Client Alert Archives

From the Derivatives Practice Group: The CFTC announced that it has issued Kalshi Klear LLC (“Kalshi”) an Order of Registration as a derivatives clearing organization (“DCO”) under the Commodity Exchange Act.

New Developments

CFTC Grants Kalshi Klear LLC DCO Registration. On August 29, the CFTC announced it has issued Kalshi Klear LLC (“Kalshi”) an Order of Registration as a derivatives clearing organization (“DCO”) under the Commodity Exchange Act. Kalshi’s affiliate, KalshiEx LLC, is registered with the CFTC as a designated contract market. [NEW]
CFTC Staff Extends Brexit-Related No-Action Positions. On August 29, the CFTC’s Division of Market Oversight (“DMO”) and Market Participants Division (“MPD”) announced they are extending temporary no-action positions in connection with the withdrawal of the United Kingdom (“UK”) from the European Union (“EU”), known as Brexit. In addition, DMO is amending its no-action position to include two additional multilateral trading facilities (“MTFs”) authorized in the UK. The no-action position was also amended to remove an MTF and an organized trading facility because the facilities are no longer authorized in the UK. [NEW]
CFTC Staff Issues No-Action Letter for EU-Based and UK-Based DCOs Regarding Certain Requirements Applicable to DCOs. On August 23, the CFTC’s Division of Clearing and Risk (DCR) issued a no-action letter to address the applicability of certain CFTC regulations to registered DCOs based in either the EU or the UK. This letter replaces CFTC Letter 16-26, which applied only to EU-based DCOs and was issued in 2016 as part of the CFTC’s response to the EU equivalence determination with regard to the CFTC’s regulatory framework for DCOs. DCR has updated CFTC Letter 16-26 to explicitly apply it to UK-based DCOs post-Brexit.
CFTC Approves a Joint Rule Proposal to Establish Technical Data Reporting Standards. On August 8, the CFTC voted to jointly propose and request public comment on the establishment of technical data reporting standards with other financial regulatory agencies. The proposal would establish uniform data standards for the collections of information reported to the CFTC, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, Federal Housing Finance Agency, Securities and Exchange Commission, and the Department of the Treasury. The proposal would also establish uniform data standards for data collected from these financial regulatory agencies on behalf of the Financial Stability Oversight Council. According to the CFTC, the proposed standards would promote interoperability of financial regulatory data across the financial regulatory agencies through the adoption of common identifiers for legal entities, financial instruments, and other data. In addition to proposing the use of common identifiers, the proposal would also further standardize the format and transmission of data to financial regulatory agencies. The CFTC explained that the proposed rule is part of the implementation of the Financial Data Transparency Act of 2022 (“FDTA”); although the CFTC is not specifically referenced in the FDTA, the Secretary of the Treasury designated the CFTC as a covered agency on May 3, 2024. Comments on the proposal are due 60 days following publication in the Federal Register.

New Developments Outside the U.S.

Markets Increasingly Sensitive After Strong Performance in Early 2024. On August 29, ESMA published its second risk monitoring report of 2024, setting out the key risk drivers currently facing EU financial markets. The report state that external events continue to have a strong impact on the evolution of financial markets, and ESMA also sees high or very high overall risks in the markets within its remit. [NEW]
ESMA Publishes Translations of its Guidelines on Funds’ Names. On August 21, ESMA published the translations in all official EU languages of its Guidelines on funds’ names using ESG or sustainability-related terms. National competent authorities must notify ESMA by October 21 2024 whether they (i) comply, (ii) do not comply, but intend to comply, or (iii) do not comply and do not intend to comply with the guidelines.
ESAs’ Joint Board of Appeal Allows the Appeal Lodged by NOVIS and Remits the Case to EIOPA. On August 13, the Joint Board of Appeal of the European Supervisory Authorities (“ESAs”) unanimously decided that the appeal brought by NOVIS against the European Insurance and Occupational Pensions Authority (“EIOPA”) is admissible. The appeal was brought in relation to the EIOPA decision not to grant access to documents, which were requested by NOVIS. In its decision, the board of appeal acknowledged that requests for access to documents laid out in Regulation No 1049/2001 can be dismissed by way of exceptions to protect certain public and private interests.
ESMA Recognizes CDS Clearing and Depository Services as Tier 1 CCP Following MoU with the British Columbia Securities Commission. On August 13, ESMA signed a Memorandum of Understanding (“MoU”) with the British Columbia Securities Commission and updated its list of recognized third-country central counterparties (“CCPs”) under the European Markets Infrastructure Regulation (“EMIR”). The MoU establishes cooperation arrangements, including the exchange of information, regarding CCPs that are established in Canada and authorized or recognized by the British Columbia Securities Commission, and which have applied for EU recognition under EMIR.
ESAs’ Joint Board of Appeal Dismisses Appeal by Euroins Insurance Group AD Against the European Insurance and Occupational Pensions Authority. On August 7, the Joint Board of Appeal of the ESAs unanimously decided that the appeal brought by Euroins Insurance Group AD (“Euroins”) against the EIOPA is inadmissible. In its decision, the board of appeal found that EIOPA’s power to initiate an investigation is of an entirely discretionary nature. Furthermore, the board of appeal also asserted that the EIOPA Chairperson’s decision to initiate an investigation is not subject to the board of appeal’s review. Finally, the decision clarified that the board of appeal does not have the power to order EIOPA to re-assess an appellant’s request to open an investigation.

New Industry-Led Developments

ISDA and IIF Respond to BCBS Consultation on CCR Management. On August 28, ISDA and the Institute of International Finance (“IIF”) submitted a joint response to the Basel Committee on Banking Supervision’s (“BCBS”) consultation on guidelines for counterparty credit risk (“CCR”) management. The new guidelines represent an update to the Sound Practices for Banks’ Interactions with Highly Leveraged Institutions, published in January 1999, to incorporate recent lessons and best practices. In the response, the associations stress the guidelines should be risk-based and proportional, considering a diverse universe of counterparties and financial markets across the world. The associations stated that they believe a common understanding and coordination between central banks, supervisors and banks can enhance the effectiveness of CCR practices. [NEW]

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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 August 2024 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

OpenSea Receives Wells Notice from SEC
On August 28, Devin Finzer, the CEO of NFT marketplace OpenSea posted on social media that the company had received a Wells notice from the SEC, which indicates that the agency is considering whether to pursue an enforcement action against the company. According to Finzer, the SEC’s contemplated enforcement action is premised on the agency’s belief that NFTs on the OpenSea platform are securities. Finzer called the Wells notice a “sweeping move against creators and artists” and pledged to “stand up and fight” while offering $5 million to cover legal fees for NFT creators who may receive similar notices. Coindesk; X.
Kraken’s Motion to Dismiss SEC Lawsuit Denied
On August 23, Judge William H. Orrick of the Northern District of California denied crypto exchange Kraken’s motion to dismiss a lawsuit brought by the SEC, which alleged that Kraken acts as a broker, dealer, exchange, and clearing agency in violation of Sections 5, 15(a) and 17(A)(b) of the Securities Act. Applying the Howey test, the court held that although digital assets themselves are not investment-contract securities, the SEC plausibly alleged that Kraken facilitates transactions involving investment contracts. August 23 Order; Bloomberg; CoinTelegraph.
Abra Settles Charges with SEC over Abra Earn
On August 26, the SEC filed settled charges against Plutus Lending LLC, known as Abra, alleging that the company improperly offered its Abra Earn product as an unregistered security and operated an unregistered investment company. The company agreed to cease violations of the registration provisions of the Securities Act and the Investment Company Act and pay civil penalties in an amount to be determined by a court. In 2020, Abra settled with the SEC and Commodities Future Trading Commission (CFTC) to end an investigation into its swaps product. SEC Press Release; CoinDesk.
Federal Prosecutors Indict Michelle Bond for Campaign Finance Violations
On August 22, prosecutors in the Southern District of New York unsealed an indictment against former Republican congressional candidate Michelle Bond. She was charged with conspiring with FTX executives to engage in an unlawful campaign-finance scheme. Prosecutors alleged that Bond and Ryan Salame, an executive at FTX, orchestrated a sham consulting agreement through which Bond received $400,000 to finance her congressional campaign. Bond is charged with one count of conspiracy to cause unlawful campaign contributions; one count of causing and accepting excessive campaign contributions; one count of causing and receiving an unlawful corporate contribution; and one count of causing and receiving a conduit contribution. Each count carries a maximum sentence of five years in prison. The Block; DOJ Press Release.
Telegram Founder Arrested in France
On August 24, Pavel Durov, the founder and CEO of Telegram was detained by French authorities in Paris, reportedly in connection with an investigation into the app’s role in failing to moderate criminal activity on the platform, including drug trafficking, child pornography, and money laundering. This detention has sparked tensions between France and Russia, as Telegram is a crucial communication platform in post-Soviet nations, used by both government authorities and opposition groups. The arrest has drawn criticism from Russian officials, who are demanding consular access to Durov, who holds citizenship in the UAE and France. BBC.
FTX and Alameda Pay $12.7 Billion to End CFTC Lawsuit
On August 7, U.S. District Judge P. Kevin Castel approved a settlement between FTX and its sister company Alameda Research to pay $12.7 billion to their customers, investors, and creditors. Under the consent order, FTX and Alameda will pay $8.7 billion in restitution to investors who sustained losses proximately caused by violations of the Commodity Exchange Act and $4 billion in disgorgement for gains received from misconduct. The repayment order implements a settlement between the CFTC and the bankrupt crypto exchange, which has committed to a bankruptcy liquidation that will repay customers whose deposits were locked during its 2022 collapse. Judge Castel also found that FTX violated the Commodity Exchange Act, concluding that the exchange misled investors by representing itself as a safe place to buy and sell cryptocurrency while co-mingling assets between the exchange and the hedge fund, Alameda. Bloomberg Law; PYMNTS; Reuters; Washington Post.
Federal Reserve Board Issues Enforcement Action with Crypto-Friendly Bank
On August 5, the U.S. Federal Reserve (Fed) entered into a written agreement with Customers Bancorp and its subsidiary bank, Customers Bank, relating to “significant deficiencies” around the bank’s risk-management and anti-money laundering practices. The enforcement action against the Pennsylvania-based bank, which provides digital-asset services and a tokenized instant payments platform, stemmed from a recent joint examination by the Fed and Commonwealth of Pennsylvania Department of Banking and Securities (Department). The consent order does not include a fine but directs the bank to overhaul its policies and internal controls to address identified shortcomings in its compliance with Bank Secrecy Act, anti-money laundering, and Office of Foreign Asset Control regulations and to periodically report its progress to regulators. On the same date, Customers Bank also entered into a Consent Order with the Department. FRB Agreement; Blockworks; PA Consent Order; CryptoNewsZ; Reuters.
SEC Files Fraud Charges Against Promoters of NovaTech
On August 12, following an earlier suit by the New York Attorney General, the SEC filed a complaint against NovaTech alleging that the company and eight of its promoters stole $650 million from 200,000 investors in a Ponzi scheme that used new investors’ money to make payments to earlier investors. According to the SEC, NovaTech’s marketing materials promised investors 2-3% returns per week and purportedly never posted a weekly trading loss, but only a small fraction of investors’ money was ever actually invested and the money that was invested suffered “significant trading losses.” SEC Press Release; CoinDesk.
CFTC Announces $1 Million Award to Whistleblower
On August 7, the CFTC announced that a whistleblower who assisted the regulator in an enforcement action “connected to digital asset markets” would receive a $1 million award. The CTFC said that it had brought an enforcement action against a firm connected to the digital-asset space based on “information about improper trading” provided by a whistleblower but did not name the whistleblower or the digital-asset firm. The CFTC filing stated that six claimants initially applied to provide information about the digital asset enforcement case, but only one claimant, whose information the CFTC described as “sufficiently specific, credible, and timely” and critical to opening its investigation, received a percentage of the monetary sanctions from the unnamed company. CFTC Notice; CoinTelegraph; The Defiant.
CluCoin Founder Pleads Guilty to Wire Fraud Scheme
On August 21, Austin Michael Taylor, the founder of crypto project CluCoin, pleaded guilty to a wire fraud scheme involving the transfer of $1,140,000 of CluCoin investor funds to Taylor’s personal account. Although he faces a maximum sentence of 20 years in prison at his sentencing hearing scheduled for October 31, U.S. Sentencing Guidelines likely will guide the sentencing judge to a much less punitive result. DOJ Press Release; CoinDesk.

INTERNATIONAL

Australian Market Regulator Sues Australian Stock Exchange over Blockchain Upgrade
On August 13, Australia’s Securities and Investment Commission sued the Australian Securities Exchange (ASX), Australia’s leading stock exchange, for making allegedly misleading statements related to its efforts to replace its systems with blockchain technology. The Australian regulator alleges that in a February 10, 2022, announcement, ASX stated that the blockchain-based replacement for its settlement of share transactions and record shareholdings was on track to go live in April 2023. The regulator claims that the project was not progressing as stated and that the delay and subsequent pause of the project caused significant cost to ASX and market participants who relied on assurances regarding the project’s progress and scheduled go-live date. Financial Times; Reuters; CoinGeek.

REGULATION AND LEGISLATION

UNITED STATES

IRS Releases New Draft Digital-Asset Tax Form
On August 9, the IRS posted an updated draft of Form 1099-DA, which will allow “brokers” to report certain digital asset sale and exchange transactions for calendar year 2025. Beginning in 2026 and for transactions occurring in 2025, regulations finalized in July will require centralized crypto exchanges to issue Forms 1099-DA reporting certain digital-asset sale and exchange transactions. The form updates a draft published by the IRS in April. It requires less data reporting and addresses some privacy concerns by removing requirements to include investors’ wallet addresses and certain transaction details in the reports, among other things. The IRS accompanied the draft with instructions for recipients of the form. The agency expects to release draft filer instructions soon, at which point the agency will publish a notice in the Federal Register and allow for a 30-day public-comment period. IRS Press Release; CoinDesk.
Financial Regulatory Agencies Propose Joint Data Standards
On August 2, the U.S. Securities Exchange Commission announced that it and eight other agencies were set to propose joint data standards under the Financial Data Transparency Act of 2022. The standards will establish technical standards for data submitted to financial regulatory agencies. The proposed standards are intended to promote interoperability of financial regulatory data across the agencies by establishing common identifiers for entities and geographic locations. The rules establish a Financial Instrument Global Identifier (FIGI) that can be used for all classes of financial instruments, including digital assets. The eight other agencies set to propose standards include the Board of Governors of the Federal Reserve, the Commodity Futures Trading Commission, the Consumer Financial Protection Bureau, the Department of the Treasury, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the Currency. SEC Press Release; PYMNTS.

INTERNATIONAL

Hong Kong Plans to Increase Digital Asset Regulation in the Next 18 Months
On August 11, Hong Kong Legislative Council member David Chiu announced that Hong Kong planned to introduce enhanced digital-asset regulations within the next 18 months. The regulations would be part of the jurisdiction’s efforts to become a global hub for financial technology by attracting technology experts, building new infrastructure, and strengthening laws around digital assets. According to Chiu, Hong Kong aims to enhance supervision and enforcement of legislation related to digital assets, including stablecoins. CoinGeek; CoinTelegraph; Crypto Times.
Bank of Ghana Issues Proposed Crypto Regulatory Framework
On August 16, the Bank of Ghana introduced draft rules for crypto exchanges. The Central Bank said that its regulations followed an “extensive internal review of the surging popularity of digital assets.” The regulatory approach would require exchanges to perform customer due diligence, comply with new reporting and registration requirements, and conduct comprehensive risk assessments. The proposed regulations would also create a pathway for crypto companies to access traditional banking services. Draft Rules; CoinTelegraph.

CIVIL LITIGATION

UNITED STATES

Bitboy and Jimmy Butler Settle Securities Lawsuit
On August 21, YouTube Influencer Ben Armstrong (aka Bitboy) and Miami Heat basketball star Jimmy Butler agreed to pay $340,000 to settle a class action lawsuit brought in March 2023, which alleged that Armstrong and Butler promoted the sale of unregistered securities. Decrypt; Bloomberg; CoinGape.
Celsius Sues Tether for Liquidating Celsius Loan Collateral
On August 9, administrators of bankrupt crypto lender Celsius sued Tether to recover 57,428 bitcoin (worth approximately $3.5 billion). Celsius’s bankruptcy administrators claim that Celsius struck a “token agreement” with Tether in February 2020, which allowed Celsius to borrow U.S. dollars by posting bitcoin as collateral. The administrators’ complaint alleges that in June 2022, when the crypto market was in sharp decline, Tether fraudulently and preferentially applied Celsius’s bitcoin against obligations owed to Tether for an average price considerably less than bitcoin’s market closing price. Tether has responded that its liquidation of Celsius’ bitcoin was done in accordance with the token agreement. Complaint; CoinDesk; CoinGeek.
Sixth Circuit Allows Constitutional Challenge to Proceed Against IRS
On August 9, a Sixth Circuit panel vacated a decision by a district judge in the Eastern District of Kentucky barring crypto think tank Coin Center’s claims alleging that a 2021 amendment to the U.S. tax code was unconstitutional. Coin Center alleges that the amendment to the tax code is unconstitutionally vague in violation of the First Amendment, exceeds the scope of Congress’s enumerated powers, and violates taxpayers’ privacy rights under the Fourth and Fifth Amendments. The Sixth Circuit reversed the district court’s ruling that Coin Center’s claims were not ripe and therefore not justiciable and remanded the case for further proceedings. Opinion; CoinDesk.

SPEAKER’S CORNER

UNITED STATES

Senator Schumer Plans to Pass Crypto Legislation in 2024
On August 14, during a crypto-related town hall, U.S. Senator Chuck Schumer (D-NY) said that his goal is to pass crypto legislation before the end of this year. He said that he believes it is Congress’s responsibility to “provide common sense and sound regulation” and that he would like to see legislation that strikes a “balance for crypto between promoting innovation and providing common sense guardrails.” Schumer did not express support for any particular bill currently under consideration in Congress. The Block; Stablecoin Act Press Release; FIT21; The Block.
Senator Scott Signals Interest in Forming Crypto-Focused Senate Subcommittee
On August 21, at a meeting of the Wyoming Blockchain Symposium, U.S. Senator Tim Scott (R-SC) suggested that he would consider creating a panel of the Senate Banking committee focused on digital assets if Republicans win the Senate and he becomes Committee Chair next year. The Block.

OTHER NOTABLE NEWS

SEC Crypto Head Leaves for Private Practice
David Hirsch, the former head of the Securities Exchange Commission’s crypto and cyber security division, has left the SEC to join a private law firm. He will be leading the firm’s securities enforcement and regulatory counseling practice. The Block.

The following Gibson Dunn lawyers contributed to this issue: Jason Cabral, Kendall Day, Jeff Steiner, Sara Weed, Chris Jones, Jay Minga, Nick Harper, Maura Carey, Justin duRivage, Jan Przerwa, and Nathaniel Tisa.

FinTech and Digital Assets Group Leaders / Members:

Ashlie Beringer, Palo Alto (+1 650.849.5327, [email protected])

Michael D. Bopp, Washington, D.C. (+1 202.955.8256, [email protected]

Stephanie L. Brooker, Washington, D.C. (+1 202.887.3502, [email protected])

Jason J. Cabral, New York (+1 212.351.6267, [email protected])

Ella Alves Capone, Washington, D.C. (+1 202.887.3511, [email protected])

M. Kendall Day, Washington, D.C. (+1 202.955.8220, [email protected])

Michael J. Desmond, Los Angeles/Washington, D.C. (+1 213.229.7531, [email protected])

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

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

Martin A. Hewett, Washington, D.C. (+1 202.955.8207, [email protected])

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

Stewart McDowell, San Francisco (+1 415.393.8322, [email protected])

Mark K. Schonfeld, New York (+1 212.351.2433, [email protected])

Orin Snyder, New York (+1 212.351.2400, [email protected])

Ro Spaziani, New York (+1 212.351.6255, [email protected])

Jeffrey L. Steiner, Washington, D.C. (+1 202.887.3632, [email protected])

Eric D. Vandevelde, Los Angeles (+1 213.229.7186, [email protected])

Benjamin Wagner, Palo Alto (+1 650.849.5395, [email protected])

Sara K. Weed, Washington, D.C. (+1 202.955.8507, [email protected])

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 July 23, 2024, America First Legal (AFL), the organization founded and run by former Trump policy advisor Stephen Miller, announced that it had filed a federal civil rights complaint with the EEOC against CrowdStrike. AFL alleges that “prohibited characteristics” are motivating CrowdStrike’s employment decisions under the guise of DEI, in violation of Title VII. The complaint points to CrowdStrike’s nine employee resource groups, including Women of CrowdStrike and Communidad. AFL contends that the lack of a resource group for “Men of CrowdStrike” or white employees is discriminatory. AFL also highlights CrowdStrike’s public proxy statement, which includes a “Board Diversity Matrix” that tracks the sex, gender identity, race, and ethnicity of its current directors. AFL sent a corresponding letter to CrowdStrike’s board of directors demanding that the company end its allegedly discriminatory workplace practices.

On July 29, 2024, Auburn University announced it will dissolve its Office of Inclusion and Diversity by August 15, 2024. Established in 2016 at the recommendation of students and staff, the office aimed to enhance the recruitment and retention of underrepresented groups and oversee educational and cultural programs. Auburn now joins four other Alabama state colleges in closing their diversity offices after Governor Kay Ivey signed a law banning DEI programs and the teaching of certain “divisive concepts” on March 19, 2024. One day later, on July 30, 2024, the University of Missouri also announced it will dissolve its Division for Inclusion, Diversity and Equity (IDE) by August 15, 2024.

On July 30, 2024, the court granted Starbucks’ motion to dismiss in Langan v. Starbucks Corporation, No. 3:23-cv-05056 (D.N.J. July 30, 2024). Langan, a white female former employee, filed a complaint against Starbucks claiming that she was wrongfully accused of racism and terminated after she rejected Starbucks’ attempt to deliver “Black Lives Matter” T-shirts to her store. The plaintiff brought claims for discrimination under Title VII, Section 1981, the New Jersey Law Against Discrimination (NJLAD), the Americans with Disabilities Act, and the Age Discrimination in Employment Act, as well as retaliation in violation of Title VII and the NJLAD and various torts. On December 8, 2023, Starbucks moved to dismiss the plaintiff’s NJLAD claims on the basis that they were barred by the statute of limitations. Starbucks also moved to dismiss the plaintiff’s tort claims and Section 1981 discrimination claim for failure to state a claim. In the ruling last week, the court granted Starbucks’ motion to dismiss in its entirety, agreeing that the NJLAD claims were untimely and that the plaintiff had failed to state her tort or Section 1981 claims. As to her Section 1981 claim, the court held that the plaintiff had not alleged that her termination was based on anything other than her “egregious” discriminatory comments and her violation of the company’s anti-harassment policy. The court granted the plaintiff leave to amend, and the plaintiff filed an amended complaint on August 11.

On July 29, 2024, the Equal Protection Project (EPP) filed a complaint with the U.S. Department of Education’s Office for Civil Rights (OCR) against the Mitchell Hamline School of Law (Hamline Law) in St. Paul, Minnesota. EPP alleges that Hamline Law’s hosting of the Minnesota Association of Black Lawyers (MABL) Law School Pathways mentorship program constitutes racial discrimination in violation of Title VI of the Civil Rights Act, as the program is exclusively available to Black students. The program selects ten to twenty juniors, seniors, and alumni from Minnesota universities and colleges each year as “MABL Pathways Scholars.” These scholars receive pre-law school programming, LSAT preparation, and academic mentoring in order “to empower Black students in Minnesota to succeed in law school and the legal profession.” In response to EPP’s complaint, Hamline Law said that it only hosts the program and does not administer it.

On July 29, 2024, Judge Trina Thompson in the Northern District of California denied a motion to dismiss a proposed securities class action against Wells Fargo in SEB Investment Management AB v. Wells Fargo & Co., No. 22-cv-03811-TLT (N.D. Cal. July 29, 2024). The lawsuit alleged that Wells Fargo engaged in sham practices related to interviewing diverse candidates, including interviewing candidates for positions that had already been filled. To support their allegations that Wells Fargo violated Section 10(b) of the Securities Act and Rule 10b-5, the plaintiffs identified eleven allegedly false or misleading statements related to Wells Fargo’s hiring program dating back to 2020. Wells Fargo argued that the plaintiffs had not adequately pled scienter, but the court held that plaintiffs had sufficiently alleged that Wells Fargo knowingly made false statements about its hiring practices sufficient to raise a strong inference of scienter. The court therefore denied Wells Fargo’s motion to dismiss.

On July 31, 2024, a three-judge panel of the Eleventh Circuit overturned the district court’s dismissal of a complaint of race discrimination against a City Commission and its Chairman in McCarthy v. City of Cordele, No. 23-11036 (11th Cir. July 31, 2024). The plaintiff sued the City Commission of Cordele, Georgia, and the newly-elected Chairman of the Commission, alleging that he was fired from his position as City Manager because he was white, in violation of Section 1981, Section 1983, Title VII, and the Equal Protection Clause of the Fourteenth Amendment. The district court granted the defendants’ motion to dismiss, holding that the plaintiff’s allegations did not support an inference of a racially discriminatory motive because the plaintiff did not adequately allege that the Commissioners who voted to fire him acted with a discriminatory intent, even though they were acting at the urging of the non-voting Chairman. The Eleventh Circuit found that the district court erred in separating the official actions of the Chairman from those of the Commission but that it correctly dismissed the claims against the Chairman in his individual capacity. The court therefore reversed the district court in part and remanded for further proceedings.

Media Coverage and Commentary:

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

Wall Street Journal, “The Activist Pushing Companies to Ditch Their Diversity Policies” (August 3): The Wall Street Journal’s Joseph Pisani and Chip Cutter profile conservative activist Robby Starbuck, who has leveraged his 500,000 followers on X to rally opposition against DEI initiatives at various companies. Pisani and Cutter report that Starbuck’s criticism has led companies such as Tractor Supply and John Deere to scale back their DEI efforts, and that his newest target is Harley-Davidson, with additional companies also in his sights. In his campaign against Harley-Davidson, Starbuck criticized the company for its support of LGBTQ+ causes and its “total commitment to DEI policies.” According to Starbuck, “Everybody should just go to work, do their job, go home. You want to be an activist in your personal time? That’s your business.”
Forbes, “Amid DEI Backlash, Support From Workers Drops Slightly – But Remains Strong” (August 5): Forbes’ Jena McGregor reports on a recent shift in support for DEI initiatives amid growing political scrutiny. McGregor highlights a survey conducted by Seramount, a DEI consulting firm, which queried 3,000 employees about their perspectives on DEI efforts. McGregor says the survey reveals that while overall support for DEI remains robust, with 76% of respondents expressing a personal commitment to advancing DEI in their workplaces, this figure has decreased from 83% in 2021. Additionally, McGregor reports that Black employees’ views of their managers’ inclusion efforts have improved, with 70% describing their managers as inclusive in 2024, up from 65% in 2021. In contrast, the percentage of white employees who view their managers as inclusive fell from 74% in 2021 to 68% this year.
Wall Street Journal, “The Fight Against DEI Programs Shifts to Medical Care” (August 14): The Wall Street Journal’s Theo Francis and Melanie Evans report on a civil rights complaint filed against the Cleveland Clinic by Wisconsin Institute for Law and Liberty (WILL). The complaint alleges that the Cleveland Clinic discriminates on the basis of race by operating a program to prevent and treat strokes and other conditions in Black and Latino patients. WILL filed the complaint on behalf of Do No Harm, a “membership group for medical professionals and others opposing diversity, equity and inclusion initiatives.” Francis and Evans note that “[t]he allegation pushes the fight against race-based programs into untested legal territory, arguing that healthcare providers can’t use racial and ethnic demographics to target treatment, preventive care or patient education.” According to Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group Jason Schwartz, telling medical institutions that they cannot help minority populations address significant medical risks could prove to be a tough sell. Schwartz says “[t]he rule is not that you have to help everyone or no one, whether it’s a charitable endeavor or a public health priority. That would shut down an awful lot of good works.”

Case Updates:

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

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

Do No Harm v. American Association of University Women, No. 1:24-cv-01782 (D.D.C. 2024): On June 20, 2024, Do No Harm filed a complaint against the American Association of University Women (AAUW), alleging that the organization is violating Section 1981 by providing “Focus Group Professions Fellowships” to only “women from ethnic minority groups historically underrepresented in certain fields within the United States: Black or African American, Hispanic or Latino/a, American Indian or Alaskan Native, Asian, and Native Hawaiian or Other Pacific Islander.” Do No Harm is seeking a temporary restraining order and preliminary injunction prohibiting AAUW from closing the application window for the fellowships, and a permanent injunction prohibiting AAUW from considering race when selecting grant recipients.
- Latest update: On August 2, 2024, AAUW filed its opposition to the plaintiff’s motion for a TRO and preliminary injunction, arguing that Do No Harm lacks standing, that the fellowship program is protected by the First Amendment, and that the program is a valid affirmative action program.
Do No Harm v. Gianforte, No. 6:24-cv-00024-BMM-KLD (D. Mont. 2024):On March 12, 2024, Do No Harm filed a complaint on behalf of “Member A,” a white female dermatologist in Montana, alleging that a Montana law violates the Equal Protection Clause by requiring the governor to “take positive action to attain gender balance and proportional representation of minorities resident in Montana to the greatest extent possible” when making appointments to the twelve-member Medical Board. Do No Harm alleges that since the ten already-filled seats are currently held by six women and four men, Montana law requires that the remaining two seats be filled by men, which would preclude Member A from holding the seat. On May 3, 2024, Governor Gianforte moved to dismiss the complaint for lack of subject matter jurisdiction, arguing that Do No Harm lacks standing because Member A has not applied for or been denied any position. Gianforte also argued that the plaintiff’s pre-enforcement challenge was not ripe because his administration does not interpret the statute as a quota. On May 24, 2024, Do No Harm filed an amended complaint, describing additional Members B, C, and D, who are each “qualified, ready, willing, and able to be appointed” to the board. On June 7, Gianforte moved to dismiss the amended complaint, arguing again that the pseudonymous members lacked standing and that the case still was not ripe because the statute imposed only reporting requirements regarding diversity, so it posed no threat to the new members. On June 28, Do No Harm opposed the motion, asserting that the case is ripe and the members have standing because they will be disadvantaged in applications for upcoming openings, given the existing composition of the Board and the statute’s requirement to take “positive action” to achieve gender and racial balance.
- Latest update: On July 26, 2024, Governor Gianforte filed a reply in support of his motion to dismiss, reiterating his standing and ripeness arguments.

