Palo Alto partners Ed Batts and Carrie LeRoy and Houston partner Charles Walker are the authors of “Tech M&A Due Diligence Checklist: Critical IP Areas Of Inquiry” [PDF] published by Law360 on September 25, 2023.

On July 27, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published a “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (the “Circular”).[1] Trustees and custodians of SFC-authorised collective investment schemes (the “relevant CIS”) will have to be licensed or registered with the SFC for the new Type 13 regulated activity (“RA 13”) from October 2, 2024.

The Circular should be read in tandem with the soon to be enacted Schedule 11 to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Schedule 11”).[2] Together, the Circular and Schedule 11 provide guidance on the SFC’s expectations regarding RA 13 licensing arrangements.

The new RA 13 regulatory regime intends to remedy what the SFC has previously described as a “patchy” approach to the regulation of depositories, whereby the SFC was unable to directly supervise depositaries. Instead, the SFC could only exercise indirect oversight through the requirements under the Product Codes.[3] The RA 13 regulatory framework was proposed by the SFC in September 2019 to fill this void left by a lack of specific, direct supervision mechanism over trustees and custodians of public funds.[4] In doing so, the new RA 13 regulatory regime will also align Hong Kong’s fund custody framework with international standards; most major jurisdictions (such as the United Kingdom and Singapore) have some form of direct regulatory powers over entities providing trustee, custodian or depositary services for public funds (at a minimum). Viewed broadly, the introduction of RA 13 is also consistent with the SFC’s focus on regulating entities providing custody services – for instance, its recent decision to regulate virtual assets custody under its new virtual assets trading platform (“VATP”) regime by requiring custody be undertaken by a wholly owned subsidiary of a licensed VATP operator.

I. Who needs a RA 13 license?

The amendments made to the Securities and Futures Ordinance (“SFO”) to introduce RA 13 define it as “providing depositary services for relevant CISs”.[5] In essence, what this means is that trustees and custodians (i.e. depositaries as defined under the amendments to the SFO) of a relevant CIS at the “top level” of the custodian chain will be required to be licensed or registered for RA 13 in order to provide the following services:

the custody and safekeeping of the CIS property, including property held on trust by the relevant CIS (“CIS Property”); and
the oversight of the CIS to ensure that it is operated according to scheme documents.[6]

In practice, many of these depositaries were not previously supervised by the SFC until the introduction of the new RA 13 regime. This suggests that individuals who will now be required to be licensed to undertake RA 13 activities will be subjected to direct SFC supervision for the first time, and may not be accustomed to being licensed.

II. What are the RA 13 regulatory requirements?

In the table below, we highlight the key regulatory requirements applicable to depositaries licensed for RA 13 (“RA 13 Depositaries”):

Capital thresholds	RA 13 Depositaries are required to maintain a paid-up share capital of not less than $10,000,000 and a liquid capital of not less than $3,000,000.[7]
Treatment of Scheme Money	RA 13 Depositaries that hold or receive scheme money under a relevant CIS (“Scheme Money”) must deposit such Scheme Money into segregated and designated trust accounts or client accounts within three business days after receipt. Each segregated account must be established and maintained for one relevant CIS only.[8] RA 13 Depositaries must not pay Scheme Money out of the segregated account unless such payment is (i) instructed in writing, or (ii) for the purpose of meeting payment, distribution, redemption settlement, or margin requirements, or (iii) to settle any charges or liabilities on behalf of the relevant CIS, as per the scheme documents.[9]
Treatment of Scheme Securities	Similarly, an RA 13 Depositary must deposit client securities which it holds or receives when providing depositary services (“Scheme Securities”) into a segregated and designated trust account or client account. Alternatively, the RA 13 Depositary can register the Scheme Securities in the name of the relevant CIS.[10] An RA 13 Depositary can only deal with Scheme Securities in accordance with written instructions or scheme documents. It must take reasonable steps to ensure that Scheme Securities are not otherwise deposited, transferred, lent or pledged.[11]
Record keeping obligations	In line with the record keeping requirements generally applicable to licensed intermediaries, RA 13 Depositaries are required to keep accounting, custody and other records to sufficiently explain and reflect the financial position and operation of the business, and support accurate profits and loss or income statements. Specifically, RA 13 Depositaries must also account for all relevant CIS Property, and make sure that its accounting systems can trace all movements of relevant CIS Property.[12]
OTCD reporting	RA 13 Depositaries are exempted from reporting specified over-the-counter (“OTC”) derivative transactions to the Hong Kong Monetary Authority (“HKMA”) when acting as a counterparty to the OTC derivative transaction.[13] Similarly, authorized institutions need not report the OTC derivative transaction to the HKMA if the counterparty of the transaction is an RA 13 Depositary acting in its capacity as a trustee of the relevant CIS.[14]

Further, the SFC has previously clarified that the Managers-In-Charge (“MIC”) requirements under the current licensing framework extend to RA 13 licensees.[15]

III. Are there any additional requirements applicable to specific classes of RA 13 Depositaries?

Schedule 11 sets out additional requirements applicable to specific classes of RA 13 Depositaries. In the table below, we summarize the key requirements applicable to RA 13 Depositaries authorized under the Code on Unit Trusts and Mutual Funds[16] and Code on Pooled Retirement Funds (“UT/RF RA 13 Depositaries”).[17] These are mostly RA 13 Depositaries operating Chapter 7 Funds (i.e. plain vanilla funds investing in equity and/or bunds), specialized schemes (such as hedge funds, listed open-ended funds), and pooled retirement funds.

Appointment and oversight of delegates or third parties	UT/RF RA 13 Depositaries should establish internal control policies and procedures to oversee appointed delegates or third parties. These internal control policies and procedures should cover the following: the selection of a delegate or third party, including assessment procedures and criteria on the delegate or third party’s competence, regulatory and financial status, capabilities and the effectiveness of their internal controls and systems; ongoing and regular monitoring of the delegate or third party to ensure compliance with regulatory requirements and maintenance of effective internal controls and systems; and management of actual or potential conflicts of interests arising from the appointment and oversight of delegates or third parties (where applicable). UT/RF RA 13 Depositaries should also establish appropriate contingency plans to cater for instances of breaches or insolvency of these delegates or third parties.[18]
Oversight of the relevant CIS	UT/RF RA 13 Depositaries should have oversight over the operations of the relevant CIS, and ensure that the CIS is operated or administered in accordance with the relevant constitutive documents.[19]
Subscription and redemption	UT/RF RA 13 Depositaries should monitor the relevant operators of each CIS to ensure (among other things): timely processing of subscription and redemption transactions; execution of subscription and redemption orders in accordance with the constitutive documents of the relevant CIS; timely deposits of subscription and redemption proceeds into a segregated bank account designated as a trust account or client account holding relevant CIS Property; reconciliation of subscription and redemption, and that the frequency of such reconciliation is consistent across subscription and redemption; and proper documentation of reasons for (i) suspension of dealing of unit or shares of the relevant CIS, and (ii) suspension of valuation, price or net asset value calculations of the relevant CIS.[20]
Distribution payments	UT/RF RA 13 Depositaries should supervise the relevant operators of each CIS to ensure that: distributions are calculated in accordance with the constitutive documents of the relevant CIS; and complete and accurate distribution payments are made on a timely basis. With respect to each relevant CIS, UT/RF RA 13 Depositaries should ensure that distribution proceeds are transferred according to the operator’s instruction on a timely basis into a designated and segregated or omnibus bank account.[21]
Custody and safekeeping of CIS Property	UT/RF RA 13 Depositaries can adopt the safeguards to ensure the safekeeping of CIS Property: assess and manage custody risk by making adequate organisational arrangements to minimise the risks of loss of the CIS Property; register the CIS Property in the name of the UT/RF RA 13 Depositary; verify ownership of the CIS Property using reliable sources; maintain updated and comprehensive records of the CIS Property; and ensure reconciliation is carried out daily for CIS Property in cash form.[22]

Notwithstanding the above, there are specific requirements applicable to RA 13 Depositaries authorized under the Code on Real Estate Investment Trusts (“REIT RA 13 Depositaries”).[23] These are RA 13 Depositaries operating closed-ended funds primarily investing in real estate. REIT RA 13 Depositaries are under a fiduciary duty to hold assets of Real Estate Investment Trusts (“REIT”) on trust for the benefit of the unitholders of the REIT. While the requirements applicable to UT/RF RA 13 Depositaries summarized above are generally applicable to REIT RA 13 Depositaries, Schedule 11 tailors some of these requirements to account for the unique features and product structure of REITs. The key modifications are summarized as follows:

Cash flow monitoring and cash reconciliation

Under the Code on Real Estate Investment Trusts (“REIT Code”), the management company of a REIT bears the obligation to manage cash flows. Schedule 11 modifies the custody requirements – which require UT/RF RA 13 Depositaries to carry out cash reconciliation of CIS Property daily – to instead require REIT RA 13 Depositaries to ensure that the management company has put in place proper cash flow management policies and controls, and supervise the implementation of such policies and controls.

Custody and safekeeping of CIS Property

REIT RA 13 Depositaries should ensure that all REIT assets (including the title documents of REIT-owned real estate) are properly segregated and held for the benefit of the unitholders in accordance with the REIT Code and the constitutive document of the REIT.

Where the REIT RA 13 Depositary considers it in the interests of the REIT for certain assets of the REIT to be held by the management company on behalf of the REIT, the REIT RA 13 Depositary should make sure that the management company has established proper safeguards and controls to properly segregate REIT assets. Additionally, the REIT RA 13 Depositary must maintain on-going oversight and control over the relevant assets.

IV. What are the next steps?

The SFC has begun accepting licensing applications for RA 13 since July 27, 2023. Depositaries are reminded to submit RA 13 applications on or before November 30, 2023. The RA 13 regime will take effect on October 2, 2024.

_____________________________

[1] “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (July 27, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC32

[2] The final text of Schedule 11 can currently be found at Appendix C, “Consultation Conclusions on Proposed Amendments to Subsidiary Legislation and SFC Codes and Guidelines to Implement the Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (March 24, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=22CP1

[3] Namely, the Code on Unit Trusts and Mutual Funds, the Code on Open-Ended Fund Companies, the Code on Real Estate Investment Trusts, and the Code on Pooled Retirement Funds.

[4] “Consultation Paper on the Proposed Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (September 27, 2019) (“2019 Consultation Paper”), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/openFile?lang=EN&refNo=19CP3

[5] Section 3, “Securities and Futures Ordinance (Amendment of Schedule 5) Notice 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271262.pdf

[6] “Scheme document” refers to (i) the trust deed constituting or governing the relevant CIS if the CIS is constituted in the form of a trust, (ii) the documents governing the formation or constitution of the relevant CIS if the CIS is constituted in any other form other than a trust, or (iii) other documents setting out the requirements relating to (a) the custody and safekeeping of any CIS Property, or (b) the oversight of the operations of the relevant CIS.

[7] Amended Schedule 1 of the Securities and Futures (Financial Resources) Rules, set out under section 10 of the “Securities and Futures (Financial Resources) (Amendment) Rules 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271256.pdf

[8] Amended rule 10B of the Securities and Futures (Client Money) Rules, set out under section 7 of the “Securities and Futures (Client Money) (Amendment) Rules 2023” (“CMR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln055-e.pdf

[9] Amended rule 10C of the of the Securities and Futures (Client Money) Rules, set out under section 7 of the CMR Amendment Rules

[10] Amended rule 9B of the Securities and Futures (Client Securities) Rules, set out under section 6 of the “Securities and Futures (Client Securities) (Amendment) Rules 2023” (“CSR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln054-e.pdf

[11] Amended rules 9C and 10A of the Securities and Futures (Client Securities) Rules, set out under sections 6 and 7 of the CSR Amendment Rules respectively

[12] Amended rule 3A of the Securities and Futures (Keeping of Records) Rules, set out under section 5 of the “Securities and Futures (Keeping of Records) (Amendment) Rules 2023” (“KKR Amendment Rules) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln057-e.pdf

[13] Amended rule 10 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 4 of the “Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) (Amendment) Rules 2023” (“OTCD Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln061-e.pdf

[14] Amended rule 11 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 5 of the OTCD Amendment Rules

[15] Paragraph 26, 2019 Consultation Paper. The SFC’s MIC requirements are listed in the “Circular to Licensed Corporations Regarding Measures for Augmenting the Accountability of Senior Management” (December 16, 2016), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=16EC68, and the related Frequently Asked Questions published by the SFC (last updated on January 26, 2022), available at https://www.sfc.hk/en/faqs/intermediaries/licensing/Measures-for-augmenting-senior-management-accountability-in-licensed-corporations

[16] “Code on Unit Trusts and Mutual Funds” (January 1, 2019), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/section-ii-code-on-unit-trusts-and-mutual-funds/section-ii-code-on-unit-trusts-and-mutual-funds.pdf

[17] “Code on Pooled Retirement Funds” (December 2021), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-on-pooled-retirement-funds/code-on-pooled-retirement-funds.pdf?rev=9badf81950734ee08c799832be6ff92b

[18] Section 6, Schedule 11

[19] Section 8, Schedule 11

[20] Section 9, Schedule 11

[21] Section 11, Schedule 11

[22] See section 14, Schedule 11 for the full list of safeguards.

[23] “Code on Real Estate Investment Trusts” (August 2022), published by the SFC, available at https://www.sfc.hk/-/media/EN/files/COM/Reports-and-surveys/REIT-Code_Aug2022_en.pdf?rev=572cff969fc344fe8c375bcaab427f3b

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, 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:

William R. Hallatt (+852 2214 3836, [email protected])
Emily Rumble (+852 2214 3839, [email protected])
Arnold Pun (+852 2214 3838, [email protected])
Becky Chung (+852 2214 3837, [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.

Gibson Dunn antitrust practitioners discuss the proposed changes to the DOJ-FTC Merger Guidelines, along with potential implications for the HSR merger review process. The speakers also share practical advice and considerations for M&A going forward.

PANELISTS:

Christopher M. Wilson is a partner in the Antitrust and Competition Practice Group of Gibson Dunn. Mr. Wilson assists clients in navigating DOJ, FTC, and international competition authority investigations as well as private party litigation involving complex antitrust and consumer protection issues. Prior to joining Gibson Dunn, Mr. Wilson served in the Antitrust Division of the DOJ where he investigated and litigated high-profile merger matters.

Kristen Limarzi is a partner in the Antitrust and Competition Practice Group of Gibson Dunn. Her practice focuses on representing clients in merger and non-merger investigations before the DOJ, FTC, and foreign antitrust enforcers. Prior to joining Gibson Dunn, Ms. Limarzi served as a top enforcement official in the Antitrust Division of the DOJ, where she was a member of the small team of attorneys and economists from the Antitrust Division and the FTC that revised the Horizontal Merger Guidelines in 2010.

Zoë Hutchinson is an associate in the Antitrust and Competition Practice Group of Gibson Dunn. Ms. Hutchinson’s practice focuses on counseling clients on antitrust risk in proposed mergers, acquisitions, joint ventures and other business transactions. She has counseled clients across multiple industries including healthcare and life sciences, oil & energy, waste, technology and social media, and consumer goods.

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Dallas partner David Woodcock is author of “ESG And The Board: Avoiding Risky Business” [PDF] published by The Corporate Board September 2023.

Starting January 1, 2024, California will be broadening its already expansive prohibitions on employee non-compete agreements. Senate Bill (SB) 699, signed into law on September 1, 2023, added Section 16600.5 to the Business & Professions Code, which expands California’s existing restrictions on non-competes to agreements created out-of-state and creates new enforcement rights for employees to challenge non-compete clauses.

California’s Business and Professions Code section 16600 currently voids contracts that restrain an employee from engaging in a lawful profession, trade, or business of any kind. State courts have historically applied Section 16600 to bar agreements made in California restricting post-employment competition, with limited exceptions.[1]

Section 16600.5 will prohibit enforcement of any contract previously forbidden under Section 16600 “regardless of where and when the contract was signed.” Plaintiffs may capitalize on this broad phrasing to argue that the new law should apply retroactively to any contract with non-compete provisions, and courts will likely have to clarify whether California’s presumption against retroactivity applies.[2] The new law will further bar “an employer or former employer from attempting to enforce a contract that is void regardless of whether the contract was signed and the employment was maintained outside of California.”[3] Employers that enter into a contract that is void or attempt to enforce a contract forbidden by Section 16600 will have committed a civil violation. The expanded restrictions are intended to (i) respond to an increasingly remote talent market, in which “California employers increasingly face the challenge of employers outside of California attempting to prevent the hiring of former employees”; and (ii) to preserve the state’s “competitive business interests” by “protecting the freedom of movement of persons whom California-based employers wish to employ to provide services in California, regardless of the person’s state of residence.”[4]

It remains to be seen how broadly Section 16600.5 will apply in practice, and whether jurisdictional challenges may limit its effect within and outside California. For example, employees who recently moved to California may cite Section 16600.5 in California courts to try to invalidate non-competes that they previously agreed to, even if such clauses were legally negotiated out-of-state with a non-California employer. Alternatively, remote workers employed in other states by California employers may try to invoke the provision in their local jurisdictions to invalidate non-competes formed outside of California, even if the employee never set foot in California. Of course, this raises the question of whether a non-California court will find Section 16600.5 to apply to an employee outside California. Section 16600.5 also raises the question of whether a California court has the authority to rule a non-compete is unenforceable even if the agreement complies with the law of the state in which it was made or has already been held enforceable by a non-California court. Employers should monitor whether and to what extent courts apply judicial principles of comity and extraterritoriality in adjudicating these types of cases.[5]

Employers should also be aware that the law authorizes employees, former employees, and prospective employees to seek injunctive relief, actual damages, or both, and entitles a prevailing plaintiff to recover reasonable attorneys’ fees and costs. But employers who prevail in litigation over restrictive covenants are not entitled under the new law to recover their fees against the losing individuals. Employers with ties to California are encouraged to review their employee agreements in light of this new law.

_____________________________

[1] Statutory exceptions to Section 16600 include restrictive covenants in the sale or dissolution of corporations, partnerships, and limited liability corporations. See Cal. Bus. & Prof. Code §§ 16601, 16602, 16602.5.

[2] Cal. Civ. Code, § 3; Evangelatos v. Super. Ct., 44 Cal. 3d 1188, 1208 (1988) (holding that a statute will not be applied retroactively unless it contains “an express retroactivity provision” or it is “very clear from extrinsic sources that the Legislature . . . must have intended a retroactive application”).

[3] 2023 Cal. S.B. No. 699 (2023-2024 Regular Session).

[4] Id. §§ 1 (d) & (f).

[5] See, e.g., Advanced Bionics Corp. v. Medtronic, Inc., 29 Cal. 4th 697, 706–07 (2002), as modified (Mar. 5, 2003) (applying the comity principle to reason that while “California has a strong interest in protecting its employees from noncompetition agreements” under section 16600, “[a] parallel action in a different state presents sovereignty concerns that compel California courts to use judicial restraint when determining whether they may properly issue a TRO against parties pursuing an action in a foreign jurisdiction.”); Ward v. United Airlines, Inc., 986 F.3d 1234, 1240 (9th Cir. 2021) (discussing the breadth of the extraterritoriality principle).

The following Gibson Dunn lawyers prepared this client alert: Tiffany Phan, Joseph Rose, Jason C. Schwartz, Katherine V. A. Smith, Stephen Weissman, and Yekaterina Reyzis.

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

Tiffany Phan – Los Angeles (+1 213-229-7522, [email protected])

Joseph R. Rose – San Francisco (+1 415-393-8277, [email protected])

Rachel S. Brass – Co-Chair, Antitrust & Competition, San Francisco (+1 415-393-8293, [email protected])

Stephen Weissman – Co-Chair, Antitrust & Competition, Washington, D.C. (+1 202-955-8678, [email protected])

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

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

New York partner Mylan Denerstein and associate Lee Crain are authors of “Accessing the Courts: Why New York Should Eliminate the Dreaded, Needless and Unduly Complex ‘Certificate of Conformity” [PDF] published by the New York Law Journal on September 6, 2023.

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

Enforcement Actions

United States

Feds Charge Tornado Cash Developers Facilitated $1 Billion in Money Laundering

On August 23, the Manhattan U.S. Attorney’s Office brought charges in the Southern District of New York against two developers of Tornado Cash, Roman Storm and Roman Semenov. Tornado Cash is a crypto application that obscures the source of assets transferred through it. Prosecutors allege that more than $1 billion was laundered through Tornado Cash, including hundreds of millions by North Korea’s Lazarus Group. Charges include conspiracy to engage in money laundering, conspiracy to violate U.S. sanctions targeting North Korea, and conspiracy to operate an unlicensed money transmitting business. Storm was arrested and released after posting bond. Also on August 23, the Office of Foreign Asset Control (OFAC) sanctioned Semenov and eight Ethereum addresses allegedly controlled by Semenov. Law360; Forbes; Indictment

SEC Brings First Enforcement Actions Alleging NFTs Are Securities

On August 28, the U.S. Securities and Exchange Commission (SEC) issued an order simultaneously filing and settling charges against Impact Theory, LLC, a Los Angeles-based media company, related to its sales of non-fungible tokens (NFTs). Applying the Howey test, the SEC concluded that Impact Theory’s KeyNFTs were investment contracts primarily because Impact Theory’s marketing statements promised “tremendous value” and “massive” appreciation. As part of a settlement of the charges, the SEC ordered Impact Theory to disgorge over $5 million. SEC Commissioners Hester Pierce and Mark Uyeda issued a joint dissent from the order, arguing in part that the tokens were not investment contracts because they were not shares of the company and did not generate any type of dividend for purchasers. Order; Law360; CoinWire

Weeks later, on September 13, the SEC issued an order simultaneously filing and settling charges against Stoner Cats 2 LLC (SC2), alleging an unregistered securities offering in the form of profile-picture NFTs. The order states that SC2 raised approximately $8 million from the sale of around 10,000 NFTs to finance the animated web series Stoner Cats, starring Mila Kunis and Ashton Kutcher. In an accompanying press release, the SEC stated that the offering led “investors to expect profits because a successful web series could cause the resale value of the Stoner Cats NFTs in the secondary market to rise.” SC2 agreed to pay a $1 million fine and destroy all remaining NFTs in its possession. Commissioners Pierce and Uyeda dissented from this order as well, arguing that “the Stoner Cats NFTs are not that different from Star Wars collectibles sold in the 1970s” and that the order “carries implications for creators of all kinds.” Order; Press Release; CoinDesk

CFTC Charges DeFi Platforms Over Crypto Derivatives

On September 7, the Commodity Futures Trading Commission (CFTC) issued orders simultaneously filing and settling charges against three decentralized finance (DeFi) trading platforms—Opyn, Inc., ZeroEx (0x), Inc., and Deridex, Inc.—for offering digital asset derivatives trading. The orders require Opyn, ZeroEx, and Deridex to pay civil penalties of $250,000, $200,000, and $100,000, respectively, and “cease and desist from violating the Commodity Exchange Act (CEA) and CFTC regulations.” The companies were all said by the CFTC to have cooperated in the investigation, getting a reduced penalty as a result. “The DeFi space may be novel, complex, and evolving, but the Division of Enforcement will continue to evolve with it and aggressively pursue those who operate unregistered platforms that allow U.S. persons to trade digital asset derivatives,” said Director of Enforcement Ian McGinley. Release; CoinDesk

LBRY to Appeal Ruling That It Violated U.S. Securities Law

On September 7, crypto file-sharing protocol LBRY filed a notice of appeal of a New Hampshire federal court’s decision that it failed to register the sale of its native LBRY tokens (LBC) with the SEC. The court’s final judgment ordered LBRY to pay a $111,614 civil penalty and barred it from participating in any unregistered crypto securities offerings in the future. “LBRY is appealing the [court’s] decision because it is unjust and incorrect,” said CEO Jeremy Kauffman. LBRY previously indicated that it would shut down following the July 11 ruling. Notice of Appeal; CoinDesk; CoinTelegraph

Former FTX Executive Ryan Salame Pleads Guilty Ahead of Bankman-Fried Trial

On September 7, former top FTX executive Ryan Salame pleaded guilty to one count of conspiracy to operate an unlicensed money transmitting business and one count of conspiracy to make unlawful political contributions and defraud the Federal Election Commission. Salame faces a maximum of 10 years in prison. He also has agreed to forfeit up to $1.5 billion and make restitution of $5.6 million to FTX debtors. His sentencing is set for March 6, 2024. This plea comes less than one month before Sam Bankman-Fried, co-founder of FTX, is set to go to trial on October 2. Salame’s attorney previously told prosecutors he would invoke his Fifth Amendment rights against self-incrimination if called as a witness against Bankman-Fried at trial. CNN; Reuters; New York Times

Former OpenSea Head of Product Receives Three-Month Prison Sentence for NFT Insider Trading

On August 23, Nate Chastain, the former Head of Product at OpenSea, the NFT trading platform, was sentenced to three months in prison for making around $50,000 by trading NFTs that he knew would be featured on the OpenSea homepage. In May, he was convicted by a jury of wire fraud and money laundering in what is considered the first insider-trading case involving digital assets. Prosecutors had sought a two-year prison sentence, but U.S. District Judge Jesse Furman imposed a shorter sentence based on Chastain’s limited profits. Judge Furman also sentenced Chastain to 200 hours of community service following his imprisonment, a $50,000 fine, and forfeiture of 15.98 ether. Reuters; Crypto News

Regulation and Legislation

United States

Treasury and IRS Propose Tax-Reporting Rules for Crypto Industry

On August 25, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) released controversial proposed regulations governing tax-reporting requirements for the crypto industry. The long-awaited regulations would broaden the definition of “broker” to encompass digital asset trading platforms, payment processors, wallet providers, and “some” DeFi platforms. Under the proposed regulations, starting on January 1, 2025, these entities would be subject to similar tax reporting rules as brokers for securities and other financial instruments. The proposal exempts crypto miners from these requirements. The proposed regulations are open for public comment until October 30. The proposed regulations were criticized by Chairman Patrick McHenry (R-NC) of the House Financial Services Committee as “an attack on the digital asset ecosystem.” Treasury; IRS; Axios; WSJ

FASB Announces New Bitcoin Accounting Rules

On September 6, the Financial Accounting Standards Board (FASB) announced forthcoming accounting rules under which companies that hold or invest in cryptocurrencies will be required to report their holdings at fair value. This would allow companies to recognize gains and losses in cryptocurrencies immediately, as they would with other financial assets. This change is widely seen as an improvement over the current practice of treating cryptocurrencies as indefinite-lived intangible assets. The forthcoming rules include other requirements as well, including that companies must make a separate entry in their financial statements for cryptocurrencies. The accounting rules will be mandatory for all companies—public and private—for fiscal years beginning after December 15, 2024, including interim periods within those years. WSJ; Bloomberg

International

UK Crypto Firms Can Apply for Extra Time to Comply with New Restrictions on Crypto Promotions

On September 7, the UK’s Financial Conduct Authority (FCA) announced that UK crypto firms could be given an extra three months to implement new restrictions on crypto promotions. The “[t]ough new rules designed to make the marketing of cryptoasset products clearer and more accurate” are set to take effect on October 8, but can be delayed until January 2024 for otherwise compliant firms to develop the right technical setup. The FCA said that it still intends to take enforcement action against overseas or unregulated firms that continue to unlawfully market to UK consumers starting October 8. Release; CoinDesk

Travel Rule Regulation Goes into Force in the UK for Crypto Asset Firms

On September 1, a new rule requiring crypto firms in the UK to comply with the Financial Action Task Force’s Travel Rule went into effect. The UK Travel Rule requires UK-based Virtual Asset Service Providers (VASPs) to collect, verify, and share information on domestic and cross-jurisdictional transactions. According to an FCA statement, crypto businesses domiciled in the UK are required to “comply with the rule when sending or receiving a cryptoasset transfer to a firm that is in the UK, or any jurisdiction that has implemented the Travel Rule.” If information is missing or incomplete, businesses must make a risk-based assessment before releasing the cryptoassets to the beneficiary. FCA Statement; The Block

Civil Litigation

United States

D.C. Circuit Vacates SEC Denial of Grayscale Bitcoin ETF as Arbitrary and Capricious

On August 29, the U.S. Court of Appeals for the D.C. Circuit ruled that the SEC will have to take another look at Grayscale Investments’ application to list a bitcoin exchange-traded product (ETP), because the SEC’s rejection of the submission was “arbitrary and capricious” and thus violated the Administrative Procedure Act. The three-judge panel’s unanimous ruling was authored by Judge Neomi Rao (a President Trump appointee) and was joined by Judges Edwards and Srinivasan (President Carter and Obama appointees, respectively). The court concluded that the SEC “failed to adequately explain why it approved the listing of two bitcoin futures ETPs but not Grayscale’s” proposed spot product, and rejected every rationale offered by the SEC for treating bitcoin spot ETPs differently than comparable bitcoin futures products. “In the absence of a coherent explanation,” the court concluded, “this unlike regulatory treatment of like products is unlawful.” The court’s ruling requires the SEC to reconsider Grayscale’s application, but it does not require the SEC to approve the application. Opinion; Law360; Barron’s

Federal Court Dismisses Uniswap Class Action

On August 30, U.S. District Court Judge Katherine Polk Failla dismissed a class action suit brought against Uniswap and its developers and investors by users claiming that they lost money on scam tokens sold on the Uniswap platform. In dismissing the claims, Judge Failla reasoned in part that “the identities of the Scam Token issuers are basically unknown and unknowable” due to Ethereum’s “decentralized nature,” and that the plaintiffs’ claims therefore were akin to “attempting to hold an application like Venmo or Zelle liable for a drug deal that used the platform to facilitate a fund transfer.” Judge Failla also rejected the plaintiffs’ claims that Uniswap was liable for the losses under the Securities Exchange Act of 1934, refusing to “stretch the federal securities laws to cover the conduct alleged.” In rejecting the securities-law claims, Judge Failla stated in passing that ether and bitcoin are “crypto commodities,” potentially suggesting that she believes those assets are not subject to the securities laws at all. Judge Failla also is presiding over the SEC’s enforcement action against Coinbase. Opinion; Fortune; Bitcoinist

New York Federal Court Holds that Electronic Fund Transfer Act Does Not Apply to Certain Crypto Transactions

On August 11, Judge Lewis J. Liman dismissed a claim asserting that the Electronic Fund Transfer Act (EFTA) applies to cryptocurrency transactions. In Yuille v. Uphold HQ, Inc., No. 1:22-cv-07453 (S.D.N.Y. Aug. 11, 2023 ), a Michigan retiree sued Uphold HQ, a crypto trading platform and wallet provider, after a hacker drained $5 million from his account. The plaintiff argued in part that Uphold HQ failed to meet the requirements of the EFTA, which imposes obligations on financial institutions to expeditiously investigate and correct errors related to electronic fund transfers. Earlier this year, a different judge in separate suit against Uphold held that the term “electronic funds transfer” in the EFTA was capacious enough to include crypto transactions. Rider v. Uphold HQ Inc., 2023 WL 2163208 (S.D.N.Y. Feb. 22, 2023) (Cote, J.). Instead of resolving that issue, Judge Liman held that the plaintiff’s transactions fell outside the EFTA because his crypto wallet was not an “account,” which is defined under the Act to include only accounts “established primarily for personal, family, or household purposes.” Judge Liman held that the plaintiff’s crypto wallet account was instead established primarily for profit-making purposes. Opinion; Law360

Gemini Earn Customers Could Recover All Funds in New Proposed Renumeration Scheme

On September 13, bankrupt crypto lender Genesis and its parent company Digital Currency Group (DCG) filed a new proposed remuneration plan. Genesis and DCG stated that, under the proposal, over 230,000 creditors who used Gemini’s Earn program “are estimated to recover approximately 95-110% of their claims.” Gemini Earn was an investment program implemented by crypto exchange Gemini with financing from Genesis. Gemini Earn customers were affected when Genesis was forced to freeze withdrawals and its lending arm—Genesis Global Holdco LLC—filed for bankruptcy in January 2023. DCG hopes to file an amended version of the proposed plan by October 6, and solicit votes by December 5. On September 15, Gemini issued a statement criticizing the proposed plan as “misleading at best and deceptive at worst.” Gemini stated that “[r]eceiving a fractional share of interest and principal payments over seven years from an incredibly risky counterparty . . . is not even remotely equivalent to receiving the actual cash and digital assets owed today by Genesis to the Gemini Lenders.” Proposed Agreement; CoinTelegraph; CoinDesk; Gemini Filing

Speaker’s Corner

United States

Former SEC Chair Says Spot Bitcoin ETF Approval Is ‘Inevitable’

On September 1, former SEC chair Jay Clayton appeared on CNBC Television to discuss the SEC’s deferral of bitcoin ETP applications: “It is clear that bitcoin is not a security. It is clear that bitcoin is something that retail investors want access to, institutional investors want access to, and, importantly, some of our most trusted providers who are fiduciaries or have duties of best interest want to provide this product to the retail public. So I think [spot bitcoin ETP] approval is inevitable,” Clayton told CNBC. Clayton’s comments follow a federal court’s ruling in Grayscale v. SEC (discussed above) that there was no justification for the SEC to allow bitcoin futures-based ETPs but deny spot bitcoin ETPs. CNBC; The Block; Grayscale Opinion

SEC Chair Gary Gensler Testifies Before Senate Banking Committee

On September 12, SEC Chair Gary Gensler testified before the Senate Banking Committee in an SEC oversight hearing. In his prepared testimony, Gensler maintained his stance that most cryptocurrencies qualify as securities that should be regulated by the SEC: “As I’ve previously said, without prejudging any one token, the vast majority of crypto tokens likely meet the investment contract test.” Gensler also reiterated his strong criticism of the crypto industry: “I’ve never seen a field that’s so rife with misconduct,” said Gensler. “It’s daunting.” The most substantive discussion on digital assets came during questioning from Senator Cynthia Lummis (R-WY), who expressed concerns over Gensler issuing an SEC staff bulletin that would require companies to report customer crypto assets on their balance sheets. Also during the hearing, Chairman Sherrod Brown (D-OH) was highly critical of the crypto industry. “The problems we saw at FTX are everywhere in crypto—the failure to provide real disclosure, the conflicts of interest, the risky bets with customer money that was supposed to be safe,” said Brown. Brown also praised the SEC’s approach to regulating crypto: “I’m glad the SEC is using its tools to crack down on abuse and enforce the law.”

Gensler is scheduled to testify next before the House Financial Services Committee on September 27. These scheduled appearances follow mounting criticism from lawmakers over the SEC’s approach to regulating crypto, which they argue prioritizes enforcement over providing clear guidance. Sept. 12 Prepared Testimony; Sept. 12 Hearing; CryptoSlate; CryptoNews

International

Chinese Central Bank Official Says China’s Digital Yuan Must Be Available in All Retail Scenarios

During a trade forum in Beijing on September 3, Changchun Mu, the head of the digital currency research institute at the People’s Bank of China, said that an essential step for the development of China’s digital yuan “is to use digital yuan as the payment tool for all retail scenarios.” Although the digital yuan is being tested in pilot regions across China, it remains far from achieving widespread adoption. “In the short term, we can start by unifying QR code standards on a technical level to achieve barcode interoperability,” Mu added. Mu’s comments follow the Chinese central bank’s pledge last year to push for universal QR payment codes. The use of QR code payment systems, dominated by WeChat Pay and Alipay, is already widespread in China. The Block; CoinTelegraph

Other Notable News

SEC Defers Decisions on All Bitcoin ETFs

On August 31, the SEC delayed until October its decisions on all pending applications for a spot bitcoin exchange-traded product, which have been filed by BlackRock, Grayscale Investments, and others. The SEC’s decisions come days after Grayscale won a key victory over the SEC (discussed above), which many have viewed as clearing a path for the long-awaited product. Bloomberg; CoinDesk; PiOnline

Visa to Use Solana and USDC Stablecoin to Boost Cross-Border Payments

On September 5, Visa announced that it has expanded its stablecoin settlement capabilities with Circle’s USDC stablecoin to the Solana (SOL) blockchain. According to its statement, Visa is one of the first major financial institutions to use the Solana network at scale for settlements. “By leveraging stablecoins like USDC and global blockchain networks like Solana and Ethereum, we’re helping to improve the speed of cross-border settlement and providing a modern option for our clients to easily send or receive funds from Visa’s treasury,” said Cuy Sheffield, head of crypto at Visa, in a statement. CoinDesk; The Block

Vitalik Buterin Co-Authors Paper on Regulation-Friendly Tornado Cash Alternative

On September 9, Ethereum co-founder Vitalik Buterin published a research paper that he co-authored with Ethereum core developer Ameen Soleimani, researcher Jacob Illum from blockchain analytics firm Chainalysis, and academics Matthias Nadler and Fabian Schar. The paper proposes a privacy protocol called Privacy Pools. The core idea of the proposal is to allow users to publish a zero-knowledge proof, demonstrating that their funds do not originate from unlawful sources, without publicly revealing their entire transaction graph. The authors argue that this proposal, if implemented, could allow financial privacy and regulation to co-exist. SSRN; The Block

FTX, BlockFi, and Genesis Claimant Data Breached in Cyberattack

On August 25, Kroll LLC, announced that cybercriminals exposed data belonging to claimants in the FTX, BlockFi, and Genesis Global Holdco bankruptcies following a sophisticated cyberattack directed against Kroll employees. Kroll stated that a cybercriminal targeted a cell phone account belonging to one of its employees “in a highly sophisticated ‘SIM swapping’ attack.” Law360; CoinDesk

Ant Group Launches Overseas Blockchain Brand ZAN

On September 8, Ant Group—the owner of the world’s largest mobile payment platform, Alipay—launched ZAN, a new blockchain service aimed at Hong Kong and overseas markets. According to the official press release, ZAN “comprises of a full suite of blockchain application development products and services for both institutional and individual Web3 developers.” ZAN will also provide “a series of technical products, including electronic Know-Your-Customer (eKYC), Anti-Money Laundering (AML) and Know-Your-Transactions (KYT), to help Web3 businesses build up their capabilities in customer identity authentication, security protection and risk management.” Press Release; CoinTelegraph; The Block

The following Gibson Dunn lawyers prepared this client alert: Ashlie Beringer, Stephanie Brooker, Jason Cabral, M. Kendall Day, Jeffrey Steiner, Sara Weed, Ella Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Apratim Vidyarthi, Alexis Levine, Zachary Montgomery, and Tin Le.

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

FinTech and Digital Assets Group:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Over the last two weeks, both the House of Commons and the House of Lords have considered the Economic Crime and Corporate Transparency Bill (“the Bill”). The government has described the Bill as the most significant reform of the identification doctrine in more than 50 years and the proposals have been welcomed by the UK’s Serious Fraud Office.

Although there is an outstanding point of contention for corporate criminal liability reform relating to the scope of the failure to prevent fraud offence, and in particular, whether it should be limited to large organisations, or expanded to non-micro organisations, the Bill is now in the final stages of its passage through Parliament and some commentators have indicated it could receive royal assent before the end of this year.

Key Takeaways

The Bill proposes a number of changes to the current law including an expansion of the identification principle and a new offence of failure to prevent fraud.
Organisations can be held liable for actions of “senior managers” for the purposes of prosecuting relevant economic crimes. Organisations should identify and train individuals who fall within this definition.
In anticipation of the new offence of failure to prevent fraud coming into force, organisations must ensure reasonable procedures are in place to prevent fraud. This could include:
- carrying out a fraud risk assessment;
- updating existing policies to identify and mitigate fraud risk;
- ensuring staff are properly trained and retaining training records; and
- ongoing monitoring of risk and compliance with policies.

The identification principle – the current position

With the exception of a small number of specific offences, including the existing failure to prevent offences under the Bribery Act 2010 and the Criminal Finances Act 2017, in order for a corporate entity to be held criminally liable for the actions of an individual, that individual must be the “directing mind and will” of the corporate entity. This is called the “identification principle”.

The leading case on the identification principle is Tesco Supermarkets Ltd v Nattrass,[1] which states that one has to identify “those natural persons who by the memorandum and articles of association or as a result of action taken by the directors, or by the company in general meeting pursuant to the articles, are entrusted with the exercise of the powers of the company”, also referred to as the primary rule of attribution.

The principle has been narrowly applied and prosecutors have had difficulty satisfying the test in a number of high profile cases including The Serious Fraud Office v Barclays PLC and Barclays Bank PLC.[2] In that case, Davis LJ found that despite the defendants being senior executive directors and two of those defendants being on the board, their actions could not be attributed to Barclays because they had not been delegated entire authority to complete the relevant acts. Davis LJ noted that the “status” of an individual is a relevant consideration, but the focus should be on the particular authority bestowed by the company for the performance of the particular function in question.

The Barclays case and others like it have triggered debate about whether the identification principle, now over fifty years old, is fit for purpose when dealing with large multinational companies with complex management structures. As it stands, smaller companies with simpler structures are more exposed to criminal prosecution given the relative ease in demonstrating which individuals control and direct the company’s actions. This has prompted concern that larger companies are not being held to account for criminal wrongdoing carried out on their behalf. The proposals to reform corporate criminal liability laws, discussed below, seek to address these difficulties.

Proposed reforms

1. New approach to “attributing criminal liability for economic crimes to certain bodies”

Rather than relying on the identification principle, under the new legislation, the corporate entity will be liable for actions committed by a “senior manager” acting within the actual or apparent scope of their authority.

“Senior manager” is defined as an individual who plays a significant role in:

the making of decisions about how the whole or a substantial part of the activities of the body corporate or partnership are to be managed or organised, or
the actual managing or organising of the whole or a substantial part of those activities.[3]

This definition is adopted from the Corporate Manslaughter and Corporate Homicide Act 2007. The Explanatory Notes to the Corporate Manslaughter and Corporate Homicide Act 2007 state that this covers both individuals in the direct chain of management, and those in, for example, strategic or regulatory compliance roles.[4] The practical impact is that the pool of potential employees whose criminal conduct could be attributed to a corporate body is widened potentially very substantially.

At this stage, the reforms to the way in which liability is attributed to an organisation will only apply to economic crimes specified in the Bill, such as offences relating to fraud, bribery, theft, false accounting and concealing criminal property.[5] However, whilst the current focus is on economic crimes (which reportedly make up over 40% of crime in the UK [6]), the government has “committed in the Economic Crime Plan 2 and the Fraud Strategy to introduce reform of the identification principle to all criminal offences in due course”.[7]

The explanatory notes to amendments made by the House of Lords following the third reading in July 2023 state that the Bill “ensures that criminal liability will not attach to an organisation based and operating overseas for conduct carried out wholly overseas, simply because the senior manager concerned was subject to the UK’s extraterritorial jurisdiction: for instance, because that manager is a British citizen […] However, certain offences, regardless of where they are committed, can be prosecuted against individuals or organisations who have certain close connections to the UK. Any such test will still apply to organisations when the new rule applies”.[8]

The reform of the identification principle is intended to make it easier for authorities to pursue corporates for primary fraud and bribery offences rather than just failure to prevent offences. Although “senior manager” is now defined, it will still be subject to judicial interpretation and the courts may favour a narrow interpretation, as in The Serious Fraud Office v Barclays PLC and Barclays Bank PLC.[9] The government has also concluded in its Impact Assessment that whilst the reforms to the identification principle are expected to increase the number of corporate prosecutions, the number of additional cases is expected to be low.[10]

2. Failure to prevent fraud

In addition to broadening the general scope for corporate criminal liability, a new corporate offence of failure to prevent fraud will also be introduced. This new offence borrows from both the existing offences of failure to prevent bribery under the Bribery Act 2010 and failure to prevent the facilitation of tax evasion under the Criminal Finances Act 2017.

Under the new offence, if they meet specific criteria, large corporates and partnerships will be held criminally liable where:

a specified fraud offence is committed by an employee or agent (such as fraud by false representation, fraud by abuse of position or fraud by failing to disclose information); and
the offence benefits the organisation.

The prosecution must establish both limbs of the offence set out above. However the company will have a defence if it can show it either had “reasonable procedures” in place to prevent the fraud, or that it was not reasonable to have relevant procedures at all. This is said to place a lesser burden on organisations than the requirement to have “adequate procedures” under the Bribery Act 2010.[11] As with the Bribery Act and the Criminal Finances Act there is a requirement for the government to issue “guidance about procedures that relevant bodies can put in place to prevent persons associated with them from committing fraud offences”.[12] This has not yet been issued but it is likely to include detailed policies, procedures and training.

