Publications Archives

From the Derivatives Practice Group: The CFTC issued a no-action letter, approved three proposed rules and extended the comment period on a fourth this week.

New Developments

CFTC Staff Issues No-Action Letter Regarding Pre-Trade Mid-Market Mark for Certain Interest Rate Swaps Referencing SOFR. On February 22, the CFTC’s Market Participants Division (MPD) issued a no-action letter applicable to all registered swap entities in relation to the requirement in Regulation 23.431 that swap dealers and major swap participants (swap entities) disclose to certain counterparties the Pre-Trade Mid-Market Mark (PTMMM) of a swap. The no-action letter states that MPD will not recommend the CFTC take an enforcement action against a registered swap entity for its failure to disclose the PTMMM to a counterparty in certain interest rate swaps referencing the Secured Overnight Financing Rate that are identified in the no-action letter, provided that: (1) real-time tradeable bid and offer prices for the swap are available electronically, in the marketplace, to the counterparty; and (2) the counterparty to the swap agrees in advance, in writing, that the registered swap entity need not disclose a PTMMM for the swap. According to the CFTC, the no-action letter provides a similar no-action position as that in CFTC Staff Letter No. 12-58 for certain interest rate swaps referencing the London Interbank Offered Rate. CFTC Commissioner Christy Goldsmith Romero objected to the no-action letter, arguing that it inappropriately shifts the burden of understanding swap dealer’s conflicts and incentives back onto counterparties, upending the Dodd-Frank Act’s intent. [NEW]
CFTC Approves Three Proposed Rules and Other Commission Business. On February 20, the CFTC approved three proposed rules through its seriatim process: (1) Regulations to Address Margin Adequacy and to Account for the Treatment of Separate Accounts by Futures Commission Merchants; (2) Foreign Boards of Trade; and (3) Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions. All three proposals have a comment deadline of April 22, 2024. Additionally, the CFTC issued an order of exemption from registration as a derivatives clearing organization (DCO) to Taiwan Futures Exchange Corporation and approved an amended order of registration for ICE NGX Canada, Inc., adding environmental contracts to the scope of contracts it is eligible to clear as a DCO. [NEW]
CFTC Extends Comment Period on Proposed Rules for Operational Resilience Frameworks. On February 20, the CFTC extended the comment period on its proposed rules implementing requirements for operational resilience frameworks for futures commission merchants, swap dealers and major swap participants. The new deadline is April 1, 2024. [NEW]
CFTC GMAC to Meet March 6. The CFTC’s Global Markets Advisory Committee (GMAC) will meet on Wednesday, March 6 at 10am ET. The GMAC will hear presentations from its Global Market Structure Subcommittee, Technical Issues Subcommittee and Digital Asset Markets Subcommittee, and consider their recommendations. [NEW]
SEC Adopts Rule to Expand Definitions of “Dealers” and “Government Securities Dealers.” On February 6, the SEC adopted a rule that requires market participants to register as “dealers” or “government securities dealers” for the first time and become members of a self-regulatory organization (SRO). The final rule, codified in Exchange Act Rules 3a5-4 and 3a44-2, purports to define the phrase “as a part of a regular business” in Sections 3(a)(5) and 3(a)(44) of the Securities Exchange Act of 1934 to identify certain activities that would cause persons engaging in such activities to be “dealers” or “government securities dealers” and be subject to the registration requirements of Sections 15 and 15C of the Act, respectively. Under the final rule, any person that engages in activities as described in the rule is a “dealer” or “government securities dealer” and, absent an exception or exemption, required to: register with the SEC under Section 15(a) or Section 15C, as applicable; become a member of an SRO; and be subject to applicable SRO and Treasury rules and requirements. Notably, the rule is non-exclusive, meaning that even if a firm does not meet any of the criteria in the rule, the SEC claims that the firm could still be a dealer anyway depending on the “facts and circumstances.”
SEC and CFTC Adopt Amendments to Enhance Private Fund Reporting. On February 8, the SEC adopted amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds, including those that also are registered with the CFTC as commodity pool operators or commodity trading advisers. According to the SEC, the amendments, which the CFTC concurrently adopted, are designed to enhance the ability of the Financial Stability Oversight Council (FSOC) to monitor and assess systemic risk and to bolster the SEC’s oversight of private fund advisers and the agency’s investor protection efforts. The SEC and CFTC also agreed to a memorandum of understanding related to the sharing of Form PF data. The SEC stated that, among other things, the amendments to Form PF will enhance how large hedge fund advisers report investment exposures, borrowing and counterparty exposure, market factor effects, currency exposure, turnover, country and industry exposure, central clearing counterparty reporting, risk metrics, investment performance by strategy, portfolio liquidity, and financing and investor liquidity in an effort to provide better insight into the operations and strategies of these funds and their advisers and improve data quality and comparability. Further, the amendments will require additional basic information about advisers and the private funds they advise, including identifying information, assets under management, withdrawal and redemption rights, gross asset value and net asset value, inflows and outflows, base currency, borrowings and types of creditors, fair value hierarchy, beneficial ownership, and fund performance, which, according to the SEC, will provide greater insight into private funds’ operations and strategies, assist in identifying trends, including those that could create systemic risk, improve data quality and comparability, and reduce reporting errors. The amendments will also require more detailed information about the investment strategies, counterparty exposures, and trading and clearing mechanisms employed by hedge funds, while also removing duplicative questions.
CFTC Global Markets Advisory Committee Advances Key Recommendations. On February 8, the CFTC’s Global Markets Advisory Committee (GMAC), sponsored by Commissioner Caroline D. Pham, formally advanced eight recommendations to the CFTC that are intended to enhance the resiliency and efficiency of global markets, including U.S. Treasury markets, repo and funding markets, and commodity markets. To date, this is the largest number of recommendations advanced by a CFTC Advisory Committee in a single meeting. The GMAC’s Global Market Structure Subcommittee prepared four recommendations: (1) appropriately calibrated block and cap sizes under CFTC Part 43 swap data reporting rules, intended to enhance market liquidity and financial stability; (2) addition of certain central counterparties (CCPs) as permitted counterparties under CFTC Rule 1.25(d), intended to promote the well-functioning of the repo market; (3) expansion of cross-margining between the CME Group and the Fixed Income Clearing Corporation, intended to support greater efficiency in the U.S. Treasury markets; and (4) best practices for exchange volatility control mechanisms, intended to address market stress and market dislocation during periods of high volatility. The GMAC’s Technical Issues Subcommittee prepared four additional recommendations, as follows: (5) adoption of lessons learned from a global default simulation across CCPs, intended to address systemic risk and promote financial stability; (6) harmonization of the treatment of money market funds as eligible collateral, intended to improve market liquidity; (7) improvement of trade reporting for market oversight, intended to ensure international standardization and global aggregation and analysis of data to address systemic risk; and (8) improvement of trade reporting for market oversight, intended to facilitate data sharing across jurisdictions for systemic risk analysis.
CFTC Customer Advisory Alerts App and Social Media Users to Financial Romance Fraud. On February 7, the CFTC’s Office of Customer Education and Outreach (OCEO) issued a customer advisory alerting dating/messaging app and social media users to a scam asking for financial support or giving investment advice using the platforms. The Customer Advisory: Six Warning Signs of Online Financial Romance Frauds, reminds app and social media users to be wary of texts and messages from strangers that promote cryptocurrency investments. According to the OCEO, the text could actually be from international criminal organizations that trick victims into investing money in cryptocurrency or foreign currency scams only to defraud them. The OCEO stated that the scam can take advantage of even the savviest of investors because fraudsters develop relationships with their victims through weeks of seemingly authentic text messaging conversations, a practice known as “grooming.” The advisory points out several warning signs of a financial grooming fraud, which include fraudsters attempting to move conversations from a dating or social media platform to a private messaging app, as well as their claims of wealth from cryptocurrency or foreign currency trading due to insider information. The advisory also includes steps users can take to avoid financial grooming frauds.

New Developments Outside the U.S.

HKMA Sets Out Expectations on Tokenized Product Offerings. On February 20, the Hong Kong Monetary Authority (HKMA) published a circular covering the sale and distribution of tokenized products. According to the HKMA, the prevailing supervisory requirements and consumer/investor protection measures for the sale and distribution of a product are also applicable to its tokenized form as it has terms, features and risks similar to those of the underlying product. The HKMA clarified that authorized institutions should conduct adequate due diligence and fully understand the tokenized products before offering them to customers and on a continuous basis at appropriate intervals. Authorized institutions are also expected to act in the best interest of their customers and make adequate disclosure of the relevant material information about a tokenized product, including its key terms, features and risks. Finally, the HKMA indicated that authorized institutions should put in place proper policies, procedures, systems and controls to identify and mitigate the risks arising from tokenized product-related activities. [NEW]
HKMA Sets Standards for Digital Asset Custodial Services. On February 20, the HKMA issued guidance for authorized institutions interested in offering custody services for digital assets. The HKMA expects authorized institutions to undertake a comprehensive risk assessment followed by the implementation of appropriate policies to manage identified risks. The entire process should be overseen by the board and senior management. The HKMA also requires authorized institutions to conduct independent systems audits, store a substantial portion of client digital assets in cold storage, ensure that private keys are secured within Hong Kong and provide all records to HKMA whenever requested. Authorized institutions should notify the HKMA and confirm that they meet the expected standards in the guidance within 6 months from the date of the guidance (i.e. February 20, 2024). [NEW]
ASIC Publishes Third Consultation Paper on OTC Derivatives Reporting. On February 15, the Australian Securities and Investments Commission (ASIC) published Consultation Paper (CP) 375: Proposed changes to the ASIC Derivatives Transaction Rules (Reporting): Third consultation. CP 375 proposes the following changes to ASIC Derivative Transaction Rules (Reporting) 2024: simplify the exclusion of exchange-traded derivatives; simplify the scope of foreign entity reporting; remove the alternative reporting provisions; clarify the exclusion of FX securities conversion transactions; and add additional allowable values for two data elements. Additionally, CP 375 proposes minor changes to ASIC Derivative Transaction Rules (Clearing) 2015: simplify and align the exclusion of exchange-traded derivatives with the 2024 reporting rules and make minor updates to re-reference certain definitions to their changed location in the Corporations Act 2001. The proposed changes would commence on October 21, 2024, except for the changes to the scope of foreign entity reporting and the removal of alternative reporting provisions, which would commence on April 1, 2025. ASIC indicated that it does not expect most reporting entities to face any material additional compliance burden upon implementation of the proposed changes. However, a small number of international reporting entities and some small-scale exempt reporting entities may be impacted, according to ASIC. The consultation period will run until March 28, 2024. [NEW]
Council of the EU Ratifies EMIR 3 Agreement at Ambassador Level. On February 14, the European Market Infrastructure Regulation 3 (EMIR 3) package (regulation and directive), as negotiated in the trilogues, was approved at ambassador level. The texts are available here. According to ISDA, the final text maintains the Council of the EU’s less punitive approach of an operational active account with representativeness. It also introduces a requirement for financial counterparties and non-financial counterparties above certain de minimis thresholds to hold an active account at an EU CCP and to clear a number of representative trades in that account. The directive amending the Capital Requirement Regulation is intended to provide more specific tools and powers under Pillar 2 in the context of excessive concentration to CCPs. [NEW]
CPMI, IOSCO Publish Paper on Streamlining VM in Centrally Cleared Markets. On February 14, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a discussion paper on streamlining variation margin (VM) in centrally cleared markets. The discussion paper follows the review of margining practices, published in 2022 by the Basel Committee on Banking Supervision, the CPMI and IOSCO. The discussion paper sets out eight effective practices, covering intraday VM call scheduling and frequency, treatment of excess collateral, the pass-through of VM by CCPs and transparency between CCPs, clearing members and their clients. The deadline for comment is April 14.
ESMA Withdraws Euronext Authorization as a Data Reporting Service Provider Under MIFIR Upon the Entity’s Request. On February 13, ESMA withdrew the authorization of Euronext Paris SA (Euronext) as a Data Reporting Service Provider (DRSP) under the Markets in Financial Instruments Regulation (MiFIR). Euronext was authorized as both an Approved Reporting Mechanism and an Approved Publication Arrangement under MiFIR since January 3, 2018. MiFIR provides that ESMA shall withdraw the authorization of a DRSP where the DRSP expressly renounces its authorization. ESMA’s withdrawal decision follows the notification by Euronext of its intention to renounce its authorization under the conditions set out in Article 27e(a) of MIFIR.
ESMA Publishes Latest Edition of its Newsletter. On February 13, ESMA published  its latest edition of the Spotlight on Markets Newsletter. The newsletter focused on the last ESMA consultation package related to the Markets in Crypto Assets Regulation (MiCA). ESMA invited stakeholders to send their feedback on reverse solicitation and classification of crypto assets as financial instruments by April 29, 2024. The newsletter also launched a call for candidates for ESMA’s Securities Markets Stakeholder Group and called interested parties who can give a strong voice to consumers, industry, users of financial services, employees in the financial sector, SMEs as well as academics to apply by March 18.
Hong Kong Government Launches Consultation on Regulating OTC Trading of Virtual Assets. On February 8, the Hong Kong government launched a public consultation on legislative proposals to introduce a licensing regime for providers of over-the-counter trading services of virtual assets (VAs). Under the proposed licensing regime, any person who conducts a business in providing spot trading services of VAs-for-money or money-for-VAs will be required to be licensed by the Commissioner of Customs and Excise, irrespective of whether the services are provided through a physical outlet and/or digital platforms. Licensees will be required to comply with AML/CFT requirements and other regulatory requirements. The public consultation period ends on April 12, 2024.
HKMA Consults on Capital Treatment of Cryptoasset Exposures. On February 7, the Hong Kong Monetary Authority (HKMA) published a Consultation Paper on CP24.01 Cryptoasset Exposures setting out a proposal for implementing new regulations on the prudential treatment of cryptoasset exposures based on the Basel Committee on Banking Supervision’s Prudential treatment of cryptoasset exposures standard. According to the consultation paper, for the purpose of the prudential treatment of cryptoasset exposures, cryptoassets will be defined as private digital assets that depend on cryptography and distributed ledger technologies or similar technologies. The HKMA has scheduled a preliminary consultation on the proposed amendments to the rules in the second half of 2024 and aims to put new standards into effect no earlier than July 1, 2025.
EU Co-Legislators Reach Provisional Agreement on EMIR 3. On February 6, the EU co-legislators reached a provisional political trilogue agreement on the EMIR 3. On the issue of an active account requirement, while the agreement is based on the less punitive operational active account with representativeness approach proposed by the Council of the EU, the European Parliament has proposed that counterparties should clear at least five trades through an EU CCP in each of the most relevant subcategories. The original approach proposed by the council only required one trade per relevant subcategory. On the topic of supervision, the agreement includes a new role for the European Securities and Markets Authority (ESMA) as co-chair of CCP supervisory colleges alongside national competent authorities and a coordinating role in an emergency.
ESA’s Joint Board of Appeal Confirms ESMA’s Decision to Withdraw the Recognition of Dubai Commodities Clearing Corporation. On February 6, the Joint Board of Appeal of the European Supervisory Authorities (the ESAs) unanimously decided to dismiss the appeal brought by Dubai Commodities Clearing Corporation (DCCC) against ESMA and to therefore confirm the ESMA decision to withdraw its recognition. The application was brought in relation to ESMA’s Decision, adopted under Article 25p of Regulation (EU) No 648/2012 (EMIR), to withdraw the recognition of DCCC as a Tier 1 third-country CCP. The decision is a consequence of the United Arab Emirates (UAE) being included by the European Commission on the list of high-risk third countries presenting strategic deficiencies in their national anti-money laundering and counter financing of terrorism (AML/CFT) regime, provided for in the Commission Delegated Regulation (EU) 2016/1675. The Joint Board of Appeal of the ESAs had decided to suspend the ESMA decision in October 2023 until the outcome of the appeal was concluded. With today’s publication, the suspension has expired and the ESMA decision has become fully operational.

New Industry-Led Developments

ISDA Responds to FCA on Commodity Derivatives. On February 15, ISDA and the Association for Financial Markets in Europe (AFME) submitted a joint response to the UK Financial Conduct Authority (FCA) consultation on the reform of the UK commodity derivatives regulatory framework. The consultation sought to remove unnecessary burdens on firms and strengthen the supervision of the UK’s commodity derivatives markets. The associations indicated that they strong support the FCA’s proposal to apply a narrower position limits regime that it views as more proportionate to the risks associated with certain commodity derivatives contracts. However, the associations expressed concern over the proposed approaches for setting position limits and adding additional reporting obligations. They noted that the complex and burdensome frameworks proposed can, in their view, discourage participation in UK trading venues by non-UK participants and may have a negative impact on the competitiveness of UK markets. The response also recommends a longer implementation period of at least 24 months, based on the association’s perception of the scale of the operational and technical changes required. [NEW]
ISDA Responds to Australian Treasury on Financial Market Infrastructure Reforms. On February 9, ISDA and the Futures Industry Association submitted a joint response to the Australian Treasury’s draft financial market infrastructure reform package. In the response, the associations considered the proposed crisis resolution regime, which would provide the Reserve Bank of Australia (RBA) with powers to step in and resolve a crisis affecting a domestic CCP, with the aim of ensuring the continuity of critical clearing functions and maintaining financial stability in Australia. The associations expressed concerns with some of the provisions contemplated in the draft regime and asked if the issues highlighted in the response (such as the ability of the RBA or statutory manager to direct and make changes to the operating rules, the lack of explicit definitions of and safeguards on resolution powers and the interaction with close-out netting) could be addressed.