2. Employment discrimination and related claims:

Wood v. Red Hat, Inc., No. 2:24-cv-237-REP (D. Idaho 2024): On May 8, 2024, a white male former employee sued Red Hat, Inc., a subsidiary of IBM. In his complaint, the plaintiff alleges that his role was terminated “as a direct result of Red Hat’s DEI policies and efforts to diversify the workforce” and claims that, of the group of employees who were terminated at the same time, “21 of the total 22 individuals were white, and 21 were male.” The plaintiff alleges that he was retaliated against for opposing his employer’s stated goals of increasing diversity, which included setting hiring quotas of 30% female employees globally and 30% employees of color in the United States by 2028. The plaintiff brought claims under Title VII, Section 1981, and the Family and Medical Leave Act.
- Latest update: On July 29, 2024, the defendant filed a motion to compel arbitration and stay proceedings, arguing that the parties had a valid arbitration agreement that covers the dispute.
Beneker v. CBS Studios, Inc., et al., No. 2:24-cv-01659 (C.D. Cal. 2024): On February 29, 2024, a heterosexual, white male writer represented by AFL, sued CBS, alleging that its de facto hiring policy discriminated against him on the bases of sex, race, and sexual orientation. In his complaint, the plaintiff alleges that CBS violated Section 1981 and Title VII by refusing to hire him as a staff writer on the TV show “Seal Team,” instead hiring several black writers, female writers, and a lesbian writer. The plaintiff is requesting a declaratory judgment that CBS’s de facto hiring policy violates Section 1981 and/or Title VII, injunctions barring CBS from continuing to violate Section 1981 and Title VII and requiring CBS to offer him a full-time job as a producer, and damages. CBS filed a motion to dismiss on June 24, 2024, arguing that the First Amendment protects its hiring choices and that two out of three of the plaintiff’s Section 1981 claims were untimely. The plaintiff opposed on July 15, 2024, arguing that the First Amendment does not protect hiring decisions, even if CBS is engaged in a creative enterprise.
- Latest update: On July 29, 2024, CBS filed a reply in support of its motion to dismiss, reiterating its First Amendment and Section 1981 arguments.
Peters v. Federal Reserve Bank of Cleveland, No. 1:24-cv-01314 (N.D. Ohio 2024): On July 31, 2024, a plaintiff filed a lawsuit under Title VII alleging that the Federal Reserve Bank of Cleveland had denied him a series of promotions and instead promoted candidates from minority backgrounds, even though he was more qualified than those candidates. The plaintiff is seeking a permanent injunction preventing the bank from continuing to implement its allegedly discriminatory policies and ordering the bank to promote the plaintiff and pay him monetary damages.
- Latest update: The docket does not reflect that the defendant has been served.

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, Janice Jiang, Elizabeth Penava, Skylar Drefcinski, Mary Lindsay Krebs, David Offit, Lauren Meyer, Kameron Mitchell, Maura Carey, and Jayee Malwankar.

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

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

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

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

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

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

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

In re Dallas County, No. 24-0426 – Decided August 23, 2024

Today, the Texas Supreme Court rejected a challenge to the constitutionality of the new Fifteenth Court of Appeals, which has exclusive, statewide jurisdiction over appeals involving the State and from the State’s new Business Court.

“Given the text, as well as our constitutional history and tradition, we cannot conclude that the legislature exceeded its authority in enacting S.B. 1045 and creating the Fifteenth Court.”

Justice Young, writing for the Court

Background:

In 2023, the Texas Legislature passed S.B. 1045, which created the Fifteenth Court of Appeals—a new intermediate appellate court with exclusive, statewide jurisdiction over appeals (1) involving the State, and (2) from Texas’s newly created Business Court.

In March 2023, Dallas County and its sheriff sued the Texas Health and Human Services Commission over the agency’s alleged failure to transfer inmates adjudicated incompetent to stand trial to state hospitals. The State appealed the denial of its plea to the jurisdiction to the Third Court of Appeals. Seeking to block the transfer of the State’s appeal to the Fifteenth Court, Dallas County filed a writ of injunction in the Texas Supreme Court, arguing that the Legislature’s creation of the new court violated several provisions of the Texas Constitution.

Issue:

Did the Legislature exceed its constitutional authority in enacting S.B. 1045 and creating an intermediate appellate court with exclusive, statewide jurisdiction over appeals involving the State and from the Business Court?

Court’s Holdings:

No. The Legislature’s creation of a specialized court of appeals with exclusive, statewide jurisdiction was entirely consistent with the Texas Constitution’s text and history.

What It Means:

The Fifteenth Court—composed of Chief Justice Scott Brister and Justices Scott Field and April Farris—will open for business as planned in September.
Initially, the court’s docket will comprise appeals of cases brought by or against the State. Under Texas Rule of Appellate Procedure 27a, all such appeals filed after September 1, 2023 will be automatically transferred to the Fifteenth Court on August 30.
The Fifteenth Court will also have exclusive jurisdiction over appeals from the newly created Business Court, which will begin hearing cases September 1.

Gibson Dunn lawyers Brad Hubbard, Kathryn Cherry, John Adams, Elizabeth A. Kiernan, Stephen Hammer, Jessica Lee, Zachary Carstens, and Jaime Barrios submitted an amicus brief on behalf of the Texas Business Law Foundation in support of Real Parties in Interest: In re Dallas County

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Brad G. Hubbard +1 214.698.3326 [email protected]

Related Practice: Texas General Litigation

Trey Cox +1 214.698.3256 [email protected]	Collin Cox +1 346.718.6604 [email protected]	Gregg Costa +1 346.718.6649 [email protected]
Andrew LeGrand +1 214.698.3405 [email protected]	Russ Falconer +1 346.718.3170 [email protected]

This alert was prepared by Texas associates Elizabeth Kiernan, Stephen Hammer, Jessica Lee, Zachary Carstens, and Jaime Barrios.

From the Derivatives Practice Group: This week, ESMA published the Guidelines on funds’ names using sustainability-related terms in all official EU languages. National competent authorities must inform ESMA by October 21 of their compliance with the Guidelines.

New Developments

CFTC Staff Issues No-Action Letter for EU-Based and UK-Based DCOs Regarding Certain Requirements Applicable to DCOs. On August 23, the CFTC’s Division of Clearing and Risk (DCR) issued a no-action letter to address the applicability of certain CFTC regulations to registered derivatives clearing organizations (“DCOs”) based in either the EU or the UK. This letter replaces CFTC Letter 16-26, which applied only to EU-based DCOs and was issued in 2016 as part of the CFTC’s response to the EU equivalence determination with regard to the CFTC’s regulatory framework for DCOs. DCR has updated CFTC Letter 16-26 to explicitly apply it to UK-based DCOs post-Brexit. [NEW]
CFTC Approves a Joint Rule Proposal to Establish Technical Data Reporting Standards. On August 8, the CFTC voted to jointly propose and request public comment on the establishment of technical data reporting standards with other financial regulatory agencies. The proposal would establish uniform data standards for the collections of information reported to the CFTC, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, Federal Housing Finance Agency, Securities and Exchange Commission, and the Department of the Treasury. The proposal would also establish uniform data standards for data collected from these financial regulatory agencies on behalf of the Financial Stability Oversight Council. According to the CFTC, the proposed standards would promote interoperability of financial regulatory data across the financial regulatory agencies through the adoption of common identifiers for legal entities, financial instruments, and other data. In addition to proposing the use of common identifiers, the proposal would also further standardize the format and transmission of data to financial regulatory agencies. The CFTC explained that the proposed rule is part of the implementation of the Financial Data Transparency Act of 2022 (“FDTA”); although the CFTC is not specifically referenced in the FDTA, the Secretary of the Treasury designated the CFTC as a covered agency on May 3, 2024. Comments on the proposal are due 60 days following publication in the Federal Register.
CFTC Exempts Additional Singapore Recognized Market Operators from SEF Registration Requirements. On August 2, the CFTC announced it unanimously approved an amended order that exempts two recognized market operators (“RMO”s) authorized within Singapore from CFTC swap execution facility (“SEF”) registration requirements. The exempted RMOs are FMX Securities (Singapore) Pte. Limited and LMAX Pte. Ltd. Section 5h(g) of the Commodity Exchange Act provides that the CFTC may grant such an exemption if it finds that a foreign SEF is subject to comparable, comprehensive supervision and regulation by the appropriate governmental authorities in the facility’s home country. Likewise, the CFTC may revoke exempt status when a facility is no longer authorized or in good standing in its home country.

New Developments Outside the U.S.

ESMA Publishes Translations of its Guidelines on Funds’ Names. On August 21, ESMA published the translations in all official EU languages of its Guidelines on funds’ names using ESG or sustainability-related terms. National competent authorities must notify ESMA by October 21 2024 whether they (i) comply, (ii) do not comply, but intend to comply, or (iii) do not comply and do not intend to comply with the guidelines. [NEW]
ESAs’ Joint Board of Appeal Allows the Appeal Lodged by NOVIS and Remits the Case to EIOPA. On August 13, the Joint Board of Appeal of the European Supervisory Authorities (“ESAs”) unanimously decided that the appeal brought by NOVIS against the European Insurance and Occupational Pensions Authority (“EIOPA”) is admissible. The appeal was brought in relation to the EIOPA decision not to grant access to documents, which were requested by NOVIS. In its decision, the board of appeal acknowledged that requests for access to documents laid out in Regulation No 1049/2001 can be dismissed by way of exceptions to protect certain public and private interests.
ESMA Recognizes CDS Clearing and Depository Services as Tier 1 CCP Following MoU with the British Columbia Securities Commission. On August 13, ESMA signed a Memorandum of Understanding (“MoU”) with the British Columbia Securities Commission and updated its list of recognized third-country central counterparties (“CCPs”) under the European Markets Infrastructure Regulation (“EMIR”). The MoU establishes cooperation arrangements, including the exchange of information, regarding CCPs that are established in Canada and authorized or recognized by the British Columbia Securities Commission, and which have applied for EU recognition under EMIR.
ESAs’ Joint Board of Appeal Dismisses Appeal by Euroins Insurance Group AD Against the European Insurance and Occupational Pensions Authority. On August 7, the Joint Board of Appeal of the ESAs unanimously decided that the appeal brought by Euroins Insurance Group AD (“Euroins”) against the EIOPA is inadmissible. In its decision, the board of appeal found that EIOPA’s power to initiate an investigation is of an entirely discretionary nature. Furthermore, the board of appeal also asserted that the EIOPA Chairperson’s decision to initiate an investigation is not subject to the board of appeal’s review. Finally, the decision clarified that the board of appeal does not have the power to order EIOPA to re-assess an appellant’s request to open an investigation.
ESMA Publishes Data for Quarterly Bond Liquidity Assessment and the Systematic Internalizer Calculations. On August 1, ESMA published the new quarterly liquidity assessment of bonds and the data for the quarterly systematic internalizer calculations for equity, equity-like instruments, bonds and for other non-equity instruments under MiFID II and MiFIR.

New Industry-Led Developments

ISDA Letter on FICC’s Proposed Rulebook Changes. On August 1, ISDA submitted a letter to the SEC in response to the Fixed Income Clearing Corporation’s (“FICC”) proposed changes to its Government Securities Division Rulebook in accordance with the Securities Exchange Act of 1934. The comment letter addresses FICC’s proposal to modify its trade submission rules in relation to mandatory clearing of certain US Treasury transactions. The proposed rule changes: (i) adopt a requirement that each netting member must submit all eligible secondary market transactions to which it is a counterparty to FICC for clearance and settlement; (ii) adopt new initial and ongoing membership requirements and other measures to facilitate FICC’s ability to monitor a netting member’s compliance with the trade submission requirement; (iii) adopt disciplinary measures to address a netting member’s failure to comply with the trade submission requirement; and (iv) modify the FICC rules to facilitate the trade submission requirement.

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

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

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

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

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

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

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

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

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

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

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

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

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

City of Los Angeles v. PricewaterhouseCoopers LLP, S277211 – Decided August 22, 2024

The California Supreme Court unanimously rejected the argument that courts may impose monetary sanctions only for discrete instances of misconduct outlined in the provisions of the Civil Discovery Act governing specific discovery methods. It held that the Act instead gives courts independent authority to impose sanctions for discovery abuses and patterns of discovery abuse beyond those specific provisions.

“Under the general sanctions provisions of the Civil Discovery Act, Code of Civil Procedure sections 2023.010 and 2023.030, the trial court had the authority to impose monetary sanctions for the City’s pattern of discovery abuse. The court was not limited to imposing sanctions for each individual violation of the rules governing depositions or other methods of discovery.”

Justice Kruger, writing for the Court

Background:

The Civil Discovery Act contains several provisions authorizing courts to impose sanctions on parties engaged in particular forms of discovery misconduct, such as unsuccessfully opposing a motion to compel interrogatory responses or responses to a demand for inspection. It also contains a more general provision, in addition to those method-specific provisions, stating that a “court may impose a monetary sanction ordering that one engaging in the misuse of the discovery process” “pay the reasonable expenses, including attorney’s fees, incurred by anyone as a result of that conduct.” Cal. Civ. Code § 2023.030. The statute includes a non-exhaustive list of discovery abuses, such as making an evasive response or disobeying a court order to provide discovery. Id. § 2023.010.

In 2010, the City of Los Angeles retained PwC to modernize the City’s Department of Water and Power (LADWP) billing system. After several LADWP customers sued the City for billing errors, the City sued PwC, alleging that PwC had misrepresented its qualifications to undertake the project. One month after the City filed its lawsuit, a putative class action was filed against the City on behalf of overbilled LADWP customers. Shortly thereafter, the City entered into a settlement with the putative class in which it agreed to pay the costs of remediating billing errors and $19 million in attorney’s fees.

It was eventually revealed that counsel for the City had engineered the class litigation and sham settlement to extort tens of millions of dollars from PwC. Yet the City engaged in more than two and a half years of discovery misconduct, such as asserting privileges in bad faith, refusing to comply with court orders requiring the production of documents, and lying to the court and to opposing counsel, in a concerted effort to cover up its fraudulent scheme—misconduct that has led to the federal guilty pleas and convictions of several former officials and lawyers for the City. After its discovery misconduct came to light and on the cusp of having to disclose further evidence of its wrongdoing, the City dismissed with prejudice its claims against PwC.

The trial court awarded PwC $2.5 million in sanctions under Code of Civil Procedure sections 2023.030 and 2023.010, as well as the court’s inherent authority. But the Court of Appeal majority, over a dissent by Justice Grimes, reversed, holding that the Civil Discovery Act gives courts authority to impose monetary sanctions only for conduct described by other, method-specific provisions of the Civil Discovery Act that authorize sanctions for particular misuses of the discovery process.

Issue Presented:

Is courts’ authority to impose monetary sanctions for misuse of the discovery process limited to the particular circumstances expressly delineated in a method-specific provision of the Civil Discovery Act authorizing sanctions for particular forms of discovery misuse?

Court’s Holding:

No. When confronted with a form or pattern of discovery abuse not addressed by a method-specific provision of the Civil Discovery Act authorizing sanctions for a particular form of discovery misuse, courts may impose monetary sanctions under sections 2023.030 and 2023.010, which give courts independent sanctioning authority.

What It Means:

Under the Court’s decision, courts are independently authorized to impose monetary sanctions for discovery abuses, especially systemic patterns of abuse, extending beyond the discrete forms of misconduct identified in method-specific provisions of the Civil Discovery Act, such as unsuccessfully opposing a motion to compel interrogatory responses or responses to a demand for inspection.
The Court clarified, however, that courts should ordinarily look to the particular limitations and procedures set forth in method-specific provisions of the Act, and should invoke their independent authority to impose monetary sanctions under sections 2023.010 and 2023.030 to redress forms of discovery abuse, or patterns of abuse, not addressed or adequately addressed by a method-specific provision of the Act authorizing sanctions for a particular form of discovery misuse.
Before imposing monetary sanctions, courts should abide by the procedures outlined elsewhere in the Act, such as affording the party accused of engaging in discovery misconduct notice and an opportunity to be heard and considering whether the party had acted with substantial justification.
Although the Court did not address whether courts also had the inherent authority to impose monetary sanctions for discovery misconduct, it disapproved one Court of Appeal decision holding that courts lack inherent authority to impose monetary sanctions for discovery abuses.

Gibson Dunn lawyers Julian W. Poon, Daniel J. Thomasch, Samuel Eckman, and Ryan Azad represented PricewaterhouseCoopers LLP.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Lucas C. Townsend +1 202.887.3731 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]	Michael J. Holecek +1 213.229.7018 [email protected]

Related Practice: Litigation

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

Theane Evangelis
+1 213.229.7726
[email protected]

This alert was prepared by Julian W. Poon, Samuel Eckman, Daniel R. Adler, Ryan Azad, Matt Aidan Getz, and Lindsay Laird.

A dichotomy in enforcement: a continued aggressive enforcement agenda tempered by litigation setbacks.

I. INTRODUCTION

The first half of 2024 reflected a dichotomy in SEC enforcement. On one hand, the Enforcement Division continued to pursue an aggressive enforcement agenda, including a number of notable enforcement actions, and continued demand for heightened penalties. On the other hand, the Commission incurred a number of significant litigation setbacks with potentially broad implications for the SEC’s enforcement program.

A. Notable Enforcement Activity

In the first half of 2024, the SEC won a significant insider trading litigation and continued to recover unprecedent penalties as part of its sweep activities relating to recordkeeping and whistleblower protections rules.

Shadow Trading Victory

In April 2024, the SEC won its trial against Matthew Panuwat, in a highly publicized insider trading case relating to a novel “shadow trading” theory. The SEC alleged that Panuwat’s trading in a competitor company (Incyte)—which was critically not the subject of the inside information that he received concerning the proposed acquisition of his company (Medivation)—constituted trading on the basis of material non-public information. In denying Panuwat’s motion for summary judgment, the Court held that a jury could find that information concerning Medivation was material to Incyte on the basis that Incyte had a “market connection” to Medivation. The Court also held that a jury could find that Panuwat breached a fiduciary duty when trading (a necessary component of a misappropriation theory of insider trading) on three potential grounds: (i) Medivation’s insider trading policy, which broadly prohibited trading in any company on the basis of confidential information; (ii) Medivation’s confidentiality policy; and (iii) Panuwat’s general duties as an employee of Medivation. As we described in our alert, although the SEC described its theory as standard insider trading, there is no doubt that Panuwat expanded potential insider trading liability, with broad implications for future civil and criminal enforcement.

Recordkeeping

To date, in 2024, the SEC has brought three additional rounds of settlements with broker-dealers and investment advisers as part of its ongoing sweep relating to recordkeeping and off-channel communications. Firms have paid a combined total of over $480 million in penalties in 2024, and over $3 billion in fines as part of the overall sweep. Each of the firms have also agreed to retain independent compliance consultants to conduct comprehensive reviews of their implementation and enforcement of policies and procedures related to the retention of electronic communications on personal devices. Notably, the firms admitted the facts in the SEC’s orders.

In February, the SEC announced settled charges against five broker-dealers, seven dually registered broker-dealers and investment advisers, and four affiliated investment advisers for failing to maintain and preserve electronic communications.[1]
In April, the SEC announced settled enforcement charges against a registered investment adviser for alleged recordkeeping and ethics code violations.[2]
In August, the SEC announced settled charges against 26 broker-dealers, investment advisers, and dually-registered broker-dealers and investment advisers.[3]

The SEC has used its recordkeeping sweep enforcement efforts as an example of the benefits of cooperation. In his remarks at SEC Speaks in April, Deputy Director of Enforcement Sanjay Wadhwa noted that self-reporting is “the most significant factor in moving the needle on penalties” in the recordkeeping matters.[4] In its August announcement, the SEC noted that three of the firms paid significantly lower civil penalties, ranging from $400,000 to $1.6 million, as a result of self-reporting, which Director of Enforcement Gurbir Grewal described as “demonstrating once again the real benefits of proactive cooperation.”[5]

Whistleblower Protection

In 2024, the SEC has also continued to expand the scope of what it interprets as a violation of whistleblower protection rules under Exchange Act Rule 21F. In January, the SEC announced settled charges against a broker-dealer for allegedly violating Rule 21F not with respect to its employees, but to its clients.[6] Moreover, the information that the broker-dealer allegedly forbade individuals from disclosing did not relate broadly to the broker-dealer’s operations or financial undertakings, but instead related narrowly to the contents of specific release agreements between the clients and the broker-dealer. The SEC order alleged that, from March 2020 to July 2023, the broker-dealer asked retail clients to sign release agreements through which clients promised “not to sue or solicit others to institute any action or proceeding against [the broker-dealer] arising out of events concerning the Account.” With respect to the alleged Rule 21F violations, the release agreements included a clause requiring clients to “keep t[he] Agreement confidential and not use or disclose the allegations, facts, contentions, liability, damages, or other information relating in any way to the Account, including but not limited to, the existence or terms of t[he] Agreement.” Though the clause also included a carveout that “neither prohibited nor restricted [clients] from responding to any inquiry about t[he] settlement or its underlying facts by FINRA, the SEC, or any other government entity,” the SEC alleged that the carveout was not expansive enough, and that the release agreements nonetheless prohibited clients from “affirmatively reporting” information to the Commission staff. Without admitting or denying the SEC’s findings, the broker-dealer agreed to pay an $18 million civil penalty.

The above enforcement action marks yet another instance where the SEC expanded the scope of the types of conduct it perceives as violating Rule 21F. For example, even confidentiality agreements between an entity and its external clients (as opposed to internal employees with more intimate knowledge of the entity) are subject to the rule. Moreover, it seems that any confidentiality clause, regardless of how narrow its scope, may fall within the seemingly expanding contours of whistleblower protection. Though it is unclear from publicly available materials whether the confidentiality clause in the above action related narrowly to the information in the release agreement and its underlying facts, or more broadly to any information about the clients’ accounts, the SEC’s discussion throughout the order implied that the Commission may require whistleblower carveout clauses for any confidentiality agreement, no matter how narrow.

B. Litigation Setbacks

In June and July 2024, the SEC suffered a number of notable litigation setbacks, including decisive decisions vacating the SEC’s proposed private funds rule and prohibiting the use of the SEC’s in-house courts when seeking civil penalties for fraud. A recent ruling in the SolarWinds case also casts doubt—echoing the sentiments voiced by Commissioners Peirce and Uyeda—on the SEC’s ability to continue to use the internal accounting controls provision as a wide-ranging hammer in enforcement matters.

Private Funds Rule

In June, a unanimous panel of the Fifth Circuit vacated the SEC’s proposed private funds rule. As described in our alert on the ruling, the Court held that the rule exceeded the SEC’s statutory authority. The SEC’s proposed rule would have required a host of restrictions on private funds. Gibson Dunn represented the petitioners in the Fifth Circuit case.

In-House Courts

Also in June, the Supreme Court held 7-3 in SEC v. Jarkesy that the Seventh Amendment requires the SEC to sue in federal court when seeking civil penalties for fraud. As described in our 2023 Mid-Year alert, the Court held that the SEC’s prior use of its in-house adjudication process was unconstitutional. Although the decision may have little impact on pending enforcement actions (given that the SEC has not recently pursued actions in its in-house tribunals), there is no doubt that the decision alters the calculus going forward of whether to settle with the SEC by putting defendants on equal footing with the government before a federal court.

Internal Accounting Controls

In June 2024, the SEC announced settled charges against a public company that was the subject of a ransomware attack for alleged violations of the internal accounting controls and disclosure controls provisions of the federal securities laws.[7] As we described in our alert regarding the action, the SEC’s order, which alleged that the company failed to develop and maintain a system of cybersecurity-related internal accounting controls sufficient to prevent unauthorized access to the company’s information technology systems and networks, is notable for extending the internal controls provisions of Section 13(b)(2)(B) of the Exchange Act to a company’s IT systems. The SEC had previously brought actions in 2020 and 2023 using the same provision to bring cases relating to stock buybacks and Rule 10b5-1 plans. As with those cases, the action brought a strongly-worded dissent from Commissioners Hester Peirce and Mark Uyeda criticizing “the Commission’s decision to stretch the law to punish a company that was the victim of a cyberattack.”[8]

One month later, in a separate ongoing litigation, the United States District Court for the Southern District of New York largely granted SolarWinds’ motion to dismiss the SEC’s claims in a litigation against the company and its former Chief Information Security Officer (CISO) propounding a similar theory of liability. Specifically, as described in our alert concerning the case, the Court dismissed the SEC’s claim that cybersecurity-related deficiencies are actionable under rules relating to internal accounting and disclosure controls. The Court echoed the prior views of Commissioners Peirce and Uyeda, noting that “[a]s a matter of statutory construction, [the SEC’s] reading is not tenable.” The Court’s decision calls into question the SEC’s attempts to adopt an expansive reading of its rules relating to internal accounting controls and disclosure controls.

C. Senior Staffing Update

The Commission has already announced notable staff updates in Fiscal Year 2024 and has also publicized plans to shut down one of its regional offices.

Just before the turn of the year, Mark T. Uyeda was sworn in as a Commissioner for a second term, which expires in 2028.[9] Commissioner Uyeda first joined the SEC in 2006 as a staff member, and subsequently served in various roles—including as Senior Advisor to Chairman Jay Clayton, Senior Advisor to Acting Chairman Michael S. Piwowar, and Counsel to Commissioner Paul S. Atkins—before becoming a Commissioner in 2022. Prior to his service with the SEC, Commissioner Uyeda served as Chief Advisor to the California Corporations Commissioner and worked as an attorney for several law firms.

In June, the SEC announced the appointment of Erica Y. Williams to a second term as Chair of the Public Company Accounting Oversight Board (PCAOB), which will run from October 25, 2024, and through October 24, 2029.[10] Prior to joining the PCAOB in January 2022, Chair Williams was a litigation partner at a law firm, and had previously served in various roles at the SEC, including as Deputy Chief of Staff to three former SEC Chairs and Assistant Chief Litigation Counsel in the SEC’s Division of Enforcement trial unit. Chair Williams also served as Special Assistant and Associate Counsel to President Barack Obama.

There were also several changes at the senior staff level and in regional leadership, including within the Division of Investment Management, Office of the Advocate for Small Business Capital Formation, Office of Minority and Women Inclusion, and other policy and office directors:

In January, Stacey Bowers was named director of the SEC’s Office of the Advocate for Small Business Capital Formation (OASB), which was formed in January 2019 as an independent office aimed to promote the interests of small businesses and their investors during the capital formation process.[11] This is not Ms. Bowers’ first time serving with the Commission; she began her legal career at the SEC as a staff attorney in the Division of Corporation Finance before leaving for private practice. From 2007 until becoming the Director of OASB, Ms. Bowers was a law professor at the University of Denver’s Sturm College of Law and served as the Director of the Corporate and Commercial Law Program since 2018.
In March, Natasha Vij Greiner, the former Deputy Director of the Division of Examinations, became Director of the Division of Investment Management, which regulates investment advisers and investment companies.[12] Greiner has served in various roles in the SEC for over 22 years including Acting Chief Counsel and Assistant Chief Counsel in the Division of Trading and Markets. As Director of the Division of Investment Management, Ms. Greiner replaced William Birdthistle, who joined the SEC in December 2021 and oversaw the adoption of major rulemakings related to public and private funds. Mr. Birdthistle left the SEC to teach law at the University of Chicago.
In May, the SEC announced the appointment of Nathaniel H. Benjamin to be the Director of the Office of Minority and Women Inclusion (OMWI) and replace Allison Wise, who is OMWI’s Deputy Director and had been serving as Acting Director since October 2023.[13] Benjamin previously served as Chief Diversity and Inclusion Officer of AmeriCorps and Deputy Chief Human Capital Officer at the Department of Education, and also served in similar roles at the Office of Management and Budget and the U.S. Department of State.
In May, the SEC named Tina Diamantopoulos as Director of the Chicago Regional Office.[14] Diamantopoulos joined the Enforcement Division in the Chicago Regional Office in 1994, and has since served in various roles, including Branch Chief, Senior Special Counsel in the Examinations Division, Counsel to the Regional Director, and Associate Director for the regional broker-dealer examination program.
In May, the SEC announced the departure of Policy Director Heather Slavkin Corzo, who joined the SEC in April 2021 to lead the policy team, and who oversaw the proposal and adoption of almost 40 rulemakings.[15] Corey Klemmer, who joined the SEC in 2021 and served as the former Corporation Finance Counsel to Chairman Gary Gensler, was appointed to fill Ms. Corzo’s role.

Separately, the SEC announced the pending closure of its Salt Lake Regional Office (SLRO), which is expected to occur later this year due to budget and organizational efficiency concerns.[16] Current SLRO staff will be aligned to existing SEC organizational components upon the office’s closure, and the enforcement jurisdiction over the state of Utah will be shifted to the SEC’s Denver Regional Office. The Commission said it has no plans to close any additional regional offices.

II. PUBLIC COMPANY ACCOUNTING, FINANCIAL REPORTING, AND DISCLOSURE

A. Financial Reporting

In February, the SEC announced settled accounting fraud charges against a China-based technology company, whose American depositary shares formerly traded on the New York Stock Exchange, for allegedly violating antifraud, reporting, recordkeeping, and internal controls provisions of the federal securities laws.[17] According to the SEC’s order, from May 2021 through February 2022, two senior managers of the company allegedly orchestrated a fraudulent scheme to prematurely recognize revenue on service contracts, and to improperly recognize revenue on contracts for which the company had not completed work. The SEC alleged that as a result of the managers’ alleged misconduct, the company overstated its unaudited financial results for the second and third quarters of 2021 and its announced revenue guidance for the fourth quarter of 2021. Without admitting or denying the allegations, the company agreed to cease and desist from further violations of the charged securities laws. The SEC did not impose civil penalties because the company self-reported the accounting issues, provided extensive cooperation, and took remedial measures, including firing or disciplining those involved in the alleged scheme, reorganizing departments engaged in the misconduct, strengthening accounting controls, and recruiting new finance and accounting staff.

In March, the SEC announced settled charges against a California-based footwear company for violations of related person transaction disclosure requirements, as well as reporting and proxy solicitation provisions, of the federal securities laws.[18] The SEC’s order alleged that, from 2019 through 2022, the company allegedly failed to disclose payments for the benefit of its executives and their immediate family members, the company’s employment of two relatives of its executives, and a consulting relationship involving an individual sharing a household with a company executive. The company allegedly further failed to disclose that two of its four executives owed more than $120,000 to the company for multiple years in relation to personal expenses paid for by the company, but subject to reimbursement by the executives. Without admitting or denying the SEC’s allegations, the company agreed to pay a $1.25 million civil penalty.

B. Public Statements and Disclosures

In January, the SEC announced settled charges against a U.S.-based special purpose acquisition company (SPAC) for allegedly making misleading statements in forms filed with the SEC as part of its January 2021 initial public offering (IPO).[19] The SEC’s order alleged that, despite a statement in the SPAC’s SEC filings that the company had not initiated any substantive discussions with potential target companies prior to the IPO, the SPAC discussed a potential business combination with a target company starting in December 2020. The SEC’s order further alleged that, after announcing a merger agreement with the target company, the SPAC did not adequately disclose its interactions with the target company in its Form S-4 filings. Without admitting or denying the allegations, the SPAC agreed to pay a $1.5 million penalty in the event it closes a merger transaction.

In February, the SEC filed fraud charges against the former CEO and co-founder of a Florida-based advertising technology company for allegedly making materially misleading false statements on social media regarding the company’s financial and performance metrics to elevate the company’s stock price.[20] The SEC’s complaint alleges that, shortly after the company’s May 2021 initial public offering, the former CEO submitted a post on social media that misrepresented company revenues to be between $10 million and $20 million, even though the company was set to report $17,450 in revenue for 2021. Soon thereafter, the former CEO allegedly falsely misrepresented in a YouTube interview that the company was entering into a new contract with the founder of a restaurant chain, though no contract existed and no related discussions had taken place. The SEC’s complaint further alleges that, in August 2021 when the company’s stock price opened at its lowest level in almost two months, the former CEO made misleading false statements on social media and in a company-issued press release that the company’s projected available advertising inventory for 2021 as more than $100 million, when at the time the company had less than $5 million in advertising inventory. The SEC‘s complaint, which is continuing to litigations, seeks a permanent injunction, an officer-and-director bar, and a civil penalty against the former CEO.

In late February, the SEC announced settled charges against an American electric vehicle automaker for violations of antifraud, proxy, and reporting provisions of the federal securities laws by allegedly misleading investors about the company’s flagship electric vehicle.[21] The SEC’s order alleged that the company exaggerated demand for the vehicle by obtaining over 100,000 “pre-orders” from non-serious customers that never intended to purchase the vehicles. The SEC’s order also alleged that the company misrepresented the delivery timeline for the vehicle by failing to account for production delays, partially due to the company’s inability to access critical parts. Though the SEC’s investigation remains ongoing, the company agreed—without admitting or denying the SEC’s findings—to pay disgorgement of $25.5 million, subject to bankruptcy court approval.

