities infringe their rights and interests (Article 69), and the People’s Procuratorate may file public interest lawsuits if the rights and interests of a large number of individuals are affected (Article 70).

Similar to the Data Security Law, the Personal Information Protection Law allows the Chinese government to take “reciprocal measures” if any country or region takes “discriminatory prohibitions, limitations, or other similar measures” against China in the area of personal information protection (Article 43). At the same time, the Personal Information Protection Law suggests a commitment by the Chinese government to “participate[] in the formulation of international rules for personal information protection, stimulate[] international exchange and cooperation in personal information protection, and promote[] mutual recognition of personal information protection rules and standards with other countries, regions, and international organizations” (Article 12). This language reinforces the notion that Beijing may be interested in challenging the Western powers by promoting an alternative “model” of global norms and standards.

D. Security Review of Foreign Investments

Finally, any discussion of China’s growing arsenal of trade controls would be incomplete without a least a brief mention of China’s foreign investment review regime. The Foreign Investment Law took effect on January 1, 2020, focusing on foreign investment promotion, protection, and administration, and also noting that China will establish a system for the security review of foreign investments. Shortly after the anniversary of the Foreign Investment Law, in January 2021, the rules for this new security review system went into effect. Additionally, in December 2021, the rules for the new cybersecurity review were also announced in connection with the Data Security Law described above.

1. National Security Review

On December 19, 2020, China’s National Development and Reform Commission (“NDRC”) and MOFCOM issued the Measures for Security Review of Foreign Investment (the “Security Review Measures”) (Chinese version here and English translation here) which apply to investments closed after January 18, 2021. Prior to the new Security Review Measures, national security review of foreign investment was set forth under circulars issued by the State Council in 2011 and 2015. In addition to formalizing the existing national security review regime, the Security Review Measures made important changes to its scope and process.

The Security Review Measures substantially expand the scope of foreign investment subject to national security review. First, the national security review now captures not only direct foreign investments, but also indirect foreign investments—which include an offshore transaction between two foreign parties in which a foreign investor acquires indirect “actual control” (whether by way of 50 percent ownership or through other decision-making powers) of a Chinese target. Second, the national security review not only covers an investment in or acquisition of equities or assets in China, but also the establishment of new enterprises, such as subsidiaries or joint ventures (also known as “greenfield investments”).

The Security Review Measures create a mandatory review requirement by a new Working Office that is jointly headed by the NDRC and MOFCOM if:

The investment is (i) in sectors related to national defense and security, or (ii) in geographic locations in close proximity to military facilities or defense-related industries facilities; or
The investment (i) involves important sectors significant for national security, such as agricultural products, energy and resources, equipment manufacturing, infrastructure facilities, transportation services, cultural products and services, information technology and internet products and services, financial services, and key technologies, and (ii) will result in foreign investors’ actual control.

Because the sectors listed above cover a broad range and are not specifically defined, the Security Review Measures potentially create a widely-applicable mandatory pre-closing filing requirement—a key difference from the U.S. CFIUS review mechanism, which is a largely voluntary process. If a party fails to submit a mandatory application, the Working Office may require the submission of an application. If the parties still fail to submit an application, the Working Office may reverse the transaction through a divestment order or other actions. This, in theory, creates a significant risk for foreign investors considering an investment involving a Chinese interest in a sensitive industry. It remains to be seen, however, how aggressively China will enforce these measures as it vows to continue opening up to foreign investments.

2. Cybersecurity Review

On July 2, 2021, the CAC launched an investigation into DiDi Global Inc.’s (“DiDi”) June 30 initial public offering (“IPO”) on the New York Stock Exchange, marking the first cybersecurity review based on the measures implemented in June 2020. The CAC expressed concerns regarding the company’s network security practices and required the company to remove its app from local app stores, thus suspending any new-user registration, during the review period. On July 5, 2021, the CAC further expanded the investigation into Full Truck Alliance and Kanzhun, which had also recently listed in the United States.

On July 10, 2021, the CAC released a draft revision to the existing Cybersecurity Review Measures. The final measures were issued on December 28, 2021 (Chinese version here and English translation here), and will go into effect on February 15, 2022. The Cybersecurity Review Measures capture not only critical information infrastructure operators but also data processing activities by internet platform operators (Article 2), and expand the regulatory and enforcement agencies to include the China Securities Regulatory Commission (“CSRC”) (Article 4). Importantly, the Cybersecurity Review Measures require operators that hold personal information of more than one million users to report for a cybersecurity review by the CAC before going public on stock exchanges outside China (Article 6). The report to the CAC must include IPO materials prepared for submission (Article 8). Finally, the Cybersecurity Review Measures extend the “special review” period for a typical case from 45 working days to 90 working days (Article 14)—potentially causing significant delays to foreign listing preparation schedules.