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])

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 revised Notice introduces new chapters on market definition in specific circumstances, notably markets characterized by significant R&D, multi-sided platforms, and digital ecosystems.

On 8 February 2024, the European Commission (“Commission”) updated its Market Definition Notice (“Notice”) for the first time since its initial publication in 1997. The revised guidance softens the rigidity of the Commission’s earlier approach and grants it more flexibility in competition assessments – particularly in relation to digital and R&D intensive markets. Companies active in these sectors should see the update as a tool to support the Commission’s stricter enforcement agenda.

A. Background

The 1997 Notice

The original Notice was published over 25 years ago. It aimed to provide companies with official guidance on how the Commission applies the concepts of relevant product and geographic market in its enforcement of EU competition law. To this day, market definition plays a pivotal role in competition enforcement. Competition authorities define the relevant market as a first step in both behavioral cases and merger control. It provides a framework for analyzing the competitive situation and identifying potential competitive constraints.

Commission’s evaluation of the 1997 Notice

The Commission acknowledged that, since publication of the 1997 Notice, there have been significant societal and technological changes, including the rise of digitalization. These changes, in conjunction with developments in EU case law and the Commission’s decisional practice, warranted re-evaluation of the Market Definition Notice.

The results of the evaluation were published in July 2021:

Despite calls from stakeholders for a more progressive approach, the Commission confirmed that, in general, market definition (and the principles on which it rests) will remain of central importance going forward.
Nevertheless, the Commission recognized the need for changes in, or additions to, individual areas, notably: digitalization, innovation, geographic market definition, and quantitative techniques. This largely follows the direction of EU court case law and the Commission’s own practice.

A revised draft of the Notice was published for consultation in November 2022. More than 100 stakeholders responded. On 8 February 2024, the final version was adopted.

B. Key takeaways of the revised Notice

While the Commission’s fundamental approach to market definition remains the same (i.e., examining demand- and supply-side substitution, product and geographical market), the revised Notice introduces the following key changes:

Relevance of non-price comparators. While the 1997 Notice focused on price as the main parameter of competition for market definition, the revised Notice adopts a broader approach. For example, it considers that the SSNIP test[1] may be ill-suited to cases where undertakings compete on parameters other than price.[2] In such instances, non-price factors such as product characteristics (including product quality or level of innovation), functionalities and intended use, might be more determinative for demand substitution.[3] This might be particularly relevant in situations involving multi-sided platforms.[4] In such cases, the Commission suggests analyzing switching behavior of customers in response to a Small but Significant Non-transitory Decrease of Quality (“SSNDQ”).[5]

Forward-looking assessment to capture market dynamics. The revised Notice states that, in markets undergoing structural transition (such as regulatory or technological changes) or where a forward-looking assessment may be appropriate, future market shares may be estimated to reflect those expected changes.[6] This chimes with the Commission’s recent merger control practice. Notably, the revised Notice states that internal ordinary course documents or independent industry reports may be particularly relevant for conducting a forward-looking assessment.[7]

Along with general guidance, the revised Notice also provides specific direction on the Commission’s approach to market definition in cases where there is: (i) significant differentiation, (ii) discrimination between customers or customer groups, (iii) significant R&D, (iv) multi-sided platforms, (v) after-markets, bundles and (digital) ecosystems.

We consider the Commission’s guidance on (iii)-(v) in more detail below.

Market definition in specific circumstances

(1) Market definition in the presence of significant R&D

Examples of industries characterized by significant R&D include pharmaceuticals, chemicals, electrical equipment, and hardware technology. The Commission explains that, while the specificities of highly innovative industries are usually taken into account during the competitive assessment, they may also be relevant for market definition. In particular, the Commission may factor in various potential outcomes of innovation efforts in its assessment of market definition.

For ‘pipeline’ products (where products are not yet available to customers), the Commission notes that there may be sufficient visibility to establish which other products are likely to be substitutable with the pipeline product. In such cases, the Commission can conclude on whether the pipeline products belong to an existing product market or a new product market.[8] However, where an R&D project is in the early stages of development,[9] the Commission concedes that it may be difficult to identify a relevant product market. However, it may still be possible to delineate the boundaries within which companies compete in early innovation efforts.[10] Factors that may be taken into account include the nature and scope of innovation efforts, the objectives of the research, and the specialization of the teams involved.

(2) Market definition in the presence of multi-sided platforms

The Commission uses the term multi-sided to refer to platforms which support interactions between different groups of users. It considers that often, demand from one group of users will have an influence on demand from others i.e., indirect network effects. Examples include payment card systems, online marketplaces, advertising-sponsored platforms, social networking services, and general search services.

The revised Notice is intended to afford the Commission with the flexibility to define a relevant product market in a way that encompasses all (or multiple) user groups, or to define separate relevant markets for the products offered on each side of the platform.[11] This will depend on factors such as the nature of the platform, the degree of product differentiation on each side, and the behavior of each user group (such as multi-homing i.e., using multiple platforms in parallel), among other things.

The Commission explains that multi-sided platforms often supply products at a monetary price of zero, a fact that it considers will render application of the SSNIP test more challenging. It also highlights that, when a product is supplied at a monetary price of zero, non-price elements become more relevant as does evidence on hypothetical substitution, and barriers or costs of switching such as interoperability.[12]

(3) Market definition in the presence of after-markets, bundles and digital
ecosystems

The Notice defines an after-market as a market where customers who buy a primary product are likely to buy a connected or complementary follow-on (secondary) product. Examples include cars and auto parts/repair services, printers and ink cartridges, etc.[13] In these circumstances, the Commission will also consider the competitive constraints imposed by market conditions in the respective connected markets when defining the relevant market(s).

The Commission lists three possible ways to define relevant product markets in the case of primary and secondary products: (i) as a system market comprising both the primary and the secondary product, (ii) as multiple markets, namely a market for the primary product and separate markets for the secondary products associated with each brand of the primary product, and (iii) as two markets, namely the market for the primary product on the one hand and the market for the secondary product on the other hand.

The Notice also makes reference to digital ecosystems.[14] This section of the revised Notice is likely to play a significant role in the coming years, considering the Commission’s increased scrutiny on interoperability in its recent decisional practice.[15]

C. Conclusion

How markets are defined will continue to play a central role in competition assessments. Market definition will remain the first step in the Commission’s analysis of any proposed transaction and any potential behavioral case. How the Commission views the relevant markets will lay the groundwork for all subsequent analysis, including on the existence of a dominant position and potential anticompetitive effects.

The revised Notice introduces new chapters on market definition in specific circumstances, notably markets characterized by significant R&D, multi-sided platforms, and digital ecosystems. The Notice leaves many questions open and seeks to allow for a less rigorous and more speculative assessment in order for the Commission to enjoy greater flexibility to pursue stricter enforcement in digital and R&D-intensive markets. Time will tell if such speculative analysis will withstand scrutiny from the Courts.

__________

[1] “Small but Significant and Non-transitory Increase in Price”.

[2] Revised Market Definition Notice, para. 30.

[3] Revised Market Definition Notice, para. 48.

[4] Revised Market Definition Notice, para. 98.

[5] At footnote 54 of the Notice, the Commission refers to case AT.40099 Google Android as an example of a case in which it used the SSNDQ test to determine the boundaries of the relevant market.

[6] Revised Market Definition Notice, para. 113.

[7] Revised Market Definition Notice, para. 77.

[8] At footnotes 121 and 122 of the Notice, the Commission refers to i) case M.7275 Novartis/GlaxoSmithKline Oncology Business as an example of a case in which it included pipeline products still under development in an existing relevant market, alongside products that were already marketed; and, conversely, ii) case M9461 AbbVie/Allergan as an example of a case in which it identified a new relevant market limited to a specific type of inhibitor for the treatment of ulcerative colitis and Crohn’s disease, even though no such inhibitor was, at the time, marketed by any supplier.

[9] The Commission makes clear at footnote 9 of the Notice that the term “product” also covers technologies.

[10] At footnote 125 of the Notice, the Commission refers to case M.7932 Dow/DuPont as an example of a case in which it applied the concept of innovation space to determine that the merging parties were involved in innovation competition.

[11] At footnote 129, the Commission refers to case M.8124 Microsoft/LinkedIn as an example of a case in which it defined a single market which included user groups on either side of the platform.

[12] See for instance Cases M.7217 Facebook/Whatsapp, AT.39740 Google Search (Shopping), M.8124 Microsoft/LinkedIn, AT.40099 Google Android.

[13] OECD, Competition issues in aftermarkets, June 2017 available here.

[14] At footnotes 142 and 143, the Commission refers to i) the judgment in Google and Alphabet v Commission T-604/18, where the General Court defined a digital ecosystem and noted the complementarity/interoperability of the products which would form such an ecosystem, highlighting the potential competitive constraints which such a system may give rise to; and ii) case AT.40099 Google Android as an example of a case where the conditions necessary to give rise to an ecosystem comprising app stores and smartphone operating systems were not present.

[15] E.g., European Commission, Mergers: Commission clears acquisition of VMware by Broadcom, subject to conditions, July 2023 available here.

The following Gibson Dunn attorneys prepared this update: Christian Riis-Madsen, Nicholas Banasevic, Katherine Nobbs, Hayley Smith, Jonas Jousma, and Alex O’Donnell*.

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

Antitrust and Competition:
Nicholas Banasevic* – Managing Director, Brussels (+32 2 554 72 40, [email protected])
Rachel S. Brass – San Francisco (+1 415.393.8293, [email protected])
Ali Nikpay – London (+44 20 7071 4273, [email protected])
Cynthia Richman – Washington, D.C. (+1 202.955.8234, [email protected])
Christian Riis-Madsen – Brussels (+32 2 554 72 05, [email protected])
Stephen Weissman – Washington, D.C. (+1 202.955.8678, [email protected])

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

Private Equity:
Richard J. Birns – New York (+1 212.351.4032, [email protected])
Wim De Vlieger – London (+44 20 7071 4279, [email protected])
Federico Fruhbeck – London (+44 20 7071 4230, [email protected])
Scott Jalowayski – Hong Kong (+852 2214 3727, [email protected])
Ari Lanin – Los Angeles (+1 310.552.8581, [email protected])
Michael Piazza – Houston (+1 346.718.6670, [email protected])
John M. Pollack – New York (+1 212.351.3903, [email protected])

Technology Transactions:
Daniel Angel – New York (+1 212.351.2329, [email protected])
Carrie M. LeRoy – New York (+1 650.849.5337, [email protected])

*Nicholas Banasevic, Managing Director in the firm’s Brussels office and an economist by background, is not admitted to practice law.

*Alex O’Donnell, a legal trainee in the Brussels office, is not admitted to practice law.

The SEC Staff advises that private fund sponsors that wish to exclude the impact of subscription credit facilities when showing a gross internal rate of return in their performance track records also must exclude such impact when showing the corresponding net internal rate of return.

On February 6, 2024, the staff of the U.S. Securities and Exchange Commission (the “SEC Staff”) updated its Marketing Compliance Frequently Asked Questions with respect to the Advisers Act Marketing Rule[1] (the “Marketing Rule”) to issue new interpretive guidance (the “FAQ”) regarding the presentation of investment performance for private investment funds that utilize fund-level subscription credit facilities.[2]

In particular, the SEC Staff advised that private fund sponsors that wish to exclude the impact of subscription credit facilities when showing a gross internal rate of return (“Gross IRR”) in their performance track records must also exclude such impact when showing the corresponding net internal rate of return (“Net IRR”). According to the SEC Staff, doing otherwise would violate the Marketing Rule’s requirement that any presentation of Gross IRR must be accompanied by Net IRR that has been calculated over the same time period and uses the same type of return and methodology as the gross performance.

In addition, the SEC Staff also took the position that it would be impermissible under the general prohibitions set forth in the Marketing Rule[3] for a private fund sponsor to use performance presentation that shows only a Net IRR that includes the impact of a fund-level subscription credit facility without also including (i) a Net IRR that does not include the impact of such facility or (ii) “appropriate disclosures”[4] describing such facility’s impact on the provided net performance.[5]

In light of the FAQ, we advise that all private fund sponsors promptly review their PPMs, pitchbooks, and related marketing materials for compliance with the new interpretive guidance summarized above.

__________

[1] Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended.

[2] “Subscription credit facilities” broadly include any borrowing secured by the unfunded capital commitments of a fund’s investors, such as subscription line financings, capital call facilities, and bridge lines.

[3] Rule 206(4)-1(a).

[4] The FAQ does not clarify what would constitute an “appropriate disclosure” in this context, though we believe it would include, at minimum, a clear statement that the Net IRR takes into account leverage, which may make the returns higher than what they would have been without the use of such leverage.

[5] A sponsor that complies with this requirement would not also need to show a corresponding gross figure, as the Marketing Rule does not generally require the inclusion of gross performance any time net performance is shown.

The following Gibson Dunn lawyers assisted in preparing this update: Kevin Bettsteller, Greg Merz, Shannon Errico, and Robert Harrington.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding the issues and considerations discussed above. 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 Investment Funds practice group:

Jennifer Bellah Maguire – Los Angeles (+1 213.229.7986, [email protected])
Kevin Bettsteller – Los Angeles (+1 310.552.8566, [email protected])
Albert S. Cho – Hong Kong (+852 2214 3811, [email protected])
Candice S. Choh – Los Angeles (+1 310.552.8658, [email protected])
John Fadely – Singapore (+65 6507 3688, [email protected])
A.J. Frey – Washington, D.C./New York (+1 202.887.3793, [email protected])
Shukie Grossman – New York (+1 212.351.2369, [email protected])
James M. Hays – Houston (+1 346.718.6642, [email protected])
Kira Idoko – New York (+1 212.351.3951, [email protected])
Gregory Merz – Washington, D.C. (+1 202.887.3637, [email protected])
Eve Mrozek – New York (+1 212.351.4053, [email protected])
Roger D. Singer – New York (+1 212.351.3888, [email protected])
Edward D. Sopher – New York (+1 212.351.3918, [email protected])
William Thomas, Jr. – Washington, D.C. (+1 202.887.3735, [email protected])

An overview of recent developments, including a U.S. Supreme Court case addressing Item 303 of Regulation S-K; significant Delaware corporate law cases; recent decisions involving special purpose acquisition companies; securities litigation involving ESG-related allegations; notable cryptocurrency cases; and other matters.

This update provides an overview of the major developments in federal and state securities litigation since our 2023 Mid-Year Securities Litigation Update:

We discuss a major addition to the Supreme Court’s October Term, in which the Court will address the extent to which Item 303 of Regulation S-K can subject a filing company to private shareholder suits. We also discuss a lower-court development calling attention to a circuit split that may end up before the Supreme Court.
We review significant developments in Delaware corporate law, including those related to the high pleading bar plaintiffs must clear to successfully bring a duty of oversight (or Caremark) claim, advance notice bylaws, lost merger-premium provisions, books and records demands, and identity-based allocations of voting power. We also discuss a case with potentially significant implications for transactions involving controlling stockholders.
We review developments in federal securities litigation involving special purpose acquisition companies (“SPACs”), including two recent decisions addressing scienter in the SPAC context.
We examine several developments in securities litigation involving environmental, social, and corporate governance-related allegations.
We survey notable developments in cryptocurrency litigation and regulation and address certain technological developments in the industry as well.
We continue to monitor developments regarding the Supreme Court’s 2019 decision Lorenzo v. SEC, in which the Court expanded the scope of scheme liability by finding that even if the disseminator of a false statement did not “make” that false statement within the meaning of Rule 10b-5(b), they may still be liable under Rule 10b-5(a) and (c) if they disseminate a false statement with intent to defraud. As discussed in our prior updates, following Lorenzo, lower courts continue to grapple with what conduct is sufficient to maintain a scheme liability claim.
We provide an update on the long-running class certification dispute in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc. and discuss how district courts are applying the Supreme Court’s guidance.
Finally, we address several other notable developments including: Omnicare developments out of the Third and Second Circuits; the Second Circuit and the Southern District of New York declining to enforce control share acquisition provisions; the Ninth Circuit ruling that SEC Rule 16b-3 does not require purpose-specific board approval of transactions; and updates in the cybersecurity litigation arena.

