Stacy Mitchell, Author at Gibson Dunn

The government successfully argued that trading in the securities of one company based upon material nonpublic information about a separate company (in whose securities the defendant does not trade) can nevertheless violate the federal securities laws.

On April 5, 2024, a civil jury found a former biopharmaceutical executive liable for insider trading under a novel theory with potentially far-reaching implications for the government’s enforcement of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, as well as potential criminal insider trading prosecutions. In a first-of-its-kind trial, in SEC v. Panuwat, the government successfully argued that trading in the securities of one company based upon material nonpublic information about a separate company (in whose securities the defendant does not trade) can nevertheless violate the federal securities laws. This is called “shadow trading.” Although the SEC has been at pains to claim that there is “nothing novel” about the “pure and simple” insider trading theory it advanced in Panuwat,[1] the ruling heralds a significant new application of the federal government’s insider trading authority to prevent such “shadow trading” in which corporate insiders allegedly exploit information about their own companies to profit by trading in the securities of “economically-linked firms.”[2]

Factual Background

Matthew Panuwat served as Senior Director of Business Development at Medivation Inc., a publicly traded biopharmaceutical company specializing in oncology drugs. At the outset of his employment, Mr. Panuwat signed the company’s insider trading policy. That policy provided that he would not “gain personal benefit” by using Medivation’s information to “profit financially by buying or selling” either Medivation’s securities “or the securities of another publicly traded company.”[3] Not all public companies prohibit their personnel (including members of the Board of Directors) from trading in the securities of other public companies or competitors. Medivation did.

As alleged by the government, on August 18, 2016, Mr. Panuwat and other senior employees received an email from David Hung, Medivation’s chief executive officer, suggesting that a deal was imminent in which Medivation would be purchased by Pfizer. Although market participants already knew that Medivation had been fielding offers for several months, the SEC alleged that Hung’s email contained several pieces of non-public information. Mr. Panuwat, who had been part of the Medivation deal team, knew that the bids from potential acquirers including Pfizer represented a substantial premium over the then-existing market price for Medivation shares. Seven minutes after receiving Mr. Hung’s email, Mr. Panuwat began purchasing call options for Incyte Corporation, one of a handful of similar publicly traded biopharmaceutical companies focused on late-stage oncology treatments. When Pfizer’s acquisition of Medivation was publicly announced a few days later, Incyte’s stock increased 7.7% and Mr. Panuwat made approximately $110,000 from his call options.

On August 17, 2021, the SEC brought an action against Mr. Panuwat for insider trading under Section 10(b) of the Exchange Act, alleging a single violation of Rule 10b-5.

The District Court Denied Mr. Panuwat’s Motion to Dismiss

Mr. Panuwat moved to dismiss the SEC’s complaint on multiple grounds, including that the SEC’s unprecedented “shadow trading” theory sought to hold him liable for trading in Incyte’s securities as a result of his knowledge of the Pfizer-Medivation acquisition violated his constitutional right to Due Process. Mr. Panuwat argued that such a theory had never before been advanced in litigation. According to this line of argument, market participants had not previously understood that “confidential information regarding an acquisition involving Company A should also be considered material to Company B (and presumably companies C, D, E, etc.) that operate within the same general industry.”[4] Although the Court agreed that there “appear to be no other cases” supporting that proposition, and the SEC “conceded this at oral argument,” the Court nevertheless rejected this Due Process argument. The Court held that the SEC’s theory fell “within the general framework of insider trading, and the expansive language” of federal securities laws.[5]

The lengthiest portion of the Court’s decision, as well as the parties’ briefing, concerned whether information regarding the Pfizer-Medivation acquisition was material to Incyte. Mr. Panuwat argued that the information he received was not “about” Incyte, a non-party to the imminent transaction.[6] But the Court concluded that “given the limited number of mid-cap, oncology-focused biopharmaceutical companies with commercial-stage drugs in 2016, the acquisition of one such company (Medivation) would make the others (i.e., Incyte) more attractive, which could then drive up their stock price.” The Court stated that it was “reasonable to infer” that other companies that had unsuccessfully attempted to acquire Medivation “would turn their attention to Incyte” after losing out to Pfizer.[7] And, more broadly, in dicta the Court endorsed the SEC’s “common-sense” argument that “information regarding business decisions by a supplier, a purchaser, or a peer can have an impact on a company” and therefore be material—a potentially far-reaching endorsement of the SEC’s novel “shadow trading” theory.[8]

In addition, the parties agreed that Mr. Panuwat owed a duty to Medivation in light of his role as a senior executive of the company. That supported the SEC’s theory that he could be liable for misappropriating Medivation’s material non-public information concerning its impending acquisition. Although Mr. Panuwat argued that trading Incyte securities did not violate his duties to Medivation, the Court disagreed. At the pleading stage, the Court relied on “the plain language” of Medivation’s insider trading policy prohibiting trading “‘the securities of another publicly traded company, including . . . competitors” of Medivation, which could be read to include Incyte.[9] The Court further found that scienter could be reasonably inferred given that Mr. Punawat allegedly traded the Incyte call options “within minutes” of receiving Mr. Hung’s email but had “never traded Incyte stock before.”[10]

A Jury Agrees Mr. Panuwat’s Trading Falls Within the SEC’s “Shadow Trading” Theory

In November 2023, the Court denied Mr. Panuwat’s motion for summary judgment. The Court found that a key question for the jury was whether the SEC could prove “a connection between Medivation and Incyte” such that “a reasonable investor would view the information in the Hung Email as altering the ‘total mix’ of information available about Incyte.”[11] In particular, the Court recognized at least three ways in which the SEC might be able to prevail on this question of fact. First, it recognized that the SEC had introduced several “analyst reports and financial news articles” that “repeatedly linked Medivation’s acquisition to Incyte’s future.”[12] Mr. Panuwat tried to sever this link by arguing that Medivation and Incyte did not consider themselves competitors because they offered somewhat different products. The Court, however, rejected this argument because “no legal authority suggest[ed] that a reasonable investor would conclude that Medivation’s acquisition would only affect the stock price of companies that directly competed” with it.[13] Second, the SEC introduced evidence that “Medivation’s investment bankers considered Incyte a ‘comparable peer’” for valuation purposes because both were mid-cap biopharmaceutical companies with cancer-related drugs.[14] Third, the Court found that Incyte’s stock price increased by 7.7% after announcement of the Pfizer-Medivation acquisition, which the Court inferred was itself “strong evidence” investors understood “the significance of that information” as being material to Incyte.[15]

SEC v. Panuwat proceeded to an eight-day jury trial that began on March 25, 2024. After only about two hours of deliberation, on April 5, the jury returned a verdict finding that Mr. Panuwat’s purchase of Incyte call options constituted insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. That same day the SEC issued a press release noting that the brevity of the jury’s deliberations supported the SEC’s position since the outset of the litigation, quoting Division of Enforcement Director Gurbir S. Grewal as saying that, “As we’ve said all along, there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple” because Mr. Panuwat “used highly confidential information about an impending announcement” of Medivation’s acquisition “to trade ahead of the news for his own enrichment” by using “his employer’s confidential information to acquire a large stake in call options” of Incyte, which “increased materially on the important news.”[16]

Depending on the Appellate Court, “Shadow Trading” Liability May Be Here to Stay

Pending the results of the anticipated appeal, the successful prosecution of Mr. Panuwat has armed the federal government with a powerful new precedent. Academic studies have claimed to find “robust evidence” that “shadow trading” is a frequent real-world phenomena in which “employees circumvent insider trading regulations” by “trading in their firm’s business partners and competitors” rather than trading in their own employers’ securities.[17] The district court’s detailed rulings in SEC v. Panuwat provide a clear blueprint for the government’s approach moving forward. Further, the jury’s findings against Mr. Panuwat after deliberating for only a few hours provides anecdotal evidence that litigating “shadow trading” cases is a viable option for government regulators and prosecutors.

Depending on whether Mr. Panuwat appeals the decision (as expected), legal and compliance professionals would be well-advised to continue to keep “shadow trading” issues in mind when designing, revising and implementing their firms’ trading policies and training programs. Indeed, anyone who trades in securities while in possession of material non-public information—including corporate insiders and directors, bankers, accountants, and lawyers, among others—could find themselves within the zone of a “shadow trading” theory. In addition, commencing with annual reports on Forms 10-K for fiscal years beginning on or after April 1, 2023, public companies will need to file as an exhibit to their Form 10-Ks any “insider trading policies and procedures governing the purchase, sale, and/or other dispositions of the registrant’s securities” that “are reasonably designed to promote compliance with insider trading laws, rules and regulations.”[18] While this requirement does not literally apply to policies addressing the trading of other companies’ securities, some companies have policies (as with Medivation) that address such trading.[19] Companies should carefully consider all factors in deciding whether to prohibit trading in other securities, and conduct training of insiders and board members as to the SEC’s expansive views on the scope of the law against insider trading.

Moreover, the securities laws impose obligations on SEC-registered firms, namely investment advisers and broker-dealers, to adopt and implement policies and procedures reasonably designed to prevent the misuse of material nonpublic information. Such firms can often be confronted with questions as to the scope of a restriction imposed by the receipt of material nonpublic information subject to a duty of confidentiality, while simultaneously fulfilling fiduciary duties to manage assets in the interests of clients. Such questions can arise at the inception of a trading restriction as well as at later points during the period of restriction. Judgments about the materiality of information about one company to the price of securities of another company are particularly nuanced and complicated. For example, it can be difficult to determine whether favorable news about one company will have a positive or negative impact on a competitor. Hanging over all of this is the ever-present risk that the SEC views the facts with the benefit of hindsight. Legal and compliance functions at investment advisers and broker-dealers may wish to revisit their policies and procedures in light of the shadow trading risk, as well as train their investment professionals to be sensitized to the risks the case highlights.

As always, Gibson Dunn remains available to help its clients in addressing these issues.

[1] SEC, Statement on Jury’s Verdict in Trial of Matthew Panuwat, Apr. 5, 2024 https://www.sec.gov/news/statement/grewal-statement-040524.

[2] Mihir Mehta, David Reeb, & Wanli Zhao, Shadow Trading 1, Accounting Review (July 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3689154.

[3] Complaint ¶ 20, SEC v. Panuwat, No. 21-cv-06322 (N.D. Cal. Aug. 17, 2021)

[4] SEC v. Panuwat, 2022 WL 633306, at *8 (N.D. Cal. Jan. 14, 2022).

[5] Id.

[6] Id. at *4.

[7] Id. at *5.

[8] Id. at *4.

[9] Id. at *6.

[10] Id. at *7.

[11] SEC v. Panuwat, 2023 WL 9375861, at *5 (N.D. Cal. Nov. 20, 2023).

[12] Id. at *6.

[13] Id.

[14] Id.

[15] Id.

[16] SEC, Statement on Jury’s Verdict in Trial of Matthew Panuwat, Apr. 5, 2024 https://www.sec.gov/news/statement/grewal-statement-040524.

[17] Mihir Mehta, David Reeb, & Wanli Zhao, Shadow Trading 1, 4, Accounting Review (July 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3689154.

[18] Item 408(b) of Regulation S-K (emphasis added). Smaller reporting companies have to comply with the requirements beginning with their Form 10-K for fiscal years beginning on or after October 1, 2023.

[19] Under Section 21A(b)(1) of the Exchange Act, public companies are not subject to controlling person liability for insider trading by executives, directors, or employees unless they disregarded the fact that a controlled person was likely to engage in the act or acts constituting the violation and failed to take appropriate steps to prevent such act or acts before they occurred.

The following Gibson Dunn lawyers assisted in preparing this update: Reed Brodsky, Benjamin Wagner, Mark Schonfeld, David Woodcock, Ronald Mueller, Lori Zyskowski, Thomas Kim, Julia Lapitskaya, Michael Nadler, Edmund Bannister, and Peter Jacobs*.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Securities Enforcement or Securities Regulation and Corporate Governance practice groups:

Securities Enforcement:
Reed Brodsky – New York (+1 212.351.5334, [email protected])
Mark K. Schonfeld – New York (+1 212.351.2433, [email protected])
Benjamin Wagner – Palo Alto (+1 650.849.5395, [email protected])
David Woodcock – Dallas/Washington, D.C. (+1 214.698.3211, [email protected])
Michael Nadler – New York (+1 212.351.2306, [email protected])

Securities Regulation and Corporate Governance:
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202.887.3550, [email protected])
Julia Lapitskaya – New York (+1 212.351.2354, [email protected])
James J. Moloney – Orange County (+1 1149.451.4343, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, [email protected])
Lori Zyskowski – New York (+1 212.351.2309, [email protected])

*Peter Jacobs is an associate working in the firm’s New York office who is not yet admitted to practice law.

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

Tax Equity Now NY LLC v. City of New York, 2024 N.Y. Slip Op. 01498, Issued March 19, 2024

The sharply divided decision could upend the City’s historical treatment of residential properties and could have broad implications for civil litigation in New York.

On March 19, 2024, the New York Court of Appeals issued an important decision reviving in part a sweeping challenge to New York City’s property tax system. The plaintiff in the case, Tax Equity Now NY LLC v. City of New York, alleges that the City “imposes substantially unequal tax bills on similarly-valued properties” that bear “little relationship” to fair market value, leading to “staggering inequities,” including along racial lines.[1]

The Court’s holding leaves in place much of the existing tax framework, notably relating to state-law caps on annual tax increases and taxes on commercial properties, but the sharply divided decision reinstates certain claims against the City and could upend the City’s historical treatment of residential properties. The decision also could have broad implications for civil litigation in New York, especially relating to New York’s liberal pleading standards and claims brought under the federal Fair Housing Act.

Background

New York City’s property tax system has a storied history. Article 18 of New York’s Real Property Tax Law (“RPTL”) was enacted in 1981, over widespread criticism and a Governor’s veto, to stave off an impending crisis. For hundreds of years, tax rates were applied to only a percentage of a property’s market value, with localities assessing commercial and industrial property at higher ratios than residential property.[2] In 1975, the Court of Appeals held that state law precluded these “fractional assessments” and required tax rates to be applied to full market value.[3] That decision “reverberated throughout the state” by threatening an “unwelcome shift of a significant portion of the property tax burden from businesses to homeowners.”[4] The Legislature therefore enacted the current statute, which allows for all real property in the City to be assessed using fractional assessments at a uniform percentage of value. See RPTL §§ 305, 1801 et seq.

Article 18 establishes four different classes of real property in New York City. “Class One” contains primarily one-, two-, and three-family residential property. “Class Two” contains all other residential property, including condos, co-ops, and large rental buildings. “Class Three” contains “utility real property.” “Class Four” contains all other real property.[5]

In order to avoid abrupt changes in tax liability, Article 18 provides a formula for determining the portion of annual taxes that each of these classes will bear, with state law capping the amount by which each share can increase every year. The statute further establishes caps on year-to-year increases for individual parcels within each class. For example, assessment increases for Class One properties cannot exceed 6% annually and 20% over any five-year period.[6]

Within this framework, the City undertakes the assessment and collection of real property taxes. First, the City determines each parcel’s taxable value by estimating its market value and multiplying it by the fractional assessment rate the City has set for that parcel’s class. The City has elected to assess Class One properties at 6% of their market value, and to assess all other classes at 45% of their market value.[7] The City then multiplies that market value by the tax rate for the class, which is the rate required to satisfy each class’s share. The City then further makes adjustments for various abatements and exemptions.[8]

The Court of Appeals Ruling

In Tax Equity Now NY LLC v. City of New York, a membership organization committed to pursuing legal and political reform, but “frustrated with the political process,”[9] brought suit against the City and State contending that New York City’s property tax system is inequitable, unlawful, and unconstitutional.[10] Broadly speaking, the plaintiff (“TENNY”) alleges that property taxes are not uniform and not based on fair-market value, and that the City’s tax system has a discriminatory disparate impact on racial minorities, in violation of state and federal law.[11]

The New York State Appellate Division dismissed TENNY’s claims,[12] but the Court of Appeals reversed that ruling in part. The Court held that TENNY’s constitutional claims were “foreclosed by the deferential standard applied to taxation legislation and policy,” as the tax system currently in place serves the rational purpose of maintaining stability over time.[13] Moreover, the Court “easily dispose[d]” of TENNY’s claims against the State of New York, explaining that “the gravamen of the complaint is a challenge to the City’s real property tax scheme and, by so focusing, fails to separately explain why the State is liable for the City’s methodological choices.”[14]

Nevertheless, the Court concluded that the complaint has sufficiently pleaded various causes of action against the City for statutory violations of the RPTL and the federal Fair Housing Act in the context of residential properties. Applying New York’s “liberal pleading standard,” the Court held that TENNY’s complaint sufficiently alleges causes of action “on the general basis that the system is unfair, inequitable, and has a discriminatory impact” on certain property owners.[15]

Lack of Uniformity in Tax Assessments

First, the Court held that TENNY has adequately pleaded a violation of RPTL § 305, which provides that “[a]ll real property in each assessing unit shall be assessed at a uniform percentage of value (fractional assessment),” based on disparate assessment and taxation of properties within Classes One and Two as compared to “fair market value.”[16]

With respect to Class One property (e.g., one-, two-, and three-family residences), TENNY alleged with data “generated by the City’s Independent Budget Office,” City-official admissions, and charts depicting geographic disparities that the City assesses taxes in a manner that sometimes requires application of the state-law caps on annual increases, resulting in disparate tax burdens for properties depending on the rate at which their value appreciates, both from borough to borough and within boroughs. Thus, “older properties in faster-appreciating neighborhoods are assessed and taxed at a lower effective rate than other properties of identical market value.”[17]

The Court rejected the argument that the law requires the City only to assess properties uniformly, without regard for the amount of taxes ultimately paid due to “factors outside of the City’s control, such as the application of state legislatively mandated caps and exemptions.”[18] Construing the statute as a “whole,” the Court held that state law “directs the City to ensure that its assessment is based on the property’s fair market value” uniformly within each class, while taking into account the state-law caps on increases. According to the Court, the City could do so by lowering assessment ratios so that assessments in rapidly appreciating areas do not implicate the caps while making up any shortfall by raising tax rates uniformly across the class.[19]

The Court similarly held that TENNY has adequately alleged, with the support of “publicly-available records,” external reports, and City-official admissions, that the City’s real property tax system violates RPTL § 305 with respect to its treatment of Class Two condos and co-ops.[20] As the Court explained, the City assesses condos and co-ops that were constructed before 1974 (a category that includes 98% of all City co-ops) by comparing them to rental properties that were built before 1974 and therefore rent-stabilized, even though condos and co-ops do not qualify for rent stabilization “and are, in fact, sold (and rented) at much higher market values.”[21] According to the complaint, this causes large disparities in taxes applicable to condos and co-ops depending on whether they were built before or after 1973. The Court rejected the argument that these disparities result from RPTL § 581, which requires assessment of condos and co-ops as if they were rental properties, yet does not require the City to “assess a luxury condominium or cooperative as if it were a regulated apartment where the properties differ in meaningful ways.”[22]

Three judges dissented from the Court’s holding. Judges Garcia, Singas, and Cannataro argued that the law’s requirement that property be “assessed at a uniform percentage of value (fractional assessment)” required the City to do just that: apply a uniform assessment rates, and nothing more, because the statute was never intended to address perceived inequities in the tax system, which serves “rational legislative objectives.”[23] They noted that the Legislature enacted statutory caps despite widespread criticism that the system was “at best ineffective and at worst unfair,” and warned that the “policy considerations underlying the caps are now written out of New York law,” which was a task best left for the Legislature.[24] As for Class Two properties, they similarly reasoned that the Court was seeking to “eliminate perceived disparities by ‘interpreting’ [state law] to accomplish exactly what those who opposed the legislation’s passage warned it did not do.”[25] Ultimately, the dissenting judges believed the Court had erroneously read the tax laws “as requiring the city to provide equal tax treatment for all properties of equal market value,” when the proper method of obtaining such treatment would be through the political process.[26]

Discriminatory Impact on Racial Minorities

The Court also held that TENNY had sufficiently pled several causes of action under the federal Fair Housing Act, which prohibits discrimination in housing.[27]

According to the Court, TENNY had sufficiently alleged that the City “disproportionately burden[s] racial minorities” in Class One properties because owners in majority-minority districts allegedly pay higher tax rates than those in majority-white districts, and higher taxes allegedly “inhibit mobility and place a disproportionate burden on the purchase, ownership and renting of Class One properties.”[28] The Court emphasized that it must “accept[] these allegations as true” and repeatedly noted that the complaint includes “hard data” and “examples,” such as that properties in majority-minority neighborhoods are over-assessed by $1.9 billion and over-taxed by $376 million, making it more difficult for minorities to buy, own, and rent homes.[29]

In addition to Class One properties, the Court held that the complaint adequately alleges discrimination in the treatment of Class Two properties because the City favors owners of Class Two condos and co-ops (who are disproportionately white) over owners of Class Two rental buildings, who in turn pass higher taxes on to renters (who are disproportionately not white), which in turn disproportionately affects the search for affordable housing in New York City.[30

Finally, the Court held that the complaint adequately alleges that the City perpetuates segregation, on the grounds that “blacks and whites are [allegedly] the most isolated from other races” in certain neighborhoods, and that disproportionate tax burdens “suppress minority mobility into wealthier, whiter neighborhoods.”[31] The Court emphasized that it was applying New York’s “liberal pleading standards,” which do not require “allegations defeating every alternative explanation.”[32] Thus, while the Court noted that individuals may “choose to live in a different neighborhood or move into or out of a community for reasons unrelated to—or despite—high taxes,” which the Court recognized “may present obstacles for TENNY[] . . . as this case progresses,” the Court reiterated that “at the pleading stage, we do not consider whether TENNY will eventually establish its cause of action, only whether it has alleged facts that support a legally viable claim.”[33]

Critically, the Court held that the Appellate Division wrongly applied a limiting principle for claims arising under the Fair Housing Act— the “robust causality” requirement previously recognized by the United States Supreme Court in Inclusive Communities Project, Inc. v. Texas Dep’t of Hous. and Community Affairs, in which the Supreme Court explained that “a disparate impact claim that relies on a statistical disparity” must fail unless the disparity is actually caused by the defendant’s policy. 576 U.S. 519, 542 (2015).[34] In the Court’s view, that analysis applies only to an “evidentiary record generated during discovery,” not to a motion to dismiss, where—under New York’s liberal pleading standard—”plaintiff’s factual assertions are accepted as true and we need only determine whether the facts fit any cognizable legal theory.”[35]

Judges Garcia and Singas dissented, arguing that the complaint must allege a “robust” causal connection between the alleged impact and challenged policies because “failings at the pleading stage lead inexorably to a failing at later procedural stages.”[36] Applying a “robust” causation requirement, Judges Garcia and Singas would have held that TENNY failed to allege that the City “caused” housing disparities because TENNY did not allege sufficient concrete facts or statistical evidence showing that the property tax system, “as opposed to other factors,” inhibits the ability of minority residents to relocate or own homes, adding that the “mere identification of higher tax rates in particular neighborhoods does not state a claim” under the FHA.[37]

What It Means

The Court’s ruling could have significant implications for New York City’s property tax system. Although it leaves in place much of the State’s overall tax framework, TENNY will now have the opportunity to substantiate its claims through litigation and pursue systemic reform against the City. As the dissent noted, this decision may result in the removal of important policy issues from the democratic process, where they had previously been hotly contested in Albany. “Instead of all interested stakeholders participating through their elected representatives in an effort to balance competing interests, [the Court’s] new rule virtually guarantees that,” if TENNY succeeds, “the parties here will craft new tax policy in a settlement conference room.”[38]

The Court’s decision also could have broad implications for civil litigation in New York, especially relating to impact claims in other cases. Here, the plaintiff successfully navigated threshold pleading challenges, such as standing, where other plaintiffs bringing similar claims have failed,[39] and convinced a slim majority on the Court that the complaint adequately alleged causes of action for broad, systemic claims of illegality in the City’s property tax system. Interested parties may therefore view the case as a roadmap for seeking reform through similar claims in the future.

It is important to note that the Court’s decision could have apparent limitations as well. As in other recent cases,[40] the Court repeatedly stressed that this ruling was based, in significant part, on the “liberal pleading standards” that apply at the outset of a case in New York state court, and it acknowledged that Fair Housing claims must satisfy a more robust causation requirement following development of an evidentiary record, which will likely prove complex. Moreover, the Court repeatedly emphasized that the complaint’s allegations were “supported with independent studies and the City’s own data of widening disparities,” resulting from its “annually-repeated assessment methodology”—unique factors that may not exist in other cases.[41]

[1] Tax Equity Now NY LLC v. City of N.Y. (“TENNY”), 2024 WL 1160498, at *1 (N.Y. Ct. App. Mar. 19, 2024).

[2] See Matter of O’Shea v. Board of Assessors of Nassau County, 8 N.Y.3d 249, 253 (2007); Matter of Hellerstein v. Assessor of Town of Islip, 37 N.Y.2d 1, 13 (1975).

[3] See Matter of Hellerstein, 37 N.Y.2d at 14.

[4] See Matter of O’Shea, 8 N.Y.3d at 253.

[5] See RPTL § 1802(1).

[6] See RPTL § 1805.

[7] Thus, for example, a Class One property with a $100,000 market value would have a $6,000 taxable value, and a Class Two property would have a $45,000 taxable value.

[8] See TENNY, 2024 WL 1160498, at *2.

[9] 2024 WL 1160498, at *9 (Garcia, J., dissenting in part).

[10] 2024 WL 1160498, at *3.

[11] Id.

[12] Mr. Rokosky was counsel for the State in the Appellate Division prior to joining Gibson Dunn, but he played no role in the Court of Appeals.

[13] TENNY, 2024 WL 1160498, at *12-13.

[14] Id. at *14 (emphasis added).

[15] See id. at *1.

[16] Id. at *4-9.

[17] Id. at *4-5.

[18] Id. at *6.

[19] See id. at *6-8.

[20] See id. at *8-9.

[21] Id. at *5.

[22] Id. at *9.

[23] Id. at *15-19 (Garcia, J., dissenting in part).

[24] Id. at *18.

[25] Id.

[26] Id. at *15.

[27] See id. at *9-12.

[28] Id. at *9.

[29] Id. at *9-10.

[30] Id. at *9.

[31] Id. at *11-12.

[32] Id. at *12.

[33] Id.

[34] Id. at *11.

[35] Id.

[36] Id. at *20 (Garcia, J., dissenting).

[37] Id.

[38] Id.

[39] See, e.g., Robinson v. City of New York, 143 A.D.3d 641 (1st Dep’t 2016).

[40] See, e.g., Taxi Tours Inc. v. Go New York Tours, Inc., 2024 WL 1097270, at *2 (N.Y. Ct. App. Mar. 14, 2024).

[41] TENNY, 2024 WL 1160498, at *6.

The Court’s opinion is available here.

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 authors:

Mylan L. Denerstein – Co-Chair, Public Policy Practice Group, New York
(+1 212.351.3850, [email protected])

Akiva Shapiro – Chair, New York Administrative Law & Regulatory Practice Group, New York
(+1 212.351.3830, [email protected])

Seth M. Rokosky – New York (+1 212.351.6389, [email protected])

Join us for a 30-minute briefing covering several M&A practice topics. The program is part of a series of quarterly webcasts designed to provide quick insights into emerging issues and practical advice on how to manage common M&A problems. Steve Glover, a partner in the firm’s Global M&A Practice Group, will act as moderator.

Topics to be discussed:

Cassandra Gaedt-Sheckter and Ahmed Baladi will discuss how to address artificial intelligence issues in acquisition agreement representations and covenants;
Tom Kim will describe how the SEC’s proposed climate change disclosure rules may impact M&A practice; and
Jonathan Whalen will provide an update on developments in the representation and warranty insurance market.

PANELISTS

Stephen I. Glover is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher who has served as Co-Chair of the firm’s Global Mergers and Acquisitions Practice. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, joint ventures, equity and debt offerings and corporate governance matters. His clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others. Mr. Glover has been ranked in the top tier of corporate transactions attorneys in Washington, D.C. for the past seventeen years (2005 – 2023) by Chambers USA America’s Leading Business Lawyers. He has also been selected by Chambers Global for the past five years as a top lawyer for USA Corporate/M&A.

Cassandra Gaedt-Sheckter is a partner in Gibson, Dunn & Crutcher’s Palo Alto office, where she co-chairs the global Artificial Intelligence (AI) practice, and is a key member of the Privacy, Cybersecurity and Data Innovation practice, including as the leader of the firm’s State Privacy Law Task Force. With extensive experience advising companies on AI, data privacy, and cybersecurity issues, Cassandra focuses on regulatory compliance counseling and privacy and AI program development, regulatory enforcement matters, and transactional representations. Cassandra advises clients in various industries, from leading tech companies and luxury fashion companies, to shipping giants.

Ahmed Baladi is a partner in the Paris office of Gibson, Dunn & Crutcher and the co-chair of the firm’s Privacy, Cybersecurity and Data Innovation Practice Group. He specializes in information technology & digital transactions, outsourcing, data privacy and cybersecurity. Ahmed has developed renowned experience in a wide range of technological and digital matters. His practice covers complex technology transactions and outsourcing projects, particularly within the financial institutions sector; strategic digital transformation, such as acquisition or development of innovative solutions (lnternet of Things [IoT], Artificial Intelligence [AI], Fintech, big data and cloud based solutions); data privacy and cybersecurity, including compliance and governance projects in light of the GDPR, cross-border litigation requiring data transfer and Binding Corporate Rules and complex commercial transactions, particularly in the technology, energy, aerospace and pharmaceutical industries.

Thomas J. Kim is a partner in the Washington D.C. office of Gibson, Dunn & Crutcher, LLP, where he is a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Kim focuses his practice on a broad range of SEC disclosure and regulatory matters, including capital raising and tender offer transactions and shareholder activist situations, as well as corporate governance, environmental social governance and compliance issues. He also advises clients on SEC enforcement investigations – as well as boards of directors and independent board committees on internal investigations – involving disclosure, registration, corporate governance and auditor independence issues. Mr. Kim has extensive experience handling regulatory matters for companies with the SEC, including obtaining no-action and exemptive relief, interpretive guidance and waivers, and responding to disclosures and financial statement reviews by the Division of Corporation Finance.

Jonathan Whalen is a partner in the Dallas office of Gibson, Dunn & Crutcher LLP. He is a member of the firm’s Mergers and Acquisitions, Capital Markets, Energy and Infrastructure, and Securities Regulation and Corporate Governance practice groups. Mr. Whalen also serves on the Gibson Dunn Hiring Committee. Mr. Whalen’s practice focuses on a wide range of corporate and securities transactions, including mergers and acquisitions, private equity investments, and public and private capital markets transactions. Chambers USA named Mr. Whalen an Up and Coming Corporate/M&A attorney in their 2022 publication. In 2018, D CEO magazine and the Association of Corporate Growth named Mr. Whalen a finalist for the 2018 Dallas Dealmaker of the Year.

MCLE CREDIT INFORMATION

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 0.50 credit hour, of which 0.50 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 0.50 hour in the General Category.

Gibson, Dunn & Crutcher LLP is authorized by the Solicitors Regulation Authority to provide in-house CPD training. This program is approved for CPD credit in the amount of 0.50 hour. Regulated by the Solicitors Regulation Authority (Number 324652).

Neither the Connecticut Judicial Branch nor the Commission on Minimum Continuing Legal Education approve or accredit CLE providers or activities. It is the opinion of this provider that this activity qualifies for up to 0 hour toward your annual CLE requirement in Connecticut, including 0 hour(s) of ethics/professionalism.

Application for approval is pending with the Illinois, Texas, Virginia and Washington State Bars.

As more private companies begin to explore IPOs again after a difficult period in the markets, strong pre-IPO readiness can position companies to more swiftly access IPO market windows when they open. This presentation explores preliminary IPO planning considerations and key issues for private companies thinking about an IPO.

PANELIST

Harrison Tucker is a partner in the Houston office of Gibson, Dunn & Crutcher, where he currently practices with the firm’s Capital Markets and Securities Regulation and Corporate Governance practice groups. He regularly represents public and private businesses in a broad range of corporate and securities matters and issuers and investment banking firms in both equity and debt offerings, including Rule 144A offerings. His practice also includes general corporate concerns, including Exchange Act reporting, stock exchange compliance, corporate governance and beneficial ownership reporting matters. In addition, he works closely with the Gibson Dunn bankruptcy and restructuring team, advising on applicable securities laws issues.

Harrison received his J.D. from the University of Houston Law Center in 2008, where he was elected to the Order of the Coif and Order of Barons. While in law school, he served as a Member of the Houston Law Review. Prior to law school, he graduated from Texas A&M University in 2005, where he received his B.A. in history and was elected to Phi Beta Kappa.

Peter W. Wardle is a partner in the Los Angeles office of Gibson, Dunn & Crutcher. He is a member of the firm’s Corporate Transactions Department and co-chair of its Capital Markets Practice Group, and previously served as partner in charge of the Los Angeles office.

Peter’s practice includes representation of issuers and underwriters in equity and debt offerings, including IPOs and secondary public offerings, and representation of both public and private companies in mergers and acquisitions, including private equity, cross border, leveraged buy-out and going private transactions. He also advises clients on a wide variety of general corporate and securities law matters, including corporate governance and disclosure issues.

Peter earned his Juris Doctor in 1997 from the University of California, Los Angeles, School of Law, where he was elected to the Order of the Coif and served as business manager of the UCLA Law Review and articles editor of the UCLA Entertainment Law Review. He received an Bachelor of Arts degree cum laude in 1992 from Harvard University. Peter is a member of the Board of Directors and chair of the Governance Committee for The Colburn School. He is a member of the firm’s Compensation Committee, National Pro Bono Committee, and serves as one of the partners in charge and pro bono partners for the Los Angeles area offices.

Melanie Neary is a senior associate in the San Francisco office of Gibson, Dunn & Crutcher, where she practices in the firm’s Corporate Transactions Practice Group, with a practice focused on advising clients in connection with a variety of financing transactions, including initial public offerings, secondary equity offerings and venture and growth equity financings as well as complex corporate transactions, including mergers and acquisitions. Melanie also regularly advises clients on corporate law matters, Securities and Exchange Commission reporting requirements and ownership filings and corporate governance.