The House of Lords disagreed with the House of Commons that the failure to prevent fraud offence should only apply to large organisations. They voted to amend the Bill so that the offence applies to “non-micro organisations” which satisfy two or more of the following conditions in a financial year: (i) turnover of more than £632,000 and less than £36 million; (ii) a balance sheet total of more than £316,000 and less than £18 million; and (iii) more than 10 but less than 250 employees.[13] In support of this amendment, Lord Garnier referred to the fact there is no exemption for small and medium enterprises for the offence of failure to prevent bribery and proposed that only the very smallest and newest commercial organisations should be exempted from the failure to prevent regime.[14] The Commons rejected these amendments on Wednesday 13 September and the Bill has been returned to the Lords for further consideration.

Extraterritorial reach

The failure to prevent fraud offence has wide extraterritorial effect, applying to a body corporate or a partnership wherever they are incorporated or formed.[15] The government factsheet summarising the failure to prevent fraud offence explains that: “if an employee commits fraud under UK law, or targeting UK victims, their employer could be prosecuted, even if the organisation (and the employee) are based overseas”.[16]

Impact

The failure to prevent fraud offence is making headlines and will inevitably need to be given serious consideration by large organisations. The new legislation is designed to close “loopholes that have allowed organisations to avoid prosecution in the past”.[17]

The government believes that the changes will “result in a deterrent effect where increased awareness and corporate liability may deter would-be fraudsters”. [18] Perhaps most compellingly, the government intends that the legislation will create cultural change and encourage the development of an anti-fraud culture within organisations.[19]

Post-legislative scrutiny of the Bribery Act 2010 identified a changing and improved corporate anti-bribery culture following the introduction of the failure to prevent bribery offence. The government hopes that the proposed changes will have a similar impact for fraud and will promote a corporate culture in which fraud detection and prevention are encouraged.[20]

It is not clear how many prosecutions the failure to prevent fraud offence will give rise to – the Serious Fraud Office (“SFO”) has only prosecuted two corporations for failure to prevent bribery since the Bribery Act came into force in 2011.[21] On the other hand, the offence of failure to prevent bribery has featured in nine of the twelve deferred prosecution agreements (“DPAs”) entered into since DPAs were introduced in February 2014. The SFO is likely to take a similar approach to prosecuting failure to prevent fraud offences.

Practical steps

In anticipation of the Economic Crime and Corporate Transparency Act coming into force, we have set out some practical steps to be considered:

Risk assessments: carry out and document appropriate risk assessments, identifying relevant fraud risks.
Reasonable policies and procedures: identify and update relevant existing policies or introduce new policies to ensure the new offences are taken into account and to mitigate the fraud risks identified in the risk assessment.
Reporting: ensure appropriate channels are in place for reporting suspicions of fraud.
Identification of potential senior managers: identify which individuals and roles may fall into the definition of “senior manager”. Ensure those individuals receive adequate training on fraud risk and applicable policies and procedures and are appropriately monitored.
Raising awareness within the company: provide adequate training to employees to embed fraud policies and procedures and ensure that employees are aware of appropriate channels for reporting suspicions of fraud. Records of this training should be retained.
Ongoing monitoring: procedures should be put in place for the ongoing monitoring of fraud risk, compliance with relevant policies and procedures (including the effectiveness of fraud detection processes), and the conduct of individuals. Companies should monitor and review their effectiveness on a regular basis to ensure that necessary improvements are made when required.

Whilst the timeline for the Bill receiving royal assent and being implemented is uncertain, it is important to understand the proposed changes and how to prepare for their implementation. The reforms demonstrate a cultural change and appetite for greater scrutiny of corporate entities. It will be interesting to see how they are used by law enforcement authorities once the Bill is passed.

Irrespective of the final content of the Bill, there is no doubt that it is a significant change for the corporate criminal liability landscape within the UK.
_____________________________

[1] [1972] AC 153.

[2] [2018] EWHC 3055 (QB).

[3] https://bills.parliament.uk/publications/51963/documents/3729.

[4] https://www.legislation.gov.uk/ukpga/2007/19/section/1/notes?view=plain.

[5] https://bills.parliament.uk/publications/51963/documents/3729.

[6] https://www.gov.uk/government/publications/fraud-strategy/fraud-strategy-stopping-scams-and-protecting-the-public.

[7] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-identification-principle-for-economic-crime-offences.

[8] https://hansard.parliament.uk/lords/2023-06-27/debates/EF8264AF-6478-470E-8B37-018C4B278F6E/EconomicCrimeAndCorporateTransparencyBill.

[9] [2018] EWHC 3055 (QB).

[10] See attachment here.

[11] See attachment here.

[12] Section 203 of the Bill https://bills.parliament.uk/publications/51963/documents/3729.

[13] https://publications.parliament.uk/pa/bills/cbill/58-03/0363/220363.pdf.

[14] https://hansard.parliament.uk/Lords/2023-09-11/debates/181F85C9-5619-4DAF-BD42-327C0DAF036F/EconomicCrimeAndCorporateTransparencyBill.

[15] https://bills.parliament.uk/publications/52462/documents/3896.

[16] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-failure-to-prevent-fraud-offence.

[17] https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/factsheet-failure-to-prevent-fraud-offence.

[18] See attachment here.

[19] https://bills.parliament.uk/publications/50688/documents/3279.

[20] https://bills.parliament.uk/publications/50688/documents/3279.

[21] https://bills.parliament.uk/publications/50688/documents/3279.

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

Michelle M. Kirschner (+44 20 7071 4212, [email protected])
Matthew Nunan (+44 20 7071 4201, [email protected])
Allan Neil (+44 20 7071 4296, [email protected])
Patrick Doris (+44 20 7071 4276, [email protected])
Maria Bračković (+44 20 7071 4143 [email protected])
Amy Cooke (+44 20 7071 4041, [email protected])
Rebecca Barry (+44 20 7071 4086, [email protected])

We have seen many notable developments in securities law during the first half of 2023 across a number of different areas. This update provides an overview of those major developments in federal and state securities litigation since our 2022 Year-End Securities Litigation Update:

We discuss major Supreme Court decisions from October Term 2022, and preview several significant grants of certiorari. In addition, we examine circuit court-level developments that may end up before the Supreme Court.
We review significant developments in Delaware corporate law, including a number of decisions concerning fiduciary duties in the context of a merger or acquisition, and the intersection of Unocal, Schnell, and Blasius when board action implicates the stockholder franchise.
We examine developments in federal securities litigation involving special purpose acquisition companies (“SPACs”). As fewer SPAC IPOs and de-SPAC transactions occur, relative to the peak in 2021, we have also seen fewer new SPAC-related cases filed. Earlier SPAC-related litigation continues to proceed through courts—we discuss a proposed class action settlement and two recent decisions on statutory standing.
We examine developments in securities litigation involving environmental, social, and corporate governance (“ESG”) allegations.
We survey litigation in the cryptocurrency space as courts continue to grapple with the application of securities laws to cryptocurrencies.
We discuss the shareholder activism landscape, including recent proxy battles and new SEC regulations related to shareholder proposals and proxy elections that could potentially encourage shareholder activists going forward.
We continue to monitor the emergence of a potential circuit split regarding the Supreme Court’s 2019 decision in Lorenzo, which allows scheme liability under Rule 10b-5(a) and (c) even if the disseminator did not “make” the statement within the meaning of Rule 10b-5(b). As discussed in our 2022 Mid-Year Securities Litigation Update, a number of courts have grappled with the effects of Lorenzo. In particular, the Second Circuit in SEC v. Rio Tinto provided some clarity for district courts within the Circuit by finding that “something extra” is required beyond misstatements for there to be scheme liability. A recent district court opinion in California, however, acknowledged that the Ninth Circuit has not adopted Rio Tinto.
Finally, we discuss the Second Circuit’s long-awaited decision in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., and a district court’s application of Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System in denying class certification in part.

I. Filing and Settlement Trends

With thanks to analysis from Cornerstone Research, new filings have increased from 93 total securities class action filings in the first half of 2022 to 114 filings in the first half of 2023. Although the median value of settlements has increased compared to the same period in 2022, the number and total value of settlements are lower than any year since 2017. SPAC-, COVID-19-, and cryptocurrency-related filings continue to be a focus, even as the nature of such suits continues to evolve.

A. Filing Trends

Figure 1 below reflects the semiannual filing rates dating back to 2014 (all charts courtesy of Cornerstone Research). For the fourth six-month period in a row, new filings remained at or below the historical semiannual average. Notably, at 114, filings in the first half of 2023 barely top 50% of the average semi-annual filing rates seen between 2017 and 2019, though this deficit is largely driven by a substantial decrease in M&A-related filings. The 110 total new “core” cases—i.e., securities cases without M&A allegations—filed in the first half of 2023 represent a modest increase from the semi-annual periods since the first half of 2021.

Figure 1:

Semiannual Number of Class Action Filings (CAF Index®)
January 2014 – June 2023

As illustrated in Figure 2 below, cryptocurrency-related actions are nearly on pace to match the record high set in 2022. The annualized number of COVID-19 and SPAC-related filings are markedly lower than prior years. Cybersecurity-related actions are on pace to be in line with historical averages.

Figure 2:

Summary of Trend Cases—Core Federal Filings
2019 – June 2023

B. Settlement Trends

The first half of 2023 has seen fewer settlements and less total settlement value than any semi-annual period since 2017. Just 32 settlements have been approved through June 2023. Similarly, as reflected in Figure 3, the total settlement value in the first half of 2023 is just $700 million, down from a high of $4.4 billion in the first half of 2018 and $2.3 billion in the previous semi-annual period. The low total settlement value is largely a product of fewer settlements and fewer large settlements (there has only been one settlement greater than or equal to $100 million through June 2023). The median value of settlements approved in the first half of 2023 is nonetheless $16.3 million, however, an increase of over 25% from the median value for the same period in 2022.

Figure 3:

II. What to Watch for in the Supreme Court

A. Recent Supreme Court Decisions

1. Slack Prevails at the Supreme Court

On June 1, 2023, the Supreme Court unanimously held that in a direct listing (as in traditional initial public offerings), a plaintiff who claims that a company’s registration statement is misleading and who sues under Section 11 of the Securities Act of 1933 must plead and prove that they bought shares registered under that registration statement. Slack Techs., LLC v. Pirani, 143 S. Ct. 1433 (2023). See our 2022 Year-End Securities Litigation Update for additional background on the case.

The Court’s opinion adopted the longstanding “tracing” requirement, noting that although “direct listings are new, the question how far § 11(a) liability extends is not,” and that “every court of appeals to consider the issue . . . reached the . . . conclusion”—like the Court—that “[t]o bring a claim under § 11, the securities held by the plaintiff must be traceable to the particular registration statement alleged to be false or misleading.” Slack Techs, 143 S. Ct. at 1440–41. In so concluding, the Court rejected Pirani’s textual argument—that the key phrase, “such security,” “should [be] read . . . to include other securities that bear some sort of minimal relationship to a defective registration statement”—and his arguments “from policy and purpose.” Id. at 1441. And in rejecting Pirani’s view of Section 11, the Court avoided an interpretation that could have unsettled the scope of liability under that section in cases beyond direct listings, including traditional IPOs and follow-on offerings. The Court’s holding thus protects reasonable expectations and avoids a potentially massive increase in litigation for companies that recently went public.

The Court, however, declined to resolve whether Section 12 of the ‘33 Act, which enforces the Act’s prospectus requirement and permits anyone who buys “such security” from the defendant to sue, 15 U.S.C. § 77l(a)(1), likewise requires proof of purchase of registered shares. It “express[ed] no views” about that question and remanded the matter to the lower courts to decide that question in the first instance. Id. at 1442 n.3. Gibson Dunn will provide further updates on this case and related issues as they arise.

Gibson Dunn represented Slack Technologies, LLC in the case. Thomas Hungar, a Gibson Dunn partner in the Washington, D.C. office, argued the case on its behalf.

2. Axon and Cochran Prevail at the Supreme Court

As detailed in our 2022 Year-End Securities Litigation Update, the Supreme Court heard oral argument in Securities and Exchange Commission v. Cochran, No. 21-1239, and a companion case, Axon Enterprise, Inc. v. Federal Trade Commission, No. 21-86, on November 7, 2022.

On April 14, 2023, the Supreme Court issued its decision and determined that “the review schemes set out in the Exchange Act and the FTC Act do not displace district court jurisdiction over Axon’s and Cochran’s far-reaching constitutional claims.” Axon Enter., Inc. v. Fed. Trade Comm’n, 143 S. Ct. 890, 900 (2023). In reaching its conclusion, the Court considered the three factors set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994): (1) whether precluding district court jurisdiction could “foreclose all meaningful judicial review” of the claim, (2) whether the claim is “wholly collateral” to the statute’s review provisions, and (3) whether the claim is “outside the agency’s expertise,” Axon, 143 S. Ct. at 900.

In an opinion authored by Justice Kagan, the Court found all three factors weighed in favor of federal court jurisdiction. First, relying on internal administrative review would “foreclose all meaningful judicial review” because Cochran and Axon would lose their “rights not to undergo the complained-of agency proceedings if they cannot assert those rights until the proceedings are over.” Id. at 904. Second, Axon’s and Cochran’s claims had “nothing to do with either the enforcement-related matters the Commissions regularly adjudicate or those they would adjudicate in assessing the charges against Axon and Cochran,” and were thus wholly collateral. Id. at 904–05. Finally, Axon’s and Cochran’s constitutional assertions were “outside the agency’s expertise.” Id. at 905.

B. Grants of Certiorari

1. Murray v. UBS Securities, LLC – Retaliation Under Sarbanes-Oxley

On May 1, 2023, the Supreme Court granted certiorari in Murray v. UBS Securities LLC, et al., a case arising from the Second Circuit that could impact the ability of whistleblowers to bring claims of retaliation under 18 U.S.C. § 1514A of the Sarbanes-Oxley Act (“SOX”). See 143 S. Ct. 2429 (2023). The case is scheduled to be argued on October 10, 2023.

The case concerns a SOX retaliation claim by former UBS employee Trevor Murray. See Murray v. UBS Securities LLC, et al., 43 F.4th 254, 256 (2d Cir. 2022). UBS had hired Murray as a strategist supporting its commercial mortgage-backed securities business. Id. After “a shift in strategy prompted by financial difficulties,” which resulted in a “series of reductions in force,” UBS terminated his employment. Id. at 257. Murray alleged that he was terminated because he had reported being pressured “to skew his research and to publish reports to support their business strategies.” Id. at 256–57.

In 2014, Murray sued UBS, and a jury returned a verdict in his favor. Id. at 258. UBS appealed, arguing the district court committed reversible error when it failed to instruct the jury that a SOX whistleblower claim requires a showing of the employer’s retaliatory intent. Id. at 256. The Second Circuit agreed with UBS, finding “retaliatory intent is an element of a section 1514A claim,” a conclusion that “flow[ed] from the plain meaning of the statutory language and [wa]s supported by [the Second Circuit’s] interpretation of nearly identical language in the [Federal Railroad Safety Act].” Id. at 262–63. The Second Circuit thus vacated the district court’s judgment and remanded for a new trial. Id. at 263.

The Supreme Court subsequently granted review. In his opening brief filed on June 27, 2023, Murray argued that a plaintiff under the burden-allocation regime applicable to SOX retaliation claims need not prove “retaliatory intent.” In response, in its brief filed on August 8, 2023, UBS argued that SOX’s statutory language—which prohibits “discrimination … because of” protected activity—requires a plaintiff to show discriminatory intent and that the burden-allocation framework does not alter that requirement.

Gibson Dunn attorneys Eugene Scalia, Thomas Hungar, and Gabrielle Levin represent UBS Securities LLC and UBS AG.

2. SEC v. Jarkesy – Constitutional Challenges to the SEC’s Enforcement Powers

On June 30, 2023, the Supreme Court granted the SEC’s petition for writ of certiorari in Securities and Exchange Commission v. Jarkesy, 2023 WL 4278448, at *1 (U.S. June 30, 2023). The case presents three questions: (1) “Whether statutory provisions that empower the Securities and Exchange Commission (SEC) to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violate the Seventh Amendment”; (2) “Whether statutory provisions that authorize the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine”; and (3) “Whether Congress violated Article II by granting for-cause removal protection to administrative law judges in agencies whose heads enjoy for-cause removal protection.” See Petition for a Writ of Certiorari, Securities and Exchange Commission v. Jarkesy, No. 22-859, at (ii) (Mar. 8, 2023).

On May 18, 2022, the Fifth Circuit issued an opinion holding that (1) the Jarkesy parties were deprived of their Seventh Amendment right to a jury trial, (2) Congress “unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power,” and (3) the “statutory removal restrictions on SEC ALJs violate Article II.” Jarkesy v. SEC, 34 F.4th 446, 451 (5th Cir. 2022). As to the first, the court reasoned that because the right to a jury trial attaches to “traditional actions at law,” and enforcement proceedings carrying civil penalties are “akin” to those “traditional actions,” parties to such enforcement proceedings have a jury trial right. Id. at 451. In addition, the Court rejected the SEC’s argument that “the action [it] brought . . . [wa]s . . . the sort that may be properly assigned to agency adjudication under the public-rights doctrine.” Id. at 455–57. As to the second, the Fifth Circuit explained that because “Congress . . . delegated to the SEC what would be legislative power absent a guiding intelligible principle”—i.e., the power to bring securities fraud actions for monetary penalties within the agency instead of in an Article III court—and Congress failed to “provide the SEC with an intelligible principle by which to exercise that power,” “Congress unconstitutionally delegated legislative power to the SEC.” Id. at 460–62. Finally, the Court reasoned that because ALJs “perform substantial executive functions,” the two layers of for-cause removal restrictions are an unconstitutional impediment to the Article II requirement that the President “take Care that the Laws be faithfully executed.” Id. at 463.

In its petition for certiorari, the SEC argued that all three of these “highly consequential” conclusions warrant the Court’s review, as they “call[] into question longstanding practices at the SEC and many other agencies.” Petition for a Writ of Certiorari, at 9. Among other things, the SEC argued that “[u]nder [a] long line of precedent, SEC administrative adjudications seeking civil penalties qualify as matters involving public rights,” id. at 11; “[t]he Commission’s decision whether to pursue an administrative or judicial remedy in a particular case is a core executive function” rather than an “exercise of legislative power,” id. at 13; ALJs are not improperly insulated because, inter alia, they “perform adjudicative rather than enforcement or policymaking functions,” id. at 18 (quoting Free Enter. Fund v. PCAOB, 561 U.S. 477, 507 n.10 (2010)), and the standard for their removal is “less stringent than the removal standard . . . held invalid in Free Enterprise Fund;” and the Merit Systems Protection Board’s “involvement in reviewing the removal of ALJs” does not “contribute[] to the violation of Article II,” id. at 18–19.

3. Loper Bright Enterprises v. Raimondo – Chevron’s Vitality

On May 1, 2023, the Supreme Court granted certiorari in Loper Bright Enterprises v. Raimondo. It presents the question of whether the Supreme Court should overrule Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984), “or at least clarify that statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute an ambiguity requiring deference to the agency.” Petition for Writ of Certiorari, Loper Bright Enters. v. Raimondo, No. 22-451 (Nov. 10, 2022); Loper Bright Enters. v. Raimondo, 143 S. Ct. 2429 (2023).

The case involves a group of commercial fishing companies and certain actions taken by the National Marine Fisheries Service (“the Service”). Loper Bright Enters., Inc. v. Raimondo, 45 F.4th 359, 363 (D.C. Cir. 2022). Specifically, “[i]n implementing an Omnibus Amendment that establishes industry-funded monitoring programs in New England fishery management plans, [the Service] promulgated a rule that required industry to fund at-sea monitoring programs.” Id. The group of commercial fishing companies then sued, “contend[ing] that the [Magnuson-Stevens Fishery Conservation and Management Act of 1976 (the “Act”)] does not specify that industry may be required to bear such costs and that the process by which the Service approved the Omnibus Amendment and promulgated the Final Rule was improper.” Id.

The district court ruled in favor of the Government, and the D.C. Circuit, relying partly on the limited scope of review permitted by Chevron, 467 U.S. 837, affirmed. Chevron requires courts to evaluate the Government’s interpretation of certain statutes by asking first “whether Congress has spoken clearly,” and if not, then, second, “whether the implementing agency’s interpretation is reasonable.” Loper Bright, 45 F.4th at 365. Here, the D.C. Circuit concluded that “[a]lthough the Act may not unambiguously resolve whether the Service can require industry-funded monitoring, the Service’s interpretation of the Act as allowing it to do so [wa]s reasonable.” Id.; see also id. at 370.

C. Circuit-Level Developments

1. Lee v. Fisher – Potential Circuit Split on Forum Selection Clauses and Section 14

On June 1, 2023, an en banc panel of the Ninth Circuit issued its opinion in Lee v. Fisher, thereby furthering a potential split with the Seventh Circuit. 70 F.4th 1129 (9th Cir. 2023). As discussed in our 2022 Year-End Securities Litigation Update, Lee concerns whether investors can file derivative suits in federal court when a company’s bylaws contain a forum-selection clause that mandates such cases be filed in Delaware state court. In Seafarers Pension Plan v. Bradway, the Seventh Circuit held that a forum-selection clause similar to the one at issue in Lee was not enforceable. 23 F.4th 714, 724 (7th Cir. 2022).

In contrast to the Seventh Circuit, the Ninth Circuit held that the at-issue forum selection clause contained in the company’s bylaws, which required “any derivative action or proceeding brought on behalf of the Corporation” to be adjudicated in the Delaware Court of Chancery, was enforceable. Lee, 70 F.4th at 1138. First, the Court held that the forum selection clause did not waive substantive compliance with the Exchange Act, i.e., compliance with the obligation not to make false or misleading statements in a proxy statement. The court explained that Lee could enforce substantive compliance through direct claims that are outside the ambit of the forum selection clause. See Lee, 70 F.4th at 1139; see also id. at 1139 n.5 (“Lee can also enforce the substantive obligation to refrain from making false or misleading statements in a proxy statement under Delaware law.”). It also rejected Lee’s argument that “the forum selection clause conflicts with § 29(a)’s antiwaiver provision” because it forecloses the “right to bring a derivative § 14(a) action,” explaining, among other things, that § 29(a) does not “forbid . . . waiver of a particular procedure for enforcing such duties.” Id. at 1141. Next, the court rejected Lee’s argument—which relied largely on J.I. Case Co. v. Borak, 337 U.S. 426 (1964)—that there is a strong public policy “of allowing shareholders to bring a § 14(a) derivative action.” Id. at 1143. The court observed, among other things, that “the [Supreme] Court now looks to state law rather than federal common law to fill in gaps relating to federal securities claims, and under Delaware law, a § 14(a) action is direct, not derivative.” Id. at 1149. The court further noted that the Supreme Court “now views implied private rights of action with disapproval, construing them narrowly, and casting doubt on the viability of a corporation’s standing to bring a § 14(a) action.” Id. The court also rejected Lee’s argument that enforcement of the forum selection clause would conflict with “the federal forum’s strong public policy of giving federal courts exclusive jurisdiction over Exchange Act claims under § 27(a).” Id. at 1150–51. Last, the court held that because “the Delaware Supreme Court has indicated that federal claims like Lee’s derivative § 14(a) action are not ‘internal corporate claims’ as defined in Section 115, and because no language in [Delaware precedent], Section 115, or the official synopsis operates to the limit the scope of what constitutes a permissible forum-selection bylaw under Section 109(b),” the forum-selection clause was valid under Delaware law. Id. at 1156.

Some had criticized the original Lee opinion for potentially foreclosing federal courts as a forum to hear federal derivative suits. Under the en banc court’s reasoning, however, that criticism rests on a mistaken premise. Whereas Seafarers concluded that “Section 14(a) may be enforced . . . in derivative actions asserting rights of a corporation harmed by a violation,” 23 F.4th at 719 (citing Borak, 337 U.S. at 431–32), the en banc panel all but held that federal derivative actions are outside the scope of the Exchange Act, see, e.g., Lee, 70 F.4th at 1147 (“[T]he injury caused by a violation of § 14(a) gives rise to a direct action under Delaware law, not a derivative action.”); id. at 1149 (“Virginia Bankshares casts grave doubt on whether a shareholder can bring a derivative § 14(a) action on behalf of a corporation. . . . [T]he [Supreme] Court now views implied private rights of action with disapproval, construing them narrowly, and casting doubt on the viability of a corporation’s standing to bring a § 14(a) action.”); id. at 1158 (“The Seventh Circuit . . . misread Borak.”).

2. Chamber of Commerce v. SEC – Challenges to the SEC’s Share-Repurchase Final Rule

On May 12, 2023, the U.S. Chamber of Commerce filed a Petition for Review challenging the SEC’s recently announced share-repurchase rule. Petition For Review, Chamber of Com. of the United States v. SEC, No. 23-60255 (May 16, 2023). As detailed in a recent Client Update, it requires companies to: (1) disclose daily repurchase data in a new table filed as an exhibit to Form 10-Q and Form 10-K, (2) indicate by a check box whether any executives or directors traded in the company’s equity securities within four business days before or after the public announcement of the repurchase plan or program or the announcement of an increase of an existing share repurchase plan or program, (3) provide narrative disclosure about the repurchase program, including its objectives and rationale, in the filing, and (4) provide quarterly disclosure regarding the company’s adoption or termination of any Rule 10b5-1 trading arrangements. Share Repurchase Disclosure Modernization, Release Nos. 34-97424; IC-34906; File No. S7-21-21. The Chamber of Commerce contends that the rule disincentivizes companies from using stock buybacks and violates both the Administrative Procedure Act and the First Amendment. Press Release, U.S. Chamber of Commerce, U.S. Chamber Sues the Securities and Exchange Commission Over Stock Buyback Rule (May 12, 2023).

3. Update on Goldman Sachs Group v. Arkansas Teacher Retirement System

On August 9, 2023, the Second Circuit issued its long-awaited decision in Arkansas Teacher Retirement System v. Goldman Sachs Group Inc., No. 22-484. As noted in our 2022 Year-End Securities Litigation Update, oral argument was held on September 21, 2022, before a panel consisting of Judges Richard Sullivan, Denny Chen, and Richard Wesley. In an opinion by Judge Wesley, the Second Circuit concluded that Goldman successfully rebutted Basic’s presumption of reliance and decertified the class. For a detailed discussion of the case, see the Market Efficiency and “Price Impact” Cases section in Part IX, infra. We will report on any future developments.

III. Delaware Developments

The Delaware Supreme Court has said that Delaware’s “corporate law is not static,” Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del. 1985), and that was certainly true in the last half-year. In some areas, Delaware courts held steady, affirming, for example, that controllers who distance themselves from conflicted transactions can win court approval, that transactions that are fair to minority stockholders can withstand scrutiny under the entire fairness standard, and that backchanneled mergers may fail to pass muster. In other areas, Delaware law marched forward with trends that began last year. For example, the Court of Chancery continued its developing trend of applying entire fairness to SPAC deals. And still elsewhere, Delaware courts broke new ground, raising the bar for merger-disclosure strike suits and reshaping the standards for board measures in control contests.

A. Delaware Carves Path for Conflicted Controllers in Oracle

In May 2023, the Delaware Court of Chancery ruled in favor of Oracle founder Larry Ellison in a lawsuit arising from Oracle’s $9.3 billion acquisition of NetSuite. In re Oracle Corp. Derivative Litig., 2023 WL 3408772 (Del. Ch. May 12, 2023). The court held that Ellison was not a controlling stockholder and therefore the transaction was governed by the business judgment rule. Id. at *27.

In January 2016, Oracle’s board of directors created a special committee to assess a potential takeover of NetSuite, a company co-founded and partly owned by Ellison. Id. at *4, *6. Oracle announced a tender offer for NetSuite in July 2016 for $109 per share. Id. at *14–15. After the purchase, Oracle stockholders sued, alleging that, in spite of the independent committee, Ellison’s status as Oracle’s controller meant the board lacked independence and that Ellison had forced the company to overpay for NetSuite for his personal benefit. Id. at *18. In 2018, the court denied Ellison’s motion to dismiss. Id. at *16.

After trial, the court issued a decision holding that even though “[p]laintiff-friendly presumptions” that Ellison’s roughly 25% holdings in Oracle and control over its actions meant the board was conflicted “were sufficient to carry this matter to trial,” the post-trial evidence did not support this theory. Id. at *2. The court distinguished earlier cases holding that minority stockholders caused a conflict because of a “combination of [their] stock holdings” and “affirmative actions taken to control the transaction.” Id. at *26. It noted that Ellison “neither possessed voting control, nor ran the company de facto,” and emphasized that even though he “had the potential to control the transaction at issue . . . he scrupulously avoided influencing the transaction.” Id. at *27. Accordingly, the business judgment rule applied. Id.

Oracle demonstrates that although Delaware courts may find that a minority holder is a controller and entire fairness applies for pleading-stage purposes, it is still possible for a putative controller to avoid application of that exacting standard at trial where he or she actively removes him or herself from the transaction at issue.

B. Mixed Verdict for Drag-Along Covenants Not to Sue

In May 2023, the Delaware Court of Chancery refused to enforce an explicit covenant not to sue over a drag-along sale. New Enter. Assocs. 14, L.P. v. Rich, 295 A.3d 520 (Del. Ch. 2023). The court explained that as a matter of public policy, a covenant not to sue cannot insulate defendants from tort liability based on intentional wrongdoing. Id. at 536. The court clarified that covenants not to sue for fiduciary-duty breaches are not facially invalid and signaled a continued receptiveness to some tailoring of fiduciary duties, despite the outcome of this decision. Id. at 530–31. We discussed the decision and its implications in more detail in our May 8, 2023 M&A Report.

C. Court Finds Merger Backchannelling Caused Conflict

In April 2023, Chancellor McCormick held that the CEO of software company Mindbody Inc. violated his fiduciary duties by tilting the company’s sales process in favor of a private-equity buyer. In re Mindbody, Inc. S’holder Litig., 2023 WL 2518149 (Del. Ch. Mar. 15, 2023). The suit followed Mindbody’s 2019 take-private transaction by Vista Equity Partners. Id. According to the court, the CEO was motivated by a personal need for liquidity and had been partial to Vista throughout the process. Id. at *2, *35. His backchanneling with Vista as the company’s formal sale process continued was, the court concluded, a breach of fiduciary duties. Id. at *35–38. He also breached his duty of disclosure by failing to disclose several meetings he had with Vista, including attending a private summit that it hosted. Id. at *1, *9, *12, *36. This case is discussed further in our April 10, 2023 M&A Report.

D. Supreme Court Affirms Tesla’s Acquisition of SolarCity Was Entirely Fair

The Delaware Supreme Court recently affirmed the Delaware Court of Chancery’s holding that Tesla’s 2016 acquisition of SolarCity was entirely fair to Tesla’s stockholders. In re Tesla Motors, Inc. S’holder Litig., — A.3d —, 2023 WL 3854008 (Del. June 6, 2023) (Tesla II). In 2016, Tesla stockholders accused Elon Musk of forcing Tesla’s board to overpay for SolarCity, a producer of solar panels that the plaintiffs claimed was insolvent at the time. Id. at *1. In addition to his Tesla leadership role, Musk was the chairman of SolarCity and the company’s largest stockholder. Id. at *2. The Court of Chancery had held, after trial, that the transaction process and price were ultimately fair despite Musk’s participation. In re Tesla Motors, Inc. S’holder Litig., 2022 WL 1237185, at *2 (Del. Ch. Apr. 27, 2022) (Tesla I). The high court’s June opinion in Tesla II affirmed that finding. 2023 WL 3854008, at *2.

The Delaware Supreme Court’s opinion reaffirms and clarifies several aspects of the entire fairness analysis. The plaintiffs had made a number of arguments on appeal as to why the trial court erred in applying that standard, but the court rejected each in turn. See Tesla II, 2023 WL 3854008, at *24, *33, *44. First, the court affirmed that a conflicted board’s decision not to utilize a special committee to negotiate a merger “does not automatically result in a finding of liability.” Id. at *26. A board may choose to subject itself to the “expensive, risky, and ‘heavy lift’” of satisfying entire fairness for a number of strategic reasons, including to avoid “transaction execution risk,” to maintain flexibility, and “to access the technical expertise and strategic vision and perspectives of the controller.” Id. at *27.

Second, the Supreme Court held that although the Court of Chancery’s analysis placed too much weight on Tesla’s pre-merger stock price—which, the Supreme Court concluded, failed to factor in material nonpublic information—the court’s overall focus on the merger price was not misplaced, and there was sufficient evidence establishing that the price was fair. Tesla II, 2023 WL 3854008, at *34. The plaintiffs had argued that the trial court “applied a bifurcated entire fairness test, concluding that its separate fair price analysis alone satisfied entire fairness.” Id. The Supreme Court disagreed, pointing out that the trial court had, in fact, made “extensive fact and credibility findings relating to the Acquisition’s process.” Id. The Supreme Court further concluded that the trial court was correct to put great weight on price because although a fair price “is not a safe-harbor that permits controllers to extract barely fair transactions,” it is “the paramount consideration” in deciding whether the merger as a whole was fair. Id. (citations omitted).

The Supreme Court, however, departed from the Court of Chancery in how the price analysis should be conducted, agreeing with the plaintiffs that the trial court should not have relied on a pre-merger stock price that did not factor in later-revealed nonpublic information. Id. at *44. Indeed, the court “cautioned against reliance on a stock price that did not account for material, nonpublic information” and “sole reliance on the unaffected market price.” Id. at *46 (citation omitted). Nonetheless, the Supreme Court found that other evidence “amply supports the [trial] court’s finding that the price was fair”; in addition to the stock price, the trial court had relied on “an array of valuation and fair price evidence,” such as its financial advisor’s analysis and evidence of SolarCity’s financial performance. Id.

E. Court of Chancery Again Holds Entire Fairness Governs De-SPAC Transactions

The Delaware Court of Chancery again affirmed that de-SPAC mergers are subject to the entire fairness standard of review. In Laidlaw v. GigAcquisitions2, LLC, stockholders brought fiduciary duty claims against the directors and controlling stockholder of GigCapital2, Inc., a special purpose acquisition company (“SPAC”). 2023 WL 2292488, at *1 (Del. Ch. Mar. 1, 2023). SPACs are publicly traded corporations created with the sole purpose of merging with a private business before a set deadline, which allows the private business to go public. When the merger takes place, the investors of the SPAC can choose to redeem their investments or invest in the post-merger company. In Laidlaw, the stockholders alleged that the defendants had issued a false and misleading proxy statement that prevented the stockholders from making an informed decision about whether to redeem their investments in the SPAC. Id.

The opinion by Vice Chancellor Will followed her earlier decisions in In re MultiPlan Corporation Stockholders Litigation, 268 A.3d 784 (Del. Ch. 2022) and Delman v. GigAcquisitions3, LLC, 288 A.3d 692 (Del. Ch. Jan 4, 2023). These earlier cases held that mergers between SPACs and their targets, also referred to as de-SPAC transactions, were inherently conflicted because the sponsors of the SPACs would lose their investments if they did not consummate the mergers before the given deadlines. Each of the earlier decisions held that the at-issue de-SPAC transaction was subject to the entire fairness standard. In re Multiplan, 268 A.3d at 813; Delman, 288 A.3d at 709.

In her recent decision, Vice Chancellor Will noted that the legal questions presented in Laidlaw were “largely indistinguishable” from those in Delman. Laidlaw, 2023 WL 2292488, at *1. The court held that the sponsors were conflicted because of the way the de-SPAC was structured: the sponsors allegedly preferred a bad merger to no merger because they would lose their Founder Shares and Private Placement Units if the SPAC did not merge with another company, while public stockholders would prefer no deal to a bad one because they would still receive their full investment plus liquidation interest if there were no merger. Id. at *8. And even after the merger agreements were signed, the sponsor had an interest in minimizing redemptions by stockholders because the deals required the SPAC to have $150 million in cash. Id. The court further noted that it was reasonably conceivable that the de-SPAC transaction was conflicted because a majority of the board members lacked independence from the owner and controller of the sponsor. Id. at *9.

As a result, the court rejected the defendant’s motion to dismiss and the plaintiffs’ claims that the defendant issued a false and misleading proxy statement were allowed to proceed. Id. at *14.

F. Supreme Court Clarifies Standard for Voting Control Measures

In Coster v. UIP Companies, Inc., the Delaware Supreme Court clarified the standards applicable to board action in a contest for corporate control that interferes with stockholders’ voting rights. ‌— A.3d —, 2023 WL 4239581 (Del. June 28, 2023) (Coster IV). As we wrote in our 2022 Year-End Securities Litigation Update, this case arose when the plaintiff became a 50% stockholder in UIP and deadlocked with the company’s other half-owner regarding UIP’s board composition. Coster v. UIP Companies, Inc., 2022 WL 1299127, at *1 (Del. Ch. May 2, 2022) (Coster III). The plaintiff brought an action to appoint a custodian with full control over the company, and the board responded by issuing one-third of the total outstanding shares to an “essential” employee who broke the deadlock. Id. at *3. After unsuccessfully challenging the stock issuance in the Court of Chancery, the plaintiff appealed to the Delaware Supreme Court, which remanded with instructions to apply the standards laid out in Blasius Industries, Inc. v. Atlas Corporation, 564 A.2d 651 (Del. Ch. 1988), and Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971). Coster IV, 2023 WL 4239581, at *4. The trial court again ruled for the defendants, and she again appealed. Id. at *5.

On June 28, 2023, the Supreme Court reconciled the various applicable standards: Schnell for board-entrenchment measures, Blasius for interference with the stockholder franchise, and Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), for antitakeover strategies. Where the board “interferes with the election of directors or a shareholder vote in a contest for corporate control”—that is, where both entrenchment or antitakeover measures and the stockholder franchise are at issue—courts should apply “Unocal . . . with the sensitivity Blasius review brings.” Coster IV, 2023 WL 4239581, at *12. First, courts should judge whether there was a threat to “an important corporate interest” that was “real and not pretextual,” such that the board’s motivation was “proper and not . . . disloyal.” Id. Per Blasius, boards cannot rely on the justification that they know what is best for stockholders. Id. Second, courts should review, per Unocal, whether the board’s response was “reasonable in relation to the threat” and “not preclusive or coercive to the stockholder franchise.” Id. Applied in this fashion, the standard also “subsume[s] the question of loyalty” and “thus address[es] issues of good faith such as were at stake in Schnell.” Id. at *11.

Judged by this standard, the court affirmed the Court of Chancery’s decision, finding the company’s actions passed muster. Id. at *17. As the trial court held, the plaintiff’s broad request for a custodian posed significant risks to the company, and even though the trial court found that “some of the board’s reasons for approving the Stock Sale were problematic, on balance[,] . . . the board was properly motivated in responding to the threat.” Id. at *14.

G. Delaware Raises the Bar for Merger Plaintiffs’ Fees

The Delaware Court of Chancery raised the bar for attorneys’ fees in cases where a plaintiff’s suit over allegedly inadequate merger disclosures causes the defendant to supplement those disclosures. Anderson v. Magellan Health, Inc., 298 A.3d 734 (Del. Ch. 2023). In Anderson, a stockholder sued the selling company in a merger saying that its proxy materials were inadequate and its deal protections stood in the way of getting the best price; in response, the company loosened the deal protections and made new disclosures. Id. In July 2023, the court held that the loosened deal protections, as a practical matter, did not create a “corporate benefit” allowing the plaintiff to collect attorneys’ fees because they had no effect on the ultimate deal price. Id. at *741–45. And the court changed the standard for when supplemental disclosures justify a fee award—previously, these only had to be “helpful,” whereas the Court of Chancery held that fees are justified “only when the information is material.” Id. at *747–51. We discussed this decision in greater detail in our August 2, 2023 Client Alert.

IV. Federal SPAC Litigation

The number of SPAC IPOs and the value of de-SPAC transactions have decreased significantly since their peak in 2021, as noted in our 2022 Mid-Year Securities Litigation Update. De-SPAC transactions, however, have given rise to significantly more securities class actions than other IPOs, and plaintiffs have generally had more success in surviving the motion to dismiss stage.

A. Clover Health: Settlement Offer Proposed in Fraud-on-the-Market SPAC Litigation

Our 2022 Mid-Year Securities Litigation Update highlighted Bond v. Clover Health Investments, Corp., 587 F. Supp. 2d 641 (M.D. Tenn. Feb. 28, 2022), as a prototypical example of the Section 10(b) class actions that survived the motion-to-dismiss stage after the 2021 SPAC boom. We also noted that, in denying the motion to dismiss in that case, the district court for the Middle District of Tennessee expressly credited a fraud-on-the-market theory, see id. at 664–66, and was apparently the first federal court to do so in the context of claims arising from a SPAC-related offering. In April 2023, less than three months after the court granted the plaintiffs’ motion for class certification, Bond v. Clover Health Invs., Corp., 2023 WL 1999859 (M.D. Tenn. Feb. 14, 2023), Clover Health announced that the parties had agreed to a proposed settlement. Under the parties’ agreement, which is subject to final court approval, the class will receive $22 million and the defendants will receive customary releases. Press Release, Clover Health, Clover Health Announces Agreement to Settle Securities Class Action Litigation (Apr. 24, 2023), https://investors.cloverhealth.com/news-releases/news-release-details/clover-health-announces-agreement-settle-securities-class-action. In May, the court preliminarily approved the agreement and scheduled a settlement hearing for October 2, 2023. Bond v. Clover Health Invs., Corp., 3:21-CV-00096 (M.D. Tenn. May 26, 2023), Dkt. No. 132.

B. Statutory Standing in the SPAC Context

Our 2022 Year-End Securities Litigation Update highlighted a decision, In re CCIV/Lucid Motors Securities Litigation, 2023 WL 325251 (N.D. Cal. Jan. 11, 2023), addressing the standing requirements for bringing a Section 10(b) action in the SPAC context. In two recent cases, lower courts continued to examine how statutory standing requirements apply in the context of SPAC litigation.

In March 2023, a SPAC-related class action in the Southern District of New York, In re CarLotz, Inc. Securities Litigation, 2023 WL 2744064 (S.D.N.Y. Mar. 31, 2023), was dismissed on standing grounds, based on the fact that the plaintiffs did not own shares of the privately held, pre-merger target, id. at *1, *5. The de-SPAC transaction in CarLotz concerned Acamar, a SPAC that went public and then identified CarLotz, a used vehicle marketplace, as a target company. Id. at *1. The plaintiffs alleged that officers of pre-merger CarLotz made materially false and misleading statements, and that the falsity of those statements was revealed in disclosures that were made after the merger. Id. at *2. In dismissing the case, the CarLotz court followed Second Circuit precedent that the CCIV court had considered, Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., 54 F.4th 82 (2d. Cir. 2022), but was not “compell[ed]” to follow, 2023 WL 2744064, at *4–5; see also In re CCIV/Lucid Motors, 2023 WL 325251, at *7–8.

The court applied the rule from an earlier Second Circuit decision that did not directly concern SPACs, Menora Mivtachim, 54 F.4th 82, which held that shareholders of an acquiring company could not sue the target company for alleged misstatements that had been made prior to the merger between the two companies, id. at 86.

The plaintiffs argued that applying Menora to companies acquired by SPACs would create a “loophole” that shields from liability the pre-merger statements of parties to SPAC transactions. CarLotz, 2023 WL 2744064, at *5. Although the court acknowledged this policy concern, it stated that it was bound by the Menora precedent. Id. The court also noted alternative means of accountability for pre-merger actions taken by a target company, such as SEC enforcement actions, shareholder derivative suits, or actions brought under state law. Id.

CarLotz and another case, Mehedi v. View, Inc., 2023 WL 3592098 (N.D. Cal. May 22, 2023), also addressed requirements for standing under Section 11 of the Securities Act, which imposes strict liability for any materially misleading statements or omissions in a registration statement, see CarLotz, 2023 WL 2744064, at *5–8; Mehedi, 2023 WL 3592098, at *5–7. Section 11 requires each plaintiff to demonstrate that he or she can trace the shares he or she purchased to the offering related to the allegedly misleading document or statement, rather than from some other source. Mehedi, 2023 WL 3592098, at *5.

In Mehedi, the plaintiffs did not allege that they had purchased securities that were directly traceable to the relevant registration statement. Id. at *5–7. In CarLotz, the plaintiffs conceded that one named plaintiff had purchased shares in Acamar, the public company, even before the de-SPAC registration statement and prospectus were effective, but argued that his shares were still traceable to the registration statement because the merger itself “functionally transformed” his Acamar shares into shares of the new public company, CarLotz. 2023 WL 2744064, at *7. The court acknowledged this theory was “creative,” but found it foreclosed by Second Circuit precedent on Section 11 traceability, which requires the plaintiff to have purchased shares “under” “the same registration statement” being challenged. Id. The plaintiffs again identified policy reasons for loosening these standing requirements in the context of SPAC transactions, including a proposed SEC regulation that, “if promulgated, would subject registration statements for de-SPAC transactions to Section 11 liability.” Id. at *8. But the court found that proposed non-final rule and other policy considerations insufficient to overcome the current binding precedent. Id.