I. FILING AND SETTLEMENT TRENDS

Data from a recent NERA Economic Consulting (“NERA”) study illustrates several trend changes. Federal securities litigation filings in 2023 increased compared to filings in 2022 and 2021. At the same time, “Health and Technology Services” and “Electronic Technology and Technology Services” filings—which represented over 50% of filings last year—decreased significantly on a relative basis. Cryptocurrency filings also decreased, from 26 filings in 2022 to 16 filings in 2023. Meanwhile, “Finance” sector filings increased to 18%, and “Producer and other Manufacturing” sector filings doubled on a relative basis. Settlement values—excluding merger-objection cases, crypto unregistered securities cases, and cases settling for more than $1 billion or $0 to the class—stayed relatively consistent. The average settlement value decreased from $37 million to $34 million, while the median settlement value increased from $13 million to $14 million.

A. Filing Trends

Figure 1 below reflects the federal filing rates from 1996 through 2023 (all charts courtesy of NERA). 228 federal cases were filed in the past year. This is a slight increase in filings compared to 2022 and 2021, but still nowhere near the number of filings in the peak years of 2017-2019. Note, however, that this figure does not include class action suits filed in state court or state court derivative suits, including those in the Delaware Court of Chancery.

Figure 1:

B. Mix Of Cases Filed In 2023

1. Filings By Industry Sector

The distribution of non-merger objections and non-crypto unregistered securities filings, as shown in Figure 2 below, had some slight variations this year compared to previous years. Notably, the “Health and Technology Services” sector percentage was the lowest it has been in the last five years, dropping from 27% to 19% in the past year. “Electronic Technology and Technology Services” filings also decreased compared with the two prior years. Thus, while “Health and Technology Services” and “Electronic Technology and Technology Services” filings accounted for over 50% of filings in both 2021 and 2022, that total decreased to 41% this year. Meanwhile, “Finance” sector filings increased steeply on a relative basis, from 8% to 18%, and filings related to the “Producer and Other Manufacturing” sector doubled on a relative basis from 3% to 6%.

Figure 2:

2. Merger Cases

As shown in Figure 3 below, there were seven merger-objection cases filed in federal court in 2023. This continues the downward trend of merger objection filings, beginning in 2020.

Figure 3:

3. Cryptocurrency Cases

Figure 4 below illustrates the trends in cryptocurrency filings in federal court from 2016 through 2023. This past year, there were 11 crypto unregistered securities filings and five crypto shareholder filings, matching the numbers for 2018. The number of both types of crypto filings decreased from 2022, with the number of crypto shareholder filings cut in half and the number of crypto unregistered securities filings decreasing by 31%.

Figure 4:

C. Settlement Trends

As reflected in Figure 5 below, the average settlement value in 2023 reached $34 million, dropping compared to the average value in 2022 of $37 million. (Note that the average settlement value excludes merger-objection cases, crypto unregistered securities cases, and cases settling for more than $1 billion or $0 to the class.)

Figure 5:

As for median settlement value, Figure 6 shows that the value remained relatively even for 2023 at $14 million. This median value has been consistent over the past 5 years, excluding the low outlier in 2021. (Note that median settlement value excludes settlements over $1 billion, merger objection cases, crypto unregistered securities cases, and zero-dollar settlements.)

Figure 6:

Figure 7:

Finally, as shown in Figure 7, Median NERA-Defined Investor Losses decreased slightly in 2023 to $923 million from $984 million in 2022. This remains relatively high compared to prior years. The Median Ratio of Settlement to Investor Losses continued to hold steady at 1.8% for the third straight year.

II. WHAT TO WATCH FOR IN THE SUPREME COURT

A. Pending Before The Supreme Court: Macquarie Infrastructure Corp. v. Moab Partners, L.P. – Private Actions Based On Violations Of Item 303

On January 16, 2024, the Supreme Court heard argument in Macquarie Infrastructure Corp. v. Moab Partners, L.P., a case with significant implications for securities class actions. The petition in that case presented one question for the Court’s review: whether a failure to make a disclosure required under Item 303 of SEC Regulation S-K can support a private claim under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, even in the absence of an otherwise-misleading statement. Petition for a Writ of Certiorari at i, 1, Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 (May 30, 2023).

As background, Item 303 is an SEC regulation that requires public companies to disclose in their filings with the SEC any “known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact” on the company’s financial condition. 17 C.F.R. § 229.303(b)(2)(ii). Although at least some courts have indicated that a violation of Item 303 does not give rise to a direct private right of action, see Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307, 1330 (11th Cir. 2019), plaintiffs in this case pursued their Item 303 claim under Section 10(b) of the Exchange Act and Rule 10b-5. Under those provisions, investors may bring a private action against a company to recover losses caused by, among other things, a the company’s material misrepresentations or omissions. City of Riviera Beach Gen. Emps. Ret. Sys. v. Macquarie Infrastructure Corp., 2021 WL 4084572, at *6-7 (S.D.N.Y. Sept. 7, 2021).

Plaintiffs alleged that defendant Macquarie Infrastructure and related parties violated Section 10(b) and Rule 10b-5 by virtue of a “host of . . . misstatements and omissions” about a then-anticipated marine fuel regulation that could affect Macquarie’s financial condition. Id. at *2, *6-7. Specific allegations included that defendants were required under Item 303 to disclose some uncertainty regarding the pending regulation, and that the failure to disclose any uncertainty was a materially misleading omission actionable under Rule 10b-5. See id. at *10.

On September 7, 2021, a district judge in the Southern District of New York dismissed plaintiffs’ case in its entirety. Id. at *13. As to plaintiffs’ theory of omissions under Item 303, the district court found that plaintiffs had not alleged any “uncertainty that should have been disclosed”; “in what SEC filing or filings Defendants were supposed to disclose it”; that any uncertainty was material enough that it needed to be disclosed under Item 303; or the time at which “Defendants ‘actually kn[ew]’” of any uncertainty that should have been disclosed earlier than February 2018. Id. at *4, *10. But on appeal, the Second Circuit vacated the district court’s dismissal. Moab Partners, L.P. v. Macquarie Infrastructure Corp., 2022 WL 17815767, at *2 (2d Cir. Dec. 20, 2022). It explained that “[t]he failure to make a material disclosure required by Item 303 can serve as the basis for . . . a claim under Section 10(b) if the other elements have been sufficiently pleaded” and held that plaintiffs had met that pleading standard. Id.

The Second Circuit’s ruling in Macquarie raised an opportunity for the Supreme Court to review an apparent split between the Second Circuit’s approach and that of the Third, Ninth, and Eleventh Circuits. Those courts held that, because Item 303 relies on a different disclosure standard than Rule 10b-5, an Item 303 violation does not, on its own, constitute an actionable omission under Rule 10b-5. See Carvelli, 934 F.3d at 1331; In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1056 (9th Cir. 2014); Oran v. Stafford, 226 F.3d 275, 288 (3d Cir. 2000). The Court had granted certiorari in an earlier case presenting this issue, but the parties in that case, Leidos, Inc. v. Indiana Public Retirement System, No. 16-581, agreed to a settlement before the Court heard oral argument. See Petition for a Writ of Certiorari at 1, Macquarie Infrastructure Corp. (citing Leidos); Gibson Dunn Client Alert (Apr. 3, 2017). Macquarie, now fully briefed and argued, is thus expected to bring clarity to this area.

B. Lower Court Development: SEC v. Govil Deepens Circuit Split

On October 31, 2023, the Second Circuit issued its opinion in SEC v. Govil, highlighting a circuit split between the Second and Fifth Circuits on the nature of the disgorgement remedy available under the Exchange Act. 86 F.4th 89 (2d Cir. 2023). For a more detailed discussion of the facts and holding of Govil, please see our November 16, 2023 Client Alert.

The split arises from the courts’ different interpretations of the Supreme Court’s 2020 decision in SEC v. Liu and Congress’ subsequent amendment of the Exchange Act. 591 U.S. ___, 140 S. Ct. 1936 (2020); 15 U.S.C. §§ 78u(d)(5) & 78u(d)(7). In Liu, the Supreme Court interpreted the term “equitable relief” in 15 U.S.C. § 78u(d)(5), which since 2002 had been recognized as expressly authorizing disgorgement as a remedy for violations of securities law. Liu, 140 S. Ct. at 1940; see also Govil, 86 F.4th at 99. The Court in Liu held that certain equitable limits apply to this disgorgement remedy, including that a proper disgorgement award must be “awarded for victims” and must not “exceed a wrongdoer’s net profits.” Liu, 140 S. Ct. at 1940, 1947. Then, six months after Liu was decided, Congress enacted 15 U.S.C. § 78u(d)(7), which expressly permits the SEC to “seek,” and federal courts to “order,” the remedy of “disgorgement.”

Before Govil, the Second and Fifth Circuit reached competing views of the effect of that statutory amendment. First, in SEC v. Hallam, the Fifth Circuit held that § 78u(d)(7) did not codify Liu’s more stringent evidentiary and procedural requirements; instead, Congress’ action was “consistent with a desire to curtail” Liu’s impact, so that the SEC could seek “disgorgement in a legal—not equitable—sense” under § 78u(d)(7), as it could before Liu. 42 F.4th 316, 334-35, 338-41 (5th Cir. 2022). The following year, in SEC v. Ahmed, the Second Circuit interpreted “disgorgement” under § 78u(d)(7) to be subject to the same limitations that Liu imposed on “equitable relief” under § 78u(d)(5). 72 F.4th 379, 296 (2d Cir. 2023). In doing so, the Second Circuit expressly disagreed with the Fifth Circuit’s approach in Hallam. See id. at 395 & n.7.

In Govil, the Second Circuit followed Ahmed, applying § 78u(d)(7) as cabined by Liu. Govil, 86 F.4th at 101-02. Govil thus held that, before ordering disgorgement, the district court was required to find that investors defrauded by a defendant’s actions had suffered pecuniary harm. Id. at 94, 105. In the absence of a finding of harm, the Second Circuit held that the district court abused its discretion by ordering disgorgement as a remedy. Id. Further, even if investors were found to have been harmed, the district court also erred by not “undertaking a valuation” of the securities defendant had already surrendered to the company. Id. at 110-11. In issuing the disgorgement order without valuing the assets already turned over to potential victims, the district court order risked “forcing [the] defendant to pay disgorgement twice,” which would “amount[] to a penalty” impermissible under Liu. Id. at 107. Accordingly, the Second Circuit vacated the district court’s judgment and remanded with instructions to find whether “the defrauded investors suffered pecuniary harm.” Id. at 111.

In reaching this decision, the court explicitly noted the circuit split, reviewing the Hallam decision and recognizing that the Fifth Circuit’s reasoning had relied on “familiar principles of statutory interpretation.” Id. at 100-02. The court also noted that the split could be outcome-determinative in cases like Govil because the Hallam rule “might authorize disgorgement” on Govil’s facts, even without a finding that affected investors were “victims” who had suffered pecuniary loss. Id. at 102 n.13.

Although it follows Second Circuit precedent in recognizing a narrower path for the SEC to seek—and courts to grant—disgorgement, Govil highlights both the existence of the post-Liu circuit split on disgorgement and its potential stakes for defendants.

III. DELAWARE DEVELOPMENTS

Delaware law has continued to develop apace over the last six months, and significant new developments are expected in the year ahead. In December 2023, the Delaware Supreme Court heard oral argument in a case that could substantially alter the landscape for transactions involving a controlling stockholder. Delaware courts also continued issuing decisions in the wake of the SEC’s Universal Proxy rule, which we discussed in our 2023 Mid-Year Securities Litigation Update; so far, Delaware courts have taken a measured approach. Courts continue to confront Caremark claims and reiterate the relatively narrow circumstances in which such claims arise. Other recent decisions applied traditional Delaware law principles to emerging dynamics—e.g., the application of case law regarding books and records demands when the demand is by a potential activist investor, and the application of Sections 151(a) and 212(a) to a certificate of incorporation that provides greater voting power to a subset of entities and individuals than to other stockholders. Finally, the Delaware Court of Chancery recently narrowed the enforceability of a “Con Ed” provision allowing a target company to seek lost stockholder premium as damages resulting from an acquiror’s breach in a failed merger.

A. The Delaware Supreme Court Considers Burdens In Conflicted Controller Transactions

In December 2023, the Delaware Supreme Court heard oral argument in In re Match Group, Inc. Derivative Litigation, a case that could clarify when burdens of proof and standards of review shift in allegedly conflicted controller transactions.

At issue in In re Match Group, Inc. Derivative Litigation is a “multi-step reverse spinoff initiated by a controller.” 2022 WL 3970159, at *1 (Del. Ch. Sept. 1, 2022). After concluding that “the process as pled satisfied MFW,” the Court of Chancery applied the deferential business judgment standard and dismissed the case. Id. MFW, which involved a squeeze-out merger, provided that, “in controller buyouts, the business judgment standard of review w[ould] be applied if and only if” several factors were met. Kahn v. M & F Worldwide Corp., 88 A.3d 635, 645 (Del. 2014). Among them is the requirement that a controller “condition[] the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders.” Id.

Plaintiffs then appealed to the Delaware Supreme Court. Relevant here, they argued that the Court of Chancery erred in concluding that MFW can be satisfied when less than the entire special committee is independent. Appellants’ Opening Brief at 18-22, In re Match, 2022 WL 3970159, Dkt. 24 (Dec. 2, 2022).

In response, a group of defendants argued that plaintiffs should carry the burden when something less than MFW is satisfied in conflicted controller transactions outside the merger squeeze-out context. See, e.g., Corrected Answering Brief of IAC Defendants at 8-10, In re Match, 2022 WL 3970159, Dkt. 57 (Jan 12, 2023). In their view, the Supreme Court should put an end to “MFW creep”—i.e., the gradual “expan[sion of] MFW’s scope.” Id. at 1-2.

After the initial round of briefing, the Delaware Supreme Court requested supplemental briefing on the issue. See Supplemental Briefing Order, In re Match Grp., Inc. Deriv. Litig. at 3, No. 368, 2022 (Del.), Dkt. 58 (requesting briefing on “whether the Court of Chancery judgement should be affirmed because [the at-issue] [t]ransactions were approved by either (a) [a special committee] or (b) a majority of the minority stockholder vote?”).

Affirming on the basis that the transactions were approved by either a special committee or a majority of the minority stockholder vote in the context of a conflicted controller transaction other than a squeeze-out merger would indicate that plaintiffs bear the burden when something less than MFW is satisfied. But whichever path it takes—confining MFW to controller squeeze-out mergers or endorsing its application to other contexts—the Supreme Court’s opinion, should it rule on this basis, could alter the playing field considerably.

B. Delaware Courts Begin Addressing Advance Notice Bylaws In The Wake Of The SEC’s Universal Proxy Rule

Since the Universal Proxy rule—discussed in our 2023 Mid-Year Update—took effect, the Delaware Court of Chancery “has only begun to hear disputes involving the wave of new and amended advance notice bylaws.” Kellner v. AIM Immunotech Inc., — A.3d —, 2023 WL 9002424, at *15 (Del. Ch. Dec. 5, 2023). Although early days, the decision discussed below indicates that Delaware courts are taking a measured approach. See, e.g., id. at *15 (“[I]t is apparent that the court must—more than ever—carefully balance the competing interests at play.”).

In Kellner v. AIM Immunotech Inc., the Court of Chancery reviewed a set of bylaws prompted, in part, by prior “activist activity.” 2023 WL 9002424, at *9. According to counsel for AIM, the group of activists had “engag[ed] in efforts to conceal who was supporting and who was funding the nomination efforts and to conceal the group’s plans for the Company.” Id. This decision arises out of a “renewed nomination attempt” made by a similar group, albeit one described as “smarter” “in many ways” “than the preceding effort.” Id. at *1.

In the end, the decision “is a tale of wins and losses on both sides.” Id. For plaintiff, for example, the court concluded that his notice “contravened valid bylaws” and “suffer[ed] from the same primary defect as his predecessor’s: it obscure[d] obvious arrangements or understandings pertaining to the nomination.” Id.

For defendants, certain bylaws were held invalid “because they inequitably imperil[ed] the stockholder franchise to no legitimate end.” Id. at *1, *16. To that end, the court reviewed the bylaws under enhanced scrutiny, asking first “whether the board faced a threat to an important corporate interest or to the achievement of a significant corporate benefit,” and, second, “whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise.” Id. at *17 (citation and quotation marks omitted).