Melanie received her J.D. from the University of Michigan Law School in 2016, where she was the Managing Editor of the Michigan Business & Entrepreneurial Law Review. She earned her B.A., magna cum laude, in Communications, Legal Institutions, Economics and Government, with a minor in French, from American University in 2013.

MCLE CREDIT INFORMATION:

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 0.75 hour in the General Category.

Gibson, Dunn & Crutcher LLP is authorized by the Solicitors Regulation Authority to provide in-house CPD training. This program is approved for CPD credit in the amount of 0.75 hour. Regulated by the Solicitors Regulation Authority (Number 324652).

Neither the Connecticut Judicial Branch nor the Commission on Minimum Continuing Legal Education approve or accredit CLE providers or activities. It is the opinion of this provider that this activity qualifies for up to 0.75 hour toward your annual CLE requirement in Connecticut, including 0 hour(s) of ethics/professionalism.

Application for approval is pending with the Colorado, Illinois, Texas, Virginia, and Washington State Bars.

Gibson Dunn’s Workplace DEI Task Force aims to help our clients develop creative, practical, and lawful approaches to accomplish their DEI objectives following the Supreme Court’s decision in SFFA v. Harvard. Prior issues of our DEI Task Force Update can be found in our DEI Resource Center. Should you have questions about developments in this space or about your own DEI programs, please do not hesitate to reach out to any member of our DEI Task Force or the authors of this Update (listed below).

Key Developments:

On March 21, 2024, Chief Judge Diane Sykes of the United States Court of Appeals for the Seventh Circuit announced the resolution of a judicial misconduct complaint filed by America First Legal (AFL) against three judges on the United States District Court for the Southern District of Illinois. The complaint accused Chief Judge Nancy J. Rosenstengel, Judge Staci M. Yandle, and Judge David W. Dugan of race and sex discrimination in violation of Rule 4(a)(3) of the Rules for Judicial-Conduct and Judicial-Disability Proceedings, Canon 2A of the Code of Conduct for United States Judges, and the Fifth Amendment of the United States Constitution. AFL took issue with the judges’ policies that a motion for oral argument would be granted if “at all practicable to do so” where the moving party “intends to have a newer, female, or minority attorney” argue. The complaint drew the attention of Senators Ted Cruz (R-TX) and John Kennedy (R-LA), who sent a letter to Chief Judge Sykes arguing that the policies are unethical and unconstitutional in light of SFFA v. Harvard. In her order, Chief Judge Sykes stated that Judge Dugan had removed references to “women and underrepresented minorities” from his courtroom policies in October 2022, and that Judge Rosenstengel and Judge Yandle had both since rescinded the policies at issue. In letters attached to Chief Judge Sykes’ order, Judge Rosenstengel stated that she “chose the wrong means to accomplish [her] goal of expanding courtroom opportunities for young lawyers,” and Judge Yandle acknowledged that the now-rescinded policy, as worded, “created a perception of preferences based on immutable characteristics.”

Governor Kay Ivey signed Alabama Senate Bill 129 (S.B. 129) into law on March 20, one day after the bill passed both chambers of the Alabama General Assembly. The sweeping anti-DEI legislation prevents higher education institutions, public school boards, and state agencies from using state funds to support DEI programming, offices, or training, and prohibits these entities from teaching about certain “divisive concepts” related to race, bias, and meritocracy. The law also includes a measure that prohibits public universities from allowing transgender people to use bathrooms designated for their gender identity. Student groups, state Democrats, and advocacy groups like PEN America have campaigned against the law, noting Alabama’s fraught history with respect to race issues and criticizing the bill’s restrictions on speech and diversity initiatives. The law takes effect on October 1, 2024. A similar Kentucky bill, SB 6, has passed both chambers and will soon be sent to Governor Beshear’s desk. The governor is expected to veto the bill, but it is anticipated that a Republican supermajority will overrule the veto.

On March 19, conservative think tank Goldwater Institute filed a complaint against the Arizona Board of Regents, claiming that Arizona State University violated state law by requiring a professor to complete ASU’s “Inclusive Communities” training. The Institute alleges that the mandatory virtual training, which addressed issues including white supremacy and microaggressions, violated an Arizona law that prohibits the state from “us[ing] public monies for training, orientation or therapy that presents any form of blame or judgment on the basis of race, ethnicity or sex.” The Institute also asserts that the training violated the state constitution’s free-speech protections.

The Congressional Hispanic Caucus sent a letter to the leaders of Fortune 100 companies on March 11, 2024, calling for an increase in representation of Hispanics in executive roles. The letter asserts that, although nearly 20 percent of people living in the United States today are of Hispanic descent, only 4 percent of Fortune 100 CEOs are Hispanic. The caucus asked recipients to provide data on current Hispanic representation among senior and government relations staff, as well as the percentages of philanthropic funding and contract dollars awarded to Hispanic recipients and Hispanic-owned businesses. The requests are similar to those made in recent months by both the Congressional Asian Pacific American Caucus and the Congressional Black Caucus.

Media Coverage and Commentary:

Below is a selection of recent media coverage and commentary on these issues:

Bloomberg Law Daily Labor Report, “Firms From KKR to Coors Flag DEI as Business, Legal Risk” (March 11): Bloomberg’s Clara Hudson and Riddhi Setty report on the increasing number of public companies listing DEI as a “risk factor” in securities filings. According to an analysis by Bloomberg Law, JetBlue Airways Corp., Molson Coors Beverage Co., Blue Owl Capital Corp., Duolingo, Inc., and Leidos Holdings, Inc.—among others—have listed DEI as a legal or brand value risk on their most recent 10-Ks. Fordham University School of Law professor Atinuke Adediran says this can be a strategic choice; in the event of future DEI-related litigation, these securities filings may help the company defend against a related shareholder action. But Hudson and Setty note that companies listing DEI as a risk in their 10-Ks also list diversity as “pivotal to the success of their business,” and that most companies continue to recognize DEI as a key corporate value.
Fast Company, “DEI needs to get back on track—these leaders have solutions” (March 13): Tania Rahman reports on “The Fight for DEI,” a panel discussion hosted by Fast Company earlier this month at the South by Southwest festival. Lenovo’s Chief Diversity Officer Calvin Crosslin, Making Space Founder and CEO Keely Cat-Wells, and Upwork’s Head of Diversity, Inclusion, Belonging, and Access Erin L. Thomas spoke about the challenges facing DEI initiatives and offered potential paths forward. Upwork’s Thomas stated that companies have to be genuinely motivated for their DEI initiatives to succeed––companies that felt forced to adopt diversity programs in the wake of George Floyd’s murder, she believes, are those that have already scaled back. Making Space’s Cat-Wells emphasized the importance of tying DEI impact to business strategy, saying that viewing diversity through a “charity lens” doesn’t lead to permanent systemic change. And Lenovo’s Crosslin recognized the significant burdens of advancing DEI initiatives in the current political and legal climate, advocating for corporate executives to better support their DEI leaders.
New York Times Magazine, “The ‘Colorblindness’ Trap: How a Civil Rights Ideal Got Hijacked” (March 13): NYT Magazine staff writer and Howard University professor Nikole Hannah-Jones opines that the recent flurry of conservative legal activism around affirmative action and reverse discrimination is the latest step in a 50-year effort to reverse the constitutional legacies of the civil rights movement. In Hannah-Jones’ view, the SFFA decision is the Supreme Court’s latest effort to erode racial minorities’ constitutional rights, following in the footsteps of Parents Involved in Community Schools v. Seattle School District No. 1 in 2007 (holding that the school district’s school assignment policy designed to remedy historic racial segregation violated the Equal Protection Clause), and Shelby County v. Holder in 2013 (invalidating the Voting Rights Act provision requiring that the DOJ or a federal court approve proposed redistricting plans as not harmful to minority interests). Hannah-Jones provides a comprehensive history of reconstruction, desegregation, and the civil rights era, and she posits that this history has developed around a still-unresolved tension: “Do we ignore race in order to eliminate its power, or do we consciously use race to undo its harms?”
Law360 Employment Authority, “Worker’s 10th Circ. Loss May Aid Future DEI Challenges” (March 15): Law360’s Anne Cullen reports on the Tenth Circuit’s recent decision affirming dismissal of a harassment and discrimination suit brought by a white male former Colorado Department of Corrections officer. The officer alleged that the Corrections Department’s DEI seminar about white supremacy and racial injustice violated Title VII, but the district court dismissed the complaint, concluding that any effects of the program were not severe or pervasive enough to constitute a hostile work environment. But in the majority opinion affirming the dismissal, Judge Timothy Tymkovich wrote that the “race-based rhetoric” included in the seminar was “well on the way to arriving at objectively and subjectively harassing messaging” that “could promote racial discrimination and stereotypes within the workplace.” Jason Schwartz, Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group, called the decision “a signal that they’re certainly not shutting the courthouse door to these claims.” “If anything, they’re saying come on back with more, and we’ll see,” said Schwartz, who concluded that the majority decision “provided a road map for a future challenge to DEI training.” Judge Scott Matheson Jr.—who wrote separately to concur only in the result—took issue with the majority’s “unnecessary” commentary on the Correction Department’s seminar and “the potential for future legal challenges to it or other [DEI] programs.”
National Law Journal, “‘Tip of the Iceberg’: Appellate Ruling Provides Roadmap for Bias Suits Over DEI Training” (March 18): The National Law Journal’s Avalon Zoppo reports on two recent appellate decisions addressing reverse-discrimination claims. On March 11, the Tenth Circuit issued one of the first appellate decisions involving a claim that DEI training creates a hostile work environment for white employees. The panel affirmed a district court’s dismissal of the case, holding that any harassment resulting from the DEI training was neither severe nor pervasive. The majority opinion nonetheless expressed concern that the training’s “race-based rhetoric” had the potential to place employees who express criticism of diversity programming at risk of “being individually targeted for discriminatory treatment.” And on March 12, the Fourth Circuit partially upheld a jury’s verdict for a former executive who contended that he was fired intentionally to make room for a more diverse workforce. Zoppo reports that Gibson Dunn’s Jason Schwartz called these two cases “the tip of the iceberg” and predicted and there will “be a huge number of reverse discrimination type cases filed this year and in subsequent years.”
Law360, “EEOC Official Flags ‘Overblown’ Takes On Admissions Ruling” (March 19): Law360’s Vin Gurrieri reports on comments made by Equal Employment Opportunity Commission Vice Chair Jocelyn Samuels about the impact of the SFFA decision on corporate diversity initiatives. Speaking as part of a panel at the American Bar Association’s recent conference on equal employment opportunity law, Vice Chair Samuels acknowledged that “there have been a lot of allegations about the ways in which the SFFA decision affects employment programs” but called those allegations “way overblown,” as “there is nothing about the SFFA decision that applies to the vast majority of DEI programs in employment for several reasons.” Vice Chair Samuels emphasized that multiple factors—the education context, the underlying law, and the degree to which challenged policies expressly authorized the consideration of race in conferring benefits—distinguish SFFA from lawful corporate initiatives attempting to ensure equal opportunities in the workplace. In light of “the persistence of entrenched inequities that are too often based on race or gender or national origin,” Vice Chair Samuels emphasized “that employers are not under the law required to turn a blind eye to trying to address these kinds of inequities.”
Law360 Employment Authority, “DEI Backers Clinch Big Wins, But The Fight Is Far From Over” (March 19): Law360’s Anne Cullen highlights three recent appellate decisions that gave “a boost” to corporate DEI initiatives. On March 4, the Eleventh Circuit affirmed a district court order preliminarily enjoining operation of Florida’s “Stop WOKE Act,” which would prohibit employers from requiring employees to participate in trainings that identify certain groups of people as “privileged” or “oppressors.” On March 6, the Second Circuit affirmed a district court dismissal of the medical advocacy association Do No Harm’s reverse-discrimination claims against Pfizer, holding that a plaintiff relying on organizational standing must name at least one affected member to establish Article III standing. And on March 11, the Tenth Circuit affirmed dismissal of a white former correctional officer’s suit against the Colorado Department of Corrections based on alleged harassment in a racial equity seminar. But Cullen refers to the Tenth Circuit decision as a “double-edged sword”––the majority opinion affirmed that the effects of the training program were not severe or pervasive enough to support a hostile work environment claim, but also expressed concern about the program, providing a road map for future challenges to DEI training programs. Meanwhile, on March 12, the Fourth Circuit partially upheld a jury verdict awarded to a white male marketing executive who sued his former employer alleging that he was fired without cause from his management position because of his race and sex. Gibson Dunn’s Jason Schwartz said the Fourth Circuit decision would encourage similar lawsuits: “If you’ve got a plaintiff who is a white employee saying that he was displaced as part of a larger corporate diversity initiative, this case is going to add fuel to that fire.”
New York Times, “America First Legal, a Trump-Aligned Group, Is Spoiling for a Fight” (March 21): The Times’ Robert Draper reports on the recent efforts of America First Legal Foundation (AFL), the conservative organization founded and run by former Trump policy advisor Stephen Miller. AFL, which Draper refers to as “a policy harbinger for a second Trump term” and which Miller has called “the long-awaited answer to the A.C.L.U.,” has filed or submitted more than 100 lawsuits, EEOC complaints, amicus briefs, and demand letters over the past three years. Draper notes that although the substance of these challenges has varied, all have sought to advance the same “hard-line views on immigration, gender and race” that Miller prioritized during his time in the White House. AFL’s success rate is hard to determine, as many of the group’s lawsuits remain pending and the EEOC does not comment on complaints or investigations. But Draper posits that “winning” is not necessarily the group’s goal; ACLU Executive Director Anthony D. Romero reportedly told Draper that AFL seems “less interested in defending core [legal] principles and more about cherry-picking cases that feed the grievances of the MAGA wing of the Republican Party.”
Washington Lawyer, “Defending Diversity: DEI Practice Groups on the Rise” (March/April 2024): Washington Lawyer contributor William Roberts reports on the growth of law firm practice groups “aimed at helping companies reduce their legal risk and defend diversity efforts” following SFFA. Molly Senger, Gibson Dunn Labor and Employment partner and co-leader of the firm’s DEI Task Force, told Roberts that the team’s work requires a dual focus on “both advice work and litigation,” highlighting the firm’s recent Eleventh Circuit defense of Fearless Fund, a venture capital group that provides financing to black female entrepreneurs. The Task Force is also watching for the Supreme Court’s much-anticipated decision in Muldrow v. City of St. Louis; Senger told Roberts that, “[d]epending on how the Supreme Court rules, it could significantly expand the scope of conduct in the workplace that could give rise to Title VII claims,” leading to “a proliferation of Title VII litigation challenging corporate DEI programs.” Although many companies, nonprofits, and other organizations are actively assessing their legal risk, they also seek to maintain commitment to diversity efforts. As Dariely Rodriguez, deputy chief counsel for the Lawyers’ Committee for Civil Rights Under Law, told Roberts, given “persistent systemic discrimination” against minorities, it remains “important to lean into what’s possible under the law.”

Case Updates:

Below is a list of updates in new and pending cases:

1. Contracting claims under Section 1981, the U.S. Constitution, and other statutes:

Do No Harm v. National Association of Emergency Medical Technicians, No. 3:24-cv-11-CWR-LGI (S.D. Miss. 2024): On January 10, 2024, Do No Harm challenged the diversity scholarship program operated by the National Association of Emergency Medical Technicians (NAEMT), an advocacy group representing paramedics, EMTs, and other emergency professionals. NAEMT awards up to four $1,250 scholarships to students of color hoping to become EMTs or Paramedics. Do No Harm requested a temporary restraining order, preliminary injunction, and permanent injunction against the program. On January 23, 2024, the court denied Do No Harm’s motion for a TRO and expressed skepticism that the group had standing to bring its Section 1981 claim, since the anonymous member had “only been deterred from applying, rather than refused a contract.” On February 29, 2024, NAEMT filed an answer and motion to dismiss.
- Latest update: On March 4, Do No Harm filed an amended complaint, alleging that “Member A,” the anonymous potential applicant for NAEMT’s scholarship program, had now enrolled in a one-semester EMS course, whereas she previously had simply registered to begin the course. As a result, Do No Harm withdrew its original motion to dismiss and filed a new answer and motion to dismiss on March 18. NAEMT argues in its new motion that even though the amended complaint now includes allegations that “Member A” has satisfied a prerequisite for the scholarship program, Do No Harm has still failed to plead a cause of action under Section 1981 because there is no contractual relationship between a would-be applicant and NAEMT. NAEMT also reasserted its argument that Do No Harm lacks associational standing because it has not identified by name a plaintiff who has suffered a concrete injury.
Am. Alliance for Equal Rights v. Zamanillo, No. 1:24-cv-509-JMC (D.D.C. 2024): On February 22, 2024, AAER filed a complaint and motion for a preliminary injunction against Jorge Zamanillo in his official capacity as the Director of the National Museum of the American Latino, part of the Smithsonian Institution. The complaint targets the Museum’s internship program, which aims to provide Latino, Latina, and Latinx undergraduates with training in non-curatorial art museum careers. AAER claims that the program constitutes race discrimination in violation of the Fifth Amendment because the Museum considers the race of applicants in choosing interns and allegedly refuses to hire non-Latino applicants. AAER has asked for an injunction to prevent the Museum from closing the application window on April 1, or selecting interns for the program (currently scheduled to begin in late April).
- Latest update: On March 8, the Museum opposed AAER’s preliminary injunction motion and moved to dismiss for lack of jurisdiction. The Museum argued that AAER does not have Article III standing because “Member A” did not apply to the challenged internship and therefore was not denied an internship based on his or her race or ethnicity. Furthermore, the museum argued that AAER does not meet the “redressability” prong of the preliminary injunction test because the program does not consider an applicant’s race, so any injunction to prohibit race-based admissions decisions would have no effect. The plaintiff’s opposition to the motion to dismiss is due on March 29.
Do No Harm v. Gianforte, No. 6:24-cv-00024 (D. Mont. 2024): On March 12, 2024, Do No Harm filed a complaint on behalf of a white female dermatologist in Montana, alleging that a Montana law requiring the governor to “take positive action to attain gender balance and proportional representation of minorities resident in Montana to the greatest extent possible” when making appointments to the Medical Board violates the Equal Protection Clause of the Fourteenth Amendment. The complaint further alleges that since the ten filled seats are currently held by six women and four men, Montana law requires that the remaining two seats be filled by men, which would preclude the plaintiff from holding the seat.
- Latest update: The defendant has not yet responded to the complaint.
Californians for Equal Rights Foundation v. City of San Diego, et al., No. 3:24-cv-00484-MMA-MSB (S.D. Cal. 2024): On March 12, 2024, the Californians for Equal Rights Foundation filed a complaint on behalf of members who are “ready, willing and able” to purchase a home in San Diego, but ineligible for a grant or loan under the City’s BIPOC First-Time Homebuyer Program. The plaintiffs allege that the program discriminates on the basis of race in violation of the Equal Protection Clause of the Fourteenth Amendment.
- Latest update: The defendants have not yet responded to the complaint.
Do No Harm v. Pfizer, No. 1:22-cv-07908–JLR (S.D.N.Y. 2022), on appeal at No. 23-15 (2d Cir. 2023): On September 15, 2022, plaintiff association representing physicians, medical students, and policymakers sued Pfizer, alleging that the company’s Breakthrough Fellowship Program, which provided minority college seniors summer internships, two years of employment post-graduation, and a scholarship, violated Section 1981, Title VII, and New York law. The association alleges that the program illegally excludes white and Asian applicants. The association is represented by Consovoy McCarthy PLLC, the firm that also represents American Alliance for Equal Rights in multiple lawsuits. In December 2022, the court granted Pfizer’s motion to dismiss, finding that the plaintiff did not have associational standing because they did not identify at least one member by name, instead only submitting declarations from anonymous members. The Second Circuit affirmed the dismissal on March 6, 2024.
- Latest update: On March 20, 2024, Do No Harm filed with the Second Circuit a petition for rehearing en banc, arguing that the panel’s opinion “splits with at least two circuits and creates an irreconcilable line of intracircuit precedent.”

2. Employment discrimination and related claims:

Gerber v. Ohio Northern University, et al., No. 2023-1107-CVH (Ohio. Ct. Common Pleas Hardin Cnty. 2023): On June 30, 2023, a law professor sued his former employer, Ohio Northern University, for terminating his employment after an internal investigation determined that he bullied and harassed other faculty members. On January 23, 2024, the plaintiff, now represented by America First Legal, filed an amended complaint. The plaintiff claims that his firing was actually in retaliation for his vocal and public opposition to the university’s stated DEI principles and race-conscious hiring, which he believed were illegal. The plaintiff alleged that the investigation and his termination breached his employment contract, violated Ohio civil rights statutes, and constituted various torts, including defamation, false light, conversion, infliction of emotional distress, and wrongful termination in violation of public policy.
- Latest update: On February 28, the plaintiff filed an opposition to Ohio Northern University’s motion to dismiss the second amended complaint, arguing that he adequately stated a claim for defamation and intentional infliction of emotional distress because he alleged that the university made false accusations of misconduct against him. On March 13, the defendants filed their reply, arguing that Gerber’s discrimination and defamation claims against university officials in their individual capacity should be dismissed because the university was engaged in official academic activities. On March 18, the plaintiff filed a motion to voluntarily dismiss two of his claims—for conversion and replevin––citing the university’s return of property left in his former office.
Rogers v. Compass Group USA, Inc., No. 23-cv-1347 (S.D. Cal. 2023): On July 24, 2023, a former recruiter for Compass Group USA sued the company under Title VII for allegedly terminating her after she refused to administer the company’s “Operation Equity” diversity program, in which only women and people of color were entitled to participate. The plaintiff alleged that she was wrongfully terminated after she requested a religious accommodation to avoid managing the program, claiming it conflicted with her religious beliefs.
- Latest update: On March 21, the parties filed a stipulation of dismissal, stating that they had reached an undisclosed agreement to settle the case on February 28.

3. Challenges to agency rules, laws, and regulatory decisions:

American Alliance for Equal Rights v. Ivey, No. 2:24-cv-00104-RAH-JTA (M.D. Ala. 2024): On February 13, 2024, AAER filed a complaint against Alabama Governor Kay Ivey, challenging a state law that requires Governor Ivey to ensure there are no fewer than two individuals “of a minority race” on the Alabama Real Estate Appraisers Board (AREAB). The AREAB consists of nine seats, including one for a member of the public with no real estate background (the at-large seat), which has been unfilled for years. Because there was only one minority member among the Board at the time of filing, AAER asserts that state law will require that the open seat go to a minority. AAER states that one of its members applied for this final seat, but was denied purely on the basis of race, in violation of the Equal Protection Clause of the Fourteenth Amendment.
- Latest update: On March 11, AAER moved for a temporary restraining order and preliminary injunction to prevent the Governor from enforcing the statute and to require her to withdraw her pending Board appointments. In response, Ivey argued that AAER had not shown irreparable harm and lacked standing via anonymous “Member A.” On March 15, the court ordered AAER to “file under seal the name of Member A” that day. On March 18, the court held a hearing on the emergency motion for a temporary restraining order and preliminary injunction, and on March 19 denied AAER’s motion, holding that AAER has standing, but is not entitled to a TRO and preliminary injunction because it will not suffer irreparable harm.
Valencia AG, LLC v. New York State Off. of Cannabis Mgmt. et al, No. 5:24-cv-116-GTS (N.D.N.Y. 2024): On January 24, 2024, Valencia AG, a cannabis company owned by white men, sued the New York State Office of Cannabis Management for discrimination, alleging that New York’s Cannabis Law and implementing regulations favored minority-owned and women-owned businesses. The regulations include goals to promote “social & economic equity” (“SEE”) applicants, which the plaintiff claims violates the Equal Protection Clause and Section 1983. On February 7, 2024, the plaintiff filed a motion for a temporary restraining order and preliminary injunction, seeking to prohibit the defendants from implementing the regulations, charging SEE applicants reduced fees, or preferentially granting SEE applicants’ applications.
- Latest update: On March 5, the defendants filed their opposition to the plaintiff’s motion for a preliminary injunction. On March 8, plaintiff’s new counsel, Pacific Legal Foundation, asked to withdraw the plaintiff’s motion for a preliminary injunction, which the court granted. On March 13, the plaintiff filed an amended complaint, naming only two New York state officials as defendants in their official capacity and voluntarily dismissing others, including the claims against the two officials in their personal capacity.

4. Actions against educational institutions:

Chu, et al. v. Rosa, No. 1:24-cv-75-DNH-CFH (N.D.N.Y. 2024): On January 17, 2024, a coalition of education groups sued the Education Commissioner of New York, alleging that its free summer program discriminates on the bases of race and ethnicity. The Science and Technology Entry Program (STEP) permits students who are Black, Hispanic, Native American, and Alaskan Native to apply regardless of their family income level, but all other students, including Asian and white students, must demonstrate “economically disadvantaged status.” The plaintiffs sued under the Equal Protection clause and requested preliminary and permanent injunctions against the enforcement of the eligibility criteria.
- Latest update: On March 18, the defendant moved to dismiss for lack of standing, arguing that neither the organizational plaintiffs (comprised of parent members) nor the named parent plaintiff have suffered any personal or individual injury, and that the plaintiffs cannot sue for alleged violations of members’ rights as prospective STEP applicants. The plaintiffs’ response is due on April 8.

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Mylan Denerstein, Blaine Evanson, Molly Senger, Zakiyyah Salim-Williams, Matt Gregory, Zoë Klein, Mollie Reiss, Alana Bevan, Marquan Robertson, Janice Jiang, Elizabeth Penava, Skylar Drefcinski, Mary Lindsay Krebs, David Offit, Lauren Meyer, Kameron Mitchell, Maura Carey, and Jayee Malwankar.

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 Labor and Employment practice group, or the following practice leaders and authors:

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

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

Mylan L. Denerstein – Partner & Co-Chair, Public Policy Group
New York (+1 212-351-3850, [email protected])

Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer
Washington, D.C. (+1 202-955-8503, [email protected])

Molly T. Senger – Partner, Labor & Employment Group
Washington, D.C. (+1 202-955-8571, [email protected])

Blaine H. Evanson – Partner, Appellate & Constitutional Law Group
Orange County (+1 949-451-3805, [email protected])

From the Derivatives Practice Group: ISDA and ESMA were particularly active this week, releasing several global reports.

New Developments

CFTC’s Energy and Environmental Markets Advisory Committee to Meet February 13. On January 30, 2024, CFTC Commissioner Summer K. Mersinger, sponsor of the Energy and Environmental Markets Advisory Committee (EEMAC) announced the EEMAC will hold a public meeting from 9:00 a.m. to 11:30 a.m. (MST) on Tuesday, February 13 at the Colorado School of Mines in Golden, Colorado. The CFTC stated that at this meeting, the EEMAC will explore the role of rare earth minerals in transitional energy and electrification, including the potential development of derivatives products to offer price discovery and hedging opportunities in these markets. Additionally, the meeting will include a presentation and discussion on the federal prudential financial regulators proposed rules implementing Basel III and the implications for and impact on the derivatives market. Finally, the two EEMAC subcommittees will offer an update on their continued work related to traditional energy infrastructure and metals markets. [NEW]
CFTC Cautions the Public to Beware of Artificial Intelligence Scams. On January 25, the CFTC’s Office of Customer Education and Outreach issued a customer advisory warning the public about Artificial Intelligence (AI) scams. Customer Advisory: AI Won’t Turn Trading Bots into Money Machines explains how the scams use the potential of AI technology to defraud investors with false claims that entice them to hand over their money or other assets to fraudsters who misappropriate the funds and deceive investors. The advisory warns investors that claims of high or guaranteed returns are red flags of fraud and that strangers promoting these claims online should be ignored. The CFTC stated that the advisory is intended to help investors identify and avoid potential scams and includes a reminder that AI technology cannot predict the future. It also lists four items investors may consider to avoid such scams: researching the background of a company or trader, researching the history of the trading website, getting a second opinion, and knowing the risks associated with the underlying assets.
CFTC Staff Releases Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets. On January 25, the CFTC’s Divisions of Market Oversight, Clearing and Risk, Market Participants, and Data and the Office of Technology Innovation issued a request for comment (RFC) in an effort to better inform them on the current and potential uses and risks of AI in the derivatives markets that the CFTC regulates. The RFC seeks comment on the definition of AI and its applications, including its use in trading, risk management, compliance, cybersecurity, recordkeeping, data processing and analytics, and customer interactions. The RFC also seeks comment on the risks of AI, including risks related to market manipulation and fraud, governance, explainability, data quality, concentration, bias, privacy and confidentiality and customer protection. The CFTC indicated that staff will consider the responses to the RFC in analyzing possible future actions by the CFTC, such as new or amended guidance, interpretations, policy statements, or regulations. Comments will be accepted until April 24, 2024.
CFTC Seeks Public Comment on Proposed Capital Comparability Determination for Swap Dealers Subject to Supervision by the UK Prudential Regulation Authority. On January 24, the CFTC solicited public comment on a substituted compliance application requesting that the CFTC determine that certain CFTC-registered nonbank swap dealers located in the United Kingdom may satisfy certain Commodity Exchange Act capital and financial reporting requirements by being subject to, and complying with, comparable capital and financial reporting requirements under UK laws and regulations. The Institute of International Bankers, the International Swaps and Derivatives Association, and the Securities Industry and Financial Markets Association submitted the application. In connection with the application, the CFTC also solicited public comment on a proposed comparability determination and related order providing for the conditional availability of substituted compliance to CFTC-registered nonbank swap dealers under the UK Prudential Regulation Authority’s prudential supervision. The comment period will be open until March 24, 2024.
BGC Group Announces Approval for FMX Futures Exchange. On January 22, BGC Group, Inc. (BGC) announced that its FMX Futures Exchange (FMX) received approval from the CFTC to operate an exchange for U.S. Treasury and SOFR futures. BGC will combine their Fenics UST cash Treasury platform and FMX to work across the CME’s U.S. interest rate complex. FMX is party to a clearing agreement with LCH SwapClear, a holder of interest rate collateral, which it indicated will allow for portfolio margining across rates of risk and provide for margin efficiencies and effective risk management.
CFTC Cancels Open Meeting. On January 20, the CFTC cancelled its open meeting scheduled for January 22. According to the CFTC, Tthe following matters will be resolved through the CFTC’s seriatim process:
- Notice of Proposed Order and Request for Comment on an Application for a Capital Comparability Determination Submitted on behalf of Nonbank Swap Dealers subject to Capital and Financial Reporting Requirements of the United Kingdom and Regulated by the United Kingdom Prudential Regulation Authority,
- Proposed Rule: Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions.
CFTC Designates IMX Health, LLC as a Contract Market. On January 18, the CFTC announced it has issued an Order of Designation to IMX Health, LLC, granting it designation as a contract market (DCM). IMX Health is a limited liability company registered in Delaware and headquartered in Chicago, Illinois. The CFTC issued the order under Section 5a of the Commodity Exchange Act (CEA) and CFTC Regulation 38.3(a). The CFTC determined IMX Health demonstrated its ability to comply with the CEA provisions and CFTC regulations applicable to DCMs. With the addition of IMX Health, there will be 17 DCMs.
CFTC Issues Staff Letter No. 24-01. On January 16, the CFTC issued Staff Letter No. 24-01, granting an exemption to LCH SA from the requirements of Regulation 1.49(d) to permit LCH SA to hold customer funds at the Banque du France. Additionally, the CFTC confirmed that it would not recommend enforcement action against LCH SA for failing to obtain, or provide the Commission with, an executed version of the template acknowledgment letter set forth in Appendix B to Regulation 1.20 , as required by Regulations 1.20(g)(4) and 22.5, for customer accounts maintained at the Banque de France.

New Developments Outside the U.S.

ESAs Recommend Steps to Enhance the Monitoring of BigTechs’ Financial Services Activities. On February 1, the European Supervisory Authorities (ESAs) published a Report setting out the results of a stock take of BigTech direct financial services provision in the EU. The Report identifies the types of financial services currently carried out by BigTechs in the EU pursuant to EU licenses and highlights inherent opportunities, risks, regulatory and supervisory challenges. The stock take showed that BigTech subsidiary companies currently licensed to provide financial services pursuant to EU law mainly provide services in the payments, e-money and insurance sectors and, in limited cases, the banking sector. However, the ESAs have yet to observe their presence in the market for securities services. To further strengthen the cross-sectoral mapping of BigTechs’ presence and relevance to the EU’s financial sector, the ESAs propose to set-up a data mapping tool. The ESAs explained that this tool is intended to provide a framework that supervisors from the National Competent Authorities would be able to use to monitor on an ongoing and dynamic basis the BigTech companies’ direct and indirect relevance to the EU financial sector. [NEW]
ESMA Publishes Risk Monitoring Report. On January 31, the European Securities and Markets Authority (ESMA) published its first risk monitoring report of 2024, where it sets out the key risk drivers currently facing financial markets. Beyond the risk drivers, ESMA’s report provides an update on structural developments and the status of key sectors of financial markets, during the second half of 2023. The report considers structural developments in various areas, including market-based finance, sustainable finance, securities markets, and asset management. [NEW]
ESMA Consults on Reverse Solicitation and Classification of Crypto Assets as Financial Instruments Under MiCA. On January 29, ESMA, published two Consultations Papers on guidelines under Markets in Crypto Assets Regulation (MiCA), one on reverse solicitation and one on the classification of crypto-assets as financial instruments. ESMA is seeking input on proposed guidance relating to the conditions of application of the reverse solicitation exemption and the supervision practices that National Competent Authorities may take to prevent its circumvention. ESMA is also seeking input on establishing clear conditions and criteria for the qualification of crypto-assets as financial instruments. [NEW]
EC Publishes Amendments to Clearing Obligation Scope in Light of Benchmark Reform. On January 22, the delegated regulation amending the regulatory technical standards (RTS) defining the scope of the clearing obligation (CO) was published in the EU Official Journal, with the amended requirements due to enter into force 20 days after publication. The European Commission (EC) stated that the amendments were introduced in light of the transition to the TONA and SOFR benchmarks referenced in certain over-the-counter derivatives contracts. The amendment to the scope of the CO consists of introducing TONA overnight indexed swaps (OIS) with maturities up to 30 years and extending the SOFR OIS class subject to the CO to maturities up to 50 years. The adoption follows the publication by ESMA, on February 1, 2023, of its final report on changes to the scope of the CO and the derivatives trading obligations (DTO) in light of the benchmark transition, following a consultation last year, to which ISDA responded on September 30, 2022. This ESMA report included two draft amending RTS: one draft RTS amending the scope of the CO and one draft RTS amending the scope of the DTO. The delegated regulation containing the RTS amending the scope of the CO has now been published. The RTS on the DTO has not yet been adopted.

