Richard Manfredi, Author at Gibson Dunn

Introduction

On 12 January 2022, the Hong Kong Monetary Authority (HKMA) released a Discussion Paper on the expansion of the Hong Kong regulatory framework to stablecoins (e.g. crypto-assets pegged to fiat currencies). The Paper considers the adequacy of the existing regulatory framework in light of the growing use of stablecoins and other types of crypto-assets in financial markets, and the challenges posed by this increase in their prevalence. It further poses eight questions for consideration by the industry, including the scope of a proposed new regulatory regime to cover what the HKMA describes as “payment-related stablecoins”.

This client alert provides an overview of the HKMA’s views on crypto-assets and stablecoins as outlined in the Paper, discusses the implications for players in the stablecoin ecosystem if the proposed changes are implemented, and suggested next steps for interested parties.

The HKMA has requested responses to the Paper by 31 March 2022, and has indicated that it intends to introduce this new stablecoin regulatory regime by 2023-2024.

HKMA’s views on crypto-assets and financial stability

The Paper provides a valuable insight into the HKMA’s views on crypto-assets in general, and stablecoins in particular, including their linkages to the traditional financial system and ramifications on financial stability.

In introducing its proposal to regulate payment related stablecoins, the HKMA has made it clear that while the current size and trading activity of crypto-assets globally may not pose an immediate threat to the stability of the global financial system from a systemic point of view, it does consider the increasing prevalence of crypto-assets to have the potential to impact financial stability. In particular, the HKMA has flagged that it considers the growing exposure of institutional investors, as well as certain segments of the retail public, to such assets as an alternative to, or to complement traditional asset classes, indicates growing interconnectedness with the mainstream financial system.

Further, as noted by the HKMA, it understands that while Hong Kong authorised banks (Authorised Institutions or AIs) currently undertake only limited activities in relation to crypto-assets, AIs are interested in pursuing these activities further, given that they face increasing demand from customers for crypto-related products and services. This is consistent with what we understand is a steady increase in high net wealth investors hungry for yield demanding access to crypto-assets through their private wealth managers, as well as an uptick in demand from retail investors in Hong Kong eager for the same exposure to upside. To this end, the HKMA has flagged that it will soon provide AIs with more detailed regulatory guidance in relation to their interface with and provision of services to customers in relation to crypto-assets.

Finally, the HKMA has also noted its concerns that the ease of anonymous transfer of crypto-assets may make them susceptible to the risk of illicit and money laundering / terrorist financing activities.

The HKMA’s views on stablecoins

The Paper also flags the HKMA’s view that stablecoins are increasingly viewed as a ‘widely acceptable means of payment’ and that this, alongside the actual increase in their use, has increased the potential for their incorporation into the mainstream financial system. In the HKMA’s opinion, this in turn raises broader monetary and financial stability implications and has resulted in the regulation of stablecoins becoming a key priority for the HKMA, which has stated in the Paper that it wishes to ensure that such coins “are appropriately regulated before they operate in Hong Kong or are marketed to the public of Hong Kong”.

The Paper goes on to identify a number of potential risks that may arise in relation to the use of stablecoins, including, in summary:

Payment integrity risks where stablecoins are commonly accepted as a means of payment and operational disruptions or failures occur in relation to the stablecoins;
Banking stability risks if banks were to increase their exposure to stablecoins, particularly if stablecoins were viewed as a substitute for bank deposits;
Monetary policy risks in relation to the issue and redemption of HKD-backed stablecoins, which could affect interbank HKD demand and supply; and
User protection risks where a user may have no or limited recourse in relation to operational disruptions or failures of a stablecoin.

Given these potential risks, the HKMA has stated in the Paper that it considers it appropriate to expand the regulatory perimeter to cover payment-related stablecoins in the first instance, although it has not ruled out the possibility of regulating other forms of stablecoins as well.

The HKMA’s discussion questions for industry consideration

The HKMA has noted in the Paper that it considers ‘the need to regulate [stablecoins] is well justified and the tool to regulate…[can] be decided at a later stage’. However, it has indicated that it wishes for feedback from the industry and the public on the scope of the regulatory regime applicable to stablecoins, and to this end has set out eight discussion questions for industry consideration. A summary of the key questions posed by the HKMA, as well as the HKMA’s views on those questions, is set out below.

Question 1: Should we regulate activities relating to all types of stablecoins or give priority to those payment-related stablecoins that pose higher risks to the monetary and financial systems while providing flexibility in the regime to make adjustments to the scope of stablecoins that may be subject to regulation as needed in the future?

In posing this question, the HKMA has noted that it intends to take a risk-based approach focused initially on payment-related stablecoins at this stage given their predominance in the market and higher potential to be incorporated into the mainstream financial market (as discussed above). However, the HKMA has noted that it intends to ensure that whatever regime is introduced is sufficiently flexible that it could extend to other types of stablecoins in the future. As such, issuers and traders of other types of stablecoins should not expect to avoid regulatory scrutiny forever.

Question 2: What types of stablecoin-related activities should fall under the regulatory ambit, e.g. issuance and redemption, custody and administration, reserves management?

The HKMA has proposed regulating a broad range of stablecoin-related activities, including:

Issuing, creating or destroying stablecoins;
Managing reserve assets to ensure stabilisation of stablecoin value;
Validating transactions and records;
Storing private keys used to provide access to stablecoins;
Facilitating the redemption of stablecoins;
Transmission of funds to settle transactions; and
Executing transactions in stablecoins.

This broad list is based on a list of activities in relation to stablecoins published by the Financial Stability Board[1] and as such may be viewed as in keeping with international standards. However, as discussed below in relation to Question 5, the breadth of this regime may raise concerns regarding the degree of overlap between this regime and others proposed by Hong Kong regulators, including the proposed VASP regime to be administered by the Securities and Futures Commission (SFC) (see our alert here).

Question 3: What kind of authorisation and regulatory requirements would be envisaged for those entities subject to the new licensing regime?

The HMKA has suggested that it considers that entities subject to the new stablecoin licensing regime would be subject to the following requirements:

authorisation and prudential requirements, including adequate financial resources and liquidity requirements;
fit and proper requirements in relation to both management and ownership;
requirements relating to the maintenance and management of reserves of backing assets; and systems; and
controls, governance and risk management requirements.

Further, given that it is common for multiple entities to be involved in different parts of a stablecoin arrangement, the HKMA has noted that such entities could be subject to part or all of the requirements, depending on the services they offer.

If requirements in relation to these matters are ultimately implemented by the HKMA, the stablecoin regime would cover some of the requirements of the proposed VASP regime, with the exception of requirements of reserves of backing assets, which will presumably only be applied to stablecoins given their nature.

Question 4: What is the intended coverage as to who needs a licence under the intended regulatory regime?

The HKMA has signalled that it believes that only entities incorporated in Hong Kong and holding a relevant licence granted by HKMA should carry out regulated activities, to enable the HKMA to exercise effective regulation on the relevant entities. As such, it has stated in the Paper that it expects that foreign companies / groups which intend to provide regulated activities in Hong Kong or actively market those activities in Hong Kong to incorporate a company in Hong Kong and apply for a licence to the HKMA under this regime.

If implemented, this would have significant ramifications for those global crypto-exchanges currently offering trading in stablecoins to Hong Kong users from offshore. These businesses would be faced with a choice between either incorporating in Hong Kong and seeking a licence, or discontinuing their trading for Hong Kong users.

Question 5: When will this new, risk-based regime on stablecoins be established, and would there be regulatory overlap with other financial regulatory regimes in Hong Kong, including but not limited to the SFC’s VASP regime, and the SVF licensing regime of the PSSVFO?

The HKMA has stated that it will collaborate and coordinate with other financial regulators when defining the scope of its oversight and will seek to avoid regulatory arbitrage, including in relation to areas which ‘may be subject to regulation by more than one local financial authority’.

However, an HKMA-administered regime of the breadth proposed above would create a situation in which an exchange undertaking transactions in non-stablecoin crypto-assets would be regulated by the SFC under its proposed new VASP regime while being regulated by both the SFC and the HKMA under its stablecoin regime. In this respect, we note that the proposed definition of ‘virtual asset’ under the proposed new VASP regime ‘applies equally to virtual coins that are stable (i.e. the so-called “stablecoins”)’.[2] While the HKMA and SFC share regulatory responsibility for Registered Institutions (i.e. Authorised Institutions which are separately licensed by the SFC to undertake securities and futures business), that shared regulatory responsibility concerns distinctly different types of activities. In contrast, we consider that from an exchange’s perspective, the act of executing transactions in stablecoins is substantially similar to executing transactions in non-stablecoin crypto-assets. As such, this approach may lead to unnecessary and undesirable regulatory inefficiencies if exchanges are required to be licensed under both the SFC and HKMA regimes to undertake transactions in crypto-assets.

Question 6: Stablecoins could be subject to run and become potential substitutes of bank deposits. Should the HKMA require stablecoin issuers to be AIs under the Banking Ordinance, similar to the recommendations in the Report on Stablecoins issued by the US President’s Working Group on Financial Markets?

While not expressly stating that it will not require stablecoin issuers to be regulated as AIs under the Banking Ordinance, the HKMA has indicated that it expects that the requirements applicable to stablecoin issuers will instead borrow from Hong Kong’s current regulatory framework for stored value facilities (SVF). However, the HKMA has signalled that certain stablecoin issuers may be subject to higher prudential requirements than SVF issuers where they issue stablecoins of systemic importance.

Question 7: [Does] the HKMA also have plan[s] to regulate unbacked crypto-assets given their growing linkage with the mainstream financial system and risk to financial stability?

The HKMA has not expressly ruled out regulating unbacked crypto-assets, and has stated that it is necessary to continue monitoring the risks posed by this asset class. In stating this, the HKMA has also pointed to the VASP regime, suggesting that the HKMA’s approach to this area is likely to depend on the success of that regime once implemented.

Question 8: For current or prospective parties and entities in the stablecoins ecosystem, what should they do before the HKMA’s regulatory regime is introduced?

The HKMA has advised current and prospective players in the stablecoin ecosystem to provide feedback on the proposals set out in the Discussion Paper, and has noted that in the interim, it will continue to supervise AIs’ activities in relation to crypto-assets and implement the SVF licensing regime pending implementation of this new regime.

Conclusion

The Discussion Paper provides a valuable insight into the HKMA’s plans for the future of stablecoin regulation in Hong Kong. While some concerns exist as to the potential overlap between the HKMA’s new proposed regime and the SFC’s VASP regime, it is clear that the HKMA intends to ensure that it is regarded as the primary regulator of stablecoins going forward, and that it sees the regulation of this asset class as closely linked to its key objective of ensuring financial stability.

____________________________

[1] See Financial Stability Board, Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Final Report and High-Level Recommendations, https://www.fsb.org/wp-content/uploads/P131020-3.pdf, page 10.

[2] See Financial Services and the Treasury Bureau, Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (Consultation Conclusions), https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf, paragraph 2.8.

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)
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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Decided January 13, 2022

National Federation of Independent Business v. Occupational Safety and Health Administration, No. 21A244; and

Ohio v. Occupational Safety and Health Administration, No. 21A247

On Thursday, January 13, 2022, by a 6–3 vote, the Supreme Court prevented the implementation of an OSHA rule that would have imposed a vaccine-or-testing regime on employers with 100 or more employees.

Background:

On November 5, 2021, the Occupational Safety and Health Administration (“OSHA”) issued an emergency temporary standard (“ETS”) governing employers with 100 or more employees. The ETS mandated covered employers to “develop, implement, and enforce a mandatory COVID-19 vaccination policy, with an exception for employers” that require unvaccinated employees to undergo weekly COVID-19 testing and to wear a mask during the workday.

Business groups and States filed petitions for review of the ETS in each regional Court of Appeals, contending that OSHA exceeded its statutory authority under the Occupational Safety and Health Act. The Fifth Circuit stayed the ETS and later held that the OSHA mandate was overly broad, not justified by a “grave” danger from COVID-19, and constitutionally dubious. After all petitions for review were consolidated in the Sixth Circuit, that court dissolved the Fifth Circuit’s stay. The panel majority held that COVID-19 was an emergency warranting an ETS and that OSHA had likely acted within its statutory authority.

Issue:

Whether to stay implementation of the vaccine-or-testing mandate pending the outcome of litigation challenging OSHA’s statutory authority to require employers with 100 or more employees to develop, adopt, and enforce a vaccine-and-testing regime for their employees.

Court’s Holding:

The vaccine-or-testing mandate should be stayed because OSHA likely lacks the statutory authority to adopt the vaccine-or-test mandate in the absence of an unmistakable delegation from Congress.

“It is telling that OSHA, in its half century of existence, has never before adopted a broad public health regulation of this kind—addressing a threat that is untethered, in any causal sense, from the workplace.”

Per Curiam Opinion of the Court

What It Means:

The Court’s decision prevents the implementation of the OSHA mandate, which applies to 84 million Americans. Echoing its recent decision in Alabama Ass’n of Realtors v. Dep’t of Health & Human Services, the Court emphasized that agency action with such “vast economic and political significance” requires a clear delegation from Congress. It is doubtful that the stay will be lifted to allow OSHA to enforce the mandate before the ETS expires in May, meaning that it is unlikely employers will ever actually be subject to the ETS’s vaccine-or-testing mandate.
The challengers had argued that covered employers would incur unrecoverable compliance costs and that employees would quit rather than comply. The federal government, for its part, had argued that the OSHA mandate would save over 6,500 lives and prevent hundreds of thousands of hospitalizations. The Court stayed the mandate without resolving this dispute on the ground that only Congress could properly weigh such tradeoffs.
The Court’s decision to hear oral argument on the stay applications may signal the beginning of a trend, as this is the second time this Term that the Court moved an application to vacate a stay from the emergency docket to the argument calendar.
Other Mandates: The Court stayed lower court injunctions against the vaccine mandate issued by the Centers for Medicare & Medicaid Services (“CMS”). See Biden v. Missouri, 21A240; Becerra v. Louisiana, 21A241. By a 5–4 vote, the Court ruled that the Secretary of Health and Human Services likely has the statutory authority to require vaccination for healthcare workers at facilities that participate in Medicare and Medicaid. Today’s decisions do not address the federal contractor vaccine mandate that is presently enjoined on a nationwide basis by a federal district court in Georgia. Four other federal district courts also have enjoined the government from enforcing that mandate. So far, the Sixth and Eleventh Circuits have refused to stay the injunctions against the federal contractor mandate pending appeal.

The Court’s opinions are available here and 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:

Appellate and Constitutional Law Practice

Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com	Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com	Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com

Related Practice: Labor and Employment:

Eugene Scalia +1 202.955.8543 escalia@gibsondunn.com	Jessica Brown +1 303.298.5944 jbrown@gibsondunn.com	Jason C. Schwartz +1 202.955.8242 jschwartz@gibsondunn.com
Katherine V.A. Smith +1 213.229.7107 ksmith@gibsondunn.com

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The tense political battles between former President Donald J. Trump and the United States House of Representatives under Democratic leadership renewed debates over the nature and extent of Congress’s authority to investigate and conduct oversight and have wide-ranging implications for congressional investigation of not just the Executive Branch but also of private parties.

In furtherance of the House of Representatives’ vigorous efforts to investigate President Trump, three House committees issued a series of subpoenas to banks and an accounting firm seeking the personal financial records of the President relating to periods both before and after he took office. The President and his business entities resisted, challenging the congressional subpoenas in court, thus drawing the judiciary into the fray. The President’s challenges culminated in the issuance of the Supreme Court’s historic decision in Trump v. Mazars and Trump v. Deutsche Bank AG, which announced groundbreaking new principles of law that will have profound implications for congressional oversight and investigations. In addition, the D.C. Circuit recently encountered related questions of congressional authority over the Executive Branch in connection with separate information requests to former White House Counsel Donald McGahn, leading to a series of hotly debated rulings (and an eventual settlement) in Committee on the Judiciary v. McGahn.

These cases arose against a seemingly well-established backdrop. It has long been understood that Congress possesses inherent constitutional authority to inquire into matters that could become the subject of legislation, such as through the use of compulsory process directed to both government officials and private citizens. As the Supreme Court recognized nearly a century ago, Congress “cannot legislate wisely or effectively in the absence of information respecting the conditions which the legislation is intended to affect or change.” Thus, “the power of inquiry—with process to enforce it—is an essential and appropriate auxiliary to the legislative function.” The Executive and Legislative Branches often resolve disputes about congressional requests for information through the “hurly-burly, the give-and-take of the political process between the legislative and the executive.” Only recently has Congress resorted repeatedly to the courts in an effort to enforce subpoenas against Executive Branch officials.

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Washington, D.C. partners Michael Bopp and Thomas Hungar, with Chantalle Carles Schropp, prepared this article, originally published by the University of Virginia’s Journal of Law & Politics, Vol. 37, No. 1, in 2021.

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

On December 15, 2021, the Securities and Exchange Commission (“SEC” or “Commission”) held a virtual open meeting where it considered four rule proposals, including two that are particularly pertinent to all public companies: (i) amendments regarding Rule 10b5-1 insider trading plans and related disclosures and (ii) new share repurchase disclosures rules.

Both proposals passed, though only the proposed amendments regarding Rule 10b5-1 insider trading plans and related disclosures passed unanimously; the proposed new share repurchase disclosures rules passed on party lines. Notably, these proposals only have a 45-day comment period, which is shorter than the more customary 60- or 90-day comment periods. Commissioner Roisman, in particular, raised concerns about the 45-day comment periods being too short, noting that the comment periods run “not only over several holidays,” but “also concurrent with five other rule proposals that have open comment periods.”

Below, please find summary descriptions of the these two rule proposals, as well as certain Commissioners’ concerns related to these proposals.

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The following Gibson Dunn attorneys assisted in preparing this update: Ronald Mueller, Andrew Fabens, James Moloney, Lori Zyskowski, Thomas Kim, Brian Lane, and Elizabeth Ising.

The current Supreme Court term promises to be one of the most eventful and impactful in recent memory. In this episode of “The Two Teds,” Ted Boutrous and Ted Olson discuss some of the key cases that will be heard during this session, covering topics that include abortion rights and the First Amendment.