V. ESG Civil Litigation

For the past several years, a number of lawsuits have been filed against public companies or their boards related to the 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

Fagen v. Enviva Inc., No. 8:22-CV-02844 (D. Md. Nov. 3, 2022): We first reported on this case in our 2022 Year-End Securities Litigation Update. After the court appointed a lead plaintiff in January 2023, an amended complaint was filed in April 2023. ECF No. 34. In the amended complaint, the plaintiff alleges that Enviva made false or misleading statements in offering documents and other communications to investors that exaggerated the sustainability of Enviva’s wood pellet production and procurement methods. Id. at 1–4. The amended complaint claims Enviva’s stock price dropped after various third parties published reports challenging Enviva’s environmental claims. Id. at 3. The defendants have filed motions to dismiss the amended complaint. ECF Nos. 62, 63. In those motions, the defendants argue that the alleged “misrepresentations” are merely part of “an ongoing public debate about the environmental benefits of using wood pellets—rather than fossil fuels—to generate heat and electricity,” which cannot give rise to securities fraud. ECF No. 62-1 at 1. The motions to dismiss are fully briefed and pending before the court.

Wong v. New York City Emp. Ret. Sys., No. 652297/2023 (N.Y. Sup. Ct., N.Y. Cnty. May 11, 2023): In Wong, the plaintiffs have brought 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 plaintiffs allege that the retirement boards impermissibly prioritized political goals unrelated to the financial health of the plans over their obligation to pursue the best financial returns for plan participants, declaring the pension fund’s actions an “utter abandonment of fiduciary responsibilities.” Id. at 2–3. 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. Id. at 18. The plaintiffs sought 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” going forward. Id. at 24. The defendants filed a motion to dismiss the complaint on August 7, 2023. NYSCEF No. 20 at 1. Gibson Dunn is representing Plaintiffs in this case.

B. Social Litigation

City of St. Clair Shores Police and Fire Ret. Sys. v. Unilever PLC, No. 22-CV-05011 (S.D.N.Y. June 15, 2022): As reported in our 2022 Year-End Securities Litigation Update, in at least one action, investors challenged corporate commitments on ESG-related topics. The allegations in Unilever arose from a 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. The 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. The defendants filed a motion to dismiss in late 2022, arguing, among other things, that the plaintiffs failed to plead an actionable misstatement or omission and failed to plead scienter. See, e.g., ECF No. 31 at 3. The motion to dismiss is now fully briefed and pending before the court.

C. Diversity and Inclusion

Ardalan v. Wells Fargo & Co., No. 22-CV-03811 (N.D. Cal. July 28, 2022): In this putative class action, the plaintiffs alleged that Wells Fargo announced an initiative which required that 50 percent of interviewees be diverse for most roles above a certain salary threshold, and then purported to meet that requirement by conducting interviews for positions that had already been filled. ECF No. 1 at 2–4. These practices, the plaintiffs allege, made the bank’s statements about its diversity initiatives materially misleading. Id. The plaintiffs alleged that the bank’s stock price fell by more than ten percent after the New York Times published an article purporting to reveal that certain of the bank’s employees were holding interviews for filled positions. Id. In April 2023, the defendants filed a motion to dismiss the complaint. In that motion, the defendants argued that the plaintiffs’ allegations of isolated incidents of employee misconduct cannot render the bank’s general statements about its diversity program false or misleading. ECF No. 100 at 2–3. The district court agreed. In an August 18, 2023 opinion granting the defendants’ motion to dismiss, the district court held that the PSLRA “requires particularized allegations sufficient to infer that sham interviews took place during the Class Period and that they were widespread.” ECF No. 112 at 8. The district court dismissed the complaint without prejudice. Id. at 15.

* * * * *

Gibson Dunn will continue to monitor developments in ESG-related securities litigation. Additional resources relating to ESG issues can be found on Gibson Dunn’s ESG practice group page.

VI. Cryptocurrency Litigation

A growing number of both class action and regulatory lawsuits are being filed against cryptocurrency platforms and their operators. Many of these lawsuits seek to classify cryptocurrencies as “securities” under existing federal securities law, and courts continue to grapple with the application of securities laws to cryptocurrency. Defendants have crafted multiple arguments in favor of dismissing these actions, with varying levels of success.

A. Class Actions

Underwood v. Coinbase Glob., Inc., 2023 WL 1431965 (S.D.N.Y. Feb. 1, 2023): A putative class of users of Coinbase’s trading platform, a platform which facilitates cryptocurrency transactions, brought claims under Sections 12(a)(1) and 15 of the Securities Act, Section 29(b) of the Exchange Act, and state law, alleging that they suffered damages in connection with the defendants’ sale and solicitation of allegedly unregistered securities. 2023 WL 1431965 at *1. The defendants filed a motion to dismiss arguing that under the terms of Section 12, Coinbase was not the “statutory seller” of the tokens sold to the plaintiffs. Id. at *1, 6. The court concluded in ruling on a motion to dismiss the Section 12 claims that Coinbase did not directly sell tokens to the plaintiffs because the company did not hold title to the cryptocurrency traded on its platform during the transaction. Id. at *6–8. The court also reasoned that Coinbase did not “solicit” transactions because it did not partake in the “direct and active participation in the solicitation of the immediate sale.” Id. at *9. Based on this reasoning, the court dismissed the plaintiffs’ Section 12 claim as Coinbase was not the “statutory seller” of the tokens. The court also dismissed the plaintiffs’ control-person claim, which was predicated on the Section 12 violation. Id. at *10. The court likewise dismissed the plaintiffs’ claim under Section 29(b) of the Exchange Act, holding that the plaintiffs failed to demonstrate that their user agreements with Coinbase’s platform involved a “prohibited transaction” under Section 29(b). Id. at *11–12. The court declined to exercise supplemental jurisdiction over the plaintiffs’ state law claims. Id. at *12–13. The plaintiffs are currently appealing the district court’s decision to the Second Circuit. See Underwood v. Coinbase Glob., Inc., 2023 WL 1431965 (S.D.N.Y. Feb. 1, 2023), appeal docketed, No. 23-184 (2d Cir. Feb. 9, 2023).

De Ford v. Koutoulas, 2023 WL 2709816 (M.D. Fla. Mar. 30, 2023), reconsideration denied, 2023 WL 3584077 (M.D. Fla. May 22, 2023): The plaintiffs represent a group of individuals who purchased the token “LGBCoin.” The plaintiffs brought a putative class action asserting multiple claims, including a claim under Section 12 of the Securities Act. 2023 WL 2709816 at *13–16. Section 12(a)(1) of the Securities Act provides a private right of action against any person who offers or sells a security in violation of Section 5 of the Securities Act. The plaintiffs allege in their complaint that LGBCoin is a security, and that the defendants created, marketed, and offered the tokens for sale to customers in the United States. See ECF No. 1 at ¶¶ 173–83. Two defendants filed motions to dismiss the Section 12 claims for failure to state a claim. ECF Nos. 101, 104. While ruling on the motions to dismiss, the court held that, when drawing “all reasonable inferences in Plaintiffs’ favor . . . it is at least plausible that LGBCoin is a security.” 2023 WL 2709816, at *13–15. The court then concluded that the plaintiffs had plausibly alleged that one of the defendants, an executive at LGBCoin who made social media posts promoting the token, could be held liable as a “seller” of a security under Section 12. Id. at *15. The court reasoned that because of this defendant’s “extensively documented alleged promotion of LGBCoin in-person or online in videos, on social media, and on podcasts,” he was a seller and was “plausibly alleged to have made the[] solicitations to serve his own financial interests.” Id. The court found, however, that a separate defendant-executive of the company who was not alleged to have made similar public solicitations for his own financial interest, was not a seller. Id. The court thus denied the former executive’s motion to dismiss the securities fraud claim, while granting the latter executive’s motion to dismiss. Id. at *16–17. On April 14, 2023, the plaintiffs filed a third amended complaint. ECF No. 245.

B. Regulatory Lawsuits

SEC v. Arbitrade Ltd., 2023 WL 2785015 (S.D. Fla. Apr. 5, 2023): The SEC brought claims under Sections 5 and 17 of the Securities Act and under Section 10b of the Exchange Act, alleging that Arbitrade Ltd., Cryptobontix Inc., SION Trading FZE, and their respective control persons were operating “a classic pump and dump scheme” involving the crypto asset “Dignity” (“DIG”). 2023 WL 2785015 at *1–2. Specifically, the SEC alleged that defendants generated artificial demand for DIG tokens by claiming that they had received title to $10 billion in gold bullion that they would use to back the tokens. Id. The defendants then sold their DIG tokens and converted the proceeds to cash. DIG tokens reached a zero dollar valuation soon after. Id. at *2. On April 5, 2023, the court denied two separate motions to dismiss brought by individual defendants. Id. at *11. In doing so, the court held that the SEC had jurisdiction over the case because, based on the facts alleged in the complaint, DIG tokens could be considered securities from which investors expected to derive profits. Id. at *3–6.

SEC v. Payward Ventures, No. 23-CV-0588 (N.D. Cal. Feb. 9, 2023): The SEC charged Payward Ventures, Inc. and Payward Trading, Ltd., both commonly known as “Kraken,” for their crypto staking service. ECF No. 1 at 1–2. Crypto staking is a process that crypto networks use to process and validate transactions. Id. at 2. The SEC alleged that Kraken’s staking service, which launched in 2019, caused investors to lose control of their assets and assume the risk of the staking platform. Id. at 3, 9. The SEC alleged that Kraken did not provide sufficient information to substantiate the staking program’s representations of certain program features. See id. at 10–17. The complaint further claimed that because crypto investors entrust money to the staking service with expectations of profit, Kraken’s staking program was marketed as an investment opportunity, and that the service was offered and sold as a security. Id. at 16, 19–22. The SEC complaint concluded that Kraken needed to register the offers and sales on the platform with the SEC and make adequate disclosures under the Securities Act because it used interstate commerce to offer investment contracts in exchange for investors’ cryptocurrency. Id. at 22. Kraken settled the case by ceasing the offering and selling of alleged securities through its staking program, and by agreeing to pay $30 million in disgorgement, prejudgment interest, and civil penalties. See Press Release, Kraken to Discontinue Unregistered Offer and Sale of Crypto Asset Staking-As-A-Service Program and Pay $30 Million to Settle SEC Charges (Feb. 9, 2023), https://www.sec.gov/news/press-release/2023-25.

SEC v. Binance Holdings Ltd., No. 23-CV-01599 (D.D.C. June 5, 2023): 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 they engaged in unregistered offers and sales of crypto asset securities. ECF No. 1. The SEC claims Binance Holdings Limited and BAM were both acting as exchanges, broker-dealers, and clearing agencies, and that they intentionally chose not to register with the SEC. Id. at 2. A day after filing the complaint, the SEC filed a motion for a TRO, seeking to freeze BAM’s assets. ECF No. 4. On June 13, 2023, consistent with the arguments set forth in the defendants’ briefing, the government admitted that it had no evidence that customer assets have been misused or dissipated and, as a result, the 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. Gibson Dunn is representing Binance Holdings Limited.

SEC v. Coinbase, Inc., No. 23-CV-4738 (S.D.N.Y. June 6, 2023): On June 6, 2023 the SEC filed a 5-count complaint against Coinbase and its parent company Coinbase Global. ECF No. 1. The SEC alleges that Coinbase has violated the securities laws since 2019 by failing to register as an exchange, broker, or clearing agency despite facilitating trading and settlement of several digital assets that the SEC alleges are securities, including ADA, SOL, MATIC, and others. Id. at 1, 33. The SEC also alleges that Coinbase has operated as an unregistered broker by offering its Coinbase Prime and Coinbase Wallet services, and that Coinbase’s staking service for several digital assets, including Ethereum, constitutes unregistered securities offerings. Id. at 2. On June 28, 2023, Coinbase filed a 177-page answer to the SEC’s complaint, calling the suit an “extraordinary abuse of process” that “offends due process and the constitutional separation of powers.” ECF No. 22. at 2. On August 4, 2023, Coinbase filed its motion for judgment on the pleadings claiming both that in bringing the action the “SEC has violated due process, abused its discretion, and abandoned its own earlier interpretations of the securities laws” and that “[t]he subject matter falls outside the agency’s delegated authority” because none of the digital assets identified in the complaint qualify as securities under the Securities Act. ECF No. 36 at 1.

SEC v. Ripple Labs, Inc., 2023 WL 4507900 (S.D.N.Y. July 13, 2023): In 2020, the SEC sued Ripple in the Southern District of New York for the unregistered offer and sale of securities in violation of Section 5 of the Securities Act related to Ripple’s offer and sale of XRP, a crypto token. 2023 WL 4507900 at *1–4. In September 2022, the parties filed cross-motions for summary judgment. Id. at *4. On July 13, U.S. District Judge Analisa Torres ruled that the SEC could not establish as a matter of law that a crypto token was a security in and of itself. In a partial victory for Ripple, the court determined that Ripple’s XRP sales on public exchanges were not offers of securities. In a partial victory for the SEC, the ruling also found that sales to sophisticated investors did amount to unregistered sales of securities. On August 17, 2023, the court permitted the SEC to file a motion for leave to file an interlocutory appeal. ECF No. 891. Briefing on the motion is set to conclude on September 8, 2023. ECF No. 892.

SEC v. Terraform Labs Pte. Ltd., 2023 WL 4858299 (S.D.N.Y. July 31, 2023): The SEC brought an enforcement action in February of this year alleging that Terraform Labs and its founder, Do Hyeong Kwon, perpetrated a multi-billion 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. ECF No. 1. The complaint alleges violations of the anti-fraud provisions of the Securities Act and Exchange Act and the securities-offering-registration and security-based swap provisions of the federal securities laws. Id. at 4. On July 31, 2023, Judge Rakoff denied the defendants’ motion to dismiss, finding that the court had personal jurisdiction over the defendants and that the complaint plausibly alleged that “the defendants used false and materially misleading statements to entice U.S. investors to purchase and hold on to the defendants’ products;” the products being “unregistered investment-contract securities that enabled investors to profit from the supposed investment activities of the defendants and others.” 2023 WL 4858299 at 1–2. Notably, Judge Rakoff agreed with the Ripple ruling’s holding that the SEC could not establish as a matter of law that a crypto token was a security in and of itself. But Judge Rakoff rejected Judge Torres’s distinction between institutional and retail purchasers as to whether a token was offered as a security. Id. at *15. Instead, Judge Rakoff found that “secondary-market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf,” and thus held that “the SEC’s assertion that the crypto assets at issue here are securities . . . survives the defendants’ motion to dismiss.” Id.

VII. Shareholder Activism

Activists have continued targeting large U.S. companies in the first half of 2023, and recent changes to SEC regulations related to shareholder proposals and proxy elections could potentially encourage shareholder activists going forward.

A. Activist Campaigns Persist, with Companies Responding Swiftly

Four out of the six largest activist campaigns by volume in the first half of 2023 were resolved prior to formal proxy fights. The remaining contests have had different outcomes: one activist investor successfully replaced an incumbent director, and the final campaign has litigation in progress.

Salesforce, Inc.: In January 2023, Elliott Management announced a multibillion-dollar stake in Salesforce and nominated a slate of directors pushing for changes in corporate governance in light of Elliott Management’s view of the company’s performance. See Lauren Thomas and Laura Cooper, Elliott Management Takes Big Stake in Salesforce, Wall Street Journal (Jan. 23, 2023). The activists dropped the campaign in light of the company’s “announced ‘New Day’ multi-year profitable growth framework, strong fiscal year 2023 results, fiscal year 2024 transformation initiatives, Board and management actions and clear focus on value creation.” Salesforce and Elliott Issue Joint Statement, Salesforce (Mar. 27, 2023).

The Walt Disney Company: In January 2023, Trian Partners, led by activist investor Nelson Peltz, announced a $900 million position in Disney and released a detailed press release describing its intention to nominate Peltz to the Disney board of directors. Trian Nominates Nelson Pretz for Election to Disney Board, Trian Partners (Jan. 11, 2023). In the press release, Trian described examples of what it viewed as poor corporate governance, strategic decisions, and capital allocation decisions that had caused Disney to underperform its peers. A week after the launch of the proxy fight, Disney replaced its then-CEO, Bob Chapek, with former CEO Bob Iger, whom Trian said it would not oppose. Trian Applauds Recent Initiatives Announced by Disney as a Win for All Shareholders and Concludes Proxy Campaign, Trian Partners (Feb. 9, 2023). Trian abandoned Peltz’s board nomination after Disney announced corporate restructuring and cost-cutting plans. Id.

Fleetcor Technologies, Inc.: In March 2023, Fleetcor Technologies, Inc., a business payments company operating in the fuel, corporate payments, toll and lodging spaces, reached a cooperation agreement with its longstanding shareholder D. E. Shaw to add two new directors and form an ad hoc strategic review committee to explore possible divestiture. See Fleetcor Technologies, Inc., Cooperation Agreement (Mar. 15, 2023). Following the agreement, the ad hoc strategic review committee will assess alternatives for Fleetcor’s portfolio, including a possible separation of one or more of its businesses. See FLEETCOR Enters into Cooperation Agreement with the D. E. Shaw Group, FleetCor (Mar. 20, 2023).

Bath & Body Works, Inc.: In March 2023, Bath & Body Works avoided a proxy fight with the hedge fund Third Point, led by Third Point’s founder and CEO, Dan Loeb. At Third Point’s request, Bath & Body Works agreed to appoint Lucy Brady as a director and hire a technology services firm, and agreed with Third Point’s feedback that the Board would benefit from additional financial and capital allocation expertise. See Bath & Body Works Board of Directors Sends Letter to Shareholders Highlighting Transformative Value-Creating Actions and Responding to Third Point’s Potential Proxy Contest, Bath & Body Works (Feb. 27, 2023). Bath & Body Works also agreed to appoint Thomas J. Kuhn to the board in exchange for Third Point’s promise not to nominate other candidates at the 2023 annual shareholder meeting. See Bath & Body Works Announces Appointment of Thomas J. Kuhn to Board of Directors, Bath & Body Works (Mar. 6, 2023). Third Point ultimately opted to abandon its proxy contest.

Illumina, Inc.: In May 2023, gene sequencing company Illumina faced a proxy fight led by activist investor Carl Icahn. Icahn protested Illumina’s decision to acquire a cancer test developer company, Grail, Inc., without informing the shareholders of European and U.S. regulatory opposition. See Carl Icahn, Carl C. Icahn Issues Open Letter to Shareholders of Illumina, Inc. (Mar. 13, 2023). Icahn nominated three new director candidates to prevent the current board from further pursuing the deal. Id. The European Commission ultimately blocked the acquisition due to antitrust concerns last year, a result Illumina has now appealed. Annika Kim Constantino, Biotech Company Illumina Pushes Back against Carl Icahn’s Proxy Fight over $7.1 Billion Grail Deal, CNBC (Mar. 20, 2023). An unsuccessful appeal could result in a fine of up to 10% of Illumina’s annual revenues. Id. Illumina set aside $453 million in case of an EU fine. See Foo Yun Chee, Exclusive: Illumina to face EU fine of 10% of turnover over Grail deal-sources, Reuters (Jan. 11, 2023). The two-month proxy contest resulted in the board appointment of Andrew Teno, portfolio manager at Icahn Capital LP. See Illumina Announces Preliminary Results of Annual Meeting, Illumina (May 25, 2023).

Freshpet, Inc.: In May and June 2023, JANA Partners (the largest shareholder of Freshpet, Inc.) and James Panek (a putative stockholder of Freshpet) filed two separate actions against Fresphet, Inc. and its directors for allegedly interfering with Freshpet, Inc.’s shareholders’ right to nominate directors for the upcoming election, and thereby entrenching the incumbent directors. See Compl. ¶¶ 12, 19, 102, 120, JANA Partners LLC v. Norris, 2023 WL 3764931 (Del. Ch. June 1, 2023); and Compl. ¶¶ 4, 9, 32, 40, 44, Panek v. Cyr, 2023 WL 3738885 (Del. Ch. May 30, 2023). JANA Partners intended to nominate four candidates for election at Freshpet’s 2023 annual meeting. See Compl. ¶¶ 1, 81, JANA Partners LLC v. Norris, 2023 WL 3764931 (Del. Ch. June 1, 2023). Amid settlement discussions regarding board composition, Freshpet accelerated the 2023 annual meeting to an earlier date and reduced the number of directors up for election from four to three. Id. ¶ 1. JANA subsequently filed a lawsuit alleging a breach of the duty of loyalty, and seeking declaratory relief that (1) JANA has an opportunity to nominate, and the shareholders have an opportunity to elect, four directors at the 2023 annual meeting; and (2) the Freshpet directors breached their fiduciary duties. See id. at Prayer for Relief. Freshpet has postponed the 2023 annual meeting to October. Freshpet Provides Update on 2023 Annual Meeting of Stockholders, Freshpet (June 6, 2023). Gibson Dunn will continue to monitor developments on the two ongoing cases.

B. Two Regulatory Changes over SEC Proxy Rules Could Potentially Embolden Activist Investors

A new SEC rule and proposed amendments to Rule 14a-8 of the Securities Exchange Act of 1934 could potentially encourage activist campaigns to nominate new board members or submit shareholder proposals ahead of upcoming shareholder meetings. The SEC’s new “Universal Proxy” rule provides activist campaigns with potential support in efforts to elect new board members and bring provisions to a vote at corporate meetings. And proposed SEC amendments to Rule 14a-8, which could take effect in October 2023, would require companies to include with greater specificity why shareholder proposals should be excluded on implementation, duplication, or resubmission grounds.

The “Universal Proxy” rule that went into effect in January 2022 requires the issuer of a proxy card to list all candidates rather than the slate of candidates they support only. Universal Proxy, 86 Fed. Reg. 68330 (Dec. 1, 2021). The use of a “universal proxy card” is required in all non-exempt solicitations involving director election contests. Id. With universal proxies, shareholders can more easily vote for nominees from a combination of two slates, potentially increasing the chance for activist investors to have at least one of their dissident nominees elected. SEC Adopts Rules Mandating Use of Universal Proxy Card, Gibson Dunn (Nov. 18, 2021).

Among other things, incumbent boards have responded to the Universal Proxy rule by implementing advance notice bylaw provisions that include additional disclosure requirements. For example, medical device maker Masimo enacted and subsequently withdrew a bylaw amendment in 2022 that required “any person (including any hedge fund) seeking to nominate a candidate for election to the board to disclose,” among other things, “the identity of . . . any limited partner or other investor who owned 5% or more of the hedge fund, as well as all investors in any sidecar vehicle.” John C. Coffee, Jr., Proxy Tactics Are Changing: Can Advance Notice Bylaws Do What Poison Pills Cannot?, The CLS Blue Sky Blog (Oct. 19, 2022); see Masimo Corp., Current Report (Form 8-K) (Feb. 5, 2023). The case law in this area is still developing. See Coffee, supra; see also Jorgl v. AIM ImmunoTech Inc., 2022 WL 16543834 at *11 (Del. Ch. Oct. 28, 2022); Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *12 (Del. Ch. Oct. 13, 2021).

The SEC is poised to finalize its proposed amendments to SEC Rule 14a-8 in October 2023. Substantial Implementation, Duplication, and Resubmission of Shareholder Proposals Under Exchange Act Rule 14a-8, Release No. 34-95267, SEC (July 13, 2022); Office of Information and Regulatory Affairs, Agency Rule List – Spring 2023, RIN: 3235-AM91 . The new amendments, if enacted, would heighten the bar for a company to exclude shareholder proposals on substantial implementation, duplication, and resubmission grounds. Id. The amendments could potentially build on the recent rise in shareholder proposals reaching a shareholder vote. From 2021 to 2023, there was an 18% increase in shareholder proposals and a 40% increase on proposals that were voted on. Mark T. Uyeda, Commissioner, SEC, Remarks at the Society for Corporate Governance 2023 National Conference (June 21, 2023).

VIII. Lorenzo Disseminator Liability

As discussed in our 2019 Mid-Year Securities Litigation Update, in Lorenzo v. Securities and Exchange Commission, the Supreme Court expanded scheme liability to encompass “those who do not ‘make’ statements” but nevertheless “disseminate false or misleading statements to potential investors with the intent to defraud.” 139 S. Ct. 1094, 1099 (2019). In the wake of Lorenzo, secondary actors—such as financial advisors and lawyers—face potential scheme liability under SEC Rules 10b-5(a) and 10b-5(c) for disseminating the alleged misstatement of another if a plaintiff can show that the secondary actor knew the alleged misstatement contained false or misleading information.

In 2022, the Second Circuit, interpreting Lorenzo, held in Securities and Exchange Commission v. Rio Tinto plc, that the defendants must do “something extra” beyond making material misstatements or omissions to be subject to scheme liability under SEC Rule 10b-5(a) and (c). 41 F.4th 47, 54 (2d Cir. 2022); see Client Alert (Gibson Dunn represents Rio Tinto in this litigation.) Although the Supreme Court and other circuit courts have not directly addressed the requirements for scheme liability after Lorenzo, several recent district court decisions have added to the debate. Specifically, one California district court has explicitly refused to apply Rio Tinto’s “something extra” requirement, another California district court has adopted a less onerous standard for plaintiffs than the Rio Tinto court, and one district court in Massachusetts engaged in an analysis similar to the Rio Tinto decision without specifically adopting the Second Circuit’s analysis.

In Securities and Exchange Commission v. Earle, a California district court declined to adopt Rio Tinto and noted that the Ninth Circuit “has not adopted” the “something extra” requirement, while denying an individual defendant’s motion to dismiss the SEC’s scheme liability claims. 2023 WL 2899529, at *7 (S.D. Cal. Apr. 11, 2023). In Earle, the defendant, citing Rio Tinto, moved to dismiss the SEC’s 10b-5(a) and (c) claims on the grounds that the SEC had not alleged “something extra” beyond a “recitation of allegations of a violation of Rule 10b-5(b).” Id. The court disagreed with the defendant. The court reasoned that the Supreme Court in Lorenzo had “recognized the ‘considerable overlap’ between the subsections of Rule 10b-5,” and that the Ninth Circuit made “clear that the argument that Rule 10b-5(a) and (c) claims cannot overlap with Rule 10b-5(b) statement liability claims is foreclosed by Lorenzo.” Id. (citation and quotation marks omitted). The court also found that the SEC alleged that the defendant disseminated misstatements, which the Supreme Court in Lorenzo held was enough to establish scheme liability. Id.

In another recent order rejecting defendants’ motion to dismiss 10b-5(a) and (c) claims, a different district court in California also emphasized the “‘considerable overlap’ between the subsections of Rule 10b-5.” In re Vaxart, Inc. Sec. Litig., 2023 WL 3637093, at *3 (N.D. Cal. May 25, 2023). The court stated that, although Lorenzo established that the dissemination of material misstatements can serve as the basis of 10b-5 scheme liability, “Rule 10b-5(a) and (c) prohibit more than just the dissemination of misleading statements; the language of these provisions is ‘expansive.’” Id. (quoting Lorenzo, 139 S. Ct. at 1102). Although the court did not mention Rio Tinto in its order, the court found that the defendants had allegedly committed many acts beyond misstatements and omissions—acts that were potentially sufficient to establish a claim for scheme liability even under a “something extra” requirement. Id.

In Securities and Exchange Commission v. Wilcox, the district court denied an individual defendant’s motion to dismiss, concluding that “the allegation that [the defendant] provided false support to an external audit firm constitute[d] a deceptive act that, even if related to the making of a false statement by another, may establish her liability under . . . Rule 10b-5(a) and (c).” 2023 WL 2617348, at *9 (D. Mass. Mar. 23, 2023). The defendant, citing Rio Tinto, had moved to dismiss the SEC’s Rule 10b-5(a) and (c) claims, arguing that the SEC alleged only that she prepared and provided support for misstatements. Id. at *8. The defendant claimed that these actions could not operate as the basis for scheme liability because they were not distinct, or “something extra,” from the misstatements themselves. Id. The court disagreed. Although the court did not explicitly address the Rio Tinto “something extra” requirement, it mirrored Rio Tinto’s analysis in denying the motion to dismiss by holding that the alleged corruption of an auditing process, in conjunction with alleged misstatements, “may form the basis for scheme liability.” Id.

These cases indicate that the landscape of Rule 10b-5 scheme liability remains dynamic in the wake of Lorenzo, with many circuits yet to address the issue.

IX. Market Efficiency and “Price Impact” Cases

As we explained in our recent Client Alert, the Second Circuit recently decertified a class of investors in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., No. 22-484, — F.4th —, 2023 WL 5112157 (2d Cir. 2023), in the highly awaited decision following the fourth time this long-running class certification dispute has reached that court.

Two years ago, the Supreme Court considered questions regarding price-impact analysis for the first time since its 2014 decision preserving the “fraud-on-the-market” theory which enables a presumption of classwide reliance in Rule 10b-5 cases, but also permits defendants to rebut that presumption with evidence that the challenged statements did not impact the issuer’s stock price. In that 2021 decision, which we detailed in our 2021 Mid-Year Securities Litigation Update, the Supreme Court confirmed that the generic nature of statements should be a part of the pre-certification price impact analysis, even though the same evidence may also be relevant to the merits question of materiality. Goldman Sachs Grp., Inc. v. Ark. Tchr. Ret. Sys., 141 S. Ct. 1951, 1960–61 (2021). The Supreme Court also observed that where the plaintiffs’ price impact theory is based on “inflation maintenance”—i.e., the alleged misstatement did not cause the stock price to increase but instead merely prevented it from dropping—any mismatch between generic challenged statements and specific alleged corrective disclosures will be a key consideration. Id. at 1961. After the Supreme Court’s decision, the Second Circuit remanded the case to the district court, which certified the proposed class again. With this latest decision, the Second Circuit reversed the class certification order and remanded with instructions to decertify the class.

The plaintiffs in this long-running dispute alleged that the defendants’ general statements about Goldman’s business principles and conflict-of-interest management procedures were false and misleading, which artificially maintained Goldman’s stock price, and that the “truth” was “revealed” through announcements about regulatory enforcement actions and investigations into certain transactions. At class certification, the plaintiffs relied on the Basic presumption of reliance, arguing that because Goldman’s stock trades in an efficient market, anyone purchasing the stock implicitly relied on all public, material information incorporated into the current price, including defendants’ alleged misstatements. The defendants argued that the statements about Goldman Sachs’s business principles and conflict-of-interest management procedures—which included statements such as “[i]ntegrity and honesty are at the heart of our business” and “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest”—were so generic that they could not have affected Goldman’s stock price.

In this most recent decision, the Second Circuit decertified the class, holding that there was “an insufficient link between the corrective disclosures and the alleged misrepresentations” and that “Defendants have demonstrated, by a preponderance of the evidence, that the misrepresentations did not impact Goldman Sachs’ stock price, and, by doing so, rebutted Basic’s presumption of reliance.” Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., 2023 WL 5112157, at *24. The Second Circuit concluded that when plaintiffs rely on inflation maintenance theory, they cannot just “identify a specific back-end, price-dropping event,” “find a front-end disclosure bearing on the same subject,” and then “assert securities fraud, unless the front-end disclosure is sufficiently detailed in the first place.” Id. at *21. The specificity of the statement and alleged correction must “stand on equal footing.” Id.

The Second Circuit is not the only court to apply the Supreme Court’s guidance from Goldman and find a mismatch between generic alleged misrepresentations and specific corrective disclosures sufficient to defeat the presumption of reliance. In In re Qualcomm Inc. Securities Litigation, 2023 WL 2583306 (S.D. Cal. Mar 20, 2023), the plaintiffs alleged that Qualcomm, a company that sells computer chips and licenses its patents to device manufacturers, made misrepresentations about its licensing and bundling practices. Id. at *1–2. In denying class certification regarding the licensing-related statements, the court credited Qualcomm’s argument that statements describing its licensing practices as “broad,” “fair,” and “nondiscriminatory” were too generic to be “corrected” by disclosures confirming Qualcomm licensed only at the device level. Id. at *11–12. The court explained “the generic nature of the alleged misrepresentations makes it less likely that those misrepresentations deceived the market in the way Plaintiffs theorize, and therefore, less likely that they caused ‘front-end price inflation.’” Id. The court was also persuaded by Qualcomm’s argument that the alleged corrective disclosure amounted to information that was already publicly available and known in the market. Id. at *12–13. Taken together, the court concluded that Qualcomm successfully rebutted the Basic presumption of reliance and established a lack of price impact by a preponderance of the evidence. Id. The court, however, certified the class as to the bundling-related statements. Id. at *14.

These two cases suggest that courts are following the Supreme Court’s approach in Goldman and conducting holistic analyses taking into account all evidence presented and applying “common sense” about the generic nature of statements when assessing whether defendants have rebutted the Basic presumption of reliance. We will continue to monitor this developing line of caselaw.

The following Gibson Dunn attorneys assisted in preparing this client update: Monica K. Loseman, Brian M. Lutz, Craig Varnen, Jefferson E. Bell, Christopher D. Belelieu, Michael D. Celio, Johnathan D. Fortney, Mary Beth Maloney, Jessica Valenzuela, Allison Kostecka, Lissa Percopo, H. Chase Weidner, Luke A. Dougherty, Trevor Gopnik, Tim Kolesk, Mark H. Mixon, Jr., Megan R. Murphy, Kevin Reilly, Marc Aaron Takagaki, Dillon M. Westfall, Kevin J. White, Eitan Arom, Angela A. Coco, Dasha Dubinsky, Graham Ellis, Mason Gauch, Nathalie Gunasekera, Amir Heidari, Tin Le, Lydia Lulkin, Michelle Lou, and Nicholas Whetstone.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the developments in the Delaware Court of Chancery. 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:

Securities Litigation 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/New York (+1 415-393-8379/+1 212-351-3881, [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])
Jessica Valenzuela – Palo Alto (+1 650-849-5282, [email protected])
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, [email protected])
Mark H. Mixon, Jr. – New York (+1 212-351-2394, [email protected])

On June 29th, 2023, the Department of the Interior (“DOI”), acting through the Bureau of Ocean Energy Management (“BOEM”), published a proposed rule that would modify the criteria it uses to determine financial assurance and bond requirements for the offshore oil and gas industry in the Outer Continental Shelf (“OCS”).[1] This proposed rule modifies and does away with a proposed joint rulemaking with the Bureau of Safety and Environmental Enforcement (“BSEE”) from October 16, 2020 which also sought to update BOEM’s financial assurance criteria, along with other BSEE-administered regulations (further described in Section II below). This latest iteration is intended by BOEM to be more protective of taxpayers by ensuring that OCS lessees have sufficient resources to meet their lease and regulatory obligations.

The publication of the proposed rule triggered a 60-day comment period during which BOEM sought comments from the public and offshore oil and gas industry (further described in Section IV below). The comment period closed on September 7, 2023, and BOEM will now review and analyze all comments that were submitted during the comment period and may choose to modify the proposed rule, issue a final rule to be effective no sooner than 30 days after publication in the Federal Register, withdraw the proposal, or re-open the comment period. This alert will discuss (a) the history and current state of BOEM’s financial assurance regulations and the proposed changes thereto, (b) potential industry impacts as a result of the proposed changes, and (c) a general overview of the significant comments received by BOEM during the comment period.

History of Financial Assurance Rules and Proposed Changes

BOEM’s current regulations contemplate two forms of financial assurance to ensure that a grant holder or lessee can fulfill its regulatory and contractual obligations, including decommissioning liabilities: (a) base bonds in amounts prescribed by the regulations and (b) supplemental financial assurance, determined on the basis of a five-factor test. The posting of base bonds and any additional financial assurance is intended to cover the costs of clean-up and the decommissioning of offshore wells and infrastructure once they are no longer in use and to ensure that the federal government does not have to perform such activities, with taxpayers footing the bill.[2]

BOEM requires all lessees of an OCS oil and gas or sulfur lease to post base bonds at the time of (a) issuance of a new lease or (b) assignment of an existing lease. Base bonds can range from $50,000 for a lease-specific bond with no approved operational activity up to $3,000,000 for an area-wide bond that includes a development production plan.[3]

BOEM’s Regional Director may determine that additional security above the base bond is necessary. This additional security is often referred to as supplemental financial assurance and is determined based on the Regional Director’s evaluation of a lessee or grant holder’s ability to carry out present and future financial obligations demonstrated by a five-factor test. The five factors that the Regional Director will consider are (a) financial capacity, (b) projected financial strength (initial proposals that were done away with would have considered net worth in determining financial strength), (c) business stability, (d) record of compliance with current regulations, laws, and lease terms, and (e) reliability in meeting credit rating obligations. The Regional Director will determine the amount of supplemental financial assurance required to guarantee compliance, considering potential underpayment of royalty and cumulative decommissioning obligations.[4]

In October of 2020, BOEM and BSEE issued a joint-proposed rule with the intention of revising BOEM’s financial assurance regulations and BSEE’s decommissioning orders. This joint-proposed rule would have modified BOEM’s financial assurance requirements such that BOEM would consider a lessee’s credit rating from certain recognized rating agencies and proved reserves to determine whether supplemental financial assurance would be required. BOEM proposed an S&P Global Ratings (“S&P”) credit rating threshold of BB or a Ba3 from Moody’s Investor Service (“Moody’s”). Under the proposed framework, BOEM would waive supplemental financial assurance requirements of lessees in the event their predecessors had strong credit ratings. Ultimately, however, in response to comments received by BOEM and BSEE, they decided not to proceed with the joint-proposed rule.[5]

BOEM’s 2023 iteration of the proposed rule would update its criteria for determining whether oil, gas, and sulfur lessees, Rights-of-Use Easement grant holders, and Right-of-Way grant holders may be required to provide supplemental financial assurance. The change is intended to better protect taxpayers from bearing the cost of facility decommissioning and financial risks associated with OCS development, such as oil spill cleanup and other environmental remediation by switching to a metric more predictive of financial stress and bankruptcy (as discussed below), thus allowing BOEM to ensure vulnerable lessees and grant holders are providing adequate security for their decommissioning obligations and protecting the federal government, and, in-turn, the taxpayer from having to absorb said obligations in the event of default. In its latest form, the proposed rule does away with the five-factor test and, similar to the 2020 proposal, instead considers an OCS lessee’s (a) credit rating and (b) proved oil reserves in determining whether a grant holder or lessee in the OCS is required to obtain supplemental financial assurance.

Based on its credit rating and the valuation of its proved oil reserves, an OCS lessee would not be required by BOEM to provide supplemental financial assurance in any of the following cases: (a) if the lessee has an investment grade credit rating (greater than or equal to either BBB- from S&P or Baa3 from Moody’s),[6] (b) if there are multiple co-lessees on a lease, if any one lessee meets the credit rating threshold, or (c) for leases where all lessees are below investment grade, if the value of the lease’s proved oil and gas reserves is three times the decommissioning cost estimate for such lease. The shift from relying primarily on the net worth of a lessee to its credit rating to determine whether supplemental financial assurance is needed is based on studies that suggest a strong correlation between credit rating and the probability of default due to credit ratings being based on cash flow, debt-to-earnings ratios, debt-to-funds ratios, and past performance, amongst other financial metrics.[7] The ability of an entity’s credit rating to predict financial distress and, in turn, an inability to absorb future decommissioning liabilities better than its net worth will allow BOEM to ensure those lessees and grant holders that are most vulnerable to defaulting will have provided sufficient security to cover their liabilities in the form of supplemental financial assurance.

Further, under the proposed rules, BOEM will no longer set a lower supplemental financial assurance requirement for lessees with financially strong predecessor lessees, as was proposed by BOEM and BSEE in their 2020 joint-proposed rule. While BOEM will retain the authority to pursue predecessor lessees for the performance of decommissioning, the proposed rule would not allow BOEM to rely upon the financial strength of predecessor lessees when determining whether, or how much, supplemental financial assurance should be provided by current OCS leaseholders, thus ensuring that current lessees have the financial capability to fulfill decommissioning obligations and discouraging lessees from ignoring end-of-life decommissioning costs, further reducing the likelihood that such obligations would fall upon the federal government and taxpayers in the event of default.

In order to value the proved oil and gas reserves, the proposed rules require lessees to submit a reserve report that complies with the SEC’s accounting and reporting standards valuing the oil and gas reserves located on a given lease. Leases for which the value of the reserves exceeds three times the cost of the associated decommissioning estimate (using BSEE’s P70 decommissioning level, which provides a 70% likelihood of covering the full cost of decommissioning) would not be required to obtain supplemental financial assurance. Under the proposal, the P70 value would be used to set the amount of any required supplemental financial assurance.

In order to ease the significant financial burden on impacted lessees and grant holders, BOEM proposes to phase in its new bonding requirements over a three-year period, whereby a lessee receiving a supplemental financial assurance demand will be required to post 33% of the total financial assurance amount by the deadline listed in the demand and a second 33% of the total financial assurance amount by the end of the second year after receipt of the demand letter, with the final 33% of the total assurance amount due within 36 months after receipt of the demand letter. If a lessee’s credit rating improves to investment grade during the three-year period, BOEM will no longer collect the remaining financial assurance and will return any supplemental financial assurance previously provided.

Industry Impacts

BOEM’s proposed rule changes will be at the front of OCS lessees’ minds for the next few years. Investment grade companies will have new opportunities because they will be more attractive as lease partners. Meanwhile, sub-investment grade companies, particularly “small businesses” (which have less than 1,250 to 1,500 employees),[8] will have to figure out how to navigate the costs and challenges of complying with these new changes.

The most obvious impact will be the new premiums for the supplemental financial assurance that lessees will have to acquire in order to comply with the rule, which is expected to cost sub-investment grade companies an additional $319 million per year (assuming 7% discounting).[9] The costs of these new premiums will fall disproportionately on the 76% of OCS lessees that are small businesses which, without the support from an investment grade co-lessee, may have difficulty satisfying either prong of the revised financial assurance rule. The average investment grade company has a net worth of approximately $115 billion,[10] which is a hurdle that most small businesses are unlikely to meet. Small businesses also tend to focus on late-stage wind down of assets to extract value from marginal wells and will have a harder time meeting the 3x ratio of reserve value to decommissioning liability than larger entities that are drilling new reserves.[11] Relying on the ratio of reserve value to decommissioning liability likely may not be a long-term solution because (a) the lessee would be actively producing the asset (and lowering the ratio) and (b) in the event of a downturn in oil prices, the reserve value could get marked down and the lessee would be forced to secure a bond in a time of relative economic distress.

For some small businesses, these rules may change the calculus on whether to seek an investment grade partner for any current or future offshore projects. The current method of determining whether a lessee needed to provide additional financial security relied on a mix of objective and non-objective measures (see the five-factor test described in Section II above) that afforded small businesses the opportunity to avoid the need to post additional bonds by showing a history of sound operatorship and regulatory compliance without looking exclusively to hard financial metrics or a rating from a credit agency. The proposed rule may eliminate this opportunity. Seeking an investment grade partner may be a more attractive alternative than paying for additional bonding, securing an adequate credit rating, or relying on the ratio of reserves to decommissioning liabilities.

BOEM assesses that, based on P70 levels, there is approximately $42.8 billion of offshore decommissioning liability, $20.2 billion of which is held by sub-investment grade companies.[12] The revised bonding requirements would result in a $9.2 billion increase in the amount of bonds to cover that liability (on top of the approximately $3.0 billion that is currently in place).[13] BOEM cited the need to protect taxpayers from potential decommissioning liability as a justification for revising the rule and pointed to the more than 30 lessee bankruptcies since 2009, which resulted in $7.5 billion of un-bonded decommissioning liabilities. The ultimate risk to the taxpayer was not near that figure (BSEE requested a mere $30 million in its FY2023 budget to address unbonded liabilities).[14] In the vast majority of cases, the decommissioning costs were covered by either co-lessees or predecessors or acquired by entities who purchased the related assets out of bankruptcy. Ultimately, the biggest winner of these changes may be predecessors to the leases who sought a “clean exit” and may now have greater barriers between outstanding decommissioning liabilities and their balance sheets.