New Industry-Led Developments

ISDA Response on Anti-Greenwashing Rules. On January 26, ISDA submitted a response to the UK Financial Conduct Authority’s consultation on xGC23/3: Guidance on the Anti-Greenwashing Rule. In the response, ISDA highlights that actual or perceived misrepresentation of sustainability features may have a detrimental impact on investor and consumer perceptions of sustainable finance products, and ISDA supports efforts to enhance trust in the market. ISDA considers that sustainability-linked derivatives, environmental, social and governance derivatives and voluntary carbon credits fall within the scope of the rule. [NEW]
Joint Response to EC on BMR. On January 23, ISDA, the Global Financial Markets Association and the Futures Industry Association (FIA) submitted a joint response to the EC call for feedback on the review of the scope and regime for non-EU benchmarks. The response sets out the associations’ comments on the EC’s proposal, along with potential draft amendments and additional revisions that were considered to support the EC’s aims. In the response, the associations welcome the EC’s recognition of the problems caused by the current drafting of the Benchmark Regulation (BMR). The associations support the aim of establishing a third-country regime that is sustainable in the long term once the current transitional regime expires, and overall consider that the proposal will result in a more proportionate regime for users and administrators of benchmarks. [NEW]
ISDA, FIA Respond to MAS Consultation on Amendments to the Capital Framework for Approved Exchanges and Clearing Houses. On January 22, ISDA and the FIA jointly responded to the consultation from the Monetary Authority of Singapore (MAS) on proposed amendments to the capital framework for approved exchanges and approved clearing houses. The scope of the response is limited to the capital framework for approved clearing houses. The associations stated that they welcomed the introduction of a separate liquidity requirement and proposed that MAS consider a more conservative minimum threshold of at least 12 months of operating expenses. They also agreed with the proposed amendments that capital components should only include equity instruments and exclude an approved clearing house’s skin-in-the-game. For total risk requirement, the response suggests the alignment of the operational risk component with the liquidity risk requirement and the inclusion of some clarifications on the investment risk and general counterparty risk components.
ISDA Launches Digital Version of 2002 ISDA Equity Derivatives Definitions. On January 18, ISDA launched a fully digital edition of the 2002 ISDA Equity Derivatives Definitions on the ISDA MyLibrary platform, enabling new versions to be released more efficiently as products and market practices evolve in the future. Following consultation with buy- and sell-side market participants, ISDA identified support to move the definitions to a digital format, develop new product provisions and streamline certain components over time. Publication of the 2002 ISDA Equity Derivatives Definitions in digital form is a first step and enables further changes to be made in future versions.
BCBS-IOSCO Report Sets Out Recommendations for Good Margin Practices in Non-Centrally Cleared Markets. On January 17, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) published a report on streamlining VM processes and IM responsiveness of margin models in non-centrally cleared markets, which sets out recommendations for market practices intended to enhance market functioning. The report articulates the policy analyses work carried out by the BCBS-IOSCO in two areas discussed in the September 2022 Review of margining practices: (i) exploring the need to streamline variation margin processes in non-centrally cleared markets and (ii) investigating the responsiveness of initial margin models in non-centrally cleared markets. The consultative report sets out eight recommendations intended to encourage the widespread implementation of good market practices but does not propose any policy changes to the BCBS-IOSCO frameworks. BCBS and IOSCO stated that the first four recommendations aim to address challenges that could inhibit a seamless exchange of variation margin during a period of stress. The other four highlight practices for market participants to implement initiatives in an effort to ensure the calculation of initial margin is consistently adequate for contemporaneous market conditions and proposes that supervisors should monitor whether these developments are sufficient to make this model responsive enough to extreme market shocks.
ISDA Launches Sustainability-linked Derivatives Clause Library. On January 17, ISDA launched a clause library for sustainability-linked derivatives (SLDs), designed to provide standardized drafting options for market participants to use when negotiating SLD transactions with counterparties. SLDs embed a sustainability-linked cashflow in a derivatives structure and use key performance indicators (KPIs) to monitor compliance with environmental, social and governance (ESG) targets, incentivizing parties to meet their sustainability objectives.
BCBS, CPMI, and IOSCO Publish Consultative Report on Transparency and Responsiveness of Initial Margin in Centrally Cleared Markets. On January 16, BCBS, the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) and IOSCO jointly published a consultative report—Transparency and responsiveness of initial margin in centrally cleared markets– review and policy proposals—which interested parties are invited to comment on. BCBS, CPMI, and IOSCO stated that the ten policy proposals in the report aim to increase the resilience of the centrally cleared ecosystem by improving participants’ understanding of central counterparties (CCPs) initial margin calculations and potential future margin requirements. The proposals cover CCP simulation tools, CCP disclosures, measurement of initial margin responsiveness, governance frameworks and margin model overrides, and clearing member transparency.
ISDA and SIFMA Response to US Basel III NPR. On January 16, ISDA and the Securities Industry and Financial Markets Association (SIFMA) submitted a joint response on the US Basel III ‘endgame’ notice of proposed rulemaking (NPR). The response focuses on the Fundamental Review of the Trading Book (FRTB), the revised credit valuation adjustment (CVA) framework, the securities financing transactions requirements and elements of the standardized approach to counterparty credit risk rules. In the response, the associations propose a number of calibration changes to ensure the rules are appropriate and risk sensitive and avoid adverse consequences to US capital markets.
ISDA and SIFMA Response to G-SIB Surcharge Framework Consultation. On January 16, ISDA and SIFMA submitted a response to a consultation by the US Federal Reserve on proposed changes to the G-SIB surcharge. The response raises concerns that the revised G-SIB surcharge would lead to inappropriately high capital requirements for banks offering client clearing services, potentially discouraging them from participating in this business and contravening a long-standing policy objective to promote central clearing. Specifically, the response argues that client derivatives transactions cleared under the agency model should not be included in the complexity and interconnectedness categories of the G-SIB surcharge calculation.

The following Gibson Dunn attorneys assisted in preparing this update: Jeffrey Steiner, Adam Lapidus, Marc Aaron Takagaki, Hayden McGovern, and Karin Thrasher.

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 Derivatives practice group, or the following practice leaders and authors:

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, [email protected])

Michael D. Bopp, Washington, D.C. (202.955.8256, [email protected])

Michelle M. Kirschner, London (+44 (0)20 7071.4212, [email protected])

Darius Mehraban, New York (212.351.2428, [email protected])

Jason J. Cabral, New York (212.351.6267, [email protected])

Adam Lapidus – New York (+1 212.351.3869, [email protected])

Stephanie L. Brooker, Washington, D.C. (202.887.3502, [email protected])

Roscoe Jones Jr., Washington, D.C. (202.887.3530, [email protected])

William R. Hallatt, Hong Kong (+852 2214 3836, [email protected])

David P. Burns, Washington, D.C. (202.887.3786, [email protected])

Marc Aaron Takagaki, New York (212.351.4028, [email protected])

Hayden K. McGovern, Dallas (214.698.3142, [email protected])

Karin Thrasher, Washington, D.C. (202.887.3712, [email protected])

Among the meaningful changes in the Final Rules, the Commission did not adopt a safe harbor from the “investment company” definition under the Investment Company Act of 1940, as amended (the “Investment Company Act”) for SPACs.

On January 24, 2024, the U.S. Securities and Exchange Commission (the “Commission”), by a three-to-two vote, adopted new rules and amendments (the “Final Rules”) to enhance disclosure and investor protections in initial public offerings (“IPO”) by special purpose acquisition companies (“SPACs”) and in subsequent business combinations between SPACs and private operating companies (“de-SPAC transaction”).[1]

The Final Rules are thematically aligned with the rule proposal issued by the Commission nearly two years ago in March 2020,[2] but with meaningful changes as noted below, including not adopting a safe harbor from the “investment company” definition under the Investment Company Act of 1940, as amended (the “Investment Company Act”) for SPACs.

The adopting release for the Final Rules (the “Adopting Release”) provides a lengthy and comprehensive discussion that builds upon the Commission’s prior statements and actions regarding SPAC IPOs and de-SPAC transactions.[3] As noted by the Commission’s Chair, Gary Gensler, in the accompanying press release, the Final Rules are intended to “help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs.”[4] Chair Gensler further noted that the measures adopted in the Final Rules “will help protect investors by addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions.”[5]

The Adopting Release is available here and a Fact Sheet is available here. The Final Rules will become effective 125 days after publication in the Federal Register. Compliance with the structured data requirements, which require tagging of information disclosed pursuant to new subpart 1600 of Regulation S-K in Inline XBRL, will be required 490 days after publication of the rules in the Federal Register.

I. Overview

There are four key components of the Final Rules:

Disclosure and Investor Protection. The Final Rules impose specific disclosure requirements with respect to, among other things, compensation paid to sponsors, potential conflicts of interest, shareholder dilution, and the fairness of the business combination, for both the SPAC IPOs and de‑SPAC transactions;
Business Combinations Involving Shell Companies. Under the Final Rules, the Commission will deem a business combination transaction involving a reporting shell company and a private operating company as a “sale” of securities under the Securities Act of 1933, as amended (the “Securities Act”), amend the financial statement requirements applicable to transactions involving shell companies, and amend the current “blank check company” definition to make clear that SPACs cannot rely on the safe harbor provision under the Private Securities Litigation Reform Act of 1995, as amended (the “PSLRA”) when marketing a de-SPAC transaction;
Projections. The Final Rules amend the Commission’s guidance on the presentation of projections in any filings with the Commission (not only on de-SPAC transactions, but affecting all projections filed with the Commission) and adds new guidance only for de-SPAC transactions, in both instances to address the reliability of such projections; and
Status of SPACs under the Investment Company Act of 1940. The Proposed Rules included a safe harbor that qualifying SPACs could have used to avoid registering as investment companies under the Investment Company Act. The Final Rules do not include a safe harbor, and instead, the Commission takes the position that SPACs should consider investment company status in light of the facts and circumstances and provides further guidance on what actions might cause a SPAC to fall into the investment company definition.

We provide below our key takeaways, a summary of the Final Rules and links to Commissioner statements regarding the Final Rules.

II. Key Takeaways

Below are the key takeaways from the Final Rules:

Timing. Although the Final Rules will not be in effect for about 4 months, existing SPACs and their targets should expect to receive comments from the Commission staff along the broader lines of the Final Rules. SPACs and their targets also should consider the extent to which they will want to comply voluntarily with certain of the Final Rules, especially those focused on financial statement requirements and enhanced disclosures.
Conforming SPACs to Traditional IPOs. The Final Rules go to great lengths to contrast the current SPAC regulatory regime against the one applicable to traditional IPOs and to “level” the playing field between the two. Closer alignment of the two regimes may reduce some potential benefits of a de-SPAC transaction (g., availability of alternative financing sources and expedited path to becoming a public company) while also exposing the SPAC, its target and their advisors to additional liability.
No PSLRA Protection. The PSLRA safe harbor against a private right of action for forward-looking statements is not available in, among other transactions, an offering by a blank check company or a “penny stock” issuer, or in an initial public offering. Some market participants believed the PSLRA safe harbor was otherwise available in de-SPAC transactions when a SPAC is not a blank check company under Rule 419. Under the Final Rules, the Commission adopts a new definition of “blank check company” for purposes of the PSLRA making clear that SPACs may no longer rely on the safe harbor provision under the PSLRA as it relates to the use of projections and other forward-looking statements when marketing a de-SPAC The lack of the PSLRA safe harbor, especially coupled with enhanced disclosure requirements relating to projections under the Final Rules, may lead to changes in the presentation of projections and assumptions, or the abandonment of projections in a SPAC board’s evaluation of a potential de-SPAC target, which will further undermine the viability of the de-SPAC transaction as an alternative to traditional IPOs for target companies that do not have a lengthy operating history.
Co-Registrant Liability. The Final Rules impose Section 11 liability on target companies and their officers and directors as co-registrants under Form S-4 and Form F-4 Liability will now extend to both SPAC and target company disclosures contained in such filings. Target companies assessing a de-SPAC transaction should now consider whether its current director and officer liability insurance is sufficient prior to the filing of an initial Form S-4 or Form F-4 for its de-SPAC transaction given the potential for increased liability related to the target’s disclosures.
Extension of Current Disclosure Guidance (Projections, Dilution, Sponsor, Conflicts). The Final Rules codify current guidance and practice by the Commission, and require additional information and specificity (in some cases, beyond current rules and guidance). Nonetheless, some of the prescriptive rulemakings around enhanced disclosures—including required financial statements, disclosure of sources of dilution, sponsor control and relationships, and potential conflicts of interest—should not be particularly novel for practitioners as many of these requirements are based on existing rules and guidance.
Board Determination. If required by the law of the jurisdiction of a SPAC’s organization, a SPAC must disclose its board’s determination whether the de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders and discuss the material factors considered in making the determination. The Final Rules specify that such factors must include, without limitation and to the extent considered, the valuation of the target company, financial projections relied upon by the board of directors, the terms of any financing materially related to the de-SPAC transaction, the dilutive impact of the transaction, and any fairness opinion. While the Proposed Rules would have required disclosure of the SPAC board’s reasonable belief as to the fairness of a de-SPAC transaction and related financings to the SPAC’s shareholders when approving a de-SPAC transaction, that requirement is not included in the Final Rules. Coupled with the enhanced disclosure requirements related to any projections used in a de-SPAC transaction, the Final Rules may result in SPACs not using a target company’s projections to assess a transaction or for marketing purposes, and SPACs may decide against obtaining fairness opinions in connection with de-SPAC transactions.
Underwriter Liability. The Commission did not adopt its proposal of extending underwriter status (and resulting potential liability) in the de-SPAC transaction to those underwriters to SPAC IPOs involved, directly or indirectly, in the de-SPAC transaction (g., advisory services, placement agent services, and other activities related to the de-SPAC transaction would all be considered direct and indirect activities). Rather, the Commission noted in the Final Rules that it will apply the terms “distribution” and “underwriter” “broadly and flexibly” in light of the facts and circumstances of a particular transaction, including a de-SPAC transaction. The introduction of proposed underwriter liability in the Proposed Rules and pivot back to statutory interpretation creates further ambiguity and uncertainty on a going-forward basis. 2022 and 2023 saw a dramatic pullback by financial advisors in their participation in the SPAC market, and we anticipate that certain financial advisors will choose not to participate in SPAC IPOs and de-SPAC transactions as a result of the ambiguity under the Final Rules.
Investment Company Act Safe Harbor. The Commission did not adopt its proposed new safe harbor for SPACs under the Investment Company Act, which would have exempted SPACs from being treated as an “investment company” if the SPAC met certain subjective criteria, related to, among other things, the nature and management of the assets held by the SPAC and the SPAC’s general purpose. Similar to its approach with respect to SPAC IPO underwriter liability, the Final Rules opt to provide general guidance regarding activities that could cause a SPAC to be an “investment company.” As a result, SPACs should carefully assess and monitor their activities, and consider changing their operations if necessary to bring them into compliance with the Investment Company Act.

III. Summary of Final Rules

1. New Subpart 1600 of Regulation S-K

The Final Rules create a new Subpart 1600 of Regulation S-K solely related to SPAC IPOs and de-SPAC transactions. Among other things, this new Subpart 1600 prescribes specific disclosure requirements with respect to the sponsor, potential conflicts of interest, potential shareholder dilution, and fairness to shareholders.

Sponsor, Affiliates, and Promoters

To provide investors with a more complete understanding of the role of SPAC sponsors, affiliates, and promoters,[6] the Commission has adopted Item 1603(a) of Regulation S-K, to require:

Experience. Description of the experience, material roles, and responsibilities of sponsors, affiliates, and promoters.
Arrangements. Discussion of any agreement, arrangement, or understanding (i) between the sponsor and the SPAC, its officers, directors, or affiliates, in determining whether to proceed with a de-SPAC transaction and (ii) regarding the redemption of outstanding securities.
Sponsor Control. Discussion of the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor. The Commission declined to adopt the proposed requirement that SPACs also provide an organizational chart that shows the relationship between the SPAC, the sponsor, and the sponsor’s affiliates.
Lock-Ups. A table describing the material terms of any lock-up agreements with the sponsor and its affiliates.
Compensation. Discussion of the nature and amounts of all compensation (including securities issued by the SPAC) that has been or will be awarded to, earned by, or paid to the sponsor, its affiliates, and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as the nature and amounts of any reimbursements to be paid to the sponsor, its affiliates, and any promoters upon the completion of a de-SPAC

Potential Conflicts of Interest

To provide investors with a more complete understanding of the potential conflicts of interest between (i) any SPAC sponsor or affiliate, target company officers and directors, or the SPAC’s officers, directors, or promoters, and (ii) unaffiliated security holders of the SPAC, the Commission adopted a new Item 1603(b) of Regulation S-K. This new Item includes a discussion of conflicts arising as a result of a determination to proceed with a de-SPAC transaction and from the manner in which a SPAC compensates the sponsor or the SPAC’s executive officers and directors, or the manner in which the sponsor compensates its own executive officers and directors.

Relatedly, Item 1603(c) of Regulation S-K will require disclosure of the fiduciary duties that each officer and director of a SPAC owes to other companies.

Sources of Dilution

In an effort to conform and enhance disclosure relating to dilution in SPAC IPOs and de-SPAC transactions, the Commission has adopted Items 1602 and 1604 of Regulation S-K, respectively.

IPO Dilution Disclosure. In providing disclosure pursuant to Item 506, SPAC disclosure previously estimated dilution as a function of the difference between the initial public offering price and the pro forma net tangible book value per share after the offering, often including an assumption of the maximum number of shares eligible for redemption in a de-SPAC transaction. The Final Rules will now require additional granularity on the prospectus cover page, requiring SPACs to present redemption scenarios in quartiles up to the maximum redemption scenario. In addition to changes to the cover page, the Final Rules also supplement Item 506 disclosure by requiring a description of material potential sources of future dilution following a SPAC’s initial public offering, as well as tabular disclosure of the amount of potential future dilution from the public offering price that will be absorbed by non-redeeming SPAC shareholders, to the extent quantifiable.
De-SPAC Dilution Disclosure. In addition to disclosure at the IPO stage of a SPAC’s lifecycle, the Final Rules require additional disclosure regarding material potential sources of dilution as a result of the de-SPAC As seen in comment letters issued by the Commission following the release of the Proposed Rules, the Commission has requested additional granularity with respect to post-closing pro forma ownership disclosure, often requiring the disclosure of various redemption thresholds and the effects of potential sources of dilution. The Final Rules now codify this practice by requiring disclosure in a tabular format that includes intervals representing selected potential redemption levels that may occur across a reasonably likely range of outcomes. The Final Rules do not prescribe specific redemption levels for which dilution information must be provided, but looking at the SPAC IPO dilution requirements (as discussed above), quartile disclosure up to the maximum redemption scenario may be acceptable.

Board Determination Regarding De-SPAC Transaction

Under Item 1606, if the law of the jurisdiction of the SPAC’s organization requires the SPAC’s board of directors to determine whether the de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders, then the SPAC will be required to disclose that determination. Item 1606 of Regulation S-K will also require a discussion, of the material factors considered in making that determination. This is one of the few areas of the Final Rule where the Commission declined to adopt a more stringent standard, with the initial proposed rule creating a potential “backdoor” opinion requirement by asking that a board of directors affirmatively state whether it reasonably believes a de-SPAC transaction, including any related financing, was fair to the unaffiliated securityholders of the SPAC.

Relatedly, if any director voted against, or abstained from voting on, approval of the de-SPAC transaction or any related financing transaction, SPACs would be required to identify the director, and indicate, if known, after making reasonable inquiry, the reasons for the vote against the transaction or abstention.

2. Aligning De-SPAC Transactions with IPOs

Target Company as Co-Registrant

Under the current rules, only the SPAC and its officers and directors are required to sign the registration statement and are liable for material misstatements or omissions. The Final Rules require the target company to be treated as a co-registrant with the SPAC when a Form S-4 or Form F-4 registration statement is filed by the SPAC in connection with a de-SPAC transaction.[7] Registrant status for a target company and its officers and directors will result in such parties being liable for material misstatements or omissions pursuant to Section 11 of the Securities Act. Under the Final Rules, target companies and their officers and directors will be liable with respect to their own material misstatements or omissions, as well as any material misstatements or omissions made by the SPAC or its officers and directors. As a result, the Final Rules seeks to further incentivize target companies and SPACs to be diligent in monitoring each other’s disclosure.

Smaller Reporting Company Status

Currently, de-SPAC companies are able to avail themselves – as almost all SPACs have done since 2016[8] – of the smaller reporting company rules for at least one year following the de-SPAC transaction (and most SPACs would still retain this status at the time of the de-SPAC transaction when the SPAC is the legal acquirer of the target company). The “smaller reporting company” status benefits the combined company after the de-SPAC transaction by availing it of scaled disclosure and other accommodations as it adjusts to being a public company.

Citing the disparate treatment between traditional IPO companies and de-SPAC companies (the former having to determine smaller reporting company status at the time it files its initial registration statement and the latter retaining the SPAC’s smaller reporting company status until the next annual determination date), the Final Rules require de-SPAC companies to determine compliance with the public float threshold (i.e., public float of (i) less than $250 million, or (ii) in addition to annual revenues less than $100 million, less than $700 million or no public float)[9] prior to the time it makes its first filing with the Commission (other than the Form 8-K filed with Form 10 information).

The public float must be measured as of a date within four business days after the consummation of the de-SPAC transaction. The revenue threshold must be determined by using the annual revenues of the target company as of the most recently completed fiscal year for which audited financial statements are available. The de-SPAC company must reflect its re-determination in its first periodic report due after a 45-day period following the consummation of the de-SPAC transaction.

Target companies will need to consider the burdens of additional reporting requirements in light of the potential of not being able to qualify as a smaller reporting company following their de-SPAC transactions.

PSLRA Safe Harbor

The PSLRA provides a safe harbor for forward-looking statements under the Securities Act and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under which a company is protected from liability for forward-looking statements in any private right of action under the Securities Act or Exchange Act when, among other things, the forward-looking statement is identified as such and is accompanied by meaningful cautionary statements.

The safe harbor, however, is not available when the forward looking statement is made in connection with an offering by a “blank check company,” a company that is (i) a development stage company with no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person, and (ii) is issuing “penny stock.”[10]

Because of the penny stock requirement, many practitioners have considered SPACs to be afforded protection under the PSLRA safe harbor as it does not otherwise meet the second prong of the definition of blank check company for purposes of the PSLRA safe harbor. The Final Rules will adopt a new definition of “blank check company” for purposes of the PSLRA to remove the penny stock requirement, thus effectively removing a SPAC’s ability to qualify for the PSLRA safe harbor provision for the de-SPAC transaction.

This inability to rely on the PSLRA is coupled with the Final Rules’ addition of new and modified projections disclosure requirements (as further discussed below). It remains unclear whether the application of the Final Rules will lead to changes in the use of projections and assumptions (especially considering the current environment where market participants, investors, and financiers have come to expect detailed projections disclosure, similar to what is used in public merger and acquisitions (“M&A”) transactions), or the abandonment of projections in assessing and marketing a de-SPAC transaction.

Underwriter Status and Liability

Historically, Section 11 and Section 12(a)(2) of the Securities Act[11] have imposed underwriter liability on underwriters of a SPAC’s IPO. The Commission declined to adopt its proposal to establish that a de-SPAC transaction would constitute a “distribution” under applicable underwriter regulations, which would have automatically extended underwriter liability to the SPAC IPO underwriter if it engaged in certain de-SPAC activities or compensation arrangements.

Instead, the Final Rules provide general guidance regarding statutory underwriter status, following its “longstanding practice of applying the statutory terms “distribution” and “underwriter” broadly and flexibly, as the facts and circumstances of any transaction may warrant.”[12] The Commission may find a “statutory underwriter” where someone is selling for the issuer or participating in the distribution of securities in the combined company to the SPAC’s investors and the broader public, even though it may not be named as an underwriter in any given offering or may not be engaged in activities typical of a named underwriter in traditional capital raising.[13]

The Commission’s extensive broad interpretation of the concept of “statutory underwriter,” coupled with the traditional “due diligence” defenses of underwriters,[14] suggests that SPACs and target companies should expect extensive diligence requests from financial institutions, advisors, and their counsel in connection with a de-SPAC transaction, requests from investment banks that advisors to a SPAC and its target provide negative assurance and comfort letters in connection with the de-SPAC transaction, and other related changes to the de-SPAC transaction process that add complexity, time, and cost.

3. Business Combinations Involving Shell Companies

The Commission’s concern related to private companies becoming U.S. public companies via de-SPAC transactions is substantially related to the perceived opportunity for such private companies to avoid “Securities Act registration and the related disclosures which are intended to protect investors.”[15]

Rule 145a

Based on the structure of certain de-SPAC transactions, the Commission expressed concern that, unlike investors in transaction structures in which the Securities Act applies (and a registration statement would be filed, absent an exemption), investors in reporting shell companies may not always receive the disclosures and other protection afforded by the Securities Act at the time the change in the nature of their investment occurs, due to the business combination involving another entity that is not a shell company.

Rule 145a intends to address the issue by deeming any direct or indirect business combination of a reporting shell company (other than a business combination related shell company) involving another entity that is not a shell company constitutes “a sale of securities to the reporting shell company’s shareholders.”[16] By deeming such transaction to be a “sale” of securities for the purposes of the Securities Act, the Final Rule is intended to address potential disparities in the disclosure and liability protections available to shareholders of reporting shell companies, depending on the transaction structure deployed.

Rule 145a defines a reporting shell company as a company (other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB) that has:

no or nominal operations;
either:
- no or nominal assets;
- assets consisting solely of cash and cash equivalents; or
- assets consisting of any amount of cash and cash equivalents and nominal other assets; and
an obligation to file reports under Section 13 or Section 15(d) of the Exchange Act.

The Final Rule notes that the sales covered by Rule 145a will not be covered by the exemption provided under Section 3(a)(9) of the Securities Act, because the exchange of securities would not be exclusively with the reporting shell company’s existing security holders, but also would include the target company’s existing security holders.

We would also note that this provision has broader market implications as it would apply to all reporting shell companies (other than a “business combination related shell company,” as defined in Rule 405 under the Securities Act and Rule 12b-2 under the Exchange Act), and not just SPAC transactions.

Financial Statement Requirements in Business Combination Transactions Involving Shell Companies

The Final Rule amends the financial statements required to be provided in a business combination with an intention to bridge the gap between such financial statements and the financial statements required to be provided in an IPO. The Commission views such Final Rule as simply codifying “current staff guidance for transactions involving shell companies.”[17] While the below information is presented in the context of a de-SPAC transaction, we would note that these requirements will apply to all shell companies (other than a “business combination related shell company,” as defined in Rule 405 under the Securities Act and Rule 12b-2 under the Exchange Act), and not just SPAC transactions.

Number of Years of Financial Statements

Rule 15-01(b) will require a registration statement for a de-SPAC transaction where a business is combining with a shell company registrant to include the same financial statements for that business as would be required in a Securities Act registration statement for an IPO of that business.

Audit Requirements

Rule 15-01(a) will require the examination of the financial statements of a business that is or will be a predecessor to a shell company to be audited by an independent accountant in accordance with the standards of the Public Company Accounting Oversight Board (“PCAOB”) for the purpose of expressing an opinion, to the same extent as a registrant would be audited for an IPO, effectively codifying the staff’s existing guidance.[18]

Age of Financial Statements

Rule 15-01(c) will provide for the age of the financial statements of a business involved in a business combination with a shell company to be based on whether such private company would qualify as a smaller reporting company in a traditional IPO process, ultimately aligning with the financial statement requirements in a traditional IPO.

Acquisitions of a Business or Real Estate Operation by a Predecessor

The Commission is implementing a series of rules intended to clarify when companies should disclose financial statements of businesses acquired by SPAC targets or where such business are probable of being acquired by SPAC targets. Rule 15-01(d) will address situations where financial statements of other businesses (other than the predecessor) that have been acquired or are probable to be acquired should be included in a registration statement or proxy/information statement for a de-SPAC transaction. The Final Rule will require application of Rule 3-05 and Rule 8-04 (or Rule 3-14 and Rule 8-06 with respect to real estate operation) of Regulation S-X to acquisitions by a predecessor to the shell company, which the staff views as codifying its existing guidance.

Amendments to the significance tests in Rule 1-02(w) of Regulation S-X will require the significance of the acquisition target of the private target in a de-SPAC transaction to be calculated using the SPAC’s target’s financial information, rather than the SPAC’s financial information.

In addition, Rule 15-01(d)(2) will require the de-SPAC company to file the financial statements of a recently acquired business, that is not or will not be its predecessor pursuant to Rule 3-05(b)(4)(i) in an Item 2.01(f) of Form 8-K filed in connection with the closing of the de-SPAC transaction where such financial statements were omitted from the registration statement for the de-SPAC transaction, to the extent the significance of the acquisition is greater than 20% but less than 50%.

Financial Statements of a Shell Company Registrant after the Combination with Predecessor

Rule 15-01(e) allows a registrant to exclude the financial statements of a SPAC for the period prior to the de-SPAC transaction if (i) all financial statements of the SPAC have been filed for all required periods through the de-SPAC transaction, and (ii) the financial statements of the registrant include the period on which the de-SPAC transaction was consummated. The Final Rule eliminates any distinction between a de-SPAC structured as a forward acquisition or a reverse recapitalization.

Other Amendments

In addition, the Final Rules are also addressing the following related amendments:

amendment of Item 2.01(f) of Form 8-K to (i) refer to “predecessor,” rather than “registrant,” to clarify that the information required to be provided “relates to the acquired business and for periods prior to consummation of the acquisition”[19] and (ii) establish that registrant need not present audited financial statements for predecessor for any period prior to the earliest audited period if, at the time of filing, the predecessor meets the conditions of an “emerging growth company”; and
amendment of Rules 3-01, 8-02, and 10-01(a)(1) of Regulation S-X to expressly refer to the balance sheet of the predecessors, consistent with the provision regarding income statements.

4. Enhanced Projections Disclosure

Disclosure of financial projections is not expressly required by the U.S. federal securities laws; however, it has been common practice for SPACs to use projections of the target company and post-de-SPAC company in its assessment of a proposed de-SPAC transaction, its investor presentations, and soliciting material once a definitive agreement is executed.

The Final Rules amend existing Commission guidance under Item 10(b) of Regulation S-K with respect to the use of any projections of future economic performance for any registrant and persons other than the registrant for any filings subject to Regulation S-K, as well as to add new, supplemental disclosure requirements applying only to de-SPAC transactions, under the new Item 1609 of Regulation S‑K.

Amended Item 10(b) of Regulation S-K

Under Item 10(b) of Regulation S-K, management may present projections regarding a registrant’s future performance, provided that (i) there is a reasonable and good faith basis for such projections, and (ii) they include disclosure of the assumptions underlying the projections and the limitations of such projections, and the presentation and format of such projections. Citing concerns of instances where target companies have disclosed projections that lack a reasonable basis,[20] the Final Rules amend Item 10(b) of Regulation S-K as follows:[21]

Clarification of Applicability to Target Company. Item 10(b) of Regulation S-K currently refers to projections regarding the “registrant.” The Final Rule will modify the language to clarify that the guidance therein applies to any projections of future economic performance of both the registrant and persons other than the registrant (which would include a target company in a de-SPAC transaction), that are included in the registrant’s Commission filings.
Historical Results. Disclosure of projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history.
Prominence of Historical Results. Similar to non-GAAP presentation, the Commission will consider it misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence.
Non-GAAP Measures. Presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure. The Final Rule notes that the reference to the nearest GAAP measure called for by amended Item 10(b) will not require a reconciliation to that GAAP measure; however, the need to provide a GAAP reconciliation for any non-GAAP financial measures will continue to be governed by Regulation G and Item 10(e) of Regulation S-K.

Important to note that the guidance in the amended Item 10(b) applies to all projections of future economic performance of any registrant and persons other than the registrant that are included in the registrant’s filings with the Commission (not only to de-SPAC transactions).

Proposed Item 1609 of Regulation S-K

In light of the traditional SPAC sponsor compensation structure (i.e., compensation in the form of post-closing equity) and the potential incentives and overall dynamics of a de-SPAC transaction, the Commission has adopted a new rule specific to de-SPAC transactions that will supplement the amendments to Item 10(b) of Regulation S-K (as discussed above). Specifically, the new Item 1609 of Regulation S-K that will require SPACs to provide the accompanying disclosures to financial projections:

Purpose of Projections. Any projection disclosed by the registrant in the filing (or any exhibit thereto) must include disclosure regarding (i) the purpose for which the projection was prepared, and (ii) the party that prepared the projection.
Bases and Assumptions. Disclosure will include all material bases of the disclosed projections and all material assumptions underlying the projections, and any material factors that may materially affect such assumptions. This would include a discussion of any factors that may cause the assumptions to be no longer reasonable, material growth or reduction rates or discount rates used in preparing the projections, and the reasons for selecting such growth or reduction rates or discount rates[22].
Views of Management and the Board. Disclosure must discuss whether or not the projections disclosed continue to reflect the views of the board of directors (or similar governing body) and/or management of the SPAC or target company, as applicable, as of the most recent practicable date prior to the date of the disclosure document required to be disseminated to security holders. If the projections do not continue to reflect the views of the board of directors (or similar governing body) and/or management, the SPAC should include a discussion of the purpose of disclosing the projections and the reasons for any continued reliance by the management or board on the projections.

Similar to the amendments to Item 10(b), the first two requirements summarized above should not come as a particular surprise to existing SPACs and their counsel as projections disclosure has been a significant area of scrutiny by the Commission in the registration statement and proxy statement review process.