The SEC also announced settled charges in a related administrative proceeding against the company’s former auditor for violating auditor independence standards.[22] The SEC’s order alleged that, prior to the company becoming public in 2020 through merging with a SPAC, the auditor provided certain non-audit services, including financial statement services and bookkeeping, during the company’s audit. The auditor then audited the same financial statements related to the company’s merger with the SPAC, thus allegedly violating auditor independence standards of the SEC and the PCAOB. Without admitting or denying the allegations, the auditor agreed to a censure, a cease-and-desist order, payment of over $80,000 in civil penalties, disgorgement, and certain undertakings to improve policies and procedures.

C. Auditors and Accountants

In May, the SEC announced settled charges against a Colorado-based audit firm and its owner for violations of antifraud, recordkeeping, and other provisions of the federal securities laws, by allegedly failing to comply with PCAOB standards in hundreds of audits and reviews, and in thousands of SEC filings, on behalf of hundreds of clients from January 2021 through June 2023.[23] The SEC’s order alleged that the audit firm and owner misrepresented to clients their compliance with PCAOB standards, fabricated documents to appear compliant, and falsely claimed adequate compliance in over 500 public company SEC filings. With respect to the owner, the SEC’s order alleged that he failed to adequately prepare and maintain audit documentation, resulting in the firm’s lack of quality reviews of audits, and the false documentation of uncompleted work. Without admitting or denying the SEC’s findings, the audit firm and owner settled the charges—agreeing to pay civil penalties of $12 million and $2 million, respectively, and to a permanent accounting bar.

III. INVESTMENT ADVISERS

A. Misleading Statements and Disclosures

In January, the SEC announced settled charges against a Chicago-based registered investment adviser and one of its former partners for allegedly misleading a client regarding investment returns.[24] The SEC order alleged that, in June 2020, the company and the partner misled a public-school pension fund as to the reason for a discrepancy between investment returns. Without admitting or denying the SEC’s findings, the company agreed to settle the charges and pay over $1.5 million in penalties and disgorgement, and the former partner agreed to settle the charges and pay a civil penalty of $30,000.

In February, the SEC announced settled charges against a registered investment adviser for failing to disclose certain details to a client about how it planned to launch the client’s product.[25] The SEC order alleged that, in March 2021, the adviser failed to inform the Board of an exchange-traded fund (ETF) about a social media influencer’s role in the launch of the ETF. The investment adviser also allegedly did not inform the ETF Board about the sliding-scale fee structure under which the provider of the ETF-tracked index would receive a greater proportion of the ETF-paid management fees based on how much the fund grew. Without admitting or denying the SEC’s findings, the investment adviser agreed to settle the charges and pay a $1.75 million civil penalty.

In June, the SEC filed charges against an investment management firm and its founder for allegedly defrauding investors of at least $3 million.[26] The SEC’s complaint alleged that, from 2020 to 2023, the firm and its founder raised at least $3 million from investors by lying about nearly every aspect of the fund, and then used over $1 million on personal expenses, lost more than $1.7 million on high-risk trading and speculative investments, and falsified documents to conceal the trading losses from investors. The firm and its founder settled the civil charges, agreeing to permanent injunctions and to pay disgorgement and civil penalties determined by the court. The company’s founder has also pleaded guilty to related criminal charges brought against him by the U.S. Attorney’s Office for the District of New Jersey.

B. Marketing Rule

In April, the SEC announced settled charges against five registered investment advisers for Marketing Rule violations.[27] The SEC’s orders alleged that the five firms advertised hypothetical performance to the general public on their websites without adopting and implementing policies and procedures reasonably designed to ensure that the hypothetical performance was relevant to the likely financial situation and investment objectives of each advertisement’s intended audience, as required by the Marketing Rule. One of the firms allegedly committed additional securities laws violations by making false and misleading statements in advertisements, failing to enter into written agreements with people it compensated for endorsements, and committing recordkeeping and compliance violations. Without admitting or denying the SEC’s findings, all five firms agreed to settle the charges regarding alleged violations of the Investment Advisers Act of 1940, to pay civil penalties totaling $200,000, and to comply with certain undertakings. Four of the firms received reduced penalties for taking corrective steps in advance of being contacted by the SEC, and they resultingly paid civil penalties ranging from $20,000 to $30,000. The other firm, which was the firm alleged to have committed additional regulatory violations beyond the Marketing Rule violations, agreed to pay a civil penalty of $100,000.

C. Conflicts of Interest

In May, the SEC announced settled charges against a New York-based registered investment adviser and its owner for breaching fiduciary duties by allegedly failing to disclose conflicts of interest and making misleading statements to clients.[28] The SEC’s order alleged that, between September 2017 and October 2021, the company and the owner advised certain clients to invest in films produced by a particular film production company without disclosing that the adviser would receive payments from the production company in exchange for the money the clients invested in the films. The adviser and owner then later allegedly misrepresented to clients that such payments to the owner were for work as an executive producer on the films. The SEC’s order also alleged that the firm and its owner satisfied a redemption request from one client but not from several others submitted at the same time, and that by preferencing one client over the others they violated their fiduciary duties to the other clients. The adviser and owner agreed to settle the charges, which involved alleged violations of the antifraud provisions of the Investment Advisers Act—with the firm agreeing to pay a civil penalty of $200,000, and the owner agreeing to pay disgorgement and penalties totaling more than $750,000.

Also in May, the SEC announced settled charges against a New York-based, formerly registered investment adviser and its co-founder and CEO for making false and misleading statements to investors.[29] The SEC’s orders alleged that, from 2020 to 2022, the firm made a series of materially false and misleading statements about its flagship opportunity fund’s holdings and exposures. The SEC’s orders alleged that these statements were the result of modifications the co-founder and CEO made to underlying portfolio data which was then included in various investor communications. The firm allegedly also did not report to investors a conflict of interest arising from its other co-founder’s operation of a separate hedge fund in China. Without admitting or denying the SEC’s findings, the firm and the co-founder and CEO agreed to settle the charges, which involved alleged violations of the antifraud and compliance provisions of the Investment Advisers Act—with the firm agreeing to pay a civil penalty of $350,000, and the co-founder and CEO agreeing to pay a civil penalty of $250,000 and undergo a 12-month suspension from industry-related work.

D. Beneficial Ownership Rules

In March, the SEC announced settled charges against a New York-based investment adviser for its alleged failure to make timely ownership disclosures in the lead-up to its May 2022 acquisition bid for a publicly traded trucking fleet company.[30] The SEC’s order alleged that the investment adviser increased its position in the trucking company and formed a control purpose no later than April 26, 2022, requiring it to report that information by May 6, 2022, but that it did not do so until May 13, 2022. Additionally, before the time it reported its control purpose, the investment adviser allegedly purchased swap agreements giving it economic exposure to the equivalent of 450,000 more shares of the trucking fleet company’s stock. Further, according to the order, when the investment adviser eventually reported the information, it allegedly proposed to buy all the trucking fleet company’s shares for a sizable premium over the trading price, and the trucking company’s stock price increased significantly. Without admitting or denying the SEC’s findings, the investment adviser settled the charges alleging violations of the beneficial ownership provisions of the Securities Exchange Act of 1934, and agreed to pay a $950,000 civil penalty.

IV. BROKER-DEALERS

A. Regulation Best Interest and Pricing

In February, the SEC announced settled charges against a broker-dealer for failing to comply with Regulation Best Interest (Reg BI), allegedly causing investors to collectively incur hundreds of thousands of dollars in combined expenses.[31] According to the SEC order, the broker-dealer allegedly disclosed to investors that for certain funds it only offered certain share classes, and failed to inform investors that equivalent, lower-cost share classes for affiliated funds were also available. As a result, a portion of investors paid higher expenses for certain funds that they could have avoided by purchasing substantially similar funds. Without admitting or denying the findings, the broker-dealer agreed to pay a combined total of $2.2 million in disgorgement and civil penalties.

We predicted in an alert in June that the SEC would pursue more Reg BI cases, particularly on the conflicts and duty of care elements of the Rule. In late July, the SEC charged a dual registrant for “a risky day trading strategy” one of its registered representatives employed for several of his customers.[32] The trading strategy involved the purchase and sale of options contracts for customers, some of whom had “moderate to conservative risk profiles.” The SEC imposed a relatively small penalty of $140,000, but specifically noted (1) the firm’s cooperation (e.g., disclosing information about conduct the Staff had not yet uncovered, conducting an internal investigation, regularly briefing the Staff regarding its investigation, identifying key documents found in its investigation, and voluntarily providing tables summarizing information from these documents), and (2) the firm’s remediation, including “changes to senior management, the $9 million in financial remediation paid to affected customers, and substantive improvements in [the firm’s] policies and procedures,” as mitigating factors.

B. Disclosure Obligations

In May, the SEC announced settled charges against an American multinational financial services company and nine of its affiliates.[33] According to the SEC order, following a cyber intrusion, the company allegedly failed to alert the appropriate legal and compliance officials promptly. As a result, the company and its affiliates allegedly did not inform the Commission within the required period, violating regulatory disclosure obligations. Without admitting or denying the Commission’s findings, the company and its affiliates consented to the SEC’s order and agreed to pay a $10 million penalty.

In June, the SEC charged three individuals who allegedly engaged in a multi-year scheme defrauding investors by selling unregistered membership interests in LLCs investing in shares of two pre-IPO companies.[34] The complaint alleged that from mid-2019 to early 2022, the individuals directed an unregistered sales force to pressure investors into making investments without disclosing substantial markups on the shares. The individuals further allegedly misled investors by overstating their research capabilities and market projections, violating antifraud and other provisions of the federal securities laws. The complaint seeks permanent injunctive relief, disgorgement, and civil penalties, and litigation is ongoing.

V. CRYPTOCURRENCY AND ARTIFICIAL INTELLIGENCE

The SEC’s enforcement activity in the crypto space has remained active but has slowed compared to past periods and has changed form. In the past, the Commission focused its efforts on enforcing what it does, and does not, believe qualifies as a security under the securities laws. Such enforcement efforts have remained in place, but the SEC now has seemingly begun to shift its enforcement efforts toward entities and individuals it believes are taking advantage of the novelty of the crypto space, and other emerging informational and technological advances, such as artificial intelligence, to secure improper investments and investor proceeds.

A. Cryptocurrency

In January, the SEC charged two individuals with violating the antifraud and registration provisions of the federal securities laws for allegedly operating a crypto asset pyramid scheme.[35] According to the SEC’s complaint, from mid-2020 to early 2022, both individuals allegedly lured investors with promises of high profits despite lacking any genuine revenue source other than the funds received from investors. The complaint seeks permanent injunctive relief, conduct-based injunctions prohibiting the defendants from engaging in multi-level marketing or offering crypto assets, disgorgement, and civil penalties. One of the individuals settled the charges and agreed to pay disgorgement and civil penalties to be announced at a later court date.

In February, the SEC charged a company and its founder with violating the antifraud provisions under the federal securities laws through an alleged scheme targeting students of the founder’s online crypto trading course.[36] From early 2018 to mid-2019, the founder allegedly encouraged hundreds of students to invest in the founder’s hedge fund he claimed would utilize advanced strategies to secure profits. The SEC alleged that the founder never launched the fund or executed the advertised strategies, instead holding the invested money in bitcoin. Without admitting or denying the allegations, the defendants consented to injunctive relief and agreed to pay $1.2 million in disgorgement and civil penalties.

Also in February, the SEC announced settled charges against a broker-dealer for allegedly failing to register the offer and sale of a crypto lending product that allowed investors to deposit or purchase crypto assets in their account in exchange for the company’s promise to pay interest.[37] According to the SEC order, from late 2020 to early 2022, the broker-dealer allegedly offered a crypto lending product intended to generate revenue to pay interest to investors. However, the broker-dealer allegedly sold this product as a security without registering it, violating registration provisions of the federal security laws. Without admitting or denying the SEC’s findings, the broker-dealer agreed to pay $1.5 million in civil penalties.

In March, the SEC announced final judgment against a financial services company for violating disclosure requirements by allegedly failing to register its retail crypto lending product before offering it to the public.[38] The SEC further alleged that the company was unable to liquidate its assets when investors sought to withdraw their funds due to the volatility of the crypto market. Without admitting or denying the allegations, the company settled charges and agreed to pay $21 million in civil penalties.

In June, the SEC announced settled fraud charges against a publicly traded South Korean crypto asset company and its co-founder.[39] According to the SEC’s order, the company allegedly misrepresented the use of its blockchain for transaction settlements and the stability of its crypto asset security, violating antifraud provisions of the federal securities laws. The SEC further alleged that in May 2022, after the company’s token asset de-pegged from the U.S. dollar, the value of the token and the company’s other tokens plummeted to near zero, allegedly wiping out $40 billion in market value overnight and causing significant losses to investors. The company settled the charges, which included allegations of securities fraud and the offering and selling of securities in unregistered transactions, agreeing to pay a combined total of $4.5 billion in disgorgement and civil penalties. The company also agreed to cease the sale of its crypto asset securities, wind down its operations, replace two of its directors, and distribute its remaining assets to investor victims and creditors. The company’s co-founder also settled charges and agreed to pay a combined total of $204 million in disgorgement and civil penalties.

B. Artificial Intelligence

In March, the SEC announced settled charges against two investment advisers, one Toronto-based and the other San Francisco-based, for allegedly making false and misleading statements about their purported use of artificial intelligence (AI).[40] The SEC’s order against the Toronto-based firm alleged that, from 2019 to 2023, it violated the marketing rule and made false and misleading statements in its SEC filings, in a press release, and on its website regarding its purported use of AI and machine learning capabilities that it did not in fact have. The SEC’s order against the San Francisco-based firm similarly alleged that the firm made false and misleading claims in 2023 on its website and on social media about its purported use of AI, and that it violated the Marketing Rule by, among other things, falsely claiming it offered tax-loss harvesting services. Without admitting or denying the SEC’s findings, both firms agreed to settle the charges against them, which involved violations of the Advisers Act—with the Toronto-based firm agreeing to pay a civil penalty of $225,000, and the San Francisco-based firm agreeing to pay a civil penalty of $175,000.

In June, the SEC charged the CEO of an artificial intelligence recruitment startup who allegedly made false and misleading statements in a multi-year scheme that defrauded investors.[41] According to the complaint, from 2018 to mid-2023, the CEO allegedly lied to investors about the quantity and quality of customers, the number of candidates on the platform, and the company’s revenue, violating the antifraud provisions of the federal securities laws. The complaint seeks a permanent injunction, civil monetary penalties, disgorgement, and an officer-and-director bar against the company’s CEO. Additionally, the U.S. Attorney’s Office for the Southern District of New York brought criminal charges against the CEO in a parallel action.

VI. INSIDER TRADING AND MARKET MANIPULATION

The SEC has continued to aggressively investigate potential insider trading. The Commission’s enforcement in this area will likely maintain its pace, given not only the trends that are prevalent, but also the SEC’s victory at trial in April 2024 in the Panuwat case discussed supra.

In January, the SEC announced settled charges against an investment bank and its former head of equity syndicate chair for their alleged involvement in an alleged multi-year fraud related to the disclosure of purportedly confidential information about block trades and alleged failure to enforce policies regarding the misuse of material non-public information related to the block-trades.[42] According to the SEC’s order, from mid-2018 to mid-2021, the investment bank and former head allegedly disseminated non-public information concerning upcoming block trades, violating federal securities laws. The SEC further alleged that the investment bank failed to enforce information barriers that would have prevented the former head from disseminating the information. Both the investment bank and the former equity syndicate chair settled the charges; the bank agreed to pay a combined total of $249 million in disgorgement and civil penalties (which were partially satisfied by payments in a parallel action brought by the U.S. Attorney’s Office for the Southern District of New York). The Southern District of New York resolved its criminal investigation pursuant to a Non-Prosecution Agreement with the bank, and Deferred Prosecution Agreement with the former equity syndicate chair.

Also in January, the SEC charged the CEO of a China-based FinTech company with violating the antifraud and beneficial ownership provisions of the Securities Exchange Act of 1934.[43] The SEC’s complaint alleged that the CEO manipulatively traded company stock through an offshore account prior to becoming CEO in 2020 to raise the company stock price, and that the CEO failed to disclose his beneficial ownership of, and transactions in, company stock. According to the complaint, in late 2019 or early 2020, the founder and former CEO of the company approached the current CEO with the prospect of taking over the CEO position. At that time, the company risked delisting from NASDAQ due to its stock price falling below the minimum $1.00 per share bid price requirement. Beginning in January 2020 and prior to becoming CEO, the current CEO allegedly traded company stock through a Hong Kong account, purchasing more than 530,000 shares of company stock over the next two-month period—allegedly making nonsensical trades at such a high volume that they comprised a high percentage of daily volume of company stock transactions—with the intent and eventual effect of driving the stock price up. Then, upon becoming CEO in March 2020, the CEO allegedly failed to file change of ownership forms regarding his holdings of company stock. Similarly, the following year after he allegedly no longer owned any company stock, the CEO belatedly filed a misleading initial form representing that he owned no company stock. The SEC is seeking permanent injunctive relief, a civil penalty, and an officer-and-director bar, in the ongoing litigation.

In February, the SEC filed charges against the husband of an energy company manager for allegedly trading on material, nonpublic information about a proposed acquisition the energy company planned to execute.[44] The individual allegedly overheard his wife’s work-related conversations about the proposed acquisition and executed trades based on that information in February 2023 without his wife’s knowledge, for a profit of $1.76 million. The individual agreed to the entry of a partial judgment permanently enjoining him from violating the antifraud provisions of the federal securities laws, barring him from acting as an officer or director of a public company, and requiring him to pay disgorgement and an undetermined civil penalty. The SEC’s investigation is still ongoing, and the U.S. Attorney’s Officer for the Southern District of Texas has brought charges against the individual in a parallel action.

In March, the SEC announced charges against a former board member of an energy company, along with four of his associates, for allegedly trading on material nonpublic information.[45] According to the complaint, in July 2019, the former board member learned of a pending investment offered to privatize the energy company. The former board member and four of his associates then allegedly purchased company securities prior to the public announcement of the offer, and then traded the shares to earn gains totaling tens of thousands of dollars. The former board member settled with the SEC, agreeing to a $801,742 civil penalty plus disgorgement, along with an officer and director bar. The four other defendants each agreed to pay civil penalties plus disgorgement.

In March, the SEC filed insider trading charges against the founder of a technology company regarding trades he made in July 2019 that earned profits of $415,726.[46] The individual allegedly learned from a friend about a multinational technology company’s pending acquisition of a communications equipment company, and then he allegedly traded options for the target company through a close relative and an associate. The individual settled with the SEC and agreed to a civil penalty of $923,740 and a five-year officer and director bar.

In May, the SEC charged an individual with violations of the securities laws for allegedly trading on inside information about a publicly traded company that resulted in profits of more than $800,000.[47] According to the complaint, between November 2019 and May 2021, the individual solicited updates from a company employee on the company’s performance. Then, despite requests from the employee not to trade company securities, the individual allegedly used the information to trade in the company’s securities. The individual settled with the SEC and agreed to pay disgorgement, prejudgment interest, and a civil penalty to be determined by the U.S. District Court for the Western District of Pennsylvania. The U.S. Attorney’s Office for the Western District of Pennsylvania also brought criminal charges against the individual in a parallel action.

In May, the SEC charged a Massachusetts-based venture investment company and its founder with violations of antifraud provisions under the federal securities laws arising from an alleged scheme to artificially inflate the stock price of a Seattle-based visual media company.[48] The SEC’s complaint alleged that in April 2023, the founder and venture investment company issued a press release offering to purchase all outstanding stock of the media company for $10 a share, almost double the closing price of the previous trading day, which allegedly caused the company’s stock price to spike. Though the founder and his company allegedly pledged in the press release to hold their shares, they allegedly began liquidating stock in the visual media company shortly after the market opened on April 24, 2023, before the media company responded to the offer. The founder and venture investment company settled the charges—agreeing to pay civil penalties and disgorgement to be determined by the court, along with an officer and director bar. In a parallel action, the U.S. Attorney’s Office for the District of Massachusetts announced criminal charges against the founder of the venture investment company.

[1] SEC Press Release, Sixteen Firms to Pay More Than $81 Million Combined to Settle Charges for Widespread Recordkeeping Failures (February. 9, 2024), available at https://www.sec.gov/news/press-release/2024-18.

[2] SEC Press Release, SEC Charges Advisory Firm Senvest Management with Recordkeeping and Other Failures (Apr. 3, 2024), available at https://www.sec.gov/news/press-release/2024-44.

[3] SEC Press Release, Twenty-Six Firms to Pay More Than $390 Million Combined to Settle SEC’s Charges for Widespread Recordkeeping Failures (Aug. 14, 2024), available at https://www.sec.gov/newsroom/press-releases/2024-98.

[4] SEC Speech, Remarks at SEC Speaks 2024, Sanjay Wadhwa, Deputy Director, Division of Enforcement (Apr. 3, 2024), available at https://www.sec.gov/newsroom/speeches-statements/sanjay-wadhwa-sec-speaks-2024-04032024.

[5] SEC Press Release, Twenty-Six Firms to Pay More Than $390 Million Combined to Settle SEC’s Charges for Widespread Recordkeeping Failures (Aug. 14, 2024), available at https://www.sec.gov/newsroom/press-releases/2024-98.

[6] SEC Press Release, J.P. Morgan to Pay $18 Million for Violating Whistleblower Protection Rule (Jan. 16, 2024), available at https://www.sec.gov/news/press-release/2024-7.

[7] SEC Press Release, SEC Charges R.R. Donnelley & Sons Co. with Cybersecurity-Related Controls Violations (June 18, 2024), available at https://www.sec.gov/news/press-release/2024-75.

[8] SEC Statement, Hey, look, there’s a hoof cleaner! Statement on R.R. Donnelley & Sons, Co., Commissioners Hester M. Peirce and Mark T. Uyeda (June 18, 2024), available at https://www.sec.gov/newsroom/speeches-statements/peirce-uyeda-statement-rr-donnelley-061824.

[9] SEC Press Release, Mark Uyeda Sworn in for Second Term as SEC Commissioner (Jan. 3, 2024), available at https://www.sec.gov/news/press-release/2024-1.

[10] SEC Press Release, SEC Appoints Erica Y. Williams to a Second Term as PCAOB Chairperson (Jun. 11, 2024), available at https://www.sec.gov/news/press-release/2024-71.

[11] SEC Press Release, SEC Appoints Stacey Bowers as Small Business Advocate (Jan. 5, 2024), available at https://www.sec.gov/news/press-release/2024-3.

[12] SEC Press Release, SEC Announces Departure of William Birdthistle; Natasha Vij Greiner Named Director of the Division of Investment Management (Feb. 28, 2024), available at https://www.sec.gov/news/press-release/2024-27.

[13] SEC Press Release, SEC Names Nathaniel H. Benjamin as Director of the Office of Minority and Women Inclusion (May 3, 2024), available at https://www.sec.gov/news/press-release/2024-52.

[14] SEC Press Release, Tina Diamantopoulos Named Regional Director of Chicago Office (May 16, 2024), available at https://www.sec.gov/news/press-release/2024-59.

[15] SEC Press Release, SEC Announces Departure of Policy Director Heather Slavkin Corzo and Appointment of Corey Klemmer to the Role (May 17, 2024), available at https://www.sec.gov/news/press-release/2024-60.

[16] SEC Press Release, SEC to Close Salt Lake Regional Office (Jun. 4, 2024), available at https://www.sec.gov/news/press-release/2024-67.

[17] SEC Press Release, SEC Charges China-Based Tech Company Cloopen Group with Accounting Fraud (Feb. 6, 2024), available at https://www.sec.gov/news/press-release/2024-15.

[18] SEC Press Release, SEC Charges Skechers with Making Undisclosed Payments to Executives’ Family Members (Mar. 7, 2024), available at https://www.sec.gov/news/press-release/2024-33.

[19] SEC Press Release, SEC Charges Northern Star SPAC for Material Misrepresentations in its IPO-Related Disclosures (Jan. 25, 2024), available at https://www.sec.gov/news/press-release/2024-10.

[20] SEC Press Release, SEC Charges Former Alfi CEO Paul Pereira with Fraud for Making False Statements on Social Media (Feb. 27, 2024), available at https://www.sec.gov/news/press-release/2024-26.

[21] SEC Press Release, SEC Charges Lordstown Motors with Misleading Investors about Company’s Flagship Electric Vehicle (Feb. 29, 2024), available at https://www.sec.gov/news/press-release/2024-29.

[22] Id.

[23] SEC Press Release, SEC Charges Audit Firm BF Borgers and Its Owner with Massive Fraud Affecting More Than 1,500 SEC Filings (May 3, 2024), available at https://www.sec.gov/news/press-release/2024-51.

[24] SEC Press Release, SEC Charges Chicago-based Aon Investments and Former Partner with Misleading Pennsylvania Public Employees’ Pension Fund (Jan. 25, 2024), available at https://www.sec.gov/news/press-release/2024-9.

[25] SEC Press Release, SEC Charges Van Eck Associates for Failing to Disclose Influencer’s Role in Connection with ETF Launch (Feb. 16, 2024), available at https://www.sec.gov/news/press-release/2024-20.

[26] SEC Press Release, SEC Charges JAG Capital Advisors and its Founder Joshua Goltry with Defrauding Investors (Jun. 12, 2024), available at https://www.sec.gov/news/press-release/2024-72; DOJ Press Release, New York Fund Manager Admits Multimillion-Dollar Investment Fraud Scheme (June 12, 2024), available at https://www.justice.gov/usao-nj/pr/new-york-fund-manager-admits-multimillion-dollar-investment-fraud-scheme.

[27] SEC Press Release, SEC Charges Five Investment Advisers for Marketing Rule Violations (Apr. 12, 2024), available at https://www.sec.gov/news/press-release/2024-46.

[28] SEC Press Release, SEC Charges Hudson Valley Wealth Management Advisory Firm and Founder for Failing to Disclose Conflicts of Interest (May 14, 2024), available at https://www.sec.gov/news/press-release/2024-55.

[29] SEC Press Release, SEC Charges Advisory Firm Mass Ave Global and Co-Founder and CEO Winston Feng with False Statements and Undisclosed Conflicts (May 29, 2024), available at https://www.sec.gov/news/press-release/2024-64.

[30] SEC Press Release, SEC Charges Advisory Firm HG Vora for Disclosure Failures Ahead of Ryder Acquisition Bid (Mar. 1, 2024), available at https://www.sec.gov/news/press-release/2024-30.

[31] SEC Press Release, SEC Charges TIAA Subsidiary for Failing to Act in the Best Interest of Retail Customers (Feb. 16, 2024), available at https://www.sec.gov/news/press-release/2024-22.

[32] SEC Order Instituting Administrative and Cease and Desist Proceedings, In the Mater of Western International Securities, Inc. (Administrative Proceeding File No. 3-21986) (July 30, 2024), available at https://www.sec.gov/files/litigation/admin/2024/34-100618.pdf.

[33] SEC Press Release, SEC Charges Intercontinental Exchange and Nine Affiliates Including the New York Stock Exchange with Failing to Inform the Commission of a Cyber Intrusion (May 22, 2024), available at https://www.sec.gov/news/press-release/2024-63.

[34] SEC Press Release, SEC Charges Three New Yorkers for Raising More Than $184 Million Through Pre-IPO Fraud Schemes (June 7, 2024), available at https://www.sec.gov/news/press-release/2024-69.

[35] SEC Press Release, SEC Charges Founder of $1.7 Billion “HyperFund” Crypto Pyramid Scheme and Top Promoter with Fraud (Jan. 29, 2024), available at https://www.sec.gov/news/press-release/2024-11.

[36] SEC Press Release, SEC Charges Founder of American Bitcoin Academy Online Crypto Course with Fraud Targeting Students (Feb. 2, 2024), available at https://www.sec.gov/news/press-release/2024-13.

[37] SEC Press Release, SEC Charges TradeStation Crypto for Unregistered Offer and Sale of Crypto Asset Lending Product (Feb. 7, 2024), available at https://www.sec.gov/news/press-release/2024-16.

[38] SEC Press Release, Genesis Agrees to Pay $21 Million Penalty to Settle SEC Charges (Mar. 19, 2024), available at https://www.sec.gov/news/press-release/2024-37.

[39] SEC Press Release, Terraform and Kwon to Pay $4.5 Billion Following Fraud Verdict (June 11, 2024), available at https://www.sec.gov/news/press-release/2024-73.

[40] SEC Press Release, SEC Charges Two Investment Advisers with Making False and Misleading Statements About Their Use of Artificial Intelligence (Mar. 18, 2024), available at https://www.sec.gov/news/press-release/2024-36.

[41] SEC Press Release, SEC Charges Founder of AI Hiring Startup Joonko with Fraud (June 11, 2024), available at https://www.sec.gov/news/press-release/2024-70.

[42] SEC Press Release, SEC Charges Morgan Stanley and Former Executive Pawan Passi with Fraud in Block Trading Business (Jan. 12, 2024), available at https://www.sec.gov/news/press-release/2024-6.

[43] SEC Press Release, SEC Charges Future FinTech CEO Shanchun Huang With Fraud and Disclosure Failures (Jan. 11, 2024), available at https://www.sec.gov/news/press-release/2024-5.

[44] SEC Press Release, SEC Charges Husband of Energy Company Manager with Insider Trading (Feb. 22, 2024), available at https://www.sec.gov/news/press-release/2024-24.

[45] SEC Press Release, SEC Charges Tallgrass Energy’s Former Board Member Roy Cook and Four Others with Insider Trading in Advance of Blackstone Acquisition (Mar. 12, 2024), available at https://www.sec.gov/news/press-release/2024-34.

[46] SEC Press Release, SEC Charges Former Arista Networks Chairman Andy Bechtolsheim with Insider Trading (Mar. 26, 2024), available at https://www.sec.gov/news/press-release/2024-40.

[47] SEC Press Release, SEC Charges Pennsylvania Resident with Insider Trading in Dick’s Sporting Goods Securities (May 10, 2024), available at https://www.sec.gov/news/press-release/2024-53.

[48] SEC Press Release, SEC Charges Robert Scott Murray and Trillium Capital with Fraudulent Scheme to Manipulate Getty Images Stock (May 31, 2024), available at https://www.sec.gov/news/press-release/2024-66.

The following Gibson Dunn lawyers assisted in preparing this update: Mark Schonfeld, David Woodcock, Tina Samanta, Lauren Jackson, Timothy Zimmerman, and Michael Ulmer.

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

Mark K. Schonfeld – Co-Chair, New York (+1 212.351.2433, [email protected])
David Woodcock – Co-Chair, Dallas (+1 214.698.3211, [email protected])
Tina Samanta – New York (+1 212.351.2469, [email protected])
Lauren Cook Jackson – Washington, D.C. (+1 202.955.8293, [email protected])
Timothy M. Zimmerman – Denver (+1 303.298.5721, [email protected])

Ryan, LLC v. Federal Trade Commission

The United States District Court for the Northern District of Texas today granted summary judgment to Gibson Dunn’s client, Ryan, LLC, in its challenge to the Federal Trade Commission’s Non-Compete Rule. The Rule would have retroactively invalidated over 30 million employment contracts and preempted the laws of 46 states. The court set aside the rule, with nationwide effect, ordering that “the Rule shall not be enforced or otherwise take effect on its effective date of September 4, 2024 or thereafter.”

Ryan, LLC was the first party to challenge the lawfulness of the Non-Compete Rule. A group of trade associations led by the United States Chamber of Commerce intervened in the case to challenge the Rule as well. Ryan and the intervenors had previously won a preliminary injunction and stay of the Rule.[1]

The court today re-affirmed its core holdings that (1) the Rule exceeded the FTC’s statutory authority because the FTC does not have authority to promulgate substantive rules regarding unfair methods of competition and (2) the Rule is arbitrary and capricious, in violation of the Administrative Procedure Act, because the FTC failed to justify the nearly universal breadth of its ban. The court’s summary judgment order applies nationwide.