Significant Comments/Overview of Comments

During the comment period, BOEM sought comments on, amongst other things, (a) the wisdom in setting the supplemental financial assurance requirements based on each of the P50, P70, and P90 decommissioning liability levels, (b) the appropriateness of relying on S&P’s Credit Analytics credit model, or other similar, widely accepted credit rating models to generate proxy credit ratings and the appropriateness of relying on lessee and grant holder credit ratings, including whether BOEM has proposed an appropriate credit rating threshold of BBB-, and if not, what threshold would best protect taxpayer interests while balancing burdens on the industry, (c) whether financial assurance should be required of all companies, regardless of credit rating, and the impacts such a requirement might have on OCS investment and on potential taxpayer liabilities, (d) whether the elimination of the current five-factor test would create a disincentive to comply with regulations, (e) whether the use of a minimum number of years of production remaining is an appropriate criteria to qualify for an exemption from supplemental financial assurance as an alternative to the 3:1 ratio of value of reserves to decommissioning costs, and (f) the costs and benefits of considering the financial capacity of predecessor lessees or grantees in determining the level of supplemental financial assurance required.

BOEM received close to 1,200 comments during the public comment period which closed on September 7 after the initial August 28 deadline was extended. The comments received were generally opposed to the proposed rule, questioning the validity of BOEM’s claims and highlighting the lack of supporting evidence provided by BOEM. The submitted public comments generally claimed that BOEM (a) did not adequately account for adverse economic consequences, (b) conducted an inadequate cost-benefit analysis, and (c) overstated the current impact to taxpayers, and the claimed benefits to the taxpayer, of the proposed rule. The public comments further claimed that the proposed rule will disproportionately burden smaller businesses, and will “create more emissions harm than benefit by making it more expensive to explore in the Gulf of Mexico, resulting in more demand for higher carbon intensity oil from global sources.”[15]

One comment of note cited a study which independently calculated OCS plugging and abandonment liability, assessed the risk it presents to the U.S. taxpayer, and performed a cost-benefit analysis of the proposed rule’s economic impact on the offshore oil and gas industry, the Gulf Coast, and the United States. According to the study, additional bonding requirements will spur bankruptcies as surety markets have threatened to exit the offshore sector, reducing available bonding capacity and driving up costs, which will in turn guarantee that small independent lessees will not be able to obtain the required supplemental bonding. Further, the study claims that additional bonding will reduce offshore drilling and related production to the tune of approximately 55 million barrels of oil equivalent over a 10-year period, reducing associated U.S. royalty revenues by approximately $573 million over the 10-year period. Moreover, according to the study, additional bonding requirements will cause reduced revenues and operations for companies serving the OCS, resulting in a loss of jobs and tax revenues along the Gulf Coast, with the study estimating the impact of the additional bonding requirements on the U.S. Gross Domestic Product to be a reduction of approximately $9.9 billion over a 10-year period.[16]

Conclusion

BOEM’s proposed rule is intended to safeguard U.S. taxpayers by strengthening bonding and financial assurance requirements for the offshore oil and gas industry in the OCS; however, as seen in the volume and content of public comments BOEM has received, those in the industry are skeptical and fear that it may do more harm than good. How BOEM proceeds from here bears close scrutiny.

___________________________

[1] Risk Management and Financial Assurance for OCS Lease and Grant Obligations, 88 Fed. Reg. 42136-42176 (June 29, 2023).

[2] Id.

[3] 30 CFR 556.900.

[4] 30 CFR 556.901.

[5] BSEE instead issued a stand-alone final rule (88 Fed. Reg. 23569) effective as of May 18, 2023, which (a) included Rights-of-Use and Easements (“RUEs”) and RUE grant holders in the agency’s decommissioning regulations for the first time, and (b) formalized BSEE’s procedures for enforcement of decommissioning orders issued to predecessors when a subsequent assignee defaults on its obligations. RUE grants are authorizations from BOEM to use a portion of the seabed not encompassed by the holder’s lease to construct, modify, or maintain platforms, artificial islands, facilities, installations, and other devices that support exploration, development, or production from another lease. Pursuant to the BSEE rule, RUE holders and prior lessees or owners of operating rights are jointly and severally liable for meeting accrued decommissioning obligations for infrastructure installed subject to a lease and maintained after lease expiration under a RUE. Further, when BSEE issues a decommissioning order to predecessors, it requires them to monitor, maintain, and decommission all wells, pipelines, and facilities by (a) initiating maintenance and monitoring within 30 days of receipt, (b) designating an operator or agent for decommissioning activities within 90 days, and (c) submitting a decommissioning plan to BSEE within 150 days. BSEE did not promulgate previous proposals (x) requiring parties appealing decommissioning orders to file an appeal bond or (y) requiring the proceeding up the chain of title in “reverse chronological order” against predecessor lessees, grant holders, and owners of operating rights when subsequent assignees fail to perform.

[6] For entities not rated by a major credit rating agency, BOEM proposes using an “equivalent proxy credit rating.” Such entities would be required to submit audited financial statements, which BOEM would use to determine its equivalent proxy credit rating using a commercially available credit model. (88 Fed. Reg. 42143).

[7] 88 Fed. Reg. 42136-42176 (June 29, 2023).

[8] See Id. (BOEM is required to analyze the impact of its regulations on “small” entities pursuant to the Regulatory Flexibility Act, 5 U.S.C. 601–12. The Small Business Administration (SBA) defines a small entity as one that is “independently owned and operated and which is not dominant in its field of operation.” What constitutes a “small business” varies by industry, but in the context of offshore hydrocarbon development, the SBA defines a small business as one with fewer than (i) 1,250 employees for upstream companies and (ii) 1,500 employees for midstream companies.)

[9] Id.

[10] Id.

[11] See Id.

[12] Id.

[13] Id.; BOEM Collateral List Report.

[14] Id.

[15] For comments, please see: https://www.regulations.gov/document/BOEM-2023-0027-0001/comment.

[16] https://opportune.com/insights/news/a-cost-benefit-analysis-of-increased-ocs-bonding-july-2023.

The following Gibson Dunn attorneys assisted in preparing this client update: Michael P. Darden, Rahul D. Vashi, Graham Valenta, Zain Hassan, and Luke Strother.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Oil and Gas practice group, or the following authors:

Oil and Gas Group:
Michael P. Darden – Co-Chair, Houston (+1 346-718-6789, [email protected])
Rahul D. Vashi – Co-Chair, Houston (+1 346-718-6659, [email protected])

On September 11, 2023, the Chief Judge of the U.S. District Court for the Eastern District of Washington issued a strongly worded order confirming his August 11, 2023 dismissal of a stockholder derivative suit, National Center for Public Policy Research v. Schultz et al., No. 2:22-cv-00267. The suit, brought by a conservative think tank as a derivative claim purportedly on behalf of Starbucks Corporation against certain of its officers and directors, sought declaratory judgment and injunctive relief on the grounds that some of Starbucks’ diversity initiatives allegedly violated Section 1981 of the 1866 Civil Rights Act, Title VII of the Civil Rights Act of 1964, and state anti-discrimination laws, and further alleged that the policies constituted a breach of directors’ fiduciary duties.

A. Allegations

In its August 30, 2022 complaint (which was removed to federal court on November 7), the National Center for Public Policy Research (“NCPPR”) took aim at certain of Starbucks’ diversity, equity, and inclusion (“DEI”) policies, including (1) Starbucks’ goal to “achiev[e] BIPOC representation of at least 30% at all corporate levels and at least 40% [of] all retail and manufacturing roles by 2025” and various initiatives aimed at achieving that goal (Compl. ¶ 51); (2) its commitment to increase its spending with diverse suppliers from $800 million “to $1.5 billion by 2030” (id. ¶ 53); (3) its goal of allocating 15% of Starbucks’ 2022 advertising budget to minority-owned and targeted media companies (id.); and (4) its internal “Leadership Accelerator Program,” which would initially only be open to certain racially and ethnically diverse employees, and which aimed to improve those employees’ “capacity for self-promotion, advocacy and career navigation” and help them access “the leadership pipeline at Starbucks” (id).

According to NCPPR, these policies “facially violate § 1981” because they “expressly require the ‘but-for’ exclusion of individuals and businesses from contracts because of their race” (Compl. ¶ 88), and “facially violate Title VII” because they purport to make hiring, firing, compensation, and promotional decisions on the basis of race. See id. ¶ 98. The plaintiff also argued that the policies “expose Starbucks to potential litigation” and other liabilities (id. ¶ 110), and that implementing the policies breached Starbucks directors’ fiduciary duties, as they “knew or should have known that the [p]olicies were illegal.” Id. ¶ 127.

B. Opinion

Chief Judge Stanley A. Bastian granted Starbucks’ and the individual defendants’ motion to dismiss on August 11, 2023. Chief Judge Bastian indicated in an oral decision that a stockholder derivative suit was an improper forum for making political statements, and observed, “If the plaintiff doesn’t want to be invested in ‘woke’ corporate America, perhaps it should seek other investment opportunities rather than wasting this court’s time.” He also stated that “[t]he plaintiffs have ignored the fundamental rules of corporate law, including the business judgment rule. Courts of law have no business involving themselves with legitimate and legal decisions made by the board of directors of public corporations.”

The written order, issued on September 11, echoed these sentiments, noting that “Plaintiff is apparently unhappy with its investment decisions in so-called ‘woke’ corporations. This Court is uncertain what that term means but Plaintiff uses it repeatedly as somehow negative.” Order at 8. The court disapproved of the political nature of the complaint, stating, “This Complaint has no business being before this Court and resembles nothing more than a political platform,” and “[w]hether DEI and ESG initiatives are good for addressing long simmering inequalities in American society is up for the political branches to decide. If Plaintiff remains so concerned with Starbucks’ DEI and ESG initiatives and programs, the American version of capitalism allows them to freely reallocate their capital elsewhere.” Id. Notably, the court considered the context of NCPPR’s overall mission, explaining that “Plaintiff has a clear goal of dismantling what it sees as destructive DEI and ESG initiatives in corporate America. Contempt for DEI and ESG programming and practices is clear in Plaintiff’s publications and literature.” Id. at 7. The court concluded that, “[b]ased on the briefing and nature of Plaintiff’s self-described political interests, it is clear to the Court that Plaintiff did not file this action to enforce the interests of Starbucks, but to advance its own political and public policy agendas.” Id.

In its opinion, the court found it “unnecessary” to address the adequacy of the plaintiff’s factual and legal allegations under a Fed. R. Civ. P. 12(b)(6) standard (id. at 8), and instead analyzed “whether a derivative plaintiff fairly and adequately represents the interests of a corporation or its shareholders.” Id. at 5. The court explained that “[i]n Washington corporate law [where Starbucks is incorporated], a corporation’s board of directors have exclusive authority to make decisions concerning the management of the corporation’s business” and that “[s]hareholder derivative lawsuits are disfavored and may be brought only in exceptional circumstances.” Id. at 6 (citations and quotations omitted). Thus, the court declined to allow NCPPR to litigate these claims on behalf of Starbucks and its stockholders, adding, “It is clear Plaintiff is pursuing its personal interests rather than those of Starbucks.” Id. The court further determined that, far from representing the interests of most Starbucks stockholders, the plaintiff “has shown obvious vindictiveness toward Starbucks,” aimed to “cause significant harm to Starbucks and other investors,” and “lacks the support of the vast majority of Starbucks shareholders.” Id. at 6-7.

C. Implications

The Starbucks suit predated the Supreme Court’s decision in Students for Fair Admissions v. President & Fellows of Harvard Coll., No. 20-1199 (U.S. Jun. 29, 2023) (“SFFA”), which struck down the use of affirmative action in college and university admissions. Nevertheless, this case has been closely watched by companies that have been affected by increasing scrutiny of corporate DEI post-SFFA. The SFFA decision incited a flurry of reverse-discrimination litigation and other challenges to corporate DEI policies, as well as a warning from a group of 13 Republican attorneys general to Fortune 100 companies, threatening “serious legal consequences” over certain DEI policies.

The opinion in NCPPR suggests that, despite increasing scrutiny of DEI policies, there will be substantial defenses to shareholder derivative litigation in this area, as courts tend to disfavor judicial meddling “with reasonable and legal decisions made by the board of directors of public corporations.” Order, at 6. Indeed, two other recent high profile shareholder cases challenging corporate diversity initiatives or alleging failure to abide by those initiatives—including in Delaware, where many companies are incorporated—have not survived beyond the motion to dismiss stage.[1]

___________________________

[1] See Simeone v. Walt Disney Co., 2023 WL 4208481, at *1 (Del. Ch. Jun. 27, 2023) (in lawsuit where plaintiff requested records to determine whether Disney breached its fiduciary duties by failing to withdraw its public opposition to Florida’s so-called “Don’t Say Gay” bill, declining to grant books and records request on the grounds that Disney’s “business decision” “cannot provide a credible basis to suspect potential mismanagement irrespective of its outcome”); Lee v. Fisher et al., 70 F.4th 1129 (9th Cir. 2023) (dismissing on procedural grounds a lawsuit alleging that Gap Inc. and its directors breached fiduciary duties by ignoring public promises to increase management-level diversity).

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Jessica Brown, Brian Lutz, Elizabeth Ising, Ronald Mueller, Lori Zyskowski, and Anna Ziv.

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

Jessica Brown – Partner, Labor & Employment Group, Denver (+1 303-298-5944, [email protected])

Elizabeth A. Ising – Partner & Co-Chair, Securities Regulation & Corporate Governance Group, Washington, D.C. (+1 202-955-8287, [email protected])

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

Brian Lutz – Partner & Co-Chair, Securities Litigation Group, San Francisco (+1 415-393-8379, [email protected])

Jason J. Mendro – Partner, Securities Litigation Group, Washington, D.C. (+1 202-887-3726, [email protected])

Ronald O. Mueller – Partner, Securities Regulation & Corporate Governance Group, Washington, D.C. (+1 202-955-8671, [email protected])

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

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

Jessica Valenzuela – Partner, Securities Litigation Group, Palo Alto (+1 650-849-5282, [email protected])

Craig Varnen – Partner & Co-Chair, Securities Litigation Group, Los Angeles (+1 213-229-7922, [email protected])

Lori Zyskowski – Partner & Co-Chair, Securities Regulation & Corporate Governance Group, New York (+1 212-351-2309, [email protected])

For the seventh successive Congress, Gibson Dunn is pleased to release a table of authorities summarizing the oversight and investigative (“O&I”) authorities of each House and Senate committee. Congressional investigations can arise with little warning and immediately attract the media spotlight. Understanding the full extent of a committee’s investigative arsenal is crucial to successfully navigating a congressional investigation.

Congressional committees have broad investigatory powers, including the power to issue subpoenas to compel witnesses to produce documents, testify at committee hearings, and, in some cases, appear for depositions. Committees may adopt their own procedural rules for issuing subpoenas, taking testimony, and conducting depositions, and many committees update their rules each Congress. Committees are also subject to the rules of the full House or Senate, and, in the House, the Chair of the Committee on Rules issues regulations prescribing general deposition procedures applicable to all committees.

Failing to comply with a subpoena from a committee or to otherwise adhere to committee rules during an investigation may have severe legal, strategic, and reputational consequences. If a subpoena recipient refuses to comply with a subpoena, committees may resort to additional demands, initiate judicial enforcement or contempt proceedings, and/or generate negative press coverage of the noncompliant recipient. Although rarely used, criminal contempt prosecutions can also be brought in the event of willful refusals to comply with lawful congressional subpoenas. As we have detailed in previous client alerts,[1] however, defenses exist to congressional subpoenas, including challenging a committee’s jurisdiction, asserting attorney-client privilege and work product claims, and raising constitutional challenges.

With Republicans in control of the House, committee investigations to date have focused on environmental, social, and corporate governance (“ESG”) investing, social media censorship, collusion between the government and private parties to censor conservative speech, China, and COVID-19 origins and the government’s response to the pandemic. In the Senate, where Democrats have an effective one-seat majority, investigations have centered on climate change, healthcare, prescription drug costs and labor-related issues. We also anticipate that committees in both chambers will pursue investigations regarding the power of technology companies, international corporate and military competition and espionage, cybersecurity breaches, and supply chain issues, including forced and child labor.

Attached you will find a table that presents key investigative powers and authorities for each House and Senate committee. The table includes information for each committee that answers key O&I related questions, including:

What is the scope of the committee’s investigative authority?
What are the procedures for exercising the committee’s subpoena power?
Can the chair of the committee issue a subpoena unilaterally?
Does the committee permit staff to question witnesses at a hearing?
Can the committee compel a witness to sit for a deposition? If so, what are the procedures for doing so?
What are the rules that apply to depositions before the committee?

The table includes hyperlinks to the sources of committee rules and jurisdiction and is meant to be a one-stop-shop for information relevant to O&I activities.

Below, we have highlighted noteworthy changes in the committee rules, which House and Senate committees of the 118th Congress adopted earlier this year.

If you see something missing from our discussion or the table, please let us know. We welcome your feedback.

Some items of note:

House:

As we detailed in earlier this year,[2] the House Republican majority is well-equipped to conduct investigations. In 2019, the new Democratic majority expanded their set of investigative tools and continued to add new ones in 2021. Republicans are taking full advantage of those expanded tools.
The Rules of the 118th Congress authorized three new investigative committees in the House: The Committee on Oversight and Accountability (formerly known as the Committee on Oversight and Reform) now has a Select Subcommittee on the Coronavirus Pandemic; the House Judiciary Committee now has a Select Subcommittee on the Weaponization of the Federal Government; and the Rules package and a separate House resolution created a new full investigative committee, the Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party.
- The Select Subcommittee on the Coronavirus Pandemic is tasked with investigating and reporting on the origins of the COVID-19 pandemic, waste or fraud involving pandemic-relief funds, vaccine development, and COVID-related school closings. The Select Subcommittee does not have subpoena power nor legislative authority and, thus, cannot report legislation. However, the full Oversight and Accountability Committee or its Chair “may authorize and issue subpoenas to be returned at the select subcommittee,” and the select subcommittee can from “time to time” report to the House or any House committee the results of its investigations or legislative recommendations.[3] To date, the Select Subcommittee has focused on the origins of COVID-19, allegations of government cover-ups regarding its origins, and the consequences of school closures.
- The Select Subcommittee on the Weaponization of the Federal Government is directed to study and issue a final report on its findings regarding executive branch collection of information on and investigation of U.S. citizens as well as “how executive branch agencies work with, obtain information from, and provide information to the private sector, non-profit entities, or other government agencies to facilitate action against American citizens.”[4] The Select Subcommittee does not have its own subpoena authority, but the Chair of the full Judiciary Committee may issue subpoenas for the Subcommittee.[5] The Subcommittee has cast a wide net and has issued document and information requests to a broad range of companies, non-profits, and government entities.
- The Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party is directed to investigate and submit policy recommendations concerning the status of the economic, technological, and security progress of the Chinese Communist Party and its competition with the United States.[6] The Chair has the power to authorize and issue subpoenas for testimony and documents.[7] Thus far, the Select Committee has held seven hearings on a variety of topics relating to China’s economic aggression, human rights record, and threat to the security of the United States.

Senate:

In the Senate, the Democrats’ one-seat majority gives them significantly more power to investigate in the 118th Congress. During the 117th Congress, subpoenas required bipartisan support in the evenly divided Senate. Now, Democratic chairs can issue subpoenas with the consent of their ranking members or by majority vote of their committees. We’ve already seen a strong start to their investigative agenda in the 118th Congress, as evidenced by investigations into technology companies,[8] labor practices,[9] and bank failures.[10]
Although its rules have not meaningfully changed since last Congress, the Senate Health, Labor, Education and Pensions (“HELP”) Committee has interpreted its Rule 17(a) to require a separate vote to authorize an investigation prior to voting on authorizing a subpoena.
The Senate Budget Committee issued its first subpoena in decades in a congressional investigation. The move, which had bipartisan support, signals a possible expansion or congressional use to subpoenas to committees beyond those we typically see active in the investigatory space. The move indicates that Senate Democrats are actively strengthening their investigative arsenal across committees, particularly regarding subpoena and deposition authority.

Our table of authorities provides an overview of how individual committees can compel a witness to cooperate with their investigations. But each committee conducts congressional investigations in its own particular way, and investigations vary materially even within a particular committee. While our table of authorities provides a general overview of what rules apply in given circumstances, it is essential to look carefully at a committee’s rules and be familiar with its practices to understand how its authorities apply in a particular context.

Gibson Dunn lawyers have extensive experience defending targets of and witnesses in congressional investigations. They know how investigative committees operate and can anticipate strategies and moves in particular circumstances because they also ran or advised on congressional investigations when they worked on the Hill. If you have any questions about how a committee’s rules apply in a given circumstance or the ways in which a particular committee tends to exercise its authorities, please feel free to contact us for assistance. We are available to assist should a congressional committee seek testimony, information, or documents from you.

Table of Authorities of House and Senate Committees

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[1] Michael Bopp, Thomas Hungar, and Megan Kiernan, 118th Congress: Investigative Tools And Potential Defenses, Law 360 (March 3, 2023), https://www.gibsondunn.com/wp-content/uploads/2023/03/Bopp-Hungar-Kiernan-118th-Congress-Investigative-Tools-And-Potential-Defenses-Law360-03-03-2023.pdf.

[2] Congressional Investigations in the 118th Congress: ESG, China, and the Biden Administration Take Center Stage, (Jan. 13, 2023), https://www.gibsondunn.com/wp-content/uploads/2023/01/congressional-investigations-in-118th-congress-esg-china-and-the-biden-administration-take-center-stage.pdf.

[3] H.R. Res. 5, 118th Cong. § 4(a)(2).

[4] H.R. Res. 12, 118th Cong. § 1(b)(1) (2023).

[5] H.R. Res. 12, 118th Cong. § 1(c)(1)(B) (2023).

[6] H.R. Res. 11, 118th Cong. § 1(b)(2) (2023).

[7] House Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party, Committee Rule VI.

[8] Sen. Cruz Launches Sweeping Big Tech Oversight Investigation, (Feb. 13, 2023) https://www.commerce.senate.gov/2023/2/sen-cruz-launches-sweeping-big-tech-oversight-investigation.

[9] Chairman Sanders Questions Howard Schultz in HELP Committee Hearing and Calls on Starbucks to End the Illegal Union Busting, (Mar. 29, 2023) https://www.help.senate.gov/chair/newsroom/press/prepared-remarks-chairman-sanders-questions-howard-schultz-in-help-committee-hearing-and-calls-on-starbucks-to-end-the-illegal-union-busting.

[10] Recent Bank Failures and the Federal Regulatory Response, (Mar. 28, 2023) https://www.banking.senate.gov/hearings/recent-bank-failures-and-the-federal-regulatory-response.

The following Gibson Dunn attorneys assisted in preparing this client update: Michael D. Bopp, Thomas G. Hungar, Roscoe Jones, Jr., Amanda H. Neely, Daniel P. Smith, Tommy McCormac, Hayley Lawrence, and Wynne Leahy.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work or the following lawyers in the firm’s Congressional Investigations group in Washington, D.C.:

Michael D. Bopp – Chair, Congressional Investigations Group (+1 202-955-8256, [email protected])

Thomas G. Hungar (+1 202-887-3784, [email protected])

Roscoe Jones, Jr. (+1 202-887-3530, [email protected])

Geopolitical tensions and strategic competition between the United States and China have increasingly influenced the investment landscape in recent years, implicating established regulatory frameworks such as that of the Committee on Foreign Investment in the United States (“CFIUS”), as well as driving non-traditional government actors to take action. Recently, plans to build a corn milling plant in North Dakota have caused states governments to consider their role in protecting both state and national security. In December 2022, CFIUS determined that it did not have jurisdiction to review the proposed acquisition of North Dakota land by a Chinese company, Fufeng Group, with the intent to build a $700 million corn milling plant. The Fufeng case generated significant national security and geopolitical debate in Washington given the proximity of the land to the Grand Forks Air Force Base.[1] These debates rapidly radiated beyond the beltway to state legislatures.

Since that CFIUS determination, lawmakers in a growing number of U.S. states have been quick to introduce and, in some cases, pass legislation that restricts foreign ownership of land within their states by governments, individuals, and/or entities associated with certain identified “foreign adversaries” of the United States. While the bills often include other “foreign adversaries,” most of the bills are particularly focused on China and Chinese investments. The list of states that have enacted such legislation in 2023 includes Alabama, Arkansas, Florida, Idaho, Indiana, Louisiana, Mississippi, Montana, North Dakota, Oklahoma, South Dakota, Tennessee, Utah, West Virginia, and Virginia—an additional 20 states have introduced bills that would regulate foreign ownership of real estate if enacted.[2]

In this alert, we discuss:

The typical contours of state legislation relating to certain foreign real estate activities;
The emerging trendline of state legislation regulating the acquisition of real estate by certain foreign persons;
A spotlight on Florida SB 264;
The closely watched case of Shen v. Simpson; and
Federal activity in this space, and the potential impact on state initiatives.

I. General Contours of State Legislation Restricting Certain Foreign Real Estate Activities

The bills introduced in state legislatures across the country in recent months vary in scope. They tend, however, to share certain core areas of focus:

The type of land restricted—e.g., agricultural land, land with proximity to military installations, or all real property;
The class of foreign persons restricted—e.g., foreign governments; government officials and political parties; designated military companies; foreign companies; foreign nationals; or a combination of the above;
The jurisdictions targeted—e.g., federally designated “foreign adversaries,” which includes China and the Hong Kong Special Administrative Region (“Hong Kong”), Cuba, Iran, North Korea, Russia, and the Nicolás Maduro Regime (“Maduro Regime”) of Venezuela;[3] a broader list which could also include countries such as Burma, Saudi Arabia, or Syria; or restrictions solely focused on China and Hong Kong;
The types of activities restricted—e.g., whether the restrictions apply to ownership/purchases, direct and indirect investments, and/or leaseholds;
Retroactivity and forced divestments; and
Specific exceptions and carve outs.

II. A New Trendline—With an Established Precedent

While the trendline of state governments imposing restrictions on certain foreign ownership of real estate is new, there is established precedent for state government involvement in the broader foreign policy sphere. Specifically, these laws are similar in type to the scores of state statutes that impose various restrictions on the ability of state actors (including pension funds and procurement offices) to do business with Iran or Sudan or with parties who refuse to do business with Israel. Such laws have withstood judicial challenge in large part because Congress has granted states the authority to impose such restrictions—to effectively legislate their own foreign policy in this narrow lane.[4] However, as of yet, Congress has not authorized the same powers to states regarding dealings with China or some of the other foreign states that these bills frequently address, such as Russia, Venezuela, and others. In addition, by implicitly or explicitly targeting nationals of foreign countries or seeking to force divestment of current interests, many of these state property laws may be vulnerable to other constitutional challenges based on equal protection or due process grounds, as discussed further in Section IV.

III. Spotlight on Florida SB 264

Of the various bills that have been introduced, Florida Senate Bill 264 (2023) (“SB 264”), has garnered significant attention as it is one of the most restrictive of this new wave of legislation.[5] SB 264 was codified at Florida Statutes § 692.201–.204, and took effect on July 1, 2023. As we discuss further in Section IV, SB 264 is also the subject of a constitutional and statutory challenge in the federal courts in the case of Shen v. Simpson (“Shen”).[6]

In particular, SB 264 contains three separate sections prohibiting covered foreign persons from owning or acquiring interests in land in Florida:

Section 692.202 states that “foreign principals” cannot “directly or indirectly own, have a controlling interest in, or acquire by purchase, grant, devise, or descent” any “agricultural land” in the state.[7]
- The term “foreign principal” captures, inter alia, governments and government officials; political parties and their members; partnerships or corporations organized under the laws of or having its principal place of business in, or persons (other than U.S. citizens or lawful permanent residents) domiciled in, a “foreign country of concern.”[8] The term “foreign country of concern” includes China, Russia, Iran, North Korea, Cuba, the Maduro Regime of Venezuela, and Syria, as well as “any agency of or any other entity of significant control of such foreign country of concern.”[9]
Section 692.203 applies the same prohibition to real property within ten miles of any “military installation”[10] or “critical infrastructure facility” (such as airports, seaports, power plants, or refineries).[11]
Section 692.204 goes further, specifically targeting China by prohibiting certain China-related persons from “directly or indirectly own[ing], hav[ing] a controlling interest in, or acquir[ing] by purchase, grant, devise or descent” any real property in Florida, including land, buildings, fixtures, and all other improvements to land.[12] This prohibition applies to the PRC government and the Chinese Communist Party, respective officials or members thereof; any partnership or corporation organized under the laws of or having its principal place of business in China, and its subsidiaries; and any person who is domiciled in China and who is not a U.S. citizen or lawful permanent resident, and “any person, entity, or collection of persons or entities described [above] having a controlling interest in a partnership, association, corporation, organization, trust, or any other legal entity or subsidiary formed for the purpose of owning real property in this state” (collectively, “Relevant Chinese Persons”).[13]

There are four exceptions provided under SB 264 that are applicable to the restrictions set out above (under Sections 692.202, 692.203 and 692.204). In summary, these are:

Ownership and interests in land or real property acquired prior to July 1, 2023—a foreign principal or Relevant Chinese Person that owns or acquires interests in land or real property that is subject to the restrictions set out above before July 1, 2023, may continue to own or hold such land or real property.[14] However, such foreign principal must register their property ownership with the Department of Agriculture and Consumer Services by January 1, 2024 (with respect to the restriction on agricultural land), or with the Department of Economic Opportunity by December 31, 2023 (with respect to real property that is not agricultural land).[15]
De minimis indirect interest—a foreign principal or Relevant Chinese Person may own or acquire land or real property that is subject to the restrictions set out above provided that the foreign principal or Relevant Chinese Person only has a “de minimus [sic] indirect interest” in such land or real property. A foreign principal or Relevant Chinese Person has a de minimis indirect interest if “any ownership is the result of [their] ownership of registered equities in a publicly traded company owning the land and if [their] ownership interest in the company is either: (a) less than 5 percent of any class of registered equities or less than 5 percent in the aggregate in multiple classes of registered equities; or (b) a noncontrolling interest in an entity controlled by a company that is both registered with the United States Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended, and is not a foreign entity.”[16]
Land or real property interests acquired by certain means—a foreign principal or Relevant Chinese Person may, on or after July 1, 2023, acquire land or real property that is subject to the restrictions set out above provided that such acquisition was by “devise or descent, through the enforcement of security interests, or through the collection of debts,” and provided that such foreign principal or Relevant Chinese Person “sells, transfers, or otherwise divests itself of such real property within 3 years after acquiring the real property.”[17] A Relevant Chinese Person relying on this exception, and who owns or acquires more than a de minimis indirect interest in real property in Florida on or after July 1, 2023, is required to register their real property within 30 days after the property is acquired.[18]
Residential real property—a foreign principal or a Relevant Chinese Person who is a natural person may purchase one residential real property that is up to two acres in size if all of the following apply: “(a) The parcel is not on or within 5 miles of any military installation in [Florida]. (b) The person has a current verified [U.S.] Visa that is not limited to authorizing tourist-based travel or official documentation confirming that the person has been granted asylum in the United States, and such visa or documentation authorizes the person to be legally present within [Florida]. (c) The purchase is in the name of the person who holds the visa or official documentation described in paragraph (b).”[19] Such foreign principles and Relevant Chinese Persons are required to register with the Department of Economic Opportunity within 30 days of owning or acquiring such residential real estate on or after July 1, 2023.[20] This exception only applies to residential real property, and is therefore not applicable to the restriction under Section 692.202 that applies with respect to agricultural land.

SB 264 remains untested in terms of enforcement, and the state has yet to provide significant regulatory guidance. At this point, the law appears to be broad in scope, seemingly restricting not only direct purchases of covered land but also indirect investments, such as through investment funds.

Moreover, SB 264 leaves important nuances unclear. For example, it is not clear from the plain language of SB 264 whether its restrictions extend to leasehold interests in addition to purchases and investments. However, we have seen some indications that the law does not. In August 2023, the Florida Department of Commerce released a Notice of Development of Rulemaking,[21] stating that it planned to “create a rule that aligns with new legislative changes from [SB 264] that prohibits the purchase of real property […] by foreign principals.” In the same notice, the Department explained that the subject area to be addressed is the “purchase of real property […] by foreign principals.” The fact that the Notice only refers to rulemaking regarding the purchase of real property, while making no mention of leases, could indicate that SB 264 will likely, at least at this stage, not apply to leasehold interests.[22]

Another question is whether Hong Kong, a popular place of incorporation for many companies (including those not based in a foreign country of concern) due to the ease of incorporation and favorable tax regime, will be treated as part of China for the purposes of SB 264. Although there is no Florida guidance on this point, the U.S. government revoked Hong Kong’s special status in 2020.[23] It now treats Hong Kong as part of China for trade and security purposes. For example, as we noted in our client alert, the Biden Administration’s recent Executive Order regarding outbound investment restrictions included Hong Kong as part of China. And, the U.S. Secretary of Commerce has explicitly included Hong Kong as part of China under U.S. export controls as well as federal regulation that designates China a “foreign adversary” for information security purposes.[24] Many of the other states that have passed or are considering legislation in this area have adopted the Department of Commerce definition, which includes Hong Kong as part of China.

IV. Shen v. Simpson—Key Developments and Areas to Watch

In May 2023, four Chinese citizens residing in Florida and a real estate brokerage firm that does business with Chinese citizens launched a constitutional challenge against SB 264, contending that it violates the Fourteenth Amendment’s Equal Protection and Due Process Clauses and the Supremacy Clause, as well as the Fair Housing Act.[25] Plaintiffs sought declaratory relief and a preliminary injunction to preclude the enforcement of SB 264. On August 17, 2023, the U.S. District Court for the Northern District of Florida denied the motion for a preliminary injunction, ruling that Plaintiffs had not shown that their case had a “substantial likelihood of success on the merits,” of their various causes of action, including the constitutional challenges.

Subsequently, on August 21, 2023, the Plaintiffs filed an emergency motion for an injunction against the implementation of SB 264 pending appeal.[26] The district court also denied this motion on August 23, 2023.[27] On August 26, 2023, the Plaintiffs-Appellants filed an emergency motion for an injunction pending appeal and motion for expedited appeal to the Eleventh Circuit to halt the implementation of portions of SB 264 with respect to the restrictions on the ability of people whose “domicile” is in China to purchase residential real estate in Florida.[28] This motion is still pending as of the date of this alert.

Many interested parties are tracking developments in Shen as an indication not only of whether SB 264 will survive the constitutional challenge, but also as an indication of the potential viability of other similar state laws that have been or are in the process of being enacted.

Twelve other U.S. states collectively filed an amicus brief in Shen opposing Plaintiffs’ challenge to SB 264.[29] State legislatures in some of those states have proposed laws similar to SB 264 and therefore would have an interest in the outcome of the constitutional challenge in Shen. Conversely the U.S. federal government filed an amicus brief supporting Plaintiffs’ motion in this case, underlining the federal government’s opposition to SB 264 and similar state laws, and potentially highlighting that a challenge to SB 264 or other such state law may eventually make its way to the U.S. Supreme Court.[30]

Courts will need to decide the extent to which federal law preempts state law in this area. Given the existing laws and regulations governing foreign investment at the federal level—and pending legislation in Congress that would enhance restrictions on real estate investments by foreign persons as described further below—it is not clear how the courts will navigate a preemption challenge in this context. An important question here is whether courts will apply the finding in Crosby v. National Foreign Trade Council[31] in which the U.S. Supreme Court unanimously struck down a Massachusetts state law prohibiting State business with Burma as unconstitutional under the Supremacy Clause. In Crosby, the Court held that Congress had preempted the subject matter and delegated the application of economic sanctions against Burma to the President.[32]

In addition to preemption concerns, other potential constitutional challenges may undermine these state laws, including potential challenges based on Equal Protection concerns due to a focus on national origin, or due process failings. In the meantime, however, in light of the district court’s refusal to enjoin the law (despite requests from the federal government), the Florida law and others like it may cause significant upheaval regarding real estate investment throughout the United States. We do not expect these issues to be resolved quickly, and it is reasonable to anticipate it could be several years before a final resolution by the Supreme Court.

V. The Federal Landscape Continues to Evolve Regarding Foreign Investment in Real Estate

While state legislatures are increasingly active, the Fufeng CFIUS case has also spurred action at the federal level. On May 5, 2023, the Department of the Treasury published a proposed rule expanding the list of military installations covered under the CFIUS regulations; Grand Forks Air Base, the military base at issue in the Fufeng was included amongst the eight new installations subject to CFIUS jurisdiction. Members of Congress have also introduced bills that would restrict foreign ownership of agricultural land at the federal level. For example, on July 25, 2023, with a broad bipartisan majority, the Senate voted to include the Promoting Agriculture Safeguards and Security Act (“PASS Act”) of 2023 into the National Defense Authorization Act (“NDAA”) for Fiscal Year 2024.[33] The PASS Act would expand CFIUS jurisdiction to certain agricultural transactions involving investments by a foreign person. If such an agricultural transaction would result in control over such agricultural land or business by a “covered foreign person,” the President would be required to prohibit the transaction.[34] The “covered foreign persons” who are targeted by the restrictions captures, inter alia, persons who are citizens or residents of, entities registered in or organized under the laws of, or entities that have a principal place of business in, China, Russia, Iran, or North Korea.[35] The PASS Act does provide a waiver process for the President on a case-by-case basis if the waiver is deemed “vital” to U.S. national security interests.[36] It is not yet clear if the PASS Act will become law as part of the FY 2024 NDAA, which will require the Senate and House versions to be reconciled in conference committee. Regardless of the outcome, the bipartisan support it received in the Senate is reflective of the broader U.S. political climate regarding certain foreign investments into the United States and the continuing trendline of heightened restrictions for foreign persons acquiring certain real estate. Should the PASS Act be enacted, it could reinforce the preemption challenges discussed in Section IV.

VI. Conclusions

The passage of SB 264 and similar state legislation throughout the United States is a manifestation of the increasingly complex and rapidly evolving geopolitical rivalry between Beijing and Washington. These state regulations add another complex layer to the various and broad U.S. restrictions at the federal level targeting trade and financial flows with China. While Biden Administration officials have sought to decrease tensions during recent visits to Beijing, simultaneous Biden Administration initiatives, such as the issuance of the long-awaited executive order outlining an outbound investment regime, have reinforced the strategic competition between the two countries and have tempered the salutary effect of these senior-level engagements.[37]

Given the controversy surrounding SB 264, we anticipate further challenges like Shen. These state developments mean that international investors and multinational businesses must not only consider federal law when undertaking transactions in the United States, but must factor in state-specific restrictions that may also play increasingly important roles in managing their commercial engagements and exposure in the country.

___________________________

[1] TJ Nelson, Fufeng USA Looking To Move Ahead With Grand Forks Project After Federal Agency Review Suddenly Ends, KVRR Local News (Dec. 13, 2022), https://www.kvrr.com/2022/12/13/fufeng-usa-looking-to-move-ahead-with-grand-forks-project-after-federal-agency-review-suddenly-ends/ (publishing CFIUS letter).

[2] Anderson, Mulligan, Hawkins, State Regulation of Foreign Ownership of U.S. Land: January to June 2023, Cong’l Research Service (July 28, 2023), chrome-https://crsreports.congress.gov/product/pdf/LSB/LSB11013.

[3] See 15 C.F.R. § 7.4 (determination of foreign adversaries), https://www.ecfr.gov/current/title-15/subtitle-A/part-7/subpart-A/section-7.4.

[4] See Crosby v. National Foreign Trade Council, 530 U.S. 363 (2000) (unanimously striking down as unconstitutional under the Supremacy Clause a Massachusetts state law prohibiting State business with Burma, holding that subject matter had been preempted by federal statute and the delegation of application of economic sanctions against Burma to the President). See also Cong. Rsch. Serv., State and Local Economic Sanctions: Constitutional Issues (Feb. 20, 2013), here.

[5] S. B. 245, 2023 Leg. (Fla. 2023), https://www.flsenate.gov/Session/Bill/2023/264/BillText/er/PDF.

[6] See Shen v. Simpson, 2023 WL 5517253 (N.D. Fla. Aug. 17, 2023), appeal docketed, No. 23-12737 (11th Cir. Aug. 23, 2023).

[7] Defined separately under Fla. Stat. § 193.461.

[8] Fla. Stat. § 692.201(4).

[9] Fla. Stat. § 692.201(3).

[10] Fla. Stat. § 692.201(5) (“military installation” means a base, camp, post, station, yard, or center encompassing at least 10 contiguous acres that is under the jurisdiction of the Department of Defense or its affiliates).

[11] Fla. Stat. § 692.201(2).

[12] Fla. Stat. §§ 692.204(1), 692.201(1)(6).

[13] Id.

[14] Fla. Stat. §§ 692.202(2); 692.203(2); 692.204(3).

[15] Fla. Stat. §§ 692.202(3); 692.203(3); 692.204(4).

[16] Fla. Stat. §§ 692.201(1); 692.203(1); 692.204(1).

[17] Fla. Stat. §§ 692.201(4); 692.203(5); 692.204(5).

[18] Fla. Stat. § 692.204(4).

[19] Fla. Stat. §§ 692.203(4); 692.204(2).

[20] Fla. Stat. §§ 692.203(3); 692.204(4).

[21] Notice of Development of Rulemaking No. 27393496, https://www.flrules.org/Gateway/View_Notice.asp?ID=27393496.

[22] In the same vein, the court in Shen, though not legally binding, described SB 264 as a law that restricts “land purchases” and requires “anyone purchasing real property ..[…] [to] sign an affidavit attesting that he is not a foreign principal.” Ord. Denying Preliminary Injunction Mot. at 2-3, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 17, 2023), ECF No. 69.

[23] Exec. Ord. No. 13936, 85 Fed. Reg. 138 (July 14, 2020).

[24] See 15 C.F.R. § 7.4.

[25] 42 U.S.C. §§ 3604, 3605.

[26] Emergency Mot. for Injunction Pending Appeal, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 21, 2023), ECF No. 71.

[27] Ord. Denying Mot. for Injunction Pending Appeal, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. Aug. 23, 2023), ECF No. 72.

[28] Time-Sensitive Mot. for Injunction Pending Appeal and For Expedited Appeal, Shen v. Simpson, No. 23-12737 (11th Cir. Aug. 26, 2023), ECF No. 4.

[29] The 12 states are: Idaho, Arkansas, Georgia, Indiana, Mississippi, Missouri, Montana, New Hampshire, North Dakota, South Carolina, South Dakota, and Utah.

[30] Statement of Int. of the U.S. in Support of Plaintiffs’ Mot. for Preliminary Injunction, Shen v. Simpson, No. 4:23-cv-00208-AW-MAF (N.D. Fla. June 27, 2023), ECF No. 54.

[31] Crosby v. National Foreign Trade Council, 530 U.S. 363 (2000).

[32] Id.

[33] S. Amdt. 813 to S. Amdt. 935, 118th Congress (2023-2024), https://www.congress.gov/amendment/118th-congress/senate-amendment/813.

[34] Id.

[35] Id.

[36] Id.

[37] For further detailed background on these various issues, see several recent Gibson Dunn sample client alerts addressing U.S. China trade issues: With Biden Executive Order, a U.S. Outbound Investment Control Regime Takes an Important Step Forward – Focused on China, but Significant Steps Remain Before Implementation, Gibson Dunn (Aug. 14, 2023), https://www.gibsondunn.com/with-biden-executive-order-us-outbound-investment-control-regime-takes-important-step-forward-focused-on-china/; 2022 Year-End Sanctions and Export Controls Update, Gibson Dunn (Feb. 7, 2023), https://www.gibsondunn.com/2022-year-end-sanctions-and-export-controls-update/#_Toc126615914; Biden’s National Security Strategy Reinforces Tech Decoupling and Increased Regulatory Focus, Gibson Dunn (Nov. 18, 2022), https://www.gibsondunn.com/bidens-national-security-strategy-reinforces-tech-decoupling-and-increased-regulatory-focus/; Webcast: U.S. Export Controls: New Sweeping Tech Controls on China – What You Need to Know, Gibson Dunn (Nov. 15, 2022) https://www.gibsondunn.com/webcast-u-s-export-controls-new-sweeping-tech-controls-on-china-what-you-need-to-know/.

The following Gibson Dunn lawyers prepared this client alert: Adam M. Smith, Stephenie Gosnell Handler, David Wolber, Amanda Neely, Arnold Pun, Sarah Pongrace, Dasha Dubinsky, and Jane Lu.

Gibson Dunn’s International Trade lawyers are highly experienced in advising companies about the potential legal implications of their international transactions and regularly assist clients in their efforts to comply with the shifting legal landscape and to implement best practices. The firm’s Congressional Investigations team has represented numerous clients responding to congressional inquiries regarding national security issues, and its Public Policy Practice Group frequently works with clients to monitor developments on Capitol Hill and the Administration in real time and to ensure their voices are heard in the policy debate. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Gibson Dunn attorneys also have vast experience preparing effective submissions to government regulators and remain ready to assist with this process as well as to help prepare stakeholders for discussions with members of the Treasury or other federal agencies on the proposed regulations.