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All episodes of The Two Teds are available on GibsonDunn.com and wherever you listen to podcasts. You can also subscribe to be notified of new episodes via e-mail.

HOSTS:

Ted Boutrous – Theodore J. Boutrous, Jr., a partner in the Los Angeles office of Gibson, Dunn & Crutcher LLP, is global Co-Chair of the firm’s Litigation Group and previously led the firm’s Appellate, Crisis Management, Transnational Litigation and Media groups. He also is a member of the firm’s Executive and Management Committees. Recognized for a decade of excellence in the legal profession, the Daily Journal in 2021 named Mr. Boutrous as a Top Lawyer of the Decade for his victories. As a tireless advocate and leader for high-stakes and high-profile cases, Mr. Boutrous was also named the 2019 “Litigator of the Year, Grand Prize Winner” by The American Lawyer.

Ted Olson – Theodore B. Olson is a Partner in Gibson, Dunn & Crutcher’s Washington, D.C. office; a founder of the Firm’s Crisis Management, Sports Law, and Appellate and Constitutional Law Practice Groups. Mr. Olson was Solicitor General of the United States during the period 2001-2004. From 1981-1984, he was Assistant Attorney General in charge of the Office of Legal Counsel in the U.S. Department of Justice. Except for those two intervals, he has been a lawyer with Gibson, Dunn & Crutcher in Los Angeles and Washington, D.C. since 1965.

This year marks an important turning point for the seven-member Court, as new judges will soon comprise nearly half its bench. In June, the New York Senate confirmed the appointment of Anthony Cannataro and Madeline Singas. Judge Cannataro, who was formerly the Administrative Judge of the Civil Court of the City of New York, filled the vacancy left by Judge Paul Feinman, who passed away. Judge Singas, who was formerly the Nassau County District Attorney, filled the vacancy left by the retired Judge Leslie Stein. As Judges Feinman and Stein often voted with Chief Judge DiFiore and Judge Garcia to form a majority in the Court’s decisions, it remains to be seen if that pattern continues.

The Court will also change in 2022 because Judge Eugene Fahey, a swing vote, reaches his mandatory retirement age at the end of this year. To fill his seat, Governor Kathy Hochul nominated Shirley Troutman, a justice in the Appellate Division, Third Department. If confirmed, she would be the second African American woman to sit on the Court. Justice Troutman has extensive experience as a prosecutor and a judge. She also has spent her career upstate, providing geographic balance. On the other hand, analysts have expressed concern that the Court lacks “professional diversity,” as it would include four former prosecutors and only one judge (Fahey, or Troutman) with judicial experience in the Appellate Division.

Despite this turnover, the Court continued previous trends, with the pace of decisions reduced and a high number of fractured opinions. After Judge Feinman’s passing, the Court ordered several cases to be reargued in a “future court session,” which may suggest that his was a potential swing vote in those cases. Nevertheless, the Court continued to resolve significant issues in a wide array of areas, from territorial jurisdiction and agency deference to consumer protection and insurance contracts.

The New York Court of Appeals Round-Up & Preview summarizes key opinions primarily in civil cases issued by the Court over the past year and highlights a number of cases of potentially broad significance that the Court will hear during the coming year. The cases are organized by subject.

To view the Round-Up, click here.

Gibson Dunn’s New York office is home to a team of top appellate specialists and litigators who regularly represent clients in appellate matters involving an array of constitutional, statutory, regulatory, and common-law issues, including securities, antitrust, commercial, intellectual property, insurance, First Amendment, class action, and complex contract disputes. In addition to our expertise in New York’s appellate courts, we regularly brief and argue some of the firm’s most important appeals, file amicus briefs, participate in motion practice, develop policy arguments, and preserve critical arguments for appeal. That is nowhere more critical than in New York—the epicenter of domestic and global commerce—where appellate procedure is complex, the state political system is arcane, and interlocutory appeals are permitted from the vast majority of trial-court rulings.

Our lawyers are available to assist in addressing any questions you may have regarding developments at the New York Court of Appeals, or any other state or federal appellate courts in New York. Please feel free to contact any member of the firm’s Appellate and Constitutional Law practice group, or the following lawyers in New York:

Mylan L. Denerstein (+1 212-351-3850, mdenerstein@gibsondunn.com)
Akiva Shapiro (+1 212-351-3830, ashapiro@gibsondunn.com)
Seth M. Rokosky (+1 212-351-6389, srokosky@gibsondunn.com)

Please also feel free to contact the following practice group leaders:

Allyson N. Ho – Dallas (+1 214.698.3233, aho@gibsondunn.com)
Mark A. Perry – Washington, D.C. (+1 202.887.3667, mperry@gibsondunn.com)

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Virginia and Colorado, which earlier this year enacted comprehensive state privacy laws following California’s 2018 lead, are now poised to follow California in another way in 2022: writing implementing regulations and weighing changes to the laws themselves. Companies should account for these regulations and changes as they develop programs to comply with the laws, which take effect in 2023.

In Virginia, lawmakers are exploring possible updates to the Virginia Consumer Data Protection Act (“VCDPA”), which passed in March 2021, such as giving a state agency rulemaking authority. Unlike the California and Colorado laws, the VCDPA itself does not give a state agency the power to issue regulations to implement the new law. But a recent report mandated by the VCDPA recommended that the legislature give the Virginia Attorney General’s Office (“Virginia AG”) or another agency such rulemaking authority.

The report was issued in response to a provision in the VCDPA, which required the creation of a working group made up of government, business, and community representatives to study potential changes to the VCDPA before it goes into effect. The group met six times before issuing its final report in November. In addition to rulemaking authority, the report also suggested other significant changes, including increasing the Virginia AG’s enforcement budget, allowing the Virginia AG to collect actual damages from violations that cause consumer harm, giving companies a right to cure violations that would sunset in the future, requiring companies to honor an automated global opt-out signal, changing the “right to delete” to a “right to opt out of sale,” and considering amending statutory definitions such as “sale,” “personal data,” “publicly available information,” and “sensitive data,” among others. The final report is available here.

In Colorado, meanwhile, the Colorado Attorney General’s Office (“Colorado AG”), which already has rulemaking authority, has begun the rulemaking process for the Colorado Privacy Act (“CPA”), which passed in July 2021. In its regulatory agenda for 2022, the Colorado AG stated that it expects to propose and finalize rules for universal opt-out tools, which are mechanisms that allow users to automatically inform websites that they want to opt out of the processing of their personal data.

As we have reported in prior updates, California is tackling these issues in its own privacy laws, particularly as California is transitioning from the California Consumer Privacy Act (“CCPA”) to the California Privacy Rights Act (“CPRA”), which will take effect in 2023. In the meantime, the California Attorney General’s Office (“California AG”) promulgation of CCPA regulations that were last revised in March 2021, remain in force. Now, the new CPRA-created California Privacy Protection Agency has embarked in earnest on its own rulemaking to consider amending the California AG’s CCPA rules and to enact its own rules for the CPRA. In response to a request for comments on its proposed rulemaking, the agency received scores of comments from individuals, organizations, and government officials, which are available here.

There is no sign of a slowdown in the development of state privacy laws. In fact, more than two dozen other states have floated their own proposals for comprehensive privacy laws.

Although the precise contours of these laws remain in flux, the laws will almost certainly usher in notable regulatory changes affecting how companies collect and manage data while imposing a host of new obligations and potential liability. Companies would be well-served to focus their compliance programs accordingly.

We will continue to monitor developments, and are available to discuss these issues as applied to your particular business.

This alert was prepared by Ryan T. Bergsieker, Cassandra L. Gaedt-Sheckter, and Eric M. Hornbeck.

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

Privacy, Cybersecurity and Data Innovation Group:

United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)
Matthew Benjamin – New York (+1 212-351-4079, mbenjamin@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
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Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Robert K. Hur – Washington, D.C. (+1 202-887-3674, rhur@gibsondunn.com)
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com)
Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com)
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Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com)
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com)
James A. Cox – London (+44 (0) 20 7071 4250, jacox@gibsondunn.com)
Patrick Doris – London (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Kai Gesing – Munich (+49 89 189 33-180, kgesing@gibsondunn.com)
Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, bgrinspan@gibsondunn.com)
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Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Alejandro Guerrero – Brussels (+32 2 554 7218, aguerrero@gibsondunn.com)
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Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”), the two major proxy advisory firms, recently released updates to their proxy voting policies for the 2022 proxy season. The ISS U.S. policy updates are available here. The ISS updates will apply for shareholder meetings on or after February 1, 2022, except for those policies subject to a transition period. ISS plans to release an updated Frequently Asked Questions document that will include more information about its policy changes in the coming weeks.[1]

The Glass Lewis updates are included in its 2022 U.S. Policy Guidelines and the 2022 ESG Initiatives Policy Guidelines, which cover shareholder proposals. Both documents are available here. The Glass Lewis 2022 voting guidelines will apply for shareholder meetings held on or after January 1, 2022.

This alert reviews the ISS and Glass Lewis updates. Both firms have announced policy updates on the topics of board diversity, multi-class stock structures, and climate-related management and shareholder proposals. Glass Lewis also issued several policy updates that focus on nominating/governance committee chairs, as well new policies specific to special purpose acquisition companies (“SPACs”).

A. Board Diversity

ISS – Racial/Ethnic Diversity. At S&P 1500 and Russell 3000 companies, beginning in 2022, ISS will generally recommend “against” or “withhold” votes for the chair of the nominating/governance committee (or other directors, on a case-by-case basis) if the board “has no apparent racially or ethnically diverse members.” This policy was announced last year, with a one-year transition. There is an exception for companies where there was at least one racially or ethnically diverse director at the prior annual meeting and the board makes a firm commitment to appoint at least one such director within a year.
ISS – Gender Diversity. ISS announced that, beginning in 2023, it will expand its policy on gender diversity, which since 2020 has applied to S&P 1500 and Russell 3000 companies, to all other companies. Under this policy, ISS generally recommends “against” or “withhold” votes for the chair of the nominating/governance committee (or other directors, on a case-by-case basis) where there are no women on the board. The policy includes an exception analogous to the one in the voting policy on racial/ethnic diversity.
Glass Lewis – Gender Diversity. Beginning in 2022, Glass Lewis will generally recommend “against” or “withhold” votes for the chair of the nominating/governance committee at Russell 3000 companies that do not have at least two gender diverse directors (as announced in connection with its 2021 policy updates), or the entire committee if there is no gender diversity on the board. In 2023, Glass Lewis will move to a percentage-based approach and issue negative voting recommendations for the nominating/governance committee chair if the board is not at least 30% gender diverse. Glass Lewis is using the term “gender diverse” in order to include individuals who identify as non-binary. Glass Lewis also updated its policies to reflect that it will recommend in accordance with mandatory board composition requirements in applicable state laws, whether they relate to gender or other forms of diversity. It will not issue negative voting recommendations for directors where applicable state laws do not mandate board composition requirements, are non-binding, or only impose reporting requirements.
Glass Lewis – Diversity Disclosures. With respect to disclosure about director diversity and skills, for 2021, Glass Lewis had announced that it would begin tracking companies’ diversity disclosures in four categories: (1) the percentage of racial/ethnic diversity represented on the board; (2) whether the board’s definition of diversity explicitly includes gender and/or race/ethnicity; (3) whether the board has a policy requiring women and other diverse individuals to be part of the director candidate pool; and (4) board skills disclosure. For S&P 500 companies, beginning in 2022, Glass Lewis may recommend “against” or “withhold” votes for the chair of the nominating/governance committee if a company fails to provide any disclosure in each of these four categories. Beginning in 2023, it will generally oppose election of the committee chair at S&P 500 companies that have not provided any aggregate or individual disclosure about the racial/ethnic demographics of the board.

B. Companies with Multi-Class Stock or Other Unequal Voting Rights

ISS. ISS announced that, after a one-year transition period, in 2023, it will begin issuing adverse voting recommendations with respect to directors at all U.S. companies with unequal voting rights. Stock with “unequal voting rights” includes multi-class stock structures, as well as less common practices such as maintaining classes of stock that are not entitled to vote on the same ballot items or nominees, and loyalty shares (stock with time-phased voting rights). ISS’s policy since 2015 has been to recommend “against” or “withhold” votes for directors of newly-public companies that have multiple classes of stock with unequal voting rights or certain other “poor” governance provisions that are not subject to a reasonable sunset, including classified boards and supermajority voting requirements to amend the governing documents. Companies that were publicly traded before the 2015 policy change, however, were grandfathered and so were not subject to this policy. ISS had sought public comment about whether, in connection with the potential expansion of this policy to all U.S. companies, the policy should apply to all or only some nominees. The final policy does not specify, saying that the adverse voting recommendations may apply to “directors individually, committee members, or the entire board” (except new nominees, who will be evaluated case-by-case). For 2022, the current policy would continue to apply to newly-public companies. ISS tweaked the policy language to reflect that a “newly added reasonable sunset” would prevent negative voting recommendations in subsequent years. ISS considers a sunset period reasonable if it is no more than seven years.
Glass Lewis. Beginning in 2022, Glass Lewis will recommend “against” or “withhold” votes for the chair of the nominating/governance committee at companies that have multi-class share structures with unequal voting rights if they are not subject to a “reasonable” sunset (generally seven years or less).

C. Climate-Related Proposals and Board Accountability at “High-Impact” Companies

ISS – Say on Climate. In 2021, both shareholders and management submitted Say on Climate proposals. For 2022, ISS is adopting voting policies that document the frameworks it has developed for analyzing these proposals, as supplemented by feedback from ISS’s 2021 policy development process. Under the new policies, ISS will recommend votes case-by-case on both management and shareholder proposals, taking into consideration a list of factors set forth in each policy. For management proposals asking shareholders to approve a company’s climate transition action plan, ISS will focus on “the completeness and rigor of the plan,” including the extent to which a company’s climate-related disclosures align with Task Force on Climate-related Financial Disclosure (“TCFD”) recommendations and other market standards, disclosure of the company’s operational and supply chain greenhouse gas (“GHG”) emissions (Scopes 1, 2 and 3), and whether the company has made a commitment to be “net zero” for operational and supply chain emissions (Scopes 1, 2 and 3) by 2050. For shareholder proposals requesting Say on Climate votes or other climate-related actions (such as a report outlining a company’s GHG emissions levels and reduction targets), ISS will recommend votes case-by-case taking into account information such as the completeness and rigor of a company’s climate-related disclosures and the company’s actual GHG emissions performance.
ISS – Board Accountability on Climate at High-Impact Companies. ISS also adopted a new policy applicable to companies that are “significant GHG emitters” through their operations or value chain. For 2022, these are companies that Climate Action 100+ has identified as disproportionately responsible for GHG emissions. During 2022, ISS will generally recommend “against” or “withhold” votes for the responsible committee chair in cases where ISS determines a company is not taking minimum steps needed to understand, assess and mitigate climate change risks to the company and the larger economy. Expectations about the minimum steps that are sufficient “will increase over time.” For 2022, minimum steps are detailed disclosure of climate-related risks (such as according to the TCFD framework”) and “appropriate GHG emissions reduction targets,” which ISS considers “any well-defined GHG reduction targets.” Targets for Scope 3 emissions are not required for 2022, but targets should cover at least a significant portion of the company’s direct emissions. For 2022, ISS plans to provide additional data in its voting analyses on all Climate Action 100+ companies to assist its clients in making voting decisions and in their engagement efforts. As a result of this new policy, companies on the Climate Action 100 + list should be aware that the policy requires both disclosure in accordance with a recognized framework, and quantitative GHG reduction targets, and that ISS plans to address its new climate policies in its updated FAQs, so there may be more specifics about this policy when the FAQs are released.
Glass Lewis – Say on Climate. Glass Lewis also added a policy on Say on Climate proposals for 2022, but takes a different approach from ISS. Glass Lewis supports robust disclosure about companies’ climate change strategies. However, it has concerns with Say on Climate votes because it views the setting of long-term strategy (which it believes includes climate strategy) as the province of the board and believes shareholders may not have the information necessary to make fully informed voting decisions in this area. In evaluating management proposals asking shareholders to approve a company’s climate transition plans, Glass Lewis will evaluate the “governance of the Say on Climate vote” (the board’s role in setting strategy in light of the Say on Climate vote, how the board intends to interpret the results of the vote, and the company’s engagement efforts with shareholders) and the quality of the plan on a case-by-case basis. Glass Lewis expects companies to clearly identify their climate plans “in a distinct and easily understandable document,” which it believes should align with the TCFD framework. Glass Lewis will generally oppose shareholder proposals seeking to approve climate transition plans or to adopt a Say on Climate vote, but will take into account the request in the proposal and company-specific factors.

D. Additional ISS Updates

ISS adopted the following additional updates of note:

Shareholder Proposals Seeking Racial Equity Audits. ISS adopted a formal policy reflecting its approach to shareholder proposals asking companies to oversee an independent racial equity or civil rights audit. These proposals, which were new for 2021, are expected to return again in 2022 given the continued public focus on issues related to race and equality. ISS will recommend votes case-by-case on these proposals, taking into account several factors listed in its new policy. These factors focus on a company’s processes or framework for addressing racial inequity and discrimination internally, its public statements and track record on racial justice, and whether the company’s actions are aligned with market norms on civil rights and racial/ethnic diversity.
Capital Authorizations. ISS adopted what it characterizes as “minor” and “clarifying” changes to its voting policies on common and preferred stock authorizations. For both policies, ISS will apply the same dilution limits to underperforming companies, and will no longer treat companies with total shareholder returns in the bottom 10% of the U.S. market differently. ISS also clarified that problematic uses of capital that would lead to a vote “against” a proposed share increase include long-term poison pills that are not shareholder-approved, rather than just poison pills adopted in the last three years. ISS reorganized the policy on common stock authorizations to distinguish between general and specific uses of capital and to clarify the hierarchy of factors it considers in applying the policy.
Three-Year Burn Rate Calculation for Equity Plans. Beginning in 2023, ISS will move to a “Value-Adjusted Burn Rate” in analyzing equity plans. ISS believes this will more accurately measure the value of recently granted equity awards, using a methodology that more precisely measures the value of option grants and calculations that are more readily understood by the market (actual stock price for full-value awards, and the Black-Scholes value for stock options). According to ISS, when the current methodology was adopted, resource limitations prevented it from doing the more extensive calculations needed for the Value-Adjusted Burn Rate.
Updated FAQs on ISS Compensation Policies and COVID-19. ISS also issued an updated set of FAQs (available here) with guidance on how it intends to approach COVID-related pay decisions in conducting its pay-for-performance qualitative evaluation. According to the FAQs, many investors believe that boards are now positioned to return to annual incentive program structures as they existed prior to the pandemic. Accordingly, the FAQs reflect that ISS plans to return to its pre-pandemic approach on mid-year changes to metrics, targets and measurement periods, and on company responsiveness where a say-on-pay proposal gets less than 70% support.