The court’s ruling means that the Non-Compete Rule will not take effect on September 4. The FTC cannot enforce it against anyone, non-competes that were enforceable before the rule remain enforceable, and businesses and workers are free to enter into new non-competes. The FTC may appeal the ruling to the Fifth Circuit. The FTC has not yet indicated whether or when it may appeal.

[1] A discussion of that preliminary injunction is available here.

Gibson Dunn lawyers Eugene Scalia, Allyson N. Ho, Amir C. Tayrani, Andrew Kilberg, Elizabeth A. Kiernan, Aaron Hauptman, and Josh Zuckerman represent Ryan, LLC.

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, the authors, or any leader or member of the firm’s Administrative Law & Regulatory, Labor & Employment, or Antitrust & Competition practice groups:

Administrative Law and Regulatory:
Allyson N. Ho – Dallas (+1 214.698.3233, [email protected])
Eugene Scalia – Washington, D.C. (+1 202.955.8673, [email protected])
Amir C. Tayrani – Washington, D.C. (+1 202.887.3692, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202.887.3599, [email protected])

Labor and Employment:
Andrew G.I. Kilberg – Washington, D.C. (+1 202.887.3759, [email protected])
Karl G. Nelson – Dallas (+1 214.698.3203, [email protected])
Jason C. Schwartz – Washington, D.C. (+1 202.955.8242, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213.229.7107, [email protected])

Antitrust and Competition:
Rachel S. Brass – San Francisco (+1 415.393.8293, [email protected])
Svetlana S. Gans – Washington, D.C. (+1 202.955.8657, [email protected])
Cynthia Richman – Washington, D.C. (+1 202.955.8234, [email protected])
Stephen Weissman – Washington, D.C. (+1 202.955.8678, [email protected])

On August 13, 2024, the Federal Circuit issued a precedential decision on the issue of obviousness-type double patenting (ODP) and patent-term adjustment (PTA) in Allergan USA, Inc. et al., v. MSN Laboratories Private Ltd., et al., No. 24-1061 (Fed. Cir. Aug. 13, 2024). While the decision also addressed other issues, this update focuses on summarizing the Court’s holding on the ODP issue.

Allergan markets and sells eluxadoline tablets under the brand name Viberzi®. Allergan owns patents that cover the drug compound and composition; specifically, claim 40 of the ’356 patent recites the eluxadoline compound. The ’356 patent was awarded 1,107 days of PTA due to delays in its prosecution. All but 467 of those PTA days were disclaimed. Continuing applications were filed claiming the same priority date as the ’356 patent (the ’011 and ’709 patents). Neither received PTA, and each was therefore set to expire before the ’356 patent. Defendant argued based on In re Cellect, LLC, 81 F.4th 1216, 1228–29 (Fed. Cir. 2023), that the ’011 and ’709 patents were ODP references that rendered the ’356 patent invalid. The district court agreed, and Allergan appealed.

The Federal Circuit (Lourie, J., joined by Dyk[1] and Reyna, J.J.) reversed, concluding that the claims of the ’011 and ’709 reference patents were not proper ODP references that could be used to invalidate claim 40 of the ’356 patent. The Court held that a “first-filed, first-issued, later-expiring claim cannot be invalidated by a later-filed, later-issued, earlier-expiring reference claim having a common priority date.” The Federal Circuit distinguished the facts and questions presented in In re Cellect from Allergan and stated that “Cellect does not address, let alone resolve, any variation of the question presented here—namely, under what circumstances can a claim properly serve as an ODP reference—and therefore has little to say on the precise issue before us.” The Court then held that a “later-filed, later-issued” patent cannot be an ODP reference to “the first-filed, first-issued patent in its family,” stating: “[t]hat is the only conclusion consistent with the purpose of the ODP doctrine, which is to prevent patentees from obtaining a second patent on a patentably indistinct invention to effectively extend the life of a first patent to that subject matter.” The Court further asserted that “the first-filed, first-issued patent in its family . . . is the patent that sets the maximum period of exclusivity for the claimed subject matter and any patentably indistinct variants.”

The Court provided the following further rationale for its decision:

“When seeking patent protection, it is not atypical for a patent applicant to first seek to protect the most valuable inventive asset (e.g., a pharmaceutical genus claim) before filing continuing applications on enhancements or modifications to that inventive asset (e.g., a particular compound in that genus, a method of using the compounds of that genus, etc.). And it is unsurprising that prosecution of a first-of-its-kind invention can be protracted, requiring greater time and effort by the applicant and examiner alike, such that any eventual patent on that invention is awarded some amount of PTA. Nor is it surprising that, for one reason or another (e.g., the examiner’s newfound familiarity with the subject matter), a subsequently filed continuing application claiming the same priority date and covering a modification of that invention proceeds much more efficiently through prosecution such that any patent awarded to that modification receives little to no award of PTA. As a result, that later-filed, later-issued continuing, or “child,” patent, whether subject to a terminal disclaimer over the parent or not, generally expires no later than the parent patent. That child patent does not, then, result in any extension of patent term of the invention claimed in the parent patent given that it expires first. Nor can the parent patent be said to result in an extension of patent term of the invention claimed in the child patent when, as here, the claims in the child patent did not even exist until after the parent patent issued. To hold otherwise—that a first-filed, first-issued parent patent having duly received PTA can be invalidated by a later-filed, later-issued child patent with less, if any, PTA—would not only run afoul of the fundamental purposes of ODP, but effectively abrogate the benefit Congress intended to bestow on patentees when codifying PTA. That is because such a holding would require patent owners, in order to preserve the validity of the parent patent, to file a terminal disclaimer disclaiming any term of the parent that extends beyond that of the child, which, given that the patents share a priority date, would amount to the disclaimer of only PTA. That parent patent, then, would not receive the benefit of its congressionally guaranteed patent term, see 35 U.S.C. § 154(b), and would instead be limited to the, presumably shorter, term of its own child. Such a result would be untenable.”

After this decision, there could be more proceedings forthcoming, including a petition for panel rehearing, a petition for rehearing en banc, and/or a petition for certiorari. Please stay tuned for further developments on this front.

[1] Judge Dyk joined this portion of the majority opinion. He dissented with respect to other issues addressed by the Court, which have not been summarized in this update.

The following Gibson Dunn lawyers assisted in preparing this update: Robert Trenchard, Jane M. Love, Ph.D., and Kate Dominguez.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work, any leader or member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups, or the authors:

Robert W. Trenchard – New York (+1 212.351.3942, [email protected])
Jane M. Love, Ph.D. – New York (+1 212.351.3922, [email protected])
Kate Dominguez – New York (+1 212.351.2338, [email protected])

Appellate and Constitutional Law:
Thomas H. Dupree Jr. – Washington, D.C. (+1 202.955.8547, [email protected])
Allyson N. Ho – Dallas (+1 214.698.3233, [email protected])
Julian W. Poon – Los Angeles (+ 213.229.7758, [email protected])

Intellectual Property:
Kate Dominguez – New York (+1 212.351.2338, [email protected])
Y. Ernest Hsin – San Francisco (+1 415.393.8224, [email protected])
Josh Krevitt – New York (+1 212.351.4000, [email protected])
Jane M. Love, Ph.D. – New York (+1 212.351.3922, [email protected])

From the Derivatives Practice Group: This week, ESMA signed a Memorandum of Understanding with the British Columbia Securities Commission and updated its list of recognized third-country central counterparties to include those which are established in Canada and authorized or recognized by the British Columbia Securities Commission.

New Developments

CFTC Approves a Joint Rule Proposal to Establish Technical Data Reporting Standards. On August 8, the CFTC voted to jointly propose and request public comment on the establishment of technical data reporting standards with other financial regulatory agencies. The proposal would establish uniform data standards for the collections of information reported to the CFTC, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, Federal Housing Finance Agency, Securities and Exchange Commission, and the Department of the Treasury. The proposal would also establish uniform data standards for data collected from these financial regulatory agencies on behalf of the Financial Stability Oversight Council. According to the CFTC, the proposed standards would promote interoperability of financial regulatory data across the financial regulatory agencies through the adoption of common identifiers for legal entities, financial instruments, and other data. In addition to proposing the use of common identifiers, the proposal would also further standardize the format and transmission of data to financial regulatory agencies. The CFTC explained that the proposed rule is part of the implementation of the Financial Data Transparency Act of 2022 (“FDTA”); although the CFTC is not specifically referenced in the FDTA, the Secretary of the Treasury designated the CFTC as a covered agency on May 3, 2024. Comments on the proposal are due 60 days following publication in the Federal Register.
CFTC Exempts Additional Singapore Recognized Market Operators from SEF Registration Requirements. On August 2, the CFTC announced it unanimously approved an amended order that exempts two recognized market operators (“RMO”s) authorized within Singapore from CFTC swap execution facility (“SEF”) registration requirements. The exempted RMOs are FMX Securities (Singapore) Pte. Limited and LMAX Pte. Ltd. Section 5h(g) of the Commodity Exchange Act provides that the CFTC may grant such an exemption if it finds that a foreign SEF is subject to comparable, comprehensive supervision and regulation by the appropriate governmental authorities in the facility’s home country. Likewise, the CFTC may revoke exempt status when a facility is no longer authorized or in good standing in its home country.
CFTC Approves Final Rule Allowing U.S. Introducing Brokers Direct Access to Registered Foreign Boards of Trade for the Submission of Customer Orders. On July 29, the CFTC announced it approved final rules amending Part 48 of its regulations. The final rules permit a foreign board of trade (“FBOT”), registered with the CFTC, to provide direct access to its electronic trading and order matching system to an introducing broker, located in the United States and registered with the CFTC, for the submission of customer orders to the FBOT’s trading system for execution. The final rules also establish a procedure for an FBOT to request revocation of its registration and remove certain outdated references to “existing no-action relief” in Part 48.

New Developments Outside the U.S.

ESAs’ Joint Board of Appeal Allows the Appeal Lodged by NOVIS and Remits the Case to EIOPA. On August 13, the Joint Board of Appeal of the European Supervisory Authorities (“ESAs”) unanimously decided that the appeal brought by NOVIS against the European Insurance and Occupational Pensions Authority (“EIOPA”) is admissible. The appeal was brought in relation to the EIOPA decision not to grant access to documents, which were requested by NOVIS. In its decision, the board of appeal acknowledged that requests for access to documents laid out in Regulation No 1049/2001 can be dismissed by way of exceptions to protect certain public and private interests. [NEW]
ESMA Recognizes CDS Clearing and Depository Services as Tier 1 CCP Following MoU with the British Columbia Securities Commission. On August 13, ESMA signed a Memorandum of Understanding (“MoU”) with the British Columbia Securities Commission and updated its list of recognized third-country central counterparties (“CCPs”) under the European Markets Infrastructure Regulation (“EMIR”). The MoU establishes cooperation arrangements, including the exchange of information, regarding CCPs that are established in Canada and authorized or recognized by the British Columbia Securities Commission, and which have applied for EU recognition under EMIR. [NEW]
ESAs’ Joint Board of Appeal Dismisses Appeal by Euroins Insurance Group AD Against the European Insurance and Occupational Pensions Authority. On August 7, the Joint Board of Appeal of the ESAs unanimously decided that the appeal brought by Euroins Insurance Group AD (“Euroins”) against the EIOPA is inadmissible. In its decision, the board of appeal found that EIOPA’s power to initiate an investigation is of an entirely discretionary nature. Furthermore, the board of appeal also asserted that the EIOPA Chairperson’s decision to initiate an investigation is not subject to the board of appeal’s review. Finally, the decision clarified that the board of appeal does not have the power to order EIOPA to re-assess an appellant’s request to open an investigation.
ESMA Publishes Data for Quarterly Bond Liquidity Assessment and the Systematic Internalizer Calculations. On August 1, ESMA published the new quarterly liquidity assessment of bonds and the data for the quarterly systematic internalizer calculations for equity, equity-like instruments, bonds and for other non-equity instruments under MiFID II and MiFIR.
ESMA Delivers Opinion on Global Crypto Firms Using their non-EU Execution Venues. On July 31, ESMA issued an Opinion to address the risks presented by global crypto firms seeking authorization under the Markets in Crypto Assets (“MiCA”) Regulation for part of their activities (crypto brokerage) while keeping a substantial part of their group activities (intra-group execution venues) outside the EU regulatory scope. The opinion calls for a case-by-case assessment, outlining the specific requirements that ESMA believes should be met regarding best execution, conflicts of interest, the obligation to act honestly, fairly, and professionally in the best interests of clients and the obligation relating to the custody and administration of crypto-assets on behalf of clients.
The FCA Publishes Consultation Paper on the Derivatives Trading Obligation and Post-Trade Risk Reduction Services. On July 26, the Financial Conduct Authority (“FCA”) published a consultation paper on aspects of the derivatives trading obligation (“DTO”) as part of HM Treasury’s Wholesale Markets Review. The FCA is consulting on proposals to (1) include certain overnight index swaps based on the US Secured Overnight Financing Rate within the classes of derivatives subject to the DTO; (2) expand the list of post-trade risk reduction services exempted from the DTO and from other obligations; and (3) the FCA’s intention to use its power to suspend or modify the DTO once its transitional powers expire. The consultation closes on September 30, 2024. The FCA will publish a policy statement with final rules in Q4 2024.
ESAs Publish Joint Final Report on the Draft Technical Standards on Subcontracting under DORA. On July 26, the European Supervisory Authorities published their joint Final Report on the draft Regulatory Technical Standards (“RTS”) specifying how to determine and assess the conditions for subcontracting information and communication technology (“ICT”) services that support critical or important functions under the Digital Operational Resilience Act (“DORA”). These RTS aim to enhance the digital operational resilience of the EU financial sector by strengthening the financial entities’ ICT risk management over the use of subcontracting.

New Industry-Led Developments

ISDA Letter on FICC’s Proposed Rulebook Changes. On August 1, ISDA submitted a letter to the SEC in response to the Fixed Income Clearing Corporation’s (“FICC”) proposed changes to its Government Securities Division Rulebook in accordance with the Securities Exchange Act of 1934. The comment letter addresses FICC’s proposal to modify its trade submission rules in relation to mandatory clearing of certain US Treasury transactions. The proposed rule changes: (i) adopt a requirement that each netting member must submit all eligible secondary market transactions to which it is a counterparty to FICC for clearance and settlement; (ii) adopt new initial and ongoing membership requirements and other measures to facilitate FICC’s ability to monitor a netting member’s compliance with the trade submission requirement; (iii) adopt disciplinary measures to address a netting member’s failure to comply with the trade submission requirement; and (iv) modify the FICC rules to facilitate the trade submission requirement.
Joint Association Letter on CFTC Block Thresholds and Cap Sizes. On July 29, ISDA, the Securities Industry and Financial Markets Association, the Securities Industry and Financial Markets Association Asset Management Group, the American Council of Life Insurers and the Investment Company Institute sent a letter to the CFTC requesting a public forum be provided to continue to evaluate the methodology for calculating the block thresholds and cap sizes under Part 43 of the CFTC’s regulations.

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

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

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

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

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

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

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

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

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

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

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

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

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

Key Developments:

Media Coverage and Commentary:

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

Wall Street Journal, “The Activist Pushing Companies to Ditch Their Diversity Policies” (August 3): The Wall Street Journal’s Joseph Pisani and Chip Cutter profile conservative activist Robby Starbuck, who has leveraged his 500,000 followers on X to rally opposition against DEI initiatives at various companies. Pisani and Cutter report that Starbuck’s criticism has led companies such as Tractor Supply and John Deere to scale back their DEI efforts, and that his newest target is Harley-Davidson, with additional companies also in his sights. In his campaign against Harley-Davidson, Starbuck criticized the company for its support of LGBTQ+ causes and its “total commitment to DEI policies.” According to Starbuck, “Everybody should just go to work, do their job, go home. You want to be an activist in your personal time? That’s your business.”
Forbes, “Amid DEI Backlash, Support From Workers Drops Slightly – But Remains Strong” (August 5): Forbes’ Jena McGregor reports on a recent shift in support for DEI initiatives amid growing political scrutiny. McGregor highlights a survey conducted by Seramount, a DEI consulting firm, which queried 3,000 employees about their perspectives on DEI efforts. McGregor says the survey reveals that while overall support for DEI remains robust, with 76% of respondents expressing a personal commitment to advancing DEI in their workplaces, this figure has decreased from 83% in 2021. Additionally, McGregor reports that Black employees’ views of their managers’ inclusion efforts have improved, with 70% describing their managers as inclusive in 2024, up from 65% in 2021. In contrast, the percentage of white employees who view their managers as inclusive fell from 74% in 2021 to 68% this year.
Wall Street Journal, “The Fight Against DEI Programs Shifts to Medical Care” (August 14): The Wall Street Journal’s Theo Francis and Melanie Evans report on a civil rights complaint filed against the Cleveland Clinic by Wisconsin Institute for Law and Liberty (WILL). The complaint alleges that the Cleveland Clinic discriminates on the basis of race by operating a program to prevent and treat strokes and other conditions in Black and Latino patients. WILL filed the complaint on behalf of Do No Harm, a “membership group for medical professionals and others opposing diversity, equity and inclusion initiatives.” Francis and Evans note that “[t]he allegation pushes the fight against race-based programs into untested legal territory, arguing that healthcare providers can’t use racial and ethnic demographics to target treatment, preventive care or patient education.” According to Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group Jason Schwartz, telling medical institutions that they cannot help minority populations address significant medical risks could prove to be a tough sell. Schwartz says “[t]he rule is not that you have to help everyone or no one, whether it’s a charitable endeavor or a public health priority. That would shut down an awful lot of good works.”

Case Updates:

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

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

Do No Harm v. American Association of University Women, No. 1:24-cv-01782 (D.D.C. 2024): On June 20, 2024, Do No Harm filed a complaint against the American Association of University Women (AAUW), alleging that the organization is violating Section 1981 by providing “Focus Group Professions Fellowships” to only “women from ethnic minority groups historically underrepresented in certain fields within the United States: Black or African American, Hispanic or Latino/a, American Indian or Alaskan Native, Asian, and Native Hawaiian or Other Pacific Islander.” Do No Harm is seeking a temporary restraining order and preliminary injunction prohibiting AAUW from closing the application window for the fellowships, and a permanent injunction prohibiting AAUW from considering race when selecting grant recipients.
- Latest update: On August 2, 2024, AAUW filed its opposition to the plaintiff’s motion for a TRO and preliminary injunction, arguing that Do No Harm lacks standing, that the fellowship program is protected by the First Amendment, and that the program is a valid affirmative action program.
Do No Harm v. Gianforte, No. 6:24-cv-00024-BMM-KLD (D. Mont. 2024):On March 12, 2024, Do No Harm filed a complaint on behalf of “Member A,” a white female dermatologist in Montana, alleging that a Montana law violates the Equal Protection Clause by requiring the governor to “take positive action to attain gender balance and proportional representation of minorities resident in Montana to the greatest extent possible” when making appointments to the twelve-member Medical Board. Do No Harm alleges that since the ten already-filled seats are currently held by six women and four men, Montana law requires that the remaining two seats be filled by men, which would preclude Member A from holding the seat. On May 3, 2024, Governor Gianforte moved to dismiss the complaint for lack of subject matter jurisdiction, arguing that Do No Harm lacks standing because Member A has not applied for or been denied any position. Gianforte also argued that the plaintiff’s pre-enforcement challenge was not ripe because his administration does not interpret the statute as a quota. On May 24, 2024, Do No Harm filed an amended complaint, describing additional Members B, C, and D, who are each “qualified, ready, willing, and able to be appointed” to the board. On June 7, Gianforte moved to dismiss the amended complaint, arguing again that the pseudonymous members lacked standing and that the case still was not ripe because the statute imposed only reporting requirements regarding diversity, so it posed no threat to the new members. On June 28, Do No Harm opposed the motion, asserting that the case is ripe and the members have standing because they will be disadvantaged in applications for upcoming openings, given the existing composition of the Board and the statute’s requirement to take “positive action” to achieve gender and racial balance.
- Latest update: On July 26, 2024, Governor Gianforte filed a reply in support of his motion to dismiss, reiterating his standing and ripeness arguments.

2. Employment discrimination and related claims:

Wood v. Red Hat, Inc., No. 2:24-cv-237-REP (D. Idaho 2024): On May 8, 2024, a white male former employee sued Red Hat, Inc., a subsidiary of IBM. In his complaint, the plaintiff alleges that his role was terminated “as a direct result of Red Hat’s DEI policies and efforts to diversify the workforce” and claims that, of the group of employees who were terminated at the same time, “21 of the total 22 individuals were white, and 21 were male.” The plaintiff alleges that he was retaliated against for opposing his employer’s stated goals of increasing diversity, which included setting hiring quotas of 30% female employees globally and 30% employees of color in the United States by 2028. The plaintiff brought claims under Title VII, Section 1981, and the Family and Medical Leave Act.
- Latest update: On July 29, 2024, the defendant filed a motion to compel arbitration and stay proceedings, arguing that the parties had a valid arbitration agreement that covers the dispute.
Beneker v. CBS Studios, Inc., et al., No. 2:24-cv-01659 (C.D. Cal. 2024): On February 29, 2024, a heterosexual, white male writer represented by AFL, sued CBS, alleging that its de facto hiring policy discriminated against him on the bases of sex, race, and sexual orientation. In his complaint, the plaintiff alleges that CBS violated Section 1981 and Title VII by refusing to hire him as a staff writer on the TV show “Seal Team,” instead hiring several black writers, female writers, and a lesbian writer. The plaintiff is requesting a declaratory judgment that CBS’s de facto hiring policy violates Section 1981 and/or Title VII, injunctions barring CBS from continuing to violate Section 1981 and Title VII and requiring CBS to offer him a full-time job as a producer, and damages. CBS filed a motion to dismiss on June 24, 2024, arguing that the First Amendment protects its hiring choices and that two out of three of the plaintiff’s Section 1981 claims were untimely. The plaintiff opposed on July 15, 2024, arguing that the First Amendment does not protect hiring decisions, even if CBS is engaged in a creative enterprise.
- Latest update: On July 29, 2024, CBS filed a reply in support of its motion to dismiss, reiterating its First Amendment and Section 1981 arguments.
Peters v. Federal Reserve Bank of Cleveland, No. 1:24-cv-01314 (N.D. Ohio 2024): On July 31, 2024, a plaintiff filed a lawsuit under Title VII alleging that the Federal Reserve Bank of Cleveland had denied him a series of promotions and instead promoted candidates from minority backgrounds, even though he was more qualified than those candidates. The plaintiff is seeking a permanent injunction preventing the bank from continuing to implement its allegedly discriminatory policies and ordering the bank to promote the plaintiff and pay him monetary damages.
- Latest update: The docket does not reflect that the defendant has been served.

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

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

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

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

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

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

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

This update highlights the issuance of staggering civil monetary penalties and key takeaways from CFIUS’s most recent annual report and provides our team’s perspectives on foreign direct investment review and enforcement trends moving forward.

On July 24, 2024, the Committee on Foreign Investment in the United States (CFIUS or the Committee) released its annual report covering calendar year 2023 (the Annual Report). Shortly thereafter, on August 14, 2024, CFIUS provided an update on civil monetary penalties issued in 2023 and 2024. The past year and a half was a time of meaningful rulemaking activity for CFIUS—and a banner year for enforcement, with CFIUS assessing a record number of penalties, in amounts ranging up to $60 million dollars. In a statement accompanying the penalty update, Assistant Secretary for Investment Security Paul Rosen warned: “In the last few years, CFIUS has redoubled its resources and focus on enforcement and accountability, and that is by design: if CFIUS requires companies to make certain commitments to protect national security and they fail to do so, there must be consequences.”

Below, we provide an overview of the decrease in global M&A and CFIUS filings in contrast with the increase in mitigation and enforcement, amidst a backdrop of efforts by the Committee to further expand its jurisdiction. We follow this discussion with our key takeaways for continued CFIUS compliance through the second half of 2024 and beyond.

1. CFIUS Filings Substantially Decreased, in Line with Global Market Slowdown

For the first time since the Foreign Investment Risk Review Modernization Act (FIRRMA) was implemented, the total number of CFIUS filings decreased. The drop was significant compared to the rates of change we have witnessed in recent years, with notices down nearly 19 percent and short-form declarations down over 29 percent.[1]

Year-Over-Year Comparison of the Number of CFIUS Filings

	2021	2022 (∆ from 2021)	2023 (∆ from 2022)
Notices	272	286 (↑5.1%)	233 (↓18.5%)
Declarations	164	154 (↓6.1%)	109 (↓29.2%)
Total Filings	436	440 (↑0.9%)	342 (↓22.3%)

As noted by CFIUS in the press release accompanying the Annual Report, this decline is ostensibly driven by the downswing in the global M&A market experienced in the latter half of 2022 and in 2023. Global deal volumes decreased for two consecutive years (by 37 percent in 2022 and 26 percent in 2023).[2] Similarly, expenditures by foreign direct investors to acquire, establish, or expand U.S. businesses continued to decrease (by 51 percent in 2022 and 16 percent in 2023).[3]

Another factor potentially driving the decrease in notices is transaction parties’ perception of the CFIUS process and outcomes. In a recent statement made to the United States Committee on Banking, Housing, and Urban Affairs, Assistant Secretary Paul Rosen reiterated the longstanding policy goals of “maintain[ing] an open investment environment” and “the status of the United States as the world’s top destination for foreign direct investment.” However, many transaction parties have been receiving more daunting comments on their draft CFIUS filings and more and longer question sets, incurring a higher cost to parties to participate in the filing process and—in a trend continuing from 2022—continued high rates of mitigation, which we discuss in further detail below. An overly onerous review process across transactions combined with a higher likelihood of mitigation for some minority investments can result in investors shying away from submitting voluntary notices, even if the transactions present heightened risk of a non-notified review and potential mitigation. This trend may continue into 2024 with transaction parties weighing the benefits of a CFIUS safe harbor against the costs of the review process and potential mitigation.

Although there were fewer filings in 2023, more of them were mandatory. While a CFIUS filing is voluntary for most transactions over which CFIUS has jurisdiction, filings are mandatory for certain investments in U.S. businesses that implicate critical technology, critical infrastructure, and/or sensitive personal data. In 2023, there was a slight uptick in the percentage of declarations that were submitted as mandatory filings. CFIUS does not share how many notices were mandatory, but we expect that more notices were mandatory as well.

2. Non-Notified Reviews Are Not Going Anywhere

As in prior years, CFIUS dedicated considerable time and resources to identifying “non-notified transactions” for which CFIUS had jurisdiction and the parties did not file a notice or declaration (whether mandatory or voluntary). CFIUS uses a variety of means to identify such transactions, including, as stated in the Annual Report, “interagency referrals, tips from the public, classified reporting, media reports, voluntary self-disclosures, congressional notifications, and multiple commercial and proprietary databases.”

The Annual Report shares that in 2023 the CFIUS non-notified team reviewed “thousands” of potential non-notified transactions, ultimately putting 60 of them forward for the Committee’s consideration. CFIUS requested notices for 13 such transactions.[4]

The number of non-notified transactions put forward for the Committee’s review has been decreasing for the past two years, due in part to a better resourced non-notified team having “caught up” on old transactions. However, while the total number of non-notified inquiries decreased, the percentage of inquiries resulting in a request for a filing increased—with over 20% of inquiries in 2023 resulting in a request for a filing, up from 13% in 2022.

Non-Notified Inquiries, 2020–2023

	2020	2021	2022	2023
Number of Inquiries	117	135	84	60
Number of Filings requested (%)	17 (14.5%)	8 (5.9%)	11 (13.1%) (plus eight from prior year cases)	13 (21.7%)

CFIUS remains committed to identifying and reviewing transactions that parties do not bring forward voluntarily, and non-notified filings remain subject to mitigation and other conditions up to and including divestment. For example, the MineOne transaction, which we discussed in more detail in a prior Gibson Dunn client alert, was initiated by a public tip and then became subject to a non-notified review that ultimately resulted in divestment. CFIUS will continue leveraging its non-notified resources to identify and place conditions on transactions that raise U.S. national security concerns. In April 2024, CFIUS published a proposed rule that would expand the types of information that the Committee can request during the non-notified process, further strengthening CFIUS’s non-notified capabilities.

Last, the Annual Report disclosed that CFIUS filed one “agency notice”, a rare occurrence, after the parties filed a notice that was rejected and then refused to resubmit a corrected notice. Unlike a standard filing or a non-notified review, an agency notice allows CFIUS to conduct a review without cooperation from the transaction parties. There were zero agency notices filed between 2020-2022, and this year’s anomaly serves as a stark reminder of the Committee’s power to initiate a unilateral review even if parties forgo a voluntary filing.

3. Record High Number of CFIUS Mitigation Agreements; Site Visits Continue Apace

CFIUS is authorized to review certain investments in U.S. businesses and, if it identifies a risk to national security, mitigate that risk through a variety of methods, one being entry into a mitigation agreement (e.g., a national security agreement) with the transaction parties. Each national security agreement contains a panoply of restrictions and requirements relating to, for example, corporate governance, protection of certain technology or data, the use of third-party vendors, product quality and supply assurance, various reporting and notification requirements, and day-to-day compliance policies and oversight. For each mitigation agreement, Committee members take on responsibilities to monitor it and enforce compliance—drawing down personnel and resources.

CFIUS is now monitoring a record number of mitigation agreements—246 total agreements, up from 214 in 2022. The Committee reported devoting additional staff and resources to support compliance monitoring, made possible by increased hiring in 2022 and 2023. However, the year-over-year requirements to monitor compliance will continue to increase as CFIUS adds more mitigation agreements (35 in 2023)[5] than it terminates (15 in 2023). As an indicator of the Committee’s commitment to active oversight, CFIUS conducted 43 site visits in 2023, representing just over 20% of the agreements that had been in force since 2022.

4. Enforcement-Bent Committee Issues Record Number of Penalties—Early Glimpse at 2024 Penalties Show Staggering Dollar Values

The Annual Report reflects CFIUS’s more recent shift in emphasis on enforcement. In 2023, the Committee assessed four civil monetary penalties for breaches of material provisions in mitigation agreements—a record number of penalties in one year. Notwithstanding this sharp rise, the level of consensus required to issue a penalty suggests these were the result of more egregious violations, not minor compliance foot-faults.

Year-Over-Year Comparison of Civil Monetary Penalties Through 2023

	2018	2019	2020-2022	2023
Number of Penalties	One	One	None	One	One	Two
Penalty Amount	$1 M	$750 K	–	$100 K	$200 K	$990 K
Type of Violation	Breach of mitigation agreement	Breach of interim order	–	Breaches of agreements
Snapshot of Violation	Failure to established required security policies and provide adequate reports to CFIUS.	Failure to restrict and adequately monitor access to protected data.	–	Failure to timely divest foreign acquirer’s interest and repeated violations of other mitigation agreement provisions.	Failure to timely divest foreign acquirer’s interest and repeated violations of other mitigation agreement provisions.	Failure to maintain website statement regarding foreign ownership, as required by CFIUS, possibly putting customers’ data and technology at risk.

Although noteworthy, the penalties do not come as a surprise. In October 2022, CFIUS released its first-ever guidelines for enforcement actions, focusing on three types of violations: (1) failure to submit a mandatory notice or declaration; (2) failure to comply with a mitigation agreement or other order (including divestiture); and (3) material misstatements or omissions in filings/submissions. The 2022 guidelines did not grant new authorities to CFIUS. Rather, they put transaction parties on notice that CFIUS was focused on enforcement and highlighted what the Committee would consider when issuing penalties. CFIUS resumed assessing penalties in 2023 and 2024, including an eye-popping $60 million penalty for breach of a mitigation agreement. More penalties are likely on the way in the last months of 2024.

