Publications Archives

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:

America First Legal (AFL), the conservative organization founded and run by former Trump policy advisor Stephen Miller, announced two new actions targeting DEI policies. On March 27, the organization sent a letter to The Walt Disney Company’s CEO Bob Iger, Board of Directors, and management, alleging breaches of fiduciary duty and violations of federal securities laws. AFL claims that Disney’s internal DEI policies and certain diversity-related content in Disney’s children’s streaming programming have contributed to a nearly 40% decline in the company’s market capitalization. AFL has asked Disney to immediately cease and desist from all employment and contracting practices that may discriminate on the basis of race, color, sex, or national origin; disclose the risks associated with its DEI practices and policies in its Form 10-K and proxy statements; and retain an independent counsel for a full investigation of the company’s hiring, promotion, recruitment, and purchasing practices. Two days later, on March 29, AFL released internal research alleging that the Bill and Melinda Gates Foundation is funding DEI programs, highlighting donations made by the Gates Foundation to the Inland Empire Community Foundation’s Black Equity Fund, the Indian American Impact Project, and the Equity in Education Coalition, among others. Miller said in a statement that “these foundation gifts appear to be funding extreme activists and programs that promote illegal racial discrimination against whites and other groups, radically undermine public safety, and foment dangerous anti-cop extremism.” AFL demanded an “explanation and accounting” from the Foundation.

On March 25, the Equal Protection Project of the Legal Insurrection Foundation (EPP), a conservative non-profit organization, filed a complaint with the Department of Education’s Office for Civil Rights (DOE) alleging that the George Floyd Memorial Scholarship at Minnesota’s North Central University violates Title VI of the Civil Rights Act. The scholarship, a four-year, full-tuition award, is granted to one undergraduate Black student based on community recommendations and a written essay. EPP contends that the scholarship discriminates against non-Black students by excluding them from consideration. This complaint follows EPP’s January 22nd complaint against the University of Wisconsin-Madison regarding its Creando Comunidad: Community Engaged BIPOC Fellows program. That scholarship program requires applicants to be a “member of a historically underrepresented racial or ethnic group or community.” EPP alleges that UW’s active promotion of the program violates the Equal Protection Clause of the Fourteenth Amendment and Title VI of the Civil Rights Act. The same day that EPP filed its complaint against North Central University, DOE confirmed it is investigating UW’s program.

On March 21, Idaho Governor Brad Little (R) signed into law Senate Bill 1274, which restricts the use of diversity statements by colleges and universities. The law prohibits public postsecondary institutions from requiring candidates for employment or admission to submit or ascribe to any “diversity statement,” defined broadly to include written or oral statements relating to “race, sex, color, ethnicity, or sexual orientation,” views on DEI and social justice, or experiences working with others of diverse backgrounds. The law also prohibits institutions from requiring or soliciting diversity statements in any contract renewal or promotion process “or as a condition of participation in any administrative or decision-making function of the institution.” The law does not bar students from voluntarily submitting information that would fall under the definition of a diversity statement. Because the law states that it is responsive to an “emergency,” it takes effect on July 1, 2024.

On March 6, the Congressional Black Caucus, chaired by Representative Steven Horsford (D-Nev.), issued a letter to Attorney General Merrick Garland, calling for the Department of Justice to “examine the lawfulness of states acting to dismantle the Diversity, Equity, and Inclusion (DEI) programs at American institutions of higher learning.” The letter emphasizes the historical importance of civil rights laws in promoting the growth of diversity on college campuses, and notes that diverse college students continue to face ongoing challenges in obtaining equal access to higher education. The letter—which follows the recent moves by the University of Florida to eliminate all of its DEI-related spending, Alabama Senate Bill 129 which limits DEI programs and teaching, and Texas Senate Bill 17 that eliminates DEI programs in state colleges—stresses that “Anti-DEI bills have been introduced in more than 30 states as of February 29, 2024.” The letter contends that because these university systems are recipients of federal funding, their anti-DEI actions constitute potential violations of federal anti discrimination laws codified in Title VI and Title IX of the Civil Rights Act of 1964.

Media Coverage and Commentary:

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

Axios, “‘The backlash is real’: Behind DEI’s rise and fall” (April 2): Emily Peck of Axios reports on the recent decline of corporate DEI programs over the past two years in the wake of widespread attacks from lawmakers and conservative activists. Peck suggests that some companies, which may have been less invested in DEI or more concerned about potential lawsuits, are using this moment to back away. Peck reports that these businesses are cutting back funding, trimming DEI staff, and considering limits to initiatives like employee resource groups based on workers’ races, ethnicities or interests. Conversely, according to Peck, companies that are continuing their DEI efforts are doing so quietly and altering their approach.
Bloomberg Law, “States Clash With First Amendment on DEI, Captive Audience Laws” (April 1): Bloomberg Law’s Chris Marr reports on the impact of recent state legislation on private companies’ approach to communications with their employees regarding diversity-related topics. Roughly a half-dozen states, including California and New York, have enacted statutes requiring diversity training, while courts in other states such as Michigan have found diversity training to be an implied part of employers’ obligations under state anti-discrimination laws. However, Marr opines that the First Amendment may be in tension with these diversity statutes, which may be construed as impermissibly requiring content-based communication. Marr also discusses instances where the courts have struck down conservative state legislation aimed at limiting diversity-related discussion in the workplace as a violation of employees’ free-speech rights, such as the Eleventh Circuit’s recent decision in Honeyfund.com, Inc. v. DeSantis, — F.4th —, 2024 WL 909379 (11th Cir. Mar. 4, 2024). Marr notes that states are poised to continue testing the bounds of when and how they can regulate workplace speech, setting up future courtroom clashes over the extent of employers’ First Amendment rights in protecting their communications with employees.
Law.com, “What’s in a Name? Group Urges Full 2nd Circuit to Scrap Rule Against Pseudonymity” (March 29): Avalon Zoppo of Law.com reports on the efforts of conservative nonprofit group Do No Harm to petition the U.S. Court of Appeals for the Second Circuit to scrap its new standing test requiring organizations to provide members’ names when seeking preliminary injunctions. In its petition for en banc review of the court’s recent decision in Do No Harm v. Pfizer, Inc., — F.4th —, 2024 WL 949506 (2d Cir. Mar. 6, 2024), Do No Harm argues that the rule will deter organizations from bringing lawsuits on behalf of individuals who may wish to remain anonymous due to fears of retaliation. Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group Jason Schwartz said the case could affect a recent influx of lawsuits against corporate diversity initiatives, where conservative groups have sued on behalf of anonymous members: “This is a super important threshold question for a lot of this new wave of lawsuits . . . If the court says you have to come forward with real live human beings, that’s going to change the wave of these cases in a material way.”
The Hill, “Texas AG Paxton probes Boeing supplier, takes aim at DEI practices” (March 29): The Hill’s Saul Elbein reports on Texas Attorney General Ken Paxton’s investigation of a major supplier to aerospace company Boeing, whose flagship 737 MAX aircraft has been linked to a series of deadly accidents since 2018. Paxton ordered the supplier, Spirit AeroSystems, to provide documents related to manufacturing defects that resulted in the grounding of numerous Boeing planes. Elbein reports that, as part of his request for information, Paxton also asked for information related to the company’s DEI policy and demanded the company substantiate its claim that a diverse workplace improves product quality, enhances performance, and/or helps Spirit make better decisions. Paxton reportedly also asked the company to explain how company-wide demographics for race, national origin, sexual orientation, and age have changed since 2022, when Spirit first adopted its DEI policy.
CNN, “University of Texas at Austin students say cultural programs are struggling to stay afloat in wake of anti-DEI law” (March 28): CNN’s Nicquel Terry Ellis reports on the impact of Texas SB17 on students at the University of Texas at Austin. Signed into law in 2023 by Texas Governor Greg Abbott, SB17 prohibits public colleges and universities in Texas from maintaining diversity, equity, and inclusion offices; hiring or assigning anyone to perform DEI office duties; giving preference to any job applicants or employees based on race, sex, color, ethnicity or national origin; or requiring anyone to complete DEI training. Ellis reports that, at UT Austin, the implementation of the law has caused cultural and identity groups on campus to struggle to find funding for events, meetings, and conferences previously sponsored by the school. According to Aaliyah Barlow, president of the University’s Black Student Alliance, the anti-DEI law makes marginalized communities feel unwanted on campus. However, UT Austin President Jay Hartzell emphasized that although the University will comply with the new law, it will not change the institution’s “commitment to attracting, supporting, and retaining exceptional talent across diverse backgrounds and perspectives.”
Wall Street Journal, “Government Changes How It Asks About Race and Ethnicity, Adds Middle Eastern” (March 28): The Wall Street Journal’s Paul Overberg and Michelle Hackman report on how, for the first time in 27 years, the U.S. government is changing the racial and ethnic categories used in the federal census and on other government forms. Under the new standard, respondents can now identify with more than one race, including American Indian or Alaska Native; Asian; Black or African-American; Hispanic or Latino; Middle Eastern or North African; Native Hawaiian or Pacific Islander; and white. Overberg and Hackman note that the change marks the first time that “Middle Eastern or North African” is included as its own category. Under the previous standard, individuals from these backgrounds were categorized as white.
CNN, “US House Office of Diversity and Inclusion to be disbanded as part of government spending bill” (March 25): Reporting for CNN, Nicquel Terry Ellis, Chandelis Duster, and Eva McKend cover the dissolution of the U.S. House of Representatives’ Office of Diversity and Inclusion as part of the spending bill that passed on March 22. The office, established in March 2020 with a mission to foster a congressional workforce reflective of the nation’s demographics, will be replaced by a newly-formed entity, the Office of Talent Management.