E. Additional Glass Lewis Updates

Glass Lewis adopted several additional updates, as outlined below. Where relevant, for purposes of comparison, the discussion also addresses how ISS approaches the issue.

Waiver of Retirement or Tenure Policies. Glass Lewis appears to be taking a stronger stance on boards that waive their retirement or tenure policies. Beginning in 2022, if the board waives a retirement age or term limit for two or more years in a row, Glass Lewis will generally recommend “against” or “withhold” votes for the nominating/governance committee chair, unless a company provides a “compelling rationale” for the waiver. By way of comparison, ISS does not have an analogous policy.
Adoption of Exclusive Forum Clauses Without Shareholder Approval. Under its existing policies, Glass Lewis generally recommends “against” or “withhold” votes for the nominating/governance committee chair at companies that adopted an exclusive forum clause during the past year without shareholder approval. With a growing number of companies adopting exclusive forum clauses that apply to claims under the Securities Act of 1933, Glass Lewis updated its policy to reflect that the policy applies to the adoption of state and/or federal exclusive forum clauses. The existing exception will remain in place for clauses that are “narrowly crafted to suit the particular circumstances” facing a company and/or include a reasonable sunset provision. By way of comparison, ISS does not have an analogous policy.
Board Oversight of E&S Issues. For S&P 500 companies, starting in 2022, Glass Lewis will generally recommend “against” or “withhold” votes for the chair of the nominating/governance committee if a company does not provide “explicit disclosure” about the board’s role in overseeing environmental and social issues. This policy is taking effect after a transition year in which Glass Lewis noted concerns about disclosures it did not view as adequate. For 2022, Glass Lewis also will take the same approach for Russell 1000 companies that it took last year with S&P 500 companies, noting a concern where there is a lack of “clear disclosure” about which committees or directors are charged with oversight of E&S issues. Glass Lewis does not express a preference for a particular oversight structure, stating that boards should select the structure they believe is best for them.
Independence Standard on Direct Payments for Directors. In evaluating director independence, Glass Lewis treats a director as not independent if the director is paid to perform services for the company (other than serving on the board) and the payments exceed $50,000 or no amount is disclosed. Glass Lewis clarified that this standard also captures payments to firms where a director is the principal or majority owner. By way of comparison, ISS’s independence standards likewise cover situations where a director is a partner or controlling shareholder in an entity that has business relationships with the company in excess of numerical thresholds used by ISS.
Approach to Committee Chairs at Companies with Classified Boards. A number of Glass Lewis’ voting policies focus on committee chairs because it believes the chair has “primary responsibility” for a committee’s actions. Currently, if Glass Lewis policies would lead to a negative voting recommendation for a committee chair, but the chair is not up for election because the board is classified, Glass Lewis notes a concern with respect to the chair in its proxy voting analysis. Beginning in 2022, this policy will change and if Glass Lewis has identified “multiple concerns,” it will generally issue (on a case-by-case basis) negative voting recommendations for other committee members who are up for election.
Written Consent Shareholder Proposals. Glass Lewis documented its approach to shareholder proposals asking companies to lower the ownership threshold required for shareholders to act by written consent. It will generally recommend in favor of these proposals if a company has no special meeting right or the special meeting ownership threshold is over 15%. Glass Lewis will continue its existing policy of opposing proposals to adopt written consent if a company has a special meeting threshold of 15% or lower and “reasonable” proxy access provisions. By way of comparison, ISS generally supports proposals to adopt written consent, taking into account a variety of factors including the ownership threshold. It will recommend votes case-by-case only if a company has an “unfettered” special meeting right with a 10% ownership threshold and other “good” governance practices, including majority voting in uncontested director elections and an annually elected board.
SPAC Governance. Glass Lewis added voting guidelines that are specific to the SPAC context. When evaluating companies that have gone public through a de-SPAC transaction during the past year, it will review their governance practices to assess “whether shareholder rights are being severely restricted indefinitely” and whether restrictive provisions were submitted to an advisory vote at the meeting where shareholders voted on the de-SPAC transaction. If the board adopted certain practices prior to the transaction (such as a multi-class stock structure or a poison pill, classified board or other anti-takeover device), Glass Lewis will generally recommend “against” or “withhold” votes for all directors who served at the time the de-SPAC entity became publicly traded if the board: (a) did not also submit these provisions for a shareholder advisory vote at the meeting where the shareholders voted on the de-SPAC transaction; or (b) did not also commit to submitting the provisions for shareholder approval at the company’s first annual meeting after the de-SPAC transaction; or (c) did not also provide for a reasonable sunset (three to five years for a poison pill or classified board and seven years or less for multi-class stock structures). By way of comparison, as discussed above, for several years, ISS has had voting policies that address “poor” governance provisions at newly-public companies, including multiple classes of stock with unequal voting rights, classified boards and supermajority voting requirements to amend the governing documents. For 2022, ISS has clarified that the definition of “newly-public companies” includes SPACs.
“Overboarding” and SPAC Board Seats. Under its “overboarding” policies, Glass Lewis generally recommends “against” or “withhold” votes for directors who are public company executives if they serve on a total of more than two public company boards. It applies a higher limit of five public company boards for other directors. The 2022 policy updates clarify that where a director’s only executive role is at a SPAC, the higher limit will apply. By way of comparison, ISS treats SPAC CEOs the same as other public company CEOs, on the grounds that a SPAC CEO “has a time-consuming job: to find a suitable target and consummate a transaction within a limited time period.” Accordingly, SPAC CEOs are subject to the same overboarding limit ISS applies to other public company CEOs (two public company boards besides their own).

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[1] ISS also issued an updated set of FAQs on COVID-related compensation decisions.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Elizabeth Ising, Ronald Mueller, and Lori Zyskowski.

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

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As we head into a new year, and the California Privacy Rights Act (“CPRA”) inches closer to its effective date of January 1, 2023 (with enforcement scheduled to begin six months later), the new California Privacy Protection Agency (“CPPA”) has begun holding regular public meetings. The CPPA’s chair and board members were appointed in March, and the tasks ahead are substantial: the board is charged with writing and revising a slew of new regulations to implement the sweeping privacy law under the pioneering agency’s purview, before it turns to enforcing them. At the CPPA’s recent meetings, board members have discussed the agency’s goals and the steps they have taken to launch the new agency.

By way of background, the California Attorney General (“AG”) already drafted rules under the CPRA’s predecessor, the California Consumer Privacy Act (“CCPA”), and both the CCPA and its implementing regulations remain enforceable until July 1, 2023, when enforcement of the CPRA begins.[1] The CPRA will amend the CCPA when it takes effect, and the CPPA has the authority to update the current CCPA regulations, in addition to writing new regulations that will implement the CPRA.

The CPPA’s first meeting took place in June 2021, and the board has met several times since then, including as recently as Monday, November 15. These initial meetings have given some clues about what to expect from its rulemaking—and when to expect it:

Impact of Hiring Delays: The CPPA’s five-member board noted that the pace of hiring has slowed the CPPA’s ability to structure the organization, hold informational hearings, and conduct research to determine the focus of its rulemaking. That said, the pace may pick up soon—in October, the CPPA hired an executive director, Ashkan Soltani, a former FTC chief technologist who is now running the agency’s day-to-day operations. Those operations include hiring much of the staff, with the board’s input. The CPPA’s board has also been tackling the minutiae of creating a new agency, from finding office space in Sacramento, to adopting a required conflict-of-interest code. In the meantime, the AG’s Office has been providing the CPPA with administrative support as the agency gets off the ground.
Current Clues on Timing of the Draft Regulations: The CPPA will soon replace the AG’s Office in drafting implementing regulations, and could begin promulgating those rules as soon as April, though timing is still unclear. Under the CPRA, the CPPA will supersede the AG’s authority to promulgate rules the later of July 1, 2021, or six months after the CPPA formally notifies the AG that it is prepared to issue rules. (Note that although the language in the CPRA initially stated that this deadline would be the earlier of the two, AB 694 clarified that it would be the later of the two, including in light of the delays noted above.) In its October meeting, the CPPA approved providing that notice to the AG’s Office. Depending on when the notice was actually sent, and whether the CPPA will issue rules at the time the authority is transitioned, the CPPA could issue rules around April 19, 2022. Interestingly, however, the final regulations must be adopted by July 1, 2022. As some may remember from CCPA’s regulatory rulemaking process, there were various required comment periods, which would make meeting that deadline difficult even with promulgation of a draft on that day.
Considerations of Expedited Rulemaking or Delayed Enforcement: In the November meeting, the board considered potential solutions for the challenges it is facing in connection with its rulemaking responsibilities, including the complexity of the issues and its limited staff. These potential solutions include (i) engaging in emergency rulemaking to write rules faster than the standard timeline, (ii) delaying enforcement of the CPRA, (iii) hiring temporary staff, and (iv) staggering rulemaking, many of which could have significant effects on companies’ compliance programs and timing.
Public Comment Period: In September 2021, the board called for public comment on its preliminary rulemaking activities, asking the public for feedback on “any area on which the [CPPA] has authority to adopt rules.” Some of the specific areas it sought comments on included: when a business’s processing of personal information creates a “significant risk” for consumers, triggering additional compliance steps for businesses; how to regulate automated decision making; what information should be provided to respond to a consumer’s request for their information; how to define various terms; and specifics regarding effectuating consumers’ rights to opt out of the sale of their information, to delete their information, and others. According to the board, it received “dozens” of comments to this initial open-ended call for comments by the November 8, 2021 deadline.
Rulemaking Priorities: While the CPPA reviews its initial public comments, board members are also studying a number of areas for potential rulemaking and considering topics for informational hearings—presumably similar to what we saw in the CCPA rulemaking process—which are used to gather information on certain key issues. To tackle its many tasks, the CPPA board has divided itself into several subcommittees, including ones focused on updates to existing CCPA rules, new CPRA rules, and on the rulemaking process itself. Those subcommittees are considering for rulemaking areas such as defining the terms “business purposes” and “law enforcement agency approved investigation;” recordkeeping requirements for cybersecurity audits, risk assessments, automated decision making, and other areas; clarifying how the CPRA will apply to insurance companies; and prescribing how to conduct the rulemaking process itself. For informational hearings, the board highlighted areas such as automated decision-making technologies, profiling, and harmonization with global frameworks; and how the current rules governing consumer opt outs are operating “in the wild” for consumers and businesses.
Additional Goals: Board members also noted they want to make sure they are educating Californians about their privacy rights and ensure that outreach is available to speakers of languages other than English.

Further Legislative Privacy Measures

The CPPA is not alone in crafting new data privacy requirements. In October, California Governor Gavin Newsom signed legislation that made technical changes in the CPRA through AB 694 (mentioned above), clarifying when the CPPA would assume its rulemaking authority.

Also in October, Governor Newsom signed the Genetic Information Privacy Act to impose new requirements on direct-to-consumer genetic testing companies and other companies that use the genetic data they collect. The new law requires those companies to, among other things, make additional disclosures to consumers, obtain express consumer consent for different uses of consumers’ genetic information, and timely destroy consumers’ genetic samples if requested. The law allows the AG to collect civil penalties of up to $10,000 for each willful violation. Separately, the governor also signed a bill that adds “genetic information” to the definition of personal information in California’s data-breach law.

Next Steps

Despite Governor Newsom’s initiatives and all of the CPPA’s efforts so far, we can expect months of uncertainty before companies have a clear sense of what rules may supplement the CPRA’s language. But companies cannot wait until the CPPA completes its rulemaking to start thinking about their compliance programs, particularly in those areas not covered under existing regulations, such as automated decision making and profiling. Given the complexity of the CPRA and its new requirements—and important sunsetting provisions on employment and B2B data that may have left companies with opportunities to avoid compliance with CCPA on large swaths of data—companies should begin planning now for how they will comply with the enacted amendments to the CCPA. In particular, companies should, sooner than later:

(Re)consider collection and storage of personal information: Even though the CPRA does not come into effect until January 2023, the CPRA will give consumers the right to request access to personal information collected on or after January 1, 2022, and for any personal information collected from January 1, 2023 forward, the CPRA may give consumers the right to request their historical information beyond the CCPA’s 12-month look back. Companies should start thinking about how to collect and store personal information in a way that will allow them to respond to such a request (if such information is indeed subject to the right), and begin analyzing how new rights such as the right to limit the use of sensitive personal information, right to opt out of sharing, and right of employees to the same protections, may apply to your business. In particular, the distinction between personal information and sensitive personal information may affect how information should be collected and stored.
Design a plan to revise privacy-related documents: In light of changes to service provider and contractor requirements, transparency and disclosure requirements (including relating to data subject rights), retention limitation requirements, and additional changes in the CPRA, it is a good time to start reviewing vendor contracts, privacy statements, data retention practices and policies, and other privacy-related documents.
Prepare for compliance with respect to employment and B2B data: The CPRA extended until January 1, 2023, exemptions in the CCPA for business-to-business and employment-related data. To the extent companies have avoided bringing those categories of data into compliance so far, they may want to revisit those decisions as the exemptions near their end.
Don’t neglect CCPA compliance: Given that CCPA will continue to be enforceable until July 1, 2023, and the roll-out of regulations over the course of 2020 may have left some with outdated compliance programs that should be updated, it is a good time to revisit that compliance as well.
Remain nimble: Rulemaking will clarify certain requirements. Companies should therefore be prepared to modify certain aspects of their compliance programs as those rules take shape.

Of course, businesses should also take heed that it’s not just California they should be paying attention to: Colorado and Virginia have also implemented comprehensive privacy laws that will take effect in 2023, as our prior updates have detailed, and consideration of a national privacy program from the ground up may be most efficient.

We will continue to monitor developments, and are available to discuss these issues as applied to your particular business.

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[1] Cal Civ. Code § 1798.185(d).

This alert was prepared by Ashlie Beringer, Alexander H. Southwell, Cassandra L. Gaedt-Sheckter, Abbey A. Barrera, Eric M. Hornbeck, and Tony Bedel.

Privacy, Cybersecurity and Data Innovation Group:

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On November 12, 2021, the Delaware Court of Chancery issued a post-trial decision finding that the general partner of a Master Limited Partnership (“MLP”) breached the partnership agreement of the MLP that it controlled and engaged in willful misconduct that left the general partner unprotected from the exculpatory provisions in the partnership agreement. It is rare for a court to find such a breach on the part of the general partner of an MLP, and this decision is based on the particular facts of the case, not a change in established law. The decision offers useful reminders to participants in MLP transactions about the limits of acceptable conduct under standard partnership agreement provisions.

Background

In 2005, Loews Corporation (“Loews”) formed and took Boardwalk Pipeline Partners, LP (the “Partnership” or “Boardwalk”) public as an MLP after the Federal Energy Regulatory Commission (“FERC”) implemented a regulatory policy that made MLPs an attractive investment vehicle for pipeline companies. Boardwalk served as a holding company for its subsidiaries that operate interstate pipeline systems for transportation and storage of natural gas. Loews, through its control of the general partner of the Partnership (the “General Partner”), controlled Boardwalk.

The General Partner itself was a general partnership controlled by its general partner, Boardwalk GP, LLP (“GPGP”). GPGP had a sole member, Boardwalk Pipelines Holding Corp., a wholly owned subsidiary of Loews (“Holdings”). Holdings had exclusive authority over the business and affairs of GPGP not relating to the management and control of Boardwalk. Holdings’ board of directors consisted entirely of directors affiliated with Loews. GPGP had its own eight-person board (the “GPGP Board”), consisting of four directors affiliated with Loews and four directors unaffiliated with Loews. The GPGP Board had authority over the business and affairs of GPGP related to the management and control of Boardwalk. The different composition of the GPGP Board and the Holdings Board meant that if Holdings made a decision for GPGP as its sole member, then Loews controlled the decision. If the GPGP Board made the decision for GPGP, however, then the four directors unaffiliated with Loews could potentially prevent GPGP from taking the action that Loews wanted.

Boardwalk’s Agreement of Limited Partnership (“Partnership Agreement”) included a provision that would allow the General Partner to acquire all of the common equity of Boardwalk not owned by Loews through the exercise of a Call Right, so long as three conditions were met. First, the General Partner had to own “more than 50% of the total Limited Partnership Interests of all classes then Outstanding.” Second, the General Partner had to receive “an Opinion of Counsel (the “Opinion”) that Boardwalk’s status as an association not taxable as a corporation and not otherwise subject to an entity-level tax for federal, state or local income tax purposes has or will reasonably likely in the future have a material adverse effect on the maximum applicable rate that can be charged to customers” (the “Opinion Condition”). Third, the General Partner had to determine that the Opinion was acceptable (the “Acceptability Condition”). The Partnership Agreement did not specify whether the GPGP Board, as the board that managed the publicly traded partnership, or Holdings, as the General Partner’s sole member, should determine whether the Opinion was acceptable on behalf of the General Partner.

If the three conditions above were met, then, under the terms of the Partnership Agreement, the General Partner could exercise the Call Right in its individual capacity “free of any fiduciary duty or obligation whatsoever to the Partnership, any [l]imited [p]artner or [a]ssignee” and not subject to any contractual obligations. The Call Right would be exercised based on a trailing market price average.