Please contact the Gibson Dunn lawyer with whom you usually work or any of the following authors for additional information about how we may assist you:

Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
David A. Wolber – Hong Kong (+852 2214 3764, [email protected])

International Trade Group:

United States
Judith Alison Lee – Co-Chair, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, Dallas (+1 214-698-3295, [email protected])
Adam M. Smith – Co-Chair, Washington, D.C. (+1 202-887-3547, [email protected])
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Hayley Lawrence – Washington, D.C. (+1 202-777-9523, [email protected])
Annie Motto – Washington, D.C. (+1 212-351-3803, [email protected])
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, [email protected])
Sarah L. Pongrace – New York (+1 212-351-3972, [email protected])
Anna Searcey – Washington, D.C. (+1 202-887-3655, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])
Claire Yi – New York (+1 212-351-2603, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

Asia
Kelly Austin – Hong Kong/Denver (+1 303-298-5980, [email protected])
David A. Wolber – Hong Kong (+852 2214 3764, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Hong Kong (+852 2214 3731, [email protected])
Felicia Chen – Hong Kong (+852 2214 3728, [email protected])
Arnold Pun – Hong Kong (+852 2214 3838, [email protected])

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

We are pleased to provide you with Gibson Dunn’s ESG monthly update for August 2023. This month, our update covers the following key developments. Please click on the links below for further details.

I. International

1. World Water Week and the announcement of the COP28 Water Agenda

Between August 20-24, 2023, the Stockholm International Water Institute (SIWI) hosted the annual World Water Week conference. The event brought together 15,000 business leaders, decision-makers, planners and researchers, from 193 countries and territories, to explore how the natural resource of water can be harnessed to address the climate crisis. This year’s theme, Seeds of Change: Innovative Solutions For a Water-Wise World, sought to promote the benefits of a mission-driven approach to global planning for the increasing scarcity of water world-wide. It also sought to raise awareness of the significance of designing policy to work with the water cycle.

SIWI identified some Key Trends from the week: (i) interconnectivity and inclusion being critical for progress; (ii) shifting perceptions of innovation away from conventional thought towards broader governance, finance, values and culture; (iii) learning from indigenous peoples for innovation; (iv) oceans, and the connectivity between freshwater, coasts and oceans as opposed to separate bodies of water; (v) urgency of global approaches to water governance, given current pressures on the global water cycle; and (vi) international processes to ensure collective action.

Additionally, the progress made so far on the UN’s Water Action Agenda, set out in March 2023, was analyzed, and participants were prepared for COP28 which takes place in the UAE from November 30 until December 12, 2023. The COP28 UAE Presidency announced its own Water Agenda and that the Netherlands and Tajikistan will serve as COP28 Water Champions. Both of these signal that the management of global water resources will be a top priority at COP28.

2. S&P Global Ratings Drops ESG Scores

S&P Global Ratings (S&P) announced on August 4, 2023, that it will no longer give alphanumeric ESG ratings when assessing creditworthiness. The scores were originally introduced in 2021 to supplement the narrative ESG reports which S&P provide. S&P has instead determined that these narrative reports are “most effective at providing detail and transparency on ESG credit factors material to our rating analysis.” The move is seen as a response to growing pressure from international policymakers on those bodies currently providing ESG rating standards.

The dropping of the rating system does not affect the S&P’s ESG General Criteria, which is still applied by S&P when incorporating ESG factors into its credit ratings analysis.

3. International Auditing Assurance Standards Board opens consultation on proposed global sustainability assurance standards

On August 2, 2023, the International Auditing and Assurance Standards Board (IAASB) opened a consultation on proposed new global sustainability assurance standards, focused on sustainability reporting. The IAASB’s proposed standards – ‘ISSA 5000’ – are based on principles intended to apply across different sectors and regions, and include proposals such as requiring practitioners to design and perform sustainability-related risk procedures. The standards aim to be the ‘most comprehensive sustainability assurance standard available to all assurance practitioners across the globe’. The consultation is open until December 1, 2023.

4. Vanguard and Blackrock report falls in support for ESG-related proposals

The world’s two biggest investment managers revealed sharp falls in their support for ESG-related shareholder proposals during the 2023 proxy season compared to 2022. Both Vanguard and Blackrock said that many ESG-related proposals had been rejected because the risks raised were already being addressed by the recipient companies’ boards, or the proposals did not improve on existing company disclosures. The investment stewardship reports show an increase in the volume of ESG-related shareholder proposals, but suggest an overall decrease in their viability. For a deeper discussion of ESG and other shareholder proposal developments during the 2023 proxy season, please see our client alert here.

Vanguard:

On August 28, 2023, Vanguard reported that it supported only 2% of environmental and social shareholder proposals submitted to its U.S. portfolio companies in 2023, down from 12% in the previous year. Vanguard stated this decline was ‘largely attributable’ to the increasing number of such proposals and the nature of their requests. Vanguard specifically noted the impacts of the SEC’s November 2021 changes to its no-action request standards, including when a proposal addresses a “significant social policy” and cannot be excluded as relating to the company’s “ordinary business” under Rule 14a-8(i)(7) Securities Exchange Act 1934. Vanguard reported that the number of environmental shareholder proposals rose 50% from the prior year, with target-setting for greenhouse gas emissions becoming an increasingly common request.

BlackRock:

On August 18, 2023, BlackRock reported a 34% increase in environmental and social shareholder proposals submitted to U.S. companies compared to 2022. Echoing the sentiments from Vanguard, Joud Abdel Majeid, BlackRock Global Head of Investment Stewardship, commented that “[b]ecause so many shareholder proposals were over-reaching, lacking economic merit, or simply redundant, they were unlikely to help promote long-term shareholder value and received less support from shareholders, including BlackRock, than in years past.”. BlackRock supported only 7% of the environmental and social shareholder proposals submitted globally.

II. UK

1. UK Government increase in funding for renewable funding – multi-million backing for renewables

On August 3, 2023 the UK government published a press release announcing a £22m increase in the budget of the Contracts for Difference scheme, taking the total budget to £227m for this auction. The aim is to foster investment, growth, and diversity in the UK’s renewables industry and improve the UK’s energy security via reducing its exposure to potentially volatile global fossil fuel prices. The scheme is to encourage growth in established technologies such as solar and offshore wind via an increase in their budgets to £190m from £170m in the latest auction. Emerging technologies such as carbon capture are also seeing increased investment, with those increasing in budget from £35m to £37m, with a £10m ring-fenced budget for tidal stream projects. The target is to increase the proportion of the UK’s electricity generation, building on the existing trend which has seen an increase from 7% in 2010 to 42% in 2022.

2. Updates on UK moves to adopt the new ISSB Sustainability Disclosure Standards

The UK government has issued guidance on its Sustainability Disclosure Standards (SDS), which will set out corporate disclosures on the sustainability-related risks and opportunities faced by companies. They will include climate change related assessment of risks and opportunities and will be published by the Department for Business and Trade. SDS will be based on the IFRS Sustainability Disclosure Standards issued by the International Sustainability Standards Board (ISSB). The UK-endorsed standards will only divert from the global baseline if absolutely necessary for UK-specific matters. These SDS’s may be referenced in any legal or regulatory requirements for UK entities. Decisions to require disclosure will be taken independently by the UK government, for UK registered companies and limited liability partnerships, and by the Financial Conduct Authority (FCA) for UK listed companies. By adopting a global baseline for environmental standards (as envisioned when ISSB was announced at COP26), it is hoped that this will enable globally harmonised and comparable standards and be a useful metric for decision making by investors allocating capital.

The FCA has issued its own proposed approach to the implementation of the ISSB standards, noting that it expects to open a consultation in the first half of 2024. The FCA aims to finalise its policy position by the end of 2024, with a view to bringing new requirements into force for accounting periods beginning on or after January 1, 2025. The first reporting would begin from 2026.

3. UK Government Consultation: Role of biomass in achieving net zero: call for evidence

The Department for Energy Security & Net Zero had previously sought evidence from a range of stakeholders on how sustainable biomass should best support the UK’s Net Zero target, and has now issued its detailed analysis of responses and key findings. The information gathered will be used in connection with the development of the UK government’s Biomass Strategy. The consultation received 144 responses across 4 topics. Firstly ‘Supply’, focusing on underutilised waste, forestry, and energy crops. Secondly, ‘End Uses’ covering a variety of examples from heating to transport and electricity. Thirdly, ‘Sustainability and Accounting for Emissions’, which proposed a set of criteria and ideas for monitoring in accordance with potential international standards. Finally, ‘Innovation’, which covered waste processing technologies, BECCS (bioenergy with carbon capture and storage), and the regional innovation potential of different parts of the UK.

4. UK Charity Commission guidance on investing charity money for charity trustees

The UK Charity Commission has issued updated guidance and a summary of the legal framework on investing charity money for charity trustees. The guidance is intended to assist trustees in making financial and social investment decisions, whilst fulfilling their duties as trustees. The guidance intends to streamline and clarify existing guidance on trustee responsibilities, following a 2022 High Court decision on charity trustee investment duties, which established that it was possible for charities to adopt climate-conscious investment strategies.

5. Collective action claim against water companies in the UK’s Competition Appeal Tribunal

Collective action cases have been launched with the Competition Appeal Tribunal against water companies in the UK accused of falsely reporting sewage discharges in breach of environmental regulations. Around £330 million in damages are sought from Severn Trent (ST) on behalf of ST’s eight million customers, in the first of this series of claims, with up to five more such claims expected to be launched. Law firm Leigh Day brings the claims on behalf of household customers on the basis of alleged breach of competition laws by ST, who, it claims, abused its dominant market position to mislead regulators on the environmental damage caused by sewage discharges.

III. Europe

1. AFME report for Q2 2023

The Association for Financial Markets in Europe (AFME) has published its European environmental, social and governance (ESG) finance report for the second quarter of 2023 (Q2 2023), which provides detailed data trends alongside a regulatory and supervisory snapshot of the sustainable finance market in Europe. The report includes statistics on European ESG bond and loan issuance: half year volumes for ESG-labelled bonds increased 17% year-on-year, driven by the robust green bond issuance during Q1 2023. Sustainable-linked bond market witnessed a sharp decline with a 16.3% year-on-year decrease. The report also noted that UK carbon prices have declined by 35% since December 2022 with European Union Allowance carbon prices 10% higher over the same period. Global ESG Funds are noted as decreasing marginally since Q1 2023, but increasing by 25.3% since Q2 2022. Spreads of corporate ESG bonds against non-sustainable benchmarks are reported as increasing by c. 1.6bps between April and late July 2023. A primarily UK and EU regulatory update is also provided, with a quarter-by-quarter breakdown.

2. European Commission adoption of European Sustainability Reporting Standards and EFRAG’s Response

As summarised in the Gibson Dunn ESG Update of June 2023, the European Commission is in the process of implementing a set of European Sustainability Reporting Standards (ESRS), due to come into effect January 1, 2024. The ESRS aim to provide investors and other stakeholders with granular reporting on sustainability and climate-related issues, an essential prerequisite for informing investment decisions and allocating capital in line with sustainability goals, including those of the European Green Deal and the EU Climate Law.

On 31 July, 2023, the Commission adopted the Commission Delegated Regulation supplementing the Directive, which sets out the first set of sector-agnostic ESRS – as covered in the Gibson Dunn ESG Update of July 2023.

The Commission must adopt the ESRS taking into account the technical advice provided by EFRAG, who themselves issued a press release welcoming the adoption of the first set of ESRS. EFRAG’s advice focuses on streamlining the proposed reporting obligations to reduce the potential cost burdens. In response, the Commission has included phase-in provisions for the reporting obligations of smaller companies and changed some reporting requirements from mandatory to voluntary.

Additionally, EFRAG also highlighted its continuing efforts to ensure the interoperability of the ESRS with other relevant international standards of ESG reporting, such as the International Sustainability Standards Board (ISSB) and Global Reporting Initiative (GRI) standards. The ongoing collaboration between those setting ESG reporting standards suggests the potential for further convergence of the global reporting regimes, and increased clarity for those subject to them in future.

3. Appointment of new Executive Vice-President for the European Green Deal, Maroš Šefčovič

Following the resignation of Frans Timmermans as Member of the European Commission, Maroš Šefčovič has been appointed as his replacement to become Vice-President of the European Green Deal. In connection with the appointment, European Commission President, Ursula von der Leyen, has taken the opportunity to flag the Commission’s intentions to prioritise the European Green Deal and consolidate Europe’s leadership role on global renewables and energy efficiency targets. Von der Leyen notes the requirement for ‘more intensive dialogue with industry, key stakeholders like forest owners, farmers, as well as citizens’.

4. EU announces emissions reporting rules for Carbon Border Adjustment Mechanism (CBAM)

The European Commission adopted new rules on August 17, 2023 in connection with the initial trial phase of the Carbon Border Adjustment Mechanism (CBAM). These implement carbon emissions reporting obligations for EU importers of CBAM goods and set out fines for failures to satisfy such reporting requirements. The transitional phase begins on October 1 2023 until the end of 2025, during which time, traders will not be subject to the fines or taxes on emissions envisaged by the regulation, but must report on emissions, allowing for the ‘definitive methodology to be fine-tuned by 2026’, as the Commission reports. Guidance has been published in conjunction with the CBAM implementation and initial trial phase.

5. Denmark announces new carbon capture storage project plans

The Danish Ministry of Climate, Energy and Utilities has announced it has pioneered a scheme to promote carbon capture and storage (CCS) technology, by allocating the equivalent of almost USD4bn in government subsidies to companies over a period of 15 years. The initiative is set up to enable the capture of around 2.3 million tons of CO2 per year. The scheme proposes to function with 20 per cent state ownership of future carbon storage licences, meaning Danes will share in profits of the scheme.

IV. North America

1. Companies plea for climate disclosure legislation with the return to session of California lawmakers

As California lawmakers return to session, 15 companies have written a letter to the California Assembly Appropriations Committee Chair to express their support of the proposed Climate Corporate Data Accountability Act (SB 253), which would require U.S. companies with more than $1 billion in total annual revenues and doing business in California to annually report their Scope 1, 2, and 3 greenhouse gas emissions. The companies state in their letter that ‘consistent, comparable, and reliable emissions data at scale is necessary to fully assess the global economy’s risk exposure and to navigate the path to a net-zero future. All sectors and economic actors must work together to shift the entire economy …. we need legislation like SB 253 to cover privately held and midmarket companies to better ensure economy-wide accountability and action’.

2. U.S. antitrust agencies increasing scrutiny of ‘interlocking directorates,’ raising pressure on board members at competing companies

August has seen the U.S. Government increasingly focused on directors operating on boards of competing companies, a practice that violates Section 8 of the Clayton Act, a federal law designed to promote competition and avoid contraband co-ordination.

The Federal Trade Commission (FTC) on August 16, 2023 stepped in to re-structure a deal that would have given Quantum Energy Partners a board seat at EQT, its direct competitor in the sale and production of natural gas. The FTC issued its proposed consent agreement to settle ‘alleged violations of Federal law prohibiting unfair methods of competition’.

Similarly, the Department of Justice (DOJ) announced the resignation of two Nextdoor board members who were simultaneously directors on the board of its competitor, Pinterest, following the DOJ antitrust division’s ongoing enforcement efforts relating to the Clayton Act. Deputy Assistant Attorney General Andrew Forman of the Antitrust Division noted that ‘enforcement involving interlocking directorates will continue to be one of the top priorities of the Antitrust Division’.

3. New U.S. Department of Energy initiatives

The U.S. Department of Energy has announced a number of new environmental initiatives, including the availability of $350 million in grants to help states monitor and cut methane emissions, and to provide support to reduce inefficiencies. States must apply for funding by September 30, 2023.

The Department of Energy also announced the launch of a Responsible Carbon Management Initiative, which seeks to ensure the highest standards of management required for safety, environmental stewardship, accountability, community engagement and societal benefits related to carbon management projects.

It was also announced that $1.2 billion would be made available for the development of the first direct air capture facilities in Texas and Louisiana, aiming to start a nationwide network of commercial-scale carbon removal sites to reduce emissions. The investment would be the world’s largest to date in connection with carbon removal technology.

4. Government of Canada consultation on clean electricity regulations

As part of the nation’s broader electrification and decarbonisation strategy, the Government of Canada has published a consultation on its draft Clean Electricity Regulations, aimed to reduce emissions through the modification of electricity generation units and the requirement of reporting on all eligible units. The consultation remains open until November 2, 2023.

V. APAC

1. ASEAN to establish guidelines for company climate transition

A joint statement of the ASEAN Finance Ministers and Central Bank Governors (AFMGM) was issued on August 25, 2023, affirming that regulatory authorities across ASEAN countries are working on a voluntary corporate transition framework that is estimated to be released by the end of 2023. The forthcoming guidelines will adopt a principles-based approach, combining and taking inspiration from the most effective existing frameworks internationally. The primary objective is to assist companies in developing and sustaining transparency in their climate transition strategies, and to support an ‘affordable, credible and orderly transition’.

The meeting also outlined progress of the ASEAN Taxonomy Board’s consultation on the ASEAN Taxonomy version 2, which commenced in June 2023, and which is expected to complete by November 2023 (ahead of the UN Climate Change Conference in Dubai). The consultation will assist with the implementation of and the focus on particular sectors for Version 3, which is anticipated to be released over the next two years.

2. New investors have increased the AUM of sovereign climate engagement group to $8trn

Eighteen new investors joined the Australian pilot of the Collaborative Sovereign Engagement on Climate Change, raising the combined assets under management of the programme to $8trn. The initiative consists of a network of institutional investors who aim to support Australian governments to mitigate climate change in accordance with the Paris Agreement. The initiative runs under the aegis of the United Nations-supported Principles for Responsible Investment (UNPRI). The press release of the UNPRI, which announced the new members, also laid out the four goals which investors will seek to reach by improving sovereign climate change responses: (i) narrowing the gap between ongoing efforts and a path that aligns with the emission reduction goals of the Paris Agreement; (ii) developing comprehensive and credible net zero transition plans, including supportive policies, budget allocations and investment strategies; (iii) enhancing climate resilience across the economy and society to mitigate the harm and disruption caused by environmental threats; and (iv) enhancing transparency of sovereign exposure to climate-related risks and opportunities, following global standards.

3. Net zero organisation GFANZ sets up Hong Kong Chapter

The Glasgow Financial Alliance for Net Zero (GFANZ), a global coalition of financial institutions committed to the climate transition, issued a press statement of their intention to open a Hong Kong Chapter. The Hong Kong Chapter will serve as an extension of the GFANZ’s Asia-Pacific Network with the strategic goal of collaborating with financial institutions in Greater China on matters of comprehensive transition planning, scaling transition finance, and furthering net zero efforts.

4. New ESG standards coming into effect in South Korea

South Korea implemented new ESG evaluation standards on September 1, 2023. These ‘best practices for ESG evaluation work’ have been prepared and implemented by the ESG Standards Institute, Korea ESG Research Institude, and Sustinvest, and have the support of three major South Korean ESG rating agencies (Financial Services Commission (FSC), the Korea Exchange, and the Korea Capital Market Institute). The FSC has established a council composed of these evaluation agencies to assist in overseeing and enhancing the standards going forward.

5. New carbon markets registry launched in Singapore

The Asia Carbon Institute (ACI), a voluntary carbon credit registry and carbon standards organisation was launched in Singapore on August 29, 2023. The non-profit, established by Shell trader John Lo, seeks to scrutinise sustainability initiatives in the urban- and tech-space by issuing carbon credits that represent a quantifiable and permanent reduction in greenhouse gas emissions. ACI aims to provide independent and science-based reviews of project developments and expects to register around 100 projects per year.

6. India has issued a Green Hydrogen Standard

To advance the National Green Hydrogen Mission, the Ministry of New & Renewable Energy of India (MNRE) has announced a Green Hydrogen Standard that specifies emissions thresholds which need to be met in order to classify hydrogen production as ‘green’. The scope of the definition includes both biomass-based and electrolysis-based production methods and it characterises green hydrogen as having a well-to-gate emission not exceeding an average of 2 (two) kilograms of carbon dioxide equivalent per kilogram of hydrogen produced over 12 (twelve) months. The office memorandum dated August 18, 2023, sets out that a detailed methodology for the measurement, monitoring, reporting, on-site validation and certification of green hydrogen and its derivatives will be developed by the MNRE.

7. Taiwan opens carbon trading exchange

President Tsai Ing-wen launched Taiwan’s first carbon exchange in Kaohsiung on August 7, 2023, to assist the government’s goal of achieving net-zero emissions by 2050. In its initial phase, the exchange, set up jointly by the Executive Yuan’s National Development Fund and the Taiwan Stock Exchange, aims to support local businesses with carbon consultation and training on topics such as supply chain carbon neutrality, international carbon border taxes and domestic carbon fees. It is also expected that after pertinent sub-laws regarding carbon pricing are drafted by the Environmental Protection Administration, the exchange will begin to facilitate international carbon credit trading.

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

Warmest regards,

Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam

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

The following Gibson Dunn lawyers prepared this client update: Lauren Assaf-Holmes, Elizabeth Ising, Grace Chong, Lily Loeffler, Patricia Tan Openshaw and Selina S. Sagayam.

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

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Perlette M. Jura – Los Angeles (+1 213-229-7121, [email protected])
Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])

With five publicized agreements, the U.S. Department of Justice (“DOJ”) resolved significantly fewer cases using non-prosecution agreements (“NPAs”) and deferred prosecution agreements (“DPAs”) in the first half of 2023 than in similar periods in previous years.[1] At the same time, DOJ continued to refine its corporate enforcement policy, which addresses the factors DOJ considers when evaluating whether to prosecute a company, and if so, what form of resolution—if any—to offer the organization. Through July 31, 2023, four of the top five largest corporate resolutions in terms of dollars were negotiated plea agreements, and there were a total of 28 corporate plea agreements. As DOJ very publicly evolves its corporate enforcement policy and priorities, our discussion of NPAs and DPAs would be remiss outside of the context of their counterparts – guilty pleas on the one hand, and declinations-with-disgorgement on the other. Thus, beginning with this publication, Gibson Dunn’s client alerts on NPAs and DPAs also will track these important members of the family of corporate resolutions.

In this client alert, we: (1) report key statistics regarding NPAs and DPAs from 2000 through the present; (2) report key statistics on corporate guilty pleas from 2023; (3) discuss recent policy statements regarding corporate enforcement; and (4) summarize the 33 agreements through July 31, 2023.

Chart 1 below reflects the NPAs and DPAs that Gibson Dunn has identified through public-source research from 2000 through the end of July. Of the five total NPAs and DPAs thus far in 2023, three are NPAs and two are DPAs. The SEC, consistent with its trend since 2016, has not entered into any NPAs or DPAs in 2023 to date.

Chart 2 reflects total monetary recoveries related to NPAs and DPAs from 2000 through the end of July. At approximately $642 million, year-to-date recoveries associated with DPAs and NPAs are trending significantly higher than they were in the same period in 2022, but remain a fraction of the recoveries by mid-year in the last half-decade. For example, by this time in 2021, DOJ had recovered approximately $3.63 billion through NPAs and DPAs in the first half of the year; in 2020, the figure was approximately $6.03 billion. At the same time, we are not seeing plea agreements take up the slack; NPAs and DPAs still took the lion’s share of DOJ’s recoveries to date, at approximately 68% of the total approximately $944.6 million. The largest resolution thus far in 2023, in terms of dollar value, was a DPA.

Chart 3 reflects the relative mix of NPAs, DPAs, and declinations-with-disgorgement since DOJ first began issuing the latter agreements under the then-FCPA Pilot Program in 2016. Thus far in 2023 DOJ has issued one public declination-with-disgorgement pursuant to its Corporate Enforcement Policy; DOJ had also issued one such agreement by the end of July last year.

Charts 4 and 5 focus on specifically 2023 through the mid-year mark and show the numbers of DPAs, NPAs, plea agreements, and declinations-with-disgorgement in 2023 and the total dollar values associated with each type of resolution. As noted above, while plea agreements represented the majority of resolutions in terms of sheer number of agreements, DPAs dominated in terms of the dollar values of the government’s recoveries.

Continued Developments in DOJ Corporate Enforcement Policy

Introduction

On September 15, 2022, Deputy Attorney General (DAG) Lisa Monaco issued a memorandum detailing several updates to DOJ’s corporate criminal enforcement policies (the “Monaco Memorandum”).[2] She also delivered a speech on the same day expanding on the memorandum’s updates.[3] The updates addressed five key areas of corporate criminal enforcement in which DOJ planned to increase its emphasis on responsible corporate behavior:

individual accountability;
prior corporate misconduct;
voluntary self-disclosures;
compliance monitors; and
compensation structure to promote compliance.

DAG Monaco also asked all DOJ components—i.e., divisions of Main Justice and the U.S. Attorneys’ Offices—to write voluntary self-disclosure policies and “to clarify the benefits of [corporations] promptly coming forward to self-report.”[4] These updates aimed to give businesses the tools they needed to promote responsible corporate behavior—in short, “empowering companies to do the right thing.”[5]

DOJ policies, speeches, and enforcement actions following the Monaco Memorandum and speech have continued to build on the message that DOJ will look favorably on corporations proactively identifying misconduct, voluntarily reporting it to DOJ, and driving the remediation process forward themselves. Companies failing to fully comply and cooperate will face harsher consequences. The message is clear that corporations hoping to benefit from these policies must keep their compliance, monitoring, self-disclosure, and remediation procedures robust and up-to-date.

Recent key changes, discussed below, include (1) the roll-out of a uniform voluntary self-disclosure program across U.S. Attorneys’ Offices; (2) updates to the Criminal Division’s Corporate Enforcement Policy; (3) a new DOJ pilot program on compensation incentives and clawbacks; (4) an increased focus on third-party communications platforms; and (5) a DOJ “resource surge” to address the intersection of national security and corporate crime.

A Uniform Program for Voluntary Self-Disclosure

On March 3, 2023, in a speech at the American Bar Association’s National Institute on White Collar Crime, DAG Monaco announced that, for the first time, DOJ has adopted a uniform self-disclosure policy, applicable across all 94 U.S. Attorney’s Offices, that is designed to put in place “an operative, predictable and transparent voluntary self-disclosure program” (the “USAO VSD”).[6] Under this policy, prosecutors generally will not seek a guilty plea where a company has voluntarily self-disclosed, cooperated, and remediated its misconduct, in the absence of aggravating factors.[7] Aggravating factors under the USAO VSD may include (but are not limited to) misconduct that “poses a grave threat to national security, public health, or the environment;” “is deeply pervasive throughout the company;” or “involved current executive management of the company.”[8]

The USAO VSD noticeably does not identify repeat misconduct as an aggravating factor, and indeed, DOJ officials have favorably cited the Criminal Division’s December 2022 DPA with ABB Ltd., a Swiss multinational engineering company, which settled an investigation into alleged violations of the Foreign Corrupt Practices Act (“FCPA”), as an example of leniency despite repeat misconduct.[9] ABB’s 2022 resolution was not its first DPA, and DOJ had previously articulated a strong disfavoring of successive agreements.[10] But, as Principal Associate Deputy Attorney General (PADAG) Marshall Miller noted in December 2022[11] and DAG Monaco reemphasized in March 2023,[12] DOJ nevertheless “assigned significant weight” to ABB’s efforts to self-disclose.[13] According to PADAG Miller, the company’s disclosure efforts, along with its commitment to further enhance its compliance program, “A+ cooperation” and extensive remediation, factored heavily into DOJ’s view that a DPA was the appropriate resolution. As noted by DAG Monaco, “had ABB not promptly come forward, the result would have been drastically different.”[14]

Updates to the Criminal Division’s Corporate Enforcement Policy

In a speech on January 17, 2023, then-Assistant Attorney General (AAG) for the Criminal Division, Kenneth Polite, announced revisions to the Criminal Division’s Corporate Enforcement Policy (CEP).[15] The revisions offer new incentives for companies to self-disclose misconduct. The policy revisions aim to incentivize companies to go “far above and beyond the bare minimum” when cooperating with DOJ. Department officials have further expanded and clarified the new CEP in subsequent speeches.

Clarification of Declination Policy

Like the USAO VSD that followed it, the Criminal Division’s CEP provides that a company that voluntarily self-discloses misconduct, fully cooperates with DOJ, and timely and appropriately remediates enjoys a presumption that DOJ will decline to prosecute, absent any aggravating circumstances.[16] Unlike the USAO VSD, the Criminal Division CEP has always included history of prior misconduct among the list of “aggravating circumstances” that may merit a guilty plea (others include “involvement by executive management of the company in the misconduct; a significant profit to the company from the wrongdoing; [and] egregiousness or pervasiveness of the misconduct within the company”).[17]

Before January 2023, the CEP articulated aggravating circumstances as a bar to declination.[18] After January 2023, companies that have engaged in misconduct involving any of these factors still do not enjoy the presumption of a declination, but prosecutors may, in their discretion, decline to prosecute if the company can demonstrate that it:

Made a voluntary self-disclosure immediately upon becoming aware of the allegation of misconduct;
Had an effective compliance program and system of internal accounting controls in place at the time of the misconduct and disclosure that enabled the identification of the misconduct and led to voluntary self-disclosure; and
Provided extraordinary cooperation with DOJ’s investigation and undertook extraordinary remediation.[19]

Then-AAG Polite later explained in March that what constitutes “extraordinary” cooperation and remediation is subject to DOJ discretion.[20] He noted that in considering whether cooperation is “extraordinary,” DOJ evaluates the immediacy, consistency, degree, and impact of the cooperation.[21] Extraordinary remediation “includes conducting root cause analyses and taking action to prevent the misconduct from occurring, even in the face of substantial cost or pressure from the business.”[22] This can include, for example, significant organizational changes, suspensions or terminations, and recoupment of compensation.[23]

Then-AAG Polite also explained that the terms “immediate” and “extraordinary” in these revisions only apply when aggravating circumstances are present.[24] For companies without aggravating circumstances, DOJ still requires companies to voluntarily self-disclose only “within a reasonably prompt time after becoming aware of the misconduct.”[25]

DOJ has cited two recent declinations-with-disgorgement as exemplifying the Criminal Division’s current practices under the CEP. In December 2022, DOJ declined to prosecute Safran S.A., a French aerospace company, for alleged FCPA violations.[26] Safran voluntarily self-disclosed the conduct after discovering it during post-acquisition due diligence, fully cooperated, ensured remediation occurred, and disgorged ill-gotten profits.[27] Deputy Assistant Attorney General Lisa Miller pointed to the Safran declination in urging corporations to “call us before we call you.”[28] In March 2023, DOJ issued a declination-with-disgorgement to U.S.-based Corsa Coal following FCPA bribery violations.[29] Corsa fully cooperated with the investigation, remediated the misconduct by terminating a salesman involved in the scheme, disgorged a portion of the alleged ill-gotten profits (following a finding that it was unable to pay the full amount of $32.7 million), and substantially improved its compliance program and internal controls.[30]

DOJ’s message is clear that a proactive approach will best position the corporation to receive a declination under the CEP and avoid a more serious criminal resolution. A corporation that has self-identified misconduct, including conduct with aggravating circumstances present, should therefore carefully weigh the potential benefits flowing from proactively cooperating and providing DOJ with accurate information—including information otherwise unavailable to the Department.

Changes in Sentence Reductions Where Criminal Resolution is Warranted

Even where aggravating factors are too great to allow for a declination, the revised CEP provides that if a company voluntarily self-discloses, fully cooperates, and timely and appropriately remediates, the Criminal Division will accord or recommend at least 50% and up to 75% off the low end of the U.S. Sentencing Guidelines (“USSG”) fine range, except in the case of a “criminal recidivist.”[31] This is a significant increase from the previous potential maximum reduction of 50% off the Guidelines range. “Recidivist” companies that disclose, cooperate, and appropriately remediate will still be eligible for the reduction, but not off the low end of the range.[32]

The revised CEP provides for reductions even for those companies that do not voluntarily self-disclose. If such companies fully cooperate and timely and appropriately remediate, the Criminal Division will accord or recommend up to a 50% reduction off the low end of the USSG range, up from a maximum of 25% under the previous policy.[33] As in voluntary disclosure scenarios, “recidivist” companies are still eligible for this reduction, but not from the low end of the range. In his January remarks, then-AAG Polite lauded these changes as increasing the range of incentives for companies and providing prosecutors with a “greater range of options to distinguish among companies that commit crime,” but he also cautioned that a reduction of 50% will not be the new norm for companies that do not self-disclose; rather, he noted that “it will be reserved for companies that truly distinguish themselves and demonstrate extraordinary cooperation and remediation.”[34]

New DOJ Pilot Program on Compensation Incentives and Clawbacks

In an address at the ABA’s 38th Annual National Institute on White Collar Crime, DAG Monaco announced the Department’s first-ever Pilot Program on Compensation Incentives and Clawbacks, administered by the Criminal Division.[35] Then‑AAG Polite expanded on the program at the same conference the next day.[36] The two-part program, a three-year initiative that became effective March 15, 2023, fits with DOJ’s increased emphasis on corporate action in response to misconduct.

Part One requires that, as part of every criminal resolution entered into by the Criminal Division, companies shall be required to implement criteria related to compliance in their compensation and bonus systems to reward ethical behavior and to punish and deter misconduct.[37] As an example, DAG Monaco highlighted Danske’s December 2022 plea agreement, in which Danske, a Danish bank facing fraud allegations, agreed to revise its performance review and bonus system to include criteria related to compliance.[38] Part Two of the pilot program offers fine reductions for companies seeking to claw back compensation in appropriate cases.[39] These cases may include not only clawbacks from those employees who engaged in wrongdoing in connection with a given investigation, but also from those with supervisory authority over the culpable employees and who knew of, or were willfully blind to, the misconduct.[40] And the fine reductions accorded under the program equal 100% of the clawed-back compensation.[41] Moreover, even if companies are unsuccessful in clawing back compensation, prosecutors have discretion to grant a fine reduction of up to 25% of the compensation sought.[42]

The program will be in effect for three years, during which time DOJ will analyze its effectiveness. Please see our March 2023 publication on this, for further information.

Personal Devices and Communications Platforms

The Criminal Division continues to examine what revisions may be warranted to its framework for evaluating corporate compliance programs to address one of the most vexing issues facing corporate America—the use of personal devices and third-party messaging applications, including those offering ephemeral messaging.[43] The Division is focused on ensuring that DOJ can access relevant data and communications stored on these applications during investigations. In his keynote address at the ABA’s 38th Annual National Institute on White Collar Crime, then‑AAG Polite stated that DOJ will consider whether corporate policies governing these messaging applications allow business-related electronic data and communications to be preserved and accessed, along with how well companies communicate and enforce these policies.[44] If a company fails to produce data from messaging applications, prosecutors will probe the company’s ability to access such communications, whether the company stores them on corporate devices or servers, and applicable privacy laws. The company’s answers—or lack thereof—“may very well affect the offer it receives to resolve criminal liability.”[45]

Given DOJ’s increased focus on access to corporate communications, clear corporate policies regarding personal devices and third-party messaging applications, including across international borders, are becoming increasingly important, and companies would be well advised to review their corporate communications policies with an eye to preservation requirements, prohibitions on uses of off-platform communication channels, and disciplinary measures in the event of noncompliance.

Surging Resources to Address Intersection of National Security and Corporate Crime

In a May 2023 speech, PADAG Miller noted the growing link between corporate criminal enforcement and national security risks.[46] In response, DOJ is “dramatically scaling up [its] investment in fighting national security-related corporate crime.”[47] The Department will add over two dozen new prosecutors to the National Security Division (“NSD”) to focus on corporate crime, including the first-ever Chief Counsel for Corporate Enforcement. It plans to “staff[] up” the Bank Integrity Unit of the Criminal Division’s Money Laundering & Asset Recovery Section to home in on complex and cross-border sanctions cases involving financial institutions.[48] And it is issuing joint advisories with the Commerce and Treasury Departments to inform the private sector about national security-related compliance trends and expectations. For example, on July 26, 2023, those three agencies issued a “Tri-Seal Compliance Note” setting forth their respective views on voluntary self-disclosure of “potential violations of U.S. national security laws, including those governing sanctions and export controls.”[49] The document is significant not only for its detailed summaries of each agency’s self-disclosure requirements, but also for its clear statement—on behalf of all three agencies—that “[t]he benefits of VSDs are clear” and include “making companies eligible for significant mitigation.”[50]

2023 Agreements to Date

The remainder of this alert summarizes corporate resolutions through July 31, 2023. The appendix at the end of the alert provides key facts and figures regarding these resolutions, along with links to the resolution documents themselves (where available). Although we have continued to see relative consistency in the approaches taken to resolutions involving Main Justice, U.S. Attorneys’ Offices around the country continue to enter into agreements that vary widely and lack the uniformity of approach taken by Main Justice.

ABC Polymer Industries LLC (Guilty Plea)

On January 3, 2023, ABC Polymer Industries LLC (“ABC Polymer”) entered into a plea agreement with the Environment and Natural Resources Division’s Environmental Crimes Section and the U.S. Attorney’s Office for the Northern District of Alabama to resolve allegations that ABC Polymer, a manufacturer of extruded plastic products and other goods, had failed to install machine guards on the side of an equipment’s roller drums—in violation of the Occupational Health and Safety Act (“OSHA”)—leading to the death of an employee in its Alabama plant who was operating the machine.[51] OSHA requires machinery “whose operations exposes an employee to injury” to be guarded or to be designed and constructed in such a way to “prevent the operator from having any part of his [or her] body in the danger zone during the operating cycle.”[52] The agreement cited that while ABC Polymer had written policies addressing machine guards, it had trained its employees in procedures that involved lowering the guard during operations, exposing the operators to risk of injury.[53]

In connection with the plea agreement, ABC Polymer agreed to pay a criminal fine of $167,928, as well as $242,928 plus funeral expenses in restitution to the decedent’s estate.[54] ABC Polymer also agreed to serve a two-year term of probation, during which time ABC Polymer would be required to comply with an OSHA Safety Compliance Plan (“SCP”).[55] The SCP, among other things, requires ABC Polymer to designate a Safety Compliance Manager; extend a contract with its third party auditor or submit a list of qualified candidates if ABC Polymer intends to substitute a new third party auditor; maintain mechanisms for reporting safety concerns; and provide policies and training in English, Spanish, and any other language necessary to ensure all employees are able to understand.[56] Three weeks after its guilty plea, ABC Polymer was sentenced to the fine, restitution amount, and probation term set forth in the plea agreement.[57]

Aifa Seafood Inc. (Guilty Plea)

On March 8, 2023, Aifa Seafood Inc. (“Aifa”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Florida, to resolve allegations that Aifa violated the Lacey Act, which punishes illegal trade in fish and wildlife.[58] According to the agreement, the government alleged that Aifa engaged in false labeling of lobster imported from Haiti and bound for China, by labeling the lobster as product of the United States.[59] While the plea agreement indicates that the maximum fine Aifa could face is $500,000 per count and that Aifa could be sentenced to probation for up to five years, the agreement does not contain a recommended sentence.[60] The agreement itself also does not impose any form of reporting or monitoring requirement on Aifa.[61]

On May 23, 2023, Aifa was sentenced to a five-year term of probation, one condition of which is that it “establish and maintain an effective compliance program,” including by employing “an appropriately qualified Compliance Officer.”[62] Another condition of Aifa’s probation is that it retain an independent third‑party auditor and “fund a Court Appointed Monitor.”[63] Both the auditor and the monitor are required to submit reports to the company’s probation officer, and the monitor must submit its reports to the court as well.[64] The court sentenced Aifa to pay a $250,000 fine.[65]

American Management and Administration Corporation (Guilty Plea)

On April 13, 2023, the American Management and Administration Corporation (“AMAC”) entered a plea agreement with the U.S. Attorney’s Office for the District of Puerto Rico to resolve one count of theft of federal program funds, in relation to the alleged misappropriation of operational funds provided by the U.S. Department of Housing and Urban Development for the administration of public housing projects by Puerto Rican authorities.[66] AMAC was one of the private companies that contracted with Puerto Rican authorities to operate and maintain the public housing projects, in return for a monthly fee.[67] According to the government, AMAC knowingly and intentionally stole $3.7 million in funds from 2014 to 2022, including by diverting funds to personal bank accounts and writing checks for services not rendered.[68]

The plea agreement does not contain an agreed-upon penalty, nor does it reflect an agreement on a term of probation or impose ongoing reporting obligations.[69] Under the agreement, AMAC agreed to pay $3,712,000 in restitution.[70] At sentencing, the court imposed restitution in that amount and sentenced AMAC to three years of probation, and included as a condition of probation that AMAC report periodically to the court or its probation officer regarding its financial condition and any new investigations, litigations, or administrative proceedings commenced against AMAC.[71]

Anyclo International Inc. (Guilty Plea)

On June 12, 2023, Anyclo International Inc. (“Anyclo”), a South Korean clothing manufacturer, entered into a plea agreement with the U.S. Attorney’s Office for the District of New Jersey, to resolve charges that the company evaded customs duties on clothing it imported into the United States between 2012 and 2019.[72] According to the agreement, Anyclo prepared one accurate invoice for U.S. purchasers of the imported merchandise, and prepared another invoice for its U.S. Customs broker that falsely undervalued the goods and thus caused Anyclo to underpay customs duties.[73]

In the agreement, Anyclo and the government agreed to recommend to the court a fine of $250,000, as well as restitution of $2.05 million.[74] The parties agreed not to recommend probation to the court, and the agreement does not contain an ongoing compliance program or reporting obligation.[75] In sentencing Anyclo, the court accepted the fine recommendation but reduced the restitution amount to $1,850,000.[76] The court did not impose probation.[77]

BDF Enterprises, Inc., Michelle’s DVD Funhouse, Inc., MJR Prime LLC, and Prime Brooklyn LLC (Guilty Plea)

In January 2023, four entities, including BDF Enterprises, Inc. (“BDF”), Michelle’s DVD Funhouse, Inc., MJR Prime LLC, and Prime Brooklyn LLC separately pleaded guilty to one count each of conspiring to fix prices for DVDs and Blu-Ray discs on Amazon Marketplace, in violation of the Sherman Act, 15 U.S.C. § 1.[78] The agreements state that, from approximately October 2016 to October 2019, these Amazon Marketplace vendors and their owners colluded to sell video media at non-competitive prices to suppress and eliminate competition.[79]

Pursuant to these agreements with the Antitrust Division and the U.S. Attorney’s Office for the Eastern District of Tennessee, the companies agreed to recommended criminal fines ranging from $68,000 to $234,000.[80] The agreements did not recommend any restitution payments, in light of the availability of civil causes of action through which damages may be sought.[81] The parties also agreed to recommend that no probationary period be assessed.[82] The two individual owners of these four entities separately pleaded guilty in connection with the alleged scheme.[83]

As of the publication of this alert, only BDF has been sentenced. The court imposed a fine of $185,250, compared to the $234,000 agreed upon in BDF’s plea agreement—the result of the court applying U.S. Sentencing Guideline Section 8C3.4, which permits fine offsets for closely-held companies where one or more owners of the company have been sentenced for the same offense conduct.[84]

British American Tobacco P.L.C. (DPA)

On April 25, 2023, British American Tobacco P.L.C. (“BAT”), a UK-based corporation, entered into a three-year DPA with DOJ NSD and the U.S. Attorney’s Office for the District of Columbia,[85] resolving allegations that BAT and its Singaporean subsidiary (“BATMS”) had conspired to commit bank fraud and to violate the International Emergency Economic Powers Act (“IEEPA”), 50 U.S.C. § 1705(a), in connection with prohibited sales of tobacco products in North Korea.[86] In particular, according to the Statement of Facts attached to the DPA, in 2005 BAT purported to divest itself of a North Korean joint venture established in 2001, but instead continued to exert significant control over the entity, using it to transact business in North Korea.[87] The DPA alleges that BATMS and BAT structured transactions with this entity in a manner that obfuscated BATMS’s sales to North Korea, thereby causing U.S. banks to process improper U.S. dollar transactions for BATMS’s benefit, in violation of the bank fraud statute.[88] Some of these transactions were also made through sanctioned North Korean entities in violation of the IEEPA.[89]

As a part of the DPA, BAT agreed to joint and several liability with BATMS for over $440 million in criminal penalties and over $189.5 million in forfeiture payments.[90] The company has also implemented, and agreed to continue to implement, a corporate compliance program designed to prevent and detect violations of the Bank Secrecy Act and U.S. sanctions laws, specifically including maintaining the electronic database of SWIFT MT payment messages and documents and materials relevant to the investigation during the term of the DPA. The company must also annually report on the status of its compliance measures.[91] Additionally, if BAT breaches its obligations under the agreement, the government may extend the term of the agreement by up to one year; if, conversely, BAT demonstrates that it is no longer necessary to enforce the terms of the agreement, it may be terminated after less than three years.[92] The BAT DPA also has several related actions announced or commenced on the same day as the DPA, including a guilty plea by BATMS to the same charges, a civil action against both BAT and BATMS brought by the Department of the Treasury’s Office of Foreign Assets Control,[93] and several actions brought by DOJ against individuals alleging related conduct.[94]

Davey Tree Expert Company and Wolf Tree, Inc. (NPA)

On July 13, 2023, Davey Tree Expert Company (“Davey Tree”)—a company that provides tree-trimming services for utility companies—and its wholly-owned subsidiary, Wolf Tree, Inc. (“Wolf Tree”), jointly entered into an NPA with the U.S. Attorney’s Office for the Southern District of Georgia.[95] The agreement resolved allegations that, in connection with a tree-trimming contract for an electric utility company in Savannah, Georgia, Davey Tree and Wolf Tree illegally employed persons unlawfully in the United States.[96] The government alleged that Davey Tree and Wolf Tree provided these employees with false names and social security numbers, falsified payroll records for the employees, and paid the employees in cash in order to avoid detection.[97] One employee was allegedly killed after reporting that his supervisor was unlawfully in the United States and was hiring other undocumented individuals.[98]

Davey Tree and Wolf Tree agreed to pay $1,326,000 in restitution to the estate of the deceased employee; $21,804 in restitution to another employee for back wages; and $1,136,521 in forfeiture of the proceeds of the alleged violations.[99] The NPA also resolves civil allegations against Davey Tree and Wolf Tree, and accordingly imposes $1,500,000 in civil penalties and releases the companies from both civil and administrative liability that could otherwise be pursued by the Department of Homeland Security.[100] Although the agreement imposes cooperation obligations on Davey Tree and Wolf Tree, it does not require them to self-report to the government and it does not impose a monitor.[101]

DES International Co. Ltd. and Soltech Industry Co. Ltd. (Guilty Plea)

On March 29, 2023, DES International Co. Ltd. (“DES”) and Soltech Industry Co. Ltd. (“Soltech”), electronics companies based in Taiwan and Brunei, respectively, entered into plea agreements with the U.S. Attorney’s Office for the District of Columbia and DOJ NSD, resolving allegations of conspiracy to defraud the United States and violate the IEEPA and Iranian Transactions and Sanctions Regulations (“ITSRs”)—which restrict the trade, export, or sales of U.S.-origin goods, technology, or services to Iran.[102]

[103] According to the agreements, a sales agent of both DES and Soltech conspired and agreed with DES, Soltech, and an Iranian entity to export a U.S.-originated power amplifier and its related components, as well as cybersecurity software to the Iranian entity without a required license from the U.S. Department of the Treasury.[104] This sales agent took steps to conceal the U.S. origin of the products, such as by removing stickers with the phrase “Made in USA” from the packaging. The agent also misled the two U.S. companies exporting the goods and software to believe that the items they sold were to be used in Taiwan or Hong Kong, or used by DES or Soltech.[105]

DES and Soltech each agreed to a five-year period of corporate probation and a criminal fine of $83,769—three times the value of goods unlawfully exported to Iran—based on a consideration of several factors, including an “absence of cooperation or of any known compliance or remediation efforts,” and the lack of timely and voluntary self-disclosure.[106] At sentencing, the court imposed the penalty amounts and probation period contained in the plea agreements.[107]

Diesel Tune-Ups of RI, Inc. and M&D Transportation, Inc. (Guilty Plea)

On January 26, 2023, Diesel Tune-Ups of RI, Inc. (“Diesel Tune-Ups”) and M&D Transportation, Inc. (“M&D”) jointly entered into a plea agreement with the U.S. Attorney’s Office for the District of Rhode Island to resolve allegations that the companies conspired to violate the Clean Air Act.[108] The government alleged that between 2014 and 2019, Diesel Tune-Ups and M&D conspired among themselves and others to tamper with emission monitoring systems on diesel vehicles.[109] The alleged scheme consisted of both disabling or removing emission controls on the vehicles, and installing software in the vehicles so that the built-in monitoring systems could not detect the modifications to the controls.[110]

In the plea agreement, the parties agreed to recommend to the court that it impose a term of probation of three years.[111] As a probation condition, Diesel Tune-Ups and M&D agreed to hire a third-party independent consultant within 30 days of sentencing “to conduct an audit of all vehicles owned or operated by M&D to determine that no aftermarket emissions alterations have been made and that there has been no emissions-related tampering.”[112] No later than 60 days after sentencing, M&D must certify that all its vehicles are in compliance with the Clean Air Act’s emission-related provisions.[113] The agreement does not contain a penalty recommendation, stating instead that “[t]he parties will be free to recommend [at sentencing] whatever fine . . . they feel [is] appropriate.”[114] The agreement also explicitly states that the government and the defendants had not reached agreement on which offense level and criminal history category are appropriate for purposes of Sentencing Guidelines calculations.[115] The agreement notes that each count charged against Diesel Tune-Ups and M&D carries a maximum of $500,000 in fines.[116] Sentencing has not yet occurred in the case.