Spotlight on 2024 Penalties
On August 14, 2024, CFIUS shared an update on penalties issued in 2023 and 2024—including the *largest penalty in CFIUS’s history*, and the first penalty for material misstatements provided in connection with CFIUS filings. Importantly, also for the first time in its history, CFIUS published the name of the parties involved in one of these matters—noteworthy as CFIUS filings and negotiations are confidential. CFIUS anticipated the questions this raises about its confidentiality obligations, highlighting in its update that in situations where (i) there is public disclosure of CFIUS matters and (ii) the Committee assesses public disclosure serves broader enforcement and national security goals, it may determine it is appropriate to disclose more information. We suspect the parties agreed to the disclosure pursuant to the terms of a settlement with the government. In its update, CFIUS highlighted the three new penalties assessed thus far in 2024:
Penalty Amount	$8.5 Million	$1.25 Million	$60 Million
Type of Violation	Breach of mitigation agreement	Material misstatements	Breach of mitigation agreement
Snapshot of Violation	Majority shareholders caused removal of independent directors, leading to vacancy of CFIUS-mandated Security Director position, and causing government security committee to be defunct, resulting in failure to perform required compliance oversight.	Forged documents and signatures, as well as material misstatements in the joint voluntary notice and supplemental information submitted to CFIUS during their review, impairing CFIUS’s ability to assess transaction risk.	Failure to take appropriate measures to prevent unauthorized access to sensitive data and report incidents promptly, resulting in harm to U.S. national security equities.

Notably, neither the Annual Report—nor the update for 2024—included any penalties for failures to make a mandatory filing. Instead, CFIUS noted, in the Annual Report, that it issued its “first ever formal determinations of noncompliance” in several cases. One reason for forgoing penalties for certain failures to make mandatory filings is the more recent change in how parties have structured minority investments, particularly in U.S. businesses that produce critical technologies. In prior years, businesses used “springing rights” whereby U.S. businesses would accept funding from foreign investors while deferring the investor’s acquisition of control, governance, or information access rights until after CFIUS review. In 2023, CFIUS issued a frequently asked question (FAQ) clarifying that the “completion date” for a transaction is the earliest date upon which the foreign person acquired any equity interest.[6] In practice, the FAQ means that parties cannot use a springing rights strategy to permit funding before filing because CFIUS does not view the issuance of initial passive equity and the subsequent grant of rights as distinct transactions. Now, transaction parties must submit a mandatory filing no later than 30 days prior to the transfer of the initial passive equity interest. As with the 2022 enforcement guidelines, the FAQ put parties on notice that CFIUS would take a more aggressive enforcement posture moving forward, and we could see the first monetary penalties for a failure to make a mandatory filing in 2024.

We fully expect this enforcement focus to continue through 2024 and beyond. In April 2024, CFIUS published a proposed rule to substantially increase the maximum civil monetary penalty for certain violations. As CFIUS expands its enforcement toolkit, U.S. businesses and their investors must update their compliance tools to match. In 2023, CFIUS received one voluntary self-disclosure (VSD) from a party for failure to submit a mandatory filing. CFIUS does not provide a well-established form or process for submitting VSDs, and this has never been an established practice for CFIUS practitioners in the past. However, it may become more commonplace as parties look to receive the benefit of mitigating a potential violation through self-disclosure and cooperation with the Committee.

5. CFIUS Continues Efforts to Expand its Jurisdiction, Particularly in Real Estate

One of the most important parts of the Committee’s work, while less clearly captured in the Annual Report statistics, is its work drafting new legislation, rules, and clarifications. In the press release accompanying the Annual Report, Assistant Secretary Paul Rosen noted that “2023 was a busy year for CFIUS in reviewing transactions for national security risk, monitoring compliance with mitigation agreements, expanding the reach of its jurisdiction, and enforcing against violations of CFIUS legal authorities” (emphasis added). Noteworthy policy initiatives in 2023 included:

CFIUS published the “completion date” FAQ, discussed above, which had a significant impact on the way that transaction parties structure investments.
In August 2023, the Department of Treasury (Treasury) issued a final rule updating the Part 802 real estate regulations by adding eight additional military installations. Despite the update, only three declarations and two notices were filed under Part 802 in 2023. However, CFIUS continued its efforts to broaden its jurisdiction and narrow the exception for greenfield investments by drafting further updated—and much more expansive—real estate regulations to be issued very soon in 2024, which we discussed in more detail in a prior Gibson Dunn client alert.

Separate from CFIUS, Treasury’s Office of Investment Security has also taken the lead on drafting regulations to implement President Biden’s August 2023 Executive Order “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern”, the so-called “Outbound Investment” regime for which Treasury requested over $16 million dollars in the FY25 budget (and which we discussed in more detail in a prior Gibson Dunn client alert). Moreover, Treasury is not alone in focusing on the national security threat posed by certain types of foreign investment. The Office of the Director of National Intelligence and partner agencies recently issued a joint bulletin outlining a variety of threats posed by investment from certain foreign actors, including the theft of intellectual property, personal data, and technology by means of a variety of investment schemes. This joint bulletin is indicative of a wider U.S. government attempt to target and address investments by foreign actors with nefarious intents.

This year’s Annual Report included some striking but expected highlights, such as the downturn in filings and the substantial number of penalties assessed for breaches of mitigation agreements, as well as some unexpected news, such as the filing of an agency notice. Our top three takeaways follow.

Top Takeaways to Guide 2024 and Beyond:

CFIUS has a bite to match its bark. Recent CFIUS actions range from issuing clarifications of rules to proposing increases to the maximum penalty amounts—and parties must pay ever more attention to their obligations under the regulations and any mitigation agreements into which they enter. Transaction parties should consider themselves on notice that CFIUS is well-positioned to assess civil monetary penalties for failures to make a mandatory filing in 2024—and the penalty amounts may be substantial.
Non-notified reviews are as relevant as ever. CFIUS remains committed to expanding and leveraging its resources to identify and review non-notified transactions. Parties must continue to closely review the national security sensitivities of all transactions—not only those subject to a mandatory filing requirement—because transactions subject to voluntary filings can and do result in attention from CFIUS and serious mitigation measures, including divestment.
The Committee shows no signs of slowing down on policy-making initiatives and efforts to broaden its jurisdiction, and Committee members are using all tools at their disposal to further national security reviews. Despite it being an election year, Companies should prepare for 2024 to bring more legislation and rulemaking for CFIUS and Outbound Investment, and having a finger on the pulse of what is happening on the Hill is more important than ever.

[1] The total number of distinct transactions reviewed by the Committee is even lower than the sum of filings. The 233 notices include 34 that were withdrawn and refiled the same year and the 109 declarations include 20 that resulted in a request from the Committee to file a full written notice. After accounting for these duplicate filings, the Committee would have reviewed approximately 288 distinct transactions, down nearly 15 percent from the 337 distinct transactions reviewed in 2022.

[2] S&P Global, Global M&A by the Numbers: Q4 2023 (Feb. 22, 2024), available here.

[3] U.S. Bureau of Economic Analysis, New Foreign Direct Investment in the United States (July 12, 2024), available here.

[4] Per the Annual Report, three of the parties that received non-notified questions proactively filed a declaration or notice and are not counted among the 13.

[5] CFIUS also imposed mitigation requirements under one interim order and six withdrawal and abandonment letters.

[6] See the Frequently Asked Question “How does CFIUS determine the “completion date,” in assessing when a mandatory filing should be submitted, where the foreign person first acquires equity interest but will not receive control or covered investment rights until after CFIUS’s review?” found at CFIUS, CFIUS Frequently Asked Questions, available here (last accessed Aug. 15, 2024).

The following Gibson Dunn lawyers prepared this update: Michelle Weinbaum, Claire Yi, Chris Mullen, Mason Gauch, Stephenie Gosnell Handler, and David Wolber.

Gibson Dunn lawyers are monitoring the proposed changes to U.S. export control laws closely and are available to counsel clients regarding potential or ongoing transactions and other compliance or public policy concerns.

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 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, [email protected])
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202.887.3547, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202.955.8510, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202.887.3690, [email protected])
David P. Burns – Washington, D.C. (+1 202.887.3786, [email protected])
Nicola T. Hanna – Los Angeles (+1 213.229.7269, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202.955.8685, [email protected])
Samantha Sewall – Washington, D.C. (+1 202.887.3509, [email protected])
Michelle A. Weinbaum – Washington, D.C. (+1 202.955.8274, [email protected])
Mason Gauch – Houston (+1 346.718.6723, [email protected])
Chris R. Mullen – Washington, D.C. (+1 202.955.8250, [email protected])
Sarah L. Pongrace – New York (+1 212.351.3972, [email protected])
Anna Searcey – Washington, D.C. (+1 202.887.3655, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202.955.8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202.887.3588, [email protected])
Claire Yi – New York (+1 212.351.2603, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202.955.8270, [email protected])

Asia:
Kelly Austin – Hong Kong/Denver (+1 303.298.5980, [email protected])
David A. Wolber – Hong Kong (+852 2214 3764, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing (+86 10 6502 8534, [email protected])
Dharak Bhavsar – Hong Kong (+852 2214 3755, [email protected])
Felicia Chen – Hong Kong (+852 2214 3728, [email protected])
Arnold Pun – Hong Kong (+852 2214 3838, [email protected])

Europe:
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Patrick Doris – London (+44 207 071 4276, [email protected])
Michelle M. Kirschner – London (+44 20 7071 4212, [email protected])
Penny Madden KC – London (+44 20 7071 4226, [email protected])
Irene Polieri – London (+44 20 7071 4199, [email protected])
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Nikita Malevanny – Munich (+49 89 189 33 224, [email protected])
Melina Kronester – Munich (+49 89 189 33 225, [email protected])
Vanessa Ludwig – Frankfurt (+49 69 247 411 531, [email protected])

In this update, we analyze the most important mid-year trends and developments in Anti-Money Laundering (AML) regulation and enforcement thus far in 2024.

Overall, 2024 has been very active, with many new key rules in the AML space. This update includes key rule-making priorities emphasized by enforcers, notable enforcement actions, and significant judicial opinions in the AML space.

NEW RULES/RULEMAKING

[*Note: This alert was published before FinCEN issued the final real estate and investment adviser rules. For a discussion of the final rules, see our piece at the NYU Compliance Blog.]

In the first half of 2024, the Financial Crimes Enforcement Network (FinCEN) has been active in releasing new proposed rules to, most notably, expand coverage of the Bank Secrecy Act (BSA) to certain residential real estate transactions and investment advisers, both industries which had long been FinCEN priorities. The agency also released a notable proposed rule to update AML Program requirements for all financial institutions, as well as continued to implement the Corporate Transparency Act (CTA), among other things.

1. FinCEN Proposes New Reporting Obligations for Residential Real Estate Transfers

On February 7, 2024, FinCEN issued a long-awaited Notice of Proposed Rulemaking (NPRM) to apply certain AML requirements to U.S. residential real estate transactions (hereinafter the “Real Estate Rule”).[1] The Real Estate Rule would require certain professionals involved in real estate closings and settlements to report information to FinCEN about non-financed transfers of residential real estate to certain legal entities and trusts.[2]

Specifically, the Real Estate Rule would cover non-financed transfers of various types of residential real estate, including single-family houses, townhouses, condominiums, and other buildings designed for occupancy by one to four families.[3] It would also cover non-financed transfers of certain vacant or unimproved land that is zoned for occupancy by one to four families, as well as transfers of shares of cooperative housing corporations.[4] A transaction is considered “non-financed” if it does not involve an extension of credit issued by a financial institution otherwise required to maintain an AML program.[5] Transfers resulting from death or divorce, as well as transfers to a bankruptcy estate and transfers resulting from a grant or revocation of an easement, would be exempted from the Real Estate Rule.[6]

The Real Estate Rule identifies persons required to file a report (“Reporting Persons”) through a “cascade” framework which assigns the reporting responsibility in sequential order to various persons who perform closing or settlement functions for residential real estate transfers.[7] The reporting obligation would first fall upon the person listed as the closing or settlement agent.[8] But if no individual executes that settlement function, the reporting obligation would then fall upon the following individuals in the following order: (1) the person that underwrites an owner’s title insurance policy; (2) the person that disburses the greatest amount of funds in connection with the reportable transfer; (3) the person that prepares an evaluation of the title status; or (4) the person who prepares the deed.[9] Alternatively, persons specified in this list can designate by written agreement who will serve as a Reporting Person for the transfer.[10] Reports filed for a covered transfer would be required to include certain information, including:[11]

Beneficial ownership information of the transferee receiving the property;
Information about individuals representing the transferee (such as legal name, current address, and tax identification number);
Information about the Reporting Person (such as legal name, current address, and tax identification number);
Information about the property being transferred (such as physical address and description of the section, lot, or block to be conveyed);
Information about the transferor (such as legal name, current address, and tax identification number); and
Information about any payments made (including total amount paid by the transferee entity or trust, the method of each payment made by the transferee entity or transferee trust, the accounts and financial institutions used for each such payment, and, if the payor is anyone other than the transferee entity or transferee trust, the name of the payor on the payment form).

Under the proposed rule, Reporting Persons would be required to file the disclosure report within 30 days of the date of the transfer.[12]

FinCEN accepted comments on the Real Estate Rule through April 16.[13] The NPRM also proposes an effective implementation date one year after the final version of the rule is eventually issued.[14]

2. FinCEN Proposes Substantial BSA Expansion to Investment Advisers

Just a week after announcing the Real Estate Rule, on February 13, 2024, FinCEN issued another long-awaited proposal to once again propose to extend BSA/AML coverage to certain investment advisers (hereinafter the “Investment Advisers Rule”).[15] The Investment Advisers Rule would add certain investment advisers to the list of businesses classified as “financial institutions” under the BSA.[16] Specifically, the Investment Advisers Rule would cover two types of advisers: (1) those that are registered or required to register with the U.S. Securities and Exchange Commission (SEC), and (2) those that report to the SEC as Exempt Reporting Advisers.[17]

As a result, covered investment advisers would be required to implement risk-based Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) programs, file Suspicious Activity Reports (SARs) with FinCEN, keep records relating to the transmittal of funds that equal or exceed $3,000, and comply with other obligations of financial institutions under the BSA.[18] The Investment Advisers Rule would also apply information-sharing provisions between and among FinCEN, law enforcement government agencies, and certain financial institutions.[19] Notably though, because investment advisers provide services to open-end investment companies such as mutual funds (which are already defined as “financial institutions” under the BSA), the Investment Advisers Rule would not require investment advisers to apply AML/CFT program or SAR filing requirements to mutual funds they advise.[20]

The Investment Advisers Rule also proposes to delegate examination/supervisory authority to the SEC, given the SEC’s expertise in supervising the investment adviser industry.[21]

FinCEN accepted comments on the Investment Advisers Rule through April 15.[22] The NPRM proposes an effective date of one year after the date the final rule is eventually issued.[23]

On May 13, 2024, FinCEN and the SEC also jointly issued an NPRM setting forth the proposed Customer Identification Program (CIP) requirements for the investment advisers that would be covered by the Investment Advisers Rule (hereinafter the “CIP Proposal”).[24] Specifically, covered investment advisers would be required to develop a CIP that includes risk-based procedures for determining and verifying the identity of customers to the extent reasonable and practicable, and the rule further requires that verification occurs within a reasonable time before or after a customer’s account is opened.[25] At a minimum, covered investment advisers would, like other financial institutions, be required to obtain each customer’s name, date of birth or formation, address, identification number, and any other information necessary to form a reasonable belief the adviser knows the true identity of each customer.[26]

Covered investment advisers would need to also include procedures in the CIP for recordkeeping of information used to verify a customer’s identity, as well as for notifying customers that the adviser is requesting information to verify their identities.[27] The CIP would also need to include procedures for determining whether a customer appears on any list of known or suspected terrorist organizations provided by a government agency.[28] The CIP Proposal does recognize that covered investment advisers may rely on other financial institutions to perform some or all required CIP duties, but it requires that such reliance occur pursuant to a written agreement and be reasonable under the circumstances.[29]

The comment period on the CIP Proposal ran through July 22, 2024. The NPRM proposes an effective date of 60 days after the final version of the rule is eventually issued, but it notes that compliance would only be required within six months of the effective date of the regulation.[30] The NPRM further notes compliance would not be required sooner than the corresponding compliance date of a final rule arising out of the Investment Advisers Rule.[31]

3. FinCEN Proposes Updates to AML Program Requirements

In June of 2024, along with issuing a series of proposals to extend or modify certain due diligence requirements,[32] FinCEN separately issued another long-awaited NPRM to implement updates to the AML Program requirements for financial institutions geared towards modernizing the regulations to better ensure that financial institutions implement effective and risk-based AML/CTF programs.[33] This too was a requirement of the Anti-Money Laundering Act of 2020 (AML Act). The proposed rule would add language to the AML program regulations to codify the regulatory expectation that AML programs must be “effective, risk-based, and reasonably designed…to identify, manage, and mitigate illicit finance activity risks.”[34] The NPRM would maintain the four AML program requirements that all financial institutions are currently, subject to, namely: (i) implementation of risk-based, written policies, procedures and controls to ensure ongoing compliance with the BSA; (ii) designation of one or more qualified individuals to be responsible for coordinating and monitoring day-to-day BSA compliance; (iii) periodic training of employees; and (iv) periodic, independent testing of the AML/CTF program by qualified persons. The NPRM also does not propose changes to the CIP and Customer Due Diligence (CDD) AML Program requirements that certain financial institutions are subject to. However, the NPRM proposes adding a few new requirements to the current AML program obligations for all financial institutions:

Risk Assessment Process: All financial institutions would need to establish a “dynamic and recurrent risk assessment process” to enable each institution to understand its particular AML/CTF risks and to reasonably manage and mitigate those risks.[35] As part of that process, financial institutions would need to periodically “identify, evaluate, and document” their AML/CTF risks, including by consideration of FinCEN’s BSA/AML Priorities, the institution’s business, operational, and customer characteristics, and SAR and other BSA reports filed by the institution.[36] FinCEN’s AML Priorities include focusing on specific predicate crimes that often generate illicit proceeds, including corruption, cybercrime, terrorist financing, fraud, transnational criminal organization activity, drug trafficking organization activity, human trafficking and human smuggling, and financing of certain state-sponsored weapons programs (known as proliferation financing).[37] If adopted, institutions would need to review these predicate offenses and consider ways in which their products, services, distribution channels, intermediaries, and payment patterns conceivably facilitate said crimes.[38] The resulting risk assessment, as periodically updated, should then inform how the institution’s AML/CTF Program and each of its components are developed and updated to include risk-based internal policies, procedures, and controls designed to mitigate identified risks.[39]

Board Approval and Oversight: All AML/CTF programs would need to be approved and overseen by the institution’s Board of Directors, or if the institution does not have a Board of Directors, an equivalent governing body. While some financial institutions are already required by the BSA or their functional regulator to have their AML/CTF programs approved by their Boards, this rule, if adopted, would extend that requirement to all financial institutions. It would also require Board approval of not just a primary AML/CTF Program document, but also “each of the components of the AML/CTF program.”[40] In the NPRM, FinCEN further explained that the oversight requirement would be distinct from the approval requirement and would require “appropriate and effective oversight measures…to ensure that the board (or equivalent) can properly oversee whether AML/CFT programs are operating in an effective, risk-based, and reasonably designed manner.”[41]

On-shore Compliance: The NPRM would implement the AML Act’s requirement that financial institutions with “the duty to establish, maintain, and enforce the AML/CFT program must remain the responsibility of, and be performed by, persons in the United States who are accessible to, and subject to oversight and supervision by FinCEN and [any] Federal functional regulator.”[42] FinCEN acknowledged that “financial institutions may currently have AML/CFT staff and operations outside of the United States, or contract out or parts of their AML/CFT operations to third-party providers located outside of the United States” for reasons such as cost or efficiency—all of which may conflict with the onshoring proposal as stated.[43] As such, the agency has “requested comment on a variety of potential questions that may arise for financial institutions as they address this statutory onshoring requirement, including questions about the scope of the statutory requirement and the obligations of persons that are covered.”[44]

As noted, a central purpose of this NPRM is to modernize the BSA regulations by clarifying and streamlining the AML Program requirements, including by making them more consistent across financial institution types, and by adding new requirements designed to make AML Programs more risk-based and effective. These changes may prove useful to regulated entities, as it may help them better understand their obligations and better appreciate what specific steps must be taken to develop an effective AML/CFT program. The comment period on this proposal runs through September 3, 2024, and the NPRM proposes an effective date of six months after the date the final rule is eventually issued.[45]

Following FinCEN’s lead, on July 19, 2024, other agencies (the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency) issued their own NPRMs designed to facilitate the creation of similar risk-based compliance programs.[46] Financial institutions subject to these agencies’ regulatory regimes will be tasked with similarly monitoring FinCEN’s AML/CFT priorities to look for ways to implement those requirements into its own internal auditing/risk-assessment processes.[47] Regulated financial institutions must subsequently update their risk assessments on a periodic basis to assure it accounts for risks newly flagged by FinCEN and other government authorities.

CTA DEVELOPMENTS[48]

As discussed in our last update, the Corporate Transparency Act (“CTA”) took effect on January 1, 2024.[49] As FinCEN continues to roll out the CTA, it has issued a number of pieces of notable guidance this year while, at the same time, private plaintiffs have begun to challenge the constitutionality of the act. We address both updates in turn.

4. Notable FinCEN Guidance

FinCEN maintains a Frequently Asked Questions (FAQs) website, where it offers guidance on compliance with BOI reporting.[50] We note two particularly important clarifications FinCEN has issued this year. First, in January, FinCEN provided important clarification on the scope of what is known as the “subsidiary exemption.”[51] The subsidiary exemption applies to subsidiaries whose “ownership interests” are “controlled or wholly owned” by certain exempt entities.[52] As written, the term “controlled” left room for uncertainty. Specifically, the qualifier “controlled or wholly owned” implies that while total ownership is required for the exemption, control may not be similarly limited. FinCEN addressed this in guidance on January 6 by explaining its position: “If an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify [for the exemption]. To [instead] qualify, a subsidiary’s ownership interests must be fully, 100 percent owned or controlled by an exempt entity.”[53] FinCEN further added that “the exempt entity [must] entirely control[] all of the ownership interests in the reporting company, in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests.”[54] FinCEN’s clarification effectively narrows the exception and could require more subsidiaries to file reports with FinCEN.

Next, FinCEN offered clarification as to when dissolved entities are required to disclose BOI. Procedurally, uncertainty existed as to whether companies dissolved before the date of a reporting deadline needed to file. A new FAQ clarifies that if an entity is reportable and existed at any time during 2024, it needs to file, even if the entity is dissolved before the date a report would otherwise be due.[55] But if a reportable company ceased to exist before the CTA went into effect (i.e., January 1, 2024), then the entity does not need to file because it was never subject to the applicable reporting requirements.[56]

5. Constitutional Challenges to the CTA

Since the CTA’s enactment in January, there have been several challenges to the constitutionality of the CTA filed in federal court. Actions have been filed in the Northern District of Alabama,[57] the District of Maine,[58] the Western District of Michigan,[59] the Eastern District of Texas,[60] and the District of Massachusetts.[61]

In each of these cases, plaintiffs have levied many of the same objections. These primarily include that the CTA exceeds Congress’s authority by infringing on states’ exclusive power to regulate business entity formation within their borders, in violation of the Tenth and Fourteenth Amendments to the Constitution.[62] Moreover, plaintiffs argue that the mere fact of forming a “reporting company” (e.g., filing articles of incorporation) does not implicate foreign affairs or national security, and therefore is a power reserved to the states (not Congress). In addition, other plaintiffs allege violations of the Fourth Amendment’s prohibitions against unreasonable searches and seizures, and the Fifth Amendment’s guarantee of Due Process. With respect to the Fourth Amendment claim, plaintiffs argue that the compelled disclosure to FinCEN of BOI without reasonable suspicion, probable cause, or pre-compliance review constitutes illegal acts at the hands of the federal government.[63] The Due Process claim rests on the assertion that the CTA is unconstitutionally vague. Plaintiffs argue, among other points, that terms such as “beneficial owner” and “substantial control” are insufficiently defined, depriving regulated parties of sufficient notice as to what conduct triggers criminal liability.[64]

While decisions remain pending in most of these actions, on March 1, 2024, in the Northern District of Alabama, a federal judge granted summary judgment in favor of the plaintiffs.[65] Therein, the court concluded that the CTA unconstitutionally exceeds Congress’ enumerated powers.[66] The court proceeded to enter a permanent injunction barring the government from enforcing the CTA as to the plaintiffs in the case, but did not issue a national injunction barring enforcement of the law as to other entities.[67] In accordance with that ruling’s limited scope, FinCEN clarified that “reporting companies” must still generally comply with the CTA, and only the plaintiffs in the Alabama action need not submit BOI.[68] Oral argument on that appeal has been set for September 23, 2024.

Given the narrow scope of relief issued in the proceedings in Alabama—as well as the fact that decisions remain pending in the suits in Michigan, Maine, Texas, and Massachusetts—entities should generally assume (as FinCEN has itself indicated) that they remain subject to the CTA unless an applicable exemption applies.[69] Accordingly, the CTA continues to impose imminent deadlines for many entities as to which the law remains applicable.

PRIORITIES

The below updates include those areas that executive officials, particularly FinCEN, have targeted to boost AML measures through the first half of 2024.

6. Biden Administration Continues to Prioritize Prevention of the Financing of Terrorism

In the first half of 2024, the Biden administration has continued to prioritize investigations and enforcement in the national security area, particularly those implicating AML and terrorism. On June 26, 2024, for instance, FinCEN issued a final rule that identified Al-Huda Bank—an Iraqi bank FinCEN considers to be a conduit for terrorist financing—as a foreign financial institution of primary money laundering concern.[70] Alongside such a designation, the final rule FinCEN issued imposes a special measure severing Al-Huda Bank from the U.S. financial system by prohibiting domestic financial institutions and agencies from opening or maintaining a correspondent account for, or on behalf of, Al-Huda Bank.[71] Covered entities would be required to apply special due diligence to all of their foreign correspondent accounts—implementing measures designed to effectively prevent such accounts from being used to process transactions involving Al-Huda Bank.[72] This final rule comes on the heels of Treasury’s Office of Foreign Assets Control (OFAC) designating the chairman of Al-Huda Bank as having materially assisted, sponsored, or provided financial, material, or technological support to an Iranian foreign terrorist organization (FTO).[73]

In a similar vein, on May 8, 2024, FinCEN issued an advisory providing the private sector with information to assist in detecting potentially illicit transactions related to Iranian and Iran-backed FTOs.[74] The advisory highlights the various ways Iran raises and moves funds in support of FTOs and details the other typologies such FTOs use to raise revenue.[75] The advisory identifies various red flags financial institutions should identify and consider and provides a reminder of relevant BSA reporting obligations for financial institutions to follow.[76] On July 11, 2024, FinCEN issued a series of similar red flags designed to assist institutions detect, prevent, and report potential financing of Israeli extremist settlor violence against Palestinians located in the West Bank.[77]

7. FinCEN’s Broad and Expanding Mission

While FinCEN has been focused on priorities such as national security, in recent years it has also been focusing on a wider range of issues ranging from drug trafficking to environmental crimes to elder abuse to digital assets. We briefly discuss some of these priorities.

a. Drug Trafficking

In December 2023, the U.S. government announced a Treasury Department Counter-Fentanyl Task Force, including FinCEN.[78] In June 2024, FinCEN Director Andrea Gacki traveled to Arizona and led a “FinCEN Exchange,” focused on disrupting the fentanyl trade.[79] This trip came on the heels of a similar meeting the previous month, where the Director and senior leadership attended a roundtable in Iowa with Congressman Zach Nunn. The meeting focused on law enforcement priorities, emphasizing the agency’s efforts to “degrade and disrupt transnational criminal organizations that traffic opioids and other dangerous substances.”[80] The Arizona and Iowa meetings follow a March statement by the White House on its efforts to reduce opioid overdose deaths, including by “investing over $100 billion to disrupt the flow of illicit drugs.”[81]

Additionally, in June of 2024, Treasury issued an advisory alert to U.S. financial institutions—informing them of new alarming transaction trends in the fentanyl supply chain.[82] The alert aims to equip institutions with a better understanding of when certain transactions should raise red flags and require reporting. The report specifically informs institutions to monitor shell companies purportedly associated with textiles, food, or the electronics industry, as illicit suppliers frequently use entities of that variety to obfuscate their illegal transactions.[83] Of additional concern to FinCEN is the increased use of virtual currencies, like bitcoin, by Mexican-based cartels to purchase fentanyl’s precursor chemicals from Chinese-located suppliers.[84] The report also lists 14 red flags designed to assist financial institutions in detecting transactions related to the illicit production of fentanyl—including increased monitoring of transactions between Chinese sellers and Mexican buyers.[85] Companies obligated to file SARs should take note of these new guidelines and update AML policies with these specific considerations in mind.

b. Environmental Crimes

In April, FinCEN published a notice reminding financial institutions to be vigilant “in identifying and reporting suspicious activity related to environmental crimes,” which are frequently related to “fraud, human trafficking, and drug trafficking.”[86] Environmental crimes can include wildlife trafficking, illegal mining, and logging.[87] The notice references a prior threat analysis “[highlighting] wildlife trafficking as a transnational criminal organization-related concern,” asserting it often supports transnational criminal organizations linked to corrupt foreign governments.[88] SARs relating to wildlife trafficking increased each year from 2018 through October 2021, helping to identify “various levels of potential foreign government corruption.”[89] Wildlife trafficking, in particular, is a “low risk and high reward” crime and presents money laundering concerns.[90] The statutory authorization for the Presidential Task Force on Wildlife Trafficking was recently renewed through 2028.[91] The Task Force includes in its mission the goal of increasing cooperation between “law enforcement and financial institutions to identify [wildlife] trafficking activity.”[92]

c. Elder Exploitation

Elder exploitation continues to be an enforcement priority for FinCEN as well.[93] FinCEN reported detection of approximately $27 billion of attempted or completed instances of Elder Financial Exploitation (EFE) between June 2022 and June 2023.[94] In a trend report, FinCEN found scammers are increasingly avoiding in-person contact with banks and money transmitting businesses (e.g., wire transfer companies), which may “identify EFE activity more frequently [because] victims or perpetrators [conduct] transactions in person, and presumably [do] not permit the requested transactions.”[95] Instead, perpetrators are increasingly relying on methods not requiring direct contact with intermediaries, like peer-to-peer payment systems and digital payments.[96] The report highlights the “critical role of financial institutions” in detecting and deterring this type of activity.[97]

d. Cryptocurrency and Child and Human Trafficking

In February, FinCEN published a report identifying purported links between “convertible virtual currency” (CVC, or cryptocurrency), online child sexual exploitation (OCSE), and human trafficking.[98] The agency claims the number of OCSE and human trafficking-related SARs increased by about 400% from 2020 to 2021.[99] It also identified typologies used by individuals engaging in these activities, such as “CVC kiosks” (e.g., Bitcoin ATMs), mixers (a way to hide the parties in a CVC transaction), and peer-to-peer exchanges.[100] Most SARs related to OCSE and human trafficking that involve CVCs are linked to child pornography. Generally, the SARs describe possible purchases of child sex abuse materials using CVC, or attempts to exchange the CVC proceeds from those sales into fiat currency.[101] FinCEN indicated that bitcoin is the CVC of choice in an overwhelming majority of the reports. Bitcoin transactions are pseudonymous and readily traceable, but FinCEN warned that privacy-enhancing CVCs can present obstacles to a financial institution’s ability to detect these transactions.[102]

In general, firms and individuals should take note of FinCEN’s ever-expanding regulatory reach, even to areas not traditionally considered to be under the agency’s purview.

POLICIES

The first half of 2024 also featured a number of notable program announcements from the DOJ relating to AML, including its new whistleblower policy.