On March 15, 2018, the FERC proposed a package of regulatory policies that potentially made MLPs an unattractive investment vehicle for pipeline companies. The trading price of Boardwalk’s common units declined following the FERC announcement. In response to the March 15th FERC action, several MLPs issued press releases stating that they did not anticipate the proposed FERC policies would have a material impact on their rates, primarily because customers were locked into negotiated rate agreements. Boardwalk issued a press release stating that it did not expect FERC’s proposed change to have a material impact on revenues (rather than rates). A few weeks after the press release, Boardwalk publicly disclosed the General Partner’s intention to potentially exercise the Call Right (the “Potential-Exercise Disclosure”). The common unit price of Boardwalk further declined.

Loews retained outside counsel to prepare the Opinion required under the Partnership Agreement. The Court found that counsel, after discussion with Loews, created a “contrived” opinion in order to find an adverse impact on rates when the FERC proposals were not final. Loews also sought advice from additional outside counsel to advise on whether the Opinion was sufficient for purposes of the Opinion Condition requirements under the Partnership Agreement and whether Holdings had the authority to make the acceptability determination, or whether the GPGP should make such determination. Ultimately, following the legal advice it received, Loews had the Holdings board, comprised entirely of Loews insiders, find the Opinion acceptable.

On May 24, 2018, Boardwalk’s unitholders filed suit in the Court of Chancery seeking to prevent the General Partner from exercising the Call Right using a 180-day measurement period that included trading days affected by the Potential-Exercise Disclosure, claiming that the disclosure artificially lowered the unit trading price and undermined the contractual call price methodology. The parties soon reached a settlement on the 180-day measurement period. On July 18, 2018, Loews exercised the Call Right and closed the transaction just one day before FERC announced a final package of regulatory measures that made MLPs an even more attractive investment vehicle. After the Court of Chancery rejected the settlement Loews reached with the original plaintiffs, the current plaintiffs took over the litigation.

The Court’s Findings

In its post-trial opinion, the Court held that the General Partner breached the Partnership Agreement by exercising the Call Right without first satisfying the Opinion Condition or the Acceptability Condition. The Court found that the General Partner acted manipulatively and opportunistically and engaged in willful misconduct when it exercised the Call Right. Further, the Court held that the exculpatory provisions in the Partnership Agreement do not protect the General Partner from liability.

The Court held the Opinion failed to satisfy the Opinion Condition, because the Opinion did not reflect a good faith effort on the part of the outside counsel to discern the facts and apply professional judgment. In making the determination, the Court reviewed in detail factual events submitted at trial and took into account the professional and personal incentives the outside counsel faced in rendering the Opinion.

In holding the General Partner failed to satisfy the Acceptability Condition, the Court noted that a partnership agreement for an MLP is not the product of bilateral negotiations and the limited partners do not negotiate the agreement’s terms, and, as a result, Delaware courts would construe ambiguous provisions of the partnership agreement against the general partner. The Court found that, “because the question of who could make the acceptability determination was ambiguous, well-settled interpretive principles require that the court construe the agreement in favor of the limited partners.” As such, the Court determined that the GPGP Board, which included directors who were independent of Loews, was the body that had the authority to make the acceptability determination. Because the GPGP Board did not make the determination regarding the Acceptability Condition, the General Partner breached the Partnership Agreement by exercising the Call Right.

The Court further held that the provision in the Partnership Agreement stating the General Partner would be “conclusively presumed” to have acted in good faith if it relied on opinions, reports or other statements provided by someone that the General Partner reasonably believes to be an expert did not apply to protect the General Partner from liability, because the General Partner participated knowingly in the efforts to create the “contrived” Opinion and provided the propulsive force that led the outside counsel to reach the conclusions that Loews wanted.

In addition, the Court held the exculpation provision in the Partnership Agreement, which would generally protect the General Partner from liability except in case of bad faith, fraud or willful misconduct, did not apply because the General Partner engaged in willful misconduct when it exercised the Call Right.

The Court found the General Partner liable for damages of approximately $690 million, plus pre- and post-judgment interest.

Key Takeaways

While this case does not reflect a departure from established law, it provides helpful lessons for participants in MLP transactions to consider, including:

Outside counsel and advisors should be independent. The Boardwalk decision highlights the importance of retaining independent outside counsel and advisors in transactions involving conflicts of interest. Outside counsel and advisors should independently discern the facts, conduct analysis, and apply professional judgment.
Ambiguity in the partnership agreement may be resolved in favor of the public limited partners. MLPs and their sponsors should carefully consider their approach when making determinations with respect to any ambiguous provisions of the partnership agreement. Although the partnership agreement may provide for a presumption that they have acted in good faith, the general partner and sponsor should conduct their activities with respect to a conflict transaction as if there were no such presumptive provision.
Focus on precise compliance with the partnership agreement. Consistent with previously issued case law, to obtain the benefits provided in the partnership agreement, MLPs and their sponsors must strictly comply with the terms of the partnership agreement. Equally as important, they should be prepared to establish a clear and consistent record of satisfaction of such conditions.
Always be mindful of written communications and that actions will be judged with benefit of hindsight. The Court cited multiple emails, handwritten notes and other written communications (including from lawyers and within law firms) introduced as evidence at the trial. The Court also cited drafts of minutes of committee meetings in reviewing the written record. Participants in MLP transactions should be mindful that any written communications, including those thought to be privileged, could be evidence in litigation. Participants should also recognize that communications and actions taken will be reviewed with the benefit of 20/20 hindsight.

For the full opinion, please reference: Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions, Oil and Gas or Securities Litigation practice groups, or the following authors:

Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Gerry Spedale – Houston (+1 346-718-6888, gspedale@gibsondunn.com)
Tull Florey – Houston (+1 346-718-6767, tflorey@gibsondunn.com)
Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)

Special appreciation to Stella Tang and Matthew Ross, associates in the Houston office, for their work on this client alert.

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

On November 15, 2021, President Biden signed into law HR 3684, the “Infrastructure Investment and Jobs Act” (the “Act”), commonly referred to as the “infrastructure bill.” The Act allocates funding and other resources focused on roads and bridges, water infrastructure, resilience, internet and cybersecurity, among other areas (a full summary of the Act from Gibson Dunn is forthcoming).

The 1039-page Act also contains three pages adding new reporting requirements for certain cryptocurrency transactions that have little to do with infrastructure, but could have potentially dramatic implications for millions of United States businesses and consumers who have embraced cryptocurrency for its efficiency, transparency, and accessibility.

Here are the key takeaways for the Act’s expanded “cash” reporting provision applicable to cryptocurrencies:

The Act extends traditional reporting requirements for certain transactions involving over $10,000 in physical cash to transactions involving a newly defined category of “digital assets,” including cryptocurrencies.
Depending on how this new reporting obligation is interpreted and implemented, it could require businesses to collect new types of information and report to the IRS details of crypto transactions, in circumstances that bear little resemblance to cash purchases—or face civil and criminal penalties for failing to do so. An expansive application could have sweeping and unintended consequences for the cryptocurrency industry, potentially driving crypto transactions towards unregulated services and private wallet transactions, defeating the core policy objectives behind these requirements.
To avoid these consequences, it will be critical for stakeholders in the cryptocurrency ecosystem to advocate for regulators to adhere to the traditionally narrow scope of the cash-reporting requirement when it comes to digital assets, to educate legislators and regulators alike on the privacy and democratic values served by peer-to-peer blockchain technologies, and to explain the pitfalls of creating disincentives for consumers to participate in the regulated system of digital transactions.

In the coming months and years, there will be critical opportunities for industry participants to shape legislation and regulation on these issues. Gibson Dunn represents many clients at the forefront of crypto and blockchain innovation and stands ready to help guide industry players through these complex challenges at the intersection of regulation, public policy, and technology.

“Cash Reporting” Requirements Extended to Digital-Asset Transactions Greater than $10,000

The Act amends the anti-money-laundering “cash reporting” requirements of 26 U.S.C. § 6050I to encompass transactions in “digital assets.”

Section 6050I requires businesses that “receive” over $10,000 in cash (or other untraceable instruments like cashiers’ checks and money orders) to file a Form 8300 with the IRS, which includes the name, address, and taxpayer identification number, among other information, of both the payer and the beneficiary (usually the recipient) of the transaction. Because the “receipt” of physical cash generally involves an in-person transaction, Section 6050I historically has been applied mainly to transactions involving the in-person purchase of goods or services, such as when a person pays cash for jewelry, a car, or legal representation. See 26 C.F.R. § 1.6050I-1. Importantly, Section 6050I does not apply to transactions at financial institutions, which are subject to parallel requirements under the Bank Secrecy Act. See 31 U.S.C. §§ 5312, 5313. Nor does it apply to traceable electronic transactions involving credit cards, debit cards, or peer-to-peer payment services like PayPal and Venmo.

The Act forays into the digital world by amending Section 6050I’s definition of “cash” to include “digital assets,” thereby requiring persons that “receive” greater than $10,000 worth of digital assets in the course of their trade or business to file Form 8300 reports. The Act broadly defines digital asset as follows: “Except as otherwise provided by the Secretary, the term ‘digital asset’ means any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.” Sec. 80603(b)(1)(B) (emphasis added). That definition potentially could encompass a broad range of digital assets, including traditional cryptocurrencies and even non-fungible tokens (“NFTs”). Likewise, the Treasury Secretary’s authority to “provide[]” “otherwise” would allow the Secretary to exempt certain digital assets or scenarios.

The Act does not alter the information that must be reported for digital-asset transactions on Form 8300, but the Secretary and the IRS may seek to clarify how Form 8300 applies to digital-asset transactions through regulation. This discretion will be important because, as discussed below, there are potential pitfalls in applying reporting requirements that were designed for retail purchases in cash to transactions involving cryptocurrency.

Failure to comply with Section 6050I can result in civil penalties of up to $3 million per year—with much higher penalties possible if the failure is due to “intentional disregard” of the filing requirements. 26 U.S.C. §§ 6721, 6722. In addition, willful violation of Section 6050I is a federal felony, with violators facing up to 5 years imprisonment and corporate violators facing fines of up to $100,000. Id. § 7203.

This new reporting requirement will not take effect until 2024. The delayed effective date gives time for the Treasury Secretary and the IRS to consider whether to issue regulations clarifying: (1) the scope of the definition of digital assets; and (2) the reporting requirements for digital-asset transactions above $10,000. It also provides time for parties affected by the legislation to engage in the rulemaking process to shape the outcome of these regulations.

In addition to the amendment to Section 6050I, the Act also expands existing IRS Form 1099 reporting obligations by amending the definition of “broker” under 26 U.S.C. § 6045 to include businesses “responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Sec. 80603(a)(3). This amendment would appear to apply to cryptocurrency exchanges, peer-to-peer money transmission services, and financial institutions that support cryptocurrency transactions. Its reach beyond that is unclear and regulations are expected to be issued addressing the scope of the new provision. As discussed in Part III, members of Congress have expressed interest in amending the newly expanded definition of broker, suggesting that there may be future legislation addressing this issue.

II.

Real-World Consequences

The Act’s new requirement for businesses to collect and report personal information about the parties to certain cryptocurrency transactions greater than $10,000 could have unintended consequences, but much will depend on how this new reporting obligation is implemented. More broadly, the Act highlights the challenges of applying old-world legislative concepts to emerging technologies that are not well understood.

As discussed, Section 6050I’s cash-reporting requirements traditionally have applied mainly to in-person and otherwise untraceable cash payments for goods and services. Those requirements, and the rationales underlying them, do not map cleanly onto digital assets, which are transacted online and in a public and traceable manner by virtue of blockchain technology. If forthcoming regulations clarify that Section 6050I, as amended, will cover only “cash-like” digital-asset transactions—such as the use of bitcoin to pay for goods and services (like a car) in person—then the Act may have a more limited impact on the cryptocurrency industry. Even then, though, there will be many gaps for the Secretary and the IRS to fill in attempting to translate a reporting scheme designed for mostly in-person, cash transactions in the physical world to the cryptographic world of digital-asset transactions.

If, however, the implementing regulations sweep more broadly and seek to encompass parties that “receive” cryptocurrency as payments in online or peer-to-peer transactions (or the intermediaries that facilitate those transactions), the Act could have sweeping consequences for the future of the new and rapidly evolving cryptocurrency technology.

Privacy, efficiency, and decentralization are the core features driving the proliferation of blockchain technology. Blockchain enables radical transparency with respect to every transaction through a publicly available distributed ledger, and it is built on technology that enables secure and trusted peer-to-peer transactions without the costs and other implications associated with centralized intermediaries. This appeals to privacy-conscious consumers, as well as those who may have faced barriers to access to the traditional financial system, for reasons of cost or due to the need to pass credit requirements or other hurdles.

To the extent that the regulations under the Act require online businesses receiving payments in cryptocurrency (versus via a fiat-linked wallet or credit card) to collect and report new forms of information, this would put cryptocurrency at a fundamental disadvantage relative to other forms of traceable currency that have not been subject to cash reporting requirements. Moreover, requiring and reporting extensive information about the parties to a cryptocurrency transaction could alienate privacy-conscious customers or those who have embraced the simplicity and agency inherent in managing transactions directly from their digital wallet. Unlike consumers of traditional banking products, digital-asset customers have readily accessible alternatives to transact digital assets using any number of private and unlicensed services that operate outside the system of regulated transactions. Given this, an expansive and unprecedented application of cash reporting requirements to cryptocurrency transactions could have the effect of driving digital-asset consumers away from industry participants operating inside the U.S. and global regulatory system and towards a rapidly expanding market of unencumbered alternatives.

The Act also presents challenges for a new category of digital asset “brokers.” Digital-asset brokers with customers outside the United States may have complex reporting, withholding, and other compliance challenges that could encourage users to move their cryptocurrency activities to non-U.S. competitors. Moreover, a broad implementation of the cash reporting provision could overlap with the new broker reporting rules, creating duplicative and burdensome reporting for the same transactions (e.g., where a transferor broker facilitates and reports a transaction under Section 6045 and a transferee broker facilitates and reports the same transaction under Section 6050I).

In addition, if the Act is interpreted to apply to certain participants in decentralized finance (“DeFi”) transactions, it could pose an existential threat to the burgeoning industry. At present, it is unclear whether many DeFi participants could gather the information necessary to report digital-asset transactions over $10,000. In some decentralized exchanges (DEXs), for example, there is no way for a business that receives a digital asset from a liquidity pool to trace the asset to particular individuals or entities. Nor is there a centralized third party that could collect this information—indeed, the distinguishing feature of many DEXs is that they rely on automated smart contracts. If the Act’s reporting requirements nevertheless are interpreted to apply in this context—for example, by requiring smart-contract developers to modify DeFi protocols to collect customer information—the effect might be to handcuff this emerging industry.

To avoid these or other consequences that could unintentionally burden cryptocurrency moving forward, it will be critical to develop early and strategic advocacy with the IRS and Treasury during rulemaking, and to educate regulators and legislators alike on the distinguishing and beneficial features of blockchain technology and the dangers of disincentivizing customers to use licensed and regulated institutions to host and enable their digital assets and transactions.

III.

Looking Forward

Congress and regulators are increasingly active in regulating blockchain and cryptocurrency technology, but in many cases lack critical context and understanding of the benefits and application of this technology to address long-running policy objectives, including access to capital, particularly for unbanked and underbanked communities.

Near Term

In the short term, opportunities will exist to shape the Treasury Department’s rulemaking to implement the Act. Before the recently passed cryptocurrency provisions take effect in 2024, the Treasury Secretary and the IRS are expected to clarify the scope of Section 6050I as applied to digital assets, including the definition of “digital assets,” the scenarios that give rise to reporting requirements, and the particular reporting requirements for digital assets. Such a rulemaking would represent both a risk and an opportunity for companies, consumers, and other stakeholders in the cryptocurrency space. It will be critical for industry participants to ensure that in applying Section 6050I to digital assets, the Secretary and the IRS adhere to the traditional and narrow understanding of that provision, and do not inadvertently sweep in online or peer-to-peer digital-asset transactions. It likewise will be important to ensure that any regulations properly account for the private, traceable, and decentralized nature of cryptocurrency transactions.

Moreover, the current Congress is not done passing legislation that could impact cryptocurrency businesses and consumers. The $1.7 trillion reconciliation bill, officially known as the Build Back Better Act, is expected to address cryptocurrency again and may pass Congress before the end of the year. Though the exact provisions continue to be negotiated, the current bill would address the tax treatment of certain cryptocurrency transactions. For example, the reconciliation bill may subject cryptocurrency transactions to the “wash sale rule” (which prohibits reporting a tax loss by selling a security at a loss but then buying the same security within 30 days), and constructive sale rules (which prevent a taxpayer from deferring gains by holding opposing positions on a security). There may be opportunities to advocate for legislative changes to avoid some of the pitfalls created by the Act.

This is an area of intensive congressional focus, and there will be many opportunities to educate legislators and shape legislation. For example, recent reports indicate that Senate Finance Committee Chairman Ron Wyden (OR-D) and Senator Cynthia Lummis (WY-R) are planning to introduce legislation that would narrow the definition of “broker” included in the Act. (The Block) Senator Pat Toomey (R-PA) also has stated that he would work to amend the definition of broker so as to exempt miners and other parties not involved with directly handling customers’ cryptocurrency transactions. Senator Toomey conceded that Congress will “have to do it in subsequent legislation” if the infrastructure bill was not amended before its passage (Yahoo Finance). Others in Congress have also noted the need to amend the current definition. In August, the bipartisan co-chairs of the Congressional Blockchain Caucus—Rep. Tom Emmer (R-MN-6), Rep. Darren Soto (D-FL-9), Rep. David Schweikert (R-AZ-6), and Rep. Bill Foster (D-IL-11)—called for “amending this language.”

Long Term

In the longer term, it may be necessary to lobby Congress to modify legislation and advocate before federal agencies to influence rulemaking. As described above, it is quite likely that Congress will continue to pass legislation addressing cryptocurrency and other digital assets. And regardless of these potential legislative developments, the Act alone will require substantial rulemaking from the Treasury Department and the IRS to address critical definitions and specifics regarding reporting requirements.

That said, any long-term developments need not be adversarial. There will continue to be opportunities to work on these complicated issues and align the goals of federal and state lawmakers and clients when it comes to this important new technology.