After concluding that the Board’s response was objectively reasonable at step one, the court found that the Board “failed to show that certain of the provisions [we]re proportionate in relation to [the Board’s] objectives.” Id. For example, one provision generally required “the disclosure of all arrangements, agreements, or understandings [“AAUs”] ‘whether written or oral, and including promises,’ relating to a Board nomination.” Id. at *19. In addition, the provision contained a “a bespoke 24-month lookback provision” and required “a nominating stockholder to disclose AAUs both with persons acting in concert with the stockholder and any”—broadly defined—”‘Stockholder Associated Person’ (or ‘SAP’).” Id. at *20-21. This latter requirement was where the provision went “off the rails,” as it created “an ill-defined web of disclosure requirements” more “akin to a tripwire than an information gathering tool.” Id. at *22. In short, it “render[ed] the AAU Provision overbroad, unworkable, and ripe for subjective interpretation by the Board.” Id. In addition, the Board “presented no evidence to suggest that” it was “proportionate to its objective of preventing stockholders from misconstruing and evading the Amended Bylaws’ disclosure requirements.” Id

As another example, the bylaws required “the nominator and nominees to list all known supporters.” Id. at *23. AIM argued that the bylaw was consistent with a prior decision, Rosenbaum v. CytoDyn, Inc., 2021 WL 4775140 (Del. Ch. Oct. 13, 2021). (Discussed in our 2021 Year-End Update.) The court disagreed, noting the provision went “farther than what the precedent supports.” Kellner, 2023 WL 9002424, at *23. Whereas, the court explained, CytoDyn concerned a bylaw mandating the disclosure of known financial supports, the bylaw at issue in AIM “s[ought] disclosure of any sort of support whatsoever, including that of other stockholders known by SAPs to support the nomination.” Id. As a result, its “limits . . . [we]re ambiguous—both in the terms of the types of support and supporters one must disclose.” Id. Accordingly, it “impede[d] the stockholder franchise while exceeding any reasonable approach to ensuring thorough disclosure.” Id.

This decision “hints at what coming activism disputes may bring,” id. at *1, and Gibson Dunn will follow future developments.

C. Delaware Courts Reiterate The Requirements For Pleading Caremark Claims

In In re ProAssurance Corp. Stockholder Derivative Litigation, the court dismissed duty of oversight—i.e., Caremark—and disclosure claims brought against the officers and directors of ProAssurance, a healthcare professional liability insurance provider. 2023 WL 6426294, at *1 (Del. Ch. Oct. 2, 2023). In doing so, the court emphasized that Caremark claims are “reserved for extreme events.” Id. By contrast, the events underlying the litigation “quite obviously[] involve[d] a commercial decision that went poorly—the stuff that business judgment is made of.” Id. Together with Segway, discussed below, ProAssurance reaffirms the high pleading bar set by Caremark and its progeny.

Starting around 2015, the healthcare professional liability insurance “competitive marketplace shifted toward underwriting policies for larger physician groups, hospitals, and major national healthcare provider entities.” Id. at *2. Concomitantly, ProAssurance began to consider following—and ultimately did follow—that trend, which presented business risks and opportunities. See, e.g., id. at *3-4. Recognizing as much, ProAssurance focused on potential risks and worked with third parties to assess the same. Id. at *3. Indeed, the court found, ProAssurance’s “Board was consistently—even painfully—involved in monitoring the Company’s underwriting and reserves.” Id. at *10. Meanwhile, “[t]he Company. . . attest[ed] to the conservative nature of its loss reserves practices.” Id. at *6. Over time, however, claims grew, and in early 2020, ProAssurance publicly announced “adverse development[s]” related to “large national healthcare account.” Id. at *9.

In dismissing the complaint on demand futility grounds, the court explained, among other things, that plaintiffs’ allegations fell far short of pleading either of the two “necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations.” Id. at *12. Among other things, the court highlighted that, in addition to failing to allege illegality or bad faith, the pleadings “detail[ed] the engagement of auditors and actuarial advisors, oversight of management charged with the Company’s underwriting functions, meetings to discuss severity trends and reserves, and Board-level updates on large accounts.” Id. at *13. As for plaintiffs’ disclosure claims, they were dismissed due to a lack of “any particularized allegations of scienter.” Id. at 16.

In Segway Inc., v. Cai, the court dismissed at the pleading stage a Caremark claim brought against the former president and “in-house accountant” of Segway Inc., related to Segway’s “declining sales . . . and increased accounts receivable.” 2023 WL 8643017, at *1 (Del. Ch. Dec. 14, 2023). The complaint alleged that the former president “knew or should have known that there were potential issues” with “some of [Segway’s] customers, which caused [Segway’s] accounts receivable to continuously rise.” Id. at *3. Thus, plaintiffs claimed, the former president “breached her fiduciary duties as an officer of Segway by ‘continuously ignoring’ these ‘issues (and the resulting impact on [Segway’s] profitability), fail[ing] to take any action to address them . . . and/or fail[ing] to advise [Segway’s] board.’” Id. (alterations in original).

In dismissing Segway’s Caremark claim, the court took pains to correct a “distressing reading of” Delaware law—i.e., that “the high bar to plead a Caremark claim is lowered when the claim is brought against an officer.” Id. at *1. “[B]ad faith remains a necessary predicate to any Caremark claim,” the court explained, and “[l]iability can only attach in the rare case where fiduciaries knowingly disregard this oversight obligation and trauma ensues.” Id. Emphasizing that the Caremark doctrine is “not a tool to hold fiduciaries liable for everyday business problems,” the court dismissed Segway’s claims because they failed to adequately plead bad faith or illegality. Id. at *5.

Both Segway and ProAssurance reinforce that, “[i]rrespective of the defendant’s corporate title, a Caremark claim is ‘possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.’” Id. at *5 (quoting In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996)).

D. Section 220 Demands In The Context Of Potential Stockholder Activism

In Greenlight Capital Offshore Partners, Ltd. v Brighthouse Financial, Inc., the court ruled largely in defendant’s favor in a case concerning a books and records demand under Section 220 of the DGCL. 2023 WL 8009057, at *1 (Del. Ch. 2023). Although concluding that plaintiff Greenlight Capital’s purpose for the demand was proper, the court nonetheless found that Greenlight had “only proven that a narrow subset of the materials it request[ed] [we]re necessary and essential to its valuation purpose.” Id. at *1, *8.

Greenlight, a hedge fund, owned shares of defendant Brighthouse Financial, Inc. Id. Brighthouse Financial, Inc. “is a public holding company that sells insurance products through private subsidiaries.” Id. “In 2020 and 2021, Brighthouse’s stock price jumped after [a subsidiary] . . . issued extraordinary dividends with the approval of the Delaware Department of Insurance.” Id. Those dividends, in turn, aroused Greenlight’s interest in that subsidiary and prompted Greenlight to “‘consider activism’ towards Brighthouse.” Id. at *1, *6.

After its FOIA request failed, Greenlight turned to a books and records demand with the stated purpose of “‘more accurately determin[ing] the value’ of its Brighthouse shares;” “[i]t sought, ‘[i]n particular[,] . . . to determine the true financial impact of [the dividend-issuing subsidiary] . . . on the value of’ the shares.” Id. at *4. To that end, Greenlight requested several categories of documents spanning a number of years. Id. Brighthouse rejected Greenlight’s demand for several reasons, including that they were overbroad, it could glean the information it sought from public filings, and its stated purpose was neither its real purpose nor, possibly, a proper purpose. Id.

Greenlight then filed suit. Id. To prevail on a Section 220 claim, a party must, among other things, offer a proper purpose for its request and demonstrate that the requested materials are “essential to accomplish[] the . . . articulated purpose.” Id. at *5.

After trial, the court found that Greenlight’s stated purpose was “a proper purpose” under “settled law in Delaware” and rejected Brighthouse’s contention that Greenlight’s stated purpose was merely “a pretext [for] activism.” Id. at *5-6. The court explained that “[activism] is not . . . a purpose unto itself,” and because Greenlight demonstrated a proper primary purpose, any additional motivations were irrelevant. Id. at *7.

Turning to Greenlight’s specific requests, the court found that it had “only proven that a narrow subset of the materials it request[ed] [we]re necessary and essential to its valuation purpose.” Id. at *8. This was partly due to Brighthouse’s and its subsidiary’s public filings and partly due to Greenlight’s requests seeking either stale information or information pertaining to “future potential dividend capacity”—both of which were “too attenuated from Greenlight’s purpose of more accurately determining the current value of its Brighthouse shares.” Id. at *8-9.

E. Court Of Chancery Upholds Differential Voting Power Based On Identity

In Colon v. Bumble, Inc., the Delaware Court of Chancery upheld the validity of provisions that resulted in all shares of Bumble stock carrying one vote unless held by a “Principal Stockholder.” — A.3d —-, 2023 WL 5920100, at *2-4, *9 (Del. Ch. Sept. 12, 2023). Principal Stockholders (who are party to a separate, publicly disclosed stockholder agreement) are, by contrast, entitled to 10 votes per share. Id. at *3-4.

Plaintiff claimed that the provisions giving rise to that dynamic violated Sections 151(a) and 212(a) of the DGCL. Id. at *4. In rejecting plaintiff’s challenge and concluding that it “is permissible” to “hav[e] the level of voting power turn on the identity of the owner,” id. at *9, the court explained that Delaware precedent already concluded that formula-based allocations of voting power are consistent with Delaware law, and the DGCL expressly permits voting power to “depend on facts ascertainable outside of the certificate of incorporation.” Id. at *8.

As to Section 212(a), the court disagreed with plaintiff’s assertion—based not on Section 212(a)’s text but on an earlier Delaware Supreme Court opinion—that “a corporation cannot create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them.” Id. at *9. Among other things, it explained that despite the Supreme Court’s somewhat “puzzl[ing]” reasoning, it approved of provisions that are relevantly similar to the ones before the court. Id. at *9-15.

As to Section 151(a), the court rejected the assertion that it requires “a class of stock [to] assign the same voting rights to all shares.” Id. at *15. Section 151(a), the court explained, does not require either that a formula “generate the same result for all shares,” or that different results can flow from the formula “but it must be a formula that gives any holder an opportunity to gain” its benefits. Id. Section 151(a) only requires that “the method”—”not the outcome”—”be identical across all shares in [a] class.” Id. at *10 (“Section 151(a) expressly permits the use of formulas and procedures that apply across all shares but which can generate different results for different shares based on facts ascertainable outside of the charter (such as the identity of the holder).”).

F. Court Of Chancery Limits The Options For “Con Ed” Provisions

In October 2023, the court in Crispo v. Musk held that a so-called “Con Ed” provision in a merger agreement between Elon Musk and Twitter, Inc., which “purport[ed] to define a target company’s damages to include lost-premium damages,” was an unenforceable contract penalty. 304 A.3d 567, 584 (Del. Ch. 2023). In this decision on plaintiff’s mootness fee petition, the court found that plaintiff lacked standing because the merger agreement did not confer third-party beneficiary status to stockholders and Twitter’s pursuit of a claim for specific performance of the merger agreement negated plaintiff’s ability to pursue damages under a theory that Lost-Premium Provision provided plaintiff with implicit third-party status. Id. at 578. In the course of determining the viability of plaintiff’s claim, the court also held that a Lost-Premium Provision that defines lost-premium damages as exclusive to the target, a damages-definition “Con-Ed” provision, is unenforceable as an unlawful contract penalty under Delaware Law. Id. at 584. We discussed this decision in greater detail in our November 8, 2023 Client Alert.

G. Court Of Chancery Invalides $55.8 Billion Equity Compensation Package

In Tornetta v. Musk, a court ruled in favor of Tesla stockholders who brought a derivative lawsuit challenging the multiyear compensation arrangement awarded to Tesla CEO Elon Musk. — A.3d —, 2024 WL 343699, at *1 (Del. Ch. Jan. 30, 2024). For more information, please see our February 5, 2024 Client Alert.

IV. FEDERAL SPAC LITIGATION

In 2023, the number of SPAC IPOs again declined, continuing a trend noted in our 2022 and 2023 Mid-Year Securities Litigation Updates. Between January and November 2023, there were 28 SPAC IPOs, compared to 86 in 2022 and 613 in 2021. 2023 saw a corresponding decline in SPAC-related securities suits, with just 18 new SPAC-related federal securities complaints filed in 2023, down from 29 in 2022.

Although the filing of SPAC-related litigation has slowed, existing cases continue to make their way through the courts. In September 2023, a pair of district courts considered whether allegations of scienter based on general incentives present in de-SPAC transactions were sufficient and found that they were not.

Phoenix Insurance Company, Ltd. v. ATI Physical Therapy, Inc., 2023 WL 5748359 (N.D. Ill. Sept. 6, 2023): Investors brought a putative class action alleging securities fraud claims against a physical therapy services company that went public via a de-SPAC, the company’s former CEO and CFO, and the former CEO of the SPAC. Id. at *1. Plaintiffs alleged that defendants made misleading statements and omissions in proxy statements issued before the merger relating to the attrition rate of the company’s physical therapists. Id. at *4, *8. Investors alleged that the former CEO of the SPAC, who was also the former CEO of the target, acted with scienter based in part on the theory that officers of a SPAC have incentives to “present a target company in a misleadingly favorable light to ensure the company is acquired,” allowing the officers of the SPAC to “gain favorable employment in the post-merger company rather than returning the funds to the investors.” Id. at *2, *15 (internal quotations omitted).

The court found that these “exceedingly generic” motive allegations did “not contribute much to a strong inference of scienter” because they said “nothing about the motivations, circumstances, and factors particular to” the former SPAC CEO. Id. (emphasis in original). Ultimately, the court dismissed the claims against the former CEO of the SPAC, finding plaintiffs fell “far short of pleading a strong inference of scienter.” Id. at *20. The claims against the company and its former executives survived.

In re Danimer Scientific, Inc. Securities Litigation, 2023 WL 6385642 (E.D.N.Y. Sept. 30, 2023): We first reported on this case in our 2022 Year-End Securities Litigation Update. Danimer, a bioplastics company, went public in 2020 via a de-SPAC merger. Id. at *1-2. Danimer stockholders brought a class action asserting securities fraud claims against the company and several of its directors and officers, including one director who was previously the CEO of the SPAC. Id. During the period between announcing the merger agreement and the shareholder vote, defendants made allegedly misleading statements in investor presentations and press releases regarding the biodegradability of Danimer’s products, production capacity, product demand, and managerial success of Danimer’s CEO. Id. at *4-5.

The court granted defendants’ motion to dismiss because plaintiffs failed adequately to allege scienter. Id. at *1, *10-12. Plaintiffs asserted that, given the limited lifespan of a SPAC, Danimer’s former CEO was incentivized to complete the de-SPAC merger to avoid returning the money the SPAC had raised from its investors. Id. at *11. The court characterized what it described as plaintiffs’ “bet the company theory” of scienter as “still far too generalized . . . to allege the proper concrete and personal benefit required” under Second Circuit precedent, rejecting the idea that “the SPAC model of taking a company public puts unique pressures on . . . management to complete a bad deal[.]” Id. (internal citation omitted). Plaintiffs further asserted that the company and two of its directors were motivated to close the de-SPAC merger because it would provide the only available means of funding Danimer’s plans to expand its facilities. Id. at *11. Plaintiffs’ scienter allegations fell short there as well, the court explained, as defendants shared “a goal possessed by virtually all corporate insiders[,]” which “remains true even if a company decides to raise capital through merging with another company.” Id. (internal citations omitted). Thus, plaintiffs failed to meet the PSLRA’s scienter pleading standards because they invoked only “incentives supposedly faced by SPACs generally.” Id. (citing Phoenix Ins., 2023 WL 5748359, at *15).

Gibson Dunn represents defendants in this action.

V. ESG CIVIL LITIGATION

A growing number of lawsuits have been filed challenging public companies’ environmental, social, and governance (“ESG”) disclosures and policies. The following section surveys notable developments in pending cases that involve ESG allegations.

A. Environmental Litigation

In re Danimer Scientific, Inc. Securities Litigation, 2023 WL 6385642 (E.D.N.Y. Sept. 30, 2023): As noted above, plaintiffs in this action alleged that defendants made misleading statements in investor presentations and press releases regarding, among other things, the biodegradability of Danimer’s products. ECF No. 44 at 2-3. They further alleged that when an article published in The Wall Street Journal claimed that the timing in which the company’s product would biodegrade was more variable than suggested, the company’s stock price allegedly dropped. Id. at 11-13. As noted, the court concluded that plaintiffs had not adequately alleged scienter and entered an order dismissing the complaint with prejudice on September 30, 2023. In re Danimer Sci., Inc. Sec. Litig., 2023 WL 6385642 (E.D.N.Y. Sept. 30, 2023). Gibson Dunn represents the defendants in this action.

General Retirement System of the City of Detroit v. Verizon Communications Inc., No. 23-cv-05218 (D.N.J. Aug. 18, 2023): In this case, plaintiffs allege that Verizon made false or misleading statements regarding its responsibility for “an extensive network of lead cables . . . around the country, causing harm and posing the risk of further harm to the environment, Company employees, and surrounding communities.” ECF No. 1, at 5. The amended complaint alleges that Verizon’s stock price dropped after The Wall Street Journal released an article profiling workers who claimed they were sick from lead exposure. Id. at 35-39. A motion to dismiss the amended complaint is due by February 27, 2024. ECF No. 34. A similar case was filed in the Western District of Pennsylvania on August 1, 2023, and was voluntarily dismissed on October 27, 2023. See Meehan v. Verizon Commc’ns, Inc., No. 23-cv-01375 (W. D. Pa. Aug. 1, 2023).