8. DOJ Announces New Programs to Foster Reporting of Corporate AML Violations and Other Crimes

In our inaugural edition, we noted that it will be important to watch the AML whistleblower space as FinCEN’s AML whistleblower program comes online. Indeed, in February 2024, FinCEN Director Gacki testified that FinCEN has already received over 100 tips.[103]

In parallel, DOJ has announced an individual voluntary self-disclosure program to further incentivize reporting of potential corporate misconduct. On April 15, 2024, the Criminal Division of DOJ announced the Pilot Program on Voluntary Self-Disclosure for Individuals (hereinafter the “Pilot Program”), which clarifies the circumstances under which DOJ will offer non-prosecution agreements (NPAs) to individuals who voluntarily disclose original information about corporate criminal misconduct.[104] The Pilot Program sets forth various criteria a reporting individual must satisfy in order to receive an NPA.[105] As to subject-matter, a reporting individual must disclose original information that is non-public and not otherwise known to the DOJ.[106] The original information must also relate to a specified list of offenses that includes:[107]

Violations by financial institutions involving money laundering or fraud;
Violations related to the integrity of financial markets;
Violations related to foreign corruption and bribery;
Violations related to healthcare fraud or illegal healthcare kickbacks;
Violations related to fraud or deception of the U.S. in relation to federally funded contracting (not including healthcare fraud); and
Violations relating to bribes or kickbacks paid to domestic public officials.

Beyond the subject-matter requirements, there are several other limitations on eligibility for an NPA through the Pilot Program. Disclosure of the original information must be voluntary, meaning it (1) must be made before any government request or inquiry into the issue, (2) the reporting individual must have no preexisting obligation to report the information to the Criminal Division, and (3) the disclosure must occur in the absence of any government investigation or threat of imminent disclosure of the information to the government or the public.[108] The disclosure must also be truthful and complete, including any misconduct that the reporting individual participated in or is aware of.[109] The reporting individual must agree to “fully cooperate” with and provide “substantial assistance” to DOJ in its investigation.[110] The reporting individual must also agree to repay any profits obtained from the reported misconduct and pay restitution to victims.[111] Finally, the reporting individual must not be involved in any terrorist activity, violent crime, or sexual offenses, and cannot be a Chief Executive Officer, Chief Financial Officer, or organizer of the scheme.[112]

The Pilot Program comes alongside the DOJ’s announcement of its financial reward program for corporate whistleblowers, which was formally enacted on August 1, 2024.[113] Please see our recent alert for further details. Companies following these developments should evaluate and continue to invest in compliance programs that help to identify misconduct and encourage internal detection and reporting of potential violations, particularly those relating to allegations of money laundering or other criminal activity.

ENFORCEMENT ACTIONS

Although FinCEN did not have any corporate enforcement actions in the first half of 2024, DOJ continues to be active in enforcing AML compliance, including in the digital assets industry.

9. DOJ Prosecutions

Alongside new DOJ policy initiatives, the first half of 2024 also featured a number of notable enforcement actions taken by DOJ in pursuit of its AML efforts.

a. Cryptocurrency Exchanges

On March 26, 2024, the United States Attorney for the Southern District of New York unsealed an indictment against global cryptocurrency exchange KuCoin, along with two of its founders.[114] The crux of the allegation is that the indicted individuals operated KuCoin as an unlicensed money transmitting business and conspired to violate the BSA by willfully failing to maintain an adequate AML program.[115] Specific failures included the absence of reasonable procedures in place for verifying the identity of customers, and failing to file SARs.[116] As an alleged money transmitting business and futures commission merchant, KuCoin had been subject to applicable FinCEN regulations and failed to implement them as required.

Similar conduct has led to a recent guilty plea by another cryptocurrency exchange. On July 10, 2024, the Southern District of New York separately announced that Bitcoin Mercantile Exchange (BitMEX) pled guilty to violations of the BSA.[117] Similar to the allegations levied against KuCoin, BitMEX admitted to willfully failing to establish, implement, and maintain an adequate AML program.[118] Formerly one of the leading cryptocurrency derivatives platforms, BitMEX admitted that because it operated in the United States, it knew it was required to implement adequate AML and KYC policies and chose to nevertheless “flaunt” those requirements.[119] Both the DOJ’s indictment of KuCoin and the guilty plea secured against BitMEX highlight the serious ramifications that non-compliance with FinCEN regulations can pose on an entity’s operations.

b. Individual Liability

The DOJ also recently obtained a guilty plea from Gyanendra Asre—a former member of the supervisory board for the New York State Employees Federal Credit Union—for causing the institution to facilitate illicit transactions.[120] Specifically, the DOJ alleged that Asre influenced the bank to violate the BSA’s reporting requirements while, among other things, processing bulk cash deposits and checks exceeding $100 million dollars. Asre executed the scheme “to bring lucrative and high-risk international financial business to a small, unsophisticated credit union,”[121] and pled guilty to failing to maintain an effective AML program. FinCEN separately assessed a $100,000 penalty for Asre’s violations of the BSA.[122]

Similarly, a former bank executive in Missouri pled guilty to assisting customers in evading BSA protocols, as well as submitting falsified currency transaction reports. Defendant Peter McVey, a longtime Kansas City banker, “worked with other bank officials and customers to submit fraudulent . . . forms to [FinCEN] and . . . knowingly accepted forged bank forms from customers.”[123] McVey’s activities assisted unscrupulous customers and he faces a maximum of 10 years in federal prison.

These recent prosecutions illustrate that DOJ has continued to focus on holding individuals criminally liable for violations of the BSA.

RELEVANT CASE LAW UPDATES

10. Recent Acquittal on Section 1957 Charges in Trial of Backpage Executives Highlights Potential Importance of Tracing Requirements

In April, a federal court in Arizona issued a notable money laundering decision in U.S. v. Lacey.[124] Michael Lacey, who had previously been convicted at trial, allegedly participated in a money laundering conspiracy stemming from the DOJ’s allegations that a website Lacey helped operate, Backpage.com, was primarily a tool for the promotion of prostitution in violation of the Travel Act.[125] Lacey moved for acquittal of his convictions under 18 U.S.C. § 1957, the money laundering statute prohibiting the use of illicit proceeds in a financial transaction of $10,000 or more.[126] The statute does not offer guidance on how to determine when use of these proceeds triggers liability if they are comingled with “clean” money in a single account, leading to a circuit split on the issue of tracing.[127]

Here, the government’s theory had been that “all” proceeds from Backpage.com resulted from criminal activity. But the court held that the government failed to sufficiently prove that fact at trial, given that some ad revenue purportedly came from legitimate sources.[128] This decision reaffirmed the Ninth Circuit’s unique tracing requirement—which “rejects the presumption that proof that some criminally derived funds exist in an account means that a subsequent transfer of funds … involves those [same] criminally derived funds.”[129] This decision stands in contrast to opinions from other circuits, some of which presume any money transferred from a mixed accounts is tainted.[130] But in the Ninth Circuit, even if the government shows a “great majority” of the funds in an account constitute illicit proceeds, this is insufficient to support a violation of Section 1957.[131]

Thus, in ordering the acquittal, the district court reaffirmed that Section 1957’s scope is somewhat cabined, at least in the Ninth Circuit.

CONCLUSION

2024 has thus far been notable in the AML enforcement space. We anticipate that the second half of the year will be similarly active, as litigation challenging the CTA continues to unfold, and FinCEN works to finalize the rules it has proposed in the first half of the year. We will continue to monitor these updates and report accordingly on steps individuals and entities should take to navigate the ever-changing regulatory regime.

The footnotes referenced in this update are available on Gibson Dunn’s website at the following link. Please click on a particular footnote above to view details. The complete update is available at the link below:

[1] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Proposes Rule to Combat Money Laundering and Promote Transparency in Residential Real Estate (Feb. 7, 2024), https://www.fincen.gov/news/news-releases/fincen-proposes-rule-combat-money-laundering-and-promote-transparency.

[2] 88 Fed. Reg. 12424 (Feb. 16, 2024), https://www.federalregister.gov/documents/2024/02/16/2024-02565/anti-money-laundering-regulations-for-residential-real-estate-transfers.

[3] Id. at 12430–31.

[4] Id.

[5] Id. at 12425.

[6] Id. at 12436.

[7] Id. at 12437–38.

[8] Id.

[9] Id.

[10] Id. at 12438–39.

[11] Id. at 12440–41.

[12] Id. at 12424.

[13] On July 8, 2024, FinCEN submitted its Final Rule to the Office of Management and Budget (“OMB”) for review, a final step in the rulemaking process prior to publication of the Final Rule in the Federal Register. OMB generally has 90 days to conduct its review.

[14] Id. at 12442.

[15] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Proposes Rule to Combat Illicit Finance and National Security Threats in Investment Adviser Sector (Feb. 13, 2024), https://www.fincen.gov/news/news-releases/fincen-proposes-rule-combat-illicit-finance-and-national-security-threats.

[16] 89 Fed. Reg. 12108, 12114 (Feb. 15, 2024), https://www.federalregister.gov/documents/2024/02/15/2024-02854/financial-crimes-enforcement-network-anti-money-launderingcountering-the-financing-of-terrorism.

[17] Id. at 12119.

[18] Id. at 12108, 12120.

[19] Id. at 12117.

[20] Id. at 12108.

[21] Id. at 12119.

[22] On July 15, 2024, FinCEN submitted its Final Rule to OMB for review prior to publication in the Federal Register.

[23] Id. at 12191.

[24] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, SEC, FinCEN Propose Customer Identification Program Requirements for Registered Investment Advisers and Exempt Reporting Advisers (May 13, 2024), https://www.fincen.gov/news/news-releases/sec-fincen-propose-customer-identification-program-requirements-registered.

[25] Id. at 44575.

[26] Id.

[27] Id. at 44578.

[28] Id. at 44585.

[29] Id. at 44578–79

[30] Id. at 44579.

[31] Id.

[32] These measures include a proposal to renew, without change, procedures to establish and maintain due diligence programs for foreign financial institutions and for private banking accounts. See Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Agency Information Collection Activities: Proposed Renewal: Comment Request: Renewal Without Change of Due Diligence Programs for Correspondent Accounts for Foreign Financial Institutions and for Private Banking Accounts (June 11, 2024), https://www.fincen.gov/resources/statutes-regulations/federal-register-notices/agency-information-collection-activities-40. They also include a renewal, without change, of customer identification program requirements. See Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Agency Information Collection Activities: Proposed Renewal: Comment Request: Renewal Without Change of Customer Identification Program Regulatory Requirements for Certain Financial Institutions (June 20, 2024), https://www.fincen.gov/resources/statutes-regulations/federal-register-notices/agency-information-collection-activities-41. And in March of 2024, FinCEN also issued a request for comments on whether alternative identification documents may lessen the need to collect full Social Security Numbers from consumers. See Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Seeks Comments on Customer Identification Program Requirement (Mar. 28, 2024), https://www.fincen.gov/news/news-releases/fincen-seeks-comments-customer-identification-program-requirement.

[33] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Issues Proposed Rule to Strengthen and Modernize Financial Institutions’ AML/CFT Programs (June 28, 2024), https://www.fincen.gov/news/news-releases/fincen-issues-proposed-rule-strengthen-and-modernize-financial-institutions.

[34] Id. at 55435.

[35] 89 Fed. Reg. 55428 at 55437.

[36] Id.

[37] Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Anti-Money Laundering and Countering the Financing of Terrorism National Priorities (June 30, 2021), https://www.fincen.gov/sites/default/files/shared/AML_CFT%20Priorities%20(June%2030%2C%202021).pdf.

[38] 89 Fed. Reg. 55428 at 55436.

[39] Id.

[40] Id. at 55444.

[41] Id. at 55445.

[42] Id. at 55545; 31 U.S.C. § 5318(h)(5).

[43] 89 Fed. Reg. 55428, 55455 (July 3, 2024), https://www.federalregister.gov/documents/2024/07/03/2024-14414/anti-money-laundering-and-countering-the-financing-of-terrorism-programs.

[44] Id.

[45] Id. at 55446.

[46] Press Release, Interagency Statement on the Issuance of the AML/CFT Program Notices of Proposed Rulemaking (July 19, 2024), https://www.fincen.gov/sites/default/files/shared/Interagency-Statement-on-the-Issuance-of-the-AML-CFT-Program-Notices-of-Proposed-Rulemaking-FINAL.pdf.

[47] Id.

[48] We are providing this update for general information purposes only. This update is not intended as, does not constitute, and should not be relied upon as, legal advice. Because the CTA regulatory guidance is evolving rapidly, please consult with us for any necessary updates.

[49] 18 U.S.C. § 5336; Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, U.S. Beneficial Ownership Information Registry Now Accepting Reports (Jan. 1, 2024), https://www.fincen.gov/news/news-releases/us-beneficial-ownership-information-registry-now-accepting-reports.

[50] Fin. Crimes Enf’t Network, Beneficial Ownership Information Reporting: Frequently Asked Questions, https://www.fincen.gov/boi-faqs [hereinafter, “FinCEN BOI FAQs”].

[51] Id. at L.6.

[52] 31 C.F.R. § 1010.380(c)(2)(i)-(xxii).

[53] FinCEN BOI FAQs at L.6.

[54] Id.

[55] Id. at C.13.

[56] Id. at C.13.

[57] National Small Business United et al. v. Yellen et al., No. 5:22-cv-01448 (N.D. Ala. 2024).

[58] Boyle v. Yellen et. al, No. 2:24-cv-00081 (D. Me. 2024).

[59] Small Business Assn. of Mich., et al. v. Yellen, et al., 1:24-cv-00314 (D. Mich. 2024).

[60] Texas Top Cop Shop, Inc. et al. v. Garland, et al., No. 4:24-cv-00478 (E.D. Tx. 2024).

[61] Black Economic Council of Mass., et al., No. 1:24-cv-11411 (D. Mass. 2024).

[62] See, e.g., Boyle, No. 2:24-cv-00081, ECF. No. 1 (alleging Tenth Amendment claims); see, e.g., National Small Business United, No. 5:22-cv-01448, ECF. No. 1 (alleging Fourteenth Amendment, as well as additional constitutional challenges).

[63] Small Business Assn. of Mich., No. 24-cv-00314, ECF. No. 1.

[64] Id.

[65] National Small Business United, No. 5:22-cv-01448, ECF. No. 51.

[66] Id.

[67] National Small Business United, No. 5:22-cv-01448, ECF. No. 52.

[68] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Notice Regarding National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.) (Mar. 4, 2024), https://www.fincen.gov/news/news-releases/updated-notice-regarding-national-small-business-united-v-yellen-no-522-cv-01448; see also National Small Business United et al. v. U.S. Dep’t of the Treasury et al., No. 24-10736 (11th Cir. 2024), ECF. No. 1.

[69] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, Notice Regarding National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.) (Mar. 4, 2024), https://www.fincen.gov/news/news-releases/updated-notice-regarding-national-small-business-united-v-yellen-no-522-cv-01448.

[70] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Finalizes Measure Against Iraq-based Al-Huda Bank to Combat Terrorist Financing (June 26, 2024), https://www.fincen.gov/news/news-releases/fincen-finalizes-financial-measure-against-iraq-based-al-huda-bank-combat.

[71] 89 Fed. Reg. 55051, 55054 (July 3, 2024), https://www.federalregister.gov/documents/2024/07/03/2024-14415/imposition-of-special-measure-regarding-al-huda-bank-as-a-financial-institution-of-primary-money.

[72] Id. at 55051.

[73] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Finds Iraq-based Al-Huda Bank to be of Primary Money Laundering Concern and Proposes a Rule to Combat Terrorist Financing (January 29, 2024), https://www.fincen.gov/news/news-releases/fincen-finds-iraq-based-al-huda-bank-be-primary-money-laundering-concern-and.

[74] FinCEN Advisory to Financial Institutions to Counter the Financing of Iran-Backed Terrorist Organizations (May 8, 2024), https://www.fincen.gov/news/news-releases/fincen-issues-advisory-iran-backed-terrorist-organizations.

[75] Id. at 3–6.

[76] Id. at 12–17.

[77] FinCEN Supplemental Alert: FinCEN Highlights Additional Red Flags Regarding Financing of Israeli Extremist Settler Violence Against Palestinians in the West Bank (July 11, 2024), https://www.fincen.gov/sites/default/files/shared/FinCEN-Alert-West-Bank-FINAL-508C.pdf.

[78] Press Release, U.S. Dep’t of the Treasury, U.S. Treasury Launches Counter-Fentanyl Strike Force (Dec. 4, 2023), https://home.treasury.gov/news/press-releases/jy1946.

[79] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Director Gacki’s Travel to Arizona for Engagements on Beneficial Ownership Information Reporting and FinCEN Exchange to Fight Fentanyl Trafficking (Jun. 13, 2024), https://www.fincen.gov/news/news-releases/readout-fincen-director-gackis-travel-arizona-engagements-beneficial-ownership; see also Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Exchange, https://www.fincen.gov/resources/financial-crime-enforcement-network-exchange (A “FinCEN Exchange” is an information sharing exercise between the government and local businesses “to better identify risks and provide FinCEN and law enforcement with critical information to disrupt money laundering, terrorism financing, and other financial crimes.”).

[80] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Director Gacki’s Travel to Iowa for Engagements on Fentanyl and Beneficial Ownership Reporting (Jun. 3, 2024), https://www.fincen.gov/news/news-releases/readout-fincen-director-gackis-travel-iowa-engagements-fentanyl-and-beneficial.

[81] Press Release, The White House, Biden-⁠Harris Administration Launches the White House Challenge to Save Lives from Overdose (Mar. 13, 2024), https://www.whitehouse.gov/briefing-room/statements-releases/2024/03/13/fact-sheet-biden-harris-administration-launches-the-white-house-challenge-to-save-lives-from-overdose.

[82] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Issues Supplemental Advisory on the Illicit Procurement of Fentanyl Precursor Chemicals and Manufacturing Equipment (June 20, 2024), https://fincen.gov/news/news-releases/fincen-issues-supplemental-advisory-illicit-procurement-fentanyl-precursor.

[83] FinCEN Advisory, Supplemental Advisory on the Procurement of Precursor Chemicals and Manufacturing Equipment Used for the Synthesis of Illicit Fentanyl and Other Synthetic Opioids (June 20, 2024), https://www.fincen.gov/sites/default/files/advisory/2024-06-20/FinCEN-Supplemental-Advisory-on-Fentanyl-508C.pdf.

[84] Id.

[85] Id.

[86] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Reminds Financial Institutions to Remain Vigilant to Environmental Crimes (Apr. 22, 2024), https://www.fincen.gov/news/news-releases/fincen-reminds-financial-institutions-remain-vigilant-environmental-crimes.

[87] Id.

[88] Financial Threat Analysis: Illicit Finance Threat Involving Wildlife Trafficking and Related Trends in Bank Secrecy Act Data 1, 2 (Dec. 2021), https://www.fincen.gov/sites/default/files/2021-12/Financial_Threat_Analysis_IWT_FINAL%20508_122021.pdf.

[89] Id. at 2.

[90] Id. at 2 (citing Interpol & UNEP Strategic Report on Environment, Peace and Security: A Convergence of Threats 53-54 (Dec. 2016), https://www.interpol.int/en/content/download/5099/file/UNEP-INTERPOL). The Interpol & UNEP report notes that the illegal ivory trade alone nets Sub-Saharan militias with about 4 to 12 million dollars annually (p. 41). See generally Money Laundering and the Illegal Wildlife Trade, Financial Action Task Force (Jun. 2020), https://www.fatf-gafi.org/media/fatf/documents/Money-laundering-and-illegal-wildlife-trade.pdf.

[91] James M. Inhofe National Defense Authorization Act for Fiscal Year 2023, Pub. L. No. 117-263, § 5943(d)(2), 136 Stat 2395, 3471-2 (2022).

[92] 16 U.S.C. § 7631(a)(8).

[93] Press Release, Fin. Crimes Enf’t Network, U.S. Dep’t of the Treasury, FinCEN Issues Analysis on Elder Financial Exploitation (Apr. 18, 2024), https://www.fincen.gov/news/news-releases/fincen-issues-analysis-elder-financial-exploitation [hereinafter, “EFE Release”].

[94] Financial Trend Analysis: Elder Financial Exploitation: Threat Pattern & Trend Information, June 2022 to June 2023 (Apr. 2024), https://www.fincen.gov/sites/default/files/shared/FTA_Elder_Financial_Exploitation_508Final.pdf.

[95] Id.

[96] Id. at 5.

[97] EFE Release, supra, note 89.

[98] Financial Trend Analysis: Use of Convertible Virtual Currency for Suspected Online Child Sexual Exploitation and Human Trafficking: Threat Pattern & Trend Information, January 2020 to December 2021 (Feb. 2024), https://www.fincen.gov/sites/default/files/shared/FTA_Human_Trafficking_FINAL508.pdf.

[99] Id. at 2.

[100] Id. at 3.

[101] Id. at 7.

[102] Id. at 8.

[103] Press Release, Statement of FinCEN Director Andrea Gacki before the House Committee on Financial Services (Feb. 14, 2024), https://www.fincen.gov/news/testimony/statement-fincen-director-andrea-gacki-house-committee-financial-services.

[104] Press Release, U.S. Dep’t of Justice, Criminal Division Pilot Program On Voluntary Self-Disclosures For Individuals (Apr. 15, 2024), https://www.justice.gov/criminal/criminal-division-pilot-program-voluntary-self-disclosures-individuals.

[105] Memorandum, U.S. Dep’t of Justice, The Criminal Division’s Pilot Program on Voluntary Self-Disclosures for Individuals 2–3 (Apr. 15, 2024), https://www.justice.gov/criminal/media/1347991/dl?inline.

[106] Id. at 2.

[107] Id.

[108] Id. at 2–3.

[109] Id. at 3.

[110] Id.

[111] Id.

[112] Id.

[113] Dep’t of Justice Corporate Whistleblower Awards Pilot Program (Aug. 1, 2024), https://www.justice.gov/criminal/media/1362321/dl?inline.

[114] Press Release, U.S. Dep’t of Justice, Prominent Global Cryptocurrency Exchange KuCoin And Two Of Its Founders Criminally Charged With Bank Secrecy Act AND Unlicensed Money Transmission Offenses (Mar. 26, 2024), https://www.justice.gov/usao-sdny/pr/prominent-global-cryptocurrency-exchange-kucoin-and-two-its-founders-criminally.

[115] Id.

[116] Id.

[117] Press Release, U.S. Dep’t of Justice, Global Cryptocurrency Exchange BitMEX Pleads Guilty to Bank Secrecy Act Offense (July 10, 2024), https://www.justice.gov/usao-sdny/pr/global-cryptocurrency-exchange-bitmex-pleads-guilty-bank-secrecy-act-offense.

[118] Id.

[119] Id.

[120] Press Release, U.S. Dep’t of Justice, Anti-Money Laundering Specialist Pleads Guilty to Willful Failure to Implement Anti-Money Laundering Controls (Jan. 31, 2024), https://www.justice.gov/usao-edny/pr/anti-money-laundering-specialist-pleads-guilty-willful-failure-implement-anti-money.

[121] Id.

[122] Press Release, U.S. Dep’t of the Treasury, FinCEN, FinCEN Assesses $100,000 Civil Money Penalty against Gyanendra Kumar Are for Violations of the Bank Secrecy Act (Jan. 31, 2024), https://www.fincen.gov/news/news-releases/fincen-assesses-100000-civil-money-penalty-against-gyanendra-kumar-asre.

[123] Press Release, U.S. Dep’t of Justice, Former Banking Executive Pleads Guilty to Evading Anti-Money Laundering Regulations (Jan. 17, 2024), https://www.justice.gov/opa/pr/former-banking-executive-pleads-guilty-evading-anti-money-laundering-regulations.

[124] United States v. Lacey, No. CR-18-00422-001-PHX-DJH (D. Ariz. Apr. 23, 2024).

[125] Press Release, U.S. Dep’t of Justice, Backpage Principals Convicted of $500M Prostitution Promotion Scheme (Nov. 17, 2023), https://www.justice.gov/opa/pr/backpage-principals-convicted-500m-prostitution-promotion-scheme.

[126] 18 U.S.C. § 1957; see also Criminal Resource Manual, 2101 (Money Laundering Overview), U.S. Dep’t of Justice, https://www.justice.gov/archives/jm/criminal-resource-manual-2101-money-laundering-overview (“Prosecutions under 18 U.S.C. § 1957 arise when the defendant knowingly conducts a monetary transaction in criminally derived property in an amount greater than $10,000, which is in fact proceeds of a specified unlawful activity.”).

[127] See Audrey Spensley, Untangling Laundered Funds: The Tracing Requirement Under 18 U.S.C. § 1957, 75 Stanford L.R. 1157, 1160 (2023).

[128] Lacey, No. CR-18-00422-001-PHX-DJH at 57.

[129] Id. (citing United States v. Rutgard, 116 F.3d 1270, 1292-93 (9th Cir. 1997)).

[130] Id. at 56 (The Ninth Circuit “rejects the presumption that proof that some criminally derived funds exist in an account means that a subsequent transfer of funds out of that account [automatically] involves those criminally derived funds.”); see also Spensley, supra, note 123, at 1173 (the Second, Third, and Eleventh Circuits, for instance, presume any transaction from a comingled account is tainted).

[131]Lacey, No. CR-18-00422-001-PHX-DJH at 57.

The following Gibson Dunn lawyers assisted in preparing this update: M. Kendall Day, Stephanie Brooker, Chris Jones, Ella Capone, and Ben Schlichting.

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

Anti-Money Laundering / Financial Institutions:
Stephanie Brooker – Washington, D.C. (+1 202.887.3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202.955.8220, [email protected])
Ella Alves Capone – Washington, D.C. (+1 202.887.3511, [email protected])
Chris Jones – Los Angeles (+1 213.229.7786, [email protected])

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

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

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

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

The U.S. government recently proposed rules to significantly expand export control restrictions on items used to perpetuate human rights abuses and to target military, intelligence, and related end users acting contrary to U.S. national security interests. The extensive nature of these proposed restrictions will require many companies to implement enhanced compliance programs.

On July 25, 2024, the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) and the U.S. Department of State announced three proposed rules to add new controls on specific items (including commodities, software, and technology), services, end uses, and end users. Collectively, these rules propose significant restrictions on the export of items to many new classes of foreign end users in over 40 countries (in certain cases); impose additional restraints on the ability of U.S. persons to support foreign military, intelligence, and security end users; create new restrictions on facial recognition technology; and expand and refine the definition of “defense services” under the U.S. International Traffic in Arms Regulations (ITAR) to address concerns emanating from military, intelligence, and related end users, as well as to combat the use of certain items in perpetuating human rights abuses.

These proposed rules—published as three separate notices in the Federal Register[1]—build upon existing restrictions and, in part, implement provisions of the National Defense Authorization Act for Fiscal Year 2023 calling for prohibitions on U.S. persons assisting foreign military, security, and intelligence services that threaten national security interests and/or are complicit in human rights abuses. The proposed rules present yet another example of the U.S.’s continued efforts “to put human rights at the center of [its] foreign policy”[2] as discussed in our recent client alert on the Export Controls and Human Rights Initiative Code of Conduct and 2023 Year-End Sanctions and Export Controls Update.

Importantly, the proposed rules do not immediately create any new obligations and may undergo additional changes following the public comment period, though companies should begin preparing now to enhance their compliance policies and procedures. Comments on the proposed rules can be submitted directly to the relevant agency/department or at Regulations.gov until September 27, 2024.

Below we outline key provisions of the proposed rules and the changes they will bring to the U.S. Export Administration Regulations (EAR) administered by BIS and the ITAR administered by the U.S. Department of State’s Directorate of Defense Trade Controls (DDTC).

I. Proposed Revisions to the EAR Targeting Prohibited End Users and End Uses

The EAR currently restricts the export, reexport, or transfer (in-country) of items falling within its jurisdiction intended for certain end users or intended for certain end uses. In certain instances, the EAR specifically identifies restricted parties on various lists, including, most prominently, the “Entity List.”[3] In recent years, BIS has expanded the number of lists to which parties may be named and has named certain parties to the Entity List with footnote-specific designations to impose additional restrictions. The number of disparate lists has led many in government and industry to call for a more streamlined approach. The proposed rules from BIS appear to, in part, address this concern while also expanding restrictions to a broader range of end users.

These expanded controls will likely pose particular diligence challenges for companies that utilize distributors or resellers or who otherwise sell their goods indirectly to various end users in the identified jurisdictions.

A. Revised and Expanded Restrictions on “Military End User” and “Military End Uses” (15 C.F.R. § 744.21)

The EAR currently prohibits the export, reexport, or transfer of certain items subject to the EAR to Burma/Myanmar, Cambodia, China, Nicaragua, or Venezuela whenever the exporting party has “knowledge”[4] that the item is intended, entirely or in part, for “military end users” or for “military end uses” without a license from BIS.[5] Such military end user and end use restrictions apply to all items subject to the EAR when intended for such end users/end uses in Russia or Belarus (and to certain specifically-named Russian/Belarusian entities located outside of Russia or Belarus).

The proposed rules would dramatically expand these prohibitions to all items subject to the EAR (including lower-controlled EAR99 items) and to all countries specified in Country Group D:5[6] and Macau whenever the party has “knowledge” that the item is intended, in whole or in part, for a “military end user” or “military end use,” as the terms are newly defined. Additionally, BIS would no longer list military end users on the non-exhaustive Military End User (MEU) List currently included as Supplement 7 to Part 744. Rather, such entities would be added to the Entity List with either a footnote 3 (for Russia/Belarus military end users subject to additional restrictions) or footnote 5 designation (for all other military end users).

The definition of “military end users” would be redefined to focus specifically on traditional and non-traditional military actors. National police, government intelligence, and reconnaissance organizations included in the current definition of “military end users” would fall under other types of restricted end users outlined below. Specifically, the term “military end user,” as proposed, would include the “national armed services (army, navy, marine, air force, or coast guard), the national guard, or any person or entity performing the functions of a ‘military end user,’ including mercenaries, paramilitary, or irregular forces.” BIS makes clear that this definition is meant to include private companies and non-state actors that are akin to traditional armed forces.

Similarly, the definition of “military end use” would be modified slightly to apply to any item subject to the EAR (1) incorporated into a defense article described on the U.S. Munitions List (USML) outside of the United States, (2) incorporated into items classified under “600 series” Export Control Classification Numbers (ECCNs), or (3) that “supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, ‘development,’ or ‘production,’ of defense articles described on the USML,” or items classified under “600 series” ECCNs.[7] As written, these restrictions would extend to end uses involving defense articles and “600 series” foreign items that are not themselves subject to the EAR.

BIS will review related license applications with (1) a presumption of denial in connection with exports, reexports, or transfers to or within Burma/Myanmar, China, Cuba, Iran, Macau, Nicaragua, North Korea, Syria, and Venezuela and (2) under the license standard of review outlined in 15 C.F.R. § 746.8(b)(1) for Belarus and Russia—currently a policy of denial[8] for all items subject to the EAR, including for foreign-produced items subject to the EAR by application of the Russia/Belarus-Military End User Foreign Direct Product (FDP) rule. A case-by-case review policy will apply to all other destinations, consistent with the standards of review outlined in 22 C.F.R. § 126.1 of the ITAR.

B. New Restrictions on “Military-Support End Users” (15 C.F.R. § 744.22)

The proposed rules create a new type of restricted end user known as a “military-support end user” defined as “any person or entity whose actions or functions support ‘military end uses,’” as defined above. Entities that BIS proactively identifies as fulfilling this definition will be identified on the Entity List with a new footnote 6, though, importantly, this list is not exhaustive, and the restrictions apply even to entities not so designated. Specifically, parties will be prohibited from exporting, reexporting, or transferring any items subject to the EAR and specified on the Commerce Control List (CCL)—i.e., those items described by an ECCN—to all countries specified in Country Group D:5[9] and Macau whenever the party has “knowledge” that the item is intended, entirely or in part, for a “military-support end user” without first obtaining a license from BIS (unless authorized under License Exception GOV for certain U.S. government activities). Unlike the restrictions on military end users/end uses, however, the restriction targeting “military-support end users” does not apply to EAR99 items. Thus, companies supplying non-EAR99 items will need to ensure proper diligence is conducted on entities that are military-adjacent or that are included in military supply chains (e.g., contractors, raw material providers, manufacturers) in the relevant jurisdictions.