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:

Roberts & Freedom Truck Dispatch v. Progressive Preferred Ins. Co., et al., No. 23-cv-1597 (N.D. Oh. 2023): On August 16, 2023, plaintiffs represented by AFL sued defendants Progressive Insurance, Hello Alice, and Circular Board, Inc., alleging that the defendants’ grant program that awarded funding specifically to Black entrepreneurs to support their small businesses violated Section 1981.
- Latest update: On March 22, the plaintiffs filed a response to the defendants’ combined motion to dismiss, motion to stay and compel arbitration, and motion to transfer. On March 28, the Equal Protection Project of the Legal Insurrection Foundation (EPP) filed an amicus brief in support of the plaintiffs. EPP argued that the grant of the defendants’ motion would prevent civil rights groups from enforcing laws against civil rights violations by “carving out a massive loophole to characterize discriminatory conduct as protected speech.”
Am. Alliance for Equal Rights v. Zamanillo, No. 1:24-cv-509-JMC (D.D.C. 2024): On February 22, 2024, AAER filed a complaint and motion for a preliminary injunction against Jorge Zamanillo in his official capacity as the Director of the National Museum of the American Latino, part of the Smithsonian Institution. The complaint targets the Museum’s internship program, which aims to provide Latino, Latina, and Latinx undergraduates with training in non-curatorial art museum careers. AAER claimed that the program constitutes race discrimination in violation of the Fifth Amendment because the Museum allegedly considers the race of applicants in choosing interns and purportedly refuses to hire non-Latino applicants. AAER had asked for an injunction to prevent the Museum from closing the application window on April 1, or selecting interns for the program (currently scheduled to begin in late April).
- Latest update: On March 26, AAER filed a notice of settlement and stipulation of dismissal. In the settlement agreement, the Smithsonian agreed to add the following statement to the text of the scoring rubric before the application window for the undergraduate internship closes: “The Undergraduate Internship is equally open to students of all races and ethnicities. Reviewers should not give preference or restrict selection based on race or ethnicity.”
Bradley, et al. v. Gannett Co. Inc., 1:23-cv-01100 (E.D.V.A. 2023): On August 18, 2023, white plaintiffs sued Gannett over its alleged “Reverse Race Discrimination Policy,” claiming that Gannett’s expressed commitment to having its staff demographics reflect the communities it covers violates Section 1981. On November 24, 2023 Gannett moved to dismiss and to strike the plaintiffs’ class action allegations. On February 8, 2024, the plaintiffs moved for a preliminary injunction and for class certification. Gannett filed a motion to stay briefing on the plaintiffs’ motions pending a ruling on Gannett’s motion to dismiss, arguing that it may moot any need for class certification or a preliminary injunction.
- Latest update: On March 20, Gannett filed a notice of supplemental authority in support of its motion to dismiss, bringing the court’s attention to the recent Fourth Circuit opinion in Duvall v. Novant Health, Inc., No. 22-2142 (4th Cir. Mar. 12, 2024), which Gannett contends stands for the proposition that DEI programs are not per se unlawful, as long as they do not entail “a system wide decision making process” for employment based on DEI metrics.
Alexandre v. Amazon, Inc., No. 3:22-cv-1459 (S.D. Cal. 2022): White, Asian, and Native Hawaiian entrepreneur plaintiffs, on behalf of a putative class of past and future Amazon “delivery service partner” (DSP) program applicants, challenged a DEI program that provides $10,000 grants to qualifying delivery service providers who are “Black, Latinx, and Native American entrepreneurs.” The plaintiffs allege violations of California state civil rights laws prohibiting discrimination. On December 6, 2023, Amazon moved to dismiss, and the plaintiffs opposed the motion on February 16, 2024.
- Latest update: On March 20, Amazon filed a reply in support of its motion to dismiss, arguing that the plaintiffs lack standing because only a person who was already an Amazon DSP could suffer the injury of being denied a DSP diversity grant, and the plaintiffs are neither current DSPs nor applicants to become DSPs. Amazon further argued that the plaintiffs waived their claims under Section 1981 (because they did not respond to Amazon’s argument to dismiss that claim) and Section 51.5 of the Unruh Act (because they had already conceded that Section 51 does not apply). On March 26, 2024, the court announced that it would not hold oral argument on the motion.
Do No Harm v. Pfizer, No. 1:22-cv-07908 (S.D.N.Y. 2022), aff’d, No. 23-15 (2d Cir. 2023): On September 15, 2022, conservative medical advocacy organization Do No Harm filed suit against Pfizer, alleging that Pfizer discriminated against white and Asian students by excluding them from its Breakthrough Fellowship Program. To be eligible for the program, applicants must “[m]eet the program’s goals of increasing the pipeline for Black/African American, Latino/Hispanic and Native Americans.” Do No Harm alleged that the criteria violate Section 1981, Title VI of the Affordable Care Act, and multiple New York state laws banning racially discriminatory internships, training programs, and employment. In December 2022, the Southern District of New York dismissed the case for lack of subject matter jurisdiction, finding that Do No Harm did not have standing because it did not identify at least one member by name. On March 6, 2024, the United States Court of Appeals for the Second Circuit affirmed the district court’s dismissal, holding that an organization must name at least one affected member to establish Article III standing under the “clear language” of Supreme Court precedent.
- Latest update: On March 20, Do No Harm petitioned the court for a rehearing en banc, arguing that the panel’s opinion splits with at least two circuits and creates “an irreconcilable line of intracircuit precedent,” and predicting that the panel’s opinion would “deter associations from representing vulnerable members in court.” Do No Harm also moved to supplement the record on appeal with three additional anonymous declarations from potential applicants to the Pfizer Breakthrough Fellowship Program.

2. Employment discrimination and related claims:

Kascsak v. Expedia Inc., 1:23-cv-01373-DII (W.D. Tex. 2023): On November 9, 2023, a white man sued Expedia and a top executive for reverse discrimination in relation to the hiring process for a leadership role. The plaintiff claimed he was passed over in favor of a “diverse” candidate, a Black woman. The plaintiff claimed he was the victim of discrimination on the bases of race and sex in violation of Title VII, Section 1981, and the Texas Labor Code. On January 22, 2024, the defendants moved to dismiss, arguing that (1) the plaintiff lacked personal jurisdiction over the Expedia executive, and (2) the plaintiff failed to sufficiently plead a Section 1981 claim because race was not the sole but-for cause of the adverse hiring decision. The plaintiff opposed the motion on January 29, 2024, and the defendants replied on February 5.
- Latest update: On March 25, the court dismissed all claims against the individual executive defendant for lack of personal jurisdiction. The court denied the motion to dismiss as to Expedia, holding that Section 1981 permits claims where race is not the single but-for cause of an adverse contracting action.
Haltigan v. Drake, No. 5:23-cv-02437-EJD (N.D. Cal. 2023): A white male psychologist sued the University of California Santa Cruz, arguing that a requirement that prospective faculty candidates submit and be evaluated in part on the basis of statements explaining their views and understanding of DEI principles functioned as a loyalty oath that violated his First Amendment rights. The plaintiff claimed that because he is “committed to colorblindness and viewpoint diversity”––which he alleged was contrary to UC Santa Cruz’s position on DEI––he would be compelled to alter his political views to be a viable candidate for the position. The plaintiff sought a declaration that the University’s DEI statement requirement violated the First Amendment and a permanent injunction against the enforcement of the requirement. On January 12, 2024, the district court granted UC Santa Cruz’s motion to dismiss with leave to amend.
- Latest update: On March 1, the defendant moved to dismiss the plaintiff’s second amended complaint, arguing that the plaintiff lacks standing and failed to state claims of First Amendment viewpoint discrimination or compelled speech. On March 29, the plaintiff filed an opposition, arguing that he has standing because he was “as ready and able to apply [for the faculty position] as anyone could be.” The plaintiff also argued that the DEI statement is viewpoint discrimination because it is a “political litmus test,” and an unconstitutional condition rather than speech subject to Pickering balancing.

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

American Alliance for Equal Rights v. Ivey, No. 2:24-cv-00104-RAH-JTA (M.D. Ala. 2024): On February 13, 2024, AAER filed a complaint against Alabama Governor Kay Ivey, challenging a state law that requires Governor Ivey to ensure there are no fewer than two individuals “of a minority race” on the Alabama Real Estate Appraisers Board (AREAB). The AREAB consists of nine seats, including one for a member of the public with no real estate background (the at-large seat), which has been unfilled for years. Because there was only one minority member among the Board at the time of filing, AAER asserts that state law will require that the open seat go to a minority. AAER states that one of its members applied for this final seat, but was denied purely on the basis of race, in violation of the Equal Protection Clause of the Fourteenth Amendment.
- Latest update: On March 19, the district court denied AAER’s motion for a temporary restraining order/preliminary injunction. The court ordered AAER to confidentially disclose of the identity of Member A, the anonymous member of AAER who asserted an injury. It also ordered the parties to submit briefing, due in early April, on why Member A should be allowed to proceed anonymously in the case.

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

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

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

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

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

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

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

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

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

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

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

Factual Background

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[5] Id.

[6] Id. at *4.

[7] Id. at *5.

[8] Id. at *4.

[9] Id. at *6.

[10] Id. at *7.

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

[12] Id. at *6.

[13] Id.

[14] Id.

[15] Id.

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

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

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

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

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

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

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

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

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

Lennar Homes of Tex. Inc. v. Rafiei, No. 22-0830 – Decided April 5, 2024

In a unanimous per curiam opinion, the Texas Supreme Court held on Friday that when an arbitration agreement contains a clause delegating questions of arbitrability to the arbitrator, an unconscionability challenge must be supported with specific evidence showing that the cost of arbitrating any arbitrability issues is itself excessive. Because the plaintiff’s evidence went only to the overall costs of arbitration, the Court found no basis to conclude that the delegation clause was itself unconscionable.

“[T]he record fails to support a finding that the parties’ delegation clause is itself unconscionable due to prohibitive costs to adjudicate this threshold issue in arbitration.”

Per curiam

Background:

Rafiei bought a house from Lennar Homes. The purchase contract required the parties to submit their disputes to arbitration and delegated decisions about the arbitrability of disputes to the arbitrator. Rafiei later sued for personal injuries that he attributed to improper installation of a garbage disposal. Lennar moved to compel arbitration, and Rafiei opposed the motion, arguing that the agreement was unconscionable because arbitration was prohibitively expensive. In support of his unconscionability challenge, Rafiei submitted the AAA fee schedules and affidavits from himself and his attorney. The trial court denied Lennar’s motion, and the Fourteenth Court of Appeals affirmed.

Issue:

When an arbitration agreement delegates arbitrability issues to an arbitrator, may a court deny a motion to compel arbitration on unconscionability grounds absent evidence that the delegation provision is itself excessively costly?

Court’s Holdings:

No. “When an agreement delegates arbitrability issues to an arbitrator,” the only question for the court in an unconscionability challenge is whether the cost of arbitrating the “delegated threshold issue of unconscionability is excessive, standing alone.” Rafiei failed to “show that the delegation provision itself is unconscionable” as the supporting affidavits discussed only “the cost to arbitrate the overall dispute”—not “the cost to arbitrate the arbitrability question.” Nor did he present evidence of how the AAA fee schedule “would be applied to resolve the unconscionability challenge” itself. He also failed to establish that he could “afford litigation but not arbitration.” So the Court found no basis to set aside the delegation clause on unconscionability grounds. It refrained from deciding, however, whether the arbitration agreement as a whole was unconscionable because that issue was “reserved for the arbitrator.”

What It Means:

The Court continues to uphold the enforceability of arbitration agreements. When an agreement contains a delegation clause, a court’s inquiry on a motion to compel arbitration is “narrow.” Courts will order arbitration absent proof that the “delegation clause is itself unconscionable.”

Plaintiffs challenging arbitration agreements on unconscionability grounds face an uphill climb in Texas. They must adduce “specific evidence” showing (1) “the relevant costs between litigating in court and in arbitration”; and (2) their lack of “ability to pay the difference in such costs.” And if the agreement contains a delegation clause, plaintiffs must “estimate the actual costs associated with arbitrating the arbitrability question”—not the costs of the overall arbitration.

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 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, and Joseph Barakat.