E.I. du Pont de Nemours and Company Inc. (Guilty Plea)

On April 24, 2023, E.I. du Pont de Nemours and Company Inc. (“DuPont”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Texas, resolving allegations that it violated the Clean Air Act by negligently releasing an extremely hazardous substance.[117] The allegations arose out of a 2014 accident that released 24,000 pounds of highly toxic, flammable gas into the air, killing four company employees, injuring others, and causing harm to surrounding areas.

The plea agreement recommends a two-year probation term, a $12 million penalty, and a $4 million community service payment to the National Fish and Wildlife Foundation (“NFWF”).[118] The agreement directs NFWF to use the community service payment for air quality-related work in areas near the western shores of Galveston Bay, Texas.[119] The agreement recommends two years of probation but does not impose a reporting obligation on DuPont.[120] The agreement also recognizes DuPont’s cooperation and prior civil settlements related to the incident at issue.[121] DuPont was sentenced on the same day as its plea, and the court imposed the penalty, community service payment, and probation term recommended in the agreement.[122]

FeelGood Natural Health Stores Ltd. (Guilty Plea)

On April 14, 2023, FeelGood Natural Health Stores Ltd. (“FeelGood”), a Canadian corporation, pleaded guilty to violating the Lacey Act, 16 U.S.C. §§ 3371-3378, which prohibits trafficking wildlife taken in violation of state wildlife protection laws. In this case, FeelGood allegedly transported and sold marine mammal products in violation of the Marine Mammal Protection Act (“MMPA”).[123] As described in the agreement, FeelGood knowingly transported and sold harp seal oil capsules in the United States as a health supplement.[124]

The agreement states that, from April 2019 to May 2021, FeelGood offered harp seal oil capsules for sale on its own webpage and through third-party marketplaces, which it then shipped either directly or via third-party distributors to the United States.[125]

The DOJ Environmental and Natural Resources Division and the U.S. Attorney’s Office for the Eastern District of Michigan, pursuant to the agreement, recommended a $20,000 fine, representing twice the gross gain that FeelGood would have realized from the illegal sales.[126] Meanwhile, FeelGood, pursuant to the agreement, recommended a $5,000 fine, representing twice the actual profits it realized as a result of the sales.[127] The parties also agreed to recommend $1,373.43 in forfeiture payments stemming from covert purchases by U.S. law enforcement, as well as a three-year probationary period, during which time FeelGood agreed to establish and maintain a compliance program, assess whether it ships any products to the United States, and seek an import license if it does.[128] Sentencing has not yet occurred.

Genotox Laboratories Ltd. (DPA)

On March 21, 2023, Genotox Laboratories Ltd. (“Genotox”) entered into an eighteen-month DPA with the U.S. Attorney’s Office for the Western District of Texas, resolving allegations that Genotox had violated the Anti-Kickback Statute (“AKS”), 42 U.S.C. §§ 1320(a)-7(b), the False Claims Act (“FCA”), 31 U.S.C. §§ 3729-3733, and the Eliminating Kickbacks in Recovery Act (“EKRA”), 18 U.S.C. § 220, by using a volume-based commission incentive structure for third-party marketers and encouraging physician orders that were not medically necessary.[129]

According to the DPA, from approximately 2014 through March 2019, and at least in some instances until October 2020, Genotox paid its independent sales representatives, who were non-bona fide employees, on a commission basis to market its toxicological testing services.[130] The commission payments were calculated based on the revenue realized from billings to insurers, including Medicare and Tricare. Even after transitioning these independent sales representatives to a fixed-rate pay structure, Genotox allegedly continued tracking employee pay against the older commission structure.[131] Additionally, Genotox allegedly used form test orders to encourage test orders for patients that billed their insurance providers at the highest reimbursement categories, even if the tests were not necessary.[132]

Genotox received full cooperation credit but it did not receive voluntary disclosure credit.[133] The DPA did not assign any criminal penalty in light of Genotox’s payment of $477,774 pursuant to a parallel Civil Settlement Agreement (“CSA”) with the Civil Fraud Section, the U.S. Attorney’s Office for the Southern District of Georgia, the Office of Inspector General for the United States Department of Health and Human Services, and a qui tam relator.[134] The CSA, in addition to the $477,774 payment, imposed an additional $415,000 payment, to be made over five years. The CSA also provides for additional payments in the event that Genotox’s revenue exceeds certain thresholds, and contemplates that total payments under the agreement could exceed $29 million. The agreement states that all of these payments by Genotox are “restitution to the United States,” and the government stated in a press release that “[t]he settlement amount was based on the company’s ability to pay,” which likely explains the payment-over-time approach reflected in the agreement and the fact that some of the payments will be contingent on Genotox’s revenues.[135] Under the agreement, the government will not pay to Genotox nearly $5 million in Medicare payments that were suspended after the underlying qui tam action was filed.[136]

Notably, with respect to the DPA, the USAO for the Western District of Texas expressly retained discretion to find Genotox in breach of the DPA in the event that it breaches the parallel five-year Corporate Integrity Agreement (“CIA”) it entered into with the U.S. Department of Health and Human Services, Office of Inspector General.[137] The CIA imposed separate compliance requirements, including the retention of an Independent Review Organization – perhaps as a result, neither the CSA nor the DPA imposed an independent compliance monitor.[138]

Great Circle (NPA)

On January 27, 2023, Great Circle, a non‑profit provider of behavioral health services based in Missouri, entered into a three‑year NPA with the U.S. Attorney’s Office for the Eastern District of Missouri, resolving allegations that Great Circle made false statements in connection with the delivery of or payment for health care benefits.[139] According to the government’s allegations, Great Circle provided federally-reimbursed residential treatment services to children in the custody of the Children’s Division of the Missouri Department of Social Services.[140] Great Circle allegedly billed for services it did not provide, as well as for services that did not conform to contractual requirements.[141]

Under the agreement, Great Circle is obligated to undertake compliance program enhancements, but is not required to self-report or submit to a monitorship.[142] Great Circle entered into a parallel civil settlement with the government, in which it agreed to pay $1,866,000; apparently in recognition of that fact, the NPA does not impose a criminal penalty.[143] The NPA does not specify whether Great Circle voluntarily disclosed the alleged conduct to the government.[144]

Greater Boston Behavioral Health LLC (Guilty Plea)

On March 13, 2023, Greater Boston Behavioral Health LLC (“GBBH”) entered into a plea agreement with the U.S. Attorney’s Office for the District of Massachusetts, to resolve allegations that GBBH violated the federal Food, Drug and Cosmetic Act (“FDCA”).[145] According to the agreement, GBBH purchased Botox® that came from foreign sources and whose labels did not contain FDCA-required language indicating that the drugs were for prescription use only and explaining certain side effects.[146]

The plea agreement reflects an agreed disposition of $2,587,142 in penalties, allocated as $657,678 in fines and $1,929,464 in forfeiture.[147] The parties also agreed that GBBH should be put on probation for three years; unlike other plea agreements and many NPAs and DPAs, however, the agreement does not impose any reporting or monitor requirements on GBBH, and does not explicitly set forth any compliance or cooperation obligations.[148] The agreement does not include voluntary self-disclosure among the Sentencing Guideline factors that the government believed the court should consider at sentencing.[149]

GBBH was sentenced on May 12, 2023; the court imposed three years of probation and the same penalty and forfeiture amounts as in the plea agreement.[150]

Ground Zero Seeds International, Inc. (Guilty Plea)

On January 4, 2023, Ground Zero Seeds International, Inc. (“GZI”) entered into a plea agreement with the U.S. Attorney’s Office for the District of Oregon, to resolve one count of misprision of felony for allegedly paying kickbacks to a former employee of another company (Jacklin Seed Company) in connection with purchases of grass seed.[151] GZI allegedly paid a total of $191,790 to a former employee of the other company between April 2015 and September 2019, concealing the payments through inflated invoices.[152] In the plea agreement, the government agreed to recommend to the court a fine of $40,000 and a one-year term of probation.[153] GZI also agreed to pay restitution of $516,000, representing sales Jacklin Seed Company lost because of the kickbacks paid to its former employee.[154] Under the terms of the agreement, the government also agreed to “make available the evidence gathered in the investigation of this matter for on-site inspection,” and GZI accepted that offer—as well as the discovery the government had provided to date in the case—”in full satisfaction of the government’s discovery obligations in th[e] case.”[155]

Following the plea agreement, the court sentenced GZI to the probation, fine, and restitution terms contained in the plea agreement.[156] The plea agreement did not impose a monitor or compliance self-reporting as a condition of probation, and neither did the court in sentencing GZI.[157]

Interunity Management (Deutschland) GmbH (Guilty Plea)

On May 5, 2023, Interunity Management (Deutschland) GmbH (“Interunity”), a German shipping operator, entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of California and the DOJ Environment and Natural Resources Division, to resolve allegations that Interunity failed to maintain an accurate Oil Record Book, in violation of 33 U.S.C. § 1908.[158] The government alleged that, while in U.S. waters, a vessel operated by Interunity failed to record the transfer, discharge, and disposal of oily bilge water as required by U.S. law.[159] The government learned of the alleged conduct after a crewmember on the vessel reported to the U.S. Coast Guard via email concerning a discharge of oily bilge water by the vessel directly into the sea.[160]

The agreement contains a jointly recommended sentence of $1,250,000 in penalties, which Interunity agreed represented twice what it gained as a result of the alleged conduct.[161] The penalty is comprised of $937,500 in fines and a $312,500 “community service payment” to the NFWF.[162] As the agreement notes, NFWF is a Congressionally-created nonprofit with authority to administer community service payments that advance conservation of fish, wildlife, plants, and other natural resources.[163] This plea agreement requires the NFWF to use the community service payment for conservation efforts in or around the Tijuana River National Estuarine Research Reserve.[164]

The agreement contains a recommended probation period of four years, during which Interunity would be required to implement an Environmental Compliance Plan (“ECP”).[165] The ECP requires both a third-party auditor and a court-appointed monitor. The auditor is responsible for auditing Interunity’s vessels according to a detailed set of criteria and reporting audit findings to the government, while the court-appointed monitor is responsible for reporting to the government on the adequacy of the audits and on the relationship between the auditor and Interunity.[166] Sentencing has not yet occurred in the case.

IRB Brasil Resseguros SA (NPA)

On April 20, 2023, IRB Brasil Resseguros SA (“IRB”), a Brazilian reinsurance company listed on the Brazilian stock exchange, entered into a three-year NPA with the Fraud Section.[167] The NPA resolved allegations that IRB engaged in securities fraud in violation of 15 U.S.C. §§ 78j(b) and 78ff(a) and 17 C.F.R. § 240.10b-5.[168]

At the time of the relevant conduct, February through March 2020, 25% of IRB’s shareholders were U.S. investors.[169] According to the NPA, to counteract critical analyses of IRB’s financial position, IRB and its Chief Financial Officer (“CFO”) defrauded IRB’s investors by falsely claiming that Berkshire Hathaway Inc., an international conglomerate and well-known investment entity, was a shareholder.[170] The CFO allegedly furthered this scheme through falsified shareholder lists, fictitious emails between IRB and Berkshire Hathaway, and false oral statements.[171] Berkshire Hathaway issued a statement on March 3, 2020, disclaiming any relationship with IRB. On March 4, 2020, IRB’s stock price fell, causing significant losses to shareholders.[172] The CFO subsequently falsely claimed that his statements about Berkshire Hathaway had been in error.[173] IRB separated from the CFO that same day.

Pursuant to the NPA, IRB agreed to pay $5 million in shareholder compensation to the shareholders who sold IRB stock on March 4, 2020.[174] A Shareholder Payment Administrator is to be appointed to advise the Fraud Section on which shareholders should be compensated and in what amount. Similar to the process for selecting a corporate compliance monitor, the Fraud Section will select the Administrator from a pool of three candidates chosen by IRB.[175] While the NPA states that a criminal fine or penalty would be appropriate based on the law and facts, the agreement does not impose any additional criminal monetary penalties in light of IRB’s financial position.[176]

During the NPA’s term, IRB is obligated to provide periodic reports regarding the state of its compliance program.[177] As is typical of these agreements, the NPA’s term may be extended up to one year by DOJ or terminated early, as circumstances dictate.[178] One curiosity of this agreement is that it attaches executed versions of Attachments E and F, certifications by the company CEO and CFO that IRB’s reporting under various provisions of the NPA is accurate and complete. Presumably, because these reporting requirements apply for the life of the NPA, these certifications will be executed for a second time at the conclusion of the NPA’s term.

Kerry Inc. (Guilty Plea)

On February 3, 2023, Kerry Inc. (“Kerry”), a subsidiary of a manufacturing company headquartered in Ireland, pleaded guilty to one count of manufacturing breakfast cereal under insanitary conditions and introducing adulterated food into interstate commerce in violation of the FDCA, 21 U.S.C. § § 331(a) and 333(a)(1).[179] As of the date of this publication, the plea agreement remains under seal. However, as described in the Department of Justice, Civil Division’s Consumer Protection Branch’s press release, following Kerry’s guilty plea, from approximately June 2016 to June 2018, a Kerry facility in Illinois, which manufactures and distributes Kellogg’s Honey Smacks cereal, tested positive for salmonella 81 times.[180] According to the press release, the company failed to address the presence of salmonella, and the Director of Quality Assurance at the facility directed subordinates not to report the test results.[181] The press release states that the adulterated cereal manufactured by Kerry has been linked to over 130 cases of salmonellosis beginning in March 2018.[182]

In connection with this plea agreement, Kerry was sentenced to pay $10,488,000 in criminal monetary penalties and $8,740,000 million in forfeiture payments.[183] The former Director of Quality Assurance for the facility has also been charged with three misdemeanor counts.[184]

L5 Medical Holdings, LLC (Guilty Plea)

On July 26, 2023, L5 Medical Holdings, LLC d/b/a Pain Care Centers (“L5 Medical”), a medical practice and operator of pain clinics, entered into a plea agreement with the U.S. Attorney’s Office for the Western District of Virginia to resolve allegations related to a federal drug and health care fraud conspiracy.[185] According to the agreement, L5 Medical conspired with its owner and other physicians at the practice to use registration numbers that had been issued to others in the course of dispensing and distributing a controlled substance, and to execute a scheme to defraud government health care benefits programs.[186] The practice’s owner, a former mortgage broker, allegedly purchased pain clinics through L5 Medical in pursuit of a “recession proof” business model.[187] With the agreement, L5 Medical pleaded guilty to conspiracy to distribute and dispense fentanyl, hydrocodone, morphine, and oxycodone for non-legitimate purposes.[188]

In the agreement, L5 Medical and the government agreed to recommend restitution in the amount of $3.82 million to federal and state health care programs, as well as $250,000 in forfeiture.[189] The plea agreement did not include a recommended probation period, but it required L5 Medical to wind down or dissolve its business and to never again do business in the Western District of Virginia.[190]

Nine2Five, LLC (Guilty Plea)

On July 10, 2023, Nine2Five, LLC (“Nine2Five”), a Carlsbad, California–based importer and seller of herbal extract kratom, entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of California, to resolve allegations that Nine2Five imported kratom using false invoices stating that it was botanical soil conditioner.[191] According to the National Institutes of Health, kratom (scientific name Mitragyna speciose) is “an herbal substance that can produce opioid- and stimulant-like effects.”[192] After importing the kratom using false invoices, Nine2Five allegedly transferred $60,000 to a bank account in Indonesia for the purpose of kratom importation.[193]

The plea agreement contains a recommendation by the government that Nine2Five be placed on probation for three years.[194] No fine is recommended in the agreement because “the parties agree that it is readily ascertainable that [Nine2Five] has no ability to pay.”[195] Sentencing has not yet occurred in the case.

Onekey, LLC (Guilty Plea)

On February 2, 2023, Onekey, LLC (“Onekey”), a New Jersey construction company, and its principal, entered into plea agreements with the U.S. Attorney’s Office for the Southern District of New York, to resolve allegations that Onekey willfully violated OSHA regulations which led to a construction worker’s death.[196] The government alleged that, at a construction site in Poughkeepsie, New York, Onekey built a concrete retaining wall alongside large quantities of dirt called “surcharges,” without consulting with a qualified engineer, as required by OSHA, to see if the wall could withstand the surcharges’ weight.[197] On August 3, 2017, the wall collapsed, resulting the death of a construction worker.[198]

As of the date of this publication, the plea agreements are not publicly available. However, as described in Onekey’s Sentencing Memorandum, the plea agreement contains a recommendation that Onekey, throughout a three-year probationary period, retain a Certified Safety Professional for current and future major projects; implement a safety and health management system designed to identify, evaluate, analyze and control workplace safety and health hazards; and notify OSHA about its major projects for enhanced oversight.[199] The government did not seek restitution, because Onekey voluntarily paid for the worker’s funeral expenses and, in settlement of a civil lawsuit, paid the worker’s family $2.5 million.[200] Additionally, Onekey paid a fine of $281,583 to the Department of Labor.[201]

OneKey was sentenced on May 12, 2023; the court imposed the three years of probation with the conditions identified in the plea agreement and ordered the company to pay a $218,417 fine.[202] The company’s principal was sentenced to three months in prison and one year of supervised release.[203]

Partridge-Sibley Industrial Services, Inc. (Guilty Plea)

On January 11, 2023, Partridge-Sibley Industrial Services, Inc. (“PSI”) entered into a plea agreement with the U.S. Attorney’s Office for the Southern District of Mississippi to resolve allegations that it supervised the transportation and disposal of industrial waste to a site in Jackson, Mississippi and caused it to be taken to a discharge point that was not designated to receive such waste, in violation of the Clean Water Act.[204] The allegations stem from charges against Rebel High Velocity Sewer Services of Jackson, Mississippi (“Rebel”), namely that Rebel conspired to illegally discharge waste into the City of Jackson’s sewer system to avoid the cost of treating the waste, evade sewer usage fees, and avoid disposing of the waste at legal facilities.[205] PSI was responsible for transporting truckloads of the city’s industrial waste to Rebel for discharge.[206] After PSI transported the waste to Rebel, Rebel allegedly discharged the waste into the city’s sewer system, despite being prohibited from doing so, resulting in the illegal dispensation of millions of gallons of industrial waste.[207] PSI pleaded guilty to Count 1 of a ten-count misdemeanor Information for “negligently introducing and causing to be discharged trucked and hauled pollutants” into the city’s wastewater system.[208]

In the plea agreement, PSI and the government agreed on a $200,000 fine and a one-year term of probation.[209] Following the plea, PSI issued a statement noting that “all of the officers, managers and directors of PSI were cleared of any wrongdoing or involvement in Rebel’s illegal discharges,” and that PSI’s alleged negligence was a result of untrue representations and assurance made by Rebel.[210] The statement further clarified that none of the wastewater PSI transported was hazardous or acidic.[211] At sentencing, the court imposed the fine and probation terms recommended in the plea agreement.[212] Neither the plea agreement nor the court’s judgment contain any explicit requirement for voluntarily compliance self-reporting by PSI.

Quick Tricks Automotive Performance, Inc. and Kloud9Nine, LLC (Guilty Pleas)

On January 31, 2023, Quick Tricks Automotive Performance, Inc. (“Quick Tricks”) and Kloud9Nine, LLC (“Kloud9Nine”) entered into plea agreements with the U.S. Attorney’s Office for the Southern District of Florida to resolve allegations that, between 2018 and 2021, the companies conspired to violate the Clean Air Act by tampering with diesel emissions control devices and “tuning” onboard monitoring systems so that they would not detect the modifications.[213] Both companies were sellers of products used for such “tuning.”[214] Each plea agreement recommends the imposition of three years of probation on the respective company, but does not reflect an agreement on a recommendation for monetary consequences of the alleged conduct.[215] All parties expressly reserved the right to advocate for an appropriate fine at sentencing.[216]

On May 5, 2023, the court sentenced both Quick Tricks and Kloud9Nine to three years of probation.[217] The conditions of both companies’ probations include establishing and maintaining effective compliance programs, as well as appointing a third-party auditor and funding a court-appointed monitor.[218] The companies are required to report, within 30 days of the third-party auditors’ reports, on the companies’ efforts to address auditors’ findings.[219] The court did not impose a fine on either company.[220]

Pure Addiction Diesel Performance, LLC (Guilty Plea)

On May 30, 2023, Pure Addiction Diesel Performance, LLC (“Pure Addiction”), a Portland, Oregon–area diesel repair shop, entered into a plea agreement with the U.S. Attorney’s Office for the District of Oregon, to resolve allegations that Pure Addiction violated the Clean Air Act by “deleting” or removing emissions controls from vehicles and “tuning” onboard monitoring systems so that they would not detect the modifications.[221] The government alleged that, between 2018 and 2020, Pure Addiction removed the emissions control systems, which are designed to reduce pollutants being emitted from vehicles, and modified on-board diagnostic systems, for approximately 245 diesel vehicles.[222] Pure Addiction allegedly collected over $400,000 for performing these services.[223]

In the plea agreement, Pure Addiction and the government stipulated to a sentence of three years of probation, and as a condition of probation agreed to pay a penalty of $148,733 to the Environmental Protection Agency (“EPA”), under the terms of a separate consent agreement.[224] The agreement did not contain a stipulated restitution obligation.

Pure Addiction was ordered to pay the $148,733 fine to the EPA, and was sentenced to three years’ probation.[225] In connection with Pure Addiction’s plea, its owner and operator pleaded guilty to being an accessory to the tampering of monitoring devices and was sentenced to six months in prison.[226]

Rhode Island Beef and Veal, Inc. (Guilty Plea)

On April 4, 2023, Rhode Island Beef and Veal, Inc. (“Rhode Island Beef and Veal”), a slaughterhouse based in Johnson, Rhode Island, entered into a plea agreement with the U.S. Attorney’s Office for the District of Rhode Island, to resolve allegations that the company violated the Federal Meat Inspection Act (“FMIA”).[227] Specifically, the government alleged that the company defrauded customers by failing to comply with FMIA inspection requirements, by falsely stating that meat had passed such inspection, and by unlawfully using the Secretary of Agriculture’s official inspection mark.[228] The plea agreement is not accompanied by a statement of facts, but according to the government’s press release, Rhode Island Beef and Veal continued to mark meat as having been inspected by the U.S. Department of Agriculture (“USDA”) for over a week after the USDA served the company with a notice of suspension and withdrew its inspector.[229]

The plea agreement does not contain a recommended fine or probation period; instead, it states that the government would recommend a fine within the applicable Sentencing Guidelines range, and that the government “is free to recommend a period of probation” within that range.[230] The agreement likewise does not specify any ongoing reporting or compliance requirements as part of Rhode Island Beef and Veal’s sentence.[231] Sentencing has not yet occurred in the case.

Sterling Bancorp, Inc. (Guilty Plea)

On March 15, 2023, Sterling Bancorp, Inc. (“Sterling”), a holding company offering residential and commercial loans and retail banking services through its wholly-owned subsidiary—Sterling Bank and Trust, F.S.B.—pleaded guilty to a charge of securities fraud for filing false securities statements relating to its initial public offering (“IPO”) in 2017, and in its annual filings in 2018 and 2019.[232] According to the agreement, from 2011 to 2019, Sterling, through its founder and certain members of senior management and loan officers, knowingly falsified and hid information causing loans to be offered to unqualified borrowers, which in turn increased Sterling’s revenue through its Advantage Loan Program (“ALP”).[233] Sterling then engaged in an IPO and subsequent securities filings, in the process making materially false statements regarding the quality of the ALP.[234] Consequently, between 2017 and 2019, the Sterling’s alleged fraud caused ALP non-insider shareholders to experience approximately $69 million in losses.[235]

Although Sterling voluntarily disclosed the ALP misconduct to the Office of Comptroller of the Currency (“OCC”) following an internal investigation, Sterling did not receive any disclosure credit because it did not voluntarily and timely disclose the fraudulent conduct to the Criminal Fraud Section.[236] Sterling did receive credit, however, for fully disclosing its findings from its internal investigation, cooperating with the Fraud Section’s investigation, and demonstrating recognition and affirmative acceptance of responsibility for its conduct, such as by engaging in extensive remedial measures including terminating the ALP and reorganizing its senior management and several related departments.[237]

Pursuant to the plea agreement, Sterling agreed to pay a criminal fine of approximately $62 million, a 25% discount off of the bottom of the USSG range based on Sterling’s cooperation and remediation.[238] After crediting Sterling’s civil monetary penalty payment to the OCC, the fine amount totaled approximately $56 million.[239] Similarly, credit was given for Sterling’s class action payments and thus restitution was calculated at approximately $56.5 million.[240] Following a finding that Sterling was unable to pay the full criminal penalty and restitution without facing bankruptcy, the Fraud Section required that only approximately $27 million be paid towards restitution.[241] The plea agreement specified that a Special Master would be appointed to oversee the proper administration and disbursement of the $27 million in restitution.[242]

As part of the agreement, Sterling will also be required to enhance its compliance program and provide quarterly reports to the Fraud Section throughout a three-year probationary period, which can be extended by up to one year if Sterling breaches its obligations.[243] In sentencing Sterling, the court imposed the probationary period and restitution obligation recommended by the plea agreement.[244]

Telefonaktiebolaget LM Ericsson (Guilty Plea)

On March 2, 2023, Telefonaktiebolaget LM Ericsson (“Ericsson”), a Swedish multinational telecommunications company, pleaded guilty to one count of conspiracy to violate the anti-bribery provisions of the FCPA, 15 U.S.C. § 78dd-1, and one count of conspiracy to violate the books and records provisions of the FCPA, 15 U.S.C. §§ 78m(b)(2)(A), 78m(b)(2)(B), and 78m(b)(5).[245] These counts were previously resolved in a 2019 DPA between Ericsson, the Fraud Section, and the U.S. Attorney’s Office for the Southern District of New York, in connection with which Ericsson paid more than $1 billion in penalties and disgorgement between the DPA and a related civil settlement with the SEC.[246] This year, DOJ determined, in its sole discretion, that Ericsson had breached the DPA by failing to promptly disclose all factual evidence and information related to certain pre-DPA conduct, as required by the DPA.[247] Accordingly, Ericsson pleaded guilty to the charges deferred by the 2019 DPA and agreed to an additional penalty of approximately $206.7 million.[248]

Zeus Lines Management S.A. (Guilty Plea)

On March 24, 2023, Zeus Lines Management S.A. (“Zeus”), a Liberian vessel operator with its principal place of business in Greece, pleaded guilty to violating the Act to Prevent Pollution from Ships (“APPS”), 33 U.S.C. § 1908, and the Ports and Waterways Safety Act (“PWSA”), 46 U.S.C. § 70036(b).[249] As to the APPS violations, the plea agreement states that, on three occasions between November 2021 and February 2022, one of Zeus’s ships illegally dumped 9,544 gallons of oily bilge water directly into the ocean, rather than through required pollution-prevention apparatus, and did not accurately report this discharge.[250] The agreement therefore states that Zeus failed to maintain accurate records as to its discharge of oily bilge water, in violation of the APPS.[251]

As to the PWSA violations, according to the agreement, Zeus did not report its discovery of an inoperable inert gas system on board on February 2, 2022.[252] The system’s failure, discovered while the ship was in the Netherlands, caused the ship’s oxygen levels to drastically exceed safe levels, posing a threat of fire and explosion.[253] The agreement states that Zeus sailed to the United States to retrieve a spare part during this time, and in so doing failed to report the system failure to the U.S. Coast Guard.[254] According to the agreement, after the Coast Guard became aware of the unsafe oxygen levels, Zeus falsified records to reflect that the oxygen levels were still safe during the ship’s voyage.[255]

Pursuant to its plea agreement with the Environmental and Natural Resources Division and the U.S. Attorney’s Office for the District of Rhode Island, Zeus agreed to a recommended criminal fine of over $1.6 million and $562,500 in community service to the NFWF.[256] Additionally, the agreement recommends a four-year probationary period, which can be extended by a period of time determined by the court if Zeus violates the agreement’s terms, during which Zeus must establish an Environmental Compliance Plan for all ships sailing to the United States.[257] Zeus must name a Compliance Manager who will report directly to Zeus’s Managing Director,[258] and retain a Third Party Auditor (“TPA”) to coordinate assessments of the fleet’s environmental safety practices and submit periodic reports to DOJ.[259] Zeus must also retain a Court Appointed Monitor that will oversee the audit process and Zeus’s compliance with applicable regulations, receiving reports from the TPA.[260] The court has not yet imposed sentence on Zeus.

The ship’s captain and chief engineer also pleaded guilty to charges under the APPS and PWSA.[261]

Appendix

The chart below summarizes the agreements concluded by DOJ through July 2023. The complete text of each publicly available agreement in hyperlinked in the chart.

The figures for “Monetary Recoveries” may include amounts not strictly limited to an NPA, DPA, or guilty plea, such as fines, penalties, forfeitures, and restitution requirements imposed by other regulators and enforcement agencies, as well as amounts from related settlement agreements, all of which may be part of a global resolution in connection with the NPA or DPA, paid by the named entity and/or subsidiaries. The term “Monitoring & Reporting” includes traditional compliance monitors, self-reporting arrangements, and other monitorship arrangements found in resolution agreements.

U.S. Deferred Prosecution Agreements, Non-Prosecution Agreements, and Plea Agreements in 2023 YTD
Company	Agency	Alleged Violation	Type	Monetary Recoveries	Monitoring & Reporting	Term of Agreement (Months)
ABC Polymer Industries, LLC	N.D. Ala.; DOJ ENRD	OSHA	Guilty Plea	$410,856	Yes	24
Aifa Seafood Inc.	S.D. Fla.	Lacey Act	Guilty Plea	$0	No	N/A
American Management and Administration Corporation	D.P.R.	Theft of Federal Funds	Guilty Plea	$3,712,000	No	N/A
Anyclo International, Inc.	D.N.J.	Entry of Goods by Means of False Statements	Guilty Plea	$2,300,000	No	N/A
BDF Enterprises, Inc.	E.D. Tenn.; DOJ, Antitrust Division	Sherman Act	Guilty Plea	$234,000	No	0
British American Tobacco	D.D.C.; DOJ NSD	Fraud (Bank)	DPA	$629,891,853	Yes	36
Davey Tree Expert Company and Wolf Tree, Inc.	S.D. Ga.	Immigration Violations	NPA	$3,984,325	No	N/A
DES International Co., Ltd.	D.D.C.; DOJ NSD	IEEPA	Guilty Plea	$83,769	No	60
Diesel Tune-Ups of RI, Inc.	D.R.I.	Clean Air Act	Guilty Plea	$0	Yes	36
E.I. Dupont de Nemours and Co.	S.D. Tex.	Clean Air Act	Guilty Plea	$16,000,000	No	24
FeelGood Natural Health Stores, Ltd.	E.D. Mich.; DOJ ENRD	Lacey Act	Guilty Plea	$21,373	Yes	36
Genotox Laboratories Ltd.[262]	W.D. Tex.; S.D. Ga.	Anti-Kickback Statute	DPA	$892,784	No	18
Great Circle	E.D. Mo.	Fraud (Healthcare)	NPA	$1,866,000	No	36
Greater Boston Behavioral Health LLC	D. Mass.	FDCA	Guilty Plea	$2,587,142	No	36
Ground Zero International Seeds, Inc.	D. Or.	Misprision of Felony	Guilty Plea	$556,000	No	12
Interunity Management (Deutschland) GMBH	S.D. Cal.; DOJ ENRD	Failure to Maintain an Accurate Oil Record Book	Guilty Plea	$1,250,000	Yes	48
IRB Brasil Resseguros	DOJ Fraud	Fraud (Securities)	NPA	$5,000,000	Yes	36
Kerry Inc.	DOJ CPB; C.D. Ill.	FDCA	Guilty Plea	$19,228,000	Unknown	Unknown
L5 Medical Holdings, LLC	W.D. Va.	Healthcare fraud	Guilty Plea	$4,070,000	No	N/A
M&D Transportation, Inc.	D.R.I.	Clean Air Act	Guilty Plea	$0	Yes	36
Michelle’s DVD Funhouse, Inc.	E.D. Tenn.; DOJ, Antitrust Division	Sherman Act	Guilty plea	$184,000	No	N/A
MJR Prime LLC	E.D. Tenn.; DOJ, Antitrust Division	Sherman Act	Guilty plea	$130,000	No	N/A
Nine2Five, LLC	S.D. Cal.	Money Laundering	Guilty Plea	$0	No	36
Onekey, LLC	S.D.N.Y.	OSHA	Guilty Plea	$218,417	Unknown	36
Partridge-Sibley Industrial Services, Inc.	S.D. Miss.	Clean Water Act	Guilty Plea	$200,000	No	12
Prime Brooklyn LLC	E.D. Tenn.; DOJ, Antitrust Division	Sherman Act	Guilty Plea	$68,000	No	N/A
Pure Addiction Diesel Performance, LLC	D. Or.	Clean Air Act	Guilty Plea	$148,733	No	36
Quick Tricks Automotive Performance, Inc. and Kloud9Nine, LLC	S.D. Fla.	Clean Air Act	Guilty Plea	$0	No	36
Rhode Island Beef and Veal, Inc.	D.R.I.	Federal Meat Inspection Act	Guilty Plea	$0	No	N/A
Soltech Industry Co., Ltd.	D.D.C.; DOJ NSD	IEEPA	Guilty Plea	$83,769	No	60
Sterling Bancorp, Inc.	DOJ Fraud	Fraud (Securities)	Guilty Plea	$39,739,000	Yes	36
Telefonaktiebolaget LM Ericsson	DOJ Fraud; S.D.N.Y.	FCPA	Guilty Plea	$206,728,848	Yes	12
Zeus Lines Management S.A.	D.R.I.; DOJ ENRD	Failure to Maintain Accurate Oil Record Book	Guilty Plea	$2,250,000	Yes	48

__________________________________________________________

[1] This update addresses developments and statistics through July 31, 2023. NPAs and DPAs are two kinds of voluntary, pre-trial agreements between a corporation and the government, most commonly used by DOJ. They are standard methods to resolve investigations into corporate criminal misconduct and are designed to avoid the severe consequences, both direct and collateral, that conviction would have on a company, its shareholders, and its employees. Though NPAs and DPAs differ procedurally—a DPA, unlike an NPA, is formally filed with a court along with charging documents—both usually require an admission of wrongdoing, payment of fines and penalties, cooperation with the government during the pendency of the agreement, and remedial efforts, such as enhancing a compliance program or cooperating with a monitor who reports to the government. Although NPAs and DPAs are used by multiple agencies, since Gibson Dunn began tracking corporate NPAs and DPAs in 2000, we have identified over 600 agreements initiated by DOJ, and 10 initiated by the U.S. Securities and Exchange Commission (“SEC”).

[2] Memorandum from Lisa O. Monaco, Deputy Attorney General, U.S. Dep’t of Justice, to Assistant Attorney General, Criminal Division, et al., Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.

[3] Deputy Attorney General Lisa O. Monaco Delivers Remarks on Corporate Criminal Enforcement (Sept. 15, 2022), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement.

[4] Id.

[5] Id.

[6] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national; see also DOJ, United States Attorneys’ Offices Voluntary Self-Disclosure Policy, https://www.justice.gov/d9/2023-03/usao_voluntary_self-disclosure_policy_2.21.23.pdf.

[7] Memorandum from DAG Monaco to DOJ on Further Revisions to Corporate Criminal Enforcement Policies (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.

[8] DOJ, United States Attorneys’ Offices Voluntary Self-Disclosure Policy at 4, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.justice.gov/d9/2023-03/usao_voluntary_self-disclosure_policy_2.21.23.pdf

[9] Press Release, ABB Agrees to Pay Over $315 Million to Resolve Coordinated Global Foreign Bribery Case (Dec. 2, 2022), https://www.justice.gov/opa/pr/abb-agrees-pay-over-315-million-resolve-coordinated-global-foreign-bribery-case.

[10] Memorandum from DAG Monaco to DOJ on Further Revisions to Corporate Criminal Enforcement Policies (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.

[11] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the American Bankers Association Financial Crimes Enforcement Conference (Dec. 6, 2022), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-american.

[12] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[13] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the American Bankers Association Financial Crimes Enforcement Conference (Dec. 6, 2022), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-american.

[14] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[15] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law; see also, U.S. Dep’t of Justice, Criminal Division Corporate Enforcement and Voluntary Self-Disclosure Policy, https://www.justice.gov/criminal-fraud/file/1562831/download.

[16] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.

[17] Id.

[18] Justice Manual § 9-47.120(1) (Nov. 2019).

[19] Id.

[20] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.

[21] Id.

[22] Id.

[23] Id.

[24] Id.

[25] Id.

[26] Letter from Glenn S. Leon, Chief, U.S. Dep’t of Justice, Fraud Section & E. Martin Estrada, U.S. Attorney for the Central District of California, to Peter Spivack, Counsel for Safran S.A. (Dec. 21, 2022), https://www.justice.gov/criminal-fraud/file/1559236/download.

[27] Id.

[28] Deputy Assistant Attorney General Lisa H. Miller Delivers Remarks at the University of Southern California Gould School of Law on Corporate Enforcement and Compliance (Feb. 16, 2023), https://www.justice.gov/opa/speech/deputy-assistant-attorney-general-lisa-h-miller-delivers-remarks-university-southern.

[29] Letter from Glenn S. Leon, Chief, U.S. Dep’t of Justice, Fraud Section & Troy Rivetti, Acting U.S. Attorney for the Western District of Pennsylvania, to Brian E. Spears et al., Counsel for Corsa Coal Corporation (Mar. 8, 2023), https://www.justice.gov/criminal-fraud/file/1573526/download.

[30] Id.; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.

[31] JM 9-47.120(2); see also Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.

[32] Id.

[33] Id.

[34] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Remarks on Revisions to the Criminal Division’s Corporate Enforcement Policy (Jan. 17, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-georgetown-university-law.

[35] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[36] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.

[37] Id.; The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks (Mar. 3, 2023), chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.justice.gov/criminal-fraud/file/1571941/download.

[38] Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime (Mar. 2, 2023), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[39] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.

[40] Id.; The Criminal Division’s Pilot Program Regarding Compensation Incentives and Clawbacks 2 (Mar. 3, 2023).

[41] Id.

[42] Id.

[43] See Deputy Assistant Attorney General Lisa H. Miller Delivers Remarks at the University of Southern California Gould School of Law on Corporate Enforcement and Compliance (Feb. 16, 2023), https://www.justice.gov/opa/speech/deputy-assistant-attorney-general-lisa-h-miller-delivers-remarks-university-southern; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national; Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote Address at the Global Investigations Review Live: DC Spring Conference (Mar. 23, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-address-global.

[44] Assistant Attorney General Kenneth A. Polite, Jr. Delivers Keynote at the ABA’s 38th Annual National Institute on White Collar Crime (Mar. 3, 2023), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-keynote-aba-s-38th-annual-national.

[45] Id.

[46] Principal Associate Deputy Attorney General Marshall Miller Delivers Remarks at the Ethics and Compliance Initiative IMPACT Conference (May 3, 2023), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-remarks-ethics-and.

[47] Id.

[48] Id.

[49] Dep’t of Commerce, Dep’t of the Treasury, and Dep’t of Justice Tri-Seal Compliance Note: Voluntary Self-Disclosure of Potential Violations (July 26, 2023), https://ofac.treasury.gov/media/932036/download?inline.