Brazinsky v. AT&T Inc., No. 23-cv-04064 (D.N.J. July 28, 2023): In this case, plaintiff alleged that AT&T misled investors by failing to disclose ownership of lead cables around the United States, which pose risks of environmental harm. ECF No. 1, at 9. AT&T has neither answered nor moved to dismiss this complaint. AT&T filed a motion to transfer the case to the Northern District of Texas, which remains pending before the court. ECF. No. 43.

In re Oatly Group AB Securities Litigation, No. 21-cv-06360 (S.D.N.Y. July 26, 2021): A putative class action complaint has been filed against Oatly Group AB, the world’s largest oat milk company, and several of its officers and directors. Plaintiffs allege that Oatly made false or misleading statements related to the sustainability of its product. ECF No. 91, at 29-34. More specifically, plaintiffs allege that Oatly overstated its substantiality practices and minimized its environmental impact, which led to an inflated share price. Id. Oatly has not answered or filed a motion to dismiss the complaint. On November 3, 2023, the parties disclosed an intent to settle the litigation. ECF No. 95. On February 16, 2024, plaintiffs moved for preliminary approval of settlement, and the parties are scheduled to appear before the court to discuss the settlement on February 21, 2024. ECF No. 99, at 1-2.

City of St. Clair Shores Police and Fire Retirement System v. Unilever PLC, No. 22-cv-05011 (S.D.N.Y. June 15, 2022): We reported on this case in our 2022 Year-End Securities Litigation Update and our 2023 Mid-Year Securities Litigation Update. The allegations against Unilever arose from a proposed Ben & Jerry’s board resolution purporting to end the sale of Ben & Jerry’s products in areas deemed “to be Palestinian territories illegally occupied by Israel.” ECF No. 1, at 6. Plaintiffs alleged that Ben & Jerry’s parent company made misleading statements to investors by failing to adequately disclose the business risks associated with the resolution. Id. at 10-18. Defendants in Unilever filed a motion to dismiss these allegations. ECF No. 31. The court granted the motion to dismiss, holding plaintiffs failed to plead scienter because the complaint lacked plausible allegations that defendants knew implementation of the board resolution “was a certainty or at least probable.” City of St. Clair Shores Police and Fire Ret. Sys. v. Unilever PLC, 2023 WL 5578090, at *3-5 (S.D.N.Y. Aug. 29, 2023).

Wong v. New York City Employee Retirement System, No. 652297/2023 (N.Y. Sup. Ct., N.Y. Cnty. May 11, 2023): We first reported on this case in our 2023 Mid-Year Securities Litigation Update. Plaintiffs in this case filed breach of fiduciary duty claims against three New York City pension funds that divested approximately $4 billion in fossil fuel investments. NYSCEF No. 2. The divestment allegedly caused the pension fund to lose out on the energy’s sector significant growth, and therefore lucrative returns, over the past few years and was undertaken for political reasons unrelated to the retirement interests of plan participants. Id. at 19. Plaintiffs seek an injunction, requiring the pension fund to cease the ongoing divestment and make decisions regarding fuel-related and other potential investments “exclusively on relevant risk-return factors.” Id. at 25. Defendants filed a motion to dismiss the complaint, arguing that the plaintiffs lack standing and fail to state a claim because the complaint does not contain any allegations showing that the funds’ trustees acted disloyally or carelessly and the decision to divest was made based on relevant financial considerations. NYSCEF No. 20, at 6-7. The motion to dismiss is pending before the court. Gibson Dunn represents plaintiffs in this case.

Exxon Mobile Corp. v. Arjuna Capital, No. 24-cv-00069 (N.D. Tex. Jan. 21, 2024): ExxonMobil filed a complaint seeking a declaratory judgment that it may exclude activist investors’ shareholder proposal from Exxon’s 2024 proxy statement. ECF No. 1, at 25. The complaint alleges that defendants’ proposal, requesting Exxon to accelerate greenhouse gas emissions reductions, “does not seek to improve ExxonMobil’s economic performance or create shareholder value.” Id. at 3-4. Exxon asserts that it may properly exclude defendants’ proposal under the ordinary business (Rule 14a-8(i)(7)) and resubmission exclusions ((i)(12)). Defendants responded to the complaint by withdrawing their proposal and agreeing not to propose it again in the future. The litigation is continuing. Gibson Dunn represents plaintiff in this action.

Securities Industry & Financial Markets Association v. Ashcroft, No. 23-cv-04154 (W.D. Mo. Aug. 10, 2023): In June 2023, the Missouri Securities Division adopted new rules requiring investment professionals to obtain client signatures before providing advice that “incorporates a social objective or other nonfinancial objective.” ECF No. 24, at 22-33. In August 2023, plaintiff filed a lawsuit challenging these rules. ECF No. 1, at 41. Plaintiff alleges that the rules are preempted by the National Securities Markets Improvement Act of 1996 and the Employee Retirement Income Security Act, violate the First Amendment, and are unconstitutionally vague. ECF No. 24, at 33-42. On January 5, 2024, the court denied defendant’s motion to dismiss, allowing this matter to proceed to discovery. ECF No. 39.

B. Diversity And Inclusion

Ardalan v. Wells Fargo & Co., No. 22-cv-03811 (N.D. Cal. July 28, 2022): We first reported on this case in our 2023 Mid-Year Securities Litigation Update. After the district court dismissed the initial complaint, ECF Nos. 112, at 15, plaintiffs filed an amended complaint. ECF No. 116. In the amended complaint, plaintiffs allege that Wells Fargo conducted interviews for positions that had already been filled to comply with its disclosed intent that 50 percent of interviewees be diverse for most roles above a certain salary threshold. ECF No. 116, at 9-10. In particular, the amended complaint alleges that diverse interviewees either did not have a legitimate chance to obtain the job for which they were interviewing or were interviewing for roles already filled. Id. at 44-48. Defendants filed a motion to dismiss the amended complaint, which is fully briefed and pending before the court.

National Center for Public Policy Research v. Schultz, 2023 WL 5945958 (E.D. Wa. Sept. 11, 2023): In this derivative action, plaintiff alleged that directors and officers of Starbucks breached their fiduciary duties by rejecting a proposal (that plaintiff itself filed) challenging Starbucks’ diversity, equity, and inclusion (“DEI”) initiatives. ECF No. 1-2, at 33-35. Defendants filed a motion to dismiss the complaint, arguing that plaintiff does not fairly and adequately represent the interest of shareholders. ECF No. 19, at 12-21. The court granted defendants’ motions to dismiss, holding that plaintiff had filed this action “to advance its own political and public policy agenda” and failed to allege that the board’s rejection of its demand to retract the DEI initiatives was wrongful. Nat’l Ctr. for Pub. Pol’y Rsch. v. Schultz, 2023 WL 5945958, at *3-4 (E.D. Wa. Sept. 11, 2023).

VI. CRYPTOCURRENCY LITIGATION

A. Class Actions

Risley v. Universal Navigation Inc., 2023 WL 5609200 (S.D.N.Y. Aug. 29, 2023): On August 29, 2023, a U.S. District Judge dismissed a putative class action complaint against the developers of and investors in the Uniswap Protocol trading platform, a decentralized cryptocurrency exchange. Id. at *1. Plaintiffs, a class made up of individuals who each purchased certain of the tokens that were issued and traded on this exchange, brought claims under Section 12(a)(1) of the Securities Act and Section 29(b) of the Securities Exchange Act, alleging that they lost money after investing in what turned out to be “scam tokens.” Id. at *1, *11. The District Judge, in assuming (but not confirming) that the tokens were securities, dismissed the complaint in full, emphasizing that the identity of the issuers of the tokens was largely unknown both to plaintiffs and defendants due to the decentralized nature of the exchange. Id. at *11. The District Judge observed that plaintiffs are “looking for a scapegoat for their claims because defendants they truly seek are unidentifiable” and opined that whether “this anonymity is troublesome enough to merit regulation is not for the court to decide, but for Congress.” Id. at *19. This case is currently on appeal to the Second Circuit. Risley v. Universal Navigation Inc., 2023 WL 5609200 (S.D.N.Y. Aug. 29, 2023), appeal docketed, No. 23-1340 (2d Cir. Sept. 28, 2023).

Ohman J:or Fonder AB v. NVIDIA Corp., 81 F.4th 918 (9th Cir. 2023): On August 25, 2023, the Ninth Circuit partially revived a putative class’s securities fraud claims against NVIDIA and its officers. In this case, the putative class of shareholders alleged that defendants knowingly or recklessly made materially “misleading and false statements regarding the impact of cryptocurrency sales on NVIDIA’s financial performance” in order to conceal the extent to which NVIDIA’s revenue growth depended on the demand for cryptocurrency, in violation of Sections 10(b) and 20(a) of the Exchange Act and Rule. Id. at 923. The U.S. District Court for the Northern District of California initially dismissed the amended complaint in its entirety. However, on appeal, the Ninth Circuit, in a split opinion, reversed in part and remanded for further proceedings, finding that plaintiffs had stated claims against NVIDIA and its cofounder, President, and CEO, but not against the other officers. Id. at 947. The appellate court concluded that the complaint sufficiently alleged that the cofounder, President, and CEO knowingly or recklessly made false or misleading statements about the degree to which NVIDIA’s revenues were dependent on sales of GeForce GPUs to crypto miners, based on his repeated statements to investors and analysts throughout 2017 and 2018 downplaying the degree of such dependency. Id. at 933-34, 937, 940. Judge Gabriel Sanchez dissented, concluding that the complaint was entirely based on a post hoc, unreliable analysis done by an outside expert and that it did not allege with sufficient particularity information that would have put NVIDIA’s executives on notice that their public statements were false or misleading when made. Id. at 947. The petition for rehearing en banc was denied. See E. Ohman J.:or Fonder AB v. Nvidia Corp., 2023 WL 7984780, at *1 (9th Cir. Nov. 15, 2023). On December 5, 2023, the Ninth Circuit granted defendants’ motion to stay the mandate for ninety days. See Order, E. Ohman J. or Fonder AB v. NVIDIA Corp., No. 21-15604 (9th Cir. Dec. 5, 2023).

B. Regulatory Lawsuits

SEC v. Binance Holdings Ltd., No. 23-cv-01599 (D.D.C. June 5, 2023): As reported in our Securities Litigation 2023 Mid-Year Update, on June 5, 2023, the SEC filed a 13-claim complaint against Binance Holdings Limited, BAM Trading Services Inc., BAM Management Holdings Inc. and Changpeng Zhao in D.C. federal court, alleging defendants engaged in unregistered offers and sales of crypto asset securities. ECF No. 1. On June 13, 2023, consistent with the arguments set forth in defendants’ briefing, the government admitted that it had no evidence that customer assets have been misused or dissipated and, as a result, defendants successfully prevented the SEC from obtaining the extensive relief it sought. Instead, at the court’s direction, Binance, the SEC, and the other defendants in the action negotiated a consent order that will remain in place while the action is pending. ECF No. 71. After the entry of the Consent Order, defendants filed motions to dismiss. ECF No. 114. Primarily, defendants argued that the cryptocurrencies at issue are not “investment contracts” under SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (“Howey”) and that the major-questions doctrine bars the SEC from unilaterally deciding it can regulate the burgeoning cryptocurrency industry. ECF Nos. 117-1, 118. Judge Amy Berman Jackson heard oral argument on the pending motions to dismiss on January 22, 2024.

In the backdrop of this ongoing SEC litigation, Binance and related entities entered into settlements with the DOJ and CFTC. On November 21, 2023, Binance and its CEO entered a guilty plea to resolve its outstanding DOJ litigation. See Binance and CEO Plead Guilty to Federal Charges in $4B Resolution, Dep’t of Just. (Nov. 21, 2023). Subsequently, on December 18, 2023, a federal court approved a separate settlement with the CFTC. See Federal Court Enters Order Against Binance and Former CEO, Zhao, Concluding CFTC Enforcement Action, Commodities Futures Trading Comm’n (Dec. 18, 2023).

Gibson Dunn represents Binance Holdings Limited.

SEC v. Schueler, No. 23-cv-05749 (E.D.N.Y. July 31, 2023): On July 31, 2023, the SEC charged Richard Schueler (otherwise known as “Richard Heart”) and three affiliated companies for the unregistered offer and sale of securities as well as the misappropriation of investor assets. According to the SEC’s complaint, Heart created and marketed his “Hex” token to investors, promising them a 38% annual return on investment in the form of future Hex tokens if they “staked,” or locked up, their existing Hex tokens. ECF No. 1, at 7. Through the “staking” process, Heart purportedly hoped to inflate the price of Hex tokens. Id. The SEC also alleged that Heart developed Pulsechain and PulseX, a blockchain and crypto token, that each raised hundreds of millions of dollars from investors. Id. at 16-18, 21. Heart allegedly misappropriated at least 12.1 million dollars of investor assets in order to purchase luxury goods, including a 555-carat black diamond. Id. at 19-20. Accordingly, the SEC charged Heart both with fraud under Sections 10(b), 17(a)(1), and 17(a)(3) of the Exchange Act, as well as with failure to comply with the registration provisions of Section 5 of the Securities Act. Id. at 4. Defendants’ motion to dismiss is due by April 8, 2024 with Judge Carol Bagley Amon set to hear oral arguments on October 24, 2024. Scheduling Order, SEC v. Schueler, No. 23-cv-05749 (E.D.N.Y. Jan. 18, 2024).

SEC v. Payward, Inc. and Payward Ventures, Inc., No. 23-cv-06003 (N. D. Cal. Nov. 20, 2023): On November 20, 2023, the SEC filed a three-count complaint against Payward Ventures and Payward Trading, Ltd. (also known as “Kraken”) in the United States District Court for the Northern District of California for violations of Sections 5, 15(a), and 17A(b) of the Exchange Act. ECF No. 1, at 4. In its complaint, the SEC alleged that 11 assets that Kraken traded were “investment contracts represented by the underlying crypto asset” and that they are therefore subject to the Exchange Act’s regulations. Id. at 15. In addition to claiming that Kraken’s traded assets should have been registered, the SEC also alleged that the online trading platform acted as an exchange, broker, dealer, and clearing agency for crypto assets without first registering with the agency. Id. at 18-35. Further, the SEC alleged that Kraken’s failure to register enabled it to commingle its customers’ crypto assets along with fiat in its custodial accounts without ever disclosing that fact to customers. Id. at 39. Accordingly, the SEC seeks injunctive relief, disgorgement of gains with interest, and civil money penalties. Id. at 4. Defendants’ motion to dismiss is due on February 22, 2024. ECF No. 21, at 1.

People v. Mek Global Ltd., d/b/a/ KuCoin, Index No. 450703/2023 (Sup. Ct. N.Y. Cnty. Dec. 12, 2023): In March 2023, the New York Attorney General’s Office brought claims against the Seychelles-based crypto exchange KuCoin, alleging that KuCoin violated New York securities laws by unlawfully offering and selling cryptocurrency and by unlawfully representing itself as an “exchange.” Stipulation and Consent Order at 1, People v. Mek Global Ltd., d/b/a/ KuCoin, Index No. 450703/2023 (Sup. Ct. N.Y. Cnty. Dec. 12, 2023). On December 12, 2023, KuCoin agreed to return $16.7 million dollars to New York investors, pay $5.3 million in fines, take steps to close New York accounts within 120 days, and preclude the creation of new New York-based accounts. Id. at 3-4. KuCoin also admitted that it falsely represented itself as a registered exchange and that it operated in New York as an unregistered securities or commodities broker-dealer. Id. at 2-3. As a part of the consent order, KuCoin must update the Office of the Attorney General (“OAG”) on the number of New York customers that have withdrawn money and also provide the Office with detailed information on New York customers who have had an open account at KuCoin. Id. at 10-11. The consent order resolves the OAG’s claims against KuCoin. Id. at 2.

SEC v. Terraform Labs Pte. Ltd., 2023 WL 8944860 (S.D.N.Y. Dec. 28, 2023): As reported in our 2023 Mid-Year Litigation Update, the SEC brought an enforcement action early last year alleging that Terraform Labs and its founder perpetrated a multibillion dollar crypto asset securities fraud scheme by offering and selling crypto asset securities in unregistered transactions and misleading investors about the Terraform blockchain and its crypto assets. On July 31, 2023, U.S. District Judge Jed S. Rakoff denied defendants’ motion to dismiss. On December 28, 2023, Judge Rakoff granted summary judgment for the SEC, finding that Terraform’s crypto assets—UST, LUNA, wLUNA, and MIR—are securities because they are investment contracts under Howey, and that defendants offered and sold LUNA and MIR in unregistered transactions in violation of the federal securities laws. 2023 WL 8944860, at *12-16. Judge Rakoff further held that defendants offered unregistered security-based swaps to non-eligible contract participants and effected transactions in security-based swaps with non-eligible contract participants in violation of the federal securities laws. Id. at *17. Trial on the remaining fraud claims is scheduled for late March of 2024.