Los Angeles partner James Zelenay and Denver associate José Madrid are the authors of “Supreme Court decisions and cyber-fraud focus drive record-setting FCA enforcement in 2023” [PDF] published by the Daily Journal on April 8, 2023.

From the Derivatives Practice Group: ISDA submitted responses to proposals from various bodies this week, both domestically and abroad.

New Developments

CFTC’s Energy and Environmental Markets Advisory Committee to Meet. The CFTC’s Energy and Environmental Markets Advisory (EEMAC) will hold a public meeting from 9:00 a.m. to 12:00 p.m. (CDT) on Wednesday, April 10 at the University of Missouri – Kansas City in Kansas City, Missouri. At this meeting, the EEMAC will continue its discussion on the federal prudential financial regulators’ proposed rules implementing Basel III and the implications for and impact on the derivatives market. There will also be presentations and discussions on the state of crude oil markets and the future of power markets. Finally, the two EEMAC subcommittees will offer updates on their continued work related to traditional energy infrastructure and metals markets.
CFTC’s Agricultural Advisory Committee to Meet. The CFTC’s Agricultural Advisory Committee (AAC) will hold a public meeting on April 11 from 9:30 a.m. to 11:00 a.m. (CDT) at the Sheraton Overland Park Hotel in Overland Park, Kansas. At this meeting, the AAC will discuss topics related to the agricultural economy and recent developments in the agricultural derivatives markets.
SEC Adopts Reforms Relating to Investment Advisers Operating Exclusively Through the Internet. On March 27, the SEC adopted amendments to the rule permitting certain internet investment advisers to register with the Commission (the “internet adviser exemption”). The amendments will require an investment adviser relying on the internet adviser exemption to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The amendments will also eliminate the current rule’s de minimis exception by requiring an internet investment adviser to provide advice to all of its clients exclusively through an operational interactive website and to make certain corresponding changes to Form ADV.
CFTC’s Market Risk Advisory Committee to Meet. The CFTC’s Market Risk Advisory Committee (MRAC) will meet on April 9 at 9:30 am ET. The MRAC will introduce recommendations, reports and presentations on current topics and developments, including an approach to manage the resilience, recovery or wind down of central counterparties, the implications of concentration risk in intermediation, the U.S. treasury cash-futures basis trade and risk-management considerations, a work plan for the integration of artificial intelligence in the markets; possible recommendations regarding efforts to manage climate-related market risks; and updates on the work of several workstreams on block implementation rules, post-trade risk reduction services, and margin transparency, margin procyclicality and margin calls.

New Developments Outside the U.S.

UK’s Accelerated Settlement Taskforce Publishes Report on the Path to T+1. On March 28, the UK’s Accelerated Settlement Taskforce published its report on the path to a T+1 settlement cycle. The report finds there is a clear consensus on the need for the UK to move to a T+1 settlement cycle and this shift will require substantial investment in greater automation and standardization. In addition, the report emphasizes a need for ongoing engagement with stakeholders during the transition period and the opportunity to learn from the U.S. move to T+1 in May 2024. The report recommends the immediate creation of a technical group to identify the challenges of transition and formulate solutions and suggests a two-step transition to T+1 before the end of 2027, with the exact date to be determined by the technical group. [NEW]
ESMA Clarifies Application of Certain MIFIR Provisions, Including Volume Cap. On March 27, the European Securities and Markets Authority (ESMA) published a statement, including practical guidance supporting the transition and the consistent application of the revised Markets in Financial Instruments Regulation (MiFIR).The statement covers guidance on equity transparency and non-equity transparency; the systematic internaliser (SIs) regime; designated publishing entities (DPEs); and reporting. Regarding the volume cap, following the publication by the European Commission, ESMA confirmsed that DVC data will continue to be published, with the next publication scheduled for early April.
ESMA Provides Market Participants with Guidance on the Clearing Obligation for Trading with 3rd Country Pension Schemes. On March 27, ESMA issued a public statement on deprioritizing supervisory actions linked to the clearing obligation for third-country pension scheme arrangements (TC PSA), pending the finalization of the review of EMIR. ESMA expects National Competent Authorities (NCAs) not to prioritize supervisory actions in relation to the clearing obligation for derivative transactions conducted with TC PSAs exempted from the clearing obligation under their third-country’s national law. Additionally, ESMA recommends that NCAs apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in this area in a proportionate manner. The Council and the European Parliament reached a provisional agreement on February 7. The political agreement on the EMIR 3 text provides for an exemption regime from the EMIR clearing obligation when the TC PSA is exempted from the clearing obligation under that third country’s national law.
ESMA Finalizes First Rules on Crypto-Asset Service Providers. On March 25, ESMA published the first Final Report under the Markets in Crypto-Assets Regulation (MiCA). ESMA stated that Tthe report, which aims to foster clarity and predictability, promote fair competition between crypto-asset service providers (CASPs) and a safer environment for investors across the Union, includes proposals on: (1) information required for the authorization of CASPs; (2) the information required where financial entities notify their intent to provide crypto-asset services; (3) information required for the assessment of intended acquisition of a qualifying holding in a CASP, and (4) how CASPs should address complaints.
ESMA Launches the Third Consultation Under MiCA. On March 25, ESMA published its third consultation package under the MiCA. In the consultation package, ESMA is seeking input on four sets of proposed rules and guidelines, covering: (1) detection and reporting of suspected market abuse in crypto-assets; (2) policies and procedures, including the rights of clients, for crypto-asset transfer services; (3) suitability requirements for certain crypto-asset services and format of the periodic statement for portfolio management; and (4) ICT operational resilience for certain entities under MiCA.
SGX Issues Consultation on Revised Limit on Clearing Members’ Liability for Multiple Defaults. On March 22, Singapore Exchange (SGX) issued a consultation paper proposing to refine the existing cap on a clearing member’s liability to meet default losses arising from multiple events of default. The cap is imposed on clearing members of Singapore Exchange Derivatives Clearing Limited (SGX-DC) and The Central Depository (Pte) Limited (CDP). The proposal purports to limit a non-defaulting clearing member’s liability to meet multiple default losses arising within a 30-day period to three times the aggregate of its funded and unfunded clearing fund contributions (prescribed contribution) as determined at the start of the 30-day period. The revised limit is intended to be independent of the clearing member’s resignation. SGX has also proposed changes to the SGX-DC clearing rules set out in Appendix B of the consultation. SGX is seeking views and comments on: (1) capping the limit for multiple defaults at three times a clearing member’s clearing fund contribution amount for all defaults occurring within a 30-day period; (2) the methodology for calculating the amount of a non-defaulting clearing member’s clearing fund contributions available to meet losses suffered by the SGX central counterparty arising from or in connection with an event of default (as set out in SGX-DC Clearing Rule 7A.06.9.2); and (3) the rule amendments to effect the proposed change. The consultation closes on April 24, 2024. [NEW]
SFC and HKMA Further Consult on Enhancements to Hong Kong’s OTC Derivatives Reporting Regime. On March 22, 2024, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) launched a joint-further consultation on enhancements to the over-the-counter (OTC) derivatives reporting regime in Hong Kong. This further consultation follows an earlier joint-consultation in April 2019, in which the SFC and HKMA proposed a requirement to identify transactions submitted to the Hong Kong Trade Repository (HKTR) for the reporting obligation by a Unique Transaction Identifier. The current joint-further consultation consults on the implementation of the Unique Transaction Identifier, together with the mandatory use of Unique Product Identifier and Critical Data Elements for submission of transactions to the HKTR. The Interested parties are encouraged to submit responses to the SFC or HKMA on the consultation by May 17, 2024.
ESMA Publishes Feedback on Shortening Settlement Cycle. On March 21, the ESMA published feedback received to its Call for Evidence on shortening the settlement cycle in the EU. According to ESMA’s report on the feedback, respondents focused on four areas: (1) many operational impacts, beyond adaptations of post-trade processes, were identified as the result of a reduction of the securities settlement cycle in the EU; (2) respondents identified a wide range of both potential costs and benefits of a shortened cycle, with some responses supporting a thorough impact assessment; (3) respondents provided suggestions around how and when a shorter settlement cycle could be achieved, with a strong demand for a clear signal from the regulatory front at the start of the work and clear coordination between regulators and the industry; and (4) stakeholders made clear the need for a proactive approach to adapt their own processes to the transition to T+1 in other jurisdictions. Additionally, according to ESMA, some responses warned about potential infringements due to the misalignment of the EU and North America settlement cycles.

New Industry-Led Developments

IOSCO Seeks Feedback on the Evolution of Market Structures and Proposed Good Practices. On April 4, the International Organization of Securities Commissions (IOSCO) published a consultation report on Evolution in the Operation, Governance and Business Models of Exchanges: Regulatory Implications and Good Practices. The consultation report analyzes the structural and organizational changes within exchanges, focusing on business models and ownership structures. It highlights a shift towards more competitive, cross-border, and diversified operations as exchanges integrate into larger corporate groups. The consultation report discusses regulatory considerations, particularly in the organization of individual exchanges and exchange groups and the supervision of multinational exchange groups. It addresses potential conflicts of interest arising from matrix structures and the challenges of overseeing individual exchanges within exchange groups. Additionally, it outlines a set of six proposed good practices for regulators to consider in the supervision of exchanges, particularly when they provide multiple services and/or are part of an exchange group. The good practices are also complemented by a non-exclusive list of supervisory tools used by IOSCO jurisdictions to address the issues under discussion, in the form of “toolkits”. While the Consultation Report focuses on equities listing trading venues, the findings are also relevant to other trading venues, including non-listing trading venues and derivatives trading venues. IOSCO is seeking input from market participants on the major trends and risks observed, and the proposed good practices on or before July 3, 2024. [NEW]
ISDA Submits Response to CFTC Proposed Operational Resilience Rules. On April 1, ISDA submitted comments on the CFTC’s notice of proposed rulemaking on requirements to establish an Operational Resilience Framework for Futures Commission Merchants, Swap Dealers and Major Swap Participants, which was published in the Federal Register on January 24, 2024. ISDA recommended that the CFTC adjust adjust portions of the proposed rules relating to governance, third-party relationships, incident notification and implementation period. [NEW]
ISDA Submits Response to IOSCO Consultation on Post-Trade Risk Reduction. On March 29, ISDA submitted a response to IOSCO consultation on post-trade risk reduction (PTRR) services. According to ISDA, PTRR services are intended to optimize bilateral and cleared derivatives portfolios to minimize the build-up of notional amounts and trade count, counterparty risk, and basis risk respectively, which in turn reduces systemic risk. ISDA stated that it is broadly supportive of IOSCO’s proposed sound practices. [NEW]
ISDA Submits Joint Response to PRA on Approach to Policy. On March 28, ISDA and the Association for Financial Markets in Europe (AFME) submitted a joint response to the Prudential Regulation Authority (PRA) consultation on its approach to policy. The associations highlighted the importance of considering UK market specificities in meeting the secondary competitiveness and growth objective, and in the implementation of international standards. The associations expressed support for the continuation of structured policy development in dialogue with the industry, while also advocating for the enhancement of the PRA’s stakeholder engagement by re-establishing standing groups and horizon risk scanning groups, and greater industry cooperation during the initiation phase of the policy cycle. ISDA highlighted certain other points in the response, including recommendations on clustering regulatory principles and suggested improvements to the cost-benefit analysis and data collection processes to achieve greater transparency. [NEW]
ISDA Submits Joint Response to BCBS Crypto Standard Amendments Consultation. On March 28, ISDA, with the Global Financial Markets Association, the Futures Industry Association, the Institute of International Finance and the Financial Services Forum, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on proposed crypto asset standard amendments. ISDA and the other trade associations stated that they welcome the BCBS’s continued focus on designing and improving the prudential framework for crypto assets. The key topics in the consultation response include public permissionless blockchains, classification condition 2 and settlement finality and Group 1b eligibility.
ISDA Responds to CFTC on Clearing Member Funds Protection. On March 18, ISDA responded to the CFTC’s consultation on proposed rules for the protection of clearing member funds held by derivatives clearing organizations (DCOs), including the assets of futures commission merchants (FCMs). According to ISDA, it proposed that the CFTC should finalize the enhanced protection for clearing member assets in connection with an intermediated DCO only, which includes multiple FCMs, unaffiliated with the DCO, as its members. Regarding a DCO providing direct clearing without multiple FCMs unaffiliated with the DCO, ISDA suggested the CFTC should wait to propose enhanced protection for clearing members’ assets, once a full assessment of the risks and complications associated with a DCO providing direct clearing has been completed. At which point, in ISDA’s opinion, it would be appropriate for the CFTC to propose a comprehensive framework to address these risks holistically. Otherwise, ISDA said, the current notice of proposed rulemaking would create a sense of safety for the disintermediated model, which is superficial due to the rule not creating a comprehensive safety regime for disintermediated central counterparties (CCPs), with many risks arising from such models being left unaddressed.
ISDA Responds to FASB on Induced Conversion of Convertible Debt. On March 18, ISDA submitted a response to the Financial Accounting Standards Board’s (FASB) exposure draft on File Reference No. 2023-ED600, Debt—Debt with Conversion and Other Options (Subtopic 470-20): Induced Conversions of Convertible Debt Instruments. ISDA indicated that it supports FASB’s proposals in the exposure draft and believes it achieves the objective of improving the application and relevance of the induced conversion guidance to cash convertible debt instruments.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Delaware Supreme Court announced that MFW remains the lodestar of earning the business judgment rule’s protections for all conflicted controller transactions, and a single conflict on a special committee can be fatal to those efforts.