We note, however, that the requirement under Item 1609 to add disclosure as to management’s and/or the board’s current views likely will require additional disclosure beyond what has been typical market practice. In particular, projections disclosure in a registration statement or proxy statement is often made in the context of a historical lookback to the projections in place at the time the board of directors of the SPAC assessed whether to enter into a de-SPAC transaction with the target company. These projections typically are not updated with newer data during the pendency of the transaction since the purpose of such disclosure is to inform investors of the board’s rationale for approving the transaction. Item 1609 does not explicitly require the updating of projections, but it does require the parties to disclose whether the included projections reflect the view of the SPAC and the target company as of the date of filing. Moreover, the potential to provide revised projections, coupled with obligations to disclose management’s and board’s continuing views, may prove challenging disclosure to be made between the signing of a business combination agreement and the filing of a registration statement or proxy statement and during the review period for such registration statement or proxy statement.

5. Status of SPACs under the Investment Company Act of 1940

Because pre-transaction SPACs are not engaged in any meaningful business other than investing their IPO proceeds, there has been uncertainty regarding whether they are “investment companies” under the Investment Company Act of 1940.[23] The Proposed Rules included a safe harbor that would have excluded certain SPACs from being defined as investment companies; however, the Commission instead set forth in the Final Rules facts and circumstances guidance relevant to investment-company classification using the five Tonopah factors employed in the standard analysis.[24]

Nature of SPAC Assets and Income. If a SPAC were to invest in investment securities like corporate bonds—especially if those investments exceeded 40% of the SPAC’s assets—it would likely be an investment company. (Assets commonly held by SPACs today, such as U.S. government securities, money market funds, and cash, likely would not count heavily toward investment-company status.) Similarly, if a SPAC were to derive most of its income from investment securities, it would likely be an investment company.
Management Activities. If a SPAC were to hold investment securities while its managers did not actively seek a de-SPAC transaction, or while its managers actively managed those securities to achieve investment returns, the SPAC would more likely be an investment company. Relatedly, SPAC sponsors should be aware that they may be classified as “investment advisors” under the Investment Advisors Act of 1940.[25]
Duration. The longer a SPAC takes to achieve a de-SPAC transaction, the more likely its investment-company-like characteristics qualify it as an investment company. The Commission identifies two timelines as relevant for this analysis. Rule 3a-2 under the Investment Company Act provides a one-year safe harbor for “transient investment companies.” And blank-check companies under Investment Company Act Rule 419 are not investment companies because their duration is limited to 18 months. Because these timelines reflect the Commission’s thinking in similar circumstances, though outside of the SPAC context, SPACs operating beyond 12 or 18 months should assess whether they otherwise qualify as investment companies.
Holding Out. A SPAC that markets itself like an investment company is likely to be considered to be an investment company. For example, a SPAC that advertises itself an alternative to mutual funds is holding itself out as an investment company.
Merging with an Investment Company. A SPAC that proposes to engage in a de-SPAC transaction with an investment company is likely to itself be an investment company.

SPACs should carefully assess all the facts and circumstances to determine whether they must register as investment companies. In particular, they should pay attention to the 12- and 18-month thresholds and whether investment securities account for most of their assets, income, or efforts.

IV. Conclusions

These Final Rules come as no surprise to SPAC market participants. Indeed, a comparison of existing de-SPAC transaction disclosure practices with many of the Final Rules merely evidences a codification of what the market has already adopted and anticipated over the nearly twenty-two month period since the Proposed Rules were first released. While the market appears to have already anticipated some of these changes, it remains to be seen whether the Final Rules will have any meaningful effect on current market conditions, as evidenced by the substantial retraction in the SPAC market over the last year, or if the SPAC market itself has naturally run its course in light of broader macro-economic trends.

Although we may view many of the Final Rules as reiterating the status quo, the Commission’s efforts here are noteworthy in that the Final Rules also touch upon broader market considerations. For example, the Final Rules’ facts and circumstances guidance with respect to the applicability of “underwriter” or “investment company” status, and the changes to Item 10(b) related to projections disclosure, are not limited solely to SPACs and should be considered relevant to other public market participants and advisors in similar and adjacent circumstances. As a result, we encourage our clients and public market participants to reach out to us to see how this rulemaking may affect their going-forward operations and business plans.

V. Commissioner Statements

For the published statements of the Commissioners, please see the following links:

Commissioner Jaime Lizárraga

Commissioner Caroline A. Crenshaw

Commissioner Mark T. Uyeda (Dissenting)

Commissioner Hester M. Peirce (Dissenting)

[1] U.S. Securities and Exchange Commission, Special Purpose Acquisition Companies, Shell Companies, and Projections, Exchange Act Release No. 99418 (January 24, 2024) (“Final Rules”), available at https://www.sec.gov/files/rules/final/2024/33-11265.pdf.

[2] For our discussion of the proposed rules, see Gibson, Dunn & Crutcher LLP, SEC Proposes Rules to Align SPACs More Closely with IPOs (April 6, 2022), available at https://www.gibsondunn.com/sec-proposes-rules-to-align-spacs-more-closely-with-ipos/.

[3] See Gibson, Dunn & Crutcher LLP, SEC Staff Issues Cautionary Guidance Related to Business Combinations with SPACs (April 6, 2021), link here (addressing certain accounting, financial reporting and governance issues related to SPACs and the combined company following a SPAC business combination), see also Gibson, Dunn & Crutcher LLP, SEC Division of Corporation Finance Issues Interpretations Addressed to SPACs’ Business Combinations (March 24, 2022), link here (discussing new Compliance and Disclosure Interpretations that addressed certain issues related to the business combination process of de-SPAC transactions), and Gibson, Dunn & Crutcher LLP, SEC Publishes C&DIs Addressing Tender Offer Issues (March 17, 2023), link here (discussing new Compliance and Disclosure Interpretations that addressed various tender offer issues in connection with de-SPAC transactions).

[4] U.S. Securities and Exchange Commission, Press Release (2024-8), SEC Adopts Rules to Enhance Investor Protections Relating to SPACs, Shell Companies, and Projections (January 24, 2024), available at https://www.sec.gov/news/press-release/2024-8.

[5] Id.

[6] The term “promoter” is defined in Securities Act Rule 405 and Exchange Act Rule 12b-2.

[7] Under Section 6(a) of the Securities Act, each “issuer” must sign a Securities Act registration statement. The Securities Act broadly defines the term “issuer” to include every person who issues or proposes to issue any securities.

[8] Final Rules, p. 220.

[9] 17 CFR 229.10(f)(1).

[10] The term “penny stock” is defined in 17 CFR 240.3a51-1.

[11] Section 11 of the Securities Act imposes on underwriters, among other parties identified in Section 11(a), civil liability for any part of the registration statement, at effectiveness, which contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, to any person acquiring such security. Further, Section 12(a)(2) imposes liability upon anyone, including underwriters, who offers or sells a security, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading, to any person purchasing such security from them.

[12] Final Rules, p. 284

[13] Id., p. 285

[14] Although the Securities Act does not expressly require an underwriter to conduct a due diligence investigation, the Final Rules reiterates the Commission’s long-standing view that underwriters nonetheless have an affirmative obligation to conduct reasonable due diligence. Final Rules, p. 288. This was also mentioned by the Commission in fn. 184 of the Proposed Rule (citing In re Charles E. Bailey & Co., 35 S.E.C. 33, at 41 (Mar. 25, 1953) (“[An underwriter] owe[s] a duty to the investing public to exercise a degree of care reasonable under the circumstances of th[e] offering to assure the substantial accuracy of representations made in the prospectus and other sales literature.”); In re Brown, Barton & Engel, 41 SEC 59, at 64 (June 8, 1962) (“[I]n undertaking a distribution . . . [the underwriter] had a responsibility to make a reasonable investigation to assure [itself] that there was a basis for the representations they made and that a fair picture, including adverse as well as favorable factors, was presented to investors.”); In the Matter of the Richmond Corp., infra note 185 (“It is a well-established practice, and a standard of the business, for underwriters to exercise diligence and care in examining into an issuer’s business and the accuracy and adequacy of the information contained in the registration statement . . . The underwriter who does not make a reasonable investigation is derelict in his responsibilities to deal fairly with the investing public.”)).

[15] Final Rules, p. 290.

[16] Id., p. 290-91.

[17] Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual).

[18] Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual at Section 4110.5).

[19] Id., p. 339.

[20] For example, the Commission cites to recent enforcement actions against SPACs, alleging the use of baseless or unsupported projections about future revenues and the use of materially misleading underlying financial projections. See, e.g., In the Matter of Momentus, Inc., et al., Exch. Act Rel. No. 34-92391 (July 13, 2021); SEC vs. Hurgin, et al., Case No. 1:19-cv05705 (S.D.N.Y., filed June 18, 2019); In the Matter of Benjamin H. Gordon, Exch. Act Rel. No. 34-86164 (June 20, 2019); and SEC vs. Milton, Case No. 1:21-cv-6445 (S.D.N.Y., filed July 29, 2021).

[21] The Final Rules made three technical revisions to item 10(b). The first two changes are to enhance clarity and avoid potential ambiguity. The third revision is to create consistency with the terms used in existing Item 10(e)(1)(i)(A) of Regulation S-K. In Item 10(b)(2)(i), they replaced the term “foregoing measures of income” with the term “foregoing measurers of income (loss).” In Item 10(b)(2)(iii), they replaced the term “historical financial measure” with the term “historical financial results.” In Item 10(b)(2)(iv), they revised the item to require a description of the GAAP financial measure “most directly comparable” to the non-GAAP measure, rather than “mostly closely related.”

[22] Two examples of “discount rates” are: (1) the weighted average cost of capital used to discount to present value the future cash flows over the period of years projected in a discounted cash flow analysis and (2) the rate applied to the terminal value in a discounted cash flow analysis to calculate its present value.

[23] See 15 U.S.C. §§ 80a-3(a)(1)(A), (a)(1)(C).

[24] See In the Matter of Tonopah Mining Co., 26 S.E.C. 426 (July 21, 1947).

[25] See 15 U.S.C. § 80b-2(a)(11).

__________

The following Gibson Dunn attorneys assisted in preparing this update: Evan D’Amico, Gerry Spedale, James Springer, and Rodrigo Surcan.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Capital Markets, Mergers and Acquisitions, Securities Enforcement, or Securities Regulation and Corporate Governance practice groups, or the following practice leaders and authors:

Evan M. D’Amico – Washington, D.C. (+1 202.887.3613, [email protected])
Gerry Spedale – Houston (+1 346.718.6888, [email protected])
James O. Springer – Washington, D.C. (+1 202.887.3516, [email protected])
Rodrigo Surcan – New York (+1 212.351.5329, [email protected])

Mergers and Acquisitions:
Robert B. Little – Dallas (+1 214.698.3260, [email protected])
Saee Muzumdar – New York (+1 212.351.3966, [email protected])

Capital Markets:
Andrew L. Fabens – New York (+1 212.351.4034, [email protected])
Hillary H. Holmes – Houston (+1 346.718.6602, [email protected])
Stewart L. McDowell – San Francisco (+1 415.393.8322, [email protected])
Peter W. Wardle – Los Angeles (+1 213.229.7242, [email protected])

Securities Regulation and Corporate Governance:
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, [email protected])
James J. Moloney – Orange County (+1 949.451.4343, [email protected])
Lori Zyskowski – New York (+1 212.351.2309, [email protected])
Brian J. Lane – Washington, D.C. (+1 202.887.3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202.887.3550, [email protected])
Mike Titera – Orange County (+1 949.451.4365, [email protected])
Aaron Briggs – San Francisco (+1 415.393.8297, [email protected])
Julia Lapitskaya – New York (+1 212.351.2354, [email protected])

An analysis of important trends and developments in AML regulation and enforcement, including key priorities emphasized by enforcers, notable enforcement actions and prosecutions, significant judicial opinions, and an important legislative development.

U.S. enforcers increasingly rely on the anti-money laundering (“AML”) statutes to police a wide variety of conduct. Broadly speaking, there are two types of AML statutes: (1) statutes that prohibit certain conduct (for example, knowingly engaging in a financial transaction with the intent to conceal unlawful activity), or (2) statutes that impose affirmative obligations on certain types of businesses to engage in identification and reporting of suspicious financial activity (for example, the Bank Secrecy Act (“BSA”)).

In this alert, we analyze the most important trends and developments in AML regulation and enforcement by recapping significant developments during the preceding year. In this inaugural edition, we recap 12 of the most important developments of 2023, including key priorities emphasized by enforcers, notable enforcement actions and prosecutions, significant judicial opinions, and an important legislative development.

Agency Priorities

We begin with a look at some of the U.S. government’s most significant priorities in the AML space: national security and the Corporate Transparency Act.

The Biden Administration Continues to Focus on National Security and AML

In 2023, the Biden administration prioritized investigations and prosecutions in the national security arena, particularly those implicating AML and sanctions. Department of Justice (“DOJ”) officials have repeatedly described sanctions as “the new FCPA”—relevant to an expanding number of industries, the focus of an increasingly multilateral enforcement regime, and subject to voluntary self-disclosure incentives.[1] Even businesses far removed from the defense sector such as tobacco, cement, and shipping faced enforcement actions for allegedly paying insufficient attention to the national security risks posed by certain actors, regions, and activities.[2] Further, money laundering-related cases now routinely intersect with international sanctions and export control violations.[3]

The U.S. government has backed its enforcement priorities with substantial resourcing. DOJ’s National Security Division designated its first Chief Counsel for Corporate Enforcement, Ian Richardson, and announced the hiring of 25 new prosecutors to investigate national security-related economic crimes.[4] Moreover, the Criminal Division’s Bank Integrity Unit likewise added six prosecutors—a 40 percent increase—to target national security-related financial misconduct.[5]

DOJ, along with the Departments of Treasury and Commerce, has embraced a “whole of government” approach to national security and illicit finance. One example is its growing use of inter-agency task forces. In 2023, DOJ’s Task Force Kleptocapture hit its stride with asset seizures (using inter alia money-laundering seizure theories) totaling more than $500 million of criminal assets with ties to the Russian regime.[6] Building on the success of Kleptocapture, the Departments of Justice and Commerce also launched the Disruptive Technology Strike Force,[7] a multi-agency task force that works to prevent U.S. adversaries from illicitly acquiring sensitive U.S. technology. The Disruptive Technology Strike Force already has brought money laundering prosecutions against those who allegedly evaded U.S. trade restrictions.[8] DOJ and Treasury—along with U.S. allies—have likewise continued to convene the Russian Elites, Proxies, and Oligarchs (REPO) Task Force.[9] This task force works to investigate and counter Russian sanctions evasion, including cryptocurrency and money laundering, and has blocked or frozen more than $58 billion of sanctioned Russian assets.[10]

U.S. enforcers have also released a number of alerts emphasizing the interplay between money laundering and national security issues. Treasury’s Financial Crimes Enforcement Network (“FinCEN”) is the U.S. government’s leading anti-money laundering regulator. In 2023, FinCEN issued three AML alerts to help detect potentially suspicious activity relating to Hamas’s financing and Russian export control violations.[11] FinCEN also issued supplemental AML alerts with Commerce’s Bureau of Industry and Security (“BIS”) that highlighted export evasion typologies.[12] In a similar vein, DOJ’s National Security Division began issuing joint advisories with Commerce and Treasury that provide the private sector with information about enforcement actions against those who use money laundering to support violations of U.S. sanctions and export controls.[13]

The Corporate Transparency Act’s Reporting Requirements to Assist AML Investigations

In January of 2021, the Anti-Money Laundering Act of 2020 became law.[14] One of the provisions in the bill was the Corporate Transparency Act (“CTA”), which established a new regime in the United States requiring many corporate entities to file a form with FinCEN disclosing their beneficial owners.[15]

To implement the CTA, FinCEN has currently issued two rules (with a third in progress). The first rule, the “Reporting Rule,” sets forth which entities need to disclose their beneficial ownership information (“BOI”) to FinCEN and by when. Entities subject to these reporting requirements include both “domestic reporting companies” and “foreign reporting companies.” Domestic reporting companies are defined as corporations, limited liability companies, or any other entity created by the filing of a document with a secretary of state or tribal nation.[16] Foreign reporting companies are corporations, LLCs, or other entities formed under the laws of a foreign country and registered to do business within any U.S. state.[17]

Domestic and foreign reporting companies must file BOI data with FinCEN unless an exemption applies. The CTA affords 23 exemptions for various entities—including public companies, money services businesses, select banks and credit unions, and large operating companies, defined as having more than 20 full time employees, an office space, and $5 million in gross receipts or sales in the United States the prior tax year.[18] There is also an exemption for investment advisers and investment funds, as detailed further in a prior Gibson Dunn client alert.[19] Additionally, subsidiaries of certain exempt entities need not report BOI information in particular circumstances as well.[20] However, pursuant to recent guidance from FinCEN, that exception only applies to subsidiaries that are “fully, 100 percent owned or controlled by an exempt entity.”[21]

If no exemption applies, then select domestic and foreign entities must disclose relevant BOI information. In general, these BOI reports must identify two categories of individuals: (1) the beneficial owners of the entity (defined as those natural persons who own at least 25% of the entity or who exercise “substantial control” over it); and (2) the company applicants of the entity (meaning those directly involved in or responsible for the filing that creates the company).[22] Companies formed before January 1, 2024, however, need only submit the names of their beneficial owners and not the identities of company applicants.[23] FinCEN’s Reporting Rule became operative as of January 1, 2024, with the regulation specifying varying deadlines for submission of BOI data.[24]

The effects of the CTA will continue to unfold in the coming months and years, but it has created significant work for companies as they sort through which of their corporate entities have any reporting obligations.

Notable Corporate AML Resolutions

2023 saw a number of notable AML resolutions. We discuss those which broke new ground below.

MindGeek: A Novel Application of The Spending Statute, 18 U.S.C. § 1957

In a prototypical case, U.S. prosecutors must prove three things to establish a violation of the general money laundering statute (18 U.S.C. § 1956): (1) the commission of an underlying felony (a “Specified Unlawful Activity” or “SUA”); (2) knowingly engaging in a financial transaction; and (3) specific intent to conceal or further the SUA through the financial transaction.[25] U.S. enforcers, however, have a second powerful tool at their disposal—the money laundering “spending statute” (18 U.S.C. § 1957). In a case involving the spending statute, prosecutors are relieved of the burden to prove specific intent to conceal or commit a further crime. Rather, the spending statute requires only (1) the commission of an SUA; and (2) knowingly engaging in a financial transaction involving $10,000 or more of proceeds from the SUA.[26]

On December 21, 2023, DOJ entered into a Deferred Prosecution Agreement with Aylo Holdings S.A.R.L. and its subsidiaries (collectively known as “MindGeek”) involving a novel and aggressive theory using the money laundering spending statute. MindGeek is the parent company of Pornhub and similar websites.[27] DOJ charged MindGeek with violating the spending statute for knowingly engaging in monetary transactions related to sex trafficking activity. DOJ’s theory centered on MindGeek’s relationship with two of its content partners, GirlsDoPorn.com (“GDP”) and GirlsDoToys.com (“GDT”) and the operators of those sites (referred to in the DPA as “the GDP Operators”).[28] According to the resolution documents, both GDP and GDT had specialized channels on MindGeek’s platforms, including Pornhub. Between mid-2017 and mid-2019, MindGeek allegedly received over $100,000 in payments from the GDP Operators.[29] DOJ also alleged that MindGeek “received payments from advertisers attributable to GDP and GDT content” totaling approximately $763,000.[30]

In order to establish that MindGeek had knowledge that the proceeds were from illicit origins, DOJ relied on a mosaic of sources to purportedly establish knowledge, including civil and criminal legal filings, news stories about these cases, takedown requests, and a business records subpoena.[31] Specifically, DOJ alleged that MindGeek’s knowledge derived from:

MindGeek’s receipt of a subpoena for production of business records from plaintiffs’ counsel in a lawsuit filed against GDP in 2016. The complaint in that lawsuit alleged that the GDP Operators had tricked the plaintiffs into appearing in pornographic videos posted to GDP by promising them that their videos would not be posted online;[32]
MindGeek’s receipt of content removal requests from plaintiffs in the lawsuit,[33] plaintiffs’ counsel, and other individuals;[34]
Publicly available criminal filings announcing the sex trafficking charges against GDP operators;[35] and
MindGeek executives’ receipt and internal discussion of news articles about the stages of the civil and criminal proceedings against GDP operators.[36]

On the basis of these allegations, MindGeek entered into a DPA asserting a violation of 18 U.S.C. § 1957.[37] MindGeek agreed to submit to a monitorship for three years[38] and pay a total fine of $974,692.06.[39] Notably, MindGeek agreed to compensate victims in the “full amount of [their] losses” caused by publication of their images on MindGeek’s websites, not including losses for pain and suffering, including a minimum of $3,000 per victim who can demonstrate harm.[40] Also, the DPA contained a stipulation that MindGeek “did not commit, conspire to commit, or aid and abet the commission of sex trafficking.”[41]

This is a novel and aggressive use of § 1957 because DOJ relied on sources such as the public allegations of wrongdoing and a business records subpoena to establish knowledge. Although the resolution may be explained in part by the nature of the industry involved, the resolution nevertheless suggests that public allegations of wrongdoing, the receipt of a business records subpoena, take down requests, and receipt and discussion of news articles about allegations can serve as ways that DOJ may try to establish knowledge under § 1957 against companies.

U.S. Enforcers Extend Reach of BSA and Sanctions to Non-U.S. Crypto Company

Binance is the world’s largest crypto currency exchange by trading volume and it is an overseas, non-U.S. company. On November 21, 2023, Binance reached a settlement to resolve a multi-year investigation with DOJ, the Commodity Futures Trading Commission (“CFTC”), the U.S. Department of Treasury’s Office of Foreign Assets Control (“OFAC”), and FinCEN.[42] Gibson Dunn represented Binance in this resolution.

Although Binance is a non-U.S. company, the enforcers alleged that it historically had U.S. users on its platform. As a result, the enforcers alleged that Binance needed to register as a foreign-located money services business and maintain an adequate AML program under U.S. law because it did business “wholly or in substantial part” within the United States.[43]

Prior to the Binance resolution, sanctions resolutions with cryptocurrency exchanges generally involved U.S. exchanges, which are prohibited from providing financial services to persons in jurisdictions subject to sanctions regulated by OFAC.[44] As a non-U.S. person, Binance could do business in sanctioned jurisdictions.[45] However, because Binance’s platform historically had both U.S. users and users from sanctioned jurisdictions, enforcers alleged that Binance used a “matching engine [. . .] that matched customer bids and offers to execute cryptocurrency trades.”[46] The failure to have sufficient controls on the matching engine, which operated randomly in matching users for trades, meant that it would “necessarily cause” transactions between U.S. users and users targeted by U.S. sanctions.[47] Enforcers took the position that these transactions violated U.S. civil and criminal sanctions law because the International Emergency Economic Powers Act (“IEEPA”) prohibits, among other things, “causing” a violation of sanctions by another party.[48] In other words, by randomly pairing trades between a historical U.S. user and person from a sanctioned jurisdiction, Binance was causing the U.S. person to violate their sanctions obligations. This resolution illustrates the breadth of U.S. jurisdiction to police sanctions offenses, even against non-U.S. companies.

Criminally, Binance pled guilty to (1) conspiracy to conduct an unlicensed money transmitting business, in violation of 18 U.S.C. § 1960 and 31 U.S.C. § 5330 for failure to register,[49] (2) failure to maintain an effective anti-money laundering program, in violation of 31 U.S.C. §§ 5318(h), 5322,[50] and (3) violating IEEPA, 50 U.S.C. § 1701 et seq.[51] Binance also entered into parallel civil settlements with FinCEN (failure to register, AML program) and OFAC (sanctions).[52] Further, Binance also entered into a settlement with the CFTC for violating various sections of the Commodities Exchange Act and related provisions.[53]

As part of the resolution, Binance agreed to pay $4.3 billion to the U.S. government over an approximately 18-month period.[54] Binance also agreed to continue with certain compliance enhancements and agreed to a three-year DOJ monitorship.[55]

FinCEN Designates Bitzlato as a “Primary Money-Laundering Concern” Pursuant to New Powers Designed to Target Russian Money Laundering

On January 18, 2023, FinCEN issued an order identifying Bitzlato Limited, a Hong Kong based cryptocurrency exchange, as a “primary money laundering concern.”[56] It issued this designation because Bitzlato was allegedly “repeatedly facilitating transactions for Russian-affiliated ransomware groups, including Conti, a Ransomware-as-a-Service group that has links to the Russian government and to Russian-connected darknet markets.”[57] The Bitzlato order is the first order issued pursuant to FinCEN’s powers under the Combatting Russian Money Laundering Act.[58]

In 2021, Congress passed the Combatting Russian Money Laundering Act (“Section 9714(a)”), which expanded the actions that FinCEN can take whenever it designates an entity as a “primary money laundering concern.”[59] Previously, whenever the Treasury Secretary had “reasonable grounds” for concluding that an entity is of “primary money laundering concern,”[60] then the Treasury Secretary could impose special measures that would limit the entity’s access to the global financial system.[61] Section 9714(a) provides additional powers to FinCEN to “prohibit, or impose conditions upon, certain transmittals of funds (to be defined by the Secretary) by any domestic financial institution or domestic financial agency.”

Under the terms of the Bitzlato order, FinCEN prohibits financial institutions (as defined in 31 C.F.R. § 1010.100(t)) from engaging in the transmittal of funds from or to Bitzlato. In remarks addressing the order, Deputy Secretary Adeyemo remarked that designating Bitzlato as a primary money laundering concern was a “unique step” that has only been taken a handful of times.[62]

DOJ also brought a parallel criminal proceeding against Bitzlato co-founder and Russian national Anatoly Legkodymov, who pleaded guilty to operating an unlicensed money transmitter and agreed to dissolve Bitzlato.[63]

Looking ahead, FinCEN will likely continue to be aggressive in using its authorities in the digital assets space. On October 19, 2023, for instance, FinCEN issued a Notice of Proposed Rulemaking which proposed to designate cryptocurrency mixers as a primary money laundering concern under Section 311 of the Patriot Act.[64] This is FinCEN’s first proposed Section 311 action involving a class of transactions.

FinCEN Imposes Civil Penalty on Shinhan, Reflecting Increased Scrutiny of Customer Due Diligence and Transaction Monitoring Systems

On September 29, 2023, FinCEN imposed a $15 million civil penalty on Shinhan Bank America for willful violation of the BSA.[65] The Consent Order reflects FinCEN’s growing scrutiny of—and increasingly granular expectations for—customer due diligence and transaction monitoring systems.

Notably, FinCEN criticized Shinhan’s overly “rigid” methodology for calculating customer risk rating scores and emphasized that banks should maintain formal customer risk rating procedures.[66] Risk ratings should not be solely based on customer type (e.g., individual vs. corporate entity) or the type of product (e.g., home mortgage vs. letter of credit). Rather, they should be individually assessed—both at onboarding and throughout the customer relationship—and be based on the customer’s activity and any new information learned about the customer.[67]

The Shinhan Order also makes clear that customers’ risk ratings should inform financial institutions’ monitoring of transactions. The Order notes that Shinhan’s transaction monitoring system did not cluster accounts belonging to the same customer relationship or aggregate transaction activity across different transaction types, undermining its ability to identify suspicious activity. It also includes examples of scenarios that banks should consider incorporating into their transaction monitoring systems, including:

wire transfers sent to several beneficiaries from a single originator, or sent from several originators to a single beneficiary;
transactions passing through a large number of jurisdictions; and
transactions conducted using Remote Deposit Capture.

Moreover, the Order states that these systems should be regularly and comprehensively tested to ensure all scenarios alert as intended, all relevant data properly feeds into the system, scenarios are sufficient and tailored for each product, and scenarios are appropriately applied to ingested data.[68]

FinCEN Issues First Action Against Trust Company

On April 26, 2023, FinCEN assessed a $1.5 million civil penalty against South Dakota-chartered Kingdom Trust Company for willful violation of the BSA.[69] This was FinCEN’s first action against a trust company.

FinCEN assessed a penalty against Kingdom Trust after the company opened accounts and provided services for Latin America-based trading companies and financial institutions with virtually no controls to identify or assess suspicious transactions.[70] A consultant referred clients based in Uruguay, Argentina, Panama, and other locations to the Trust.[71] Kingdom Trust then held cash and securities for these customers and initiated a high volume of suspicious transactions worth approximately $4 billion that went unchecked and unreported.[72] Despite providing services to customers who were the subject of prior media reports related to money laundering and securities fraud, the Trust’s AML compliance program consisted of a single individual responsible for manually reviewing daily transactions.[73]

FinCEN’s action against Kingdom Trust reflects the agency’s growing focus on entities beyond traditional financial institutions, including those not historically subject to the BSA, such as real estate businesses and investment advisors.[74] FinCEN’s action against Kingdom Trust reflects the agency’s unwillingness to “tolerate trust companies with weak compliance programs that fail to identify and report suspicious activities, particularly with respect to high-risk customers whose businesses pose an elevated risk of money laundering.”[75]

FinCEN Issues First Action Under Gap Rule Against Bancrédito for Failing to Report Suspicious Transactions

On September 15, 2023, FinCEN levied a $15 million civil monetary penalty against Bancrédito International Bank and Trust Corporation (Bancrédito).[76] Bancrédito (which held U.S. dollar-denominated accounts on behalf of numerous Central American and Caribbean financial institutions) allegedly failed to both report suspicious transactions (“SARs”) involving movement of U.S. dollars and never established or maintained an AML program, as required by the recently enacted “Gap Rule” (31 C.F.R. § 1020.210).[77]

The enforcement action against Bancrédito is notable in multiple respects. It is the first time that FinCEN took action against a Puerto Rican International Banking Entity (“IBE”). The U.S. Department of the Treasury’s 2022 National Money Laundering Risk Assessment alleged that IBEs pose an elevated risk of money laundering.[78] It is also the first enforcement action under FinCEN’s recently enacted “Gap Rule.” Previously, banks lacking federal functional regulators (such as private banks, non-federally insured credit unions, and certain trust companies) were exempt from select AML program obligations, namely (1) the development of internal policies, procedures, and controls; (2) the designation of a compliance officer; (3) facilitating an ongoing employee training program; and (4) requiring an independent audit function to test programs.[79] However, the “Gap Rule,” effective beginning in 2021, functionally filled that “gap” by requiring the newly covered entities to meet those specific AML requirements (along with also complying with pre-existing BSA obligations such as reporting SARs).[80]

Individual Prosecutions

2023 also featured a number of notable prosecutions of individuals under U.S. money laundering statutes, including in connection with sanctions evasion and in the digital assets industry.

Money Laundering and Sanctions Evasion

In 2023, federal prosecutors on DOJ’s Task Force KleptoCapture brought several prosecutions against the associates of sanctioned oligarch Viktor Vekselberg. OFAC designated Vekselberg as a Specially Designated National (“SDN”) in March 2018.[81] In 2023, DOJ brought a number of prosecutions which reflect the growing intersection between money laundering and sanctions evasion.[82]

On January, 20, 2023, DOJ announced the indictment of Vladislav Osipov and Richard Masters for facilitating a sanctions evasion and money laundering scheme related to a 255-foot luxury yacht owned by Vekselberg.[83] Osipov and Masters used U.S. companies to manage the operation of the vessel and to obfuscate Vekselberg’s involvement, including using payments through third parties and non-U.S. currencies to do business with U.S. companies.[84]

DOJ also targeted Vekselberg’s property portfolio in the United States and those who helped him manage it. On February 7, 2023, federal prosecutors announced the indictment of Vladimir Voronchenko, an associate of Vekselberg’s, for making more than $4 million in payments to maintain four U.S. properties owned by Vekselberg and for his attempt to sell two of those properties.[85] A few weeks later, on February 24, prosecutors brought a civil forfeiture complaint against six of Vekselberg’s properties in New York City, Southampton, New York, and Fisher Island, Florida, alleging that they were the proceeds of sanctions violations and involved in international money laundering.[86]

Vekselberg’s U.S. associates also faced prosecution for their role in money laundering and evading U.S. sanctions. On April 25, 2023, New York attorney Robert Wise pled guilty to conspiracy to commit international money laundering for unlawfully transferring Russian funds into the United States in violations of U.S. sanctions.[87] Voronchenko had retained Wise to assist him in managing Vekselberg’s U.S. properties.[88] Immediately after Vekselberg’s designation as an SDN, Wise’s IOLTA Account began to receive wires from new sources, a Russian bank account, and a bank account in the Bahamas held in the name of a shell company controlled by Voronchenko.[89] Despite being aware of Vekselberg’s designation as an SDN, Wise received 25 wire transfers totaling nearly $3.8 million in his IOLTA account between June 2018 and March 2022 and used these funds to maintain and service Vekselberg’s properties in defiance of U.S. sanctions.[90]

Collectively, these actions demonstrate the increasing interplay between violations of U.S. sanctions and money laundering laws.

Money Laundering Prosecutions of Cryptocurrency Executives for Fraud

2023 also included a number of money laundering prosecutions against executives in the digital assets industry. The most significant of 2023’s individual prosecutions sounded in fraud and subsequent laundering of the fraud proceeds.