As things stand today, there is a rapidly expanding patchwork of federal and state legislation and regulation, as legislators and regulators struggle to map traditional financial regulatory structures onto digital assets. At the federal level, the SEC, CFTC, OFAC, and FinCEN all have asserted enforcement authority over various, sometimes overlapping sectors of the cryptocurrency industry. And these same businesses often are subject to dozens of state licensing requirements, leading some to advocate for a centralized federal approach.

This complex regulatory framework—which was developed for banking in the twentieth century—is unlikely to effectively handle the needs of the government, businesses, and individuals in the twenty-first century with respect to cryptocurrency and other digital assets. It therefore will be essential to work closely with federal and state legislators and regulators to develop a coherent regulatory structure for digital assets that will promote, rather than hinder, innovation. As the Congressional Blockchain Caucus Co-Chairs explained in their August 2021 letter: “Cryptocurrency tax reporting is important, but it must be done correctly” and must “ensure that civil liberties are protected.”

Gibson Dunn stands ready to help guide industry players through the most complex challenges that lay at the intersection of regulation, public policy and technical innovation of blockchain and cryptocurrency. If you wish to discuss any of the matters set out above, please contact Gibson Dunn’s Crypto Taskforce (cryptotasforce@gibsondunn.com), or any member of its Financial Institutions, Global Financial Regulatory, Public Policy, Administrative Law and Regulatory, Privacy, Cybersecurity and Data Innovation, or Tax Controversy and Litigation teams, including the following authors:

Ashlie Beringer – Co-Chair, Privacy, Cybersecurity & Data Innovation Group, Palo Alto
(+1 650-849-5327, aberinger@gibsondunn.com)

Matthew L. Biben – Co-Chair, Financial Institutions Group, New York
(+1 212-351-6300, mbiben@gibsondunn.com)

M. Kendall Day – Co-Chair, Financial Institutions Group, Washington, D.C.
(+1 202-955-8220, kday@gibsondunn.com)

Michael J. Desmond – Co-Chair, Global Tax Controversy & Litigation Group, Los Angeles/ Washington, D.C.
(+1 213-229-7531, mdesmond@gibsondunn.com)

Roscoe Jones, Jr. – Co-Chair, Public Policy Group, Washington, D.C.
(+1 202-887-3530, rjones@gibsondunn.com)

Elizabeth P. Papez – Member, Administrative Law and Regulatory Group, Washington, D.C.
(+1 202-955-8608, epapez@gibsondunn.com)

Eugene Scalia – Co-Chair, Administrative Law and Regulatory Group, Washington, D.C.
(+1 202-955-8543, escalia@gibsondunn.com)

Jeffrey L. Steiner – Co-Chair, Global Financial Regulatory Group, Washington, D.C.
(+1 202-887-3632, jsteiner@gibsondunn.com)

The following associates contributed to this client alert: Sean Brennan, Nick Harper, Prachi Mistry and Luke Zaro.

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

On November 17, 2021, the Securities and Exchange Commission (SEC) approved amendments to the federal proxy rules to mandate the use of a universal proxy card in public solicitations involving director election contests. After the rules become effective on August 31, 2022, proxy cards distributed by both public companies and activist shareholders in a contested director election will have to include both sides’ director nominees, such that shareholders casting their vote can “mix and match” nominees from the company’s and dissident’s slates of nominees. We believe that the new rules are likely to embolden activists and increase the incidence of contested director elections.

Rule Amendments

The final rules adopted by the SEC require that both public companies and activists use a universal proxy card when soliciting shareholders in a director election contest – that is, each proxy card, regardless of who delivers it, must include the names of both the company and activist nominees. Such a proxy card allows shareholders to combine candidates from the separate slates submitted by the company and activist shareholder. This contrasts with the current system in which shareholders generally have a binary choice of casting their vote for the company’s slate in the company’s proxy card, or the activist’s slate in the activist’s proxy card.[1]

In order to implement the use of universal proxy cards, the new rules also mandate the following in connection with director election contests:

Activist’s Notice of Intent to Solicit: Activist shareholders must provide companies with notice of their intent to solicit proxies and provide the names of their nominees no later than 60 calendar days before the anniversary of the previous year’s annual meeting. We expect this “guardrail” to provide no benefit to most public companies since standard advance notice bylaws require activists to give notice of their intent to make director nominations 90 calendar days or more before the anniversary of the previous year’s annual meeting.
Company’s Notice to Activist: Companies must notify activists of the names of the company’s nominees no later than 50 calendar days before the anniversary of the previous year’s annual meeting.
Deadline for Filing of Activist’s Proxy Statement: The activist will be required to file its definitive proxy statement by the later of 25 calendar days before the shareholder meeting or five calendar days after the company files its definitive proxy statement. Again, we expect this rule to have no practical implication on activists’ behavior since they already typically file their definitive proxy materials at least one month before the meeting.
Minimum Solicitation: The activist must solicit the holders of shares representing at least 67% of the voting power of the shares entitled to vote at the meeting. Although the SEC touts this provision as “a key piece” of the universal proxy requirement, it is a provision of no real consequence: activist campaigns involving director contests almost invariably involve solicitations by the activist of holders of over 67% of the outstanding shares. Of note, “soliciting” for purposes of the rule does not involve knocking on the door or otherwise meeting and actively engaging a shareholder. Mailing proxy materials to beneficial owners via Broadridge, standard practice for activists, would satisfy the requirement. The rule even permits the use of notice-and-access solicitation; as noted by Commissioner Hester M. Peirce in her dissent “sending a postcard with a website link to proxy materials will suffice.”

The new rules also require each side of the contest to refer shareholders to the other party’s proxy statement for information about the other party’s nominees, and establish presentation and formatting requirements for universal proxy cards.

What Does Universal Proxy Mean For Public Companies?

Although the impact of mandated universal proxies has been the subject of intense debate since 2016, the reality is that before the rules come into effect in the fall of 2022, we are all only able to engage in (educated) speculation:

More Contested Director Elections: Shareholders will be more inclined to support one or two dissident nominees when they can do it on a universal proxy card, as opposed to the current system that generally requires shareholders voting by proxy to sign the activist’s card if they want to support any member of the activist’s slate. Therefore, the use of universal proxies should make it easier for activists to win at least one board seat, which will likely embolden traditional and new ESG-focused activists to run director campaigns.
Potential for Cheaper Activist Election Campaigns: One of the traditional economic barriers for conducting a director proxy contest was the activist’s strategic need to make multiple mailings of its proxy card. This results from the fact that in a proxy contest only the last executed proxy card counts, so it has been imperative in a proxy contest for each side to make sure that it matches every proxy card mailing by the other side with one of its own to mitigate against the risk that a shareholder switches proxy cards (and thus entire slates). When a universal ballot is used by both the company and dissident, the consequences of a shareholder switching cards is less important as every proxy card, regardless of which side mails it, includes the nominees from both the company and dissident. Activists can therefore avoid the expense of making multiple mailings of a proxy card.

At the risk of oversimplifying: going forward an activist can comply with state law and the company’s governing documents to submit a nomination within the prescribed timeline, file electronically with the SEC a proxy statement, disseminate the proxy statement via notice-and-access with distribution of electronic copy (pdf) to the largest institutional holders, lobby ISS and Glass Lewis, and rely on the company’s mailing of a universal proxy card to get the activist’s nominees across the finish line. There is certainly more to it, but even the perception of a faster and cheaper process is likely to encourage activists (and aspiring activists) to launch a director election campaign. And needless to say, the new system compels companies to make sure they have state-of-the-art advance notice bylaws to protect the integrity of the director election process.

Nirvana For Proxy Advisors: Proxy advisors such as ISS and Glass Lewis have traditionally expressed frustration at the constraints imposed by being unable to “mix and match” candidates from the management and dissident slate in making recommendations. Proxy advisors will feel liberated by universal proxy and will be more ready to recommend slates that include one or two dissident nominees in situations where they might have felt previously compelled to recommend that clients vote on the company’s proxy card. This will further embolden activists.
But Universal Proxy Might Not Always Be Good For Activists: For those looking for the silver lining, it is not difficult to imagine a scenario where an activist might have been better off forcing shareholders into a binary choice of voting on the company’s proxy card (for all of the company’s nominees) versus the activist’s card (for the activist’s nominees). This phenomenon might be more pronounced where the activist was seeking to take control of the board, including hostile M&A situations.

________________________

[1] In the case of certain short slate elections, the activist’s slate may include company nominees cherry-picked by the activist.

Gibson Dunn’s lawyers are available to assist with 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 in the firm’s Mergers and Acquisitions, Capital Markets, or Securities Regulation and Corporate Governance practice groups, or the following authors:

Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com)
James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com)
Andrew Kaplan – New York (+1 212-351-4064, akaplan@gibsondunn.com)

Please also feel free to contact the following practice leaders:

Mergers and Acquisitions Group:
Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com)
Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com)

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
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On October 25, 2021, the Dubai Financial Services Authority (“DFSA”) updated its Rulebook for “crypto” based investments by launching a regulatory framework for “Investment Tokens”. This framework follows, on the whole, the approach proposed in the DFSA’s “Consultation Paper No. 138 – Regulation of Security Tokens”, published in March 2021 (the “Consultation Paper”).

Peter Smith, Managing Director, Head of Strategy, Policy and Risk at the DFSA has noted that: “Creating an ecosystem for innovative firms to thrive in the UAE is a key priority for both the UAE and Dubai Governments, and the DFSA. Our consultation on Investment Tokens enabled us to understand what firms were looking for in a regulatory framework and introduce a regime that is relevant to the market. We look forward to receiving applications from interested firms and contributing to the ongoing growth of future-focused financial services in the DIFC.”[1]

What is an “Investment Token”?

An “Investment Token” is defined as either a “Security Token” or a “Derivative Token”[2]. Broadly speaking, these are:

a security (which includes, for example, a share, debenture or warrant) or derivative (an option or future) in the form of a cryptographically secured digital representation of rights and obligations that is issued, transferred and stored using Distributed Ledger Technology (“DLT”) or other similar technology; or
a cryptographically secured digital representation of rights and obligations that is issued, transferred and stored using DLT or other similar technology and: (i) confers rights and obligations that are substantially similar in nature to those conferred by a security or derivative; or (ii) has a substantially similar purpose or effect to a security or derivative.

However, importantly, the definition of “Investment Token” will not capture virtual assets which do not either confer rights and obligations substantially similar in nature to those conferred by a security or derivative, or have a substantially similar purpose or effect to a security or derivative. This means that key cryptocurrencies such as Bitcoin and Ethereum, as well as stablecoins such as Tether, will remain unregulated under the Investment Tokens regime.

Scope of framework

This regulatory framework applies to persons interested in marketing, issuing, trading or holding Investment Tokens in or from the Dubai International Financial Centre (“DIFC”). It also applies with respect to DFSA authorised firms wishing to undertake “financial services” relating to Investment Tokens. Such financial services would include (amongst other things) dealing in, advising on, or arranging transactions relating to, Investment Tokens, or managing discretionary portfolios or collective investment funds investing in Investment Tokens.

Approach taken by the DFSA

The approach taken by the DFSA has been to, rather than establish an entirely separate regime for Investment Tokens, bring these instruments within scope of the existing regime for “Investments”, subject to certain changes. The Consultation Paper noted that “in line with the approach adopted in the benchmarked jurisdictions, [the] aim is to ensure that the DFSA regime for regulating financial products and services will apply in an appropriate and robust manner to those tokens that [the DFSA considers] to be the same as, or sufficiently similar to, existing Investments to warrant regulation”.

The Consultation Paper proposed to do this through four means: (i) by making use of the existing regime for “Investments” as far as possible, whilst addressing specific risks associated with the tokens, especially technology risks; (ii) by not being too restrictive, so that the DFSA can accommodate the evolving nature of the underlying technologies that might drive tokenization of traditional financial products and services; (iii) by addressing risks to investor/customer communication and market integrity, and systemic risks, should they arise, where new technologies are used in the provision of financial products or services in or from the DIFC; and (iv) remaining true to the underlying key characteristics and attributes of regulated financial products and services, as far as practicable.

As noted at (i) above, the changes brought about on October 25, 2021 necessarily involved the addition of new requirements to address specific issues related to Investment Tokens. For instance, added requirements are imposed on firms providing financial services relating to Investment Tokens in Chapter 14 of the Conduct of Business Module of the DFSA Rulebook.

This sets out (amongst other things):

technology and governance requirements for firms operating facilities (trading venues) for Investment Tokens – for instance, they must: (i) ensure that any DLT application used by the facility operates on the basis of permissioned access, so that the operator is able to maintain adequate control of persons granted access; and (ii) have regard to industry best practices in developing their technology design and technology governance relating to DLT that is used by the facility;
rules relating to operators of facilities for Investment Tokens which permit direct access – for example, the operator must ensure that its operating rules clearly articulate: (i) the duties owed by the operator to the direct access member; (ii) the duties owed by the direct access member to the operator; and (iii) appropriate investor redress mechanisms available. The operator must also make certain risk disclosures and have in place adequate systems and controls to address market integrity, anti-money laundering and other investor protection risks;
requirements for firms providing custody of Investment Tokens (termed “digital wallet service providers”) – for example: (i) any DLT application used in providing custody of the Investment Tokens must be resilient, reliable and compatible with any relevant facility on which the Investment Tokens are traded or cleared; and (ii) the technology used and its associated procedures must have adequate security measures (including cyber security) to enable the safe storage and transmission of data relating to the Investment Tokens; and
a requirement that firms carrying on one or more financial services with respect to Investment Tokens (such as dealing in investments as principal/agent, arranging deals in investments, advising on financial products and managing assets), provide the client with a “key features document” in good time before the service is provided. This must contain, amongst other things: (i) the risks associated with, and the essential characteristics of, the Investment Token; (ii) whether the Investment Token is, or will be, admitted to trading (and, if so, the details of its admission); (iii) how the client may exercise any rights conferred by the Investment Tokens (such as voting); and (iv) any other information relevant to the particular Investment Token that would reasonably assist the client to understand the product and technology better and to make informed decisions in respect of it.

Comment

In taking the approach to Investment Tokens outlined in this alert, the DFSA has aligned with the approach taken by certain key jurisdictions. It is similar to that taken by the U.K. Financial Conduct Authority, for example, which has issued guidance to the effect that tokens with specific characteristics that mean they provide rights and obligations akin to specified investments, like a share or a debt instrument (the U.K. version of Investment Tokens) be treated as specified investments and, therefore, be considered within the existing regulatory framework[3].

The DFSA’s regime has baked-in flexibility, particularly as a consequence of the fairly high level, principles-based approach. This will likely prove helpful, given the evolving nature of the virtual assets world. However, the exclusion of key cryptocurrencies from the scope of this regime may limit the attractiveness of the regime, particularly to cryptocurrency exchanges seeking to offer spot trading. However, this may be offset to some extent by the DFSA regime’s willingness to allow operators of facilities for Investment Tokens to provide direct access to retail clients, subject to those clients meeting certain requirements (such as having sufficient competence and experience). This is in contrast to the approach proposed by the Hong Kong Financial Services and the Treasury Bureau, which has proposed restricting access to cryptocurrency trading to professional investors only.[4]

Next steps

As noted above, the Investment Tokens regime does not cover many key virtual assets. However, we understand that the DFSA is drafting proposals for tokens not covered by the Investment Tokens regulatory framework. These proposals are expected to cover exchange tokens, utility tokens and certain asset-backed tokens (stablecoins). The DFSA intends to issue a second consultation paper later in Q4 of this year.[5]

____________________________

[1] https://www.dfsa.ae/news/dfsa-introduces-regulatory-framework-investment-tokens

[2] DFSA Rulebook: General Module, A.2.1.1

[3] FCA Policy Statement (PS 19/22), Guidance on Cryptoassets (July 2019)

[4] See our previous alert on the proposed Hong Kong regime: https://www.gibsondunn.com/licensing-regime-for-virtual-asset-services-providers-in-hong-kong/

[5] https://www.dfsa.ae/news/dfsa-introduces-regulatory-framework-investment-tokens

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) on the Global Financial Regulatory team, or the following authors:

Hardeep Plahe – Dubai (+971 (0) 4 318 4611, hplahe@gibsondunn.com)
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
William R. Hallatt – Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Chris Hickey – London (+44 (0) 20 7071 4265, chickey@gibsondunn.com)
Martin Coombes – London (+44 (0) 20 7071 4258, mcoombes@gibsondunn.com)
Emily Rumble – Hong Kong (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)
Becky Chung – Hong Kong (+852 2214 3837, bchung@gibsondunn.com)

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On November 10, 2021, the UK Supreme Court issued a unanimous Judgment in Lloyd v Google LLC [2021] UKSC 50, overturning a ruling of the Court of Appeal and disallowing a data privacy class action. The Judgment denied Mr. Lloyd the ability to pursue a collective claim for compensation on behalf of around four million iPhone users in England and Wales whose internet activity data were allegedly collected by Google in late 2011 and early 2012 for commercial purposes without the users’ knowledge or consent, and in alleged breach of section 4(4) of the Data Protection Act 1998 (“the 1998 Act”). The 1998 Act has since been replaced by the UK GDPR and the Data Protection Act 2018 (“the 2018 Act”). The claim was backed by substantial litigation funding.

The Supreme Court’s Judgment provides, in brief, that the procedural mechanism used to bring the claims on a collective basis (known as a “representative action”) can be used for claims of this kind, but only for the purposes of establishing liability for a breach of relevant data protection laws. The question of damages cannot be addressed through a representative action, and would have to be dealt with through individual claims, which could be managed together through group litigation case management devices (see below).

The Court held that a representative action is unsuitable for damages assessment in a case of this kind because:

first, damages for mere loss of control of data (as distinct from damages for actual loss or distress caused by the data breach) are not available for breaches of the 1998 Act (although the Supreme Court intimated that they may have been for another tort, misuse of private information); and
second, even if such damages had been available, assessment of loss can only be determined on the basis of an individualised assessment of the alleged misuse of each individual’s data by Google.

The Supreme Court’s official summary of the Judgment can be found here.

In this alert we provide an overview of the Supreme Court’s decision and offer our observations on the implications of the Judgment.