On April 4, 2024, the Delaware Supreme Court issued its highly anticipated decision in In re Match Group, Inc. Derivative Litigation, — A.3d —, 2024 WL 1449815 (Del. Apr. 4, 2024), which we previewed in our 2023 Year-End Securities Litigation Update. The opinion includes two notable holdings.

First, the Court held that the entire fairness standard is the default standard of review applicable to all transactions with a controlling stockholder in which the controller receives a non-ratable benefit. For the transaction at issue, involving IAC/InterActiveCorp’s reverse spinoff from its controlled subsidiary March Group, Inc., the Court concluded that in order to invoke more deferential business judgment rule review, both requirements of Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) must be satisfied: review and approval by an independent and well-functioning special committee, and the informed approval of disinterested stockholders.

Second, the Court held that to satisfy the first MFW element, all members of the special committee reviewing and approving the transaction must be independent of the controller. The Court found that one committee member’s historical business ties with the controller were sufficient at the pleadings stage to compromise the member’s independence, and therefore cast “a reasonable doubt” on “the entire [s]eparation [c]ommittee’s independence.” The Court therefore reversed the Court of Chancery’s holding that MFW can be satisfied when a majority of a special committee’s members are independent of the controller.

Takeaways

This decision confirms the Delaware Supreme Court’s view of transactions involving a controlling stockholder and their potential for coerciveness. Because any transaction with a controlling stockholder from which the controller conceivably derives a non-ratable benefit presumptively will be reviewed under the entire fairness standard, careful attention and adherence to all aspects of the MFW framework is important to parties seeking to invoke its protections.

That is especially true after In re Match Group, Inc. with respect to the independence of special committee members. The Delaware Supreme Court’s holding expressly requires the independence of all members of a special committee, meaning that even a foot-fault in committee-member independence could subject a transaction to lengthy and expensive litigation. This was the case even though the Court of Chancery found that the conflicted special committee member “did not ‘infect’ or ‘dominate’ the separation committee process”—a finding that was unchallenged on appeal. Thus, even a rigorous, arms-length process alone will not be sufficient to invoke the protections of the business judgment rule at the pleadings stage if even one member lacks independence from a controlling stockholder.

Together, these holdings provide important clarity to parties undertaking transactions in which a conflicted controller is, or may be, present. In short, MFW remains the lodestar of earning the business judgment rule’s protections for all conflicted controller transactions, and a single conflict on a special committee can be fatal to those efforts.

The following Gibson Dunn lawyers participated in preparing this update: Monica K. Loseman, Brian M. Lutz, Colin B. Davis, Mark H. Mixon, Jr., Chase Weidner, and Dasha Dubinsky.

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

Christopher D. Belelieu – New York (+1 212.351.3801, [email protected])
Jefferson Bell – New York (+1 212.351.2395, [email protected])
Michael D. Celio – Palo Alto (+1 650.849.5326, [email protected])
Colin B. Davis – Orange County (+1 949.451.3993, [email protected])
Jonathan D. Fortney – New York (+1 212.351.2386, [email protected])
Monica K. Loseman – Co-Chair, Denver (+1 303.298.5784, [email protected])
Brian M. Lutz – Co-Chair, San Francisco (+1 415.393.8379, [email protected])
Mary Beth Maloney – New York (+1 212.351.2315, [email protected])
Jason J. Mendro – Washington, D.C. (+1 202.887.3726, [email protected])
Alex Mircheff – Los Angeles (+1 213.229.7307, [email protected])
Lissa M. Percopo – Washington, D.C. (+1 202.887.3770, [email protected])
Jessica Valenzuela – Palo Alto (+1 650.849.5282, [email protected])
Craig Varnen – Co-Chair, Los Angeles (+1 213.229.7922, [email protected])
Allison K. Kostecka – Denver (+1 303.298.5718, [email protected])
Mark H. Mixon, Jr. – New York (+1 212.351.2394, [email protected])

This edition of Gibson Dunn’s Federal Circuit Update for March 2024 summarizes the current status of several petitions pending before the Supreme Court, and recent Federal Circuit decisions concerning indefiniteness, obviousness, eligibility under Section 101, and the safe harbor provision under Section 271.

Federal Circuit News

Noteworthy Petitions for a Writ of Certiorari:

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

In Vanda Pharmaceuticals Inc. v. Teva Pharmaceuticals USA, Inc. (US No. 23-768), after the respondents waived their right to file a response, the Court requested a response, which was filed on March 18, 2024. Three amicus curiae briefs have been filed.

The Court denied the petition in Ficep Corp. v. Peddinghaus Corp. (US No. 23-796).

Upcoming Oral Argument Calendar

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

Key Case Summaries (March 2024)

Chewy, Inc. v. International Business Machines Corporation, No. 22-1756 (Fed. Cir. Mar. 5. 2024): Chewy sued IBM seeking a declaratory judgment of noninfringement of several patents including two patents relating to improvements in web-based advertising. Following claim construction, the district court granted Chewy’s motion for summary judgment of noninfringement of the asserted claims for one patent, because it determined no reasonable factfinder could find Chewy’s accused products “establish[] characterizations for respective users based on the compiled data” as required by the claims. The district court also granted a motion for summary judgment that claims from the second patent were ineligible under 35 U.S.C. § 101.

The Federal Circuit (Moore, C.J., joined by Stoll and Cunningham, JJ.) affirmed-in-part and reversed-in-part. The Court reversed the grant of summary judgment of noninfringement, because it determined that Chewy’s privacy policy and other documents created a genuine dispute of material fact regarding whether Chewy “establish[es] characterizations for respective users.” Indeed, the privacy policy explained that the ads were based on information such as “browsing or purchasing,” and drawing all inferences in the nonmoving party’s favor, this provided evidence that Chewy uses a specific user’s browsing or purchasing history to provide personalized or targeted ads. The Court affirmed the grant of summary judgment that the second patent was ineligible under § 101, determining that the patent was directed to the abstract idea of “identifying advertisements based on search results.” The Court concluded that the patent claims as an ordered combination did not recite an inventive concept because none of the three distinctive concepts raised by IBM—(1) a generic database configured to associate search results with advertisements, (2) offline batching process, and (3) assigning session identifiers to a search query—transformed the claimed abstract idea into patent-eligible subject matter.

Maxell, Ltd. v. Amperex Technology Limited, No. 23-1194 (Fed. Cir. Mar. 6, 2024): Maxell sued Amperex for infringement of Maxell’s patent directed to a rechargeable lithium-ion battery. The district court conducted claim construction proceedings and held that the claims were indefinite because the claim language recited a contradiction—one limitation did not require the presence of cobalt (it was optional), whereas the second limitation did.

The Federal Circuit (Taranto, J., joined by Prost and Chen, JJ.) reversed and remanded. The Court concluded that the claim language was not indefinite because even “[i]f there are two requirements,” if “it is possible to meet both, there is no contradiction.” Moreover, “[t]hat there are other ways of drafting the claim does not render the claim language contradictory or indefinite.”

Edwards Lifesciences Corp. et al. v. Meril Life Sciences Pvt. Ltd. et al., No. 22-1877 (Fed. Cir. Mar. 25, 2024): Edwards sued Meril for patent infringement after Meril imported two transcatheter heart valve systems into the United States that it intended to display at a conference in order to, among other things, find clinical investigators for its FDA premarket submission. The district court held that their importation fell within the safe harbor provision of 35 U.S.C. § 271(e)(1), and therefore granted summary judgment of noninfringement to Meril.

The majority (Stoll, J., joined by Cunningham, J.) affirmed. Section 271(e)(1) “is a safe harbor for defendants for what would otherwise constitute infringing activity.” It states that it “shall not be an act of infringement to . . . import into the United States a patented invention . . . solely for uses reasonably related to the development and submission of information under a Federal law . . . .” The majority held that “solely” in § 271(e)(1) modifies the phrase “for uses,” meaning that a use falls within the safe harbor provision if it is reasonably related to preparing a regulatory submission, even if the use also has additional (e.g., commercial) purposes.

Judge Lourie dissented, reasoning that the Court has consistently erred in interpreting the word “solely” in the safe harbor provision and that the question could benefit from en banc review. Specifically, Judge Lourie explained that the plain meaning of “solely” and the legislative history of § 271(e)(1) requires an otherwise infringing use to be carried out only for regulatory purposes (i.e., not for additional or commercial purposes) to benefit from the safe harbor.