On November 2, 2023, a New York jury convicted FTX founder Sam Bankman-Fried of stealing billions of dollars’ worth of FTX customer deposits, capping one of the highest-profile criminal fraud trials in recent history.[91] One of the charges against Bankman-Fried was violating 18 U.S.C. § 1956(a)(1)(B)(i), on the basis that he knowingly engaged in a transaction involving proceeds of illegal activity in order hide the illegal origins of the funds; and Section 1957(a), on the basis that he engaged in a transaction involving criminally derived property exceeding $10,000.[92] These charges related to the transfer of customer funds from Bankman-Fried’s centralized exchange, FTX, to FTX’s sister organization, the hedge fund Alameda Research.[93] Bankman-Fried was convicted on all seven counts, including the money laundering charges.[94] Bankman-Fried’s sentencing hearing is scheduled for March 2024.[95]

Earlier in 2023, Nate Chastain, the former Head of Product at NFT Trading Platform OpenSea, was convicted by a jury of wire fraud and money laundering in what is considered the first insider-trading case involving digital assets. Chastain was accused of purchasing NFTs before they were featured on OpenSea’s homepage, where they subsequently rose in price. Perhaps because the question of whether NFTs are subject to securities laws remains open,[96] DOJ prosecuted Chastain under wire fraud and money laundering statutes.[97] DOJ alleged money laundering because, by engaging in insider trading of NFTs, Chastain knowingly conducted a financial transaction involving the proceeds of an unlawful activity (i.e., wire fraud), in violation of 18 U.S.C. § 1956(a)(1)(B)(i).[98]

Another notable fraud-based cryptocurrency executive prosecution of 2023 involved the former SafeMoon executives, who were accused of making a series of fraudulent misrepresentations about the cryptocurrency that they managed and marketed.[99] DOJ charged a violation of 18 U.S.C. § 1956(a)(1)(B)(i) on the theory that the executives knowingly engaged in and covered up transactions involving the proceeds of securities fraud and wire fraud.[100]

Judicial Opinions

The Implications of Narrowing the Honest Services Wire Fraud Statute

Two judicial decisions in 2023 could affect how prosecutors pursue future money laundering prosecutions. These opinions involve the now highly-publicized FIFA corruption and Varsity Blues scandals—occasions where individuals allegedly made illicit payments to secure lucrative FIFA contracts and favorable college admission decisions, respectively. In both United States v. Full Play Grp., S.A., 2023 WL 5672268 (E.D.N.Y. Sept. 1, 2023) (involving the FIFA corruption matter) and United States United States v. Abdelaziz, 68 F.4th 1 (1st Cir. 2023) (a decision relating to Varsity Blues), federal courts held that certain transactions failed to qualify as unlawful instances of honest services wire fraud—a predicate offense that prosecutors frequently rely on when charging money laundering.[101]

In Full Play, several individuals and companies in the entertainment industry sought to earn media and other related contracts with various sports organizations (including soccer’s FIFA).[102] In an effort to secure these contracts, the media representatives were alleged to have paid FIFA officials significant sums in side payments.[103] Though various individuals were charged with honest services wire fraud for their actions, the district court found that such payments (i.e., those made to private employees of a foreign corporation and labeled as foreign commercial bribery) did not qualify as actionable instances of honest services fraud under 18 U.S.C. §§ 1343 and 1346.[104] In reaching that conclusion, the district court applied two Supreme Court opinions issued last term: Percoco v. United States, 598 U.S. 319 (2023) and Ciminelli v. United States, 598 U.S. 306 (2023). Citing specifically to the Percoco decision, the district court found that honest services fraud “must be defined with the clarity typical of criminal statutes and should not be held to reach an ill-defined category of circumstances simply because of a smattering” of earlier precedents.[105] Applying that standard, the district court vacated the convictions because no applicable precedents precisely addressed (and thus criminalized) comparable instances of foreign commercial bribery.[106] Full Play is currently the subject of an appeal in the Second Circuit.[107]

Similarly, albeit before Percoco and Ciminelli were decided, the Abdelaziz court removed another type of transaction from the range of prosecutable offenses under the honest services fraud provision. In that case, a parent was convicted of making illicit side payments to college admissions personnel—intending that the payments would secure preferential admissions decisions for his child.[108] On appeal, the Abdelaziz court overturned the conviction—finding that such conduct did not amount to honest services wire fraud. In reaching that result, the court specified that the transaction at issue—one where the alleged briber (the convicted parent) actually compensated the alleged victim (the university)—did not fit the conventional understanding of “bribe” or “kickback” under 18 U.S.C. §§ 1343 and 1346.[109] Because no prior decision had specifically barred payments that so clearly benefitted an alleged victim, it could not be considered a criminal deprivation of honest services.

As the courts continue to narrow the scope of the honest services wire fraud statute, prosecutors will be forced to craft different theories of honest services wire fraud and/or rely on different predicate offenses when identifying an SUA required for charging money laundering.

Legislation

2023 also saw an important legislative change in the bribery space, which will also impact money laundering prosecutions.

The Impact of FEPA for Money Laundering Prosecutions

On December 22, 2023, federal lawmakers passed the Foreign Extortion Prevention Act (“FEPA”). FEPA criminalizes what is colloquially referred to as “demand side” bribery—instances in which foreign officials demand, solicit, seek, or receive bribes from a domestic person or U.S.-located company.[110] Before FEPA’s passage, no particular provision under federal law penalized this particular scheme—with the Foreign Corrupt Practices Act (“FCPA”) focusing instead on the supply side of offering or paying bribes to foreign persons.[111] FEPA arms prosecutors with a new tool to root out alleged instances of foreign bribery or extortion that is focused on foreign public officials.

More than just an anti-corruption mechanism, FEPA will also equip prosecutors with an additional tool to pursue money laundering prosecutions as well. By its terms, any contemplated or actual violation of FEPA would qualify as an SUA under the money laundering statutes.[112] Passage of this law will allow prosecutors to rely on U.S. law (i.e., FEPA) when charging foreign officials with money laundering, as opposed to having to allege that the conduct constituted bribery under the foreign laws of another country, which is also an SUA.

Conclusion

2023 was a notable year in the AML enforcement space. We anticipate that 2024 will also be active, as the impacts of FinCEN’s AML whistleblower program begin to be felt, and the additional prosecutors come online in the Criminal Division’s Bank Integrity Unit and the National Security Division’s Counterintelligence and Export Control Section. Moreover, there are yet-to-be issued rules expected both for regulation of the real estate industry and for registered investment advisors.

__________

[1] See, e.g., Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Global Investigations Review Annual Meeting (Sept. 21, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-global (“It is for all of these reasons that the DAG [Deputy Attorney General] has warned that from a compliance standpoint ‘sanctions are the new FCPA.’”).

[2] See Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Global Investigations Review Annual Meeting (Sept. 21, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-global (“Even business operations and lines far removed from the defense sector – like cigarettes, cement, and shipping – can pose dire national security risks if companies are not highly sensitive to high-risk actors, high-risk regions, and high-risk activities.”).

[3] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Ethics and Compliance Initiative IMPACT Conference (May 3, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-ethics-and (“From money laundering and cyber- and crypto-enabled crime to sanctions and export control evasion and even funneled payments to terrorist groups, corporate crime increasingly — now almost routinely — intersects with national security concerns.”).

[4] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Global Investigations Review Annual Meeting (Sept. 21, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-global.

[5] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national; Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Global Investigations Review Annual Meeting (Sept. 21, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-global.

[6] Deputy Assistant Attorney General Eun Young Choi Delivers Keynote Remarks at GIR Live: Sanctions & Anti-Money Laundering Meeting (Nov. 16, 2023), https://www.justice.gov/opa/speech/deputy-assistant-attorney-general-eun-young-choi-delivers-keynote-remarks-gir-.live.

[7] Press Release, U.S. Dep’t of Just., Justice and Commerce Departments Announce Creation of Disruptive Technology Strike Force (May 16, 2023), https://www.justice.gov/opa/pr/justice-and-commerce-departments-announce-creation-disruptive-technology-strike-force; see also Press Release, U.S. Dep’t of Just., Justice Department Announces Five Cases as Part of Recently Launched Disruptive Technology Strike Force (May 16, 2023), https://www.justice.gov/opa/pr/justice-department-announces-five-cases-part-recently-launched-disruptive-technology-strike.

[8] Id.

[9] Press Release, U.S. Dep’t of Just., Russian Elites, Proxies, and Oligarchs Task Force Ministerial Joint Statement (Mar. 17, 2022), https://www.justice.gov/opa/pr/russian-elites-proxies-and-oligarchs-task-force-ministerial-joint-statement.

[10] Press Release, U.S. Dep’t of Just., Russian Elites, Proxies, and Oligarchs Task Force Ministerial Joint Statement (Mar. 17, 2023), https://www.justice.gov/opa/pr/russian-elites-proxies-and-oligarchs-task-force-ministerial-joint-statement; Statement, U.S. Dep’t of Just., Joint Statement from the REPO Task Force (Mar. 9, 2023), https://home.treasury.gov/news/press-releases/jy1329.

[11] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Alert to Financial Institutions to Counter Financing to Hamas and its Terrorist Activities (Oct. 20, 2023), https://www.fincen.gov/sites/default/files/2023-10/FinCEN_Alert_Terrorist_Financing_FINAL508.pdf; Supplemental Alert: FinCEN and the U.S. Department of Commerce’s Bureau of Industry and Security Urge Continued Vigilance for Potential Russian Export Control Evasion Attempts (May 19, 2023), https://www.fincen.gov/sites/default/files/shared/FinCEN%20and%20BIS%20Joint%20Alert%20_FINAL_508C.pdf; FinCEN Alert on Potential U.S. Commercial Real Estate Investments by Sanctioned Russian Elites, Oligarchs, and Their Proxies (Jan. 25, 2023), https://www.fincen.gov/sites/default/files/shared/FinCEN%20Alert%20Real%20Estate%20FINAL%20508_1-25-23%20FINAL%20FINAL.pdf.

[12] Supplemental Alert: FinCEN and the U.S. Department of Commerce’s Bureau of Industry and Security Urge Continued Vigilance for Potential Russian Export Control Evasion Attempts (May 19, 2023), https://www.fincen.gov/sites/default/files/shared/FinCEN%20and%20BIS%20Joint%20Alert%20_FINAL_508C.pdf; FinCEN & BIS Joint Notice: FinCEN and the U.S. Department of Commerce’s Bureau of Industry and Security Announce New Reporting Key Term and Highlight Red Flags Relating to Global Evasion of U.S. Export Controls (Nov. 6, 2023), https://www.fincen.gov/sites/default/files/shared/FinCEN_Joint_Notice_US_Export_Controls_FINAL508.pdf.

[13] See U.S. Dep’t of Com., U.S. Dep’t of the Treasury, and U.S. Dep’t of Just., Tri-Seal Compliance Note: Cracking Down on Third-Party Intermediaries Used to Evade Russia-Related Sanctions and Export Controls (Mar. 2, 2023), https://www.justice.gov/nsd/file/1277536/dl?inline. See also Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[14] See William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Pub. L. 116-283, Div. F.

[15] Id., § 6403 (adding 31 U.S.C. § 5336).

[16] 31 C.F.R. § 1010.380(c)(1)(i).

[17] 31 C.F.R. § 1010.380(c)(1)(ii).

[18] 31 C.F.R. § 1010.380(c)(2)(i)-(xxiii).

[19] 31 C.F.R. § 1010.380(c)(2)(x)-(xi); Gibson Dunn, The Impact of FinCEN’s Beneficial Ownership Regulation on Investment Funds (Aug. 10, 2023), https://www.gibsondunn.com/the-impact-of-fincens-beneficial-ownership-regulation-on-investment-funds/.

[20] 31 C.F.R. § 1010.380(c)(2)(xxii).

[21] FinCEN: Beneficial Ownership Information Reporting, Frequently Asked Questions (Jan. 12, 2024), https://www.fincen.gov/boi-faqs.

[22] 31 C.F.R. § 1010.380(b)-(e).

[23] 31 C.F.R. § 1010.380(b)(2)(iv).

[24] 31 C.F.R. § 1010.380(a)(1)(i)(B).

[25] See United States v. Huezo, 546 F.3d 174, 178 (2d Cir. 2008) (“The substantive offense of ‘transaction money laundering’ requires proof of both knowledge and specific intent.”) (citing Cuellar v. United States, 128 S. Ct. 1994 (2008)).

[26] See United States v. Wright, 341 F. App’x 709, 713 (2d Cir. 2009) (“To demonstrate a § 1957 violation, the government must prove, inter alia, that the money Wright used to lease the car exceeded $10,000 and was ‘derived from specified unlawful activity.’”).

[27] Deferred Prosecution Agreement at 1, United States v. Aylo Holdings S.A.R.L., No. 1:23-cr-00463 (E.D.N.Y. Dec. 21, 2023), https://www.justice.gov/d9/2023-12/2023.12.21_dpa_final_court_exhibit_version_0.pdf (hereinafter “DPA”).

[28] Attachment B to Deferred Prosecution Agreement, United States v. Aylo Holdings S.A.R.L., No. 1:23-cr-00463 (E.D.N.Y. Dec. 21, 2023) (hereinafter “MindGeek Information”), https://www.justice.gov/d9/2023-12/2023.12.21_dpa_final_court_exhibit_version_0.pdf, ¶ 8.

[29] Id. ¶ 10.

[30] Id.

[31] Id.

[32] Id. ¶ 16.

[33] Id. ¶ 17.

[34] Id. ¶¶ 20, 27.

[35] Id. ¶ 23.

[36] Id. ¶¶ 18, 22, 29, 30.

[37] See DPA at 1.

[38] Id. at 2.

[39] Id. at 2–3.

[40] Id. at 9–10.

[41] Id. at 5.

[42] See Binance Blog, Binance Announcement: Reaching Resolution with U.S. Regulators (Nov. 21, 2023), https://www.binance.com/en/blog/leadership/binance-announcement-reaching-resolution-with-us-regulators-2904832835382364558.

[43] 31 C.F.R. § 1010.100(ff).

[44] See, e.g., Press Release, U.S. Dep’t of the Treasury, Treasury Announces Two Enforcement Actions for Over $24M and $29M Against Virtual Currency Exchange Bittrex, Inc. (Oct. 11, 2022), https://home.treasury.gov/news/press-releases/jy1006 (announcing an enforcement action against Bittrex, Inc., a virtual currency exchange that was based in Washington state).

[45] See International Emergency Economic Powers Act (IEEPA), 50 U.S.C. § 1701(a)(1)(A) (empowering the President to prohibit transactions by “any person, or with respect to any property, subject to the jurisdiction of the United States.”); see also Office of Foreign Assets Control, Frequently Asked Questions: 11. Who Must Comply with OFAC Regulations?, https://ofac.treasury.gov/faqs/11 (“U.S. persons must comply with OFAC regulations, including all U.S. citizens and permanent resident aliens regardless of where they are located, all persons and entities within the United States, all U.S. incorporated entities and their foreign branches. In the cases of certain programs, foreign subsidiaries owned or controlled by U.S. companies also must comply. Certain programs also require foreign persons in possession of U.S.-origin goods to comply.”).

[46] Attachment A, “Statement of Facts,” to the Plea Agreement in United States v. Binance Holdings Ltd., No. 23-178RAJ (Nov. 21, 2023), https://www.justice.gov/opa/media/1326901/dl?inline (hereinafter “Binance SOF”) at 7, ¶ 22.

[47] Id.

[48] 50 U.S.C. § 1705(a) (“It shall be unlawful for a person to violate, attempt to violate, conspire to violate or cause a violation of any license, order, regulation, or prohibition issued [pursuant to IEEPA].”).

[49] Plea Agreement in United States v. Binance Holdings Ltd., No. 23-178RAJ (Nov. 21, 2023), https://www.justice.gov/opa/media/1326901/dl?inline (hereinafter “Binance Plea Agreement”), at ¶ 2.

[50] Id.

[51] Id.

[52] See Nikhilesh De, Binance to Make ‘Complete Exit’ From U.S., Pay Billions to FinCEN, OFAC on Top of DOJ Settlement, CoinDesk (Nov. 21, 2023), https://www.coindesk.com/policy/2023/11/21/binance-to-make-complete-exit-from-us-pay-billions-to-fincen-ofac-on-top-of-doj-settlement/.

[53] Id.

[54] Binance Plea Agreement ¶ 24.

[55] Id at ¶ 32.

[56] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Identifies Virtual Currency Exchange Bitzlato as a ‘Primary Money Laundering Concern’ in Connection with Russian Illicit Finance (Jan. 18, 2023), https://www.fincen.gov/news/news-releases/fincen-identifies-virtual-currency-exchange-bitzlato-primary-money-laundering.

[57] Press Release, U.S. Dep’t of the Treasury, Remarks by Wally Adeyemo on Action Against Russian Illicit Finance (Jan. 18, 2023), https://home.treasury.gov/news/press-releases/jy1193.

[58] Public Law 116-283, § 9714(a) (Jan. 1, 2021).

[59] See 88 Fed. Reg. 3919, 3920 (Feb. 1, 2023), https://www.federalregister.gov/documents/2023/01/23/2023-01189/imposition-of-special-measure-prohibiting-the-transmittal-of-funds-involving-bitzlato (explaining passage of the Combatting Russian Money Laundering Act).

[60] 31 U.S.C. § 5381A(a)(1).

[61] 31 U.S.C. § 5381A(b) (commonly known as Section 311 of the Patriot Act).

[62] Press Release, U.S. Dep’t of the Treasury, Remarks by Wally Adeyemo on Action Against Russian Illicit Finance (Jan. 18, 2023), https://home.treasury.gov/news/press-releases/jy1193.

[63] Press Release, U.S. Dep’t of Just., Founder and Majority Owner of Bitzlato, a Cryptocurrency Exchange Charged with Unlicensed Money Transmitting (Jan. 18, 2023), https://www.justice.gov/usao-edny/pr/founder-and-majority-owner-bitzlato-cryptocurrency-exchange-charged-unlicensed-money.

[64] 88 Fed. Reg. 72701, 72704 (Oct. 23, 2023), https://www.federalregister.gov/documents/2023/10/23/2023-23449/proposal-of-special-measure-regarding-convertible-virtual-currency-mixing-as-a-class-of-transactions.

[65] In The Matter Of: Shinhan Bank America, No. 2023-03 (Sept. 29, 2023), https://www.fincen.gov/sites/default/files/enforcement_action/2023-09-29/SHBA_9-28_FINAL_508.pdf.

[66] Id.

[67] Id.

[68] Id.

[69] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Assesses $1.5 Million Civil Money Penalty against Kingdom Trust Company for Violations of the Bank Secrecy Act (Apr. 26, 2023), https://www.fincen.gov/news/news-releases/fincen-assesses-15-million-civil-money-penalty-against-kingdom-trust-company.

[70] Id.

[71] Id.

[72] Id.

[73] Id.

[74] See generally Statement of Himamauli Das, Acting Dir., Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Before the Comm. on Fin. Servs., U.S. House of Representatives (Apr. 27, 2023), https://www.fincen.gov/sites/default/files/2023-04/HHRG-118-HFSC-DasH-20230427.pdf; Remarks by Brian Nelson, Under Sec. for Terrorism and Fin. Intel., U.S. Dep’t of the Treasury, at SIFMA’s Anti-Money Laundering and Financial Crimes Conference (May 25, 2022), https://home.treasury.gov/news/press-releases/jy0800.

[75] Id.

[76] In The Matter Of: Bancrédito International Bank and Trust Corporation, No. 2023-02 (Sept. 15, 2023), https://www.fincen.gov/sites/default/files/enforcement_action/2023-09-15/Bancredito_Consent_FINAL_091523_508C.pdf.

[77] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCen Announces $15 Million Civil Money Penalty against Bancrédito International Bank and Trust Corporation for Violations of the Bank Secrecy Act (Sept. 15, 2023), https://www.fincen.gov/news/news-releases/fincen-announces-15-million-civil-money-penalty-against-bancredito-international.

[78] National Money Laundering Risk Assessment (Feb. 2022), https://home.treasury.gov/system/files/136/2022-National-Money-Laundering-Risk-Assessment.pdf.

[79] Id.; see also 31 U.S.C. § 5318(h).

[80] See generally 31 C.F.R. § 1020.210; see also 85 Fed. Reg. 57129 (Nov. 16, 2020), https://www.federalregister.gov/documents/2020/09/15/2020-20325/financial-crimes-enforcement-network-customer-identification-programs-anti-money-laundering-programs.

[81] Press Release, U.S. Dep’t of Just., Associate of Sanctioned Oligarch Indicted for Sanctions Evasion and Money Laundering (Feb. 7, 2023), https://www.justice.gov/opa/pr/associate-sanctioned-oligarch-indicted-sanctions-evasion-and-money-laundering.

[82] Press Release, U.S. Dep’t of Just., New York Attorney Pleads Guilty to Conspiring to Commit Money Laundering to Promote Sanctions Violations by Associate of Sanctioned Russian Oligarch (Apr. 25, 2023), https://www.justice.gov/opa/pr/new-york-attorney-pleads-guilty-conspiring-commit-money-laundering-promote-sanctions.

[83] Press Release, U.S. Dep’t of Just., Arrest and Criminal Charges Against British and Russian Businessmen for Facilitating Sanctions Evasion of Russian Oligarch’s $90 Million Yacht (Jan. 20, 2023), https://www.justice.gov/usao-dc/pr/arrest-and-criminal-charges-against-british-and-russian-businessmen-facilitating.

[84] Id.

[85] Press Release, U.S. Dep’t of Just., Associate of Sanctioned Oligarch Indicted for Sanctions Evasion and Money Laundering (Feb. 7, 2023), https://www.justice.gov/opa/pr/associate-sanctioned-oligarch-indicted-sanctions-evasion-and-money-laundering.

[86] Press Release, U.S. Dep’t of Just., Civil Forfeiture Complaint Filed Against Six Luxury Real Estate Properties Involved In Sanctions Evasion And Money Laundering (Feb. 24, 2023), https://www.justice.gov/usao-sdny/pr/civil-forfeiture-complaint-filed-against-six-luxury-real-estate-properties-involved?utm_medium=email&utm_source=govdelivery.

[87] See Superseding Information, United States v. Wise, No. 1:23-cr-00073, Dkt. 4 (S.D.N.Y. 2023).

[88] Id.

[89] Id.

[90] Press Release, U.S. Dep’t of Just., New York Attorney Pleads Guilty to Conspiring to Commit Money Laundering to Promote Sanctions Violations by Associate of Sanctioned Russian Oligarch (Apr. 25, 2023), https://www.justice.gov/opa/pr/new-york-attorney-pleads-guilty-conspiring-commit-money-laundering-promote-sanctions.

[91] See Gibson Dunn, Gibson Dunn Digital Assets Recent Updates – November 2023 (Nov. 6, 2023), https://www.gibsondunn.com/gibson-dunn-digital-assets-recent-updates-november-2023/.

[92] See Superseding Indictment, United States v. Bankman-Fried, No. 1:22-cr-00673, Dkt. 115 (S.D.N.Y. March 28, 2023), https://www.justice.gov/criminal-fraud/file/1593626/dl at ¶¶ 92–95.

[93] Press Release, U.S. Dep’t of Just., United States Attorney Announces Charges Against FTX Founder Sam Bankman-Fried (Dec. 13, 2022), https://www.justice.gov/usao-sdny/pr/united-states-attorney-announces-charges-against-ftx-founder-samuel-bankman-fried.

[94] James Fanelli and Corinne Ramey, Sam Bankman-Fried Is Convicted of Fraud in FTX Collapse, Wall St. J. (Nov. 2, 2023), https://www.wsj.com/finance/currencies/verdict-sam-bankman-fried-trial-ftx-guilty-4a54dbfe.

[95] Id.

[96] Id.

[97] See Chris Dolmestch and Bob Van Voris, First NFT Insider-Trading Trial Leads to Criminal Conviction, Wall St. J. (May 3, 2023), https://www.bloomberg.com/news/articles/2023-05-03/first-nft-insider-trading-trial-leads-to-criminal-conviction.

[98] See Jody Godoy, Ex-OpenSea manager sentenced to 3 months in prison for NFT insider trading (Aug. 22, 2023), https://www.reuters.com/legal/ex-opensea-manager-sentenced-3-months-prison-nft-insider-trading-2023-08-22/.

[99] Press Release, U.S. Dep’t of Just., Founders and Executives of Digital-Asset Company Charged in Multi-Million Dollar International Fraud Scheme (Nov. 1, 2023), https://www.justice.gov/usao-edny/pr/founders-and-executives-digital-asset-company-charged-multi-million-dollar.

[100] United States v. Karony, No. CR-23-433 (E.D.N.Y Oct. 31, 2023), https://www.justice.gov/media/1334306/dl.

[101] See 18 U.S.C. § 1956(c)(7).

[102] United States v. Full Play Grp., S.A., No. 15-CR-252S3PKC, 2023 WL 5672268, at *1-9 (E.D.N.Y. Sept. 1, 2023).

[103] Id.

[104] Id. at *23.

[105] Id. at *20 (internal quotation omitted).

[106] Id. at *23 n.26.

[107] U.S. v. Webb, No. 23-7183 (2d. Cir. 2024).

[108] Abdelaziz, 68 F.4th at 13.

[109] Id. at 29.

[110] National Defense Authorization Act for Fiscal Year 2024, S. 2226, 118th Cong. § 5101(2), codified at 18 U.S.C. § 201(f).

[111] See generally 15 U.S.C. § 78dd-1.

[112] Defining specified unlawful activities to include violations of 18 U.S.C. § 201—the subsection of the federal code wherein FEPA will be codified.

The following Gibson Dunn attorneys assisted in preparing this update: M. Kendall Day, Stephanie Brooker, Chris Jones, Ella Capone, Justin duRivage*, Maura Carey*, and Ben Schlichting.

Gibson Dunn has deep experience with issues relating to the Bank Secrecy Act, other AML and sanctions laws and regulations, and the defense of financial institutions more broadly. For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Anti-Money Laundering / Financial Institutions, White Collar Defense & Investigations, or International Trade practice groups, the authors, or any of the following practice group leaders:

Anti-Money Laundering / Financial Institutions:
Stephanie Brooker – Washington, D.C.(+1 202.887.3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202.955.8220, [email protected])

White Collar Defense and Investigations:
Stephanie Brooker – Washington, D.C. (+1 202.887.3502, [email protected])
Winston Y. Chan – San Francisco (+1 415.393.8362, [email protected])
Nicola T. Hanna – Los Angeles (+1 213.229.7269, [email protected])
F. Joseph Warin – Washington, D.C. (+1 202.887.3609, [email protected])

Global Fintech and Digital Assets:
M. Kendall Day – Washington, D.C. (+1 202.955.8220, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202.887.3632, [email protected])
Sara K. Weed – Washington, D.C. (+1 202.955.8507, [email protected])

Global Financial Regulatory:
William R. Hallatt – Hong Kong (+852 2214 3836, [email protected])
Michelle M. Kirschner – London (:+44 20 7071 4212, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202.887.3632, [email protected])

International Trade:
Ronald Kirk – Dallas (+1 214.698.3295, [email protected])
Adam M. Smith – Washington, D.C. (+1 202.887.3547, [email protected])

*Maura Carey and Justin duRivage are associates practicing in the firm’s Palo Alto office who are not yet admitted to practice law.

On October 27, 2023, the National Labor Relations Board (“NLRB”) published a final rule setting forth a new standard for determining joint-employer status under the National Labor Relations Act (“NLRA”). This new rule replaces a prior rule published by the NLRB in 2020. Notably, the final rule replaces the prior “substantial direct and immediate control” threshold with an analysis of whether the putative joint employer has the authority to control the essential terms and conditions of employment, regardless of whether such control is actually exercised. The final rule is set to take effect on December 26, 2023.

1) Inclusion of Reserved Control

The new standard’s inclusion of reserved control contemplates situations where an entity maintains the authority to control the essential terms and conditions of employment (i.e., by potentially intervening at any moment), even if it has not exercised it and remains passive in day-to-day operations. This is similar to an aspect of the Labor Department’s proposed rule addressing employee and independent contractor classification under the Fair Labor Standards Act, which would eliminate a regulatory provision stating that actual practice is more probative of employment status than what is contractually or theoretically possible. See 87 Fed. Reg. 62,218, 62,257–59 (Oct. 13, 2022). The Labor Department recently submitted its draft final rule to the White House’s Office of Management and Budget for review, which is usually the final step in the rulemaking process.

2) Recognition of Indirect Control

In addition to reserved control, the NLRB’s final rule takes into account control exercised through an intermediary or controlled third parties, a concept drawn from Section 2(2) of the NLRA. The NLRB explained that the inclusion of indirect control as a means for establishing joint employment is intended to prevent entities from evading joint-employer status by using intermediaries to make decisions about the essential terms and conditions of employment.

3) Defined Essential Terms & Conditions of Employment

The final rule broadly defines essential terms and conditions of employment to include wages, benefits, hours of work, scheduling, job assignments, supervision, work rules, tenure, and working conditions related to safety and health. Joint-employer status is only found under the final rule when an entity employs workers and has the authority to control at least one of these terms or conditions, regardless of whether they exercise that control directly or indirectly.

4) Collective Bargaining Obligations

Once an entity is deemed a joint employer due to its control over the essential terms and conditions of employment, the NLRB takes the position that it must engage in collective bargaining regarding these specific terms. Note, however, that the final rule clarifies that a joint employer is only obligated to bargain over subjects it has the authority to control, not those beyond its purview.

5) Challenges to the Final Rule Likely Ahead

The NLRB’s new rule is likely to face litigation (as prior rules have) and challenges from Congress. On October 26, Senators Bill Cassidy (R-La.) and Joe Manchin (D-W.Va.) announced that they will introduce a Congressional Review Act (“CRA”) resolution to overturn the new rule in light of their concern about its implications for small businesses and the American franchise model. If successful, the CRA would not only nullify the new rule but also prohibit the NLRB from publishing a rule that is “substantially the same.”

* * * *

The NLRB’s 2023 joint-employer standard could have far-reaching implications for employers across industries. Accordingly, in preparation for the final rule’s implementation on December 26, 2023, employers should proactively engage in a careful, case-specific examination to grasp and clearly define their employment relationships with other entities, including roles, responsibilities, and the extent of control exerted over the essential terms and conditions of employment.

Gibson Dunn attorneys are closely monitoring these developments and available to discuss these issues as applied to your particular business.

The following Gibson Dunn attorneys assisted in preparing this client update: Michael Holecek, Jason Schwartz, Svetlana Gans, Rachel Brass, Katherine Smith, Andrew Kilberg, and Emily Lamm.

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

Rachel S. Brass – Partner, Labor & Employment Group, San Francisco
(+1 415-393-8293, [email protected])

Svetlana S. Gans – Partner, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-955-8657, [email protected])

Michael Holecek – Partner, Labor & Employment Group, Los Angeles
(+1 213-229-7018, [email protected])

Eugene Scalia – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-955-8210, [email protected])

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

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

Helgi C. Walker – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-887-3599, [email protected])

On October 10, 2023, the Securities and Exchange Commission (the “Commission” or “SEC”) adopted final rules (the “Final Amendments”), significantly amending the beneficial ownership reporting requirements under Regulation 13D-G as promulgated pursuant to Sections 13(d) and 13(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Final Amendments are based on the Commission’s February 10, 2022 proposed amendments (the “Proposed Amendments”), and primarily impact Schedule 13D and 13G (“13D/G”) filing deadlines, while issuing guidance on topics such as the reporting obligations related to certain derivatives and the scenarios for potential group formation.

Specifically, the Final Amendments:

Accelerate the 13D/G filing deadlines as detailed below
Extend the 13D/G filing cut-off times from 5:30 p.m. to 10 p.m. EST
Require disclosure of cash-settled derivative securities under Item 6 of Schedule 13D
Impute group member acquisitions to the group once a group has been formed (excluding intragroup transfers of securities)
Require the use of a structured, machine-readable data language (XBRL) for 13D/G filings

In addition, instead of adopting certain of the Proposed Amendments, the SEC provided guidance with respect to (i) the reporting obligations related to cash-settled derivatives and (ii) the types of situations where a Section 13(d) group may or may not be deemed to have formed.

The tables below summarize the more substantive changes to the Schedule 13D/G beneficial ownership reporting requirements.

Schedule 13D	Current	Revised (starting Feb. 5, 2024)
Initial 13D Due Date (under Rule 13d-1(a))	Within 10 days of acquiring more than 5% beneficial ownership	Within 5 business days of acquiring more than 5% beneficial ownership
Initial 13D Due Date (Following Loss of 13G Eligibility under Rules 13d-1(e), (f), and (g))	Within 10 calendar days after the event that causes ineligibility	Within 5 business days of losing eligibility to file on Schedule 13G
13D/A Trigger	“Material” change	“Material” change
13D/A Due Date	“Promptly”	Within two business days after the triggering event

Schedule 13G filed by Qualified Institutional Investors (“QIIs”)	Current	Revised (starting Sept. 30, 2024)
Initial 13G Due Date	45 days after year-end in which beneficial ownership exceeds 5%	45 days after quarter-end in which beneficial ownership exceeds 5%
Periodic 13G/A Due Date and Trigger	Annual amendments: due 45 days after year-end if any change (not including changes due to fluctuations in number of shares outstanding)	Quarterly amendments: due 45 days after quarter-end if a material change (not including changes due to fluctuations in number of shares outstanding)
Ownership Change 13G/A Due Date	10 business days after month-end if beneficial ownership exceeds 10% or there is a 5% decrease in beneficial ownership Thereafter, upon deviation by more than 5% of a covered class of equity securities	Five business days after month-end if beneficial ownership exceeds 10% Thereafter, upon deviation by more than 5% of a covered class of equity securities

Schedule 13G filed by “Passive” Investors (Rule 13d-1(c))	Current	Revised (starting Sept. 30, 2024)
Initial 13G Due Date	Within 10 days of acquiring more than 5% beneficial ownership	Within 5 business days of acquiring more than 5% beneficial ownership
Periodic 13G/A Due Date and Trigger	Annual amendments: due 45 days after year-end if any change (not including changes due to changes in shares outstanding)	Quarterly amendments: due 45 days after quarter-end if a material change (not including changes due to changes in shares outstanding)
Ownership Change 13G/A Due Date	“Promptly” upon acquiring more than 10% beneficial ownership Thereafter, upon deviation by more than 5% of a covered class of equity securities	Within 2 business days of acquiring more than 10% beneficial ownership Thereafter, upon deviation by more than 5% of a covered class of equity securities

Schedule 13G filed by “Exempt” Investors
(Rule 13d-1(d))

Current

Revised
(starting Sept. 30, 2024)

Initial 13G
Due Date

45 days after year-end in which beneficial ownership exceeds 5%

45 days after quarter-end in which beneficial ownership exceeds 5%

Periodic
13G/A Due Date and Trigger

Annual amendments: due 45 days after year-end in which any change occurred (other than change in percentage solely due to change in shares outstanding)

Quarterly amendments: due 45 days after quarter-end if material change occurred

Cash-Settled Derivatives

The Commission declined to adopt proposed Rule 13d-3(e), which would have caused holders of certain cash-settled derivative securities, excluding security-based swaps (“SBS”), to be considered beneficial owners of the reference equity security. Instead, the Commission issued guidance on the circumstances under which a holder of a cash-settled derivative security, excluding SBS, may be deemed the beneficial owner of the reference equity security under Rule 13d‑3.

The SEC originally proposed Rule 13d-3(e) in response to concerns that holders of certain cash-settled derivatives were excluded from the definition of “beneficial owner” but could still exert influence over an issuer by, among other methods, pressuring a counterparty to the derivative transaction to make certain decisions regarding the voting and disposition of the issuer’s securities. In response to public comments, the Commission determined that issuing guidance on the topic would be sufficient.