Background to Collective Actions in the UK

There are a number of ways in which collective actions can be brought in the UK. Typically, such claims are brought on an “opt-in” basis. For example under the Data Protection Act 2018, individuals can authorise non-profit organisations to bring certain proceedings on their behalf, or under a group litigation order (“GLO”), courts can manage in a co-ordinated way claims which give rise to “common or related issues” of fact or law (Civil Procedure Rules (“CPR”) Parts 19.10 and 19.11).

However, there are two procedures that can be used in England and Wales to bring collective claims on an “opt-out” basis:

A collective redress regime for competition claims, which was introduced on 1 October 2015 under the Consumer Rights Act 2015, and which provides for opt-out claims to be brought in appropriate circumstances for damages for certain breaches of competition laws (see our alert on the Supreme Court’s 2020 decision in Merricks v Mastercard for more information on these types of claims). Opt-in claims can also be brought under the Consumer Rights Act 2015 regime; and
The “representative action” procedure, under which Lloyd v Google was brought, in which a party brings the claim as a “representative” of a group of litigants who have the “same interest” in the claim (under CPR 19.6). The “same interest” requirement has to date been interpreted strictly by the courts as requiring the claimants to have a common interest and grievance (which generally precludes claims relying on different fact patterns) and to all benefit from the remedy sought (which generally precludes claims for different remedies).

Summary of the Lloyd Action and Judgment

Background

The alleged conduct by Google had given rise to a number of individual claims in the U.S. and the UK which had settled, and had been the subject of a civil settlement between Google and the U.S. Federal Trade Commission. In May 2017, the claimant, Richard Lloyd, a consumer rights activist, commenced proceedings alleging that Google breached the 1998 Act, seeking damages on behalf of himself and other affected individuals under section 13(1) of the 1998 Act. That section provides: “An individual who suffers damage by reason of any contravention by a data controller of any of the requirements of this Act is entitled to compensation from the data controller for that damage.” He did not allege or prove any distinctive facts affecting any of the individuals, save that they did not consent to the abstraction of their data.

Mr. Lloyd applied for permission to serve the claim on Google outside England & Wales, namely, in the U.S. As with any such application, in order to succeed, Mr Lloyd had to establish that his claim has a reasonable prospect of success (CPR Part 6.37(1)(b)), that there is a good arguable case that the claim fell within one of the so-called jurisdictional “gateways” in paragraph 3.1 of CPR Practice Direction 6B (in this case, he sought to show that damage was sustained either within the jurisdiction or from an act committed within the jurisdiction), and that England and Wales was clearly or distinctly the most appropriate jurisdiction in which to try the claim (CPR Part 6.37(3)).

Google opposed the application on the grounds that: (i) the pleaded facts did not disclose any basis for claiming compensation under the 1998 Act; and (ii) the court should not permit the claim to continue as a representative action.

At first instance, Warby J refused to grant Mr. Lloyd permission to serve Google outside the jurisdiction on the basis that: (a) none of the represented class had suffered “damage” under section 13 of the 1998 Act; (b) the members of the class did not have the “same interest” within CPR 19.6(1) so as to justify allowing the claim to proceed as a representative action; and (c) the court’s discretion under CPR Part 19.6(2) should be exercised against allowing the claim to proceed.

The Court of Appeal reversed Warby J’s judgment on each of these issues, holding that: (a) the members of the class were entitled to recover damages pursuant to section 13 of the 1998 Act, based on the loss of control of their personal data alone, regardless of whether they had suffered actual pecuniary loss or distress as a result of Google’s alleged breaches; (b) the members of the class did, in fact, have the “same interest” for the purposes of CPR 19.6(1) and Warby J had defined the concept of “damage” too narrowly; and (c) the Court should exercise its discretion to permit Mr Lloyd to bring the claim on a representative basis.

Issues Before the Supreme Court

The claimant was granted leave to appeal to the Supreme Court. The three issues for determination by the Supreme Court were:

Are damages recoverable for loss of control of data under section 13 of 1998 Act, even if there is no pecuniary loss or distress?
Do the four million individuals allegedly affected by Google’s conduct share the “same interest”?
If the “same interest” test is satisfied, should the Court exercise its discretion and disallow the representative action in any event?

The Supreme Court’s Judgment

The Supreme Court’s unanimous Judgment, delivered by Lord Leggatt, reverses the Court of Appeal and re-instates the order of Warby J denying permission to serve out, essentially bringing the proceedings to an end. The key issues emerging from the Judgment are as follows:

The representative action is a long-standing “flexible tool of convenience in the administration of justice”, which might be used today in appropriate cases to bring mass tort claims arising in connection with alleged misuse of digital technologies, particularly in matters involving mass, low-value consumer claims.
There are limitations on the appropriateness of the use of representative actions to bring damages claims. Damages, as a remedy, by its very nature under English law, will typically require individualised assessment of loss, which requires participation of the affected parties.
In the case at hand, the question of liability (i.e., whether Google had breached the 1998 Act) was suitable to be brought through a representative action. The purpose of such a claim may be to obtain declaratory relief, which could include a declaration that affected persons may be entitled to compensation for the breaches identified. However, damages would need to be assessed on an individualised basis. The Supreme Court noted that the claimant, Mr. Lloyd, had not proposed such a two-stage approach, presumably because that declaratory relief would not itself have generated an award of damages that would provide his litigation funders with a return on their investment.
Section 13 of the 1998 Act does not, on its own wording, allow for damages claims on the “loss of control of data” basis pleaded by Mr. Lloyd. The Supreme Court appears to have acknowledged that “loss of control” damages may be available for the tort of misuse of private information, but held that section 13 could not be interpreted as giving an individual a right to compensation without proof of material damage or distress. Lord Leggatt indicated that, had a claim of this kind been brought, such damages would have been an appropriate way to assess loss, but no case had been brought under that tort. Even if loss of control damages were available, there would be a need to individualised assessment of the unlawful data processing in the case of each individual claimant; again, this would be inconsistent with proceeding by means of a representative action.

Analysis of the Lloyd Judgment

This Judgment appears to represent a significant victory for Google and other major data controllers, and a blow to funding-assisted collective actions in the data protection field in England and Wales.

While it is notable that the Supreme Court was at pains to assert the potential utility of the representative action in mass data rights violations in appropriate circumstances, it is not obvious what those circumstances are, and it seems unlikely that the representative action will represent a fruitful mechanism for bringing such claims going forward. At the very least, future claimants and their funders will need to give careful thought to the economics of bifurcated claims involving the bringing of a representative action for a declaration of liability and entitlement to compensation, followed by a large volume of coordinated damages claims for which a GLO is sought.

The historic nature of the claims offers little comfort to claimants here. The Judgment relates to the regime in place prior to entry to the GDPR. Article 82(1) of the GDPR, which is retained in law in the UK post-Brexit, provides: “Any person who has suffered material or non-material damage as a result of an infringement of this Regulation shall have the right to receive compensation from the controller or processor for the damage suffered.” It is an open question whether the English courts will consider the Supreme Court’s analysis of section 13 to apply equally to Article 82(1), but the reasoning seems to apply.

Furthermore, even in observing, at paragraph 4 of the Judgment, that “Parliament has not legislated to establish a class action regime in the field of data protection”, the Supreme Court did not take the obvious opportunity to encourage Parliament to do so. Parliament will be in no doubt that, if a collective action regime is to be developed to address consumer data rights, it will need to legislate for it – it would now seem unlikely that such a culture can be developed from the procedural tools currently available to claimants.

Some claimants may find encouragement in the Judgment’s indication that the relatively new tort of misuse of private information may be used to recover “loss of control” damages, without proof of specific loss. The circumstances in which that tort will be relevant to breaches of the GDPR and the 2018 Act, however, may be limited in practice, due to the need to establish a reasonable expectation of privacy supported by evidence of facts particular to each individual claimant.

In sum, major data controllers will be content with this outcome, and the nascent plaintiff bar and funding industry in the UK will likely be turning its attention to other areas of potential multi-party actions – unless and until, of course, Parliament intervenes. With the current challenges facing the British government, that may be some time.

This alert was prepared by Patrick Doris, Doug Watson, Harriet Codd, Gail Elman, Ahmed Baladi, Vera Lukic, Ryan Bergsieker, Ashlie Beringer, Alexander Southwell, and Cassandra Gaedt-Sheckter.

Privacy, Cybersecurity and Data Innovation Group:

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Please join us as our distinguished panelists discuss the challenging interplay between internal audit and white collar investigations. The discussion will include strategies to ensure that internal audit complements the compliance function and how best to deal with legal problems identified by internal audit activities. Our panelists will also discuss recent FCPA enforcement actions that leverage internal audit findings to support alleged violations.

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PANELISTS:

Michael Diamant is a partner in Gibson Dunn’s Washington, D.C. office. He is a member of the White Collar Defense and Investigations Practice Group, and serves on the firm’s Finance Committee. Mr. Diamant has managed numerous internal investigations for publicly traded corporations and conducted fieldwork in nineteen different countries on five continents. He also regularly advises major corporations on the structure and effectiveness of their compliance programs.

Patrick Stokes is a partner in Gibson Dunn’s Washington, D.C. office, and Co-Chair of the firm’s Anti-Corruption and FCPA practice group. His practice focuses on internal corporate investigations and enforcement actions regarding corruption, securities fraud, and financial institutions fraud. Prior to joining the firm, Mr. Stokes headed the DOJ’s FCPA Unit, managing the FCPA enforcement program and all criminal FCPA matters throughout the United States covering every significant business sector. Previously, he served as Co-Chief of the DOJ’s Securities and Financial Fraud Unit.

Oleh Vretsona is a partner in the Washington, D.C. office of Gibson Dunn. He currently practices in the firm’s Litigation Department, where he focuses on white collar criminal defense, internal investigations, regulatory inquiries, antitrust, and corporate compliance. Mr. Vretsona has represented clients in a wide variety of matters, including matters arising under the U.S. Foreign Corrupt Practices Act and antitrust matters, and he has advised clients on structure and implementation of corporate compliance programs.

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New Guidance Unwinds Four Years of Staff Precedent and Raises the Burden for Companies Seeking to Exclude Environmental and Social Proposals from Proxy Statements

On November 3, 2021, the Division of Corporation Finance (the “Staff”) of the U.S. Securities and Exchange Commission (the “Commission”) published Staff Legal Bulletin 14L (“SLB 14L”), which sets forth new Staff guidance on shareholder proposals submitted to publicly traded companies under SEC Rule 14a-8. As discussed in greater detail below, SLB 14L:

rescinds each of the Staff Legal Bulletins issued under the Clayton Commission; specifically, Staff Legal Bulletin 14I (Nov. 1, 2017) (“SLB 14I”), Staff Legal Bulletin 14J (Oct. 23, 2018) (“SLB 14J”), and Staff Legal Bulletin 14K (Oct. 16, 2019) (“SLB 14K”) (collectively, the “Prior SLBs”);
reverses the Prior SLBs’ company-specific approach to evaluating the significance of a policy issue that is the subject of a shareholder proposal for purposes of the ordinary business exclusion in Rule 14a-8(i)(7) (thereby negating the need for a board analysis or “delta” analysis to support future no-action requests);
reverses the Prior SLBs’ approach on micromanagement arguments for purposes of the ordinary business exclusion in Rule 14a-8(i)(7);
outlines the Staff’s view regarding application of the economic relevance exclusion in Rule 14a-8(i)(5), which reverses the Prior SLBs’ approach that proposals raising social concerns could be excludable where not economically or otherwise significant to the company;
republishes prior guidance regarding the use of graphics and images;
furthers the Staff’s retreat in applying the procedural requirements of Rule 14a-8 by reflecting more leniency in interpreting proof of ownership letters and suggesting the use of a second deficiency notice in certain circumstances; and
provides new guidance on the use of email for submission of proposals, delivery of deficiency notices and responses (encouraging a bilateral use of email confirmation receipts by companies and shareholder proponents alike).

The new guidance was issued with the 2022 shareholder proposal season already underway and – unlike with many past Staff Legal Bulletins – was not previewed or discussed in advance at the traditional “stakeholders” meeting with proponents and companies (as the Staff did not host such a meeting this year). As a result, SLB 14L injects more uncertainty for companies evaluating shareholder proposals under Rule 14a-8 and further clouds an already opaque no-action review process. The Staff states that SLB 14L is intended to streamline and simplify the Staff’s process for reviewing no-action requests, and to clarify the standards the Staff will apply. Notably, however, the Staff has not addressed changes to its process for responding to no-action letters, including its 2019 decision to no longer issue individual responses explaining its views on each no-action request, which has been decried by both proponents and companies.

Summary of the New Staff Guidance

In SLB 14I, the Staff addressed standards for evaluating both the ordinary business exclusion and the economic relevance exclusion, including challenges in determining whether a particular proposal focused on a policy issue that was sufficiently significant to the company’s business. SLB 14I also introduced the concept of a board analysis by a company to buttress its no-action analysis on whether a proposal raised a significant policy issue or was relevant to a company’s business. Subsequently, SLB 14J and SLB 14K provided further interpretive gloss on these bases for exclusion, including the use of a “delta” analysis to distinguish whether a proposal’s request represented a significant variance from actions already taken by a company. SLB 14J and SLB 14K also provided the Staff’s expanded view of when proposals could be excluded on the basis of micromanagement (leading to a notable increase in climate proposals subsequently being excluded based on micromanagement). New SLB 14L tosses all of that guidance and analysis and announces, among other things, the Staff’s intent to apply a “realigned” approach to analyzing significance and social policy issues.

Changes to the Application of the Ordinary Business Exclusion in Rule 14a-8(i)(7).

Company-Specific Approach to Significance is Out; Significant Social Policy Issues are Back; and Board and Delta Analyses are No Longer Necessary.

SLB 14L begins with a rebuke of the Staff’s more recent company-specific approach to significance, as articulated and developed in the Prior SLBs. The Staff expressed its current view that this approach has placed undue emphasis on evaluating the significance of a policy issue to a particular company at the expense of whether or not the proposal focuses on a significant social policy, noting too that such approach did not always yield “consistent, predictable results.” SLB 14L states that, going forward, the Staff plans to “realign” its approach with the standard outlined in Release No. 34-12000 (Nov. 22, 1976), and which the Commission subsequently reaffirmed in Release No. 34-40018 (May 21, 1998) (the “1998 Release”), which SLB 14L interprets as having the Staff focus on the social policy significance of the issue that is the subject of the proposal, including considering whether the proposal raises issues with a broad societal impact such that they transcend the company’s ordinary business.

It is unclear how much this reflects a return to past interpretations under Rule 14a-8(i)(7), or represents a wholesale abandonment of any assessment of relevance of a proposal to a company’s business (as compared to relevance to society at large). Notably, SLB 14L states that the Staff “will no longer focus on determining the nexus between a policy issue and the company.” However, the “nexus” concept was embedded in the 1998 Release, as stated in Staff Legal Bulletin 14E (Oct. 27, 2009), at footnote 4 (citing the 1998 Release), and reaffirmed in Staff Legal Bulletin 14H (Oct. 22, 2015). Ominously, SLB 14L states that it also supersedes any earlier Staff Legal Bulletin to the extent the views expressed therein are contrary to the views expressed in SLB 14L. Indeed, SLB 14L concedes that its “realigned” approach will result in nullifying certain recent precedent, citing specifically to a shareholder proposal that raised human capital management issues but which was determined excludable under Rule 14a-8(i)(7) because the proponent failed to demonstrate that the issue was significant to the company.[1]

In connection with the Staff’s rejection of the company-specific approach to evaluating significance, SLB 14L also rejects the use of board analyses and “delta” analyses by companies in their no-action requests. Specifically, the Staff no longer expects a board analysis as part of demonstrating that a proposal is excludable under the ordinary business exclusion, referring to the board analysis as both a distraction from the proper application of Rule 14a-8(i)(7) and as muddying the application of the substantial implementation standard under Rule 14a-8(i)(10) (in situations where the board analysis involved a “delta” component).

Hitting the Brakes on Micromanagement.

The Staff determined that recent application of the micromanagement exclusion, as outlined in SLB 14J and SLB 14K, expanded the concept of micromanagement beyond the Commission’s intent, and SLB 14L specifically rescinds guidance suggesting that any limit on a company’s or board’s discretion constitutes micromanagement. The new guidance indicates that the Staff “will take a measured approach” to evaluating micromanagement arguments, stating that proposals seeking detail, suggesting targets, or seeking to promote time frames for methods do not per se constitute impermissible micromanagement, provided that the proposals afford discretion to management as to how to achieve the desired goals. The Staff will instead focus on the level of granularity sought by the proposal and whether and to what extent it inappropriately limits discretion of the board or management. Moreover, the Staff states that it expects proposals to include the level of detail required to enable investors to assess a company’s impact, progress towards goals, risk or other strategic matters.

While much of the language surrounding the Staff’s new application of the micromanagement exclusion relates to climate change shareholder proposals, including a reference to the Staff’s decision in ConocoPhillips Co. (Mar. 19, 2021)[2] as an example of the Staff’s current approach to micromanagement, SLB 14L also addresses the Staff’s views on the micromanagement exclusion generally. For example, the Staff states that in order to assess whether a proposal probes too deeply into matters of a complex nature, the Staff “may consider the sophistication of investors generally on the matter, the availability of data, and the robustness of public discussion and analysis on the topic” as well as “references to well-established national or international frameworks when assessing proposals related to disclosure, target setting, and timeframes as indicative of topics that shareholders are well-equipped to evaluate.”[3]

The Staff explained that these changes are designed to help proponents navigate Rule 14a-8: enabling them to craft proposals with sufficient specificity and direction to avoid exclusion under substantial implementation (Rule 14a-8(i)(10)), while being general enough to avoid exclusion under micromanagement. The foregoing should come as no surprise given the Commission’s numerous public statements indicating that climate change and social issues are a priority.[4]

Changes to the Application of the Economic Relevance Exclusion in Rule 14a-8(i)(5).