BIS will review license applications with (1) a presumption of denial in connection with exports, reexports, or transfers to or within Burma/Myanmar, China, Cuba, Iran, Macau, North Korea, Syria, and Venezuela and (2) under a policy of denial for Belarus and Russia (including for items covered by the Russia/Belarus-Military End User FDP rule). License applications for all other destinations will be reviewed on a case-by-case basis review policy, consistent with the standards of review outlined in 22 C.F.R. § 126.1 of the ITAR.

C. Revised and Expanded Restrictions on “Intelligence End Users” (15 C.F.R. § 744.24)

Since 2021, the EAR has restricted the export, report, or transfer of items intended for certain “military-intelligence end users” or for “military-intelligence end uses.” The due diligence required to verify whether certain end users/end uses meet these definitions has often proved difficult for industry, particularly in countries where the line between military intelligence and civilian government services is blurred. Likely in part to address this issue, the proposed rule drops the “military” qualifier from the new restrictions and instead expands the applicable restrictions to both military and civilian intelligence end users.

Like the restrictions targeting “military-support end users” described above, the proposed rule prohibits parties from exporting, reexporting, or transferring any items subject to the EAR and specified on the CCL (i.e., all non-EAR99 items that are subject to the EAR) whenever the party has “knowledge” that the item is intended, entirely or in part, for an “intelligence end user” without first obtaining a license from BIS (unless authorized under License Exception GOV for certain U.S. government activities). The new “intelligence end user” definition includes “foreign government intelligence, surveillance, or reconnaissance organizations or other entities performing functions on behalf of such organizations.” In the proposed rule, BIS makes clear the intended breadth of this restriction, noting that “entities performing intelligence functions such as planning and directing, processing and exploiting, analyzing and producing, disseminating and integrating, surveilling, and evaluating and providing feedback” would fall within the new definition. Entities meeting the proposed definition will be identified on the Entity List with a new footnote 7 designation, though BIS makes clear this list is not exhaustive, and the restrictions apply even to entities not so designated.

Unlike other types of restricted end users discussed previously, the geographic scope of the proposed “intelligence end user” restriction is much broader and includes “intelligence end users,” from over 40 destinations included in Country Group D or E, that are not also listed in Country Group A:5 or A:6, wherever such entities may be located.[10] For example, if an intelligence end user from China (a Country Group D country) were located in the United Kingdom (a Country Group A and B country), the restriction would still apply.

As with the restrictions targeting “military-support” end users, BIS will review license applications with a (1) presumption of denial in connection with exports, reexports, or transfers to or within Burma/Myanmar, China, Cuba, Iran, Macau, North Korea, Syria, and Venezuela and (2) under a policy of denial for Belarus and Russia (including for items covered by the Russia/Belarus-Military End User FDP rule). License applications for all other destinations will be reviewed on a case-by-case basis, consistent with the standards of review outlined in 22 C.F.R. § 126.1 of the ITAR.

D. New Restrictions on “Foreign-Security End Users” (15 C.F.R. § 744.25)

The proposed rules also create another new type of restricted end user known as a “foreign-security end user.” Parties would be prohibited from exporting, reexporting, or transferring any items subject to the EAR and specified on the CCL (i.e., all non-EAR99 items) to all countries specified in Country Group D:5 or E whenever the party has “knowledge” that the item is intended, entirely or in part, for a “foreign-security end user” without first obtaining a license from BIS or unless authorized under certain provisions of License Exception GOV (applicable to certain U.S. and NATO activities). “Foreign-security end users” are defined as:

Governmental and other entities with the authority to arrest, detain, monitor, search, or use force in furtherance of their official duties, including persons or entities at all levels of the government police and security services from the national headquarters or the Ministry level, down to all subordinate agencies/bureaus (e.g., municipal, provincial, regional);
Other persons or entities performing functions of a “foreign-security end user,” such as arrest, detention, monitoring, or search, and may include analytic and data centers (e.g., genomic data centers) forensic laboratories, jails, prisons, other detention facilities, labor camps, and reeducation facilities; or
Entities designated with a footnote 8 designation on the Entity List.

While not as open-ended as some other restricted party definitions, the proposed definition of “foreign-security end user” will require parties to transactions to conduct sufficient due diligence on the nature of any potential end user to determine if the new restrictions will apply, as the definition includes many entities (e.g., forensic labs, certain data centers) that may appear at first glance merely civilian oriented. BIS does, however, provide some helpful guidelines, adding in supplemental notes that the definition does not include “civilian emergency medical, firefighting, and search-and-rescue end users,” including in certain situations where such services are integrated into a single public safety department. Importantly, when any end user otherwise fulfills the definition of a “military end user,” the more restrictive “military end user” prohibitions described above will apply.

BIS proposes to use an approach grounded in human rights in reviewing license applications, stating that all such applications will be assessed according to “whether there is an unacceptable risk of use in human rights violations or abuses.” Cases posing such “unacceptable risk” will be subject to a policy of denial, though no additional information is provided for what metrics BIS will use to determine what constitutes “unacceptable.” Considering human rights in license review policies would not be a novel approach for BIS. In the context of items controlled for crime control purposes, BIS has historically treated license applications favorably “unless there is civil disorder in the country or region or unless there is a risk that the items will be used to violate or abuse human rights,” a restriction that is expressly designed “to deter human rights violations and abuses, distance the United States from such violations and abuses, and avoid contributing to civil disorder in a country or region.”[11] In October 2020, BIS explicitly expanded this licensing policy beyond items controlled for crime control reasons to include those items controlled for any other reason (except for short supply reasons).[12]

E. “As Informed” Provisions

Finally, each of the proposed restrictions either maintains or includes an “as informed” provision, whereby BIS may inform individual parties individually or through separate notice in the Federal Register that a license requirement applies to specific end users. Such provisions already exist in many parts of the EAR (including with respect to restrictions on the activities of U.S. persons discussed below) and allow BIS to move quickly in response to pressing national security concerns. In recent years, such provisions were used to restrict the flow of semiconductors and associated items to certain end users in China prior to the release of more detailed regulations.

F. Overview of Proposed End User and End Use Restrictions

Below we provide a chart outlining the end users and end use restrictions contained in the proposed rules.

Table 1:

End User/ End Use	Proposed Definition	Restricted Jurisdictions	Restricted Items	License Exceptions	License Review
Military End Use (15 C.F.R. § 744.21)	Incorporation occurring outside the United States into a defense article described on the USML; incorporation into items classified under ECCNs under ‘‘600 series’’ ECCNs; or any item that supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, ‘‘development,’’ or ‘‘production,’’ of defense articles described on the USML, or items classified under ECCNs under ‘‘600 series’’ ECCNs. See 15 C.F.R. § 772.1 for relevant definitions.	Occurs in, or the product of the “military end use” is destined to Macau or a country specified in Country Group D:5.	Any item subject to the EAR (including EAR99 items) wherever a party has “knowledge” of a restricted end use.	License Exception GOV (b)(2)	Presumption of Denial: Burma/Myanmar, China, Cuba, Iran, Macau, Nicaragua, North Korea, Syria, and Venezuela. Policy of Denial: Belarus and Russia (including items subject to the Russia/Belarus-Military End User FDP Rule). Case-by-case: All other destinations, consistent with § 126.1 of the ITAR.
Military End User (15 C.F.R. § 744.21)	National armed services (army, navy, marine, air force, or coast guard), the national guard, or any person or entity performing the functions of a “military end user,” including mercenaries, paramilitary, or irregular forces (including those designated with footnotes 3 or 5 on the Entity List).	Macau; Country Group D:5 destinations.	Any item subject to the EAR (including EAR99 items) wherever a party has “knowledge” of a restricted end user.	License Exception GOV (b)(2)	Presumption of Denial: Burma/Myanmar, China, Cuba, Iran, Macau, Nicaragua, North Korea, Syria, and Venezuela. Policy of Denial: Belarus and Russia (including items subject to the Russia/Belarus-Military End User FDP Rule). Case-by-case: All other destinations, consistent with § 126.1 of the ITAR.
Military-Support End User (15 C.F.R. § 744.22)	Any person or entity whose actions or functions support “military end uses” (including those designated with a footnote 6 on the Entity List).	Macau; Country Group D:5 destinations.	Any item subject to the EAR specified on the CCL wherever a party has “knowledge” of a restricted end user.	License Exception GOV (b)(2)	Presumption of Denial: Burma/Myanmar, China, Cuba, Iran, Macau, North Korea, Syria, and Venezuela. Policy of Denial: Belarus and Russia (including items subject to the Russia/Belarus-Military End User FDP Rule). Case-by-case: All other destinations, consistent with § 126.1 of the ITAR.
Intelligence End User (15 C.F.R. § 744.24)	Any foreign government intelligence, surveillance, or reconnaissance organizations or other entities performing functions on behalf of such organizations (including those designated with a footnote 7 on the Entity List).	Country Groups D and E, excluding Israel and Taiwan.	Any item subject to the EAR (including EAR99 items) wherever a party has “knowledge” of a restricted end user.	License Exception GOV (b)(2)	Presumption of Denial: Burma/Myanmar, China, Cuba, Iran, Macau, North Korea, Syria, and Venezuela. Policy of Denial: Belarus and Russia (including items subject to the Russia/Belarus-Military End User FDP Rule). Case-by-case: All other destinations, consistent with § 126.1 of the ITAR.
Foreign-Security End User (15 C.F.R. § 744.25)	Any of the following: (1) Governmental and other entities with the authority to arrest, detain, monitor, search, or use force in furtherance of their official duties, including persons or entities at all levels of the government police and security services from the national headquarters or the Ministry level, down to all subordinate agencies/bureaus (e.g., municipal, provincial, regional);* (2) Other persons or entities performing functions of a “foreign- security end user,” such as arrest, detention, monitoring, or search, and may include analytic and data centers (e.g., genomic data centers) forensic laboratories, jails, prisons, other detention facilities, labor camps, and reeducation facilities;* or (3) Entities designated with a footnote 8 on the Entity List. *Does not include civilian emergency medical, firefighting, and search-and-rescue end users.	Country Groups D:5 and E.	Any item subject to the EAR specified on the CCL wherever a party has “knowledge” of a restricted end user.	License Exception GOV (b)(2), (c)(2)	Case-by-case: All relevant destinations on the basis of whether there is an unacceptable risk of use in human rights violations or abuses, consistent with § 126.1 of the ITAR. Applications for transactions that would pose such an unacceptable risk will be reviewed with a presumption of denial.

II. Proposed Revisions to the EAR Restricting U.S. Persons “Support” for Activities Contrary to U.S. National Security Interests (15 C.F.R. § 744.6)

In addition to restricting the flow of items subject to U.S. jurisdiction, BIS has long restricted the ability of “U.S. persons”[13] to support activities contrary to U.S. national security interests, even in the absence of items subject to the EAR. The proposed rules aim to (1) clarify the types of “support” targeted by the current and proposed restrictions, (2) restrict the types of activities U.S. persons can provide to “military end users,” “intelligence end users,” and “foreign-security end users,” and (3) propose a new restriction on “military-production activities.”

Given the breadth of these new restrictions, many U.S. companies and non-U.S. companies with U.S. employees will likely need to expand and enhance their diligence efforts to better understand the nature of their end users, particularly in the case of companies that use a distributor or reseller model. For example, cloud service providers—such as infrastructure as a service (IaaS), platform as a service (PaaS), and software as a service (SaaS) providers—will need to carefully examine their due diligence procedures to ensure no U.S. persons are providing prohibited services or “support” to the restricted parties or otherwise related to the restricted activities outlined below, even when no items subject to the EAR are involved.

A. Revisions to Definition of “Support”

The EAR currently defines “support” is the context of U.S. person activities to include:

Shipping or transmitting from one foreign country to another foreign country any item not subject to the EAR a U.S. person knows will be used in or by any restricted end users or end uses as identified in 15 C.F.R. § 744.6(b)(1)-(5),[14] including the sending or taking of such item to or from foreign countries in any manner;
Transferring (in-country) any item not subject to the EAR a U.S. person knows will be used in or by any of the restricted end users or end uses as identified in 15 C.F.R. § 744.6(b)(1)-(5),
Facilitating such shipment, transmission, or transfer (in-country); or
Performing any contract, service, or employment a U.S. person knows may assist or benefit any of the restricted end users or end uses as identified in 15 C.F.R. § 744.6(b)(1)-(5), including, but not limited to: ordering, buying, removing, concealing, storing, using, selling, loaning, disposing, servicing, financing, transporting, freight forwarding, or conducting negotiations in furtherance of.[15]

The proposed rules would clarify and make explicit certain exclusions from these restrictions, consistent with BIS practice. Specifically, the proposed rules would exclude from the definition of “support” the following:

Activities involving items described in 15 C.F.R. § 734.3(b) that are deemed not subject to the EAR (e.g., items regulated by other U.S. government agencies, published informational materials, certain other published information and software);
Activities related to items enumerated on the USML (including services) subject to the ITAR;
Activities limited to administrative services, such as providing or arranging office space and equipment, hospitality, advertising, or clerical, visa, or translation services, collecting product and pricing information to prepare a response to a request for proposal, generally promoting company goodwill at trade shows, or activities by an attorney that are limited to the provision of legal advice (providing the U.S. person does not undertake such activities with “knowledge” that any items provided will support restricted end users or activities); and
Certain activities conducted for, on behalf of, or in connection with the U.S. Government.

Additionally, the proposed rules would exclude “commercial activities related to the movement of goods by common carriers,” but only for prohibitions targeting U.S. person activities involving “military end users,” “military-production activities,” “intelligence end users,” or “foreign-security end users,” as described in detail below.

B. Restrictions on U.S. Person Activities Involving Restricted End Users

Most prominently, BIS proposes restrictions on U.S. person activities to match those restrictions targeting certain end users discussed in Section I above. U.S. persons would be prohibited from providing support to “military end users,” “intelligence end users,” “foreign-security end users” and parties named to the Entity List with a footnote 6 designation (i.e., parties specifically designated as “military-support end users”).[16] Importantly, the prohibitions on U.S. person support apply even when no items subject to the EAR are involved (provided one of the exclusions discussed in the previous section do not apply). The same restrictions and licensing policies outlined in Table 1 above apply to the activities of U.S. persons when such activities involve the corresponding restricted end users.

C. Restrictions on Support for “Military-Production Activities”

U.S. persons are also restricted from supporting a new class of “military-production activities.” BIS defines “military production activities” to include (1) activities supporting incorporation into or (2) any other activity that supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, ‘‘development,’’ or ‘‘production’’[17] of the following types of items:

‘‘600 series’’ items, including foreign-origin items not subject to the EAR; or
Any other item that is either described on the CCL in other than a ‘‘600 series’’ ECCN, or designated EAR99, including foreign-origin items not subject to the EAR, when the U.S. person has knowledge that the item is ultimately destined to or for use by a “military end user.”

Notably, the restriction on supporting “military-production activities” includes services provided to private sector companies involved in military production such as contractors. Specific examples of covered activities provided by BIS in the relevant proposed rule include:

Assisting a defense contractor in a targeted country in producing an ECCN 0A606.a armored vehicle;
Assisting a defense contractor in a targeted country in installing an ECCN 8A002.g light system in an ECCN 8A620.a submersible vessel; and
Assisting an electronics company in a targeted country in developing ECCN 3A001 integrated circuits that have been ordered by the armed services of a targeted country.

Importantly, this restriction is only applicable to U.S. person activities that occur in or that result in a product intended for a country in country Group D:5 or Macau, thus tracking the same geographic scope as the restrictions targeting “military-support end users” discussed in Section I.

D. General Order 6 and Related Exclusions

In an attempt to clearly delineate between the parameters of the EAR and ITAR, the proposed rules include the addition of General Order 6 clarifying that the U.S. person restrictions of 15 C.F.R. § 744.6 do not restrict activities “when required for the performance of defense services subject to control under the ITAR” and authorized by DDTC. This provision is meant to eliminate perceived overlapping licensing requirements and to ensure that the relevant provisions of the EAR and ITAR work in concert to achieve national security priorities.

Relatedly, the “support” prohibitions discussed in 15 C.F.R. § 744.6 do not extend to the performance of official duties in furtherance of a U.S. Government program (including duties performed by “contract support personnel” in certain circumstances) and do not themselves prevent U.S. persons from serving in foreign military force or paramilitary organizations (though restrictions under other U.S. laws and regulations may apply).

III. Proposed Revisions to Control Facial Recognition Technology for Most Destinations

In addition to the end use / end user- and activity-based controls discussed above, BIS also proposes to add new item-based controls. The proposed rules would amend ECCN 3A981 on the CCL to specifically include “facial recognition systems.” Importantly, these controls would not apply to detection or authentication items (as opposed to identification items) or items that facilitate individual access to personal devices or facilities. Additionally, new corresponding software controls in ECCN 3D980 would apply to software ‘‘specially designed’’ for the ‘‘development,’’ ‘‘production’’ or ‘‘use’’ of commodities controlled by 3A980 and 3A981 and software “specially designed’’ for the “analysis and matching of voice, fingerprints, or facial features for facial recognition,” excluding software “solely for person or object detection or for individual authentication to facilitate individual access to personal devices or facilities.” These ECCNs, as well as ECCN 3E980 for corresponding technology, will remain controlled for crime control (column 1) purposes, thereby restricting the export, reexport, or transfer of such items to nearly all destinations other than certain European countries and U.S. allies (e.g., Australia, Canada, India, Japan, New Zealand, Türkiye, South Korea, and the United Kingdom). As with the restrictions discussed above, these new item-based controls reflect the U.S. government’s growing concern that many U.S. dual-use items are being exploited abroad to perpetrate human rights abuses.

IV. Proposed Revisions to the ITAR to Refine and Expand Definition of “Defense Services”

In conjunction with the EAR revisions discussed above, DDTC has similarly proposed revisions to the ITAR to (1) clarify and arguably expand the definition of “defense services” in 22 C.F.R. § 120.32 and (2) implement new controls over defense services related to intelligence assistance and foreign military assistance services that do not necessarily involve military articles.

A. Revised Definition of Defense Services

DDTC proposes to reorganize and revise the definition of “defense services” to explicitly include consulting activities and activities meant to disable or degrade defense articles, as well as to provide examples to clarify the intended breadth of the definition. Further, DDTC proposes to clarify that certain types of training and consulting provided to foreign persons—even in the absence of defense articles—are still restricted.

The proposed revised definition of “defense services” would include the following activities:

The furnishing of assistance, including training or consulting, to foreign persons in the development (including, e.g., design), production (including, e.g., engineering and manufacture), assembly, testing, repair, maintenance, modification, disabling, degradation, destruction, operation, processing, use, or demilitarization of a defense article; or
The furnishing of assistance, including training or consulting, to foreign persons, regardless of whether a defense article is involved, as described in USML Category IX(s)(2) or (3).

While DDTC frames these revisions as clarifications of existing coverage, parties should consider reviewing existing compliance policies to ensure alignment with the broad scope of activities that DDTC now explicitly considers “defense services.”

B. New Categories of Defense Services Added to Category IX of the USML (Military Training Equipment and Training)

The proposed rule also aims to replace existing controls on military training in USML Category IX(e)(3) with new controls under Category IX(s), which would correspond to the new definition of “defense services” and regulate certain military training activities even when no defense articles are involved. Category IX(s)(2) would specifically address intelligence assistance services that were provided for compensation. In the proposed rule, DDTC provides a non-exhaustive list of compensation types, including monetary payment, gifts, lodging, goods, services, political favors, and legislative or legal relief. DDTC notes the compensation requirement is explicitly meant to exclude from the new controls the activities of hobbyists or persons casually commenting on open-source, publicly available information (e.g., satellite imagery relevant to the invasion of Ukraine). Category IX(s)(3) would target military assistance services, even in the absence of defense articles. Both categories include exceptions as outlined in Table 2 below.

Table 2:

	Covered Activities	Exceptions
Proposed Category IX(s)(1)	Reserved for future regulations.	Reserved for future regulations.
Proposed Category IX(s)(2)	Assistance, including training or consulting, to a foreign government, unit, or force, or their proxy or agent, that creates, supports, or improves intelligence activities, including through planning, conducting, leading, providing analysis for, participating in, evaluating, or otherwise consulting on such activities, for compensation (unless an exception applies).	Furnishing of medical, translation, financial, insurance, legal, scheduling, or administrative services, or acting as a common carrier; Participation as a member of a regular military force of a foreign nation by a U.S. person who has been drafted into such a force; Training and advice that is entirely composed of general scientific, mathematical, or engineering principles commonly taught in schools, colleges, and universities; Information technology services that support ordinary business activities not specific to a particular business sector; Any lawfully authorized investigative, protective, or intelligence activity of a law enforcement or intelligence agency of the United States or of a territory, possession, State, or District of the United States, including political subdivisions thereof; or Maintenance or repair of a commodity or software.
Proposed Category IX(s)(3)	Assistance, including training or consulting, to a foreign government, unit, or force, or their proxy or agent, that creates, supports, or improves the following (unless an exception applies): The organization or formation of military or paramilitary forces; Military or paramilitary operations, by planning, leading, or evaluating such operations; or Military or paramilitary capabilities through advice or training, including formal or informal instruction.	Furnishing of medical, translation, financial, insurance, legal, scheduling, or administrative services, or acting as a common carrier; Participation as a member of a regular military force of a foreign nation by a U.S. person who has been drafted into such a force; Training and advice that is entirely composed of general scientific, mathematical, or engineering principles commonly taught in schools, colleges, and universities.

V. Looking Forward

The proposed rules represent significant changes to U.S. export controls under both the EAR and ITAR, and companies should begin preparing now to address forthcoming compliance responsibilities. Specific steps companies should consider taking include:

Provide Written Comments: As noted above, both BIS and the U.S. Department of State will accept written comments until September 27, 2024. Companies may provide comments directly to the relevant agency/department or at Regulations.gov.
Improve Human Rights Visibility and Awareness: As discussed in our prior client alert, companies should identify key personnel within their operations with responsibilities over human-rights related functions and engage with civil society to stay ahead of the enforcement curve.
Examine Restricted Party Screening Procedures: Companies should ensure they are adequately screening third parties (e.g., suppliers, distributors, customers) against all relevant restricted party lists to ensure prohibited transactions do not occur.
Review and Enhance End Party Due Diligence: In addition to conducting restricted party screening, companies will need to ensure transactions do not involve any categories of restricted end users or end uses, including entities not specifically named to the Entity List but that otherwise meet the requirements of restricted parties. In certain cases, companies may want to require End User Declarations from ultimate end users, as well as intermediate parties, to address diversion concerns.
Expand Scope of Due Diligence: Given the expanded geographic scope of the new end user and end use controls (in some cases to over 40 countries), companies will need to consider a greater number of jurisdictions for enhanced due diligence—especially for companies that utilize distributors or otherwise engage in indirect sales in these jurisdictions.
Update Compliance Terms in Transactional Documents: To address the proliferation of restricted end users and uses, companies may wish to revise contractual compliance terms, including to specifically require contracting parties to certify they are not providing items to restricted parties or for restricted end uses, provide for audit rights, and set forth consequences for non-compliance, including termination and indemnification. Companies should also educate their distributors and resellers on the new regulatory requirements and corresponding diligence required to remain compliant. Further, companies should consider requiring distributors and resellers to include similar compliance requirements in transaction agreements (i.e., “flow down” provisions) with downstream customers (e.g., end users, intermediate consignees).
Flag Sensitive Transactions: Companies should review and identify transactions that may involve prohibited end users and/or end uses or unauthorized defense services. Companies should proactively develop or update compliance plans to identify and prevent such restricted transactions. In some cases, companies may need to acquire licenses from BIS or DDTC before proceeding with certain transactions.
Establish Guardrails for U.S. Person Activities: Even when companies are not otherwise subject to U.S. export controls, restrictions can still apply to their U.S. person employees. Companies should identify any activities that may implicate such restrictions and establish clear policies and procedures to minimize the likelihood of any violations.

[1] See International Traffic in Arms Regulations: Revisions to Definition and Controls Related to Defense Services, 89 Fed. Reg. 60,980 (July 29, 2024); End-Use and End-User Based Export Controls, Including U.S. Persons Activities Controls: Military and Intelligence End Uses and End Users, 89 Fed. Reg. 60,985 (July 29, 2024); Export Administration Regulations: Crime Controls and Expansion/Update of U.S. Persons Controls, 89 Fed. Reb. 60,998 (July 29, 2024).

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

[3] See 15 C.F.R. § 744.16; 15 C.F.R. Part 744, Supplement No. 4.

[4] “Knowledge” is defined under the EAR to cover actual knowledge and an awareness of a high probability, which can be inferred from acts constituting willful blindness. See 15 C.F.R. § 772.1.

[5] In certain cases, items may also be exported for certain U.S. government activities as outlined in License Exception GOV. See 15 C.F.R. §§ 740.11, 744.21.

[6] Destinations listed in Country Group D:5 are those subject to a U.S. arms embargo and include Afghanistan, Belarus, Burma/Myanmar, Cambodia, Central African Republic, China, Cuba, Democratic Republic of Congo, Eritrea, Haiti, Iran, Iraq, North Korea, Lebanon, Libya, Nicaragua, Russia, Somalia, South Sudan, Sudan, Syria, Venezuela, and Zimbabwe. See 15 C.F.R. Part 740, Supplement No. 1.

[7] The terms “600 series,” “development,” and “production” are specifically defined in 15 C.F.R. § 772.1.

[8] While a “presumption of denial” licensing policy means that a license may be granted in rare circumstances, a “policy of denial” is slightly more restrictive and implies that a license will not be granted by BIS in nearly all circumstances.

[9] See supra note 6.

[10] Destinations listed in Country Group D or E include Afghanistan, Armenia, Azerbaijan, Bahrain, Belarus, Burma/Myanmar, Cambodia, Central African Republic, China, Democratic Republic of Congo, Cuba, Egypt, Eritrea, Georgia, Haiti, Iran, Iraq, Jordan, Kazakhstan, Kuwait, Kyrgyzstan, Laos, Lebanon, Libya, Macau, Moldova, Mongolia, Nicaragua, North Korea, Oman, Pakistan, Qatar, Russia, Saudi Arabia, Somalia, South Sudan, Sudan, Syria, Tajikistan, Turkmenistan, United Arab Emirates, Uzbekistan, Venezuela, Vietnam, Yemen, and Zimbabwe. See 15 C.F.R. Part 740, Supplement No. 1. Currently only Israel and Taiwan fulfill the exception as destinations also included in Country Group A:6.

[11] Amendment to Licensing Policy for Items Controlled for Crime Control Reasons, 85 Fed. Reg. 63,007, 63,009 (Oct. 6, 2020) (emphasis added).

[12] Id.

[13] “U.S. person” is broadly defined to include citizens, permanent residents, and protected individuals (e.g., asylees) in the United States; any entity organized in the United States, including foreign branches; and any person located in the United States. See 15 C.F.R. § 772.1.

[14] Currently, 15 C.F.R. § 744.6(b)(1)-(5) restricts certain U.S. person activities that provide “support” for nuclear explosive devices, “missiles,” chemical and biological weapons, certain chemical weapons precursors, “military-intelligence end users,” and “military-intelligence end uses.” More detailed “support” restrictions related to the “development” and “production” of advanced-node integrated circuits and related items and semiconductor manufacturing equipment are outlined in 15 C.F.R. § 744.6(c)(2)-(3).

[15] See 15 C.F.R. § 744.6(b)(6).

[16] Importantly, the prohibition on U.S. person activities in “support” of footnote 6 entities is limited to only those entities explicitly designated as such and applies only to the items specified in the designated party’s entry on the Entity List. In this manner, the restriction on U.S. person activities is narrower than the corresponding end user restrictions discussed in Section I above.

[17] See 15 C.F.R. § 772.1 for relevant definitions.

The following Gibson Dunn lawyers prepared this update: Mason Gauch, Hayley Lawrence, Chris Mullen, Stephenie Gosnell Handler, Adam M. Smith, Chris Timura, Samantha Sewall, Michelle Weinbaum, and David Wolber.

This edition of Gibson Dunn’s Federal Circuit Update for July 2024 summarizes the current status of petitions pending before the Supreme Court and recent Federal Circuit decisions concerning preliminary injunctions, contempt orders, issue preclusion, motions to amend before the Patent Trial and Appeal Board (Board), and the meaning of “publicly disclosed” under the America Invest Act (AIA).

Federal Circuit News

Noteworthy Petitions for a Writ of Certiorari:

There were no new potentially impactful petitions filed before the Supreme Court in July 2024. We provide an update below of the petitions pending before the Supreme Court that were summarized in our June 2024 update:

In United Therapeutics Corp. v. Liquidia Technologies, Inc. (US No. 23-1298), after the respondent waived its right to respond, a response was requested by the Court. The response will be due on August 28, 2024.

There were no new updates in Chestek PLLC v. Vidal (US No. 23-1217) and Cellect LLC v. Vidal (US No. 23-1231). In Chestek, the response brief is still due August 14, 2024, and five amicus curiae briefs have been filed. In Cellect, the response brief is still due August 21, 2024, and seven amicus curiae briefs have been filed.

Other Federal Circuit News:

Release of Materials in Judicial Investigation. The Federal Circuit released additional materials in connection with the proceeding under the Judicial Conduct and Disability Act and the implementing Rules involving Judge Pauline Newman. The materials may be accessed at the following links:

Upcoming Oral Argument Calendar

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

Key Case Summaries (July 2024)

Natera, Inc. v. NeoGenomics Laboratories, Inc., Nos. 24-1324, 24-1409 (Fed. Cir. July 12, 2024): Natera and NeoGenomics manufacture products used to detect circulating tumor DNA (ctDNA), the presence of which is called molecular residual disease (MRD), which can indicate cancer relapse. Natera sued NeoGenomics alleging that NeoGenomics’ product, RaDaR, infringed two of Natera’s patents relating to methods of amplifying targeted genetic material and for detecting variations in genetic material indicative of disease, such as ctDNA. Natera uses the claimed methods in its patents in its own Signatera product. Natera moved for a preliminary injunction, which the district court granted. The preliminary injunction barred NeoGenomics from making, using, selling, or offering for sale RaDaR, but carved out exceptions for patients already using RaDaR and for ongoing research projects, studies, and clinical trials.

The Federal Circuit (Moore, C.J., joined by Taranto and Chen, JJ.) affirmed the district court’s “carefully crafted” preliminary injunction. In particular, the Court concluded that the district court carefully considered the evidence before it in evaluating the irreparable harm to Natera, including that Natera and NeoGenomics directly compete in a two-player market for tumor-informed MRD testing products that would result in lost sales to Natera and harm to Natera’s market share. Because patients using MRD therapies require continuity of care, patients who begin using RaDaR will likely not switch to Signatera, which would not only cause Natera a loss of current sales, but also repeat business in the future. The Court also concluded that the district court did not err in concluding that the public interest weighs in favor of the injunction. Natera had the capacity to take on more patients and satisfy the demand for MRD tests. To avoid disruption to ongoing treatment and research, the district court did not enjoin use of RaDaR for existing patients and ongoing clinical trials and research projects.

Backertop Licensing LLC v. Canary Connect, Inc., No. 23-2367 (Fed. Cir. July 16, 2024): Lori LaPray is the sole owner of Backertop and is also the managing member of six other LLCs that have filed at least 97 patent infringement cases in the federal district courts. Backertop is seemingly associated with IP Edge (a patent monetization firm) and Maxevar (an affiliated consulting firm). The district court had concerns that IP Edge and Maxevar had perpetrated a fraud on the court by conveying patents to a shell LLC and filing false patent assignments with the USPTO to shield IP Edge and Maxevar from any potential liability they might face in asserting those patents in litigation. As a result, it ordered Ms. LaPray to disclose communications and documents relating to concerns regarding fraud on the court. Ms. LaPray produced several documents to the district court, but the district court had concerns regarding the legitimacy of the documents and set an in-person hearing to “assess her credibility.” Ms. LaPray refused to attend the hearing and did not attend a subsequent show cause hearing the district court set. The district court therefore found Ms. LaPray in civil contempt of court and imposed a fine of $200 per day until Ms. LaPray appeared in person in court.