The SEC’s guidance makes reference to its Security-Based Swaps Release which outlines three characteristics of a derivative position that may lead to the imputation of beneficial ownership: (i) the derivative security confers voting and/or investment power (or a person otherwise acquires such power based on the purchase or sale of a derivative security); (ii) the derivative security is used with the purpose or effect of divesting or preventing the vesting of beneficial ownership as part of a plan or scheme to evade the reporting requirements; or (iii) the derivative security grants a right to acquire an equity security. The Commission clarified that this guidance applies to non-SBS cash-settled derivatives, indicating that holders of a wide range of cash-settled derivatives could be considered beneficial owners when these circumstances exist.

The Commission also amended Item 6 of Schedule 13D to explicitly remove any implication that a person is not required to disclose interests in all derivative securities that use a covered class of security as a reference security. The new Item 6 expressly states that derivative contracts, arrangements, understandings, and relationships with respect to an issuer’s securities, including cash-settled SBS and other derivatives which are settled exclusively in cash, must be disclosed. The SEC believes that investors will benefit from this more complete picture of Schedule 13D filers’ economic interests in the relevant issuer.

Group Formation

In addition, the SEC declined to adopt certain of the Proposed Amendments relating to Rule 13d-5 that would have broadly expanded the type of investor activities giving rise to group formation. Instead, the Commission chose to issue guidance directly in the adopting release to the Final Amendments (the “Adopting Release”) on the scope of activities that could give rise to group formation.

In doing so, the Commission acknowledged that neither the relevant statute nor SEC rules define “group.” Instead, the Commission reiterated that the relevant standard for determining the existence of a “group” is found in Sections 13(d)(3) and 13(g)(3) of the Exchange Act. The Commission stated that the determination of whether two or more persons are acting as a group “depends on an analysis of all the relevant facts and circumstances and not solely on the presence or absence of an express agreement, as two or more persons may take concerted action or agree informally.”

The guidance on activities that may or may not give rise to formation of a group is presented in question and answer format. In a helpful manner, the Commission described the following situations where a Section 13(d) group would not arise:

Communications between two or more shareholders concerning a particular issuer, including topics relating to the improvement of the issuer’s long-term performance, changes in issuer practices, submissions or solicitations in support of a non-binding shareholder proposal, a joint engagement strategy (that is not control-related), or a “vote no” campaign against individual directors in uncontested elections.
Two or more shareholders engaging in joint communications with an issuer’s management.
Two or more shareholders making recommendations regarding the structure of the board of directors (so long as no discussion of individual directors or board expansion occurs and no commitments, agreements, or understandings are made among shareholders regarding their voting for director candidates).
Two or more shareholders jointly submitting a non-binding shareholder proposal.
A shareholder and an activist investor communicating regarding the activist’s proposals, (so long as the shareholder does not make a commitment to a particular course of action).

However, in the Commission’s view a group is likely to form where a beneficial owner of a substantial block of shares (one that is or will be required to file a Schedule 13D) intentionally communicates to other market participants (including investors) that such a filing will be made (to the extent this information is not yet public) with the purpose of causing such persons to make purchases, and one or more of the other market participants makes purchases in the same covered class of securities as a direct result of that communication. The concept of such “tipping” was discussed in the Proposing Release and is used in the Adopting Release as an example of where, in the Commission’s view, a group would likely result.

Effective Dates

The Final Amendments were published in the Federal Register on November 7, 2023 and will become effective on February 5, 2024. Compliance with the revised Schedule 13G filing deadlines will be required beginning on September 30, 2024. Compliance with the structured data requirement for Schedules 13D and 13G will be required on December 18, 2024. Compliance with the other rule amendments will be required upon their effectiveness. In determining whether to file a Schedule 13G/A for year-end 2023, on or before February 14, 2024, we recommend holders file if there is any change (other than changes due to a fluctuation in the number of shares outstanding) consistent with most filers’ traditional approach to reporting their ownership as of December 31.

Implications

As long anticipated in light of prior comments by Chair Gensler as well as the previously proposed changes, these final amendments in theory seek to modernize the reporting timing for Schedules 13D and 13G given the modern computer age and instant nature of disclosure dissemination. That said, as a practical matter, the new rules are likely to materially impact equity accumulation strategies for activist investor hedge funds in three respects:

The reduction from 10 calendar days to 5 business days for an initial Schedule 13D filing will shave down the period that activists have to purchase equity securities more gradually to mitigate upward price pressure and optimize their basis. Commentators have differing opinions on how material the time deadline reduction will be – but it is likely to be non-trivial.
Second, it is clear that the Commission will be looking closely at synthetic alternatives to actual equity ownership of a reportable class. Derivatives – particularly cash-settled equity swaps – have become popular instruments for activist hedge funds to lever the financial impact of their positions without having to actually purchase securities (or arguably, in the past having had to disclose all such positions).
Finally, while the Commission’s guidance regarding group formation in and of itself does not represent a paradigm shift, the attention placed on this area by the Commission makes it clear that interactions between activist funds – sometimes in practice performed intentionally casually by such funds – can still trigger group formation. The Commission is poised to scrutinize ‘wolf packs’ of multiple activists who can suddenly take near-concurrent positions in a given company while denying purported coordination that would in turn require formal recognition of the formation of a group.

Separate from ‘pure play’ activist hedge funds, the changes could also alter the landscape for potential acquirers who use a minority stake as a foothold in an acquisition strategy – albeit a complex strategy with the interplay of shareholder rights plans and other factors. Such investors may start as a ‘passive investor’ who must flip from Schedule 13G to Schedule 13D if they develop ‘control intent’ with respect to a given company. Investors who hold equity stakes from 5%-19.9% qualify for the ‘short form’ Schedule 13G so long as they are ‘passive’ and do not have ‘control intent’ through actions such as advocating for board changes or a change of control process/acquisition intent. If a ‘passive investor’ develops ‘control intent’ and seeks to consummate an acquisition transaction with the company – the new timeline reduces the amount of time to proceed from developing control intent to inking an acquisition contract before required public disclosure of intent on a Schedule 13D.

The following Gibson Dunn attorneys assisted in preparing this update: James J. Moloney, Ed Batts, Jeffrey L. Steiner, David Korvin, Lexi Hart, Chris Connelly, and Nicholas Whetstone.

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

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

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

Derivatives Group:
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Darius Mehraban – New York (+1 212-351-2428, [email protected])
Adam Lapidus – New York (+1 212-351-3869, [email protected])

Mergers and Acquisitions Group:
Ed Batts – Palo Alto (+1 650-849-5392, [email protected])
Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – New York (+1 212-351-3966, [email protected])

As Hispanic Heritage Month draws to a close, we wanted to highlight some of Gibson, Dunn & Crutcher LLP’s recent pro bono work on behalf of members of the Latinx community. Of course, the Latinx community is incredibly diverse, reflecting a wide range of histories, cultures, and experiences. Our pro bono work on behalf of Latinx clients is similarly broad in scope. We have represented nonprofits and small businesses that serve Latinx individuals, helping to maintain and promote Latinx culture in their wider communities. On a larger scale, we have advocated for students and educators fighting for the freedom to study and discuss Latinx culture. And on an individual level, we have represented clients from throughout Latin America in their immigration proceedings—from political dissidents to LGBTQ+ individuals, and from women who have survived gender-based violence to children who have overcome abuse and neglect.

We are proud to work on these matters, and are committed to continuing this important work in the years to come.

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On June 30, 2023, the New York City Department of Consumer and Worker Protection (the “DCWP”) released Frequently Asked Questions (“FAQ”)[1] regarding New York City’s Local Law 144,[2] which went into effect on July 5, 2023.

Local Law 144 restricts employers and employment agencies from using an automated employment decision tool (“AEDT”) in hiring and promotion decisions unless it has been subject to an annual bias audit conducted by an “independent auditor.” The law also imposes posting and notice requirements to New York City applicants and employees subject to the use of AEDTs. The FAQs provide insight into how the DCWP will approach enforcing Local Law 144, including its penalty schedule, which imposes penalties ranging from $375 to $1500 for each violation of the bias audit, notice, and posting requirements.[3]

As summarized at a high-level below, the FAQs provide some helpful guidance for covered employers but questions remain regarding the law’s scope and audit requirements.

1. NYC Office Location Is Key.

The FAQs clarify that Local Law 144 only applies to employers with a physical office in New York City that use an AEDT for (i) jobs located in New York City, at least part-time or (ii) for remote positions, if the location “associated with [such remote position]” is an office in New York City.

2. Covered Employment Decisions Need Not Be Final.

The DCWP previously emphasized during May 2023 roundtable events that Local Law 144 covers employment decisions “at any point in the process.” Otherwise stated, the analysis of whether Local Law 144 applies is not limited to the ultimate employment decision.[4]

The FAQs echo this position and emphasize that the law defines “employment decisions” to include screening for hire or promotion. However, the FAQs also make clear that conducting outreach or sending invitations to potential job or promotion candidates falls outside the scope of the law.

3. Compliance Responsibility Rests With Employers, Not Vendors.

The FAQs state that a vendor of an AEDT is not responsible for conducting a bias audit of its tool. Instead, in the DCWP’s view, covered employers and employment agencies are responsible for complying with Local Law 144’s bias audit requirements.

4. Demographic Information May Not Be Inferred.

The FAQs expressly state that employers and employment agencies may not infer or impute data about an applicant’s demographic information. This differs from other areas of law, such as the EEO-1 Component 1 Report, which permits observer identification to be used to determine an employee’s race or ethnicity.[5]

Accordingly, bias audits may only be conducted using historical or test data, and cannot be run on demographic information inferred by an algorithm or otherwise.

5. No Set Threshold For Statistical Significance.

The DCWP has chosen not to set a specific standard for determining statistical significance, thereby leaving the determination to the independent auditor. If test data is used in lieu of historical data because the auditor determined that the historical data was not statistically significant, the public summary of the bias audit results must explain this decision.

6. No Specific Test Data Requirements.

The DCWP previously stated that Local Law 144’s bias audit requirement provides flexibility regarding what data is used and who (e.g., the vendor or employer) may provide data to the independent auditor.[6] The FAQs likewise provide that the DCWP has not set requirements for test data to allow for the “development of best practices in this rapidly developing field.”

Notwithstanding this apparent flexibility and flux, the FAQs state that the summary of the bias audit must include the source of the data and an explanation of the data used. For example, if the test data is limited to a specific region or time period, the public summary is expected to explain why and/or how.

7. Bias Audit Need Not Be Position Specific.

Employers that hire for an array of different positions may rely on a bias audit that is based on the historical data of multiple employers if it is either (a) their first time using the AEDT or (b) they provide historical data from their use of the AEDT to the independent auditor. To that end, the FAQs state that there is no requirement that the employers providing historical data for a bias audit use the AEDT to hire or promote for the same type of position. The FAQs therefore suggest that the data used for the bias audit can be aggregated from an assortment of different positions—though whether doing so may be accurate or prudent will vary case-by-case.

8. Notice Need Not Be Position Specific.

The notice posted in the employment section of an employer’s website for job applicants or in a written policy or procedure for candidates for promotion need not be position specific. The FAQs therefore appear to indicate that a notice’s description of the job qualifications and characteristics assessed by the AEDT may be categorical.

9. Discrimination Claims Will Be Referred To The City Commission On Human Rights.

The FAQs state that any claims of discrimination involving AEDTs that are sent to the DCWP will be automatically referred to the New York City Commission on Human Rights. The DCWP will enforce only Local Law 144’s prohibition on the use of AEDTs without a bias audit and the required notice and posting.

10. Numerous Questions And Ambiguities Remain.

Despite committing to address many unanswered questions raised during the DCWP’s roundtable events, the FAQs leave a number of open questions.

For example, there is still no clarification regarding the statute’s ill-fitting definition of an employment agency.[7] The final rules implementing Local Law 144 defined an “employment agency” as “all persons who, for a fee, render vocational guidance or counseling services, and who directly or indirectly represent” that they perform one of the enumerated functions such as arranging interviews or having knowledge of job openings or positions that cannot be obtained from other sources with a reasonable effort.[8] Since Local Law 144 is limited to applicants who have applied for a position (and not potential applicants), it is unclear how a definition focused on employment agencies attracting or assisting prospective applicants will be reconciled with the apparently narrower scope of the law.

The FAQs state that test data can be used to conduct a bias audit if demographic data is not available or collected, but it remains unclear whether covered employers could (let alone must) artificially create test data to conduct a bias audit, especially since the FAQs state that demographic data should not be inferred.

Finally, the FAQs state that a remote position “associated” with a New York City office is within the scope of the law, but the DCWP does not clarify or explain how a remote position may be “associated” with a New York City office. For example, it remains unclear if an “association” will be found if a remote employee reports to a manager in New York City, must occasionally come into the New York City office, or if their paycheck is issued from the employer’s New York City office.

Conclusion

To date, New York City’s Local Law 144 is the most expansive effort in the United States to attempt to regulate the use of automated decision tools in employment. Its impact will undoubtedly be closely watched (and scrutinized) by legal commentators and other states and cities. In the wake of the law’s passage and throughout the subsequent rulemaking process, employers in New York City have been grappling with various questions about the law’s scope and requirements. The FAQs are helpful in answering some of these questions. But many remain. As such, effective July 5, employers are faced with the unsettling prospect of attempting to comply with Local Law 144 without clear and comprehensive guidance.

______________________________

[1] DCWP, Automated Employment Decision Tools: Frequently Asked Questions (June 2023), https://www.nyc.gov/assets/dca/downloads/pdf/about/DCWP-AEDT-FAQ.pdf.

[2] NYC Int 1894-2020, Local Law 144 (enacted December 11, 2021), https://legistar.council.nyc.gov/LegislationDetail.aspx?ID=4344524&GUID=B051915D-A9AC-451E-81F8-6596032FA3F9.

[3] RCNY, tit. 6, ch. 6, § 6-81, Automated Employment Decision Tools Penalty Schedule (effective Aug. 5, 2022), https://codelibrary.amlegal.com/codes/newyorkcity/latest/NYCrules/0-0-0-134007.

[4] DCWP, Local Law 144 of 2021 Automated Employment Decision Tool Roundtable with Business Advocates/Employers (May 2023), https://www.nyc.gov/assets/dca/downloads/pdf/about/DCWP-AEDT-Educational-Roundtable-with-Business-Advocates-Employers.pdf.

[5] U.S. EEOC, 2021 EEO-1 Component 1 Frequently Asked Questions (FAQs), https://www.eeocdata.org/pdfs/2021_EEO_1_Component_1_FAQs.pdf.

[6] Id.

[7] See Harris Mufson, Danielle Moss, and Emily Lamm, 10 Ways NYC AI Discrimination Rules May Affect Employers, Law360 (Apr. 19, 2023) (discussing the definition of “employment agency” under the final rules implementing Local Law 144).

[8] DCWP, Notice of Adoption of Final Rule, https://rules.cityofnewyork.us/wp-content/uploads/2023/04/DCWP-NOA-for-Use-of-Automated-Employment-Decisionmaking-Tools-2.pdf.

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Harris Mufson, Danielle Moss, and Emily Lamm.

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

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

Emily M. Lamm – Washington, D.C. (+1 202-955-8255, [email protected])

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

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

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

This edition of Gibson Dunn’s Federal Circuit Update summarizes the current status of several petitions pending before the Supreme Court, provides an update on a proceeding by the Judicial Council of the Federal Circuit, and summarizes recent Federal Circuit decisions concerning secondary considerations, inventorship, inherency, and enablement.

Federal Circuit News

Noteworthy Petitions for a Writ of Certiorari:

A new potentially impactful petition was filed before the Supreme Court in June 2023:

Killian v. Vidal (US No. 22-1220): The petition raises the questions (1) whether the Federal Circuit’s “departures of the Supreme Court’s Alice/Mayo jurisprudence . . . enabled the USPTO to violate the” Administrative Procedure Act (“APA”) and the Due Process Clause of the Fifth Amendment; and (2) whether the exceptions created by Article III courts to 35 U.S.C. § 101 exceeds the courts’ constitutional authority.

As we summarized in our May 2023 update, there are several other petitions pending before the Supreme Court. We provide an update below:

In CareDx Inc. v. Natera, Inc. (US No. 22-1066), after the respondents waived their right to file a response, retired Federal Circuit Judge Paul R. Michel and Professor John F. Duffy filed an amici curiae brief in support of Petitioners. The Court thereafter requested a response, which is now due on July 31, 2023.

The Court denied the petitions in Nike, Inc. v. Adidas AG (US No. 22-927) and NST Global, LLC v. Sig Sauer Inc. (US No. 22-1001). A response has been filed in Ingenio, Inc. v. Click-to-Call Technologies, LP (US No. 22-873).

Noteworthy Federal Circuit En Banc Petitions:

On June 30, 2023, the Federal Circuit granted the en banc petition filed in LKQ Corp. v. GM Global Technology Operations LLC, No. 21-2348 (Fed. Cir. June 30, 2023). The Court requested that the parties file new briefs to address questions related to the obviousness inquiry for design patents.

Other Federal Circuit News:

Release of Materials in Ongoing Judicial Investigation. As we summarized in our May 2023 update, there is an ongoing proceeding by the Judicial Council of the Federal Circuit under the Judicial Conduct and Disability Act and the implementing Rules involving Judge Pauline Newman. Last month, the Court approved and released public versions of all prior orders of the Special Committee and the Judicial Council, as well as Judge Newman’s letter responses to date. On June 20, 2023, the Court released additional materials in the ongoing investigation. The orders may be accessed here.

Upcoming Oral Argument Calendar

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

Key Case Summaries (June 2023)

Yita LLC v. MacNeil IP LLC, No. 22-1383 (Fed. Cir. June 6, 2023): The Patent Trial and Appeal Board (“Board”) determined as part of an inter partes review (“IPR”) that the challenged claims of one of MacNeil’s patents directed to constructing a vehicle floor tray based on digital scans would not have been obvious. Despite determining that the claims would have been obvious over the asserted prior art, the Board found MacNeil’s evidence of secondary considerations “compelling” enough to overcome this determination of obviousness.

The Federal Circuit (Taranto, J., joined by Chen and Stoll, JJ.) reversed. The Court stated that under the Court’s precedent, objective evidence of nonobviousness lacks a nexus to the claimed invention if the evidence exclusively relates to a “known” feature in the prior art. The Court held that the Board therefore erred in concluding that because the feature was not “well known” in the prior art, that MacNeil’s secondary considerations evidence was sufficient to overcome its prior art based obviousness determination.

Blue Gentian, LLC v. Tristar Products, Inc., Nos. 21-2316, 21-2317 (Fed. Cir. June 9, 2023): Blue Gentian sued Tristar for infringement of its patents generally related to an expandable hose. Tristar counterclaimed that each of the asserted patents were invalid for failing to name a co-inventor, Gary Ragner. The district court agreed and concluded that Mr. Ragner contributed three key features of the invention and should have been named an inventor on the patents.

The Federal Circuit (Prost, J., joined by Chen and Stark, JJ.) affirmed. The Court first rejected Blue Gentian’s argument that the district court erred by not engaging in claim construction, holding that there must be a material dispute about claim scope to require claim construction prior to an inventorship determination. Here, Blue Gentian failed to identify “a dispute about claim scope that was material, or even related to, inventorship.” Additionally, because the patent owner argued during prosecution that the three key features at issue distinguished the invention over the prior art, the Court held that it follows that these features are not insignificant in quality and amounted to a significant contribution to conception that met the requirements needed to be considered a joint inventor.

Parus Holdings, Inc., v. Google LLC, Nos. 2022-1269, 2022-1270 (Fed. Cir. June 12, 2023): Google filed an IPR petition concerning Parus’s patents directed to an interactive voice system that allowed a user to request information from a voice web browser. Google asserted that certain claims of these patents would have been obvious over a number of prior art references, including Kovatch. Parus argued that Kovatch did not qualify as prior art because the claimed inventions were conceived of and reduced to practice before the earliest possible priority date for Kovatch. In support of its arguments, Parus submitted over 1,400 pages of material, but only cited small portions of that material in its briefs without meaningful explanation. The Board declined to consider these arguments because Parus failed to comply with 37 C.F.R. § 42.6(a)(3), which prohibits incorporation by reference.

The Federal Circuit (Lourie, J., joined by Bryson and Reyna, JJ.) affirmed. The Court held that the Board did not violate the APA. The Board had determined that Parus failed to cite to the relevant record evidence with specificity and explain the significance of the produced materials in its briefing, and incorporated its arguments by reference in violation of 37 C.F.R. § 42.6(a)(3), and thus, the Court determined that the Board’s disregard of Parus’s arguments cannot be an abuse of discretion.

In re Couvaras, No. 22-1489 (Fed. Cir. June 14, 2023): The pending claims of the patent application at issue are directed to a method of increasing prostacyclin release to improve vasodilation, which decreases blood pressure. The increased prostacyclin is achieved by co-administering two well-known antihypertensive agents. The examiner finally rejected the claims finding that the claimed results of the compounds’ administration naturally flowed from administration of the known antihypertensive agents. Couvaras then appealed to the Board. The Board agreed with the examiner and found that the increase in prostacyclin release was “inherent in the obvious administration of the two known antihypertension agents.”

The Federal Circuit (Lourie, J., joined by Dyk and Stoll, JJ.) affirmed. Courvaras argued that even if the recited mechanism of action (the increased release of prostacyclin) was inherent, the Board erred in dismissing it as having no patentable weight, because the mechanism was unexpected. The Court rejected this argument holding that “[r]eciting the mechanism for known compounds to yield a known result cannot overcome a prima facie case of obviousness, even if the nature of that mechanism is unexpected.”

Medytox v. Galderma, No. 22-1165 (Fed. Cir. June 27, 2023): Galderma filed a post-grant petition of Medytox’s patent directed to a method for treating frown lines using an animal-protein-free botulinum toxin composition, which allegedly displayed an increased sustained effect compared to BOTOX^®. Medytox filed a motion to amend seeking to cancel the challenged claims and file substitute claims. In a final written decision, the Board found in part that the substitute claims were unpatentable for lack of enablement, because the specification only disclosed three responder rates: 52%, 61%, and 62%, and a skilled artisan would not have been able to achieve higher responder rates included in the claimed ranges without undue experimentation.

The Federal Circuit (Reyna, J., joined by Dyk and Stark, JJ.) affirmed. Citing the Supreme Court’s recent opinion in Amgen Inc. v. Sanofi, 143 S. Ct. 1243 (2023), the Federal Circuit determined that the Board did not err in concluding that the substitute claims were not enabled because a skilled artisan would not have been able to achieve responder rates higher than the limited examples disclosed in the specification.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this update:

Blaine H. Evanson – Orange County (+1 949-451-3805, [email protected])
Audrey Yang – Dallas (+1 214-698-3215, [email protected])

Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:

Appellate and Constitutional Law Group:
Thomas H. Dupree Jr. – Washington, D.C. (+1 202-955-8547, [email protected])
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Julian W. Poon – Los Angeles (+ 213-229-7758, jpoon@gibsondunn.com)

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

On June 30, 2023, Sacramento Superior Court Judge James Arguelles held that the California Privacy Protection Agency (CPPA) cannot enforce its regulations issued on March 29, 2023, until March 29, 2024—about nine months later than the date the California Privacy Rights Act (CPRA) permitted enforcement of any provisions added or amended by the law.[1] This development provides helpful breathing room for businesses seeking to comply. It is important to note that this reprieve only exists for the new regulations issued under the CPRA on March 29, 2023, not all aspects of the CPRA, as explained below.

Delay Begets Delay

The saga of the CCPA, which ultimately led to the California privacy regulations saga, began in 2017. An advocacy group, Californians for Consumer Privacy, began collecting signatures and by 2018, was in position to successfully submit a ballot initiative for consideration by California voters in the November 2018 election titled the “California Consumer Privacy Act,” or CCPA. State legislators negotiated a compromise with key stakeholders, including Californians for Consumer Privacy, and enacted a last-minute compromise draft through the legislative process in exchange for pulling the initiative off of the November 2018 ballot.[2] The state legislature passed the California Consumer Privacy Act (CCPA) as AB 375 and it was signed into law on June 28, 2018, with provisions becoming operative January 1, 2020.

After the passage of the CCPA, but even before it came into effect, Californians for Consumer Privacy remained dissatisfied with the state of California privacy law and began a second ballot initiative, the California Privacy Rights Act (CPRA). Voters approved the initiative (Proposition 24) in November 2020. The CPRA amended the CCPA by, among other things, adding additional consumer rights, including the right to correct inaccurate personal information, the right to opt out of certain “sharing” of data (rather than just the right to opt out of “sale” of data), and the right to limit the use and disclosure of sensitive personal information.

The CPRA also created the California Privacy Protection Agency (CPPA) and charged it with promulgating final regulations under the law and, along with the Attorney General, enforcing the law and those regulations. The CPRA specified that “[t]he timeline for adopting final regulations required by the act … shall be July 1, 2022” and “[n]otwithstanding any other law, civil and administrative enforcement … shall not commence until July 1, 2023[.]”[3]

The CPPA, however, failed to finalize regulations by July 1, 2022, and businesses seeking to comply with the new requirements were left to wonder about both the ultimate content of the regulations and their potential enforcement exposure and liability. On March 29, 2023, nine months after the deadline, the CPPA issued final regulations relating to twelve of the fifteen topics contemplated by the CPRA—leaving businesses just three months to comply. Today, there are still no regulations concerning three key elements of the CPRA, that the CPPA is tasked with tackling, namely cybersecurity audits, risk assessments, and automated decision-making technology.[4] Further, the CPPA has publicly discussed other specific topics of consideration that it intends to address (on a much longer timeline), including employment-related data issues, and social media API access. The CPPA has not indicated a clear timeline to promulgate regulations or enforce the law in any of the remaining areas, despite consideration that certain of them are more difficult than others, and undergoing a diligence process.[5]

The Chamber of Commerce’s Lawsuit

The California Chamber of Commerce sued, seeking a delay of the CPRA for a period of one year after all required regulations were issued.[6]

Following a hearing on June 30, 2023, the California Superior Court, Sacramento County issued a Minute Order considering this request, applying rules of statutory interpretation to determine the voters’ intent in passing the CPRA and the appropriate resultant timeline for enforcement.[7] The court held that “the plain language of the statute indicates the [CPPA] was required to have final regulations in place by July 1, 2022” and “the [CPPA] should be prohibited from enforcing the Act on July 1, 2023 when it failed to pass final regulations by the July 1, 2022 deadline.”[8] “The very inclusion of [the timeline prescribed by subdivision (d)] indicates the voters intended there to be a gap between the passing of final regulations and enforcement of those regulations.”[9] The court also disagreed with the CPPA’s argument that the delayed regulations did not prejudice businesses seeking to comply with the law.[10]

Yet the court did not agree that enforcement of the entire regulatory scheme should be delayed. “[T]he Court agrees with the [CPPA] that delaying the [CPPA]’s ability to enforce any violation of the Act for 12 months after the last regulation in a single area has been implemented would likewise thwart the voters’ intent to protect the privacy of Californians as contemplated by Proposition 24.”[11]

The court struck a balance between the Chamber’s and the CPPA’s arguments, allowing enforcement of the regulations on a piecemeal basis, one year after they are finalized: “the Court hereby stays the Agency’s enforcement of any Agency regulation implemented pursuant to Subdivision (d) for 12 months after that individual regulation is implemented.”[12] “By way of example, if an Agency regulation passes regarding Section 1798.185 subdivision (a), subsection (16) (requiring the Agency issue regulations governing automated decision-making technology) on October 1, 2023, the Agency will be prohibited from enforcing a violation of said regulation until October 1, 2024. The Agency may begin enforcing those regulations that became final on March 29, 2023 on March 29, 2024.”[13]

The order is good news for businesses subject to the law, which will have an extra nine months to comply with the CPRA regulations that were finalized on March 29, 2023. The order also provides a clear timeline for enforcement of forthcoming CPRA regulations, including in the three areas mentioned above. The CPRA is only permitted to enforce these new regulations twelve months after they have been finalized by the Office of Administrative Law.

Other California Privacy Regulations—and the Underlying Laws—Are in Force

It is important to note that the court’s ruling focuses regulations promulgated under the CPRA. To the extent the statutory basis for existing CCPA regulations remained unchanged by the CPRA, those regulations may continue to be enforced. In addition, to the extent the CPPA intends to bring enforcement actions for a business’s failure to comply with requirements set out in the CPRA’s statutory text, itself, the court’s ruling is not likely to prevent it from doing so. But enforcement may be muddied by questions as to whether any compliance failures are the result of actual non-compliance or whether they were caused by a good-faith misunderstanding based on lack of insights from the regulations. In any case, the CPPA remains able to bring enforcement actions for failure to comply with provisions of the CCPA that were left unamended when the CPRA was enacted.

Viewed through that lens, though the ruling provides relief for businesses rushing to comply with the delayed CPRA regulations, the impact of the court’s ruling may be considered somewhat limited: only enforcement of the March 29, 2023 regulations are delayed until March 29, 2024 (and enforcement of any forthcoming regulations will begin one year after they are finalized). Enforceable regulations concern a host of topics relating to the seven core consumer rights under the CCPA and related topics.[14]

The CPPA May Continue the Fight

The CPPA may appeal the Superior Court order. The default California rules provide an automatic stay of trial court proceedings and of enforcement of the Superior Court’s order.[15] This means that the Superior Court’s order to delay the enforcement of the CPRA regulations could be put on pause. If that happens, the CPPA’s regulations could be enforceable, pending the CPPA’s appeal. If appealed, the Chamber could seek to maintain the status quo of the Superior Court’s order, allowing the delay of enforcement of the CPRA regulations to continue. In assessing such a request, the Court of Appeal would balance hardships and benefits, likely weighing the public’s and state’s interests in earlier enforcement of privacy regulations against the interests of businesses in having the time that voters’ prescribed to comply with the law.[16]

The CPPA Will Speak

The CPPA has scheduled a public meeting for July 14, 2023. The proposed agenda confirms that the CPPA Board will publicly discuss key updates, including enforcement. In addition, “the Board will meet in closed session to confer and receive advice from legal counsel regarding” the Chamber lawsuit.[17] We will continue to monitor the development of the CPPA, CCPA, CPRA, and other notable state privacy laws and regulations.

__________________________

[1] California Chamber Of Commerce vs. California Privacy Protection Agency (June 30, 2023) 34-2023-80004106-CU-WM-GDS (J. Arguelles order); Cal. Civ. Code § 1798.185, subd. (d) (“Notwithstanding any other law, civil and administrative enforcement of the provisions of law added or amended by this act shall not commence until July 1, 2023, and shall only apply to violations occurring on or after that date.”).

[2] The California legislature generally cannot repeal voter initiatives, once passed. These compromises are a common way for the legislature to refine voter initiatives. California Constitution, Article II, Section 10 (c); California Election Code, Section 9034.

[3] Cal. Civ. Code § 1798.185, subd. (d).

[4] Id. § 1798.185, subd. (a).

[5] The CPPA has invited and received pre-rulemaking comments on the three remaining topics. California Privacy Protection Agency, Preliminary Rulemaking Activities on Cybersecurity Audits, Risk Assessments, and Automated Decisionmaking (Feb. 10, 2023), available at https://cppa.ca.gov/regulations/pre_rulemaking_activities_pr_02-2023.html

[6] California Chamber of Commerce vs. California Privacy Protection Agency (March 30, 2023) 34-2023-80004106-CU-WM-GDS (complaint).

[7] Order at 3-5.

[8] Id. at 4.

[9] Id.

[10] Id. at 5.

[11] Id. at 4-5.

[12] Id.

[13] Id.

[14] For additional reading concerning the scope of the enforceable regulations, please review our Privacy, Cybersecurity and Data Innovation Practice Group’s publications.

[15] Cal. Cod Civ. Proc. § 916. The Superior Court’s order proceeded on the Chamber’s petition for writ of mandate (dismissing other causes of action for declaratory and injunctive relief as moot). Order at 5. In traditional mandamus, perfecting appeal automatically stays effect of the writ. Johnston v. Jones (1925) 74 Cal.App. 272; Cal. Code Civ. Proc. § 1094.5.

[16] See Building Code Action v. Energy Resources Conservation & Dev. Com. (1979) 88 Cal.App.3d 913, 922.

[17] California Privacy Protection Agency Board, Meeting Notice and Agenda (June, 30, 2023), available at https://www.cppa.ca.gov/meetings/agendas/20230714.pdf.

The following Gibson Dunn lawyers assisted in preparing this alert: Cassandra Gaedt-Sheckter, Jane Horvath, Vivek Mohan, Eric Vandevelde, Benjamin Wagner, Christopher Rosina, and Tony Bedel.

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

United States
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
Jane C. Horvath – Co-Chair, PCDI Practice, Washington, D.C. (+1 202-955-8505, [email protected])
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, [email protected])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])
Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])
Lauren R. Goldman – New York (+1 212-351-2375, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
Vivek Mohan – Palo Alto (+1 650-849-5345, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Rosemarie T. Ring – San Francisco (+1 415-393-8247, [email protected])
Ashley Rogers – Dallas (+1 214-698-3316, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0) 1 56 43 13 00, [email protected])
Kai Gesing – Munich (+49 89 189 33-180, [email protected])
Joel Harrison – London (+44(0) 20 7071 4289, [email protected])
Vera Lukic – Paris (+33 (0) 1 56 43 13 00, [email protected])

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

Decided July 6, 2023

Kuciemba v. Victory Woodworks, Inc., S274191

The California Supreme Court held today that employers owe no duty of care, under state tort law, to nonemployees (including employees’ family members) to prevent the spread of COVID-19.

Background:
Robert Kuciemba worked for Victory Woodworks in San Francisco. He contracted COVID-19 while at work, allegedly because Victory transferred workers from a job site where there were many infections to his site. He brought the virus home and transmitted it to his wife, whose age and ill health made her especially vulnerable to COVID. She was hospitalized for over a month as a result.

The Kuciembas sued Victory in California court, raising a variety of state-law tort claims. After Victory removed the case to federal court, the district court dismissed the complaint. It first ruled that Mrs. Kuciemba’s claims against Victory were barred by the derivative-injury doctrine—namely, that California’s Workers Compensation Act provides the exclusive remedy for work-related injuries and third-party claims that are “collateral to or derivative of” work-related injuries. The court also ruled in the alternative that Victory had no duty of care to prevent the spread of COVID to Mrs. Kuciemba.