SLB 14L announces the Staff’s return to a pre-SLB 14I approach to interpreting the economic relevance exclusion under Rule 14a-8(i)(5), in what the Staff described as consistent with Lovenheim v. Iriquois Brands, Ltd.[5] As a result, shareholder proposals that raise issues of broad social or ethical concern related to the company’s business may not be excluded, even if the relevant business falls below the economic thresholds in Rule 14a-8(i)(5). Relatedly, a board analysis (which had been largely used to demonstrate the qualitative insignificance of the subject matter of the proposal vis-à-vis the company) will no longer be necessary.

The Staff Reaffirms its Views on the Use of Images in Shareholder Proposals, Including When Exclusion is Appropriate.

SLB 14L republishes the Staff’s guidance on the use of images in shareholder proposals, previously set forth in SLB 14I. The guidance appears to have been republished simply to preserve the Staff’s views on this topic since SLB 14I is rescinded.

In short, the Staff continues to believe that Rule 14a-8(d) does not preclude shareholders from using graphics and/or images to convey information about their proposal. That said, recognizing the potential for abuse in this area, the Staff also reaffirmed its views on when exclusion of such graphics/images would be appropriate under Rule 14a-8(i)(3), and that it is appropriate to include any words used in the graphics towards the total proposal word count for purposes of determining whether or not the proposal exceeds 500 words. Helpfully, SLB 14L indicates that companies do not need to give greater prominence to proponent graphics than to their own, and may reprint graphics in the same colors used by the company for its own graphics.

The Staff Reaffirms its Plain Meaning Approach to Interpreting Broker Letters; Adds New Burden for Companies.

In SLB 14K, the Staff explained its approach to interpreting proof of ownership letters; namely, that it takes a “plain meaning” approach to interpreting the text of proof of ownership letters and generally finds arguments to exclude based on “overly technical reading[s]” unpersuasive.[6] SLB 14L largely republishes and reaffirms the Staff’s prior guidance in this regard, with two notable exceptions.

First, the guidance provides an updated, suggested (but not required) format for shareholders and their brokers or banks to follow when supplying proof of ownership. In this regard, the updated language references the new ownership thresholds reflected in the Commission’s 2020 rulemaking. The format is as follows:

As of [date the proposal is submitted], [name of shareholder] held, and has held continuously for at least [one year] [two years] [three years], [number of securities] shares of [company name] [class of securities].[7]

Consistent with prior guidance, SLB 14L provides that use of the aforementioned format “is neither mandatory nor the exclusive means of demonstrating ownership” under Rule 14a-8(b), and that “companies should not seek to exclude a shareholder proposal based on drafting variances in the proof of ownership letter if the language used in such letter is clear and sufficiently evidences the requisite minimum ownership requirements.”[8] The Staff also confirms that the recent amendments to the ownership standards under Rule 14a-8 are not intended to change the nature of proof of ownership provided by proponents’ brokers and banks.

Second, and more notably, the guidance suggests that if, after receiving an initial deficiency letter from a company, a shareholder returns a deficient proof of ownership, the Staff believes that the company should identify such defects explicitly in a follow-up deficiency notice. SLB 14L provides no citation in support of this position, and it does not attempt to reconcile the position with decades of precedent that are based on the language of Rule 14a-8, which ties the deadlines for addressing a deficiency notice to when a proposal is first submitted. Since in many cases a company may not receive a proponent’s response to a deficiency notice within 14 days of the date that the proposal was received by the company, it is unclear whether the Staff intends this process to impose obligations on companies that are outside the scope of Rule 14a-8 and presents a quandary on whether companies need to follow new procedures beyond those expressly provided for in Rule 14a-8.

Guidance on the Use of Email Communications.

The new guidance recognizes the growing reliance by proponents and companies alike on the use of emails to submit proposals and make other communications. Consistent with prior no-action letter precedent in this area, SLB 14L provides that, unlike third-party mail delivery (which provides the sender with a proof of delivery), methods for email confirmation of delivery may vary. In particular, the Staff states its view that email delivery confirmations and company server logs may not be sufficient to prove receipt of emails as they only serve to prove that emails were sent. In light of this, the Staff suggests that both parties increasingly rely on email confirmation from the recipient expressly acknowledging receipt. The Staff encourages both companies and shareholder proponents to acknowledge receipt of emails when requested, and it suggests the use of email read receipts (if received by the sender).

The Staff goes on to specifically address the use of email for submission of proposals, delivery of deficiency notices, and submitting responses to such notices. In regards to submissions, the Staff encourages shareholders to submit a proposal by means that permit them to prove the date of delivery, including electronic means (though the Staff acknowledges the inherent risk of using email exclusively as a means of submission in the event timely receipt is disputed and if the proponent does not receive confirmation of receipt from the company). If a company does not provide an email address for receiving proposals in its proxy statement, shareholders are encouraged to contact the company to obtain the proper email address. Similarly, if companies use email to deliver deficiency notices, they are encouraged to seek a confirmation of receipt from the proponent, since the company has the burden of proving timely delivery of the notice. Likewise, if a shareholder uses email to respond to a company’s deficiency notice, the burden to show receipt is on the shareholder, and therefore shareholders are encouraged both to use an appropriate company email address and to seek confirmation of receipt.

Commissioners’ Dissent Underscores Deep Divisions within the Commission.

Chair Gensler publicly endorsed the Staff’s new guidance,[9] asserting that SLB 14L will provide greater clarity to companies and shareholders on when certain exclusions may or may not apply. At the same time, Republican Commissioners Hester M. Pierce and Elad L. Roisman (the “Commissioners”) released a joint statement that articulated their concerns regarding the Staff’s new guidance.[10] First, the Commissioners expressed disappointment at SLB 14L’s explicit singling out of proposals “squarely raising human capital management issues with a broad societal impact,” and proposals that “request[] companies adopt timeframes or targets to address climate change” as likely non-excludable.[11] Second, the Commissioners said that the actions of the Staff in publishing the guidance were the result of the current Commission’s “flavor-of-the-day regulatory approach.”[12] Next, the Commissioners espoused the belief that SLB 14L ultimately creates significantly less clarity for companies, dramatically slows down the Rule 14a-8 no-action request process and wastes taxpayer dollars on shareholder proposals that “involve issues that are, at best, only tangential to our securities laws.”[13] Finally, the Commissioners noted that they would be open to either shifting responsibility for the no-action process from the Staff to the Commission directly, or even amending Rule 14a-8 to excise the Commission and Staff from the process altogether. These views, taken together, demonstrate a clear division among the Commission, right down political party lines, on matters relating to shareholder proposals.

Takeaways

While the practical consequences of the Staff’s new interpretive guidance will likely become clearer over time, this much is evident: the Staff’s latest guidance cements the end of the Trump-era Commission and is a bellwether for the challenging shareholder proposal season that awaits companies, particularly with respect to climate and social proposals, as well as the nature of changes that we might expect to see later in 2022 when the Commission revisits Rule 14a-8 rulemaking.[14] In many respects, SLB 14L serves up what the proponent community has been asking for. For example, shareholder proponents have long argued that the Staff should not be involved in assessing the relevancy of a social policy issue for a company – that shareholders can do so through their voting – and SLB 14L appears to lean in that direction. Similarly, after stating in the Prior SLBs that the extent to which a proposal dealt with a “complex” topic was not a determinative factor under a micromanagement analysis, SLB 14L now suggests that complexity was relevant and that it will be assessing that matter differently. Further, it is notable that SLB 14L follows a shareholder proposal season in which the Staff failed to host its annual “stakeholders” meeting, which historically has been an annual opportunity for various parties that are part of the shareholder proposal process to dialogue with the Staff and each other about Rule 14a-8 issues.

In light of the guidance set forth in SLB 14L, we urge public companies to keep the following in mind.

Companies May Need to Send a Second Deficiency Letter in Certain Circumstances. Excluding proposals based on a shareholder proponent’s failure to satisfy the Rule 14a-8 procedural requirements just got harder. The new Staff guidance increases the burden on companies by now suggesting that they may need to send a second deficiency notice in certain situations.[15] Now, even when a proponent only sends ownership proof in response to a company’s deficiency notice requesting such documentation, companies will need to evaluate whether to send a second notice to the proponent identifying any defects in such proof of ownership. At a minimum, this will prolong the uncertainty for companies on whether a proponent has demonstrated eligibility to submit a proposal, and places significant pressure on subsequently challenging eligibility within the time periods set forth in Rule 14a-8. Similarly, while the Staff has objected in years past to arguments to exclude proposals based on minor issues, new SLB 14L reiterates that fact and suggests that the Staff intends for companies to actively assist proponents in complying with well-established procedural requirements.
Companies Should Continue to Send Deficiency Notices Via Mail (and Email). In spite of the Staff’s well-intended guidance encouraging the use of email, because there can be no guarantee that a proponent will promptly confirm receipt via email, companies seeking certainty should continue to send deficiency letters via a means that enables them to indisputably prove receipt by the proponent (g., overnight mail). That said, some companies may be comfortable with email communications alone depending on the specific shareholder proponent and the nature of their relationship with the company.
The Staff Appears Poised to Enforce the New Ownership Thresholds. Although the 2020 amendments to Rule 14a-8 are now in effect for meetings held after January 1, 2022, the Staff has not yet affirmed or denied any no-action requests seeking relief based on any of the amended Rule 14a-8 requirements. That said, despite litigation[16] suggesting that the Staff should not enforce the amended rules, SLB 14L expressly acknowledges the new tiered ownership thresholds (as part of the revised format provided for proof of ownership letters), suggesting that the Staff may concur with exclusion of proposals based on failure to comply with the new one-, two- and three-year ownership requirements.[17]
The Staff Will Once Again be Positioned as Arbiter of Social Issues. Gone is the company-specific approach to analyzing significance under the ordinary business exclusion, and back in vogue are topically significant policy issues, as determined by the Staff. Determining what constitutes a significant policy issue will be all the more difficult to predict and discern given the Staff’s increased reliance on the shareholder proposal no-action response chart[18] and reluctance to issue response letters explaining their reasoning.[19]
Let’s Call it What it is: Open Season for Environmental and Social Proposals. The Staff’s new guidance is likely to lead to an increase in the submission of social, political and environmental shareholder proposals and to an increase in the number of such proposals being included in proxy statements.

___________________________

[1] See Dollar General Corp. (Mar. 6, 2020).

[2] In ConocoPhillips Co., a decision that was inconsistent with the Staff’s position in recent proxy seasons, the Staff denied a request to exclude a shareholder proposal that requested that the company set emission reduction targets. In its only written response letter of the season on this topic, the Staff indicated that the proposal did not impose a specific method and thus did not micromanage to such a degree that exclusion was warranted under Rule 14a-8(i)(7).

[3] See SLB 14L.

[4] In this regard, and as already described in Gibson Dunn’s client alert of June 21, 2021, the SEC’s recently announced rulemaking agenda highlights the SEC’s near-term focus on prescribing climate change disclosure.

[5] 618 F. Supp. 554 (D.D.C. 1985).

[6] See SLB 14L.

[7] Id.

[8] Id.

[9] See Chair Gary Gensler, Statement regarding Shareholder Proposals: Staff Legal Bulletin No. 14L, SEC (Nov. 3, 2021), available here.

[10] See Commissioner Hester M. Peirce & Commissioner Elad L. Roisman, Statement on Shareholder Proposals: Staff Legal Bulletin No. 14L, SEC (Nov. 3, 2021), available here.

[11] Id. (quoting SLB 14L)

[12] Id.

[13] Id.

[14] See Agency Rule List – Spring 2021 Securities and Exchange Commission, Office of Information and Regulatory Affairs (2021), available here, as discussed in Gibson Dunn’s client alert of August 19, 2021.

[15] In this regard, 37% of all successful no-action requests were granted based on procedural grounds in 2021 and the overall success rate for procedural arguments was 84% and 80% in 2021 and 2020, respectively, as discussed in Gibson Dunn’s client alert of August 19, 2021.

[16] Compl., Interfaith Ctr. on Corp. Responsibility v. SEC, No. 1:21-cv-01620-RBW (D.D.C. June 15, 2021), ECF No. 1.

[17] The Commission’s deadline to submit its response in the aforementioned litigation involving Interfaith Ctr. on Corp. Responsibility, As You Sow and James McRitchie is November 19, 2021.

[18] Available here.

[19] As discussed in Gibson Dunn’s client alert of August 19, 2021, the number of Staff response letters declined significantly in 2021, with the Staff providing response letters only 5% of the time during the 2021 proposal season, compared to 18% in 2020.

The following Gibson Dunn attorneys assisted in preparing this update: Courtney Haseley, Elizabeth Ising, Thomas Kim, Ronald Mueller and Lori Zyskowski.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following lawyers in the firm’s Securities Regulation and Corporate Governance practice group:

Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)
David Korvin – Washington, D.C. (+1 202-887-3679, dkorvin@gibsondunn.com)
Geoffrey Walter – Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com)

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

Yesterday, the proxy advisory firm Institutional Shareholder Services (“ISS”) proposed and published for comment voting policy changes for the 2022 proxy season. There are five proposed updates that would apply to U.S. companies, including two related to “Say on Climate” proposals and a third related to climate issues.

In addition, ISS is proposing (starting in 2023) to begin issuing negative voting recommendations for directors at all companies with multi-class stock structures. Companies that went public before 2015 would no longer be grandfathered under ISS policy. ISS is requesting comment on whether to take a similar approach for companies that have other “poor” governance practices—specifically, a classified board, or the requirement of a supermajority vote to amend the governing documents.

The proposed U.S. policy changes are available here and are summarized below. Comments on the proposals can be submitted by e-mail to policy@issgovernance.com until 5 p.m. ET on November 16, 2021. ISS will take the comments into account as part of its policy review and expects to release final changes to its voting policies by or around the end of November. It is important to note that ISS’s final 2022 proxy voting policies may reflect additional changes, beyond those on which ISS is soliciting comment. The final voting policies will apply to shareholder meetings held on or after February 1, 2022, except for policies subject to transition periods.

Comments submitted to ISS may be published on its website, unless requested otherwise in the body of email submissions.

Read More

The following Gibson Dunn attorneys assisted in preparing this update: Ronald Mueller, Elizabeth Ising, and Lori Zyskowski.

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

On November 1, 2021, the President’s Working Group on Financial Markets,[1] joined by the Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC), issued its expected report (Report) on stablecoins, a type of digital asset that has recently grown significantly in market capitalization and importance to the broader digital asset markets.[2]

Noting gaps in the regulation of stablecoins, the Report makes the following principal recommendations:

Congress should promptly enact legislation to provide a “consistent and comprehensive” federal prudential framework for stablecoins –
- Stablecoin issuers should be required to be insured depository institutions
- Custodial wallet providers that hold stablecoins on behalf of customers should be subject to federal oversight and risk-management standards
- Stablecoin issuers and wallet providers should be subject to restrictions on affiliations with commercial entities.
In the absence of Congressional action, the Financial Stability Oversight Council (FSOC) should consider steps to limit stablecoin risk, including designation of certain stablecoin activities as systemically important payment, clearing, and settlement activities.

The Report thus calls for the imposition of bank-like regulation on the world of stablecoins, and it does so with a sense of urgency. Below we summarize the Report’s key conclusions and recommendations, and then preview the path forward if the FSOC is to take up the Report’s call to action.

Stablecoins

A stablecoin is a digital asset that is created in exchange for fiat currency that a stablecoin issuer receives from a third-party; most stablecoins offer a promise or expectation that the stablecoin can be redeemed at par on request. Although certain stablecoins are advertised as being backed by “reserve assets,” there are currently no regulatory standards governing such assets, which can range on the risk spectrum from insured bank deposits and Treasury bills to commercial paper, corporate and municipal bonds, and other digital assets. Indeed, in October, the CFTC took enforcement action against the issuers of US Dollar Tether (USD Tether) for allegedly making untrue or misleading statements about USD Tether’s reserves.[3]

The market capitalization of stablecoins has grown extremely rapidly in the last year; according to the Report, the largest stablecoin issuers had, as of October, a market capitalization exceeding $127 billion.[4] The Report states that stablecoins are predominantly used in the United States to facilitate the trading, lending, and borrowing of other digital assets – they replace fiat currency for participants in the trading markets for Bitcoin and other digital assets and allow users to store and transfer value associated with digital asset trading, lending, and borrowing within distributed ledger environments.[5] The Report further notes that certain stablecoin issuers believe that stablecoins should be used in the payment system, both for domestic goods and services, and for international remittances.[6] Stablecoins, the Report asserts, are also used as a source of collateral against which participants in the digital assets markets can borrow to fund additional activity, “sometimes using extremely high leverage,” as well as to “earn yield,” by using stablecoins as collateral for extending loans and engaging in margined transactions.[7]

Perceived Risks of Stablecoins

The Report views the stablecoin market as currently having substantial risks not subject to regulation.

