Navigating turbulent waters in the face of an impending storm.

Using President-elect Trump’s first term as a guide, we assess it as highly likely that the next four years will see a fast-paced, aggressive, and far-reaching use of international trade tools to further the administration’s national security and foreign policy goals.  These measures will be paired with diplomatic and other instruments of both soft and hard U.S. power.  Companies, individuals, and organizations must stay abreast of changes in international trade rules in the United States and in any jurisdiction in which they have exposure to navigate what could be uncharted waters. 

The second Trump administration, supported by a Republican-controlled Congress, is poised to deploy expansive international trade tools to respond to national security concerns and to achieve foreign policy goals.  Based on our analysis of the first Trump administration’s trade practices, trends and developments under the Biden administration over the last four years, and President-elect Trump’s campaign promises and early personnel appointments, this alert explores key international trade issues and how they might unfold in the second Trump administration.  While we assess that there will be some consistency—in particular with respect to the view that the People’s Republic of China (“China”) is a core focus and concern—in many respects the Trump administration is poised to deploy international trade measures in potentially radical ways.

In this note, we focus on seven key areas we assess to be among the most relevant to clients that have international exposure and that are involved in cross border investments and transactions: tariffs, the new outbound investment program, U.S. foreign direct investment review under the Committee on Foreign Investment in the United States (CFIUS), economic sanctions, export controls, the bulk sensitive personal data proposed rule, and the connected vehicles proposed rule.  While many of these areas have a China focus, we also assess it as highly likely that the new administration will use these tools to address other national security and foreign policy issues, including with respect to the Middle East and Latin America.

Of course, the overview of the seven areas discussed below is not a comprehensive listing of likely international trade matters.  There are many other international trade and investment issues that will almost certainly arise—both on the federal and state levels and emanating from not just the executive branch of government but also the legislative and judicial branches which have become increasingly involved, respectively, in promulgating and adjudicating on international trade.  Moreover, other jurisdictions, in Europe, Asia, and the Americas may also deploy these tools either in opposition to U.S. measures or in pursuit of their own unrelated interests.

Understanding the trends in these and other key areas and monitoring ongoing developments will be critical for clients to successfully navigate the turbulent waters of a change in presidential administrations amid persistent and ever-growing national security threats.

1. Tariffs

Tariffs will be a key feature of international trade policy in the new administration.  President-elect Trump has proposed to establish a universal baseline tariff of up to twenty percent on nearly all goods imported into the United States (the “Proposed Universal Tariff”) and a sixty percent tariff on all imports from China (the “Proposed China Tariff”, and together with the Proposed Universal Tariff, the “Proposed Tariffs”).  Relatedly, President-elect Trump has reiterated calls from his first term to pass a “Reciprocal Trade Act“ which would empower the president to increase tariffs to either the rate imposed by the opposite country or the determined value of the applicable nontariff barriers.

While there are a handful of existing statutes that authorize the president to impose tariffs under certain circumstances, there are two that are most likely to provide support for the Proposed Tariffs.

First, Section 301 of the Trade Act of 1974[1] authorizes the president to impose tariffs in response to foreign practices that either violate trade agreements or are unjustifiable, unreasonable, or discriminatory and burden or restrict U.S. commerce.  While Section 301 would authorize the Proposed China Tariff based on findings of unfair trade practices, it is unlikely to authorize the Proposed Universal Tariff, as it requires the identification of such acts, policies, or practices by a specific foreign country.

Second, Section 203 of the International Emergency Economic Powers Act (“IEEPA”)[2] authorizes the president, during a period of national emergency declared by the President, to regulate any importation of any property in which any foreign country or a national thereof has any interest.  Section 203 may be invoked to authorize the Proposed Tariffs on the basis that trade deficits threaten the national security of the United States.

A possible, but less likely, option to support the Proposed Tariffs is Section 232 of the Trade Expansion Act of 1962, which authorizes the president to impose tariffs on imports of articles determined by a U.S. Department of Commerce (“Commerce”) investigation to undermine national security.[3]  While Section 232 would authorize the Proposed China Tariff, doing so would be delayed by a lengthy investigation and could only be applied to specific articles with a national security nexus.  Section 232 also may not be the most effective vehicle to authorize the Proposed Universal Tariff because there is unlikely to be a plausible national security nexus to imports of all articles from all countries.

Regardless of the authority used to implement the Proposed Tariffs, such actions along with likely retaliation by foreign governments could significantly impact global supply chains and could lead to decreases in the availability of certain goods and increases in the cost of goods around the world.  Already, the European Union (“EU”) and China have indicated they are prepared to retaliate should President-elect Trump move forward with the Proposed Tariffs.  We note that President-elect Trump’s promise to reduce regulation and taxes during his second term could offset some of the impact of the Proposed Tariffs.

Any executive action that might be taken to impose the Proposed Tariffs will almost certainly be the subject of substantial legal challenges, particularly as the U.S. Constitution provides that Congress has general tariff authorities.  However, challenging the Proposed Tariffs could still prove difficult, particularly those imposed under IEEPA, which broadly authorizes the president to impose tariffs based on a national emergency declaration.  Despite the newfound possibility of meaningful challenges to agency decisions due to the fall of Chevron deference[4] and the revitalization of the major questions doctrine, we assess that in other than truly unusual matters, it is likely that courts could continue to broadly defer to the executive in matters of national security and foreign affairs.

Alternatively, the new administration could look to effectuate the Proposed Tariffs legislatively—something that has not happened since the Smoot-Hawley Tariff Act of 1930.  President-elect Trump’s team has reportedly engaged the House Ways and Means Committee about developing legislation that would cut taxes and raise revenue through tariff increases.  There has also been legislation proposed in both the Senate and the House to strip China of its Permanent Normal Trade Relations (“PNTR”) status, create a new China-specific tariff schedule, and impose 100% tariffs on goods critical to U.S. national security.[5]  Should such legislation succeed—now more likely given the Republican control of both houses of Congress—it would be very difficult to challenge congressionally enacted tariffs.

2. Outbound Investment

Treasury provided that the final rule “sought to maintain the goals of both open investment and protection of national security.”  But as hawkishness toward China seems poised to grow in the second Trump administration (and enjoys a large degree of bipartisan support), that balance could tip towards protecting national security.  While the regulations are presently targeted at U.S. outbound investments in China and limited to a narrow group of critical technology sectors, the regime could be expanded both with respect to target countries and sectors of interest.  For example, the second Trump administration could expand the list of restricted investments to other sensitive sectors such as hypersonics, satellite-based communications, and networked laser scanning systems with dual-use applications.[6]

Although the Biden administration relied on executive authorities in promulgating its outbound investment regime, Congress may quickly seek to enact its own regime.  House Speaker Mike Johnson, Foreign Affairs Committee Chairman Michael McCaul, and Select Committee on the Chinese Communist Party Chairman John Moolenaar strongly support addressing outbound investment in the FY 2025 National Defense Authorization Act (“NDAA”)—a “must pass” piece of legislation that funds the military and to which unrelated amendments (regularly involving sanctions and trade matters) are frequently attached.

The day after Treasury released the final rule, Chairman Moolenaar issued a statement “commending” the regulation but calling for Congress to “build on these rules and address a broader set of technologies and transactions that threaten our national security.”[7] However, House Financial Services Committee Chairman Patrick McHenry favors a sanctions regime rather than a sectoral approach to limiting outbound investment.  He had opposed the inclusion of outbound investment provisions in the FY 2024 NDAA, effectively blocking it from becoming law, and appears poised to do so again this year.  Moolenaar has made clear that House leadership is pushing for legislation before the next Congress and hinted that such legislation could involve a compromise including both sanctions and sectoral regulation.[8]  But with McHenry retiring from Congress and Republicans poised to control the executive and both houses of Congress, proponents of stronger outbound investment regulation could decide to forego a negotiated compromise and push for more aggressive legislation in the new Congress.

3. CFIUS

In contrast to the new and rapidly developing outbound investment regime, we assess that the Committee on Foreign Investment in the United States (“CFIUS”) we continue its efforts.  CFIUS’s reviews of inbound investment—which also enjoy bipartisan support—are unlikely to undergo meaningful changes under President-elect Trump.  Both the Biden and first Trump administrations have been tough on Chinese investment into the United States, and this stance will continue and perhaps intensify.  In addition to a generally harsh climate for Chinese investment, we have seen—for many years—calls from Congressional leaders on both sides of the aisle to more strictly scrutinize Chinese investments in agricultural land near military bases (discussed in a prior alert).  This rigorous scrutiny of Chinese investment in real estate is likely to evolve further, including through ever-increasing state and local legislative efforts, in addition to CFIUS reviews.

While major changes to CFIUS’s regulations and practices are unlikely, there may be some shift in priorities.  For example, during the Biden administration, CFIUS carefully scrutinized investments from Saudi Arabia.  Under the leadership of President-elect Trump, who previously enjoyed a relatively close relationship with Saudi Arabia, CFIUS may place slightly lower scrutiny on Saudi investments.  Similarly, potential easing of Russian sanctions (described below) could crack the door for a return to Russian minority investments in U.S. businesses.

Although CFIUS is unlikely to undergo any paradigm shift in the next year or so, its importance as a regulatory gating item for transactions will continue apace and could grow.  Under the Biden administration, CFIUS took unprecedented actions to ramp up enforcement activities related to CFIUS filings and noncompliance with mitigation agreements reached that allowed certain investments to proceed so long as the parties complied with agreed upon restrictions.  We discussed CFIUS’s formal guidelines for enforcement and subsequent increase in the frequency and size of civil monetary penalties in a prior alert.  One indicator of President-elect Trump’s stance on CFIUS enforcement is the fact that, of the fewer than ten transactions that CFIUS has referred to a President to block since its inception, then-President Trump was responsible for blocking four during his first term.  CFIUS’s enforcement focus is likely to persist under the incoming administration.

4. Sanctions

Although expanded tariffs have taken center stage with respect to a second Trump administration’s trade policy toward China, we assess it as likely that the Trump White House will also leverage economic sanctions in the strategic competition between Washington and Beijing.  The first Trump administration and the outgoing Biden administration have each imposed restrictions on the ability of U.S. persons to invest in publicly traded securities of certain named Chinese companies.  Those measures presently restrict dealings involving sixty-eight entities that appear by name on the Non-SDN Chinese Military-Industrial Complex Companies (“NS-CMIC”) List maintained by Treasury’s Office of Foreign Assets Control (“OFAC”).  The second Trump administration may continue to expand the number of entities named to the NS-CMIC List, further restricting U.S. investment in certain Chinese public companies.  It may also designate additional individuals and entities to OFAC’s more restrictive Specially Designated Nationals and Blocked Persons (“SDN”) List.  Designations to the SDN List were employed during President-elect Trump’s first term in response to various foreign policy disputes with China, including to impose consequences on certain Hong Kong and mainland Chinese government officials for their alleged involvement in implementing the 2020 Hong Kong National Security Law or perpetrating human rights abuses in China’s Xinjiang Uyghur Autonomous Region.  Upon returning to the White House, President Trump could resume the practice he began in his first administration of imposing blocking sanctions on senior Hong Kong, and potentially mainland Chinese, government officials.

The Trump administration could also revive certain China-related sanctions authorities that have fallen dormant during the Biden administration.  For example, during his first term in office, President Trump signed into law the Hong Kong Autonomy Act (“HKAA”), which authorizes the imposition of sanctions such as asset freezes and visa bans on individuals identified by the U.S. Secretary of State as enforcing the Hong Kong National Security Law.  Notably, the HKAA authorizes “secondary” sanctions on non-U.S. financial institutions that knowingly conduct “significant” transactions with such designated persons—potentially subjecting non-U.S. financial institutions that engage in such dealings to a range of consequences, including loss of access to the U.S. financial system.  Although the United States has yet to designate any non-U.S. financial institutions under this authority, the recent passage of a new National Security regime in Hong Kong suggests that it remains a viable tool for the Trump White House should the new administration be inclined to further pressure Beijing.

Following Russia’s full-scale invasion of Ukraine in early 2022, a coalition of global powers—including the United States, the EU, the United Kingdom, Canada, Australia, and Japan—deployed an unprecedented barrage of trade restrictions on Russia.  Novel, targeted measures were unleashed and, as the war in Ukraine unfolded, the United States and its allies incrementally expanded the scope of blocking sanctions, sectoral sanctions targeting specific segments of the Russian economy, services bans (including on the maritime transport of Russian origin crude purchased at or above a specified price), export controls, and import bans.

The first Trump administration imposed sanctions on more targets in each of its four years than any previous administration.  However, in light of President-elect Trump’s pronouncements on the campaign trail about quickly ending the war in Ukraine and his recent statements on the proper use of sanctions as short-term coercive tools (having condemned long-term use of sanctions as weakening the dollar’s dominance as a global currency), U.S. sanctions on Russia could potentially be eased under the second Trump administration as part of a negotiated resolution to the conflict.

Should President-elect Trump be inclined to relax U.S. sanctions on Russia, there are several avenues at his disposal to do so.  For example, upon re-entering the White House, President Trump could narrow or revoke existing measures that have been implemented solely via executive order (e.g., the prohibition on “new investment” in the Russian Federation set forth in Executive Order 14071) by issuing new or amended executive orders, or by issuing permissive general licenses.  Because many of the Biden-era sanctions measures targeting Russia are ones implemented solely via executive order, they are among those measures which are susceptible to unilateral amendment or revocation by the new executive, President Trump.

Where statutes direct the president to impose sanctions in response to specific events, President Trump may enjoy less flexibility to unilaterally alter the status quo.  For example, the Countering America’s Adversaries Through Sanctions Act (“CAATSA”), which imposed sanctions on Iran, North Korea, and Russia, and codified certain Obama-era sanctions authorities, provides that the president must submit the easing or lifting sanctions promulgated under CAATSA for congressional review.  Specifically, the president must submit a report to the appropriate congressional committees describing the proposed action and supporting reasons.  Congress’s views are subject to presidential veto, and congressional checks can merely delay, not stop, presidential action.  Thus, although CAATSA creates some hurdles to lifting certain Russia sanctions, President-elect Trump may still do so, especially given Republican party control of both the House and the Senate.

Furthermore, while the modus operandi of the Biden administration has been to garner international cooperation in the field of sanctions—exemplified most prominently by relying on a coalition of G7 and other partner countries to coordinate a collective response to Russia’s invasion of Ukraine—the first Trump administration favored unilateral actions and an often-confrontational stance toward traditional U.S. allies.  EU officials anticipate a decrease in multilateral cooperation during President Trump’s second term and are reportedly working on domestic measures to guarantee the efficacy and endurance of sanctions on Russia, including through tighter enforcement.  The United Kingdom has also reaffirmed its “iron-clad” support for Ukraine, and the Starmer government has not indicated any intention to scale back sanctions on Russia.  The Russia-related regulatory environment is already difficult to navigate as even coordinated measures do not always align across jurisdictions.  Further divergence among the United States, the United Kingdom and the EU could dramatically increase the compliance burden for global enterprises.

A second Trump administration could also aggressively wield sanctions to advance U.S. national security objectives in the Middle East, with a particular focus on Iran and its regional proxies.  Notably, the United States during President-elect Trump’s first term withdrew from the Joint Comprehensive Plan of Action (“JCPOA”)—the 2015 Iran nuclear deal—and launched a “maximum pressure” economic campaign that aimed to deny Tehran the resources needed to fund its destabilizing activities.  Although the outgoing Biden administration has left most U.S. sanctions on Iran in place—and indeed has continued to periodically designate additional Iranian parties to the SDN List, including Iranian government officials, entities involved in exporting unmanned aerial vehicles to Russia, and entities involved in the Iranian petroleum and petrochemicals trade—the pace of Iran-related sanctions designations could sharply increase upon President-elect Trump’s return to office.

As part of a widely anticipated resumption of the “maximum pressure” campaign, the second Trump administration could also target third-country shipping companies, port operators, oil traders, and financial institutions that enable Iranian oil exports.  President-elect Trump could also continue his predecessor’s practice of using U.S. counter-terrorism sanctions authorities expansively to target Iran-backed militias, including Hamas, Hezbollah, and the Houthis.  In a possible break from the current administration and in light of certain early nominees to core Middle East policy positions, we assess it as possible that the President-elect could revoke a February 2024 executive order that created a new West Bank sanctions program which has been used to target a small number of Israeli settlers.

As discussed in our 2023 Year-End Sanctions and Export Controls Update, the Biden administration brought record-breaking sanctions enforcement actions, as well as an increased focus on and dedication of resources to criminal enforcement of sanctions violations.  Indeed, the Biden Administration has actually broken the Trump Administration’s sanctions record, with each of his four years in office seeing record numbers of additions to OFAC sanctions lists.  This has been matched by an increasing pace and severity of civil and criminal enforcement actions.  Although aggressive enforcement of sanctions is likely to continue, the Trump administration could effect a shift in the industries and types of violations that give rise to enforcement actions by OFAC and the U.S. Department of Justice (“DOJ”).  For example, while the Biden administration has heavily focused on the virtual currency sector, including the largest settlement in OFAC history with a cryptocurrency exchange, the Trump campaign has signaled the potential for a friendlier regulatory environment for cryptocurrency industry participants.

5. Export Controls

As was the case in the first Trump administration, export controls targeting China are expected to play a key role in the second Trump administration’s management of the U.S.-China strategic competition.  The first Trump administration deployed export controls to respond to several Chinese actions deemed contrary to U.S. interests and values, including:

• Chinese industrial policy initiatives, such as Made in China 2025 and the National Innovation-Driven Development Strategy, that are designed to catalyze Chinese advancements, and ultimately leadership, in strategic technologies including advanced manufacturing, AI, information technology, robotics and semiconductors;
• China’s strategy of military-civil fusion (“MCF”), which seeks to integrate commercial advancements in advanced technologies (including quantum computing, big data, semiconductors, 5G, advanced nuclear technology, aerospace technology, and AI) into military applications to further the Chinese military’s technological capabilities; and
• Alleged deficiencies in China’s human rights record through the use of surveillance and other technologies as well as Chinese actions in Hong Kong.

Measures adopted by the first Trump administration included, among others, enhanced scrutiny requirements for an increasing number of civil and military Chinese end users and end uses in China; changes to China-related export license requirements; designation of several large, multinational Chinese firms to the Entity List, including the Semiconductor Manufacturing International Corporation; targeted controls on Huawei, including by designating Huawei to the Entity List and crafting a Huawei-specific foreign direct product rule intended to impede Huawei’s ability to procure certain items; and the removal of Hong Kong as a separate destination under the Export Administration Regulations (“EAR”).

The Biden administration continued the first Trump administration’s widespread deployment of export controls to counter China and in fact implemented an even more expansive regime.  Notably, the Biden administration’s controls on semiconductors marked a fundamental shift in the U.S. government’s long-standing policy on such export controls: in contrast to the previous approach of maintaining a relative advantage (i.e., “two generations ahead”) in certain key technologies, the Biden Administration views it as a national security imperative to “maintain as large of a lead as possible.”  President-elect Trump’s expected appointments of “China hawks” to key national security positions for his second term appear to indicate a continuation of this maximalist approach to export controls.

The second Trump administration will also likely see the continued and enhanced focus on restricting exports of “emerging technologies” to China.  The Biden administration has focused on technological competition with China by controlling the export to China of advanced technologies such as advanced integrated circuits, semiconductor manufacturing equipment, and items related to AI and quantum computing and by working to multi-lateralize these controls with counterparts in Europe, Japan and South Korea outside of the traditional multilateral regimes like the Wassenaar Arrangement.

The Biden administration has also issued proposed rules that would greatly expand the licensing requirements that would apply to exports of most items to companies and other entities in China with ties to its military and intelligence sectors, and to U.S. person services to these same entities even when no U.S. exports are involved.  The second Trump administration could build upon these policies by lowering the De Minimis Rule value threshold at which foreign made items that incorporate U.S. controlled content would be subject to export controls and by imposing controls on additional sectors.

Restrictions could also come in the form of modifications to some of the more technical aspects of the EAR.  For example, partly in response to China’s MCF strategy, the first Trump administration removed License Exception Civil End Users (“CIV”) which previously authorized exports, reexports, and transfers of certain national security-controlled items, without prior review by BIS and subject to satisfaction of certain conditions, to multiple countries including China.  Senator Marco Rubio, the presumptive Secretary of State, has previously called for the Bureau of Industry and Security (“BIS”) to adopt a “blanket ‘presumption of denial’” posture for export license applications seeking to send “critical technology” to any entity in China.  While the Department of State does not exercise control over the EAR, Senator Rubio’s comments are instructive of the types of changes to export controls that advisors may be considering.  And although President-elect Trump has distanced himself from Project 2025, regulatory changes proposed in Project 2025’s Mandate for Leadership provide an insight into the export controls thinking of potential advisors.  Project 2025’s proposals with respect to China and other countries of concern include:

• eliminating the “specially designed” licensing exceptions;
• redesignating China and Russia to more highly prohibitive export licensing groups (country groups D or E);
• eliminating license exceptions;
• broadening foreign direct product rules;
• reducing the de minimis threshold from twenty-five percent to ten percent, or zero percent for critical technologies;
• tightening the deemed export rules to prevent technology transfer to foreign nationals from countries of concern;
• tightening the definition of “fundamental research” to address exploitation of the open U.S. university system by authoritarian governments through funding, students and researchers, and recruitment;
• eliminating license exceptions for sharing technology with controlled entities/countries through standards-setting “activities” and bodies; and
• improving regulations regarding published information for technology transfers.

Combined, such modifications to the EAR have the potential for significant impact on bilateral trade between the United States and China and could severely restrict Chinese companies’ ability to source items subject to the EAR (including many foreign-manufactured goods).  These changes may also have significant collateral consequences for non-U.S. companies who continue to make use of supply chains that include links in China.  They may also have a significant impact on the ability of the United States to continue to attract the world’s best and brightest to pursue graduate studies in U.S. universities, the ability of U.S. companies to participate in global standards development for next generation technologies, and lead to decreasing use of U.S. origin software, technology, and design and production by non-U.S. companies.

Notably, the Department of State administers and enforces the International Traffic in Arms Regulations (“ITAR”).  ITAR, which applies only to items designed for and used in military and intelligence applications, is the other primary legal regime for implementing U.S. export controls.  Should Senator Rubio be confirmed as the Secretary of State, and given his focus on export controls during his time in the Senate, he is likely to ensure that State Department reviewers in interagency export licensing reviews and in Entity List and other restricted party export control designations take less business-friendly positions in any determinations that touch on China.

Consistent with the approach of the first Trump administration and the Biden administration, the second Trump administration may aggressively use Entity List designations to target entities in China. Persons added to the Entity List are subject to additional licensing requirements and specific, often restrictive, licensing policies.  For instance, Project 2025’s proposals specifically advocate for designating certain Chinese apps to the Entity List in an effort to prevent the applications’ software from updating within the United States, with the ultimate goal of rendering these applications (and potentially others) non-functional in the United States over time.

One of the major export controls-related complaints of the China hawks in D.C. is the approval rate of  licenses for export of EAR controlled items to China, including items controlled for national security purposes.  The House Foreign Affairs Committee as well as the Select Committee on the Chinese Communist Party have called for implementing significant restrictions on licensing requirements, and in particular imposing a “policy of denial” for all exports of national security-controlled items to China.  Taken within the context of the generally aggressive view on China the second Trump administration is expected to hold, we could see a fundamental shift in export licensing policy, and in particular, the number of licenses granted, especially for the export to China of “critical technology” such as semiconductors and advanced computing items.

Another area of export controls that could receive significant attention under the second Trump administration is enforcement.  Reports in late October and early November 2024 that highly advanced semiconductor technology manufactured by TSMC, which is subject to U.S. export controls, was found in Huawei’s Ascend 910B chips has highlighted the difficulties that the U.S. government faces in enforcing its panoply of China-focused export controls.  In fact, this is not the first time that doubts regarding the efficacy of export controls have been raised.  Huawei’s use of an indigenously designed and produced 7 nm chip in its Mate 60 Pro phone (the release of which was timed during Commerce Secretary’s Raimondo visit to China in August 2023) raised similar concerns.  Influential members of Congress have repeatedly focused on what they consider inadequate enforcement and implementation of export controls. There could be increased pressure on the incoming administration to prioritize enforcement.

Although the second Trump administration is widely expected to pursue an aggressive export controls policy, there are several factors that could temper its approach, at least in certain instances.  During the first Trump administration, media reports indicated that Chinese leader Xi Jinping’s personal intervention persuaded President Trump to temporarily roll back certain restrictions targeting Huawei.  Personal diplomacy of a similar nature could impact the severity, duration, targets or other aspects of certain export controls.  Moreover, recent media reports indicate that Chinese officials are in increasing contact with American business leaders, including individuals identified as close to President-elect Trump and with business interests in China, to counter the influence of the China hawks.  China could attempt to use such high-level intermediaries to moderate current and proposed export controls.

Lastly, over the past several years, China has steadily built up its economic lawfare toolkit.  These tools give Beijing the ability to not only counter U.S. economic statecraft, but also to use its economic strengths to further its foreign policy goals.  For instance, primarily in response to the semiconductors-related export controls, China imposed export controls on gallium, germanium, and graphite, key critical minerals with applications in a range of industries.  The list was further expanded to include antimony.  China has threatened to cut Japan’s access to critical minerals essential for automotive production if Japan imposes further semiconductor-related export controls on China.  Separately, China has imposed standalone export controls on several technologies, and in October 2024 published comprehensive export controls regulations to regulate dual-use items, which include provisions similar to the EAR’s de minimis rule and foreign direct product rules to regulate foreign-produced items incorporating Chinese-origin items or produced using Chinese technology.  More recently, China sanctioned Skydio, the largest American drone manufacturer, ostensibly for its sales to Taiwan and for its lobbying efforts against Chinese drone manufacturer DJI.  As part of the sanctions, Beijing banned Chinese companies, including Chinese entities of non-China-headquartered companies, from supplying Skydio with critical components, including battery supplies from its sole provider.  China’s ability, and willingness, to leverage these tools, which could cause significant adverse consequences for U.S. companies, could also serve as a moderating force in the Trump administration’s export controls deliberations.  On the other hand, formalized weaponization of the supply chain could empower Trump administration officials calling for strategic decoupling.

One other issue that we are following closely—in the event that the new administration is successful in ending the Ukraine war (on whatever terms can be agreed)—is the possibility that in addition to the easing of sanctions, President-elect Trump may seek to ease export controls restrictions which have also played a significant role in the U.S. and international response to Russian aggression.  While it would be legally possible for President-elect Trump to ease many of these restrictions, it is also possible that allies across the G7 would be unwilling to do so.  Similarly, if a “grand bargain” is made with China, there is a similar potential of easing of many of these restrictions as well.

6. Bulk Sensitive Personal Data Notice of Proposed Rulemaking

President-elect Trump is likely to advance efforts to restrict and prohibit the transfer of sensitive data to foreign adversaries.  However, despite both the Trump and Biden administrations’ efforts to protect sensitive U.S. data and the bipartisan consensus about the risks posed, the fate of a potentially high-impact rule recently proposed by the Biden administration to regulate transfers of bulk sensitive data to foreign adversaries remains uncertain.

Efforts to restrict foreign adversaries’ access to sensitive data concerning U.S. persons span both the Trump and Biden administrations.  In his first term, President-elect Trump issued an executive order restricting the acquisition or use of communications and information technology by foreign adversaries seeking to obtain sensitive data about U.S. persons.  The U.S. government’s focus on disrupting the flow of sensitive data to adversaries has continued under the Biden administration.  At the forefront of these efforts is a notice of proposed rulemaking (“NPRM”) issued by DOJ on October 21, 2024 which would, for the first time, allow DOJ to restrict or prohibit the bulk transfer of certain categories of sensitive data to individuals or entities associated with six “countries of concern.”

The NPRM follows a February 28, 2024 executive order in which President Biden called for DOJ to address the risk that bulk sensitive data on U.S. persons could be accessed and weaponized by foreign adversaries for espionage, influence, and blackmailing operations.  The NPRM would impose compliance and due diligence requirements on U.S. entities involved in data brokerage transactions, data transfers, vendor and employment agreements, and investment agreements for certain kinds of data above specified quantity thresholds.  Regulated data would include genomic, biometric, geolocation, health, financial, personally identifiable, and government-related information.  Regulated entities would be expected to create risk-based compliance programs which would vary based on the size of the regulated entities and the volume and type of data which they process.  Presently, only data transferred to six “countries of concern”—China, Cuba, Iran, North Korea, Russia, and Venezuela—would fall within the proposed rule’s scope.  Except for China, each of the countries of concern is already subject to broad-reaching sanctions which comprehensively limit their ability to do business with U.S. persons.

The proposed rule’s future is uncertain.  The NPRM is subject to public comment until November 29, 2024, after which DOJ may attempt to issue a final rule before the presidential transition on January 20, 2025.  To do so, DOJ would first consider public comments, issue a final rule, and publish the rule in the Federal Register.  Either the White House Office of Information and Regulatory Affairs (OIRA) or DOJ itself is likely to deem the rule a “major rule” for purposes of the Congressional Review Act[9] (“CRA”), since DOJ estimates that the combined value of lost transactions resulting from the proposed rule would exceed $300 million annually[10], far surpassing the CRA’s $100 million annual economic impact threshold for major rules.  As a result, the rule would take effect no earlier than sixty days after publication.  Even if the rule were not deemed major, DOJ would have fewer than two months between the public comment period and President-elect Trump’s inauguration in which to issue the final rule and yet less time if it was in fact a major rule.  In any event, Congress could overturn the rule through a joint resolution of disapproval under the CRA.

If DOJ publishes its final rule before January 20, it is unclear whether the Trump administration will allow it to remain in place.  The NPRM aligns with the first Trump administration’s hawkish stance: since China is not subject to the same comprehensive sanctions as the other five “countries of concern,” data transfers to Chinese persons and entities would likely constitute the vast majority of transactions subject to the rule’s restrictions or prohibitions.  As noted above, the proposed rule also addresses a bipartisan concern that received significant attention in the first Trump administration: the flow of sensitive data about U.S. persons to foreign adversaries.  The Trump administration could therefore decide to retain the rule because it is consistent with the administration’s policy priorities.

The second Trump administration could also amend the rule, revoke it and replace it with a regulation or executive order of its own, or work with Congress to address the issue.  In this case, the second Trump administration’s emphasis on deregulation could result in efforts to restrict bulk sensitive data transfers in ways that would impose fewer compliance and due diligence requirements on U.S. entities.  Carveouts and exceptions in the NPRM—including, for example, with respect to data transfers between U.S. companies and their foreign subsidiaries—would likely remain or be expanded.  Revocation or amendment of the rule would require notice and public comment and could be disruptive for U.S. entities already adjusting or expanding their compliance and due diligence programs in anticipation of the NPRM’s promulgation.

If the NPRM is not issued as a final rule under the Biden administration, the second Trump administration could also choose not to act on the issue.  Indeed, Congress has already taken action: in the Protecting Americans’ Data from Foreign Adversaries Act of 2024 (“PADFAA”), signed by President Biden in April, Congress empowered the U.S. Federal Trade Commission to regulate data brokers engaging in sensitive data transactions with entities affiliated with China, Russia, North Korea, and Iran.[11]  While PADFAA and the NPRM overlap in many respects, importantly, PADFAA’s narrow definition of “data brokers” and its provisions excepting many types of data brokers from its scope mean that allowing the NPRM to lapse, or declining to issue a similar rule, would leave substantial gaps in the United States’ response to the access and weaponization of U.S. persons’ sensitive data by foreign adversaries.

7. Connected Vehicles Notice of Proposed Rulemaking

Another key rule to watch in the second Trump administration is the Biden administration’s proposed connected vehicles rule.  On September 23, 2024, BIS announced an NPRM that, once implemented, would ban certain imports of vehicles from China (including Hong Kong) and Russia, as well as key hardware and software components, based on identified “undue or unacceptable risks” to national security and the privacy of U.S. citizens.

There is likely bipartisan consensus to finalize the rule.  However, it remains to be seen whether BIS will finalize the rule before the second Trump administration begins.  The comment period closed on October 28, 2024, and BIS has stated that its goal is to publish a final rule by January 2025.  If finalization slips past inauguration day, it is possible the second Trump administration could consider revising and strengthening the rule.  In any event, the connected vehicles rule could serve as a model for additional rules in the new Trump administration to address the increasing bipartisan concern about national security risks posed by foreign adversaries.

The connected vehicles NPRM effectuates EO 13873, which, inter alia, identifies “undue or unacceptable risks” posed by a class of transactions that involve information and communications technology and services (“ICTS”) designed, developed, manufactured, or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary.[12]  Such ICTS includes “connected software applications,” as outlined in greater detail in the ICTS regulations currently in effect.[13]

According to the NPRM, the proposed regulations are meant to address, in part, the ability of China and Russia—under their respective domestic legal and regulatory regimes—to compel companies subject to their jurisdiction to cooperate with security and intelligence services.  Such access could enable China and Russia to exfiltrate sensitive data and potentially allow remote access and manipulation of connected vehicles in the United States.

The proposed measure focuses on hardware and software integrated into a car’s Vehicle Connectivity System (“VCS”) and the software integrated into its Automated Driving System (“ADS”).  Both are critical systems that allow for external connectivity and autonomous driving capabilities in the increasingly commonplace “connected vehicles” traversing American roads.  The proposed rule would apply to all on-road vehicles such as cars, trucks, and buses, but would exclude vehicles not used on public roads like agricultural or mining vehicles.

In general, the NRPM would prohibit the import and sale in the United States of (1) completed connected vehicles that incorporate covered software designed or developed by persons under Chinese (or Russian) control, and (2) such VCS or ADS components.  In order to import VCS hardware or completed connected vehicles, or sell completed connected vehicles manufactured outside of the United States that are not prohibited, companies would be required to submit “Declarations of Conformity” to BIS.  These submissions would require substantive technical information—including a Hardware Bill of Materials and Software Bill of Materials, as relevant.

Once implemented, the final regulations will have a delayed impact in theory, but companies will need to proactively take steps to prepare for new compliance obligations and supply chain requirements (including designing and manufacturing processes associated with the identified vehicle model years).  As proposed, the software prohibitions impacting connected vehicle manufacturers would take effect for Model Year 2027 vehicles.  As proposed, the hardware prohibitions impacting VCS hardware importers and connected vehicle manufacturers would take effect for Model Year 2030 vehicles, or starting on January 1, 2029 for units without a model year.  Parties (including manufacturers and importers) impacted by the new regulations, once implemented, will need to carefully review and modify supply chains involving covered vehicles, hardware, or software from China (including Hong Kong) or Russia unless a general or specific authorization applies.

[1] Trade Act of 1974, 19 U.S.C. § 2411, Pub. L. No. 93-618, § 301, 88 Stat. 1978.

[2] 50 U.S.C. § 1702.

[3] Trade Expansion Act of 1962, 19 U.S.C. § 1862, Pub. L. No. 87-794, § 232, 76 Stat. 872 (1962).

^[4] See Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024) (Supreme Court overruled the Chevron doctrine but noted that agency interpretation of a statute will be accorded Skidmore deference).

[5] E.g., S. 5264, Neither Permanent Nor Normal Trade Relations Act, 118th Cong. (Sept. 25, 2024), https://www.congress.gov/bill/118th-congress/senate-bill/5264/text.

[6] Indeed, proposed outbound legislation circulating in Congress already contemplates including these sectors.  See, e.g., S. Amend. 3284 to National Defense Authorization Act for Fiscal Year 2025 (NDAA), S. 4638, 118th Cong. (2024), https://www.congress.gov/amendment/118th-congress/senate-amendment/3284/text?s=a&r=1.

^[7] Press Release, Chairman of the Select Comm. on the Strategic Competition Between the U.S. and the Chinese Communist Party John Moolenaar, Moolenaar: Biden Regulations on Outbound Investment to China a Good Step, Congress Must Strengthen (Oct. 29, 2024), https://selectcommitteeontheccp.house.gov/media/press-releases/moolenaar-biden-regulations-outbound-investment-china-good-step-congress-must.

[8] Jasper Goodman, POLITICO Pro Q&A: Rep. John Moolenaar, Politico Pro (Nov. 8, 2024), https://subscriber.politicopro.com/article/2024/11/politico-pro-q-a-rep-john-moolenaar-00188480?site=pro&prod=alert&prodname=alertmail&linktype=article&source=email.

[9] See 5 U.S.C. §§ 801–808.

[10] See NPRM at 269–70.

[11] Protecting Americans’ Data from Foreign Adversaries Act (PADFAA), 15 U.S.C. § 9901.

[12] Executive Order 13,873 invoked the International Emergency Economic Powers Act and the National Emergencies Act to provide BIS the authority to engage in rulemaking.  Securing the Information and Communications Technology and Services Supply Chain, 84 Fed. Reg. 22,689 (May 15, 2019).

[13] See 15 C.F.R. Part 791.

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The following Gibson Dunn lawyers prepared this update: Adam M. Smith, Donald Harrison, Stephenie Gosnell Handler, Christopher Timura, David Wolber, Amanda Neely, Michelle Weinbaum, Samantha Sewall, Audi Syarief, Chris Mullen, Scott Toussaint, Anna Searcey, Dharak Bhavsar, Hugh Danilack, Irene Polieri, Hui Fang*, and Karsten Ball*.

Gibson Dunn attorneys are available to counsel clients regarding potential or ongoing transactions and other compliance or public policy concerns. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s International Trade practice group:

United States:
Ronald Kirk – Co-Chair, Dallas (+1 214.698.3295, rkirk@gibsondunn.com)
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202.887.3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202.955.8510, shandler@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202.887.3690, ctimura@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202.887.3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213.229.7269, nhanna@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202.955.8685, cmbrown@gibsondunn.com)
Amanda H. Neely – Washington, D.C. (+1 202.777.9566, aneely@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202.887.3509, ssewall@gibsondunn.com)
Michelle A. Weinbaum – Washington, D.C. (+1 202.955.8274, mweinbaum@gibsondunn.com)
Hugh N. Danilack – Washington, D.C. (+1 202.777.9536, hdanilack@gibsondunn.com)
Mason Gauch – Houston (+1 346.718.6723, mgauch@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202.955.8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212.351.3972, spongrace@gibsondunn.com)
Anna Searcey – Washington, D.C. (+1 202.887.3655, asearcey@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202.955.8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202.887.3588, stoussaint@gibsondunn.com)
Claire Yi – New York (+1 212.351.2603, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202.955.8270, szhang@gibsondunn.com)

Asia:
Kelly Austin – Hong Kong/Denver (+1 303.298.5980, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing (+86 10 6502 8534, qyue@gibsondunn.com)
Dharak Bhavsar – Hong Kong (+852 2214 3755, dbhavsar@gibsondunn.com)
Felicia Chen – Hong Kong (+852 2214 3728, fchen@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)

Europe:
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Patrick Doris – London (+44 207 071 4276, pdoris@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 224, nmalevanny@gibsondunn.com)
Melina Kronester – Munich (+49 89 189 33 225, mkronester@gibsondunn.com)
Vanessa Ludwig – Frankfurt (+49 69 247 411 531, vludwig@gibsondunn.com)

* Hui Fang and Karsten Ball, associates working in the firm’s Washington, D.C. office, are not yet admitted to practice law.

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

From the Derivatives Practice Group: This week, the European Supervisory Authorities published a Decision on the information that competent authorities must report to them for the designation of critical Information and Communication Technology third-party service providers under the Digital Operational Resilience Act.

New Developments

• CFTC Publishes Customer Alert Regarding CFTC v. Traders Domain FX Ltd. On November 14, the CFTC published an alert to customers who believe they may be victims of alleged fraud by Traders Domain FX Ltd. Customers are urged to complete this voluntary confidential customer survey, which will provide CFTC with pertinent information on this case. [NEW]
• CFTC Publishes Final Rule Adopting Amendments to Regulations Governing Registered Entities. On November 7, the CFTC adopted amendments to its regulations under the Commodity Exchange Act that govern how registered entities submit self-certifications, and requests for approval, of their rules, rule amendments, and new products for trading and clearing, as well as the CFTC’s review and processing of such submissions. According to the CFTC, the amendments are intended to clarify, simplify and enhance the utility of those regulations for registered entities, market participants and the CFTC. The effective date for this final rule is December 9, 2024.
• CFTC Market Risk Advisory Committee to Hold Public Meeting on December 10. On November 5, the CFTC’s Market Risk Advisory Committee (“MRAC”) announced that, on December 10, 2024, from 9:30 a.m. to 12:30 p.m. (Eastern Standard Time), it will hold a public, in-person meeting at the CFTC’s Washington, DC headquarters, with options for virtual attendance. The MRAC indicated that it plans to discuss current topics and developments in the areas of central counterparty (“CCP”) risk and governance, market structure, climate-related risk, and innovative and emerging technologies affecting the derivatives and related financial markets, including discussions led by the CCP Risk & Governance and Market Structure subcommittees with recommendations related to CCP cyber resilience and critical third-party service providers and the cash futures basis trade, respectively.
• Commissioner Pham Announces CFTC Global Markets Advisory Committee Meeting on November 21. CFTC Commissioner Caroline D. Pham, sponsor of the Global Markets Advisory Committee (“GMAC”), announced the GMAC will hold a virtual public meeting Thursday, Nov. 21, from 9:30 a.m. to 10:30 a.m. EST. At this meeting, the GMAC will hear a presentation by the Tokenized Collateral workstream of the GMAC’s Digital Asset Markets Subcommittee on expanding use of non-cash collateral through use of distributed ledger technology and consider a recommendation from the Subcommittee. The meeting will also include a presentation by the Utility Tokens workstream of the Digital Asset Markets Subcommittee summarizing their work to-date on defining utility tokens and developing guidance for market participants.

New Developments Outside the U.S.

• The ESAs Announce Timeline to Collect Information for the Designation of Critical ICT Third-Party Service Providers under the Digital Operational Resilience Act. On November 15, the European Supervisory Authorities (“ESAs”) published a Decision on the information that competent authorities must report to them for the designation of critical Information and Communication Technology (“ICT”) third-party service providers under the Digital Operational Resilience Act (“DORA”). In particular, the Decision requires competent authorities to report by April 30, 2025 the registers of information on contractual arrangements of the financial entities with ICT third-party service providers. [NEW]
• ESMA Collects Data on Costs Linked to Investments in AIFs and UCITS. On November 14, ESMA announced it is launching a data collection exercise together with the national competent authorities (“NCAs”), on costs linked to investments in Alternative Investment Funds (“AIFs”) and Undertakings for Collective Investment in Transferable Securities (“UCITS”). ESMA with the NCAs has designed a two-stage data collection involving both manufacturers and distributors of investment funds. Information requested from manufacturers will provide an indication on the different costs charged for the management of the investment funds. Information requested from distributors (i.e., investment firms, independent financial advisors, neo-brokers) will inform on the fees paid directly by investors to distributors. A report based on this data will be submitted to the European Parliament, the Council and the European Commission in October 2025. [NEW]

New Industry-Led Developments

• Ark 51 Adopts CDM for CSA Data Extraction. On November 5, ISDA announced that Ark 51, an artificial intelligence (“AI”) and data analytics service developed by legal services provider DRS, has used the Common Domain Model (“CDM”) to convert information from ISDA’s regulatory initial margin (IM) and variation margin (“VM”) credit support annexes (“CSAs”) into digital form. Ark 51 is a contract and risk management system that uses AI to extract key data from legal agreements, including IM and VM CSAs. The CDM transforms that data into a machine-readable format that can be quickly and efficiently exported to other systems, cutting the resources associated with manual processing.

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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, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus  – New York (212.351.3869,  alapidus@gibsondunn.com )

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

William R. Hallatt , Hong Kong (+852 2214 3836, whallatt@gibsondunn.com )

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki , New York (212.351.4028, mtakagaki@gibsondunn.com )

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

Gibson Dunn has created a Presidential Transition Task Force to track and analyze key activities throughout the transition and into the early days of the Trump-Vance Administration and the 119th Congress. Through Gibson Dunn’s Task Force, we plan to keep our clients and friends informed of notable developments, to explain certain transition resources and how they work, and to predict what the administration is likely to focus on in a variety of areas post-inauguration. This is the Task Force’s first release. There will be a number that will follow.