The Kuciembas appealed to the Ninth Circuit, which—noting the lack of clear precedent addressing the scope of the derivative-injury doctrine or the duty of care in a case like the Kuciembas’—certified both issues to the California Supreme Court. The Supreme Court accepted certification and heard argument in May 2023.

Issues:
1. If an employee gets COVID-19 at work and transmits the virus to his spouse, does the derivative-injury doctrine bar the spouse’s claim against the employer?

2. Does an employer owe a duty to the households of employees to exercise ordinary care to prevent the spread of COVID-19?

Court’s Holding:
1. No. Third-party claims are barred by the derivative-injury doctrine only when they are “legally dependent on the employee’s injury,” such as with an heir’s wrongful-death or spouse’s loss-of-consortium claim. The derivative-injury doctrine does not bar “a family member’s claim for her own independent injury,” even if the injury was “caused by the same negligent conduct of the employer” that injured the employee.

2. No. Although it is generally “foreseeable that an employer’s negligence in permitting workplace spread of COVID-19 will cause members of employees’ households to contract the disease,” “the significant and unpredictable burden that recognizing a duty of care would impose on California businesses, the court system, and the community at large counsels in favor of” declining to impose such a duty on employers.

What It Means:

The opinion acknowledges that “there is only so much an employer can do” to prevent the spread of viruses such as COVID-19: “Employers have little to no control over the safety precautions taken by employees or their household members outside the workplace,” and they cannot control whether individual employees comply with precautions such as “mask wearing and social distancing.”
The Court’s opinion clarifies the scope of California’s “analytically challenging” derivative-injury doctrine, explaining that it bars a plaintiff’s claim only if she must “prove injury to the employee as at least part of a legal element” of her claim. It is not enough that the third party’s injury would not have occurred but for the employee’s injury.
Even where foreseeability factors weigh in favor of recognizing a duty, courts will decline to impose a duty of care that would “alter employers’ behavior in ways that are harmful to society.”
The Court declined to address “[w]hether a local measure enacted on an emergency basis could appropriately impose a tort duty extending to employees’ household members,” which was beyond the scope of the questions certified from the Ninth Circuit.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Blaine H. Evanson +1 949.451.3805 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]	Michael J. Holecek +1 213.229.7018 [email protected]

Related Practice: Labor and Employment

Jason C. Schwartz
+1 202.955.8242
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Katherine V.A. Smith
+1 213.229.7107
[email protected]

Related Practice: Litigation

Theodore J. Boutrous, Jr.
+1 213.229.7804
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Theane Evangelis
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[email protected]

We are pleased to provide you with the first edition of Gibson Dunn’s digital assets regular update. This update will cover recent legal news regarding all types of digital assets, including cryptocurrencies, stablecoins, CBDCs, and NFTs, as well as other blockchain and Web3 technologies. Thank you for your interest.

Enforcement Actions

United States

SEC Sues Binance, Binance.US, and Founder Changpeng Zhao
On June 5, the SEC filed a 13-claim complaint against Binance, Binance.US, and Binance founder Changpeng Zhao in D.C. federal court, alleging they engaged in unregistered offers and sales of crypto asset securities, including the Binance branded, fiat-backed stablecoin BUSD. The SEC claims Binance and Binance.US were acting as an exchange, broker-dealer, and clearing agency, and intentionally chose not to register with the SEC. Binance and Binance.US dispute these allegations. The SEC subsequently filed a motion for a TRO, seeking to freeze Binance.US’s assets. On June 13, after a hearing, Judge Amy Berman Jackson ordered the parties to mediation to attempt to negotiate a resolution to the SEC’s requested TRO. On June 19, the parties submitted and Judge Jackson signed a consent order. Complaint; Law360; Law360 2; Law360 3; Rolling Stone; Order.
SEC Sues Coinbase
On June 6, the SEC filed a 5-count complaint against Coinbase and its parent company Coinbase Global in the Southern District of New York. The SEC alleges that Coinbase violated securities laws since 2019 by failing to register as an exchange, broker, or clearing agency despite facilitating trading and settlement of several digital assets that the SEC alleges are securities, including ADA, SOL, MATIC, and others. The SEC also alleges that Coinbase has operated as an unregistered broker by offering its Coinbase Prime and Coinbase Wallet services, and that Coinbase’s staking service for several digital assets, including Ethereum, constitutes unregistered securities offerings. On June 28, Coinbase filed a 177-page answer to the SEC’s complaint, calling the suit an “extraordinary abuse of process” that “offends due process and the constitutional separation of powers.” In a separate letter to the Court, Coinbase said that it intended to file a motion for judgment on the pleadings on the ground that the SEC lacks jurisdiction over the subject matter of the suit because the tokens at issue are not securities. Complaint; CoinDesk; CoinDesk 2; Rolling Stone.
Crypto Exchange Bittrex Moves to Dismiss SEC Enforcement Action
On June 30, crypto exchange Bittrex moved to dismiss an SEC enforcement action alleging that the exchange operated as an unregistered securities exchange, broker, and clearing agency. Echoing arguments made by others in the industry, Bittrex argues that the major questions doctrine bars the SEC’s efforts to regulate tokens as securities, that secondary market transactions in tokens do not involve “investment contracts,” and that the SEC’s lawsuit deprives Bittrex of constitutionally required fair notice. The case is pending in the U.S. District Court for the Western District of Washington. CoinTelegraph; Motion.
Judge Severs Bankman-Fried Criminal Charges, Declines to Dismiss Them
On May 8, FTX’s founder and former CEO filed motions to dismiss most of the criminal charges against him, marking Bankman-Fried’s first detailed defense in his U.S. federal criminal case. Among other things, Bankman-Fried argued that under the U.S.-Bahamas extradition treaty the Bahamas needs to “consent” to the additional charges brought after the extradition. On May 30, prosecutors responded to these motions. Among other things, the government argued it has sought the consent of the Bahamian government to proceed with the charges brought post-extradition and will drop those charges if the Bahamas does not consent. On June 15, District Judge Lewis Kaplan severed the post-extradition charges against Bankman-Fried and ordered a second trial on those charges in March 2024. On June 30, Judge Kaplan denied Bankman-Fried’s motions to dismiss. CoinTelegraph 1; CoinDesk; New York Times; Law360; Docket; CoinTelegraph 2.
CoinEx Agrees to Settle Registration Charges for $1.8 Million
On June 14, global cryptocurrency exchange CoinEx agreed to settle charges that it had failed to register as a broker-dealer with the New York Attorney General for $1.8 million. The company also terminated its U.S. users’ accounts and blocked them from creating new accounts. Law360; Stipulation.
Wahi Brothers Settle Insider Trading Charges with the SEC
On May 30, the SEC settled charges with a former Coinbase product manager, Ishan Wahi, and his brother Nikhil. The two were arrested last year on charges of wire fraud conspiracy and “wire fraud in connection with a scheme to commit insider trading.” Both brothers pleaded guilty. Ishan Wahi was sentenced to 24 months in prison and ordered to forfeit 10.97 ether and 9,440 Tether, and Nikhil was sentenced to 10 months in prison and ordered to forfeit $892,500—with more than half as restitution to Coinbase as a victim of the Wahi defendants’ misconduct. The court has since held the restitution order in abeyance while the brothers contest the amount of attorneys’ fees awarded to Coinbase. On June 29, Coinbase asked the court to again grant its restitution request. The SEC announced that because of the brother’s prison sentences, it will not seek any other penalties. The settlement puts an end to the case brought by the SEC which was set to answer the question of whether cryptocurrencies at the heart of the case were indeed securities, as the SEC has argued and Coinbase, as amicus, forcefully disputed. SEC; CoinDesk; Law360.
Judge Torres Denies SEC’s Motion to Seal Hinman Documents
On May 16, United States District Judge Analisa Torres denied the SEC’s motion to seal records of its internal deliberations regarding a speech by former director William Hinman. In the June 2018 speech, the former SEC corporation finance director stated that ether is not a security. The SEC filed the motion on December 22, 2022 to seal the internal emails, text messages, and expert reports that followed Hinman’s speech. Judge Torres found that these documents “are not protected by the deliberative process privilege because they do not relate to an agency position, decision or policy.” Ripple has considered the speech a key piece of evidence in its ongoing legal battle with the SEC, which alleges that sales of Ripple’s XRP violated U.S. securities laws. Order; CoinTelegraph.
Gemini Moves to Dismiss SEC Suit
On May 29, Gemini filed a motion to dismiss the SEC’s lawsuit claiming that the operation of Gemini’s now defunct crypto lending program, called Gemini Earn, was a sale of unregistered securities. Gemini argued that the contracts involved were “simple lending arrangements” and that the SEC case is complicating the process of returning funds to investors. Law360; CoinTelegraph.
Green United Executives Argue SEC Has No Authority Over Crypto
On May 19, Wright Thurston and Kristoffer Krohn filed motions to dismiss an SEC enforcement action in the U.S. District Court for the District of Utah. The SEC sued the defendants in March 2023, alleging that the defendants fraudulently offered securities by selling “Green Boxes” and “Green nodes” marketed as miners for the GREEN token on the “Green Blockchain.” The SEC claimed the hardware sold didn’t mine GREEN as it was an Ethereum-based ERC-20 token that could not be mined and the Green Blockchain didn’t exist. The defendants in their motions to dismiss argue, among other things, that the SEC has no authority over the digital asset ecosystem, claiming that Congress “considered and rejected” the SEC’s authority over crypto. They also argue that the SEC has been “unclear and inconsistent” in defining digital assets and criticize the agency’s regulation-by-enforcement approach in the crypto space. CoinTelegraph; Thurston’s Motion; Krohn’s Motion.

International

Do Kwon Wins Bail Request, Upends Montenegrin Elections with Campaign Funding Claim, Is Sentenced to Four Months
On June 5, a Montenegro high court again approved $428,000 bail forDo Kwon subject to house arrest pending an extradition request from South Korea. Only days before a June 11 election in Montenegro, Do Kwon claimed in a letter from custody that “crypto friends” had provided campaign funding to a leading candidate, upending the election’s anticipated results. In March, Kwon, along with former Terraform Labs executive Han Chang-joon, was arrested in Montenegro for allegedly attempting to travel with falsified documents. South Korean authorities had been searching for Kwon since Terraform Labs collapsed in May last year. The two South Korean nationals were back in court on June 16 for a hearing in which Kwon’s lawyers said their client denied having funded the leading candidate’s campaign. Kwon and Han were subsequently sentenced to four months for falsifying official documents. Since his arrest, both South Korea and the U.S. have requested Kwon’s extradition to face criminal charges following his trial in Montenegro. CoinDesk 1; CoinTelegraph 1; CoinDesk 2; New York Times; CoinTelegraph 2; TechCrunch.

Regulation and Legislation

United States

Republicans Release Digital Asset Market Structure Proposal
On June 2, Chairman McHenry of the House Financial Services Committee and Chairman Thompson of the House Committee on Agriculture released a discussion draft of legislation providing a statutory framework for digital asset regulation. The discussion draft represents a “common approach to digital asset regulation that would bring existing consumer and investor protections to digital asset-related activities and intermediaries.” The House Financial Services Committee plans to vote on the proposed legislation in the second week of July. Press Release; Discussion Draft; The Block.
House Proposed a Comprehensive Regulatory Framework for Stablecoins
On June 13, the House Financial Services Committee released a discussion draft of a proposed statutory framework for stablecoins. During a June 21 oversight hearing, Chairman McHenry indicated that the committee will debate the bill during the July session. Press Release; Discussion Draft; The Block.
New NFA Regulation Takes Effect
On May 31, a new rule issued by the National Futures Association—the self-regulatory organization for the U.S. derivatives industry—takes effect. Compliance Rule 2-51 is applicable to NFA member firms and associated persons engaging in activities involving bitcoin and ether, including spot or cash market activities. The rule imposes anti-fraud, just and equitable principles of trade, and supervision requirements on members and associates, and codifies members’ existing disclosure obligations under NFA Interpretative Notice 9073. Law360.
Prometheum Congressional Testimony Attracts Industry Criticism
On June 13, Aaron Kaplan, the founder and co-CEO of crypto exchange Prometheum, testified before the House Financial Services Committee that the SEC has laid out a compliant path for crypto in the United States. Prometheum recently received a first-of-its-kind FINRA approval to operate as a special purpose broker-dealer for digital assets in anticipation of listing digital assets for trading. Kaplan’s remarks provoked some controversy across the industry and on Twitter, with certain competitors criticizing the company and Kaplan’s remarks. The Blockchain Association submitted FOIA requests for more information about the company. Hearing; CoinTelegraph 1; CoinTelegraph 2.
CFTC Warns Clearing Agencies to Monitor Crypto Risks
On May 30, the CFTC’s Division of Clearing and Risk issued a staff advisory warning clearing agencies that provide services for crypto products that they must contain risks associated with digital assets through mitigation strategies, or they will face the agency’s scrutiny. The advisory also notes that, given increased cybersecurity risks and other perceived dangers involving digital assets, the CFTC’s division will emphasize compliance regarding its “core principles” of system safeguards, conflicts of interest, and physical delivery.” Law360.
Proposed Tax on Crypto Mining Removed from Spending Bill
On May 28, in the lead up to legislation to raise the U.S. debt ceiling, lawmakers released a draft bill that did not include the previously proposed Digital Assets Mining Energy (DAME) 30% excise tax on electricity used by crypto miners. The tax would have increased by 10% each year over three years on electricity generated starting in 2024. CoinTelegraph.
Filecoin Sponsor Receives SEC Comment Letter
On May 17, Grayscale announced that it received a comment letter from the SEC asking it to withdraw the registration of a trust investing in Filecoin, because the SEC believes Filecoin meets the definition of a security. On May 31, crypto trading firm Cumberland announced that it would halt over-the-counter trading in the token used by the decentralized storage platform Filecoin, citing regulatory environment concerns. GlobeNewswire; The Block.
Federal Bank Regulatory Agencies Release Interagency Guidance on Third-Party Risk Management
On June 6, the Federal Reserve, FDIC and OCC released final interagency guidance designed to aid banking organizations in managing risks associated with third-party relationships, including those with FinTechs and companies in the digital assets space. The interagency guidance replaces prior guidance of the agencies and details risk management strategies at various stages of third-party relationships, such as planning, due diligence, contract negotiation, ongoing monitoring, and termination. The agencies underscore that the interagency guidance does not have the force and effect of law and does not impose any new requirements on banking organizations. Nonetheless, third-party risk management will remain an area of heightened focus and scrutiny by supervisors and examiners, particularly with respect to third parties that are: FinTechs; digital assets providers; critical to bank operations or organizational business continuity and resiliency; customer-facing; subject to heightened consumer compliance and other prudential requirements; or represent concentration risk. As such, FinTechs and other companies and service providers that partner with banks to deliver regulated financial services should expect potential additional scrutiny from both their bank partners and their bank partners’ regulators. Interagency Press Release; Interagency Guidance on Third-Party Relationships: Risk Management; Federal Reserve Board Memo; Federal Reserve SR 23-4: Interagency Guidance on Third-Party Relationships: Risk Management; FDIC Financial Institution Letter (FIL-29-2023); OCC Bulletin 2023-17.
Federal Deposit Insurance Corporation Continues Focus on Deposit Insurance Representations
On June 15, the FDIC issued advisory letters demanding three companies cease and desist from making false and misleading statements about FDIC deposit insurance. The advisory letters highlight the FDIC’s continuing efforts to review companies’ public statements, disclosures and other marketing materials for compliance with Section 18(a)(4) of the Federal Deposit Insurance Act (12 U.S.C. § 1828(a)(4)) and the FDIC’s 2022 final rule regarding advertising or other representations about FDIC deposit insurance (12 C.F.R. Part 328, Subpart B). To ensure compliance, banks and bank partners should, at a minimum, ensure subject materials: (a) clearly disclose that the nonbank company offering the service is not an insured bank; (b) identify the insured bank(s) where any customer funds may be held on deposit; (c) communicate that FDIC deposit insurance is not available in the event of the bankruptcy of the nonbank company and is only available should the FDIC-insured bank at which deposits are properly held fail; and (d) communicate that non-deposit products are not FDIC-insured products and may lose value. FDIC’s Letter to Bodega Importadora de Pallets; FDIC’s Letter to Money Avenue, LLC; FDIC’s Letter to OKCoin USA, Inc.

International

EU Formally Adopts Markets in Crypto-Assets Regulation (MiCA)
On May 31, the EU formally adopted MiCA, the first EU legal framework expressly regulating crypto assets. MiCA aims to protect investors by increasing transparency and putting in place a comprehensive framework for issuers and service providers such as trading venue and crypto asset wallets, including compliance with anti-money laundering rules. MiCA was published in the EU’s official journal on June 9, 2023, and entered into force on June 29, 2023, the 20th day following the date of its publication. Stablecoin issuers, which will face much stricter regulations under the new law, will have 12 months to ensure they are in compliance with the law, while other crypto issuers and so-called crypto asset service providers (CASPs) will have 18 months to prepare. CoinDesk; European Council.
EU Countries, Lawmakers Reach Deal on Data Act
On June 27, legislative negotiators from the European Union reached an agreement on the Data Act, a set of new rules governing fair access and use of data on internet-connected devices. The Act, which was passed by the European Parliament on March 14, has been criticized by the crypto industry for imposing requirements on smart contracts, including requiring them to include a kill switch. There are conflicting reports about whether the final draft, which has not yet been released, will assuage these concerns. The Data Act now awaits voting by the European Parliament and Council before it can become law. CoinDesk.

UK Crypto, Stablecoin Legislation Formally Approved
On June 29, King Charles formally approved the Financial Services and Markets Act, which gives UK regulators authority to supervise cryptocurrencies and stablecoins. The bill treats all crypto as a regulated activity, supervises crypto promotions, and incorporates stablecoins into payment rules. The U.K.’s Treasury, Financial Conduct Authority, the Bank of England, and Payments Systems Regulator will have the power to introduce and enforce regulations for the sector. Specific rules for the crypto sector could be implemented within a year. CoinDesk.

ESMA Calls on EU Investment Firms to Clearly State That Crypto Is Unregulated
On May 25, the European Securities and Markets Authority (ESMA), EU’s securities regulator, issued a public statement highlighting the risks arising from the provision of unregulated products and/or services by investment firms in the EU. ESMA expressed its concerns that where “investment firms engage in providing both regulated and unregulated products and/or services there is a significant risk that investors may misunderstand the protections they are afforded when investing in those unregulated products and/or services.” In such situations, ESMA recommended few steps for the investment firms, including noting in all marketing communications whether a given product is regulated or not, or clearly explaining “what investor protections are lost/not applicable when investing in a product.” ESMA.
UAE Issues New AML Rules for Digital Assets
On May 31, the Central Bank of the United Arab Emirates published guidance for licensed financial institutions on risks “related to virtual assets and virtual assets service providers.” The guidance specifies new rules on anti-money laundering and combating the financing of terrorism for banking institutions engaging with crypto in the UAE, including requiring licensed financial institutions to verify the identities of all customers. CoinTelegraph.
Hong Kong and UAE Central Banks Coordinate on Crypto Regulations
On May 29, the Central Bank of the UAE and the Hong Kong Monetary Authority held a bilateral meeting in which they agreed to cooperate on regulating virtual assets by implementing financial infrastructure and cross-border trade settlements. Decrypt.
Singapore Releases New Crypto Regulations
On July 3, the Monetary Authority of Singapore (MAS) announced new regulations for Digital Payment Token (DPT) service providers to safekeep customer assets under a statutory trust before the end of the year. The statutory trust is intended to mitigate the risk of loss or misuse of customers’ assets, and facilitate the recovery of customers’ assets in the event of a DPT service provider’s insolvency. MAS will also restrict DPT service providers from facilitating lending and staking of DPT tokens by their retail customers. These measures were introduced following an October 2022 public consultation on regulatory measures to enhance investor protection and market integrity in DPT services. Among other things, the MAS also issued a new consultation paper proposing requirements for DPT service providers to address unfair trading practices. Consultation Feedback; Consultation Paper on Proposed Amendments; Consultation Paper on Market Integrity

Civil Litigation

United States

Court Rules Bankman-Fried Cannot Subpoena Former FTX Counsel
On June 23, Judge Kaplan of the Southern District of New York denied FTX founder and former CEO Sam Bankman-Fried’s request to subpoena documents from Fenwick & West related to their earlier legal work for FTX, finding that the requested subpoena was “a fishing expedition.” Judge Kaplan also rejected Bankman-Fried’s argument that FTX was “so enmeshed in the government’s investigation that [it] must be considered part of the ‘prosecution team’ for purposes of the government’s discovery obligations,” holding that documents held by FTX are not in the government’s “possession, custody, or control.” CoinDesk; Law360; Order.
Third Circuit Retains Jurisdiction over Coinbase Mandamus Petition
On June 20, the U.S. Court of Appeals for the Third Circuit ruled that the SEC must provide an update on its progress in deciding Coinbase’s petition for rulemaking by October 11, 2023. The Court will maintain jurisdiction over Coinbase’s rulemaking petition in the interim. Coinbase’s rulemaking petition asks the SEC to explain, among other things, which digital assets the SEC believes to be securities and how industry players should go about registering them. CoinGeek.
Supreme Court Rules in Favor of Coinbase in Arbitration Lawsuit
On June 23, the U.S. Supreme Court held that a lawsuit against Coinbase should have been automatically stayed when the company appealed the federal district court’s denial of its motion to compel arbitration of a putative class action. Although the decision does not touch on issues specific to the crypto industry, the ruling is the first by the Supreme Court involving a crypto industry participant. Client Alert; Law360; Opinion.
Proposed Class Action Suit Filed Against Shaq for NFT Promotion
On May 23, a proposed class action was filed against basketball player Shaquille O’Neal, alleging that his promotion of Astrals Project NFTs violated securities laws by marketing unregistered digital assets. Law360.
MDL Created for FTX Investor Actions
On May 25, FTX investors asked the Judicial Panel on Multidistrict Litigation (JPML) to consolidate investor litigation actions relating to the demise of FTX before one federal judge in the Southern District of Florida. On June 5, the panel granted the motion and ordered the creation of a multi-district litigation before U.S. District Judge K. Michael Moore in Miami. Law360; Bloomberg.

Speaker’s Corner

United States

Senator Elizabeth Warren Calls for Crypto Legislation to Stop Fentanyl Trade
On May 31, Elizabeth Warren stated during a Senate hearing that she aims to combat cryptocurrency’s role in the illegal Chinese fentanyl trade. Warren suggested her Digital Asset Anti-Money Laundering Act may help cut off the crypto payments, and she said the bill will be reintroduced in this Congress.CoinDesk.

DeSantis Urges to ‘Protect’ Bitcoin in His Campaign Launch
On May 24, in announcing a bid for President in an interview on Twitter with Elon Musk, Ron DeSantis said that “as president, we’ll protect the ability to do things like Bitcoin.” DeSantis called those on Capitol Hill “central planners” who “want to have control over society.” DeSantis also mentioned that Congress has never specifically addressed cryptocurrency, and instead the regulation was created by “the bureaucracy” and made it so “that people cannot operate in that space.”CoinTelegraph.

International

Chief of G-7’s Financial Action Task Force Calls for Stronger Global Collaboration to Target Crime and Terrorism Financing
On May 18, T. Raja Kumar, President of FATF, an intergovernmental organization that sets money laundering and terrorist financing standards, urged G-7 leaders to “effectively” implement FATF’s crypto anti-money laundering norms ahead of the May G-7 summit in Hiroshima. Kumar said that “countries need to take urgent action to shut down lawless spaces, which allow criminals, terrorists and rogue states to use crypto assets.” In particular, he called on the implementation of the ‘travel rule,’ which requires virtual assets service providers to identify the sender and receiver of the transaction. His recommendations were echoed by the G-7 finance ministers and central bank governors meeting on May 13 in Japan. Global Governance Project; G7 Finance Ministers and Central Bank Governors Meeting Communiqué.

Other Notable News

BlackRock Applies for Spot Bitcoin ETF
On June 15, BlackRock filed an S-1 with the SEC for the iShares Bitcoin Trust, whose assets would consist primarily of Bitcoin held by Coinbase and which would reflect the spot price of Bitcoin. The move was seen as an indication of continued institutional support for crypto and was quickly followed by a number of similar filings, including by Fidelity Investments. According to a June 30 Wall Street Journal report, the SEC informed Nasdaq and Cboe Global Markets, the exchanges that filed on behalf of Blackrock and Fidelity, that their applications are not sufficiently clear and comprehensive. Cboe updated and re-filed its applications on June 30. On July 3, BlackRock resubmitted its filing through Nasdaq with new details. CoinDesk 1; S-1; CoinDesk 2; Wall Street Journal; MarketWatch.
Crypto Custodian Prime Trust Faces Nevada Receivership, Asset Freeze
On June 27, Nevada’s Financial Institutions Division filed a request to take crypto custodian Prime Trust into receivership and freeze its operations due to alleged insolvency. The request for receivership states that Prime Trust owes clients around $150 million in fiat currency and cryptocurrencies and that part of this shortfall resulted from the company losing its ability to access “legacy wallets.” CoinDesk.
NY Fed and Singapore Monetary Authority Publish Joint CBDC Study Results
On May 18, the Federal Reserve Bank of New York’s New York Innovation Center and the Monetary Authority of Singapore published a research report detailing the results of a joint study, with findings that distributed ledger technology could be used to improve the efficiency of cross-border wholesale payments and settlements involving multiple currencies. Report; CoinTelegraph.

The following Gibson Dunn lawyers prepared this client alert: Ashlie Beringer, Stephanie Brooker, Jason Cabral, M. Kendall Day, Jeffrey Steiner, Sara Weed, Ella Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Alfie Lim, Bart Jordan, Andrea Lattanzio, and Jan Przerwa.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s FinTech and Digital Assets practice group, or the following:

FinTech and Digital Assets Group:

Ashlie Beringer, Palo Alto (650.849.5327, [email protected])

Michael D. Bopp, Washington, D.C. (202.955.8256, [email protected]

Stephanie L. Brooker, Washington, D.C. (202.887.3502, [email protected])

Jason J. Cabral, New York (212.351.6267, [email protected])

M. Kendall Day, Washington, D.C. (202.955.8220, [email protected])

Michael J. Desmond, Los Angeles/Washington, D.C. (213.229.7531, [email protected])

Sébastien Evrard, Hong Kong (+852 2214 3798, [email protected])

William R. Hallatt, Hong Kong (+852 2214 3836, [email protected])

Martin A. Hewett, Washington, D.C. (202.955.8207, [email protected])

Michelle M. Kirschner, London (+44 (0)20 7071.4212, [email protected])

Stewart McDowell, San Francisco (415.393.8322, [email protected])

Mark K. Schonfeld, New York (212.351.2433, [email protected])

Orin Snyder, New York (212.351.2400, [email protected])

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, [email protected])

Eric D. Vandevelde, Los Angeles (213.229.7186, [email protected])

Benjamin Wagner, Palo Alto (650.849.5395, [email protected])

Sara K. Weed, Washington, D.C. (202.955.8507, [email protected])

On March 23, 2023, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (“NPRM”) to significantly expand legal requirements for sellers that use negative option offers.[1] Negative option offers allow a seller to interpret a consumer’s silence or inaction as acceptance of an offer and include prenotification and continuity plans, automatic renewal plans, and free trial offers that convert into automatic renewal plans unless canceled before the end of the trial period. The NPRM was published in the Federal Register on April 24, 2023, and the comment deadline is June 23, 2023.

The FTC’s stated objective is to create enforceable performance-based requirements for all negative option offers across all media pertaining to: misrepresentations, disclosures, consents, and cancellation methods.[2] But the proposed Rule would extend beyond the offer’s negative option features to “any material fact related to the [offer’s] underlying good or service.”[3] Consequently, negative option sellers could face substantial civil penalties for violations of the proposed Rule for any allegedly deceptive facet of the broader consumer transaction.

The proposed Rule could be finalized by the end of the year. Companies should consider how this Rule might impact their business and consider submitting a comment to the NPRM addressing: (i) the prevalence of the alleged deceptive and unfair conduct relating to negative option features; (ii) empirical evidence concerning compliance costs, and the degree to which they would outweigh anticipated benefits; (iii) negative consequences to consumers that might arise from the Rule; and (iv) potential exemptions to the rules, including for industries subject to billing and notice requirements under separate federal or state legal regimes, such as the telecommunications or energy industries.

The Proposed Rule Would Significantly Broaden Requirements and Risks For Sellers Using Negative Option Features.

The proposed Rule would replace regulations that apply only to prenotification negative option plans for physical goods with more expansive requirements that would be applicable to all media containing any type of negative option feature. The proposed Rule would also incorporate negative option rules contained in other laws and regulations, such as the Restore Online Shoppers’ Confidence Act (“ROSCA”) and the Telemarketing Sales Rule (“TSR”) to “establish a comprehensive scheme for regulation of negative option marketing in a single rule… — [a] one-stop regulatory shop[.]”[4] The FTC asserts that the existing ROSCA and TSR rules are insufficient to protect consumers and serve as a deterrence because misrepresentations concerning negative options continue to be prevalent in the marketplace.[5]

The proposed requirements include the following:

Disclosures of Material Terms: Sellers must disclose clearly and conspicuously all material terms related to both the negative option feature and the underlying good or service prior to collecting billing information from the consumer. Material terms include: (i) the nature and amount of charges to be imposed, including any future increases or recurring payments; (ii) deadline(s) for a consumer to affirmatively object to charges; (iii) the date(s) charges will be submitted for payment; and (iv) information on how to cancel a negative option feature.[6]
Broad Prohibition on Misrepresentations: Sellers must not misrepresent, expressly or by implication, any material fact related to the transaction, including the negative option feature, or those related to the underlying good or service.[7]
Easy Cancellation Methods: Sellers must provide consumers with a cancellation method that is at least as easy as the method used to initiate the negative option feature. For instance, if consumers enter into a negative option feature on a seller’s website, they should be able to cancel the negative option feature through the same or an easier process on the seller’s website. If a consumer consented to the feature in-person, the seller must offer a simple cancellation option by phone and/or on its website in addition to, where practical, a similar in-person cancellation method. Sellers cannot require consumers who signed up via their website to call a phone number in order to cancel their negative option agreement.[8]
Consent to Negative Option Feature: Sellers must obtain consumers’ express, informed consent to a negative option feature separately from any other part of a transaction and prior to charging them. Sellers cannot obtain simultaneous consent to charges for an instant purchase and to accept a negative option feature. Sellers must retain records of these consents for three years, or one year after the negative option ends, whichever is longer.[9]
Requirement for Immediate Cancellation Upon Consumer Request: Sellers must immediately cancel the negative option feature upon request from a consumer, unless the seller obtains the consumer’s unambiguous affirmative consent to receive a save prior to cancellation. Sellers cannot present additional and alternative offers during a cancellation attempt, unless a consumer first expressly consents to receive information about offers. Sellers must retain records of these consents for three years, or one year after the negative option ends, whichever is longer.[10]
Annual Reminders: At least annually, sellers must send consumers reminders describing the product or service, the frequency and amount of charges, and the means to cancel. This provision does not apply to negative option agreements involving the delivery of physical goods.[11]

Noncompliance with any of these requirements would be considered an unfair or deceptive practice in violation of Sections 5 and 19 of the FTC Act, subject to civil penalties, currently up to $50,120 per day for ongoing violations.[12]

Former Commissioner Christine Wilson wrote a five-page dissent stating that the proposed Rule went “far beyond practices for which the rulemaking record supports a prevalence of unfair or deceptive practices.”[13] Among other problems, Commissioner Wilson noted that the proposed Rule “is not confined to negative option marketing” and “covers any misrepresentation made about the underlying good or service sold with a negative option feature,” notwithstanding that the Commission did not include and seek comments about such general misrepresentations in its Advance Notice of Proposed Rulemaking.[14] Because the proposed Rule would allow the FTC to invoke Section 19 of the FTC Act to obtain civil penalties or consumer redress, she explained, marketers could be liable for civil penalties for product-efficacy claims “even if the negative option terms are clearly described, informed consent is obtained, and cancellation is simple.”[15]

Commissioner Wilson also stated that the breadth of the proposed Rule would evade the Supreme Court’s decision limiting the FTC’s authority to seek disgorgement in cases enforcing the general prohibition on unfair or deceptive practices in Section 5 of the FTC Act.[16] In addition, she said that the breadth of the proposed Rule is inconsistent with the FTC’s cases under ROSCA, and “will treat marketers differently for purposes of potential Section 5 violations, depending on whether they sell products or services with or without negative option features.”[17] We anticipate that there will be a significant number of comments submitted that raise similar arguments, potentially among others, in opposition to the proposed rulemaking, and if the rulemaking is finalized, similar legal challenges are likely to be raised in courts.

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

_________________________

[1] Negative Option Rule NPRM, Fed. Trade Comm’n (Mar. 23, 2023). The Commission voted 3-1, along party lines, to publish the NPRM. Chair Khan and Commissioners Slaughter and Bedoya released a joint statement in support of the proposed Rule. See Joint Statement, Fed. Trade Comm’n (Mar. 23, 2023). Former Commissioner Wilson dissented. See Dissenting Statement of Commissioner Christine S. Wilson, Fed. Trade Comm’n (Mar. 23, 2023).

[2] Id. at 3.

[3] Id. at 77-78 (the proposed Rule’s requirements pertaining to misrepresentations and disclosures).

[4] Id. at 42.

[5] Id. at 10-12.

[6] Id. at 77-78.

[7] Id. at 77.

[8] Id. at 80-81.

[9] Id. at 78-80.

[10] Id. at 81.

[11] Id. at 82.

[12] FTC Publishes Inflation-Adjusted Civil Penalty Amounts for 2023, Fed. Trade Comm’n (Jan. 6, 2023).

[13] Dissenting Statement of Commissioner Christine S. Wilson, pg. 1, Fed. Trade Comm’n (Mar. 23, 2023).

[14] Id. at 2.

[15] Id.

[16] Id. at 2, 5; see also AMG Capital Mgmt., LLC v. FTC, 141 S. Ct. 1341 (2021).