These reviews can cause significant disruption. For example, on December 3, 2021, DiDi eventually announced that it would de-list from the New York Stock Exchange, following a five-month investigation. Amidst market turmoil from the series of investigations, the CSRC assured foreign investors that China has always supported Chinese companies choosing listing destinations of their own. However, uncertainties linger for Chinese companies listed in the United States, especially after the December 2020 enactment of the Holding Foreign Companies Accountable Act and the December 2021 adoption by the U.S. Securities and Exchange Commission of its final rule implementing this legislation, which would authorize the de-listing of Chinese firms unless they abide by U.S. accounting and auditing requirements. This, of course, requires careful balancing with the Data Security Law and the Personal Information Protection Law, both discussed above. Thus, foreign investors who have already invested or plan to make investments in China or Chinese companies should closely monitor the changing legislative landscape with respect to data security.

The following Gibson Dunn lawyers assisted in preparing this client update: Scott Toussaint, Richard Roeder, Judith Alison Lee, Adam M. Smith, Patrick Doris, Michael Walther, Attila Borsos, Fang Xue, Qi Yue, Christopher Timura, Sean Brennan, Laura Cole, Kanchana Harendran, Nicole Lee, Chris Mullen, Rose Naing, Sarah Pongrace, Cody Poplin, Anna Searcey, Samantha Sewall, Audi Syarief, Lindsay Bernsen Wardlaw, Xuechun Wen, Brian Williamson, and Claire Yi.

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia:
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)

Europe:
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0)20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Steve Melrose – London (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
Matt Aleksic – London (+44 (0)20 7071 4042, maleksic@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com)

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

New Requirements

New Prohibitions

1. Legislative / Regulatory Developments

2. Merger Control

2.1 Prohibition Decision

2.2 Conditional Approval Decisions

2.3 Enforcement Against Non-Notified Transactions

3. Non-Merger Enforcement

Contents

I. U.S. Trade Restrictions on China

A. Protecting Communications Networks and Sensitive Personal Data

B. Slowing the Advance of China’s Military Capabilities

C. Promoting Human Rights in Xinjiang

D. Promoting Human Rights in Hong Kong

E. Trade Imbalances and Tariffs

II. U.S. Sanctions

A. Treasury Department Sanctions Review

B. Myanmar

C. Russia

1. Nord Stream 2

2. Navalny Sanctions

3. Russian Harmful Foreign Activities Sanctions

4. Possible Ukraine-Related Sanctions and Export Controls

D. Belarus

E. Iran

F. Cuba

G. Ethiopia

H. Other Sanctions Developments

1. Virtual Currency and Ransomware

2. Reversal of International Criminal Court Sanctions

3. Taliban Sanctions and Impact on Afghanistan

4. Notable SDN De-Listings

III. Information and Communications Technology and Services (ICTS)

A. Executive Order 13873: ICTS Supply Chain Framework

1. ICTS Interim Final Rule

2. Review Process

3. Safe Harbor Licensing Process

B. Executive Order 14034: Connected Software Applications

C. Executive Order 14017: Supply Chain Security

D. Executive Order 14028: Cybersecurity

E. Transatlantic Dialogues

IV. U.S. Export Controls

A. Commerce Department

1. Military End Use / User Rule

2. Military-Intelligence End Use / User Rule

3. Sudan Moved to Less Restrictive Country Group B

4. Burma Added to More Restrictive Country Group D:1

5. Cambodia Subjected to More Restrictive Licensing Policy

6. BIS Eases Restrictions of Exports of Vaccines

7. Implementation of Wassenaar Arrangement Controls

8. Emerging and Foundational Technology Controls

9. Solicitation of Public Comments on Issues Related to Supply Chains

10. Entity List Designations

B. Antiboycott Developments

C. White House Export Controls and Human Rights Initiative

D. State Department

1. Revisions to ITAR Proscribed Country List

2. Revisions to United States Munitions List

3. Changes to Regulations in Light of Remote Work Future

V. European Union

A. Sanctions Developments

1. Belarus

2. Russia

B. Export Controls Developments

1. Overview

2. Human Rights Considerations

3. Due Diligence Obligations and Compliance Requirements for Exporters

4. Increased Coordination Between EU Member States

5. EU-U.S. Trade and Technology Council

C. Noteworthy Judgments and Enforcement Actions

1. EU Blocking Statute Regulation

2. Denmark

3. Germany

VI. United Kingdom

A. Sanctions Developments

1. OFSI Annual Review 2020-2021

2. Sanctions Regulations Report on Annual Reviews 2021

3. Changes to Sanctions Lists

B. Export Controls Developments

1. Overview