[50] Id. at 5.

[51] Plea Agreement, United States v. ABC Polymer Indus., LLC, No. 22-cr-294 (N.D. Ala. Jan. 9, 2023), at 2-6.).

[52] Id. at 3 (citing 29 C.F.R. § 1910.212(a)(3)(ii)).).

[53] Id. at 5.

[54] Id. at 1, 7.

[55] Id.

[56] Id., Attach. A at 2-8.

[57] Press Release, U.S. Dep’t of Justice, Alabama Company Sentenced in Worker Death Case (Jan. 24, 2023), https://www.justice.gov/usao-ndal/pr/alabama-company-sentenced-worker-death-case.

[58] Plea Agreement, United States v. Aifa Seafood Inc., No. 1:22-CR-20479-FAMCR (S.D. Fla. Mar. 8, 2023).

[59] Id. at I.A.

[60] See id. at B.

[61] See generally id.

[62] Judgment, United States v. Aifa Seafood Inc., No. 1:22-CR-20479-FAM (S.D. Fla. May 25, 2023).

[63] Id.

[64] Id.

[65] Id.

[66] Plea Agreement, United States v. AMAC, No. 3:23-CR-00148-CVR (D.P.R. Apr. 13, 2023), at 13–19.

[67] Id.

[68] Id. at 17–18.

[69] See generally id.

[70] Id. at 3.

[71] Judgment, United States v. AMAC, No. 23-cr-00148-CVR (D.P.R. July 13, 2023).

[72] Plea Agreement, United States v. Anyclo Int’l, Inc., No. 23-cr-00419-ES (D.N.J. Feb. 6, 2023), at Sched. A.

[73] Id.

[74] Id. at 2.

[75] Id.

[76] Judgment, United States v. Anyclo Int’l, Inc., No. 23-cr-00419-ES (D.N.J. June 12, 2023).

[77] Id.

[78] Press Release, U.S. Dep’t of Justice, Two Amazon Marketplace Sellers and Four Companies Plead Guilty to Price Fixing DVDs and Blu-Ray Discs (Feb. 13, 2023), at 1, https://www.justice.gov/opa/pr/two-amazon-marketplace-sellers-and-four-companies-plead-guilty-price-fixing-dvds-and-blu-ray (hereinafter “BDF Enterprises et al. Press Release”).

[79] Plea Agreement, United States v. BDF Enterprises, Inc., No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (e) (“BDF Plea Agreement”); Plea Agreement, United States v. Prime Brooklyn, LLC, No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (e) (“Prime Brooklyn Plea Agreement”); Plea Agreement, United States v. Michelle’s DVD Funhouse, Inc., No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (c) (“Michelle’s DVD Plea Agreement”); Plea Agreement, United States v. MJR Prime, LLC, No. 3:22-cr-24 (E.D. Tenn. Jan. 11, 2023), ¶ 5(a) – (c) (“MJR Prime Plea Agreement”).

[80] BDF Plea Agreement ¶ 10; Prime Brooklyn Plea Agreement ¶ 10; Michelle’s DVD Plea Agreement ¶ 10; MJR Prime Plea Agreement ¶ 10.

[81] BDF Plea Agreement ¶ 13; Prime Brooklyn Plea Agreement ¶ 14; Michelle’s DVD Plea Agreement ¶ 14; MJR Prime Plea Agreement ¶ 14.

[82] BDF Plea Agreement ¶ 10; Prime Brooklyn Plea Agreement ¶ 10; Michelle’s DVD Plea Agreement ¶ 10; MJR Prime Plea Agreement ¶ 10.

[83] BDF Enterprises et al. Press Release.

[84] Judgment, United States v. BDF Enters., Inc., No. 22-cr-00024-KAC-DCP (E.D. Tenn. July 24, 2023); U.S.S.G. § 8C3.4.

[85] Deferred Prosecution Agreement, United States v. Brit. Am. Tobacco P.L.C., No. 23-cr-118 (D.D.C. Apr. 25, 2023), at ¶ 1.

[86] Id.

[87] Id., at Attach. A ¶¶ 31, 36-41.

[88] Id., at Attach. A ¶¶ 30-31.

[89] Id., at Attach. A ¶¶ 4-11, 59-73.

[90] Id. at ¶ 7.

[91] Id. at ¶¶ 12-17.

[92] Id. at ¶ 3.

[93] OFAC Enforcement Release (Apr. 25, 2022), chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://ofac.treasury.gov/media/931666/download?inline.

[94] See DOJ Press Release, “British American Tobacco to Pay $629 Million in Fines for N. Korean Tobacco Sales; Charges Unsealed Against Tobacco Facilitators” (Apr. 25, 2023), https://www.justice.gov/usao-dc/pr/british-american-tobacco-pay-629-million-fines-n-korean-tobacco-sales-charges-unsealed.

[95] Non-Prosecution Agreement, Davey Tree and Wolf Tree, Inc. (July 13, 2023).

[96] Id. at 3–4.

[97] Id. at 4.

[98] Id. at 5.

[99] Id. at 6–7.

[100] Id. at 7.

[101] Id. at 10.

[102] Plea Agreement, United States v. Des International Co., Ltd., 1:23-cr-00107 (D.D.C. Mar., 23, 2023) (hereinafter “DES Plea Agreement”); Plea Agreement, United States v. Soltech Industry Co. Ltd., 1:23-cr-00107 (D.D.C. Mar., 23, 2023) (hereinafter “Soltech Plea Agreement”).

[103] Statement of Offense, DES Plea Agreement at 3–4; Statement of Offense, Soltech Plea Agreement at 3–4.

[104] Statement of Offense, DES Plea Agreement at 2, 4–8; Statement of Offense, Soltech Plea Agreement at 2, 4–8. Id. at 2, 4.

[105] Statement of Offense, DES Plea Agreement at 4–8; Statement of Offense, Soltech Plea Agreement at 4–8. Id. at 4–8.

[106] DES Plea Agreement at 4; Soltech Plea Agreement at 4.

[107] Judgment, United States v. Soltech Indus. Co., Ltd., No. 23-cr-00107-JMC (D.D.C. Apr. 26, 2023); Judgment, United States v. DES Int’l Co., Ltd., No. 23-cr-00107-JMC (D.D.C. Apr. 26, 2023).

[108] Plea Agreement, United States v. M&D Transp., Inc. & Diesel Tune-Ups of RI, Inc., No. 23-cr-00008-MSM-LDA (D.R.I. Jan. 26, 2023).),

[109] Id. at 8.

[110] Id. at 8–9.

[111] Id. at ¶ 5.

[112] Id.

[113] Id.

[114] Id.

[115] Id. at ¶ 6.

[116] Id. at ¶ 4.

[117] Plea Agreement, United States v. E.I. Du Pont De Nemours and Co. (April 24, 2023) (hereinafter “DuPont Plea Agreement”); Press Release, U.S. Dep’t of Justice, DuPont and former employee sentenced for gas release that killed four (April 24, 2023), https://www.justice.gov/usao-sdtx/pr/dupont-and-former-employee-sentenced-gas-release-killed-four.

[118] DuPont Plea Agreement at 2-3.

[119] Id. at 3.

[120] Id.

[121] Id. at 11.

[122] Judgment, United States v. E.I. Du Pont De Nemours and Co., No. 21-cr-00016 (S.D. Tex. May 2, 2023).

[123] 16 U.S.C. §§ 3372(a)(1), 3372(a)(4), and 3373(d)(1)(B); see also Press Release, U.S. Dep’t of Justice, Canadian Company Pleads Guilty to Selling Harp Seal Oil in the United States (June 5, 2023), at 1, https://www.justice.gov/opa/pr/canadian-company-pleads-guilty-illegally-selling-harp-seal-oil-united-states#:~:text=All%20News-,Canadian%20Company%20Pleads%20Guilty%20to%20Illegally%20Selling,Oil%20in%20the%20United%20States&text=FeelGood%20Natural%20Health%20Stores%20Ltd,Mammal%20Protection%20Act%20(MMPA).

[124] Plea Agreement, United States v. FeelGood Natural Health Stores, No. 2:23-cr-20189 (E.D.M.I. June 5, 2023), ¶¶ 4(1)-(5).

[125] Id. ¶¶ 5(B), (C).

[126] Id. ¶ 9(D)(a).

[127] Id.

[128] Id. ¶¶ 9(D)(a), (b)(i)-(ii).

[129] Deferred Prosecution Agreement, United States v. Genotox Lab’ys Ltd., No. 1:23-cr-00062 (W.D. Tex. Apr. 5, 2023), at 1 (hereinafter “Genotox DPA”).

[130] Id. at 2-3.

[131] Id.

[132] Id. at 4-5; see also DOJ Press Release, “Texas Laboratory Agrees to Pay $5.9 Million to Settle Allegations of Kickbacks to Third Party Marketers and Unnecessary Drug Tests” (Apr. 4, 2023), https://www.justice.gov/opa/pr/texas-laboratory-agrees-pay-59-million-settle-allegations-kickbacks-third-party-marketers-and.

[133] Genotox DPA at 13.

[134] Id. at 15.

[135] Settlement Agreement, United States v. Genotox Lab’ys Ltd., No. 2:20-cv-97 (S.D. Ga. Mar. 19, 2023), at 5 (hereinafter “Genotox Settlement Agreement”); Press Release, U.S. Dep’t of Justice, Texas Laboratory Agrees to Pay $5.9 Million to Settle Allegations of Kickbacks to Third Party Marketers and Unnecessary Drug Tests (Apr. 4, 2023), https://www.justice.gov/opa/pr/texas-laboratory-agrees-pay-59-million-settle-allegations-kickbacks-third-party-marketers-and.

[136] Genotox Settlement Agreement at 1, 3-5.

[137] Id. at 14.

[138] Genotox Settlement Agreement at 7, 12.

[139] Non-Prosecution Agreement, Great Circle (Jan. 27, 2023), at 1–2.

[140] Id., Statement of Facts, at ¶ 2.

[141] See id., Statement of Facts, at ¶¶ 3–6.

[142] See id., Attach. B.

[143] See id. at 1.

[144] See generally id.

[145] Plea Agreement, United States v. Greater Boston Behavioral Health LLC, No. 23-cr-10112-DLC (Mar. 13, 2023).

[146] Id., Statement of Facts, at ¶ 4–5.

[147] Id. at 3–4.

[148] Id. at 4.

[149] See id. at 2–3.

[150] Judgment, United States v. Greater Boston Behavioral Health, No. 23-cr-10112-DLC (D. Mass. May 16, 2023).

[151] Plea Agreement, United States v. Ground Zero Seeds Int’l, Inc., No. 3:22-cr-00073-IM (D. Or.) (hereinafter “GZI Plea Agreement”), at 2–3.

[152] Id.

[153] Id. at 3.

[154] Id. at 4.

[155] Id. at 3.

[156] See Judgment, United States v. Ground Zero Seeds Int’l, Inc., No. 3:22-cr-00073-IM (D. Or.).

[157] See generally id.; GZI Plea Agreement.

[158] Plea Agreement, United States v. Interunity Mgmt. (Deutschland) GmbH, No. 23-cr-01044-TWR (S.D. Cal. May 30, 2023) (hereinafter “Interunity Plea Agreement”), at 3.

[159] Id. at 4.

[160] Id. at 6.

[161] Id. at 14.

[162] Id. at 12.

[163] Id. at 13.

[164] Id.

[165] Id. at Attach. A.

[166] Id. at Attach. A., at 16.

[167] Non-Prosecution Agreement, United States v. IRB Brasil Resseguors SA (Apr. 20, 2023), at ¶ 1.

[168] Id. at ¶ 4.

[169] Id., Attach. A at A-1.

[170] Id., Attach. A at A-2.

[171] Id., Attach. A at A-3.

[172] Id., Attach. A at A-3, A-4.

[173] Id., Attach. A at A-3.

[174] Id. at ¶ 3.

[175] Id. at ¶¶ 11-13.

[176] Id. at ¶ 3.

[177] Id., Attach. C ¶¶ 1-15.

[178] Id. at ¶¶ 5, 15.

[179] Press Release, U.S. Dep’t of Justice, Kerry Inc. Pleads Guilty and Agrees to Pay $19.228 Million in Connection with Insanitary Plant Conditions Linked to 2018 Salmonella Poisoning Outbreak (Feb. 3, 2023), https://www.justice.gov/opa/pr/kerry-inc-pleads-guilty-and-agrees-pay-19228-million-connection-insanitary-plant-conditions (hereinafter “Kerry Press Release”).

[180] Id.

[181] Id.

[182] Id.

[183] Judgment, United States v. Kerry, Inc., No. 22-cr-10051-001 (C.D. Ill. Mar. 23, 2023) at 1, 3.

[184] Kerry Press Release.

[185] Plea Agreement, United States v. L5 Medical Holdings, LLC, d/b/a/ Pain Care Centers, No. 6:23-cr-12 (W.D. Va. (July 26, 2023) (hereinafter “L5 Medical Plea Agreement”).

[186] Id. at 1.

[187] See DOJ Press Release, “Pain Clinic Owner, L5 Medical Holdings Plead Guilty-Agree to Pay $4 Million in Restitution,” (July. 28, 2023), https://www.justice.gov/usao-wdva/pr/pain-clinic-owner-l5-medical-holdings-plead-guilty-agree-pay-4-million-restitution.

[188] Id.; see also L5 Medical Plea Agreement at 1.

[189] L5 Medical Plea Agreement at 4.

[190] Id. at 7.

[191] Plea Agreement, United States v. Nine2Five, LLC, No. 23-cr-179-TWR (July 10, 2023) (hereinafter “Nine2Five Plea Agreement”), at 3.

[192] Kratom, National Institute on Drug Abuse (March 25, 2022), https://nida.nih.gov/research-topics/kratom.

[193] Nine2Five Plea Agreement at 3.

[194] Id. at 8.

[195] Id. at 7.

[196] Press Release, U.S. Dep’t of Justice, General Contractor and Real Estate Developer Plead Guilty In Connection With Worker Death On Construction Site In Poughkeepsie (Feb. 2, 2023), https://www.justice.gov/usao-sdny/pr/general-contractor-and-real-estate-developer-plead-guilty-connection-worker-death.

[197] Id.

[198] Id.

[199] Sentencing Memorandum on Behalf of Onekey, LLC, United States v. Onekey LLC et al., No. 22-cr-000414 (PED) (S.D.N.Y. Apr. 28, 2023), at 2, 7.

[200] Id. at 1–2.

[201] Id. at 2.

[202] Judgment, United States v. One Key, LLC et al., No. 7:22-cr-00414-VR (S.D.N.Y. May 17, 2023); see also Press Release, U.S. Dep’t of Justice, Construction Company Principal Sentenced To Three Months In Prison In Connection With Worker Death On Construction Site In Poughkeepsie (May 12, 2023), https://www.justice.gov/usao-sdny/pr/construction-company-principal-sentenced-three-months-prison-connection-worker-death.

[203] Judgment, United States v. Finbar O’Neill, No. 7:22-cr-00414-VR (S.D.N.Y. May 12, 2023).

[204] See Press Release, U.S. Dep’t of Justice, “Mississippi Wastewater Hauling Business Pleads Guilty to Clean Water Act Violation,” (Jan. 11, 2023), https://www.justice.gov/usao-sdms/pr/mississippi-wastewater-hauling-business-pleads-guilty-clean-water-act-violation.

[205] See Press Release, U.S. Dep’t of Justice, “Owner of Jackson Business Pleads Guilty to Illegally Discharging Industrial Waste into Jackson’s Sewer System,” (Jan. 27, 2021), https://www.justice.gov/usao-sdms/pr/owner-jackson-business-pleads-guilty-illegally-discharging-industrial-waste-jackson-s.

[206] Information, United States v. Partridge-Sibley Industrial Services, Inc., No. 3:22-cr-131-CWR-FKB, at 3 (Dec. 19, 2022).

[207] See Press Release, U.S. Dep’t of Justice, “Owner of Jackson Business Pleads Guilty to Illegally Discharging Industrial Waste into Jackson’s Sewer System,” (Jan. 27, 2021), https://www.justice.gov/usao-sdms/pr/owner-jackson-business-pleads-guilty-illegally-discharging-industrial-waste-jackson-s.

[208] Plea Agreement, United States v. Partridge-Sibley Industrial Services, Inc., No. 3:22-cr-131-CWR-FKB, at 1 (Jan. 11, 2023, S.D. Miss.).

[209] Id. at 4.

[210] See Press Release, PSI, “Response to Gold Coast Commodities and Rebel High Velocity Case,” http://partridgesibley.com/downloads/Partridge_Sibley_Press_Release.pdf.

[211] Id.

[212] Judgment, United States v. Partridge-Sibley Indus. Servs., Inc., No. 22-cr-00131-FKB (S.D. Miss. Feb. 17, 2023).

[213] Plea Agreement, United States v. Quick Tricks Automotive Performance, Inc., 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023); Plea Agreement, United States v. Kloud9Nine, LLC, 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023) (hereinafter jointly “Quick Tricks and Kloud9Nine Plea Agreement”).

[214] Joint Statement of Facts, United States v. Quick Tricks Automotive Performance, Inc., 22-20516-CR-Williams (S.D. Fla. Jan. 27, 2023), at 4–5 (hereinafter “Quick Tricks and Kloud9Nine Joint Statement of Facts”). Id. at 4–5.

[215] Quick Tricks and Kloud9Nine Plea Agreements, at 5.

[216] Id.

[217] Judgment, United States v. Quick Tricks Auto. Perf., Inc., 22-cr-20516-KMW (S.D. Fla. May 10, 2023) (hereinafter “QuickTricks Judgment”); Judgment, United States v. Kloud9Nine, LLC, 22-cr-20516-KMW (S.D. Fla. June 13, 2023) (hereinafter “Kloud9Nine Judgment”).

[218] QuickTricks Judgment; Kloud9Nine Judgment.

[219] QuickTricks Judgment; Kloud9Nine Judgment.

[220] QuickTricks Judgment; Kloud9Nine Judgment.

[221] Plea Agreement, United States v. Pure Addiction Diesel Performance, LLC, No. 3:23-cr-00189-SI (D. Or. May 30, 2023).

[222] Id. at 2-3.

[223] Id. at 3.

[224] Id. at 3–4.

[225] Id.

[226] Plea Agreement, United States v. Travis Turner, No. 3:23-cr-00189-SI (D. Or. May 30, 2023).

[227] Plea Agreement, United States v. Rhode Island Beef and Veal, No. 20-cr-00093-MSM-PAS (D.R.I. Apr. 4, 2023) (hereinafter “Rhode Island Beef and Veal Plea Agreement”).).

[228] Id. at 1.

[229] Press Release, U.S. Dep’t of Justice, Rhode Island Beef Slaughterhouse, Owner Admit to Violating the Federal Meat Inspection Act (June 8, 2023), https://www.justice.gov/usao-ri/pr/rhode-island-beef-slaughterhouse-owner-admit-violating-federal-meat-inspection-act.

[230] Rhode Island Beef and Veal Plea Agreement at 2.

[231] Id.

[232] Plea Agreement, United States v. Sterling Bancorp, Inc., 5:23-CR-20174 (E.D. Mich. Mar. 15, 2023) (hereinafter “Sterling Plea Agreement”).).

[233] Id. at 4–5; Attach. A-4–A-6.

[234] Id.

[235] Sterling Plea Agreement at 4–5; Attach. A-4–A-6.

[236] Id.

[237] Id. at 6–7.

[238] Id. at 21.

[239] Id.

[240] Id. at 22.

[241] Id. at 23–24.

[242] Id. at 25.

[243] Id. at 7–8.

[244] Judgment, United States v. Sterling Bancorp, Inc., No. 23-cr-20174-LVP-DRG (July 21, 2023), ECF No. 14.

[245] Plea Agreement, United States v. Telefonaktiebolaget LM Ericsson, No. 1:19-CR-00884-LTS (S.D.N.Y. Mar. 20, 2023), at ¶ 2 (hereinafter “Ericsson Plea Agreement”).

[246] Id., Attach. A-1, Factual Basis for Breach.

[247] Id.

[248] Ericsson Plea Agreement at 19.

[249] Plea Agreement, United States v. Zeus Lines Management S.A., No. 1:23-CR-00028-MSM-LDA-01 (D.R.I. Mar. 24, 2023), (hereinafter “Zeus Plea Agreement”).

[250] Id. at 8-9.

[251] Id. at 3-4.

[252] Id. at 6-7.

[253] Id. at 7.

[254] Id. at 3-4.

[255] Id. at 8-9.

[256] Press Release, U.S. Dep’t of Justice, Vessel Operator, Captain and Chief Engineer Convicted of Environmental Crimes (May 3, 2023), at 2, https://www.justice.gov/opa/pr/vessel-operator-captain-and-chief-engineer-convicted-environmental-crimes.

[257] Zeus Plea Agreement, at 16.

[258] See id., Attach A, at 2.

[259] Id., Attach A, at 4-5.

[260] Id., Attach A, at 10.

[261] Press Release, U.S. Dep’t of Justice, United States v. Zeus Lines Mgmt. S.A. et al., No. 1:23-CR-00028 (May 10, 2023), https://www.justice.gov/enrd/case/united-states-v-zeus-lines-management-sa-et-al.

[262] As discussed in this alert’s full summary of the Genotox resolutions, the Genotox civil resolution included $4,995,278.85 as a “suspended” amount. While the settlement agreement refers to Genotox’s “payments” to the government as “restitution to the United States,” the suspended amount is not a payment by Genotox but rather is a sum the government retained after the underlying lawsuit was filed. See Genotox CSA at 1, 3–5. Accordingly, we have not counted the “suspended” amount in the total monetary recoveries for the Genotox resolutions. Similarly, the Genotox CSA calls for additional, contingent restitution depending upon Genotox’s future revenues. Id. at 4–5. Because of the contingent nature of those obligations, we have not accounted for them in the total monetary recoveries figure for Genotox.

The following Gibson Dunn lawyers participated in preparing this client update: F. Joseph Warin, M. Kendall Day, Courtney Brown, Melissa Farrar, Michael Dziuban, Benjamin Belair, Alexandra Buettner, Sarah Hafeez, Erika Suh Holmberg, Teddy Kristek, Madelyn La France, Andrea Lattanzio, Allison Lewis, Jacob McGee, Kelly Skowera, Alyse Ullery-Glod, Mike Ulmer, and Blair Watler.

Gibson Dunn’s White Collar Defense and Investigations Practice Group successfully defends corporations and senior corporate executives in a wide range of federal and state investigations and prosecutions, and conducts sensitive internal investigations for leading companies and their boards of directors in almost every business sector. The Group has members across the globe and in every domestic office of the Firm and draws on more than 125 attorneys with deep government experience, including more than 50 former federal and state prosecutors and officials, many of whom served at high levels within the Department of Justice and the Securities and Exchange Commission, as well as former non-U.S. enforcers. Joe Warin, a former federal prosecutor, is co-chair of the Group and served as the U.S. counsel for the compliance monitor for Siemens and as the FCPA compliance monitor for Alliance One International. He previously served as the monitor for Statoil pursuant to a DOJ and SEC enforcement action. He co-authored the seminal law review article on NPAs and DPAs in 2007. M. Kendall Day is a partner in the Group and a former white collar federal prosecutor who spent 15 years at the Department of Justice, rising to the highest career position in the DOJ’s Criminal Division as an Acting Deputy Assistant Attorney General.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, the authors, or any of the following leaders and members of the White Collar Defense and Investigations practice group:

Washington, D.C.
F. Joseph Warin (+1 202-887-3609, [email protected])
Stephanie Brooker (+1 202-887-3502, [email protected])
Courtney M. Brown (+1 202-955-8685, [email protected])
David P. Burns (+1 202-887-3786, [email protected])
John W.F. Chesley (+1 202-887-3788, [email protected])
Daniel P. Chung (+1 202-887-3729, [email protected])
M. Kendall Day (+1 202-955-8220, [email protected])
David Debold (+1 202-955-8551, [email protected])
Michael S. Diamant (+1 202-887-3604, [email protected])
Gustav W. Eyler (+1 202-955-8610, [email protected])
Richard W. Grime (+1 202-955-8219, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
George J. Hazel (+1 202-887-3674, [email protected])
Judith A. Lee (+1 202-887-3591, [email protected])
Adam M. Smith (+1 202-887-3547, [email protected])
Patrick F. Stokes (+1 202-955-8504, [email protected])
Oleh Vretsona (+1 202-887-3779, [email protected])
Amy Feagles (+1 202-887-3699, [email protected])
David C. Ware (+1 202-887-3652, [email protected])
Ella Alves Capone (+1 202-887-3511, [email protected])
Nick Murphy (+1 202-777-9504, [email protected])
Melissa Farrar (+1 202-887-3579, [email protected])
Nicole Lee (+1 202-887-3717, [email protected])
Jason H. Smith (+1 202-887-3576, [email protected])
Pedro G. Soto (+1 202-955-8661, [email protected])

New York
Zainab N. Ahmad (+1 212-351-2609, [email protected])
Reed Brodsky (+1 212-351-5334, [email protected])
Mylan L. Denerstein (+1 212-351-3850, [email protected])
Barry R. Goldsmith (+1 212-351-2440, [email protected])
Karin Portlock (+1 212-351-2666, [email protected])
Mark K. Schonfeld (+1 212-351-2433, [email protected])
Orin Snyder (+1 212-351-2400, [email protected])
Alexander H. Southwell (+1 212-351-3981, [email protected])
Brendan Stewart (+1 212-351-6393, [email protected])

Denver
Ryan T. Bergsieker (+1 303-298-5774, [email protected])
Robert C. Blume (+1 303-298-5758, [email protected])
John D.W. Partridge (+1 303-298-5931, [email protected])
Laura M. Sturges (+1 303-298-5929, [email protected])

Houston
Gregg J. Costa (+1 346-718-6649, [email protected])

Los Angeles
Michael H. Dore (+1 213-229-7652, [email protected])
Michael M. Farhang (+1 213-229-7005, [email protected])
Diana M. Feinstein (+1 213-229-7351, [email protected])
Douglas Fuchs (+1 213-229-7605, [email protected])
Nicola T. Hanna (+1 213-229-7269, [email protected])
Poonam G. Kumar (+1 213-229-7554, [email protected])
Marcellus McRae (+1 213-229-7675, [email protected])
Eric D. Vandevelde (+1 213-229-7186, [email protected])
Debra Wong Yang (+1 213-229-7472, [email protected])

San Francisco
Winston Y. Chan (+1 415-393-8362, [email protected])
Charles J. Stevens (+1 415-393-8391, [email protected])
Michael Li-Ming Wong (+1 415-393-8333, [email protected])

Palo Alto
Benjamin Wagner (+1 650-849-5395, [email protected])

London
Patrick Doris (+44 20 7071 4276, [email protected])
Sacha Harber-Kelly (+44 20 7071 4205, [email protected])
Michelle Kirschner (+44 20 7071 4212, [email protected])
Matthew Nunan (+44 20 7071 4201, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])

Paris
Benoît Fleury (+33 1 56 43 13 00, [email protected])
Bernard Grinspan (+33 1 56 43 13 00, [email protected])

Frankfurt
Finn Zeidler (+49 69 247 411 530, [email protected])

Munich
Katharina Humphrey (+49 89 189 33 155, [email protected])
Benno Schwarz (+49 89 189 33 110, [email protected])
Mark Zimmer (+49 89 189 33 115, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788/+1 303-298-5980, [email protected])
Oliver D. Welch (+852 2214 3716, [email protected])

Singapore
Joerg Biswas-Bartz (+65 6507 3635, [email protected])

Originally published by PLI Chronicle

Much ink has been spilled about the role of artificial intelligence (AI) in employment, especially in light of the developing menagerie of laws seeking to govern automated decision tools in the workplace. And rightly so—this is a burgeoning area with daily developments that must be carefully monitored. From enforcement of New York City’s AI employment law beginning on July 5, 2023 to a barrage of proposed bills like U.S. Senator Casey’s No Robot Bosses Act, there has seldom been a dull moment in 2023. However, amidst all of the buzz around automation in the workplace, privacy regulations have emerged as yet another piece of the employment puzzle.

Where Does Privacy Come In?

Privacy regulations play a key role in the effective governance of AI in the workplace. AI systems are increasingly processing personal data—ranging from demographic data to biometric data—by using algorithms to analyze and extract insights from various types of information to make predictions, recommendations, or even decisions for an employer. By implementing an AI system that collects and processes this personal data, the employer may be responsible for ensuring compliance with the evolving patchwork of laws governing the use of AI in employment decision making but also with many existing data protection laws, depending on their geographical scope and use.

Read More

Reproduced with permission. Originally published in PLI Chronicle: Insights and Perspectives for the Legal Community (August 2023).

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 Artificial Intelligence, Labor & Employment, or Privacy, Cybersecurity & Data Innovation practice groups, or the authors:

Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])

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

On August 30, 2023, the IRS and Treasury published proposed Treasury regulations (the “Proposed Regulations”) providing expansive guidance on the prevailing wage and apprenticeship requirements (the “PWA Requirements”) that taxpayers must[1] satisfy to receive the full credit amount[2] available under various revised and new tax credits provided for in the Inflation Reduction Act of 2022 (the “IRA”).[3] Taxpayers are permitted to rely on the Proposed Regulations with respect to a facility[4] on which construction began on or after January 29, 2023 but before final regulations are published.[5]

The Proposed Regulations are detailed, and a comprehensive discussion of them is beyond the scope of this alert. Instead, this alert begins with some background regarding these requirements, then provides a short summary of the Prevailing Wage Requirement and the Apprentice Requirements (including, with respect to each requirement, a short description of the consequences of noncompliance, remediation opportunities, and recordkeeping obligations), and concludes with observations regarding key implications of the guidance for market participants.

Background

The IRA introduced the PWA Requirements with the intent of “creating good-paying union jobs” in the clean energy, manufacturing, and construction sectors.[6] At a high level, the “Prevailing Wage Requirement” requires that all laborers and mechanics employed by a taxpayer (or a contractor or subcontractor of such taxpayer) claiming an applicable credit[7] are paid wages for construction, alteration, or repair of the applicable facility that are not less that the “prevailing” wage for that type of work. The Apprenticeship Requirements (as defined below) are focused on making sure that project developers make on-the-job training opportunities available to the next generation of skilled tradesmen.

Key Prevailing Wage Requirements

The Proposed Regulations provide substantial practical guidance on compliance with the Prevailing Wage Requirement. The Proposed Regulations clarify which workers must be paid prevailing wages, describe the types of work that constitutes construction, alteration, or repair of a facility, and explain how to determine and pay prevailing wages. The subsections below describe some of the most significant aspects of the guidance on these topics.

Workers Subject to the Prevailing Wage Requirement

Workers engaging in construction, alteration, or repair of a facility (described below) must be paid at or above the prevailing wage if they are laborers or mechanics employed by the taxpayer or its contractor or subcontractor. The Proposed Regulations provide clarity on the meaning of these terms.

A laborer or mechanic is any worker whose duties are manual or physical in nature and includes apprentices and helpers. Generally, this definition excludes individuals with roles that are primarily administrative, executive, or clerical. The IRS and Treasury are seeking comments regarding the treatment of persons whose roles are not primarily physical in nature, such as a foreperson, owner, or administrator, but who perform certain duties that are physical in nature.[8]

A person is employed if the person performs the duties of a laborer, mechanic, contractor, or subcontractor. The term “employed” is intended to be significantly broader in the prevailing wage context than in the employment tax context.[9] Accordingly, workers, regardless of whether they would be viewed as employees or independent contractors for other purposes of the Code, may be “employed” by the taxpayer, its contractor, or its subcontractor.

The taxpayer[10] can be any person subject to taxation under the Internal Revenue Code (including a partnership and an entity that is permitted to make a “direct pay” election under section 6417[11]).

A contractor is any person that enters into a contract with the taxpayer for construction, alteration, or repair of a qualified facility and a subcontractor is any person that agrees to perform or be responsible for any part of such a contract.

Scope of Construction, Alteration, or Repair of the Facility

The Proposed Regulations clarify that “construction, alteration, or repair” (i.e., the types of work covered by the Prevailing Wage Requirement) should be construed expansively, but do clarify that ordinary maintenance work (i.e., work that is intended to sustain the existing functionality of the facility) is not covered by the Prevailing Wage Requirement.[12] In addition, work that would fit within the broad definition of “construction, alteration, or repair” is subject to the Prevailing Wage Requirement only if the physical work occurs at the physical site of the facility (including any adjacent or virtually adjacent dedicated support site) or at a secondary site that is established specifically for or dedicated exclusively to the construction of such facility for a meaningful time.[13]

For example, if a taxpayer builds a wind farm, the construction at the site where the wind farm will be located would be subject to the Prevailing Wage Requirement. If a significant portion of the facility is constructed at an off-site warehouse that was established specifically to assist with, or dedicated exclusively for a specific period of time to, the construction of the wind farm, work completed at the off-site warehouse also would be subject to the Prevailing Wage Requirement. However, if the step-up transformer is constructed at an off-site location that (during the transformer’s construction) is building transformers for other wind farms, the labor performed on the transformer at that location is generally not subject to the Prevailing Wage Requirement, at least with respect to the construction of the taxpayer’s wind farm.

How to Determine Prevailing Wages

The Wage and Hour Division of the Department of Labor is responsible for making prevailing wage determinations. The prevailing wage is based on the type of construction, the type of labor performed, and the geographic area in which the labor is performed. The Proposed Regulations indicate that, when a taxpayer plans to construct, alter, or repair a facility, the taxpayer (and its contractors or subcontractors) will be able to find the prevailing wage for the applicable type of construction and location for each type of labor they expect to require on a website approved by the Department of Labor (currently www.sam.gov), rather than being required to seek an individualized, project-specific ruling.

In general, taxpayers can pay registered apprentices less than the prevailing wage rate that would need to be paid to a journeyworker[14] performing the same type of work, but not less than the rate (and fringe benefits) specified by the registered apprenticeship program.[15] For any hours worked by an apprentice in excess of the ratio permitted by the Ratio Requirement (a requirement described below requiring an appropriate ratio of apprentices to more experienced workers), the Proposed Regulations provide that the apprentice must be paid not less than the wage rate that would need to be paid to a journeyworker for the same type of work.

As noted above, the IRS and Treasury expect that prevailing wages will be available from the website approved by the Department of Labor. The Proposed Regulations make clear, however, that a supplemental, facility-specific wage determination can be requested from the Department of Labor if (i) the facility spans more than one geographic area,[16] (ii) there is no general wage determination currently available for a particular geographic area or type of work, or (iii) the wages for certain labor classifications are not listed on the generalized Department of Labor website.[17] If a taxpayer only discovers that it has not paid prevailing wages when the Department of Labor subsequently makes a determination of the prevailing wage rate, the taxpayer has 30 days from the date of determination to remediate the failure by making “catch-up” payments to the laborers and mechanics who have received insufficient wages.

The Proposed Regulations helpfully clarify that, in general, applicable prevailing wages are required to be determined only at the outset of the work, although wage rates must be refreshed if a contract is expanded to cover additional work not within its original scope. In addition, for any alteration or repair work on a facility that occurs after the facility is placed in service, taxpayers must use the prevailing wage in effect at the time the alteration or repair work begins.

How to Pay and How Long to Pay the Prevailing Wage

After determining both which workers are subject to the Prevailing Wage Requirement and the prevailing wage rates applicable to those workers, employers must pay workers prevailing wages through regular payroll practices, without subsequent deduction or rebate of any kind (except as required by law or permitted by regulations issued by the Secretary of Labor). For production tax credit facilities, the Prevailing Wage Requirement generally applies during the life of the production tax credit, whereas for an investment tax credit facility the relevant period is, in general, five years (i.e., the recapture period).

Apprenticeship Requirements

In addition to the Prevailing Wage Requirement, taxpayers must abide by three apprenticeship requirements (the “Apprenticeship Requirements”) in connection with construction, alteration, or repair of a facility to receive full tax amounts for certain tax credits.[18] First, the “Labor Hours Requirement” specifies the required percentage of labor hours that must be performed by qualified apprentices.[19] Second, the “Ratio Requirement” mandates that the taxpayer abide by the applicable apprentice-to-journeyworker ratio, as determined by the Department of Labor or applicable state apprenticeship agency. Third, under the “Participation Requirement,” each taxpayer, contractor, or subcontractor that employs four or more individuals to perform construction, alteration, or repair work with respect to the construction of the qualified facility must employ one or more qualified apprentices to perform that work. The Proposed Regulations clarify the relationship among the Apprenticeship Requirements and provide further explanation and rules that generally tighten the requirements.

Labor Hours Requirement

The Proposed Regulations reiterate that, under the Labor Hours Requirement, the “applicable percentage”[20] of total labor hours must be performed by qualified apprentices.[21] The Proposed Regulations make clear that the Labor Hours Requirement is subject to the Ratio Requirement, meaning that hours worked by a qualified apprentice that do not comply with the Ratio Requirement will not be counted as labor hours by a qualified apprentice for purposes of meeting the Labor Hours Requirement.

Ratio Requirement

The Ratio Requirement is intended to ensure there are sufficient supervising journeyworkers onsite.[22] The applicable apprentice-to-journeyworker ratio for a particular apprentice will be determined by the registered apprenticeship program in which that apprentice is participating, and also would be subject to the requirements of the Department of Labor and applicable state apprenticeship agencies. The Proposed Regulations clarify that the Ratio Requirement applies on a daily basis.

Participation Requirement

The Participation Requirement requires that each taxpayer, contractor, or subcontractor who employs four or more individuals to perform construction, alteration, or repair work with respect to the construction of a qualified facility must employ one or more qualified apprentices to perform such work. The Proposed Regulations clarify that the Participation Requirement is not a daily requirement. Because the Participation Requirement is designed to prevent taxpayers from satisfying the Labor Hours Requirement by only hiring apprentices to perform one type of work, the Proposed Regulations provide that the Participation Requirement must be satisfied separately by the taxpayer and each contractor and subcontractor (if any such person has four or more employees who perform relevant work on the facility); however, the taxpayer ultimately must ensure that each of its contractors and subcontractors (if applicable) has satisfied the Participation Requirement.

Noncompliance Rules and Remedies

Prevailing Wage Requirement – Penalties and Correction Payments

Under the Proposed Regulations, if a taxpayer fails to satisfy the Prevailing Wage Requirement, the taxpayer may cure that failure and retain the credit by making a correction payment to all impacted laborers and mechanics, as well as paying any applicable penalties.

For any period during which a laborer or mechanic was paid wages that failed to satisfy the Prevailing Wage Requirement, the correction payment is calculated as the difference between the wages that should have been paid under the Prevailing Wage Requirement and all wages paid to that laborer or mechanic for the period, plus interest.[23] The Proposed Regulations require that a correction payment must be made even if the taxpayer is not able to locate one or more of the impacted laborers or mechanics, requiring taxpayers to comply with, for example, state-administered unclaimed wage programs.

In addition to any back wages and interest, taxpayers are required to pay a $5,000 penalty for each laborer or mechanic who was underpaid for each applicable year. Helpfully, the Proposed Regulations provided that this penalty is waived automatically in certain quickly discovered and corrected situations. The automatic waiver has two conditions:

The taxpayer makes the correction payment not later than the earlier of (i) 30 days after the date taxpayer becomes aware of the error and (ii) the date on which the tax return claiming the credit is filed; and

Either (i) the laborer or mechanic was underpaid for not more than 10 percent of all relevant periods or (ii) the underpayment was not greater than 2.5 percent of what the laborer or mechanic should have been paid under the Prevailing Wage Requirements.

If the IRS determines that any failure to satisfy the Prevailing Wage Requirements was due to intentional disregard, the required correction payment amount is increased by a multiple of three and the penalty rate is increased from $5,000 to $10,000.[24] The Proposed Regulations provide a non-exclusive list of facts that might be considered in the determination of whether a failure to meet the Prevailing Wage Requirements is due to intentional disregard, including whether (i) the failure to pay prevailing wages by the taxpayer is part of a pattern of conduct, (ii) the taxpayer promptly cured any failures to pay prevailing wages, (iii) the taxpayer included (and caused to be included) provisions in contracts with contractors and subcontractors ensuring compliance with the Prevailing Wage Requirement, and (iv) the taxpayer provided notice to laborers and mechanics of the Prevailing Wage Requirement (such as by posting information prominently at the site of work). Notably, the Proposed Regulations provide a rebuttable presumption that a failure was not intentional with respect to the Prevailing Wage Requirements if the taxpayer makes all correction and penalty payments before receiving a notice from the IRS, giving taxpayers a meaningful incentive to take steps proactively to monitor compliance with the Prevailing Wage Requirement.[25]

The Proposed Regulations also clarify that, for credits sold pursuant to section 6418, credit sellers would be responsible for any correction payments and penalties with respect to the Prevailing Wage Requirements, although credit buyers would still remain liable for any resulting excessive credit transfer tax resulting from the failure to meet the Prevailing Wage Requirements.

Apprenticeship Requirements – Penalties

If a taxpayer does not satisfy the Apprenticeship Requirements or the Good Faith Effort Exception (discussed below), the taxpayer may still receive the full tax credit amount if the taxpayer pays a $50 penalty ($500 for intentional disregard) for each labor hour for which the taxpayer failed to meet the Labor Hours Requirement or the Participation Requirement. For the Labor Hours Requirement, the penalty is applied to the shortfall by which the “applicable percentage” of labor hours exceeded the hours actually worked by qualified apprentices (a single aggregate computation). For the Participation Requirement, the penalty is computed separately for the taxpayer and each of its contractor(s) and subcontractor(s) (but the penalty is payable only by the taxpayer) and is applied to the quotient of the total number of relevant labor hours worked by all individuals employed by the non-compliant employer divided by the total number of such individuals employed by such non-compliant employer.

Similar to the Prevailing Wage Requirement, the Proposed Regulations provide a non-exclusive list of facts that might be considered in the determination of whether a failure to meet the Apprenticeship Requirements is due to intentional disregard, including whether (i) the failure was part of a pattern of conduct by the taxpayer, (ii) the taxpayer promptly cured the failure, (iii) the taxpayer included (and caused to be included) provisions in contracts with contractors and subcontractors ensuring compliance with the Apprenticeship Requirements, and (iv) the taxpayer had been required to make a penalty payment in respect of the Apprenticeship Requirements in prior tax years. As with the Prevailing Wage Requirements, the Proposed Regulations also provide a rebuttable presumption that a failure was not intentional if the taxpayer makes all penalty payments before receiving a notice from the IRS.

As is the case for the Prevailing Wage Requirements, credit sellers under section 6418 would be responsible for any penalties with respect to the Apprenticeship Requirement, but credit buyers would still remain liable for any resulting excessive credit transfer tax resulting from the failure to meet the Apprenticeship Requirements.

Qualifying Project Labor Agreement

The Proposed Regulations would provide that penalty payments will not be required if there is a Qualifying Project Labor Agreement in place and if a correction payment is paid to a laborer or mechanic on or prior to the date on which the tax credit is claimed. In general, a Qualifying Project Labor Agreement is a pre-hire collective bargaining agreement with one or more labor organizations for a specific construction project that meets criteria detailed in the Proposed Regulations.[26]

Good Faith Effort Exception

The Code excuses taxpayers from complying with the Apprenticeship Requirements if they have requested qualified apprentices from a registered apprenticeship program and either the request is denied for a reason other than noncompliance with the standards or requirements of the program or the program does not acknowledge receipt of the request or otherwise respond to the taxpayer within five business days after receiving a request (the “Good Faith Effort Exception”).[27]

Generally, the Proposed Regulations would require additional effort by a taxpayer to satisfy the Good Faith Effort Exception. One key modification is that the Proposed Regulations would require a written request be made to at least one registered apprenticeship program that trains apprentices in the necessary occupation(s) and has a customary business practice of entering into agreements with employers to place apprentices in their trained occupation.[28] In addition, the registered apprenticeship program to which the taxpayer submits the written request either must (i) operate within the geographic area that includes the location of the facility or (ii) reasonably be expected to be able to provide apprentices to the facility’s location. The IRS expects that taxpayers may need to submit requests to multiple apprenticeship programs, depending on the number of occupations involved in the project and the anticipated number of required apprentice labor hours.

Under the Proposed Regulations, a denial of a written request from a registered apprenticeship program, or a non-response to such a written request, will permit a taxpayer to rely on the Good Faith Effort Exception only for 120 days after the date on which the request was submitted. Thereafter, the taxpayer would be required to submit an additional request to continue to rely on the Good Faith Effort Exception. As a result, to continue to rely on the Good Faith Effort Exception, a taxpayer would have to submit requests to a registered apprenticeship program and have those requests be denied by the registered apprenticeship program on a rolling 120-day basis. Further, a partially denied request is to be treated as a denial solely with respect to that part of the request that is denied.