First, the Report asserts that stablecoins have “unique risks” associated with secondary market activity and market participants beyond the stablecoin issuers themselves, because most market participants rely on digital asset trading platforms to exchange stablecoins with national currencies and other stablecoins.[8] In addition, the Report states that the active trading of stablecoins is part of an essential stabilization mechanism to keep the price of the stablecoin close to or at its pegged value.[9] It further asserts that digital asset trading platforms typically hold stablecoins for customers in non-segregated omnibus custodial wallets and reflect trades on internal records only, and that such platforms and their affiliates may also engage in active trading of stablecoins and as market makers.[10]

Second, the Report argues that stablecoins play a central role in Decentralized Finance (DeFi). It gives two examples – first, stablecoins often are one asset in a pair of digital assets used in “automated market maker” arrangements, and second, they are frequently “locked” in DeFi arrangements to garner yield from interest payments made by persons borrowing stablecoins for leveraged transactions.[11]

As a result, the Report describes a range of risks arising from stablecoins, including risks of fraud, misappropriation, and conflicts of interest and market manipulation; the risk that failure of disruption of a digital asset trading platform could threaten stablecoins; the risk that failure or disruption of a stablecoin could threaten digital asset trading platforms; money laundering and terrorist financing risks; risks of excessive leverage on unregulated trading platforms; risks of non-compliance with applicable regulations; risks of co-mingling trading platform funds with funds of customers; risks flowing from information asymmetries and market abuse; risks from unsupervised trading; risks from distributed-ledger based arrangements, including governance, cybersecurity, and other operational risks; and risks from novel custody and settlement processes.[12]

The Report also notes the risk of stablecoin “runs” that could occur upon loss of confidence in a stablecoin and the reserves backing it, as well as risks to the payment system generally if stablecoins became an important part of the payment system. The Report notes that “unlike traditional payment systems where risk is managed centrally by the payment system operator,” some stablecoin arrangements feature “complex operations where no single organization is responsible or accountable for risk management and resilient operation of the entire arrangement.”[13]

Finally, the Report asserts that the rapid scaling of stablecoins raises three other sets of policy concerns. First is the potential systemic risk of the failure of a significant stablecoin issuer or key participant in a stablecoin arrangement, such as a custodial wallet provider.[14] Second, the Report points to the business combination of a stablecoin issuer or wallet provider with a commercial firm as raising economic concentration concerns traditionally associated with the mixing of banking and commerce.[15] Third, the Report states that if a stablecoin became widely accepted as a means of payment, it could raise antitrust concerns.[16]

Recommendations

The Report’s key takeaway is that the President’s Working Group, the OCC and the FDIC believe that there are currently too many regulatory gaps relating to stablecoins and DeFi. The Report does note that, in addition to existing anti-money laundering and anti-terrorist financing regulations, stablecoin activities may implicate the jurisdiction of the SEC and CFTC, because certain stablecoins may be securities or commodities. Indeed, the CFTC just recently asserted that Bitcoin, Ether, Litecoin and USD Tether are commodities.[17] Nonetheless, the Report states that as stablecoin markets continue to grow, “it is essential to address the significant investor and market risks that could threaten end users and other participants in stablecoin arrangements and secondary market activity.”[18]

The Report therefore calls for legislation to close what it sees as the critical gaps. First, it argues that stablecoin issuance, and the related activities of redemption and maintenance of reserve assets, should be limited to entities that are insured depository institutions: state and federally chartered banks and savings associations that are FDIC insured and have access to Federal Reserve services, including emergency liquidity.[19] Legislation should also ensure that supervisors have authority to implement standards to promote interoperability among stablecoins.[20] Given the global nature of stablecoins, the Report contends that legislation should apply to stablecoin issuers, custodial wallet providers, and other key entities “that are domiciled in the United States, offer products that are accessible to U.S. persons, or that otherwise have a significant U.S. nexus.”[21]

Second, given the Report’s perceived risks of custodial wallet providers, the Report argues that Congress should require those providers to be subject to “appropriate federal oversight,” including restricting them from lending customer stablecoins and requiring them to comply with appropriate risk-management, liquidity, and capital requirements.[22]

Third, because other entities may perform activities that are critical to the stablecoin arrangement, the Report argues that legislation should provide the supervisor of a stablecoin issuer with the authority to require any entity that performs activities “critical to the functioning of the stablecoin arrangement” to meet appropriate risk-management standards, and give the appropriate regulatory agencies examination and enforcement authority with respect to such activities.[23]

Finally, the Report advocates that both stablecoin issuers and wallet providers should, like banks, be limited in their ability to affiliate with commercial firms.[24]

Interim Measures

The Report characterizes the need for legislation as “urgent.” While legislation is being considered, the Report recommends that the Financial Stability Oversight Council (FSOC) consider taking actions within its jurisdiction, such as designating certain activities conducted within stablecoin arrangements as systemically significant payment, clearing, and settlement activities.[25] The Report states that such designation would permit the appropriate federal regulatory agency to establish risk-management requirements for financial institutions[26] that engage in the designated activities.

Such designations would occur pursuant to Title VIII of the Dodd-Frank Act, and it would be the first time that the FSOC would make them.[27] The procedure that the FSOC must follow is set forth in Title VIII, and, absent an emergency, it appears that it would not be a quick one. First, the FSOC must consult with the relevant federal supervisory agencies and the Federal Reserve.[28] Next, it must provide notice to the financial institutions whose activities are to be designated, and offer those institutions the opportunity for a hearing.[29] The institutions may then choose to appear, personally or through counsel, to submit written materials, or, at the sole discretion of FSOC, to present oral testimony or argument.[30] The FSOC must approve the activity designation by a vote of at least two-thirds of its members, including an affirmative vote by the Chair.[31] The FSOC must consider the designation in light of the following factors: (i) the aggregate monetary value of transactions carried out through the activity, (ii) the aggregate exposure of the institutions engaged in the activity to their counterparties, (iii) the relationship, interdependencies, or other interactions of the activity with other payment, clearing, or settlement activities, (iv) the effect that the failure of or a disruption to the activity would have on critical markets, financial institutions, or the broader financial system, and (v) any other factors that the FSOC deems appropriate.[32]

Conclusion

With the Report, Treasury and the relevant federal agencies – the Federal Reserve, the SEC, CFTC, OCC, and FDIC – have made it clear that they believe that the risks of stablecoin activities are not fully mitigated by existing regulation. Their recommendations for legislation look principally to bringing stablecoins within the banking system and to bank regulation as a means of addressing those risks. It is an open question, however, whether Congress will act, much less with the urgency that the Report desires. Action by the FSOC, moreover, will almost certainly take some time, given the statutory designation procedures. In the near term, therefore, it is likely to fall to the existing agencies with some jurisdiction over stablecoins – the CFTC and SEC – to address the gaps with the tools at their disposal.[33]

__________________________

[1] The Working Group comprises representatives of the Treasury Department (Treasury), Board of Governors of the Federal Reserve System (Federal Reserve), the Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC).

[2] See https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.

[3] See https://www.gibsondunn.com/digital-asset-developments-us-commodity-futures-trading-commission-asserts-that-tether-is-a-commodity/.

[4] Report, at 7. In addition to USD Tether, the most circulated stablecoins are USD Coin, Binance USD, Dai Stablecoin, and TrueUSD. All are pegged to the U.S. dollar.

[5] Id. at 8.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

[11] Id. at 9.

[12] Id. at 10-11.

[13] Id. at 12-13.

[14] Id. at 14.

[15] Id.

[16] Id.

[17] See https://www.gibsondunn.com/digital-asset-developments-us-commodity-futures-trading-commission-asserts-that-tether-is-a-commodity/.

[18] Report, at 11.

[19] Id. at 16. Unless the insured depository institution in question is an industrial bank, requiring the stablecoin issuer to be an insured depository institution would also be a requirement for the issuer’s parent company, if any, to be a bank or thrift holding company supervised and regulated by the Federal Reserve.

[20] Id.

[21] Id. n. 29.

[22] Id. at 17.

[23] Id.

[24] Id.

[25] Id. at 18.

[26] Title VIII defines “financial institution” broadly to reach “any company engaged in activities that are financial in nature or incidental to a financial activity, as described in section 4 of the Bank Holding Company Act,” in addition to banks, credit unions, broker-dealers, insurance companies, investment advisers, investment companies, futures commission merchants, commodity pool operators and commodity trading advisers.

[27] The FSOC has previously undertaken designations of systemically significant nonbank financial companies under Title I of the Dodd-Frank Act and systemically significant financial market utilities under Title VIII of the Dodd-Frank Act.

[28] 12 U.S.C. § 5463(c)(1).

[29] Id. § 5463(c)(2).

[30] Id. § 5463(b)(1).

[31] Id. § 5463(c)(3).

[32] Id. § 5463(a)(2).

[33] In a press release issued just after the Report, the Director of the Consumer Financial Protection Bureau, Rohit Chopra, stated that “stablecoins may . . . be used for and in connection with consumer deposits, stored value instruments, retail and other consumer payments mechanisms, and in consumer credit arrangements. These use cases and others trigger obligations under federal consumer financial protection laws, including the prohibition on unfair, deceptive, or abusive acts or practices.” See https://www.consumerfinance.gov/about-us/newsroom/statement-cfpb-director-chopra-stablecoin-report/.

The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and Jeffrey Steiner.

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

Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Mylan L. Denerstein – New York (+1 212-351- 3850, mdenerstein@gibsondunn.com)
William R. Hallatt – Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Matthew Nunan – London (+44 (0) 20 7071 4201, mnunan@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)

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

This update provides an overview of key class action developments during the third quarter of 2021.

Part I covers two important decisions from the Third and Ninth Circuits regarding the scope of the Section 1 exemption under the Federal Arbitration Act.

Part II addresses a Ninth Circuit decision endorsing the use of a motion to deny class certification at the pleadings stage.

Part III reports on a Fourth Circuit decision vacating a class certification order because of the numerosity requirement.

Part IV discusses a Third Circuit decision rejecting the certification of an “issue” class under Rule 23(c)(4) where the district court did not find that one of the Rule 23(b) factors was satisfied.

And finally, Part V analyzes a Ninth Circuit decision clarifying that a defendant need not raise a personal jurisdiction defense as to a putative absent class member at the outset of a case, and instead can assert that defense for the first time at the class certification stage.

I. The Third and Ninth Circuits Address the Federal Arbitration Act’s Section 1 Exemption

The Third and Ninth Circuits both weighed in this past quarter on the so-called Section 1 exemption in the Federal Arbitration Act (“FAA”), which exempts “workers engaged in foreign or interstate commerce” from having to arbitrate their claims under federal law. 9 U.S.C. § 1. The Section 1 exemption has been the subject of substantial litigation in recent years, particularly in the context of class actions involving “gig” economy workers, and the decisions from the Third and Ninth Circuits provide additional clarity to litigants regarding the scope of this exemption. Gibson Dunn served as counsel to the defendants in both appeals.

In Harper v. Amazon.com Services, Inc., 12 F.4th 287 (3d Cir. 2021), a delivery driver claiming he was misclassified as an independent contractor asserted that he could not be compelled to arbitrate his claim because he and other New Jersey drivers made some deliveries across state lines and therefore qualified for the Section 1 exemption. Id. at 292. The district court deemed that contention to raise a question of fact and it ordered discovery, without examining Amazon’s contention that state law would also require arbitration even if the Plaintiff was exempt from arbitration under the FAA. Id. The Third Circuit vacated the district court’s order and “clarif[ied] the steps courts should follow––before discovery about the scope of § 1—when the parties’ agreement reveals a clear intent to arbitrate.” Id. at 296. Under this three-part framework, a district court must first determine, based on the allegations in the complaint, whether the agreement applies to a class of workers that fall within the exemption. If it is not clear from the face of the complaint, the court must assume § 1 applies and “consider[] whether the contract still requires arbitration under any applicable state law.” Id. If the arbitration clause is unenforceable under state law, only then does the court “return to federal law and decide whether § 1 applies, a determination that may benefit from limited and restricted discovery on whether the class of workers primarily engage in interstate or foreign commerce.” Id.

In Capriole v. Uber Technologies, Inc., 7 F.4th 854 (9th Cir. 2021), the Ninth Circuit addressed whether rideshare drivers are transportation workers engaged in foreign or interstate commerce; it joined the growing number of courts holding that such drivers do not fall within this Section 1 exemption. Although the plaintiffs claimed they fell under the Section 1 exemption because they sometimes cross state lines, and also pick up and drop off passengers from airports who are engaging in interstate travel, the Ninth Circuit held this was not enough to qualify for the exemption. Id. at 863. In particular, the Ninth Circuit cited the district court’s finding that only 2.5% of trips fulfilled by Uber started and ended in different states, and that only 10.1% of trips began or ended at an airport (and not all of the customers’ flights involved interstate travel). Id. at 864. This sporadic interstate movement “cannot be said to be a central part of the class member’s job description,” and thus a driver “does not qualify for the exemption just because she occasionally performs” work in interstate commerce. Id. at 865. The Ninth Circuit’s holding “join[s] the growing majority of courts holding that Uber drivers as a class of workers do not fall within the ‘interstate commerce’ exemption from the FAA.” Id. at 861.

II. The Ninth Circuit Affirms the Granting of a Motion to Deny Class Certification at the Pleadings Stage

The propriety of class certification is typically decided after discovery occurs and the plaintiff moves to certify a class. But in some cases, a defendant can properly move to deny class certification at the outset of a case. That is exactly what the Ninth Circuit endorsed this quarter in Lawson v. Grubhub, Inc., 13 F.4th 908 (9th Cir. 2021), a case in which Gibson Dunn served as counsel for the defendant.

In Lawson, the district court granted the defendant’s motion to deny class certification on the ground that the vast majority of putative class members were bound by arbitration agreements with class action waivers. Lawson, 13 F.4th at 913. The Ninth Circuit affirmed, explaining that because only the plaintiff and one other person had opted out of the arbitration clause and class action waiver in their contracts, the plaintiff was “neither typical of the class nor an adequate representative,” and the proceedings were “unlikely to generate common answers.” Id. The Ninth Circuit also rejected the plaintiff’s argument that the denial of class certification was premature because the plaintiff had not yet moved for certification, and specifically held that Rule 23 “allows a preemptive motion by a defendant to deny class certification.” Id.

III. The Fourth Circuit Addresses the Numerosity Requirement

Plaintiffs seeking class certification often have little trouble satisfying Rule 23(a)(1)’s requirement that “the class is so numerous that joinder of all members is impracticable.” With proposed classes commonly covering thousands or millions of members, appellate courts rarely have an opportunity to address this numerosity requirement. But in certain areas, including in pharmaceutical antitrust class actions, it has become increasingly common for plaintiffs to seek certification of small classes of sophisticated and well-resourced businesses claiming substantial damages. This past quarter, however, the Fourth Circuit vacated an order certifying such a class after finding that the district court had applied an erroneous standard for assessing numerosity. Gibson Dunn represented one of the defendants in this action.

In re Zetia (Ezetimibe) Antitrust Litigation, 7 F.4th 227 (4th Cir. 2021), rejected a district court’s conclusion that a putative class of 35 purchasers of certain prescription drugs had satisfied Rule 23’s numerosity requirement. The court explained that the district court’s numerosity analysis rested on “faulty logic” and neglected to consider that “the text of Rule 23(a)(1) refers to whether ‘the class is so numerous that joinder of all members is impracticable,’ not whether the class is so numerous that failing to certify presents the risk of many separate lawsuits.” 7 F.4th at 234–35 (quoting In re Modafinil Antitrust Litig., 837 F.3d 238 (3d Cir. 2016)). Accordingly, when evaluating numerosity, the question is whether a class action is preferable as compared to joinder—not as compared to the prospect of individual lawsuits. Id. at 235. And with respect to class members’ ability and motivation to litigate, the court emphasized that the proper comparison is not individual suits, but rather whether it is practicable to join class members into a single action. Significantly, the Fourth Circuit emphasized that Rule 23(a)(1) requires plaintiffs to produce evidence that, absent certification of a class, the putative class members would not join the suit and that it would be uneconomical for smaller claimants to be individually joined. Id. at 235–36 & nn. 5 & 6.

IV. The Third Circuit Heightens the Standard for the Certification of “Issue” Classes

Rule 23(c)(4) provides that, “[w]hen appropriate, an action may be brought or maintained as a class action with respect to particular issues.” Some courts have read this language as permitting the certification of classes without a separate showing that the requirements of Rule 23(b)(1), (b)(2), or (b)(3) are satisfied. In practice, this view of Rule 23(c)(4) can permit plaintiffs to bypass the need to establish that common questions predominate. The Third Circuit this quarter refused to adopt such a reading of Rule 23, and instead held that a certification of an “issue” class under Rule 23(c)(4) is not permissible unless one of the Rule 23(b) requirements is also satisfied.

In Russell v. Educational Commission for Foreign Medical Graduates, the Third Circuit reversed a district court’s certification of an “issue” class under Rule 23(c)(4) because the district court had not found that any subsection of Rule 23(b) was satisfied. 15 F.4th 259, 271 (3d Cir. 2021). The court explained that “[t]o be a ‘class action,’ a party must satisfy Rule 23 and all of its requirements,” and concluded that class certification was improperly granted because there had been no determination if Rule 23(b) could be met. Id. at 262, 271–73. Thus, plaintiffs in the Third Circuit seeking to certify an issue-only class under Rule 23(c)(4) must still satisfy the other requirements of Rule 23, including showing that “action is maintainable under Rule 23(b)(1), (2), or (3).” Id. at 267.

V. The Ninth Circuit Holds That a Defendant Does Not Waive a Personal Jurisdiction Defense to Absent Class Members by Not Raising It at the Pleadings Stage

In our First Quarter 2020 Update on Class Actions, we covered decisions from the Fifth and D.C. Circuits holding that the proper time to adjudicate whether a court has personal jurisdiction over absent class members is at the class certification stage, not at the pleading stage. This past quarter, the Ninth Circuit aligned itself with these other Circuits.

In Moser v. Benefytt, Inc., 8 F.4th 872 (9th Cir. 2021), the Ninth Circuit ruled that a defendant can raise a personal jurisdiction objection as to absent class members at the class certification stage, even if the defendant did not raise it in its first responsive pleading. In Moser, a California resident filed a putative nationwide class action alleging that the defendant, a Delaware corporation with its principal place of business in Florida, violated the Telephone Consumer Protection Act by making calls to persons across the country. Id. at 874. When the plaintiff moved to certify a nationwide class, the defendant argued that the district court could not certify a nationwide class because the court lacked personal jurisdiction over any of the non-California plaintiffs’ claims under the Supreme Court’s decision in Bristol-Myers Squibb v. Superior Court, 137 S. Ct. 1773 (2017). But the district court declined to consider the argument, holding that the defendant waived it by failing to raise the objection to personal jurisdiction in its first Rule 12 motion to dismiss. Moser, 8 F.4th at 875.

The Ninth Circuit reversed. It held that the defendant had not waived its personal jurisdiction objection to nationwide certification by not raising it in the first responsive pleading. Id. at 877. The court reasoned that because defendants do not yet have “available” a “personal jurisdiction defense to the claims of unnamed putative class members who were not yet parties to the case” at the pleadings stage, defendants could not waive such an objection before the certification stage. Id. This ruling clarifies that defendants in the Ninth Circuit do not need to raise personal jurisdiction challenges to putative absent class members at the outset of the case, and instead should raise such challenges at the class certification stage.

The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Wesley Sze, Emily Riff, Jeremy Weese, and Dylan Noceda.

Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers:

Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
Lauren M. Blas – Los Angeles (+1 213-229-7503, lblas@gibsondunn.com)

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