The Federal Circuit (Hughes, J., joined by Prost and Stoll, JJ.) affirmed. Although civil contempt orders are generally interlocutory and non-appealable, the Federal Circuit determined that the law allowed Ms. LaPray, as the officer of Backertop and a non-party, to “immediately appeal the contempt order.” The Court then held that the district court’s order for Ms. LaPray to appear in person fell within the district court’s inherent powers. Contrary to Ms. LaPray’s arguments, the district court’s order did not conflict with Rule 45’s 100-mile requirement, which only applies to a party or attorney’s efforts to subpoena a person, and not to a court’s sua sponte order to appear. The Court also found the district court had not abused its discretion in ordering Ms. LaPray to appear in person and determined that it was an appropriate means by which to investigate potential misconduct by Backertop and potential fraud on the court by IP Edge and Maxevar.

Koss Corp. v. Bose Corp., Nos. 22-2090, 23-1173, 23-1179, 23-1180, 23-1191 (Fed. Cir. July 19, 2024): Koss sued Bose alleging infringement of patents directed to wireless earphone communication. Bose in turn petitioned for inter partes review (IPR) of Koss’s patent, and the district court litigation was stayed pending the IPRs. Koss now appeals the Board’s final written decisions. Separately, Koss also sued Plantronics for infringing its patents, including the same patents asserted against Bose, which proceeded in parallel with Bose’s IPRs. Plantronics moved to dismiss on grounds that all claims of the asserted patents were ineligible under 35 U.S.C. § 101. The district court granted the motion. Koss filed an amended complaint, and Plantronics again moved to dismiss the asserted claims as ineligible under Section 101. Before the district court could rule on the motion, Koss voluntarily stipulated to dismiss the case with prejudice, but did not ask the district court to vacate its earlier ruling holding that all claims were ineligible. The district court entered final judgment, and Koss did not appeal the Plantronics judgment. Bose then moved to dismiss these current appeals as moot because all claims had been determined to be ineligible.

The Federal Circuit (Hughes, J., joined by Stoll and Cunningham, JJ.) dismissed the appeals as moot. Koss argued that the district court’s ineligibility ruling in Plantronics became a nullity upon the filing of the amended complaint. The Federal Circuit determined this was incorrect, explaining that the ineligibility ruling became final and appealable when the district court entered final judgment after Koss stipulated to dismissal of its suit. As Koss chose not to appeal that judgment, there were no viable patent claims left to assert and no longer a live case or controversy, rendering the appeals moot.

ZyXEL Communications Corp. v. UNM Rainforest Innovations, Nos. 22-2220, 22-2250 (Fed. Cir. July 22, 2024): ZyXEL filed a petition for IPR of UNMRI’s patent directed to methods for constructing frame structures (organization of information transmitted across time and frequency) in orthogonal frequency-division multiple access (OFDMA) systems. ZyXEL contended that certain claims would have been obvious in view of the asserted prior art. UNMRI filed a contingent motion to amend and requested the Board’s preliminary guidance on its motion under the Board’s MTA Pilot Program. ZyXEL opposed the motion to amend, arguing that UNMRI had not complied with the regulation requiring it to identify written support for every claimed limitation in the substitute claims—not just the newly-claimed features—in its motion. In its preliminary guidance, the Board agreed and permitted UNMRI to file an extended reply brief addressing written description support and, correspondingly, allowed ZyXEL to respond in an extended sur-reply. The Board then granted UNMRI’s motion to amend to substitute its claims and determined that the substitute claims would not have been obvious.

The Federal Circuit (Dyk, J., joined by Prost and Stark, JJ.) affirmed-in-part, reversed-in-part, and remanded-in-part as to the appeal, and affirmed as to the cross-appeal. In particular, the Court affirmed the Board’s grant of the motion to amend. Specifically, the Court noted that the purpose of the MTA Pilot Program is to provide preliminary guidance and to allow the patentees to correct errors in its original motion. The MTA Pilot Program also allows a patentee to respond to the Board’s preliminary guidance in reply. Thus, the Court determined that the Board did not err in permitting UNMRI to use its reply brief to supplement the written description support that should have been, but was not, included in its original motion.

Sanho Corp. v. Kaijet Technology International Limited, Inc., No. 23-1336 (Fed. Cir. July 31, 2024): Kaijet petitioned for IPR of Sanho’s patent directed to a port extension apparatus for devices like laptops. The Board found all challenged claims unpatentable as obvious over prior art reference Kuo. Sanho contended that Kuo was not prior art because the inventor “publicly disclosed” the relevant subject matter of Kuo through the private sale of a device called the HyperDrive before Kuo’s priority date. The Board, however, concluded that the private sale was not a public disclosure, and therefore Kuo was prior art.

The Federal Circuit (Dyk, J., joined by Clevenger and Stoll, JJ.) affirmed. Section 102(b)(2)(B) provides that a “disclosure shall not be prior art” if “the subject matter disclosed had . . . been publicly disclosed by the inventor.” Sanho argued that a private sale should be considered a “disclosure” under the statute, and that the term “publicly disclosed” would necessarily include “disclosures,” such as private sales. The Court determined this interpretation was incorrect because “publicly disclosed” is not the same as “disclosed,” and the use of different phrases suggests Congress intended the phrases to have different meanings. Additionally, Section 102(b) was meant to provide protection for an inventor who publicly discloses his invention from later disclosures made by others, as public disclosure is a major objective for providing patent protection in the first place. Thus, the Court concluded that “publicly disclosed by the inventor” must require that the invention was made available to the public. As a result, the Court decided that Sanho’s private sale did not qualify as a public disclosure under Section 102(b)(2)(B), and thus the Board did not err in determining that Kuo was prior art.

The following Gibson Dunn lawyers assisted in preparing this update: Blaine Evanson, Audrey Yang, Vivian Lu, Julia Tabat, and Michelle Zhu.

Blaine H. Evanson – Orange County (+1 949.451.3805, [email protected])
Audrey Yang – Dallas (+1 214.698.3215, [email protected])

From the Derivatives Practice Group: The CFTC has approved a joint rule proposal to establish technical data reporting standards, and final rules permitting a foreign board of trade to provide direct access to its electronic trading and order matching system to an introducing broker.

New Developments

CFTC Approves a Joint Rule Proposal to Establish Technical Data Reporting Standards. On August 8, the CFTC voted to jointly propose and request public comment on the establishment of technical data reporting standards with other financial regulatory agencies. The proposal would establish uniform data standards for the collections of information reported to the CFTC, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, Federal Housing Finance Agency, Securities and Exchange Commission, and the Department of the Treasury. The proposal would also establish uniform data standards for data collected from these financial regulatory agencies on behalf of the Financial Stability Oversight Council. According to the CFTC, the proposed standards would promote interoperability of financial regulatory data across the financial regulatory agencies through the adoption of common identifiers for legal entities, financial instruments, and other data. In addition to proposing the use of common identifiers, the proposal would also further standardize the format and transmission of data to financial regulatory agencies. The CFTC explained that the proposed rule is part of the implementation of the Financial Data Transparency Act of 2022 (“FDTA”); although the CFTC is not specifically referenced in the FDTA, the Secretary of the Treasury designated the CFTC as a covered agency on May 3, 2024. Comments on the proposal are due 60 days following publication in the Federal Register. [NEW]
CFTC Exempts Additional Singapore Recognized Market Operators from SEF Registration Requirements. On August 2, the CFTC announced it unanimously approved an amended order that exempts two recognized market operators (“RMO”s) authorized within Singapore from CFTC swap execution facility (“SEF”) registration requirements. The exempted RMOs are FMX Securities (Singapore) Pte. Limited and LMAX Pte. Ltd. Section 5h(g) of the Commodity Exchange Act provides that the CFTC may grant such an exemption if it finds that a foreign SEF is subject to comparable, comprehensive supervision and regulation by the appropriate governmental authorities in the facility’s home country. Likewise, the CFTC may revoke exempt status when a facility is no longer authorized or in good standing in its home country. [NEW]
CFTC Approves Final Rule Allowing U.S. Introducing Brokers Direct Access to Registered Foreign Boards of Trade for the Submission of Customer Orders. On July 29, the CFTC announced it approved final rules amending Part 48 of its regulations. The final rules permit a foreign board of trade (“FBOT”), registered with the CFTC, to provide direct access to its electronic trading and order matching system to an introducing broker, located in the United States and registered with the CFTC, for the submission of customer orders to the FBOT’s trading system for execution. The final rules also establish a procedure for an FBOT to request revocation of its registration and remove certain outdated references to “existing no-action relief” in Part 48. [NEW]

New Developments Outside the U.S.

ESAs’ Joint Board of Appeal Dismisses Appeal by Euroins Insurance Group AD Against the European Insurance and Occupational Pensions Authority. On August 7, the Joint Board of Appeal (“the Board”) of the ESAs unanimously decided that the appeal brought by Euroins Insurance Group AD (“Euroins”) against the European Insurance and Occupational Pensions Authority (“EIOPA”) is inadmissible. In its decision, the Board found that EIOPA’s power to initiate an investigation is of an entirely discretionary nature. Furthermore, the Board also asserted that the EIOPA Chairperson’s decision to initiate an investigation is not subject to the Board’s review. Finally, the decision clarified that the Board does not have the power to order EIOPA to re-assess an appellant’s request to open an investigation. [NEW]
ESMA Publishes Data for Quarterly Bond Liquidity Assessment and the Systematic Internalizer Calculations. On August 1, ESMA published the new quarterly liquidity assessment of bonds and the data for the quarterly systematic internalizer calculations for equity, equity-like instruments, bonds and for other non-equity instruments under MiFID II and MiFIR. [NEW]
ESMA Delivers Opinion on Global Crypto Firms Using their non-EU Execution Venues. On July 31, ESMA issued an Opinion to address the risks presented by global crypto firms seeking authorization under the Markets in Crypto Assets (“MiCA”) Regulation for part of their activities (crypto brokerage) while keeping a substantial part of their group activities (intra-group execution venues) outside the European Union (“EU”) regulatory scope. The opinion calls for a case-by-case assessment, outlining the specific requirements that ESMA believes should be met regarding best execution, conflicts of interest, the obligation to act honestly, fairly, and professionally in the best interests of clients and the obligation relating to the custody and administration of crypto-assets on behalf of clients. [NEW]
The FCA Publishes Consultation Paper on the Derivatives Trading Obligation and Post-Trade Risk Reduction Services. On July 26, the Financial Conduct Authority (“FCA”) published a consultation paper on aspects of the derivatives trading obligation (“DTO”) as part of HM Treasury’s Wholesale Markets Review. The FCA is consulting on proposals to (1) include certain overnight index swaps based on the US Secured Overnight Financing Rate within the classes of derivatives subject to the DTO; (2) expand the list of post-trade risk reduction services exempted from the DTO and from other obligations; and (3) the FCA’s intention to use its power to suspend or modify the DTO once its transitional powers expire. The consultation closes on September 30, 2024. The FCA will publish a policy statement with final rules in Q4 2024. [NEW]
ESAs Publish Joint Final Report on the Draft Technical Standards on Subcontracting under DORA. On July 26, the European Supervisory Authorities published their joint Final Report on the draft Regulatory Technical Standards (“RTS”) specifying how to determine and assess the conditions for subcontracting information and communication technology (“ICT”) services that support critical or important functions under the Digital Operational Resilience Act (“DORA”). These RTS aim to enhance the digital operational resilience of the EU financial sector by strengthening the financial entities’ ICT risk management over the use of subcontracting.
ESMA Sets Out Its Long Term Vision on the Functioning of the Sustainable Finance Framework. On July 24, ESMA published an Opinion on the Sustainable Finance Regulatory Framework, setting out possible long-term improvements. ESMA considers that, in the longer-term, the Framework could further evolve to facilitate investors’ access to sustainable investments and support the effective functioning of the Sustainable Investment Value Chain. The opinion recommends several action items, including that all financial products should disclose some minimum basic sustainability information, covering environmental and social characteristics, and a product categorization system, based on a set of clear eligibility criteria and binding transparency obligations.

New Industry-Led Developments

ISDA Letter on FICC’s Proposed Rulebook Changes. On August 1, ISDA submitted a letter to the Securities and Exchange Commission in response to the Fixed Income Clearing Corporation’s (“FICC”) proposed changes to its Government Securities Division Rulebook in accordance with the Securities Exchange Act of 1934. The comment letter addresses FICC’s proposal to modify its trade submission rules in relation to mandatory clearing of certain US Treasury transactions. The proposed rule changes: (i) adopt a requirement that each netting member must submit all eligible secondary market transactions to which it is a counterparty to FICC for clearance and settlement; (ii) adopt new initial and ongoing membership requirements and other measures to facilitate FICC’s ability to monitor a netting member’s compliance with the trade submission requirement; (iii) adopt disciplinary measures to address a netting member’s failure to comply with the trade submission requirement; and (iv) modify the FICC rules to facilitate the trade submission requirement. [NEW]
Joint Association Letter on CFTC Block Thresholds and Cap Sizes. On July 29, ISDA, the Securities Industry and Financial Markets Association, the Securities Industry and Financial Markets Association Asset Management Group, the American Council of Life Insurers and the Investment Company Institute sent a letter to the CFTC requesting a public forum be provided to continue to evaluate the methodology for calculating the block thresholds and cap sizes under Part 43 of the CFTC’s regulations. [NEW]

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

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

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

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

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

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

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

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

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

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

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

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

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

We are pleased to provide you with the July 2024 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 Sues Consensys over MetaMask
On June 28, the SEC sued Consensys Software Inc. (an Ethereum software provider) over its MetaMask cryptocurrency wallet, which is the most used wallet on Ethereum. The SEC alleged that MetaMask is an unregistered broker because it permits users to buy and sell digital assets directly in-app. Additionally, the SEC alleged that Consensys has offered and sold unregistered securities through its staking service, which provides consumers with “liquid staking tokens” via third-party providers Lido and Rocket Pool, in exchange for depositing assets to secure the Ethereum blockchain. Soon after filing this enforcement action, the SEC moved to dismiss or transfer the declaratory judgment action that Consensys previously filed against the SEC in Texas. SEC Press Release; CoinDesk; The Block; Law360.
SEC Drops Hiro And Stacks Investigation
On July 12, the SEC dropped its investigation of Hiro, formerly known as Blockstack, which launched Stacks—a Bitcoin layer-2 blockchain. Early on, Blockstack treated its tokens as securities and attempted to register them through various exemptions. In 2021, Hiro launched a new consensus mechanism and concluded that the network had become so decentralized that its coin no longer constituted a security. The SEC then began a three-year investigation of Hiro. The SEC has now closed that investigation, with SEC staff stating in a letter that they do “not intend to recommend an enforcement action by the SEC.” SEC 1; SEC 2; CoinDesk; CoinTelegraph; The Block.
FTX and CFTC Reach $12.7 Billion Settlement
On July 12, following months of negotiations, FTX and the U.S. Commodity Futures Trading Commission (CFTC) agreed to a $12.7 billion settlement, pending approval from the U.S. Bankruptcy Court for the District of Delaware. The CFTC filed suit against FTX, its former CEO Sam Bankman-Fried, and its sister company Alameda Research in December 2022, alleging that they made misrepresentations by marketing FTX.com as a digital commodity asset platform. According to the July 12 filing, the proposed settlement “resolves ongoing litigation and disputes with one of the largest creditors of the Debtors, avoids the cost and delay of further litigation, and mitigates a significant risk of diminution of the assets available for distribution to creditors.” The settlement agreement is divided into $8.7 billion in restitution and $4 billion in disgorgement. As part of the settlement agreement, the CFTC has also agreed to forgo pursuing a civil monetary penalty against FTX, prioritizing the payment of FTX’s creditors. TheBlock; Cointelegraph.
Two Former FTX Executives and Cooperators in Bankman-Fried Case Will Be Sentenced in the Fall
On July 9, U.S. District Judge Lewis A. Kaplan scheduled an October 30, 2024 sentencing hearing for Nishad Singh, a former engineering director at the now-defunct crypto exchange FTX, and set a November 20, 2024 hearing for Zixiao “Gary” Wang, who co-founded FTX with Sam Bankman-Fried. Singh and Wang were among the first to plead guilty to charges related to their roles in the collapse of FTX, and both testified for the government at the 2023 trial of Bankman-Fried. A sentencing date has not been set for Caroline Ellison, the former CEO of Alameda Research who also pleaded guilty and testified against Bankman-Fried. The Block; Law360; Cointelegraph.
BitMEX Pleads Guilty to Violating the Bank Secrecy Act
On July 10, cryptocurrency exchange and derivative trading platform BitMEX pleaded guilty in the Southern District of New York to a charge alleging the exchange violated the Bank Secrecy Act by willfully failing to maintain adequate anti-money laundering and customer identification programs between September 2015 and September 2020. BitMEX’s co-founders previously pleaded guilty to similar charges. The exchange will be sentenced on October 7, 2024 before U.S. District Judge John Koeltl. DOJ Press Release; Law360; CoinDesk.
Hydrogen Technology Executives Sentenced to Prison for Price Manipulation
On June 25, the CEO of Hydrogen Technology was sentenced to two years and 11 months in prison and the Head of Financial Engineering was sentenced to three years and nine months in prison for their involvement in manipulating the price of the company’s cryptocurrency, HYDRO, through wash trades and spoofing. According to the DOJ, the case marked the first time a federal jury found that a cryptocurrency was a security and that manipulating cryptocurrency prices was securities fraud. DOJ Press Release; CoinDesk .
Silvergate Bank Settles Charges with Federal and California Regulators
On July 1, Silvergate Capital Corporation, the parent of the crypto-friendly Silvergate Bank, agreed to pay $63 million to settle charges from the SEC, Federal Reserve, and the California Department of Financial Protection and Innovation. Silvergate Bank liquidated in 2023 following a run on deposits. Regulators sued Silvergate, alleging the bank misled the public and failed to implement adequate anti-money laundering programs. CoinDesk; The Block; Cointelegraph.
Paxful Co-Founder Pleads Guilty to Anti-Money Laundering Charge
On July 8, Artur Schaback, co-founder of peer-to-peer crypto trading platform Paxful pleaded guilty to one count of conspiracy to willfully fail to establish, develop, implement, and maintain an effective anti-money laundering program under the Bank Secrecy Act. The government alleged that between 2015 and 2019 Schaback operated a virtual currency platform without collecting sufficient know-your-customer data, failed to implement appropriate anti-money laundering policies, and did not file any suspicious activity reports despite knowing that the platform’s users were participating in criminal activities. Schaback is scheduled to be sentenced on November 4 and faces a potential maximum penalty of five years in prison. Additionally, as part of the plea agreement, Schaback will pay a $5 million fine and step down from Paxful’s board of directors. Plea Agreement; GIR; Coinspeaker.
Guo Wengui Convicted in U.S. in $1 Billion Fraud SchemeOn July 16, Guo Wengui (AKA Miles Guo), self-exiled Chinese billionaire and businessman, was convicted by a New York jury on several counts, including racketeering conspiracy, wire fraud, and money laundering, for soliciting investments in various entities through false statements and representations to hundreds of thousands of his online followers. Guo was previously arrested in March 2023 on suspicion of orchestrating a more than $1 billion fraud conspiracy that involved cryptocurrency. According to the DOJ following his arrest, Guo obtained more than $262 million in victim funds through the Himalaya Exchange, a purported cryptocurrency ecosystem. Guo’s sentencing has been scheduled for November 19. TheBlock; USAO Statement; BBC.
Abra Settles with 25 States for Unlicensed Money TransmissionOn June 26, Abra, a cryptocurrency investing platform, and its CEO settled a collective action with 25 state financial regulators for operating the Abra App without the required state money transmitting licenses. Under the settlement agreement, Abra will return up to $82.1 million in cryptocurrency to U.S. customers in the settling states. Abra also agreed to stop “accepting virtual asset Allocations from U.S. Abra Trade Account customers” and to stop “making buying, selling, or trading cryptocurrencies available to U.S. Abra Trade customers.” Conference of State Bank Supervisors; Reuters; CoinDesk.

INTERNATIONAL

Crypto Payment Company Payeer Faces $10M Fine in Lithuania
On July 7, the Lithuanian Financial Crime Investigation Service (FNTT) imposed fines of 9.29 million euros (approximately $10 million USD) on crypto exchange and e-commerce payment service company Payeer, alleging the company violated anti-money laundering regulations and allowed customers to transfer money through sanctioned Russian banks. According to the FNTT’s announcement, the fines were the largest ever imposed on a virtual asset service provider in Lithuania. FNTT Press Release; Cointelegraph.

REGULATION AND LEGISLATION

UNITED STATES

New Crypto Bill Seeks to Permit Payment of Federal Income Tax in Bitcoin
On June 25, Rep. Matt Gaetz (R-FL) introduced a bill to Congress that would allow for federal income tax to be paid with Bitcoin. In a statement promoting the bill, Rep. Gaetz explained, “By enabling taxpayers to use Bitcoin for federal tax payments, we can promote innovation, increase efficiency, and offer more flexibility to American citizens.” In 2022, Colorado was the first state to approve cryptocurrency payments for state income taxes. The Hill; Forbes.
SEC Approves Ethereum ETFs
On July 22, the SEC approved the first Ethereum spot exchange-traded funds (ETFs), marking the second cryptocurrency to gain spot ETF approval after Bitcoin spot ETFs were approved in January 2024. Many in the industry believe that these approvals, combined with the SEC’s closure of its Ethereum 2.0 investigation, indicate that the agency does not believe Ether is a security. CoinDesk; The Block; Financial Times.
IRS Releases New Rules for Custodial Cryptocurrency Brokers
On June 28, the IRS released final regulations governing cryptocurrency brokers who take possession of the digital assets sold by their customers (including exchanges, hosted wallet services, and digital assets kiosks). The new rules require such cryptocurrency brokers to disclose the movements and gains of customers’ assets. The rules apply to transactions starting from January 1, 2025. Brokers will be required to track cost basis for assets starting in 2026. Notably, the IRS reserved addressing issues regarding non-custodial services (including self-hosted wallets) for a later rulemaking. IRS News Release; CoinDesk; Reuters.
Congress Does Not Override White House Veto of SEC Bill
On July 11, the House of Representatives voted on whether to override President Biden’s veto of legislation overturning Staff Accounting Bulletin No. 121—an SEC guidance document making it difficult for banks to hold custodial digital assets. Although a majority of the House voted to overturn the veto, the vote fell short of the required two-thirds threshold. The same day, it was reported that the SEC was granting exemptions from SAB121 to certain unidentified financial institutions. CoinDesk; White House; SEC; The Block.

INTERNATIONAL

First Phase of the EU’s MiCA Regulation Goes into Effect, Targeting Stablecoins
On June 30, the first phase of the Markets in Crypto-Assets Regulation (MiCA) took effect, focusing on stablecoins. MiCA was initially approved by the EU in April 2023 to provide a uniform framework for digital assets. The new laws permit only regulated stablecoins to be used within the bloc, causing some exchanges to begin delisting non-compliant stablecoins. Additionally, MiCA prohibits issuers from issuing more stablecoins within the bloc if the “estimated quarterly average number and average aggregate value of transactions per day associated to its uses as a means of exchange within a single currency area is higher than 1 million transactions and EUR 200 000 000, respectively.” MiCA implementation will be a gradual process, with regulations impacting digital asset service providers coming in December 2024. MiCA Full Text; The Block; Cointelegraph.
ESMA Publishes Second Final Report Under the Markets in Crypto-Assets Regulation
On July 4, the European Securities and Markets Authority (ESMA) published the second Final Report under MiCA “covering eight draft technical standards that aim to provide more transparency for retail investors, clarity for providers on the technical aspects of disclosure and record-keeping requirements, and data standards to facilitate supervision by National Competent Authorities (NCAs).” This final report includes draft technical standards including sustainability indicators for crypto-asset consensus mechanisms and business continuity measures for crypto-asset service providers. Once finalized, these draft technical standards will be submitted to the European Commission, which will decide whether to adopt them within three months. ESMA Press Release; Final Report.
EBA Extends Travel Guidelines for Crypto Exchanges
On July 6, in an effort to ramp up its anti-money laundering measures, the European Banking Authority (EBA) announced the extension of Travel Rules guidelines (Regulation (EU) 2023/1113) for crypto-asset service providers (CASPs) and their intermediaries. These guidelines, which requires exchanges to collect and transmit information on the sender, recipient, and transaction nature, will become mandatory for all crypto exchanges operating within the EU by December 30, 2024. These requirements include declaring the CASPs’ policies on multi-intermediation and cross-border transfers, collecting users’ information for the transfer of funds or crypto assets, and identifying whether transactions are related to the purchase of services. Once effective, CASPs and their intermediaries will be given a two-month compliance period. Cointelegraph; JD Supra; Cointribune.
Bolivia Lifts Ban on Crypto Payments
On June 26, the Banco Central de Bolivia, Bolivia’s Central Bank, lifted the country’s ban on cryptocurrency payments in a move to help boost Bolivia’s economy and align Bolivia with the crypto policies other Latin American countries. Financial institutions may now transact with digital assets, but the government does not recognize any digital assets as legal tender. Bolivia’s ban dates back to 2014. Banco Central de Bolivia’s X Announcement; Cointelegraph.
South Korea Enacts First Comprehensive Cryptocurrency Regulation
On July 19, South Korea’s new set of cryptocurrency regulations went into effect. The Virtual Asset User Protection Act (VAUPA), including the related enforcement decree approved on June 25, 2024, is the country’s first comprehensive cryptocurrency regulation. VAUPA requires that local crypto exchanges store 80% of user deposits in cold wallets protected from cyberattacks. These cold wallets must be held separately from operation funds and must generate a return of 1% to 1.5% interest. Exchanges must also conduct real-time monitoring for abnormal trading activity and must maintain either insurance or reserve funds to prepare for hacks or liquidity crises. Coinpedia 1; Coinpedia 2; Korean Financial Services Commission; CoinMarketCap; Cointelegraph.
Russia Approves New Crypto Laws
On July 30, Russia passed two crypto laws. The first law, effective November 1, 2024, legalizes crypto mining for registered entities and individuals, while unregistered persons may mine only if they do not exceed specified energy consumption limits. The second law, effective September 1, 2024, provides for an experimental regime granting the Bank of Russia “powers to allow authorized companies to conduct cross-border settlements and exchange trading in digital currency.” Companies need to apply to participate in the experimental regime. CoinDesk.
Taiwan Amends Anti-Money Laundering Laws to Cover Crypto
On July 16, the Legislative Yuan, Taiwan’s parliament, passed amendments to its anti-money laundering (AML) laws. Under the new AML laws, entities and individuals providing crypto services could face two years of imprisonment or a fine of up to NT $ 5 million if they fail to complete AML procedures and registration. The laws apply to any service provider that operates in Taiwan and mandates that overseas providers create local entities for registration compliance. The Block.

CIVIL LITIGATION

UNITED STATES

Coinbase-Backed Lawsuits Seek Documents from the SEC and FDIC
On June 27, History Associates Incorporated, a research firm retained by Coinbase, initiated suits against the SEC and FDIC for failure to comply with Freedom of Information Act (FOIA) requests. In 2023, History Associates, at Coinbase’s direction, submitted FOIA requests to the SEC for documents concerning three closed digital-asset-related investigations. History Associates separately submitted a FOIA request to the FDIC related to “pause letters” sent by the agency to financial institutions asking them to cease their crypto activities. Both agencies withheld documents claiming that they are covered by FOIA exemptions. Coinbase and History Associates seek a court order to compel the agencies to disclose the requested records. History Associates v. SEC; History Associates v. FDIC; The Block; CoinDesk; Cointelegraph.
Artists Sue SEC Seeking Clarity Over NFTs
On July 29, law professor Brian Frye and songwriter Jonathan Mann filed suit against the SEC and its five commissioners in the U.S. District Court in the Eastern District of Louisiana to determine whether NFTs fall under the agency’s jurisdiction and what steps artists must take when creating and selling NFTs. Both have NFT projects in progress and are seeking a declaratory judgment from the court. The SEC’s NFT enforcement actions generally have settled, so courts have rarely had an opportunity to consider whether NFTs may be securities. TheBlock; Cointelegraph.

SPEAKER’S CORNER

UNITED STATES

Senator Lummis’s Draft Bitcoin Bill Proposes U.S. Treasury Bitcoin Reserve
On July 27, at the Bitcoin Nashville conference, Sen. Cynthia Lummis (R-WY) announced her intention to propose a bill titled “Boosting Innovation, Technology, and Competitiveness through Optimized Investment Nationwide Act of 2024” (“BITCOIN Act of 2024”) that would establish a Bitcoin Purchase Program for the U.S. Treasury. According to a draft of the bill that was shared with CoinDesk on July 31, the Bitcoin Purchase Program would buy no more than 200,000 bitcoin a year over a five-year period. States could also voluntarily participate in storing bitcoin holdings as part of the reserve. Part of the proposed plan to fund this program relies on adjustments made to gold certificates, with Federal Reserve banks returning their existing gold certificates to the U.S. Treasury. TheBlock; CoinDesk; Crypto News.
CFTC Chairman Asserts Agency Is Ready to Take on Oversight of the Cryptocurrency Market
On July 10, U.S. Commodity Futures Trading Commission Chair Rostin Behnam testified before the Senate Agriculture Committee seeking to assure the Senate that his agency is ready to protect retail investors if it is given oversight of the digital-asset market. Although multiple lawmakers pointed out that much of the agency’s oversight concerns institutional-focused products, Benham asserted that the CFTC already has a wealth of experience protecting retail investors in crypto markets through the agency’s enforcement efforts. According to Behnam, more than half of the agency’s enforcement docket during the past fiscal year consisted of crypto cases, and a significant portion of the agency’s suits deal with alleged fraud of retail investors. Behnam estimated that the CFTC would need around $30 to 35 million in the first year and $50 to 60 million in the second to properly oversee cryptocurrency markets. Law360.

OTHER NOTABLE NEWS

U.S. Senate Annual Report Pushes Blockchain for National Security Applications
On July 9, the United States Senate Committee on Armed Services issued a report for the 2025 fiscal year, in part assessing the viability of utilizing blockchain technology for supply chain security and other national security uses. According to the report, “blockchain technology has the potential to enhance the cryptographic integrity of the defense supply chain, improve data integrity, and reduce the risk of the manipulation or corruption of certain types of data by near-peer competitors.” The committee also wants to explore blockchain use cases “to achieve national security goals and to create secure, transparent, accountable, and auditable data related to supply chains.” With these goals in mind, the report directed the U.S. Secretary of Defense to provide a briefing on this subject by April 1, 2025. Committee Report; Cointelegraph.
First Cross-Agency Fraud Disruption Conference Convened to Combat Crypto Scams
American citizens lose billions of dollars each year to such scams. On July 11, the Commodity Futures Trading Commission and the Department of Justice Computer Crime and Intellectual Property Section announced a first-of-its-kind interagency Fraud Disruption Conference, which will focus on efforts to combat “pig butchering” scams, a common type of scam in which a victim is induced to transfer large sums of money (usually cryptocurrency) to a scammer pretending to be a new friend or romantic partner. Other participants in the conference include the Federal Bureau of Investigations, the Secret Service, the Securities and Exchange Commission, the Social Security Administration, the Treasury, the Drug Enforcement Administration, the Postal Inspection Service, and several US Attorney’s offices. CFTC 1; CFTC 2.

The following Gibson Dunn lawyers contributed to this issue: Jason Cabral, Kendall Day, Jeff Steiner, Sara Weed, Chris Jones, Jay Minga, Nick Harper, Justin Fishman, Tin Le, and Cody Wong.