Virtek Vision International ULC v. Assembly Guidance Systems, Inc., No. 22-1998 (Fed. Cir. Mar. 27, 2024): Assembly Guidance d/b/a Aligned Vision challenged Virtek’s patent directed to an improved method for aligning a laser project with respect to a work surface in an inter partes review (“IPR”). The Patent Trial and Appeal Board (“Board”) had found that a skilled artisan would have been motivated to use the 3D coordinate system in one prior art reference (Briggs) instead of the angular direction systems found in the other prior art references (Keitler, Bridges), and that it would have been obvious to try because Briggs disclosed both. The Board issued a final written decision holding that certain claims of the patent were unpatentable.

The Federal Circuit (Moore, C.J., joined by Hughes and Stark, JJ.) reversed-in-part and affirmed-in-part. The Court concluded that the Board erred as a matter of law with regard to the motivation to combine. The Court found that although Briggs disclosed that different possible arrangements existed, this did not provide a reason why a skilled artisan would have substituted the one-camera angular direction system in Keitler and Bridges with the two-camera 3D coordinate system disclosed in Briggs. “In short, this case involves nothing other than an assertion that because two coordinate systems were disclosed in a prior art reference and were therefore ‘known,’ that satisfies the motivation to combine analysis. That is an error as a matter of law. It does not suffice to simply be known. A reason for combining must exist.”

The following Gibson Dunn lawyers assisted in preparing this update: Blaine Evanson, Jaysen Chung, Audrey Yang, Julia Tabat, Michelle Zhu, and Evan Kratzer.

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 following authors:

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

Paris partner Ahmed Baladi and associate Thomas Baculard are the authors of “Artificial intelligence and the GDPR” [PDF] published by Financier Worldwide in its April 2024 issue.

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

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

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

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

Background

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

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

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

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

The Court of Appeals Ruling

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

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

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

Lack of Uniformity in Tax Assessments

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

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

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

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

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

Discriminatory Impact on Racial Minorities

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

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

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

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

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

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

What It Means

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

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

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

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

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

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

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

[5] See RPTL § 1802(1).

[6] See RPTL § 1805.

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

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

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

[10] 2024 WL 1160498, at *3.

[11] Id.

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

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

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

[15] See id. at *1.

[16] Id. at *4-9.

[17] Id. at *4-5.

[18] Id. at *6.

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

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

[21] Id. at *5.

[22] Id. at *9.

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

[24] Id. at *18.

[25] Id.

[26] Id. at *15.

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

[28] Id. at *9.

[29] Id. at *9-10.

[30] Id. at *9.

[31] Id. at *11-12.

[32] Id. at *12.

[33] Id.

[34] Id. at *11.

[35] Id.

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

[37] Id.

[38] Id.

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

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

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

The Court’s opinion is available here.

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

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

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

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

=We are pleased to provide you with the next 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

FTX Founder Sam Bankman-Fried Sentenced to 25 Years in Prison
On March 28, Sam Bankman-Fried was sentenced to 25 years in prison after being found guilty of fraud and money laundering in connection with the collapse of his FTX cryptocurrency exchange. Bankman-Fried’s presentencing report recommended he be sentenced to 100 years in prison. Bankman-Fried’s legal team urged the court to impose a lenient sentence, relied on 29 character references in his sentencing memo, and argued that he did not intend to cause the harms alleged. Bankman-Fried has been held at the Metropolitan Detention Center in New York since his bail was revoked on August 23, 2023, and will be transferred to a low or medium-security prison near his parents in San Francisco to serve his sentence. At sentencing Bankman-Fried said, “I’m sorry about what happened at every stage . . . It haunts me every day.“ He has stated that he plans to appeal his conviction. NYT; Financial Times; CNBC; Reuters; Law360.
DOJ Makes First Public Indictment of Individual for Underreporting Cryptocurrency Capital Gains
On February 6, Frank Ahlgren III was indicted for unreported capital gains from a $4 million sale of bitcoin. According to the DOJ, Ahlgren willfully failed to report capital gains from bitcoin sales between 2017-2019, and knowingly evaded reporting requirements by making cash deposits “in individual amounts of $10,000 or less to avoid the filing of a [Currency Transaction Report].” This marks the first public indictment of an individual for unreported capital gains from legal transactions involving cryptocurrency. This development showcases the federal government’s continued scrutiny of digital asset transactions. DOJ; Law360.
SEC Sanctioned in Debt Box Case
On March 18, the SEC was sanctioned for misstatements made by its counsel in proceedings against the crypto project Debt Box. The court found that the SEC acted in bad faith by making misleading statements about evidence it used to obtain a temporary restraining order and other emergency measures. The SEC initiated the suit against Debt Box in July 2023, and obtained a temporary asset freeze, restraining order, and receivership. Utah Federal District Judge Robert Shelby said in his sanctions order that the SEC acted in “bad faith” and “deliberately perpetuat[ed] falsehoods.” The SEC was ordered to pay attorneys’ fees and all expenses arising from the emergency measures. Judge Shelby rejected the SEC’s argument that it was protected from monetary sanctions by sovereign immunity, instead finding that the common law permits assessment of attorneys’ fees when a party has acted in bad faith. The court also denied the SEC’s motion to dismiss the case without prejudice. Law360; Yahoo Finance; The Block.
SEC Accepts Settlement with ShapeShift AG
On March 5, the SEC entered into a settlement with ShapeShift AG, which, according to the SEC, facilitated the buying and selling of digital assets from 2014 until early 2021 through its ShapeShift.io platform. The SEC’s order alleges ShapeShift violated Section 15(a) of the Securities Exchange Act of 1934. Without admitting liability, ShapeShift agreed to pay a $275,000 penalty and consented to a cease-and-desist order. Commissioners Uyeda and Peirce criticized the enforcement action, calling it “the latest installment in the serial drama of the Commission’s poorly conceived crypto policy.” SEC Press Release; Peirce and Uyeda Statement; The Block.
SEC Demands Information Related to Ethereum Foundation
As of March 20, as part of an investigation into Ethereum, the SEC demanded information from companies regarding dealings with the Ethereum Foundation. Gary Gensler, chair of the SEC, has not commented on Ethereum’s status, but according to companies that have received subpoenas, the SEC seeks to classify Ethereum as a security. Gensler has said that some digital assets are unregistered securities and therefore subject to SEC rules. If Ether is designated as a security, it could create pressure to delist the token. In addition, it could decrease the likelihood of SEC approval of ETFs investing directly in Ether, which is currently being sought by multiple issuers. In the past, the threat of action by the SEC has negatively impacted token prices. Ether, however, gained rather than lost value as news of the investigation spread. Fortune; Bloomberg; Bloomberg.
DOJ Charges Digitex CEO for Failing to Implement Anti-Money Laundering Safeguards
On February 12, Adam Todd, the CEO of Digitex Futures Exchange (Digitex), was charged with allegedly violating the Bank Secrecy Act by failing to implement proper anti-money laundering and know-your-customer protocols. Todd faces up to five years in prison, if convicted. DOJ; Law360; Cointelegraph.
Trial Commences for Accused Operator of Cryptocurrency Mixer Bitcoin Fog
On February 13, the trial for Roman Sterlingov, accused operator of cryptocurrency mixer Bitcoin Fog, commenced in D.C. federal court. Sterlingov was charged with money laundering and operating an unlicensed money transmitting business, among other things. Prosecutors allege that Sterlingov knew Bitcoin Fog facilitated illegal transactions and made a concerted effort to conceal his involvement, including the use of the pseudonym “Akemashite Omedotou.” Law360; Bloomberg.
Crypto Exchange Kraken Seeks Dismissal of Claims in Dispute with SEC
On February 22, Kraken filed a motion to dismiss the SEC lawsuit filed against it in November 2023. The SEC alleges that Kraken failed to register as a securities exchange, broker, and clearinghouse. Kraken’s motion to dismiss argues that the SEC has failed to establish that the tokens on its platform are investment-contract securities. Kraken’s motion also cites the major questions doctrine, arguing that the SEC has expanded its authority beyond what has been delegated to it by Congress. Kraken’s argument echoes those made by other exchanges in their respective SEC enforcement actions. Law360; Bloomberg; CoinDesk; Kraken.
Digital Currency Group Files Motion to Dismiss NY AG’s Suit
On March 6, Digital Currency Group (DCG) filed a motion to dismiss a lawsuit brought by New York Attorney General Letitia James, denying allegations of concealing losses and defrauding investors. DCG founder Barry Silbert also filed a motion to dismiss the claims. In an accompanying press release, the firm described the New York Attorney General’s allegations as based upon “blatant mischaracterizations and unsupported conclusory statements,” and asserted that DCG proceeded based on the advice of its accountants, investment bankers, and advisors. The motion further alleges that rather than creating a “liquidity crunch” as alleged by the AG, DCG invested hundreds of millions of dollars into its subsidiary leading up to its bankruptcy, despite no obligation to do so. CoinDesk; The Block; DCG Motion; Silbert Motion; Press Release.
U.S. District Court Dismisses SEC Claim Against Coinbase Wallet, Allows Lawsuit to Continue
On March 27, a U.S. District Court judge partially ruled in favor of Coinbase’s motion to dismiss by dismissing the SEC’s claim that Coinbase’s Wallet application acts as an unregistered broker under U.S. law. The judge concluded however that the lawsuit could proceed for now with the claim that Coinbase had failed to register its staking program with the SEC, finding that the SEC had plausibly alleged that staking customers had a reasonable expectation of profit due to “Coinbase’s managerial efforts.” CoinDesk; Cointelegraph; Bloomberg.

INTERNATIONAL

Do Kwon Wins Extradition Appeal – Will be Extradited to South Korea Instead of United States
The Appellate Court of Montenegro has overturned a previous decision by the High Court of Podgorica to extradite Terraform Labs co-founder, Do Kwon, to the United States. Now, Kwon likely will be extradited to South Korea after March 23. Kwon, arrested in Montenegro in March 2023, faced extradition requests from both the U.S. and South Korea, with ongoing speculation as to his whereabouts amidst allegations of fraud related to Terraform Labs and its Terra blockchain. AP News; Reuters.
Worldcoin Must Stop Data Collection in Spain for Three Months
On March 6, the Spanish Agency for the Protection of Data (AEPD) directed Worldcoin to cease collecting and processing data in Spain for three months as it investigates complaints related to data collection. Worldcoin, a project that seeks to create a private and secure technology that allows individuals to prove their humanness online, filed suit against AEPD’s order. On March 11, the Spanish High Court upheld the three month pause. Worldcoin has over 4 million users, states that it operates lawfully in all locations in which it is available, and is “grateful to now have the opportunity to help the AEPD better understand the important facts regarding” the technology. Worldcoin Statement; Reuters; Cointelegraph.