Recordkeeping and Reporting Requirements

The Proposed Regulations specify certain records that taxpayers must maintain to substantiate that the Prevailing Wage Requirement and Apprenticeship Requirements have been satisfied, including (at a minimum) payroll records that reflect the wages paid to laborers, mechanics and qualified apprentices engaged in the construction, alteration, or repair of the facility, regardless of whether the laborers and mechanics are employed by the taxpayer, a contractor, or a subcontractor.

For the Prevailing Wage Requirement, sufficient records “may include” the labor classification(s) used for determining the prevailing wage rate (and documentation supporting the applicable classification), the hourly rate(s) of wages paid for each applicable labor classification, records supporting fringe benefit calculations (detailed in the Proposed Regulations), the total number of labor hours worked and wages paid per pay period, records to support wages paid to any apprentices (including records reflecting the registration of the apprentices, the applicable wage rates and apprentice-to-journeyworker ratios), and the amount and timing of any correction payments (and documentation reflecting their calculation).

For the Apprenticeship Requirements, records sufficient to establish compliance may include copies of any written requests for apprentices, any agreements with a registered apprenticeship program, documents verifying participation in a registered apprenticeship program by each apprentice, and the payroll records for any work performed by apprentices. Like the Prevailing Wage Requirement, the Proposed Regulations would provide that it is the responsibility of the taxpayer to maintain the relevant records for each apprentice, regardless of whether the apprentice is employed by the taxpayer, a contractor, or a subcontractor.

The Proposed Regulations do not include detailed reporting requirements, but the preamble indicates that the IRS and Treasury expect that taxpayers will be required to report, at the time of filing a return: (i) the location and type of qualified facility; (ii) the applicable wage determinations for the type and location of the facility; (iii) the wages paid (including any correction payments) and hours worked for each of the laborer or mechanic classifications engaged in the construction, alteration, or repair of the facility; (iv) the number of workers who received correction payments; (v) the wages paid and hours worked by qualified apprentices for each of the laborer or mechanic classifications engaged in the construction, alteration, or repair of the facility; (vi) the total labor hours for the construction, alteration, or repair of the facility by any laborer or mechanic employed by the taxpayer or any contractor or subcontractor; and (vii) the total credit claimed.[29]

Commentary

Many aspects of the Proposed Regulations will facilitate efficient administration of the IRA, though other aspects of the guidance could be clarified further to provide taxpayers with greater guidance as to their obligations under the PWA Requirements.

Allocation of Legal Responsibility for PWA Requirements. The Proposed Regulations make clear that the taxpayers who claim or transfer tax credits (and not the contractors or subcontractors of those taxpayers) are ultimately responsible for complying with the PWA Requirements. Thus, the onus is on the taxpayer to carefully monitor compliance with the PWA Requirements, ensure its contractors and subcontractors comply with the PWA Requirements, and maintain adequate records demonstrating compliance with the PWA Requirements. Well-advised taxpayers likely will seek to include provisions in their agreements with contractors to ensure that the PWA Requirements are satisfied and that necessary records and information substantiating the satisfaction of those requirements is maintained.

Incentives for Self-Policing. The Proposed Regulations encourage taxpayers to carefully monitor failures to meet the PWA Requirements, proactively report these failures to the IRS, and then affirmatively and timely make correction payments. If taxpayers take these steps, as long as the noncompliance is relatively minor, then the Proposed Regulations generally allow taxpayers to avoid the application of penalties. Given these benefits, taxpayers will want to put in place procedures for monitoring compliance, including compliance by contractors and their subcontractors.

Useful Begun Construction Rule, with Limits. Under the Proposed Regulations, prevailing wage determinations generally have to be made only once, in connection with the commencement of construction. This rule does not apply, however, if there is a change in the scope of work originally envisioned. Given that scope changes are relatively common in the course of constructing a facility, this exception could apply relatively frequently. It would be useful if the exception were adjusted to apply in more limited circumstances (g., to major changes that result in a more than 10 percent adjustment to the contract price).[30]

Enhanced Apprenticeship Requirements. The Proposed Regulations would tighten significantly the rules applicable to the Apprenticeship Requirements, including by limiting the scope of the Good Faith Effort Exception by providing that denial of a request for qualified apprentices lasts only 120 days after the submission of the request. This rule will make it necessary for developers to approach registered apprenticeship programs repeatedly. The IRS and Treasury’s further clarification that it may be necessary to make inquiries to multiple registered apprenticeship programs suggests that the IRS and Treasury are very focused on making sure that apprentices receive training opportunities, even if doing so imposes incremental compliance burdens.

Incentives for Entering into Qualifying Project Labor Agreement. Under the Proposed Regulations, if a Qualifying Project Labor Agreement (e.g., collective bargaining agreement meeting certain criteria) is entered into, various penalties can be eliminated as long as any needed correction payment is made before the credit is claimed. This rule will provide some level of incentive for developers to pursue these types of agreements.

Helpful Rule for Offshore Wind Projects. The Proposed Regulations include a helpful convention for offshore wind projects. Rather than requiring that each offshore wind project make a request for an individualized supplemental wage determination (given that general Department of Labor data is unlikely to cover offshore sites), the Proposed Regulations allow use of the generalized information prepared by the Department of Labor for the closest geographical area.

Scope of Apprenticeship Requirements. The Code contains an ambiguity concerning whether the Labor Hours Requirement and Participation Requirements apply only to the “construction” of a facility (as opposed to the Prevailing Wage Requirements, which apply to both the construction phase of a facility and alteration and repair work performed after the construction phase with respect to the facility). Interestingly, the Proposed Regulations suggest that the Participation Requirement would apply only to the construction phase of a facility (but would apply to all alteration and repair work, if any, occurring during that construction phase). In contrast, the Proposed Regulations suggest that the Labor Hours Requirement would apply to both the construction of the facility and alteration and repair work performed after the construction phase with respect to the facility. It would be helpful for the IRS and Treasury to state its interpretation explicitly and to clarify this apparent discrepancy in the preamble to the final regulations. Further, more examples of the application of these and other rules that are more fact-intensive in application (including, for example, the secondary site rule) would be especially helpful.

____________________________

[1] Compliance with the prevailing wage and apprenticeship requirements is not required for facilities (i) that have a maximum net output or storage capacity of less than one megawatt or (ii) the construction of which began before January 29, 2023.

[2] Technically, the baseline tax credit is multiplied by five if the PWA Requirements are met, resulting in a tax credit amount that traditionally has been considered the full amount of the federal income tax credits that may be claimed in respect of clean energy technologies. This full credit amount also can be increased by so-called adders, such as the domestic content adder and the energy community adder. Please see our prior client alerts on these adders, which can be found here and here, respectively.

[3] As was the case with the so-called Tax Cuts and Jobs Act, the Senate’s reconciliation rules prevented Senators from changing the Act’s name, and the formal name of the so-called Inflation Reduction Act is actually “An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.” In addition to tax credit guidance, the proposed regulations also include guidance regarding the PWA Requirements under section 179D, which provides a deduction for the cost of energy efficient commercial building property placed in service during the taxable year.

[4] Depending on the type of credit at issue, the applicable facility may be a qualified facility, property, project, or certain other equipment or facilities. For the purposes of this alert, we use the term “facility” to refer generally to those assets in respect of which a taxpayer is permitted to claim an applicable credit.

[5] Unless indicated otherwise, all section references are to the Internal Revenue Code of 1986, as amended (the “Code”).

[6] See Fact Sheet: One Year In, President Biden’s Inflation Reduction Act is Driving Historic Climate Action and Investing in America to Create Good Paying Jobs and Reduce Costs, The White House, Aug. 16, 2023, here.

[7] Tax credits with a prevailing wage or apprenticeship requirement include those credits provided for under sections 30C, 45, 45L, 45Q, 45U, 45V, 45Y, 45Z, 48, 48C, and 48E.

[8] Under the Proposed Regulations, working forepersons who devote more than 20 percent of their time during a workweek to laborer or mechanic duties, and who do not meet the criteria for exemption of 29 CFR part 541, would be considered laborers and mechanics for the time spent conducting laborer and mechanic duties.

[9] The preamble to the Proposed Regulations expressly provides that the term “employed,” as used in connection with the PWA Requirements, is not intended to apply for other purposes of the Code.

[10] In the case of any credits that were transferred pursuant to section 6418, the “taxpayer” is the credit transferor, not the transferee. Please see our prior alert on the proposed regulations on credit transferability, which is found here.

[11] Please see our prior client alert on the proposed regulations on direct pay, found here.

[12] The Proposed Regulations provide that maintenance expressly does not include work that improves a facility, adapts it for a different use, or restores functionality as a result of inoperability.

[13] The Proposed Regulations clarify that the work performed by a manufacturer that focuses on constructing components for a particular facility for some limited period of time (measured in hours or days) in order to meet a deadline is not subjected to the Prevailing Wage Requirement. A longer period of exclusive dedication (measured in weeks or months) to the preparation of products made to specifications would potentially subject this type of work to the Prevailing Wage Requirement.

[14] For these purposes, a journeyworker is an individual who has attained a level of skill, abilities, and competencies recognized within an industry as having mastered the skills and competencies required for the occupation (regardless as to whether such skills are acquired through formal apprenticeship or through practical on-the-job experience and formal training).

[15] Registered apprentices are those employed pursuant to an apprenticeship program registered with the Department of Labor’s Office of Apprenticeship (or with a state apprenticeship agency recognized by that office). If the apprenticeship program does not require the payment of bona fide fringe benefits, then the Proposed Regulations would require that apprentices be paid the full amount of bona fide fringe benefits listed on the applicable wage determination.

[16] If, however, construction, alteration, or repair of a facility occurs in more than one geographic area, then the Proposed Regulations generally would require that the applicable wage determination for the work performed in each geographic area be used for the work performed in that area, though the preamble to the Proposed Regulations suggests that taxpayers can ensure compliance with the Prevailing Wage Requirement by paying the highest rate for each classification in both geographic areas. The Proposed Regulations also include an important rule that benefits developers of offshore wind projects, providing that taxpayers may rely on the general wage determination for the relevant category of construction that is applicable in the geographic area closest to the location of the facility.

[17] The IRS and Treasury generally expect that supplemental wage determinations would be requested no more than 90 days before the beginning of construction, alteration, or repair of a facility.

[18] Section 45L (new energy efficient home credit) and section 45U (zero-emission nuclear power production credit) do not have apprenticeship requirements.

[19] Under the Proposed Regulations, a “qualified apprentice” is “an individual who is employed by the taxpayer or by any contractor or subcontractor and who is participating in a registered apprenticeship program.” The preamble to the Proposed Regulations indicate that participants in pre-apprenticeship programs would not be considered “qualified apprentices.”

[20] For a facility on which construction begins during 2023, the applicable percentage is 12.5 percent. For a facility on which construction begins in 2024 or later, the applicable percentage is 15 percent.

[21] Under the Proposed Regulations, “labor hours” means the total number of hours devoted to the performance of construction, alteration, or repair work by any individual employed by the taxpayer or by any contractor or subcontractor. Labor hours would not include hours worked by foremen, superintendents, owners, or persons employed in bona fide executive, administrative, or professional capacities.

[22] Under the Proposed Regulations, a journeyworker is any laborer or mechanic that has mastered the skills and competencies required for the applicable occupation. A journeyworker can acquire these skills and competencies either through experience or through a formal apprenticeship.

[23] Interest is imposed at the federal short-term rate as determined under section 6621, but substituting “6 percentage points” for “3 percentage points” in section 6621(a)(2).

[24] The Proposed Regulations do not address specifically whether an automatic waiver of the penalty would potentially be available in the case of intentional disregard, although in practice we do not anticipate automatic waiver relief would be available in that case.

[25] A taxpayer generally is not be permitted to cure non-compliance with the Prevailing Wage Requirement if the taxpayer does not make the penalty payment on or prior to the date that is 180 days after the IRS makes a final determination that a penalty is due.

[26] The agreement needs (i) to be a collective bargaining agreement with a labor organization (i.e., a union), (ii) to include provisions obligating taxpayers to pay prevailing wages and to use qualified apprentices to perform work, and (iii) to provide guarantees against strikes, lockouts, and other similar job disruptions.

[27] Under the Proposed Regulations, a “registered apprenticeship program” is defined as “a program that has been registered by the U.S. Department of Labor’s Office of Apprenticeship or a recognized State apprenticeship agency, pursuant to the National Apprenticeship Act and its implementing regulations for registered apprenticeship at 29 CFR parts 29 and 30, as meeting the basic standards and requirements of the Department of Labor for approval of such program for Federal purposes.”

[28] The Proposed Regulations also provide additional specificity as to what the contents of such a written request would need to be.

[29] The IRS and Treasury affirmatively decided not to require certified weekly reporting of payroll records.

[30] There is precedent for using a ten percent standard in determining whether a contract modification is significant. See, e.g., PLR 8930013 (concluding that a taxpayer was eligible for transitional relief provisions in the Tax Reform Act of 1986 that exempted property from new depreciation and investment tax credit rules if that property was constructed, reconstructed, or acquired pursuant to a written contract binding on March 1, 1986, notwithstanding later adjustments to the contract that increased its cost by 10.02 percent, relying on legislative history suggesting design changes made for reasons of technical or economic efficiencies of operation that caused an insignificant increase in cost nevertheless were treated as insignificant).

This alert was prepared by Mike Cannon, Matt Donnelly, Josiah Bethards, Alissa Fromkin Freltz, Blake Hoerster, and Hayden Theis.

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

Tax Group:
Michael Q. Cannon – Dallas (+1 214-698-3232, [email protected])
Matt Donnelly – Washington, D.C. (+1 202-887-3567, [email protected])
Josiah Bethards – Dallas (+1 214-698-3354, [email protected])
Alissa Fromkin Freltz – Washington, D.C. (+1 202-777-9572, [email protected])
Blake Hoerster – Dallas (+1 214-698-3180, [email protected])
Hayden Theis – Houston (+1 346-718-6695, [email protected])

Power and Renewables Group:
Peter J. Hanlon – New York (+1 212-351-2425, [email protected])
Nicholas H. Politan, Jr. – New York (+1 212-351-2616, [email protected])

This edition of Gibson Dunn’s Federal Circuit Update summarizes the current status of several petitions pending before the Supreme Court, additional materials released from the ongoing investigation by the Judicial Council of the Federal Circuit, and recent Federal Circuit decisions concerning claim construction, secondary considerations, and obviousness-type double patenting.

Federal Circuit News

Noteworthy Petitions for a Writ of Certiorari:

A couple potentially impactful petitions were filed before the Supreme Court in August 2023:

Intel Corp. v. Vidal (US No. 23-135): “The question presented is whether 35 U.S.C. § 314(d), which bars judicial review of “[t]he determination … whether to institute an inter partes review,” applies even when no institution decision is challenged to preclude review of [the United States Patent & Trademark Office] rules setting standards governing institution decisions.”

HIP, Inc. v. Hormel Foods Corp. (US No. 23-185): The questions presented are: “1. Whether joint inventorship requires anything more than a contribution to conception that is stated in a patent claim. Whether, under Section 116(a), a claimed and enabled contribution to conception can be deemed insignificant in quality based on the quantity of disclosure in the specification.” The Federal Circuit opinion being petitioned was summarized in our May 2023 update.

As we summarized in our July 2023 update, the Court will consider Killian v. Vidal (US No. 22-1220) and Ingenio, Inc. v. Click-to-Call Technologies, LP (US No. 22-873) during its September 26, 2023 conference. In CareDx Inc. v. Natera, Inc. (US No. 22-1066), after the respondents waived their right to file a response, retired Federal Circuit Judge Paul R. Michel and Professor John F. Duffy filed an amici curiae brief in support of Petitioners. The Court thereafter requested a response, which was filed on August 9, 2023. The Court will also consider this petition during its September 26, 2023 conference.

Other Federal Circuit News:

Report and Recommendation in Judicial Investigation. As we summarized in our July 2023 update, there is an ongoing proceeding by the Judicial Council of the Federal Circuit under the Judicial Conduct and Disability Act and the implementing Rules involving Judge Pauline Newman. On August 16, 2023, the Special Committee released additional materials in the investigation. The materials may be accessed here.

Upcoming Oral Argument Calendar

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

Key Case Summaries (August 2023)

Axonics, Inc. v. Medtronic, Inc., Nos. 22-1532, 22-1533 (Fed. Cir. Aug. 7, 2023): Axonics filed petitions for inter partes review (“IPR”) challenging Medtronic’s patents directed to transcutaneous (through the skin) charging of implanted medical devices through inductive coupling. After institution, Medtronic advanced for the first time a construction of a claim term in its Patent Owner Response, which Axonics disagreed with, and argued in reply that the claims would be unpatentable even under Medtronic’s construction. Medtronic then argued in its sur-reply that it would be prejudicial for the Board to consider Axonics’s new reply arguments. The Board agreed with Medtronic and refused to consider Axonics’s new reply arguments, because these arguments had not been made in its petition.

The Federal Circuit (Dyk, J., joined by Lourie and Taranto, JJ.) vacated and remanded. The Court explained that, under the Board’s rules and the Supreme Court’s decision in SAS Inst., Inc. v. Iancu, 138 S. Ct. 1348, 1345 (2018), a petitioner is entitled to respond to new arguments made in a patent owner response. Additionally, under the Administrative Procedure Act (“APA”), the Board may adopt a new construction after institution, if it gives the petitioner an opportunity to respond to constructions that are not sufficiently similar to one disputed by the parties. Consistent with this precedent, the Court held that the petitioner must have adequate notice and an opportunity to respond to post-institution claim constructions, including a reasonable opportunity in reply to present argument and evidence under that new construction.

Rembrandt Diagnostics, LP v. Alere, Inc., No. 21-1796 (Fed. Cir. Aug. 11, 2023): Alere sought an IPR challenging Rembrandt’s patent directed to test assay devices and methods for testing biological fluids. Alere initially identified “efficiency” as a reason that a relevant artisan would have been motivated to combine the asserted prior art. In response, Rembrandt challenged Alere’s motivation arguments, but did not submit expert testimony. In reply, Alere submitted an expert declaration and argued that combining the prior art references would save cost and time, and that there was thus a motivation to combine them, as well as a reasonable expectation of success. The Board found all the claims unpatentable, relying on Alere’s cost and time savings arguments and unrebutted expert testimony.

The Federal Circuit (Reyna, J., joined by Moore, C.J., and Dyk, J.) affirmed. Rembrandt argued that Alere improperly raised the benefit of cost and time savings for the first time in its reply. However, the Court determined that Rembrandt had forfeited this argument by only lodging a “generic objection” to Alere’s reply generally and not to that specific benefit argument, which was insufficient to constitute a proper objection. The Court also held that Alere’s cost and time savings arguments were not new arguments raised for the first time in its reply, but arguments that responded to Rembrandt’s opposition and also properly expands on and is a fair extension of its efficiency arguments raised in the petition.

Volvo Penta of the Americas, LLC v. Brunswick Corp., No. 22-1765 (Fed. Cir. Aug. 24, 2023): In 2015, Volvo launched the Forward Drive embodying its patent directed to a tractor-type stern drive for a boat. In 2020, Brunswick launched a similar product called the Bravo Four S, and on the same day as its launch, filed an IPR petition challenging Volvo’s patent. The Board determined that the challenged claims would have been obvious over the asserted prior art. The Board also found a lack of nexus with the embodying products, but determined that even if there had been nexus, Brunswick’s strong evidence of obviousness outweighed Volvo’s evidence of nonobviousness.

The Federal Circuit (Lourie, J., joined by Moore, C.J. and Cunningham, J.) vacated and remanded. The Court explained that there were two ways to prove nexus: (1) via a presumption of nexus or (2) via a showing that the evidence is a direct result of the unique characteristics of the claimed invention. While the Court agreed that Volvo’s arguments regarding presumption were insufficient, the Court determined that Volvo had put forth evidence that Brunswick recognized the success of Forward Drive was directly tied to the unique characteristics of the claimed tractor-type stern drive. Indeed, the Court noted that the Board found that boat manufacturers strongly desired Volvo’s Forward Drive and urged Brunswick to bring a similar product to market. The Court therefore concluded that there was a nexus between the unique features of the claimed invention and the evidence of secondary considerations.

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

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

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

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

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

On August 29, 2023, the federal banking agencies (the Board of Governors of the Federal Reserve System (“Federal Reserve”), the Federal Deposit Insurance Corporation (“FDIC”) and the Office of the Comptroller of the Currency (“OCC”)) issued a joint notice of proposed rulemaking that would require certain large banking organizations to issue and maintain minimum amounts of long-term debt (“LTD”).[1] The Proposed Rule represents another major step in the federal banking agencies’ continued efforts to impose heightened enhanced prudential standards on banking organizations with $100 billion or more in total consolidated assets and align those enhanced prudential standards with those currently applicable to global systemically important banking organizations (“GSIBs”).

As anticipated, the Proposed Rule would require Category II, III and IV bank holding companies (“BHCs”), savings and loan holding companies (“SLHCs”) and U.S. intermediate holding companies (“IHCs”) of foreign banking organizations (“FBOs”) that are not GSIBs (collectively, “covered entities”) to issue and maintain minimum amounts of LTD that satisfies certain requirements.[2]

The Proposed Rule also would require four categories of insured depository institutions (“IDIs”) that are not consolidated subsidiaries of U.S. GSIBs to issue and maintain minimum amounts of LTD. Those “covered IDIs” are:

any IDI that has at least $100 billion in total consolidated assets and that is a consolidated subsidiary of a covered entity or a U.S. IHC of a foreign GSIB;
any IDI that has at least $100 billion in total consolidated assets and is not controlled by a parent entity;
any IDI that has at least $100 billion in total consolidated assets and (i) is a consolidated subsidiary of a company that is not a covered entity, a U.S. GSIB or a foreign GSIB subject to the Federal Reserve’s total loss-absorbing capacity (“TLAC”) rule or (ii) is controlled but not consolidated by another company; and
any IDI (regardless of size) that is affiliated with an IDI in one of the foregoing three categories.[3]

IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the Proposed Rule because their parent holding companies are subject to LTD requirements under the Federal Reserve’s TLAC rule and the most stringent capital, liquidity and other enhanced prudential standards.[4] However, covered IDIs that are consolidated subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the Proposed Rule and would be required to issue and maintain minimum amounts of LTD.

The Proposed Rule follows closely the federal banking agencies’ release of the Basel III endgame reforms in July 2023 (see our prior Client Alert). The Basel III endgame proposal would significantly reduce the differences that apply across the four categories established by the federal banking agencies in 2019 for determining the applicability and stringency of regulatory capital requirements for large banking organizations. Like the Basel III endgame proposal, the Proposed Rule would align LTD requirements applicable to large banking organizations with total assets of $100 billion or more in a similar manner across the four categories—although, as noted above, IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the Proposed Rule.

Unlike the Basel III endgame proposal, the Proposed Rule was adopted unanimously. However, Federal Reserve Governors Bowman and Waller raised concerns with the Proposed Rule, including concerns that the Proposed Rule, like the Basel III endgame proposal, would not comply with the tailoring requirements of Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), as amended by the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”).[5]

As with prior rulemakings, the Proposed Rule, if finalized, would include a three-year transition period and the LTD requirements under any final rule would be fully phased in over that three-year period. Entities that become subject to the Proposed Rule after the effective date also would benefit from a three-year transition period. The Proposed Rule also would allow banking organizations to include, as part of the required minimum amounts, certain “grandfathered” existing LTD.

Comments on the Proposed Rule are due by November 30, 2023 – the same date that comments to the Basel III endgame proposal are due.[6] The agencies have included 67 questions as prompts (almost all of which include multiple related sub-prompts) to solicit comments on all aspects of the Proposed Rule.

I. Key Aspects of the Proposed Rule

Scope of Application. The Proposed Rule would apply to all non-U.S. GSIBs with $100 billion or more in total consolidated assets. Large banking organizations subject to the Proposed Rule would be required to comply with LTD requirements at both the holding company level and IDI level. U.S. GSIBs would not be subject to the LTD requirements at the IDI level, though IDI subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the Proposed Rule.

Application of the Proposed Rule
U.S. GSIBs and their IDI subsidiaries	Category II, III and IV BHCs and SLHCs and their IDI subsidiaries	Category II, III and IV U.S. IHCs and their IDI subsidiaries
U.S. GSIBs are already subject to LTD requirements under the TLAC rule.	Category II, III and IV BHCs and SLHCs would be subject to the LTD requirements.	Category II, III and IV U.S. IHCs of FBOs would be subject to the LTD requirements. U.S. IHCs controlled by foreign GSIBs are already subject to LTD requirements under the TLAC rule.
IDIs that are consolidated subsidiaries of U.S. GSIBs would not be subject to the LTD requirements.	IDIs with at least $100 billion in total consolidated assets and their affiliated IDIs would be subject to the LTD requirements. IDI subsidiaries of U.S. IHCs controlled by foreign GSIBs would be subject to the LTD requirements.

Minimum LTD Levels. Under the Proposed Rule, covered entities and covered IDIs would be subject to the same minimum LTD levels as U.S. IHCs of foreign GSIBs under the TLAC rule:

Minimum LTD Levels

U.S. GSIBs under TLAC Rule

U.S. IHCs of foreign GSIBs under TLAC Rule

Covered Entities and Covered IDIs under Proposed Rule

Outstanding eligible external LTD in an amount not less than the greater of:

– 6% of total risk-weighted assets plus the surcharge applicable under the GSIB surcharge rule; and

– 4.5% of total leverage exposure.

Outstanding eligible external LTD in an amount not less than the greater of:

– 6% of total risk-weighted assets;

– 3.5% of average total consolidated assets; and

– 2.5% of total leverage exposure if subject to the supplementary leverage ratio (“SLR”).

Outstanding eligible LTD in an amount not less than the greater of:

– 6% of total risk-weighted assets;

– 3.5% of average total consolidated assets; and

– 2.5% of total leverage exposure if subject to the SLR.

As with the LTD requirements applicable to U.S. GSIBs and the U.S. IHCs of foreign GSIBs, the Proposed Rule’s eligible LTD requirement was calibrated primarily on the basis of a “capital refill” framework. The Proposed Rule would not tailor the LTD requirements for Category II, III or IV banking organizations or their IDI subsidiaries.

The Proposed Rule would prohibit a covered entity from redeeming or repurchasing any outstanding eligible LTD without the prior approval of the Federal Reserve if after the redemption or repurchase the covered entity would not meet its minimum LTD requirement. Additionally, the Proposed Rule would authorize the agencies, after providing an external LTD issuer with notice and an opportunity to respond, to order the external issuer to exclude from its outstanding eligible LTD amount any otherwise eligible debt securities “with features that would significantly impair the ability of such debt securities to absorb losses in resolution.”[7]

Externally/Internally Issued LTD. Under the Proposed Rule, certain covered entities and covered IDIs would be required or permitted to issue eligible LTD externally, while others would be required or permitted to issue eligible LTD internally.

Externally/Internally Issued LTD
Covered U.S. Holding Companies	May only issue eligible “external” LTD
Covered IHCs of FBOs	“Resolution IHCs”[8] may issue eligible “internal” or “external” LTD “Non-resolution IHCs”[9] may only issue eligible “internal” LTD
Covered IDIs	Covered IDIs that are consolidated subsidiaries of covered entities or a foreign GSIB IHC may only issue eligible “internal” LTD Covered IDIs that are not controlled subsidiaries of a parent entity may only issue eligible “external” LTD Covered IDIs that are consolidated subsidiaries of a parent entity that is not a covered entity or that are controlled but not consolidated by a covered entity or foreign GSIB IHC entity may issue eligible “internal” or “external” LTD

Eligible External and Internal LTD. The Proposed Rule would generally align the requirements for externally issued LTD with the requirements for eligible LTD under the Federal Reserve’s TLAC rule.

Eligible External LTD
Category II, III and IV BHCs and SLHCs, covered IDIs required or permitted to issue external LTD and “resolution IHCs”
Paid in and issued directly by the external issuer (debt instruments issued by a subsidiary of a covered entity or covered IDI would not qualify as eligible external LTD) Held by a non-affiliate (except that a covered IDI may issue eligible external LTD to an affiliate that controls but does not consolidate the covered IDI)[10] Unsecured, not guaranteed by the issuer or a subsidiary or an affiliate of the issuer, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument (such as a credit enhancement provided by an affiliate) Maturity of greater than or equal to one year from the date of issuance “Plain vanilla” features Excluded from treatment as eligible external LTD if instruments are: (i) structured notes, (ii) have a credit-sensitive feature, (iii) include a contractual provision for conversion into or exchange for equity in the issuer, or (iv) include a provision that gives the holder a contractual right to accelerate payment (including automatic acceleration) Permissible acceleration rights include rights exercisable: (i) on one or more dates specified in the instrument, (ii) in the event of the issuer entering into insolvency or resolution proceedings, or (iii) upon the issuer’s failure to pay principal or interest on the instrument and which remains uncured for 30 days or more[11] In the case of eligible external LTD issued by a covered IDI, instrument must be contractually subordinated so that the claim represented by the LTD in the receivership of the IDI would be junior to deposit and general unsecured claims Issued in a minimum principal denomination of $400,000 Governed by U.S. law or the laws of any state

Principal due to be paid on eligible external LTD in one year or more and less than two years would be subject to a 50% haircut for purposes of the external LTD requirement and principal due to be paid on eligible external LTD in less than one year would not count toward the external LTD requirement.

Eligible Internal LTD
Covered IDIs required or permitted to issue internal LTD and “non-resolution IHCs”
The requirements for eligible internal LTD are generally the same as those for eligible external LTD, with two principal differences: eligible internal LTD issued by a covered IDI must be issued to and remain held by a company that consolidates the covered IDI, generally an upstream parent; and no minimum principal denomination requirement Eligible internal LTD issued by a covered IHC would be required to include a contractual conversion trigger approved by the Federal Reserve pursuant to which the Federal Reserve could require the covered IHC, under certain circumstances, to convert or exchange some or all of the internal LTD into common equity tier 1 capital of the covered IHC without the covered IHC’s entry into a resolution proceeding and would not include a prohibition against credit sensitive features[12] Non-resolution IHCs would be required to issue eligible internal LTD to a foreign company that directly or indirectly controls the covered IHC, or to a wholly owned subsidiary of a controlling foreign company For a covered IDI that is a consolidated subsidiary of a covered IHC, the Proposed Rule would require that eligible internal LTD of the covered IDI be issued to the covered IHC, or a subsidiary of the covered IHC that consolidates the IDI (the LTD could not be directly issued to a foreign affiliate that controls the IDI)

Grandfathering of Legacy External LTD. The Proposed Rule would permit some legacy external LTD to count towards the minimum LTD requirements, even where such legacy external LTD does not meet certain eligibility requirements:

instruments that contain impermissible acceleration clauses;
instruments issued with principal denominations that are less than the proposed $400,000 minimum amount; and
in the case of legacy instruments issued externally by a covered IDI, are not contractually subordinated to general unsecured creditors (collectively, “eligible legacy external LTD”).

Notably, eligible legacy external LTD issued by a consolidated subsidiary IDI of a covered entity may be used to satisfy the minimum external LTD requirement applicable to both its covered parent holding company or covered resolution IHC and any internal LTD requirement applicable to the subsidiary IDI itself. However, eligible legacy external LTD cannot be used to satisfy the internal LTD requirement for non-resolution covered IHCs. To qualify as “eligible legacy external LTD,” an instrument must be issued prior to the date that notice of the final rule is published in the Federal Register. The Proposed Rule would authorize the federal banking agencies, after providing a covered entity or covered IDI with notice and an opportunity to respond, to order the covered entity or covered IDI to exclude from its outstanding eligible LTD amount any eligible legacy external LTD.[13]

Transition Period. The Proposed Rule would provide a transition period for covered entities and covered IDIs that would be subject to the rule upon its effectiveness, and a transition period for covered entities and covered IDIs that become subject to the rule after it becomes effective. Over that three-year period, covered entities and covered IDIs would need to meet:

25% of their LTD requirements by one year after the effective date of the final rule (or one year after becoming subject to the rule);
50% after two years of the effective date of the final rule (or two years after becoming subject to the rule); and
100% after three years of the effective date of the final rule (or three years after becoming subject to the rule).

The federal banking agencies would be authorized to accelerate or extend the transition period. The transition period would not re-start for a covered IDI that converts its charter or any holding company thereof. Finally, covered entities that transition from being subject to the final rule to the Federal Reserve’s TLAC rule would have three years to comply with the requirements imposed under the TLAC rule.[14]

Clean Holding Company Requirements. The Proposed Rule also would include “clean holding company” requirements like those that apply to U.S. GSIBs and U.S. IHCs of foreign GSIBs subject to the Federal Reserve’s TLAC rule. In particular, the Proposed Rule would prohibit covered entities from:

externally issuing short-term debt instruments (i.e., instruments with an original maturity of less than one year);
entering into qualified financial contracts, or “QFCs”, with third parties;[15]
guaranteeing (including by providing credit support for) a subsidiary’s liabilities with an external counterparty if the covered entity’s insolvency or entry into a resolution proceeding (other than resolution under Title II of the Dodd-Frank Act) would create default rights for a counterparty of the subsidiary; and
having outstanding liabilities that are guaranteed by a subsidiary of the covered entity or that are subject to rights that would allow a third party to offset its debt to a subsidiary upon the covered entity’s default on an obligation owed to the third party.

The Proposed Rule would amend the QFC prohibition of the clean holding company requirements so that holding companies subject to the TLAC rule may enter into underwriting agreements, fully paid structured share repurchase agreements and employee and director compensation agreements. These changes also would be applied to the clean holding company requirements proposed for covered BHCs and SLHCs (not covered IHCs) under the Proposed Rule. The Proposed Rule would authorize the Federal Reserve to determine that additional agreements would not be subject to the QFC prohibition.

Capital Deduction Framework. Under the current capital rule, U.S. GSIBs, their subsidiary depository institutions and Category II banking organizations are required to deduct investments in LTD issued by banking organizations that are required to issue LTD to the extent that aggregate investments by the investing banking organization in the capital and LTD of other financial institutions exceed a specified threshold. The Proposed Rule would expand the existing capital deduction framework for LTD issued by U.S. GSIBs and the IHCs of foreign GSIBs to include external LTD issued by covered entities and external LTD issued by covered IDIs by amending the capital rule’s definition of “covered debt instrument.” The Proposed Rule would not otherwise amend the capital rule’s deduction framework.

Notably, the Basel III endgame proposal would subject Category III and IV banking organizations to the LTD deduction framework that currently only applies to U.S. GSIBs, their subsidiary depository institutions and Category II banking organizations and would apply a heightened risk weight to investments in LTD that are not deducted.

Changes to the Existing TLAC Rule. The Proposed Rule would make conforming and certain other changes to the TLAC rule, including:

conforming changes to require minimum denominations for eligible LTD;[16]
changes to the haircuts that are applied to eligible LTD for purposes of compliance with the TLAC requirement to conform to haircuts that apply for purposes of the LTD requirement – accordingly, the Proposed Rule would allow only 50% of the amount of eligible LTD with a maturity of one year or more but less than two years to count towards the TLAC requirement;
clarifications to the clean holding company requirements so that U.S. GSIBs and U.S. IHCs of foreign GSIBs may enter into underwriting agreements, fully paid structured share repurchase agreements and employee and director compensation agreements; and
enhanced disclosure requirements.

Finally, the Proposed Rule would authorize the Federal Reserve to require LTD and TLAC levels greater than or less than the minimum requirement currently required under the TLAC rule.[17]

II. Issues with the Proposed Rule

As they did with the Basel III endgame proposal, each of Federal Reserve Governors Bowman and Waller—although voting in support of the Proposed Rule—raised concerns with the authority for the Proposed Rule being in conflict with the tailoring requirements under Section 165 of the Dodd-Frank Act, as amended by EGRRCPA, and the federal banking agencies’ tailoring rules implementing Section 165. These statements raise the prospects that the Proposed Rule could be subject to challenge if adopted substantially as proposed.

Governor Bowman: “Today’s proposal would weaken the current risk-based, tailored approach to regulation by applying the same regulatory requirements to firms from $100 billion to $1 trillion regardless of their activities and potential risks to the financial system. I am concerned that collapsing Categories II, III, and IV into a single prudential category may call into question whether the Federal Reserve is complying with the statutory requirements to tailor prudential requirements for large firms.[2] … In 2017, when the rules addressing total loss-absorbing capacity and long-term debt for GSIBs and the U.S. intermediate holding companies of foreign GSIBs were adopted, the [Federal Reserve] expressly noted that the application of the rules were limited, ‘in keeping with the Dodd-Frank Act’s mandate that more stringent prudential standards be applied to the most systemically important bank holding companies.’[3] In my view, there is a legitimate question about whether the proposal meets the statutory bar for tailoring the stringency of enhanced prudential standards, and applying such standards to banks with $100 billion to $250 billion in assets. I look forward to receiving feedback from commenters on this issue.”[18]
Governor Waller: “More importantly, I am concerned that our regulatory framework for large banks is moving in a direction that does not tailor requirements in a manner consistent with the spirit of the Dodd-Frank Act, as amended by Congress in 2018.”[19]

Governor Bowman also focused on the potential impacts of the Proposed Rule on competition and highlighted that the joint implementation of the Basel III endgame proposal and LTD requirements would have unclear effects. On competition, she noted:

In my view, as the differences between the regulatory requirements for GSIBs and firms with more than $100 billion in assets continue to be eroded, it will become less economically rational for firms to remain in Category IV and creates an even steeper “cliff” effect for regional banks that seek to grow into this category. Ultimately, the cumulative effect of these proposals and others to be considered in the coming months could exacerbate the pressure on banks to grow larger through acquisition resulting in harmful effects on competition, the reduction of banking options in some geographic or product markets, and rendering some institutions competitively unviable.[20]

Governor Bowman has long stressed that enhanced supervision should be the federal banking agencies’ focus, consistently highlighting that the Dodd-Frank Act provides regulators the toolkit they need to supervise banking organizations through the cycle, and that as banks grow, those tools are in place for supervision and regulation to become more stringent. In her statement accompanying the release of the Proposed Rule, she again reiterated the need for enhanced supervision, rather than a “belt, suspenders, and elastic waistband approach” to regulatory reform.[21]

Finally, as the federal banking agencies acknowledge in the preamble to the Proposed Rule, “there is a risk that efforts by covered entities and covered IDIs to issue a large volume of LTD over a limited period could strain the market capacity to absorb the full amount of such issuance if issuance volume exceeds debt market appetite for LTD instruments,” particularly in periods of adverse funding market conditions.[22] In recent years, a number of large banking organizations have been issuing LTD instruments in the market in anticipation of LTD requirements similar to those imposed on U.S. GSIBs under the TLAC rule being imposed on firms with $100 billion in more in total assets. It will be important for organizations that could become subject to the Proposed Rule to contemplate further LTD issuances in anticipation of the Proposed Rule being adopted substantially as proposed and taking advantage of the grandfathering provisions for eligible legacy external LTD and the Proposed Rule’s three-year transition period to satisfy expected LTD requirements going forward.

III. Conclusions

As with the Basel III endgame proposal, it is imperative that all stakeholders actively engage in the rulemaking process with the federal banking agencies and other policymakers to facilitate a thoughtful approach to the final rule. The comment process will play a critical role in shaping the substance of the final rule and the federal banking agencies’ consideration of the myriad issues raised by the Proposed Rule, its interaction with the Basel III endgame proposal, its potentially broader unintended consequences, including impacts on competition, and may also form the basis for any future legal challenges to the federal banking agencies’ final rule.

________________________

[1] Federal Reserve, FDIC, OCC, Long-term Debt Requirements for Large Bank Holding Companies, Certain Intermediate Holding Companies of Foreign Banking Organizations, and Large Insured Depository Institutions (July 27, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20230829a1.pdf (the “Proposed Rule”). The Proposed Rule follows an advance notice of proposed rulemaking issued in October 2022 by the Federal Reserve and FDIC seeking input on a long-term debt requirement for certain large banking organizations that are not GSIBs. See Federal Reserve, FDIC, Resolution-Related Resource Requirements for Large Banking Organizations, 87 Fed. Reg. 64170 (Oct. 24, 2022).

[2] Proposed Rule, p. 9. This part of the Proposed Rule is issued by the Federal Reserve.

[3] Proposed Rule, p. 10. This part of the Proposed Rule is issued by the Federal Reserve, FDIC and OCC.

[4] Proposed Rule, p. 9, n. 2.

[5] See 12 U.S.C. § 5365(a)(1), (2)(A), (2)(C). As it relates to covered IDIs, Director Chopra argued in his statement in support of the Proposed Rule that the proposal “for an [IDI] to issue minimum amounts of long-term debt is not a Dodd-Frank Act Section 165 ‘enhanced prudential standard,’ and is therefore not tied to the [EGRRCPA’s] $100 billion asset threshold.” Statement of CFPB Director Rohit Chopra Member, FDIC Board of Directors Regarding Proposals to Improve the FDIC’s Options for Managing Large Bank Failures (Aug. 29, 2023), available at: https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-regarding-proposals-to-improve-the-fdics-options-for-managing-large-bank-failures/#6 (“Director Chopra Statement”).

[6] The Basel III endgame proposal provided for a 126-day comment period; the Proposed Rule provides for a 93-day comment period.

[7] See Proposed Rule, p. 42.

[8] “Resolution IHCs” are “covered IHCs of FBOs with a top-tier group-level resolution plan that contemplates their covered IHCs or subsidiaries of their covered IHCs entering into resolution, receivership, insolvency, or similar proceedings in the United States.” Proposed Rule, p. 60.

[9] “Non-resolution IHCs” are “covered IHCs of FBOs with top-tier group-level resolution plans that do not contemplate their covered IHCs or the subsidiaries of their covered IHCs entering into resolution, receivership, insolvency, or similar proceedings.” Proposed Rule, p. 60.

[10] See Proposed Rule, pp. 43-44.

[11] Eligible external LTD instruments would be permitted to give the holder a put right as of a future date certain (such an instrument would be treated as if it were due to be paid on the day on which it first became subject to the put right, regardless of whether the put right would be exercisable on that date only if another event occurred (e.g., a credit rating downgrade)). See Proposed Rule, p. 52, n. 48.

[12] The conversion provision may be triggered if both (a) the Federal Reserve determines that the covered IHC is “in default or in danger of default,” and (b) any of the following circumstances apply: (i) the top-tier FBO or any subsidiary of the top-tier FBO has been placed into resolution proceedings in its home country; (ii) the home country supervisory authority consents to the conversion or exchange or does not object to the conversion or exchange following 24 hours’ notice; or (iii) the Federal Reserve makes a written recommendation to the Secretary of the Treasury that the FDIC should be appointed as receiver of the covered IHC under the “orderly liquidation authority” under Title II of the Dodd-Frank Act. The terms of the contractual conversion provision in the debt instrument would have to be approved by the Federal Reserve. See Proposed Rule, p. 63.

[13] See Proposed Rule, pp. 65-66.

[14] See Proposed Rule, pp. 83-85.

[15] The proposed requirement would only apply prospectively to new agreements entered into after the post-transition period effective date of a final rule. See Proposed Rule, p. 73.

[16] Question 59 asks: “Should the [Federal Reserve] impose a higher minimum denomination for TLAC companies subject to the TLAC rule? Should the minimum denomination be higher (e.g., $1 million) for companies subject to the TLAC rule than for covered entities subject to the newly proposed LTD requirement?” Proposed Rule, p. 90.

[17] See Proposed Rule, pp. 86-97.

[18] Statement by Federal Reserve Governor by Michelle W. Bowman (August 29, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20230829.htm. (citing to 12 U.S.C. § 5365(a)(1), (2)(C) and 82 Fed. Reg. 8266, 8288 (Jan. 24, 2017), respectively) (“Governor Bowman Statement”).

[19] Statement by Federal Reserve Governor Christopher J. Waller (August 29, 2023), available at: https://www.federalreserve.gov/newsevents/pressreleases/waller-statement-20230829.htm. In contrast, Director Chopra proposed whether “we should determine whether institutions below $100 billion, such as those with high levels of ‘uninsured’ deposits or those that have grown very rapidly, should also be subjected to a similar requirement.” Director Chopra Statement.

[20] Governor Bowman Statement.

[21] See id.

[22] See Proposed Rule, p. 114.

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