To understand the priorities and strategies of the incoming Trump-Vance administration, we can look to President-elect Trump’s track record from his first term and his statements on the campaign trail regarding his post-inauguration priorities.  Those priorities likely will include a largely deregulatory agenda coupled with additional regulation in some discrete areas.  The President-elect also will be looking to extend provisions of the Tax Cuts and Jobs Act (“TCJA”), the signature legislative achievement of his first term.  Certain corporate tax provisions are set to expire in 2025 and individual rate cuts are slated to expire in 2026.  Additionally, he will be looking to confirm as many administration officials and federal judges as possible.

The President-elect will have several tools available to him and a Republican-controlled Congress to halt or otherwise claw back federal regulations promulgated during the Biden Administration, enact legislative priorities, and staff the executive and judicial branches (as well as independent agencies) with his nominees.  This alert discusses the transition process as well as several of these tools and their likely efficacy and limits in facilitating the implementation of President-elect Trump’s agenda.  These executive and congressional tools include: (1) a White House memorandum that directs federal agencies to freeze the finalization of pending rules (or repeal or modification of rules or policy documents under the ordinary procedures), (2) legislative repeal of rules promulgated in the last few months of the Biden Administration under the Congressional Review Act, (3) the budget reconciliation process in Congress, and (4) confirmation of executive branch and judicial appointees with a simple majority vote in the Senate.  In addition, the Department of Justice could decline to defend certain regulatory actions in court, increasing the likelihood those actions would be vacated.  Each of these tools is discussed below.

President-elect Trump also has floated significant initiatives to reform the administrative state for which these tools may become important.  For example, he announced that Elon Musk and Vivek Ramaswamy will head a task force to audit the federal government for inefficiencies.  He also committed to slashing ten regulations for every new regulation his administration implements.  Finally, President-elect Trump promised to reissue and expand an executive order that converted tens of thousands of career government employees into political appointees.  If these employees lose civil service protections, President-elect Trump would have more power to replace them.

I. Transition Mechanics and Personnel

A. Transition Process

The Trump Administration will be the first to take office under the Electoral Count Reform and Presidential Transition Improvement Act, enacted in December 2022 to address challenges that arose most prominently in the 2020–2021 transition period.  That bill amended two laws—the Presidential Transition Act of 1963 and the Electoral Count Act of 1887 (“ECA”).[1]

The Presidential Transition Act, as amended, directs the General Services Administration and the President to enter into memoranda of understanding with the campaigns prior to the election.  The memoranda provide the conditions under which the candidates may receive access to federal transition funding, facilities, agency documents, and security clearances.  They also are to include the transition team’s ethics plan, which is to address the role of registered lobbyists and foreign agents and prevent transition team members from working on matters that may give rise to a conflict of interest.  Although the conflict-of-interest provisions are supposed to be the equivalent of the criminal statutory provisions that apply to federal employees, the transition team is responsible for enforcing its own ethical code.

To date, the Trump transition team has not signed either of the required memoranda of understanding.  Until the transition team signs the memoranda, it can accept unlimited private contributions and does not have to disclose them.[2]  But it also means the transition team currently does not have access to federal agency resources—including significant amounts of briefing materials—or security clearances.  Reporting suggests that the Trump transition team is planning to sign the memoranda at some point.[3]

As the transition moves forward, we can expect to see President-elect Trump send agency review teams, also known as landing teams, to key agencies to assess personnel, budget, and ongoing work.  The Biden Administration established a formal transition process earlier this year, led by the Office of Management and Budget and General Services Administration, and directed that all agencies identify career officials to lead the transition process and prepare detailed briefing materials by November 1.[4]

At the same time, the transition team will be vetting candidates for top-level agency and White House positions.  For those who require Senate confirmation, the transition team will begin working with relevant congressional committees to get their paperwork in order so the committees can move quickly once President-elect Trump is inaugurated.  The transition team also will continue drafting “Day One” executive orders and proposed regulations—a process President-elect Trump’s allies began at the America First Policy Institute nearly as soon as he left office in 2021.[5]

B. Transition and Administration Personnel

Former Trump Small Business Administration head Linda McMahon and CEO of Cantor Fitzgerald Howard Lutnick are co-chairing the transition.  McMahon is focusing on developing policy, while Lutnick is leading the personnel effort.  The honorary co-chairs are Donald Trump, Jr., Eric Trump, Vice President-elect JD Vance, Robert F. Kennedy, Jr., and former Representative Tulsi Gabbard.  Susie Wiles, who will serve as the President’s Chief of Staff, also will be involved in the transition.  The transition is relying on a number of advisors from the America First Policy Institute and former administration personnel from the first Trump Administration.  The reported members of the team—acting as either official members or unofficial advisors—include:

Economic Policy:
Jamieson Greer, Former USTR Chief of Staff
Vince Haley, Former Trump speechwriter
Robert Lighthizer, Former U.S. Trade Representative
Kevin Warsh, Former Member of the Federal Reserve Board of Governors

Technology Policy:
Michael Kratsios, Former Trump Administration Chief Technology Officer
Gail Slater, Economic policy advisor to Vice President-elect JD Vance

Energy Policy:
Doug Burgum, Governor of North Dakota
Harold Hamm, Executive Chairman, Continental Resources

Department of Defense:
Robert Wilkie, Former Secretary of Veterans Affairs

Department of Homeland Security:
Rob Law, Former Chief of Policy at USCIS

Department of Justice:
Mark Paoletta, Former Office of Management and Budget General Counsel

Other:
David Bernhardt, Former Interior Secretary
Doug Hoeschler, Former Director of the White House Office of Intergovernmental Affairs

II. Regulatory Moratorium and Postponement

As President Biden did at the start of the current administration and as President Trump did at the start of his first administration, on January 20, 2025, President-elect Trump likely will direct executive branch agencies to freeze pending rulemakings and recommend that independent regulatory agencies do the same.[6]  He also may request that departments and agencies withdraw proposed rules that have been sent to the Office of the Federal Register (OFR) but have not yet been published and postpone the effective dates of rules that have been published but have not yet taken effect, although these options may face immediate challenges under the Administrative Procedure Act (“APA”).

On January 20, 2021, at the start of the Biden Administration, Assistant to the President and Chief of Staff Ronald A. Klain sent a memorandum to the heads and acting heads of all executive departments and agencies asking them to take the following steps “to ensure that the President’s appointees or designees ha[d] the opportunity to review any new or pending regulations”:

1. Refrain from proposing or issuing any rule in any manner—including by sending a rule to the OFR—until after review and approval by a department or agency head appointed or designated by President Biden;
2. Withdraw from the OFR any regulations that had been sent to the OFR but not yet published in the Federal Register for review and approval; and
3. Consider postponing for 60 days the effective date of regulations that had been published in the Federal Register but had not yet taken effect.[7]

The Klain memorandum permitted exceptions for “emergency . . . situations related to health, safety, environmental, financial, or national security matters” and “regulations promulgated pursuant to statutory or judicial deadlines.”[8]  This memorandum was generally understood not to apply to independent agencies, but a new administration might take a more aggressive approach and seek to exert more direct control over traditionally independent agencies such as the Securities and Exchange Commission (“SEC”) and Federal Trade Commission (“FTC”). [9]

At the start of the first Trump Administration in 2017, Assistant to the President and Chief of Staff Reince Preibus issued a similar memorandum, although there were some differences from the Klain iteration.[10]  First, the Klain memorandum allowed exceptions for “emergency situations” relating to “environmental . . . matters,” whereas the Preibus memo did not.[11]  Second, the Klain memorandum asked agencies to “consider” extending the effective dates of rules that had not taken effect, rather than requiring them to do so.[12]  The change in the Klain memorandum was likely due to court rulings during the first Trump Administration holding that delays in the effective date of Obama Administration rules violated the APA because the delays did not go through the notice-and-comment process.[13]  Third, the Klain memorandum suggested that before the effective dates of rules were extended, agencies should provide 30 days for parties to “provide comments about issues of fact, law, and policy raised by those rules,” likely to reduce the risk of similar legal challenges. [14]

Although it is difficult to evaluate the effect of these memoranda on federal agencies, it appears that agencies generally comply with their instructions.  For example, in February 2002, the Government Accountability Office determined that “federal agencies delayed the effective dates for 90 of the 371 final rules that were subject to” a similar memorandum published at the beginning of the Bush Administration (i.e., had been published in the Federal Register but had not yet taken effect when President Bush took office), and that a majority of the rules that were not delayed were non-controversial rules that the White House had previously agreed should be issued as scheduled.[15]

Independent regulatory agencies in some cases also abide by the regulatory moratoria, although they have not delayed the effective dates of previously published rules.[16]  An agency is an “independent regulatory agency” if it is “run by principal officers appointed by the President, whom the President may not remove at will but only for cause.”[17]  In contrast to non-independent agencies (sometimes referred to as executive agencies), the President’s control over independent agencies is limited by his inability to fire the commissioners, board members, and directors that make these agencies’ final decisions, unless he has “cause” to remove them from office.  For-cause removal protections are typically understood to preclude the President from removing an agency official simply because the President disagrees with the official’s policy decisions.[18]  At the SEC, for example, five commissioners decide whether to propose and adopt new regulations, and under current law the President is widely believed to lack the ability to prevent them from doing so if he disagrees (though an aggressive administration might argue that the President’s lack of control over independent agencies is unconstitutional).  Likewise, if the President orders the commissioners to repeal regulations adopted during the Biden Administration, nothing clearly requires them to obey that order.  In contrast, if the Administrator of the Environmental Protection Agency (“EPA”) refuses to repeal a regulation that the President wants to eliminate, then the President undoubtedly can replace him or her with a new Administrator.

It is likely that President-elect Trump will direct his Chief of Staff to issue a memorandum similar to the Klain and Preibus memoranda directing executive departments and encouraging independent regulatory agencies to refrain from promulgating any new rules left over from the Biden Administration, and to postpone the effective dates of rules that have been published but have not yet taken effect.

Generally, once final legislative rules have been published in the Federal Register, the only way for a new administration to eliminate or change them is through the notice-and-comment rulemaking process delineated in the APA.[19]  The APA specifies only very narrow exceptions to notice-and-comment for legislative rules on the theory that regulated parties are entitled to notice of the regulations with which they must comply and an opportunity to comment on the government’s proposal and explain what compliance will entail.[20]  These limited exceptions include when the agency is issuing a “rul[e] of agency organization, procedure, or practice,” or when the agency determines “for good cause” that notice-and-comment procedures are “impracticable, unnecessary, or contrary to the public interest.”[21]  Agencies have typically relied on one or more of these exceptions when they have attempted to postpone the effective dates of published rules at the direction of a new administration without following the notice-and-comment process.[22]  In many instances, however, courts have invalidated these changes as requiring notice-and-comment rulemaking.[23]

Of course, a new administration can also reverse or modify the prior administration’s rules through the ordinary procedures that govern agency decisionmaking.  In seeking to undo a prior administration’s policies through these ordinary procedures, a key issue includes whether the prior administration adopted the policy through notice-and-comment rulemaking or more streamlined mechanisms.

As relevant here, the APA distinguishes two kinds of actions: (1) legislative rules adopted by, for example, notice-and-comment rulemaking and (2) interpretive rules, statements of policy, and guidance documents.  Legislative rules must go through notice-and-comment rulemaking absent an exception, whereas other kinds of agency documents such as guidance letters can be adopted (or withdrawn) through more informal procedures.  Agencies must typically “use the same procedures when they amend or repeal a rule as they used to issue the rule in the first instance.”[24]  Accordingly, it is generally harder to repeal or amend a rule adopted through notice-and-comment rulemaking than to repeal or amend interpretive rules, statements of policy, or guidance documents.  And, as explained above, a new administration that tries to bypass notice-and-comment rulemaking may run into legal obstacles.

III. The Congressional Review Act

The Congressional Review Act (“CRA” or “Act”) enables Congress to enact joint resolutions invalidating new rules adopted by federal agencies.[25]  Among other things, the Act provides for expedited procedures that enable Congress to repeal a new regulation relatively quickly and with a simple majority in the Senate.[26]

A. Background and Process 

Other than at the start of a new presidential administration, the CRA is generally not a widely used tool for invalidating new regulations because the President is likely to veto any resolution invalidating a rule adopted by an agency during his administration.[27]  President Obama, for example, vetoed five disapproval resolutions during the 104th Congress, and President Biden vetoed a resolution disapproving the National Labor Relations Board’s joint employer rule in May 2024.[28]  In theory, a President might seek to deploy the CRA to repeal a regulation adopted by an independent agency like the SEC or Federal Communications Commission (“FCC”) because they are not currently subject to the President’s direct control and supervision.  However, the CRA has never been used in this manner.

Although the CRA was used to invalidate a rule only once in the first twenty years after it was enacted in 1996, recent Congresses have more aggressively used the CRA to overturn final rules adopted in the last year of an outgoing administration.  At the start of the first Trump Administration, Congress used the CRA to overturn 16 rules, including rules adopted by the SEC, Department of Education, and Department of Labor.  In 2021, at the onset of the Biden Administration, Congress used the CRA to overturn three rules that had been adopted by the first Trump Administration.[29]

As these examples show, the CRA is most effective at the start of a new administration in which the same political party controls both houses of Congress and did not control the White House during the prior administration—i.e., in the very circumstances that likely will occur come January 2025.  It is also helpful in enabling Congress to repeal so-called “midnight regulations” adopted during the prior administration’s final months.  As discussed in further detail below, however, the Act’s timing provisions render its expedited-repeal provisions inapplicable to the vast majority of regulations adopted during the Biden Administration.

The Act includes a series of complicated deadlines that govern when new rules take effect, when Congress may propose and adopt joint resolutions invalidating them, and when Congress may take advantage of the Act’s expedited procedures.  The process is as follows:  Starting from the later of the date an agency publishes a rule in the Federal Register or submits it to Congress, Congress has sixty days to introduce a joint resolution disapproving the rule in either chamber, excluding days either chamber is adjourned for more than three days during a congressional session.[30]  To give Congress sufficient time to review rules a president submits in the waning days of a session, any rule submitted less than sixty House legislative days or sixty Senate session days prior to at least one chamber adjourning for more than three days without a session (usually only at the end of a congressional session) gets a new sixty-day review period, starting from the fifteenth House or Senate legislative day of the new session.  This new sixty-day period also excludes days either chamber is adjourned for more than three days during the session.[31]

In practice, if one party holds the majority in both chambers, Congress can move a joint resolution through this process very quickly, requiring very little Senate floor time, which is the limiting factor for much legislation.  After introduction, the joint resolution goes to the appropriate House or Senate committee.[32]  The House follows its usual legislative course of considering joint resolutions in committee and on the floor with passage requiring a simple majority vote.  During its sixty-session-day review period, however, the Senate may use fast-track procedures to consider a CRA resolution.  Twenty calendar days after introduction, in the Senate, if the committee has not already reported the resolution, thirty senators may file a petition on the Senate floor to discharge the joint resolution from committee.[33]  Once the resolution is reported or discharged, a senator may move to consider the resolution on the floor.  That motion is subject to a simple majority vote, and is privileged, meaning that the motion to consider it may not be postponed and no one can move to consider other business.  After the Senate passes the motion to consider the resolution, debate is limited to 10 hours divided equally between supporters and opponents—meaning that the Senate does not have to follow its usual cloture procedures to end debate, which usually require a super-majority vote.  The Senate also may consider a non-debatable motion to limit debate.[34]  The joint resolution itself may not be amended.[35] Once debate has concluded, the Senate may pass the resolution by a simple majority vote.[36]  Once either the House or Senate passes a joint resolution, it is transmitted directly to the floor rather than a committee of the other chamber.[37]  Once Congress passes the resolution, as with other legislation, the President may sign or veto it, and, if he vetoes it, Congress may override the veto with a two-thirds majority vote of each chamber.

If Congress enacts a CRA joint resolution overturning a regulation, the agency may not reissue the rule “in substantially the same form” unless Congress passes legislation authorizing such a rule.[38]  Note that the CRA deadlines do not affect rules’ effective dates.  The CRA does require that major rules—i.e., rules that have an annual economic effect of more than $100 million, result in “a major increase in costs or prices,” or have “significant adverse effects on” competition or employment—generally may not take effect until sixty calendar days after an agency submits the rule to Congress or publishes the rule in the Federal Register, whichever is later.[39]  The APA requires only a thirty-day delay for other rules.  Once these time periods expire, the rules may take effect, even if a CRA resolution is pending.  If Congress passes a CRA resolution after the rule takes effect, the rule “shall be treated as though [it] had never taken effect.”[40]

B. Application to Biden-Era Regulations 

Wary of the CRA, agencies now try to finalize rules sufficiently in advance of a presidential election to prevent the streamlined legislative procedures in the CRA from being available to the next administration and Congress.  As relevant here, the Biden Administration finalized new rules almost daily in April 2024 on matters ranging from “forever chemicals” to nursing homes.[41]

Because we do not know yet for certain how many legislative days will pass before the House and Senate will adjourn on January 3, 2025, we cannot precisely calculate which rules will be subject to the CRA in the 119th Congress, but the Congressional Research Service estimates that rules submitted to the House or Senate on or after August 1, 2024 will qualify for the additional review period.[42]  That means the sixty-day time limit has already expired for most of the major regulations adopted during the Biden Administration.

Still, according to one estimate, the next Congress could use the CRA to repeal several dozen significant new rules.[43]  If the cutoff is August 1, vulnerable rules include construction and safety standards for manufactured housing and lead and copper in drinking water.[44]  Moreover, the Biden Administration (including independent agencies) has yet to finalize some significant rules such as the Department of Labor’s heat-stress regulation, the Food and Drug Administration’s proposed rules to ban flavored cigars and menthol cigarettes, the FTC’s proposed rule to ban junk fees, the SEC’s proposed Best Execution rule, the Federal Reserve’s proposed rule implementing the Basel III capital requirements, and several of the EPA’s proposed rules on “high-priority” chemicals.  These pending rulemakings will be vulnerable to the CRA if agencies finalize them between now and January 20, or if an independent agency finalizes a pending rulemaking after January 20 over the Trump Administration’s opposition.  And repeal under the Act would have the added effect of preventing agencies from readopting substantially similar rules in the future.

IV. Reconciliation

Budget reconciliation is a fast-track procedure by which Congress can pass legislation that affects federal spending.  Part of the Congressional Budget Act of 1974, reconciliation permits Congress to pass certain types of budget and tax-related legislation without facing a filibuster in the Senate.[45]

A. Background and Process 

Each year, Congress prepares a budget for the federal government by adopting a budget resolution—that is, a resolution adopted by both houses of Congress that sets forth the levels of spending, revenue, and debt.[46]  Because the bill is not submitted to the President for signature, the budget resolution itself lacks the force of law.

A budget resolution may include “reconciliation instructions” designed to reconcile existing law with the dictates of the budget resolution.  These instructions direct particular congressional committees to propose legislation that will help achieve the resolution’s goals, without specifying the changes that should be made.[47]  For example, the 2021 budget resolution directed 12 Senate committees and 13 House committees to increase the deficit between FY 2022 to FY 2031 by a specified amount for each committee totaling no more than $1.75 trillion.[48]

When multiple committees are subject to reconciliation instructions, each committee submits its proposed amendments to the relevant chamber’s budget committee, which packages together and reports the amendments without substantive changes in a single, consolidated reconciliation bill.[49]  There are no immediate penalties if the reconciliation bill fails to satisfy the reconciliation instructions, but the committees generally satisfy them.  (If they do not, the reconciliation bill can be amended on the floor.)  Notably, the targets set by the reconciliation instructions apply only to the initial proposals from the committees, not to the final bill that results from the reconciliation process.

The procedural rules that govern consideration of reconciliation bills make a profound difference in the Senate, which—unlike the House—does not use bill-specific rules to limit debate time or structure amendments.  Most significantly, the rules restrict debate on reconciliation bills to 20 hours and prohibit a filibuster, thus eliminating the need for a 60-vote supermajority to invoke cloture and proceed to a vote on final passage of the bill.[50]  The practical effect of this provision is that reconciliation bills can pass the Senate by a simple majority.

The “Byrd Rule” limits the permissible scope of a reconciliation bill in the Senate.[51]  Named for the late West Virginia Senator Robert Byrd, the rule generally provides that provisions “extraneous to the instructions to a committee” may be stricken from the reconciliation bill and may not be offered as an amendment.[52]  The Byrd Rule defines “extraneous” material to include six types of provisions:  (1) provisions that do not affect the budget (unless this is due to offsetting changes to revenues and outlays); (2) provisions that increase the budget deficit, if the committee does not satisfy the reconciliation instructions; (3) provisions that are outside the jurisdiction of the relevant committee; (4) provisions that produce budgetary changes that are merely incidental to the provisions’ non-budgetary components; (5) provisions that increase the budget deficit for a year not within the scope of the budget resolution or the reconciliation bill; and (6) provisions that would make changes to Social Security programs.[53]  When a senator raises a Byrd Rule objection, the Senate Parliamentarian decides the question, unless the Senate—using ordinary rules—votes to waive the objection.[54]  In practice, many of these deliberations take place prior behind the scenes in Byrd Rule sessions between Senate committee staff and the Parliamentarian prior to floor consideration of the bill.

Once the House and Senate have agreed on their respective reconciliation bills, they work out the differences between them to develop a final bill that will be voted on by both chambers.  This process typically occurs through a conference committee consisting of members from both chambers.

B. Examples and Implications 

Reconciliation has been used more than 20 times since 1980 to achieve results favored by both major parties.  In 2001 and 2003, for example, Congress used reconciliation to enact tax cuts proposed by President Bush; in 2010, Democrats used it to enact a portion of the Affordable Care Act (“ACA”); the first Trump Administration used it to enact the Tax Cut and Jobs Act; and in 2022, Democrats again used reconciliation to enact the Inflation Reduction Act.[55]  There is no requirement that reconciliation be used to decrease the deficit.

Because it precludes a filibuster in the Senate, reconciliation is an attractive tool for a congressional majority to accomplish certain economic objectives, like revising tax rates and changing mandatory spending programs.[56]  Indeed, the reconciliation process was used by the Republican Senate during the first Trump Administration and congressional Republicans to pass the TCJA and the Republican majority will likely try to use it again to extend those cuts.  The reconciliation process could also be used to adjust spending on veterans and even to repeal some aspects of the ACA, as House Republicans voted to do in 2016.[57]  But it is not a filibuster cure-all.  The Byrd Rule sharply limits the types of provisions that may be enacted through the reconciliation process, and while the boundaries of the rule are subject to interpretation—making the Senate Parliamentarian’s role an important one—the limitations it imposes are meaningful.  Ultimately, the reconciliation process is best viewed as having the potential to secure significant changes to relatively narrow areas of U.S. law and policy.

V. Appointments and Confirmations

In light of changes to the filibuster over the last decade, President-elect Trump will need only a simple Senate majority to confirm his judicial and executive branch nominees.  Senate Democrats reinterpreted Senate rules in 2013 “so that [most] federal judicial nominees and executive-office appointments could advance to confirmation votes by a simple majority of senators, rather than the 60-vote supermajority” previously required to defeat a filibuster.[58]  Republicans expanded the interpretation in 2017 to allow Supreme Court nominees to be confirmed by a simple majority.[59]  And both parties have recently modified the “blue slip” tradition that required senators from the state where there is a vacancy to sign off on judicial nominees for courts of appeals; although the parties still expect consultation between the White House and senators from the vacancy state, they will call nominees to a vote even if a senator does not return a blue slip.  By contrast, both parties have continued to observe the tradition for judicial nominees for district courts, with the result that as a practical matter individual senators from the state where there is a vacancy still can block district court nominees.

For much of President Biden’s term, the Senate was evenly divided between Democrats and Republicans.  Thus, President Biden often needed the votes of every single Democratic senator, plus Vice-President Harris’s tiebreaking vote, to confirm his nominees.  Beginning next year, Republicans will control the Senate with at least 53 seats, giving President-elect Trump more leeway to confirm his choices on a purely partisan basis even if he loses the votes of three members of the Republican party.

VI. Reversing Course in Pending Regulatory Challenges

In the case of final rules that are already subject to legal challenge in federal court, whether a new administration can or is likely to opt not to defend a previous administration’s final rule depends on a number of factors.  A new administration may choose not to appeal a ruling invalidating its predecessor’s final rule or, on rare occasions, concede the legal invalidity of a rule being challenged.  The Department of Justice and agencies may also ask federal courts for extensions of litigation deadlines to permit agencies to reconsider their policies; courts are generally more receptive to these extension requests given that they are less susceptible to the charge that the agency is using litigation to bypass the normal requirements of the APA.

If the agency is an independent regulatory agency (such as the SEC, FTC, or Federal Reserve), it is more difficult for a new administration to direct the agency to abandon the defense of existing regulations because, as explained above, the heads of independent regulatory agencies can only be removed “for cause.”  Still, the new heads and majorities of independent agencies will likely share some of the same goals as the new administration and can decide that they do not wish to defend an existing rule adopted in the last administration.  For example, a new majority at the SEC may pull back from the current majority’s aggressive approach towards regulation and enforcement of digital assets such as cryptocurrencies.  Agencies without independent litigating authority may need to coordinate with the Department of Justice to achieve that result.  And the issue becomes further complicated for Supreme Court litigation, because most independent agencies are required by statute to be represented by the Solicitor General in the Supreme Court and even agencies that have a high degree of independent litigating authority generally must, in that forum, secure approval from the Department of Justice or at least the absence of any objection to proceed.[60]

If the agency is not an independent agency, a new president could direct the agency to refrain from defending a prior administration’s regulation.  The more likely scenario, however, is that the heads of agencies—independent or not—who are appointed by the new administration might ask the Department of Justice not to defend a rule, and the Department of Justice can agree or refuse.  If the Department of Justice agrees not to defend a final rule in a pending legal challenge, it could move for a voluntary remand back to the agency to reevaluate the rule.  Courts often grant federal agencies’ motions for voluntary remand because they allow the agency to correct its own errors without expending the resources of the court in reviewing a record that may be incorrect or incomplete, or in a case that may be mooted by subsequent agency action.[61]  In litigation, it also is possible for a new administration to support a stay of the rule pending completion of the litigation.

Recent administrations have changed the government’s position in pending legal challenges to the prior administration’s rules.  For example, the Trump Administration declined to seek a rehearing after a court vacated the Department of Labor’s “fiduciary rule.”  The Department of Justice dropped its appeal in a dispute between MetLife Inc. and the Financial Stability Oversight Council.  During the Bush Administration, the EPA and Attorney General were directed to review Clean Air Act enforcement actions stemming from Clinton-era investigations to determine whether they should be continued.  The review resulted in the EPA dismissing enforcement actions (launched by the Clinton Administration) against dozens of coal-fired power plants.[62]  The Bush administration prosecutors also changed course from the Clinton administration in the Microsoft antitrust litigation, which reportedly resulted in the company obtaining a more favorable settlement than had been offered previously.[63]  In the case of the Biden administration’s Non-Compete Rule, Department of Labor Independent Contractor Rule, and other regulations currently being reviewed by federal courts, the Trump administration could use a similar approach and opt to move for a voluntary remand back to the agency to repeal or revise the regulations being challenged.[64]

Still, some Supreme Court Justices have criticized the executive branch for acquiescing to injunctions or vacatur of a prior administration’s rules.  In one notable example, President Biden’s Department of Justice and Department of Homeland Security declined to appeal an injunction invalidating the Trump Administration’s so-called Public Charge Rule.  The Supreme Court initially granted certiorari to address whether states could intervene to defend the rule, but ultimately dismissed the writ of certiorari as improvidently granted.  In a concurrence, Chief Justice Roberts (joined by Justices Thomas, Alito and Gorsuch) expressed concern that a strategy of “rulemaking-by-collective-acquiescence” may allow a new administration to circumvent the APA’s requirements for repealing final rules, although he ultimately agreed that dismissal was appropriate because the specific procedural posture could complicate the Court’s resolution of important questions in the case.[65]

Some states have subsequently argued that courts should permit them to intervene in pending cases against the federal government to avoid this problem, and this strategy may repeat itself with Democratic state Attorneys General in the next Trump Administration[66]   More generally, states are increasingly seeking to intervene or participate as plaintiffs in regulatory litigation.  For example, in 2022, several states with Republican attorneys general sought to intervene in litigation challenging Title 42, a component of the Public Health Service Act of 1944 that enables the Centers for Disease Control director, with approval of the President, to restrict entry of individuals from a country in which there is a communicable disease.[67]  States with Democratic attorneys general will likely take a similar approach in the next Trump Administration.

For similar reasons, companies with an interest in upholding regulations that are currently being challenged in court may wish to consider intervening as defendants to make it more difficult for the next administration to settle or acquiesce to an adverse ruling.  The presence of an intervening defendant can make it more difficult for the government to change positions in the middle of litigation challenging an agency’s rule and, even if the government does change positions, an intervening defendant can make it more difficult for the government to prevent a federal court from upholding the rule on the merits.

VII. Executive Orders and Presidential Directives and Memoranda

In recent administrations, presidents have increasingly turned to executive orders and presidential memoranda and directives to achieve certain legislative and regulatory priorities without the assistance of Congress or federal agencies.

A. Executive Orders 

Executive orders are presidential directives that have the force of law when they are issued pursuant to a valid claim of constitutional or statutory authority.[68]  Unlike legislation and federal regulations, presidents are free to revoke, modify, or supersede executive orders at any time.[69]  Indeed, new administrations often begin their terms by acting quickly to revoke previously issued orders.  In October 2019, for example, President Trump revoked President Barack Obama’s executive order relating to protections for qualified civil service workers.[70]  On his first day in office, President Biden issued an executive order revoking a number of executive orders issued by President Trump[71]

President Biden has issued 143 executive orders during his presidency.  In his 100-day action plan for his first term, President Trump pledged that he would immediately “cancel every unconstitutional executive action, memorandum and order issued by President Obama” in order “to restore security and the constitutional rule of law.”[72]  During this year’s campaign, he pledged that he would “sign an executive order directing every federal agency to immediately remove every single burdensome regulation driving up the cost of goods.”[73]  While there has been much speculation about precisely which executive orders President-elect Trump could revoke, they may include:

• Regulatory Review
  • EO 14094 (directing the Office of Management and Budget to revise how executive branch agencies conduct cost-benefit analyses)
• Economy
  • EO 14036 (directing agencies to take a variety of steps to regulate business’s competitive practices)
• Energy and the Environment
  • EO 14008 (rejoining the Paris Climate Agreement)
• Labor and Federal Employment
  • EO 14035, 14091 (implementing plans to improve diversity, equity, and inclusion within the federal workforce)

B. Presidential Directives, Memoranda, and Proclamations 

In addition to executive orders, past presidents have used various written instruments to direct the executive branch and implement policy.[74]  These include presidential memoranda, directives, and proclamations, which generally are less formal than executive orders and need not be published in the Federal Register unless the President determines that they “have general applicability and legal effect.”[75]  Like executive orders, presidential memoranda, directives, and proclamations can be undone by new executive actions revoking the prior action.[76]

President Biden has used these instruments, particularly presidential memoranda, to achieve numerous policy goals.[77]  For example, in January 2021, President Biden issued several memoranda, including on discrimination in housing and the Deferred Action for Childhood Arrivals (“DACA”) program.[78]  President-elect Trump may revoke President Biden’s presidential memoranda when he assumes office on January 20, 2025, and he is likely to issue some of his own to shape the course of the administrative state during his term.

Conclusion

The tools and strategies we have discussed will be available to President-elect Trump and the likely Republican-controlled Congress in their efforts to halt or repeal regulatory actions undertaken during the Biden Administration, pursue legislative initiatives (such as extending the TCJA), and confirming judges and members of the President-elect’s team.  Each of these tools is limited in certain respects.  For example, an effort to repeal President Biden’s core legislative and regulatory enactments—with the exception of executive orders and presidential directives and memoranda, which may be revoked immediately and unilaterally by President-elect Trump—will not be immediate and will require coordination and a multi-pronged approach.  However, if pursued over time, these tools—as we have seen through their historical application—can be effective in furthering the President-elect’s agenda.

[1] 3 U.S.C. § 102; 3 U.S.C. § 15.

[2] See 3 U.S.C. § 102 note.

[3] Betsy Klein, What We Know About the Transition So Far, CNN (Nov.  6, 2024, 11:49 AM), https://www.cnn.com/2024/11/06/politics/what-we-know-about-the-transition-so-far/index.html.

[4] See Office of Management and Budget, Memorandum for Heads of Executive Departments and Agencies (April 26, 2024), https://www.whitehouse.gov/wp-content/uploads/2024/04/M-24-13-Implementing-the-Presidential-Transition-Act.pdf; Office of Management and Budget, Memorandum for Heads of Executive Departments and Agencies (Sept. 6, 2024), https://www.whitehouse.gov/wp-content/uploads/2024/09/M-24-17_2024-Memo-Guidance-on-Presidential-Transition-Planning.pdf.

[5] See Dave Davies, How a Little-Known Organization is Poised to Shape a Second Trump Administration, NPR (Oct. 30, 2024), https://www.npr.org/2024/10/30/g-s1-30917/how-a-little-known-organization-is-poised-to-shape-a-second-trump-administration.

[6] See Memorandum from Reince Preibus to the Heads and Acting Heads of Executive Departments and Agencies, 82 Fed. Reg. 8346 (Jan. 20, 2017, published Jan. 24, 2017) (the “Preibus memorandum”).

[7] Memorandum from Ronald A. Klain to the Heads and Acting Heads of Executive Departments and Agencies, 86 Fed. Reg. 7424 (Jan. 20, 2021, published Jan. 28, 2021) (the “Klain memorandum”).

[8] Id.

[9] Id.

[10] Preibus memorandum, supra note 6.

[11] Id.

[12] Id.

[13] See Open Cmtys. Alliance v. Carson, 286 F. Supp. 3d 148, 152 (D.D.C. 2017); Pineros y Campesinos Unidos Del Noroeste v. Pruitt, 293 F. Supp. 3d 1062, 1066-67 (N.D. Cal. 2018).

[14] Klain memorandum, supra note 7.

[15] See U.S. Gov’t Accountability Office, GAO-02-370R, Regulatory Review: Delay of Effective Dates of Final Rules Subject to the Administration’s January 20, 2001 Memorandum 2-5 (Feb. 15, 2002) (“GAO Report”).

[16] Compare Securities & Exchange Commission Acting Chairman Laura S. Unger, “What’s New in the Land of Regulation?” (Mar. 2, 2001), https://www.sec.gov/news/speech/spch465.htm (announcing plan to defer any rulemaking in light of the Card memorandum); with GAO Report at 4-5 (noting that none of the 30 final rules that were issued by independent regulatory agencies (the FCC, Nuclear Regulatory Commission, and SEC) during the period subject to the Card memorandum were delayed).

[17] See Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 483 (2010).

[18] See id. at 502.

[19] See 5 U.S.C. § 551 et seq.  The APA defines “rule making” as the “agency process for formulating, amending, or repealing a rule.”  Id. § 551(5).  The APA generally requires agencies to (1) publish a notice of proposed rulemaking in the Federal Register; (2) allow interested parties an opportunity to participate in the rulemaking process by providing “written data, views, or arguments”; and (3) publish a final rule 30 days before it becomes effective.  Id. § 553.  See also Humane Soc’y v. Dep’t of Agric., 41 F.4th 564, 575 (D.C. Cir. 2022) (holding that once a rule was “made available for public inspection” through the Federal Register, it “prescribe[d] law with legal consequences,” and the “APA require[d] the agency to undertake notice and comment before repealing it”).

[20] Id. § 553(b)(3).

[21] Id.

[22] GAO Report, supra note 15, at 6 & app. I.

[23] See, e.g., Am. Pub. Gas Ass’n v. United States Dep’t of Energy, 72 F.4th 1324, 1339-40 (D.C. Cir. 2023) (Department of Energy failed to show good cause to circumvent APA notice-and-comment requirements); Regeneron Pharms., Inc. v. United States Dep’t of Health & Hum. Servs., 510 F. Supp. 3d 29, 45-50 (S.D.N.Y. 2020) (plaintiffs were likely to succeed on the merits in arguing that an agency lacked good cause to implement President Biden’s executive orders without using notice and-comment procedures); Clean Water Action v. EPA, 936 F.3d 308, 314-15 (5th Cir. 2019) (“the modification of effective dates is itself a rulemaking” that requires notice-and-comment procedures); Air All. Houston v. EPA, 906 F.3d 1049, 1065 (D.C. Cir. 2018) (“EPA may not employ delay tactics to effectively repeal a final rule while sidestepping the statutorily mandated process for revising or repealing that rule on the merits.”);  Nat. Res. Def. Council v. Abraham, 355 F.3d 179, 204-06 (2d Cir. 2004) (rejecting the Department of Energy’s arguments that its notice delaying a published rule’s effective date in accordance with the Card memorandum was a procedural rule exempt from the notice-and-comment requirements, or that there was “good cause” to not comply with the notice-and-comment requirements).

[24] Perez v. Mortgage Bankers Ass’n, 575 U.S. 92, 101 (2015).

[25] See 5 U.S.C. §§ 801–808.

[26] See id. § 802.

[27] See Curtis W. Copeland & Richard S. Beth, Cong. Research Serv., RL34633, Congressional Review Act: Disapproval of Rules in a Subsequent Session of Congress 1 (2008), available at https://www.fas.org/sgp/crs/misc/RL34633.pdf; Diego Areas Munhoz, Biden Vetoes Resolution to Block Labor Board Joint Employer Rule, Bloomberg, May 3, 2024, available at https://news.bloomberglaw.com/daily-labor-report/biden-vetoes-resolution-to-block-labor-board-joint-employer-rule.

[28] Christopher M. Davis & Richard S. Beth, Cong. Research Serv., IN10437, Agency Final Rules Submitted After May 30, 2016, May Be Subject to Disapproval in 2017 Under the Congressional Review Act 1 (2016), available at https://www.fas.org/sgp/crs/misc/IN10437.pdf.

[29]  Maeve P. Carey & Christopher M. Davis, Cong. Research Serv., R43992, The Congressional Review Act (CRA): Frequently Asked Questions (2021), available at https://crsreports.congress.gov/product/pdf/R/R43992.

[30] 5 U.S.C. § 802(a).

[31] Id.

[32] 5 U.S.C. § 802(b).

[33] 5 U.S.C. § 802(c).

[34] Id.

[35] 5 U.S.C. § 802(d).

[36] Id.

[37] 5 U.S.C. § 802(f).

[38] 5 U.S.C. § 801(b)(2).

[39] 5 U.S.C. § 801(a)(3), 804(2).

[40] 5 U.S.C. § 801(f).

[41] 5 U.S.C. § 802(d).

[42] CRA Lookback Period Currently Estimated to Begin in August 1 Time Frame, Cong. Research Serv. (Aug. 21, 2024), https://crsreports.congress.gov/product/pdf/IN/IN12408.

[43] See George Washington University Regulatory Studies Center, Congressional Review Act Window Exploratory Dashboard, https://regulatorystudies.columbian.gwu.edu/congressional-review-act-window-exploratory-dashboard.

[44] See id.

[45] 2 U.S.C. §§ 601-608.

[46] See id. § 632.

[47] See id. § 641.

[48] S. Con. Res. 14, 117th Cong. (2021).

[49] See 2 U.S.C. § 641(b).

[50] See id. § 641(e)(2).

[51] Id. § 644.

[52] Id. § 644(a).

[53] Id. § 644(b)(1)(A).

[54] See id. § 644(e).

[55] See Manu Raju, GOP Targets Budget Process for Tax Reform, Politico (Jan. 13, 2015), http://www.politico.com/story/2015/01/gop-tax-reform-114201.

[56] Congress addresses discretionary spending separately through the appropriations process.

[57] See Jennifer Haberkorn, Trump Victory Puts Obamacare Dismantling Within Reach, Politico (Nov. 9, 2016), http://www.politico.com/story/2016/11/trump-victory-obamacare-risk-231090.

[58] Paul Kane, Reid, Democrats Trigger ‘nuclear’ Option; Eliminate Most Filibusters on Nominees, Wash. Post (Nov. 21, 2013), https://www.washingtonpost.com/politics/senate-poised-to-limit-filibusters-in-party-line-vote-that-would-alter-centuries-of-precedent/2013/11/21/d065cfe8-52b6-11e3-9fe0-fd2ca728e67c_story.html; see also Valerie Heitshusen, Cong. Research Serv., Majority Cloture for Nominations: Implications and the ‘Nuclear’ Proceedings 4-5 (Dec. 6, 2013), https://www.fas.org/sgp/crs/misc/R43331.pdf (“CRS Nominations Report”). Note that the Senate “did not change the text of Rule XII of the [Senate] Standing Rules,” but rather “established a new precedent by which it reinterpreted the provisions of Rule XXII to require only a simple majority to invoke cloture on most nominations.”  CRS Nominations Report, supra note 58, at 4-5; see also id. at 8- 9 (providing a detailed discussion of the procedures the Senate majority used to set new precedent in relation to consideration of nominations).

[59] Ed O’Keefe & Sean Sullivan, Senate Republicans go ‘nuclear,’ pave the way for Gorsuch confirmation to Supreme Court, Wash. Post (April 6, 2017), https://www.washingtonpost.com/powerpost/senate-poised-for-historic-clash-over-supreme-court-nominee-neil-gorsuch/2017/04/06/40295376-1aba-11e7-855e-4824bbb5d748_story.html.

[60] See, e.g., 12 U.S.C. § 5564(e) (“Appearance Before the Supreme Court”) (“The [CFPB] may represent itself in its own name before the Supreme Court of the United States, provided that the Bureau makes a written request to the Attorney General within the 10-day period which begins on the date of entry of the judgment which would permit any party to file a petition for writ of certiorari, and the Attorney General concurs with such request or fails to take action within 60 days of the request of the Bureau.”).

[61] See, e.g., Ethyl Corp v. Browner, 989 F.2d 522, 524 (D.C. Cir. 1993); SKF USA Inc. v. United States, 254 F.3d 1022, 1029 (Fed. Cir. 2001); Citizens Against Pellissippi Parkway Extension, Inc. v. Mineta, 375 F.3d 412, 417 (6th Cir. 2004); Sierra Club v. Van Antwerp, 560 F. Supp. 2d 21, 24-25 (D.D.C. 2008).

[62] Elizabeth Shogren, EPA Drops Its Cases Against Dozens of Alleged Polluters, N.Y. Times, Nov. 6, 2003.

[63] D. Ian Hopper, New Administration Takes Less Fractured View of Microsoft, AP, Sept. 7, 2001, available at http://cjonline.com/stories/090701/usw_microsoft.shtml#.WDR6k-YrLGh; Jonathan Krim, Circumstance Had Role in U.S.-Microsoft Deal, Wash. Post, Nov. 3, 2001, at A21.

[64] Tim Devaney, 14 Obama regs Trump could undo, TheHill.com (Nov. 12, 2016), http://thehill.com/regulation/305673-14-obama-regs-trump-could-undo.

[65] Arizona v. City & County of San Francisco, 142 S. Ct. 1926, 1928 (2022) (Roberts, J., concurring) (quoting City & County of San Francisco v. United States Citizenship and Immigration Servs., 992 F.3d 742, 744 (9th Cir. 2021) (VanDyke, J., dissenting)).

[66] See, e.g., Brief for Petitioners at 4, Arizona v. Mayorkas, No. 22-592 (2022).

[67] 42 U.S.C. § 265.

[68] Vivian S. Chu & Todd Garvey, Cong. Research Serv., Executive Orders: Issuance, Modification, and Revocation 1-2 n.3 (Apr. 16, 2014), https://www.fas.org/sgp/crs/misc/RS20846.pdf (quoting Staff of House Comm. on Gov’t Operations, 85th Cong., 1st Sess., Executive Orders and Proclamations: A Study of A Use of Presidential Powers (Comm. Print 1957)); see also John Contrubis, Cong. Research Serv., Executive Orders and Proclamations 2 & n.4 (Mar. 9, 1999), http://www.llsdc.org/ assets/sourcebook/crs-exec-orders-procs.pdf.

[69] Chu & Garvey, supra note 68, at 7.

[70] Exec. Order No. 13897 (Oct. 31, 2019) (revoking Exec. Order No. 13495 (Jan. 30, 2009)).