REGULATION AND LEGISLATION

UNITED STATES

Republican Senators Introduce “The CBDC Anti-Surveillance State Act”
On February 26, Republican senators introduced legislation aimed at blocking a central bank digital currency (CBDC) in the United States. U.S. Senator Ted Cruz (R-Texas), joined by Senators Bill Hagerty (R-Tenn.), Rick Scott (R-Fla.), Tedd Budd (R-N.C.), and Mike Braun (R-Ind.), filed legislation titled “The CBDC Anti-Surveillance State Act” due to concerns that a digital dollar would impinge on personal privacy. In a post on Cruz’s website, Cruz expressed his view that the “Biden administration salivates at the thought of infringing on our freedom and intruding on the privacy of citizens to surveil their personal spending habits, which is why Congress must clarify that the Federal Reserve has no authority to implement a CBDC.” Former President Donald Trump, the presumptive Republican presidential nominee, has promised to ban the creation of a CBDC. CoinDesk; Press Release.
House Finance Committee Votes to Move Forward with Measure to Overturn SEC’s Staff Accounting Bulletin 121
On February 29, the U.S. House Financial Services Committee voted to advance a resolution aimed at overturning the SEC’s Staff Accounting Bulletin 121 (SAB 121), which mandates regulated financial institutions to record their customers’ crypto holdings as liabilities on their own balance sheets. The resolution garnered bipartisan support, with 31 lawmakers voting in favor of the resolution and 20 lawmakers voting against. SAB 121 has drawn controversy over the past few years due to concerns that it would disincentivize banks from providing custodial services for digital assets and create unnecessary risks in the crypto ecosystem. Rep. Mike Flood (R-Neb.), who introduced the resolution, argues that the result of SAB 121 “is that banks must choose to either custody digital assets[,] thus inflating their balance sheet and severely affecting every other line of business[,] or stay entirely out of the market.” SAB 121 qualifies as a rule under the Congressional Review Act and therefore can be reviewed and disapproved by Congress. Disapproval requires each chamber to pass a resolution of disapproval, which must then be signed by the President. The Block; CoinDesk; Blockworks; Law360; Cointelegraph.
House Financial Services Committee Votes on Bill to Clarify Secret Service’s Authority Over Crypto Cybercrimes
On February 29, every member of the House Financial Services Committee voted in favor of the Combating Money Laundering in Cyber Crime Act, which would clarify the U.S. Secret Service’s power to investigate crypto cybercrimes. Rep. Zach Nunn (R-Iowa), one of the cosponsors of the bill, states that cybercrimes have led to hundreds of billions of dollars lost. According to Nunn, this “is a bipartisan bill and it closes the gap to empower our Secret Service professionals to continue to investigate cybercriminals[,] including cases involving digital assets[,]” around the globe. Rep. Gregory Meeks (D-NY) says this bill will “allow us to better address threats from nations like and including Russia and North Korea,” and by expanding the scope of U.S. Secret Service investigations, this bill “brings another element of protection and defense in line with the 21st century.” The Block; CoinDesk.
SEC Postpones Decision on Ether ETFs, Decision Expected in May
On March 4, the SEC postponed its decision regarding the approval or rejection of BlackRock’s and Fidelity’s spot Ether exchange-traded funds (ETFs). This delay marks the second postponement since January, when the SEC initially delayed its decision after approving several spot Bitcoin ETFs. The SEC is expected to approve or deny the ETFs in May once the first final deadline for a decision is due. Reuters; Cointelegraph.
Virginia Creates Working Group to Foster Blockchain and Digital Asset Expansion Within State
The Virginia Senate passed Senate Bill No. 339, creating a dedicated workgroup within the state to study and recommend measures for fostering the expansion of blockchain technology, digital asset mining, and cryptocurrency. Proposed by Senator Saddam Azlan Salim (D-Virginia), the bill aims to exempt miners from money transmitter licenses and prohibit targeted ordinances. The workgroup, comprising 13 members from legislative and non-legislative backgrounds, is tasked with concluding studies and presenting recommendations on the cryptocurrency ecosystem by November 1, 2024, for consideration in the 2025 Regular Session of the General Assembly. Cointelegraph.
Wyoming Gives DAOs a Nonprofit Legal Framework
On March 7, Governor Mark Gordon signed a bill into state law that would allow in-state decentralized autonomous organizations (DAOs) to establish themselves as decentralized unincorporated nonprofit associations (DUNA). This new legal framework gives DAOs more options, as DAOs have already been cleared to establish themselves as limited-liability corporations within the state of Wyoming. Establishing a DAO as a DUNA gives the DAO legal existence, enables the DAO to pay taxes, and provides the DAO with limited liability from the actions of other members. Miles Jennings, general counsel at a16z Crypto, called this development a “major breakthrough,” as this will give DAOs “much-needed protections and empower them to keep blockchain networks open.” CoinDesk; Blockworks.
President Biden Proposes Crypto Mining Tax and Wash-Sale Rules for Digital Assets
On March 11, United States President Joe Biden announced his fiscal year 2025 budget proposal, which included a crypto mining tax and changes in wash-sale rules. Last year, similar taxes were proposed, but they were not taken up by Congress in drafting budget bills. The new wash trading rules aim to inhibit people from selling an investment for a loss, and then quickly rebuying the investment. CoinDesk; CCN.

INTERNATIONAL

UK Financial Regulator Issued 450 Alerts on Illegal Cryptoasset Advertisements in Q4 2023
On February 14, the Financial Conduct Authority (FCA), an independent financial regulatory body in the UK, reported that it issued 450 consumer alerts against firms for the illegal promotion of cryptocurrency during the last three months of 2023. The FCA previously introduced financial promotion rules for cryptoassets in October 2023, heightening regulatory scrutiny. The regulator has worked with tech companies to address illegal promotions, including the removal of 35 mobile applications from app stores at the end of December 2023, and pledged it will be “continuing [its] robust action against firms issuing illegal financial promotions in 2024.” Financial Conduct Authority; CoinDesk; The Block.
English Draft Legislation Labels Crypto as Property
On February 22, England’s Law Commission published draft legislation confirming the existence of an additional category of common law personal property that includes digital assets. This legislation builds on a report on digital assets produced by the Commission in June 2023, which showed that crypto tokens and NFTs are property rights. The report also concluded that the common law was flexible enough to accommodate digital assets. The legislation seeks to confirm that digital assets are covered by the common law and to remove any legal uncertainty. The Commission accepted responses to the draft legislation until March 22. CoinDesk; Yahoo.
Taiwan Considering Implementation of Further Digital Asset Law
In response to an October 2023 bill introduced in Taiwan’s parliament and a speech by the Chairman of the Financial Supervisory Commission (FSC), Taiwan is considering the implementation of a special act to regulate the cryptocurrency industry, with results expected to be released in September 2024. The bill will aim to protect investors and to create more effective regulations for digital asset markets. The Block; Cointelegraph.
UK Considering How to Implement OECD Crypto Reporting Framework
The UK government launched a consultation to implement the Organization for Economic Co-operation and Development’s (OECD) crypto reporting framework, aiming to address tax non-compliance and enhance tax transparency in the crypto market. The framework, expected to generate £35 million ($45 million) between 2026 and 2027, and £95 million between 2027 and 2028, aims to exchange information on relevant crypto transactions across jurisdictions. The consultation, initiated after the spring budget speech, will close on May 29. The government plans to publish a response and seek further feedback on draft regulations thereafter. CoinDesk.
UAE Grants Initial Approval to Crypto Exchange Nexo
Nexo, a digital asset services provider, has received initial approval as a licensed entity in Dubai from the Virtual Assets Regulatory Authority (VARA). This marks the first step in obtaining full licensing for various activities including lending and borrowing, management and investment, and broker-dealer services. CoinDesk.
UK Law Enforcement Authority to Seize Crypto Assets Expanded
UK law enforcement agencies’ increased ability to seize cryptocurrency assets in criminal cases, including terrorism, will take effect on April 26, following approval of the legislation in March. The provisions include a civil recovery regime for crypto and crypto asset confiscation orders, which enables authorities to seize items associated with crypto assets. CoinDesk.
United Kingdom to Allow Institutional Investors to Build Crypto-Backed ETN Market
On March 11, the United Kingdom’s Financial Conduct Authority (FCA) announced it will not object to requests from Recognized Investment Exchanges (REIs) to build a listed market segment for crypto asset-backed exchange-traded notes (ETNs). ETNs are a form of exchange-traded product, which are often issued by a bank or an investment manager, that tracks an underlying asset or index. While these products would be available to professional investors, retail consumers remain banned. The FCA explained that crypto-backed products are ill-suited for retail investors. The FCA stated that exchanges will be responsible for making sure sufficient controls are in place so that ETN trading is safe and orderly. The London Stock Exchange stated that it will accept applications for bitcoin and ether ETNs in the second quarter of 2024. CoinDesk.
OKX Secures the Monetary Authority of Singapore’s In-Principle Approval for Major Payment Institution License
On March 12, the President of OKX announced that OKX secured in-principle approval for a Major Payment Institution (MPI) license from the Monetary Authority of Singapore (MAS). The license will allow OKX to facilitate multiple payment services. OKX’s President states that “the in-principle approval from MAS is a validation of [OKX’s] business strategy, and also an exciting opportunity for [OKX] to continue as a responsible stakeholder in [Singapore].” After receiving the full license from MAS, OKX will be able to facilitate cross-border transactions in the country, as well as provide digital payment token services to consumers. OKX; Cointelegraph.
EU Approves Anti-Money Laundering Legislation Targeting Anonymous Crypto Transactions Using Hosted Wallets
On March 19, the European Parliament approved a ban on anonymous crypto payments involving hosted wallets, which are wallets operated by third-party providers. The ban has no threshold and applies to any such transaction. Opponents argue that anonymity is a crucial feature of crypto that promotes financial privacy, while the new legislation would have a minimal effect on crime. The new legislation will take effect within three years from its promulgation. Cointelegraph.