C. Other Developments

1. SEC Grants Approval For Certain ETFs To Track Bitcoin

On January 10, 2024, the SEC granted approval for the first U.S.-listed exchange-traded funds (“ETFs”) to track bitcoin. SEC, Statement on the Approval of Spot Bitcoin Exchange-Traded Products (Jan. 10, 2024). The approval includes applications from 11 major entities like BlackRock, Ark Investments/21Shares, Fidelity, Invesco, and VanEck. This marks a potentially significant development for Bitcoin as the world’s largest cryptocurrency and for the broader crypto industry. Some consider the ETFs a pivotal development for Bitcoin, offering investors exposure to the cryptocurrency without directly holding it. Analysts predict significant inflows, with estimates ranging from $50 billion to $100 billion this year alone.

This move marks a change for the SEC, which had previously rejected bitcoin ETFs. Hannah Lang & Suzanne McGee, US SEC Approves Bitcoin ETFs in Watershed for Crypto Market, Reuters (Jan. 11, 2024). However, SEC Chair Gary Gensler suggested that the approval was partly in response to a circuit court ruling that the SEC wrongly denied an application from Grayscale Investments to convert its existing Grayscale Bitcoin Trust into an ETF. See SEC, Statement on the Approval of Spot Bitcoin Exchange-Traded Products (Jan. 10, 2024) (citing Grayscale Investments, LLC v. SEC, 82 F.4th 1239 (D.C. Cir. 2023)). Gensler also emphasized that the action would not change the SEC’s enforcement of “non-compliance of certain crypto asset market participants with the federal securities laws,” nor does the SEC “approve or endorse crypto trading platforms or intermediaries, which, for the most part, are non-compliant with the federal securities laws and often have conflicts of interest.” SEC, Statement on the Approval of Spot Bitcoin Exchange-Traded Products (Jan. 10, 2024).

2. Coinbase Petition For Rulemaking

On July 21, 2022, Coinbase filed a petition for rulemaking with the SEC seeking “new rules facilitating the use” of digital asset securities. See Letter from Paul Grewal, Chief Legal Officer, Coinbase Glob., Inc., to Vanessa A. Countryman, Sec’y, SEC (July 21, 2022). On December 15, 2023, in a 3-2 decision, the Commission denied Coinbase’s petition. See Letter from Vanessa A. Countryman, Sec’y, SEC, to Paul Grewal, Chief Legal Officer, Coinbase Glob., Inc. (Dec. 15, 2023). In its ruling, the Commission stated that it disagreed with the “assertion that application of existing securities statutes and regulations to crypto asset securities, issuers of those securities, and intermediaries in the trading, settlement, and custody of those securities is unworkable.” Id. In a statement supporting this decision, Chairman Gensler reaffirmed the SEC’s approach stating that “existing laws and regulations apply to the crypto securities markets.” See Statement on the Denial of a Rulemaking Petition Submitted on behalf of Coinbase Global, Inc. (Dec. 15, 2023).

On December 15, 2023, Coinbase filed a petition for review with the U.S. Court of Appeals for the Third Circuit regarding the SEC’s order. See Coinbase Inc. v. SEC, No. 23-3202 (3d Cir. Dec. 15, 2023), ECF No. 1.

Gibson Dunn represents Coinbase in its petition for review.

3. Non-fungible Tokens (NFTs)

Recent SEC enforcement actions indicate that NFTs may become part of the SEC’s increasing crypto asset enforcement efforts. See, e.g., Press Release, SEC Charges Creator of Stoner Cats Web Series for Unregistered Offerings of NFTs (Sept. 13, 2023) (charging a company with conducting an $8 million unregistered offering in the form of NFTs); Press Release, SEC Charges LA-Based Media and Entertainment Co. Impact Theory for Unregistered Offering of NFT (Aug. 28, 2023) (settling with a company for conducting an unregistered offering of crypto asset securities). In these cases, the SEC has generally relied on the Supreme Court’s test in Howey to contend that the NFTs that companies like Impact Theory sell are investment contracts, offered to investors with the process of “tremendous” future value. See Order Instituting Cease and Desist Proceedings, In re Impact Theory, No. 3-21585 (Aug. 28, 2023). The Commission’s position on NFT regulation is still unsettled with at least some commissioners objecting to the regulation of NFTs under Howey given that “NFTs were not shares of a company and did not generate any type of dividend for the purchasers.” NFTs & SEC: Statement on Impact Theory, LLC (Aug. 28, 2023).

VII. LORENZO DISSEMINATOR LIABILITY

As previously discussed in our 2019, 2022, and 2023 Mid-Year Updates, in Lorenzo, the Supreme Court expanded the scope of scheme liability to include individuals who disseminate false or misleading information, but do not make misstatement(s), to potential investors with the intent to defraud. 139 S. Ct. 1094 (2019). As a result, individuals who do not make false or misleading statements may nevertheless be subject to “scheme liability” under Rules 10b-5(a) and 10b-5(c) for disseminating the alleged misstatement(s) of another if plaintiff can show that the individual knew the alleged misstatement(s) contained false or misleading information. Following Lorenzo, the Second Circuit found that defendants must do “something beyond” making material misstatements or omissions, such as disseminating the alleged misstatements, to be subject to scheme liability under Rules 10b-5(a) and (c). SEC v. Rio Tinto plc, 41 F.4th 47, 54 (2d Cir. 2022); see also Client Alert (Gibson Dunn represents Rio Tinto in this litigation).

Although the Supreme Court and most circuit courts have not directly addressed the requirements for scheme liability after Lorenzo, several recent district court decisions have added to the debate.

In SEC v. Hwang, a case involving market manipulation claims against the CFO and principal of a family office stemming from alleged misrepresentations to counterparties in swap transactions, the Southern District of New York dismissed the scheme liability claims against the CFO while upholding the scheme liability claims against the principal. 2023 WL 6124041, at *5, *7-8, *18 (S.D.N.Y. Sept. 19, 2023). In applying the Rio Tinto “something beyond” standard, the court dismissed the scheme liability claims against the CFO because he merely directed his subordinates to craft the alleged misrepresentations and he did not participate in the dissemination of the misrepresentations himself. Id. at *8. Unlike the claims against the CFO, the court upheld scheme liability claims against the principal because the court accepted the SEC’s allegations that the principal “directed Archego’s staff to trade in a manner that would artificially inflate the price of [his company’s] holdings.” Id. at *9.

In another case in the Southern District of New York, SEC v. Farnsworth, the court sustained scheme liability claims against former executives of MoviePass, Farnsworth and Lowe, for making public statements that MoviePass was seeing a natural drop off in users, when MoviePass was allegedly manufacturing a decrease in users by artificially interfering with its own users’ ability to take full advantage of the services MoviePass offered. 2023 WL 5977240, at *1-2, *18 (S.D.N.Y. Sept. 14, 2023). Specifically, the court found that allegedly resetting customers’ passwords or subjecting them to ticket-verification procedures to discourage usage of the subscription service was sufficient additional conduct to sustain scheme liability claims under Lorenzo and Rio Tinto. Id. at *18.

In a case from the United States District Court for the District of Columbia, In re Bed Bath & Beyond Corporation Securities Litigation, the court cited positively to Rio Tinto, although it did not explicitly adopt the Second Circuit’s “something beyond” standard. 2023 WL 4824734, at *12 (D.D.C. July 27, 2023). In that case, the court sustained scheme liability claims against Bed Bath & Beyond for allegedly delaying its SEC filings to stimulate trading of its stock to piggyback off the alleged misstatements of an activist investor.

In a recent case from the Northern District Court of Texas, the Court found that the allegedly inflated valuations contained in internal planning documents were sufficient to sustain a scheme liability claim. Yoshikawa v. Exxon Mobil Corporation, 2023 WL 5489054, at *8-9 (N.D. Tex. Aug. 24, 2023). Plaintiffs alleged that an employee instructed her team to manipulate internal valuations of certain assets to support the company’s allegedly prior misleading public statements regarding the growth potential of certain assets to investors. Id. at *4-5, *8-9. Defendants argued that plaintiffs failed to plead deceptive conduct beyond misstatements and omissions, but, citing to Rio Tinto, the Court disagreed and denied the motion to dismiss with respect to the scheme liability claim. Id. at *9. The Court otherwise dismissed 10b-5(b) misstatement and omissions claims in their entirety for failure to adequately plead scienter with respect to the challenged statements. Id. at *10.

In another case from the Northern District Court of Texas, Linenweber v. Southwest Airlines Co., the court, citing Rio Tinto, granted defendants’ motion to dismiss, concluding that “misstatements and omissions alone do not suffice for scheme liability.” 2023 WL 6149106, at *14 (N.D. Tex. Sept. 19, 2023) (quoting SEC v. Rio Tinto plc, 41 F.4th 47, 48 (2d Cir. 2022)). In the case, plaintiffs claimed that defendants’ scheme was “portraying Southwest’s aircraft as safe and compliant while concealing a wide-range of safety hazards and regulatory non-compliance issues.” Id. at *14. The court dismissed plaintiffs’ scheme liability claims because plaintiffs failed to identify any fraudulent or deceptive acts beyond the misleading statements portraying Southwest’s aircraft as safe while allegedly concealing other safety hazards. Id.

VIII. MARKET EFFICIENCY AND “PRICE IMPACT” CASES

As discussed in our Client Alert and Mid-Year Update, the long-running class certification dispute in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., 77 F.4th 74, 105 (2d Cir. 2023) (“ATRS”), ended this year, with the Second Circuit reversing the class certification order and remanding with instructions to decertify the class. Following the class decertification—and more than a decade after the case was initially filed—the parties stipulated to a voluntary dismissal with prejudice.

The Second Circuit’s decision to decertify was based on guidance from the Supreme Court’s 2021 decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, 141 S. Ct. 1951 (2021) (“Goldman”), which we previously detailed in our 2021 Mid-Year Securities Litigation Update. In Goldman, the Supreme Court held that courts analyzing whether to grant class certification should consider evidence, including expert evidence, of whether the alleged misstatements were too generic to affect the price of securities, even though that same evidence could be relevant to whether the alleged misstatements were material. Goldman, 141 S. Ct. at 1960-61. The Supreme Court also held that if a plaintiffs’ price impact theory is based on “inflation maintenance” (meaning the alleged misstatement did not cause the stock price to increase but instead prevented the price from dropping), then any mismatch between the generic nature of the challenged statements and the specificity of the alleged corrective disclosures is critical in determining whether defendants have rebutted the Basic presumption of class-wide reliance. Id.

In ATRS, the Second Circuit considered—again—whether this class of investors was properly certified. ATRS, 77 F.4th at 80-81. Applying the Supreme Court’s “mismatch framework,” the Second Circuit held that when plaintiffs rely on the inflation-maintenance theory—like plaintiffs in ATRS did—they cannot simply “identify a specific back-end, price-dropping event” and match it to “a front-end disclosure bearing on the same subject” unless “the front-end disclosure is sufficiently detailed in the first place.” Id. at 81, 102. After examining the evidence in the case, the Second Circuit ultimately concluded that the mismatch between the generic nature of the alleged misstatements and the specificity of the alleged corrective disclosure was sufficient to “sever the link” between the statements and the stock price drop. Id. at 104.

Following Goldman and ATRS, lower court decisions are engaging in a more searching analysis of all evidence of price impact, including scrutiny regarding whether the alleged corrective disclosure sufficiently matches the challenged statement. See e.g., Ramirez v. Exxon Mobil Corp., 2023 WL 5415315, at *11-21 (N.D. Tex. Aug. 21, 2023); Del. Cnty. Emp. Ret. Sys. v. Cabot Oil & Gas Corp., 2023 WL 6300569, at *10-13 (S.D. Tex. Sept. 27, 2023); Hall v. Johnson & Johnson, 2023 WL 9017023, at *10-15 (D.N.J. Dec. 29, 2023).

In Ramirez, for example, a U.S. District Judge in the Northern District of Texas rejected six out of seven of plaintiffs’ alleged corrective disclosures for various reasons. These reasons included that the experts found no statistically significant price change, Ramirez, 2023 WL 5415315, at *15, *17, *20, *21; there was a lack of analyst commentary about the alleged corrective disclosures, id. at *15-16; the negative price reaction was not properly attributable to the alleged corrective disclosures, id. at *16; and one of the alleged corrective disclosures did not offer any new corrective information, id. at *20. The court held that the sole remaining alleged corrective disclosure sufficiently illustrated price impact but only in connection with some of the alleged misrepresentations. Id. at *20. Based on this analysis, the court certified a class covering a limited period and as to only a subset of challenged statements. Id. at *22.

We will continue to monitor developments in this area.

IX. OTHER NOTABLE DEVELOPMENTS

A. Circuit Developments In Omnicare Cases

As noted in prior updates, in the nearly nine years since the Supreme Court issued its seminal decision concerning opinion statements in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015), courts have regularly applied Omnicare, which was decided in the context of a Section 11 claim, to claims brought under the Exchange Act.

In a June 2023 decision, the Third Circuit joined the trend of applying Omnicare to claims brought under the Exchange Act, holding that Omnicare’s opinion-falsity framework applies to claims for violations of Rule 10b-5. City of Warren Police and Fire Retirement Sys. v. Prudential Fin., Inc., 70 F.4th 668, 685 (3d Cir. 2023). Plaintiff’s claims stemmed from announcements made by the publicly traded life insurance company, Prudential Financial, Inc. (“Prudential”), that it would need to increase its reserves by $208 million and that its earnings would be reduced by $25 million per quarter for the foreseeable future. Id. at 676. Plaintiff, a municipal retirement system and investor in Prudential, alleged that the company knew about problems with its reserves and misled investors about those issues. Id. The district court granted Prudential’s motion to dismiss the case for failure to state a claim, reasoning that plaintiff did not adequately plead falsity. Id.

On appeal, plaintiff argued that four sets of statements were pleaded with particularity and were plausibly false or misleading. Id. at 681. The Third Circuit remanded one set of statements to the district court and affirmed the district court’s dismissal of the remaining three sets of statements. Id. at 676-77. In affirming the dismissal of claims related to one set of statements, the Third Circuit applied, for the first time, Omnicare’s bases of liability to a claim brought under Section 10(b). In its ruling, the Third Circuit noted that “every other Court of Appeals to encounter the issue has applied the Omnicare framework for opinion falsity to claims for Rule 10b-5 violations.” Id. at 685. The Third Circuit ultimately held that defendant’s representations about the adequacy of its reserve were non-actionable opinions because plaintiff had failed to allege any of the three Omnicare situations in which a statement of opinion could form the basis for liability. Id. at 686-87.

In an August 2023 decision, the Second Circuit held that a statement of opinion that reflects some subjective judgment must have a sufficient evidentiary basis in order to be non-actionable under Omnicare. New Eng. Carpenters Guaranteed Annuity & Pension Funds v. DeCarlo, 80 F.4th 158, 174 (2d Cir. 2023). Plaintiffs’ claims stemmed from restatements made by the publicly traded property and casual insurance company, AmTrust Financial Services (“AmTrust”), of five years of financial results to correct “significant errors in its annual and quarterly reports.” Id. at 165. Specifically, AmTrust disclosed that it had improperly accounted for certain extended-warranty contracts and certain discretionary employee bonuses. Id. In response to the restatements, plaintiffs brought claims against AmTrust for allegedly misstating the company’s financial condition and results in violation of Sections 11, 12, and 15 of the Securities Act, Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5. Id. The district court dismissed all claims as non-actionable statements of opinion. Id.

On appeal, the Second Circuit affirmed the district court’s dismissal of plaintiffs’ Section 10(b) and Rule 10b-5 claims against AmTrust for failure to raise a strong inference of scienter. Id. at 178-79. But the Second Circuit vacated the district court’s dismissal of (1) plaintiffs’ Section 11 claims related to AmTrust’s accounting for certain extended-warranty contracts and (2) plaintiffs’ Section 11 and Section 12(a)(2) claims related to AmTrust’s accounting of discretionary employee bonuses. Id. at 172, 174-76.

First, the Second Circuit held that plaintiffs sufficiently alleged that AmTrust omitted material facts such that its financial statements related to warranty-contract revenue were misleading and reversed the district court’s dismissal of plaintiffs’ Section 11 claims arising from these statements. Id. at 174 (citing Omnicare, 575 U.S. at 192). The court rejected the argument that the accounting decision was a “judgment call” and thus non-actionable, reasoning that subjective judgments presume some historical evidence, and GAAP allows time-of-sale recognition only if evidence justifies doing so. Id.