[71] Exec. Order No. 13985 (Jan. 20, 2021) (revoking Exec. Order No. 13950 (Sept. 22, 2020); Exec. Order No. 13958 (Nov. 2, 2020)); https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-president-elect-bidens-day-one-executive-actions-deliver-relief-for-families-across-america-amid-converging-crises/.

[72] Donald Trump’s Contract with the American Voter, Donald J. Trump for President (Oct. 23, 2016), https://www.donaldjtrump.com/contract/.

[73] Robin Bravender, Trump Says New Cabinet Official Will “reduce cost of living,” E&ENews (Oct. 31, 2024), https://www.eenews.net/articles/trump-says-new-cabinet-official-will-reduce-cost-of-living/.

[74] Chu & Garvey, supra note 68, at 1.

[75] See id. at 1-2 & n.7 (citing 44 U.S.C. § 1505).

[76] Contrubis, supra note 68, at 19.

[77] John T. Woolley & Gerhard Peters, Biden’s Use of Discretion, The American Presidency Project (Feb. 10, 2023), https://www.presidency.ucsb.edu/analyses/bidens-use-discretion.

[78] Presidential Memorandum, Preserving and Fortifying Deferred Action for Childhood Arrivals (DACA), 86 Fed. Reg. 7053 (Jan. 20, 2021); Presidential Memorandum, Redressing Our Nation’s and the Federal Government’s History of Discriminatory Housing Practices and Policies, 86 Fed. Reg. 7487 (Jan. 26, 2021).

The following Gibson Dunn lawyers prepared this update: Michael Bopp, Stuart Delery, Helgi Walker, Tory Lauterbach, Jacob Spencer, Andrew Kilberg, Matt Gregory, and Amanda Neely.

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In this update, we explore the possible impacts of the 2024 presidential election on emissions regulations for light- and heavy-duty motor vehicles and on- and off-road engines, known collectively as “mobile sources.”

Based on actions during President-elect Trump’s previous term, we anticipate that the second Trump Administration will move swiftly to rescind and replace federal rules regarding mobile source emissions and seek to limit California’s authority to regulate such emissions. Below we outline the anticipated implications for industry of forthcoming changes to the existing federal and California regulations, related anticipated litigation, and potential compliance and enforcement considerations for industry.  

The key takeaways for industry are:

• The second Trump Administration is likely to deny pending requests by California for authorization to adopt and enforce its own mobile source emissions regulations and to revoke existing preemption waivers allowing California to issue mobile source greenhouse gas (GHG) standards in particular.
• If these waivers are later restored, manufacturers may face retroactive enforcement by the California Air Resources Board (CARB), which has recently stated in other contexts that it will seek to enforce its regulations back to the state law effective date upon the receipt of a preemption waiver or authorization.
• New litigation surrounding the denial or revocation of California’s waivers is likely to arise, but any cases seeking to restore California’s waivers will be heard by a judiciary—including a Supreme Court—shaped by the appointees of the first Trump Administration.
• From an enforcement perspective, the U.S. Environmental Protection Agency (EPA) will retain primacy for mobile source enforcement even if the next Trump Administration moves back to a policy focused on state-first enforcement. If the EPA de-prioritizes GHG enforcement, the balance of the enforcement docket may shift to criteria pollutant cases, such as enforcement related to NOx or PM emissions.

Federal Rules

During the first Trump Administration, the U.S. Environmental Protection Agency (EPA) undertook efforts to change mobile source emission rules, in particular by replacing an increasingly strict GHG emissions regime from the Obama Administration with rules that did not become more stringent year-over-year. We anticipate that during President-elect Trump’s second term, his administration may move again to reduce the stringency of the previous administration’s emissions regulations pertaining to GHGs.

First Trump Administration Recission of Federal Rules

In August 2018, the EPA, along with the National Highway Traffic Safety Administration (NHTSA), initiated a rulemaking to amend the existing tailpipe emissions standards and fuel economy requirements for passenger cars and light trucks and establish new standards for model years 2021 through 2026.[1] This action, which was finalized in April 2020, froze the federal GHG emissions and fuel economy standards at model year 2020 levels through 2026.[2]  

Lessons for the Second Trump Administration

During the second Trump Administration, we anticipate that the EPA will again take action to rescind the previous administration’s vehicle and engine emissions standards, particularly GHG standards. Based on campaign statements and Project 2025, an extensive suite of policy proposals from major conservative groups including many appointees from President-elect Trump’s first administration,[3] the EPA will likely rescind the Biden EPA’s model year 2027 through 2032 light- and medium-duty vehicle emissions standards.[4] The Trump Administration’s replacement rule will likely slow the rate at which the GHG standards ramp up.[5] We also anticipate that the Trump Administration’s replacement rule will significantly reduce the pressure on manufacturers to meet emissions standards through the sale of electric vehicles (although this seems less certain given the anticipated role that Tesla CEO Elon Musk will have in the second Trump Administration).[6]

Project 2025 also contemplates that NHTSA will amend its fuel economy standards and return to the minimum average fuel economy standards specified by Congress for model year 2020 vehicles, including levels aimed at achieving a fleet-wide average of 35 miles per gallon.[7] NHTSA may also reconsider existing fuel economy credits for electric vehicles.[8]

California Rules

Outlook for Section 209 Waivers

Under the Clean Air Act, states are expressly preempted from adopting or enforcing emissions standards for new motor vehicles and engines.[9] However, a statutory exemption exists for California: EPA has authority under Section 209 to issue a preemption waiver to California to establish, and enforce, its own standards for new motor vehicle and engine emissions that are at least as strict as the federal standards, if certain statutory criteria are met.[10] Currently, eight California rules are under waiver or authorization review by EPA, including the following CARB rules with significant compliance implications and costs for the regulated industry:

California Rule	Federal Register Notice
Heavy-Duty Omnibus Low NOx Waiver Request	87 Fed. Reg. 35765 (Jun. 13, 2022)
Commercial Harbor Craft Authorization Request	88 Fed. Reg. 25636 (Apr. 27, 2023)
Advanced Clean Car II Waiver Request	88 Fed. Reg. 88908 (Dec. 26, 2023)
In-Use Locomotive Authorization Request	89 Fed. Reg. 14484 (Feb. 27, 2024)
Advanced Clean Fleets Waiver Request	89 Fed. Reg. 57151 (Jul. 12, 2024)

In addition, for some other recent rules, such as the Zero-Emissions Forklift Rule, which mandates a complete transition to powertrains with no tailpipe emissions, CARB has not yet submitted a waiver application to the EPA.

If these waiver and authorization requests are not finalized during President Biden’s lame-duck period, they likely will be denied by a Trump EPA. Based on the Trump EPA’s approach during the first administration, it is likely that President-elect Trump’s EPA will revoke existing waivers granted to California. The ability of California to secure waivers or authorizations from the EPA during the second Trump Administration based on new requests is also questionable.

In particular, campaign statements and Project 2025 indicate that the next Administration will revoke any Section 209(b) waiver that does not apply only to California-specific issues such as ground-level ozone, including any waiver to issue vehicle GHG standards.[11] President-elect Trump campaigned on a platform that no state should have the authority to ban gasoline-powered cars, which implicates California’s waiver that has been used to order the phase-out of gas-powered vehicles and transition to electric vehicles beginning in model year 2026 through model year 2035.[12]

CARB Response to Waiver Recission and Restoration During the First Trump Administration

Looking back to the first Trump Administration may provide a preview of future conflict between CARB and the Trump EPA regarding Section 209 waivers. During the first Trump Administration, in August 2018, the EPA proposed to withdraw CARB’s previously granted Section 209(b) waiver for its Advanced Clean Cars regulation.[13] In September 2019, the EPA finalized this rule, revoking California’s Section 209(b) waiver to enforce unique state motor vehicle GHG standards for model years 2021 through 2025.[14]

During the interim period between the Trump EPA’s initial proposal to revoke California’s waiver and the actual revocation, CARB modified its existing GHG rules for model years 2021 through 2026 to state that, should the EPA change federal emission standards, vehicle and engine manufacturers who complied with the federal standards would no longer be considered in compliance with the significantly differing California standards.[15] In other words, CARB declared that it would no longer accept compliance with federal emissions standards as a safe harbor if the EPA were to revise the federal rules. In doing so, California departed from a prior deal struck with industry and EPA in promulgating the first harmonized GHG program at the outset of the Obama Administration (which, in turn, resolved years of litigation relating to state regulation of GHGs from motor vehicles).[16]

Next, in the summer of 2019, CARB and four automakers announced their entry into “Framework Agreements.”^[17] The Framework Agreements imposed alternative GHG standards for model year 2021 through 2026 light-duty vehicles, and were described by the Trump EPA as “a voluntary agreement with four automobile manufacturers that amongst other things, requires the manufacturers to refrain from challenging California’s GHG and [Zero-Emission Vehicle] programs, and provides that California will accept automobile manufacturer compliance with a less stringent standard” than either the existing California program or the federal regulations promulgated in 2012.[18]

As a result, during the period when CARB’s waiver was revoked, manufacturers were subject to significant regulatory uncertainty. Some manufacturers complied with the federal regulations, which EPA and NHTSA maintained were the only lawful regulations. Other manufacturers entered into agreements with CARB to comply with the requirements of the Framework Agreement. Overlaying all of this, CARB’s own original GHG emissions standards remained the law in California, and CARB maintained that their waiver was improperly revoked, raising the specter of retroactive enforcement should it be restored.[19]

In March 2022, under President Biden, the EPA reinstated California’s Section 209(b) waiver to issue and enforce motor vehicle GHG standards.[20] OEMs expressed concern that CARB could seek to retroactively enforce its separate standards for the period during which California’s waiver had been revoked.[21] This was particularly challenging because, during the period where CARB’s waiver was withdrawn, many manufacturers followed the federal regulations and made decisions that fixed their vehicle production strategies for model years 2021 and 2022, leaving them with a lack of lead time to comply with CARB’s regulations after its waiver was reinstated.

Potential CARB Retroactive Enforcement in the Second Trump Administration

The potential for retroactive enforcement will remain a challenge in the new Trump Administration. CARB has indicated in several contexts that it will seek to enforce state law retroactively upon the receipt of EPA waiver or authorization. For example, CARB’s Advanced Clean Fleets (ACF) waiver request is still pending with EPA,[22] but in December 2023, CARB issued an “Enforcement Notice” stating that it “reserves all of its rights to enforce the ACF regulation in full for any period for which a waiver is granted” including back to the effective date of the rule under California law.[23] In comments on the EPA waiver proceeding on this rule, one comment rightfully pointed out that “to apply the waiver retroactively violates both the [Clean Air Act] and basic principles of due process” and observed that CARB has increasingly sought to assert this position for its rules pending waiver determinations.[24] In October 2024, CARB clarified that it would not retroactively enforce certain aspects of the ACF regulation, but this clarification did not comprehensively address all ACF requirements.[25] Notably, CARB has not provided similar clarifications for other rules.    

During a second Trump Administration, CARB may renew its threats of retroactive enforcement for regulations between the period of a regulation becoming California law and receipt of a waiver or authorization from EPA. This would lead to significant regulatory uncertainty (and due process concerns) for automakers and engine manufacturers, as a Trump EPA is likely to delay or deny California’s waiver and authorization requests. Furthermore, if existing waivers are rescinded and then restored by a later administration, manufacturers may again face the situation where federal regulations were technically the sole law of the land, but California alleges the waiver revocation was improper, its regulations were still valid, and that it can retroactively enforce following the restoration. This Damocles’ sword could hang over industry’s head until the issue of California’s authority is decided by the U.S. Supreme Court or the next Democratic Administration.  

Waiver Litigation

EPA’s decision to reinstate CARB’s waiver is also currently being challenged in federal court by a group of states and fuel producers. Petitioners argue that the EPA exceeded its authority under the CAA and violated a constitutional requirement to treat states equally in terms of their sovereign authority.[26] The DC Circuit held that the Petitioners did not have standing to raise the statutory claims, and it rejected Petitioners’ constitutional claim on the merits.[27] Although the petition for certiorari remains pending before the Supreme Court, a Trump Administration revocation could render this case moot by again revoking the California waiver.

However, even if the existing litigation is mooted, new waiver litigation is likely to arise. Specifically, in the event that the Trump EPA denies or revokes any of California’s waivers, new litigation will almost certainly commence to challenge such decisions, including litigation brought by the State of California.[28]

In those cases—or if the existing waiver litigation proceeds to the Supreme Court—the second Trump Administration will have an advantage that the first Trump Administration did not: the benefit of a federal judiciary, and a Supreme Court, shaped by President-elect Trump’s first term.[29] In addition, the Supreme Court’s 2024 decision in Loper Bright provides the courts with greater latitude to question agency decisions that previously may have received the benefit of Chevron deference.[30] As a result, cases trying to restore California’s waivers may face more of an uphill battle during the second Trump Administration than during the first.

Implications for Enforcement

Federal Enforcement

During the first Trump Administration, EPA policy emphasized coordination with states and allowing state agencies to take the lead in enforcement. Even under a state-focused enforcement policy, EPA remains the lead for any enforcement pursuant to Title II of the Clean Air Act relating to mobile sources and fuels, especially if California’s waivers to enforce its own mobile source emission standards are delayed, denied, or revoked. Thus, EPA’s Office of Enforcement and Compliance Assurance (OECA) will retain primacy for Title II enforcement even if the next Trump Administration moves back to a policy focused on state-first enforcement.

Furthermore, where GHG enforcement becomes less of a priority, OECA may then seek to fill its enforcement docket with criteria pollutant cases. For vehicle and engine manufacturers, this could include enforcement related to NOx or PM emissions, for example. Enforcement actions under the first Trump Administration included three major mobile source cases focused on criteria emissions all of which were focused on non-U.S. manufacturers.

CARB Enforcement

As discussed above, the recission and reinstatement of CARB’s Advanced Clean Cars waiver created significant uncertainty for manufacturers regarding enforcement risks, as the fundamental issues of which regulations were in effect, and when, were in question. To date, this dilemma and the related due process concerns created by this positioning have not been squarely addressed in the context of enforcement or an as-applied constitutional challenge.

Should a similar situation develop during the second Trump Administration, another potential method for manufacturers to seek certainty on enforcement is to enter into an agreement with CARB where CARB agrees to exercise its enforcement discretion with respect to certain regulatory terms in exchange for support for CARB’s legal positions and regulations. CARB has taken this approach not only on a manufacturer-by-manufacturer basis as mentioned above, but also entered into an agreement with a trade association and a coalition of manufacturers in the association’s membership.[31] But such an approach could face retaliation by the Trump Administration: during President-elect Trump’s first term, the U.S. Department of Justice briefly sought to investigate the manufacturers involved in these agreements for violations of antitrust law.[32]

Conclusion

In his second term, President-elect Trump is likely to target California’s authority to regulate mobile source emissions, and especially GHG emissions. Lessons from the first Trump Administration indicate that CARB may respond by taking an aggressive position on retroactive enforcement to induce manufacturers to comply with California regulations during any waiver revocation period. The question of CARB’s authority to retroactively enforce mobile source emissions regulations, and the related due process concerns, has not been decided by a court or squarely addressed in litigation.

Meanwhile, even if EPA’s enforcement program shifts Title I enforcement to the states, Title II mobile source emissions enforcement will remain a federal concern. In particular, mobile source criteria pollutant cases, and especially those targeting foreign manufacturers, are likely to continue to remain part of OECA’s docket throughout President-elect Trump’s second administration.

[1] See The Safer Affordable Fuel-Efficient (“SAFE”) Vehicles Rule for Model Years 2021-2026 Passenger Cars and Light Trucks, 83 Fed. Reg. 42986 (proposed Aug. 24, 2018).

[2] See The Safer Affordable Fuel-Efficient (“SAFE”) Vehicles Rule for Model Years 2021-2026 Passenger Cars and Light Trucks, 85 Fed. Reg. 24174 (Apr. 30, 2020). Under the direction of the Biden Administration, in March 2022, EPA instituted stricter GHG standards for model years 2023 through 2026. Revised 2023 and Later Model Year Light-Duty Vehicle Greenhouse Gas Emissions Standards, 86 Fed. Reg. 74434 (Dec. 30. 2021). In April 2024, the Biden EPA promulgated model year 2027 through 2032 light- and medium-duty vehicle emissions standards, including GHG standards. Multi-Pollutant Emissions Standards for Model Years 2027 and Later Light-Duty and Medium-Duty Vehicles, 89 Fed. Reg. 27842 (Apr. 18, 2024). Currently, no major federal rules are pending for non-road engines or vehicles, or other Title II sources.

[3] BrieAnna J. Frank, Project 2025 is an effort by the Heritage Foundation, not Donald Trump | Fact check, USA TODAY (July 10, 2024, 12:05 PM ET), https://www.usatoday.com/story/news/factcheck/2024/07/10/trump-project-2025-heritage-foundation-fact-check/74340278007/.

[4] See Mandy M Gunasekara, Environmental Protection Agency, in Project 2025: Presidential Transition Project, 417, 426 (Paul Dans and Steven Groves, eds., 2023), static.project2025.org/2025_MandateForLeadership_CHAPTER-13.pdf.

[5] Id.

[6] See Ryan Hanrahan, Trump Vows to ‘End the Electric Vehicle Mandate’ in GOP Acceptance Speech, Farm Policy News (July 22, 2024), https://farmpolicynews.illinois.edu/2024/07/trump-vows-to-end-the-electric-vehicle-mandate-in-gop-acceptance-speech/.

[7] See Diana Furchtgott-Roth, Project 2025 Chapter 19 Department of Transportation 627 (2024), static.project2025.org/2025_MandateForLeadership_CHAPTER-19.pdf.

[8] See id.

[9] See 42 U.S.C. § 7543. 

[10] 42 U.S.C. §§ 7543(b), (e). Clean Air Act Section 209(b), 42 U.S.C. § 7543(b), pertains to preemption waivers for on-road vehicles and engines. Under Section 209(e), 42 U.S.C. § 7543(e), EPA may issue authorization for California to adopt and enforce its own non-road vehicle or engine emission standards.

[11] See Gunasekara, supra note 3.

[12] Alexandra Ulmer and David Shepardson, Trump says no state would be allowed to ban gasoline-powered cars if he is elected, Reuters (Oct. 4, 2024), https://www.reuters.com/business/autos-transportation/trump-says-no-state-would-be-allowed-ban-gas-powered-cars-if-he-is-elected-2024-10-03/.

[13] See The Safer Affordable Fuel-Efficient (“SAFE”) Vehicles Rule for Model Years 2021-2026 Passenger Cars and Light Trucks, 83 Fed. Reg. at 42999.

[14] See The Safer Affordable Fuel-Efficient Vehicles Rule Part One: One National Program, 84 Fed. Reg. 51310, 51337 (Sept. 27, 2019).

[15] See In re Air Resources Board, OAL Matter No. 2018-1114-03, Cal. Office of Admin. Law, (Dec. 12, 2018), https://www.arb.ca.gov/regact/2018/leviii2018/form400dtc.pdf.

[16] See Letter from Mary D. Nichols, Chairman, CARB, to U.S. EPA and U.S. Dep’t of Transp. (July 28, 2011), https://www.epa.gov/sites/default/files/2016-10/documents/carb-commitment-ltr.pdf (“California commits to propose to revise its standards on GHG emissions from new motor vehicles for model-years MYs 2017 through 2025, such that compliance with the GHG emissions standards adopted by EPA for those model years that are substantially as described in the July 2011 Notice of Intent, even if amended after 2012, shall be deemed compliance with the California GHG emissions standards . . . .”).

[17] Press Release, CARB, California and major automakers reach groundbreaking framework agreement on clean emission standards (July 25, 2019), https://ww2.arb.ca.gov/news/california-and-major-automakers-reach-groundbreaking-framework-agreement-clean-emission. Later, CARB also agreed to allow an additional OEM to enter into a Framework Agreement. See CARB, Framework Agreements on Clean Cars, https://ww2.arb.ca.gov/resources/documents/ framework-agreements-clean-cars (last visited Nov. 11, 2024).

[18] The Safer Affordable Fuel-Efficient Vehicles Rule Part One: One National Program, 84 Fed. Reg at 51329  n.211. In contemporaneous public statements, CARB explained that they offered the Framework Agreements to manufacturers that “support[ed] . . . California’s authority to set vehicle emissions standards” after EPA had indicated its intent to revoke CARB’s Section 209(b) waiver. Media Advisory, CARB, Mary Nichols to Explain Why CARB Is Not Attending the 2019 Los Angeles Auto Show (Nov. 20, 2019), https://ww2.arb.ca.gov/news/media-advisory-mary-nichols-explain-why-california-air-resources-board-not-attending-2019-los. The Framework Agreements were finalized in August 2020 after the revocation of California’s waiver under Section 209(b) of the Clean Air Act to regulate GHG emissions.

[19] See Letter from CARB Regarding Revised 2023 and Later Model Year Light-Duty Vehicle Greenhouse Gas Emissions Standards, Docket ID No. EPA-HQ-OAR-2021-020, to Michael Regan, EPA Administrator, at 9 (Sept. 27, 2021), https://ww2.arb.ca.gov/sites/default/files/2021-10/2021-9-27-final-carb-my-2023-26-usepa-ghg-stds-ccessible.pdf; see also Union of Concerned Scientists v. Nat’l Highway Traffic Safety Admin., No. 19-1230, consolidated with Nos. 19-1239, 1241, 1242, 1243, 1243, 1246, 1249, 1174, and 1178, (D.C. Cir., filed Dec. 26, 2019).

[20] California State Motor Vehicle Pollution Control Standards, 87 Fed. Reg. 14332 (Notice of Decision, Mar. 14, 2022).

[21] See, e.g., Toyota Motors North America, Comment Letter on California State Motor Vehicle Pollution Control Standards; Advanced Clean Car Program; Reconsideration of a Previous Withdrawal of a Waiver of Preemption, Docket No. EPA-HQ-OAR-2021-0257(July 6, 2021 at 4–5) (raising concerns of retroactive enforcement in public comments to EPA’s proposed reconsideration of California’s waiver).

[22] See Opportunity for Public Hearing and Public Comment; California State Motor Vehicle Pollution Control Standards, 89 Fed. Reg. 57151 (Jul. 12, 2024).

[23] CARB, Advanced Clean Fleets Regulation, Enforcement Notice (Dec. 28, 2023) https://ww2.arb.ca.gov/sites/default/files/2023-12/231228acfnotice_ADA.pdf.

[24] Truck and Engine Manufacturers Association, Comment Letter on California State Motor Vehicle Pollution Control Standards; Advanced Clean Fleets Regulation; Request for Waiver of Preemption and Authorization; Opportunity for Public Hearing and Comment, EPA-HQ-OAR-2023-0589 (Sept. 12, 2024) (“. . . to apply the waiver retroactively violates both the CAA and basic principles of due process. The Due Process Clause of the U.S. Constitution requires a government to provide individuals with “an opportunity (1) to know what the law is and (2) to conform their conduct accordingly. Landgraf v. USI Film Prods., 511 U.S. 244, 265 (1994). Retroactive laws contravene “the bedrock due process principle that the people should have fair notice of what conduct is prohibited.” PHH Corp. v. CFPB, 839 F.3d 1, 46 (D.C. Cir. 2016), reinstated in relevant part, 881 F.3d 75, 83 (D.C. Cir. 2018) (en banc). . . . Accordingly, applying CARB’s regulations retroactively would undermine due process generally and as specifically incorporated into the CAA’s preemption waiver provisions. As a result, it is clear that California has no authority to apply its mobile source standards until after a waiver is granted.”).

[25] CARB, Advanced Clean Fleets Regulation, Enforcement Notice (Dec. 28, 2023, updated Oct. 25, 2024) https://ww2.arb.ca.gov/sites/default/files/2024-10/241025acfnotice_ADA.pdf (stating CARB has “decided to exercise its enforcement discretion” to refrain from enforcement action as to certain aspects of the rule “until U.S. EPA grants a preemption waiver . . . or[]determines a waiver is not necessary.”).

[26] See Ohio v. EPA, 98 F.4th 288, 293 (DC Cir. 2024), petition for cert. filed, No. 24-450 (U.S. Oct. 22, 2024).

[27] Id. at 294.

[28] See Press Release, Office of Governor Gavin Newsom, Governor Newsom convenes a special session of the Legislature to protect California values (Nov. 7, 2024), https://www.gov.ca.gov/2024/11/07/special-session-ca-values/ (calling for the California Legislature to allocate additional funding for state agencies “to pursue robust affirmative litigation against any unlawful actions by the incoming Trump Administration, as well as defend against federal lawsuits aimed at undermining California’s laws and policies.”).

[29] See Blanca Begert and Alex Nieves, It’s Already Trump’s World. California Is Just Living In It., Politico (Oct. 15, 2024 5:00 AM EDT), https://www.politico.com/news/2024/10/15/trump-california-environment-supreme-court-00183585.

[30] Loper Bright Enterprises v. Raimondo, 603 U.S. ___, 144 S. Ct. 2244 (2024).

[31] Press Release, CARB, CARB and truck and engine manufacturers announce unprecedented partnership to meet clean air goals (July 6, 2023), https://ww2.arb.ca.gov/news/carb-and-truck-and-engine-manufacturers-announce-unprecedented-partnership-meet-clean-air.

[32] See, e.g., Timothy Puko and Ben Foldy, Justice Department Launches Antitrust Probe Into Four Auto Makers” Wall St. J. (Sept. 6, 2019, 5:55 PM ET), https://www.wsj.com/articles/justice-department-launches-antitrust-probe-into-four-auto-makers-11567778958.

---

The following Gibson Dunn lawyers prepared this update: Stacie Fletcher, Rachel Levick, and Veronica J.T. Goodson.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Environmental Litigation and Mass Tort practice group:

Environmental Litigation and Mass Tort:

Stacie B. Fletcher – Washington, D.C.
(+1 202.887.3627, sfletcher@gibsondunn.com)

Rachel Levick – Washington, D.C.
(+1 202.887.3574, rlevick@gibsondunn.com)

Raymond B. Ludwiszewski – Washington, D.C.
(+1 202-955-8665, rludwiszewski@gibsondunn.com)

Veronica J.T. Goodson – Washington, D.C.
(+1 202.887.3719, vgoodson@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

From the Derivatives Practice Group: The CFTC published a final rule adopting amendments to regulations governing the self-certification of registered entities.

New Developments

• CFTC Publishes Final Rule Adopting Amendments to Regulations Governing Registered Entities. On November 7, the CFTC adopted amendments to its regulations under the Commodity Exchange Act that govern how registered entities submit self-certifications, and requests for approval, of their rules, rule amendments, and new products for trading and clearing, as well as the CFTC’s review and processing of such submissions. According to the CFTC, the amendments are intended to clarify, simplify and enhance the utility of those regulations for registered entities, market participants and the CFTC. The effective date for this final rule is December 9, 2024. [NEW]
• CFTC Market Risk Advisory Committee to Hold Public Meeting on December 10. On November 5, the CFTC’s Market Risk Advisory Committee (“MRAC”) announced that, on December 10, 2024, from 9:30 a.m. to 12:30 p.m. (Eastern Standard Time), it will hold a public, in-person meeting at the CFTC’s Washington, DC headquarters, with options for virtual attendance. The MRAC indicated that it plans to discuss current topics and developments in the areas of central counterparty (“CCP”) risk and governance, market structure, climate-related risk, and innovative and emerging technologies affecting the derivatives and related financial markets, including discussions led by the CCP Risk & Governance and Market Structure subcommittees with recommendations related to CCP cyber resilience and critical third-party service providers and the cash futures basis trade, respectively. [NEW]
• CFTC Warns of Potential Dangers for Messaging App Users. On October 31, the CFTC Office of Customer Education and Outreach released a customer advisory alerting messaging app users to beware of schemes to defraud them of assets, specifically crypto assets. Fraudsters are exploiting the default settings of commonly used messaging apps, telephone networks, and mobile devices to lure users into crypto pump-and-dump schemes and other scams.
• Commissioner Pham Announces CFTC Global Markets Advisory Committee Meeting on November 21. CFTC Commissioner Caroline D. Pham, sponsor of the Global Markets Advisory Committee (“GMAC”), announced the GMAC will hold a virtual public meeting Thursday, Nov. 21, from 9:30 a.m. to 10:30 a.m. EST. At this meeting, the GMAC will hear a presentation by the Tokenized Collateral workstream of the GMAC’s Digital Asset Markets Subcommittee on expanding use of non-cash collateral through use of distributed ledger technology and consider a recommendation from the Subcommittee. The meeting will also include a presentation by the Utility Tokens workstream of the Digital Asset Markets Subcommittee summarizing their work to-date on defining utility tokens and developing guidance for market participants.
• SEC Adopts Rule Amendments and New Rule to Improve Risk Management and Resilience of Covered Clearing Agencies. On October 25, the SEC adopted rule amendments and a new rule to improve the resilience and recovery and wind-down planning of covered clearing agencies. The rule amendments establish new requirements regarding a covered clearing agency’s collection of intraday margin as well as a covered clearing agency’s reliance on substantive inputs to its risk-based margin model. The new rule prescribes requirements for the contents of a covered clearing agency’s recovery and wind-down plan. The rule amendments require that a covered clearing agency that provides central counterparty services has policies and procedures to establish a risk-based margin system that monitors intraday exposures on an ongoing basis, includes the authority and operational capacity to make intraday margin calls as frequently as circumstances warrant (including when risk thresholds specified by the covered clearing agency are breached or when the products cleared or markets served display elevated volatility), and documents when the covered clearing agency determines not to make an intraday call pursuant to its written policies and procedures.
• SEC Division of Examinations Announces 2025 Priorities. On October 21, the SEC’s Division of Examinations released its 2025 examination priorities. The Division of Examinations indicated that it will continue to focus on whether security-based swap dealers (“SBSDs”) have implemented policies and procedures related to compliance with security-based swap rules generally, including whether they are meeting their obligations under Regulation SBSR to accurately report security-based swap transactions to security-based swap data repositories and, where applicable, whether they are complying with relevant conditions in SEC orders governing substituted compliance. For other SBSDs, the Division of Examinations said that it may focus on SBSDs’ practices with respect to applicable capital, margin, and segregation requirements and risk management. The Division of Examinations also indicated that it expects to assess whether SBSDs have taken corrective action to address issues identified in prior examinations. Additionally, the Division of Examinations advised that it may begin conducting examinations of registered security-based swap execution facilities in late fiscal year 2025.

New Developments Outside the U.S.

• ESAs Publish 2024 Joint Report on Principal Adverse Impacts Disclosures Under the Sustainable Finance Disclosure Regulation. On October 30, the European Supervisory Authorities (“ESAs”) published their third annual Report on disclosures of principal adverse impacts under the Sustainable Finance Disclosure Regulation (“SFDR”). The Report assesses both entity and product-level Principal Adverse Impact disclosures under the SFDR. These disclosures aim at showing the negative impact of financial institutions’ investments on the environment and people and the actions taken by asset managers, insurers, investment firms, banks and pension funds to mitigate them.
• The ESAs Finalize Rules to Facilitate Access to Financial and Sustainability Information on the ESAP. On October 29, the ESAs published the Final Report on the draft implementing technical standards (“ITS”) regarding certain tasks of the collection bodies and functionalities of the European Single Access Point (“ESAP”). The requirements are designed to enable future users to be able to access and use financial and sustainability information effectively and effortlessly in a centralized ESAP platform.
• ESMA Consults on Amendments to MiFID Research Regime. On October 28, ESMA launched a consultation on amendments to the research provisions in the Markets in Financial Instruments II (“MiFID II”) Delegated Directive following changes introduced by the Listing Act. The Listing Act introduces changes that enable joint payments for execution services and research for all issuers, irrespective of the market capitalization of the issuers covered by the research. The Consultation Paper includes proposals to amend Article 13 of the MiFID II Delegated Directive in order to align it with the new payment option offered.

New Industry-Led Developments

• Ark 51 Adopts CDM for CSA Data Extraction. On November 5, ISDA announced that Ark 51, an artificial intelligence (AI) and data analytics service developed by legal services provider DRS, has used the Common Domain Model (CDM) to convert information from ISDA’s regulatory initial margin (IM) and variation margin (VM) credit support annexes (CSAs) into digital form. Ark 51 is a contract and risk management system that uses AI to extract key data from legal agreements, including IM and VM CSAs. The CDM transforms that data into a machine-readable format that can be quickly and efficiently exported to other systems, cutting the resources associated with manual processing. [NEW]
• ISDA Letter to FASB on Share-based Payment from a Customer in a Revenue Contract. On October 21, ISDA submitted a response to the Financial Accounting Standards Board (“FASB”) on File Reference No. 2024-ED100, Derivatives Scope Refinements and Scope Clarification for a Share-based Payment from a Customer in a Revenue Contract. ISDA believes the FASB’s proposal will improve the application and relevance of the Derivatives and Hedging (Topic 815) and Revenue from Contracts with Customers (Topic 606) guidance and has provided potential refinements to the guidance in the letter.

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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, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus  – New York (212.351.3869,  alapidus@gibsondunn.com )

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

William R. Hallatt , Hong Kong (+852 2214 3836, whallatt@gibsondunn.com )

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki , New York (212.351.4028, mtakagaki@gibsondunn.com )

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

The Final Rule brings the standard for determining when a person has “identified” an overpayment in line with the FCA’s knowledge standard and formalizes a six-month good-faith investigation period—but risks for providers remain.

Introduction

On November 1, 2024, the federal Centers for Medicare and Medicaid Services (CMS) issued a Final Rule (the “Final Rule“) regarding the identification, reporting, and return of overpayments by Medicare participants.  The Final Rule applies to participants in Medicare Parts A through D––providers, suppliers, managed care organizations, Medicare Advantage organizations, and prescription drug plan sponsors.  The Final Rule will be published in the Federal Register on December 9, 2024, and will go into effect on January 1, 2025.

Under the Affordable Care Act (ACA), recipients of federal health care program funds must report and return any overpayments within 60 days of “identifying” them.  The Final Rule starts the 60-day clock for return of overpayments when an entity “knowingly receives or retains an overpayment,” replacing a prior standard—rejected in a 2018 court decision—that had started the clock at the point when an entity “should have determined through . . . reasonable diligence” that it received an overpayment.  The Final Rule also introduces a 180-day suspension of the 60-day clock to allow for “good-faith” internal investigations into potential overpayments.  Prior to the Final Rule, CMS had suggested that “most” such investigations should be completed within 180 days, but did not make that a formal deadline.  However, investigations undertaken in good faith can last well over six months, and in finalizing the rule, CMS declined to reconsider the 180-day timeline or allow for extensions.  Because the Final Rule also provides that the period for investigating overpayments ends at the latest when the 180-day suspension period ends, entities may face FCA challenges based on claims that investigations lasting longer than 180 days were not conducted in “good faith.”

Background

An “overpayment” occurs when CMS reimburses an entity for health care goods or services in excess of the amount to which the entity is entitled.  Under the ACA, an entity must report and return an overpayment 60 days after the date on which the overpayment is “identified.”[1]  The ACA does not specify what it means to “identify” an overpayment.  An overpayment not returned by the appropriate deadline is considered an “obligation” under the “reverse” provision of the federal False Claims Act (FCA), which prohibits knowing and improper avoidance of an obligation to pay money to the government.[2]

In a series of regulations promulgated in 2014 and 2016, CMS stated that a Medicare participant “identifies” an overpayment when it “has determined, or should have determined through the exercise of reasonable diligence, that [it] has received an overpayment.”[3]  This was essentially a negligence standard, and meant that reverse FCA liability could be premised on something less than recklessness, which is the minimum level of scienter the FCA requires.  For several years, the CMS regulations remained intact, and in fact met with deference by some courts—most notably in the case of Kane ex rel. United States v. Healthfirst, Inc., 120 F. Supp. 3d 370 (S.D.N.Y. 2015).  There, in analyzing reverse FCA allegations regarding Medicaid overpayments, the court credited CMS’s definition of “identified” in the Medicare context.[4]

Change came in UnitedHealthcare Ins. Co. v. Azar, which struck down the “reasonable diligence” standard.[5]  The district court there held that the standard impermissibly created potential FCA liability based on mere negligence as to an obligation to return an overpayment, when the FCA itself requires at least reckless disregard.[6]  In response to the UnitedHealthcare decision, CMS proposed a rule in late 2022 that—for the entire Medicare program—defined “identified” by reference to the relatively more stringent definition of “knowing” and “knowingly” contained in the FCA itself.[7]

Both the UnitedHealthcare decision and the 2022 Proposed Rule, however, left a key question unanswered, namely:  how can providers avoid being charged with “knowledge” of an overpayment—within the meaning of the FCA—if they take longer than 60 days to conduct a good-faith investigation to determine whether overpayments have occurred?   Particularly in large organizations with high volumes of claims, the running of that clock without any action to return monies to the government is very often a sign that a good-faith investigation into potential overpayments remains underway, not that overpayments were quickly identified and are being concealed or disregarded.

While the Final Rule provides a measure of clarity, it ultimately does not answer this question—and in fact, it creates new risks for providers facing potential FCA challenges.

Changes Effectuated by the Final Rule

At the most basic level, the Final Rule codifies the UnitedHealthcare court’s holding by providing that the 60-day clock for repayments begins when an entity “knowingly receives or retains an overpayment,” and explicitly incorporates the FCA’s definition of the word “knowingly.”[8]

The Final Rule also introduces a new provision ostensibly aimed at affording Medicare participants time to conduct internal investigations into potential overpayments.  In 2015, CMS acknowledged that such investigations could take around 180 days, but prior to now the agency had not implemented either a requirement that such investigations be completed in that timeframe or an explicit provision tolling the deadline for return of overpayments pending such investigations.[9]  The Final Rule, dovetailing off of CMS’s observation in 2015, provides for a maximum 180-day suspension of the 60-day clock to allow providers to conduct internal investigations.[10]  In particular, the 180-day suspension applies if a provider has identified at least one overpayment and conducts a “good-faith investigation to determine the existence of related overpayments.”[11]

While the 180-day period seems aimed at providing greater clarity around CMS’s expectations for the timeline for investigating potential overpayments, a six-month investigation period is likely to prove a poor fit for many Medicare participants.  Smaller providers facing relatively straightforward overpayment issues may have little trouble completing investigations in 180 days.  But larger institutions such as hospitals—for which potential overpayments could span multiple providers and disease states and involve a variety of personnel over long periods of time—are likely to face significant challenges investigating and calculating potential overpayments on a six-month timeframe.  Such investigations require time not only by compliance personnel but also by caregivers themselves, who are expected to provide information to aid in the investigation while juggling the non-stop realities of patient care and the operation of the enterprise itself.  Even a fast-moving investigation in this sort of setting could easily take more than six months to yield conclusions.

That much could perhaps be addressed by a longer investigation period, at least for large institutional providers.  But the Final Rule exacerbates the challenges for such providers by providing that the investigation period closes either when the aggregate overpayments have been identified and calculated or when 180 days have passed.[12]  Because the Final Rule states that only a “good-faith” investigation will trigger the 180-day suspension period, the rule creates a risk that the government—or FCA relators—will argue that any investigation longer than 180 days was not conducted in “good faith,” and thus that any provider that does not return putative overpayments within 60 days after the expiration of the 180-day window has acted “knowingly” and faces reverse FCA liability for that reason.  As the previous CMS guidance did, the Final Rule leaves open what types of information or scenarios would trigger an obligation to investigate short of having “actual knowledge” of the potential overpayment.

The comments CMS received on the Proposed Rule pointed to the challenges of completing an investigation of potential overpayments within six months.  CMS acknowledged that they “heard from many commentators on the issue of time needed for investigations and calculations of overpayments,” and that some comments proposed that the rule include a process to extend the 180-day period for complex investigations, or include an 8-month investigation suspension.[13]  Nonetheless, CMS stated that general support for codification of an investigatory period led them to believe that they had “appropriately balanced the needs of providers and suppliers with the required statutory mandates.”[14]  It remains to be seen whether or not courts agree with that assertion—particularly in the wake of the Supreme Court’s Loper Bright decision, which empowers federal courts to independently evaluate, rather than defer to, federal agencies’ interpretations of the statutes they implement.[15]  For now, Medicare participants undertaking complex overpayment investigations may be faced with a difficult choice in some cases:  investigate for longer than 180 days and risk an accusation of “bad faith,” or somehow make a repayment to the payor before the potential overpayment is confirmed and/or quantified.  The dilemma appears designed to force on providers a commitment of resources to quickly investigate potential overpayments that may not be available in all cases.  Among other questions about how the Final Rule will be implemented, it remains to be seen whether CMS, Medicare Administrative Contractors, and/or potential FCA enforcers will be willing to consider a provider’s facts and circumstances in cases where investigative deadlines cannot be met.  Additionally, while this Final Rule is specific to Medicare, FCA cases in other regulatory contexts regularly present the question of the appropriate timeline for internal investigations to identify potential overpayments.  It remains to be seen whether the 180-day suspension period and the “good faith” requirement—and the risks they pose—have broader implications for defendants facing FCA investigations and litigation outside the health care arena.

Gibson Dunn will continue to monitor developments related to the Final Rule.  And, of course, we would be happy to discuss these developments—and their implications for your business—with you.

[1] 42 U.S.C. § 1320-7k(d).

[2] Id.; 31 U.S.C. § 3729(a)(1)(g).

[3] See, e.g., 42 C.F.R. § 422.326(c) (Medicare Advantage rule); 42 C.F.R. § 401.305(a)(2) (Part A and B rule), 42 C.F.R. § 423.360(c) (Part D rule).

[4] 120 F. Supp. 3d at 383-93.

[5] 330 F. Supp. 3d 173 (D.D.C. 2018), rev’d on other grounds sub nom. UnitedHealthcare Ins. Co. v. Becerra, 16 F.4th 867 (D.C. Cir. 2021).

[6] UnitedHealthcare Ins. Co. v. Azar, 330 F. Supp. 3d at 191.

[7] Contract Year 2024 Medicare Parts A, B, C, and D Overpayment Provisions, 87 Fed. Reg. 79452, 79559 (Dec. 27, 2022).

[8] Dep’t of Health & Hum. Servs., Centers for Medicare & Medicaid Servs., RIN 0938-AV33 and 0938-AU96, at 2446 (emphasis added).

[9] Medicare Program; Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs, 79 Fed. Reg. 29,844, 29,923 (May 23, 2014).

[10] Dep’t of Health & Hum. Servs., Centers for Medicare & Medicaid Servs., RIN 0938-AV33 and 0938-AU96, at 2447.

[11] Id.

[12] Id.

[13] Id. at 1871-72.

[14] Id. at 1871.

[15] Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244, 2273 (2024).

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The following Gibson Dunn lawyers prepared this update: Jonathan Phillips, Winston Chan, Michael Dziuban, and Heather Skrabak.