[17] Id. at 5.

The following Gibson Dunn lawyers prepared this client alert:

Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])
Ella Alves Capone – Washington, D.C. (+1 202-887-3511, [email protected])
Victoria Granda – Washington, D.C. (+1 202.955.8249, [email protected])
Natalie Hausknecht – Denver, CO (+1 303.298.5783, [email protected])

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Privacy, Cybersecurity and Data Innovation, Public Policy, and Administrative Law and Regulatory teams.

Privacy, Cybersecurity and Data Innovation Group:
S. Ashlie Beringer – Palo Alto (+1 650-849-5327, [email protected])
Jane C. Horvath – Washington, D.C. (+1 202-955-8505, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])

Public Policy Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])

Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8543, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [email protected])

In this webcast, Gibson Dunn attorneys provide an overview of the FCPA developments and emerging trends from 2022 and will discuss current and anticipated areas of focus for 2023. Intended to complement our Year-End FCPA Update, this webcast discusses in greater detail recent FCPA enforcement updates of note, including enforcement policy developments, DOJ’s use of monitorships, voluntary disclosures, declinations with disgorgement, and opinion letters within the past year. We also discuss DOJ’s increasing focus on compliance programs and what that means for companies in terms of law enforcement expectations and industry best practices.

PANELISTS:

Patrick Stokes is Co-Chair of the firm’s Anti-Corruption and FCPA Practice Group and a partner in the Washington, D.C. office, where he focuses his practice on internal corporate investigations, government investigations, enforcement actions regarding corruption, securities fraud, and financial institutions fraud, and compliance reviews. Mr. Stokes is ranked nationally and globally by Chambers USA and Chambers Global as a leading attorney in FCPA. 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.

John W.F. Chesley is a partner in the Washington, D.C. office. Mr. Chesley has served as the Interim Chief Ethics & Compliance Officer of a publicly-traded, multinational corporation, and his white collar defense work has been recognized repeatedly by Global Investigations Review, Law 360, National Law Journal, and other publications. He represents corporations, audit committees, and executives in internal investigations and before government agencies in matters involving the FCPA, procurement fraud, environmental crimes, securities violations, antitrust violations, and whistleblower claims. He also litigates government contracts disputes in federal courts and administrative tribunals.

Ella Alves Capone is Of Counsel in the Washington, D.C. office, where her practice focuses on advising multinational corporations and financial institutions in enforcement actions, internal investigations, and corporate compliance matters involving anti-corruption laws and a variety of financial services laws and regulations. She regularly counsels clients on the implementation, assessment, and enhancement of their compliance programs and internal controls.

Bryan Parr is Of Counsel in the Washington, D.C. office and a member of the White Collar Defense and Investigations, Anti-Corruption & FCPA, and Litigation Practice Groups. Mr. Parr’s practice focuses on white-collar defense and regulatory compliance matters around the world. Mr. Parr has extensive expertise in government and corporate investigations, including those involving the Foreign Corrupt Practices Act (FCPA) and anticorruption. He has defended a range of companies and individuals in U.S. Department of Justice (DOJ), SEC, and CFTC enforcement actions, as well as in litigation in federal courts and in commercial arbitrations.

MCLE CREDIT INFORMATION:

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

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Application for approval is pending with the Colorado, Illinois, Texas, Virginia and Washington State Bars.

On March 30, 2023, the United States—along with over twenty international partners—adopted a nonbinding Code of Conduct outlining its commitment to use export control tools to address serious human rights concerns. Specifically, the Subscribing States[1] to the Code of Conduct will work together to target “the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights,” with a particular focus on the misuse of surveillance tools.[2] For the United States, this effort includes amendments to the Export Administration Regulations (“EAR”) that expressly make “protecting human rights worldwide” a basis for designation to the Entity List.[3]

As the Departments of State and Commerce have acknowledged, this Export Controls and Human Rights Initiative (“ECHRI”) Code of Conduct is yet another example of the U.S.’s continued efforts “to put human rights at the center of [its] foreign policy.”[4] In fact, although the Code of Conduct makes the United States’ focus on the intersection of export controls and human rights more explicit, in reality it builds on existing agency practice in recent years.

Between these existing practices and the Code of Conduct’s focus on collaboration with civil society, academia, and the international community, however, this may suggest even more robust enforcement and creative uses of regulatory authority in the coming years. To ensure continued compliance, companies engaged in the export of sensitive technologies will need to think creatively about integrating human rights evaluations into their existing trade due diligence processes.

I. ECHRI Code of Conduct’s Key Commitments

This recent Code of Conduct is the result of more than a year of work by the Export Controls and Human Rights Initiative, a multilateral effort initially created by the United States, Australia, Denmark, and Norway in December 2021.[5] In addition to ECHRI’s founding members, the following states committed to the Code of Conduct at the time of its publication: Albania, Bulgaria, Canada, Croatia, Czechia, Ecuador, Estonia, Finland, France, Germany, Japan, Kosovo, Latvia, The Netherlands, New Zealand, North Macedonia, Republic of Korea, Slovakia, Spain, and the United Kingdom.[6]

Although a non-binding document, the ECHRI Code of Conduct outlines a number of political commitments designed to ensure the effective application of export controls to protect human rights internationally. These include commitments of each Subscribing State to:

Make efforts to ensure that domestic legal, regulatory, policy and enforcement tools are updated to control the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights;
Engage with the private sector, academia, researchers, technologists, and members of civil society (including those from vulnerable groups) for consultations concerning these issues and concerning effective implementation of export control measures;
Share information regarding threats and risks associated with such tools and technologies with other Subscribing States on an ongoing basis;
Share, develop, and implement best practices among Subscribing States to control exports of dual-use goods and technologies to state and non-state actors that pose an unacceptable risk of human rights violations or abuses;
Consult with industry and promote non-state actors’ implementation of human rights due diligence policies and procedures in line with the UN Guiding Principles on Business and Human Rights or other complementing international instruments, and share information with industry to facilitate due diligence practices;
Aim to improve the capacity of States that have not subscribed to the Code of Conduct, and encourage other States to join or act consistent with the Code of Conduct.

In addition to these substantive goals, the Code of Conduct establishes procedural commitments for Subscribing States. Most significantly, these include ongoing meetings of Subscribing States designed to further develop the Code of Conduct by sharing information and creating mechanisms for the resolution of policy questions.

Notably, these multilateral efforts to coordinate export control strategies follow the international community’s unprecedented coordination on trade controls in response to the war in Ukraine, which we have discussed further in past client alerts. In fact, there is significant crossover between the current membership of the ECHRI Code of Conduct and those states that have worked in coordination on implementing Russia-related sanctions and export controls. For example, many states who have adopted the Code of Conduct are also members of the coalition that has adopted a price cap on the maritime transport of Russian-origin oil, as discussed further in our client alert on the subject. Similarly, most Code of Conduct states are exempted from the Department of Commerce’s Russia/Belarus Foreign Direct Product Rules because they have implemented “substantially similar export controls on Russia and Belarus” as the U.S.[7] As coordination among these states on a wide range of trade issues continues to increase, we can expect robust collaboration on implementation of the Code of Conduct.

Moreover, the Code of Conduct emphasizes the goal of increased adoption by other states by highlighting that the Code “does not specifically mention any of the multilateral export control regimes, such as the Wassenaar Arrangement.” Instead, the Code of Conduct is explicitly left open for any participant in the Summit for Democracy to join, regardless of their ratification of other multilateral regimes. Not only would broad future adoption increase the Code’s efficacy, but by tying membership to participation in the Summit for Democracy, the Code of Conduct reinforces a shared commitment to the democratic values central to human rights.

II. U.S. Implementation: The Entity List

Since 1997, the U.S. Department of Commerce—specifically its Bureau of Industry & Security (“BIS”)—has maintained an “Entity List“ of foreign persons subject to heightened license requirements for the export, reexport, or in-country transfer of specified items. As the first step toward implementing the ECHRI Code of Conduct, BIS published a final rule on March 30 confirming human rights concerns as a valid basis for designation to the Entity List.[8]

Initially, inclusion on the Entity List was limited primarily to foreign persons presenting risk of involvement in the proliferation of weapons of mass destruction (“WMDs”).[9] Over time, however, grounds for inclusion expanded to include any foreign persons “reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the United States.”[10]

Despite this potentially broad language, designations to the Entity List, historically, were relatively infrequent and narrowly focused on issues such as the proliferation of conventional weapons and WMDs, support for terrorism, and violations of U.S. sanctions and export controls. Though not explicitly linked to human rights, even these narrow grounds for designation demonstrate a U.S. focus on serious humanitarian and human rights violations arising out of U.S. exports. This focus has only increased in recent years, as BIS has dramatically increased the rate of designations—including some designations explicitly based on involvement in human rights abuses.

For example, beginning in 2019, BIS began designating a number of Chinese entities “implicated in human rights violations and abuses” against the Uyghurs and other ethnic minorities in the Xinjiang Uyghur Autonomous Region (the “XUAR”) of China.[11] Likewise, in 2021, BIS designated eight Burmese entities in response to human rights violations that occurred following the country’s February 2021 military coup.[12]

In light of this enforcement history, BIS’s recent final rule merely “confirm[s]” that the “protection of human rights worldwide” is a U.S. foreign policy objective sufficient to justify designation to the Entity List.[13] Although it does not represent a change in understanding, this amendment is likely to signal an increased use of export controls to target human rights violators, especially with respect to technologies involved in “enabling campaigns of repression and other human rights abuses.”[14]

In a statement accompanying publication of this rule, Assistant Secretary of Commerce for Export Enforcement Matthew S. Axelrod warned that “Export Enforcement will continue to work vigorously to identify those who use U.S. technology to abuse human rights and will use all law enforcement tools at our disposal to hold them accountable.”[15] This robust enforcement appears to already be in motion: concurrent with the publication of its amendment to the EAR, BIS designated eleven entities to its Entity List for their involvement in human rights abuses. These newly listed entities ranged from the Nicaraguan National Police and Burmese military contractors to Chinese companies implicated in surveillance and repression in the XUAR.[16]

III. The Continued Convergence of Human Rights & Export Controls

The Entity List is one of numerous trade control mechanisms the U.S. Government has used in recent years to address the intersection of international trade and human rights violations. Looking ahead, we can expect the Department of Commerce to deploy the following additional tools and sources of authority to implement the Code of Conduct.

a. Item-Based Controls

BIS most prominently introduced the concept of human rights into item-based crime control and detection (“CC”) controls in 2020. Specifically, in July 2020, BIS requested public comments regarding potential additional or modified controls on several items that may be used to assist human rights violations abroad, including facial recognition devices and other biometric systems, non-lethal visual disruption lasers, and long-range acoustic devices.[17] In its request for comments, BIS noted that these items could be used in mass surveillance, censorship, privacy violations, or other human rights abuses.[18]

Although BIS has not yet implemented additional CC controls pursuant to the comments received, in October 2020, BIS amended its CC controls to reflect a human rights-focused licensing policy.[19] Pursuant to this amendment, for items controlled for CC reasons, license applications are generally treated favorably “unless there is civil disorder in the country or region or unless there is a risk that the items will be used to violate or abuse human rights,” a restriction that is expressly designed “to deter human rights violations and abuses, distance the United States from such violations and abuses, and avoid contributing to civil disorder in a country or region.”[20]

In light of the ECHRI Code of Conduct commitment to “control the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights,” we may see additional controls on these surveillance systems and technologies.[21]

b. End-Use Based Controls

Another area with significant human rights implications is the end-use prohibitions of the EAR. Under Section 1754(d) of the Export Control Reform Act of 2018 (“ECRA”), the Department of Commerce is directed to require a license for U.S. persons to engage in specific “activities” in connection with nuclear explosive devices, missiles, chemical or biological weapons, whole plants for chemical weapons precursors, and foreign maritime nuclear projects—even without any export, reexport, or in-country transfer of items subject to the EAR.

BIS has increasingly used this specific export controls authority in recent years. In January 2021, BIS expanded this authority to control U.S. person activities in connection with military intelligence end-use, citing to a general authority provided in the ECRA.[22] “Military intelligence end-use” involves U.S. person support provided to the intelligence or reconnaissance organization of the armed services or national guard of Burma, China, Cuba, Iran, North Korea, Russia, Syria, or Venezuela. While this control is primarily focused on foreign military intelligence efforts, as such efforts are often inextricably intertwined with political repression and human rights issues, this control can be expected to take an increasingly important approach as a tool to uphold the U.S. position on human rights. Thus, as U.S. policies shift, we may also start seeing expansions to the list of foreign governments that are subject to the military intelligence end-use and end-user controls.

Further, in October 2022, BIS announced an unprecedented expansion of this authority in controlling U.S. person support for items used to produce certain advanced semiconductors and supercomputers in China.[23] According to BIS, because “China’s military-civil fusion effort makes it more difficult to tell which items are made for restricted end uses,” U.S. person support for advanced semiconductors and supercomputers “necessary for military programs of concern” would require a license even if the precise end-use could not be determined.[24] Similar types of controls with a human rights angle may be on the horizon—whether for additional items such as surveillance systems or for additional foreign governments other than China.

IV. Engagement with Civil Society, Academia, and the Private Sector

The ECHRI Code of Conduct emphasizes Subscribing States’ commitment to engage with civil society, academia, and the private sector on various issues relating to the implementation of effective human rights-focused export controls. If other areas of trade controls focused on human rights are any indication, these sectors can be expected to play a large role in driving enforcement priorities at the intersection of human rights and export controls.

The Code of Conduct appears to envision a two-way relationship between the government and civil society, academia, and the private sector: On one hand, states commit to facilitate due diligence and work with industry groups to promote human rights compliance. On the other hand, these other sectors can provide consultations on issues of human rights and the effective implementation of export controls. In the latter scenario, civil society and academia, in particular, may play a critical role in fact-gathering and presenting allegations of human rights violations to the U.S. government.

In fact, civil society and academia already play this role in the context of other human rights-focused trade restrictions, from sanctions to customs law. For example, the U.S. nonprofit Human Rights First coordinates a coalition of over 300 civil society organizations to facilitate the production of dossiers to share with the U.S. Government to promote the designation of specific human rights violators pursuant to the Global Magnitsky Sanctions program.[25] And, in the realm of customs law, the U.S. government has been particularly responsive to reports from civil society and academia in enforcing the Uyghur Forced Labor Prevention Act (“UFLPA”), discussed in our previous client alerts. Just this past December, for example, the U.K.’s Sheffield Hallam University published a report alleging that major automotive manufacturers had used components made with forced labor in the XUAR.[26] Shortly thereafter, U.S. Customs and Border Protection began detaining shipments from numerous automotive manufacturers pursuant to the UFLPA.

In addition to human rights-focused organizations, technological organizations and industry groups may prove critical to the implementation of the Code of Conduct. The Code’s commitments specifically envision engagement with “technologists” to advise on the effective implementation of export control measures. These specialists will be able to provide BIS with the information to determine which dual-use technologies pose risks of serious human rights abuses.

V. Effective Integration of Human Rights and Trade Compliance

With increasing overlap between human rights standards and trade compliance obligations—as evinced by the Code of Conduct—companies throughout the world must think critically about how to integrate human rights and trade practices to ensure compliance in this dynamic regulatory landscape. Companies should coordinate both internally and externally to identify opportunities to make their compliance programs more human rights-focused. Referring to existing U.S. guidance and international frameworks can also help them strengthen contractual relationships and due diligence practices to better protect human rights.

a. Internal Stakeholder Mapping

To integrate corporate efforts on human rights and trade compliance, a company should first identify the team of internal stakeholders who can provide visibility into the company’s various activities. Open communication among these departments will be critical to maintaining compliance, especially as human rights concerns continue to converge with trade obligations. Accordingly, having a clear understanding of relevant stakeholders and their perspectives is an important first step.

For example, members of a company’s logistics or legal team may have access to the most up-to-date information on a particular shipment and its end-users. A member of the environmental, social, and governance (“ESG”) or public relations team, however, may be most up-to-date on human rights issues dominating the news cycle—and, therefore, government enforcement priorities. Likewise, engineering or product teams may be best equipped to assess whether any individual product—particularly in the technology sectors—may have an unintended dual use that could be exploited to violate human rights, such as integration into surveillance efforts by foreign governments. Regular communication across these groups will allow companies to foresee reputational and commercial risks posed by exporting dual-use products to entities at risk of designation.

b. Industry and Civil Society Coordination

Just as the United States will coordinate with other Subscribing States to share information and strengthen programs, companies should prioritize opportunities to coordinate among industry groups and even with civil society to develop best practices.

Since advanced goods and technologies will be a primary target of the export controls the ECHRI Code of Conduct envisions, companies producing technology with the potential to be used for repression, surveillance, or other human rights abuses should collaborate to develop due diligence and risk assessment programs scoped to the specific concerns of their industry. For example, industry groups representing companies exporting facial recognition technology—which poses a high risk of use for surveillance—can develop technology-specific export due diligence best practices that can be implemented by all of their members.

Companies should also engage with civil society to learn about evolving human rights concerns. As discussed above, the U.S. government has indicated its intention to collaborate with civil society and academia in implementing human rights-focused export controls, and reports from these organizations are likely to drive U.S. enforcement priorities. By actively engaging with civil society, companies position themselves to stay ahead of the enforcement curve by developing early awareness and risk mitigation protocols before, for example, a counterparty is added to the Entity List.

c. Contracting for Human Rights Compliance

Even after determining it is permissible to export goods to a particular entity, companies should identify opportunities to obtain legal and reputational protections through their contracts.

Companies can use contractual provisions not only to obtain access to additional information about counterparties (and their business associates) but also to secure protection in the event a counterparty is later found to be involved in human rights violations. Such provisions are even more essential in the context of distributors or channels partners, where companies may be relying on the partner to conduct diligence on the ultimate end-users. With the potential decreased visibility into these sales, partner contracts should go beyond standard compliance representations to ensure companies have a strong legal basis to investigate and remediate any issues that may arise.

These contractual protections include provisions that allow companies to obtain information from their partners, such as audit rights, or that require partners to proactively disclose information regarding end-users. Effective contracting will also provide for consequences for non-compliance, including termination and indemnification. Companies may also incorporate structural mechanisms to mitigate risk, including by expressly limiting the territorial scope of its partners.

Companies can also streamline the contracting process by grouping third parties into categories based on a human rights risk profile or by the type of contractual relationship. This process allows for category-specific risk assessments and contract templates, while also allowing companies to consider what contracting incentives can be used to motivate categories of counterparties to support their human rights and trade compliance efforts.

d. Existing Guidance & Human Rights Frameworks

Although the ECHRI Code of Conduct reflects a strengthened commitment to use export controls to address human rights concerns, existing frameworks continue to provide helpful guidance on corporate due diligence and risk assessments. Indeed, the Code of Conduct expressly encourages the private sector to conduct due diligence in line with “the UN Guiding Principles on Business and Human Rights or other complementing international instruments.”[27]

In the United States, the U.S. government has already provided specific guidance on how to implement the UN Guiding Principles for certain transactions covered by the ECHRI Code of Conduct. In September 2020, for example, the U.S. State Department published Guidance on Implementing the UN Guiding Principles for Transactions Linked to Foreign Government End-Users for Products or Services with Surveillance Capabilities in recognition of the fact that certain products or services with surveillance capabilities can be misused to violate or abuse human rights when exported to public or private end-users who do not respect basic freedoms and the rule of law.[28]

The State Department’s guidance identifies due diligence concerns and potential red flags to consider at various steps when transacting with government end-users, along with suggested safeguards to detect and halt abuse. In fact, the guidance provides a number of recommended contractual safeguards, in line with our guidance above.[29] While this guidance is primarily focused on government end-users, it also covers transactions with non-state actors in high-risk jurisdictions where governmental or quasi-governmental entities may be undisclosed end-users. Lastly, the guidance’s appendices provide helpful resources for further compliance guidance, from human rights frameworks and reports to examples of foreign laws suggesting the possible misuse of surveillance-related exports.[30]

The ECHRI Code of Conduct expresses a commitment to use export controls to address a wide range of entities—not just government end-users. However, given the Code of Conduct’s focus on “surveillance tools and other technologies . . . that can lead to serious violations of human rights,” the U.S. State Department’s 2020 guidance provides a baseline understanding of the U.S. government’s expectations for due diligence and risk mitigation when exporting goods or technologies with surveillance capabilities.[31]

Additionally, for exports destined for China—and especially the XUAR—companies should consult the Xinjiang Supply Chain Business Advisory issued by the Departments of State, Treasury, Commerce, and Homeland Security.[32] This advisory outlines specific risks and concerns about due diligence related to the export of goods or technology that could be used for surveillance in the XUAR.

While other governments will adopt their own guidance and related measures, we assess that many countries will look to the U.S. model as they develop their domestic authorities.

VI. Conclusion

The Biden administration has made clear that it will continue to use an aggressive, yet multilateral, approach to enforce human rights around the world, and the ECHRI Code of Conduct appears to be another example of this priority. By integrating their human rights and trade compliance efforts, however, companies can protect themselves from risk in this area.

As human rights concerns increasingly motivate export controls, open communication among internal stakeholders and with civil society will be key to preventing human rights-related export violations. Companies should think critically about every step of their contracting processes to maximize legal and reputational protection, particularly when working with distributors or channels partners. Existing U.S. guidance and international human rights instruments can help companies throughout the world address these and other due diligence issues as they update policies and procedures to ensure effective compliance.

_________________________

[1] At the time of the Code of Conduct’s publication, the following countries comprise the Subscribing States: Albania, Australia, Bulgaria, Canada, Costa Rica, Croatia, Czechia, Denmark, Ecuador, Estonia, Finland, France, Germany, Japan, Kosovo, Latvia, The Netherlands, New Zealand, North Macedonia, Norway, Republic of Korea, Slovakia, Spain, the United Kingdom, and the United States.

[2] Code of Conduct for Enhancing Export Controls of Goods and Technology That Could Be Misused and Lead to Serious Violations or Abuses of Human Rights, U.S. Dep’t of State, https://www.state.gov/wp-content/uploads/2023/03/230303-Updated-ECHRI-Code-of-Conduct-FINAL.pdf (hereafter “Code of Conduct”).

[3] Additions to the Entity List; Amendment to Confirm Basis for Adding Certain Entities to the Entity List Includes Foreign Policy Interest of Protection of Human Rights Worldwide, 88 Fed. Reg. 18,983 (Mar. 30, 2023) (revising 15 C.F.R. § 744.11 to explicitly add involvement in activities that are contrary to the “foreign policy interest of the protection of human rights throughout the world” as a basis for designation to the Department of Commerce’s Entity List)

[4] Press Release, Export Controls and Human Rights Initiative Code of Conduct Released at Summit for Democracy, U.S. Dep’t of State (Mar. 30, 2023), https://www.state.gov/export-controls-and-human-rights-initiative-code-of-conduct-released-at-the-summit-for-democracy/; Press Release, Biden Administration and International Partners Release Export Controls and Human Rights Initiative Code of Conduct, U.S. Dep’t of Commerce (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3257-2023-03-30-bis-press-release-echri-code-of-conduct/file.

[5] Joint Statement on the Export Controls and Human Rights Initiative, U.S. Dept. of State (Dec. 10, 2021), https://www.whitehouse.gov/briefing-room/statements-releases/2021/12/10/joint-statement-on-the-export-controls-and-human-rights-initiative/.

[6] Press Release, Export Controls and Human Rights Initiative Code of Conduct Released at Summit for Democracy, U.S. DEP’T OF STATE (Mar. 30, 2023), https://www.state.gov/export-controls-and-human-rights-initiative-code-of-conduct-released-at-the-summit-for-democracy/.

[7] Additions to the List of Countries Excluded From Certain License Requirements Under the Export Administration Regulations (EAR), 87 Fed. Reg. 21,554 (Apr. 12, 2022); see 15 C.F.R. Part 746, Supplement No. 3.

[8] Press Release, Commerce Adds Eleven to Entity List for Human Rights Abuses and Reaffirms Protection of Human Rights as Critical U.S. Foreign Policy Objective, Bureau of Indus. and Sec’y (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3256-2023-03-30-bis-press-release-human-rights-entity-list-additions/file.

[9] Entity List, Bureau of Indus. and Sec’y (last accessed Apr. 2, 2023), https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern/entity-list.

[10] 15 C.F.R. § 744.16 (2022).

[11] See, e.g., Addition of Certain Entities to the Entity List, 84 Fed. Reg. 54,002 (Oct. 9, 2019).

[12] See Addition of Entities to the Entity List, 86 Fed. Reg. 13,179 (Mar. 8, 2021); see also Addition of Certain Entities to the Entity List; Correction of Existing Entry on the Entity List, 86 Fed. Reg. 35,389 (July 6, 2021).

[13] Additions to the Entity List; Amendment to Confirm Basis for Adding Certain Entities to the Entity List Includes Foreign Policy Interest of Protection of Human Rights Worldwide, 88 Fed. Reg. 18,983 (Mar. 30, 2023) (emphasis added).

[14] Press Release, Commerce Adds Eleven to Entity List for Human Rights Abuses and Reaffirms Protection of Human Rights as Critical U.S. Foreign Policy Objective, Bureau of Indus. and Sec’y (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3256-2023-03-30-bis-press-release-human-rights-entity-list-additions/file.

[15] Id.

[16] Additions to the Entity List, supra note 13.

[17] Advanced Surveillance Systems and Other Items of Human Rights Concern, 85 Fed. Reg. 43,532 (July 17, 2020).

[18] Id. at 43,533.

[19] Amendment to Licensing Policy for Items Controlled for Crime Control Reasons, 85 Fed. Reg. 63,007 (Oct. 6, 2022).

[20] Id. at 63,009.

[21] Code of Conduct, supra note 2.

[22] Expansion of Certain End-Use and End-User Controls and Controls on Specific Activities of U.S. Persons, 86 Fed. Reg. 4,865 (Jan. 15, 2021); see 15 C.F.R. § 744.22.

[23] Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification, 87 Fed. Reg. 62,186 (Oct. 13, 2022); see 15 C.F.R. § 744.6.

[24] Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification, 87 Fed. Reg. 62,186, 62,187 (Oct. 13, 2022)

[25] Global Magnitstky and Targeted Sanctions, Human Rights First (last accessed Apr. 2, 2023), https://humanrightsfirst.org/efforts/global-magnitsky-targeted-sanctions/.

[26] Driving Force: Automotive Supply Chains and Forced Labor in the Uyghur Region, Sheffield Hallam Univ. Helena Kennedy Centre for Int’l Justice (Dec. 2022), https://acrobat.adobe.com/link/track?uri=urn%3Aaaid%3Ascds%3AUS%3A69ce4867-d7e7-4a6a-a98b-6c8350ceb714&viewer%21megaVerb=group-discover.

[27] Code of Conduct, supra note 2.

[28] Guidance on Implementing the UN Guiding Principles for Transactions Linked to Foreign Government End-Users for Products or Services with Surveillance Capabilities, U.S. Dept. of State (Sep. 30, 2020), https://www.state.gov/wp-content/uploads/2020/10/DRL-Industry-Guidance-Project-FINAL-1-pager-508-1.pdf. As this document explains, these products and services can violate a host of fundamental rights that are protected by the Universal Declaration of Human Rights and the International Covenant on Civil and Political Rights, such as the right to be free from arbitrary or unlawful interference with privacy. See id. at 3.

[29] Id. at 11.

[30] Id. at 14–19.

[31] Code of Conduct, supra note 2.

[32] Xinjiang Supply Chain Business Advisory (Jul. 2, 2020, updated Jul. 13, 2021), U.S. Dept. of Treasury, https://www.state.gov/wp-content/uploads/2021/07/Xinjiang-Business-Advisory-13July2021-1.pdf

The following Gibson Dunn lawyers prepared this client alert: Sean Brennan*, Christopher Timura, Claire Yi, Anna Searcey, Stephenie Gosnell Handler, Adam M. Smith, Chris Mullen, Maria Banda, and Annie Motto.

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

United States
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Annie Motto – Washington, D.C. (+1 212-351-3803, [email protected])
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, [email protected])
Sarah L. Pongrace – New York (+1 212-351-3972, [email protected])
Anna Searcey – Washington, D.C. (+1 202-887-3655, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])
Claire Yi – Washington, D.C. (+1 202-887-3644, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
David A. Wolber – Hong Kong (+852 2214 3764, [email protected])
Qi Yue – Hong Kong – (+852 2214 3731, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])

Europe
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Patrick Doris – London (+44 (0) 207 071 4276, [email protected])
Sacha Harber-Kelly – London (+44 (0) 20 7071 4205, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Irene Polieri – London (+44 (0) 20 7071 4199, [email protected])
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Nikita Malevanny – Munich (+49 89 189 33 160, [email protected])

*Sean Brennan is an associate working in the firm’s Washington, D.C. offices who currently is admitted to practice only in New York.

On March 27, 2023, the U.S. Department of Justice and U.S. Federal Trade Commission (together, the “Agencies”) hosted international and state antitrust enforcers for panel discussions on current and emerging enforcement trends. Agency leaders Assistant Attorney General (“AAG”) Jonathan Kanter and FTC Chair Lina M. Khan used the Summit to showcase their efforts to update the antitrust laws and expand their enforcement efforts in the “modern economy.”

Three key themes emerged from the Summit:

The Agencies believe case law based on economic theory developed in the 1970s must be updated, especially to account for application to modern economic structures.
To set new precedent, the Agencies must aggressively challenge and litigate cases, even if they lose at trial.
As part of their broader effort to expand enforcement, the Agencies are attempting to reinvigorate seldom-used enforcement tools, such as the Robinson-Patman Act and criminal enforcement of Sherman Act Section 2.

The Agencies are expected to bring merger challenges and conduct cases under novel theories of harm to develop new precedent.

During the Summit, federal, state, and international enforcers discussed their efforts to ensure competition in the “new” economy (which they described as being media and technology markets characterized by innovation, network effects, and so-called platform-based business models). Enforcers specifically celebrated the formation of technology and AI task forces, updated enforcement guidelines to reflect novel theories of harm, and recent enforcement actions against technology firms they consider dominant.

During these discussions, Agency leadership announced their intent to push courts to update judicial precedent by aggressively bringing enforcement actions under novel or seldom-used theories of harm. Chair Khan and AAG Kanter expressed concern that “stale” antitrust doctrine has been under-deterring anticompetitive conduct in the “new” and “old” economies alike and announced that aggressive test cases—even if they result in trial losses—were needed. Throughout panel presentations, Agency leadership specifically committed to bringing test cases challenging mergers and alleged monopolistic conduct.

Mergers and Acquisitions: John Newman, Deputy Director of the FTC’s Bureau of Competition, indicated that the FTC would continue to aggressively challenge acquisitions in what it views to be nascent digital markets. Newman specifically cited the FTC’s challenge to Meta’s acquisition of Within as a “success” in that the FTC persuaded the court that its market definition and theory of harm were valid, despite ultimately losing on the merits.

Monopolization: Deputy Assistant Attorney General Hetal Doshi indicated that DOJ would continue to criminally prosecute alleged monopolization and agreements to allocate labor markets. Doshi announced that DOJ was working to establish “indicia of criminality” that would elevate monopolization from a civil to a criminal offense and that DOJ would bring test cases to develop these indicia as appropriate. Chair Khan announced the FTC was focused on prosecuting “incumbent [technology firms who] resort to anticompetitive tactics to protect their moat and protect their dominance.”

The Agencies are expected to attempt to reinvigorate enforcement efforts under seldomly used statutes.

Agency leadership also recommitted to using every “tool in the toolbox” to protect competition, including the Robinson-Patman Act and Clayton Act Sections 3 and 8. Chair Khan stated that a key pillar of her leadership approach was the continued full “activation” of all antitrust statutes at her disposal. Throughout the panel, the Agencies specifically identified three statutes they intend to enforce more aggressively.

Robinson-Patman Act: The Robinson-Patman Act (RPA), which prohibits price discrimination, was enacted to protect small businesses by preventing larger companies from using their purchasing power to obtain better prices. However, it has been seldom enforced since 1970 due to concerns it harmed consumers by punishing efficient firms. Current Democratic FTC leadership has repeatedly declared the non-enforcement of the RPA was an error, and the FTC has recently launched RPA investigations into multiple industries. Chair Khan also indicated that the FTC’s next challenge under the RPA would be filed in “short order.”

Clayton Act Section 3: Section 3 of the Clayton Act prohibits anticompetitive exclusive dealing arrangements, tying arrangements, and requirements contracts. Chair Khan committed to using Section 3 and Section 5 of the FTC Act to prosecute unfair selling and buying practices and highlighted the FTC’s complaint against two companies (alleging the firms violated Section 3 by paying distributors to block generic pesticide products) as a framework for future enforcement actions.

Clayton Act Section 8: Section 8 of the Clayton Act prohibits interlocking directorates, where a person simultaneously serves as a director or officer of two competing corporations. The law is designed to prevent conflicts of interest and promote fair competition by ensuring that competing companies have independent leadership. AAG Kanter highlighted four recent enforcement actions under Section 8 and committed to enforcing the statute more broadly, especially against private equity firms.

* * *

As the Agencies expand enforcement and bring novel challenges, companies and individuals should be cognizant that district and circuit courts ultimately determine whether conduct violates the antitrust laws and tend to favor adherence to precedent instead of embracing novel and untested theories of liability. As a recent string of Agency defeats at trial demonstrate, parties may ultimately succeed in vindicating their conduct through litigation in federal court.

The following Gibson Dunn lawyers prepared this client alert: Rachel Brass, Jay Srinivasan, Stephen Weissman, Jamie France, Caroline Ziser Smith, Veronica Altabef, Hadhy Ayaz, Logan Billman, Tiffany Mickel*, and Nick Rawlinson.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition or Mergers and Acquisitions practice groups, or the following:

Antitrust and Competition Group:
Jamie E. France – Washington, D.C. (+1 202-955-8218, [email protected])
Jay P. Srinivasan – Los Angeles (+1 213-229-7296, [email protected])
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, [email protected])
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, [email protected])

Mergers and Acquisitions Group:
Robert B. Little – Co-Chair, Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – Co-Chair, New York (+1 212-351-3966, [email protected])

*Tiffany Mickel is an associate in the Washington, D.C. office admitted only in Maryland and practicing under supervision of members of the District of Columbia Bar under D.C. App. R. 49.