Second, the Second Circuit held that plaintiffs plausibly alleged that AmTrust’s statements regarding bonuses not being “probable” lacked sufficient evidentiary basis and reversed the district court’s dismissal of plaintiffs’ related Section 11 and Section 12(a)(2) claims. Id. at 175 (citing Omnicare, 575 U.S. at 188-89). In so doing, the Second Circuit noted that the district court should, at the pleading stage, accept plaintiffs’ claim that AmTrust had a practice of paying earned bonuses and that there was no reason to believe continued payment was not “probable.” Id.

The Second Circuit did affirm the district court’s dismissal of plaintiffs’ Section 11 claims concerning certifications signed by AmTrust’s officers. Id. at 176. The court held that the certifications were opinions explicitly based on the officer’s knowledge and that plaintiffs failed to allege the officers had knowledge of the financial reporting’s alleged inaccuracy. Id. Specifically, the Second Circuit held that plaintiffs failed to establish a lack of a meaningful inquiry in order to create liability and further stated that opinions that “turned out to be wrong” are not necessarily actionable. Id. (citing Omnicare, 575 U.S. at 186, 188).

B. Courts Decline To Enforce Control Share Acquisition Provisions

In 2023, two courts declined to enforce state control share acquisition statutes due to the statutes’ conflict with the guarantee of “one share, one vote” found in Section 18(i) of the Investment Company Act of 1940. Section 18(i) requires that every share of stock “be a voting stock and have equal voting rights with every other outstanding voting stock.” 15 U.S.C. § 80a-18(i). In contrast, control share acquisition statutes typically allow companies to alter or remove voting rights when a person acquires a certain minimum percentage of the company’s shares, with such minimum being determined by the specific state control share acquisition statute. Generally, control share acquisition statutes apply exclusively to closed-end funds. SEC, Control Share Acquisition Statutes, Staff Statement (May 27, 2020). Roughly half of all states have corporate control share acquisition statutes in effect. Id.

This past year, Saba Capital Management, LP and its affiliates (together, “Saba”) successfully challenged the enforceability of closed-ended funds’ and business trusts’ control share acquisition provisions on the grounds that they violate Section 18(i). See Saba Cap. CEF Opportunities 1, Ltd. v. Nuveen Floating Rate Income Fund, 88 F.4th 103, 114 (2d Cir. 2023); Saba Cap. Master Fund, Ltd. v. BlackRock Mun. Income Fund, Inc., 2024 WL 43344, at *6 (S.D.N.Y. Jan. 4, 2024). The Nuveen defendants were Massachusetts closed-ended investment funds; the BlackRock defendants were Maryland closed-ended mutual funds and individual trustees. Defendants in both cases enacted bylaws which restricted the voting power of any person holding 10% or more of the funds’ shares. Nuveen, 88 F.4th at 109; BlackRock, 2024 WL 43344, at *1. Saba sued, claiming that these provisions violated Section 18(i)’s guarantee of “one share, one vote.” Nuveen, 88 F.4th at 115; BlackRock, 2024 WL 43344, at *1.

In Nuveen and BlackRock, the Second Circuit affirmed a grant of summary judgment, and a district court in the Southern District of New York granted summary judgment, respectively, for Saba against the defendant funds. In Nuveen, the Second Circuit rejected defendants’ contention that the provision restricted the shareholder, not the shares. Nuveen, 88 F.4th at 118–20. In BlackRock, the district court rejected defendants’ argument that the control share resolutions fell under an exception Section 18(i) for provisions that are “otherwise required by law” because such provisions were authorized by Maryland’s Control Share Acquisition Act. BlackRock, 2024 WL 43344, at *6. The court did not find this argument persuasive, ruling that “[t]he fact that Maryland law allows funds to adopt such control share resolutions does not in any way mean that Maryland law requires as much.” Id. Furthermore, both courts noted that the Investment Company Act of 1940 defines “voting security” as “any security presently entitling the owner or holder thereof to vote for the election of directors of a company.” Nuveen, 88 F.4th at 117; BlackRock, 2024 WL 43344, at *6 (emphasis added). Consequently, the courts held that the restrictions denied shareholders the right to presently vote their shares, thus violating Section 18(i). Nuveen, 88 F.4th at 119–21; BlackRock, 2024 WL 43344, at *6–7.

Though other circuits have yet to test the conflict between state control share acquisition statutes and Section 18(i), these decisions suggests courts may be hesitant to allow voting restrictions placed on certain shares held by large shareholders.

C. Ninth Circuit Holds That SEC Rule 16b-3 Does Not Require Purpose-Specific Board Approval of Transactions

In a case of first impression, the Ninth Circuit held that SEC Rule 16b-3, which exempts from Section 16(b) liability transactions between an issuer and a director where the issuer’s board approves the transaction, does not require the board to approve the transaction for the “specific purpose” of exempting it from Section 16(b) liability. Roth v. Foris Ventures, LLC, 86 F.4th 832, 835, 837 (9th Cir. 2023). Roth reached the Ninth Circuit on a “rare” interlocutory appeal under 28 U.S.C. § 1292 after the district court denied defendants’ motion to dismiss the plaintiff’s claims under Section 16(b). Id. at 836.

The Ninth Circuit reversed the district court’s ruling on the issue of board approval and held that Rule 16b-3(d) does not require purpose-specific approval of a transaction. Id. at 837. The court analyzed the plain text of the rule and explained that the only relevant question was whether the transaction was “approved by the board of directors of the issuer.” Id. at 836. The court found that there was no indication in the rule that “the board must approve the transaction for the specific purpose of exempting it from Section 16(b) liability.” Id. at 836-37. In analyzing this issue, the Ninth Circuit reached the same conclusion as the Second Circuit did when presented with a similar question. See Gryl v. Shire Pharms. Grp. PLC, 298 F.3d 136, 146 (2d Cir. 2002) (holding that “a securities transaction need not receive purpose-specific approval in order to qualify for the Board Approval Exemption of Rule 16b-3(d)(1)”).

The Ninth Circuit’s ruling clarifies a developing area of securities law concerning the scope of exemptions for “short-swing” stock trades by officers, directors and other corporate insiders.

D. Sixth Circuit Grants Interlocutory Appeal Of Class Certification Decision On Affiliated Ute/Comcast Issues

In November, the Sixth Circuit granted utility company FirstEnergy’s petition for interlocutory review of a class certification. Order, In re FirstEnergy Corp., Nos. 23-0303/0304/0305/0306/0307 (6th Cir. Nov. 16, 2023). The complaint alleged a large corruption and bribery scheme purportedly carried out by FirstEnergy in which the company paid out millions to various politicians in exchange for a bailout of its nuclear power plants. In re FirstEnergy Corp. Sec. Litig., 2023 WL 2709373, at *2 (S.D. Ohio 2023). The complaint further alleged that FirstEnergy made both affirmative misrepresentations (when it represented that it complied with all lobbying registration and disclosure requirements despite purportedly making clandestine contributions to state representatives) and fraudulent omissions (when it failed to disclose the purported scheme in its SEC registration statements). Id. at *3, *5. The district court certified a class under the Affiliated Ute presumption of reliance—which provides a mechanism for plaintiffs in cases involving omissions to show reliance on a class-wide basis—ruling that plaintiffs are entitled to the Affiliated Ute presumption so long as a court finds that defendants made any omissions of material fact. Id. at *16-17, *19-20. The court also held that predominance was satisfied because damages could be calculated via a statutory formula, thus satisfying Comcast Corp. v. Behrend, 569 U.S. 27 (2013), which requires plaintiffs to offer a class-wide model for calculating damages that “measure[s] only the damages attributable to [a] [p]laintiffs’ theory of liability.” Id. at *15-16.

In its brief for petition for review of the class certification order, FirstEnergy first argued that the Sixth Circuit should clarify that the Affiliated Ute standard applies only where plaintiffs’ case primarily involves omissions and is inapplicable to cases that have a mix of both omissions and misrepresentations. Reply Brief of Defendants at 3, In re FirstEnergy Corporation Securities Litigation, No. 23-0303 (6th Cir. May 2, 2023). FirstEnergy also argued that the district court’s ruling contradicted Comcast by certifying plaintiffs’ Exchange Act class based on a damages methodology that was inconsistent with their theory of liability. Id. at 6.

E. Companies Continue To Face Exposure For Alleged Misrepresentations Related To Purported Cybersecurity Vulnerabilities

Cybersecurity and data privacy concerns continue to be an area of activity for shareholders and the SEC. In April 2023, a shareholder derivative suit was filed involving Okta, Inc., a cloud-based software company alleging that the company’s directors permitted Okta to issue misleading risk disclosures contained in its March 2022 Form 10-K. Complaint, Buono v. McKinnon, 23-cv-00413 (D. Del. Apr. 14, 2023), ECF No. 1. Plaintiff alleged that the warnings about cybersecurity incidents were misleading because they failed to disclose that the company was “susceptible and vulnerable to security breaches,” including one the company later disclosed. Id. at 31-32, 35-36, 40. The lawsuit, which is stayed by agreement of the parties, adopts allegations from a separate securities class action lawsuit in which the court dismissed securities fraud claims based on the same theory. In re Okta, Inc. Sec. Litig., No. 22-cv-02990 (N.D. Cal. Mar. 17, 2023), ECF No. 73.

In the enforcement space, the SEC filed a cybersecurity-related complaint against SolarWinds Corporation and its chief information security officer in October 2023. Complaint, SEC v. SolarWinds Corporation, No. 23-cv-9518 (S.D.N.Y. Oct. 30, 2023). The complaint alleged that SolarWinds knew since 2018 that it had major cybersecurity deficiencies after internal assessments concluded that the company’s remote access virtual private network was “not very secure” and that the vulnerability, if exploited, would let someone “basically do whatever without [SolarWinds] detecting it until it’s too late.” Id. at 5. Between January 2019 and December 2020, SolarWinds suffered a cyberattack that compromised its flagship product and impacted thousands of its customers. Id. at 2, 7. The SEC alleged that SolarWinds therefore misled investors in its filings by disclosing only generic and hypothetical risks when in reality it knew the true extent of its own cybersecurity vulnerabilities and the increased risks the company faced. Id. at 39. In a press release related to the enforcement action, the SEC cautioned issuers to “implement strong [cyber] controls calibrated to your risk environments and level with investors about known concerns.” Press Release, SEC, SEC Charges SolarWinds and Chief Information Security Officer with Fraud, Internal Control Failures (Oct. 30, 2023).

The SEC’s enforcement action against SolarWinds followed the implementation of new cybersecurity risk management rules that the SEC adopted in late July, which require companies to disclose (1) material cybersecurity incidents within four business days of the company’s determination that the cybersecurity incident is material and (2) the company’s “cybersecurity risk management, strategy, and governance.” Press Release, SEC, SEC Adopts Rules on Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure by Public Companies (July 26, 2023). For additional details on these new rules, please see the Gibson Dunn update published after the rules were adopted.

The following Gibson Dunn lawyers participated in preparing this update: Monica K. Loseman, Brian M. Lutz, Craig Varnen, Jefferson E. Bell, Christopher D. Belelieu, Michael D. Celio, Mary Beth Maloney, Lissa M. Percopo, Jessica Valenzuela, Allison K. Kostecka, Mark H. Mixon, Jr., Chase Weidner, Luke A. Dougherty, Tim Kolesk, Chase Beauclair, Trevor Gopnik, Lydia Lulkin, Dillon M. Westfall, Megan R. Murphy, Sophia Amir, Eitan Arom, Maura Carey*, Tawkir Chowdhury, Angela A. Coco, Dasha Dubinsky, Mason Gauch, John Harrison, Mary Karapogosian, Suzi Kondic, Neel Lakhanpal*, Ahin Lee*, Connor Leydecker, Daniel Liu, Riley Majeune, Zachary Montgomery, Narayan Narasimhan, Kate Oh, Ty Shockley, Alon H. Sugarman, and Hayato Watanabe.

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])
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])

*Maura Carey, a recent law graduate in the Palo Alto office, and Neel Lakhanpal and Ahin Lee, recent law graduates in the New York office, are not admitted to practice law.

The proposed information sharing system will help to bring Hong Kong in line with global trends and enhance the effectiveness of its mechanisms to combat fraud, money laundering and terrorist financing.

On January 23, 2024, the Hong Kong Monetary Authority (“HKMA”) published the “Public Consultation on a Proposal for Information Sharing Among Authorized Institutions to Aid in Prevention or Detection of Crime” (“Consultation Paper”).[1] In short, the Consultation Paper proposes to facilitate information sharing among Authorized Institutions (“AIs”) in respect of personal bank accounts for the purpose of preventing or detecting fraud or money laundering and terrorist financing (“ML/TF”). The proposal also considers the introduction of legislative amendments to provide “safe harbor” protection to AIs which share information for the purposes of preventing or detecting fraud or ML/TF, provided the AIs comply with appropriate safeguards.

I. Why encouraging information sharing between AIs?

While information sharing among AIs and law enforcement agencies has been successful in combatting a wide range of financial crimes, the HKMA recognizes that such arrangements may not, by themselves, be sufficient to fully address the risk of ML/TF via networks of accounts maintained or controlled by criminals (commonly referred to as “mule account networks”), since information might not be shared quickly enough to intercept illicit funds. Delays in information sharing provides an opportunity for criminals to exploit information gaps between AIs to rapidly move and conceal illicit funds. For example, by the time one AI has frozen the accounts maintained or controlled by criminals, those responsible may have already succeeded in moving their illicit funds to their mule accounts in another AI, which the first AI may not be able to quickly alert.

Therefore there has been a global trend towards encouraging information sharing among financial institutions to combat crime and related ML/TF. In Hong Kong, participating AIs can share information on corporate accounts with one another through the Financial Intelligence Evaluation Sharing Tool (“FINEST”) launched in June 2023. However FINEST currently does not support information sharing on personal accounts due to concerns over data privacy. The Consultation Paper points out that FINEST’s ability to prevent and detect crime would be enhanced if information sharing were extended to personal accounts because a significant portion of mule account networks involve bank accounts held by individuals. As such, the importance of safeguarding data privacy and customer confidentiality should be balanced against the need for information sharing among AIs to detect or prevent crime and facilitate the interception of illicit funds.

II. What is the effect of the “safe harbor”?

The HKMA proposes to introduce legislative amendments to provide “safe harbor” protection to AIs which share information on personal accounts with other AIs solely for the purposes of preventing or detecting fraud or ML/TF. The “safe harbor” would provide AIs with legal protection from breach of legal, contractual or other restrictions on disclosure of information, and AIs also will not be held liable for claimed loss arising out of disclosures made. However the “safe harbor” will only apply if the AI complies with the safeguards discussed below.

III. What is the scope of information that could be shared between AIs?

While the scope of information to be shared will vary on a case-by-case basis, the Consultation Paper proposes that it could generally include:

Bank account numbers;
Personal data (e.g. name, date of birth, identity card number) of a customer or counterparty who is a natural person;
Personal data of any beneficial owners or connected party (e.g. a director, partner, or trustee, as applicable) of a customer who is a legal person, a trust, or a legal arrangement similar to a trust;
Personal data of any person purporting to act on behalf of a customer (e.g. acting under power of attorney, or an account signatory);
Details of relevant transactions including counterparties;
Reasons why the transactions or activity may be involved in fraud or ML/TF.

IV. Is information sharing mandatory or voluntary?

Under the proposed system, information sharing by AIs will be made by participating AIs on a voluntary basis.

V. Will changes be made to the STR regime?

The HKMA proposes to introduce a legislative provision that will make clear for the avoidance of doubt that information sharing among AIs under the proposed arrangements will not constitute the offence of “tipping off” under the Organized and Serious Crimes Ordinance (Cap. 455) (“OSCO”) and the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap. 405) (“DTROP”).[2] The obligation to file STRs will remain unchanged.

VI. What safeguards will be implemented?

The HKMA recognizes the importance of protecting the data privacy and customer confidentiality of legitimate customers. The HKMA therefore proposes that the “safe harbor” should only apply where appropriate safeguards are complied with, as summarized below:

The information is shared solely for the purpose of detecting or preventing financial crime;
AIs receiving information are required to treat it in the same manner, and to the same standards of confidentiality, as other confirmation information;
Onward sharing of information received by an AI to another AI is only permitted if is for the purpose of detecting or preventing financial crime, and subject to the same requirements regarding confidentiality;
Information sharing will only be permitted via secure channels such as FINEST (and AIs will need to demonstrate that they are technically and operationally ready and have implemented appropriate systems and controls in order to be permitted to access such platforms);
An AI should only request for information from another AI where the requesting AI has reasonable grounds to believe that the other AI is able to provide information which will assist with preventing or detecting financial crime (including in deciding whether to file an STR);
To prevent “fishing expeditions,” requests for information must be specific and identify the subject of the request, relevant transactions and reasons for suspecting that an activity is connected with financial crime;
Sharing of information will be on a need-to-know basis, i.e. an AI will only be permitted to request or disclose information where they have observed suspicious activity that may indicate that a person, account or transaction may be involved in fraud or ML/TF;
AIs need to adopt a risk-based approach with respect to information shared under the “safe harbor”, e.g. AIs should not terminate a customer relationship merely because the customer is included in information shared or requested (instead, an AI should always conduct its own risk assessment before deciding on the appropriate action to take).