Gibson Dunn lawyers regularly counsel clients on the False Claims Act issues and 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 False Claims Act/Qui Tam Defense practice group:

Washington, D.C.
Jonathan M. Phillips – Co-Chair (+1 202.887.3546, jphillips@gibsondunn.com)
Stuart F. Delery (+1 202.955.8515,sdelery@gibsondunn.com)
F. Joseph Warin (+1 202.887.3609, fwarin@gibsondunn.com)
Gustav W. Eyler (+1 202.955.8610, geyler@gibsondunn.com)
Lindsay M. Paulin (+1 202.887.3701, lpaulin@gibsondunn.com)
Geoffrey M. Sigler (+1 202.887.3752, gsigler@gibsondunn.com)
Joseph D. West (+1 202.955.8658, jwest@gibsondunn.com)

San Francisco
Winston Y. Chan – Co-Chair (+1 415.393.8362, wchan@gibsondunn.com)
Charles J. Stevens (+1 415.393.8391, cstevens@gibsondunn.com)

New York
Reed Brodsky (+1 212.351.5334, rbrodsky@gibsondunn.com)
Mylan Denerstein (+1 212.351.3850, mdenerstein@gibsondunn.com)

Denver
John D.W. Partridge (+1 303.298.5931, jpartridge@gibsondunn.com)
Ryan T. Bergsieker (+1 303.298.5774, rbergsieker@gibsondunn.com)
Robert C. Blume (+1 303.298.5758, rblume@gibsondunn.com)
Monica K. Loseman (+1 303.298.5784, mloseman@gibsondunn.com)

Dallas
Andrew LeGrand (+1 214.698.3405, alegrand@gibsondunn.com)

Los Angeles
James L. Zelenay Jr. (+1 213.229.7449, jzelenay@gibsondunn.com)
Nicola T. Hanna (+1 213.229.7269, nhanna@gibsondunn.com)
Jeremy S. Smith (+1 213.229.7973, jssmith@gibsondunn.com)
Deborah L. Stein (+1 213.229.7164, dstein@gibsondunn.com)
Dhananjay S. Manthripragada (+1 213.229.7366, dmanthripragada@gibsondunn.com)

Palo Alto
Benjamin Wagner (+1 650.849.5395, bwagner@gibsondunn.com)

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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 October 29, the Sixth Circuit upheld summary judgment in favor of Berea College with respect to a white professor’s claims that the college discriminated against him on the basis of race and age in violation of Title VII and the ADEA. Porter v. Sergent et al., No. 23-5944 (6th Cir. 2024). The professor was fired after he emailed all students and faculty “a survey to measure ‘community perceptions and attitudes about academic freedom, freedom of speech, and hostile work environments under civil rights law,’” which contained “hypothetical scenarios based on Porter’s observations of [a colleague’s] Title IX investigation.” The professor claims “Berea fired him because he is an older, white male,” relying on an alleged comment made at a hiring committee meeting that the department did not need “any more old white guys.” The unanimous three-judge panel consisting of Judges Griffin, Kethledge, and Bush found that this comment did not influence the school’s termination decision. The panel also rejected the argument that younger female professors were not disciplined for refusing to attend meetings, while white male professors were disciplined for similar conduct, because the plaintiff was not disciplined for such conduct himself. (The court permitted the professor’s defamation claim to go to a jury.)

On October 30, a unanimous three-judge panel of the Fifth Circuit affirmed a decision by the U.S. District Court for the Southern District of Texas that a white professor who never applied for a position at Texas A&M University lacked standing to bring a reverse-discrimination case against the school. Lowery v. Texas A&M Univ, No. 23-20481 (5th Cir. 2023). The professor alleged that Texas A&M favored women and non-Asian minorities as professorial candidates, and that although he was “able and ready,” he did not apply for a position under a belief that it would be a “futile gesture.” In a per curiam opinion, Judges Jones, Willett, and Engelhardt found his failure to apply “fatal” to the case, noting that he had applied for a position at another university with similar practices. America First Legal represents the plaintiff.

On October 23, 2024, the Equal Protection Project (EPP) filed a complaint with the U.S. Department of Education’s Office for Civil Rights against Santa Clara University (SCU). EPP alleges that SCU’s Black Corporate Board Readiness Program (BCBR) violates Title VI of the Civil Rights Act. The BCBR is described as “designed to accelerate diverse representation in corporate governance,” and is allegedly available only to Black individuals.

On October 25, 2024, a coalition of investors, financial advisors, and fiduciaries led by Inspire Investing, an investment firm that promotes “biblically responsible investing,” released an open letter addressed to Fortune 1000 companies, responding to an October 15, 2024 open letter signed by 40 Democratic House Members that urged company leaders to continue to defend DEI. The investors’ response argues that corporate DEI efforts “divide[] employees from each other,” “punish[] dissenting views,” and have “little if any link [to] company performance metrics.” The letter claims that DEI programs pose “serious legal risk” following the Supreme Court’s decisions in Students for Fair Admission v. Harvard, and City of St. Louis v. Muldrow.

Media Coverage and Commentary:

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

• The New York Times, “A New Business on Wall Street: Defending Against D.E.I. Backlash” (October 24): Lauren Hirsch of The New York Times reports on the emerging business strategies of Wall Street law and communications firms to help companies prepare for attacks on their corporate DEI efforts. Hirsch highlights Robby Starbuck, who has targeted companies like Tractor Supply and John Deere, as a prominent figure in the opposition to corporate DEI programs in the wake of SFFA. Hirsch notes that companies are responding to the threat of anti-DEI attacks by “conducting vulnerability assessments, compiling research reports and writing plans for what to do if Starbuck comes calling.” And although companies are trying to mitigate the legal risk associated with DEI programs, Jason Schwartz, co-chair of Gibson Dunn’s Labor & Employment practice, says that after speaking with approximately 50 major companies about restructuring their diversity programs, few are willing to abandon these initiatives entirely.
• Bloomberg, “Companies Are Dropping the D or E From DEI to Avoid Criticism” (October 28): Bloomberg’s Jeff Green reports that companies are altering the terminology used to describe their DEI initiatives in response to ongoing backlash from conservative activists. According to a poll conducted by The Conference Board, just over 50% of 60 surveyed executives have modified diversity program descriptions, with an additional 20% considering similar adjustments. Green says that many companies are opting to drop “equity” from their program titles, as it is perceived as the most controversial term. Green highlights that it remains unclear whether these terminology changes reflect substantive modifications to DEI programs or merely an attempt to avoid controversy.
• The New York Times, “The Anti-D.E.I. Agitator That Big Companies Fear Most” (November 1): The New York Times’ David Segal profiles conservative anti-DEI activist Robby Starbuck and his role in the “counterreaction” to corporate DEI. Segal says that Starbuck views DEI as “wokeness run amok.” According to Segal, Starbuck “nearly always interprets corporate responses to his campaigns as complete surrender and often overstates his financial effect on corporate profits,” but Wall Street analysts disagree and believe that stocks “have risen and fallen for unrelated reasons.” Segal says that many companies targeted by Starbuck announced changes to their DEI programs “while restating a broad commitment to a diverse workplace.”
• Bloomberg, “Boeing Dismantles DEI Team as Pressure Builds on New CEO” (November 1): Jeff Green and Julie Johnson of Bloomberg report that Boeing has “dismantled its global diversity, equity and inclusion department,” as part of a broader restructuring of the company’s workforce. Green and Johnson say that staff from Boeing’s DEI office will be combined with another human resources team focused on talent and employee experience. Anti-DEI activist Robby Starbuck claimed credit for the move, saying that he had alerted Boeing that he was considering launching a campaign against their diversity programs before the company announced its changes. In a statement, Boeing said it “remains committed to recruiting and retaining top talent and creating an inclusive work environment.”

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:

• Faculty, Alumni, and Students Opposed to Racial Preferences (FASORP) v. Northwestern University, No. 1:24-cv-05558 (N.D. Ill. 2024): On September 30, 2024, nonprofit advocacy group FASORP filed an amended complaint against Northwestern University, alleging that discriminatory practices at Northwestern Law School violate Title VI, Title IX, and Section 1981. The suit claims that three anonymous FASORP members were wronged by the consideration of race and sex in law school faculty hiring decisions, and that student editors of the Northwestern University Law Review give discriminatory preference to “women, racial minorities, homosexuals, and transgender people when selecting their members and editors” and when selecting articles to publish. The amended complaint also alleges plagiarism among candidates who were selected for law school faculty positions and in articles published by the Law Review. FASORP seeks to enjoin Northwestern from (1) considering race, sex, sexual orientation, or gender identity in the appointment, promotion, retention, or compensation of its law school faculty or the selection of articles, editors, and members of the Northwestern University Law Review, and (2) soliciting such identity information from law school faculty candidates or Law Review applicants. FASORP also asked the court to order Northwestern to establish a new policy for selecting law school faculty and law review articles, editors, and members, to appoint a court monitor to oversee all related decisions, and to enjoin the university from accepting any federal funds until it has ceased all alleged discriminatory practices.
  • Latest update: On October 28, 2024, Northwestern moved to dismiss the first amended complaint for lack of standing and failure to state a claim. Northwestern argues that FASORP lacks standing because it has not sufficiently alleged its anonymous members’ qualifications or the steps the members took to attempt to join the Law School’s faculty. In addition, Northwestern argues that the complaint does not allege that FASORP members are qualified to submit, or did in fact submit, articles to the Law Review, or are or were ever Northwestern students. Even if FASORP has standing, Northwestern argues that its claims are outside the ambit of Title VI and Title IX, and its Section 1981-based claims are meritless, vague, and conclusory. A telephonic hearing on the motion to dismiss is set for March 11, 2025.
• Khatibi v. Hawkins, No. 23-cv-06195 (C.D. Cal. 2023), on appeal No. 24-3108 (9th Cir. 2024): On August 1, 2023, doctors Azadeh Khatibi and Marilyn M. Singelton, along with Do No Harm, a “membership group for medical professionals and others opposing diversity, equity and inclusion initiatives,” sued officials of the Medical Board of California, alleging that the Board unconstitutionally compelled their speech in violation of the First Amendment. Plaintiffs challenged a California law that, since January 1, 2022, has required all Continuing Medical Education (CME) courses to “contain curriculum that includes the understanding of implicit bias.” Khatibi and Singelton allege that, but for this law, they would never include implicit bias training in their medical curriculum because it is unrelated to their courses. On May 2, 2024, the Court granted the defendants’ motion to dismiss without leave to amend, adopting their argument that the requirements do not violate the First Amendment because teaching CME courses is government speech that is part of a state licensing scheme, and, much like teachers of a state-mandated public school curriculum, the doctor-educators are not associated with the contents of their course. On May 15, 2024, the plaintiffs appealed to the United States Court of Appeals for the Ninth Circuit. On August 23, 2024, the plaintiffs filed their opening brief.
  • Latest update: On October 24, 2024, the defendants filed their answering brief, arguing that the “implicit bias requirement does not implicate [] First Amendment rights because the content of CME courses is government speech.” The defendants also argue that even if the content is private speech protected under the First Amendment, it is a valid condition applied to a discretionary government benefit.
• American Alliance for Equal Rights v. Southwest Airlines Co., No. 24-cv-01209 (N.D. Tex. 2024): On May 20, 2024, American Alliance for Equal Rights (AAER) filed a complaint against Southwest Airlines, alleging that the company’s ¡Latanzé! Travel Award Program, which awards free flights to students who “identify direct or parental ties to a specific country” of Hispanic origin, improperly discriminates based on race. AAER seeks a declaratory judgment that the program violates Section 1981 and Title VI, a temporary restraining order barring Southwest from closing the next application period (set to open in March 2025), and a permanent injunction barring enforcement of the program’s ethnic eligibility criteria. On August 22, 2024, Southwest moved to dismiss, arguing that the case was moot because the company had signed a covenant with AAER that eliminated the challenged provisions from future program application cycles.
  • Latest update: On October 17, 2024, AAER responded to Southwest’s motion to dismiss, arguing it has standing to seek nominal damages but conceding that Southwest’s covenant could moot AAER’s request for injunctive relief.

2. Employment discrimination and related claims:

• Bradley, et al. v. Gannett Co. Inc., 1:23-cv-01100 (E.D. Va. 2023): On August 18, 2023, white plaintiffs sued Gannett over its alleged “Reverse Race Discrimination Policy,” claiming Gannett’s expressed commitment to having its staff demographics reflect the communities it covers violates Section 1981. On August 21, 2024, the court granted Gannett’s motion to dismiss, holding that Gannett’s diversity policy alone did not establish disparate treatment, since it did not define any specific goals or quotas. The court also held that each named plaintiff had failed to state a claim for individual relief pursuant to Section 1981 and dismissed the class allegations because the class was not ascertainable and lacked commonality. On September 19, 2024, the plaintiffs filed a second amended complaint. On October 3, 2024, Gannett moved to dismiss the second amended complaint for failure to state a claim and moved to dismiss or strike the class allegations.
  • Latest update: On October 17, 2024, the plaintiffs filed an opposition to Gannett’s motion to dismiss and strike class allegations. The plaintiffs argued that their second amended complaint clarified several of their arguments and sufficiently alleged a class that could meet the requirements for class certification. Furthermore, the plaintiffs argued that in its motion to dismiss, Gannett failed to acknowledge the Fourth Circuit’s recent decision in Duvall v. Novant Health, Inc., an “on point intervening decision” that held policies similar to Gannett’s were discriminatory. In its response, filed on October 23, 2024, Gannett reaffirms its position that the plaintiffs’ allegations were conclusory and failed to assert facts giving rise to any claims of discrimination. Additionally, Gannett argues that the plaintiffs’ reliance on Duvall was misplaced because it interpreted Title VII, not Section 1981. On October 29, Judge Rossie D. Alston, Jr. terminated the oral argument set for November 6 because he will decide the motion on the papers.
• Dill v. International Business Machines, Corp., No. 1:24-cv-00852 (W.D. Mich. 2024): On August 20, 2024, America First Legal filed a reverse discrimination suit against IBM on behalf of a former IBM employee, alleging violations of Title VII and Section 1981. The plaintiff claims that IBM placed him on a performance improvement plan as a “pretext to force him out of [IBM] due to [its] stated quotas related to sex and race.” The plaintiff seeks back pay, damages for emotional distress, and a declaratory judgment that IBM’s policies violate Title VII and Section 1981. The complaint cites to a leaked video in which IBM’s Chief Executive Officer and Board Chairman, Arvind Krishna, allegedly states that all executives must increase representation of underrepresented minorities on their teams by 1% each year in order to receive a “plus” on their bonuses.
  • Latest update: On October 23, 2024, IBM moved to dismiss the complaint for failure to state a claim for race and gender discrimination under Title VII and Section 1981. IBM contends that the plaintiff failed to make any factual allegations and merely relied on his personal beliefs and conjecture. Further, IBM argues that the plaintiff failed to plead sufficient “background circumstances to support the suspicion that the defendant is that unusual employer who discriminations against the majority” as required in the Sixth Circuit. (The continued viability of this test is before the Supreme Court in Ames v. Ohio Department of Youth Services (No. 23-1039).)
• De Piero v. Pennsylvania State University, No. 2:23-cv-02281-WB (E.D. Pa. 2023): A white male professor sued his employer, Penn State University, claiming that university-mandated DEI trainings, discussions with coworkers and supervisors about race and privilege in the classroom, and comments from coworkers about his “white privilege” created a hostile work environment that led him to quit his job. He claimed that after he reported this alleged harassment and published an opinion piece objecting to the impact of DEI concepts in the classroom, the university retaliated against him by investigating him for bullying and aggressive behavior towards his colleagues. The plaintiff alleged harassment, retaliation, and constructive discharge in violation of Title VI, Title VII, Section 1981, Section 1983, the First Amendment, and Pennsylvania civil rights laws.
  • Latest update: On October 21, 2024, the defendants moved for summary judgment on the plaintiff’s hostile work environment claims. The defendants argue the plaintiff cannot show that he experienced discrimination based on his race because he was not required to attend any of the meetings about which he complains. Defendants also argue that the plaintiff cannot show respondeat superior liability for Penn State, and that his claim for punitive damages fails as a matter of law.
• Fuzi v. Worthington Steel Co., No. 3:24-cv-01855-JRK (N.D. Ohio 2024): A former employee sued Worthington Steel for religious discrimination and retaliation in violation of Title VII, claiming he was fired for opposing Worthington’s DEI initiative that included a requirement that employees use each other’s preferred pronouns. The plaintiff claims that the policy violated his Christian beliefs, and that he was fired in retaliation for filing an EEOC charge relating to his complaints.
  • Latest update: The docket does not yet reflect that the defendant has been served.

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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, Cate McCaffrey, Jenna Voronov, Emma Eisendrath, Felicia Reyes, Allonna Nordhavn, Laura Wang, Maya Jeyendran, Kristen Durkan, Ashley Wilson, Lauren Meyer, Kameron Mitchell, Chelsea Clayton, Albert Le, Emma Wexler, Heather Skrabak, and Godard Solomon.

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, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment Group
Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)

Mylan L. Denerstein – Partner & Co-Chair, Public Policy Group
New York (+1 212-351-3850, mdenerstein@gibsondunn.com)

Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer
Washington, D.C. (+1 202-955-8503, zswilliams@gibsondunn.com)

Molly T. Senger – Partner, Labor & Employment Group
Washington, D.C. (+1 202-955-8571, msenger@gibsondunn.com)

Blaine H. Evanson – Partner, Appellate & Constitutional Law Group
Orange County (+1 949-451-3805, bevanson@gibsondunn.com)

We are pleased to provide you with Gibson Dunn’s ESG update covering the following key developments during October 2024. Please click on the links below for further details.

I. GLOBAL

1. Taskforce on Nature-related Financial Disclosures (TNFD) publishes guidance on nature transition planning

On October 27, 2024, the TNFD published guidance on drafting a nature transition plan. The paper also defines a nature transition plan and explains how to disclose it in accordance with the TNFD recommended disclosures. Specifically, a nature transition plan is a plan laying out the organization’s goals, targets, actions, and other accountability mechanisms to respond and contribute to the transition set out by the Global Biodiversity Framework (GBF). The GBF’s transition is to halt and reverse biodiversity loss by 2030 and put nature on a path to recovery by 2050. In creating the draft guidance, the TNFD states it built on current market practice for climate transition planning.

2. International Sustainability Standards Board (ISSB) finalizes updates to the Sustainability Accounting Standards Board (SASB) Standards Taxonomy

In October 2024, the ISSB published updates to incorporate amendments previously made to the SASB Standards. First, in June 2023, amendments were adopted to align the SASB standards with the International Financial Reporting Standards (IFRS) S2 Climate-related Disclosures. The IFRS S2 sets out the requirements for disclosing information about climate-related risks to which the entity is exposed, as well as climate-related opportunities available to the entity. Second, in December 2023, amendments were made to improve the international applicability of the SASB standards. These amendments apply to non-climate-related content and were designed to aid preparers in applying the standards regardless of the jurisdiction in which they operate or the accounting principles used. The updates are also intended to support consistency between the SASB and other standards, such as the IFRS Sustainability Disclosure Taxonomy.

II. UNITED KINGDOM

1. UK Government issues response on UK Carbon Border Adjustment Mechanism (UK CBAM) consultation

On October 30, 2024, the UK Government published its response to the UK CBAM consultation. UK CBAM is intended to ensure that “highly traded, carbon intensive” imported goods are subject to a carbon price that is comparable to goods produced in the UK. The Government confirmed that it would introduce UK CBAM on January 1, 2027, initially applying to goods imported from the aluminum, cement, fertilizer, hydrogen, iron and steel sectors. The sectoral scope will remain under review and products from the glass and ceramic sectors will be considered for future inclusion. It would apply to “direct” and “indirect” (including certain “precursor”) product emissions, and the overall UK CBAM liability is intended to account for carbon prices applicable in other jurisdictions.

2. New duty on UK employers to prevent sexual harassment in the workplace comes into force

On October 26, 2024, the Worker Protection (Amendment of Equality 2010) Act 2023, which places a new positive and anticipatory legal duty on UK employers to take “reasonable steps” to prevent sexual harassment in the workplace, came into force. Guidance suggests the duty covers sexual harassment by clients, customers and other third parties (not just by other employees). Under the new rules, the Employment Tribunal will have the power to uplift compensation for harassment by a maximum of 25% where an employer is found to have breached this duty. The Equality and Human Rights Commission has provided guidelines on the reasonable steps employers can take to identify risks and prevent sexual harassment, including: (i) developing effective anti-harassment policies; (ii) adopting a zero-tolerance approach; (iii) conducting risk assessments; (iv) training staff on dealing with potential incidents; and (v) monitoring complaints and outcomes.

We note that the Employment Rights Bill (discussed below) expands the employer’s obligation by requiring them to take “all reasonable steps” to prevent sexual harassment in the workplace.

3. Institute of Directors publishes a voluntary code of conduct for directors

Following a public consultation undertaken between June and August 2024, on October 23, 2024, the Institute of Directors launched a Code of Conduct to help directors of UK companies make better decisions and to provide organizational leaders with a behavioral framework to help them build and maintain the trust of the wider public in their business activities. The voluntary Code is structured around the following six key principles of director conduct: (1) leading by example: demonstrating exemplary standards of behavior in personal conduct and decision-making; (2) integrity: acting with honesty, adhering to strong ethical values, and doing the right thing; (3) transparency: communicating, acting and making decisions openly, honestly and clearly; (4) accountability: taking personal responsibility for actions and their consequences; (5) fairness: treating people equitably, without discrimination or bias; and (6) responsible business: integrating ethical and sustainable practices into business decisions, taking into account societal and environmental impacts.

4. House of Lords Select Committee publishes its report on The Modern Slavery Act

On October 16, 2024, the House of Lords Modern Slavery Act 2015 Committee published a report on the Modern Slavery Act 2015. In the report titled “The Modern Slavery Act 2015: becoming world-leading again,” the Select Committee recommends: (i) that the UK Government’s immigration policy and legislation should recognize and consider the difference between migrants who come to the UK willingly and those who have come because they have been trafficked; (ii) creation of an arms-length single enforcement body to ensure stronger compliance with relevant labor rights and standards, which should act as a single point of contact for labor exploitation across all sectors; and (iii) legislation requiring companies meeting the threshold to undertake modern slavery due diligence in their supply chains. The UK Government is required to respond by December 16, 2024.

5. UK’s cap-and-floor scheme to support energy storage investment

On October 10, 2024, the UK Government announced a new scheme to promote investment in long duration electricity storage capacity, including for renewable energy sources. This announcement follows the UK Government’s 2024 consultation proposing a “cap-and-floor” scheme, which the Government believes would provide a guaranteed minimum income for developers, in return for a limit on revenues. The scheme is expected to open next year, with Ofgem acting as the regulator.

6. UK Government publishes its Employment Rights Bill

On October 10, 2024, the UK Government published its Employment Rights Bill (the “Bill”). The Bill proposes enhancements to “Day One” employee rights including removing the qualifying periods for protection from unfair dismissal, flexible working, parental leave, paternity leave, and bereavement leave. The Bill also provides for sexual harassment to become a protected disclosure under whistleblowing laws, as well as changes: (i) to the controversial practice of dismissing and re-hiring employees as a means of unilaterally changing terms of employment; (ii) to the ability of employers to engage workers on “zero hours” contracts; and (iii) designed to strengthen employee rights and protections in connection with both collective redundancy situations (lay-offs) and business transfers, strategic sourcing transactions, and other transfers subject to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246). The Bill seeks to establish a single enforcement body for UK employment laws and an extension to the time limits for bringing employment claims before the Employment Tribunal. In addition, the Bill imposes further obligations on employers to address the gender pay gap, extend the gender pay gap regime to include race and disability and support employees going through menopause. The consultation process is expected to begin in 2025. Please see here for our detailed briefing.

7. UK Government pledges £21.7 billion in funding for carbon capture and storage projects

On October 4, 2024, the UK Government announced that funding will be made available to launch the UK’s first carbon capture sites, which includes Teesside and Merseyside. Over the next 25 years, funding of up to £21.7 billion is expected to be made available to be allocated between carbon capture, use and storage, and hydrogen.

III. EUROPE

1. Sustainability Statements among the European Securities and Markets Authority’s (ESMA) Key Three Enforcement Priorities

The initial reports under the Corporate Sustainability Reporting Directive (CSRD) are expected in reporting season on financial years ending December 31, 2024, i.e., in Q1/Q2 2025, and will be closely monitored by ESMA. The CSRD establishes a comprehensive reporting framework that includes more than 1,000 specific data points. On October 24, 2024, the ESMA outlined the European common enforcement priorities for the 2024 reporting period, highlighting sustainability statements as one of three key focus areas. ESMA, together with national enforcers in the EU, will pay particular attention to these areas when examining the application of the relevant reporting requirements. This comes alongside other important issues, including companies’ assessments of materiality and the disclosure of methodologies used to evaluate the materiality of certain topics.

2. EU invests EUR 4.8 billion in Decarbonization Projects Funded by Carbon Pricing

The European Commission announced on October 23, 2024, that it has chosen 85 projects focused on decarbonization technologies to receive EUR 4.8 billion in grants funded through its EU Emissions Trading System (EU ETS). This is the fourth and largest round of the Innovation Fund, bringing the total amount awarded to date to EUR 12 billion. This latest round is notable for including projects of different sizes, from large and medium-scale initiatives to small and pilot projects. It also emphasizes the manufacturing of clean technologies, supporting the development and operation of production facilities for key components in wind and solar energy, heat pumps, electrolyzers, fuel cells, energy storage technologies and the battery supply chain. The Commission plans to announce the next call for proposals for the Innovation Fund in December 2024.

3. EU Council agrees to delay the EU Deforestation Regulation (EUDR) Applicability by one year

On October 16, 2024, following a proposal by the European Commission on October 2, 2024, the Council of the European Union decided to extend the application timeline for the EUDR. The EUDR, which is directly applicable in all EU member states, in its current form starts to be effective from December 31, 2024 for large and medium sized companies and from June 30, 2025, for micro and small enterprises. In case the European Parliament ratifies the EU Council’s decision in its plenary session on November 13/14, 2024, the EUDR will only be phased-in for large and medium-sized companies on December 30, 2025, and for micro and small enterprises on June 30, 2026, allowing companies to better prepare for its vast array of requirements.

4. Open letter urges EU to establish ambitious investment plan for climate and biodiversity goals

On October 9, 2024, a coalition of 47 businesses, civil society organizations, and investors published a letter, urging the EU to establish an investment plan to achieve its climate and biodiversity targets. The letter emphasizes the need for swift mobilization of public and private resources to limit global warming and preserve ecosystems. It is argued that a predictable regulatory framework is crucial to attract private investment necessary to facilitate the green transition. Thus, without a long-term strategy, the EU may risk losing its competitive edge and undermining the Clean Industrial Deal. Notable signatories of the open letter include World Wildlife Foundation, the European Environmental Bureau, and Uber.

5. ESMA published first report on EU Carbon Markets for 2024

On October 7, 2024, ESMA published the first edition of its EU Carbon Markets report. The report will be published annually and provides an overview of the EU Emissions Trading System. According to the report, the prices in the EU Emissions Trading System have decreased significantly since the beginning of 2023. This is attributed to a combination of lower demand for EU emissions, falling natural gas prices and decarbonization of the European energy sector, along with increased supply following the decision to auction additional allowances to finance the REPowerEU plan. 

6. CSRD Transposition is progressing

A new draft of the Luxembourg CSRD transposition law has been published. Enactment of the transposition laws in Poland and Spain is imminent. An overview of the transposition of CSRD into national laws can be found here.

IV. NORTH AMERICA

1. U.S. House bill could alter the reporting of greenhouse gas emissions caused by federal legislation

On October 29, 2024, U.S. Representative Joe Neguse (D-CO) introduced H.R. 10074, a bill directing the Comptroller General of the United States, in coordination with the National Academy of Sciences, to study alternatives for a nonpartisan congressional office or agency to project the net greenhouse gas emissions likely to be caused by federal legislation. The bill also includes a provision for studying lessons that can be learned from states that have “successfully implemented carbon scoring for legislative proposals,” such as California. Co-sponsors of the bill include Representative Kathy Castor (D-Fl), Representative Sean Casten (D-IL), and Representative Jared Huffman (D-CA).

2. The Hershey Company (Hershey) accused of material misrepresentations related to bubble gum product

On October 24, 2024, plaintiffs filed a class action complaint against Hershey alleging, among other claims, that the company violated provisions of the California Business and Professions Code by issuing false and misleading statements regarding the company’s products. The complaint targets Hershey’s claims regarding its commitment to the planet, communities, and children, and the plaintiff’s claim that testing shows that the company’s popular Bubble Yum Original Flavor Bubble Gum contains organic fluorine, perfluoroalkyl and polyfluoroalkyl (PFAS) chemicals in levels dangerous to the health of the children who are targets of company marketing. California law prohibits manufacturers from selling juvenile products containing PFAS substances.

3. New York City Comptroller proposes fossil fuel ban in pension fund investing

On October 22, 2024, New York City Comptroller Brad Lander announced that his office will propose ceasing future investments in midstream and downstream infrastructure by New York City’s three public pension funds. The pension funds completed their exit from fossil fuel reserve investments in 2022, and this next proposal will be presented to the trustees of the funds in early 2025. This policy builds from previous action taken by Comptroller Lander and the trustees of several New York education retirement systems to decarbonize the holdings of those retirement funds.

4. House of Representatives introduces Stop Woke Investing Act

On October 22, 2024, U.S. Representative Andy Biggs (R-AZ) introduced the Stop Woke Investing Act, which would require the U.S. Securities and Exchange Commission (the “SEC”) to allow companies to determine which shareholder proposals to include on their proxy cards and limit the number of shareholder proposals a company is required to include on its proxy card (the number to be determined by the company’s filing status). For example, a company that is a large accelerated filer would not need to include more than seven shareholder proposals, while a non-accelerated filer would not need to include more than two shareholder proposals. This bill is identical to the Stop Woke Investing Act introduced by Senator Eric Schmitt (R-MO) in late 2023 and referred to the Senate Banking, Housing and Urban Affairs committee (though the bill did not progress further).

5. WisdomTree Asset Management, Inc. (WisdomTree) settles enforcement action related to ESG investment strategy

On October 21, 2024, the SEC charged investment advisor WisdomTree with making misstatements and failing to comply with the company’s own ESG investment strategy. The SEC’s order asserts that WisdomTree claimed in prospectuses for ESG-marketed funds that the funds would not invest in companies “involved in certain controversial products or activities,” including fossil fuels and tobacco. However, the SEC alleged that WisdomTree’s screening process was inadequate, resulting in the ESG-marketed funds investing in companies deriving revenues from fossil fuels and tobacco. The SEC’s order found that WisdomTree violated the antifraud provisions and the compliance rule in the Investment Advisers Act of 1940. WisdomTree consented to entry of the SEC’s final order and agreed to pay a $4 million penalty.

6. SEC seeks comments on Green Impact Exchange, LLC (GIX) registration

On October 21, 2024, the SEC issued an order instituting proceedings to determine whether to grant or deny GIX’s application for registration as a national securities exchange. GIX filed its Form 1 application with the SEC on May 9, 2024, and seeks to operate a fully automated electronic equity trading platform. If the SEC grants GIX’s application, companies whose securities are listed on another national securities exchange may apply to list their securities on GIX. GIX proposes to require all companies listing their securities on the trading platform to comply with GIX’s Green Governance Standards. According to GIX’s Form 1 application (Exhibit H-5), these standards provide investors with information regarding the “quality of a listed company’s commitment to sustainable ways of doing business,” rather than enforcing targets or reporting frameworks. The SEC’s order requests comments from interested persons on or before November 15, 2024.

7. Bill seeks to prevent federal agencies from considering the social cost of carbon and other greenhouse gases in agency action

On October 11, 2024, U.S. Representative Richard Hudson (R-NC) introduced the Transparency and Honesty in Energy Regulations Act of 2024. The bill seeks to prohibit federal agencies from considering the social cost of carbon, methane, nitrous oxide or any other greenhouse gas as part of any cost-benefit analysis, rulemaking, issuance of any guidance, agency action, or as a justification for any rulemaking, guidance document, or agency action. An additional section of the bill requires the head of each federal agency to submit a report to House and Senate committees detailing the number of proposed and final rulemakings, guidance documents or agency actions since January 2009, that have used the social cost of carbon or any of the other listed emissions or greenhouse gases. Twelve members, all Republicans, co-sponsored the proposed legislation.

8. Canada to require mandatory climate disclosures for large companies and provide sustainable investment guidelines

On October 9, 2024, the Canadian government announced its intention to require mandatory climate-related financial disclosures. The purpose of these disclosures, which apply to large, federally incorporated private companies, is to “help investors better understand how large businesses are thinking about and managing risks related to climate change, ensuring that capital allocation aligns with the realities of a net-zero economy.” The specific information included in these disclosures is yet to be determined, but the disclosure requirements will be incorporated into the Canada Business Corporations Act through an amendment. The reporting requirements will not apply to small and medium-sized businesses. The government may encourage voluntary disclosure, however.

The Canadian government also announced its decision to introduce Made-in-Canada sustainable investment guidelines intended to serve as a tool for “investors, lenders, and other stakeholders navigating the global race to net-zero by credibly identifying ‘green’ and ‘transition’ economic activities.”

9. U.S. Commodity Futures Trading Commission (CFTC) files lawsuit alleging carbon credit misrepresentations

On October 2, 2024, the CFTC filed a complaint in the U.S. District Court for the Southern District of New York against Kenneth Newcome, former chief executive officer and majority shareholder of carbon credit project developer C-Quest, alleging violations of securities laws. The complaint claims that Newcome “engaged in a fraudulent scheme that involved reporting false and misleading information to at least one carbon credit registry…to obtain carbon credits for beyond what the company was entitled to receive, and to increase the company’s revenue by millions of dollars.” The alleged violations occurred between 2019 and December 2023. As part of the remedy requested, the CFTC seeks orders requiring Newcome to pay a penalty, disgorge all benefits received from the alleged violations, and refrain from entering into future transactions involving certain commodities.

This complaint follows and relates to a CFTC order initiating administrative proceedings against CQC Impact Investors LLC (CQC) and an order initiating proceedings against Jason Steele, CQC’s former chief operating officer. Both orders were issued on September 30, 2024. For more on this CFTC action, see the CFTC press release relating to this matter.

In case you missed it…

The Gibson Dunn Workplace DEI Task Force has published its updates for October summarizing the latest key developments, media coverage, case updates, and legislation related to diversity, equity, and inclusion.

V. APAC

1. Asia Investor Group on Climate Change (AIGCC) calls for ambitious energy targets in Japan’s 7th Strategic Energy Plan

On October 24, 2024, AIGCC submitted a position paper on Japan’s upcoming 7th Strategic Energy Plan. AIGCC urged for Japan to set ambitious energy transition targets, emphasizing the importance of renewable energy expansion, clear phaseout plans for fossil fuels, and carbon pricing mechanisms. The position paper highlights the need for investor input in policy development, a high-ambition scenario aligned with a 1.5°C pathway, and integration of emission reduction technologies to attract capital and strengthen Japan’s position in sustainable industries.

2. Hong Kong unveils Sustainable Finance Action Agenda

On October 21, 2024, the Hong Kong Monetary Authority (HKMA) introduced its Sustainable Finance Action Agenda, setting out its vision and targets for banks to reach net-zero financed emissions by 2050. Banks are expected to disclose climate-related risks, align with global standards, and make transition plans available by 2030 on a “comply or explain” basis. The agenda also focuses on HKMA’s own investment sustainability, incentivizing green finance innovations, and addressing talent gaps in sustainable finance. These initiatives underscore Hong Kong’s aim to become a sustainable finance hub in Asia.

3. Australia releases Guide on AI for ESG practitioners

On October 21, 2024, the Australia Department of Industry, Science and Resources and the National Artificial Intelligence Centre jointly published an introductory guide to AI for ESG practitioners, highlighting how AI can help address urgent challenges in health, climate change, sustainability, accessibility, and inclusion. The introductory guide addresses why ESG practitioners should consider responsible use of AI, how to assess AI in the ESG sector, ideas for enhancing ESG solutions with AI and steps to start responsibly using AI in ESG contexts.

4. Malaysia’s ESG Disclosure Report: Establishing Baseline Standards for Reporting Practices

On October 15, 2024, the Securities Commission Malaysia (SC) and the World Bank released a joint report on “ESG Disclosure Assessment of Malaysia’s Listed Companies and Recommendations for Policy Development” at the SC-World Bank Conference 2024. This report, based on a comprehensive assessment of ESG practices among 90 companies and major asset owners, sets a baseline for sustainable reporting. While highlighting strong governance and social reporting, it identifies gaps in environmental metrics, especially on climate and biodiversity. The report concluded with a set of recommendations, including enhancing disclosure practices and supporting Malaysia’s National Sustainability Reporting Framework.

5. Hong Kong Code of Conduct for ESG ratings and data products providers

On October 3, 2024, the International Capital Market Association (ICMA) published the Hong Kong Code of Conduct for ESG Ratings and Data Products Providers (the Code). Modeled on international best practices and sponsored by the Hong Kong Securities and Futures Commission, the Code is a voluntary Code of Conduct that aims to establish and promote a globally consistent, interoperable, and proportionate voluntary code for providers offering ESG ratings and data products and services in Hong Kong. The Code is closely aligned to the recommendations by the International Organization of Securities Commissions’ Report on “Environmental, Social and Governance (ESG) Ratings and Data Products Providers.” Following the publication, the ICMA is responsible for hosting and maintaining the Code.

Please let us know if there are other topics that you would be interested in seeing covered in future editions of the monthly update.

Warmest regards,
Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Robert Spano

Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP

For further information about any of the topics discussed herein, please contact the ESG Practice Group Chairs or contributors, or the Gibson Dunn attorney with whom you regularly work.

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The following Gibson Dunn lawyers prepared this update: Lauren Assaf-Holmes, Carla Baum, Mitasha Chandok, Becky Chung, Georgia Derbyshire, Ferdinand Fromholzer, Muriel Hague, William Hallatt, Beth Ising, Sarah Leiper-Jennings, Vanessa Ludwig, Babette Milz*, Johannes Reul, Annie Saunders, Helena Silewicz*, QX Toh, and Katherine Tomsett.

*Helena Silewicz, a trainee solicitor in London, and Babette Milz, a research assistant in Munich, are not admitted to practice law.

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

ESG Practice Group Leaders and Members:
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213.229.7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214.698.3295, rkirk@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202.955.8238, mmurphy@gibsondunn.com)
Robert Spano – London/Paris (+33 1 56 43 13 00, rspano@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

The much-anticipated guidance for the new corporate offence of failure to prevent fraud (the “Guidance”) was published on 6 November 2024. This starts the countdown to the offence coming into force on 1 September 2025.[1]

Introducing a “failure to prevent” offence for fraud will have a significant impact on the ability of law enforcement agencies to combat fraud.  The SFO said it is “looking forward to using it to penalise large organisations who should be doing better”[2] and the SFO’s Director, Nick Ephgrave, recently told the Financial Times that deferred prosecution agreements (DPAs) “could come back with a vengeance once a new offence that puts the onus on businesses to prevent fraud comes into force.”[3]  The Guidance itself mentions the prospect of DPAs.

The Guidance states that the failure to prevent fraud offence should make it easier to hold organisations to account.  The Government hopes that the offence will improve fraud prevention procedures and ultimately drive a major shift in corporate culture.[4]

A) Recap of the failure to prevent fraud offence

The offence of failure to prevent fraud was introduced by the Economic Crime and Corporate Transparency Act 2023 (ECCTA).[5]  Under the new offence, an organisation will be criminally liable[6] where a specified fraud offence[7] is committed by a person associated with the organisation (such as an employee or agent) with the intention of benefitting, for example, the organisation or its clients.  Senior managers need not have ordered or known about the fraud.

The offence applies to large organisations, which are those meeting at least two of the following conditions: a turnover of more than £36m, more than £18m in total assets, or more than 250 employees.[8] A defence is available where an organisation had reasonable prevention procedures in place, or where it was unreasonable to expect it to have such procedures.

B) What does the Guidance say?

The Guidance offers clarification of certain aspects of the offence in section 199 ECCTA, provides examples of hypothetical scenarios in which the offence may apply and makes recommendations as to how companies should prepare for the new offence coming into force.  However, it remains to be seen how the offence will be prosecuted in practice.  We have outlined key aspects of the Guidance below.

1. Territoriality

ECCTA states that the failure to prevent fraud offence applies to organisations wherever incorporated or formed.[9]  However, a UK nexus is required for the offence to be committed, which means “one of the acts which was part of the underlying fraud took place in the UK or that the gain or loss occurred in the UK.”[10]  The Guidance indicates that this means that a fraud which takes place entirely outside the UK could be prosecuted if, for example, there were UK-based victims.

2. Offences committed by associated persons

The concept of a person associated with an organisation will be familiar from the UK Bribery Act.  The Guidance confirms that an employee, agent or subsidiary of a large organisation automatically falls within the definition of associated person, and a person who provides services for or on behalf of the organisation is an associated person while they provide those services.[11]

Crucially, the associated person does not need to have been convicted of one of these offences.  However, the prosecution must prove to a criminal standard that the person committed the offence before the organisation can be convicted of failure to prevent fraud.[12]

3. Subsidiaries

In respect of subsidiaries, the guidance indicates that:

• a large organisation can be prosecuted where the underlying offence is committed corporately by one of its subsidiaries and where the beneficiary is the parent organisation or its clients to whom the subsidiary provides services for or on behalf of the parent;
• such a parent company can also be prosecuted if an employee of its subsidiary commits a relevant offence that is intended to benefit the parent company;
• a subsidiary of a large organisation can be prosecuted if an employee of the subsidiary commits a relevant offence that is intended to benefit the subsidiary even if the subsidiary itself is not a large organisation.[13]

4. Benefit

The issue of who is intended to benefit from the underlying offence is key to determining whether a company can be held accountable.[14]  The benefit can be direct or indirect, actual or intended.[15]  The benefit can be to the company, its clients, or a subsidiary of the client.[16]  This is broader than the UK Bribery Act, which focuses on intended benefit to the organisation.

5. What do reasonable fraud prevention procedures look like in practice?

The defence of having reasonable fraud prevention measures in place is difficult to define, and the Guidance does not attempt to set out an exhaustive list of steps that companies should take: in fact, it notes expressly that even strict compliance with the Guidance may not be sufficient where a company faces particular risks arising from the nature of its business.

Nevertheless, the Guidance does set out six defining principles which should inform a company’s fraud prevention framework.  Some key points are highlighted below:

1. Top level commitment

• The Guidance stresses that senior management should take the lead when it comes to fraud prevention: this will include fostering a culture in which staff feel able to report potential cases of fraud, and communicating clearly the company’s policies and codes of practices to staff.
• Where fraud prevention measures are overseen by a Head of Compliance or someone in a similar role, that person should have direct access to the company’s board or CEO, and senior management should ensure that a reasonable and proportionate budget is in place to train staff and implement the company’s fraud prevention plan.

2. Risk assessment

• The Guidance makes clear that “it will rarely be considered reasonable not to have even conducted a risk assessment” but it acknowledges that companies may find it most effective to extend existing risk assessments which are already in place.
• The Guidance suggests that companies should consider the different levels of fraud risk presented by different categories of associated person, taking into account their opportunity and motive to commit fraud, as well as the potential for the “rationalisation” of a fraud: in other words, does a company’s culture and/or sector tolerate fraud, and do staff feel able to escalate any potential concerns?
• A risk assessment is not a one-off exercise: the Guidance states that the assessment should be revisited at consistent intervals, perhaps annually or bi-annually, and that a court may consider that reasonable procedures were not in place at the time of any alleged fraud if the risk assessment has not been recently reviewed.

3. Proportionate risk-based prevention procedures

• Once the risk assessment has been carried out, a fraud prevention plan should be put in place. This should be proportionate to the risks identified and their potential impact.
• Reasonable fraud prevention procedures should look to reduce the opportunity and motive to commit fraud, put in place consequences for committing fraud and reduce what the Guidance describes as “ethical fading”; in other words, where fraudulent behaviour becomes normalised within a company or industry.
• The Guidance acknowledges that many companies will be regulated, but stresses that processes and procedures already in place to ensure compliance with other regulations will not automatically qualify as reasonable procedures for the purposes of ECCTA.
• One interesting exception identified in the Guidance, presumably inspired by lessons from the Covid-19 pandemic, is where there is an emergency; i.e. where there is “a risk of widespread loss of life or damage to property, or significant financial instability”. The Guidance recognises that an emergency may not be foreseeable, and that it may therefore be reasonable not to have had fraud prevention procedures in place.  Nevertheless, the guidance stresses that reasonable procedures should be put in place as quickly as reasonably possible once the emergency has passed.

4. Due diligence

• Again, the Guidance acknowledges that many companies will already have due diligence procedures in place, but states that it will not necessarily be sufficient to apply existing procedures.
• The Guidance highlights the need to carry out due diligence on associated persons and in relation to any anticipated mergers or acquisitions. It suggests using appropriate technology to help, including third-party tools, and notes the importance of integrating existing fraud prevention measures following a merger or acquisition.

5. Communication and training

• Clear communication of a company’s stance on fraud at all levels of the organisation is important, and the Guidance suggests incorporating this in existing policies.
• Companies should put in place training for staff which is proportionate to the risks involved. That may involve additional training for those in high-risk positions.  As with the risk assessment, training should be kept up to date, particularly as new staff join or existing staff change roles, and the effectiveness of the training should be monitored.
• The Guidance also highlights the need for a robust whistleblowing process.