CIVIL LITIGATION

UNITED STATES

Coinbase Challenges SEC’s Refusal to Engage in Rulemaking Regarding Digital Assets
On March 11, U.S. crypto exchange Coinbase filed an action against the SEC in the Third Circuit arguing that the SEC violated the Administrative Procedure Act by denying a rulemaking petition that Coinbase filed in July 2022. Coinbase’s rulemaking petition asked the SEC to propose new rules explaining the basis for the broad authority the agency has asserted over the digital-asset industry. Coinbase’s petition also identified the many ways in which existing SEC rules are unworkable for digital asset firms. The SEC denied the rulemaking petition in December 2023, only after Coinbase filed a mandamus action seeking to compel a response from the agency. Coinbase is asking the Third Circuit to require the SEC to engage in rulemaking or, at a minimum, to provide a rational explanation for its refusal to engage in rulemaking. CoinDesk; CCN.
Texas Crypto Firm Sues the SEC
On February 21, LEJILEX, a Texas based crypto firm, sued the SEC in Texas federal court challenging the SEC’s jurisdiction over digital assets. Working with the Crypto Freedom Alliance of Texas (CFAT), LEJILEX hopes to preemptively avoid an SEC enforcement action against them for failing to register securities or securities exchanges on their platforms. The suit asks the court to enjoin the SEC from bringing actions against LEJILEX or other CFAT members, pointing to cases brought against other crypto exchanges. Law360; Yahoo; Bloomberg.
Survey of Crypto Miners’ Energy Use is Suspended
On February 23, the U.S. Department of Energy (DOE) agreed to suspend its mandatory survey soliciting information about electricity consumption from cryptocurrency miners. The suspension occurred in response to a suit filed by the Texas Blockchain Council and a crypto-mining company, Riot Platforms, Inc., seeking to block the survey. Later the same day, a federal district judge in Texas granted a temporary restraining order against federal agencies and the survey. The U.S. Energy Information Administration (EIA), the DOE’s statistical arm, sought the information to evaluate concerns that increased electricity use by cryptocurrency miners could threaten energy grid reliability. The Office of Management and Budget granted an emergency request from the EIA allowing them to move forward with the survey without following regular statutory processes such as notice and comment. The plaintiffs argue that the EIA failed to make the necessary showing that such emergency approval would prevent public harm, therefore unlawfully circumventing statutory procedure. Law360; Reuters.
SEC Seeks to Leverage Default Judgment in Enforcement Actions Against Crypto Exchanges
Judge Tana Lin of the Western District of Washington granted partial satisfaction of the SEC’s motion for default judgment against Sameer Ramani, a defendant in the case involving former Coinbase product manager Ishan Wahi and co-defendants. Ramani, who reportedly fled the United States and failed to respond to court summonses, faces permanent injunctions, civil penalties, and disgorgement of funds. In its default judgment order, the court assumed that the allegations in the SEC’s complaint were true and concluded that the digital assets at issue in that case were securities. The SEC subsequently filed the default judgment order as supplemental authority in its pending enforcement actions against various crypto exchanges. The exchanges responded that the default judgment order should be disregarded because it was “procured against an empty chair.” Cointelegraph; Response Letter.
Voyager Users Sue Public Relations Firm Ketchum Inc. Over Involvement in Crypto Promotion
On February 9, a class of users of Voyager, a bankrupt digital assets lender, sued public relations firm Ketchum Inc. in federal court for aiding and abetting Voyager’s sale of unregistered securities. Ketchum provided Voyager marketing and communications support for a high-profile press conference with the Dallas Mavericks, which promoted the Voyager platform and products. The complaint argues that Ketchum “knew or should have known that the objective of their partnership, and the promotional activity they undertook together, constituted promoting unregistered securities.” Law360.
Genesis Approved to Sell $1.6 Billion in Shares of Investment Trust to Fund Chapter 11 Bankruptcy Payouts
On February 14, the New York bankruptcy court granted crypto lender Genesis Global’s (Genesis) request to sell $1.6 billion in Grayscale Investments shares to fund payouts to creditors. Digital Currency Group, the parent company of Genesis, objected to the request due to the timing and a demand for Digital Currency Group to be consulted before such sales. Genesis continues its liquidation plan after filing for bankruptcy in January 2023. Bloomberg; Law360; Reuters; WSJ.
Celsius Distributes $2 Billion of Cryptocurrency Pursuant to Bankruptcy Plan
On February 15, Celsius Network filed an update with the court that “[n]early 75% of the BTC/ETH set to be distributed by PayPal/Venmo and through Coinbase has already been collected,” equating to $2 billion for nearly 172,000 creditors. This comes on the heels of the company exiting bankruptcy in late January 2024. The Block; Cointelegraph.
FTX Investors File Class Action Against the Company’s Bankruptcy Counsel
On February 16, FTX investors filed a class action racketeering lawsuit in Florida federal court against FTX’s bankruptcy counsel, alleging that the law firm aided in FTX’s fraudulent behavior. Ryne Miller, a former partner at the law firm, left to become FTX’s general counsel in 2021. The plaintiffs argue that the firm knew of FTX’s impending financial turmoil, but “realized it stood to gain hundreds of millions more from their work in bankruptcy.” According to the complaint, the firm served as counsel for FTX for 16 months prior to the company’s collapse, receiving over $8.5 million in legal fees, and has continued to serve as FTX’s bankruptcy counsel, generating $180 million in fees. Bloomberg; The Block; Reuters; Law360.
FTX Files Proposed Settlement in FTX Europe Clawback Case
On February 22, FTX filed for approval of a settlement resolving a lawsuit seeking to claw back $323 million from the co-founders of an entity they acquired. If approved by the court, the settlement would have FTX sell the subsidiary back to the co-founders for $32.7M. The proposed settlement comes after FTX tried and failed to sell the entity. In 2021, FTX bought Digital Assets DA AG and rebranded it as FTX Europe. The current lawsuit claims that the purchase price was a “massive overpayment” for a company that had just a little more than a business plan. This is one of numerous lawsuits FTX has filed to recover funds for creditors and customers since filing for bankruptcy in November 2022. FTX stated in its court filing that litigation would be costly and complicated, and that the proposed settlement is the best option for creditors. Reuters; WSJ; Law 360.

SPEAKER’S CORNER

UNITED STATES

CFTC Chair Emphasizes Need for Congress to Pass Legislation
Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam reiterated the need for Congress to pass legislation addressing regulatory gaps in the crypto industry during his annual appearance before the House Agriculture Committee. Behnam emphasized the importance of regulating cryptocurrencies like Bitcoin (BTC) and Ether (ETH), which make up a significant portion of the market. He highlighted the Financial Innovation and Technology Act for the 21st Century (FIT Act), which aims to address regulatory uncertainties but has yet to pass a floor vote. Behnam expressed confidence in the CFTC’s ability to establish a regulatory framework within 12 months if the FIT Act is enacted. CoinDesk.
House Financial Services Committee Discusses Cryptocurrency and Illicit Finance
On February 15, the House Financial Services Committee hosted a congressional panel on how to address the use of cryptocurrency for illicit finance. In his opening statement, Chairman French Hill (R-Ark.) highlighted that the “borderless nature of blockchain technology necessitates international cooperation” and that “members of both sides of the aisle are interested in working on solutions.” House Financial Services Committee; Law360; The Block; Politico.
Leading U.S. Investment Bank Argues U.S. Authorities Can Exert Some Control Over Tether via OFAC
On February 15, a leading U.S. investment bank released a research report stating that “U.S. regulators can exert some control on Tether’s offshore usage via [the Office of Foreign Assets Control],” which is a unit of the U.S. Treasury Department. The report cited Tether’s association with Tornado Cash as an example of such regulation. In 2022, OFAC sanctioned Tornado Cash for allegedly assisting in money laundering. Although Tether initially did not take action against Tornado Cash addresses, in December 2023, Tether decided to freeze stablecoin held in OFAC-sanctioned wallets as a proactive measure. The Block; CoinDesk.
OCC Acting Chief Advocates for Trip Wires Around Payments and Private Equity Activity
On February 21, the acting chief of the Office of the Comptroller of the Currency (OCC), Michael Hsu, advocated for regulators to set numerical “trip wires” around activity in the digital payments and private equity industries. In a speech given at Vanderbilt University, Hsu said that payments and private equity pose the largest risk for the next “great blurring” of banking and commerce, with activity in these areas resembling a phase of surging nonbank growth that preceded 2008 and other historic market failures. Hsu called on the Financial Stability Oversight Council (FSOC) to develop quantitative thresholds to identify when a payments or private equity firm becomes a systemic risk. When the threshold is crossed, the FSOC would then formally assess the individual firm. This assessment would inform any additional regulatory activity, which could include use of the FSOC’s designation power to apply heightened bank-like regulations. This proposal follows the FSOC’s policies enacted last year, which lay out an analytical framework for its work as a watchdog and remove procedural hurdles to the use of its designation power, which were put in place during the Trump administration. Law360; Politico; Bloomberg.
Senator and Eight Attorneys General File Amicus Briefs Opposing SEC’s Authority to Regulate Crypto Assets as Securities
On February 27, Senator Cynthia Lummis (R-Wyo.), crypto industry groups, and a veteran appellate attorney filed an amicus brief asserting that the SEC’s suit against crypto exchange Kraken expands the definition of investment contract beyond what Congress intended. Lummis argues that the SEC is overreaching its authority by encroaching on Congress’s lawmaking power. In the suit, the SEC claims that Kraken operated as an unregistered broker, dealer, exchange, and clearing agency. The amicus brief argues that the “SEC is not suited to the task of crafting a holistic regulatory framework for crypto assets, particularly through a judicial enforcement action (where neither the SEC nor this court is positioned to grapple with the unintended consequences of the SEC’s current enforcement stance and the policy implications of its novel legal opinion).” The amicus brief concludes that “such policymaking is precisely the role the Constitution assigns to Congress.” Law360.On February 29, a coalition of attorneys general from eight U.S. states submitted a joint amicus brief, also arguing that the SEC’s attempt to regulate crypto assets as securities exceeds the SEC’s authority. The brief asserts that Congress has not delegated such authority to the SEC and emphasizes the states’ interest in preventing the potential preemption of consumer protection laws. The Block.
DOJ Changes Prosecution Strategy from Whack-a-Mole to Systemic
According to veteran crypto-focused prosecutors, the Department of Justice is no longer playing “whack-a-mole” in its crypto cases, but rather focusing on large, important actors to further the goal of bringing the broader industry into compliance. On February 23, Tara La Morte and Noah Solowiejczyk, leaders of the U.S. Attorney’s Office for the Southern District of New York’s Illicit Finance and Money Laundering Unit, spoke at a New York City Bar Association event about this change in strategy. La Morte stated that law enforcement is focusing on “systemic-type prosecution that’s going to make an industry impact” and lead “the industry to take notice.” Law360.

OTHER NOTABLE NEWS

The Philippines Central Bank, Bangko Sentral ng Pilipinas, Plans to Launch Wholesale Central Bank Digital Currency Within Two Years
On February 12, the Philippines’ central bank, the Bangko Sentral ng Pilipinas (BSP), revealed the bank’s intention of introducing a wholesale central bank digital currency (CBDC) within the next two years. In discussing its decision to limit the CBDC to wholesale, the BSP acknowledged that retail CBDC could intensify bank runs in times of financial stress. Additionally, the BSP confirmed that it will not use blockchain or distributed ledger technology, stating that “[o]ther central banks have tried blockchain, but it didn’t go well.” Cointelegraph; CoinDesk; The Inquirer.
OKX Opens Crypto Exchange in Turkey as Part of International Expansion
On February 27, crypto exchange OKX entered Turkey as part of its global expansion plan. In an interview with CoinDesk, OKX President Hong Fang said that “Turkey is a very important and special market for us. It ranks high in terms of crypto adoption and crypto transaction volume.” Fang detailed that “there is a natural tendency to look for value in bitcoin in Turkey, particularly for wealth preservation.” Due to Turkey’s double-digit inflation rate, crypto has become a lifeline for many. CoinDesk; The Block.
Crypto Campaign Contributions Impacted Super Tuesday
Crypto political action committees spent more than $78 million on Super Tuesday races, helping propel Adam Schiff (D-CA), Young Kim (R-CA), Shomari Figures (D-AL), Julie Johnson (R-TX), and Tim Moore (R-NC) to win their races and advance to run offs. Fast Company; CoinDesk.