The HKMA proposes to set out the specific requirements in the legislative amendments and the HKMA will also issue statutory guidance setting out its expectations on complying with the relevant requirements. The information sharing mechanism would be supervised by the HKMA, and the HKMA proposes to have the power to impose penalties on AIs that fail to comply with the relevant requirements.

VII. Conclusion

The proposed information sharing system will help to bring Hong Kong in line with global trends and enhance the effectiveness of its mechanisms to combat fraud and ML/TF. The HKMA notes that the United States, United Kingdom and Singapore have already introduced legislation to allow financial institutions to share information concerning individuals and entities where financial crime is suspected. While the specific requirements under each jurisdiction differs, they all provide a safe harbor for financial institutions which disclose information where financial crime is suspected.

The HKMA aims to issue its consultation conclusions and prepare the necessary legislative amendments in the second half of 2024. Interested parties are encouraged to provide feedback by March 29, 2024.

__________

[1] Available at: https://www.hkma.gov.hk/media/eng/regulatory-resources/consultations/Consultation_on_AI-AI_info_sharing_en.pdf.

[2] Under section 25A(5) of OSCO and DTROP, a person commits an offence if, knowing or suspecting that an STR has been filed, the person discloses to another person any matter which is likely to prejudice any investigation which might be conducted following the filing of the STR.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Arnold Pun, and Jane Lu*.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong and Singapore:

William R. Hallatt – Hong Kong (+852 2214 3836, [email protected])
Grace Chong – Singapore (+65 6507 3608, [email protected])
Emily Rumble – Hong Kong (+852 2214 3839, [email protected])
Arnold Pun – Hong Kong (+852 2214 3838, [email protected])
Becky Chung – Hong Kong (+852 2214 3837, [email protected])

*Jane Lu is a paralegal (pending admission) in the firm’s Hong Kong office who is not yet admitted to practice law.

We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q4 2023. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

2023: The Audit Enforcement Year in Review
PCAOB Publishes Enforcement Orders Against China-Based Firms, Even as Congress Contemplates Further Action
SEC Cybersecurity Disclosure Rules Go into Effect
SEC Approves 2024 PCAOB Budget
SEC Chief Accountant Issues Statements on Cash Flow Reporting and Professional Skepticism
Second Circuit Limits SEC’s Ability to Seek Disgorgement
Canadian Public Accountability Board Provides Insights on 2023 Audit Quality Assessment Results
UK Economic Crime and Corporate Transparency Act 2023 Goes into Effect While FRC Revises Corporate Governance Code
PCAOB Makes Personnel Changes
PCAOB Announces Staff Priorities for 2024 Inspections and Interactions with Audit Committees
FinCEN Corporate Transparency Reporting Goes into Effect
Other Recent SEC and PCAOB Enforcement and Regulatory Developments

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

Read More

Accounting Firm Advisory and Defense Group:

James J. Farrell – Co-Chair, New York (+1 212-351-5326, [email protected])

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, [email protected])

Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, [email protected])

In addition to the Accounting Firm Advisory and Defense Practice Group Chairs listed above, this Update was prepared by David Ware, Timothy Zimmerman, Benjamin Belair, Adrienne Tarver, Monica Limeng Woolley, Douglas Colby, John Harrison, and Nicholas Whetstone.

From the Derivatives Practice Group: This week, ISDA, ESMA, and the CPMI published reports on various derivatives initiatives and reforms.

New Developments

SEC Adopts Rule to Expand Definitions of “Dealers” and “Government Securities Dealers.” On February 6, the SEC adopted a rule that requires market participants to register as “dealers” or “government securities dealers” for the first time and become members of a self-regulatory organization (SRO). The final rule, codified in Exchange Act Rules 3a5-4 and 3a44-2, purports to define the phrase “as a part of a regular business” in Sections 3(a)(5) and 3(a)(44) of the Securities Exchange Act of 1934 to identify certain activities that would cause persons engaging in such activities to be “dealers” or “government securities dealers” and be subject to the registration requirements of Sections 15 and 15C of the Act, respectively. Under the final rule, any person that engages in activities as described in the rule is a “dealer” or “government securities dealer” and, absent an exception or exemption, required to: register with the SEC under Section 15(a) or Section 15C, as applicable; become a member of an SRO; and be subject to applicable SRO and Treasury rules and requirements. Notably, the rule is non-exclusive, meaning that even if a firm does not meet any of the criteria in the rule, the SEC claims that the firm could still be a dealer anyway depending on the “facts and circumstances.”
SEC and CFTC Adopt Amendments to Enhance Private Fund Reporting. On February 8, the SEC adopted amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds, including those that also are registered with the CFTC as commodity pool operators or commodity trading advisers. According to the SEC, the amendments, which the CFTC concurrently adopted, are designed to enhance the ability of the Financial Stability Oversight Council (FSOC) to monitor and assess systemic risk and to bolster the SEC’s oversight of private fund advisers and the agency’s investor protection efforts. The SEC and CFTC also agreed to a memorandum of understanding related to the sharing of Form PF data. The SEC stated that, among other things, the amendments to Form PF will enhance how large hedge fund advisers report investment exposures, borrowing and counterparty exposure, market factor effects, currency exposure, turnover, country and industry exposure, central clearing counterparty reporting, risk metrics, investment performance by strategy, portfolio liquidity, and financing and investor liquidity in an effort to provide better insight into the operations and strategies of these funds and their advisers and improve data quality and comparability. Further, the amendments will require additional basic information about advisers and the private funds they advise, including identifying information, assets under management, withdrawal and redemption rights, gross asset value and net asset value, inflows and outflows, base currency, borrowings and types of creditors, fair value hierarchy, beneficial ownership, and fund performance, which, according to the SEC, will provide greater insight into private funds’ operations and strategies, assist in identifying trends, including those that could create systemic risk, improve data quality and comparability, and reduce reporting errors. The amendments will also require more detailed information about the investment strategies, counterparty exposures, and trading and clearing mechanisms employed by hedge funds, while also removing duplicative questions.
CFTC Global Markets Advisory Committee Advances Key Recommendations. On February 8, the CFTC’s Global Markets Advisory Committee (GMAC), sponsored by Commissioner Caroline D. Pham, formally advanced eight recommendations to the CFTC that are intended to enhance the resiliency and efficiency of global markets, including U.S. Treasury markets, repo and funding markets, and commodity markets. To date, this is the largest number of recommendations advanced by a CFTC Advisory Committee in a single meeting. The GMAC’s Global Market Structure Subcommittee prepared four recommendations: (1) appropriately calibrated block and cap sizes under CFTC Part 43 swap data reporting rules, intended to enhance market liquidity and financial stability; (2) addition of certain central counterparties (CCPs) as permitted counterparties under CFTC Rule 1.25(d), intended to promote the well-functioning of the repo market; (3) expansion of cross-margining between the CME Group and the Fixed Income Clearing Corporation, intended to support greater efficiency in the U.S. Treasury markets; and (4) best practices for exchange volatility control mechanisms, intended to address market stress and market dislocation during periods of high volatility. The GMAC’s Technical Issues Subcommittee prepared four additional recommendations, as follows: (5) adoption of lessons learned from a global default simulation across CCPs, intended to address systemic risk and promote financial stability; (6) harmonization of the treatment of money market funds as eligible collateral, intended to improve market liquidity; (7) improvement of trade reporting for market oversight, intended to ensure international standardization and global aggregation and analysis of data to address systemic risk; and (8) improvement of trade reporting for market oversight, intended to facilitate data sharing across jurisdictions for systemic risk analysis.
CFTC Customer Advisory Alerts App and Social Media Users to Financial Romance Fraud. On February 7, the CFTC’s Office of Customer Education and Outreach (OCEO) issued a customer advisory alerting dating/messaging app and social media users to a scam asking for financial support or giving investment advice using the platforms. The Customer Advisory: Six Warning Signs of Online Financial Romance Frauds, reminds app and social media users to be wary of texts and messages from strangers that promote cryptocurrency investments. According to the OCEO, the text could actually be from international criminal organizations that trick victims into investing money in cryptocurrency or foreign currency scams only to defraud them. The OCEO stated that the scam can take advantage of even the savviest of investors because fraudsters develop relationships with their victims through weeks of seemingly authentic text messaging conversations, a practice known as “grooming.” The advisory points out several warning signs of a financial grooming fraud, which include fraudsters attempting to move conversations from a dating or social media platform to a private messaging app, as well as their claims of wealth from cryptocurrency or foreign currency trading due to insider information. The advisory also includes steps users can take to avoid financial grooming frauds.
CFTC Extends Public Comment Period on Proposed Rule on Protection of Clearing Member Funds. On February 2, the CFTC extended the deadline for the public comment period on a proposed rule to address protecting clearing member funds held by derivatives clearing organizations. The deadline is being extended to March 18, 2024. The CFTC stated that it provided the extension in response to a request by a commenter.
Commissioner Pham Announces Additional Executive Staff Appointments. CFTC Commissioner Caroline D. Pham announced new executive staff appointments in her Washington, D.C. office on February 1. Taylor Foy joins Commissioner Pham’s team as a Senior Advisor and Nicholas Elliot has joined as a Confidential Assistant and Policy Advisor.

New Developments Outside the U.S.

CPMI, IOSCO Publish Paper on Streamlining VM in Centrally Cleared Markets. On February 14, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a discussion paper on streamlining variation margin (VM) in centrally cleared markets. The discussion paper follows the review of margining practices, published in 2022 by the Basel Committee on Banking Supervision, the CPMI and IOSCO. The discussion paper sets out eight effective practices, covering intraday VM call scheduling and frequency, treatment of excess collateral, the pass-through of VM by central counterparties (CCPs) and transparency between CCPs, clearing members and their clients. The deadline for comment is April 14. [NEW]
ESMA Withdraws Euronext Authorization as a Data Reporting Service Provider Under MIFIR Upon the Entity’s Request. On February 13, ESMA withdrew the authorization of Euronext Paris SA (Euronext) as a Data Reporting Service Provider (DRSP) under the Markets in Financial Instruments Regulation (MiFIR). Euronext was authorized as both an Approved Reporting Mechanism and an Approved Publication Arrangement under MiFIR since January 3, 2018. MiFIR provides that ESMA shall withdraw the authorization of a DRSP where the DRSP expressly renounces its authorization. ESMA’s withdrawal decision follows the notification by Euronext of its intention to renounce its authorization under the conditions set out in Article 27e(a) of MIFIR. [NEW]
ESMA Publishes Latest Edition of its Newsletter. On February 13, ESMA published  its latest edition of the Spotlight on Markets Newsletter. The newsletter focused on the last ESMA consultation package related to the Markets in Crypto Assets Regulation (MiCA). ESMA invited stakeholders to send their feedback on reverse solicitation and classification of crypto assets as financial instruments by April 29, 2024. The newsletter also launched a call for candidates for ESMA’s Securities Markets Stakeholder Group and called interested parties who can give a strong voice to consumers, industry, users of financial services, employees in the financial sector, SMEs as well as academics to apply by March 18. [NEW]
Hong Kong Government Launches Consultation on Regulating OTC Trading of Virtual Assets. On February 8, the Hong Kong government launched a public consultation on legislative proposals to introduce a licensing regime for providers of over-the-counter trading services of virtual assets (VAs). Under the proposed licensing regime, any person who conducts a business in providing spot trading services of VAs-for-money or money-for-VAs will be required to be licensed by the Commissioner of Customs and Excise, irrespective of whether the services are provided through a physical outlet and/or digital platforms. Licensees will be required to comply with AML/CFT requirements and other regulatory requirements. The public consultation period ends on April 12, 2024.
HKMA Consults on Capital Treatment of Cryptoasset Exposures. On February 7, the Hong Kong Monetary Authority (HKMA) published a Consultation Paper on CP24.01 Cryptoasset Exposures setting out a proposal for implementing new regulations on the prudential treatment of cryptoasset exposures based on the Basel Committee on Banking Supervision’s Prudential treatment of cryptoasset exposures standard. According to the consultation paper, for the purpose of the prudential treatment of cryptoasset exposures, cryptoassets will be defined as private digital assets that depend on cryptography and distributed ledger technologies or similar technologies. The HKMA has scheduled a preliminary consultation on the proposed amendments to the rules in the second half of 2024 and aims to put new standards into effect no earlier than July 1, 2025.
EU Co-Legislators Reach Provisional Agreement on EMIR 3. On February 6, the EU co-legislators reached a provisional political trilogue agreement on the European Market Infrastructure Regulation 3. On the issue of an active account requirement, while the agreement is based on the less punitive operational active account with representativeness approach proposed by the Council of the EU, the European Parliament has proposed that counterparties should clear at least five trades through an EU CCP in each of the most relevant subcategories. The original approach proposed by the council only required one trade per relevant subcategory. On the topic of supervision, the agreement includes a new role for the European Securities and Markets Authority (ESMA) as co-chair of CCP supervisory colleges alongside national competent authorities and a coordinating role in an emergency.
ESA’s Joint Board of Appeal Confirms ESMA’s Decision to Withdraw the Recognition of Dubai Commodities Clearing Corporation. On February 6, the Joint Board of Appeal of the European Supervisory Authorities (the ESAs) unanimously decided to dismiss the appeal brought by Dubai Commodities Clearing Corporation (DCCC) against ESMA and to therefore confirm the ESMA decision to withdraw its recognition. The application was brought in relation to ESMA’s Decision, adopted under Article 25p of Regulation (EU) No 648/2012 (EMIR), to withdraw the recognition of DCCC as a Tier 1 third-country CCP. The decision is a consequence of the United Arab Emirates (UAE) being included by the European Commission on the list of high-risk third countries presenting strategic deficiencies in their national anti-money laundering and counter financing of terrorism (AML/CFT) regime, provided for in the Commission Delegated Regulation (EU) 2016/1675. The Joint Board of Appeal of the ESAs had decided to suspend the ESMA decision in October 2023 until the outcome of the appeal was concluded. With today’s publication, the suspension has expired and the ESMA decision has become fully operational.
ESMA Publishes Guidelines on CCP Recovery and Resolution. On February 2, ESMA published two sets of guidelines relating to the EU CCP Recovery and Resolution Regulation. The first set of guidelines provides EU authorities with guidance on the provisions that should be included in cooperation arrangements with third-country authorities, on matters such as the exchange of information for the preparation and maintenance of resolution plans, and on the mechanisms for prompt informing to parties before any early intervention power or resolution action. The second set of guidelines provides EU authorities with guidance on practical arrangements for the establishment and functioning of the resolution college for EU CCPs, and to facilitate the effective operation of the college.
ESAs Recommend Steps to Enhance the Monitoring of BigTechs’ Financial Services Activities. On February 1, the ESAs published a Report setting out the results of a stock take of BigTech direct financial services provision in the EU. The Report identifies the types of financial services currently carried out by BigTechs in the EU pursuant to EU licenses and highlights inherent opportunities, risks, regulatory and supervisory challenges. The stock take showed that BigTech subsidiary companies currently licensed to provide financial services pursuant to EU law mainly provide services in the payments, e-money and insurance sectors and, in limited cases, the banking sector. However, the ESAs have yet to observe their presence in the market for securities services. To further strengthen the cross-sectoral mapping of BigTechs’ presence and relevance to the EU’s financial sector, the ESAs propose to set-up a data mapping tool. The ESAs explained that this tool is intended to provide a framework that supervisors from the National Competent Authorities would be able to use to monitor on an ongoing and dynamic basis the BigTech companies’ direct and indirect relevance to the EU financial sector.

New Industry-Led Developments

ISDA Response to Australian Treasury on Financial Market Infrastructure Reforms. On February 9, ISDA and the Futures Industry Association submitted a joint response to the Australian Treasury’s draft financial market infrastructure reform package. In the response, the associations considered the proposed crisis resolution regime, which would provide the Reserve Bank of Australia (RBA) with powers to step in and resolve a crisis affecting a domestic central counterparty (CCP), with the aim of ensuring the continuity of critical clearing functions and maintaining financial stability in Australia. The associations expressed concerns with some of the provisions contemplated in the draft regime and asked if the issues highlighted in the response (such as the ability of the RBA or statutory manager to direct and make changes to the operating rules, the lack of explicit definitions of and safeguards on resolution powers and the interaction with close-out netting) could be addressed. [NEW]
ISDA Response on Anti-Greenwashing Rules. On January 26, ISDA submitted a response to the UK Financial Conduct Authority’s consultation on GC23/3: Guidance on the Anti-Greenwashing Rule. In the response, ISDA highlights that actual or perceived misrepresentation of sustainability features may have a detrimental impact on investor and consumer perceptions of sustainable finance products, and ISDA supports efforts to enhance trust in the market. ISDA considers that sustainability-linked derivatives, environmental, social and governance derivatives and voluntary carbon credits fall within the scope of the rule.