6. Monitoring and review

• When it comes to detecting fraud, the Guidance again highlights the use of technology such as data analytics tools, and poses the question (but does not answer it!) as to whether AI could be used to identify potential fraud.
• Companies may need to modify existing systems to identify and investigate fraud committed against the organisation to ensure that fraud designed to benefit the organisation or its clients can also be detected.
• The Guidance stresses the need for independent, fair, legally compliant and properly resourced investigations into any suspected fraud.
• A company will need to keep under review the nature of the risks it faces, given these are likely to change over time: this means fraud prevention measures may need to change too. The Guidance suggests that reviews should happen at regular intervals, such as annually or bi-annually, and that they can be conducted internally or by an external party.
• However, where a company is audited by an external auditor, that audit alone is not sufficient evidence of the existence of reasonable fraud prevention

C) Practical steps to take now

By way of key takeaways, we recommend that clients think about the following next steps:

• Conduct a risk assessment for the organisation as a whole. It is clear that this is the minimum first step towards having reasonable fraud prevention procedures in place and, given the scope of the different definitions in ECCTA, is likely to require revision or development of existing assessments;
• Establish a reasonable and proportionate fraud prevention plan;
• Review existing policies and procedures and ensure that the company’s stance of preventing fraud is clearly communicated to staff;
• Check what training is currently provided to staff and consider where additional training on preventing fraud could be necessary;
• Ensure that robust whistleblowing policies and procedures are in place;
• Where in doubt, seek expert advice.

[1] https://www.gov.uk/government/news/new-failure-to-prevent-fraud-guidance-published

[2] https://globalinvestigationsreview.com/article/senior-sfo-lawyer-failure-prevent-fraud-heralds-exciting-time-the-agency

[3] https://www.ft.com/content/b7540e7a-97fb-481a-8805-92fb54a425f2

[4] Guidance Failure to Prevent Fraud, chapter 1.1. See also our previous client alert published on 12 January 2024: Extraterritorial Impact of New UK Corporate Criminal Liability Laws – Gibson Dunn

[5] ECCTA s.199

[6] ECCTA s.199 and Guidance Failure to Prevent Fraud, chapter 1.1

[7] Including fraud by false representation, fraud by failing to disclose information, fraud by abuse of position, cheating the public revenue, false accounting, false statements by company directors and fraudulent trading: see ECCTA, schedule 13.

[8] ECCTA s.201.  The conditions must be met in the financial year of the organisation that precedes the year of the fraud offence.

[9] ECCTA s.199(13)

[10] Guidance Failure to Prevent Fraud chapter 2.5

[11] ECCTA s.199 (7) and (8) and Guidance Failure to Prevent Fraud chapter 2.3

[12] Guidance Failure to Prevent Fraud chapter 2.2

[13] Guidance Failure to Prevent Fraud chapter 2.3.1 and ECCTA s.199

[14] Guidance Failure to Prevent Fraud chapter 2.4

[15] ECCTA s.199 (1) and (2)

[16] Guidance Failure to Prevent Fraud chapter 2.4 and 2.5

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The following Gibson Dunn lawyers prepared this update: Allan Neil, Patrick Doris, Christopher Loudon, Marija Bračković, Amy Cooke, and Katherine Tomsett.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any leader or member of Gibson Dunn’s White Collar Defense and Investigations practice group, or the authors:

Allan Neil – London (+44 20 7071 4296, aneil@gibsondunn.com)
Patrick Doris – London (+44 20 7071 4276, pdoris@gibsondunn.com)
Christopher Loudon – London (+44 20 7071 4249, cloudon@gibsondunn.com)
Maria Bračković – London (+44 20 7071 4143 mbrackovic@gibsondunn.com)
Amy Cooke – London (+44 20 7071 4041, acooke@gibsondunn.com)
Katherine Tomsett – Hong Kong (+65 6507 3673, ktomsett@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

This update provides an overview of shareholder proposals submitted to public companies during the 2024 proxy season, including statistics and notable decisions from the staff of the Securities and Exchange Commission on no-action requests.

I. Summary of Top Shareholder Proposal Takeaways from the 2024 Proxy Season

As discussed in further detail below, based on the results of the 2024 proxy season, there are several key takeaways to consider for the coming year:

• Shareholder proposal submissions rose yet again.  For the fourth year in a row, the number of proposals submitted increased.  In 2024, the number of proposals increased by 4% to 929—the highest number of shareholder proposal submissions since 2015.
• The number of governance and social proposals increased, while civic engagement and environmental proposals decreased.  Governance proposals increased notably, up 13% from 2023, with the increase largely attributable to proposals related to the adoption of prescriptive majority voting director resignation bylaws.  The number of social proposals also increased, up 4% compared to 2023.  In contrast, civic engagement and environmental proposals declined 10% and 4%, respectively.  The five most popular proposal topics in 2024, representing 34% of all shareholder proposal submissions, were (i) climate change, (ii) nondiscrimination and diversity-related, (iii) simple majority vote, (iv) director resignation bylaws, and (v) independent chair.  Of the five most popular topics in 2024, all but two were also in the top five in 2023 (simple majority vote and director resignation bylaws replaced shareholder approval of certain severance agreements and special meetings).
• The no-action request volumes and outcomes appear to have reverted to pre-2022 norms, with the number of no-action requests increasing significantly and the percentage of proposals excluded pursuant to a no-action request continuing to rebound from 2022’s historic low.  There were 267 no-action requests submitted to the Staff in 2024, representing a submission rate of 29%, up significantly from a submission rate of 20% in 2023 and consistent with a submission rate of 29% in 2022.  The overall success rate for no-action requests, after plummeting to only 38% in 2022, continued to rebound in 2024, with a success rate of 68%, compared to a success rate of 58% in 2023.  Success rates in 2024 improved for resubmission, violation of law, ordinary business, and substantial implementation grounds, while success rates declined for procedural and duplicate proposal grounds.
• The number of proposals voted on increased yet again, but overall voting support remained at historically low levels, and only 4% of proposals submitted received majority support.  In 2024, over 55% of all proposals submitted were voted on, compared with 54% of submitted proposals voted on in 2023.  Average support across all shareholder proposals was 23.0%, roughly level with average support of 23.3% in 2023 and the lowest average support in over a decade.  Average support for governance proposals increased from 2023, while overall support for both environmental and social proposals declined.  In both cases, the decline appears to have been driven by the submission of proposals that are overly prescriptive or not particularly germane to a company’s core operations and the low voting support for proposals that challenged companies’ focus on certain ESG-related policies and practices.  While the number of shareholder proposals that received majority support increased to 39 in 2024, up from 25 in 2023, majority-supported proposals still represented only 4% of proposals submitted, up slightly from 3% in 2023.
• Anti-ESG proposals proliferated in 2024, but shareholder support was low.  The 2024 proxy season saw a continued rise in the use of the Rule 14a-8 process by proponents critical of corporate initiatives or corporate leadership that they view as inappropriately involved in environmental, social or political agenda (referred to as “anti-ESG” proposals).  This year, 107 proposals were submitted by anti-ESG proponents, on topics ranging from traditional corporate governance matters to proposals challenging companies’ diversity, equity and inclusion programs and opposing efforts to reduce greenhouse gas emissions.  Of the proposals submitted by anti-ESG proponents, 78 were voted on, receiving average support of 2.4%.  Notably, no anti-ESG proposal received more than 10% support.
• With SEC amendments to Rule 14a-8 and legislative reform efforts stalled, stakeholder challenges to the SEC’s role in the shareholder proposal process foment uncertainty.  In July 2022 the SEC proposed amendments to Rule 14a-8 to significantly narrow key substantive bases that companies use to exclude shareholder proposals on substantial implementation, duplication, and resubmission grounds remain stalled.  At the same time, after a flurry of activity in July 2023, the Republican ESG Working Group formed by the Chair of the Financial Services Committee of the U.S. House of Representatives appears to have stalled in its efforts to reform the Rule 14a-8 no-action request process.  However, ongoing legal action by two stakeholder groups (the National Center for Public Policy Research (“NCPPR”) and the National Association of Manufacturers (“NAM”)), and Exxon Mobil Corp.’s legal challenge to a proposal, as well as recent Supreme Court decisions that could further invigorate challenges to the SEC’s authority to adopt Rule 14a-8, signal that uncertainty about the shareholder proposal process and the SEC staff’s role in adjudicating Rule 14a-8 no-action requests will persist.
• Proponents and third parties continue to use exempt solicitations to advance their agendas.  Exempt solicitation filings remained at record levels, with the number of filings reaching a record high again this year—up over 69% compared to 2021.  As in prior years, the vast majority of exempt solicitation filings in 2024 were filed by shareholder proponents on a voluntary basis—i.e., outside of the intended scope of the SEC’s rules—in order to draw attention and publicity to pending shareholder proposals.  Continuing a trend first noted last year, third parties are intervening in the shareholder proposal process by using exempt solicitation filings to provide their views on shareholder proposals submitted by unaffiliated shareholder proponents.  In addition, some third parties have used exempt solicitation filings to disseminate their general views on social or governance topics beyond those raised by a specific shareholder proposal.

Read More

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The following Gibson Dunn lawyers prepared this update: Aaron Briggs, Elizabeth Ising, Julia Lapitskaya, Ronald O. Mueller, Michael Titera, Lori Zyskowski, Geoffrey Walter, Victor Twu, Natalie Abshez, Meghan Sherley, Nicholas Whetstone, Chad Kang, Nathan Marak, Antony Nguyen, and Jack Strachan.

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

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

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

We are pleased to provide you with the October edition of Gibson Dunn’s digital assets regular update. This update covers 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 Files Notice of Appeal in Case Against Ripple; Ripple Files Cross-Appeal
  On October 2, the SEC filed a notice of appeal in its enforcement action against Ripple Judge Analisa Torres ruled in July 2023 that Ripple’s secondary sales of XRP did not violate the securities laws Ripple filed a cross-appeal on October 10 and indicated in a later filing that it intends to challenge several aspects of Judge Torres’s ruling, including whether institutional sales of XRP violated the securities laws and whether Ripple lacked fair notice that the securities laws apply to XRP transactions. Ripple CEO, Brad Garlinghouse, has stated that he is confident Ripple is “going to win the appeal” “because we’re on the right side of the law” and “right side of history.” CoinDesk; Garlinghouse Statement; CCN.
• Crypto Gaming Platform Immutable Issued Wells Notice By SEC
  On November 1, Immutable—a game development platform that simplifies building Web3 games—announced that it has received a Wells Notice from the SEC related to sales of its IMX token in 2021. In a statement released on its website, Immutable said that it received the Well Notice within hours of first meeting with the SEC and that “the SEC is continuing to indiscriminately assert that tokens are securities.” Immutable stated that it would continue “business as usual” and that it welcomes “regulatory clarity – but it appears that some elements of the SEC do not want to engage in a constructive dialogue.”  Immutable’s CEO and a related entity, the Digital Worlds Foundation, reportedly received separate Wells Notices. Immutable Statement; CoinDesk.
• SEC Sues Cumberland DRW Alleging It Operated as an Unregistered Dealer
  On October 10, the SEC filed a lawsuit against Cumberland DRW LLC, a crypto trading firm, in the Northern District of Illinois alleging that Cumberland operated as an unregistered dealer in violation of the Securities Exchange Act when it bought and sold more than $2 billion in digital assets. In a letter to CoinDesk, Cumberland stated that it is “not making any changes to our business operations or the assets in which we provide liquidity as a result of this action.” The complaint seeks permanent injunctive relief, disgorgement of proceeds, prejudgment interest, and civil penalties. Press Release; Complaint; CoinDesk.
• Former FTX Chief Engineer Avoids Prison After Cooperation in Bankman-Fried Case
  On October 30, U.S. District Judge Lewis A. Kaplan sentenced former FTX chief engineer, Nishad Singh, to three years of supervision and no prison time, citing his immediate cooperation with authorities and testimony against Sam Bankman-Fried. Singh had pleaded guilty to six criminal counts and faced a theoretical statutory maximum sentence of up to 75 years in prison, but prosecutors had requested leniency for his ongoing cooperation. Law360; NYT.
• Founder of Cryptocurrency Ponzi Scheme Sentenced to More Than 10 Years in Prison
  On October 4, David Carmona, the founder of IcomTech, was sentenced to 121 months in prison. IcomTech, founded in 2018, was purportedly a cryptocurrency mining and trading company where customers purchased crypto-related investment products. Instead of making investments on behalf of clients, however, Carmona and other co-defendants used the money to promote the company, repay other clients, and enrich themselves. Press Release; The Block.
• DOJ Brings Criminal Wash Trading Charges in Cryptocurrency Matter
  On October 9, the U.S. Attorney’s Office for the District of Massachusetts charged eighteen individuals and numerous entities with market manipulation and fraud based on a wash trading theory. The government alleges that cryptocurrency companies, market makers, and employees engaged in pump-and-dump schemes through false statements and sham trades. As part of an international investigation of the alleged misconduct, federal investigators used NexFundAI, a government-created token, to try to induce the defendants to engage in wash trading. Also on October 9, the SEC filed parallel civil charges against some of the same entities and individuals. DOJ Press Release; SEC Press Release; Cointelegraph; TRM Labs.
• Crypto Ponzi Scheme Promoter Sentenced to 20 Years in Prison
  On October 15, Juan Tacuri, a senior promoter in the Forcount/Weltsys crypto Ponzi scheme that targeted Spanish speakers, was sentenced to the statutory maximum 240 months in prison by Judge Analisa Torres in the Southern District of New York. Tacuri was ordered to forfeit $3.6 million, pay restitution of at least $3.6 million, and relinquish all right and title to his Florida home. Press Release.

INTERNATIONAL

• Dubai’s VARA Fines Seven Crypto Entities for Operating Without Licenses
  On October 8, Dubai’s Virtual Assets Regulatory Authority (VARA) announced that it fined and issued cease-and-desist orders to seven entities for operating without the required licenses and for breaching marketing regulations. VARA stated that these actions serve as a “public warning . . . to all engaged in any unlicensed firms.” Press Release; CoinDesk.
• Japanese Authorities Analyze Monero Transactions, Arrest 18 in Laundering Case
  On October 21, Japan’s National Police Agency’s Cyber Special Investigation Unit arrested 18 individuals after analyzing nearly 900 transactions involving Monero—a digital asset with enhanced privacy properties—to identify instances of money laundering. According to Japanese authorities, this case marks the first time the country’s law enforcement agencies had used Monero transactions to identify suspected criminals. Cointelegraph.

REGULATION AND LEGISLATION

UNITED STATES

• New California Law Targeting Sellers of Digital Goods Might Apply to NFTs
  On September 24, California enacted AB 2426, which imposes new requirements on the sale of “digital goods.” Unless a company selling a digital good gives the buyer unrestricted ownership of the good, the seller may not use words like “buy” or “purchase” in advertising the sale, without one of two conditions being satisfied: (1) the seller obtains an affirmative acknowledgment from the buyer that the buyer is receiving only a revocable license to access the digital good, or (2) the seller provides the buyer with a “clear and conspicuous statement” that the buyers is purchasing only a revocable license. Although the law is silent on whether it applies to NFTs, the definition of “digital good” is arguably broad enough to encompass at least certain NFTs. The legislation will take effect on January 1, 2025. The National Law Review.
• Pennsylvania House Passes Bipartisan Crypto Bill
  On October 23, the Pennsylvania House of Representatives overwhelmingly passed House Bill 2481, known as the Bitcoin Rights bill, which addresses the use of bitcoin as a payment method, guidelines for taxing cryptocurrency transactions, and residents’ rights to self-custody digital assets. Similar bills are being considered by legislatures in other states. The bill will move to the Pennsylvania State Senate after the election. Bill; CoinDesk; Fox Business.
• Senators Release Discussion Draft of Regulatory Framework for Stablecoins
  On October 10, Sen. Bill Hagerty (R-TN) unveiled draft legislation that would establish a new framework to regulate stablecoins. The bill is modeled on the Clarify for Payment Stablecoins Act currently being debated in the House. It would split federal supervision of stablecoins between the Federal Reserve and the Office of the Comptroller for the Currency. Among other provisions, the bill would establish currency-reserve thresholds for issuers. Discussion Draft; The Block.
• SEC Approves Listing of Bitcoin ETF Options; Delays Decision on ETH ETF Options
  On October 18, the SEC approved two Bitcoin options ETFs. A week earlier, the SEC announced it would postpone until December 3 its decision whether to approve Ethereum options tied to ETFs. CoinDesk; Cointelegraph; CoinChapter; Cointelegraph.

INTERNATIONAL

• Denmark’s Tax Law Council Recommends Taxing Unrealized Crypto Gains
  On October 23, Denmark’s tax authority announced that the Minister of Taxation will introduce a bill in the first quarter of 2025 proposing “mark-to-market” taxation for digital assets. Under this proposal, appreciation of digital assets would be treated as capital income regardless of whether the asset is sold. Taxes are levied on the annual changes in the value of the digital asset. Denmark’s Tax Law Council recommended that the rules not take effect until Jan. 1, 2026 at the earliest, if enacted. Press Release (Danish); The Block.
• Taiwan Releases New Draft AML Rules Requiring Crypto Firms to Register
  On October 1, Taiwan’s Financial Supervisory Commission (FSC) published proposed amendments to the AML guidelines for virtual asset service providers (VASPs) and opened a 30-day comment period. The new regulations will go into effect on January 1, 2025, and VASPs are expected to register with the FSC by the end of September 2025. Failure to comply may result in imprisonment for up to two years and fines up to $155,900. The Block; CCN.
• Italy Proposes Raising Capital Gains Tax on Cryptocurrencies
  On October 16, Italy’s Deputy Finance Minister announced that the Italian government will increase its capital gains tax from 26% to 42% on cryptocurrency transactions in its 2025 budget bill. The bill also will remove the minimum revenue requirements for Italy’s Digital Services Tax (DST), which currently applies to companies with global annual income exceeding €750 million and in country income exceeding €5.5 million per calendar year. Press Conference (Italian); CoinDesk; VAT Calc.
• Netherlands Opens Consultation on Crypto Tax Reporting Bill
  On October 24, in response to EU directive DAC8, the Netherlands launched a public consultation on a proposed bill that would require crypto service providers to share user data with tax authorities. Folkert Idsinga, State Secretary for Taxation and Tax Authorities, emphasized that the measure aims to enhance transparency and prevent tax evasion through improved data exchange between EU member states. The consultation runs until November 21 and the bill is expected to reach the House of Representatives in the first half of 2025. CoinDesk; Cointelegraph.

CIVIL LITIGATION

UNITED STATES

• Crypto.com Sues the SEC Alleging Regulatory Overreach
  On October 8, after receiving a Wells Notice from the SEC, exchange Crypto.com filed a lawsuit against the agency and its Commissioners in the Eastern District of Texas, Tyler Division. Crypto.com alleges that SEC overstepped its jurisdiction by asserting authority over vast swathes of digital assets. Crypto.com claims that the SEC has adopted a de facto rule that nearly all digital assets are securities, without engaging in notice-and-comment rulemaking, and is seeking to impose that view on the crypto industry through a campaign of regulation by enforcement. Among other things, Crypto.com seeks a declaration that secondary-market transactions in digital assets are not securities and an injunction preventing the SEC from pursuing enforcement against Crypto.com based on the agency’s mistaken understanding of the securities laws. Reuters; CoinDesk.
• Alameda Research Sues Crypto Exchange KuCoin Seeking Return of $50 Million
  On October 28, Alameda Research, the crypto trading affiliate of bankrupt FTX, filed suit in Delaware bankruptcy court against crypto exchange KuCoin’s operators, seeking return of $50 million in assets currently held on the platform. The complaint alleges that KuCoin locked Alameda’s account with assets valued at nearly $30 million immediately after FTX’s November 2022 bankruptcy. KuCoin allegedly has since refused requests to return the assets, which are now valued at $50 million. This action is part of the FTX bankruptcy estate’s broader efforts to recover funds transferred from FTX prior to its bankruptcy. Law360; Cointelegraph.
• Bitnomial Exchanges Sues SEC, Seeks Permission to List XRP Futures
  On October 10, crypto exchange Bitnomial filed a lawsuit against the SEC in the U.S. District Court for the Northern District of Illinois seeking a declaration that the XRP token is not a security and thus is subject to the sole jurisdiction of the CFTC. After Bitnomial filed a self-certification with the CFTC for trading of the XRP U.S. Dollar futures contract on its exchange in August 2024, the SEC informed Bitnomial that, in the agency’s view, Bitnomial would violate the federal securities laws if it proceeded with its contemplated listing of XRP futures. Complaint; CoinDesk.
• Federal Court Clears Kalshi to List Election Betting Contracts Pending CFTC Appeal
  On October 2, the U.S. Court of Appeals for the D.C. Circuit denied the CFTC’s request for a stay of the U.S. District Court for the District of Columbia order that allowed KalshiEX LLC—a financial exchange and predictions market that allows trading of event contracts—to offer election-outcome betting contracts. The appellate court found that the CFTC failed to demonstrate a “concrete basis to conclude that event contracts” would result in irreparable harm or distort the electoral process. The CFTC filed its opening brief on October 16. Oral argument will follow the completion of briefing, which is currently scheduled to conclude on December 6. Reuters; The Block.
• Delaware Judge Approves FTX Estate’s Bankruptcy Plan
  On October 8, Delaware Bankruptcy Judge John Dorsey approved FTX’s bankruptcy plan filed in September 2024. Under the plan, customers are expected to receive cash repayments averaging 118% of the value of their assets as of FTX’s bankruptcy filing in November 2022. Those payouts, however, will not wholly account for the gains that Bitcoin and other cryptocurrencies experienced during the pendency of the bankruptcy proceeding. CoinDesk.

SPEAKER’S CORNER

UNITED STATES

• Rep. Hill “Still Optimistic” on Year-End Crypto Bills
  At the 8th Annual Washington D.C. Fintech Week on October 22, Rep. French Hill (R-AR) expressed optimism about year-end cryptocurrency legislation during a conversation with Georgetown University Law Center professor Dr. Christopher Brummer. Hill stated: “I’m still optimistic that FIT21, which is the regulatory framework bill, and the stablecoin bill have possible consideration in the lame duck,” noting that “in all lame duck sessions, they take the direction from who wins the top of the ticket, so that will govern a bit of what we’re dealing with.” The Block.
• CFTC Chair Calls for Congressional Action on Crypto and Election Betting at SIFMA Meeting
  Speaking at the Securities Industry and Financial Association’s annual meeting on October 21, CFTC Chair Rostin Benham called on Congress to address crypto regulation and election betting markets, including FIT21. Benham stated “there’s a lot going on in terms of technology and disruption. Digital assets obviously comes top of mind in terms of just regulating spot markets, but what is blockchain and tokenization going to do for financial markets? And those are areas where I personally would love for Congress to weigh in a little bit more than they have.” When discussing the CFTC’s ongoing case against Kalshi, Benham noted the CFTC is in a tough position as an “election cop” and thinks the subject matter of the case is “a classic area where Congress should actually weigh in.” The Block.
• Federal Reserve Governor Waller Sees DeFi as “Complementary” to Traditional Finance
  At the 19th Annual Vienna Macroeconomic Workshop in Austria, Federal Reserve Governor Christopher Waller addressed the future relationship between DeFi and traditional finance. “While there are certain services emerging through DeFi that cannot be provided by centralized finance, the technological innovations stemming from DeFi are largely complementary to centralized finance,” he stated. He also addressed stablecoins, noting that “if appropriate guardrails can be erected to minimize run risk and mitigate other risks, such as their potential use in illicit finance, then stablecoins may have benefits in payments and by serving as a safe asset on a variety of new trading platforms.” The Block.

OTHER NOTABLE NEWS

• Stripe Acquires Stablecoin Platform Bridge for $1.1 Billion
  On October 21, Bridge CEO and co-founder, Zach Abrams, announced in a post on X that Bridge will be “joining forces with Stripe.” Bridge provides services that allow businesses to accept payments in stablecoins. The $1.1 billion deal has been finalized but not yet completed. This acquisition would be the largest for Stripe and the largest ever in the crypto industry. The Block; Cointelegraph.

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Federal and state regulators, utilities, generators, and data center developers convened to take on regulatory and technical obstacles to providing electricity to the expanding data center customer class.

Consistent with Gibson Dunn’s focus on all aspects of the data center sector, please find a comprehensive summary of the Federal Energy Regulatory Commission’s Technical Conference held last Friday. As described in more detail below, the conversations at the technical conference reflect that federal and state regulators, local utilities, grid operators, data centers, and large generators who would like to serve data centers have much work to do and many questions to answer as they navigate the expansion of the U.S. data center industry. Key issues identified for the energy and data center industries and their regulators to work to address include:

• Developing accurate energy demand forecasts to facilitate planning for generation and transmission infrastructure to serve the growing need for electricity to serve data centers;
• Ensuring there are adequate generation resources to serve both existing retail electricity customers and the expanding energy needs of data centers;
• Modernizing electricity market rules to ensure that energy customers, including data centers taking generation service directly from co-located generation, pay for the grid services that are necessary to deliver their electricity, and that there are appropriate market mechanisms to incent generation facilities to come online when needed and stay online in the long term;
• Reforming the transmission planning and interconnection processes to more quickly and efficiently add new generation to the grid; and
• Which regulatory tools are appropriately available to state versus federal regulators as they monitor and oversee grid expansion, including what policy modifications regulators may make related to data center expansion.

On Friday, November 1, 2024, the Federal Energy Regulatory Commission (FERC) convened a commissioner-led technical conference on co-location of large energy users including data centers (referred to as “loads” in the electricity business) alongside power generating facilities.  The impetus for this technical conference was the recent advent of data centers seeking to partner with large continuously operating power generators to directly supply data centers’ electricity needs, specifically embodied by a recent proposal by Talen Energy and PJM Interconnection (PJM) to employ 180 megawatts (MW) of an existing nuclear generator in Pennsylvania to directly serve a data center that would be located next to the nuclear power generating facility.  Because FERC’s ex parte rules prevent FERC’s commissioners from speaking to stakeholders or the public about that specific proposal outside of that formal proceeding, the technical conference did not directly address the Talen Energy proposal and its related FERC filing by PJM.  FERC instead convened this technical conference to discuss in a more general forum issues and policies related to the co-location of large loads including data centers at generating facilities.

The conference opened with FERC Chairman Willie Phillips acknowledging that two seemingly contradictory things can be true at once: data center growth and innovation is good for business and society, while that same innovation demands unprecedented amounts of electric energy, the need for which poses an unprecedented challenge to the U.S. electric grid.  As data center developers continue to explore co-locating large loads including data centers at existing generating facilities, FERC’s members’ questions and statements at the conference suggest the agency wants to rise to the moment and address the issues, but currently lacks sufficient information and requires its many stakeholders, including state regulators, to educate and inform FERC of the interplay of issues, collaborate with FERC, and play their appropriate roles to accommodate data center expansion while continuing to serve existing retail customers reliably and at a reasonable cost.  In furtherance of that need for collaboration, FERC gathered industry leaders and state government authorities to name the challenges, the players, and the potential roads ahead.

Chairman Philips opened by framing data centers, artificial intelligence, and other information-related technologies as national resources with multi-generational significance, deserving nationwide stewardship and active coordination between FERC and state regulators.  He highlighted the opportunity to keep data centers as a critical economic sector onshore, citing the 2020 CHIPS for America Act to emphasize the requisite cost and focus that onshoring requires.  Offshoring, he warned, would invite national security concerns and economic stagnation alike.  Chairman Phillips’s remarks closely echoed a recent memorandum from the White House aimed at advancing the nation’s commitment to leadership in artificial intelligence as a national security issue.

The rest of the commissioners provided their own opening remarks providing additional framing.  Commissioner Mark Christie flagged concerns with grid reliability impacts of data center co-location, resource adequacy impacts, and rate fairness for all consumers. Commissioner David Rosner emphasized optimism on the issue, lauding opportunities to unlock efficiencies of the nation’s infrastructure, get ahead, and get new rules right on co-location issues that fall within FERC’s jurisdiction.  Commissioner Lindsay See shared that she anticipates leveraging the panelists’ expertise to untangle FERC and state jurisdictional issues.  And Commissioner Judy Chang previewed questions about the impacts of a co-located load on the transmission system, and FERC’s tools to ensure grid reliability, address rapid load demands, and respond to challenges of the existing tight reserve margin.  The Commissioners and invited speakers from the industry and state government then explored these issues across three panel discussions led in turns by the five FERC commissioners.

Panel 1 – Overview of Large Co-Located Load Issues.  Panelists included:

• Howard Gugel, Vice President Regulatory Oversight, North American Electric Reliability Corporation (NERC) | Statement
• Stu Bresler, EVP, Market Services and Strategy, PJM Interconnection, L.L.C. | Statement
• Aubrey Johnson, Vice-President, System & Resource Planning, Midcontinent Independent System Operator  | Statement
• Zachary G. Smith, Senior Vice President, System & Resource Planning, New York Independent System Operator
• Jason Davis, Manager, Services Integration, Southwest Power Pool
• Aaron Tinjum, Director, Energy Policy and Regulatory Affairs, Data Center Coalition | Statement
• Mike Kormos, Independent Consultant | Presentation | Graphics Slide
• Kent Chandler, Resident Senior Fellow, R Street Institute | Statement
• Vincent Duane, Principal, Copper Monarch LLC | Statement | Presentation
• Stacey Burbure, Vice President, FERC and RTO Strategy and Policy, American Electric Power  | Statement

The first panel of industry leaders including regional transmission organization (RTO) representatives summarized large load and generator co-location pressure points and alternatives.  Although the discussion often focused on generation provided by large nuclear facilities, various speakers acknowledged that other types of generation have been co-located with load over the years and that natural gas-fired generators might serve as another appropriate power source for co-location projects.  For their part, commissioners focused on challenges and opportunities, including how each industry participant might adequately model and prepare for new large loads.

Representatives from RTOs and independent system operators (ISOs)—the nation’s transmission grid and market operators—addressed issues related to forecasting large load demands and impacts.  They emphasized the importance of communication and transparency to maximize equity and efficiency.  For example, Zachary Smith of the New York Independent System Operator (NYISO) described how the NYISO engages all known, New York-based data center and crypto currency mining developers to understand where they anticipate increased energy needs to assist with state load forecasts.  Aubrey Johnson of the Midcontinent Independent System Operator (MISO) described how MISO attempts to take on load planning at three levels—creating long-range transmission planning scenarios; conducting annual forecasting surveys; and understanding realities in consumer contract negotiations.  Many panelists expressed concern regarding the adequacy and accuracy of transmission owners’ forecasting.  Due in part to the rapid pace of growth and expansion, data center and crypto currency mining operations often report their loads to more than one RTO or ISO, creating a risk of duplicate counting.

The large loads’ magnitude is not their only risk, explained Howard Gugel of NERC.  Unique characteristics of each load and co-location matter, too.  According to Mr. Gugel, current models are inadequate to account for potential grid interruptions created by co-locating load and generation behind a utility meter.  While not every method of co-location would take energy or services from the grid, panelists appeared to be in alignment that most will.  Panelists further emphasized that, whatever the magnitude of the load forecast, connecting new large loads to the grid will require infrastructure that does not yet exist, and that without coordinated preparation, reliability and efficiency could be compromised.

Panelists agreed that co-location of new large loads presents novel, fact-specific issues. Commissioner Christie presented various scenarios and asked panelists to opine on rate and cost impacts.  Among those scenarios, Commissioner Christie offered by way of example a data center arranging for a previously retired generating unit to return to the grid (such as will be the case for the recently announced Crane Clean Energy Center revamp of Three Mile Island’s Unit 1 nuclear reactor), versus co-locating a large load behind the meter with an existing operating generating unit, which would effectively remove that generator from general grid participation.  Most panelists agreed that merely matching supply and demand was not their greatest concern and was almost certainly feasible in the long term.  Instead, they emphasized issues related to how co-located load would secure backup generation for critical operations relevant to national defense if their committed generator goes down for any reason, and what impact that might have on the grid and its service to other customers.

The panel emphasized customer advantages of co-location.  Mike Kormos, an independent consultant and former Executive Vice President and Chief Operating Officer of PJM, emphasized customer agency, stating that co-location permits customers to make choices and take risks regarding generation sufficiency, monetizing a voluntary load-shedding and distribution scenario. Mr. Kormos emphasized that a behind-the-meter load configuration might use significantly fewer grid services in certain configurations, especially if the parties involved are content to forego profit on surplus energy.  Kent Chandler, a former chair of the Kentucky Public Service Commission, added that these new dynamics require addressing cost allocation and rate design alike.  Mr. Chandler encouraged commissioners to seize an opportunity to shepherd improved rate design, seizing on improved metering technologies and minimizing inefficient cost bypass.

Commissioner See probed potential balancing between uniformity and innovation.  She asked how FERC should think about optimal uniformity and variety for general guidance.  MISO’s Aubrey Johnson explained that each data center will be unique as a snowflake (a theme many other speakers would come back to throughout the day), counseling either narrowly tailored or broad, moldable FERC rules for justiciability’s sake.

Similarly, Commissioner Chang asked about balancing co-location’s short- and long-term concerns.  Zachary Smith of NYISO countered that variance will be more than temporal.  FERC will need to balance regional variation with consistent national structures, and how to support interconnectivity amidst those dynamics.  In the short term, Mr. Smith suggested that FERC could clarify the load interconnection process itself, calling for consistency across RTOs and ISOs.  For the long term, Mr. Smith raised concerns about the supply mix, grid reliability and adequacy, and impacts of today’s informal, makeshift processes.

Commissioner Chang asked whether prior experience with co-generation can inform this new era. Panelist Howard Gugel of NERC answered: history’s utility is limited because today’s data centers work with unprecedented pace and energy demands.  Connecting some new large loads to the grid could impact broader systems immediately.  Data centers’ cyber security concerns are unprecedented, too, and must be managed in new ways.

Panel 2:  Exploration of Issues Presented by Large Co-Located Loads.  Panelists included:

• Joseph Bowring, Independent Market Monitor for PJM
• Pallas LeeVanSchaick, Vice President, Potomac Economics
• Karen Onaran, President & CEO, Electricity Consumers Resource Council
• Brian George, US Federal Lead, Global Energy Market Development, Google
• Kyle Hannah, Director, Electric Transmission Strategic Initiatives, Dominion Energy Statement
• Dave Weaver, Vice President of Transmission Strategy, Exelon Utilities Comments and Appendix
• Mason Emnett, SVP, Public Policy, Constellation
• Cole Muller, Executive Vice President, Strategic Ventures, Talen Energy Corporation | Statement
• J. Arnold Quinn, Senior Vice President, Regulatory Policy, Vistra
• Marjorie Rosenbluth Philips, Sr. VP, Wholesale Market Policy, LS Power Development, LLC

The second panel addressed the development and operation of co-location of large loads at generating facilities.  Panelists represented a cross-section of the electric industry, including competitive power generators (Talen Energy, LS Power, Constellation), regulated utilities (Dominion and Exelon), market monitors (PJM IMM and Potomac Economics), advocates for large energy consumers (ELCON), and an industry participant.

The commissioners probed national security, economic development, reliability, cost allocation, and market efficiency issues.  Commissioner Phillips and many panelists pointed to national security concerns associated with slow development, focusing on the need to act swiftly, while appreciating broader economic development opportunities.

Commissioners Rosner, See, and Chang requested input on how FERC should regulate both co-located behind-the-meter and grid-connected configurations, while addressing cost allocation, market improvements, and reliability.  In response, many panelists requested clarity on state regulator versus FERC jurisdictional authority, while others sought better methods for transmitting price signals across markets.  For its part, the data center industry market participant’s representative emphasized the company’s willingness to pay for grid services and costs it causes, its keen interest in utilizing grid-connected generation, and its position that it seeks to use co-located structures outside of traditional grid interconnection primarily because grid-connected generation is not coming online fast enough but would be eager to utilize and pay for grid services when and as grid-connected generation becomes available.

Commissioner Christie asked Dominion Energy, which serves more load from data centers than anywhere else in the world, on whether ratepayer-funded nuclear generation would serve data center demand.  The IMM raised similar concerns, suggesting that with generation scarcity, data centers should finance and bring generation online with them, whether co-located or elsewhere on the grid.

Cost allocation and responsibility to pay for transmission charges and ancillary services brought the most excitement to this discussion.  While all panelists agreed that fair compensation should be provided for grid services, they did not agree about the benefits of co-location, even behind the meter. Talen Energy’s representative emphasized that co-located scenarios would be most likely to take ancillary services but less likely to need transmission service, and that ancillary services account for a fraction of costs compared to transmission charges, arguing that transmission charges should track what is drawn from the grid on a net basis.

Near the end of the panel, speakers began to coalesce their thoughts around the causes of co-location, with a sentiment that co-location arrangements are becoming more common now because generator interconnection to the grid is not happening fast enough.  Generation developer representatives emphasized that once the market addresses the speed of interconnection challenge, the issue of serving data center load really comes down to a resource adequacy question.  In many of the nation’s largest energy regions, the region relies on a market construct called a “capacity market” to attract sufficient generation online to serve load even under times of stress, but the adequacy of these capacity markets to that task has been under challenge at FERC in recent years, with many stakeholders calling for reform to capacity markets even before the challenges of serving data center load came to the forefront.  A common theme raised at Friday’s technical conference, especially on the second panel, is that the trend toward co-location of large loads is a symptom of a larger problem:  that the country’s energy markets are not responding quickly enough to recent (and rapidly accelerating) load growth from data centers, electric vehicles, and residential and commercial customer electrification.

Panel 3: Roundtable with State Representatives.  Panelists included:

• Katie Fry Hester, Senator, Maryland State Senate | Comments
• Emile C. Thompson, Chairman, Public Service Commission of the District of Columbia
• Sarah Moskowitz, Executive Director, Citizens Utility Board of Illinois
• Stephen M. DeFrank, Chairman, Pennsylvania Public Utility Commission | Statement | Opening Comments
• Sarah Freeman, Commissioner, Indiana Utility Regulatory Commission

The third panel featured state-level regulators, policy makers and advocates from urban and rural, and traditionally regulated and deregulated energy market perspectives.  These panelists addressed the policy considerations that arise from co-located load arrangements, including emphasizing that customer impacts on their mind included retail consumer energy availability, environmental effects, and financial impacts.  They also addressed the interplay of state and federal regulation and FERC’s potential impact on emerging issues, fielding pointed questions from the commissioners regarding what aspects of co-location of load with generation are subject to state retail jurisdiction.  Panelists emphasized that the regulatory and market mechanisms available to state regulators vary widely depending on whether a state has adopted customer choice (i.e., electricity deregulation) or has maintained a traditional vertically-integrated utility framework.

State policy makers voiced concerns for local communities and ratepayers.  From their perspective, removing generation from the grid would increase costs for ratepayers and would impose new costs related to building regional transmission and bringing replacement generation online.  They invited FERC to collaborate with state policymakers to minimize co-location generation’s environmental impacts on local communities.  Senator Hester implored FERC to halt non-networked co-location in the PJM until FERC can provide a regulatory structure to mediate power resource development and detrimental customer impact.

Policymakers sought increased FERC guidance on co-location expectations and greater transparency for generation capacity that may be removed from the grid and converted, in whole or in part, to co-located generation arrangements.

Closing Remarks

The Commissioners closed with their appreciation for stakeholder input.  They acknowledged that co-location’s concerns do not exist in a vacuum—rather, they are intertwined with ongoing questions about adequate generation resource adequacy and transmission system capability.

They indicated that the Commission prioritizes bringing clarity to existing rules about resource adequacy and making clear the respective role of state and federal regulators in managing development of co-located loads.

Takeaways

Although the data center sector appears willing to pay the costs their projects cause to the grid, the grid—and the many entities that comprise it—has yet to find alignment on what those costs are or how they should be recovered in utility rate design.  Reaching this alignment may prove to be the linchpin of the long-term prospects for U.S. data center growth to support the age of artificial intelligence.  As Friday’s technical conference demonstrates, the work of accomplishing this task could call upon federal and state regulators, local utilities and RTOs and ISOs, and data centers and the generators who would like to serve them to, among other things, study and synthesize load growth trends and create accurate energy load forecasts, modernize longstanding market rules, and harmonize new market enhancements with recent reforms to transmission planning and interconnection processes, all within the complex and interrelated state and federal regulatory regimes that govern across U.S. jurisdictions.

Also on Friday, mere hours after the close of the technical conference, FERC issued an order rejecting PJM’s filing of the amended interconnection agreement for Talen Energy’s Pennsylvania data center co-location proposal, finding that PJM had failed to demonstrate the proposed deviations from its pro forma interconnection agreement was warranted in that case due to specific reliability concerns, novel legal issues, or other unique factors.  While PJM could refile the amended interconnection agreement with additional justification, it is not clear whether they will do so or if they will seek rehearing of Friday’s FERC order.

Thus, while FERC has demonstrated enthusiasm for addressing data center-related issues to the extent they are within its jurisdictional purview, FERC and the entities it regulates have much work to do ensure market rules, regulations, and the transmission infrastructure itself is prepared to accommodate data centers, co-located loads, and load growth into the future.

Gibson Dunn’s Data Center Task Force attorneys are available to assist clients by offering strategic advice; drafting comment letters to agencies; arranging and preparing for high-level executive branch and congressional meetings; and helping clients take advantage of potential opportunities emerging from the rapidly changing regulatory environment.

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The following Gibson Dunn lawyers prepared this update: F. Joseph Warin, William R. Hollaway, Ph.D., Tory Lauterbach, Stephenie Gosnell Handler, Taylor Cathleen Amato, David Casazza, Katherine Maddox Davis, and Simon Moskovitz.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, any leader or member of the firm’s Artificial Intelligence, Energy Regulation & Litigation, National Security, Public Policy, Real Estate, or White Collar Defense & Investigations practice groups, or the following authors:

William R. Hollaway, Ph.D. – Chair, Energy Regulation & Litigation Practice Group,
Washington, D.C. (+1 202.955.8592, whollaway@gibsondunn.com)

Tory Lauterbach – Partner, Energy Regulation & Litigation Practice Group,
Washington, D.C. (+1 202.955.8519, tlauterbach@gibsondunn.com)

Vivek Mohan – Co-Chair, Artificial Intelligence Practice Group,
Palo Alto (+1 650.849.5345, vmohan@gibsondunn.com)

Stephenie Gosnell Handler – Partner, National Security Practice Group,
Washington, D.C. (+1 202.955.8510, shandler@gibsondunn.com)

Michael D. Bopp – Co-Chair, Public Policy Practice Group,
Washington, D.C. (+1 202.955.8256, mbopp@gibsondunn.com)

Eric M. Feuerstein – Co-Chair, Real Estate Practice Group,
New York (+1 212.351.2323, efeuerstein@gibsondunn.com)

F. Joseph Warin – Co-Chair, White Collar Defense & Investigations Practice Group,
Washington, D.C. (+1 202.887.3609, fwarin@gibsondunn.com)

Amanda H. Neely – Of Counsel, Public Policy Practice Group,
Washington, D.C. (+1 202.777.9566, aneely@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

From the Derivatives Practice Group: The CFTC Global Markets Advisory Committee will hold a virtual meeting on November 21 to discuss expanding the use of non-cash collateral through the use of distributed ledger technology.