The following Gibson Dunn attorneys contributed to this issue: The following Gibson Dunn attorneys contributed to this issue: Jason Cabral, Jeff Steiner, Kendall Day, Sara Weed, Ella Alves Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Simon Moskovitz, Anne Lonowski, Amanda Goetz, and Cody Wong.

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

FinTech and Digital Assets Group:

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

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

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

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

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

Grace Chong, Singapore (+65 6507 3608, [email protected])

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

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

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

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

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

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

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

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

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

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

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

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

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

From the Derivatives Practice Group: Several CFTC advisory committees are scheduled to meet in the upcoming weeks, and ESMA was busy issuing reports and consultations on MiCA.

New Developments

CFTC’s Energy and Environmental Markets Advisory Committee to Meet. The CFTC’s Energy and Environmental Markets Advisory (EEMAC) will hold a public meeting from 9:00 a.m. to 12:00 p.m. (CDT) on Wednesday, April 10 at the University of Missouri – Kansas City in Kansas City, Missouri. At this meeting, the EEMAC will continue its discussion on the federal prudential financial regulators’ proposed rules implementing Basel III and the implications for and impact on the derivatives market. There will also be presentations and discussions on the state of crude oil markets and the future of power markets. Finally, the two EEMAC subcommittees will offer updates on their continued work related to traditional energy infrastructure and metals markets. [NEW]
CFTC’s Agricultural Advisory Committee to Meet. The CFTC’s Agricultural Advisory Committee (AAC) will hold a public meeting on April 11 from 9:30 a.m. to 11:00 a.m. (CDT) at the Sheraton Overland Park Hotel in Overland Park, Kansas. At this meeting, the AAC will discuss topics related to the agricultural economy and recent developments in the agricultural derivatives markets. [NEW]
SEC Adopts Reforms Relating to Investment Advisers Operating Exclusively Through the Internet. On March 27, the SEC adopted amendments to the rule permitting certain internet investment advisers to register with the Commission (the “internet adviser exemption”). The amendments will require an investment adviser relying on the internet adviser exemption to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The amendments will also eliminate the current rule’s de minimis exception by requiring an internet investment adviser to provide advice to all of its clients exclusively through an operational interactive website and to make certain corresponding changes to Form ADV. [NEW]
CFTC’s Market Risk Advisory Committee to Meet. The CFTC’s Market Risk Advisory Committee (MRAC) will meet on April 9 at 9:30 am ET. The MRAC will consider current topics and developments in the areas of central counterparty risk and governance, market structure, climate-related risk, and emerging technologies affecting derivatives and related financial markets.

New Developments Outside the U.S.

ESMA Clarifies Application of Certain MIFIR Provisions, Including Volume Cap. On March 27, the European Securities and Markets Authority (ESMA) published a statement, including practical guidance supporting the transition and the consistent application of the revised Markets in Financial Instruments Regulation (MiFIR).The statement covers guidance on equity transparency and non-equity transparency; the systematic internaliser (SIs) regime; designated publishing entities (DPEs); and reporting. Regarding the volume cap, following the publication by the European Commission, ESMA confirmsed that DVC data will continue to be published, with the next publication scheduled for early April. [NEW]
ESMA Provides Market Participants with Guidance on the Clearing Obligation for Trading with 3rd Country Pension Schemes. On March 27, ESMA issued a public statement on deprioritizing supervisory actions linked to the clearing obligation for third-country pension scheme arrangements (TC PSA), pending the finalization of the review of EMIR. ESMA expects National Competent Authorities (NCAs) not to prioritize supervisory actions in relation to the clearing obligation for derivative transactions conducted with TC PSAs exempted from the clearing obligation under their third-country’s national law. Additionally, ESMA recommends that NCAs apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in this area in a proportionate manner. The Council and the European Parliament reached a provisional agreement on February 7. The political agreement on the EMIR 3 text provides for an exemption regime from the EMIR clearing obligation when the TC PSA is exempted from the clearing obligation under that third country’s national law. [NEW]
ESMA Finalizes First Rules on Crypto-Asset Service Providers. On March 25, ESMA published the first Final Report under the Markets in Crypto-Assets Regulation (MiCA). ESMA stated that Tthe report, which aims to foster clarity and predictability, promote fair competition between crypto-asset service providers (CASPs) and a safer environment for investors across the Union, includes proposals on: (1) information required for the authorization of CASPs; (2) the information required where financial entities notify their intent to provide crypto-asset services; (3) information required for the assessment of intended acquisition of a qualifying holding in a CASP, and (4) how CASPs should address complaints. [NEW]
ESMA Launches the Third Consultation Under MiCA. On March 25, ESMA published its third consultation package under the MiCA. In the consultation package, ESMA is seeking input on four sets of proposed rules and guidelines, covering: (1) detection and reporting of suspected market abuse in crypto-assets; (2) policies and procedures, including the rights of clients, for crypto-asset transfer services; (3) suitability requirements for certain crypto-asset services and format of the periodic statement for portfolio management; and (4) ICT operational resilience for certain entities under MiCA. [NEW]
SFC and HKMA Further Consult on Enhancements to Hong Kong’s OTC Derivatives Reporting Regime. On March 22, 2024, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) launched a joint-further consultation on enhancements to the over-the-counter (OTC) derivatives reporting regime in Hong Kong. This further consultation follows an earlier joint-consultation in April 2019, in which the SFC and HKMA proposed a requirement to identify transactions submitted to the Hong Kong Trade Repository (HKTR) for the reporting obligation by a Unique Transaction Identifier. The current joint-further consultation consults on the implementation of the Unique Transaction Identifier, together with the mandatory use of Unique Product Identifier and Critical Data Elements for submission of transactions to the HKTR. The Interested parties are encouraged to submit responses to the SFC or HKMA on the consultation by May 17, 2024. [NEW]
ESMA Publishes Feedback on Shortening Settlement Cycle. On March 21, the ESMA published feedback received to its Call for Evidence on shortening the settlement cycle in the EU. According to ESMA’s report on the feedback, respondents focused on four areas: (1) many operational impacts, beyond adaptations of post-trade processes, were identified as the result of a reduction of the securities settlement cycle in the EU; (2) respondents identified a wide range of both potential costs and benefits of a shortened cycle, with some responses supporting a thorough impact assessment; (3) respondents provided suggestions around how and when a shorter settlement cycle could be achieved, with a strong demand for a clear signal from the regulatory front at the start of the work and clear coordination between regulators and the industry; and (4) stakeholders made clear the need for a proactive approach to adapt their own processes to the transition to T+1 in other jurisdictions. Additionally, according to ESMA, some responses warned about potential infringements due to the misalignment of the EU and North America settlement cycles.
HKMA Issues New SPM Modules on Market Risk and CVA Risk Capital Charges. On March 15, the HKMA released a circular informing the industry that it has issued new Supervisory Policy Manual (SPM) modules MR-1: Market Risk Capital Charge and MR-2: CVA Risk Capital Charge as statutory guidance, which will come into effect on a day to be appointed by the HKMA (intended to be January 1, 2025). The HKMA said that the revised market risk and credit valuation adjustment (CVA) risk capital frameworks will be set out in Part 8 and Part 8A of the Banking (Capital) Rules, respectively. The SPM MR-1: Market Risk Capital Charge covers the standardized approach for market risk, the internal models approach, the simplified standardized approach and requirements related to the boundary between the trading book and banking book, while the SPM MR-2: CVA Risk Capital Charge covers the reduced basic CVA approach, the full basic CVA approach and the standardized CVA approach. According to the HKMA, both new SPM modules are designed not just to provide additional technical details in addition to the rules but to integrally cover all of the related requirements. They set out the minimum standards that all locally incorporated authorized institutions are expected to adopt for the calculation of their market risk and CVA risk capital charges.
ASIC Finalizes Minor and Technical Changes to OTC Derivatives Reporting Rules. On March 13, the Australian Securities and Investments Commission (ASIC) finalized the minor and technical changes to the ASIC Derivative Transaction Rules (Reporting) 2024 under ASIC Derivative Transaction Rules (Reporting) 2024 Amendment Instrument 2024/1 to implement the proposed changes to the 2024 rules set out in Consultation Paper 361a ASIC Derivative Transaction Rules (Reporting) 2024: Follow-on consultation on changes to data elements and other minor amendments (CP 361a). The changes include (1) seven additional data elements; (2) provide clarifications and administrative updates to the data elements; (3) make consequential changes to Chapter 2: Reporting Requirements; and (4) make other administrative updates including re-referencing the location of definitions in the Corporations Act 2001 that have been moved by the Treasury Laws Amendment (2023 Law Improvement Package No. 1) Act 2023. According to ISDA, feedback to CP 361a was broadly supportive. In response to industry requests, the final changes also (1) provide for an additional circumstance where the name of Counterparty 2 is not reported and (2) change how the amount of one kind of collateral is reported.

New Industry-Led Developments

ISDA Submits Joint Response to BCBS Crypto Standard Amendments Consultation. On March 28, ISDA, with the Global Financial Markets Association, the Futures Industry Association, the Institute of International Finance and the Financial Services Forum, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on proposed crypto asset standard amendments. ISDA and the other trade associations stated that they welcome the BCBS’s continued focus on designing and improving the prudential framework for crypto assets. The key topics in the consultation response include public permissionless blockchains, classification condition 2 and settlement finality and Group 1b eligibility. [NEW]
ISDA Responds to CFTC on Clearing Member Funds Protection. On March 18, ISDA responded to the CFTC’s consultation on proposed rules for the protection of clearing member funds held by derivatives clearing organizations (DCOs), including the assets of futures commission merchants (FCMs). According to ISDA, it proposed that the CFTC should finalize the enhanced protection for clearing member assets in connection with an intermediated DCO only, which includes multiple FCMs, unaffiliated with the DCO, as its members. Regarding a DCO providing direct clearing without multiple FCMs unaffiliated with the DCO, ISDA suggested the CFTC should wait to propose enhanced protection for clearing members’ assets, once a full assessment of the risks and complications associated with a DCO providing direct clearing has been completed. At which point, in ISDA’s opinion, it would be appropriate for the CFTC to propose a comprehensive framework to address these risks holistically. Otherwise, ISDA said, the current notice of proposed rulemaking would create a sense of safety for the disintermediated model, which is superficial due to the rule not creating a comprehensive safety regime for disintermediated central counterparties (CCPs), with many risks arising from such models being left unaddressed.
ISDA Responds to FASB on Induced Conversion of Convertible Debt. On March 18, ISDA submitted a response to the Financial Accounting Standards Board’s (FASB) exposure draft on File Reference No. 2023-ED600, Debt—Debt with Conversion and Other Options (Subtopic 470-20): Induced Conversions of Convertible Debt Instruments. ISDA indicated that it supports FASB’s proposals in the exposure draft and believes it achieves the objective of improving the application and relevance of the induced conversion guidance to cash convertible debt instruments.