New Developments

• CFTC Warns of Potential Dangers for Messaging App Users. On October 31, the CFTC Office of Customer Education and Outreach released a customer advisory alerting messaging app users to beware of schemes to defraud them of assets, specifically crypto assets. Fraudsters are exploiting the default settings of commonly used messaging apps, telephone networks, and mobile devices to lure users into crypto pump-and-dump schemes and other scams. [NEW]
• Commissioner Pham Announces CFTC Global Markets Advisory Committee Meeting on November 21. CFTC Commissioner Caroline D. Pham, sponsor of the Global Markets Advisory Committee (“GMAC”), announced the GMAC will hold a virtual public meeting Thursday, Nov. 21, from 9:30 a.m. to 10:30 a.m. EST. At this meeting, the GMAC will hear a presentation by the Tokenized Collateral workstream of the GMAC’s Digital Asset Markets Subcommittee on expanding use of non-cash collateral through use of distributed ledger technology and consider a recommendation from the Subcommittee. The meeting will also include a presentation by the Utility Tokens workstream of the Digital Asset Markets Subcommittee summarizing their work to-date on defining utility tokens and developing guidance for market participants. [NEW]
• SEC Adopts Rule Amendments and New Rule to Improve Risk Management and Resilience of Covered Clearing Agencies. On October 25, the SEC adopted rule amendments and a new rule to improve the resilience and recovery and wind-down planning of covered clearing agencies. The rule amendments establish new requirements regarding a covered clearing agency’s collection of intraday margin as well as a covered clearing agency’s reliance on substantive inputs to its risk-based margin model. The new rule prescribes requirements for the contents of a covered clearing agency’s recovery and wind-down plan. The rule amendments require that a covered clearing agency that provides central counterparty services has policies and procedures to establish a risk-based margin system that monitors intraday exposures on an ongoing basis, includes the authority and operational capacity to make intraday margin calls as frequently as circumstances warrant (including when risk thresholds specified by the covered clearing agency are breached or when the products cleared or markets served display elevated volatility), and documents when the covered clearing agency determines not to make an intraday call pursuant to its written policies and procedures. [NEW]
• SEC Division of Examinations Announces 2025 Priorities. On October 21, the SEC’s Division of Examinations released its 2025 examination priorities. The Division of Examinations indicated that it will continue to focus on whether security-based swap dealers (“SBSDs”) have implemented policies and procedures related to compliance with security-based swap rules generally, including whether they are meeting their obligations under Regulation SBSR to accurately report security-based swap transactions to security-based swap data repositories and, where applicable, whether they are complying with relevant conditions in SEC orders governing substituted compliance. For other SBSDs, the Division of Examinations said that it may focus on SBSDs’ practices with respect to applicable capital, margin, and segregation requirements and risk management. The Division of Examinations also indicated that it expects to assess whether SBSDs have taken corrective action to address issues identified in prior examinations. Additionally, the Division of Examinations advised that it may begin conducting examinations of registered security-based swap execution facilities in late fiscal year 2025.

New Developments Outside the U.S.

• ESAs Publish 2024 Joint Report on Principal Adverse Impacts Disclosures Under the Sustainable Finance Disclosure Regulation. On October 30, the European Supervisory Authorities (“ESAs”) published their third annual Report on disclosures of principal adverse impacts under the Sustainable Finance Disclosure Regulation (“SFDR”). The Report assesses both entity and product-level Principal Adverse Impact disclosures under the SFDR. These disclosures aim at showing the negative impact of financial institutions’ investments on the environment and people and the actions taken by asset managers, insurers, investment firms, banks and pension funds to mitigate them. [NEW]
• The ESAs Finalize Rules to Facilitate Access to Financial and Sustainability Information on the ESAP. On October 29, the ESAs published the Final Report on the draft implementing technical standards (“ITS”) regarding certain tasks of the collection bodies and functionalities of the European Single Access Point (“ESAP”). The requirements are designed to enable future users to be able to access and use financial and sustainability information effectively and effortlessly in a centralized ESAP platform. [NEW]
• ESMA Consults on Amendments to MiFID Research Regime. On October 28, ESMA launched a consultation on amendments to the research provisions in the Markets in Financial Instruments II (“MiFID II”) Delegated Directive following changes introduced by the Listing Act. The Listing Act introduces changes that enable joint payments for execution services and research for all issuers, irrespective of the market capitalization of the issuers covered by the research. The Consultation Paper includes proposals to amend Article 13 of the MiFID II Delegated Directive in order to align it with the new payment option offered. [NEW]
• ESMA Responds to the Commission Rejection of Certain MiCA Technical Standards. On October 16, ESMA responded to the European Commission proposal to amend the Markets in crypto-assets Regulation (“MiCA”) Regulatory Technical Standards (“RTS”). In their response, ESMA emphasized the importance of the policy objectives behind the initial proposal.
• ESAs Respond to the European Commission’s Rejection of the Technical Standards on Registers of Information under the Digital Operational Resilience Act and Call for Swift Adoption. On October 15, the ESAs issued an Opinion on the European Commission’s rejection of the draft ITS on the registers of information under the Digital Operational Resilience Act. The ESAs raise concerns over the impacts and practicalities of the proposed EC changes to the draft ITS on the registers of information in relation to financial entities’ contractual arrangements with ICT third-party service providers.
• ESMA, ECB and EC Announce Next Steps for the Transition to T+1 Governance. On October 15, ESMA, the European Commission and the European Central Bank announced the next steps to support the preparations towards a transition to T+1 in a Joint Statement. ESMA stressed in the Joint Statement that they believe a coordinated approach across Europe is desirable, with efforts to reach consensus on the timing of any move to T+1.

New Industry-Led Developments

• ISDA Letter to FASB on Share-based Payment from a Customer in a Revenue Contract. On October 21, ISDA submitted a response to the Financial Accounting Standards Board (“FASB”) on File Reference No. 2024-ED100, Derivatives Scope Refinements and Scope Clarification for a Share-based Payment from a Customer in a Revenue Contract. ISDA believes the FASB’s proposal will improve the application and relevance of the Derivatives and Hedging (Topic 815) and Revenue from Contracts with Customers (Topic 606) guidance and has provided potential refinements to the guidance in the letter. [NEW]
• Central Database of Reporting Entity Contact Details for EU and UK EMIR. On October 17, ISDA produced a central database of contact details to assist members resolve reconciliation breaks with counterparties for EU and UK European Market Infrastructure Regulation (“EMIR”) reporting. The central database was created by contributing firms’ submissions and includes details such as entity names, legal entity identifiers and reporting contact emails.
• ISDA, GFXD respond to ESMA on Order Execution Policies. On October 16, ISDA and the Global FX Division of the Global Financial Markets Association responded to a consultation paper from ESMA on “Technical Standards specifying the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies.” In the response, the associations discuss the requirement for pre-selected execution venues, mandatory consumption of consolidated tapes and categorization of financial instruments under the Markets in Financial Instruments Regulation, among other issues.

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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, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus  – New York (212.351.3869,  alapidus@gibsondunn.com )

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

William R. Hallatt , Hong Kong (+852 2214 3836, whallatt@gibsondunn.com )

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki , New York (212.351.4028, mtakagaki@gibsondunn.com )

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

On October 28, 2024, the U.S. Department of the Treasury issued final regulations implementing an outbound investment control regime targeting AI, semiconductors, and quantum computing investments involving China that raise national security concerns. The regulations’ prohibitions and reporting requirements go into effect on January 2, 2025.

Outbound investment regulations have arrived, and with them the establishment of the newest U.S. regulatory regime concerning cross-border transactions. 

While the regulations have effectively created a new regulatory regime out of whitespace—and indeed, there is much that is truly novel in the regulations—they nonetheless draw heavily on existing processes, definitions used, and potential penalties available in existing international trade regimes—namely, the Committee on Foreign Investment in the United States (CFIUS), sanctions, and export controls. The regulations are presently targeted to U.S. outbound investments in China and limited to a narrow group of critical technology sectors. The regime, however, could be expanded both with respect to target countries and the sectors of interest. Despite the limited scope of the regulations as they currently stand, the commercial importance of the targeted sectors and the potential for its expansion, makes it critical for U.S. investors to understand the contours of the regulations and potentially to de-risk potential investments. Effectively navigating these new regulations will require a thorough understanding of the nuances of the outbound requirements, the scope of additional due diligence of targets that includes detailed technical analysis, and the contours of guardrails that need to be implemented to achieve compliance.

While the regulations will come into force over a year after the President’s Executive Order (EO) 14105 invoked the International Emergency Economic Powers Act (IEEPA) and the National Emergencies Act (NEA) to prohibit or restrict certain U.S. investments in China on the basis of national security,[1] the notion of an outbound investment regime has been the topic of discussion within the executive branch and Congress for a number of years—reflecting, in no small part, policy hesitations with restricting U.S. investors’ ability to invest in foreign companies under national security auspices. Outbound investment was ultimately not included in the Foreign Investment Risk Review Modernization Act of 2018 and faltered again when the National Critical Capabilities Defense Act failed in the summer of 2022. That failure, however, spurred support for executive action. In the span of just two years, the outbound investment regime has developed from a few provisions included in the 2023 fiscal omnibus spending bill—the Senate explanations on that bill gave Treasury 60 days to “submit a report describing its efforts and identifying the resources that would be required to establish and implement” an outbound investment initiative[2]—into a new regulatory regime that will go into effect in the new year. The speed with which the regime has been developed through regulation—including proposed rules and public comment periods—demonstrates that outbound investment controls are an important national security priority for this Administration.

As outlined in the final regulations issued on October 28, 2024 (the “Final Rule”), the new outbound investment regime targets “covered transactions” involving U.S. persons and “covered persons” from, and certain persons affiliated with, the People’s Republic of China (including the Special Administrative Regions of Hong Kong and Macau) (collectively “China”) that involve specified national security technologies and products—which currently include semiconductors and microelectronics, quantum information technologies, and artificial intelligence (AI) systems. Beginning on January 2, 2025, some “covered transactions” will be prohibited outright, while others will require post-transaction notification to the newly created Office of Global Transactions within the U.S. Department of the Treasury (Treasury), which is charged with implementing and overseeing the outbound investment regime. While this office will sit under the same Investment Security bureau as CFIUS, unlike foreign direct investment review overseen by CFIUS, the outbound investment regime will not be implemented by either an inter-agency grouping or through a screening mechanism. Rather, the new Office of Global Transactions will have the lead, and instead of a governmental review, the new rule requires industry to conduct sufficient due diligence before engaging in “covered transactions” to assess if such transactions are prohibited or notifiable. In other words, the outbound investment regime will avoid the often-lengthy CFIUS review process—U.S. investments in China beginning in 2025 will fall under three categories: (i) prohibited; (ii) require notification; or (iii) permitted (with no further process required under the outbound investment regulation).

As with CFIUS, the proposed penalties for violations are steep. Specifically, Treasury may impose civil penalties of up to the greater of $368,136 (an amount adjusted annually for inflation) or twice the amount of the transaction that is the basis for the violation. Willful violations can result in criminal penalties of up to $1,000,000 or imprisonment of up to 20 years, or both.

We provide below: (1) a brief refresher on the outbound investment rulemaking process, (2) an outline of core provisions of the Final Rule, (3) an analysis of the Final Rule, focusing on key changes from the Notice of Proposed Rulemaking (NPRM) issued in June 2024,[3] (4) the status of congressional action on outbound legislation, and (5) our key takeaways for global companies and investment firms.

I. Background on the Outbound Investment Rule and Regulatory Process

In 2022, the Biden Administration’s National Security Strategy (the “Strategy”) identified China as “the only competitor with both the intent to reshape the international order and increasingly, the economic, diplomatic, military, and technological power to advance that objective.”[4] To meet the “pacing challenge” of China, the Strategy emphasized the importance of a modern industrial strategy in which U.S. technological leadership is a key national security priority. In support of that objective, in August 2023, President Biden issued EO 14105.[5] The EO outlined proposed regulatory controls on outbound U.S. investment in certain “countries of concern,” namely China. The EO was accompanied by an Advance Notice of Proposed Rulemaking (ANPRM) issued by Treasury that provided the broad contours of the proposed outbound investment regime and sought input from industry across many areas of implementation.[6] For more details on the EO and ANPRM, please refer to our prior client alert. Nearly a year later, the Administration issued an NPRM responding to comments from industry and providing more detailed regulations for public review.

II. Core Contours of the Outbound Regulations

The Final Rule largely adopts the structure and most definitions included in the NPRM, and sets forth the following contours for this new regulatory regime:

Overview
Scope	The Final Rule applies to U.S. persons, defined as any U.S. citizen or lawful permanent resident, U.S.-organized entities—including any foreign branch of any such entity—or any person in the United States (31 C.F.R. § 850.229).
Key Terms
Country of Concern	Currently includes the People’s Republic of China (inclusive of the Special Administrative Areas of Hong Kong and Macau) (31 C.F.R. § 850.205 and Annex to EO 14105). The Final Rule leaves open the possibility of adding additional countries of concern.
Covered Foreign Persons	(1) A person of a “country of concern” that engages in a covered activity; or (2) A person that has a voting or equity interest, board seat, or certain powers with respect to a person of a country of concern where more than 50% of one or more key financial metrics of the person is attributable to a person(s) of a country of concern (31 C.F.R. § 850.209).
Covered Transactions	Covered transactions include a U.S. person’s direct or indirect: Acquisition of an equity interest or contingent equity interest; Certain debt financing that affords or will afford the U.S. person an equity interest or certain board rights; Conversion of a contingent equity interest or equivalent; Greenfield investments or other corporate expansion; Entry into a joint venture; or Acquisition of a limited partner or equivalent interest in a non-U.S. investment fund (31 C.F.R. § 850.210).
Excepted Transactions	Excepted transactions include certain: Publicly traded securities (though, note that there are other sanctions-related restrictions on dealing in publicly traded securities issued by certain Chinese entities);[7] Securities issued by investment companies or business development companies; Limited partner investments; Derivatives; Buyouts of full country of concern ownership stake; Intracompany transactions initiated before January 2, 2025; Certain binding commitments entered into before January 2, 2025; Certain syndicated debt financings; Equity-based compensation; and Transactions involving third countries designated by the Secretary of the Treasury that have adopted similar national security measures (31 C.F.R. §§ 850.213, 850.501).
Knowledge	Knowledge is defined to include: Actual knowledge that a fact or circumstance exists or is substantially certain to occur; An awareness of a high probability of a fact or circumstance’s existence or future occurrence; or Reason to know of a fact or circumstances existence (31 C.F.R. § 850.216).
National Security Technologies and Products Subject to the Final Rule
Semiconductors and Microelectronics	Prohibited: Covered transactions related to certain electronic design automation software; certain fabrication or advanced packaging tools; the design or fabrication of certain advanced integrated circuits; advanced packaging techniques for integrated circuits; and supercomputers (31 C.F.R. § 850.224). Notifiable: Covered transactions related to the design, fabrication, or packaging of integrated circuits not otherwise covered by the prohibited transaction definition (31 C.F.R. § 850.217).
Quantum IT	Prohibited: Covered transactions related to the development or production of (i) quantum computers or critical components required to produce a quantum computer; (ii) certain quantum sensing platforms; and (iii) certain quantum networks or quantum communication systems (31 C.F.R. § 850.224). Quantum technologies are those that rely on the scientific principles of quantum mechanics to solve complex problems very quickly. Notifiable: N/A
Certain AI Systems	Prohibited: Covered transactions related to the development of any AI system: designed to be exclusively used for, or intended to be used for, certain end uses, that is trained using a quantity of computing power greater than 10^25 computational operations, or trained using primarily biological sequence data and a quantity of computing power greater than 10^24 computational operations (31 C.F.R. § 850.224). Notifiable: Covered transactions related to the development of any AI system not otherwise covered by the prohibited transaction definition, where such AI system is designed or intended to be used for certain end uses or applications, or trained using a quantity of computing power greater than 10^23 computational operations (31 C.F.R. § 850.217).

As the structure and substance of the Final Rule did not change significantly from the NPRM, we refer our clients to our previous analysis of the NPRM for a more detailed explanation of the provisions of the Final Rule.

III. Key Differences From the NPRM

While the Final Rule largely tracks that of the NPRM, there are certain notable distinctions, which we analyze below.       

1. The Final Rule expands the scope of covered transactions involving AI systems.

The Final Rule combines the definitions of “artificial intelligence” and “AI system” from EO 14110 (the “AI Executive Order”), issued on October 30, 2023, outlining protections for the use and development of AI.[8] For consistency with the AI Executive Order, the Final Rule modifies the definition of AI system by moving the clause “uses data inputs” into 31 C.F.R. § 850.202(a)(1). This relatively minor definitional change indicates that Treasury is adopting this rule against the backdrop of the AI Executive Order and the recently released National Security Memorandum on AI and that the U.S. government is working to harmonize its approach to AI across agencies and regulatory programs.[9]

Throughout its rulemaking process, Treasury has grappled with where to set the computational thresholds for transactions involving AI systems that would trigger the Final Rule’s notification requirements. The ANPRM did not propose any thresholds. In the NPRM, Treasury proposed several thresholds for consideration ranging from greater than 10^23 to 10^25 computational operations. Computational operations are a measure of the compute power needed to train an AI system. The Final Rule selected greater than 10^23 computational operations (e.g., integer or floating-point operations) as the threshold for notifiable transactions involving the development of AI systems. Treasury explained that this threshold captures the lower end of large-scale AI models released to date and that the selection was based on the current number of publicly known AI models originating from China. Similarly, the Final Rule selected greater than 10^25 computational operations as the threshold for prohibited transactions involving an AI system (and at greater than 10^24 computational operations for an AI system using primarily biological sequence data). While some commenters noted (1) that a 10^26 threshold would better target AI systems that pose the most significant national security threats and (2) that widely-available commercial AI models have been trained at 10^25 computational operations, Treasury set the threshold at greater than 10^25, noting that it has identified greater than 10^25 models, including those trained on biological data, that originate from a country of concern and pose risks to national security. Treasury indicated that it relied on information from both public comments and U.S. government subject-matter experts to make its determination.

Treasury also noted that it considered how computing power may evolve as AI model development continues. Accordingly, the Final Rule acknowledges that computing power thresholds will need to be updated periodically to reflect developments in AI and directs that the Secretary of the Treasury, in consultation with the Secretary of Commerce, should assess and update the computing power threshold as appropriate. In our assessment, the notification process seems designed to help inform any future modifications to the thresholds—although the information collected extends well beyond technical specifications.

For companies, determining when a transaction involving an AI system is prohibited or notifiable based on the computational threshold may be challenging because of the limited amount of publicly available information and benchmarking about models using such thresholds. Thus, the Final Rule places a significant emphasis on effective due diligence for transactions involving AI systems.

2. The Final Rule provides clarity on the knowledge standard.

The knowledge standard describes the knowledge a U.S. person must have about certain facts and circumstances related to a covered transaction to trigger obligations under the Final Rule. Importantly, the notification requirements and prohibitions apply when a U.S. person has actual knowledge, an awareness of a high probability, or reason to know of a fact or circumstance’s existence such that the U.S. person knew or reasonably should have known that it was undertaking a covered transaction involving a covered foreign person. In other words, U.S. persons cannot ignore available information and must undertake sufficient due diligence before engaging in a transaction that may constitute a “covered transaction.” This standard of knowledge has become very common across a full scope of economic tools deployed by the Departments of the Treasury and Commerce (e.g., General Prohibition 10 under the Export Administration Regulations is triggered by a similar “knowledge” standard).

An assessment of whether a U.S. person had reason to know of a fact or circumstance takes into consideration whether a U.S. person conducted a “reasonable and diligent inquiry” at the time of the transaction. 

Section 850.104(c) of the Final Rule provides an illustrative list of factors Treasury will consider when assessing whether a U.S. person has undertaken a reasonable and diligent inquiry, including:

1. The inquiry a U.S. person has made regarding an investment target or other relevant transaction counterparty (such as a joint venture partner), including questions asked of the investment target or relevant counterparty, as of the time of the transaction;
2. The contractual representations or warranties the U.S. person has obtained or attempted to obtain from the investment target or other relevant transaction counterparty (such as a joint venture partner) with respect to the determination of a transaction’s status as a covered transaction and status of an investment target or other relevant transaction counterparty (such as a joint venture partner) as a covered foreign person;
3. The efforts by the U.S. person as of the time of the transaction to obtain and consider available non-public information relevant to the determination of a transaction’s status as a covered transaction and the status of an investment target or other relevant transaction counterparty (such as a joint venture partner) as a covered foreign person;
4. Available public information, the efforts undertaken by the U.S. person to obtain and consider such information, and the degree to which other information available to the U.S. person as of the time of the transaction is consistent or inconsistent with such publicly available information;
5. Whether the U.S. person purposefully avoided learning or seeking relevant information;
6. The presence or absence of warning signs, which may include evasive responses or non-responses from an investment target or other relevant transaction counterparty (such as a joint venture partner) to questions or a refusal to provide information, contractual representations, or warranties; and
7. The use of available public and commercial databases to identify and verify relevant information of an investment target or other relevant transaction counterparty (such as a joint venture partner).

While these questions are broad in scope, Treasury has acknowledged that some of the factors may be inapplicable or impracticable for a given transaction. Consequently, in line with Treasury’s approach to enforcing sanctions, the Final Rule emphasizes that whether a U.S. person has conducted a reasonable and diligent inquiry will be based on consideration of the totality of relevant facts and circumstances. Still, the specific nature of the illustrated diligence arguably sets an expectations bar for investors. For example, Treasury’s reference to public and commercial databases is arguably specific enough that Treasury will look to see whether an investor took time to review these kinds of resources for relevant information.

Additionally, whereas the NPRM explicitly stated that in assessing knowledge Treasury would consider diligence conducted by the U.S. person, as well as diligence conducted by legal counsel and representatives on its behalf, the Final Rule removes these additional parties. Nevertheless, Treasury will still take into account whether a U.S. person has undertaken a reasonable and diligent inquiry of the facts and circumstances surrounding the transaction.

3. The Final Rule delineates activities from which U.S. persons may withdraw to avoid “knowingly directing” transactions.

The Final Rule prohibits U.S. persons from “knowingly directing” a transaction by a non-U.S. person when the U.S. person knows the transaction would be prohibited if made by a U.S. person. This is very similar to restrictions in U.S. sanctions which prohibit the referral by U.S. persons of business that would be sanctionable if undertaken by a U.S. person to a non-U.S. person.

A U.S. person “knowingly directs” a transaction when the U.S. person possesses authority to make or substantially participate in decisions made by the non-U.S. person, and exercises such authority to direct, order, or approve a transaction. U.S. persons who are officers, directors, or who otherwise possess executive responsibilities over a non-U.S. person are identified as having such authority.

However, the Final Rule states that if a U.S. person with such authority recuses themselves from specific activities, they will not be considered to have exercised their authority to direct a transaction, which will help U.S. persons avoid running afoul of the regulations. Unlike the NPRM, the Final Rule specifically includes recusal steps that U.S. persons should take, including refraining from: (1) participating in formal approval and decision-making processes related to the transaction; (2) reviewing, editing, commenting on, approving, and signing transaction documents; and (3) engaging in negotiations with the investment target or relevant transaction counterparty. Again, this is very similar to the recusal expectations in similar contexts under U.S. sanctions. 

4. The Final Rule Updates the definition of “covered foreign person.”

The Final Rule reorganizes and clarifies the definition of a “covered foreign person” to better articulate the individuals and entities captured by the new regulations.

“Covered foreign person” specifically includes individuals and entities who may not themselves be persons “of a country” of concern—it also includes those persons who have a relationship with a person of a country of concern that is in turn engaged in a covered activity. In order to be deemed a “covered foreign person” in this circumstance, that person must hold an interest, such as a voting interest or equity interest, in the natural or corporate person engaging in the covered activity such that the relevant person has power to direct or manage that person. And if there is such an interest, more than fifty percent of the relevant person’s revenue or net income must be attributable to the person engaged in the covered activity. 

Note the Final Rule defines a “person of a country of concern” in § 850.221 as an individual that is a citizen or lawful permanent resident of a country of concern (and also not a U.S. citizen or lawful permanent resident of the United States); an entity with a principal place of business in, headquartered in, or incorporated in or otherwise organized under the laws of, a country of concern; the government (and certain subdivisions and government owned enterprises) of a country of concern; persons acting on behalf of a government of a country of concern; and certain entities individually or in the aggregate, directly or indirectly, holding at least 50 percent of the outstanding voting interest, voting power of the board, or equity interest of any of the foregoing. We note that this definition is far broader than the definition of non-U.S. person in most U.S. sanctions programs.

5. The Final Rule modifies the treatment of certain debt and contingent equity transactions.

The NPRM sought comments regarding the effect, if any, on the definition of “covered transaction” for the conversion of contingent equity interests or acquisition of limited-partnership interests. Based on responsive comments in connection with §§ 850.210(a)(1) and 850.210(a)(3) of the NPRM, the Final Rule changes how certain debt and contingent equity transactions are treated under the definition of covered transaction. We highlight three main changes from the NPRM:

• First, the Final Rule clarifies in Note 1 to § 850.210 that a U.S. person is not considered to have indirectly acquired an equity interest or contingent equity interest in a covered foreign person when the U.S. person acquires a limited partnership interest in a venture capital fund, private equity fund, fund of funds, or other pooled investment fund and that fund then acquires an equity interest or contingent equity interest in a covered foreign person. Thus, the U.S. person’s limited partnership investment into the investment fund is not a covered transaction, absent other circumstances. However, to the extent that the fund is a U.S. person, its transactions with a covered foreign person would be covered by the Final Rule if it meets the definition of a covered transaction.

• Second, the Final Rule modifies the definition of contingent equity interest to (1) refer to a “financial interest” rather than a “financial instrument” to clarify that the Final Rule covers the acquisition or conversion of interests that are convertible into an equity interest and (2) clarify that debt can constitute a financial interest that is convertible into an equity interest. This inclusion of debt and convertible interests builds on Treasury’s focus on these instruments first seen in its Venezuela and Russia sanctions programs.

• Third, the Final Rule clarifies in Note 2 to § 850.210 that neither the issuance of debt financing secured by equity collateral nor the acquisition of such secured debt on the secondary market is an acquisition of an equity or contingent equity interest. Thus, such debt transactions will not constitute covered transactions. However, the Final Rule states that foreclosure on such collateral where the debtholder takes possession of the pledged equity constitutes an acquisition of an equity interest and is thus a covered transaction. In general, the Final Rule does not cover debt financing unless it has equity-like characteristics or is convertible into an equity interest.

6. The Final Rule exempts passive limited partner investments of $2,000,000 or less.

The Final Rule does not cover any passive limited partner investments of $2 million or less, and also excepts limited partner investments that are accompanied by a binding contract that the capital invested would not be made to indirectly create a notifiable or prohibited transaction. Similar to CFIUS, the outbound regime enumerates in § 850.501(a)(2) a list of what it considers to qualify as passive minority shareholder protections.

7. The Final Rule clarifies and adds several exceptions.

The Final Rule clarifies and adds to § 850.501 several types of excepted transactions that would otherwise constitute prohibited or notifiable transactions, including the following:

• Clarifies that derivative transactions are excepted so long as the derivative “does not confer the right to acquire equity, any rights associated with equity,” or any assets related to a covered foreign person. This is in line with Treasury’s general views on allowing derivatives without the receipt of the underlying asset that was developed in the context of Russia sanctions.
• Excepts employee compensation in the form of equity, an option to purchase equity, and the exercise of such option.
• Excepts transactions between a U.S. person and its controlling foreign entity that supports or maintains operations that are not covered activities or that maintains covered activities that the entity was engaged in prior to the Final Rule’s effective date.

8. The Final Rule provides that Treasury may disclose non-public information when doing so is “important” to the national security analysis or in “the national interest.”

Generally, information or documentation submitted to Treasury pursuant to the Final Rule’s requirements shall not be publicly disclosed if it is not otherwise publicly available, unless the parties to the notification consent to its disclosure. In certain instances, however, Treasury may disclose private information and materials to certain parties including Congress and congressional committees subject to appropriate confidentiality and classification requirements. Such information and materials may also be provided to other U.S. government entities or entities of allied foreign governments when such information is “important to the national security analysis or actions of such governmental entity or [Treasury].”[10] Despite this, our assessment remains that all such notifications should be marked confidential and, if possible, exempt from the Freedom of Information Act requests under one or more provisions concerning sensitive commercial information.

Additionally, the Final Rule provides that Treasury may disclose otherwise confidential information “when such disclosure of information is determined by the Secretary to be in the national interest.”[11] While the Final Rule does not explain how the Secretary would make that determination, it specifies that the determination may not be delegated below the level of the Assistant Secretary of the Treasury. These exceptions to confidentiality are noteworthy, as they provide somewhat less protection than similar confidentiality protections in the CFIUS regulations.[12]

IV. Congressional Outlook

While the outbound investment regime derives its authority from executive authorities, IEEPA, and the NEA, the prospect of additional congressional legislative action remains.

Momentum on an outbound investment regime first picked up steam in Congress, and while the executive branch firmly took the lead in establishing a regulatory regime, we will continue to watch as Congress works on its own outbound investment protocols—which may augment, conflict with, or overtake the executive’s action depending on how Congress proceeds.

In 2023, the Senate voted 91 to 6 to include the Outbound Investment Transparency Act in the FY 2024 National Defense Authorization Act (NDAA), though the measure was ultimately stripped from the final bill. An amendment to the Senate draft of the FY 2025 NDAA similarly would require U.S. persons to notify Treasury when investing in a “covered foreign entity” and the investment involves “covered sectors” (i.e., advanced semiconductors and microelectronics, artificial intelligence, quantum information science and technology, hypersonics, satellite-based communications, and networked laser scanning systems with dual-use applications). Covered foreign entities would include entities incorporated in countries of concern (i.e., North Korea, China, Russia, or Iran), entities that are primarily traded on exchanges in a country of concern, and entities majority owned by entities that fall under one of the first two categories. We note that the bill’s notification requirement would be in addition to existing restrictions on almost all transactions with Iran and DPRK, targeted restrictions on Russian transactions, and limitations on investments in publicly traded securities of certain Chinese companies. House Financial Services Committee Chairman Patrick McHenry opposed the FY 2024 provision, effectively blocking it from becoming law, and appears poised to do so again this year. He favors a sanctions regime, rather than limiting outbound investment. Consistent with that view, after the Final Rule was released, Chairman McHenry stated that he remains “skeptical of a sectoral approach to regulating outbound investment.”[13] 

That said, House Speaker Mike Johnson, Foreign Affairs Committee Chairman Michael McCaul, and Select Committee on Strategic Competition Between the United States and the Chinese Communist Party Chairman John Moolenaar strongly support addressing outbound investment in the FY 2025 NDAA and are seeking a compromise. The day after Treasury released the Final Rule, Chairman Moolenaar issued a statement “commending” the regulation but calling for Congress to “build on these rules and address a broader set of technologies and transactions that threaten our national security.”[14]

Should such legislation pass, questions almost certainly will arise regarding harmonization with Treasury’s Final Rule.

V. Key Takeaways for the Private Sector

Even though the Final Rule does not come into effect until next year, there are steps that clients can take now to prepare.

1. Companies and other investors with global operations should review and update their operations and investment processes now so that they can come into compliance with these rules once they become effective.

The January 2, 2025 effective date will arrive quickly, especially with planning time lost to the upcoming end-of-year holidays. Companies and other investors should consider updating their approach to diligence and negotiating terms for investments now. In the comments to the NPRM, industry requested more guidance on what due diligence steps Treasury envisioned U.S. firms would take, with many asking for an illustrative list of proposed steps (e.g., a list of due diligence questions or sample agreement representations). Treasury declined to provide this level of detail. However, companies will be well placed to develop their own diligence questions and terms for use in the investments and transactions that will be agreed to in 2025. In particular, companies will want to focus their due diligence process on ascertaining whether the technology and products of potential investments fall under the prohibited or notifiable categories. For example, determining whether an AI system was trained using a quantity of computing power greater than 10^23 computational operations may well fall outside the scope of existing due diligence questions.

Importantly, the Final Rule exempts certain intracompany transactions between U.S. persons and their controlled foreign entities that are instigated prior to the January 2, 2025 effective date. Transactions that would be covered transactions but that support the U.S. person’s ongoing operations with respect to covered activities that the controlled foreign entity was engaged in prior to January 2, 2025 effective date will be excepted. Therefore, companies with global operations should review and assess their current activities in order to document them as part of their compliance plans and more clearly establish them as activities that are grandfathered for purposes of this exception.

2. Treasury will provide more information on the format for providing notifications.

Clients subject to the Final Rule will need to determine which transactions are covered by the Final Rule (both prohibited and notifiable) and navigate the new process to notify Treasury of notifiable transactions. In a guidance document published simultaneously with the Final Rule, Treasury has committed to providing additional information before the effective date to facilitate compliance. Such guidance will include instructions on how to file a notification and how to request a national interest exemption. Treasury also indicates that it will engage in stakeholder outreach about the Final Rule’s requirements. We will be closely engaging with Treasury about this and will be monitoring Treasury’s Outbound Investment Security Program website for additional information. We urge our clients to do the same. 

3. Non-U.S. private equity and investment funds must actively manage their investment in sensitive areas—U.S. limited partners may be excluded from certain investments.

The Final Rule was modified in response to several comments about the low threshold for the passive investment exception. Treasury considered alternatives to limiting the Final Rule’s impact on passive investment by U.S. limited partners in non-U.S. funds—considering a limit tied to a dollar amount versus a limit tied to a percentage of the fund’s capital. Commenters preferred the percentage approach because the dollar limit was so low as compared with typical passive investment amounts. However, in the Final Rule, Treasury applied the dollar limit, modified by raising it from $1 million to $2 million. A $2 million limit on passive investment means that the Final Rule will impact many U.S. investors such that funds and their limited partners may instead need to rely on using contractual rights for U.S. investors to be excluded from transactions that implicate outbound investment restrictions. The responsibility (and cost) to effectively implement this approach is likely to be shared by general partners/managers and limited partners alike.

[1] Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern, 88 Fed. Reg. 54,867 (Aug. 11, 2023).

[2] Staff of S. Comm. on Appropriations, 117th Cong., Explanatory Statement, Division B—Commerce, Justice, Science, and Related Agencies Appropriations Act, 2023 at 59 (Dec. 19, 2022), https://www.appropriations.senate.gov/imo/media/doc/Division%20B%20-%20CJS%20Statement%20FY23.pdf.

[3] Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern, 89 Fed. Reg. 55,846 (July 5, 2024).

[4] The White House, National Security Strategy at 8 (Oct. 2022), https://www.whitehouse.gov/wp-content/uploads/2022/10/Biden-Harris-Administrations-National-Security-Strategy-10.2022.pdf.

[5] Exec. Order No. 14105, Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern, 88 Fed. Reg. 54,867 (Aug. 11, 2023).

[6] Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern, 88 Fed. Reg. 54,961 (Aug. 14, 2023).

[7] Client Alert, 2021 Year-End Sanctions and Export Controls Update, Gibson, Dunn & Crutcher LLP (Feb. 4, 2022), https://www.gibsondunn.com/2021-year-end-sanctions-and-export-controls-update/.

[8] Exec. Order No. 14110, Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence, 88 Fed. Reg. 75,191 (Nov. 1, 2023).

[9] See White House, Memorandum on Advancing the United States’ Leadership in Artificial Intelligence; Harnessing Artificial Intelligence to Fulfill National Security Objectives; and Fostering the Safety, Security, and Trustworthiness of Artificial Intelligence (Oct. 2024), https://www.whitehouse.gov/briefing-room/presidential-actions/2024/10/24/memorandum-on-advancing-the-united-states-leadership-in-artificial-intelligence-harnessing-artificial-intelligence-to-fulfill-national-security-objectives-and-fostering-the-safety-security/.

[10] 31 C.F.R. § 850.801(b)(3).

[11] 31 C.F.R. § 850.801(d).

[12] See 31 C.F.R. § 800.802.

[13] Press Release, Chairman of the House Fin. Servs. Comm Patrick McHenry, McHenry Statement on Treasury’s Outbound Investment Final Rule (Oct. 28, 2024) here.

[14] Press Release, Chairman of the Select Comm. on the Strategic Competition Between the U.S. and the Chinese Communist Party John Moolenaar, Moolenaar: Biden Regulations on Outbound Investment to China a Good Step, Congress Must Strengthen (Oct. 29, 2024), https://selectcommitteeontheccp.house.gov/media/press-releases/moolenaar-biden-regulations-outbound-investment-china-good-step-congress-must.

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The following Gibson Dunn lawyers prepared this update: Stephenie Gosnell Handler, Adam M. Smith, Christopher Timura, Michelle Weinbaum, Amanda Neely, Chris Mullen, Hugh Danilack, Sarah Burns*, Kelly Yahner*, Jayee Malwankar, David Wolber, and Mason Gauch.

Gibson Dunn attorneys are available to counsel clients regarding potential or ongoing transactions and other compliance or public policy concerns. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s International Trade practice group:

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Ronald Kirk – Co-Chair, Dallas (+1 214.698.3295, rkirk@gibsondunn.com)
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202.887.3547, asmith@gibsondunn.com)
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Christopher T. Timura – Washington, D.C. (+1 202.887.3690, ctimura@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202.887.3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213.229.7269, nhanna@gibsondunn.com)
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Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Patrick Doris – London (+44 207 071 4276, pdoris@gibsondunn.com)
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Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 224, nmalevanny@gibsondunn.com)
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Vanessa Ludwig – Frankfurt (+49 69 247 411 531, vludwig@gibsondunn.com)

*Sarah Burns and Kelly Yahner, associates working in the firm’s Washington, D.C. office, are not yet admitted to practice law.

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We are pleased to provide you with the October edition of Gibson Dunn’s monthly U.S. bank regulatory update. Please feel free to reach out to us to discuss any of the below topics further.

KEY TAKEAWAYS

• The Office of the Comptroller of the Currency (OCC) released its bank supervision operating plan for fiscal year 2025 signaling the OCC’s supervision priorities for the next fiscal year. Although the key areas of heightened focus for supervisory strategies in fiscal year 2025 largely mirror those from fiscal year 2024, changes or updates include (predictably) a focus on third-party risk management, as well as a heightened focus on capital optimization activities (e.g., credit risk transfer transactions) and changes to the supervisory posture with respect to climate-related financial risks.
• The Consumer Financial Protection Bureau (CFPB) issued its final rule implementing Section 1033 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule was quickly met with a challenge by the Bank Policy Institute and Kentucky Bankers Association.
• On October 21, 2024, the OCC finalized revisions to its recovery planning guidelines for national banks, federal savings associations and federal branches, expanding coverage of the guidelines to institutions with at least $100 billion in total assets (reduced from $250 billion). As adopted, the guidelines include a new “risk-based” testing standard and changes designed to ensure that non-financial risks are addressed in recovery planning efforts. The final guidelines become effective on January 1, 2025, with changes to the initial compliance dates.
• The Federal Deposit Insurance Corporation (FDIC) extended the comment period on its brokered deposits proposal until November 21, 2024 and the comment period on its request for information on deposit data until December 6, 2024. See our Client Alert on both here.
• The New York State Department of Financial Services (NYDFS) released guidance to address cybersecurity risks arising from artificial intelligence (AI). The guidance does not impose new requirements beyond those obligations codified in the NYDFS’ cybersecurity regulations—23 NYCRR Part 500. Instead, according to the NYDFS, the guidance is designed “to explain how [covered entities] should use the framework set forth in Part 500 to assess and address the cybersecurity risks arising from AI.”

DEEPER DIVES

OCC Releases Bank Supervision Operating Plan for Fiscal Year 2025. On October 1, 2024, the OCC released its bank supervision operating plan for fiscal year 2025. The plan signals the OCC’s supervision priorities for the fiscal year. The key areas of heightened focus for supervisory strategies in fiscal year 2025 largely mirror key areas of focus in the fiscal year 2024 plan (e.g., BSA/AML, cybersecurity, consumer compliance, asset/liability management, credit and allowance for credit losses, operational risk, enterprise change management, payments, CRA, fair lending), with certain notable changes or updates.

• Insights. Not surprisingly, the plan includes as a new, separate line item, third-party risks and third-party risk management. The plan also specifically identifies capital as an area of heighted focus, most notably capital optimization activities, “including any new plans by banks to engage in credit risk transfer transactions.” With respect to climate-related financial risks for banks (or U.S. branches of foreign banks) with over $100 billion in total assets, the 2025 plan states that “examiners should conduct target examinations” to assess banks’ ability to identify and manage climate-related financial risks. The 2024 plan contemplated examiners’ “engagement with bank management” with respect to climate-related financial risks. Finally, the 2025 plan excludes substantive discussion of distributed ledger technology-related products and services.

OCC Finalizes Revisions to Its Recovery Planning Guidelines. On October 21, 2024, the OCC finalized revisions to its recovery planning guidelines. Under the final rule, coverage of the recovery planning guidelines was extended to institutions with $100 billion or more in total assets—down from the current $250 billion threshold. The revised guidelines become effective on January 1, 2025.

• Insights. The final guidelines implement two principal changes from the July 3, 2024 proposal. First, the testing requirement is now risk-based—i.e., “appropriate for the bank’s individual size, risk profile, activities, and complexity, including the complexity of its organizational and legal entity structure.” Second, the guidelines provide covered institutions with more time to both develop a testing framework and conduct testing. Specifically, under the final guidelines, institutions currently subject to the guidelines will have 12 months to amend their recovery plans to address non-financial risk and an additional 6 months to comply with the new testing provision; institutions that are not covered by the current guidelines but that become subject to the guidelines on the effective date (or thereafter) will have 12 months to develop their recovery plan and an additional 12 months to comply with the testing provision. Finally, the revised guidelines include the condition that recovery planning “should appropriately consider both financial risk and non-financial risk (including operational and strategic risk).”

CFPB Releases Personal Financial Data Rights Final Rule. On October 22, 2024, the CFPB issued its final rule implementing Section 1033 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the “open banking” rule. The stated policy rationale of Section 1033 is to empower consumers and authorized third parties to access account data controlled by certain financial data providers in a safe, secure, reliable and competitive manner. “Data providers” include financial institutions as defined in Regulation E, card issuers as defined in Regulation Z, digital wallet providers, and “any other person that controls or possesses information concerning a covered consumer financial product or service that the consumer obtained from that person”, but excludes depository institutions with less than $850 million in total assets—which are exempt from the final rule’s requirements.
Under the final rule, data providers are required to transfer an individual’s personal financial data (Covered Data) to another party at the consumer’s request for free. The final rule requires data providers to create and maintain a consumer interface and a developer interface, and to make this Covered Data available in a machine-readable format without charge. Data providers must also establish and maintain written policies and procedures, though data providers do have the flexibility to design policies and procedures to avoid acting inconsistently with other legal obligations, or in a way that could reasonably hinder enforcement against unlawful or potentially unlawful conduct. Although depository institutions with less than $850 million in total assets are exempt from the final rule’s requirements, nondepository entities of all sizes must comply with the final rule.

The final rule includes several other notable deviations from the October 19, 2023 proposed rule. First, it provides an extended, tiered compliance structure. The first compliance date, which applies to the largest bank and non-bank covered entities, is April 1, 2026. Second, there is no assignment of liability among commercial entities or safe harbors from the Electronic Fund Transfer Act and Regulation E or the Truth in Lending Act and Regulation Z. Third, the final rule includes an exclusion for any products or services that “merely facilitate first party payments”, defined as “a transfer initiated by the payee or an agent acting on behalf of the underlying payee.” However, this exclusion is narrow because first party payments that relate to a product that facilitates payments to other payees or a data provider that is otherwise providing a Regulation E or Regulation Z account, remain in scope.
Immediately following the release of the rule, the Bank Policy Institute and Kentucky Bankers Association filed a lawsuit against the CFPB in U.S. District Court. The lawsuit asserts that the CFPB exceeded its statutory authority and finalized a rule that jeopardizes consumers’ privacy, financial data and account security. The lawsuit raises several key concerns with the final rule.

• Insights. In parallel with legal challenges, covered entities are expected to prepare to come into compliance with the final rule. Both depository and nondepository institutions will be significantly impacted by the final rule, but the impacts will be different. All covered entities will need to engage in a mapping exercise to determine the products and data in scope and uplift their infrastructure to comply with the requirements. Banks will likely have an increased focus on ascertaining the risks associated with the compliance requirements and determining the appropriate risk mitigation. Nondepository institutions that less clearly control or possess Covered Data may be required to face significant reengineering hurdles to make Covered Data available consistent with the requirements of the final rule.

NYDFS Issues New AI Guidance. On October 16, 2024, the NYDFS published guidance addressing how AI is changing cyber risk and how covered entities can mitigate risks associated with AI. According to the NYDFS, the guidance does not impose any new requirements, but rather explains how covered entities should use the Part 500 framework to address cybersecurity risks arising from the use of AI. The Guidance addresses four risks related to the use of AI: (i) AI-enabled social engineering; (ii) AI-enhanced cybersecurity attacks; (iii) exposure or theft of vast amounts of nonpublic information; and (iv) increased vulnerabilities due to third-party, vendor, and other supply chain dependencies. The guidance maintains that covered entities must assess AI-related risks and implement minimum cybersecurity standards to address such risks. Examples of compensating controls include: (1) cybersecurity risk assessments; (2) incorporating AI-risks into business continuity and disaster recovery planning; and (3) incorporating AI-related risks into third-party risk management processes.

• Insights. The guidance provides examples on how covered entities may fortify their pre-existing programs to address AI-related risks and highlights some of the current cybersecurity risks associated with AI that all organizations should consider when developing a cybersecurity program and implementing cybersecurity controls. Critical to undertaking a risk mitigation strategy, covered entities should first consider the risks presented by AI in their cybersecurity risk assessments. Even if a covered entity itself does not deploy AI tools, the covered entity should consider both AI used by any third-party service provider, and the risks that bad actors may use AI to infiltrate covered entities’ information systems.

FSOC Continues Focus on Private Credit. On October 18, 2024, the Financial Stability Oversight Council (FSOC) met in executive session. At the meeting, the FSOC received updates from Treasury and other regulators’ staffs on efforts to provide better visibility into private credit. The readout from the meeting noted “that the current lack of transparency in the private credit market can make it challenging for regulators to fully assess the buildup of risks in the sector.”
Relatedly, both Commissioner Peirce and Acting Comptroller Hsu recently weighed in on this topic. On October 15, Commissioner Peirce gave a speech titled “Temporarily Terrified by Thomas: Remarks on Private Credit” in which she emphasized the need to understand the private credit market and to use existing tools in monitoring the evolving market. She noted that “[i]nvoking systemic risk to regulate private credit in the same way we regulate bank lending would engender risks of its own. Doing so would squelch the dynamism that enables the non-bank sector to serve companies and investors so well. It would homogenize the market, which could make future financial contagion more, not less, likely. … If anything, the growing private credit sector may highlight the need for streamlining our public market regulation.” In addition, on October 25, 2024, Acting Comptroller Hsu gave a speech titled “Systemic Risk and Crossing the Hellespont.” In his remarks, Acting Comptroller Hsu identified private credit (along with “banking supply chains and, possibly, mortgage servicing”) as areas that are being closely monitored by regulators for potential build ups of systemic risk.

• Insights. The FSOC highlighted its focus on the private credit market in its 2023 Annual Report and such attention has continued through 2024. This focus follows the FSOC’s easing of its process to designate nonbank financial companies as systemically important financial institutions coupled with banking regulation that created additional opportunities for nonbanks in the private credit sector. Whether and how the FSOC seeks to make designations in the private credit or other sectors are likely to be impacted by the upcoming U.S. election.

OTHER NOTABLE ITEMS

FDIC Announces Extension of Comment Period for Proposed Changes to its Brokered Deposits Regulations and Request for Information on Deposit Data. On October 8, 2024, the FDIC announced it will extend until November 21, 2024 the comment period on its notice of proposed rulemaking proposing significant changes to the FDIC’s brokered deposits rules. The FDIC also separately announced it is extending until December 6, 2024 the comment period on its Request for Information on deposit data.

Vice Chairman Hill Updates FDIC Staff’s Review of Applications Pending Before FDIC. Following the October 17, 2024 meeting of the FDIC Board, Vice Chairman Travis Hill released a statement lauding FDIC staff’s work to improve the application review process and reduce the number of merger and FDIC deposit insurance applications outstanding for more than nine months. According to Vice Chairman Hill, that number has “consistently hovered around 10” over the last two-and-a-half years; it currently sits at three for the first time since October 2021. Following a June 20, 2024 FDIC Board resolution, FDIC staff is now required to brief the full FDIC Board “any time a merger or deposit insurance application is outstanding for more than nine months.”

Speeches by Governor Bowman on Community Banking. On October 2, 2024 and October 11, 2024, Federal Reserve Board Governor Michelle Bowman gave speeches titled “Building a Community Banking Framework for the Future” and “Challenges to the Community Banking Model.” In her speeches, Governor Bowman reiterated consistent themes like the tradeoffs of regulation, guidance and supervision and their unintended consequences, competition and de novo banking, tailoring, and the risks faced by community banks.

Speech by Governor Bowman at the Eighth Annual Fintech Conference hosted by the Federal Reserve Bank of Philadelphia. On October 23, 2024, Federal Reserve Board Governor Michelle Bowman gave the opening remarks for the second day of the Federal Reserve Bank of Philadelphia’s annual fintech conference. In her remarks, Governor Bowman reiterated her view that regulators “have an obligation to understand the functionality of new innovations” and encouraged regulators to “prioritize how we integrate innovation as we revise or enhance regulatory frameworks.”

Speech by Governor Waller on DeFi. On October 18, 2024, Federal Reserve Board Governor Christopher Waller gave a speech titled “Centralized and Decentralized Finance: Substitutes or Complements?” Governor Waller’s speech examined whether defi and centralized finance are substitutes or complementary. While citing the benefits of the technology underlying decentralized finance, Governor Waller ultimately concluded that technological innovations stemming from defi are largely complementary to centralized finance and have the ability to “improve centralized finance” and realize “significant value” to financial intermediaries in the financial markets.

Speeches by Governor Jefferson on the Discount Window. On October 8, 2024 and October 9, 2024, Vice Chair Phillip Jefferson gave a two-part speech titled “A History of the Fed’s Discount Window: 1913–2000” and “The Fed’s Discount Window: 1990 to the Present,” respectively. In his speeches, Vice Chair Jefferson detailed the history of the Federal Reserve’s Discount Window from its inception in 1913 through its evolution in the 21st century and explored the rise of the Discount Window “stigma” and tackled ways in which the Federal Reserve is working to eliminate or reduce that stigma.

Speech by Governor Cook on AI. On October 1, 2024, Federal Reserve Board Governor Lisa Cook gave a speech titled “Artificial Intelligence, Big Data, and the Path Ahead for Productivity.” Her speech explored the potential impacts of AI and big data on productivity and labor markets. Governor Cook reiterated her “cautiously optimistic” view on AI while noting that there is still a great deal of uncertainty surrounding AI’s long-term effects.

OCC Solicits Research on AI in Banking. On October 7, 2024, the OCC announced it was soliciting academic research papers on the use of AI in banking and finance. Authors of selected papers will be invited to present to OCC staff and other stakeholders on June 6, 2025. Interested researchers can submit papers to EconomicsSymposium@occ.treas.gov. The deadline for submission is December 15, 2024.

FDIC Extends Compliance Date for Subpart A of the FDIC Official Signs and Advertising Requirements, False Advertising, Misrepresentation of Insured Status, and Misuse of the FDIC’s Name or Logo. On October 17, 2024, the FDIC announced that the compliance deadline for the FDIC’s new rule on FDIC signage and advertising (Subpart A of Part 328) has been extended from January 1, 2025, to May 1, 2025. Specifically, such rules require (i) the use of the FDIC official sign, official digital sign, and other signs differentiating deposits and non-deposit products across all banking channels; and (ii) the establishment and maintenance of policies and procedures designed to achieve compliance with Part 328. The compliance deadline for rules relating to misrepresentations of deposit insurance coverage (Subpart B of Part 328) remains January 1, 2025.

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The following Gibson Dunn lawyers contributed to this issue: Jason Cabral, Ro Spaziani, Zach Silvers, Karin Thrasher, and Nathan Marak.

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 or any of the member of the Financial Institutions practice group:

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Ro Spaziani, New York (212.351.6255, rspaziani@gibsondunn.com)

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Sara K. Weed, Washington, D.C. (202.955.8507, sweed@gibsondunn.com)

Ella Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)

Rachel Jackson, New York (212.351.6260, rjackson@gibsondunn.com)

Chris R. Jones, Los Angeles (212.351.6260, crjones@gibsondunn.com)

Zack Silvers, Washington, D.C. (202.887.3774, zsilvers@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

Nathan Marak, Washington, D.C. (202.777.9428, nmarak@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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This update examines why Germany does not require anti-(anti) suit injunctions and how EU entities with a nexus to Germany can counter Russian avoidance tactics in German courts, particularly in light of Russian anti-arbitration injunctions based on Article 248.1 of the Russian Arbitration Procedure Code. It highlights the existing tools within the German legal system available to affected parties, illustrating why Germany need not adopt Anglo-American-inspired anti-suit injunctions.

I.   Introduction

Over the past months, there has been quite a number of cases in which Russian entities have resorted to local courts, asking the court to claim exclusive jurisdiction over a dispute with EU-domiciled opponents and applying for an anti-arbitration injunction on the basis of Article 248.1 of the Russian Arbitration Procedure Code – despite an obviously valid arbitration agreement. It may well be said that, unsurprisingly, in almost all of these cases, this led to a detrimental judgment for the involved EU party,[1] including the issuance of extremely high fines in case of non‑compliance with the injunction. It is needless to say that these state court proceedings do not adhere to the rule of law. This approach exposes EU‑parties to a high economic risk, especially when judgments are to be enforced in countries where the EU entity has assets, though enforcement within EU member states remains unlikely.

This article analyzes how EU entities with nexus to Germany may tackle these avoidance tactics of Russian parties before German courts. In particular, the article examines which tools the German legal system already provides for affected parties and whether there is an actual need for the German jurisprudence to introduce the concept of anti‑suit injunctions, as inspired by Anglo‑American legal systems. Perhaps surprisingly, the German legal system already seems to provide sufficient instruments parties can resort to in order to protect themselves and finally bring their case to arbitration.

II.   Background

1.   Articles 248.1, 248.2 Russian Arbitration Procedure Code

In response to EU sanctions, Russia introduced amendments to its Arbitration Procedure Code to protect “the rights of individuals and legal entities in connection with restrictive measures introduced by a foreign state (…) or state association” in 2020.[2] This legislation gives Russian state courts the power to claim exclusive competence over disputes involving “sanctioned” parties even if the parties have explicitly agreed to submit their disputes to arbitration (Article 248.1). The only requirement is that arbitration outside of Russia is “not feasible” due to the application of restrictive measures against one party by a foreign state, which must create an “obstacle to access to justice” for that party (Art. 284.1(4)). The Russian courts interpret this requirement very broadly, as recent decisions have shown. Accordingly, obstacles to access to justice are assumed if a party is subject to “sanctions” imposed by the state in which arbitral proceedings are meant to take place. Further, parties may apply for an anti‑arbitration injunction before Russian courts in these situations (Art. 248.2).

Thus, the Russian Arbitration Procedure Code not only gives Russian entities the possibility to avoid arbitration agreements and go to state court instead, but also to effectively fend off upcoming or pending arbitral proceedings. Considering that Russian courts, when issuing anti‑suit injunctions, have often imposed additional fines in case of non-compliance, those new instruments may have serious consequences for EU parties wanting to enforce a claim or an arbitral award in Russia.

The number of anti-arbitration injunctions based on Art. 248 issued by Russian courts has significantly risen in the past two years.[3] When rendering those injunctions, Russian courts frequently invoke allegedly sweeping restrictions of Russian entities even if the company in question is not directly sanctioned under EU law. In particular, Russian courts have been arguing that Russian parties would not obtain sufficient legal representation in the EU, resorting to the ban on providing legal advice to Russian companies under Article 5n(2) of Regulation (EU) No. 833/2014 (EU-Sanctions Regulation). It has been definitively confirmed, however, that these arguments lack any foundation, as demonstrated by the General Court of the European Union: In three very recent decisions, the General Court confirmed that the general prohibition on providing legal advice to the Russian entities or bodies established in Russia under the EU‑Sanctions Regulation does not extend to services provided in connection judicial, administrative, or arbitration proceedings, as laid down in the respective exception of Article 5n(5) of EU-Sanctions Regulation.[4]

2.   The EU’s 14th Sanctions Package of June 2024

The EU responded to these developments in June 2024 by introducing provisions within a new sanctions package (Regulation (EU) 2024/1745 of 24 June 2024) setting out amendments to the EU Sanctions Regulation.[5] The sanctions package introduces a transaction ban prohibiting any direct and indirect transactions with persons and entities who have initiated claims before Russian courts based on Art. 248.1 Russian Arbitration Procedure Code, after these persons have been listed in Annex XLIII of the Regulation (Article 5ab). Further, the regulation provides EU entities with a new damage compensation mechanism in case arbitration agreements are undermined by sanctioned parties. Specifically, EU persons are entitled to damages against Russian persons or entities if (i) they initiated proceedings outside of the EU (ii) in connection with contracts or transactions affected, directly or indirectly, by EU sanctions and (iii) if no effective access to justice was provided to the EU person (Article 11a). Given that the regulation provides that entities are entitled to “any damages, including legal costs incurred by that person in a consequence of (these) claims”, damages may well include fines imposed by Russian state courts alongside with anti-arbitration injunctions. Thus, Article 11a of the EU‑Sanctions Regulation intends to provide an instrument for EU entities affected seeking to enforce damage claims within the EU. However, it is unclear how national courts of the different Member States will apply Article 11a. The regulation merely sets out the scope of the compensation, however, it does not contain any further provisions. In this regard, each Member State will apply its own civil code governing damage claims between private parties, which might lead to differences in enforcement in the relevant states.

III.   German Law: Providing a powerful Toolkit

German law already provides a powerful toolkit, based both on substantive law in the German Civil Code (BGB) and on procedural law in the German Civil Procedure Code (ZPO). Essentially, a party affected by the above-described avoidance tactics has three options before a German court: (1) applying for injunctive relief under Sec. 826, 1004(1) Sentence 2 BGB analog, (2) seeking declaratory relief under Sec. 1032(2) ZPO, and (3) seeking damages. In view of the authors, these tools are sufficient to effectively protect affected parties in these scenarios, rendering the introduction of anti-(anti-) suit injunctions in the German legal system unnecessary.

1.   Injunctive Relief under Sec. 826, 1004(1) Sentence 2 BGB analog

a)   Background

First, it is important to note that the German legal system, whether in substantive or procedural law, generally does not recognize the technical term of anti-(anti-) suit injunctions or anti‑enforcement injunctions.[6] There is a general reluctance of German courts to issue such injunctions, irrespective of the exact legal basis on which such injunction may be based.[7] The reason for this is that under German law, there is no “right not be sued abroad”, i.e. in a non-competent forum or court outside of Germany. Further, the jurisdiction of the German courts is clearly defined and limited; German judges do not possess the power to issue discretionary decisions based on fairness (Ermessensentscheidungen nach Billigkeit).[8] However, in view of the authors, anti-(anti-) suit injunctions or anti‑enforcement injunctions issued by a German court inspired by the Anglo-American model are not necessary for a party to effectively defend itself against unjust proceedings or judgments outside of Germany. Instead, affected parties can apply for injunctive relief under Sec. 826, 1004(1) Sentence 2 BGB.

b)   Substantive Basis: Sec. 826, 1004(1) Sentence 2 BGB analog

Sec. 826 BGB can form the substantive basis for injunctive relief against a Russian (“sanctioned”) party which initiated proceedings based on Art. 248.1 Russian Arbitration Procedure Code or which has already obtained a judgment from such proceedings. In fact, the injunctive relief comes somewhat close to what is considered an anti-suit injunction in Anglo‑American legal systems.

In general, Sec. 826 BGB provides relief by way of a tort claim in case there is an intentional damage inflicted in a manner offending common decency (vorsätzliche sittenwidrige Schädigung).[9] Although the intended relief provided in the wording of Sec. 826 BGB is compensation for damages in accordance with Sec. 249 et seq. BGB, it is widely acknowledged a person threatened by intentional damage may also file for injunctive relief in accordance with Sec. 826, 1004(1) Sentence 2 BGB analog.[10]

The requirements for a tort claim under Sec. 826 BGB are rather high. First, the opponent must inflict a damage, which is any adverse effect on the financial position of the other party or the impairment of a recognized interest.[11] Second, the act inflicting the damage must be immoral (i.e. offending common decency, (sittenwidrig)). According to the long‑standing definition established by the German Reichsgericht, a conduct is immoral when it goes against the of decency among all fair and just thinkers.[12] In addition, the 4th Senate of the German Federal Court of Justice requires a particular reprehensibility (Verwerflichkeit) of the conduct, which must be present in relation to the specific injured party. Reprehensibility may result from the objective pursued, the means used, the attitude revealed, or the consequences incurred.[13] Third, the party must act intentionally regarding the fact that the act causes harm to another person. It is required that intent refers to the facts giving rise to immorality, but not to immorality itself.[14]

What is crucial for the sanctions‑context is that Sec. 826 BGB also applies to damages inflicted based on procedural (immoral) conduct. In this regard, Sec. 826 BGB has played out already before the sanctions-context in different scenarios, for example in case of the immoral obtaining of a judgment (sittenwidrige Titelerschleichung). This is the case when a party has brought about either the decision itself or at least the entry into force of the decision in a manner offending common decency, for example by fraud or coercion.[15] In this case, the aggrieved party may apply to a state court to refrain from enforcing the decision under Sec. 826 BGB.[16] The same is true when a party tries to enforce a judgment that has not been obtained fraudulently but recognized as untenable and there are special circumstances making the exploitation of such a judgment appear immoral.[17] In all these cases, the legal validity of the judgment (Rechtskraft) may be exceptionally set aside. In this context, Sec. 826 BGB does not function as a damage claim but as a claim for injunctive relief.

Lastly, in case the initiating of a claim outside of Germany fulfills the requirements of Sec. 826 BGB, it has been recognized that a party may seek injunctive relief by way of an analogous application of Sec. 826, 1004(1) Sentence 2 BGB.[18] Thus, by way of invoking Sec. 826, 1004(1) Sentence 2 BGB, a party can defend itself against an unlawful act of a party who exploits a judicial measure in his favor, in an unlawful immoral manner of damage so that the party suffers damage by the other party obtaining an unlawful judgment or conducting an unlawful procedure.

Here, the damage inflicting conduct offending common decency would be applying for an anti‑arbitration injunction under Art. 248.2 Russian Arbitration Procedure Code before a Russian state court, knowing that the procedure before the state court will not be in accordance with the rule of law and will be detrimental for the opposing party (not the ignorance and violation of the arbitration agreement). Thus, the immoral conduct is using a supposed legal protection that has nothing to do with the rule of law.

It follows from the above analysis that what Anglo-American legal systems understand as anti-suit and anti-enforcement injunction is possible in German law by means of Sec. 826, 1004(1) Sentence 2 BGB on the substantive law level. The application to be submitted by a party in front of the German Court could be:

“To order the respondent to refrain from pursuing the state court proceedings in Russia and, in case there is already a rendered judgment, to refrain from enforcing this judgment against the claimant.”

Further, it is advisable to apply for a corresponding warning in accordance with Sec. 890(2) ZPO, namely that in case of a violation of the stipulated obligation, the court will impose on the defendant for each count of the violation, upon the creditor filing a corresponding petition, a coercive fine and, for the case that such payment cannot be obtained, to coercive detention or coercive detention of up to six (6) months, Sec. 890(1) ZPO.

c)   Procedural Enforcement

In general, there are two ways to procedurally enforce the injunctive relief: by way of main proceedings (Hauptsacheverfahren) or via preliminary injunction under Sec. 935 ZPO.[19] With regards to the main proceedings, it would be an action for performance in the sense of a preliminary injunction (allgemeine Leistungsklage). However, these proceedings tend to be lengthy. A faster way would be applying for a preliminary injunction under Sec. 935 ZPO (injunction regarding the subject matter of the litigation). An advantage here is that the facts giving rise to a tort claim under Sec. 826 BGB only need to be demonstrated to the satisfaction of the court (Glaubhaftmachung), Sec 935, 936, 920(2), 294 ZPO, which is a lower burden compared to the general standard of proof during the main proceedings. In particular, for the sake of introducing evidence, it is also permitted to make a statutory declaration in lieu of an oath (eidestattliche Versicherung). Additionally, the court may grant an injunction on an ex parte basis.

d)   Analysis

In sum, the German legal system does not need anti-suit injunctions as it already provides a useful toolkit in this context, injunctive relief by way of Sec. 826, 1004(1) Sentence 2 BGB analog. An important difference to anti-suit injunctions would be that a tort claim under Sec. 826 BGB is initiated to bind another party, whereas injunctions are intended to bind other courts or tribunals.

All in all, the BGB  provides a practical and well-defined framework, outlining a clear path for navigating such legal matters in Germany: The authors believe that, despite the high legal threshold, there is a credible argument that a Russian party initiating proceedings under Article 248.1 of the Russian Arbitration Procedure Code – and thereby seeking legal protection through biased means that do not adhere to the rule of law, constitutes an intentional immoral conduct. This especially applies to abusive practices where a Russian party not designated on any EU sanctions list initiates proceedings under Article 248.1 of the Russian Arbitration Procedure Code under the pretext of being subject to restrictions of Article 5n of EU-Sanctions Regulation on the provision of legal advisory services allegedly restricting its access to legal remedies within the EU, which is clearly not the case. As such, it is not unlikely that German courts will find that such behavior fulfills the requirements of Sec. 826 BGB and issue injunctive relief on that basis.

2.   Declaratory Relief under Sec. 1032(2) ZPO

a)   Background

Another tool provided for in the German Civil Procedural Code is the declaratory relief under Sec. 1032(2) ZPO.[20]  This provision is an addition to the UNCITRAL Model Law and serves as a unique mechanism within the German legal system, setting it apart from other jurisdictions.[21] According to the intent of the German legislator, the declaratory relief should precede the arbitration proceedings, safeguarding a due clarification of the question whether arbitration is admissible between the parties at an early stage of the dispute.[22] Under the provision, parties may apply for the determination of the (in‑)admissibility of arbitral proceedings until the arbitral tribunal is constituted. Upon application, the court will examine two questions: whether the arbitration agreement is valid and whether the dispute at hand is subject to it.[23]

b)   Requirements

Relief under Sec. 1032(2) ZPO is extraterritorial, meaning that declaratory relief can be sought even if the arbitral seat is outside of Germany. This can be derived from Sec. 1025(2) ZPO.[24] From its mere wording, it may seem that Sec. 1025(2) in conjunction with Sec. 1032(2) ZPO stipulates a “worldwide and universal jurisdiction”. However, most scholars and courts agree that the international jurisdiction must be limited, requiring at least some nexus of the applying party to Germany to establish jurisdiction.[25] In that sense, it can be sufficient that the party is domiciled in Germany and that its financial situation and assets in its registered seat in Germany are affected by the Russian state court proceedings.[26] On the contrary, an application will be denied when the applicant has no assets in Germany and there is no indication that this circumstance will change in the future.[27] In that regard, future cases will show which circumstances are sufficient to establish international jurisdiction over an applicant.

Application for declaratory relief must be directly filed with a German higher regional court (Oberlandesgericht). In case the arbitral seat is in Germany, the court in the district of the seat of the arbitration will be competent, Sec. 1025(1), 1026, 1062(1) No. 2 ZPO. In case the arbitration is seated outside of Germany, it will be the Higher Regional Court in the district of which the party opposing the application has their seat or place of abode, or in which assets of the party opposing the application are located or in which the object being laid claim to by the request for arbitral proceedings or affected by the measure is located; or, by way of alternative jurisdiction (hilfsweise Zuständigkeit), the Higher Regional Court of Berlin (Kammergericht), Sec. 1025(2), 1026, 1062(2) ZPO.

In general, all parties who may be affected by the arbitration proceedings have the right to file an application.[28] A special interest in a declaratory judgment is not required (Feststellungsinteresse). The applicant only needs a general legal interest worthy of protection in determining the admissibility of arbitral proceedings (allgemeines Rechtsschutzinteresse). In particular, the application is already admissible prior to the formal initiation of the arbitral proceedings.[29]

Yet, the timeframe in which application can be filed is limited. Relief under Sec. 1032(2) ZPO can be sought only until the constitution of the arbitral tribunal. A later challenge or change of arbitrators is irrelevant.[30] The deciding point in time is the day the application of the party seeking relief arrives at the court. Until this day, the arbitral tribunal must not have been constituted.[31]

In sum, due to its extraterritoriality, Sec. 1032(2) ZPO is particularly relevant for parties lacking sufficient nexus to seek a common law anti-suit injunction, offering them an alternative route through the German legal system. Additionally, it complements the tools available for the cases at hand.

c)   Recent Decisions of the Higher Regional Court Berlin (Kammergericht)

In fact, the Higher Regional Court Berlin (Kammergericht) granted declaratory relief in accordance with Sec. 1032(2) ZPO to EU entities facing anti-arbitration injunctions issued by Russian state courts on the basis of Art. 248.1, 248.2 Russian Arbitration Procedure Code in two recent cases.[32] In the 2023 decision, the court clarified that arbitration may be initiated even though the defendant is sanctioned under EU law, stating that Russian entities cannot unilaterally withdraw from arbitration agreements by referring to Russian national law. Instead, even despite sanctions, it must be ensured that a party which concluded an arbitration agreement with a Russian entity retains access to arbitral proceedings. During the proceedings, the Higher Regional Court had faced difficulties to serve the Russian party with process in accordance with Hague Convention. Several attempts to serve process were denied both by the Russian court as well as by the Russian Ministry of Justice. The Higher Regional Court Berlin finally conducted service of process via public service under Sec. 185 No. 3, 188 ZPO (öffentliche Zustellung). The public service was effected by posting a notice on the court’s notice board for one month, Sec. 186(2), 188 Sentence 1 ZPO.

The decisions show the current trend that EU member states increasingly defend themselves against unlawful behavior of other states.

d)   Analysis: Determination of Admissibility of Arbitral Proceedings (and then what?)

These cases and the current situation raise one fundamental question: What practical effect does a declaratory judgment under Sec. 1032(2) ZPO have? Does it have a purely factual effect or does it have any more far-reaching legal effects? Can it affect the enforcement of a judgment obtained in Russia under unlawful conditions within the EU?

One can easily conclude that the original purpose of Sec. 1032(2) ZPO is not actually tailored to these cases. What is certain, however, is that the declaratory relief is binding for other German courts. As an example, it has prejudicial effect for annulment proceedings before German courts. Further, it facilitates the arbitration defense under Sec. 1032(1) ZPO when case a party initiates litigation before another German court.[33]

In view of the authors, a declaratory judgment under Sec. 1032(2) ZPO could serve as a sword against the enforcement of the Russian state court judgment in another state. The court at the place of enforcement might deny enforcement due to the opposing judgment of the German court determining that arbitral proceedings are admissible.  At a minimum, the German court’s decision, particularly as issued by a higher regional court, could have a factual impact. Since decisions under Sec. 1032(2) ZPO are a fairly new phenomenon, in this regard, it remains to be seen how courts outside Germany respond to those declaratory judgments by German courts.

In light of its limited legal effect and the fact that it can only be invoked until the arbitral tribunal has been constituted, declaratory relief is a less useful tool compared to injunctive relief under Sec. 826, 1004(1) Sentence 2 BGB analog.

3.   Damage Claims

Lastly, an EU-party may seek damages before a German court, either under Art. 11a EU‑Sanctions Regulation or, provided that the arbitration agreement is subject to German law, under Sec. 280(1) BGB.

Article 11a EU‑Sanctions Regulation refers to the fact that a sanctioned party initiates proceedings before a Russian national court knowing that the court proceeding does not adhere to the rule of law and does not provide effective access to justice to the EU party. In accordance with Article 11a of the Regulation, a party may recover any damages, including legal costs, incurred by the court proceedings outside the EU. This might well include inappropriately high fines issued in conjunction with anti-arbitration injunctions by a Russian court.

A damage claim under Sec. 280(1) BGB, on the other hand, can be based on the fact that the Russian party violates the arbitration agreement.[34] An action brought before a state court in disregard of a valid arbitration agreement covering the dispute arbitration agreement will be generally considered unlawful.[35] In this regard, a declaratory judgment under Sec. 1032(2) ZPO could also have prejudicial effects with regards to the question of whether there is a valid arbitration agreement between the parties. Damages may, in accordance with Sec. 249 et seq. BGB, include all costs incurred by the unlawful foreign proceeding, including the imposed fines. Continuing this thought, it might even be possible under German law that when the state court litigation is still pending, the party seeking to initiate arbitration might force the other party to withdraw its claim under Sec. 280(1), 249(1) BGB, which constitutes the principle of restoration of the status quo ante (Naturalrestitution), which, with regards to its effect, would come close to an anti‑suit injunction.

IV.   Conclusion

The foregoing analysis shows that the German legal system as such, with its comprehensive array of procedural and substantive legal tools, does not require anti-(anti)-suit or anti-enforcement injunctions to effectively protect entities’ rights in sanctions-related disputes. Instead, it offers robust mechanisms that German courts can utilize to uphold these rights without resorting to such injunctions. Instead, the German legal system provides sufficient instruments courts may resort to in order to safeguard entities’ rights in sanction related disputes.

While declaratory relief under Sec. 1032(2) ZPO might be a unique tool to determine admissibility of arbitral proceedings, it is limited by its applicability only up until the constitution of the arbitral tribunal. Moreover, it remains less effective than injunctive relief due to its restricted flexibility and limited legal reach. In contrast, injunctive relief grounded in tort claims under Sec. 826 and Sec. 1004(1) Sentence 2 BGB provides a more powerful and adaptable tool for countering avoidance tactics by Russian parties, offering German courts a stronger and more comprehensive means of addressing such challenges.

[1] Similar considerations apply for non-EU entities where jurisdiction can be established in Germany.

[2] See Federal Law of 08.06.2020 No. 171-ФЗ “On Introducing Changes to the Arbitration Procedure Code of the Russian Federation (Protected) for the Protection of Rights of Individual and Legal Personalities State (Interstate) Institution of Foreign State or State Association and (or) Union”, See https://www.acerislaw.com/wp-content/uploads/2020/07/Anti-Russian-Sanctions-Law-English.pdf.

[3] See UniCredit Bank GmbH v RusChemAlliance LLC (RCA), judgment of 5 August 2023; Siemens Mobility v JSC Russian Railways, judgment of 18 October 2023 (Case No. 305-ES23-19401); Gazprom v JSC Naftogaz, judgment of 22 January 2024 (Case No. A56-124094/2023); Gazprom v Net4Gas, judgment of 6 March 2024 (Case No. A56-9516/2024); Deutsche Bank AG v. RusChemAlliance (RCA), judgment of 16 October 2024 (Case No. A56-90971/2024).

[4] General Court of the European Union Case Nos. T-797/22; T-798/22; T-828/22, Press Release of the General Court of 2 October 2024.

[5] Council Regulation (EU) 2024/1745 of 24 June 2024 amending Regulation (EU) No 833/2014 concerning restrictive measures in view of Russia’s actions destabilizing the situation in Ukraine, See https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:L_202401745.

[6] Higher Regional Court München (Oberlandesgericht), Judgment of 12 December 2019 ­– 6 U 5042/19, GRUR 2020, 379 para. 54; Ehlgen in GRUR 2022, 537.

[7] M. Stürner in RabelsZ Bd. 71(2007), p. 601.

[8] R. Geminer in NJW 1991, 3072, 3074; Higher Regional Court Düsseldorf (Oberlandesgericht), Judgment of 17 June 2024 – ­26 W 7/24 –, juris para. 34.

[9] Section 826 BGB reads: „A person who, in a manner offending common decency, intentionally inflicts damage on another person is liable to the other person to provide compensation for the damage. “

[10] Higher Regional Court of Saarbrücken (Saarländisches Oberlandesgericht), Judgment of 7 January 1987 – 1 U 165/84 –, juris. Section 1004(1) BGB reads: „If the ownership is interfered with by means other than removal or retention of possession, the owner may demand that the disturber remove the interference. If there is the concern that further interferences will ensue, the owner may seek a prohibitory injunction.”

[11] German Federal Court of Justice (Bundesgerichtshof), Judgment of 19 July 2004 – II ZR 402/02 –, juris.

[12] „Anstandsgefühl aller billig und gerecht Denkenden”, Reichsgericht, Judgment of 11 April 1901, RGZ 48, 114 (124).

[13] German Federal Court of Justice (Bundesgerichtshof), Judgment of 28 June 2016 – VI ZR 536/15 –, juris.

[14] German Federal Court of Justice (Bundesgerichtshof), Judgment of 21 April 2009 – VI ZR 304/07 –, juris.

[15] Braun/Heiß in Münchener Kommentar zur ZPO, 6th edition 2020, preliminary remarks on Sec. 578 ZPO, para. 12.

[16] German Federal Court of Justice (Bundesgerichtshof), Judgment of 25 May 1959 – II ZR 231/58 –, juris.

[17] German Federal Court of Justice (Bundesgerichtshof), Judgment of 21 June 1951 – III ZR 210/50 –, juris.

[18] Reichsgericht, Judgment of 3 March 1938, RGZ 157, 136, 140. M. Stürner in RabelsZ Bd. 71(2007), p. 602; Schack in: Internationales Zivilverfahrensrecht, 7th edition 2019, p. 323, Higher Regional Court Düsseldorf (Oberlandesgericht), Judgment of 17 June 2024 – ­26 W 7/24 –, juris; Higher Regional Court Düsseldorf (Oberlandesgericht), Judgment of 18 Juli 1997 – 22 U 271/96, NJW-RR 1998, 283, 284.

[19] Section 935 ZPO reads: „Injunctions regarding the subject matter of the litigation are an available remedy given the concern that a change of the status quo might frustrate the realisation of the right enjoyed by a party, or might make its realisation significantly more difficult.”

[20] Sec. 1032(2) ZPO reads: „Until the arbitral tribunal has been formed, a request may be filed with the court to have it determine the admissibility or inadmissibility of arbitral proceedings.”

[21] See BT Drs 13/5274, p. 38.

[22] German Federal Court of Justice (Bundesgerichtshof), Decision of 27 July 2023 – I ZB 43/22 –, juris para. 77; Münch in: Münchener Kommentar zur ZPO, 6th edition 2022, Sec. 1032 para. 1.

[23] German Federal Court of Justice (Bundesgerichtshof), Decision of 19 July 2012 – III ZB 66/11, SchiedsVZ 2012, 281.

[24] Sec 1025(2) ZPO reads: „The provisions of sections 1032, 1033 and 1050 are to be applied also in those cases in which the place of arbitration is located abroad or has not yet been determined.”

[25] Münch in: Münchener Kommentar zur ZPO, 6th edition 2022, Sec. 1025 para. 21; Gerl in: SchiedsVZ 2024, 218, 222; Berlin (Kammergericht), Decision of 10 August 2006, 20 Sch 7/04  –, juris para. 97.

[26] Berlin (Kammergericht), Decision of 1 June 2023, 12 SchH 5/22 –, juris para. 22.

[27] Berlin (Kammergericht), Decision of 10 August 2006, 20 Sch 7/04  –, juris para. 96.

[28] Higher Regional Court Saarbrücken (Oberlandesgericht), Decision of 29 May 2008, Sch 2/08, SchiedsVZ 2008, 313, 315.

[29] Higher Regional Court Frankfurt am Main (Oberlandesgericht), Decision of 10 June 2014, SchiedsVZ 2015, 47.

[30] Voit in: Musielak/Voit ZPO, 21st ed. 2024, Sec. 1032 para. 10; Münch in: Münchener Kommentar zur ZPO, 6th edition 2022, Sec. 1032 para. 30.

[31] Voit in: Musielak/Voit ZPO, 21st ed. 2024, Sec. 1032 para. 10.

[32] Higher Regional Court Berlin (Kammergericht), Decision of 1 June 2023, 12 SchH 5/22 –, juris. The second decision dated 3 September 2024 decision is still unpublished.

[33] Voit in: Musielak/Voit ZPO, 21st ed. 2024, Sec. 1032 para. 13.

[34] That the violation of an arbitration agreement may lead to a claim under Sec. 280(1) BGB is recognized by most scholars, although the German Federal Court of Justice has not yet ruled on the issue. See however German Federal Court of Justice (Bundesgerichtshof), Judgment of 17 October 2019 – III ZR 42/19 – juris granting damages under Sec. 280(1) BGB regarding agreements as to the choice of venue (Sec. 38 ZPO), which, in the view of most scholars, can be applied to arbitration agreements. See for example: E. Peiffer and M. Weiler in: RIW 2020, 641, 648 et seq; J. Antomo in: EuZW 2020, 143, 150; M. Oehm and C. Jung-Arras in: BakerMcKenzie Kompass, Blogpost dated 11 November 2019, available at: https://www.bakermckenzie-kompass.de/2019/11/11/gerichtsstandsvereinbarung-schadensersatz-verlangen-wenn-am-falschen-gerichtsstand-geklagt-wird/.

[35] E. Peiffer and M. Weiler in: RIW 2020, 641, 648 et seq.

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The following Gibson Dunn lawyers prepared this update: Dr. Finn Zeidler, Dr. Annekathrin Schmoll, Dr. Nikita Malevanny, and Charlotte Popp*.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. For additional information about how we may assist you, please contact the Gibson Dunn lawyer with whom you usually work, the leaders or members of the firm’s Judgment and Arbitral Award Enforcement, International Arbitration, or International Trade practice groups, or the authors in Germany:

Frankfurt:
Dr. Finn Zeidler (+49 69 247 411 530, fzeidler@gibsondunn.com)
Dr. Annekathrin Schmoll (+49 69 247 411 533, aschmoll@gibsondunn.com)

Munich:
Dr. Nikita Malevanny (+49 89 189 33 224, nmalevanny@gibsondunn.com)

*Charlotte Popp, a law clerk in the Frankfurt office, is not yet admitted to practice law.

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

This update provides an overview of key class action-related developments during the third quarter of 2024 (July to September).

Table of Contents

• Part I reviews three decisions rejecting certification based on Rule 23(b)(3)’s predominance requirement;

• Part II summarizes a Fifth Circuit decision addressing how questions of standing fit within the Rule 23 inquiry;

• Part III summarizes the Seventh Circuit’s application of Bristol-Myers Squibb to Fair Labor Standards Act collective actions, deepening an existing circuit split; and

• Part IV highlights decisions from three circuits analyzing formation and assent to online arbitration agreements.

I.   The Eighth, Ninth, and Eleventh Circuits Reject Class Certification on the Ground That Individualized Issues Would Predominate

This past quarter, three courts of appeals enforced Rule 23’s rigorous predominance requirement, clarifying that no class can be certified when adjudicating class members’ entitlement to relief and available defenses would require resolving individualized issues.

In Carter v. City of Montgomery, 108 F.4th 1334 (11th Cir. 2024), Montgomery residents brought a putative class action in connection with the city’s practice of jailing certain traffic offenders for failing to pay their fines.  The Eleventh Circuit affirmed the denial of class certification for lack of predominance, holding that each class member’s claim would ultimately depend on resolving individualized issues, including whether she (1) was individually denied certain legal rights, (2) was on probation, or (3) had a history of payments or missed payments.  Id.at 1345-46.

Similarly, in Black Lives Matter v. City of Los Angeles, 113 F.4th 1249 (9th Cir. 2024), the Ninth Circuit reversed certification of classes alleging claims for excessive force and arrests for protected activity, holding that the district court did not conduct a sufficiently rigorous analysis of whether common issues would predominate.  The court of appeals held that individual inquiries—including how any injury was caused, whether the challenged conduct was reasonable under the circumstances, the specific conditions of each arrest, and whether officers had probable cause to arrest—would be required, making it unlikely that the case could be resolved via classwide evidence.  Id. at 1259-61.

And in Ford v. TD Ameritrade, 115 F.4th 854 (8th Cir. 2024), the Eighth Circuit reversed certification of a class of investors who transacted through TD Ameritrade and who claimed that TD Ameritrade violated its “duty of best execution,” which requires brokers to “use reasonable efforts to maximize the economic benefit of the client in each transaction.”  Id. at 858.  Although the commission investors paid was a flat rate, the court of appeals held that was insufficient to establish common questions about economic loss because of individualized issues about what the best price reasonably available would be under the circumstances, the existence of alternative brokers, the fees of those brokers, and the prices those brokers could have obtained for each trade.  Id. at 861.

II.   The Fifth Circuit Addresses Whether Named Plaintiffs Have Standing to Litigate Class Actions on Behalf of Absent Class Members with Different Theories of Injury

In July, the Fifth Circuit addressed an issue subject to a longstanding circuit split:  whether a named plaintiff has standing to litigate absent class members’ injuries that are similar, but “not precisely analogous,” to those suffered by the named plaintiff.  Chavez v. Plan Benefit Servs., Inc., 108 F.4th 297, 307 (5th Cir. 2024).

In Chavez, the three named plaintiffs were employed by the same company, which disbursed their retirement and healthcare plan benefits through two trusts managed by the defendant.  The plaintiffs alleged that the defendant mismanaged employer-contributed funds based on the plaintiffs’ enrollment in certain benefit plans.  The district court certified classes consisting of “all participants and beneficiaries of plans that provide employee benefits through” each trust.  Id. at 305.  On appeal, the defendant argued that the plaintiffs lacked “standing to challenge fees that they were never subjected to, in plans that they never participated in, relating to services that they never received, from employers for whom they never worked.”  Id. at 306.

The Fifth Circuit outlined two analytical approaches to standing arguments based on a “disjuncture” between the injury alleged by a named plaintiff and the injuries purportedly suffered by the broader class.  Under the “class certification approach” favored by the First, Third, and Sixth Circuits, a court decides whether a named plaintiff has standing to bring her own claims and, if so, addresses any “disjuncture” between the plaintiff’s and the absent class members’ injuries as part of the Rule 23 analysis.  See, e.g., In re Asacol Antitrust Litig., 907 F.3d 42, 49 (1st Cir. 2018); Boley v. Universal Health Servs., Inc., 36 F.4th 124, 133 (3d Cir. 2022); Fallick v. Nationwide Mut. Ins. Co., 162 F.3d 410, 424 (6th Cir. 1998).  Under the “standing approach” taken in other circuits, a court “simply find[s] that the class representative lacks standing to pursue the class members’ claims because she did not suffer their injuries.”  Chavez, 108 F.4th at 307.  Courts of appeals have applied this approach with varied degrees of strictness, with the Second and Eleventh Circuits applying the most rigorous formulations.  See, e.g., Barrows v. Becerra, 24 F.4th 116, 129 (2d Cir. 2022); Fox v. Ritz-Carlton Hotel Co., LLC, 977 F.3d 1039, 1046 (11th Cir. 2020).  The Ninth Circuit has followed both the class certification approach and a more lenient version of the standing approach. Compare B.K. ex rel. Tinsley v. Snyder, 922 F.3d 957, 967 (9th Cir. 2019) (class certification approach), with Armstrong v. Davis, 275 F.3d 849, 867 (9th Cir. 2001) (lenient standing approach).

The Fifth Circuit in Chavez declined to adopt either approach.  Chavez, 108 F.4th at 314.  The court of appeals held that the named plaintiffs had standing for their own claims because the defendant’s alleged mismanagement of the trusts devalued their benefits, and thus any doubts about their adequacy as class representatives could be resolved under Rule 23(a).  Id. at 312.  The court also held that the plaintiffs’ alleged injuries were not “so unique” that they warranted “an isolated remedy that would be inappropriate if extended to other class members,” nor did their injuries implicate “a significantly different set of concerns” from the other class members.  According to the court, the plaintiffs therefore satisfied even the strictest formulations of the “standing approach.”  Id. at 312-13.

The Chavez defendant has filed a petition for certiorari seeking U.S. Supreme Court review (No. 24-426), and the petition remains pending.

III.   The Seventh Circuit Joins the Third, Sixth, and Eighth Circuits, in Holding That Courts Need Personal Jurisdiction Over Each Plaintiff Joining a FLSA Collective Action

The Seventh Circuit in August reversed a district court’s decision holding that a court overseeing a collective action under the Fair Labor Standards Act need not secure personal jurisdiction over each plaintiff’s claim individually (whether representative or opt-in).  Luna Vanegas v. Signet Builders, Inc., 113 F.4th 718, 724 (7th Cir. 2024).  In Luna Vanegas, the court of appeals applied the holding in Bristol-Myers Squibb Co. v. Superior Court, 582 U.S. 255 (2017), which requires a “claim-by-claim personal jurisdiction analysis” in mass actions.  Id. at 265.  The Seventh Circuit explained that an FLSA collective action is like a mass action because it is a “consolidation of individual cases, brought by individual plaintiffs.”  Luna Vanegas, 113 F.4th at 725.  As the court of appeal detailed, that distinction makes mass and FLSA collective actions, in which the individuals seeking recovery participate as parties, different from class actions under Rule 23, in which representative plaintiffs litigate the claims of absent, non-party class members.  Id. at 724.  The court thus joined the Third, Sixth, and Eighth Circuits in holding that FLSA collective actions, like mass actions, require courts to have personal jurisdiction over each plaintiff.  Id. at 724.

The Seventh Circuit’s decision adds to an existing, if lopsided, circuit split: only the First Circuit has declined to follow that line of decisions and instead has held that courts need not have personal jurisdiction over every opt-in plaintiff in FLSA cases.  Waters v. Day & Zimmerman NPS, Inc., 23 F.4th 84, 93 (1st Cir. 2022).

IV.   Multiple Circuits Address What Constitutes Reasonable Notice of and Assent to Online Arbitration Agreements

This past quarter, the First, Fourth, and Seventh Circuits all addressed what constitutes reasonable notice of and assent to online arbitration agreements, clarifying that litigants can be bound to arbitrate based on their actions in signing up for and logging into websites in view of conspicuous disclosures of terms requiring arbitration.

In Toth v. Everly Well, Inc., — F.4th —, 2024 WL 428467 (1st Cir. Sept. 25, 2024), the First Circuit affirmed an order granting a motion to compel arbitration, reasoning that the account-creation page the plaintiff used in connection with an at-home lab test gave her proper notice of the contract and that the defendant secured meaningful assent by having the plaintiff click a checkbox indicating that she read and accepted certain terms and conditions before creating her account.  Id. at *5-7.  Similarly, in Domer v. Menard, Inc., 116 F.4th 686 (7th Cir. 2024), the Seventh Circuit affirmed an order granting a motion to compel arbitration, holding that the website operator of an online paint company provided reasonably conspicuous notice of the terms to which the plaintiff would be bound when he ordered paint through the defendant’s website.  The court held that the plaintiff assented to the arbitration provision by clicking “submit order” because the reasonably conspicuous notice—advising consumers that “[b]y submitting [their] order [they] accept [the] Terms” that were hyperlinked for easy review—would have put a reasonable user on inquiry notice of the terms.  Id. at 696-97.  The Seventh Circuit also expressly rejected the plaintiff’s argument that there had to be standalone “I agree” language to manifest assent.  Id. at 700.

Conversely, in Marshall v. Georgetown Memorial Hospital, 112 F.4th 211 (4th Cir. 2024), the Fourth Circuit affirmed the denial of the defendant’s motion to compel arbitration for failure to show formation of an agreement to arbitrate.  There, the plaintiff filed a putative class action alleging disability discrimination after the defendant didn’t hire her following a failed physical agility test.  The court held that the defendant’s website did not offer reasonable notice of the agreement to arbitrate for two main reasons: (1) although the plaintiff could have scrolled down to see the arbitration agreement at the bottom of the webpage, she was not required to do so to submit her employment application, and (2) even though the webpage contained an arbitration notice, it informed the plaintiff only that her application would be subject to South Carolina arbitration law, not that it was subject to specific contract terms that could be reviewed by scrolling down or clicking a hyperlink.  Id. at 221.  The Fourth Circuit also agreed with the district court that the plaintiff did not assent to arbitration because she only had to click a “Submit” button at the top of the webpage.  As the court explained, “The word ‘submit,’ in its ordinary meaning,” does not “manifest assent to an agreement or acceptance of contract terms,” and there was no “notice near the relevant button to explain that by clicking ‘submit,’ the applicant is agreeing to any terms and conditions or that she would be bound to an arbitration agreement.”  Id. at 223.

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The following Gibson Dunn lawyers contributed to this update: Kory Hines, Nasim Khansari, Milene Minassians, Matt Aidan Getz, Wesley Sze, Lauren Blas, Bradley Hamburger, Kahn Scolnick, and Christopher Chorba.

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

Theodore J. Boutrous, Jr. – Los Angeles (+1 213.229.7000, tboutrous@gibsondunn.com)

Christopher Chorba – Co-Chair, Class Actions Practice Group, Los Angeles
(+1 213.229.7396, cchorba@gibsondunn.com)

Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles
(+1 213.229.7726, tevangelis@gibsondunn.com)

Lauren R. Goldman – Co-Chair, Technology Litigation Practice Group, New York
(+1 212.351.2375, lgoldman@gibsondunn.com)

Kahn A. Scolnick – Co-Chair, Class Actions Practice Group, Los Angeles
(+1 213.229.7656, kscolnick@gibsondunn.com)

Bradley J. Hamburger – Los Angeles (+1 213.229.7658, bhamburger@gibsondunn.com)

Michael Holecek – Los Angeles (+1 213.229.7018, mholecek@gibsondunn.com)

Lauren M. Blas – Los Angeles (+1 213.229.7503, lblas@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

From the Derivatives Practice Group: The SEC announced its 2025 examination priorities, which include continued focus on security-based swap dealers and the potential for examinations of security-based swap execution facilities in 2025. The CFTC will hold an open meeting on Tuesday, October 29.

New Developments

• CFTC to Hold a Commission Open Meeting October 29. On October 22, the CFTC announced that it will an open meeting Tuesday, Oct. 29 at 10:00 a.m. – 4:30 p.m. (EDT) at the CFTC’s Washington, D.C. headquarters. Members of the public can attend the meeting in person, listen by phone, or view a live stream at CFTC.gov. The CFTC will consider the following: (1) Final Rule – Operational Resilience Framework for Futures Commission Merchants, Swap Dealers, and Major Swap Participants; (2) Final Rule – Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations, (3) Final Rule – Derivatives Clearing Organizations Recovery and Orderly Wind-down Plans; Information for Resolution Planning; (4) Commission Fall 2024 Unified Agenda Submission; and (5) CFTC Executive and Supervisor Compensation Structures. [NEW]
• SEC Division of Examinations Announces 2025 Priorities. On October 21, the SEC’s Division of Examinations released its 2025 examination priorities. The Division of Examinations indicated that it will continue to focus on whether security-based swap dealers (“SBSDs”) have implemented policies and procedures related to compliance with security-based swap rules generally, including whether they are meeting their obligations under Regulation SBSR to accurately report security-based swap transactions to security-based swap data repositories and, where applicable, whether they are complying with relevant conditions in SEC orders governing substituted compliance. For other SBSDs, the Division of Examinations said that it may focus on SBSDs’ practices with respect to applicable capital, margin, and segregation requirements and risk management. The Division of Examinations also indicated that it expects to assess whether SBSDs have taken corrective action to address issues identified in prior examinations. Additionally, the Division of Examinations advised that it may begin conducting examinations of registered security-based swap execution facilities in late fiscal year 2025. [NEW]
• CFTC Staff Issues Supplemental Letter Regarding No-Action Position Related to Reporting and Recordkeeping Requirements for Fully Collateralized Binary Options. On October 4, the CFTC’s Division of Market Oversight and the Division of Clearing and Risk announced they have taken a no-action position regarding swap data reporting and recordkeeping regulations in response to a request from KalshiEX LLC, a designated contract market, and Kalshi Klear LLC, a derivatives clearing organization, to modify CFTC Letter No. 21-11 to cover transactions cleared through Kalshi Klear LLC. According to the announcement, the divisions will not recommend the CFTC initiate an enforcement action against KalshiEX LLC, Kalshi Klear LLC, or their participants for failure to comply with certain swap-related recordkeeping requirements and for failure to report to swap data repositories data associated with binary option transactions executed on or subject to the rules of KalshiEX LLC and cleared through Kalshi Klear LLC, subject to the terms and conditions in the no-action letter.

New Developments Outside the U.S.

• ESMA Responds to the Commission Rejection of Certain MiCA Technical Standards. On October 16, ESMA responded to the European Commission proposal to amend the Markets in crypto-assets Regulation (“MiCA”) Regulatory Technical Standards (“RTS”). In their response, ESMA emphasized the importance of the policy objectives behind the initial proposal.
• ESAs Respond to the European Commission’s Rejection of the Technical Standards on Registers of Information under the Digital Operational Resilience Act and Call for Swift Adoption. On October 15, the European Supervisory Authorities (“ESAs”) issued an Opinion on the European Commission’s rejection of the draft Implementing Technical Standards (“ITS”) on the registers of information under the Digital Operational Resilience Act. The ESAs raise concerns over the impacts and practicalities of the proposed EC changes to the draft ITS on the registers of information in relation to financial entities’ contractual arrangements with ICT third-party service providers.
• ESMA, ECB and EC Announce Next Steps for the Transition to T+1 Governance. On October 15, ESMA, the European Commission and the European Central Bank announced the next steps to support the preparations towards a transition to T+1 in a Joint Statement. ESMA stressed in the Joint Statement that they believe a coordinated approach across Europe is desirable, with efforts to reach consensus on the timing of any move to T+1.
• ESMA Publishes Its First Annual Report on EU Carbon Markets. On October 7, ESMA published the 2024 EU Carbon Markets report, providing details and insights into the functioning of the EU Emissions Trading System market. The report indicates that prices in the EU ETS have declined since the beginning of 2023; emission allowance auctions remain significantly concentrated, with 10 participants buying 90% of auctioned volumes, reflecting a preference by most EU ETS operators to source allowances from financial intermediaries; and the vast majority of emission allowance trading in secondary markets takes place through derivatives, reflecting the annual EU ETS compliance cycle where non-financial sector firms hold long positions (for compliance purposes) while banks and investment firms hold short positions. The report builds on ESMA’s 2022 report on the trading of emission allowances, mandated in the context of rising energy prices and a three-fold increase of emission allowances’ prices in 2021.

New Industry-Led Developments

• Central Database of Reporting Entity Contact Details for EU and UK EMIR. On October 17, ISDA produced a central database of contact details to assist members resolve reconciliation breaks with counterparties for EU and UK European Market Infrastructure Regulation (“EMIR”) reporting. The central database was created by contributing firms’ submissions and includes details such as entity names, legal entity identifiers and reporting contact emails.
• ISDA, GFXD respond to ESMA on Order Execution Policies. On October 16, ISDA and the Global FX Division of the Global Financial Markets Association responded to a consultation paper from ESMA on “Technical Standards specifying the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies.” In the response, the associations discuss the requirement for pre-selected execution venues, mandatory consumption of consolidated tapes and categorization of financial instruments under the Markets in Financial Instruments Regulation, among other issues.
• ISDA Submits Paper to ESMA on MIFIR Post-Trade Transparency. On October 8, ISDA submitted a paper to ESMA, in which it outlined its views on the scope of OTC derivatives post-trade transparency in the revised MiFIR. The paper outlines ISDA’s view on the treatment of certain interest rate derivatives, index credit default swaps and securitized derivatives. ISDA indicated that it is anticipating the publication of ESMA’s consultation paper on the revised regulatory technical standards, covering OTC derivatives, later in 2024 or in the first quarter of 2025.

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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, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus  – New York (212.351.3869,  alapidus@gibsondunn.com )

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

William R. Hallatt , Hong Kong (+852 2214 3836, whallatt@gibsondunn.com )

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki , New York (212.351.4028, mtakagaki@gibsondunn.com )

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

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 October 15, 2024, Do No Harm filed a complaint against the University of Washington School of Medicine and various school officials, challenging the university’s networking directory that permits medical students who are “Black, Indigenous, or People of Color” to access a database of BIPOC physicians. Do No Harm claims that the directory improperly excludes white students and white physicians in violation of the 14th Amendment, Title VI, and the Affordable Care Act. Do No Harm is seeking a declaratory judgment, permanent injunction, and reasonable costs and expenses of the litigation.

On October 15, 2024, the American Alliance for Equal Rights (AAER) filed a Section 1981 complaint against Jopwell, a recruiting and job-posting platform that is allegedly open to “Black, Latinx, and Native American students and professionals.” The complaint alleges that the platform includes companies like Google and Blackrock and exists to create a “pipeline” of diverse talent for top employers. AAER filed suit on behalf of an anonymous college student who claims to meet all the nonracial eligibility criteria but says he could not access the full Jopwell platform after he identified himself as white and Asian during the registration process. AAER is seeking an injunction, declaratory judgment, and attorney’s fees and costs.

On October 15, 2024, U.S. District Court Judge Reed O’Connor of the Northern District of Texas ordered supplemental briefing on the parties’ request to approve a plea agreement in U.S. v. The Boeing Company, 4:21-cr-00005-O (N.D. Tex. Oct. 15, 2024), a case related to the 737 Max. The agreement provides that the government will appoint an independent compliance monitor. In his order, Judge O’Connor questioned a provision allowing the government to select a monitor with input from Boeing and “in keeping with the Department’s commitment to diversity and inclusion.” Judge O’Connor asked the government to elaborate on the definitions of “diversity” and “inclusion,” and noted that both the DOJ and Boeing have publicly acknowledged their commitment to advance DEI. In his order, Judge O’Connor stated that Boeing has “aspirations” to “advance equity and diversity” that “include racial quotas,” and that Boeing “ties executive compensation to achieving DEI goals.” Judge O’Connor ordered the government and Boeing to submit supplemental briefing describing how the diversity provision in the plea agreement promotes safety and compliance efforts, what role Boeing’s internal focus on DEI plays in its compliance and ethics obligations, and how the government and Boeing will use the diversity provision to appoint the monitor.

On October 22, 2024, AAER filed a complaint under Section 1983 against Jay Pritzker, the Governor of Illinois, and Kevin Huber, the Chairman of the Illinois Student Assistance Commission, alleging that the state’s Minority Teachers of Illinois Scholarship Program violates the Equal Protection Clause by excluding non-minority students from the application and selection processes. AAER alleges the scholarship program, which defines “minority students” as “American Indian or Alaska Native, Asian, Black or African American, Hispanic or Latino, or Native Hawaiian or Other Pacific Islander,” is unconstitutional because the exclusion of potential applicants who are not racial minorities is not narrowly tailored to a compelling governmental interest. AAER is seeking an injunction, declaratory judgment, and attorney’s fees and costs.

Media Coverage and Commentary:

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

• Wall Street Journal, “Companies are Scrapping or Rolling Back DEI Grants” (October 11): Ruth Simon and Theo Francis of The Wall Street Journal report that large companies are shrinking or winding down grant and other aid programs previously designed to help Black- and Hispanic-owned small businesses. While numerous aid programs had launched or expanded in 2020, many are now pulling back amid high-profile public pressure campaigns and legal threats. Of 60+ small-business grant programs that aid racial and ethnic minorities, the authors identified more than 40% that no longer exist, and another 27% that no longer consider race or ethnicity when making awards. Simon and Francis report that the change has been most prominent for programs supported by large companies. Simon and Francis say that the funding gap may hit Black- and Hispanic-owned businesses especially hard, as data from the Federal Reserve shows that only a third of Black- or Hispanic-owned small businesses received the full amount of financing they applied for, compared to more than half of white business owners.
• Washington Post, “Racism was called a health threat. Then came the DEI backlash.” (October 11): The Washington Post’s Akilah Johnson reports that university researchers are being targeted for their work researching and teaching about the nexus between racism and health. Johnson says that these researchers, including at Tulane University School of Tropical Health and Medicine and University of Minnesota, initially experienced an outpouring of support for anti-racism research centers and programs in 2020, as racism was declared a public health threat. However, anti-DEI activists have criticized those same programs, including filing civil rights complaints targeted at programs such as the Minority Stroke Program and Minority Men’s Health Center at the Cleveland Clinic.
• ABC News, “When DEI is gone: A look at the fallout at one Texas university” (October 13): Kiara Alfonseca of ABC News reports on the impact of SB 17, a piece of legislation in Texas that bars DEI offices and programming at public higher education institutions. Alfonseca reports that DEI offices at University of Texas-Austin have been closed, staff have been terminated, and previously available resources have been discontinued. Texas Governor Greg Abbott previously stated the legislation was intended to prevent universities from using DEI offices to “advance political agendas and exclude conservative viewpoints on college campuses.” In response to SB 17, Alfonseca says that UT Austin terminated over 60 employees and eliminated targeted programming, such as support for undocumented students. According to Alfonseca, student organizations at UT Austin are trying to fill the gap and offer resources to their fellow Longhorns.
• The New York Times Magazine, “The University of Michigan Doubled Down on DEI. What Went Wrong?” (October 16): Nicholas Confessore of The New York Times reports on the frustration among students and faculty over the University of Michigan’s extensive DEI initiatives. Confessore interviewed more than 60 individuals connected with the university to understand the impact of its decade-long quarter-billion-dollar investment in DEI academic training, programming, and incorporation across disciplines, which it now calls its “DEI 1.0” strategy. Confessore says that the campus community criticized these efforts as lacking depth and failing to address specific issues, such as the low enrollment of Black students (just 5%), in a state where 14% of residents are Black. Students and faculty also expressed that the programming seems to create a framework for grievances rather than fostering genuine interaction and understanding among different groups. Nonetheless, amidst a national backlash against DEI initiatives, Confessore reports that Michigan is pushing forward with its “DEI 2.0” strategy, announced a year ago and instituted when school began this August.
• AP News, “Members of Congress call on companies to retain DEI programs as court cases grind on” (October 15): Cathy Bussewitz of AP News reports that a group of 49 House Democrats sent a letter to the leaders of the Fortune 1000, urging the businesses to retain their DEI programs in the face of recent DEI backlash. Bussewitz says that the letter was sent in response to several companies recently pulling back on their DEI initiatives in response to pressure from anti-DEI activists. According to Bussewitz, corporations are also concerned about the growing number of reverse discrimination suits, and will be closely watching the Supreme Court’s deliberations in Ames v. Ohio Department of Youth Services, where the plaintiff claims she was subject to employment discrimination because she is heterosexual. “The Supreme Court’s interest in that case signals some potential that they’re going to lower the bar,” according to Jason Schwartz, co-chair of Gibson Dunn’s Labor & Employment practice, who also notes that “[w]e already see a really massive uptick in these reverse discrimination cases.”

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:

• Faculty, Alumni, and Students Opposed to Racial Preferences (FASORP) v. Northwestern University, No. 1:24-cv-05558 (N.D. Ill. 2024): A nonprofit advocacy group filed suit against Northwestern University, alleging that the university is violating Title VI, Title IX, and Section 1981 by considering race and sex in law school faculty hiring decisions. The suit also claims that student editors of the Northwestern University Law Review give discriminatory preference to “women, racial minorities, homosexuals, and transgender people when selecting their members and editors” and when selecting articles to publish. FASORP is seeking to enjoin Northwestern from (1) considering race, sex, sexual orientation, or gender identity in the appointment, promotion, retention, or compensation of its law school faculty or the selection of articles, editors, and members of the Northwestern University Law Review, and (2) soliciting any information about the race, sex, sexual orientation, or gender identity of law school faculty candidates or applicants for the Law Review. FASORP also asked the court to order Northwestern to establish a new policy for selecting law school faculty and law review articles, editors, and members, and to appoint a court monitor to oversee all related decisions.
  • Latest update: On September 30, 2024, FASORP filed an amended complaint, adding detailed allegations of plagiarism among candidates who were selected for Law School faculty positions and more comprehensive allegations of the Law Review’s discrimination, which include details on the editor selection process based on personal statements, an article selection process based on author identity, and plagiarism in published articles. FASORP also added detail about three unnamed members who were allegedly wronged by the university. Finally, FASORP added a demand that the court enjoin Northwestern University from accepting any federal funds until it has ceased all alleged discriminatory practices.

2. Employment discrimination and related claims:

• Bradley, et al. v. Gannett Co. Inc., 1:23-cv-01100 (E.D. Va. 2023): On August 18, 2023, white plaintiffs sued Gannett over its alleged “Reverse Race Discrimination Policy,” claiming Gannett’s expressed commitment to having its staff demographics reflect the communities it covers violates Section 1981. On August 21, 2024, the court granted Gannett’s motion to dismiss, holding that Gannett’s diversity policy alone did not establish disparate treatment, since it did not define any specific goals or quotas. The court also held that each of the named plaintiffs had failed to state a claim for individual relief pursuant to Section 1981, and dismissed the class allegations because the class was not ascertainable and lacked commonality. On September 19, 2024, the plaintiffs filed a second amended complaint.
  • Latest update: On October 3, 2024, Gannett moved to dismiss the second amended complaint for failure to state a claim and a moved to dismiss or strike the class allegations. Gannett argued that because the plaintiffs did not amend any of their dismissed class allegations, the proposed class could not be certified for the reasons previously determined by the Court. Furthermore, the company argued that the plaintiffs’ allegations were again conclusory and simply recited the elements of the claim without providing any details about the allegedly discriminatory policy. The court set a hearing for November 6, 2024.

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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, Jenna Voronov, Alana Bevan, Marquan Robertson, Elizabeth Penava, Skylar Drefcinski, Mary Lindsay Krebs, David Offit, Lauren Meyer, Kameron Mitchell, Maura Carey, Jayee Malwankar and Heather Skrabak.

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, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment Group
Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)

Mylan L. Denerstein – Partner & Co-Chair, Public Policy Group
New York (+1 212-351-3850, mdenerstein@gibsondunn.com)

Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer
Washington, D.C. (+1 202-955-8503, zswilliams@gibsondunn.com)

Molly T. Senger – Partner, Labor & Employment Group
Washington, D.C. (+1 202-955-8571, msenger@gibsondunn.com)

Blaine H. Evanson – Partner, Appellate & Constitutional Law Group
Orange County (+1 949-451-3805, bevanson@gibsondunn.com)

© 2024 Gibson, Dunn & Crutcher LLP.  All rights reserved.  For contact and other information, please visit us at www.gibsondunn.com.

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.

We are pleased to provide you with Gibson Dunn’s ESG update covering the following key developments during September 2024. Please click on the links below for further details.

I. GLOBAL

1. International Financial Reporting Standards (“IFRS”) Foundation launches guide to help companies voluntarily apply International Sustainability Standards Board (“ISSB”) sustainability reporting standards

On September 25, 2024, the IFRS Foundation released a new guide to support companies that plan to voluntarily adopt the ISSB’s sustainability and climate disclosure standards, which have already been adopted by jurisdictions representing nearly 55% of global GDP and more than 40% of global market capitalization.

The new guide, titled Voluntarily Applying ISSB Standards—A Guide for Preparers, is designed to support companies that operate in jurisdictions that do not yet require application of the ISSB standards, but who nevertheless wish to voluntarily report under them, either in response to investor demand or in preparation for global requirements. The IFRS Foundation notes that the guide helps support implementation by highlighting the following: (i) transition relief that allows companies to use a phased-in approach to the ISSB standards, (ii) proportionality mechanisms to address “the range of capabilities and circumstances of companies,” and (iii) resources from the IFRS Foundation to help companies transition from other frameworks and standards (such as the Task Force on Climate-related Financial Disclosure and Sustainability Accounting Standards Board standards) to the ISSB standards.

2. International Energy Agency (“IEA”) publishes guidance on implementing COP28 energy goals

In connection with Climate Week NYC, the IEA published From Taking Stock to Taking Action on September 24, 2024. This report explores the actions needed to fully implement the global energy goals agreed on at the COP28 conference, as well as the risks of failing to do so. These goals include a 2050 net zero emissions pledge for the energy industry, a transition away from fossil fuels, and an intention to triple renewable energy capacity by 2030, among others.

3. 24% of investors in Vanguard’s proxy choice program chose ESG-focused voting policy

On September 17, 2024, Vanguard released data from its 2024 Investor Choice voting pilot program, reporting that 24% of participating investors opted for an ESG-focused voting policy. Vanguard’s pilot program allows investors to select from a range of voting policy options and covers equity funds comprising more than $100 billion in assets. Of the 40,000 participants for the 2024 proxy season, 24.4% selected the Third Party ESG Policy (which will vote in accordance with Glass Lewis’s ESG Voting Policy recommendations), 43% selected the Vanguard-Advised Funds Policy (which will vote in accordance with the guidelines of each of Vanguard’s funds), 30.3% selected the Company Board-Aligned Policy (which will vote in accordance with the recommendations of each company’s board of directors), and 2.3% selected the “Not Voting” Policy (which will leave all shares unvoted). Vanguard stated that the Investor Choice pilot is meant to “enabl[e] interested individual investors to more fully align their investment portfolios with their personal preferences in order to advance their long-term financial goals” and that Vanguard is “committed to continuing to empower investors by expanding access to the proxy voting process.”

II. UNITED KINGDOM

1. Financial Conduct Authority (“FCA”) offers temporary flexibility for firms to comply with its “naming and marketing” sustainability rules

On September 9, 2024, the FCA published a statement setting out temporary measures for firms to comply with its naming and marketing sustainability rules. The FCA noted that in-scope firms “should now be taking all reasonable steps to ensure compliance with the ‘naming and marketing’ and disclosure rules,” which come into effect starting on December 2, 2024. The FCA also noted that it is taking longer than expected for some firms to make the necessary changes. As a result, the FCA is providing further support and flexibility to firms that may need additional time to make the required changes. Until 5 pm on April 2, 2025, firms have limited temporary flexibility to comply with the naming and marketing rules in relation to a sustainability product that is a UK-authorised investment fund. The flexibility only applies to firms that comply with certain criteria outlined in the FCA’s statement. Regarding the authorization of mergers, wind-ups or terminations before December 2, 2024, the FCA has announced that it intends to take a “supportive, proportionate and outcomes-based approach in these circumstances.” Firms are requested to contact their supervisor or usual supervisory contact at the FCA to discuss on a case-by-case basis.

2. Financial Reporting Council (“FRC”) publishes 2024 Annual Review of Corporate Reporting

On September 24, 2024, the FRC published its Annual Review of Corporate Reporting with its findings from monitoring UK companies’ annual report and accounts and its expectations for the upcoming reporting season. With respect to sustainability reporting, the FRC noted that “there were comparatively few compliance issues in premium-listed companies’ reporting against the Taskforce for Climate-related Financial Disclosures (TCFD) framework.” The FRC also wrote to companies that did not report against TCFD despite being in scope of the relevant Listing Rules or provided inadequate disclosures, amongst other reasons. This winter (2024/2025), the FRC also plans to publish results of a thematic review of climate-related financial disclosures reporting under the Companies Act 2006, which will cover a selection of large private and AIM companies with a year-end between August and December 2023.

3. Competition and Markets Authority (“CMA”) publishes greenwashing guidance for the fashion industry and stakeholders

On September 18, 2024, the CMA published a compliance guide for fashion retail businesses explaining how they can follow the Green Claims Code when making environmental claims. According to the guidance, all businesses in the clothes, footwear, fashion accessories and related services (such as packaging, delivery and returns) supply chain are responsible for ensuring their environmental claims are accurate and substantiated. Given the guidance, the CMA expects there will be no excuse for using misleading claims, and that failure to ensure practices are aligned with consumer protection rules could carry a risk under the Digital Markets Competition and Consumers Act (of up to 10% of global turnover), once the Act’s enforcement provisions take effect in 2025. The publication follows a review in 2022 by the CMA into the fashion industry.

4. UK government transfers the National Grid Electricity System Operator (“ESO”) into public ownership in £630m acquisition

On September 13, 2024, the UK Government announced its decision to acquire the ESO from National Grid, transitioning it into public ownership. From October 1, 2024, the entity will be reestablished as the National Energy System Operator (the “NESO”) and will assume responsibility for the comprehensive planning of Britain’s gas and electricity networks. For the purposes of the Energy Act 2023, NESO will be designated independent from the Government as the licensed Independent System Operator and Planner for the UK, taking on all existing functions of the ESO, under the oversight of Ofgem. This follows the joint consultation (which closed on May 9, 2024) by Ofgem and the Department for Energy Security & Net Zero on the structure and licensing of NESO, which noted that NESO will take on key operational roles in electricity, as well as planning roles in gas and hydrogen. This aligns with the UK Government’s commitment to decarbonise the power grid by 2030.

5. Britain ends its dependence on coal for electricity

On September 30, 2024, the UK’s last remaining coal-fired power station at Ratcliffe-on-Soar closed, making Britain the first G7 nation to have ended its reliance on coal for electricity production. The closure follows the Government’s announcement in 2015 that all coal-fired power stations would close by 2025, a date which was later brought forward to 2024 in advance of the UK hosting COP26 in Glasgow. The phase-out of coal is a significant milestone in the UK’s transition plans.

6. New Water (Special Measures) Bill to give regulators enforcement powers against water companies damaging the environment

On September 4, 2024, the Water (Special Measures) Bill was introduced by the UK Government in the House of Lords, proposing changes to the regulation of private companies providing water and sewerage services in England and Wales, including by requiring water companies to publish annual pollution incident reduction plans, providing information on emergency sewage overflows, introducing new automatic penalties for offences committed by water companies and giving regulators new powers to recover costs for enforcement work. Alongside the bill, the government also published explanatory notes, a delegated powers memorandum and a policy statement supporting the bill.

III. EUROPE

1. Lawsuit against European Commission demands stricter emissions reductions by 2030

On August 27, 2024, Climate Action Network Europe and the Global Legal Action Network submitted their final written statements before the oral hearing in a lawsuit against the EU Commission. The NGOs challenge the legality of Europe’s emissions allowances for the period leading up to 2030, arguing that the EU Commission failed to adequately assess and establish suitable emission reduction targets and did not properly evaluate the impacts of climate change on fundamental rights. It is also alleged that the emission reductions in the EU’s Fit for 55 package are inadequate to meet the 1.5°C target of the Paris Agreement.

If the lawsuit is successful, this could lead to stricter emission targets, raising carbon allowance costs in the EU’s Emissions Trading System and impacting covered sectors and importers under the Carbon Border Adjustment Mechanism. Despite early challenges in court, a recent European Court of Human Rights ruling recognizing climate protection as a human right may bolster the NGOs’ case.

2. European Commission proposes carbon footprint labels for flights

On September 25, 2024, the European Commission published a statement announcing the launch of a consultation on a new EU Flight Emissions Label (“FEL”) initiative to provide passengers with standardized information about the carbon footprint of their flights. The initiative is part of the broader ReFuelEU Aviation regulations, adopted in 2023, which seek to decarbonize the aviation sector. The FEL aims to establish a standardized and regulated approach for calculating flight emissions by considering factors like aircraft type, average passenger count, cargo weight, and the type of fuel used. Beginning in 2025, airlines operating flights within or departing from the EU will be able to voluntarily participate in this initiative.

3. Italy launches greenwashing investigation into Shein, global fashion retailer, over environmental claims

On September 25, 2024, the Italian Competition Authority announced its investigation into Shein’s website operator, Infinite Styles Services CO. Limited, over potentially misleading advertising claims regarding the environmental sustainability of Shein-branded clothing. The inquiry focuses on claims made in various sections of the website. The Italian Authority alleges that Shein attempts to project an image of sustainable production and commercial practices through vague and potentially misleading statements, aiming to capitalize on increased consumer sensitivity to environmental issues. This investigation aligns with broader actions taken by EU regulators and lawmakers to combat greenwashing and protect consumers from misleading sustainability claims.

4. European Commission launches infringement procedures against 17 member states over Corporate Sustainability Reporting Directive (“CSRD”) transposition delays

On September 26, 2024, the European Commission initiated infringement procedures against 17 EU member states (Belgium, Czechia, Germany, Estonia, Greece, Spain, Cyprus, Latvia, Luxembourg, Malta, the Netherlands, Austria, Poland, Portugal, Romania, Slovenia, and Finland) for failing to fully transpose the CSRD into their national laws. Although the CSRD took effect in early 2024, with the first reports due in 2025 for large public-interest companies, the mentioned countries missed the July 6, 2024 deadline for transposition.

In its published statement, the Commission emphasized that without full transposition, harmonized sustainability reporting across the EU would be impossible to achieve, which could potentially hinder informed investment decisions based on companies’ sustainability performance.

Under the EU’s infringement procedures, these 17 member states have two months to respond and complete transposition before the Commission may escalate the process (ultimately referring the matter to the European Court of Justice to impose penalties). Notably, on July 25, 2024, the Commission had already initiated an infringement procedure against Sweden, which delayed the implementation of the CSRD by six months, requiring Swedish companies to report only for fiscal years starting after July 1, 2024. In a related move, the Commission also launched infringement actions against 26 member states for failing to implement provisions under the Renewable Energy Directive, which aims for renewable energy to account for 42.5% of the EU’s total energy consumption by 2030.

IV. NORTH AMERICA

1. California Governor signs amendments to climate-related legislation

On September 27, 2024, Governor Gavin Newsom signed Senate Bill (“SB”) 219, enacting amendments to SB 253 (requiring reporting of greenhouse gas emissions) and SB 261 (requiring reporting of climate-related financial risks and the measures taken to reduce and adapt to them). The amendments provide the California Air Resources Board (“CARB”) an additional six months to publish regulations related to SB 253, extending the deadline to July 1, 2025 from January 1, 2025, but do not alter the deadline for companies to comply with these regulations. SB 219 also allows emissions reports under SB 253 to be consolidated at the parent company level (which was already allowed under SB 261) and makes other changes to CARB’s responsibilities described in our client alert.  For further details on SB 253 and SB 261, please see our client alert and blog post.

2. U.S. Senate bill would prevent retirement plan managers from using ESG factors in investment decisions

On September 26, 2024, U.S. Senator Bill Cassidy (R-LA) introduced the Restoring Integrity in Fiduciary Act, legislation that would prevent fiduciaries from considering ESG factors in investment decisions. In a press release, Senator Cassidy stated, “[a]sset managers should prioritize helping Americans achieve the best return for their retirement, not funneling their clients’ money to fund a left-wing political agenda.” The bill would amend the Employee Retirement Income Security Act (“ERISA”) to require fiduciaries to make investment decisions based only on “pecuniary factors.”

Senator Cassidy’s bill responds to the U.S. Department of Labor’s November 2022 rules that permit fiduciaries of ERISA-governed retirement plans to consider ESG in the selection process for investments. In March 2024, Congressman Greg Murphy introduced a similar bill to prevent retirement plan trustees from considering ESG factors when making investment decisions (described in our client alert).

3. California sues Exxon Mobil Corporation (“Exxon”) over claims about plastic recycling

On September 23, 2024, the State of California brought a lawsuit against Exxon alleging the company made false and deceptive claims that recycling could solve the problem of plastic waste pollution. The lawsuit alleges Exxon knew the technology for recycling plastic was inadequate to process the amount of plastic waste the company produced, yet it continued to promote recycling as the solution to the plastic pollution crisis. Among other relief, California is seeking to compel Exxon to establish and contribute to an abatement fund to address plastic pollution in the state.  In the press release announcing the lawsuit, the California Attorney General notes that this lawsuit follows a two-year investigation into the fossil fuel and petrochemical industries’ role in the plastic pollution crisis and is aimed to “protect California’s natural resources from further pollution, impairment, and destruction, as well as to prevent [Exxon] from making any further false or misleading statements about plastics recycling and its plastics operations.”

4. Toyota entities accused of misrepresenting machinery emissions compliance

A complaint was filed in a California federal district court against Toyota Industries Corporation (“Toyota”) and related entities on September 22, 2024 for allegedly misrepresenting the true emissions levels of its engines used in forklifts and other construction machinery. According to the class action lawsuit, Toyota represented these vehicles were “clean-burning, low-emissions, high-performance, and sustainable,” and plaintiffs purchased the vehicles assuming they met regulatory emissions standards. However, the complaint alleges that the vehicles emitted more emissions than were reasonably expected and did not comply with emissions standards.

5. Microsoft Corporation (“Microsoft”) and Constellation announce renewable energy agreement and restart of Three Mile Island

On September 20, 2024, Constellation announced it had signed a 20-year power purchase agreement with Microsoft. Constellation intends to restart Three Mile Island Unit 1 (under the new name “Crane Clean Energy Center”) by 2028, and Microsoft will purchase the resulting energy to help match the power used for Microsoft’s data centers.  The project is expected to require significant financial investment in addition to U.S. Nuclear Regulatory Commission approval and state and local permitting.

6. U.S. Commodity Futures Trading Commission (“CFTC”) issues final guidance regarding the listing of voluntary carbon credit derivative contracts

As summarized in our alert, on September 20, 2024, the CFTC issued final guidance regarding the listing of voluntary carbon credit derivative contracts on CFTC-regulated exchanges.

7. U.S. Securities and Exchange Commission (“SEC”) finds investment advisory firm misled investors with its data-driven “biblically responsible investing” strategy

On September 19, 2024, the SEC charged investment advisory firm Inspire Investing with making misleading statements about using data-driven methodology to avoid investing in companies whose business practices did not align with biblical values. The firm represented that its methodology would score companies based on their business practices and not invest in companies that participate in certain enumerated activities or products. But according to the SEC order, as a result of a failure to adopt written policies and procedures governing its investment process, Inspire Investing inconsistently applied its investment criteria and had invested in companies that engaged in  business practices that did not align with its investment criteria, failing to comply with its representations about its investment strategy.

8. U.S. House of Representatives passes anti-ESG bills

On September 19, 2024, the House passed the Prioritizing Economic Growth Over Woke Policies Act, H.R. 4790, by a vote of 215-203. The Act contains a series of anti-ESG bills aimed at curbing corporate ESG initiatives, signaling Republicans’ 2025 legislative priorities. Among other things, the package includes measures to (i) limit the SEC’s authority to impose new ESG disclosure requirements, including by requiring that rulemakings with disclosure obligations be grounded in materiality, (ii) require the SEC to report on the effects of the E.U.’s directives on corporate sustainability on companies, consumers, and investors, (iii) allow companies to exclude shareholder proposals with subject matters that are “environmental, social, or political (or a similar subject matter)” without regard to whether the proposal relates to a significant social policy issue, and (iv) require the SEC to study the financial and other incentives of shareholder proposals, proxy advisory firms, and the proxy process.

9. Ten U.S. State Governors Form Coalition for Energy Choice

On September 17, 2024, Louisiana Governor Jeff Landry and New Hampshire Governor Chris Sununu announced the formation of The Governors’ Coalition for Energy Choice with eight other senators. The Coalition is intended to help address high energy costs and inflation and to support the formulation of smart energy policies. Its goals are to “ensure continued energy choice, minimize permitting and other regulatory barriers, limit expensive energy mandates, focus on affordability and reliability of energy infrastructure, and coordinate to positively manage energy resources and the environment.”

10. SEC disbands Climate and ESG Task Force

The SEC recently disclosed that in the past few months, it disbanded the Climate and ESG Task Force in the Division of Enforcement. Formed in 2021 and reportedly composed of 21 lawyers, it pursued companies and investment advisors for three years for ESG-related fraud. The Task Force was involved in cases against numerous companies related to ESG matters, including publicly listed companies, financial institutions, and investment advisors. The expertise from the Task Force is now said to reside more generally within the Division of Enforcement.

V. APAC

1. Australian court fines Vanguard over misleading sustainable investing claims

On September 25, 2024, an Australian federal court imposed a record A$12.9 million (USD$8.9 million) penalty on Vanguard Investments Australia for misleading claims about its ESG fund, the Vanguard Ethically Conscious Global Aggregate Bond Index Fund. The fund, launched in 2018, claimed to exclude companies with operations in fossil fuels and other controversial sectors. However, the Australian Securities & Investments Commission found that ESG research was not conducted on a significant portion of bond issuers, leading to the finding that the fund had investments in fossil fuel-related companies. Vanguard self-reported the issue in 2021 and admitted to making false claims. The court ruled that Vanguard’s misrepresentations were serious, affecting the fund’s main distinguishing feature and benefiting the company.

2. Singapore Exchange to start incorporating IFRS Sustainability Disclosure Standards

On September 24, 2024, Singapore Exchange’s market regulator, SGX RegCo, updated its sustainability reporting rules for listed companies. The update follows the announcement earlier this year by the government of Singapore that it will implement mandatory climate-related reporting requirements for listed and large non-listed companies. The changes include delaying mandatory Scope 3 emissions reporting for smaller issuers, following concerns about evolving measurement and reporting methodologies. Larger issuers are expected to begin Scope 3 reporting for fiscal year 2026. Scope 1 and 2 emissions reporting will be required for fiscal year 2025. The new rules also mandate other sustainability report disclosures beginning for fiscal year 2026, covering ESG factors, policies, practices, and governance.

3. Malaysia launches National Sustainability Reporting Framework

On September 24, 2024, Malaysia introduced a National Sustainability Reporting Framework (“NSRF”) to support its goal of reducing carbon intensity by 45% by 2030 and achieving net-zero emissions by 2050. Developed by the Advisory Committee on Sustainability Reporting, the NSRF employs ISSB Standards, specifically IFRS S1 and IFRS S2, as its baseline for sustainability disclosures. The NSRF aims to enable companies to provide reliable and comparable sustainability information, enhancing transparency regarding climate-related risks and sustainability practices. Implementation will be on a phased basis, allowing companies to adopt the standards based on their readiness, though they can also use other complementary frameworks.

4. Hong Kong proposes IFRS-aligned sustainability reporting standards

On September 16, 2024, the Hong Kong Institute of Certified Public Accountants (“HKICPA”) released new Exposure Drafts for its HKFRS Sustainability Disclosure Standards (the HKFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and HKFRS S2 Climate-related Disclosures), ( proposing full convergence with the ISSB standards. The convergence aims to enhance global comparability and meet investors’ needs for reliable sustainability information and is expected to take effect on August 1, 2025. The HKICPA is seeking public comments on the Exposure Drafts until October 27.

5. Hong Kong and Dubai strengthen collaboration on sustainable finance 

On September 16, 2024, the Hong Kong Monetary Authority (“HKMA”) and Dubai Financial Services Authority (“DFSA”) concluded their first Joint Climate Finance Conference in Hong Kong. The event, themed “Building a Net-Zero Asia – Middle East Corridor,” attracted over 240 participants from various financial sectors across Asia and the Middle East. The conference addressed transition finance demands and explored investment opportunities for the global net-zero transition. Notably, the HKMA and DFSA signed a Memorandum of Understanding to enhance their partnership in sustainable finance, promoting cross-border dialogue, knowledge sharing, and joint research.

6. New Japan low carbon hydrogen development fund launched

On September 12, 2024, the Japan Hydrogen Fund, a new initiative dedicated to developing a low-carbon hydrogen value chain, was launched by a consortium of Japanese financial and industrial companies along with French energy giant, TotalEnergies. The fund has secured USD$400 million in initial commitments from investors including Toyota Motor Corporation, Iwatani Corporation, major Japanese banks, and other corporations. This launch aligns with Japan’s 2050 carbon neutrality goal and its 2030 interim targets for emissions reduction and energy mix transformation. The fund aims to support the development of a hydrogen supply chain both in Japan and globally by providing funding to hydrogen-related companies and projects.

7. Australia passes mandatory climate reporting law

On September 9, 2024, Australia’s House of Representatives passed the Treasury Laws Amendment bill, introducing mandatory climate-related reporting requirements for large and medium-sized companies. The bill, which follows Senate approval in August, requires disclosures on climate-related risks and opportunities and greenhouse gas emissions across the value chain. Reporting will begin in January 2025 for the largest companies, with a phased approach for smaller entities, with reporting requirements varying depending on size. The legislation aligns with ISSB standards and includes a one-year grace period for Scope 3 reporting. Additionally, the House passed a law establishing the Net Zero Economy Authority, tasked with guiding Australia’s transition to net zero emissions. This includes reskilling workers and coordinating with industry and investors on transformation opportunities.

Please let us know if there are other topics that you would be interested in seeing covered in future editions of the monthly update.

Warmest regards,
Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michelle M. Kirschner
Michael K. Murphy

Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP

For further information about any of the topics discussed herein, please contact the ESG Practice Group Chairs or contributors, or the Gibson Dunn attorney with whom you regularly work.

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The following Gibson Dunn lawyers prepared this update: Lauren Assaf-Holmes, Spencer Bankhead, Mitasha Chandok, Becky Chung, Martin Coombes, Ferdinand Fromholzer, William Hallatt, Kriti Hannon*, Elizabeth Ising, Vanessa Ludwig, Cynthia Mabry, Babette Milz*, Johannes Reul, Emily Rumble, Meghan Sherley, Helena Silewicz*, and Katherine Tomsett.

*Kriti Hannon, an associate in Orange County; Babette Milz, a research assistant in Munich; and Helena Silewicz, a trainee solicitor in London, are not admitted to practice law.

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

Environmental, Social and Governance (ESG):

Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213.229.7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214.698.3295, rkirk@gibsondunn.com)
Michelle Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202.955.8238, mmurphy@gibsondunn.com)

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